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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549



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Form 10-K/A
Amendment No. 1

(Mark One)

[x]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE       ACT OF 1934. For the fiscal year ended December 31, 2000.

[  ]   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE       ACT OF 1934.

For the transition period from __________ to __________

Commission file number: 000-22302

ILLINOIS SUPERCONDUCTOR CORPORATION
(Name of Registrant as Specified in Its Charter)

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|--------------------------------------------------- | -------------------------------------------------------------- |  | ----------------------------------- | 
|                                                    | Delaware                                                       |  | 36-3688459                          | 
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|                                                    | (State or Other Jurisdiction of
Incorporation or Organization) |  | (I.R.S. EmployerIdentification No.)
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|                                                    | 451 Kingston Court Mt. Prospect, Illinois                      |  | 60056                              
|                                                    |                                                                |  |                                    
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|                                                    | (Address of Principal Executive Offices)                       |  | (Zip Code)                         
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|(847) 391-9400                                     
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|(Registrants Telephone Number, Including Are Code)

Securities registered pursuant to Section 12(b) of the Act: NONE.

Securities registered pursuant to Section 12(g) of the Act:

|                                                                         |  |  |  | 
|------------------------------------------------------------------------ |  |  |  | 
|Common Stock, par value $0.001 per share
Preferred Stock Purchase Rights
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|Title of
each class                                                     

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [  ]



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On March 30, 2001, 107,746,614 shares of the Registrants Common Stock
were outstanding. The aggregate market value on March 30, 2001 of the
Registrants Common Stock held by non-affiliates of the Registrant was
approximately $105,619,783.

Introductory Note

Illinois Superconductor Corporation is filing this amended Annual Report
on Form 10-K/A for its fiscal year ended December 31, 2000, which includes
certain sections of that Annual Report on Form 10-K previously filed on March
30, 2001 with the Securities and Exchange Commission (the 2000 Form 10-K),
with the additions/changes discussed below. The purpose of this Amendment No.
1 is to furnish the information required by Part III, Items 10, 11, 12 and 13,
of Form 10-K which was incorporated by reference in the 2000 Form 10-K, to
correct a typographical error in the Accounts Payable number contained in the
Consolidated Balance Sheets for the year ended December 31, 2000 to $599,553
(such change has no impact to the other information originally filed in such
table), to add Exhibit 10.28 to the Exhibit Index and to update
the Recent Developments sections in this Annual Report.



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|                                      |                                                                                                |  |  |  |  |  |  | 
|------------------------------------- | ---------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                               
|                                      | Item 1. Business                                                                              
|                                      | Item 2. Properties                                                                            
|                                      | Item 3. Legal Proceedings                                                                     
|                                      | Item 4. Submission of Matters to a Vote of Security Holders                                   
|PART II                              
|                                      | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                 
|                                      | Item 6. Selected Financial Data                                                               
|                                      | Item 7. Managements  Discussion and Analysis of Financial Condition and Results of Operations
|                                      | Item 7A. Quantitative and Qualitative Disclosures About Market Risk                           
|                                      | Item 8. Financial Statements and Supplementary Data                                           
|                                      | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure  
|PART III                             
|                                      | Item 10. Directors and Executive Officers                                                     
|                                      | Item 11. Executive Compensation                                                               
|                                      | Item 12. Security Ownership of Certain Beneficial Owners and Management                       
|                                      | Item 13. Certain Relationships and Related Transactions                                       
|PART IV                              
|                                      | Item 14. Exhibits, Financial Statement Schedules and Reports                                  
|EX-23.1 Consent of Grant Thornton LLP
|EX-23.2 Consent of Ernst & Young LLP 



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|         |  | PART I                                                                               
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|Item 1.  |  | Business                                                                              |  |  | 1  | 
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|Item 2.  |  | Properties                                                                            |  |  | 23 | 
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|Item 3.  |  | Legal Proceedings                                                                     |  |  | 24 | 
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|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                   |  |  | 27 | 
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|         |  | PART II                                                                              
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|Item 5.  |  | Market for Registrants Common Equity and Related Stockholder Matters                 |  |  | 27 | 
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|Item 6.  |  | Selected Financial Data                                                               |  |  | 29 | 
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|Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of
Operations |  |  | 29 | 
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|Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                            |  |  | 33 | 
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|Item 8.  |  | Financial Statements and Supplementary Data                                           |  |  | 34 | 
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|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure  |  |  | 59 | 
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|         |  | PART III                                                                             
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|Item 10. |  | Directors and Executive Officers of the Registrant                                    |  |  | 60 | 
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|Item 11. |  | Executive Compensation                                                                |  |  | 64 | 
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|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management                        |  |  | 66 | 
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|Item 13. |  | Certain Relationships and Related Transactions                                        |  |  | 68 | 
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|         |  | PART IV                                                                              
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|Item 14. |  | Exhibits, Financial Statement Schedules and Reports                                   |  |  | 69 | 

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A NOTE CONCERNING
FORWARD-LOOKING STATEMENTS

Because Illinois Superconductor Corporation (the Company or ISCO)
wants to provide investors with more meaningful and useful information, this
Annual Report on Form 10-K, as amended, (Form 10-K) contains, and incorporates by
reference, certain forward-looking statements that reflect the Companys current
expectations regarding the Companys future results of operations, performance
and achievements. The Company has tried, wherever possible, to identify these
forward-looking statements by using words such as anticipates, believes,
estimates, expects, designs, plans, intends and similar expressions.
These statements reflect the Companys current beliefs and are based on
information currently available to the Company. Accordingly, these statements
are subject to certain risks, uncertainties and contingencies, including the
factors set forth under the caption Risk Factors, which could cause the
Companys actual results, performance or achievements for 2001 and beyond to
differ materially from those expressed in, or implied by, any of these
statements. You should not place undue reliance on any forward-looking
statements. Except as otherwise required by federal securities laws, the Company
undertakes no obligation to release publicly the results of any revisions to any
such forward-looking statements that may be made to reflect events or
circumstances after the date of this Annual Report or to reflect the occurrence
of unanticipated events.




PART I




Item 1. Business

The Company provides a wide array of interference-management solutions
for the wireless telecommunications industry. It uses both its patented and
proprietary adaptive notch filter technology (ANF) and its patented and
proprietary high temperature superconductor (HTS) technology to monitor and
suppress in-band and out-of-band interference in a wireless base station. The
Company believes it is the only company in the world that has proprietary
products to address the wireless operators need to reduce or eliminate
interference that comes from in-band and out-of-band sources.

The Company believes that the benefits of using the Companys products
include: increased cell site capacity and utilization (as much as 70% or more),
increased revenues per cell site (as much as 100% increase based on minutes of
use), easier location of new cell sites due to tolerance of interference,
improved voice quality and reduced drop calls (up to 40%). These benefits have
been documented in field trials with wireless operators involving existing
cellular and PCS systems.

In addition, the Company believes, that based on test results conducted
by NTT DoCoMo (NTT), the next generation of wireless systems (3G or 3rd
Generation) will not be able to operate effectively without an HTS filter as
part of the overall system. The Company believes that with the increased data
bit rates required of 3G systems and the increased usage of 3G systems due to
the wireless internet, that interference levels will increase substantially,
thereby requiring an improved filtering system in the base station.

HTS Technology

The Companys patented HTS technology includes the use of
superconducting materials, radio frequency (RF) filter designs and cryogenic
technologies that are needed to develop, manufacture and market high performance
RF filter products. These products are designed to enhance the quality,
capacity, coverage and flexibility of wireless telecommunications services.

RF filters refine the radio signals by passing radio waves through a
series of resonators (poles), which allow certain frequencies to pass while
rejecting other frequencies. Generally, the more poles in the RF filter, the
more effective the RF filter. Each pole, however, has electrical resistance
which causes the loss (insertion loss) of desired radio waves. Therefore, the
more poles in a conventional RF filter, the greater the insertion loss.

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Superconductive materials, when cooled below a critical temperature,
are able to transmit an electric current with no loss or minimal loss of energy.
The advantage of using superconductors in RF filters is that more poles can be
added without significant increases in insertion loss, thereby creating a more
effective RF filter.

HTS filters can be designed with a variety of structures and materials,
each with different results. The Company is able to produce RF filters using the
two main HTS filter designs, thin-film and thick-film design. The Company
believes it is the only Company in the world that uses thick-film design and the
Company believes it has an extensive patent position in the thick-film area that
will protect its proprietary position.

One benefit of thick-film technology is that, according to published
data of tests conducted by NTT DoCoMo, it produces an almost theoretically
perfect RF filter for suppression of out-of-band interference (see diagram on
page 18).

Another benefit of thick-film design is already incorporated in the
Companys patented All-Temperature Performance (ATP) feature, which
eliminates the need for certain redundant backup systems in a wireless base
station. One of the hurdles of incorporating an HTS RF filter in a base station
is that the HTS filter has an active feature, the cryo-cooler, which may be
subject to failure or power loss. Non-HTS filters do not have an active
component and therefore non-HTS filter performance is not hindered by a lack of
power. The incorporation of the ATP function in an HTS RF filter eliminates the
need for a backup system in case of power failure, because even without power,
it has filtering capabilities at least equal to a non-HTS filter. Thin-film
technology requires a back-up system or a by-pass system to continue to operate
the filtering component of the base station, both of which adds cost and size to
the overall product presentation.

The Company also uses its patented thin-film superconducting technology
for its patented tower-mount RF filters. The Company believes that its
tower-mount products will become an increasing source of competitive advantage
in the deployment of HTS filters worldwide. The Company believes that there is a
trend toward the outdoor mounting of equipment in the domestic base station
market. In addition, the Company believes that a significant percentage of base
stations in Asia have already adapted to an outdoor mount configuration.

Finally, the Company believes that once the wireless operator accepts a
cryo-cooler in a base station for HTS filter applications, the entire front-end
of the base station will be open to improved performance through the use of HTS
materials, known as the Cryogenic Front End (CRFE). The Company has studied
all the components of the front end and believes that a hybrid of thin-film and
thick-film technologies will greatly improve the performance of the Digital
Wireless Communications System (see diagram on page 21).

ANF Technology

One of the difficult tasks facing any wireless operator trying to
suppress interference is determining its source and location. In general,
wireless operators do not care about the source (whether it is in-band or
out-of-band interference), just that it interferes with the efficiency of the
base station.

With the acquisition of the ANF (Adaptive Notch Filter) division of
Lockheed Martin Canada Corporation during 2000, the Company now owns proprietary
technologies to produce filters that monitor RF spectrum and block spontaneous
interference occurring within that spectrum. This allows the Company to offer
what it believes to be the only product in the world that locates and suppresses
in-band interference within 20 milliseconds.

HISTORY

The Company was founded in 1989 by ARCH Development Corporation, an
affiliate of the University of Chicago, to commercialize superconductor
technologies initially developed by Argonne National Laboratory. The Company was
incorporated in Illinois on October 18, 1989 and reincorporated in Delaware on
September 24, 1993. The Companys facilities and principal executive offices are
located at 451 Kingston Court, Mt. Prospect, Illinois 60056 and its telephone
number is (847) 391-9400.

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BUSINESS STRATEGY

The Companys objective is to be a global leader in supplying high
performance interference-management products to the growing wireless
telecommunications market. Key elements of the Companys strategy include the
following:



| |  |  | Developing or Acquiring Relevant
Intellectual Property (IP).
The Company is building what it believes to be the strongest
intellectual property portfolio in HTS wireless technology and
other areas of interference management. Unlike many other fields
of telecom technology, the base of HTS expertise is very narrow.
Today, the Company believes it has the largest patent portfolio
in the industry and is aggressively expanding the scope of its
patent program. The Company believes that as HTS technology moves
to center-stage in 3G application, in particular, the IP
portfolio will become a powerful element of the Companys overall
business strategy.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Maintaining Technological Leadership in the
Industry. The Company
believes it has the best filter performance of any HTS product
today and this allows the Company to design products over the
full range of performance requirements from rural 2G to urban 3G.
The Company intends to focus on products with unique (and
patented) value-added features that connect to operational
objectives of the wireless service providers. These include
products such as the patented tower-mount HTS RF front-end and
the ATP feature that allows HTS filters to operate as a
conventional filter in case of power loss.                                                        
|
| |  |  | Supplying Price Competitive Products. The Company has been able
to continually reduce its product cost, which has permitted the
Company to more competitively price its products. The Company
believes that it can continue to achieve further cost reductions
due to design and development projects and strategic partnering
with vendors and other manufacturers.                                                                                                                                                                                                                                                                                                       
|
| |  |  | Developing Strategic Relationships. The Company believes that in
order to adequately address the potential world-wide market for
HTS RF products and interference-management solutions, the
Company will need to develop and maintain strategic relationships
with well-established manufacturers and marketers of wireless
telecommunications equipment in various parts of the world. A
case in point of this strategic partnering includes the KMW, Inc.
joint development agreement.                                                                                                                                                                                   
|
| |  |  | Focusing on Fast Growing Commercial Markets. The Company has
focused its efforts on developing the HTS market for 3G in Asia.
The Company believes it is well positioned to become a strategic
supplier to the first implementers of 3G systems in the world.
The Company believes that 3G will become a reality and that HTS
is an enabling technology for 3G. The Company has also restarted
its marketing efforts for the domestic 2G and 2.5G systems. The
Company believes that system operators with capacity concerns
will increasingly turn towards HTS as a cost-effective solution.                                                                              

RECENT DEVELOPMENTS/SUBSEQUENT EVENTS

Change in Certifying Accountants

On December 7, 2000, we advised Ernst & Young LLP that we intended to
retain a different firm of independent auditors for the audit of our financial
statements for the fiscal year ending December 31, 2000. We have engaged Grant
Thornton LLP as our new independent public accountants to audit our consolidated
financial statements. This engagement was effective as of December 7, 2000. As
noted in the current report on Form 8-K filed with the SEC on December 18, 2001, related to this event, there have
been no disagreements with Ernst & Young on any matter of accounting principles
or practices, financial statement disclosure or auditing scope or procedure
during the Registrants two most recent fiscal years or in the subsequent
interim period through December 7, 2000 (date of termination), which
disagreement(s), if not resolved to Ernst & Youngs satisfaction, would have
caused Ernst & Young to make reference to the subject matter of disagreement(s)
in connection with its report. There were no reportable events as that term is
described in Item 304(a)(1)(v) of Regulation S-K.

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Conversion of Senior Convertible Notes

On December 29, 2000, holders of the Companys senior convertible notes
converted $14,354,778 principal amount of such notes plus accrued interest into
63,283,309 shares of Common Stock.

Joint Development with KMW

On January 3, 2001, the Company announced an agreement with KMW, Inc., of
Korea to jointly develop an advanced-design cryogenic receiver front-end (CRFE)
system to meet the requirements of third-generation (3G) Wideband-CDMA wireless
systems to be deployed, beginning this year, in Japan and Korea.

Filing of Rights Offering Statement

On January 8, 2001, the Company filed with the SEC on Form S-3 a
registration statement for a proposed common stock rights offering for up to $20
million. The purpose of the rights offering filing was to put the Company in the
position to access funds on a pro rata, non-dilutive basis from existing
shareholders as of a certain holding date. As of the date of this
Form 10-K/A filing,
the Company has not yet determined whether it will proceed with the Rights
Offering, in light of the settlements described elsewhere in this
annual report.

Filing of a Universal Shelf Offering Statement

On January 12, 2001, the Company filed with the SEC on Form S-3 a
registration statement for the purpose of offering up to $50 million of Common
Stock, warrants, or preferred stock of the Company. The filing, known as a
Universal Shelf was put in place by the Company to allow the Company to access
funds in the open market on an opportunistic or on an as needed basis. To date,
the Company has not sold any securities registered under the Universal Shelf.

$15 Million Settlement Expected to be Received

On February 22, 2001, the
Company announced that a settlement of shareholder litigation had been
reached with Elliott Associates, L.P. and Elliott International, L.P. On March 30, 2001, the settlement was approved by the court which resulted in the
Company receiving $15 million, less legal fees and certain other
expenses. The court granted $3 million in interim legal fees and
pending further review by the court,
set aside an additional $1.5 million in escrow for legal fees.

Short-Term Bridge Loan with Elliott Associates, L.P.

On February 23, 2001, the Company secured a short-term bridge loan from Elliott Associates, L.P. for up
to $3.5 million to fund the Companys working capital needs. The purpose of the short-term bridge loan was to fund the Companys working capital needs. The Company accessed the first $2 million of the loan at closing and accessed the balance of
$1.5 million on April 2, 2001. Both loans, plus accrued
interest thereon, were repaid in full on April 6, 2001, the date the first of the two settlement funds (as described above) was received.

$5 Million Settlement Expected to be Received

On March 16, 2001, the
Company announced that a settlement of shareholder litigation had been
reached with Alexander Finance, L.P., which, subject to court approval, will result in the Company receiving $5 million, less legal fees and certain other expenses. A notice regarding
the settlement has been mailed to all of the Companys stockholders. The court hearing to consider the settlement is scheduled for April 27, 2001.

Repricing of Employee Stock Options

On February 5, 2001, the Companys Board of Directors elected to reprice
certain options granted to employees and directors during 2000. In total,
2,676,000 options with exercise prices ranging from $2.9688 to $6.6094 were repriced to
$1.9375, the closing price of the Common Stock on the repricing date.
The Board elected to reprice the options to maintain employee morale and to more
clearly align the management and employee goals with those of the shareholders.
The resulting variable accounting may lead to

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substantial non-cash expense charges in the future. No other terms of the
options were affected.

$20 Million Equity Commitment Line

During March, 2001, the Company entered into an agreement with Paul Revere
Capital Partners, Ltd., whereby Paul Revere Capital commits to acquire up to $20
million of the Companys common stock over the next 24 months upon demand by the
Company, subject to the conditions contained in the agreement. Pursuant to this
facility, the Company may, at its discretion, sell shares of Common Stock to
Paul Revere Capital Partners at a discount to the market price of 94% of the
average weighted volume price over a 22 day period. Each draw down is limited to
the lesser of $4 million or 20% of the trading volume over a specified period of
time. The Company will also issue a warrant to Paul Revere Capital Partners to
purchase a number of shares equal to 0.5% of the shares issued in each draw
down. The Company has also agreed to pay its placement agent a fee equal to 4%
of each draw down and issue a warrant to the placement agent to purchase a
number of shares equal to 0.5% of the shares issued in each draw down.

Name Change

The Company applied for the right to do business as ISCO International
and intends to present a formal name change resolution to the shareholders at
the next annual meeting.

RISK FACTORS

The following factors, in addition to other information contained herein, should
be considered carefully in evaluating the Company and its business.

RISKS RELATED TO THE OPERATIONS AND FINANCING OF OUR COMPANY

Limited Operating History; History of Losses; and Uncertainty of Financial Results

We were founded in October 1989 and through 1996 were engaged
principally in research and development, product testing, manufacturing,
marketing and sales activities. We have incurred net losses since our inception.
As of December 31, 2000, our accumulated deficit was approximately $101,673,000.
We have only recently begun to generate revenues from the sale of our RF filter
products. Prior to the commencement of these sales, the majority of our revenues
were derived from R&D contracts, primarily from the U.S. government. We do not
expect revenues to increase dramatically until we ship a significantly larger
amount of our RF products. Accordingly, we expect to continue to experience net
losses, and we cannot be certain if or when we will become profitable. Spectral
Solutions and the Adaptive Notch Filtering business unit of Lockheed Martin
Canada, both of which we recently acquired, have similar operating histories and
financial uncertainties.

We have only a limited operating history upon which an evaluation of us
and our prospects can be based. We must therefore be considered in light of the
risks, expenses and difficulties frequently encountered by companies in their
early stages of product commercialization.

Future Capital Needs

To date, the Company has financed its operations primarily through
public and private equity and debt financings. The Company believes that it has
sufficient funds to operate its business as identified herein without the need
for substantial future capital sources other than those described herein until
the end of the first quarter 2002. In addition, the Company has put in place
mechanisms to raise additional capital when and if needed. The company intends
to augment its existing capital position through the funding mechanisms
identified and through other strategic sources of capital. Although the Company
believes it has sufficient capital resources available to meet its obligations
over the next year, there is no guarantee that the funding mechanisms identified
will allow to the company to access additional funds.

The actual amount of our future funding requirements will depend on
many factors, including: the amount and timing of future revenues, the level of
product marketing and sales efforts to support our commercialization plans, the
magnitude of our research and product development programs, our ability to

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improve product margins, the cost of additional plant and equipment for
manufacturing and the costs involved in protecting our patents or other
intellectual property.

Limited Experience in Manufacturing, Sales and Marketing

For us to be financially successful, we must either manufacture our
products in substantial quantities, at acceptable costs and on a timely basis or
enter into an outsourcing arrangement with a qualified manufacturer that will
allow us the same. In the event that we are unable to enter into a manufacturing
arrangement on acceptable terms with a qualified manufacturer, the Company would
have to produce the products in commercial quantities in our own facilities.
Although to date we have produced limited quantities of our products for
commercial installations and for use in development and customer field trial
programs, production of large quantities of our products at competitive costs
presents a number of technological and engineering challenges for us. We may be
unable to manufacture such products in sufficient volume. We have limited
experience in manufacturing, and substantial costs and expenses may be incurred
in connection with attempts to manufacture larger quantities of our products. We
may be unable to make the transition to large-scale commercial production
successfully.

Our sales and marketing experience to date is very limited. The Company
will be required to further develop its marketing and sales force in order to
effectively demonstrate the advantages of our products over more traditional
products, as well as other competitors HTS products. The Company also may elect
to enter into arrangement with third parties regarding the commercialization and
marketing of its products. If the Company enters into such agreements or
relationships, it will be substantially dependent upon the efforts of others in
deriving commercial benefits from its products. The Company may be unable to
establish adequate sales and distribution capabilities, it may be unable to
enter into marketing arrangements or relationships with third parties on
financially acceptable terms, and any such third party may not be successful in
marketing the Companys products. There is no guarantee that our sales and
marketing experience will be successful.

Management of Growth

Our growth to date has caused, and will continue to cause, a
significant strain on our management, operational, financial and other
resources. Our ability to manage growth effectively will require us to implement
and improve our operational, financial, manufacturing and management information
systems and expand, train, manage and motivate our employees. These demands may
require the addition of new management personnel and the development of
additional expertise by management. Any increase in resources devoted to product
development and marketing and sales efforts could have an adverse effect on our
financial performance in the next several fiscal quarters. If we were to receive
substantial orders, we may have to expand our current facilities, which could
cause an additional strain on our management personnel and development
resources. The failure of our management team to effectively manage growth could
have a material adverse effect on our business, operating results and financial
condition.

RISKS RELATED TO OUR COMMON STOCK AND CHARTER PROVISIONS

Delisting of Common Stock

Our common stock was de-listed from trading on the NASDAQ National
Market in June 1999 due to our inability to meet the net tangible assets
requirement for continued listing. Our common stock is now traded in the
over-the-counter market and quoted on the over-the-counter bulletin board
(OTCBB). While to date, the OTCBB market has not diminished the liquidity of
the common stock, there is no guarantee that the OTCBB will provide the same
liquidity for the trading of securities as the NASDAQ National Market in the
future. We intend to apply for relisting on the NASDAQ National Market when we
are reasonably confident that our application would be approved. However, there
is no guarantee that our application for relisting will be approved.

Volatility of Common Stock Price

The market price of our common stock, like that of many other
high-technology companies, has fluctuated significantly and is likely to
continue to fluctuate in the future. Since January 1, 1999 and through December
31, 2000, the closing price of our common stock has ranged from a low of $0.3438
per share to a high of $39.00 per share. Announcements by us or others regarding

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the receipt of customer orders, quarterly variations in operating results,
acquisitions or divestitures, additional equity or debt financings, results of
customer field trials, scientific discoveries, technological innovations,
litigation, product developments, patent or proprietary rights, government
regulation and general market conditions may have a significant impact on the
market price of our common stock. In addition, fluctuations in the price of our
common stock could affect our ability to have our common stock accepted for
listing on a securities market or exchange.

Risk of Dilution

As of December 31, 2000, we had (i) outstanding warrants to purchase
95,533 shares of common stock at a weighted average exercise price of $10.20 per
share and (ii) outstanding options to purchase 5,442,596 shares of common stock
at a weighted average exercise price of $3.02 per share (3,876,578 of which have
not yet vested) issued to employees, directors and consultants pursuant to our
1993 Stock Option Plan, the merger agreement with Spectral Solutions, and
individual agreements with our management and directors. In order to attract and
retain key personnel, we may issue additional securities, including stock
options, in connection with our employee benefit plans, or may lower the price
of existing stock options.

On January 8, 2001 we filed a registration statement on Form S-3 for
the sale of up to $20 million of shares of our common stock in a rights
offering to common shareholders as of a certain holding date not yet determined.
On January 12, 2001, we filed a registration statement on Form S-3 for the sale
of up to $50 million of shares of our common stock in a universal shelf
offering. During March, 2001, the Company entered into an agreement with Paul
Revere Capital Partners, Ltd., whereby Paul Revere Capital commits to acquire up
to $20 million of the Companys stock over the next 24 months upon demand by the
Company, subject to the conditions contained in the agreement. Pursuant to this
facility, the Company may, at its discretion, sell shares of its common stock to
Paul Revere Capital Partners at a discount to the market price of 94% of the
average weighted volume price over a 22 day period. Each draw down is limited to
the lesser of $4 million or 20% of the trading volume over a specified period of
time. The Company will also issue a warrant to Paul Revere Capital Partners to
purchase a number of shares equal to 0.5% of the shares issued in each draw
down. The Company has also agreed to pay its placement agent a fee equal to 4%
of each draw down and issue a warrant to the placement agent to purchase a
number of shares equal to 0.5% of the shares issued in each draw down.

The exercise of options and warrants for common stock and the issuance
of additional shares of common stock and/or rights to purchase common stock at
prices below market value will be dilutive to existing stockholders and may have
an adverse effect on the market value of the common stock.

Concentration of Our Stock Ownership

Our officers, directors and principal stockholders (holding greater
than 5% of outstanding shares) together control approximately 66% of our
outstanding voting power. Consequently, these stockholders, if they act
together, would be able to exert significant influence over all matters
requiring stockholder approval, including the election of directors and approval
of significant corporate transactions. In addition, this concentration of
ownership may delay or prevent a change of control of our company, even when a
change may be in the best interests of our stockholders. The interests of these
stockholders may not always coincide with our interests as a company or the
interests of other stockholders. Accordingly, these stockholders could cause us
to enter into transactions or agreements that we would not otherwise consider.

Anti-Takeover Provisions

We have certain arrangements which may be deemed to have a potential
anti-takeover effect in that such provisions may delay, defer or prevent a
change of control of our company. In February 1996, our Board of Directors
adopted a stockholders rights plan. In addition, our Certificate of
Incorporation and By-Laws provide that (i) stockholder action may be taken only
at stockholders meetings; (ii) the Board of Directors has authority to issue
series of our preferred stock with such voting rights and other powers as the
Board of Directors may determine; (iii) prior specified notice must be given by
a stockholder making nominations to the Board of Directors or raising business
matters at stockholders meetings; and (iv) the Board of Directors is divided

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into three classes, each serving for staggered three-year terms. The effect of
the rights plan and the anti-takeover provisions in our charter documents may be
to deter business combination transactions not approved by our Board of
Directors, including acquisitions that may offer a premium over market price to
some or all of our stockholders.

TECHNOLOGY AND MARKET RISKS

We are Dependent on the Build-out of 3G Networks and the Capital Spending
Patterns of Wireless Network Operators

Increased sales of our products is dependent on the build-out of 3G
enabled wireless communications networks. Building these networks is capital
intensive, as is the process of upgrading existing second generation equipment.
Further, the capital spending patterns of wireless network operators is beyond
our control and depends on a variety of factors, including access to financing,
the status of federal, local and foreign government regulation and deregulation,
changing standards for wireless technology, the overall demand for wireless
services, competitive pressures and general economic conditions. The build-out
of 3G enabled networks may take years to complete and is dependent upon the
level of capital spending by wireless network operators. The magnitude and
timing of capital spending by these operators for constructing, rebuilding or
upgrading their systems significantly impacts the demand for our products. Any
decrease or delay in capital spending patterns in the wireless communication
industry, whether because of a general business slowdown or a reevaluation of
the prospective demand for 3G services, would delay the build-out of 3G networks
and significantly harm our business prospects.

Uncertain Market Acceptance of HTS
Telecommunications Products

Our radio frequency (RF) filter products, which are based on our high
temperature superconductor (HTS) technology, and our ANF technology, have not
been sold in very large quantities and a sufficient market may not develop for
our products. Our customers establish demanding specifications for performance
and reliability, and although we believe we have met or exceeded these
specifications to date, there is no guarantee that the wireless service
providers will elect to use the HTS or ANF solutions to solve their interference
problems.

Rapid Technological Change and Future Competitive
Technologies

The field of superconductivity is characterized by rapidly advancing
technology. Our success will depend in large part upon our ability to keep pace
with advancing superconducting technology, high performance RF filter design and
efficient, low cost cryogenic technologies. Rapid changes have occurred, and are
likely to continue to occur, in the development of superconducting materials and
processes. Our development efforts may be rendered obsolete by the adoption of
alternative solutions to current wireless operator problems or by technological
advances made by others. In addition, other materials or processes, including
other superconducting materials or fabrication processes, may prove more
advantageous for the commercialization of high performance wireless products
than the materials and processes selected by us.

Focus on Wireless Telecommunications Market and on
the 3G Market

Our principal target market for our products is wireless
telecommunications. The devotion of substantial resources to the wireless
telecommunications market makes us vulnerable to adverse changes in this market.
Adverse developments in the wireless telecommunications market, which could come
from a variety of sources, including future competition, new technologies or
regulatory decisions, could affect the competitive position of wireless systems.
Any adverse developments in the wireless telecommunications market during the
foreseeable future would have a material adverse effect on our business,
operating results and financial condition.

Our principal focus within the wireless telecommunications market has
been on the emerging 3G wireless systems in Asia. The devotion of substantial
resources to this emerging market makes us vulnerable to adverse developments in
this market, including the potential decisions by 3G wireless operators to not
adopt HTS RF filters into their system specifications or on a retrofit schedule;
to delay in the roll-out of 3G systems; to future competition, new technologies
or regulatory decisions, all of which could have an adverse effect on our
business, operating results and financial condition.

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BUSINESS RISKS

Dependence on a Limited Number of Customers

To date, our sales and marketing efforts have focused on cellular and
PCS service providers in retrofit applications. Sales to three of our customers
accounted for over 80% and 65% of our companys total revenues for 2000 and
1999, respectively. In addition, we have focused a significant amount of our
technical and managerial resources to working with the limited number of 3G
license holders in Japan and Korea, as well as, established Original Equipment
Manufacturers (OEMs) who may provide telecommunications equipment to these 3G
wireless operators in these markets.

We expect that if our RF filter products achieve market acceptance, a
limited number of wireless service providers and OEMs will account for a
substantial portion of our revenue during any period. Sales of many of our
companys RF filter products depend in significant part upon the decision of
prospective customers and current customers to adopt and expand their use of our
products. Wireless service providers, wireless equipment OEMs and our other
customers are significantly larger than, and are able to exert a high degree of
influence over us. Customers orders are affected by a variety of factors such
as new product introductions, regulatory approvals, end user demand for wireless
services, customer budgeting cycles, inventory levels, customer integration
requirements, competitive conditions and general economic conditions. The
failure to attract new customers would have a material adverse effect on our
business, operating results and financial condition.

Lengthy Sales Cycles

Prior to selling our products to our customers, we must generally
undergo lengthy approval and purchase processes. Technical and business
evaluation by potential customers can take up to a year or more for products
based on new technologies such as HTS. The length of the approval process is
affected by a number of factors, including, among others, the complexity of the
product involved, priorities of the customers, budgets and regulatory issues
affecting customers. We may not obtain the necessary approvals or ensuing sales
of such products may not occur. The length of our customers approval process or
delays could have a material adverse effect on our business, operating results
and financial condition.

Dependence on Limited Sources of Supply

Certain parts and components used in our RF filter products, including
substrates, vacuum components, and cryogenic coolers, are only available from a
limited number of sources. Our reliance on these limited source suppliers
exposes us to certain risks and uncertainties, including the possibility of a
shortage or discontinuation of certain key components and reduced control over
delivery schedules, manufacturing capabilities, quality and costs. Any reduced
availability of such parts or components when required could materially impair
our ability to manufacture and deliver our products on a timely basis and result
in the cancellation of orders, which could have a material adverse effect on our
business, operating results and financial condition.

In addition, the purchase of certain key components involves long lead
times and, in the event of unanticipated increases in demand for our products,
we may be unable to manufacture products in quantities sufficient to meet our
customers demand in any particular period. We have no guaranteed supply
arrangements with our limited source suppliers, do not maintain an extensive
inventory of parts or components, and customarily purchase parts and components
pursuant to purchase orders placed from time to time in the ordinary course of
business.

To satisfy customer requirements, we may be required to stock certain
long lead time parts in anticipation of future orders. The failure of such
orders to materialize as forecasted could limit resources available for other
important purposes or accelerate our requirement for additional funds. In
addition, such excess inventory could become obsolete, which would adversely
affect our financial performance. Business disruption, production shortfalls or
financial difficulties of a limited source supplier could materially and
adversely affect us by increasing product costs or reducing or eliminating the
availability of such parts or components. In such events, our inability to
develop alternative sources of supply quickly and on a cost-effective basis
could materially impair our ability to manufacture and deliver our products on a
timely basis and could have a material adverse effect on our business, operating
results and financial condition.

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Dependence on Key Personnel

Our success will depend in large part upon our ability to attract and
retain highly qualified management, engineering, manufacturing, marketing, sales
and R&D personnel. Due to the specialized nature of our business, it may be
difficult to locate and hire qualified personnel. The loss of services of one of
our executive officers or other key personnel, or the failure to attract and
retain other executive officers or key personnel, could have a material adverse
effect on our business, operating results and financial condition.

Product Liability

To date, our products have been installed in more than 300 cell sites
with a wide geographic dispersion. Although we believe our products have not
experienced any significant reliability problems to date, our products may
develop reliability problems in the future. Repeated or widespread quality
problems could result in significant warranty expenses and/or the loss of
customer confidence. The occurrence of such quality problems could have a
material adverse effect on our business, operating results and financial
condition.

Competition

The wireless telecommunications equipment market is very competitive.
Our products compete directly with products which embody existing and future
competing commercial technologies. Many of these companies have substantially
greater financial resources, larger R&D staffs and greater manufacturing and
marketing capabilities than we do. Other emerging wireless technologies,
including smart antennas and tower mounted amplifiers, may also provide
protection from RF interference and offer enhanced range to wireless
communication service providers at lower prices and/or superior performance, and
may therefore compete with our products. High performance HTS RF filters may not
become a preferred technology to address the needs of wireless communication
service providers. Failure of our products to improve performance sufficiently,
reliably, or at an acceptable price or to achieve commercial acceptance or
otherwise compete with conventional and new technologies will have a material
adverse effect on the our business, operating results and financial condition.

Although the market for superconductive electronics currently is
small, we believe it will become intensely competitive, especially if products
with significant market potential are successfully developed. In addition, if
the superconducting industry develops, additional competitors with significantly
greater resources are likely to enter the field. In order to compete
successfully, we must continue to develop and maintain technologically advanced
products, reduce production costs, attract and retain highly qualified
personnel, obtain additional patent or other protection for our technology and
products and manufacture and market our products, either alone or with third
parties. We may be unable to achieve these objectives. Failure to achieve these
objectives would have a material adverse effect on our business, operating
results and financial condition.

LEGAL RISKS

Intellectual Property and Patents

Our success will depend in part on our ability to obtain patent
protection for our products and processes, to preserve our trade secrets and to
operate without infringing upon the patent or other proprietary rights of others
and without breaching or otherwise losing rights in the technology licenses upon
which any of our products are based. As of December 31, 2000, we had been issued
35 U.S. and 4 foreign patents, had filed and were actively pursuing applications
for 13 other U.S. and 23 other patents, and were the licensee of 7 U.S. patents
and patent applications held by others. We acquired additional patent rights in
connection with our purchase of the Adaptive Notch Filtering business unit of
Lockheed Martin Canada. One of our patents is jointly owned with Lucent
Technologies, Inc. We believe that, since the discovery of HTS materials in
1986, a large number of patent applications have been filed worldwide, and many
patents have been granted in the U.S. relating to HTS materials. The claims in
those patents often appear to overlap and there have been interference
proceedings pending in the United States Patent and Trademark Office (not
currently involving our company) regarding rights to inventions claimed in some

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of the HTS materials patent applications. We also believe there are a large
number of patents and patent applications covering RF filter products and other
products and technologies that we are pursuing. Accordingly, the patent
positions of companies using HTS materials technologies and RF technologies,
including our company, are uncertain and involve complex legal and factual
questions. The patent applications filed by us or by our licensors may not
result in issued patents or the scope and breadth of any claims allowed in any
patents issued to us or our licensors may not exclude competitors or provide
competitive advantages to us. In addition, patents issued to us, our
subsidiaries or our licensors may not be held valid if subsequently challenged
or others may claim rights in the patents and other proprietary technologies
owned or licensed by us. Others may have developed or may in the future develop
similar products or technologies without violating any of our proprietary
rights. Furthermore, our loss of any license to technology that we now have or
acquire in the future may have a material adverse effect on our business,
operating results and financial condition.

Some of the patents and patent applications owned or licensed by us
are subject to non-exclusive, royalty-free licenses held by various U.S.
governmental units. These licenses permit these U.S. government units to select
vendors other than us to produce products for the U.S. Government, which would
otherwise infringe our patent rights that are subject to the royalty-free
licenses. In addition, the U.S. Government has the right to require us to grant
licenses (including exclusive licenses) under such patents and patent
applications or other inventions to third parties in certain instances.

Older patent applications in the U.S. are currently maintained in
secrecy until patents are issued. In foreign countries and for newer U.S. patent
applications, this secrecy is maintained for a period of time after filing.
Accordingly, publication of discoveries in the scientific literature or of
patents themselves or laying open of patent applications in foreign countries or
for newer U.S. patent applications tends to lag behind actual discoveries and
filing of related patent applications. Due to this factor and the large number
of patents and patent applications related to HTS materials, RF technologies and
other products and technologies that we are pursuing, comprehensive patent
searches and analyses associated with HTS materials, RF technologies and other
products and technologies that we are pursuing are often impractical or not
cost-effective. As a result, our patent and literature searches cannot fully
evaluate the patentability of the claims in our patent applications or whether
materials or processes used by us for our planned products infringe or will
infringe upon existing technologies described in U.S. patents or may infringe
upon claims in patent applications made available in the future. Because of the
volume of patents issued and patent applications filed relating to HTS
materials, RF technologies and other products and technologies that we are
pursuing, we believe there is a significant risk that current and potential
competitors and other third-parties have filed or will file patent applications
for, or have obtained or will obtain, patents or other proprietary rights
relating to materials, products or processes used or proposed to be used by us.
In any such case, to avoid infringement, we would have to either license such
technologies or design around any such patents. We may be unable to obtain
licenses to such technologies or, if obtainable, such licenses may not be
available on terms acceptable to us or we may be unable to successfully design
around these third-party patents.

Participation in litigation or patent office proceedings in the U.S.
or other countries, which could result in substantial cost to and diversion of
effort by our company, may be necessary to enforce patents issued or licensed to
us, to defend our company against infringement claims made by others or to
determine the ownership, scope or validity of the proprietary rights of our
company and others. The parties to such litigation may be larger, better
capitalized than us and better able to support the cost of litigation. An
adverse outcome in any such proceedings could subject us to significant
liabilities to third parties, require us to seek licenses from third parties
and/or require us to cease using certain technologies, any of which could have a
material adverse effect on our business, operating results and financial
condition.

We believe that a number of patent applications, including
applications filed by International Business Machines Corporation, Lucent
Technologies, Inc., and other potential competitors of our company are pending
that may cover the useful compositions and uses of certain HTS materials
including yttrium barium copper oxide (YBCO), the principal HTS material used
by us in our present and currently proposed products. Therefore, there is a
substantial risk that one or

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more third parties may be granted patents covering YBCO and other HTS materials
and their uses, in which case we could not use these materials without an
appropriate license. As with other patents, we have no assurance that we will be
able to obtain licenses to any such patents for YBCO or other HTS materials,
processes for manufacturing those materials, or their uses or that such licenses
would be available on commercially reasonable terms. Any of these problems would
have a material adverse effect on our business, operating results and financial
condition.

Litigation

The Company has been subject to a number of lawsuits and currently has
a number of legal proceedings against it involving various claims. Although the
Company has been successful in defending itself against these claims to date,
there is no guarantee that this success will continue. If the Company is not
successful in defending itself against these claims, there may be a material and
adverse effect on our business, operating results and financial condition.

Government Regulations

Although we believe that our wireless telecommunications products
themselves would not be subject to licensing by, or approval requirements of,
the FCC, the operation of base stations is subject to FCC licensing and the
radio equipment into which our products would be incorporated is subject to FCC
approval. Base stations and the equipment marketed for use therein must meet
specified technical standards. Our ability to sell our wireless
telecommunications products is dependent on the ability of wireless base station
equipment manufacturers and wireless base station operators to obtain and retain
the necessary FCC approvals and licenses. In order for them to be acceptable to
base station equipment manufacturers and to base station operators, the
characteristics, quality and reliability of our base station products must
enable them to meet FCC technical standards. We may be subject to similar
regulations of the Canadian federal and provincial governments. Any failure to
meet such standards or delays by base station equipment manufacturers and
wireless base station operators in obtaining the necessary approvals or licenses
could have a material adverse effect on our business, operating results and
financial condition. In addition, HTS RF filters are on the U.S. Department of
Commerces export regulation list. Therefore, exportation of such RF filters to
certain countries may be restricted or subject to export licenses.

We are subject to governmental labor, safety and discrimination laws
and regulations with substantial penalties for violations. In addition,
employees and others may bring suit against us for perceived violations of such
laws and regulations. Defense against such complaints could result in
significant legal costs for us. Although we endeavor to comply with all
applicable laws and regulations, we may be the subject of complaints in the
future, which could have a material adverse effect on our business, operating
results and financial condition.

Environmental Liability

We use certain hazardous materials in our research, development and
manufacturing operations. As a result, we are subject to stringent federal,
state and local regulations governing the storage, use and disposal of such
materials. It is possible that current or future laws and regulations could
require us to make substantial expenditures for preventive or remedial action,
reduction of chemical exposure, or waste treatment or disposal. We believe we
are in material compliance with all environmental regulations and to date we
have not had to incur significant expenditures for preventive or remedial action
with respect to the use of hazardous materials. However, our operations,
business or assets could be materially and adversely affected by the
interpretation and enforcement of current or future environmental laws and
regulations. In addition, although we believe that our safety procedures for
handling and disposing of such materials comply with the standards prescribed by
state and federal regulations, there is the risk of accidental contamination or
injury from these materials. In the event of an accident, we could be held
liable for any damages that result. Furthermore, the use and disposal of
hazardous materials involves the risk that we could incur substantial
expenditures for such preventive or remedial actions. The liability in the event
of an accident or the costs of such actions could exceed our resources or
otherwise have a material adverse effect on our business, results of operations
and financial condition. We carry property and workmans compensation insurances
in full force and effect through nationally known carriers which include
pollution cleanup or removal and medical claims for industrial incidents.

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RISKS RELATED TO ACQUISITIONS AND BUSINESS EXPANSION

Risks Associated with Lockheed Martin Canada, Inc. Transaction

We acquired the Adaptive Notch Filtering business unit of Lockheed
Martin Canada in December 2000. There are certain risks associated with this
transaction, including the risk that we will not be able to successfully
integrate the Adaptive Notch Filtering business into our existing business.

Risks Associated with Spectral Solutions Transaction

We acquired Spectral
Solutions, Inc. in August 2000. There are certain risks
associated with this transaction, including the risk that we will not be able to
successfully integrate the Spectral Solutions business. Spectral Solutions
develops and manufactures primarily thin-film HTS RF applications for the
wireless communications industry. We have concentrated our manufacturing and
marketing efforts to date on thick-film applications, and there can be no
assurance that we will successfully integrate thin-film technology into our
product offerings. There is also no assurance that we will be able to achieve
the synergies we believe should result from the acquisition of Spectral
Solutions.

Risks of Future Acquisitions

In the future, we may pursue acquisitions to obtain products, services
and technologies that we believe will complement or enhance our current product
or services offerings. At present, we have no agreements or other arrangements
with respect to any acquisition. An acquisition may not produce the revenue,
earnings or business synergies that we anticipated and may cause us to assume
significant unforeseen liabilities, and an acquired product, service or
technology might not perform as we expected. If we pursue any acquisition, our
management could spend a significant amount of time and effort in identifying
and completing the acquisition and may be distracted from the operations of our
business. If we complete an acquisition, we would probably have to devote a
significant amount of management resources to integrating the acquired business
with our existing business, and that integration may not be successful.

International Operations

We are in discussions with several companies in non-U.S. markets, in
particular in Japan and other parts of Asia, to form manufacturing, product
development joint ventures and other marketing or consulting arrangements.
Results of these discussions include a joint marketing agreement with CTR
Ventures in Japan and the opening of a Japanese office in Tokyo; a joint product
development and manufacturing arrangement with KMW, Inc. in Korea and the
acquisition of the ANF division from Lockheed Martin Canada.

We believe that non-U.S. markets could provide a substantial source of
revenue in the future. However, there are certain risks applicable to doing
business in foreign markets that are not applicable to companies doing business
solely in the U.S. For example, we will be subject to risks related to
fluctuations in the exchange rate between the U.S. dollar and foreign currencies
in countries in which we do business. In addition, we will be subject to the
additional laws and regulations of these foreign jurisdictions, some of which
might be substantially more restrictive than similar U.S. ones. Foreign
jurisdictions may also provide less patent protection than is available in the
U.S., and we may be less able to protect our intellectual property from
misappropriation and infringement in these foreign markets.

HTS AND WIRELESS TELECOMMUNICATIONS INDUSTRY BACKGROUND

There are two distinct market applications for HTS front-end systems.
The larger opportunity will be as an enabling technology for Third Generation
(3G) wireless systems, which is expected to be deployed in 2002 to support
mobile Internet services. The more immediate application will be based on
retrofitting existing 2G networks (principally CDMA) to provide capacity
solutions as these networks begin to run out of spectrum to support rapidly
growing customer traffic.

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The 3G Opportunity: A True Wireless Internet

Existing wireless networks are based on technical architectures that
were standardized in the late 1980s and early 1990s, and are highly optimized
for voice signals. The guiding principle of 2G systems (including TDMA, GSM,
CDMA) is signal compression to achieve spectrum efficiency. The basic user
data-rate in these networks is typically around 10 kb/s, which is adequate for
telephony voice traffic.

These networks are not capable of supporting true Internet
applications. Recent experience with the i-Mode service introduced in 1999 by
NTT DoCoMo in Japan has demonstrated a strong demand for wireless Internet type
service, while also exposing the difficulties of delivering this service over
existing 2G networks. The i-Mode service was launched in 1999 in Japan, and
rapidly became the most successful new service introduction in the history of
the wireless industry, adding six million customers in only six months. The
service itself comprises an Internet-type connectivity for email, messaging,
file transfer, as well as voice telephony, and by early 2000, more than 80% of
the new subscribers being added in NTTs wireless network were i-Mode
subscribers. However, beginning in February 2000, the network began to
experience severe technical difficulties stemming from overloading of the basic
2G transmission facilities. By July 2000, it had become necessary to suspend the
promotion of the service to new customers. While clearly demonstrating a strong
demand for wireless Internet service, the i-Mode experiment clearly showed that
a new network architecture will be needed to deliver this service effectively.

3G standards are being developed to meet the needs for a true wireless
Internet service. There are several competing versions of the 3G standard,
including W-CDMA which is favored by most of the Europeans and by NTT DoCoMo,
and cdma2000, promoted by Qualcomm and supported by many existing IS-95 (2G
CDMA) operators. Both standards are broadly similar. They are based on wideband
CDMA architecture, and will require the same general ultra-clean interference
suppression solutions. These new standards will allow for user data-rates of up
to 2 MB/s  nearly two hundred times faster than 2G networks. Moreover, 3G
networks will have to support traffic patterns characteristic of Internet
connectivity (always on service that may generate several hours of connect
time per user per day) rather than todays short voice telephony patterns.

One system element that is especially affected by 3G performance
objectives is the receiver front-end, especially the filters and low-noise
amplifiers that acquire the desired signal and block interference from other
sources. Existing 1G and 2G networks are designed around the less-than-perfect
performance characteristics of conventional front-end systems based on metallic
or ceramic (dielectric) filter technology. These systems allow for a great deal
of interference to penetrate the desired signal. There is evidence that even in
existing networks (2G CDMA) there are large losses in system capacity
 up to
50% or more of nominal capacity lost, according to recent tests with major CDMA
carriers  due solely to the imperfections in receiver front-end filtering based
on conventional technology. With 3G, extensive testing by NTT DoCoMo and others
indicates that conventional front-end technology will not deliver adequate
performance. HTS-based receiver front-ends provide an almost theoretically
perfect control over out-of-band interference. Recent publications and
announcements by NTT scientists indicate that HTS is increasingly viewed as a
basic requirement for 3G networks

High-temperature superconducting materials are used to design RF
subsystems such as receiver front-end filters which eliminate interference that
can reduce the quality and capacity of wireless systems. Superconductor-based
filters far outperform the best conventional front-end filters, as shown in
Figure 1, which is adapted from NTT DoCoMo sponsored published test results in
Japan:

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[RELATIVE FREQUENCY GRAPH]

Size of the 3G HTS Market

The size of the 3G market is developed from two overarching premises:

Network Replacement: 3G will require completely new networks: new base stations,
new switches, new handsets ­ and new technology. It is not possible to retrofit
existing 2G networks. The Company expects that the entire wireless industry,
which now encompasses almost 1 million base stations and perhaps 500 million
handsets, will eventually be completely replaced or overbuilt with new 3G
equipment.

Internet Pressure: The fundamental demand driver for 3G is Internet traffic
(pure data, email, plus mixed voice-and-data for mobile applications and various
multimedia services). As the i-Mode experience shows clearly, the demand
pressure should follow Internet growth patterns rather than conventional
circuit-switched telephony growth or even mobile telephony growth trajectories.

Taken together, these premises imply that the scope of the total 3G
equipment market will be enormous, requiring hundreds of billions of dollars of
new technology investment worldwide over the next ten years. The scope of the
HTS front-end segment could well be in the billions of dollars annually.

Based upon analysis of available information, the HTS market potential
in Japan alone could potentially be considerably more than $1 billion over the
next five years. [Equivalent single-sector (omni) base stations. Some of these
will be co-located as sectored sites, either 3 or 6 sectors per site.] The total
number of 3G base stations deployed by all three licensed operators in Japan is
estimated to be between 75,000 to 100,000 over a 5-8 year period. The Korean
market is estimated to be approximately 40% of the size of the Japanese market
overall and the European and US markets are estimated to be approximately 4 and
2 times the size of the Japanese market respectively.

Timing of 3G

Japan: NTTs stated goal is to begin commercial 3G service in mid-2001. Other
operators (KDDI and Japan Phone) have announced their intentions to deploy 3G
within a year or so of NTT. Based on information available to ISCO, we believe
that the main build-out for 3G will develop beginning about 1 year later:
mid-2002, reaching high volume in 2003. We anticipate the 2003 level will be
sustained for several years as the networks are built out.

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Korea: We believe that Korea will be developing according to approximately the
same time-table as Japan, perhaps delayed by 6-12 months.

Europe: The European 3G market development is in flux. Last year there was a
consensus that 3G would be delayed in Europe, but recent auction results and
even some announced contracts indicate that the deployment schedule may be
accelerating. We estimate that European deployments (other than the UK) will lag
the Japanese deployment by 1.5 to 2 years. The UK deployment may be ahead of the
rest of the European market.

United States: The timetable for 3G in the United States is uncertain. A signal
event will be the commencement of spectrum auctioning for the 700 MHz bands in
2002; this event should crystallize 3G service plans and timetables should
become clearer. However, the non-standard frequency band will add further timing
uncertainty.

Spectrum Congestion: Different markets may show some differences in the uptake
of HTS solutions due to different specific interference considerations. In
Japan, for example, the co-existence of PHS services in near-adjacent bands with
the new 3G systems appears to have accentuated engineering concern over
interference. In the US, the continued operation of some TV broadcasters in the
proposed 700 MHz band has also spurred the FCC and others to focus on the
problems of interference-management.

The 2G Opportunity: Capacity Upgrades for CDMA

Well before the arrival of 3G, there is strong market pressure
developing which the Company believes will be favorable to HTS applications.
Existing wireless operators (cellular and PCS) are now beginning to run out of
capacity in major markets. Whereas until last year most carriers were much more
concerned with coverage than capacity, we believe that capacity shortages in key
urban markets are becoming a critical concern for many operators this year, and
will intensify next year.

Adding capacity can be fundamentally quite expensive. The standard
solution is to split cells or add extra base stations, which costs anywhere from
$200,000 to $1 million per cell-site. Exotic technology solutions like smart
antennas are still maturing and also very expensive ($100,000 or more per
site). By contrast, HTS front-end systems can increase capacity substantially at
a modest cost ($15,000-$40,000 per site today).

The capacity gains are most significant for CDMA-based networks. CDMA
is a complex 2G air-interface which creates capacity by carefully designing
orthogonal and semi-orthogonal cross-interference patterns between different
signals sharing the same spectrum. This type of system is very sensitive to
non-optimal conditions such as uncontrolled interference from out-of-band
sources. Beginning last year, the Company has been testing the effects of HTS on
regaining lost capacity with a major US CDMA carrier. Representative results are
shown in the following Figure. Under specified test conditions, in a multi-cell
network, the standard configuration cell-site (single carrier) was capable of
supporting NINE simultaneous telephone calls.

CDMA CELL, CONVENTIONAL FRONT-END: 9 SIMULTANEOUS CALLS

[CDMA CELL GRAPH]

OEM CONFIGURATION MAXIMUM NUMBER OF STABLE CALLS = 9

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The same cell-site, with an HTS receiver, was able to support FOURTEEN
simultaneous calls. These results pertain to the downlink. Similar gains are
seen on the uplink, along with a reduction in mobile unit power of 3-5 dB on
average.

[CODE DOMAIN GRAPH]

These gains are highly significant. HTS front-end solutions are
emerging as the cheapest capacity enhancement solution available to CDMA
carriers. This could potentially lead to the deployment of HTS as a network-wide
capacity solution (rather than a site-specific interference-suppression tool).

Timing of the 2G Market

The 2G market is beginning to develop now in the United States, and it
will be the focus of our near-term sales effort in the next 18 months. The
driver for this market is the developing capacity crisis in important CDMA
markets.

The same application also
exists in Korea  an all-CDMA market  and
potentially with the current CDMA carrier in Japan (KDDI).

Competition

All other HTS companies are limited to thin-film HTS. These include
two small U.S. based thin-film companies (Conductus, Inc. and Superconductor
Technologies, Inc.) which have sold systems in the U.S. for receive filter
applications. DuPont, a holder of a number of patents in the HTS materials area,
has indicated an interest in developing a CRFE. However, the Company is not
aware of DuPont having produced a functional HTS prototype, nor is it aware of
the development or delivery of any commercial system. A number of other
companies in Japan and Europe have engaged in development towards thin-film HTS,
but to our knowledge have not delivered commercial HTS systems. In Japan,
Cryodevices Ltd. is a joint venture between two Japanese companies, which has
been working on thin-film technology for several years. Toshiba has also
indicated an interest in developing a HTS filter for wireless
telecommunications. In Europe, Cryoelectrica is a university-affiliated entity
that has also been pursuing thin-film designs. To our knowledge, neither has
delivered a commercial system. There was also a European consortium called
Sucoms, which was established for the same purpose. Sucoms was apparently
disbanded earlier this year.

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The following chart summarizes the relative publicly announced
technology and product position of the current HTS competitors to the Company:

|     |  |           |     |            |  |     |     |          |  |        |     |          |  |        |     |  |  |  |     |         |  |  |     |  |  |  |     | 
|---- |  | --------- | --- | ---------- |  | --- | --- | -------- |  | ------ | --- | -------- |  | ------ | --- |  |  |  | --- | ------- |  |  | --- |  |  |  | --- | 
|     |  |           |     |            |  |     |     |          |  | Hybrid |     | Transmit |  | Tower- |     |  |  |  |     | Equali-
|     |  | Thin-film |     | Thick-film |  | HTS |     | Products |  | Mount  |     | ATP      |  | zation
|     |  |           |     |            |  |     |     |          |  |        |     |          |  |       
|ISCO |  |           | YES |            |  |     | YES |          |  |        | YES |          |  |        | YES |  |  |  | YES |         |  |  | YES |  |  |  | YES | 
|    
|    
|    
|    
|CDTS |  |           | YES |            |  |     | NO  |          |  |        | NO  |          |  |        | NO  |  |  |  | NO  |         |  |  | NO  |  |  |  | NO  | 
|    
|    
|    
|    
|SCON |  |           | YES |            |  |     | NO  |          |  |        | NO  |          |  |        | NO  |  |  |  | NO  |         |  |  | NO  |  |  |  | NO  | 

The Company believes it has the broadest HTS technology base of any
company in the world. The Companys goal is to position itself to lead the
industry in HTS wireless applications as HTS solutions move toward the
mainstream with 2G and 3G applications.

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TECHNOLOGY OVERVIEW

A wireless base station is divided (roughly) into two halves: the
digital portion, and the so-called front-end.

[DIGITAL WIRELESS COMMUNICATION SYSTEM GRAPH]

The core expertise of ISCO is the application of HTS to wireless
front-end systems. The components in the receiver front-end are designed to
acquire the desired information-bearing signal and pass it through to the
digital portion of the system, where it is processed digitally and the user
information is extracted. Typically, much of the signal is lost as it passes
through the front-end components. As well, undesired electromagnetic
interference also leaks into the system due to imperfections in the filtering
characteristics of the front-end devices. 1G and 2G systems are designed around
these losses and interference levels, and the information carrying capacity of
these systems are inherently limited.

Superconductivity is a property of certain materials, at certain
temperatures, in which electrical resistance is reduced essentially to zero.
High-temperature superconductivity (HTS) refers to materials, which exhibit this
property at relatively higher temperatures, which are suitable for practical
industry applications. [These materials were first discovered in the 1980s.
There are two main materials used today: Yttrium Barium Cupric Oxide (YBCO) and
Thallium Barium Calcium Cupric Oxide (TBCCO). These materials exhibit
superconductivity at temperatures up to 80-100(degree) K, which is suitable for
industrial applications.]

The use of HTS for wireless front-end systems is based on the following
general concept: by coating the surfaces of filter elements and other elements
of the front-end, it is possible to create front-end components which introduce
very little signal loss or degradation (no electrical resistance). In turn, this
allows for much more powerful filter architectures to be employed practically-
which results in much better performance. For example, the complexity of a
filter is related to the number of serial stages or poles in the filter design.
With conventional technology, it is impractical to construct a filter of more
than around 8-10 poles (and most are less complex). With HTS, ISCO has delivered
systems using 32 poles, with nearly perfect out-of-band filter performance.
Finally, the fact that these systems are cooled cryogenically reduces the
thermal noise component.

Thin-film & Thick-film HTS

There are two ways of designing an HTS component. So-called thin-film
techniques use vacuum deposition processes to carefully lay down extremely thin
layers of HTS material upon an appropriate substrate. The result is a wafer
which can be etched to

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create components such as a filter, in a process similar to semi-conductor chip
fabrication. The advantages of thin-film techniques are a somewhat smaller size
of the filter component, and the potential for integration with other components
in an Integrated Circuit or chip-type architecture.

Thick-Film techniques use a series of processes more similar to the
ceramic firing of a coating to create a somewhat thicker HTS layer on the
substrate, and are typically employed to coat three-dimensional resonator
elements and other larger structures. The manufacturing process is generally
much simpler and less expensive (no clean room required as for thin-film). The
advantages of thick-film HTS are much higher filter performance [i.e., better
selectivity and ultimate rejection; much better intermodulation characteristics;
larger numbers of poles can be employed.] as well as the ability to support
high-power applications for transmit filters and other transmitter components.

ISCO is the only company in the world with both thin-film and
thick-film HTS technology. Because of this, ISCO can design products using the
best available HTS technology for a given application, and is the only company
with the ability to combine thin-film and thick-film solutions in the same
front-end platform.

Front-End Architectures

ISCO has extensive experience in designing and producing a wide range
of RF front-end systems using HTS. We believe that our experience base is
greater than any other company in the world in the application of HTS to
wireless systems. Key platform technologies (all patented by ISCO) include:

- Tower-mounted cryogenic RF receiver front-end (plus LNA) the
only HTS system designed for tower-top installations
- All-temperature Performance (ATP) RF filter technology,
capable of operating at either cryogenic or ambient temperatures
(eliminating system failure point and need for conventional back-up
system required by competing thin-film vendors); ATP encompasses unique
HTS materials as well as frequency-compensation filter architectures
- Cryogenic equalization technologies to control group delay in
high-performance 3G systems. Group delay is the tendency of the digital
signal to spread out in time, so that information-bearing digital
pulses tend to smear together and cause inter-symbol interference
(ISI). ISI is combated by equalization techniques, which can be
implemented either in the front-end or in the digital domain. Digital
equalization is a significant signal processing overhead that can
eventually impose limits on system throughput; hence, it is desirable
to accomplish as much of the equalization of the signal as possible in
the analog front-end. ISCO is the only HTS company that has implemented
equalization in HTS front-end systems.
- Transmit filter designs capable of handling up to 100 watts of power.

Adaptive Notch Filters

The Company also offers adaptive notch filter products that continually
scan a segment of RF spectrum for interference and block that interference
within 20 milliseconds. The blocking feature is in place as long as needed for
noise suppression. These products are especially useful in dealing with sporadic
in-band interference as they adapt the Companys interference-management
technology to the fluid environment. The complementary nature of these products
with the Companys HTS solutions for adjacent-band interference allows the
Company to offer complete interference-management solutions to its customers,
rather than force customers to try to isolate the primary cause of their
interference problems prior to looking for an effective solution.

Product Benefits

The Companys products are designed to address the high performance RF
front-end needs of domestic and international commercial wireless
telecommunication systems by providing the following advantages:

Greater Network Capacity and Utilization. The Companys interference
management solutions can increase capacity and utilization by up to 70%. In some
cases, capacity increases because channels which were previously unusable due to
interference are recovered. In other cases, system utilization increases because
of lower levels of

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blocked or dropped calls, and increases in the ability of the system to permit
weak signals to be processed with acceptable call quality. In CDMA systems,
increased capacity frequently results from lowering the systems noise floor.

Improved Base Station
Range. The Companys RF front-end systems can
extend the uplink range of a wireless system by up to 30%. Greater range can
reduce a service operators capital expenditure per customer in lower density
areas by filling in coverage gaps in existing systems or by reducing the number
of required cell sites for new system deployments.

Improved Flexibility in Locating Base Stations. The Companys RF
front-end products can allow wireless telecommunications service providers to
co-locate base stations near other RF transmitters. The Companys products allow
the base station radio to better tolerate RF interference while reducing out-of
band signals that could interfere with other nearby wireless telecommunication
operators.

Improved Call Quality. The Companys products improve call quality by
reducing dropped and blocked calls. During commercial installations, the
Companys RF filter products have demonstrated up to a 40% reduction in dropped
calls. The Companys products also improve audio fidelity by reducing noise and
interference.

Improved Digital System Capacity. Tests conducted by wireless operators
show that on a single base station test, capacity of the base station increases
by as much as 30%. The Company believes that with a system wide deployment of
its products, the capacity of the system may increase by more than 70%.

COMPANY HIGHLIGHTS

Sales and Marketing

The Company has historically focused its sales and marketing effort on U.S.
wireless service providers for retrofit applications. To date, the Company has
sold its products to many of the largest cellular operators in the United States
as well as to numerous mid-size and smaller U.S. wireless operators.

Recently, the Company has also focused on international customers,
marketing both its existing products and presenting the benefits of its
interference-management technology in the design and early stages of new systems
for Third Generation Wireless (3G) Systems. The first of these systems is
expected to be deployed during 2001 in Japan, with deployment in Korea and
Europe expected thereafter. Toward that end, the Company opened a sales office
in Japan during 2000. The Company also sold its existing products in Chile,
Spain, and Canada during 2000 and looks to continue to market its products
internationally during 2001 and beyond.

Manufacturing

The Companys manufacturing processes provide predictable product yields
and can be easily expanded to meet increased customer demand. However, it is
possible that substantial growth in demand could overwhelm existing capacity to
supply products. To deal with this possibility, the Company is in the process of
qualifying third party manufacturers of the RF filter products. The Company also
has an agreement in place with a contract manufacturer that outsources
production of its Adaptive Notch Filters (ANF units) at a facility in Toronto,
Canada.

The Companys manufacturing operations can be found in Mount Prospect, IL,
Louisville, CO and Toronto, Canada.

Research and Development

The Companys R&D efforts have been focused on developing and improving RF
filter products for wireless telecommunications systems. As a result of such
efforts, filter performance has been improved, product size has been reduced,
production costs have been lowered, product reliability has been increased, and
product packaging has been streamlined. The Company expects to continue to
invest in R&D to further improve and adapt its filter products to meet and
exceed market expectations. The Company also intends to develop related products
that are synergistic with its core filter offerings and which utilize the
Companys core technical competencies in RF filter design, superconducting
materials, and cryogenic cooling systems.

The Companys total R&D expenses during 1998, 1999 and 2000 were

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approximately $2,935,000, $1,757,000 and $3,188,000, respectively.

Intellectual Property and Patents

The Company regards certain elements of its product design, fabrication
technology and manufacturing process as proprietary and protects its rights in
them through a combination of patents, trade secrets and non-disclosure
agreements. The Company also has obtained exclusive and non-exclusive licenses
for technology developed with or by its research partners, Argonne National
Laboratory (Argonne) and Northwestern University, and expects to continue to
obtain licenses from such research partners and others. The Company believes
that its success will depend in part upon the protection of its proprietary
information, its patents and licenses of key technologies from third parties,
and its ability to operate without infringing on the proprietary rights of
others.

As of December 31, 2000, we had been issued 35 U.S. and 4 foreign patents,
had filed and were actively pursuing applications for 13 other U.S. and 23 other
patents, and were the licensee of 7 U.S. patents and patent applications held by
others. We acquired additional patents, through assignment of a license from the
Canadian government, in connection with our purchase of the Adaptive Notch
Filtering business unit of Lockheed Martin Canada. One of our patents is jointly
owned with Lucent Technologies, Inc. We believe that, since the discovery of HTS
materials in 1986, a large number of patent applications have been filed
worldwide, and many patents have been granted in the U.S. relating to HTS
materials. The claims in those patents often appear to overlap and there are
interference proceedings pending in the United States Patent and Trademark
Office (not currently involving our company) regarding rights to inventions
claimed in some of the HTS materials patent applications. Furthermore, the
Company expects to pursue foreign patent rights on certain of its inventions and
technologies critical to its products.

In 1994, the Company purchased from Ceramic Process Systems two additional
patents and the related technical know-how covering a process for producing
yttrium barium copper oxide (YBCO) powder and manufacturing YBCO electrical
fibers. In 1994, the Company also purchased technology relating to the
fabrication of HTS thick-film components from the University of Birmingham (UK).
This thick-film technology complements the Companys existing patented processes
for making thick-film superconducting components.

Through collaborative relationships with Argonne and Northwestern
University, the Company has licensed patents and patent applications issued or
filed in the United States and in certain foreign countries arising under or
related to such collaborative relationships. These licenses primarily relate to
the processing and composition of HTS materials, including the preferential
orientation of HTS materials and the processing of YBCO on a variety of metals,
as well as design technology for some of the Companys current and proposed
products. The Companys licenses from ARCH Development Corporation and
Northwestern University continues for the lives of the patent rights licensed
thereby, subject to termination on certain events, and permit the Company to
retain rights to its patentable improvements to the licensed technology. Certain
of the Companys research has been funded in part by Small Business Innovation
Research and other government contracts. Although the U.S. Government has or
will have certain rights in the technology developed with this funding, the
Company does not believe that these rights will have a material impact on the
Companys current RF filter products.

Non-HTS Competition

The market for wireless telecommunications products is very competitive.
The Company views its competition as (i) conventional RF filter products, (ii)
RF products based on new technologies and (iii) other superconductor-based RF
products.

The Companys RF filter products compete against conventional RF filter
products produced by such companies as Celwave, certain divisions of the Allen
Telecom Group, Inc., Filtronic Comtek, Sinclair Radio Labs, Inc., K&L Microwave,
Inc., Wacom Technology Corp., EMR Corp. and TX-RX Systems, Inc., among others.
Although these conventional RF filter products are generally less expensive than
the Companys products, the Company believes its RF filter products are superior
on a cost/benefit basis.

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Other competitive RF products based on other technologies may provide
competition in the future to the Companys RF filter products. In addition to
competitive RF filter products, other companies including, Hazeltine Corp.,
Metawave Communications Corporation, Allen Telecom Group, Inc., Repeater
Technologies, Inc. and Array Com, Inc., among others, are developing products
based on smart antenna, digital signal processing technologies, microcells and
repeaters which are also aimed at reducing interference problems or providing
range extension by means other than RF filtering. Furthermore, various vendors
are offering tower mounted amplifiers (TMAs) which provide similar range
extension benefits to the Companys filters with cooled LNAs. TMAs are generally
less expensive than the Companys products but require greater maintenance costs
due to their location on top of the operators antenna tower.

Various filter companies appear to be experimenting with cooled dielectric
filters or with filters that combine dielectric materials and superconducting
technology. K&L Microwave, Inc. has been experimenting with a cooled dielectric
filter design. In addition, COM DEV International, Ltd., a Canadian corporation,
has published research in which a dielectric material is mounted on a
superconducting ground plane. The Company does not believe that either of these
efforts currently pose a competitive threat but cannot exclude them as
competition to the Companys product lines at some point in the future.

The Company believes that it competes on the basis of product performance,
price, breadth of product portfolio, customer support, quality, reliability and
focus on the wireless telecommunications market. Many of the Companys
competitors have substantially greater financial resources, larger R&D staffs
and greater manufacturing and marketing capabilities than the Company.

Government Regulations

Although the Company believes that its wireless telecommunications products
themselves are not licensed or governed by approval requirements of the Federal
Communications Commission (FCC), the operation of base stations is subject to
FCC licensing and the radio equipment into which the Companys products would be
incorporated is subject to FCC approval. Base stations and the equipment
marketed for use therein must meet specified technical standards. The Companys
ability to sell its RF filter products is dependent on the ability of wireless
base station equipment manufacturers and of wireless base station operators to
obtain and retain the necessary FCC approvals and licenses. In order to be
acceptable to base station equipment manufacturers and to base station
operators, the characteristics, quality, and reliability of the Companys base
station products must enable them to meet FCC technical standards.

The Company uses certain hazardous materials in its research, development
and manufacturing operations. As a result, the Company is subject to stringent
federal, state and local regulations governing the storage, use and disposal of
such materials. It is possible that current or future laws and regulations could
require the Company to make substantial expenditures for preventive or remedial
action, reduction of chemical exposure, or waste treatment or disposal. The
Company believes it is in material compliance with all environmental regulations
and to date the Company has not had to incur significant expenditures for
preventive or remedial action with respect to the use of hazardous materials.

Employees

As of January 31, 2001, the Company had a total of 71 employees, 19 of whom
hold advanced degrees. Of the employees, 18 are engaged in manufacturing and
production, 34 are engaged in research, development and engineering, and 19 are
engaged in general management, marketing, sales, finance and administration. The
Company also periodically employs a number of consultants and independent
contractors. None of the Companys employees are covered by a collective
bargaining agreement. The Company believes its relationship with its employees
is good.




Item 2. Properties.

The Company maintains its corporate headquarters in a 35,000 square foot
building located in Mt. Prospect, Illinois under a lease which expires in
October 2004. Additionally, it maintains a 29,000 square foot building located
in Louisville, Colorado under a lease which expires in May 2003 and a 6,500
square foot facility located in North York, Ontario under a sublease that
expires in August, 2004. These facilities house the Companys manufacturing,
research, development, engineering

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and marketing activities. The Company believes that these facilities are
adequate and suitable for its current needs and that additional space would be
available on commercial terms as necessary to meet any future needs.




Item 3. Legal Proceedings.

Siegler Litigation

On June 5, 1996, Craig M. Siegler filed a complaint against the Company
in the Circuit Court of Cook County, Illinois, County Department, Chancery
Division. The complaint alleged that, in connection with the Companys private
placement of securities in November 1995, the Company breached and repudiated an
oral contract with Mr. Siegler for the issuance and sale by the Company to Mr.
Siegler of 370,370.37 shares of the Common Stock, plus warrants (immediately
exercisable at $12.96 per share) to purchase an additional 370,370.37 shares of
the Common Stock, for a total price of $4,000,000. The remedy sought by Mr.
Siegler was a sale to him of such securities on the terms of the November 1995
private placement. On August 16, 1996, the Companys motion to dismiss Mr.
Sieglers complaint was granted with leave to amend. On September 19, 1996, Mr.
Sieglers motion for reconsideration was denied.

On October 10, 1996, Mr. Siegler filed his First Amended Verified
Complaint and Jury Demand, seeking a jury trial and money damages equal to the
difference between $8,800,000 (370,370.37 shares at $10.80 per share and
370,370.37 shares at $12.96 per share) and 740,740.74 multiplied by the highest
price at which the Common Stock traded on The Nasdaq Stock Market between
November 20, 1995 and the date of judgment. Mr. Siegler also preserved his claim
for specific performance for purposes of appeal. On November 1, 1996, the case
was transferred to the Circuit Court of Cook County, Illinois, County
Department, Law Division. The Companys Answer was filed on November 21, 1996.

The Company filed a motion for summary judgment against Mr. Siegler,
which was on hold pending the deposition of an expert retained by Mr. Siegler in
the case. The Company deposed this witness in March 2000. A hearing on the
Companys summary judgment motion was held in June 2000, and the motion was
subsequently denied. The trial date has been set for August 7, 2001.

The Company believes that the suit is without merit and intends to
continue to defend itself vigorously in this litigation. The Company is also
disputing Mr. Sieglers method of calculating damages. However, if Mr. Siegler
prevails in this litigation and is awarded damages in accordance with the
formula described above, such judgment would have a material adverse effect on
the Companys operating results and financial condition.

Note Litigation

On February 22, 2000, the Company reached a settlement agreement with
the Borrowers (defined below), whereby the Company agreed to release the
Borrowers obligations under the notes in return for the Borrowers surrender of
210,196 warrants to purchase common stock of the Company held by them and
discharge of their counterclaims. As a result of this settlement, the Company
recorded a charge of $822,776 to additional paid-in capital in the first quarter
of 2000, reflecting the carrying amount of the notes of $680,696 and related
accrued interest of $142,080, which approximated the fair value of the warrants
surrendered. The following is a historical summary of events that led to the
settlement agreement just described:

On July 10, 1997, the Company filed a complaint against Sheldon Drobny;
Howard L. Buzz Simons, joint tenant with Aric and Corey Simons; Aaron Fischer;
Stewart Shiman; Sharon D. Gonsky, d/b/a SDG Associates; Gregg Rosenberg; Stacey
Rosenberg; Merrill Weber & Co., Inc.; Drobny/Fischer Partnership, an Illinois
general partnership; and Ruben Rosenberg (collectively, the Borrowers), and
Paradigm Venture Investors, L.L.C. (the Guarantor) in the Circuit Court of
Cook County, Illinois, County Department, Law Division. The complaint seeks to
enforce the terms of loans made to the Borrowers by the Company and evidenced by
promissory notes dated December 13, 1996, in the aggregate principal amount of
$698,508 ($680,696 of which remains unpaid as of December 31, 1999) and the
guarantee by the Guarantor of the Borrowers obligations under these promissory
notes. The Borrowers notes were issued to the Company in connection with the
Borrowers exercise of warrants to purchase shares of the Common Stock in
December 1996.

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On September 30, 1997, the Borrowers and the Guarantor responded to the
Companys complaint. Concurrently, the Borrowers filed a counterclaim alleging
that they exercised the warrants in reliance on the Companys alleged fraudulent
representations to certain Borrowers concerning a third-partys future
underwriting of a secondary public offering of the Companys Common Stock.

Lipman Litigation

The Illinois Appellate Court denied plaintiffs subsequent motion for a
re-hearing on October 23, 2000 and plaintiffs did not seek review before the
Illinois Supreme Court. Accordingly, this litigation has been concluded without
any loss to the Company or its directors. The following is a historical summary
of events that led to the dismissal of this litigation against the Company:

In January 1998, Jerome H. Lipman, individually and on behalf of all others
similarly situated, filed a complaint against the Company and eight of its
former or current directors: Leonard A. Batterson, Michael J. Friduss, Peter S.
Fuss, Edward W. Laves, Steven L. Lazarus, Tom L. Powers, Ora E. Smith and Paul
G. Yovovich (collectively, the Named Directors) in the Circuit Court of Cook
County, Illinois, County Department, Chancery Division. The complaint alleged
that the Named Directors breached their duties of loyalty and due care to the
putative class of stockholders by selecting financing for the Company in June
1997 which supposedly entrenched the Directors and reduced the Common Stock
price. The complaint also alleged that the Named Directors breached their duty
of disclosure by not informing the stockholders that the selected financing
would erode the Common Stock price. Mr. Lipmans complaint sought certification
of a class consisting of all owners of the Common Stock during the period from
June 6, 1997 through November 21, 1997, excluding the Named Directors and
Sheldon Drobny. The complaint also sought an unspecified amount of compensatory
and punitive damages, and attorneys fees.

In February 1998, the Company and the Named Directors filed a motion to
dismiss Mr. Lipmans complaint, arguing in part that the plaintiffs claims were
barred by their failure to fulfill the legal prerequisites for suing the Named
Directors. In June 1998, the court granted the Companys and the Named
Directors motion to dismiss the complaint. Thereafter Mr. Lipman filed an
amended complaint against the Named Directors but excluding the Company itself
as a defendant. The amended complaint alleged that the Named Directors breached
their duties of loyalty and due care to the putative class of stockholders by
selecting financing for the Company in June 1997 and thereafter drawing two
tranches of the financing. The amended complaint sought certification of a class
consisting of all owners of the Common Stock during the period from May 15, 1997
through December 31, 1997, excluding the Named Directors. Mr. Lipmans amended
complaint alleged that the stock owned by the putative class lost $61 million
due to the financing the Named Directors selected, and sought an unspecified
amount of compensatory and punitive damages. The Named Directors filed a motion
to dismiss Mr. Lipmans amended complaint which the court granted in December
1998, finding that Mr. Lipman still had failed to fulfill the prerequisites for
maintaining a shareholder derivative action against the Named Directors. In
January 1999, Mr. Lipman and two added former stockholders filed a second
amended complaint against the Named Directors and again including the Company
itself as a defendant. The second amended complaint alleged that the Named
Directors breached their duties of loyalty and due care to the putative class
and further alleged that the purported devaluation of the plaintiffs stock
resulting from the June 1997 financing was an improper assessment on the
plaintiffs shares for which they sought an unspecified amount of compensatory
and punitive damages. The Company and the Named Directors filed a motion to
dismiss the second amended complaint which the Court granted in April 1999,
finding that (i) the plaintiffs could not assert their stock devaluation claims,
except derivatively, and (ii) the plaintiffs still had failed to fulfill the
prerequisites for maintaining a shareholder derivative action against the Named
Directors. In May 1999, the plaintiffs filed a third amended complaint against
the Company and the Named Directors. The third amended complaint reiterated the
plaintiffs previous allegations that the Named Directors breached their duties
of loyalty, due care and candor to the putative class, and again alleged the
plaintiffs claims of an improper assessment. The third amended complaint also
asserted two claims of purported common law fraud and a supposed violation of
the Illinois Consumer Fraud Act based on allegations that the Company and the
Named Directors had selectively disclosed material, non-public confidential
information to the non-party financier in order to obtain the financing that
the Company selected in June 1997, which allegedly reduced the Common Stock
price. The plaintiffs sought an unspecified amount of

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compensatory and punitive damages, and attorneys fees. In June 1999, the
Company and the Named Directors filed a motion to dismiss the third amended
complaint, arguing in part that the plaintiffs still had failed to fulfill the
prerequisites for asserting their stock devaluation claims as a shareholder
derivative action, and that the plaintiffs claims of selective disclosure and
fraud was barred on substantive and procedural grounds. In August 1999, the
Court granted the Companys and the Named Directors motion, and dismissed the
suit with prejudice.

Thereafter the plaintiffs filed a motion for reconsideration of the
dismissal which the Court denied in September 1999. In October 1999, the
plaintiffs filed their notice of appeal from the dismissal orders. All briefing
on the appeal was completed in May 2000. The Illinois Appellate Court denied
plaintiffs subsequent motion for rehearing on October 23, 2000 and plaintiffs
did not seek review before the Illinois Supreme Court.

Laves Litigation

On July 17, 2000 Edward
W. Laves filed an action (the Complaint) in the
Law Division of the Circuit Court of Cook County, Illinois, against the Company
and three of its directors (George Calhoun, Samuel Perlman, and Mark Brodsky)
charging the Company with constructive termination under and in breach of
plaintiffs employment agreement, and with violation of the Illinois Wage
Payment and Collection Act. Plaintiff seeks damages estimated to exceed $9.5
million. The Company filed an appearance on behalf of all Defendants on October
3, 2000. On October 6, 2000, the Company filed on Defendants behalf a Motion to
Dismiss the Complaint. On January 22, 2001, the court issued an order granting
our Motion to Dismiss the claims against the Individual Defendants, but denied
our Motion to Dismiss with respect to claims against the Company. On February
21, 2001, Plaintiff filed a Motion to reconsider the courts dismissal of claims
against the Individual Defendants. On March 13, 2001, we filed an Answer to the
Complaint and a Memorandum in Opposition to this Motion to Reconsider. By order
dated March 15, 2001, the court allowed Laves leave to file an amended Motion to
Reconsider. A hearing is scheduled for May 16, 2001, to consider the amended
Motion to Reconsider. Laves has submitted discovery requests in support of the
Complaint. The Company believes the claims to be without merit and plans to
vigorously defend itself in this action.

16(b) Litigation

On February 22, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $15 million, less legal fees and
certain other expenses. Two of the Companys stockholders, Elliott Associates,
L.P. and Elliott International, L.P. (formerly Westgate International, L.P.),
have agreed to make this settlement payment in order to resolve claims asserted
against them and certain present and former directors. The shareholder
litigation remains outstanding against other third parties. A notice regarding
the settlement has been mailed to all shareholders. The court hearing to
consider the settlement is scheduled for March 30, 2001.

On March 16, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $5 million, less legal fees and
certain other expenses. Alexander Finance has agreed to make this settlement
payment in order to resolve claims asserted against them. A notice regarding the
settlement has been mailed to all shareholders. The court hearing to consider
the settlement is scheduled for April 27, 2001.

The following is an historical summary of events that led to the settlements
announced above:

On February 26, 1999, Mark Levy, derivatively on behalf of the Company,
filed a complaint against Southbrook International Investments, Ltd.
(Southbrook), Elliott Associates, L.P. (Elliott), and Elliott International,
L.P. (Elliott International), and against the Company as a nominal
defendant. The complaint filed in the United States District Court for the
Southern District of New York, alleges that Southbrook, Elliott and Elliott
International, while having beneficial ownership of more than 10% of the
Companys common stock, traded the Companys common stock such that the Company
is entitled to recover short swing profits under Section 16(b) of the Securities
Exchange Act of 1934 in connection with purchases and sales of Company
securities within six month

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periods. The complaint seeks to recover from Southbrook, Elliott and Elliott
International their respective profits (in unspecified amounts) from those
transactions. No relief is sought against the Company as a nominal defendant.

Elliott and Elliott International are currently investors in the Company
with substantial rights to acquire Company common stock by conversion of notes
and exercise of warrants, and three of the current six directors of the Company
were appointed in accordance with an agreement dated November 5, 1999 by and
between
Elliott, Elliott International, an unaffiliated investor, and the Company. Two
of such directors, Messrs. Mark Brodsky and Norbert Lou, are employed by a
company that provides management services to, and is under common control with,
Elliott and Elliott International.

An amended complaint dated September 2, 1999 was served on the Company. The
amended complaint raises the same claims alleged in the original complaint. As a
nominal defendant the Company, by agreement with the plaintiff, has not
responded to the lawsuit, but has reserved its right to move to dismiss any
amended pleading.

Defendants moved to dismiss the amended complaint in February 2000. In
response, the plaintiff cross-moved for leave to amend its complaint again. The
proposed new pleading added Alexander Finance, LP as a defendant for the Section
16(b) claims, proposed to add two new theories pursuant to which defendants may
be found liable under Section 16(b), and also proposed to add state law breach
of fiduciary duty claims against current directors, at the time of filing,
Howard Hoffman, Tom L. Powers, Mark D. Brodsky, George Calhoun and Samuel
Perlman and former directors Edward W. Laves, Robert D. Mitchum and Terry S.
Parker, based on the board of directors decision to issue convertible notes and
warrants to the defendants convertible or exercisable for shares of common stock
at $0.25 per share.

Following a hearing on August 17, 2000, the court allowed plaintiff leave
to file his new amended complaint. The court also denied without prejudice
defendants motion to dismiss the initial 16(b) complaint (as amended). However,
defendants may raise this motion again following resolution of a similar case by
the Second Circuit Court of Appeals.

On February 22, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $15 million, less legal fees and
notice expenses. Two of the Companys stockholders, Elliott Associates, L.P. and
Elliott International, L.P. (formerly Westgate International, L.P.), have agreed
to make this settlement payment in order to resolve claims asserted against them
and certain present and former directors. The shareholder litigation remains
outstanding against other third parties. A notice regarding the settlement has
been mailed to all shareholders. The court hearing to consider the settlement is
scheduled for March 30, 2001.

On March 16, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $5 million, less legal fees and
notice expenses. Alexander Finance has agreed to make this settlement payment in
order to resolve claims asserted against them. A notice regarding the settlement
has been mailed to all shareholders. The court hearing to consider the
settlement is scheduled for April 27, 2001.




Item 4. Submission of Matters to a Vote of
Security Holders.

No matters were submitted to a vote of security holders during the quarter
ended December 31, 2000.




PART II




Item 5. Market for Registrants Common Equity
and Related Stockholder Matters.

The Common Stock has been quoted since April 1999 on the OTC
Bulletin Board under the symbol ISCO. From 1993 until April 1999, the Common
Stock was quoted on the NASDAQ National Market. The following table shows, for
the periods indicated, the reported high and low sale prices for the Common
Stock. Such prices reflect prices between dealers, without retail mark up, mark
down, or commissions and may or may not reflect actual transactions.

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|                                     |                |  |      |       |     |  |   |      | 
|------------------------------------ | -------------- |  | ---- | ----- | --- |  | - | ---- | 
|                                     |                |  | HIGH |       | LOW
|                                     |                |  |      |       |    
|FISCAL YEAR ENDING DECEMBER 31, 1999
|                                    
|                                    
|                                    
|                                    
|                                     | First Quarter  |  | $    | 1.69  |     |  | $ | 0.94 | 
|                                    
|                                    
|                                    
|                                    
|                                     | Second Quarter |  | $    | 1.50  |     |  | $ | 0.47 | 
|                                    
|                                    
|                                    
|                                    
|                                     | Third Quarter  |  | $    | 1.13  |     |  | $ | 0.50 | 
|                                    
|                                    
|                                    
|                                    
|                                     | Fourth Quarter |  | $    | 2.06  |     |  | $ | 0.33 | 
|                                    
|                                    
|                                    
|                                    
|FISCAL YEAR ENDING DECEMBER 31, 2000
|                                    
|                                    
|                                    
|                                    
|                                     | First Quarter  |  | $    | 29.38 |     |  | $ | 1.22 | 
|                                    
|                                    
|                                    
|                                    
|                                     | Second Quarter |  | $    | 7.75  |     |  | $ | 2.81 | 
|                                    
|                                    
|                                    
|                                    
|                                     | Third Quarter  |  | $    | 4.94  |     |  | $ | 2.78 | 
|                                    
|                                    
|                                    
|                                    
|                                     | Fourth Quarter |  | $    | 3.81  |     |  | $ | 0.81 | 

On January 31, 2001, there were approximately 300 holders of record of the
Common Stock. On such date the closing bid price for the Common Stock
as reported on the OTC Bulletin Board was $2.19.

The Company has never paid cash dividends on the Common Stock and the
Company does not expect to pay any dividends on its Common Stock in the
foreseeable future.

Recent Sales of Unregistered Securities

On October 20, 2000, Elliott Associates, L.P. and Westgate International,
L.P. purchased, for an aggregate purchase price of $5 million, an aggregate of 1,818,182
shares of Common Stock. The price paid was 10% above the closing
price of the Common Stock on that date. It is the Companys intention
to register these shares under the investment agreement with those
purchasers.

The Company relied upon the private placement exemption under Section 4(2)
of the Securities Act of 1933, as amended, including Rule 506 of Regulation D
for the transaction. The shares were sold to accredited investors as that term
is defined in Regulation D, for investment purposes, without solicitation or
advertising by the Company. No underwriters were involved and no commissions
were paid.

On December 20, 2000, the Company issued 2.5 million shares of Common
Stock to Lockheed Martin Canada, Inc. in connection with the Companys
acquisition of the Adaptive Notch Filtering (ANF) Business Unit pursuant to an
asset purchase agreement. No underwriters were involved and no commissions were
paid. The securities were issued pursuant to the private placement exemption
under Section 4(2) of the Securities Act of 1933, as amended.

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##### Table of Contents






Item 6. Selected Financial Data.

The following table presents selected consolidated financial data with
respect to the Company as of and for the years ended December 31, 1996, 1997,
1998, 1999 and 2000. The selected consolidated financial data for each of the
years in the five-year period ended December 31, 2000 have been derived from the
audited consolidated financial statements of the Company. The information set
forth below should be read in conjunction with Item 7. Managements Discussion
and Analysis of Financial Condition and Results of Operations and Item 8
Financial Statements and Supplementary Data.

|                                                                  |                         |                             |             |         |             |      |             |           |             |      |             |           |             |   |             |           |             |   |             |         |             |  
|----------------------------------------------------------------- | ----------------------- | --------------------------- | ----------- | ------- | ----------- | ---- | ----------- | --------- | ----------- | ---- | ----------- | --------- | ----------- | - | ----------- | --------- | ----------- | - | ----------- | ------- | ----------- | -
|                                                                  |                         |                             |             | 1996    |             | 1997 |             | 1998      |             | 1999 |             | 2000     
|                                                                  |                         |                             |             |         |             |      |             |           |             |      |             |          
|CONSOLIDATED STATEMENT OF OPERATIONS DATA:                       
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  | Net sales               |                             | $           | 209,822 |             |      | $           | 1,038,134 |             |      | $           | 3,242,930 |             |   | $           | 2,408,604 |             |   | $           | 495,885 |            
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  | Costs and expenses:    
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  |                         | Cost of revenues            |             |         | 49,534      |      |             |           | 4,401,077   |      |             |           | 7,047,347   |   |             |           | 5,923,173   |   |             |         | 2,672,578   |  
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  |                         | Research and development    |             |         | 6,422,921   |      |             |           | 4,132,019   |      |             |           | 2,934,784   |   |             |           | 1,757,214   |   |             |         | 3,187,768   |  
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  |                         | Selling and marketing       |             |         | 1,834,640   |      |             |           | 1,918,044   |      |             |           | 1,847,680   |   |             |           | 1,581,545   |   |             |         | 1,239,959   |  
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  |                         | General and administrative  |             |         | 3,290,810   |      |             |           | 2,772,274   |      |             |           | 3,370,058   |   |             |           | 2,617,809   |   |             |         | 6,671,796   |  
|                                                                  |                         |                             |             |         |             |      |             |           |             |      |             |           |             |   |             |           |             |   |             |        
|                                                                  |                         | Operating loss              |             |         | (11,388,083 | )    |             |           | (12,185,280 | )    |             |           | (11,956,939 | ) |             |           | (9,471,137  | ) |             |         | (13,276,216 | )
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  | Other income (expense):
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  |                         | Interest income             |             |         | 503,911     |      |             |           | 254,781     |      |             |           | 354,738     |   |             |           | 98,194      |   |             |         | 174,919     |  
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  |                         | Interest expense            |             |         | (29,602     | )    |             |           | (17,969     | )    |             |           | (10,247,919 | ) |             |           | (12,634,745 |   |             |         | (5,650,572  | )
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                  |                         | Other income (expense), net |             |         |            |      |             |           |            |      |             |           |            |   |             |           | 36,623      |   |             |         | (16,017     | )
|                                                                  |                         |                             |             |         |             |      |             |           |             |      |             |           |             |   |             |           |             |   |             |        
|                                                                  |                         |                             | 474,309     |         |             |      | 236,812     |           |             |      | (9,893,181  | )         |             |   | (12,499,928 | )         |             |   | (5,491,670  | )      
|                                                                  |                         |                             |             |         |             |      |             |           |             |      |             |           |             |   |             |           |             |   |             |        
|Loss before extraordinary item                                    |                         |                             | (10,913,774 | )       |             |      | (11,948,468 | )         |             |      | (21,850,120 | )         |             |   | (21,971,065 | )         |             |   | (18,767,886 | )      
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|Extraordinary
item-debt extinguishment                            |                         |                             |            |         |             |      |            |           |             |      |            |           |             |   | (745,197    | )         |             |   | (28,297     | )      
|                                                                  |                         |                             |             |         |             |      |             |           |             |      |             |           |             |   |             |           |             |   |             |        
|Net loss                                                          |                         |                             | (10,913,774 | )       |             |      | (11,948,468 | )         |             |      | (21,850,120 | )         |             |   | (22,716,262 | )         |             |   | (18,796,183 | )      
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|Preferred Stock dividends                                         |                         |                             |            |         |             |      |            |           |             |      | (143,302    | )         |             |   | (61,834     | )         |             |   |            |        
|                                                                  |                         |                             |             |         |             |      |             |           |             |      |             |           |             |   |             |           |             |   |             |        
|Net
loss plus Preferred Stock dividends                           |                         | $                           | (10,913,774 | )       |             | $    | (12,091,770 | )         |             | $    | (21,911,954 | )         |             | $ | (22,716,262 | )         |             |   | (18,796,183 | )      
|                                                                  |                         |                             |             |         |             |      |             |           |             |      |             |           |             |   |             |           |             |   |             |        
|Basic and diluted loss per common share
before extraordinary item |                         | $                           | (2.41       | )       |             | $    | (2.34       | )         |             | $    | (1.93       | )         |             | $ | (1.71       | )         |             | $ | (0.57       | )      
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|Extraordinary
item-debt extinguishment                            |                         |                             |            |         |             |      |            |           |             |      |            |           |             |   | (0.06       | )         |             |   |            |        
|                                                                  |                         |                             |             |         |             |      |             |           |             |      |             |           |             |   |             |           |             |   |             |        
|Basic
and diluted loss per common share                           |                         | $                           | (2.41       | )       |             | $    | (2.34       | )         |             | $    | (1.93       | )         |             | $ | (1.77       | )         |             | $ | (0.57       | )      
|                                                                  |                         |                             |             |         |             |      |             |           |             |      |             |           |             |   |             |           |             |   |             |        
|Weighted average number of
common shares outstanding              |                         |                             | 4,536,034   |         |             |      | 5,156,663   |           |             |      | 11,345,540  |           |             |   | 12,841,497  |           |             |   | 33,037,106  |        
|                                                                  |                         |                             |             |         |             |      |             |           |             |      |             |           |             |   |             |           |             |   |             |        

|                                                               |  |      |            |      |  |      |            |      |  |      |            |   |  |   |            |   |  |  |            | 
|-------------------------------------------------------------- |  | ---- | ---------- | ---- |  | ---- | ---------- | ---- |  | ---- | ---------- | - |  | - | ---------- | - |  |  | ---------- | 
|                                                               |  | 1996 |            | 1997 |  | 1998 |            | 1999 |  | 2000
|                                                               |  |      |            |      |  |      |            |      |  |     
|CONSOLIDATED BALANCE SHEET DATA:                              
|                                                              
|                                                              
|                                                              
|                                                              
|Cash and cash equivalents                                      |  | $    | 5,188,047  |      |  | $    | 2,766,886  |      |  | $    | 2,152,595  |   |  | $ | 723,711    |   |  |  | 2,453,845  | 
|                                                              
|                                                              
|                                                              
|                                                              
|Working capital                                                |  |      | 5,207,923  |      |  |      | 4,668,982  |      |  |      | 4,190,548  |   |  |   | 831,724    |   |  |  | 3,096,173  | 
|                                                              
|                                                              
|                                                              
|                                                              
|Total assets                                                   |  |      | 13,388,496 |      |  |      | 11,534,309 |      |  |      | 10,028,088 |   |  |   | 6,039,159  |   |  |  | 23,750,073 | 
|                                                              
|                                                              
|                                                              
|                                                              
|Long-term debt/capital lease
obligations, less current portion |  |      | 91,618     |      |  |      | 13,541     |      |  |      | 9,432,026  |   |  |   | 13,650,885 |   |  |  | 198        | 
|                                                              
|                                                              
|                                                              
|                                                              
|Stockholders equity (net
capital deficiency)                  |  |      | 11,520,128 |      |  |      | 10,046,569 |      |  |      | (772,968   | ) |  |   | (9,291,712 | ) |  |  | 21,644,211 | 




Item 7. Managements  Discussion
and Analysis of Financial Condition and Results of Operations.

Recent Events

Change in Certifying Accountants

On December 7, 2000, the Company advised Ernst & Young LLP that it intended
to retain a different firm of independent auditors for the audit of the
Companys financial statements for the fiscal year ending December 31, 2000. The
Company has engaged Grant Thornton LLP as its new independent public accountants
to audit the Companys

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##### Table of Contents



consolidated financial statements. This engagement was effective as of December
7, 2000. As noted in the current report on Form 8-K filed with
the SEC on December 18, 2001, related to this
event, there have been no disagreements with Ernst & Young on any matter of
accounting principles or practices, financial statement disclosure or auditing
scope or procedure during the Companys two most recent fiscal years or in the
subsequent interim period through December 7, 2000 (date of termination), which
disagreement(s), if not resolved to Ernst & Youngs satisfaction, would have
caused Ernst & Young to make reference to the subject matter of disagreement(s)
in connection with its report. There were no reportable events as that term is
described in Item 304(a)(1)(v) of Regulation S-K.

Conversion of Senior Convertible Notes

On December 29, 2000, holders of the Companys senior convertible notes
converted $14,354,778 principal amount of such notes plus accrued interest into
63,283,309 shares of Common Stock.

Joint Development with KMW

On January 3, 2001, the Company announced an agreement with KMW, Inc., of
Korea to jointly develop an advanced-design cryogenic receiver front-end (CRFE)
system to meet the requirements of third-generation (3G) Wideband-CDMA wireless
systems to be deployed, beginning this year, in Japan and Korea.

Filing of Rights Offering Statement

On January 8, 2001, the Company filed with the SEC on Form S-3 a
registration statement for a proposed common stock rights offering for up to $20
million. The purpose of the rights offering filing was to put the Company in the
position to access funds on a pro rata, non-dilutive basis from existing
shareholders as of a certain holding date. As of the date of this
Form 10-K/A filing,
the Company has not yet determined whether it will proceed with the rights
offering, in light of the settlements described elsewhere in this
annual report.

Filing of a Universal Shelf Offering Statement

On January 12, 2001, the Company filed with the SEC on Form S-3 a
registration statement for the purpose of offering up to $50 million of common
stock, warrants, or preferred stock of the Company. The filing, known as a
Universal Shelf was put in place by the Company to allow the Company to access
funds in the open market on an opportunistic or on an as needed basis. To date,
the Company has not sold any securities registered under the Universal Shelf.

$15 Million Settlement Expected to be Received

On February 22, 2001, the
Company announced that a settlement of shareholder
litigation had been reached with Elliott Associates, L.P. and Elliott International, L.P.
On March 30, 2001, the settlement was approved by the court which resulted in the Company receiving $15 million, less
legal fees and certain other expenses. The court granted $3 million in interim legal fees and pending further review by the court,
set aside an additional $1.5 million in escrow for legal fees.

Short-Term Bridge Loan with Elliott Associates, L.P.

On February 23, 2001, the Company secured a short-term bridge loan from
Elliott Associates, L.P. for up to $3.5 million to fund the Companys working capital needs. The purpose of the short-term
bridge loan was to fund the Companys working capital needs. The Company accessed the first $2 million of the loan at closing and accessed the balance
of $1.5 million on April 2, 2001. Both loans, plus accrued interest thereon, were repaid in full
on April 6, 2001, the date the first of the two settlement funds (as described above) was received.

$5 Million Settlement Expected to be Received

On March 16, 2001, the
Company announced that a settlement of shareholder litigation had been
reached with Alexander, which, subject to court approval, will result in the Company receiving $5 million, less legal fees and certain other expenses. A notice regarding the settlement has been mailed to all
of the Companys stockholders. The court hearing to consider the
settlement is scheduled for April 27, 2001.

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##### Table of Contents



Repricing of Employee Stock Options

On February 5, 2001, the Companys Board of Directors elected to reprice
certain options granted to employees and directors during 2000. In total,
2,676,000 options with prices ranging from $2.9688 to $6.6094 were repriced to
$1.9375, the closing price of the Common Stock on the repricing date.
The Board elected to reprice the options to maintain employee morale and to more
clearly align the management and employee goals with those of the shareholders.
The resulting variable accounting may lead to substantial non-cash expense
charges in the future. No other terms of the options were affected.

$20 Million Equity Commitment Line

During March, 2001, the Company entered into an agreement with Paul Revere
Capital Partners, Ltd., whereby Paul Revere Capital commits to acquire up to $20
million of the Companys common stock over the next 24 months upon demand by the
Company, subject to the conditions contained in the agreement. Pursuant to this
facility, the Company may, at its discretion, sell shares of Common Stock to
Paul Revere Capital Partners at a discount to the market price of 94% of the
average weighted volume price over a 22 day period. Each draw down is limited to
the lesser of $4 million or 20% of the trading volume over a specified period of
time. The Company will also issue a warrant to Paul Revere Capital Partners to
purchase a number of shares equal to 0.5% of the shares issued in each draw
down. The Company has also agreed to pay its placement agent a fee equal to 4%
of each draw down and issue a warrant to the placement agent to purchase a
number of shares equal to 0.5% of the shares issued in each draw down.

Name Change

The Company applied for the right to do business as ISCO International and
intends to present a formal name change resolution to the shareholders at the
next annual meeting.

Results of Operations

Years Ended December 31, 2000 and 1999

The Companys net sales decreased $1,913,000, or 79.4%, from $2,409,000 in
1999 to $496,000 in 2000, as a result of lower unit volume of the Companys
radio frequency (RF) front-end products. Net sales during 2000 consisted of
both sales resulting from the acquisition of SSI,during August, 2000, as well as
the sale of new products developed internally. This decline was a result of
lower unit volume in 2000 compared to 1999 related to the Companys strategic
plan to focus on new products and new markets. The Company anticipates its net
sales to increase substantially in 2001 based on existing and/or anticipated
customer orders, as well as a result of the two acquisitions that occurred
during the second half of 2000. All of the net sales in 2000 and 1999 were from
commercial product sales. The Company has concentrated its efforts on its
commercial product research and development.

Cost of products sold decreased to $2,673,000 from $5,923,000, a reduction
of $3,250,000 or 54.9%. The cost of products sold for 2000 and 1999 consisted of
direct material, labor and overhead costs associated with the products that were
shipped during the period, plus approximately $460,000 and $649,000,
respectively, of costs, which consisted primarily of allocated overhead costs,
incurred to produce units in ending finished goods inventory that exceed net
realizable value. Due to low utilization levels and excess capacity in the
Companys manufacturing facility, cost of products sold exceeded net sales for
2000 and 1999. The Company expects the cost of products sold as a percentage of
revenue to improve during 2001 due to anticipated revenue increases and related
efficiencies, as well as certain cost control initiatives.

The Companys internally funded research and development expenses increased
to $3,188,000 from $1,757,000, an increase of $1,431,000 or 81.4%. These costs
were higher due to increased prototype spending (substantially due to 3G related
activities) and the acquisitions of SSI and ANF. During 2001, the Company
expects its research and development expenditures to continue to increase due to
both factors listed above.

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Selling and marketing expenses decreased to $1,240,000 from $1,582,000, a
reduction of $342,000 or 21.6%. This decrease was due primarily to a temporary
reduction in personnel and, with the acquisitions and a related expansion in
sales force and marketing programs, is expected to increase substantially during
2001.

General and administrative expenses increased to $6,672,000 from
$2,618,000, an increase of $4,054,000 or 155%. In addition to the two
acquisitions, this increase was primarily due to goodwill amortization
attributable to the acquisitions of SSI and ANF, non-cash compensation charges,
and an increase in professional fees and travel costs. These costs are expected
to increase in 2001, but at a much lower growth rate than occurred during 2000.

Interest income increased $77,000, from $98,000 in 1999 to $175,000 in
2000. This increase was a result of various financing events that provided
higher average balances of cash and cash equivalents on hand during 2000
compared to 1999.

Interest expense decreased $6,984,000, from $12,635,000 in 1999 to
$5,651,000 in 2000. This decrease was primarily due to a decrease in non-cash
interest expense related to the Companys Senior Convertible Notes. As stated
previously, all of the Companys Senior Convertible Notes were converted to
equity during 2000, leaving the Company with no debt on its balance sheet. See
Note 8 to the Companys financial statements.

Extraordinary charges of $28,000 and $745,000 were recorded in 2000 and
1999, respectively, as a result of amendments to the terms of certain of the
Companys Senior Convertible Notes issued in May 1998 and March 1999. These
amendments increased the interest rate of certain of the notes issued in May
1998 from 2% to 6% and reduced the conversion prices of these notes and the
exercise prices of warrants issued in conjunction with these notes. In March
1999, the conversion price of certain of the notes issued in May 1998 was
reduced from $1.50 to $1.125 per share, and the exercise price of the related
warrants was reduced from $3.75 to $1.4625 per share. In November 1999, the
conversion price of certain of the notes issued in both May 1998 and March 1999
and the exercise price of the related warrants were reduced from $1.125 to $0.25
per share and from $1.4625 to $0.25 per share, respectively. In addition, the
exercise price of certain of the Companys G Warrants was reduced from $10.0625
to $0.25 per share. See Note 8 to the Companys financial statements.

Years Ended December 31, 1999 and 1998

The Companys net sales decreased $835,000, or 25.7%, from $3,243,000 in
1998 to $2,409,000 in 1999, as a result of lower unit volume and reduced selling
prices of the Companys radio frequency (RF) front-end products. Net sales in
the fourth quarter of 1999 were $453,000, as compared to $1,504,000 for the
fourth quarter of 1998. This decline was a result of lower unit volume in 1999
compared to 1998, when there was a large-scale deployment of the Companys
products by one of the largest cellular operators in the U.S. This large-scale
deployment did not reoccur in 1999.

Cost of products sold decreased to $5,923,000 from $7,047,000, a reduction
of $1,124,000 or 16.0%. The cost of products sold for 1999 and 1998 consisted of
direct material, labor and overhead costs associated with the products that were
shipped during the period, plus approximately $649,000 and $375,000,
respectively, of costs, which consisted primarily of allocated overhead costs,
incurred to produce units in ending finished goods inventory that exceed net
realizable value. Due to low utilization levels and excess capacity in the
Companys manufacturing facility, cost of products sold exceeded net sales for
1999 and 1998.

The Companys internally funded research and development expenses decreased
to $1,757,000 from $2,935,000, a reduction of $1,178,000 or 40.1%. These costs
were lower due to the successful development of the Companys core products,
increased efficiency in the Companys development processes, personnel
reductions, and the focusing of development efforts on products with a greater
probability of commercial sales.

Selling and marketing expenses decreased to $1,582,000 from $1,848,000, a
reduction of $266,000 or 14.4%. This decrease was due primarily to personnel
reductions and decreased trade show, travel and delivery expenses.

General and administrative expenses decreased to $2,618,000 from
$3,370,000, a reduction of $752,000 or 22.3%. This expense reduction was
primarily due to personnel reductions and lower professional fees and office

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supply expenses.

Interest income decreased $257,000 from $355,000 in 1998 to $98,000 in
1999. This decrease is a result of lower average balances of cash and cash
equivalents on hand during 1999 compared to 1998.

Interest expense increased $2,387,000 from $10,248,000 in 1998 to
$12,635,000 in 1999. This increase was primarily due to an increase of
$2,507,000 in non-cash interest charges related to the Companys Senior
Convertible Notes. See Note 8 to the Companys financial statements.

An extraordinary charge of $745,000 was recorded in 1999 as a result of
amendments to the terms of certain of the Companys Senior Convertible Notes
issued in May 1998 and March 1999. These amendments increased the interest rate
of certain of the notes issued in May 1998 from 2% to 6% and reduced the
conversion prices of these notes and the exercise prices of warrants issued in
conjunction with these notes. In March 1999, the conversion price of certain of
the notes issued in May 1998 was reduced from $1.50 to $1.125 per share, and the
exercise price of the related warrants was reduced from $3.75 to $1.4625 per
share. In November 1999, the conversion price of certain of the notes issued in
both May 1998 and March 1999 and the exercise price of the related warrants were
reduced from $1.125 to $0.25 per share and from $1.4625 to $0.25 per share,
respectively. In addition, the exercise price of certain of the Companys G
Warrants was reduced from $10.0625 to $0.25 per share. See Note 8 to the
Companys financial statements.

Liquidity and Capital Resources

At December 31, 2000, the Companys cash and cash equivalents, including
restricted certificates of deposit, were $2,454,000, an increase of $1,730,000
from the December 31, 1999 balance of $724,000.

The continuing development of and expansion in sales of the Companys RF
filter product lines will require a commitment of substantial funds to
undertake product line development and expansion of manufacturing capabilities
and to market and sell its RF front-end products. The actual amount of the
Companys future funding requirements will depend on many factors, including:
the amount and timing of future revenues, the level of product marketing and
sales efforts to support the Companys commercialization plans, the magnitude of
its research and product development programs, the ability of the Company to
improve product margins, the potential cost of additional plant and equipment
for manufacturing and the costs involved in protecting the Companys patents or
other intellectual property.

As of the date of this filing, the Company has cash resources available and
other committed sources of capital to fund the activities of the Company beyond
the next 12 months. The Company announced in February and March the settlement
of certain on-going shareholder litigation, pursuant to which the Company would
receive, subject to court approval, $20 million (less legal and certain other
expenses). On February 23, 2001, the Company secured a short-term bridge loan
from Elliott Associates, L.P. for up to $3.5 million to fund working capital
needs. The loan matures in 120 days and bears a market rate of interest at 12%.
The purpose of the short-term bridge loan was to fund working capital needs of
the Company until such time that the funds from the above-described settlement
have been received by the Company. The Company accessed the first $2 million of
the loan during February, 2001, and the remaining $1.5 is available, at the
Companys option, during the first week in April, 2001. In addition, in March,
2001, the Company announced an agreement with Paul Revere Capital Fund for a $20
million committed equity line. Under this committed line, the company can, at
its option, elect to sell to Paul Revere Capital Fund from time to time over the
next two years up to $4.0 million per notice of the companys common stock,
subject to the conditions contained in the agreement.




Item 7A. Quantitative and Qualitative Disclosures
About Market Risk.

The Company does not have any material market risk sensitive instruments.

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Item 8. Financial Statements and Supplementary
Data.

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Board of Directors
Illinois Superconductor Corporation

We have audited the accompanying consolidated balance sheet of Illinois
Superconductor Corporation (a Delaware corporation) and subsidiaries, as of
December 31, 2000, and the related consolidated statements of operations,
shareholders equity (net capital deficiency), and cash flows for the year ended
December 31, 2000. These financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these
financial statements based on our audit.

We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Illinois
Superconductor Corporation and subsidiaries at December 31, 2000, and the
consolidated results of their operations and their cash flows for the year ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States of America.

We have also audited Schedule II of Illinois Superconductor Corporation and
subsidiaries for the year ended December 31, 2000. In our opinion, this schedule
presents fairly, in all material respects, the information required to be set
forth herein.



| |                   
| | ------------------
| | GRANT THORNTON LLP

Chicago, Illinois

January 12, 2001, except for the final section of Note 12 and for Note 13, as to
which the dates are February 26, 2001 and March 19, 2001, respectively.

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

The Board of Directors
Illinois Superconductor Corporation

We have audited the accompanying balance sheet of Illinois Superconductor
Corporation as of December 31, 1999, and the related statements of operations,
stockholders equity (net capital deficiency), and cash flows for each of the
two years in the period ended December 31, 1999. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement

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##### Table of Contents



presentation. We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Illinois Superconductor
Corporation at December 31, 1999, and the results of its operations and its cash
flows for each of the two years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.

The accompanying financial statements have been prepared assuming that Illinois
Superconductor Corporation will continue as a going concern. Illinois
Superconductor Corporation has incurred ongoing operating losses and does not
currently have financing commitments in place to meet expected cash requirements
through 2000. These conditions raise substantial doubt about Illinois
Superconductor Corporations ability to continue as a going concern. The
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classification of liabilities that may result from the outcome of this
uncertainty.



| |                  
| | -----------------
| | Ernst & Young LLP

Chicago, Illinois
February 25, 2000

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ILLINOIS SUPERCONDUCTOR CORPORATION

CONSOLIDATED BALANCE SHEETS

|                                   |                                                                                                                                           |   |            |           |              |   |           |           |  |  | 
|---------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------- | - | ---------- | --------- | ------------ | - | --------- | --------- |  |  | 
|                                   |                                                                                                                                           |   |            |           | DECEMBER 31,
|                                   |                                                                                                                                           |   |            |           |             
|                                   |                                                                                                                                           |   |            |           | 2000         |   | 1999     
|                                   |                                                                                                                                           |   |            |           |              |   |          
|ASSETS                            
|                                  
|                                  
|                                  
|                                  
|Current assets:                   
|                                  
|                                  
|                                  
|                                  
|                                   | Cash and cash equivalents                                                                                                                 |   | $          | 2,453,845 |              |   | $         | 723,711   | 
|                                  
|                                  
|                                  
|                                  
|                                   | Inventories                                                                                                                               |   |            | 1,928,347 |              |   |           | 1,092,713 | 
|                                  
|                                  
|                                  
|                                  
|                                   | Accounts receivable, net of allowance for doubtful      accounts of $12,354 and $35,340 at December 31,
      2000 and 1999, respectively |   |            | 192,295   |              |   |           | 175,801   | 
|                                  
|                                  
|                                  
|                                  
|                                   | Prepaid expenses and other                                                                                                                |   |            | 536,541   |              |   |           | 428,475   | 
|                                   |                                                                                                                                           |   |            |           |              |   |           |          
|Total current assets               |                                                                                                                                           |   | 5,111,028  |           |              |   | 2,420,700 |          
|                                  
|                                  
|                                  
|                                  
|Property and equipment:           
|                                  
|                                  
|                                  
|                                  
|                                   | Property and Equipment                                                                                                                    |   |            | 8,769,962 |              |   |           | 8,089,169 | 
|                                  
|                                  
|                                  
|                                  
|                                   | Less: Accumulated depreciation                                                                                                            |   |            | 6,193,019 |              |   |           | 5,433,808 | 
|                                   |                                                                                                                                           |   |            |           |              |   |           |          
|                                   |                                                                                                                                           |   | 2,576,943  |           |              |   | 2,655,361 |          
|                                  
|                                  
|                                  
|                                  
|Restricted certificates of deposit |                                                                                                                                           |   | 203,178    |           |              |   | 291,575   |          
|                                  
|                                  
|                                  
|                                  
|Intangible assets, net             |                                                                                                                                           |   | 15,710,024 |           |              |   | 592,823   |          
|                                  
|                                  
|                                  
|                                  
|Other assets, net                  |                                                                                                                                           |   | 148,900    |           |              |   | 78,700    |          
|                                   |                                                                                                                                           |   |            |           |              |   |           |          
|Total assets                       |                                                                                                                                           | $ | 23,750,073 |           |              | $ | 6,039,159 |          
|                                   |                                                                                                                                           |   |            |           |              |   |           |          

|                                                                      |                           |                                                                                                                                                                                                      |            |              |              |      |            |           |             |  
|--------------------------------------------------------------------- | ------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------- | ------------ | ------------ | ---- | ---------- | --------- | ----------- | -
|                                                                      |                           |                                                                                                                                                                                                      |            | DECEMBER 31,
|                                                                      |                           |                                                                                                                                                                                                      |            |             
|                                                                      |                           |                                                                                                                                                                                                      |            | 2000         |              | 1999
|                                                                      |                           |                                                                                                                                                                                                      |            |              |              |     
|LIABILITIES AND
STOCKHOLDERS EQUITY (NET CAPITAL DEFICIENCY)        
|Current liabilities:                                                 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      |                           | Accounts payable                                                                                                                                                                                     |            | $            | 599,553      |      |            | $         | 990,913     |  
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      |                           | Accrued liabilities                                                                                                                                                                                  |            |              | 1,406,802    |      |            |           | 589,043     |  
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      |                           | Current portion of other long-term debt                                                                                                                                                              |            |              | 8,500        |      |            |           | 9,020       |  
|                                                                      |                           |                                                                                                                                                                                                      |            |              |              |      |            |          
|                                                                      | Total current liabilities |                                                                                                                                                                                                      |            | 2,014,855    |              |      |            | 1,588,976 |            
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Senior convertible notes, net of discount                             |                           |                                                                                                                                                                                                      |           |              |              |      | 13,002,068 |          
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Accrued interest on senior convertible notes                          |                           |                                                                                                                                                                                                      |           |              |              |      | 638,743    |          
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Other long-term debt, less current portion                            |                           |                                                                                                                                                                                                      | 198        |              |              |      | 10,074     |          
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Deferred occupancy costs                                              |                           |                                                                                                                                                                                                      | 90,809     |              |              |      | 91,010     |          
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Stockholders equity (net capital deficiency):                       
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      |                           | Preferred Stock; 300,000 and
100,000 shares authorized;      No shares issued and outstanding at December 31,
      2000 and 1999, respectively                                                      |            |              |             |      |            |           |            |  
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      |                           | Common stock ($.001 par
value); 250,000,000 and      60,000,000 shares authorized and 107,719,307 and      15,753,001 shares
issued and outstanding
at      December 31, 2000 and 1999, respectively |            |              | 107,719      |      |            |           | 15,753      |  
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      |                           | Additional paid-in capital (net of unearned comp.)                                                                                                                                                   |            |              | 123,209,087  |      |            |           | 74,249,643  |  
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      |                           | Notes receivable from stockholders                                                                                                                                                                   |            |              |             |      |            |           | (680,696    | )
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      |                           | Accumulated deficit                                                                                                                                                                                  |            |              | (101,672,595 | )    |            |           | (82,876,412 | )
|                                                                      |                           |                                                                                                                                                                                                      |            |              |              |      |            |          
|Total stockholders equity (net capital deficiency)                   |                           |                                                                                                                                                                                                      | 21,644,211 |              |              |      | (9,291,712 | )        
|                                                                      |                           |                                                                                                                                                                                                      |            |              |              |      |            |          
|Total liabilities and stockholders equity (net capital
  deficiency) |                           | $                                                                                                                                                                                                    | 23,750,073 |              |              | $    | 6,039,159  |          
|                                                                      |                           |                                                                                                                                                                                                      |            |              |              |      |            |          

See the accompanying Notes which are an integral part
of the financial statements.

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##### Table of Contents



ILLINOIS SUPERCONDUCTOR CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

|                                                                      |                                                                |   |                         |            |      |   |             |             |   |   |             |             |  
|--------------------------------------------------------------------- | -------------------------------------------------------------- | - | ----------------------- | ---------- | ---- | - | ----------- | ----------- | - | - | ----------- | ----------- | -
|                                                                      |                                                                |   | YEAR ENDED DECEMBER 31,
|                                                                      |                                                                |   |                        
|                                                                      |                                                                |   | 2000                    |            | 1999 |   | 1998       
|                                                                      |                                                                |   |                         |            |      |   |            
|Net sales                                                             |                                                                | $ | 495,885                 |            |      | $ | 2,408,604   |             |   | $ | 3,242,930   |            
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Costs and expenses:                                                  
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Cost of sales                                                  |   |                         | 2,672,578  |      |   |             | 5,923,173   |   |   |             | 7,047,347   |  
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Research and development                                       |   |                         | 3,187,768  |      |   |             | 1,757,214   |   |   |             | 2,934,784   |  
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Selling and marketing                                          |   |                         | 1,239,959  |      |   |             | 1,581,545   |   |   |             | 1,847,680   |  
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | General and administrative                                     |   |                         | 6,671,796  |      |   |             | 2,617,809   |   |   |             | 3,370,058   |  
|                                                                      |                                                                |   |                         |            |      |   |             |             |   |   |             |            
|Total costs and expenses                                              |                                                                |   | 13,772,101              |            |      |   | 11,879,741  |             |   |   | 15,199,869  |            
|                                                                      |                                                                |   |                         |            |      |   |             |             |   |   |             |            
|Operating loss                                                        |                                                                |   | (13,276,216             | )          |      |   | (9,471,137  | )           |   |   | (11,956,939 | )          
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Other income and (expense):                                          
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Interest income                                                |   |                         | 174,919    |      |   |             | 98,194      |   |   |             | 354,738     |  
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Non-cash interest expense on Senior
convertible notes (Note 7) |   |                         | (5,631,581 | )    |   |             | (12,608,355 | ) |   |             | (10,101,401 | )
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Other interest expense                                         |   |                         | (18,991    | )    |   |             | (26,390     | ) |   |             | (146,518    | )
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Other income (expense), net                                    |   |                         | (16,017    | )    |   |             | 36,623      |   |   |             |            |  
|                                                                      |                                                                |   |                         |            |      |   |             |             |   |   |             |            
|                                                                      |                                                                |   | (5,491,670              | )          |      |   | (12,499,928 | )           |   |   | (9,893,181  | )          
|                                                                      |                                                                |   |                         |            |      |   |             |             |   |   |             |            
|Loss before extraordinary item                                        |                                                                |   | (18,767,886             | )          |      |   | (21,971,065 | )           |   |   | (21,850,120 | )          
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Extraordinary item - debt extinguishment                              |                                                                |   | (28,297                 | )          |      |   | (745,197    | )           |   |   |            |            
|                                                                      |                                                                |   |                         |            |      |   |             |             |   |   |             |            
|Net loss                                                              |                                                                |   | (18,796,183             | )          |      |   | (22,716,262 | )           |   |   | (21,850,120 | )          
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Preferred Stock dividends                                             |                                                                |   |                        |            |      |   |            |             |   |   | (61,834     | )          
|                                                                      |                                                                |   |                         |            |      |   |             |             |   |   |             |            
|Net loss plus Preferred Stock dividends                               |                                                                | $ | (18,796,183             | )          |      | $ | (22,716,262 | )           |   | $ | (21,911,954 | )          
|                                                                      |                                                                |   |                         |            |      |   |             |             |   |   |             |            
|Basic and diluted loss per common share before
    extraordinary item |                                                                | $ | (0.57                   | )          |      | $ | (1.71       | )           |   | $ | (1.93       | )          
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Extraordinary item - debt extinguishment                              |                                                                |   |                        |            |      |   | (0.06       | )           |   |   |            |            
|                                                                      |                                                                |   |                         |            |      |   |             |             |   |   |             |            
|Basic and diluted loss per common share                               |                                                                | $ | (0.57                   | )          |      | $ | (1.77       | )           |   | $ | (1.93       | )          
|                                                                      |                                                                |   |                         |            |      |   |             |             |   |   |             |            
|Weighted average number of common shares
outstanding                  |                                                                |   | 33,037,106              |            |      |   | 12,841,497  |             |   |   | 11,345,540  |            
|                                                                      |                                                                |   |                         |            |      |   |             |             |   |   |             |            

See the accompanying Notes which are an integral part of
the financial statements.

Page 37



---



##### Table of Contents



ILLINOIS SUPERCONDUCTOR CORPORATION

CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY (NET CAPITAL DEFICIENCY)

YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998

|                                |                                   |                                                                                  |                 |  |                      |   |                      |  |                      |   |              |  |        |   |           |  |            |   |        |  |      |   |           |  |            |   |             |  |            |         |         |   |        |     | 
|------------------------------- | --------------------------------- | -------------------------------------------------------------------------------- | --------------- |  | -------------------- | - | -------------------- |  | -------------------- | - | ------------ |  | ------ | - | --------- |  | ---------- | - | ------ |  | ---- | - | --------- |  | ---------- | - | ----------- |  | ---------- | ------- | ------- | - | ------ | --- | 
|                                |                                   |                                                                                  |                 |  | SERIES B CONVERTIBLE |   | SERIES C CONVERTIBLE |  | SERIES G CONVERTIBLE
|                                |                                   |                                                                                  |                 |  | PREFERRED STOCK      |   | PREFERRED STOCK      |  | PREFERRED STOCK      |   | COMMON STOCK
|                                |                                   |                                                                                  |                 |  |                      |   |                      |  |                      |   |             
|                                |                                   |                                                                                  |                 |  | NUMBER               |   |                      |  |                      |   | NUMBER       |  |        |   |           |  | NUMBER     |   |        |  |      |   | NUMBER   
|                                |                                   |                                                                                  |                 |  | OF                   |   |                      |  |                      |   | OF           |  |        |   |           |  | OF         |   |        |  |      |   | OF       
|                                |                                   |                                                                                  |                 |  | SHARES               |   | AMOUNT               |  | SHARES               |   | AMOUNT       |  | SHARES |   | AMOUNT    |  | SHARES     |   | AMOUNT
|                                |                                   |                                                                                  |                 |  |                      |   |                      |  |                      |   |              |  |        |   |           |  |            |   |       
|Balance as of January 1, 1998   |                                   |                                                                                  | 95              |  |                      |   | 488,534              |  |                      |   | 600          |  |        |   | 3,038,424 |  |            |   | 700    |  |      |   | 3,530,206 |  |            |   | 6,001,925   |  |            |         | 6,002   |  
|                               
|                               
|                               
|                               
|                                |                                   | Additional offering costs
related to
  issuance of preferred stock               |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  |           |         |         |   |       |    
|                               
|                               
|                               
|                               
|                                |                                   | Exercise of stock options; $. 18 -                                              
|                               
|                               
|                               
|                               
|                                |                                   |                                                                                  | $.23 per share  |  |                      |  |                      |  |                      |  |              |  |        |  |           |  |            |  |        |  |      |  |           |  |            |  |             |  |            | 33,942  |         |   |        | 34  | 
|                               
|                               
|                               
|                               
|                                |                                   | Payment of stockholder notes
  receivable                                        |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  |           |         |         |   |       |    
|                               
|                               
|                               
|                               
|                                |                                   | Preferred stock dividends                                                        |                 |  |                     |   |                      |  | 260                  |   |              |  |       |   |           |  | 24,377     |   |        |  |     |   |           |  | 37,197     |   |             |  |           |         |         |   |       |    
|                               
|                               
|                               
|                               
|                                |                                   | Conversion of preferred stock
to  common stock                                   |                 |  | (95                  | ) |                      |  | (488,794             | ) |              |  | (600   | ) |           |  | (3,062,801 | ) |        |  | (700 | ) |           |  | (3,567,403 | ) |             |  | 6,521,178  |         |         |   | 6,521  |    
|                               
|                               
|                               
|                               
|                                |                                   | Discount on issuance of
senior  convertible notes (Note 7)                       |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  |           |         |         |   |       |    
|                               
|                               
|                               
|                               
|                                |                                   | Net loss                                                                         |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  |           |         |         |   |       |    
|                                |                                   |                                                                                  |                 |  |                      |   |                      |  |                      |   |              |  |        |   |           |  |            |   |        |  |      |   |           |  |            |   |             |  |            |         |         |  
|Balance as of December 31, 1998 |                                   |                                                                                  |                |  |                      |   |                     |  |                      |   |             |  |        |   |          |  |            |   |       |  |      |   |          |  |            |   | 12,557,045  |  |            |         | 12,557  |  
|                               
|                               
|                               
|                               
|                                |                                   | Exercise of stock options; $.18 -                                               
|                               
|                               
|                               
|                               
|                                |                                   |                                                                                  | $.23 per share  |  |                      |  |                      |  |                      |  |              |  |        |  |           |  |            |  |        |  |      |  |           |  |            |  |             |  |            | 17,250  |         |   |        | 17  | 
|                               
|                               
|                               
|                               
|                                |                                   | Conversion of senior
convertible  notes to common stock                          |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  | 3,178,706  |         |         |   | 3,179  |    
|                               
|                               
|                               
|                               
|                                |                                   | Discount on issuance of
senior  convertible notes (Note 7)                       |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  |           |         |         |   |       |    
|                               
|                               
|                               
|                               
|                                |                                   | Additional discount on
amendments to  certain senior convertible notes  (Note 7) |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  |           |         |         |   |       |    
|                               
|                               
|                               
|                               
|                                |                                   | Net loss                                                                         |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  |           |         |         |   |       |    
|                                |                                   |                                                                                  |                 |  |                      |   |                      |  |                      |   |              |  |        |   |           |  |            |   |        |  |      |   |           |  |            |   |             |  |            |         |         |  
|Balance as of December 31, 1999 |                                   |                                                                                  |                |  |                      | $ |                     |  |                      |   |             |  |        | $ |          |  |            |   |       |  |      | $ |          |  |            |   | 15,753,001  |  |            | $       | 15,753  |  
|                               
|                               
|                               
|                               
|                                | Exercise of stock options; $.48 -
|                               
|                               
|                               
|                               
|                                |                                   |                                                                                  | $1.81 per share |  |                      |  |                      |  |                      |  |              |  |        |  |           |  |            |  |        |  |      |  |           |  |            |  |             |  |            | 362,812 |         |   | $      | 363 | 
|                               
|                               
|                               
|                               
|                                |                                   | Conversion of senior convertible
  notes to common stock                         |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  | 75,894,430 |         |         | $ | 75,894 |    
|                               
|                               
|                               
|                               
|                                |                                   | Conversion of warrants to
common  stock                                          |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  | 7,950,356  |         |         | $ | 7,950  |    
|                               
|                               
|                               
|                               
|                                |                                   | Conversion of senior
convertible  notes                                          |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  |           |         |         |   |       |    
|                               
|                               
|                               
|                               
|                                |                                   | Acquisition of Spectral
Solutions,  Inc.                                         |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  | 3,440,526  |         |         | $ | 3,441  |    
|                               
|                               
|                               
|                               
|                                |                                   | Acquisition of Adaptive Notch Filter
  Division of Lockheed Martin Canada        |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  | 2,500,000  |         |         | $ | 2,500  |    
|                               
|                               
|                               
|                               
|                                |                                   | Equity Issuance                                                                  |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  | 1,818,182  |         |         | $ | 1,818  |    
|                               
|                               
|                               
|                               
|                                |                                   | Litigation settlement                                                            |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  |           |         |         |   |       |    
|                               
|                               
|                               
|                               
|                                |                                   | Dfd stock units granted, net of amort                                            |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  |           |         |         |   |       |    
|                               
|                               
|                               
|                               
|                                |                                   | Comp. expense for non-employee
  options                                         |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |  
|                               
|                               
|                               
|                               
|                                |                                   | Net loss                                                                         |                 |  |                     |   |                      |  |                     |   |              |  |       |   |           |  |           |   |        |  |     |   |           |  |           |   |             |  |           |         |         |   |       |    
|                                |                                   |                                                                                  |                 |  |                      |   |                      |  |                      |   |              |  |        |   |           |  |            |   |        |  |      |   |           |  |            |   |             |  |            |         |         |  
|Balance as of December 31, 2000 |                                   |                                                                                  |                |  |                      | $ |                     |  |                      |   |             |  |        | $ |          |  |            |   |       |  |      | $ |          |  |            |   | 107,719,307 |  |            | $       | 107,719 |  
|                                |                                   |                                                                                  |                 |  |                      |   |                      |  |                      |   |              |  |        |   |           |  |            |   |        |  |      |   |           |  |            |   |             |  |            |         |         |  

See the accompanying Notes which are an integral part of
the financial statements.

Page 38



---



##### Table of Contents



ILLINOIS SUPERCONDUCTOR CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (NET CAPITAL DEFICIENCY)

YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998

(CONTINUED)

|                                |                                                                                     |                 |             |            |         |              |          |             |   |              |              |             |   |   |            |            |   |   |            |             |         | 
|------------------------------- | ----------------------------------------------------------------------------------- | --------------- | ----------- | ---------- | ------- | ------------ | -------- | ----------- | - | ------------ | ------------ | ----------- | - | - | ---------- | ---------- | - | - | ---------- | ----------- | ------- | 
|                                |                                                                                     |                 |             |            |         |              |          | NOTES      
|                                |                                                                                     |                 |             | ADDITIONAL |         | RECEIVABLE  
|                                |                                                                                     |                 |             | PAID-IN    |         | FROM         |          | ACCUMULATED |   | UNEARNED    
|                                |                                                                                     |                 |             | CAPITAL    |         | STOCKHOLDERS |          | DEFICIT     |   | COMPENSATION |              | TOTAL      
|                                |                                                                                     |                 |             |            |         |              |          |             |   |              |              |            
|Balance as of December 31, 1997 |                                                                                     |                 | 41,991,941  |            |         |              | (698,508 | )           |   |              | (38,310,030  | )           |   |   |           |            |   |   | 10,046,569 |            
|                               
|                               
|                               
|                               
|                                | Additional offering costs related to
issuance of preferred stock                    |                 |             | (143,400   | )       |              |          |            |   |              |              |            |   |   |            |           |   |   |            | (143,400    | )      
|                               
|                               
|                               
|                               
|                                | Exercise of stock options; $. 18 -                                                 
|                               
|                               
|                               
|                               
|                                |                                                                                     | $.23 per share  |             |            | 7,387   |              |          |             |  |              |              |             |  |   |            |            |  |   |            |             | 7,421   | 
|                               
|                               
|                               
|                               
|                                | Payment of stockholder notes
receivable                                             |                 |             |           |         |              |          | 17,812      |   |              |              |            |   |   |            |           |   |   |            | 17,812      |        
|                               
|                               
|                               
|                               
|                                | Preferred stock dividends                                                           |                 |             | (61,834    | )       |              |          |            |   |              |              |            |   |   |            |           |   |   |            |            |        
|                               
|                               
|                               
|                               
|                                | Conversion of preferred stock to
common stock                                       |                 |             | 7,112,477  |         |              |          |            |   |              |              |            |   |   |            |           |   |   |            |            |        
|                               
|                               
|                               
|                               
|                                | Discount on issuance of senior
convertible notes (Note 7)                           |                 |             | 11,148,750 |         |              |          |            |   |              |              |            |   |   |            |           |   |   |            | 11,148,750  |        
|                               
|                               
|                               
|                               
|                                | Net loss                                                                            |                 |             |           |         |              |          |            |   |              |              | (21,850,120 | ) |   |            |           |   |   |            | (21,850,120 | )      
|                                |                                                                                     |                 |             |            |         |              |          |             |   |              |              |             |   |   |            |            |   |   |            |            
|                               
|                               
|                               
|                               
|Balance as of December 31, 1998 |                                                                                     |                 | 60,055,321  |            |         |              | (680,696 | )           |   |              | (60,160,150  | )           |   |   |           |            |   |   | (772,968   | )          
|                               
|                               
|                               
|                               
|                                | Exercise of stock options; $.18 -                                                  
|                               
|                               
|                               
|                               
|                                |                                                                                     | $.23 per share  |             |            | 3,769   |              |          |             |  |              |              |             |  |   |            |            |  |   |            |             | 3,786   | 
|                               
|                               
|                               
|                               
|                                | Conversion of senior convertible
notes to common stock                              |                 |             | 849,554    |         |              |          |            |   |              |              |            |   |   |            |           |   |   |            | 852,733     |        
|                               
|                               
|                               
|                               
|                                | Discount on issuance of senior
convertible notes (Note 7)                           |                 |             | 1,904,000  |         |              |          |            |   |              |              |            |   |   |            |           |   |   |            | 1,904,000   |        
|                               
|                               
|                               
|                               
|                                | Additional discount on amendments to
certain senior convertible      notes
(Note 7) |                 |             | 11,436,999 |         |              |          |            |   |              |              |            |   |   |            |           |   |   |            | 11,436,999  |        
|                               
|                               
|                               
|                               
|                                | Net loss                                                                            |                 |             |           |         |              |          |            |   |              |              | (22,716,262 | ) |   |            |           |   |   |            | (22,716,262 | )      
|                                |                                                                                     |                 |             |            |         |              |          |             |   |              |              |             |   |   |            |            |   |   |            |            
|                               
|                               
|                               
|                               
|Balance as of December 31, 1999 |                                                                                     | $               | 74,249,643  |            |         | $            | (680,696 | )           |   | $            | (82,876,412  | )           |   |   |           |            |   | $ | (9,291,712 | )          
|                               
|                               
|                               
|                               
|                                | Exercise of stock options; $.48 -                                                  
|                               
|                               
|                               
|                               
|                                |                                                                                     | $1.81 per share |             |            | 219,565 |              |          |             |  |              |              |             |  |   |            |            |  |   |            |             | 219,928 | 
|                               
|                               
|                               
|                               
|                                | Conversion of senior convertible
notes to common stock                              |                 |             | 19,110,980 |         |              |          |            |   |              |              |            |   |   |            |           |   |   |            | 19,186,874  |        
|                               
|                               
|                               
|                               
|                                | Conversion of warrants to common stock                                              |                 |             | 4,007,072  |         |              |          |            |   |              |              |            |   |   |            |           |   |   |            | 4,015,022   |        
|                               
|                               
|                               
|                               
|                                | Conversion of senior convertible notes                                              |                 |             | 4,000,000  |         |              |          |            |   |              |              |            |   |   |            |           |   |   |            | 4,000,000   |        
|                               
|                               
|                               
|                               
|                                | Acquisition of Spectral Solutions, Inc.                                             |                 |             | 14,324,800 |         |              |          |            |   |              |              |            |   |   |            | (108,915   | ) |   |            | 14,219,326  |        
|                               
|                               
|                               
|                               
|                                | Acquisition of ANF division of LMC                                                  |                 |             | 2,653,750  |         |              |          |            |   |              |              |            |   |   |            |           |   |   |            | 2,656,250   |        
|                               
|                               
|                               
|                               
|                                | Equity Issuance                                                                     |                 |             | 4,998,182  |         |              |          |            |   |              |              |            |   |   |            |           |   |   |            | 5,000,000   |        
|                               
|                               
|                               
|                               
|                                | Litigation Settlement                                                               |                 |             | (822,766   | )       |              |          | 680,696     |   |              |              |            |   |   |            |           |   |   |            | (142,070    | )      
|                               
|                               
|                               
|                               
|                                | Dfd Stock Units Granted, net of amort                                               |                 |             | 1,925,000  |         |              |          |            |   |              |              |            |   |   |            | (1,693,175 | ) |   |            | 231,825     |        
|                               
|                               
|                               
|                               
|                                | Comp. Exp. for non-empee stock options                                              |                 |             | 344,951    |         |              |          |            |   |              |              |            |   |   |            |           |   |   |            | 344,951     |        
|                               
|                               
|                               
|                               
|                                | Net loss                                                                            |                 |             |           |         |              |          |            |   |              |              | (18,796,183 | ) |   |            |           |   |   |            | (18,796,183 | )      
|                                |                                                                                     |                 |             |            |         |              |          |             |   |              |              |             |   |   |            |            |   |   |            |            
|                               
|                               
|                               
|                               
|Balance as of December 31, 2000 |                                                                                     | $               | 125,011,177 |            |         |              |         |             |   | $            | (101,672,595 | )           |   | $ | (1,802,090 | )          |   | $ | 21,644,211 |            
|                                |                                                                                     |                 |             |            |         |              |          |             |   |              |              |             |   |   |            |            |   |   |            |            

See the accompanying Notes which are an integral part
of the financial statements.

Page 39



---



##### Table of Contents



ILLINOIS SUPERCONDUCTOR CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                             |                                                                     |                            |             |                          |          |      |             |            |           |   |             |            |          |  
|---------------------------------------------------------------------------- | ------------------------------------------------------------------- | -------------------------- | ----------- | ------------------------ | -------- | ---- | ----------- | ---------- | --------- | - | ----------- | ---------- | -------- | -
|                                                                             |                                                                     |                            |             | YEARS ENDED DECEMBER 31,
|                                                                             |                                                                     |                            |             |                         
|                                                                             |                                                                     |                            |             | 2000                     |          | 1999 |             | 1998      
|                                                                             |                                                                     |                            |             |                          |          |      |             |           
|OPERATING ACTIVITIES                                                        
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Net loss                                                                     |                                                                     | $                          | (18,796,183 | )                        |          | $    | (22,716,262 | )          |           | $ | (21,850,120 | )         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Adjustments to reconcile net loss to net cash
used in  operating activities:
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Depreciation                                                        |                            |             | 759,210                  |          |      |             | 953,971    |           |   |             | 1,107,360  |         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Amortization                                                        |                            |             | 744,493                  |          |      |             | 28,434     |           |   |             | 14,881     |         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Extraordinary item                                                  |                            |             | 28,297                   |          |      |             | 745,197    |           |   |             |           |         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Non-cash interest expense on senior
convertible notes      (Note 7) |                            |             | 5,631,673                |          |      |             | 12,608,355 |           |   |             | 10,101,401 |         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Loss on available-for-sale securities                               |                            |             |                         |          |      |             |           |           |   |             | 4,963      |         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Gain on sale of property and equipment                              |                            |             |                         |          |      |             | (30,662    | )         |   |             |           |         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Non-cash compensation charges                                       |                            |             | 576,778                  |          |      |             |           |           |   |             |           |         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Write-off of capitalized patent costs                               |                            |             | 176,472                  |          |      |             | 57,741     |           |   |             | 61,333     |         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Changes in operating assets and liabilities:                                
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             |                                                                     | Accounts receivable        |             |                          | (2,525   | )    |             |            | 1,318,617 |   |             |            | (907,917 | )
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             |                                                                     | Inventories                |             |                          | 515,176  |      |             |            | 331,714   |   |             |            | 301,714  |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             |                                                                     | Prepaid expenses and other |             |                          | (200,063 | )    |             |            | (31,549   | ) |             |            | 86,864   |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             |                                                                     | Accounts payable           |             |                          | (761,670 | )    |             |            | 526,161   |   |             |            | (252,673 | )
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             |                                                                     | Accrued liabilities        |             |                          | 456,910  |      |             |            | (210,728  | ) |             |            | 341,459  |  
|                                                                             |                                                                     |                            |             |                          |          |      |             |            |           |   |             |           
|Net cash used in operating activities                                        |                                                                     |                            | (10,871,432 | )                        |          |      | (6,419,011  | )          |           |   | (10,990,735 | )         
|                                                                            
|INVESTING ACTIVITIES                                                        
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Sales of available-for-sale securities                                       |                                                                     |                            |             |                          |          |      |            |            |           |   | 495,350     |           
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|(Increase) decrease in restricted certificates of
deposit                    |                                                                     |                            | 88,397      |                          |          |      | 45,772      |            |           |   | 42,653      |           
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Payments of patent costs                                                     |                                                                     |                            | (164,295    | )                        |          |      | (63,119     | )          |           |   | (112,607    | )         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Proceeds from sale of property and equipment                                 |                                                                     |                            |            |                          |          |      | 58,006      |            |           |   |            |           
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Payment of Deferred Acquisition Costs                                        |                                                                     |                            | (343,560    | )                        |          |      |            |            |           |   |            |           
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Acquisitions of property and equipment                                       |                                                                     |                            | (203,528    | )                        |          |      | (85,450     | )          |           |   | (108,417    | )         
|                                                                             |                                                                     |                            |             |                          |          |      |             |            |           |   |             |           
|Net cash (used in) provided by investing
activities                          |                                                                     |                            | (622,986    | )                        |          |      | (44,791     | )          |           |   | 316,979     |           
|                                                                            
|FINANCING ACTIVITIES                                                        
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Proceeds from issuance of preferred stock net
of offering  costs            |                                                                     |                            |            |                          |          |      |            |            |           |   | (143,400    | )         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Proceeds from issuance of common stock net of
offering  costs               |                                                                     |                            | 5,000,000   |                          |          |      |            |            |           |   |            |           
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Exercise of stock options                                                    |                                                                     |                            | 219,926     |                          |          |      | 3,786       |            |           |   | 7,421       |           
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Exercise of warrants                                                         |                                                                     |                            | 4,015,022   |                          |          |      |            |            |           |   |            |           
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Payments on stockholder notes receivable                                     |                                                                     |                            |            |                          |          |      |            |            |           |   | 17,812      |           
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Proceeds from issuance of senior convertible notes                           |                                                                     |                            | 4,000,000   |                          |          |      | 5,300,000   |            |           |   | 10,350,000  |           
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Payment of deferred financing fees                                           |                                                                     |                            |            |                          |          |      | (247,349    | )          |           |   | (94,247     | )         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Payments on other long-term debt                                             |                                                                     |                            | (10,396     | )                        |          |      | (21,519     | )          |           |   | (78,121     | )         
|                                                                             |                                                                     |                            |             |                          |          |      |             |            |           |   |             |           
|Net cash provided by financing activities                                    |                                                                     |                            | 13,224,552  |                          |          |      | 5,034,918   |            |           |   | 10,059,465  |           
|                                                                             |                                                                     |                            |             |                          |          |      |             |            |           |   |             |           
|Increase/(Decrease) in cash and cash equivalents                             |                                                                     |                            | 1,730,134   |                          |          |      | (1,428,884  | )          |           |   | (614,291    | )         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Cash and cash equivalents at beginning of period                             |                                                                     |                            | 723,711     |                          |          |      | 2,152,595   |            |           |   | 2,766,886   |           
|                                                                             |                                                                     |                            |             |                          |          |      |             |            |           |   |             |           
|Cash and cash equivalents at end of period                                   |                                                                     | $                          | 2,453,845   |                          |          | $    | 723,711     |            |           | $ | 2,152,595   |           
|                                                                             |                                                                     |                            |             |                          |          |      |             |            |           |   |             |           
|Supplemental cash flow information:                                         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Cash paid for interest                                                       |                                                                     | $                          | 18,991      |                          |          | $    | 26,390      |            |           | $ | 8,994       |           
|                                                                             |                                                                     |                            |             |                          |          |      |             |            |           |   |             |           

See the accompanying Notes which are an integral part
of the financial statements

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ILLINOIS SUPERCONDUCTOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. DESCRIPTION OF BUSINESS

Illinois Superconductor Corporation and its subsidiaries, Spectral
Solutions, Inc., and Illinois Superconductor Canada Corporation, (the Company)
use both patented and proprietary high-temperature superconducting materials
technologies and proprietary ANF technologies to develop and manufacture radio
frequency front-end products designed to enhance the quality, capacity, coverage
and flexibility of cellular, PCS and other wireless telecommunications services.
The Company has historically marketed its products to cellular, PCS and wireless
telecommunications service providers located primarily in the United States and
expects to begin to market its products to these same types of
telecommunications service providers located in certain international markets.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Cash and Cash Equivalents

Cash and cash equivalents consist of demand deposits, time deposits, money
market funds, and commercial paper which have maturities of three months or less
from the date of purchase. Management believes that the financial institutions
in which it maintains such deposits are financially sound and, accordingly,
minimal credit risk exists with respect to these deposits.

Inventories

Inventories are stated at the lower of cost (determined on a first in, first
out basis) or market.

Patents and Trademarks

Patents and trademarks represent costs, primarily legal fees and expenses,
incurred in order to prepare and file patent applications related to various
aspects of the Companys superconductor technology and to its current and
proposed products. Patents and trademarks are recorded at cost and are amortized
using the straight-line method over the shorter of their estimated useful lives
or 17 years. The recoverability of the carrying values of patents and trademarks
is evaluated on an ongoing basis. During 2000 and 1999, the Company wrote off
$177,000 and $58,000, respectively, of patent-related costs. Total capitalized
patent and trademark costs are $628,000 and $647,000 at December 31, 2000 and
1999, respectively. Capitalized patent costs related to pending patents are
$194,000 and $218,000 at December 31, 2000 and 1999, respectively. Patents and
trademarks are net of accumulated amortization of $88,000 and $54,000 at
December 31, 2000 and 1999, respectively.

Property and Equipment

Property and equipment are stated at cost, less accumulated depreciation,
and are depreciated over the estimated useful lives of the assets using
accelerated methods. Leasehold improvements are amortized using the
straight-line method over the shorter of the useful life of the asset or the
term of the lease. Amortization of leasehold improvements is included in
depreciation expense. The useful lives assigned to property and equipment for
the purpose of computing book depreciation are as follows:

|                        |  |              
|----------------------- |  | -------------
|Lab equipment           |  | 5 years      
|                       
|                       
|                       
|                       
|Manufacturing equipment |  | 3 to 5 years 
|                       
|                       
|                       
|                       
|Office equipment        |  | 3 to 5 years 
|                       
|                       
|                       
|                       
|Furniture and fixtures  |  | 5 years      
|                       
|                       
|                       
|                       
|Leasehold improvements  |  | Life of lease

Income Taxes

Deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.

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Revenue Recognition and Product Warranty

Revenues from product sales are generally recognized at the time of shipment
and are recorded net of estimated returns and allowances. The Company has, under
certain conditions, granted customers the right to return product during a
specified period of time after shipment. In these situations, the Company
establishes a liability for estimated returns and allowances at the time of
shipment. The Company has established a program which, in certain situations,
allows customers or prospective customers to field test the Companys products
for a specified period of time. Revenues from field test arrangements are
recognized upon customer acceptance of the products. The Company warrants its
products against defects in materials and workmanship typically for an
eighteen-month period from the date of shipment, except for superconducting
materials contained in the products, which are warranted for ten years from the
date of shipment, though these terms are negotiated on a case by case basis. A
provision for estimated future costs related to warranty expenses is recorded
when revenues are recognized. At December 31, 2000 and 1999, respectively, the
Company has accrued $298,000 and $283,000 for warranty costs. Returns and
allowances were not significant in any period reported.

Advertising Costs

Advertising costs are charged to expense in the period incurred. Advertising
expense for the years ended December 31, 2000, 1999 and 1998, was approximately
$13,000, $26,000 and $18,000, respectively.

Research and Development Costs

Research and development costs related to both present and future products
are charged to expense in the period incurred.

Net Loss Per Common Share

Basic and diluted net loss per common share are computed based upon the
weighted average number of common shares outstanding. Approximately 5.4 million
common shares issuable as of December 31, 2000 upon the exercise of options and
warrants are not included in the per share calculations since the effect of
their inclusion would be antidilutive.

Use of Estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.

Description of Certain Concentrations and Risks

The Company operates in a highly competitive and rapidly changing industry.
Product revenues are currently concentrated with a limited number of customers,
and the supply of certain materials is concentrated among a few providers. The
development and commercialization of new technologies by any competitor could
adversely affect the Companys results of operations.

Long Lived Assets

The excess of cost over net assets acquired is amortized on a straight-line
basis over 8 years (in the case of goodwill). The Company assesses long-lived
assets for impairment under FASB Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of. In
accordance with this Statement, the excess of cost over net assets acquired
associated with assets acquired in a purchase business combination is included
in impairment evaluations when events or circumstances exist that indicate the
carrying amount of those asses may not be recoverable. If this review indicates
that the carrying amount will not be recoverable as determined based on the
estimated undiscounted cash flows over the remaining amortization period, the
carrying amount of the excess of cost of net assets acquired will be reduced to
the estimated fair value.

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Reclassifications

Certain amounts in the financial statements of prior years have been
reclassified to conform to the 2000 presentation.

3. BUSINESS PLANS



| | The Company has incurred, and continues to incur, losses from operations.
For the years ended December 31, 2000, 1999, and 1998, the Company incurred
net losses of $18,796,183, $22,716,262, and $21,850,120, respectively.
During 2000 and 1999, the Company implemented a strategy to reduce its
losses from operations and cash used in operating activities. The Companys
strategy included a targeted reduction of the employee workforce, increasing
the efficiency of the Companys research and development processes, focusing
development efforts on products with a greater probability of commercial
sales, reducing professional fees and discretionary expenditures, and
negotiating favorable payment arrangements with suppliers and service
providers.                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | To date, the Company has financed its operations primarily through public
and private equity and debt financings. The Company believes that it has
sufficient funds to operate its business as identified herein without the
need for substantial future capital through the first quarter of 2002,
except as described herein. In addition, the Company has put in place
mechanisms to raise additional capital when and if needed. The Company
intends to augment its existing capital position through the funding
mechanisms identified and through other strategic sources of capital.
Although the Company believes it has sufficient capital resources available
to meet its obligations over the next year, there is no guarantee that the
funding mechanisms identified will allow the Company to access the necessary
funds.

4. ACQUISITIONS



| | On August 8, 2000, the Company acquired Spectral Solutions, Inc. in exchange
for 3,440,526 shares of its common stock. On December 20, 2000, the Company
acquired the Adaptive Notch Filter (ANF) division of Lockheed Martin
Canada, Inc. in exchange for 2,500,000 shares of its common stock. Both
transactions were accounted for under the purchase method of accounting. In
each case, goodwill was recorded and is to be amortized under the
straight-line method over an 8 year period.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | The Purchase Prices, plus direct costs of the acquisitions, were allocated
as follow:                                                                                                                                                                                                                                                                                                                                                                                                            

|                                        |  |   |            |  
|--------------------------------------- |  | - | ---------- | -
|Inventory                               |  | $ | 1,379,000  |  
|                                       
|                                       
|                                       
|                                       
|Property, Plant, and Equipment          |  |   | 477,000    |  
|                                       
|                                       
|                                       
|                                       
|Other Assets/Liabilities                |  |   | (824,000   | )
|                                       
|                                       
|                                       
|                                       
|Excess of Cost over Net Assets Acquired |  | $ | 15,843,000 |  
|                                        |  |   |            |  
|Total                                   |  | $ | 16,875,000 |  
|                                        |  |   |            |  



| | Pro Forma operating results for the years ended December 31, 2000 and 1999,
as required under APB 16 (Accounting Principles Board Opinion number 16,
regarding Business Combinations), are as follow:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                   |  |      |             |      |  |   |             |  
|------------------ |  | ---- | ----------- | ---- |  | - | ----------- | -
|                   |  | 2000 |             | 1999
|                   |  |      |             |     
|Revenue            |  | $    | 552,000     |      |  | $ | 3,073,000   |  
|                  
|                  
|                  
|                  
|Operating Loss     |  | $    | (15,385,000 | )    |  | $ | (12,074,000 | )
|                  
|                  
|                  
|                  
|Net Loss           |  | $    | (20,899,000 | )    |  | $ | (25,531,000 | )
|                  
|                  
|                  
|                  
|                  
|                  
|                  
|                  
|                  
|                  
|                  
|                  
|Net Loss per share |  | $    | (0.63       | )    |  | $ | (1.99       | )

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5. INVENTORIES

Inventories consist of the following:

|                 |  |              |           |      |  |   |           | 
|---------------- |  | ------------ | --------- | ---- |  | - | --------- | 
|                 |  | DECEMBER 31,
|                 |  |             
|                 |  | 2000         |           | 1999
|                 |  |              |           |     
|Raw materials    |  | $            | 1,266,803 |      |  | $ | 735,787   | 
|                
|                
|                
|                
|Work-in-process  |  |              | 397,274   |      |  |   |          | 
|                
|                
|                
|                
|Finished product |  |              | 264,270   |      |  |   | 356,926   | 
|                 |  |              |           |      |  |   |           | 
|                 |  | $            | 1,928,347 |      |  | $ | 1,092,713 | 
|                 |  |              |           |      |  |   |           | 

Cost of product sales for the years ending December 31, 2000 and 1999
includes approximately $864,000 and $649,000, respectively, of costs in excess
of the net realizable value of inventory.

6. CAPITAL STOCK

The Company has an authorized class of undesignated preferred stock
consisting of 300,000 shares. Preferred stock may be issued in series from time
to time with such designations, relative rights, priorities, preferences,
qualifications, limitations and restrictions thereof, to the extent that such
are not fixed in the Companys certificate of incorporation, as the Board of
Directors determines.

On February 9, 1996, the Board of Directors adopted a shareholder rights
plan (the Rights Plan). In conjunction with the adoption of the Rights Plan,
the Company created one series of preferred stock, consisting of 10,000 shares
of Series A Junior Participating Preferred Stock (Series A Preferred). Each
share of Series A Preferred would entitle the holder to receive dividends equal
to 1,000 times the dividends per share declared with respect to the Companys
common stock and, in the event of liquidation, such holders would receive a
preference of 1,000 times the aggregate amount to be distributed per share to
the holders of the Companys common stock. Pursuant to the Rights Plan, a Series
A Right is associated with, and trades with, each share of common stock
outstanding.

The record date for distribution of such Series A Rights was February 22,
1996, and for so long as the Series A Rights are associated with the common
stock, each new share of common stock issued by the Company will include a
Series A Right.

Each Series A Right will entitle its holder to purchase one one-thousandth
of a share of Series A Preferred for $200, subject to adjustment as defined in
the Rights Plan. The Series A Rights are not exercisable until the earlier of
(i) 10 days after any person or group becomes the beneficial owner of 15% or
more of the Companys outstanding common stock, or (ii) 10 business days (unless
extended by the Board of Directors) after the commencement of a tender offer or
exchange offer that would result in a person or group beneficially owning 15% or
more of the Companys outstanding common stock.

If any person or group (Acquiring Party) acquires 15% or more of the
Companys outstanding common stock (Shares Acquisition Date), each holder of a
Series A Right, except the Acquiring Party, has the right to receive upon
exercise (i) shares of the Companys common stock having a market value equal to
two times the exercise price of the Series A Right, and (ii) one Series B Right
(Series A Rights and Series B Rights are hereinafter collectively referred to as
the Rights). The Board of Directors has the option, after the Shares
Acquisition Date but before there has been a 50% acquisition of the Company, to
exchange one share of common stock (or one one-thousandth of a share of
preferred stock) and one Series B Right for each Series A Right (other than
Series A Rights held by the Acquiring Party).

If, after the Series A Rights become exercisable, the Company is involved in
a merger or other business combination, or if the Company sells or transfers

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more than 50% of its assets or earning power, or if an acquiring party engages
in certain self-dealing transactions with the Company, as defined in the
Rights Plan, each Right then outstanding (other than Rights held by the
Acquiring Party) will be exercisable for common stock of the other party to such
transaction having a market value of two times the exercise price of the Right.
The Company has the right to redeem each Series A Right for $0.01 prior to the
Shares Acquisition Date. The Series B Rights, once issued, are not redeemable.
The Rights expire on February 9, 2006.

On November 14, 1995, the Company completed the private placement and
issuance of 356,473 Units, which raised $3,581,282, net of related expenses.
Each Unit consisted of one share of common stock and one detachable common stock
purchase warrant. Each warrant had a term of two years and was exercisable for
the purchase of one share of common stock at $13.00 per share. Warrants for
15,700 of these shares were exercised prior to December 23, 1996. The remaining
340,773 warrants were redeemed by the Company on December 23, 1996. In
conjunction with the redemption, the Company issued 340,773 shares of its common
stock in exchange for $3,287,304 in cash plus $1,142,754 of notes. The notes,
bearing interest at 8.25% per annum, were due on April 30, 1997, and were
guaranteed by an affiliate of a stockholder. Payments made during 1998 and 1997
on the notes receivable totaled $17,812 and $444,246, respectively. The
remaining balance due of $680,696 was forgiven as part of a settlement agreement
and was charged to additional paid-in capital in the first quarter of 2000 (Note
11).

On June 6, 1997, the Company issued 600 shares of Series B Convertible
Preferred Stock (Series B Stock) for $5,000 per share, or $3,000,000. In
connection with the sale, the Company issued warrants to purchase 62,500 shares
of common stock at $14.8125 per share expiring on June 6, 2001. On each of
August 29, 1997 and October 29, 1997, the Company issued 300 shares of Series C
Convertible Preferred Stock (Series C Stock) for $5,000 per share, or
$3,000,000 in aggregate. In addition, on October 29, 1997, the Company issued
700 shares of Series G Convertible Preferred Stock (Series G Stock) for $5,000
per share, or $3,500,000. In connection with the sale of Series G Stock, the
Company issued warrants to purchase an aggregate of 34,782 shares of common
stock at an original exercise price of $10.0625 per share, expiring on October
29, 2001. On November 5, 1999, in conjunction with certain amendments to the
Companys senior convertible notes (Note 7), these outstanding warrants were
amended to reduce the exercise price to $0.25 per share. Total proceeds for the
above issuances, net of related expenses, was $9,020,028. None of the Preferred
Stock has voting rights. The Series B Stock was convertible into common stock at
a conversion price equal to the lessor of (a) $11.85, or (b) 101% of the average
of the lowest per share market value for the five consecutive trading days
during the 60 trading days immediately preceding the date of the conversion. The
Series C Stock and Series G Stock was convertible into common stock at a
conversion price equal to the lessor of (a) $8.05 or (b) 101% of the average of
the lowest per share market value for the five consecutive trading days during
the 60 trading days immediately proceeding the date of conversion. The
conversion ratio was subject to adjustment. Dividends on the Series B, Series C
and Series G Convertible Preferred Stock were payable at the rate of 5% per
annum, and were payable in cash or shares of common stock, at the option of the
Company.

During 1997, $2,525,000 (505 shares) of Series B Convertible Preferred Stock
were converted into 801,992 shares of common stock. Accrued dividends thereon of
$61,138 were also converted into 19,940 shares of common stock.

During 1998, $475,000 (95 shares) of Series B Convertible Preferred Stock
were converted into 270,671 shares of common stock. Accrued dividends thereon of
$13,794 were also converted into 7,860 shares of common stock. In addition,
$3,000,000 (600 shares) of Series C Convertible Preferred Stock were converted
into 2,611,299 shares of common stock. Accrued dividends thereon of $62,801 were
also converted into 54,646 shares of common stock. In addition, $3,500,000 (700
shares) of Series G Convertible Preferred Stock were converted into 3,509,125
shares of common stock. Accrued dividends thereon of $67,403 were also converted
into 67,577 shares of common stock.

On July 18, 2000, the stockholders of the Company approved an increase in
the number of shares of authorized common stock from 60,000,000 to 250,000,000.

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On October 20, 2000, the Company sold 1,818,182 shares of common stock to
its investors (Elliott Associates, L.P. and Westgate International, L.P.) in
exchange for $5 million.

At December 31, 2000, authorized but unissued shares of common stock have
been reserved for future issuance as follows:

|                                                    |                            |  |           |         | 
|--------------------------------------------------- | -------------------------- |  | --------- | ------- | 
|Warrants outstanding (Note 7)                       |                            |  | 96,000    |        
|                                                   
|                                                   
|                                                   
|                                                   
|Options outstanding (Note 7)                        |                            |  | 5,443,000 |        
|                                                   
|                                                   
|                                                   
|                                                   
|Options reserved for future issuance under the 1993
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Stock Option Plan (Note 7) |  |           | 223,000 | 
|                                                    |                            |  |           |        
|                                                    |                            |  | 5,762,000 |        
|                                                    |                            |  |           |        

7. STOCK OPTIONS AND WARRANTS

On August 19, 1993, the Board of Directors adopted the 1993 Stock Option
Plan (the Plan) for employees, consultants, and directors who are not also
employees of the Company (outside directors). The maximum number of shares
issuable under the Plan, as amended in 2000, is 5,704,957 (5,666,000 options
shown above plus those reserved for under the option program absorbed during the
Spectral Solutions, Inc. acquisition). The Plan is administered by a committee
(the Committee) consisting of two or more outside directors appointed by the
board of directors of the Company.

For employees and consultants, the Plan provides for granting of Incentive
Stock Options (ISOs) and Nonstatutory Stock Options (NSOs). In the case of ISOs,
the exercise price shall not be less than 100% (110% in certain cases) of the
fair value of the Companys common stock, as determined by the Committee, on the
date of grant. In the case of NSOs, the exercise price shall not be less than
85% (110% in certain cases) of the fair value of the Companys common stock, as
determined by the Committee, on the date of grant. The term of options granted
to employees and consultants will be for a period not to exceed 10 years (five
years in certain cases). Options granted under the Plan generally vest over a
four year period (one-fourth of options granted vest after one year from the
grant date and the remaining options vest ratably each month thereafter). In
addition, the Committee may authorize option grants with vesting provisions that
are not based solely on employees rendering of additional service to the
Company.

For outside directors, NSOs only will be granted with an exercise price of
100% of the fair value of the stock, as determined by the Committee, on the date
of grant. The Plan provides that each outside director will be automatically
granted 10,000 NSOs on the date of their initial election to the board of
directors. On the date of the annual meeting of the stockholders of the Company,
each outside director who is elected, reelected, or continues to serve as a
director, shall be granted not less than 3,000 nor more than 10,000 NSOs, except
for those outside directors who are first elected to the Board of Directors at
the meeting or three months prior. The options granted vest ratably over three
years and expire after ten years from the grant date.

The Company entered into stock option agreements with certain employees and
a consultant prior to the adoption of the Plan. These stock options expire 10
years from the date of grant. Exercise prices were determined by the Board of
Directors and represented estimated fair values of the Companys common stock at
the grant date.

On May 10, 1999, the Board of Directors granted to each employee of the
Company (other than the executive officers of the Company) (collectively, the
Non-Executive Employees) the option to (i) reduce the exercise prices of up to
a maximum of 15,000 of the unexercised stock options previously granted to such
Non-Executive Employee under the Plan to $.5625 per share (the closing price of
the Companys Common Stock on May 10, 1999) and (ii) cause all of such stock
options not otherwise scheduled to become fully vested on or before May 10, 2000
to become fully vested on such date. As a result thereof, an aggregate of
279,550 stock options previously granted under the Plan were amended as
described in the preceding sentence. In addition, on May 10, 1999 the Board of
Directors granted to the executive officers and certain Non-Executive Employees
of the Company additional non-statutory stock options to purchase an aggregate

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of 343,575 shares of the Companys Common Stock under the Plan. Such stock
options become fully vested on the first anniversary of the date of grant, have
exercise prices of $.5625 per share and expire 10 years from the date of grant.

The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees (APB 25) and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under
Financial Accounting Standards Board No. 123, Accounting for Stock-Based
Compensation (FASB 123) requires the use of option valuation models that were
not developed for use in valuing employee stock options. Under APB 25, since the
exercise price of the Companys employee stock option grants has equaled the
market price of the underlying stock on the date of grant, generally no
compensation expense is recognized. However, based on the recently adopted
interpretation of APB 25, the Company must record non-cash charges to the extent
the 279,550 modified options under this plan have an underlying share value in
excess of $4.78 per share (the price on the July 1, 2000 adoption date of the
interpretation).

Pro forma information regarding net income and earnings per share is
required under FASB 123, and has been determined as if the Company had accounted
for its stock options granted subsequent to December 31, 1994 under the fair
value method of that Statement. The fair value for these options was estimated
at the date of grant using a Black-Scholes option pricing model with the
following weighted-average assumptions for the years ended December 31, 2000,
1999 and 1998: risk-free interest rate of 5.1%, 6.0%, and 5.6%, respectively; a
dividend yield of 0%; volatility factor of the expected market price of the
Companys common stock of 2.33, 1.68, and .96, respectively; and expected life
of the options of 4.0 years.

The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions, including the expected stock price volatility.
Because the Companys employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in managements
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options vesting period. The Companys
pro forma information is as follows:

|                                                  |  |                         |             |      |  |      |             |   |  |   |             |  
|------------------------------------------------- |  | ----------------------- | ----------- | ---- |  | ---- | ----------- | - |  | - | ----------- | -
|                                                  |  | YEAR ENDED DECEMBER 31,
|                                                  |  |                        
|                                                  |  | 2000                    |             | 1999 |  | 1998
|                                                  |  |                         |             |      |  |     
|Pro forma net loss                                |  | $                       | (18,796,183 | )    |  | $    | (23,522,352 | ) |  | $ | (22,863,252 | )
|                                                 
|                                                 
|                                                 
|                                                 
|Pro forma basic and diluted loss per
common share |  | $                       | (0.57       | )    |  | $    | (1.83       | ) |  | $ | (2.02       | )

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The table below summarizes all option activity during the three year period
ended December 31, 2000:

|                                 |  |             |             |           |  |              
|-------------------------------- |  | ----------- | ----------- | --------- |  | -------------
|                                 |  |             |             |           |  | EXERCISE     
|                                 |  | OPTIONS     |             | PRICE    
|                                 |  | OUTSTANDING |             | PER SHARE
|                                 |  |             |             |          
|Outstanding at December 31, 1997 |  |             | 683,333     |           |  | .18 - 26.50  
|                                
|                                
|                                
|                                
|Granted                          |  |             | 780,900     |           |  | 1.03 - 2.00  
|                                
|                                
|                                
|                                
|Exercised                        |  |             | (33,942)    |           |  | .18 - .23    
|                                
|                                
|                                
|                                
|Forfeited                        |  |             | (236,314)   |           |  | .23 - 26.50  
|                                 |  |             |             |          
|Outstanding at December 31, 1998 |  |             | 1,193,977   |           |  | .18 - 26.50  
|                                
|                                
|                                
|                                
|Granted                          |  |             | 1,935,125   |           |  | .45 - 1.31   
|                                
|                                
|                                
|                                
|Exercised                        |  |             | (17,250)    |           |  | .18 - .23    
|                                
|                                
|                                
|                                
|Forfeited                        |  |             | (1,197,005) |           |  | .48 - 26.50  
|                                 |  |             |             |          
|Outstanding at December 31, 1999 |  |             | 1,914,847   |           |  | $ .18 - 26.50
|                                 |  |             |             |          
|Granted                          |  |             | 3,986,561   |           |  | .00 - 6.60   
|                                
|                                
|                                
|                                
|Exercised                        |  |             | (362,812)   |           |  | .48 - 1.81   
|                                
|                                
|                                
|                                
|Forfeited                        |  |             | (96,000)    |           |  | .48 - 4.94   
|                                 |  |             |             |          
|Outstanding at December 31, 2000 |  |             | 5,442,596   |           |  | $ .00 - 26.50
|                                 |  |             |             |          

The weighted-average exercise price of options outstanding at December 31,
2000, 1999 and 1998, was $2.97, $1.83 and $6.71, respectively. The
weighted-average exercise price of options granted, exercised, and forfeited
during 2000 was $3.86, $0.61 and $4.20, respectively. The weighted-average fair
value of options granted during 2000, 1999 and 1998 was $3.86, $0.53 and $1.09,
respectively.

Following is additional information with respect to options outstanding at
December 31, 2000:

|                                  |                                                      |  |            |         |            |  |            |           |            |  |            |         |  |  |   |           |  |  |   |         | 
|--------------------------------- | ---------------------------------------------------- |  | ---------- | ------- | ---------- |  | ---------- | --------- | ---------- |  | ---------- | ------- |  |  | - | --------- |  |  | - | ------- | 
|                                  |                                                      |  | EXERCISE   |         | EXERCISE   |  | EXERCISE   |           | EXERCISE   |  | EXERCISE  
|                                  |                                                      |  | PRICE FROM |         | PRICE FROM |  | PRICE FROM |           | PRICE FROM |  | PRICE FROM
|                                  |                                                      |  | $0.00 TO   |         | $0.40 TO   |  | $0.66 TO   |           | $2.96 TO   |  | $6.60 TO  
|                                  |                                                      |  | $0.30      |         | $0.56      |  | $2.00      |           | $4.94      |  | $26.50    
|                                  |                                                      |  |            |         |            |  |            |           |            |  |           
|OUTSTANDING AT DECEMBER 31, 2000:
|                                 
|                                 
|                                 
|                                 
|                                  | Number of options                                    |  |            | 501,369 |            |  |            | 1,058,140 |            |  |            | 843,500 |  |  |   | 2,376,000 |  |  |   | 663,587 | 
|                                 
|                                 
|                                 
|                                 
|                                  | Weighted-average
exercise price                      |  | $          | 0.04    |            |  | $          | 0.49      |            |  | $          | 1.34    |  |  | $ | 3.74      |  |  | $ | 8.50    | 
|                                 
|                                 
|                                 
|                                 
|                                  | Weighted-average remaining
contractual life in years |  |            | 8.47    |            |  |            | 8.39      |            |  |            | 9.11    |  |  |   | 9.05      |  |  |   | 8.01    | 
|                                 
|                                 
|                                 
|                                 
|EXERCISABLE AT DECEMBER 31, 2000:
|                                 
|                                 
|                                 
|                                 
|                                  | Number of options                                    |  |            | 38,344  |            |  |            | 1,057,432 |            |  |            | 241,270 |  |  |   | 65,385    |  |  |   | 163,587 | 
|                                 
|                                 
|                                 
|                                 
|                                  | Weighted-average
exercise price                      |  | $          | 0.29    |            |  | $          | 0.49      |            |  | $          | 1.27    |  |  | $ | 3.25      |  |  | $ | 14.27   | 

The total number of unvested options outstanding at December 31, 2000 was
3,876,578, all of which will vest based on employees continued service to the
Company.

On February 15, 2000, the Board of Directors of the Company granted to
certain executive level employees (i) an aggregate of 440,000 Deferred Stock
Units (DSUs) and (ii) an aggregate of 585,000 NSOs under the Plan. The NSOs have
an exercise price of $4.1875 per share (the closing price of the Companys
common stock on February 15, 2000). The Deferred Stock Units represent the right
to

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receive an equivalent number of restricted shares of the Companys common
stock. Both the Deferred Stock Units and the NSOs vest at the rate of 10%, 20%,
30% and 40% on the first, second, third and fourth anniversary, respectively, of
the date of grant. For accounting purposes, the value of the DSUs is amortized
using the straight-line method over the four year period. The executive level
employees have the right to defer receipt of the common stock subject to the
Deferred Stock Units to a later date as elected by the employee. Both the NSOs
and the DSUs are included in table above.

In December 1991 and January 1992, the Company issued common stock purchase
warrants for 34,063 and 74,938 shares, respectively, to preferred stockholders
in conjunction with short-term loans from the stockholders. These warrants have
an exercise price of $1.4679 per share and expire 10 years from the date of
issue. Warrants for 33,033 were still outstanding as of December 31, 2000.

The Company issued warrants to purchase 470,589 shares of common stock in
connection with the July 1993 issuance of Series C Preferred Stock. These
warrants are exercisable at $9.56 per share. Warrants for 64,614 and 69,020 of
these shares were exercised during 1997 and 1996, respectively. On February 22,
2000, 210,196 of these warrants were surrendered to the Company as part of a
settlement agreement (Note 11). The remaining warrants expired in November 2000.

On June 6, 1997, the Company issued warrants to purchase 62,500 shares of
common stock in connection with the issuance of Series B Convertible Preferred
Stock (Note 5). These warrants had an exercise price of $14.8125 per share and
expire on June 6, 2001.

On October 29, 1997, the Company issued warrants to purchase 34,782 shares
of common stock in connection with the issuance of Series G Convertible
Preferred Stock (Note 5). These warrants had an original exercise price of
$10.0625 per share and expire on October 29, 2001. On November 5, 1999, in
conjunction with certain amendments to the Companys senior convertible notes
(Note 7), these outstanding warrants were amended to reduce the exercise price
to $0.25 per share. These warrants were exercised during 2000, leaving no
warrants outstanding.

On May 15, 1998, the Company issued warrants to purchase 4,140,000 shares of
common stock in connection with the issuance of the Companys senior convertible
notes (Note 7). Of the original warrants issued, 3,800,000 of these warrants
have an exercise price of $0.25 per share and 340,000 of these warrants had an
exercise price of $3.75 per share. These warrants expire on May 15, 2001. These
warrants were fully exercised, leaving none outstanding.

On March 31, 1999, the Company issued warrants to purchase 1,320,000 shares
of common stock in connection with the issuance of the Companys senior
convertible notes (Note 7). Of the original warrants issued, 1,200,000 of these
warrants have an exercise price of $0.25 per share and 120,000 of these warrants
had an exercise price of $1.4625 per share. These warrants expire on March 31,
2002. These warrants were fully exercised, leaving none outstanding.

On November 5, 1999 and December 29, 1999, the Company issued warrants to
purchase an aggregate total of 800,000 shares of common stock in connection with
the issuance of the Companys senior convertible notes (Note 7). These warrants
had an exercise price of $0.25 per share and expire on November 5, 2004. These
warrants were fully exercised, leaving none outstanding.

On July 17, 2000, the Company issued 200,000 stock options to non-employees
in connection with the opening of the Japanese sales office. 25% of these
options vested immediately, while the remaining 75% are to vest ratably over a
three year period. These options had a value according to the Black-Scholes
model on the date of grant of $4.53 per share. Compensation expense of $906,000
will be recognized over the life of the options, 25% immediately and the
remaining 75% over a three year straight-line amortization.

During 2000, a total of 7,950,356 shares of common stock were issued in
association with the exercise of warrants.

8. LONG-TERM DEBT

On May 15, 1998, the Company issued and sold $10,350,000 in aggregate

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principal amount of senior convertible notes due May 15, 2002 (the May 1998
Notes) and issued warrants (the May 1998 Warrants) to purchase 4,140,000
shares of the Companys common stock. The May 1998 Notes (based upon the terms
at their time of issue) bear interest at 2% per annum, payable in cash or shares
of Common Stock, at the Companys option (unless the Company does not meet
certain requirements commencing November 5, 2001, in which case interest must be
paid in cash). The May 1998 Notes mature on May 15, 2002 and (based upon the
terms at their time of issue) are convertible (based on the principal amount,
plus accrued and unpaid interest, if any) into shares of the Companys common
stock at a fixed conversion price of $1.50 per share. On and after May 15, 2000,
the Company may redeem all or a portion of the May 1998 Notes at a redemption
price equal to the principal amount plus accrued interest thereon, if any, under
certain conditions. The May 1998 Warrants (based upon the terms at their time of
issue) have an exercise price of $3.75 per share and expire on May 15, 2001.

Since the May 1998 Notes were issued with a non-detachable conversion
feature that was in-the-money at the date of issuance, a portion of the
proceeds equal to the intrinsic value of the conversion feature (equal to
$9,918,750, and calculated as the difference between the conversion price and
the quoted market price of the Companys common stock on the date of issuance,
multiplied by the number of shares into which the May 1998 Notes are
convertible) was allocated to additional paid-in capital, thus creating a
discount to the debt. This discount was recognized as a charge to interest
expense using the effective interest method over the period from the date of
issuance to the date that the May 1998 Notes first became convertible (August
15, 1998 for up to one-half of the original principal amount and November 15,
1998 for the remaining principal amount). In addition, a portion of the proceeds
equal to the fair value of the May 1998 Warrants issued in conjunction with the
May 1998 Notes (equal to $1,230,000, and calculated using a Black-Scholes
valuation model) was allocated to additional paid-in capital, thus creating an
additional discount to the debt. This discount is being recognized as a charge
to interest expense using the effective interest method over the four year term
of the May 1998 Notes.

On March 31, 1999, the Company issued and sold $3,300,000 in aggregate
initial principal amount of senior convertible notes due May 15, 2002 (the
March 1999 Notes) and issued warrants (the March 1999 Warrants) to purchase
1,320,000 shares of the Companys common stock. The March 1999 Notes bear
interest at 6% per annum, payable in kind or in cash, at the Companys option
(unless the Company fails to meet certain requirements commencing November 5,
2001, in which case interest must be paid in cash). Holders of the March 1999
Notes may convert the principal amount, plus accrued interest not paid in cash,
if any, into shares of the Companys common stock at a fixed conversion price of
$1.125 per share (based upon the terms at their time of issue). On and after May
15, 2000, the Company may redeem all or a portion of the March 1999 Notes at a
redemption price equal to the principal amount plus accrued interest thereon, if
any, under certain conditions. The March 1999 Warrants (based upon the terms at
their time of issue) have an exercise price of $1.4625 per share and expire on
March 31, 2002.

Concurrently with the issuance of the March 1999 Notes, the Company amended
certain terms of $5,500,000 in aggregate principal amount of the May 1998 Notes
(the Amended Notes) and May 1998 Warrants exercisable for an aggregate of
2,200,000 shares of the Companys common stock (the Amended Warrants) issued
in connection therewith (the March 1999 Amendments). The Amended Notes, as so
amended, bear interest at the rate of 6% per annum, payable in cash or shares of
the Companys common stock, at the Companys option (unless the Company failed
to meet certain requirements commencing November 5, 2001, in which case interest
would have been paid in cash), and the fixed conversion price for the Amended
Notes was reduced from $1.50 to $1.125 per share. The exercise price of the
Amended Warrants was reduced from $3.75 to $1.4625 per share and the expiration
date was extended from May 15, 2001 to March 31, 2002.

A portion of the proceeds of the March 1999 Notes equal to the fair value of
the March 1999 Warrants issued in conjunction with the March 1999 Notes (equal
to $300,000 and calculated using a Black-Scholes valuation model) was allocated
to additional paid-in capital, thus creating a discount to the debt. This
discount is being recognized as a charge to interest expense using the effective
interest method over the three year term of the March 1999 Notes. In addition,
the increase in fair value of the Amended Warrants as a result of the

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decrease in exercise price (equal to $41,000 and calculated using a
Black-Scholes valuation model) was allocated to additional paid-in capital, thus
creating an additional discount on the Amended Notes. This discount was
recognized as a charge to interest expense using the effective interest method
over the remaining three-year term of the Amended Notes.

On November 5, 1999, the Company issued and sold $1,000,000 in aggregate
principal amount of senior convertible notes due January 2, 2001 (the November
1999 Notes) and issued warrants (the November 1999 Warrants) to purchase
400,000 shares of the Companys common stock. The November 1999 Notes bear
interest at 10% per annum, payable in kind or in cash, at the Companys option
(unless the Company does not meet certain requirements commencing November 5,
2001, in which case interest must be paid in cash). Holders of the November 1999
Notes may convert the principal amount, plus accrued interest not paid in cash,
if any, into shares of the Companys common stock at a fixed conversion price of
$0.25 per share. The November 1999 Warrants have an exercise price of $0.25 per
share and expire on November 5, 2004. All notes were converted into equity
before December 31, 2000.

Concurrently with the issuance of the November 1999 Notes, the Company
amended certain terms of $11,800,000 in aggregate principal amount of the March
1999 Notes, the Amended Notes and the May 1998 Notes (the Further Amended
Notes) and certain terms of the March 1999 Warrants, the Amended Warrants and
the May 1998 Warrants previously exercisable for an aggregate of 4,800,000
shares of the Companys common stock (the Further Amended Warrants) issued in
connection therewith (the November 1999 Amendments). The Further Amended
Notes were amended to reduce their fixed conversion price to $0.25 per share and
to provide that interest on the Further Amended Notes can be paid in cash or
shares of the Companys common stock, at the Companys option until November 5,
2000, after which interest must be paid in cash if the Company fails to meet
certain requirements. The exercise price of the Further Amended Warrants was
reduced to $0.25 per share. All notes were converted into equity before December
31, 2000.

Since the November 1999 Notes were issued with a non-detachable conversion
feature that was in-the-money at the date of issuance, a portion of the
proceeds equal to the intrinsic value of the conversion feature (calculated as
the difference between the conversion price ($0.25 per share) and the quoted
market price of the Companys common stock on the date of issuance ($0.46875 per
share) multiplied by the number of shares into which the November 1999 Notes are
convertible (4,000,000 shares)) must be allocated to additional paid-in capital,
thus creating a discount to the debt. This discount, which was limited to
$844,000 because the intrinsic value of the beneficial conversion feature cannot
exceed the amount allocated to the convertible instrument, was recognized as a
charge to interest expense during the fourth quarter of 1999 since the November
1999 Notes are immediately convertible into common stock. In addition, a portion
of the proceeds of the November 1999 Notes equal to the fair value of the
November 1999 Warrants issued in conjunction with the November 1999 Notes (equal
to $156,000 and calculated using a Black-Scholes valuation model) was allocated
to additional paid-in capital, thus creating an additional discount to the debt.
This additional discount was to be recognized as a charge to interest expense
using the effective interest method over the fourteen month term of the November
1999 Notes. All notes were converted into equity before December 31, 2000.

Since the Further Amended Notes were amended to reduce the non-detachable
conversion feature so that they were in-the-money on November 5, 1999, a
portion of the principal amount equal to the intrinsic value of the conversion
feature (calculated as the difference between the amended conversion price
($0.25 per share) and the quoted market price of the Companys common stock on
the amendment date ($0.46875) multiplied by the number of shares into which the
Further Amended Notes are convertible (47,200,000)) must be allocated to
additional paid-in capital, thus creating a discount to the debt. This discount,
which was limited to $10,264,000 because the intrinsic value of the beneficial
conversion feature cannot exceed the amount allocated to the convertible
instrument, was recognized as a charge to interest expense during the fourth
quarter of 1999 since the Further Amended Notes are immediately convertible into
common stock. In addition, the increase in fair value of the Further Amended
Warrants as a result of the decrease in exercise price (equal to $1,132,000 and
calculated using a Black-Scholes valuation model) was allocated to additional
paid-in capital, thus creating an additional discount on the Further Amended
Notes. This additional discount was to be recognized as a charge to interest

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expense using the effective interest method over the remaining term of the
Further Amended Notes. All notes were converted into equity before December 31,
2000.

The March 1999 Amendments and the November 1999 Amendments were accounted
for and reported in the same manner as a debt extinguishment. This resulted in a
$745,197 charge, which is shown as an extraordinary item in the Companys
Statements of Operations for the year ended December 31, 1999.

On December 29, 1999, the Company issued and sold $1,000,000 in aggregate
principal amount of senior convertible notes due January 2, 2001 (the December
1999 Notes) and issued warrants (the December 1999 Warrants) to purchase
400,000 shares of the Companys common stock. The December 1999 Notes bear
interest at 10% per annum, payable in kind or in cash, at the Companys option
(unless the Company does not meet certain requirements commencing November 5,
2001, in which case interest must be paid in cash). Holders of the December 1999
Notes may convert the principal amount, plus accrued interest not paid in cash,
if any, into shares of the Companys common stock at a fixed conversion price of
$0.25 per share. The December 1999 Warrants had an exercise price of $0.25 per
share and expire on November 5, 2004. All notes were converted into equity
before December 31, 2000.

Since the December 1999 Notes were issued with a non-detachable conversion
feature that was in-the-money at the date of issuance, a portion of the
proceeds equal to the intrinsic value of the conversion feature (equal to
$500,000, and calculated as the difference between the conversion price ($0.25
per share) and the quoted market price of the Companys common stock on the date
of issuance ($0.375 per share) multiplied by the number of shares into which the
December 1999 Notes are convertible (4,000,000 shares)) was allocated to
additional paid-in capital, thus creating a discount to the debt. This discount
was recognized as a charge to interest expense since the notes are immediately
convertible into common stock. In addition, a portion of the proceeds of the
December 1999 Notes equal to the fair value of the December 1999 Warrants issued
in conjunction with the December 1999 Notes (equal to $104,000 and calculated
using a Black-Scholes valuation model) was allocated to additional paid-in
capital, thus creating an additional discount to the debt. This additional
discount was recognized as a charge to interest expense using the effective
interest method over the twelve month term of the December 1999 Notes. All notes
were converted into equity before December 31, 2000.

During 2000, all of the outstanding senior convertible notes were converted
into 75,894,430 shares of common stock. This action removed all debt from the
Companys books.

The Company recognized $5,631,581, $12,608,355, and $10,101,401 of non-cash
interest charges during 2000, 1999, and 1998, respectively as a result of
amortizing the debt discount and the deferred financing fees related to the
Companys senior convertible notes.

9. INCOME TAXES

The Company has net operating loss and research and development credit
carryforwards for tax purposes of approximately $60,584,000 and $1,075,000,
respectively, at December 31, 1999. The net operating loss carryforwards expire
in the following years:

|     |  |        |            | 
|---- |  | ------ | ---------- | 
|YEAR |  | AMOUNT
|     |  |       
|2005 |  | $      | 7,000      | 
|    
|    
|    
|    
|2006 |  |        | 638,000    | 
|    
|    
|    
|    
|2007 |  |        | 974,000    | 
|    
|    
|    
|    
|2008 |  |        | 1,658,000  | 
|    
|    
|    
|    
|2009 |  |        | 3,973,000  | 
|    
|    
|    
|    
|2010 |  |        | 8,199,000  | 
|    
|    
|    
|    
|2011 |  |        | 11,953,000 | 
|    
|    
|    
|    
|2012 |  |        | 11,922,000 | 
|    
|    
|    
|    
|2018 |  |        | 11,146,000 | 
|    
|    
|    
|    
|2019 |  |        | 10,726,000 | 
|    
|    
|    
|    
|2020 |  |        | 15,105,000 | 
|     |  |        |            | 
|     |  | $      | 75,689,000 | 
|     |  |        |            | 

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Significant components of the Companys deferred tax assets and liabilities
are as follows:

|                          |                                                   |   |              |            |      |   |             |            |  
|------------------------- | ------------------------------------------------- | - | ------------ | ---------- | ---- | - | ----------- | ---------- | -
|                          |                                                   |   | DECEMBER 31,
|                          |                                                   |   |             
|                          |                                                   |   | 2000         |            | 1999
|                          |                                                   |   |              |            |     
|Deferred tax assets:     
|                         
|                         
|                         
|                         
|                          | Net operating loss carryforward                   |   | $            | 28,754,000 |      |   | $           | 23,023,000 |  
|                         
|                         
|                         
|                         
|                          | Research and development tax credit
carryforwards |   |              | 1,153,000  |      |   |             | 1,075,000  |  
|                         
|                         
|                         
|                         
|                          | Deferred compensation                             |   |              | 3,000      |      |   |             | 3,000      |  
|                         
|                         
|                         
|                         
|                          | Accrued liabilities                               |   |              | 277,000    |      |   |             | 130,000    |  
|                         
|                         
|                         
|                         
|                          | Accounts receivable                               |   |              |           |      |   |             | 13,000     |  
|                         
|                         
|                         
|                         
|                          | Inventories                                       |   |              | 234,000    |      |   |             | 324,000    |  
|                         
|                         
|                         
|                         
|                          | Property, Equipment, and Goodwill                 |   |              | 217,000    |      |   |             |           |  
|                          |                                                   |   |              |            |      |   |             |           
|Total deferred tax assets |                                                   |   | 30,638,000   |            |      |   | 24,568,000  |           
|                         
|                         
|                         
|                         
|Deferred tax liabilities:
|                         
|                         
|                         
|                         
|                          | Patent costs                                      |   |              | (205,000   | )    |   |             | (225,000   | )
|                         
|                         
|                         
|                         
|                          | Property and equipment                            |   |              |           |      |   |             | (29,000    | )
|                          |                                                   |   |              |            |      |   |             |           
|                          |                                                   |   | (205,000     | )          |      |   | (254,000    | )         
|                          |                                                   |   |              |            |      |   |             |           
|Net deferred tax assets   |                                                   |   | 30,433,000   |            |      |   | 24,314,000  |           
|                         
|                         
|                         
|                         
|Valuation allowance       |                                                   |   | (30,433,000  | )          |      |   | (24,314,000 | )         
|                          |                                                   |   |              |            |      |   |             |           
|Net deferred tax assets   |                                                   | $ |             |            |      | $ |            |           
|                          |                                                   |   |              |            |      |   |             |           

The valuation allowance increased during 2000 and 1999 by $6,119,000 and
$4,176,000, respectively, due primarily to the increase in the net operating
loss carryforward. Based on the Internal Revenue Code and changes in the
ownership of the Company, utilization of the net operating loss carryforwards
will be subject to annual limitations.

10. LEASES

The Company leases its manufacturing and office space. Under the terms of
the lease in Mount Prospect, IL, which expires October 2004, the Company is
responsible for all real estate taxes and operating expenses. The lease provides
for a security deposit($150,000 at December 31, 2000) that is secured by a
certificate of deposit owned by the Company.

Future minimum payments under the operating lease consist of the following
at December 31, 2000:

|           |  |        |           | 
|---------- |  | ------ | --------- | 
|YEAR       |  | AMOUNT
|           |  |       
|2001       |  | $      | 639,000   | 
|          
|          
|          
|          
|2002       |  |        | 615,000   | 
|          
|          
|          
|          
|2003       |  |        | 470,000   | 
|          
|          
|          
|          
|2004       |  |        | 288,000   | 
|          
|          
|          
|          
|2005       |  |        |          | 
|          
|          
|          
|          
|Thereafter |  |        |          | 
|           |  |        |           | 
|           |  | $      | 2,012,000 | 
|           |  |        |           | 

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Rent expense totaled $312,000, $228,000 and $230,000, for the years ended
December 31, 2000, 1999, and 1998, respectively.

11. 401(k) PLAN

The Company has a 401(k) plan covering all employees who meet prescribed
service requirements. The plan provides for deferred salary contributions by the
plan participants and a Company contribution. Company contributions, if any, are
at the discretion of the Board of Directors and are not to exceed the amount
deductible under applicable income tax laws. No Company contribution was made
for the years ended December 31, 2000, 1999, and 1998.

12. LITIGATION

Siegler Litigation

On June 5, 1996, Craig M. Siegler filed a complaint against the Company in
the Circuit Court of Cook County, Illinois, County Department, Chancery
Division. The complaint alleged that, in connection with the Companys private
placement of securities in November 1995, the Company breached and repudiated an
oral contract with Mr. Siegler for the issuance and sale by the Company to Mr.
Siegler of 370,370.37 shares of the Common Stock, plus warrants (immediately
exercisable at $12.96 per share) to purchase an additional 370,370.37 shares of
the Common Stock, for a total price of $4,000,000. The remedy sought by Mr.
Siegler was a sale to him of such securities on the terms of the November 1995
private placement. On August 16, 1996, the Companys motion to dismiss Mr.
Sieglers complaint was granted with leave to amend. On September 19, 1996, Mr.
Sieglers motion for reconsideration was denied.

On October 10, 1996, Mr. Siegler filed his First Amended Verified Complaint
and Jury Demand, seeking a jury trial and money damages equal to the difference
between $8,800,000 (370,370.37 shares at $10.80 per share and 370,370.37 shares
at $12.96 per share) and 740,740.74 multiplied by the highest price at which the
Common Stock traded on The Nasdaq Stock Market between November 20, 1995 and the
date of judgment. Mr. Siegler also preserved his claim for specific performance
for purposes of appeal. On November 1, 1996, the case was transferred to the
Circuit Court of Cook County, Illinois, County Department, Law Division. The
Companys Answer was filed on November 21, 1996.

The Company filed a motion for summary judgment against Mr. Siegler, which
was on hold pending the deposition of an expert retained by Mr. Siegler in the
case. The Company deposed this witness in March 2000. A hearing on the Companys
summary judgment motion was held in June 2000, and the motion was subsequently
denied. The trial date has been set for August 7, 2001.

The Company believes that the suit is without merit and intends to continue
to defend itself vigorously in this litigation. The Company is also disputing
Mr. Sieglers method of calculating damages. However, if Mr. Siegler prevails in
this litigation and is awarded damages in accordance with the formula described
above, such judgment would have a material adverse effect on the Companys
operating results and financial condition.

Note Litigation

On February 22, 2000, the Company reached a settlement agreement with the
Borrowers (defined below), whereby the Company agreed to release the Borrowers
obligations under the notes in return for the Borrowers surrender of 210,196
warrants to purchase common stock of the Company held by them and discharge of
their counterclaims. As a result of this settlement, the Company recorded a
charge of $822,776 to additional paid-in capital in the first quarter of 2000,
reflecting the carrying amount of the notes of $680,696 and related accrued
interest of $142,080, which approximated the fair value of the warrants
surrendered. The following is a historical summary of events that led to the
settlement agreement just described:

On July 10, 1997, the Company filed a complaint against Sheldon Drobny;

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Howard L. Buzz Simons, joint tenant with Aric and Corey Simons; Aaron Fischer;
Stewart Shiman; Sharon D. Gonsky, d/b/a SDG Associates; Gregg Rosenberg; Stacey
Rosenberg; Merrill Weber & Co., Inc.; Drobny/Fischer Partnership, an Illinois
general partnership; and Ruben Rosenberg (collectively, the Borrowers), and
Paradigm Venture Investors, L.L.C. (the Guarantor) in the Circuit Court of
Cook County, Illinois, County Department, Law Division. The complaint seeks to
enforce the terms of loans made to the Borrowers by the Company and evidenced by
promissory notes dated December 13, 1996, in the aggregate principal amount of
$698,508 ($680,696 of which remains unpaid as of December 31, 1999) and the
guarantee by the Guarantor of the Borrowers obligations under these promissory
notes. The Borrowers notes were issued to the Company in connection with the
Borrowers exercise of warrants to purchase shares of the Common Stock in
December 1996.

On September 30, 1997, the Borrowers and the Guarantor responded to the
Companys complaint. Concurrently, the Borrowers filed a counterclaim alleging
that they exercised the warrants in reliance on the Companys alleged fraudulent
representations to certain Borrowers concerning a third-partys future
underwriting of a secondary public offering of the Companys Common Stock.

Lipman Litigation

The Illinois Appellate Court denied plaintiffs subsequent motion for a
re-hearing on October 23, 2000 and plaintiffs did not seek review before the
Illinois Supreme Court. Accordingly, this litigation has been concluded without
any loss to the Company or its directors. The following is a historical summary
of events that led to the dismissal of this litigation against the Company:

In January 1998, Jerome H. Lipman, individually and on behalf of all others
similarly situated, filed a complaint against the Company and eight of its
former or current directors: Leonard A. Batterson, Michael J. Friduss, Peter S.
Fuss, Edward W. Laves, Steven L. Lazarus, Tom L. Powers, Ora E. Smith and Paul
G. Yovovich (collectively, the Named Directors) in the Circuit Court of Cook
County, Illinois, County Department, Chancery Division. The complaint alleged
that the Named Directors breached their duties of loyalty and due care to the
putative class of stockholders by selecting financing for the Company in June
1997 which supposedly entrenched the Directors and reduced the Common Stock
price. The complaint also alleged that the Named Directors breached their duty
of disclosure by not informing the stockholders that the selected financing
would erode the Common Stock price. Mr. Lipmans complaint sought certification
of a class consisting of all owners of the Common Stock during the period from
June 6, 1997 through November 21, 1997, excluding the Named Directors and
Sheldon Drobny. The complaint also sought an unspecified amount of compensatory
and punitive damages, and attorneys fees.

In February 1998, the Company and the Named Directors filed a motion to
dismiss Mr. Lipmans complaint, arguing in part that the plaintiffs claims were
barred by their failure to fulfill the legal prerequisites for suing the Named
Directors. In June 1998, the court granted the Companys and the Named
Directors motion to dismiss the complaint. Thereafter Mr. Lipman filed an
amended complaint against the Named Directors but excluding the Company itself
as a defendant. The amended complaint alleged that the Named Directors breached
their duties of loyalty and due care to the putative class of stockholders by
selecting financing for the Company in June 1997 and thereafter drawing two
tranches of the financing. The amended complaint sought certification of a class
consisting of all owners of the Common Stock during the period from May 15, 1997
through December 31, 1997, excluding the Named Directors. Mr. Lipmans amended
complaint alleged that the stock owned by the putative class lost $61 million
due to the financing the Named Directors selected, and sought an unspecified
amount of compensatory and punitive damages. The Named Directors filed a motion
to dismiss Mr. Lipmans amended complaint which the court granted in December
1998, finding that Mr. Lipman still had failed to fulfill the prerequisites for
maintaining a shareholder derivative action against the Named Directors. In
January 1999, Mr. Lipman and two added former stockholders filed a second
amended complaint against the Named Directors and again including the Company
itself as a defendant. The second amended complaint alleged that the Named
Directors breached their duties of loyalty and due care to the putative class
and further alleged that the purported devaluation of the plaintiffs stock
resulting from the June 1997 financing was an improper assessment on the
plaintiffs shares for which they sought an unspecified amount of compensatory
and punitive damages. The Company and the Named Directors filed a motion to
dismiss the second amended complaint which the Court granted in April 1999,
finding that (i) the plaintiffs could not assert their stock devaluation claims,
except derivatively, and (ii) the plaintiffs

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still had failed to fulfill the prerequisites for maintaining a shareholder
derivative action against the Named Directors. In May 1999, the plaintiffs filed
a third amended complaint against the Company and the Named Directors. The third
amended complaint reiterated the plaintiffs previous allegations that the Named
Directors breached their duties of loyalty, due care and candor to the putative
class, and again alleged the plaintiffs claims of an improper assessment. The
third amended complaint also asserted two claims of purported common law fraud
and a supposed violation of the Illinois Consumer Fraud Act based on allegations
that the Company and the Named Directors had selectively disclosed material,
non-public confidential information to the non-party financier in order to
obtain the financing that the Company selected in June 1997, which allegedly
reduced the Common Stock price. The plaintiffs sought an unspecified amount of
compensatory and punitive damages, and attorneys fees. In June 1999, the
Company and the Named Directors filed a motion to dismiss the third amended
complaint, arguing in part that the plaintiffs still had failed to fulfill the
prerequisites for asserting their stock devaluation claims as a shareholder
derivative action, and that the plaintiffs claims of selective disclosure and
fraud was barred on substantive and procedural grounds. In August 1999, the
Court granted the Companys and the Named Directors motion, and dismissed the
suit with prejudice.

Thereafter the plaintiffs filed a motion for reconsideration of the
dismissal which the Court denied in September 1999. In October 1999, the
plaintiffs filed their notice of appeal from the dismissal orders. All briefing
on the appeal was completed in May 2000. The Illinois Appellate Court denied
plaintiffs subsequent motion for rehearing on October 23, 2000 and plaintiffs
did not seek review before the Illinois Supreme Court.

Laves Litigation

On July 17, 2000 Edward W. Laves filed an action (the Complaint) in the
Law Division of the Circuit Court of Cook County, Illinois, against the Company
and three of its directors (George Calhoun, Samuel Perlman, and Mark Brodsky)
charging the Company with constructive termination under and in breach of
plaintiffs employment agreement, and with violation of the Illinois Wage
Payment and Collection Act. Plaintiff seeks damages estimated to exceed $9.5
million. The Company filed an appearance on behalf of all Defendants on October
3, 2000. On October 6, 2000, the Company filed on Defendants behalf a Motion to
Dismiss the Complaint. On January 22, 2001, the court issued an order granting
our Motion to Dismiss the claims against the Individual Defendants, but denied
our Motion to Dismiss with respect to claims against the Company. On February
21, 2001, Plaintiff filed a Motion to reconsider the courts dismissal of claims
against the Individual Defendants. On March 13, 2001, we filed an Answer to the
Complaint and a Memorandum in Opposition to this Motion to Reconsider. By order
dated March 15, 2001, the court allowed Laves leave to file an amended Motion to
Reconsider. A hearing is scheduled for May 16, 2001, to consider the amended
Motion to Reconsider. Laves has submitted discovery requests in support of the
Complaint. The Company believes the claims to be without merit and plans to
vigorously defend itself in this action.

16(b) Litigation

On February 22, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $15 million, less legal fees and
certain other expenses. Two of the Companys stockholders, Elliott Associates,
L.P. and Elliott International, L.P. (formerly Westgate International, L.P.),
have agreed to make this settlement payment in order to resolve claims asserted
against them and certain present and former directors. The shareholder
litigation remains outstanding against other third parties. A notice regarding
the settlement has been mailed to all shareholders. The court hearing to
consider the settlement is scheduled for March 30, 2001.

On March 16, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $5 million, less legal fees and
certain other expenses. Alexander Finance has agreed to make this settlement
payment in order to resolve claims asserted against them. A notice regarding the
settlement has been mailed to all shareholders. The court hearing to consider
the settlement is scheduled for April 27, 2001.

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The following is an historical summary of events that led to the settlements
announced above:

On February 26, 1999, Mark Levy, derivatively on behalf of the Company,
filed a complaint against Southbrook International Investments, Ltd.
(Southbrook), Elliott Associates, L.P. (Elliott), and Elliott International,
L.P. (Elliott International), and against the Company as a nominal
defendant. The complaint filed in the United States District Court for the
Southern District of New York, alleges that Southbrook, Elliott and Elliott
International, while having beneficial ownership of more than 10% of the
Companys common stock, traded the Companys common stock such that the Company
is entitled to recover short swing profits under Section 16(b) of the Securities
Exchange Act of 1934 in connection with purchases and sales of Company
securities within six month periods. The complaint seeks to recover from
Southbrook, Elliott and Elliott International their respective profits (in
unspecified amounts) from those transactions. No relief is sought against the
Company as a nominal defendant.

Elliott and Elliott International are currently investors in the Company
with substantial rights to acquire Company common stock by conversion of notes
and exercise of warrants, and three of the current six directors of the Company
were appointed in accordance with an agreement dated November 5, 1999 by and
between Elliott, Elliott International, an unaffiliated investor, and the
Company. Two of such directors, Messrs. Mark Brodsky and Norbert Lou, are
employed by a company that provides management services to, and is under common
control with, Elliott and Elliott International.

An amended complaint dated September 2, 1999 was served on the Company. The
amended complaint raises the same claims alleged in the original complaint. As a
nominal defendant the Company, by agreement with the plaintiff, has not
responded to the lawsuit, but has reserved its right to move to dismiss any
amended pleading.

Defendants moved to dismiss the amended complaint in February 2000. In
response, the plaintiff cross-moved for leave to amend its complaint again. The
proposed new pleading added Alexander Finance, LP as a defendant for the Section
16(b) claims, proposed to add two new theories pursuant to which defendants may
be found liable under Section 16(b), and also proposed to add state law breach
of fiduciary duty claims against current directors, at the time of filing,
Howard Hoffman, Tom L. Powers, Mark D. Brodsky, George Calhoun and Samuel
Perlman and former directors Edward W. Laves, Robert D. Mitchum and Terry S.
Parker, based on the board of directors decision to issue convertible notes and
warrants to the defendants convertible or exercisable for shares of common stock
at $0.25 per share.

Following a hearing on August 17, 2000, the court allowed plaintiff leave to
file his new amended complaint. The court also denied without prejudice
defendants motion to dismiss the initial 16(b) complaint (as amended). However,
defendants may raise this motion again following resolution of a similar case by
the Second Circuit Court of Appeals.

On February 22, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $15 million, less legal fees and
notice expenses. Two of the Companys stockholders, Elliott Associates, L.P. and
Elliott International, L.P. (formerly Westgate International, L.P.), have agreed
to make this settlement payment in order to resolve claims asserted against them
and certain present and former directors. The shareholder litigation remains
outstanding against other third parties. A notice regarding the settlement has
been mailed to all shareholders. The court hearing to consider the settlement is
scheduled for March 30, 2001.

On March 16, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $5 million, less legal fees and
notice expenses. Alexander Finance has agreed to make this settlement payment in
order to resolve claims asserted against them. A notice regarding the settlement
has been mailed to all shareholders. The court hearing to consider the
settlement is scheduled for April 27, 2001.

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13. SUBSEQUENT EVENTS

Filing of Rights Offering Statement

On January 8, 2001, the Company filed with the SEC on Form S-3 a
registration statement for a proposed common stock rights offering for up to $20
million. The purpose of the rights offering filing was to put the Company in the
position to access funds on a pro rata, non-dilutive basis from existing
shareholders as of a certain holding date. As of the date of this 10K filing,
the Company has not yet determined whether it will proceed with the Rights
Offering, in light of the settlements described elsewhere in this report.

Filing of a Universal Shelf Offering Statement

On January 12, 2001, the Company filed with the SEC on Form S-3 a
registration statement for the purpose of offering up to $50 million of common
stock, warrants, or preferred stock of the Company. The filing, known as a
Universal Shelf was put in place by the Company to allow the Company to access
funds in the open market on an opportunistic or on an as needed basis. To date,
the Company has not sold any securities registered under the Universal Shelf.

Short-Term Bridge Loan with Elliott Associates, L.P.

On February 23, 2001, the Company secured a short-term bridge loan from
Elliott Associates, L.P. for up to $3.5 million to fund the
Company's working capital needs.
The purpose of the short-term bridge loan was to fund the Company's working capital needs.
The Company accessed the first $2 million of the
loan at closing and accessed the balance of $1.5 million on April 2, 2001.
Both loans, plus accrued interest thereon, were repaid in full on April 6, 2001, the date the
first of the two settlement funds (as described above) was received.

Repricing of Employee Stock Options

On February 5, 2001, the Companys Board of Directors elected to reprice
certain options granted to employees and directors during 2000. In total,
2,676,000 options with prices ranging from $2.9688 to $6.6094 were repriced to
$1.9375, the closing price of the Companys common stock on the repricing date.
The Board elected to reprice the options to maintain employee morale and to more
clearly align the management and employee goals with those of the shareholders.
The resulting variable accounting may lead to substantial non-cash expense
charges in the future. No other terms of the options were affected.

$20 Million Equity Commitment Line

During March, 2001, the Company entered into an agreement with Paul Revere
Capital Partners, Ltd., whereby Paul Revere Capital commits to acquire up to $20
million of the Companys stock over the next 24 months upon demand by the
Company, subject to the conditions contained in the agreement. Pursuant to this
facility, the Company may, at its discretion, sell shares of its common stock to
Paul Revere Capital Partners at a discount to the market price of 94% of the
average weighted volume price over a 22 day period. Each draw down is limited to
the lesser of $4 million or 20% of the trading volume over a specified period of
time. The Company will also issue a warrant to Paul Revere Capital Partners to
purchase a number of shares equal to 0.5% of the shares issued in each draw
down. The Company has also agreed to pay its placement agent a fee equal to 4%
of each draw down and issue a warrant to the placement agent to purchase a
number of shares equal to 0.5% of the shares issued in each draw down.

Name Change

The Company applied for the right to do business as ISCO International and
intends to present a formal name change resolution to the shareholders at the
next annual meeting.

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14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

A summary of selected quarterly information for 2000 and 1999 is as follows:

|                                                |  |                                                         |        |         |  |         |        |         |  |   |        |   |  |   |        |  
|----------------------------------------------- |  | ------------------------------------------------------- | ------ | ------- |  | ------- | ------ | ------- |  | - | ------ | - |  | - | ------ | -
|                                                |  | 2000 Quarter Ended                                     
|                                                |  | (in thousands of U.S. dollars except per share amounts)
|                                                |  | March 31                                                |        | June 30 |  | Sep. 30 |        | Dec. 31
|                                                |  |                                                         |        |         |  |         |        |        
|Net Sales                                       |  | $                                                       | 172    |         |  | $       | 15     |         |  | $ | 22     |   |  | $ | 287    |  
|                                               
|                                               
|                                               
|                                               
|Gross Profit                                    |  |                                                         | (477   | )       |  |         | (315   | )       |  |   | (465   | ) |  |   | (920   | )
|                                               
|                                               
|                                               
|                                               
|Net Earnings before
Extraordinary Item          |  |                                                         | (2,403 | )       |  |         | (3,782 | )       |  |   | (5,283 | ) |  |   | (7,300 | )
|                                               
|                                               
|                                               
|                                               
|Net Earnings                                    |  |                                                         | (2,431 | )       |  |         | (3,782 | )       |  |   | (5,283 | ) |  |   | (7,300 | )
|                                               
|
|Earnings per Share excluding
Extraordinary Item |  | $                                                       | (0.10  | )       |  | $       | (0.12  | )       |  | $ | (0.16  | ) |  | $ | (0.19  | )
|                                               
|                                               
|                                               
|                                               
|Earnings per Share                              |  | $                                                       | (0.10  | )       |  | $       | (0.12  | )       |  | $ | (0.16  | ) |  | $ | (0.19  | )

|                                                |  |                                                         |        |         |  |         |        |         |  |   |        |   |  |   |         |  
|----------------------------------------------- |  | ------------------------------------------------------- | ------ | ------- |  | ------- | ------ | ------- |  | - | ------ | - |  | - | ------- | -
|                                                |  | 1999 Quarter Ended                                     
|                                                |  | (in thousands of U.S. dollars except per share amounts)
|                                                |  | March 31                                                |        | June 30 |  | Sep. 30 |        | Dec. 31
|                                                |  |                                                         |        |         |  |         |        |        
|Net Sales                                       |  | $                                                       | 512    |         |  | $       | 317    |         |  | $ | 1,127  |   |  | $ | 453     |  
|                                               
|                                               
|                                               
|                                               
|Gross Profit                                    |  |                                                         | (497   | )       |  |         | (630   | )       |  |   | (1,009 | ) |  |   | (1,378  | )
|                                               
|                                               
|                                               
|                                               
|Net Earnings before
Extraordinary Item          |  |                                                         | (2,275 | )       |  |         | (2,424 | )       |  |   | (2,633 | ) |  |   | (14,639 | )
|                                               
|                                               
|                                               
|                                               
|Net Earnings                                    |  |                                                         | (2,348 | )       |  |         | (2,424 | )       |  |   | (2,633 | ) |  |   | (15,311 | )
|                                               
|Earnings per Share excluding
Extraordinary Item |  | $                                                       | (0.18  | )       |  | $       | (0.19  | )       |  | $ | (0.21  | ) |  | $ | (1.13   | )
|                                               
|                                               
|                                               
|                                               
|Earnings per Share                              |  | $                                                       | (0.18  | )       |  | $       | (0.19  | )       |  | $ | (0.21  | ) |  | $ | (1.18   | )




Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial
Disclosure.

The Company filed a Form 8-K on December 18, 2000, reporting a change in
the Companys auditors.

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PART III




Item 10. Directors and Executive Officers.

The Companys executive officers and directors as of April 27, 2001 are
set forth below. The terms of Messrs. Hoffmann and Powers expire at the Annual
Meeting of the Companys stockholders on June 22, 2001 or at such later time as
their successors have been duly elected and qualified.

|                   |  |     |    |                           |  |                                                             |  |  |      |           |  | 
|------------------ |  | --- | -- | ------------------------- |  | ----------------------------------------------------------- |  |  | ---- | --------- |  | 
|                   |  |     |    |                           |  |                                                             |  |  |      | Served as
|Name               |  | Age |    | Position with the Company |  | Director Since                                             
|                   |  |     |    |                           |  |                                                            
|George M. Calhoun  |  |     | 48 |                           |  | Director, Chairman of the Board and Chief Executive Officer |  |  | 1999 |          
|                  
|                  
|                  
|                  
|Tom L. Powers      |  |     | 64 |                           |  | Director                                                    |  |  | 1996 |          
|                  
|                  
|                  
|                  
|Howard S. Hoffmann |  |     | 47 |                           |  | Director                                                    |  |  | 1998 |          
|                  
|                  
|                  
|                  
|Mark D. Brodsky    |  |     | 47 |                           |  | Director                                                    |  |  | 1999 |          
|                  
|                  
|                  
|                  
|Daniel Spoor       |  |     | 45 |                           |  | Director                                                    |  |  | 2000 |          
|                  
|                  
|                  
|                  
|Norbert Lou        |  |     | 27 |                           |  | Director                                                    |  |  | 2001 |          
|                  
|                  
|                  
|                  
|Amr Abdelmonem     |  |     | 35 |                           |  | EVP and Chief Technology Officer                            |  |  | N/A  |          
|                  
|                  
|                  
|                  
|Charles F. Willes  |  |     | 46 |                           |  | Chief Financial Officer                                     |  |  | N/A  |          
|                  
|                  
|                  
|                  
|Shawn P. Doyle     |  |     | 46 |                           |  | EVP, Commercial Development                                 |  |  | N/A  |          
|                  
|                  
|                  
|                  
|Dennis M. Craig    |  |     | 41 |                           |  | Vice President/General Manager - Manufacturing              |  |  | N/A  |          
|                  
|                  
|                  
|                  
|Michael Cromar     |  |     | 54 |                           |  | Vice President Louisville, CO Operations                    |  |  | N/A  |          

Dr. Calhoun has served as a director and as the Chief Executive Officer of
the Company since November 1999 and as Chairman since November 2000. He has
more than 20 years of experience in high-tech wireless systems development,
beginning in 1980 as the co-founder of InterDigital Communications Corporation
(Nasdaq: IDCC), where he participated in the development of the first
commercial application of digital TDMA radio technology, and introduced the
first wireless local loop system to the North American telecommunications
industry. While at InterDigital, Dr. Calhoun held a number of executive
positions, including Senior Vice-President of the North American business unit,
Senior VP of technology & strategy, and President of IMM Technology, an
intellectual property and licensing subsidiary. In 1992, Dr. Calhoun joined
Geotek Communications to help lead its technology development program for a
spread spectrum frequency hopping radio system for fleet applications. Dr.
Calhoun was a Director and Vice-Chairman of Geotek (which filed for
reorganization under Chapter 11 of the Federal Bankruptcy Code in 1998), and
served as the Chairman of the companys engineering joint venture in Israel,
PowerSpectrum Technologies, Ltd. until 1998. In 1998, Dr. Calhoun founded
Davinci Solutions, LLC, a consulting firm focused on wireless and Internet
technology companies. Dr. Calhoun is also Chairman of ExpertCall LLC, an
Internet start-up focused on B2B customer care applications. He is the author
of two technical books on digital wireless technology, and of the forthcoming
Third Generation Wireless Systems: Volume I, Post-Shannon Architectures. Dr.
Calhoun holds a Ph.D. in Systems Science from the Wharton School at the
University of Pennsylvania, as well as a B.A. from the same university.

Mr. Powers has served as a director of the Company since October 1996. He
is currently an adjunct professor of the Advanced Manufacturing Center at New
Mexico State University (which he served as associate director until March
1999) in Las Cruces, New Mexico, as well as a consultant to a number of
companies. From 1989 to 1991, Mr. Powers was President of the cellular systems
business unit of AT&T Network Systems Group, now known as Lucent Technologies,
Inc. Under his leadership, the business unit became the market leader in
wireless infrastructure equipment in the United States, opened markets
internationally and introduced the industrys first digital cellular system.
In 1983, he became Vice President of a joint venture between AT&T and Philips
Telecommunications B.V. located in the Netherlands. He joined AT&T in 1958 as
a member of the technical staff of Bell Laboratories and went on to management
positions in consumer products, customer switching systems engineering and

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##### Table of Contents



network planning. Mr. Powers holds a M.E.E. degree in Electrical
Engineering for New York University and a B.S. degree in Electrical Engineering
from the University of Arkansas. Mr. Powers is a member of the Compensation
Committee and serves as its Chairman.

Mr. Hoffmann has served as a director of the Company since July 1998. Mr.
Hoffmann is currently a principal of Nightingale & Associates, LLC, a
management consulting firm. Mr. Hoffmann has over 20 years of financial,
operational and general management experience in a wide range of industries
including computer hardware and software, consumer products, financial
services, distribution and transportation. He joined Nightingale & Associates
in 1990 after serving as interim Chief Financial Officer of two privately held
businesses. Mr. Hoffmann began his career with Irving Trust Company as a
commercial lending officer and later served as Vice President, Corporate
Lending at Bank of America in the high technology group. More recently, he
served as Chief Financial Officer of Applications Systems, Inc., an information
technology firm operating in seven European countries, and as interim Chief
Financial Officer and Chief Operating Officer of a $100 million consumer
products company with international operations. Mr. Hoffmann is the Chairman
of the Audit Committee and a member of the Compensation Committee.

Mr. Brodsky has served as a director of the Company since November 1999
and was previously a director between June 1998 and March 1999. Since 1996 he
has been a Portfolio Manager at Stonington Management Corporation
(Stonington). In that capacity, Mr. Brodsky provides services for the benefit
of Elliott Associates, L.P. (Elliott Associates) and Elliott International,
L.P. (f/k/a Westgate International, L.P.)(Elliott International). Elliott
Associates and Elliott International are institutional investment firms having
combined capital of $1.3 billion, and are two of the three principal investors
in the Company. Prior to joining Stonington, Mr. Brodsky served for two years
as a vice president and partner at Dickstein Partners, L.P., another investment
institution. Prior to Dickstein, he practiced law for 16 years, primarily at
Kramer, Levin, Naftalis & Frankel in New York City, where he was a partner for
several years. Mr. Brodsky holds a J.D. degree, cum laude, from Harvard Law
School and an M.A. and B.A. in Political Science, summa cum laude, from the
University of Pennsylvania.

Mr. Spoor has served as a director of the Company since December 2000.
Mr. Spoor was appointed President and Chief Executive Officer of Lockheed
Martin Canada Inc. in December 1999. Lockheed Martin Canada is a highly
diversified global enterprise principally engaged in the research, design,
manufacture, and integration of advanced-technology products. Prior to
becoming Lockheed Martin Canadas President and CEO in 1999, Mr. Spoor was Vice
President-Operations for the Lockheed Martin Electronics Sector and held
executive positions at the Lockheed Martin Ocean, Radar & Sensor Systems
business, Vice President-Traffic Management and Vice President-Manufacturing
Operations. From 1989 to 1995, Mr. Spoor was Vice President with General
Signal. Earlier, during his 12 years with General Electric, he held a variety
of management positions. Mr. Spoor earned a B.S. degree in Mechanical
Engineering from Clarkson University, and an M.B.A. from the University of
South Carolina.

Mr. Lou has served as a director of the Company since January 2001. Since
1998 he has been a Portfolio Analyst at Elliott Management Corporation
(Elliott). In that capacity, Mr. Lou provides services for the benefit of
Elliott Associates and Elliott International. Prior to joining Elliott, Mr.
Lou was an Analyst in the Mergers and Acquisitions Group at Brown Brothers
Harriman & Company. Mr. Lou holds a B.S. degree in Biological Engineering from
Cornell University.

Dr. Abdelmonem joined the Company in January 1995 as a Filter Engineer and
was promoted to Director of Engineering in August 1998, to Vice President of
Development Engineering in March 1999 and to Chief Technology Officer in
December 1999. Before joining the Company, Dr. Abdelmonem was an engineer with
Exxon Corporation in Egypt. Subsequently, he was affiliated with the
University of Maryland in a number of research and teaching positions where
much of his research focused on semi-

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conductor laser and advanced filter design. Dr. Abdelmonem earned his B.S. and
M.S. degrees in Electrical Engineering from Ain-Shams University in Cairo,
Egypt, and his Ph.D. from the University of Maryland. Much of his research
focused on semi-conductor laser design, superconducting technology and advanced
filter design. Dr. Abdelmonem is a Senior Member of the IEEE and has published
numerous documents for industry conferences and trade journals. He holds three
patents and has four patent applications pending.

Mr. Willes joined the Company in July 2000 and brings more than 20 years
executive and corporate finance experience, including 10 years experience in
the fields of high technology and wireless communication. Mr. Willes has
extensive experience with start-up firms, focusing on their efforts to achieve
initial profitability, and negotiating strategic partnerships, joint venture
arrangements, and M&A transactions, with more than 60 such transactions
completed. Before joining the Company, Mr. Willes served as President and CEO
of Hallcrest, Inc., a leading manufacturer of thermochromic liquid crystals and
microencapsulated products. He has held corporate development positions at
Motorola, Inc. and AirTouch Communications, Inc. While in those positions, he
led the efforts in completing nine major domestic and international
telecommunication joint ventures. Throughout his corporate finance career, he
has raised more than $1 billion in capital funding. Mr. Willes started his
career as a CPA at KPMG Peat Marwick. Mr. Willes holds an M.B.A. in
Finance/Accounting from the University of Illinois and a B.S. degree in Business from
Eastern Illinois University. In addition, he has completed additional
post-graduate work at both the University of Michigan and DePaul University.

Mr. Doyle, formerly Executive Vice President Commercial Development for
Spectral Solutions, Inc. (SSI), continues in that role with the Company. Mr.
Doyle has served as Vice President of Sales of Triton Network Systems, a
broadband wireless company. As Vice President, Sales for Wireless Networks at
Northern Telecom, Inc. he led a sales team that secured over $1 billion in
wireless customer contracts over three years. In his 19-year career with
Nortel, Mr. Doyle served as Director of Sales for various departments,
including MSL-100 Distributor Sales, Cellular Systems, the Motorola-Nortel
Wireless Systems joint venture, and Wireless Networks. Mr. Doyle holds an
M.B.A. from Vanderbilt University and a B.S. degree in Chemistry from St.
Johns University.

Mr. Craig joined the Company in December 1996 as Vice President,
Engineering and Manufacturing. Before joining the Company, Mr. Craig was at
Motorola, Inc., where he served as Manufacturing and Technical Operations
Manager in the Component Products Division, where his responsibilities included
the management of engineering, process engineering, manufacturing operations
and development of new product platforms. Prior to joining Motorola, Mr. Craig
spent four years at Northrop/Grumman Defense Systems Division, leading teams to
develop numerous cost reduction and production process improvement programs.
He holds a B.S. degree in Mechanical Engineering from the University of
Illinois at Chicago and an M.B.A. degree from Lake Forest Graduate School of
Management. He currently holds two patents.

Dr. Cromar joined the Company as Vice President, Engineering and
Development, a post he held at SSI. Dr. Cromar is principally responsible for
the development and prototyping of the SupeRx, a tower-top HTS front-end
receiver. Formerly head of Research and Development at SCT, Dr. Cromar managed
numerous development projects for commercial customers and government sponsors.
During his 16-year tenure with the National Institute of Standards and
Technology (NIST), Boulder Laboratories, Dr. Cromar supervised and performed
research and development in superconducting devices, materials, and
fabrication. As the first Project Leader of the High Tc Superconducting
Electronics Project at NIST, Dr. Cromar developed and led a team that achieved
worldwide recognition for its research on high Tc Josephson junctions and
microwave devices. He is the recipient of the Department of Commerce Gold and
Silver medals for his work on superconducting devices. He received his Ph.D. in
Physics from the University of Oregon and a B.S. degree in Physics and a B.A.
degree in Psychology from Stanford

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University.

Legal Proceedings with
Affiliates. In February, 1999, Mark Levy,
derivatively on behalf of the Company, filed a complaint against Southbrook
International Investments, Ltd. (Southbrook), Elliott Associates, Elliott
International, Alexander Finance L.P. (Alexander) and against the Company as a
nominal defendant. The complaint filed in the United States District Court
for the Southern District of New York, alleges that Southbrook, Elliott
Associates, Elliott International and Alexander, while having beneficial
ownership of more than 10% of our Common Stock, traded the Common Stock such
that the Company is entitled to recover short swing profits under Section 16(b)
of the Securities Exchange Act of 1934 in connection with purchases and sales
of Company securities within six month periods. The complaint sought to
recover from Southbrook, Elliott Associates, Elliott International and
Alexander their respective profits (in unspecified amounts) from those
transactions. No relief is sought against the Company as a nominal defendant.

Elliott Associates, Elliott International and Alexander are each currently
holders of more than 10% of our Common Stock. Two of the current six
directors of the Company, Mr. Brodsky and Mr. Lou, are employed by a company that
provides management services to, and is under common control with, Elliott
Associates and Elliott International. Mr. Brodsky was appointed in accordance with an
agreement dated November 5, 1999 by and between Elliott Associates, Elliott
International, an unaffiliated investor, and the Company.

On February 22, 2001, the Company announced that a settlement of this
litigation had been reached with Elliott Associates and Elliott International.
On March 30, 2001, the settlement was approved by the court which resulted in
the Company receiving $15 million, less legal fees and certain other expenses.
The court granted $3 million in interim legal fees and pending further review
by the court, set aside an additional $1.5 million in escrow for legal fees.

On March 16, 2001, the Company announced that a settlement of this
litigation had been reached with Alexander, which, subject to court approval,
will result in the Company receiving $5 million, less legal fees and certain
other expenses. A notice regarding the settlement has been mailed to all of the
Companys stockholders. The court hearing to consider the settlement is
scheduled for April 27, 2001.

Section 16(a) Beneficial Ownership Reporting Compliance.

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Companys officers (as defined under Section 16(a) of the Securities
Exchange Act), directors and persons who own greater than 10% of a registered
class of the Companys equity securities to file reports of ownership and
changes in ownership with the Securities and Exchange Commission. Based solely on a
review of the forms the Company has received and on written representations from certain
reporting persons that no such forms were required for them, the Company
believes that during 2000, all of the Section 16(a) filing requirements
applicable to its officers, directors and 10% beneficial owners were complied
with by such persons.

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Item 11. Executive Compensation.

The following table provides information concerning the annual and
long-term compensation for services in all capacities to the Company for the
years ended December 31, 2000, 1999 and 1998 of (i) the Companys Chief
Executive Officer and (ii) all other executive officers whose salary and bonus
for services rendered in all capacities to the Company for the fiscal year
ended December 31, 2000 exceeded $100,000 (collectively, the Named Executive
Officers).

Summary Compensation Table

|                               |  |      |      |        |  |                     |         |                               |  |                    |        |  |  |                  |         |            |  |  |         |  | 
|------------------------------ |  | ---- | ---- | ------ |  | ------------------- | ------- | ----------------------------- |  | ------------------ | ------ |  |  | ---------------- | ------- | ---------- |  |  | ------- |  | 
|                               |  |      |      |        |  | Annual Compensation |         | Long-Term Compensation Awards
|                               |  |      |      |        |  |                     |         |                              
|                               |  |      |      |        |  |                     |         |                               |  |                    |        |  |  | Restricted Stock |         | Securities
|Name and Principal Position    |  | Year |      | Salary |  | Bonus               |         | Awards                        |  | Underlying Options
|                               |  |      |      |        |  |                     |         |                               |  |                   
|George M. Calhoun              |  |      | 2000 |        |  | $                   | 163,288 |                               |  |                    |       |  |  |                  |        |            |  |  | 500,000 | 
|                              
|                              
|                              
|                              
|Chief Executive Officer        |  |      | 1999 |        |  |                     | 4,730   |                               |  | $                  | 10,000 |  |  |                  |        |            |  |  | 100,000 | 
|                              
|                              
|                              
|                              
|                               |  |      | 1998 |        |  |                     |        |                               |  |                    |       |  |  |                  |        |            |  |  |        | 
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|Dennis M. Craig                |  |      | 2000 |        |  |                     | 150,000 |                               |  |                    |       |  |  | $                | 502,440 | (1)        |  |  | 205,000 | 
|                              
|                              
|                              
|                              
|Vice President/General Manager |  |      | 1999 |        |  |                     | 150,575 |                               |  |                    |       |  |  |                  |        |            |  |  | 95,000  | 
|                              
|                              
|                              
|                              
|                               |  |      | 1998 |        |  |                     | 141,760 |                               |  |                    |       |  |  |                  |        |            |  |  | 70,000  | 
|                               |  |      |      |        |  |                     |         |                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|Amr Abdelmonem                 |  |      | 2000 |        |  |                     | 138,661 |                               |  |                    |       |  |  | $                | 502,440 | (1)        |  |  | 280,000 | 
|                              
|                              
|                              
|                              
|Chief Technical Officer        |  |      | 1999 |        |  |                     | 116,345 |                               |  |                    |       |  |  |                  |        |            |  |  | 69,575  | 
|                              
|                              
|                              
|                              
|                               |  |      | 1998 |        |  |                     | 95,675  |                               |  |                    |       |  |  |                  |        |            |  |  | 5,000   | 
|                               |  |      |      |        |  |                     |         |                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|Charles F. Willes (2)          |  |      | 2000 |        |  |                     | 66,346  |                               |  |                    |       |  |  |                  |        |            |  |  | 300,000 | 
|                              
|                              
|                              
|                              
|Chief Financial Officer        |  |      | 1999 |        |  |                     |        |                               |  |                    |       |  |  |                  |        |            |  |  |        | 
|                              
|                              
|                              
|                              
|                               |  |      | 1998 |        |  |                     |        |                               |  |                    |       |  |  |                  |        |            |  |  |        | 
|                               |  |      |      |        |  |                     |         |                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|Cynthia Quigley (3)            |  |      | 2000 |        |  |                     | 101,635 |                               |  |                    | 35,000 |  |  |                  |        |            |  |  |        | 
|                              
|                              
|                              
|                              
|Former Chief Financial Officer |  |      | 1999 |        |  |                     | 69,325  |                               |  |                    | 12,000 |  |  |                  |        |            |  |  | 30,000  | 
|                              
|                              
|                              
|                              
|                               |  |      | 1998 |        |  |                     |        |                               |  |                    |       |  |  |                  |        |            |  |  |        | 



---

|(1) |  | Based on 120,000 shares granted to each of Mr. Craig and Dr. Abdelmonem
and the closing price of the Common Stock ($4.187) on the date of grant,
February 15, 2000. The value of these shares at December 30, 2000, based
on a closing price of $1.406 on that date, was $168,720, respectively. The
shares vest at the rate of 10%, 20%, 30% and 40% on the first, second,
third and fourth anniversary, respectively, of the date of the grant. If
any dividends are paid on the Common Stock, such dividends also will be
paid on the restricted shares granted to each Named Executive Officer.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | Mr. Willes commenced employment with the Company in July 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   
|   
|   
|   
|(3) |  | Ms. Quigley discontinued her employment with the Company in July 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

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Option Grants In 2000

The following table contains information concerning the grant of stock
options by the Company to the Named Executive Officers during 2000. There were
no stock appreciation rights granted in 2000.

|                  |  |                    |         |                    |  |           |      |        |  |                 |        |     |  |                              |          |  |  |                               |           |  |  |   |           | 
|----------------- |  | ------------------ | ------- | ------------------ |  | --------- | ---- | ------ |  | --------------- | ------ | --- |  | ---------------------------- | -------- |  |  | ----------------------------- | --------- |  |  | - | --------- | 
|                  |  |                    |         |                    |  |           |      |        |  |                 |        |     |  |                              |          |  |  | Potential Realizable Value at
|                  |  |                    |         |                    |  |           |      |        |  |                 |        |     |  |                              |          |  |  | Assumed Annual Rates of      
|                  |  | Number of          |         | Percent of Total   |  |           |      |        |  |                 |        |     |  | Stock Price Appreciation for
|                  |  | Securities         |         | Options Granted to |  | Exercise  |      | Expir- |  | Option Term (1)
|                  |  | Underlying Options |         | Employees in       |  | Price Per |      | ation  |  |                
|Name              |  | Granted            |         | Fiscal Year        |  | Share     |      | Date   |  | 5%              |        | 10%
|                  |  |                    |         |                    |  |           |      |        |  |                 |        |    
|George M. Calhoun |  |                    | 500,000 |                    |  |           | 15.4 |        |  | $               | 6.6094 |     |  |                              | 3/24/10  |  |  | $                             | 2,078,657 |  |  | $ | 5,267,692 | 
|                 
|                 
|                 
|                 
|Dennis M. Craig   |  |                    | 205,000 |                    |  |           | 6.3  |        |  | $               | 4.1875 |     |  |                              | 2/15/10  |  |  |                               | 539,957   |  |  |   | 1,368,350 | 
|                 
|                 
|                 
|                 
|Amr Abdelmonem    |  |                    | 180,000 |                    |  |           | 8.6  |        |  | $               | 4.1875 |     |  |                              | 2/15/10  |  |  |                               | 474,109   |  |  |   | 1,201,478 | 
|                 
|                 
|                 
|                 
|                  |  |                    | 100,000 |                    |  |           |      |        |  | $               | 1.3438 |     |  |                              | 12/19/10 |  |  |                               | 84,525    |  |  |   | 214,202   | 
|                 
|                 
|                 
|                 
|Charles F. Willes |  |                    | 200,000 |                    |  |           | 9.3  |        |  | $               | 4.75   |     |  |                              | 7/14/10  |  |  |                               | 597,550   |  |  |   | 1,514,300 | 
|                 
|                 
|                 
|                 
|                  |  |                    | 100,000 |                    |  |           |      |        |  | $               | 1.3438 |     |  |                              | 12/19/10 |  |  |                               | 84,525    |  |  |   | 214,202   | 
|                 
|                 
|                 
|                 
|Cynthia Quigley   |  |                    |        |                   



---

|(1) |  | Potential realizable value is presented net of the option exercise price
but before any federal or state income taxes associated with exercise. The
assumed stock price appreciation rates used to determine the potential
realize value are prescribed by the Securities and Exchange Commission
rules for illustrative purposes only and are not intended to forecast or
predict future stock prices. Actual gains are dependent on the future
performance of the Common Stock and the option holders continued
employment throughout the vesting period.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option
Values

The following table provides information concerning the Named Executive
Officers unexercised options at December 31, 2000. None of the Named
Executive Officers held or exercised any stock appreciation rights, during
2000.

|                  |  |              |        |          |  |                        |        |                      |  |                      |         |               |  |             |         |               |  |   |        |  |  |   |         | 
|----------------- |  | ------------ | ------ | -------- |  | ---------------------- | ------ | -------------------- |  | -------------------- | ------- | ------------- |  | ----------- | ------- | ------------- |  | - | ------ |  |  | - | ------- | 
|                  |  | Shares       |        |          |  |                        |        | Number of Securities |  | Value of Unexercised
|                  |  | Acquired     |        | Value    |  | Underlying Unexercised |        | In-The-Money        
|                  |  | On           |        | Realized |  | Options at             |        | Options at          
|Name              |  | Exercise (#) |        | ($)(1)   |  | December 31, 2000      |        | December 31, 2000   
|                  |  |              |        |          |  |                        |        |                     
|                  |  |              |        |          |  |                        |        |                      |  | Exercisable          |         | Unexercisable |  | Exercisable |         | Unexercisable
|                  |  |              |        |          |  |                        |        |                      |  |                      |         |               |  |             |         |              
|George M. Calhoun |  |              |       |          |  |                        |       |                      |  |                      | 100,000 |               |  |             | 500,000 |               |  | $ | 95,310 |  |  |   |        | 
|                 
|                 
|                 
|                 
|Dennis M. Craig   |  |              |       |          |  |                        |       |                      |  |                      | 171,042 |               |  |             | 343,958 |               |  |   | 80,151 |  |  | $ | 168,744 | 
|                 
|                 
|                 
|                 
|Amr Abdelmonem    |  |              | 15,250 |          |  | $                      | 64,654 |                      |  |                      | 65,025  |               |  |             | 401,875 |               |  |   | 45,733 |  |  |   | 175,173 | 
|                 
|                 
|                 
|                 
|Charles F. Willes |  |              |       |          |  |                        |       |                      |  |                      |        |               |  |             | 300,000 |               |  |   |       |  |  |   |        | 
|                 
|                 
|                 
|                 
|Cynthia Quigley   |  |              |       |          |  |                        |       |                      |  |                      | 30,000  |               |  |             |        |               |  |   | 25,311 |  |  |   |        | 



---

|(1) |  | The value per option is calculated by subtracting the exercise price from
the closing price of the Common Stock on the OTC Bulletin Board on
December 29, 2000 (the last business day of 2000) of $1.406.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Director Compensation.

During 2000, the Company did not provide any cash compensation to its
directors for their service on the board of directors. Each director of the
Company who is not an employee of the Company (a Non-Employee Director)
participates in the Illinois Superconductor Corporation 1993 Stock Option Plan
(the 1993 Stock Option Plan). The 1993 Stock Option Plan provides for the
automatic grant of

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---



##### Table of Contents



non-qualified stock options (NQSOs) to each Non-Employee Director who is
re-elected or continues to serve as a director because his or her term has not
expired in consideration of his or her service on the board of directors to
purchase 10,000 shares of Common Stock at the reported closing price of the
Common Stock on the date of each annual meeting of the stockholders of the
Company, provided that no such automatic grant shall be made to a Non-Employee
Director who is first elected to the board of directors at the first such
meeting or was first elected to the board of directors within three months
prior to such annual meeting. These stock options vest in three equal annual
installments beginning on the first anniversary of the date of grant and expire
ten years from the date of grant. Pursuant to the foregoing, Messrs. Perlmann,
Powers, Brodsky and Hoffmann were each granted an option to purchase 10,000
shares of Common Stock on July 18, 2000 and Mr. Spoor was granted an option to
purchase 10,000 shares of Common Stock in December 2000. In addition, each
Non-Employee Director may also be granted additional stock options at the
discretion of the board of directors; provided, however, that during any calendar year,
stock options for no more than 500,000 shares of Common Stock may be granted to
any individual Non-Employee Director. The terms of such discretionary stock
option grants shall be determined by the board of directors.

All Non-Employee Directors are reimbursed for their reasonable
out-of-pocket expenses incurred in attending board and committee meetings.

Employment Agreements.

Effective August 11, 1999, the Company entered into an employment
agreement with Ms. Quigley and Tatum CFO Partners LLP. The agreement, which
was terminated in July 2000, provided for a base salary of $175,000, plus a
quarterly bonus of up to 33% of Ms. Quigleys base salary. The Company
entered into an employment agreement with Amr Abdelmonem dated as of January 1,
2001 to be Chief Technology Officer of the Company for a term of three years.
Dr. Abdelmonem is paid an annual salary of $200,000 and is paid a severance of
one years salary if (i) the Company terminates his employment without Cause
(as defined in the agreement) or (ii) Dr. Abdelmonem terminates his employment
for Good Reason (as defined in the agreement), which such severance is offset
by any income received by Dr. Abdelmonem during the severance period. His
severance is increased to two years salary in the case of a change in control
(as defined in the agreement) of the Company and a termination as described
previously. Dr. Abdelmonems agreement includes a provision for a bonus to be
paid at the discretion of the board of directors and certain non-competition,
non-solicitation, assignment of invention and confidentiality provisions.

Compensation Committee Interlocks and Insider Participation

Tom L. Powers and Howard S. Hoffmann served as members of the Compensation
Committee of the board of directors. Neither Mr. Powers nor Mr. Hoffmann
currently serves as an officer of the Company. There are no compensation
committee interlocks between the Company and any other entity involving the
Companys or such entitys executive officers or board members.




Item 12. Security Ownership of Certain Beneficial Owners and Management.

The following table sets forth information regarding the beneficial
ownership of Common Sock as of April 1, 2001, except as otherwise indicated in
the relevant footnote, by (1) each person or group that the Company knows
beneficially owns more than 5% of the Common Stock, (2) each of the Companys
directors, (3) each of the Named Executive Officers, and (4) all current
executive officers and directors as a group. Unless otherwise indicated, the
address of each person identified below is c/o the Company at its principal
executive offices.

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---



##### Table of Contents



The percentages of beneficial ownership shown below are based on
107,751,614 shares of Common Stock outstanding as of April 1, 2001. Beneficial ownership is determined in accordance with the
rules of the Securities and Exchange Commission and generally includes those
securities over which a person may exercise voting or investment power. In
addition, shares of Common Stock which a person has the right to acquire upon
the exercise of stock options and/or warrants within 60 days of the date of
this table are deemed outstanding for the purpose of computing the percentage
ownership of that person, but are not deemed outstanding for computing the
percentage ownership of any other person. Except as indicated in the footnotes
to this table or as affected by applicable community property laws, the persons
named in the table have sole voting and investment power with respect to all
shares of Common Stock beneficially owned.

|                                                             |  |                    |            |            |  |  |      |   | 
|------------------------------------------------------------ |  | ------------------ | ---------- | ---------- |  |  | ---- | - | 
|                                                             |  | Number of Shares  
|                                                             |  | of Common Stock    |            | Percent of | 
|Beneficial Owner                                             |  | Beneficially Owned |            | Class      | 
|                                                             |  |                    |            |            | 
|5% Stockholders                                             
|                                                            
|                                                            
|                                                            
|                                                            
|Alexander Finance, L.P.                                      |  |                    | 31,032,780 | (1)        |  |  | 28.8 | % | 
|                                                            
|                                                            
|                                                            
|                                                            
|Elliott Associates, L.P.                                     |  |                    | 19,900,979 | (2)        |  |  | 18.5 | % | 
|                                                            
|                                                            
|                                                            
|                                                            
|Elliott International, L.P.                                  |  |                    | 19,900,974 | (2)        |  |  | 18.5 | % | 
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|Directors and Named Executive Officers                      
|                                                            
|                                                            
|                                                            
|                                                            
|George M. Calhoun                                            |  |                    | 360,000    | (3)        |  |  | *    |  
|                                                            
|                                                            
|                                                            
|                                                            
|Dennis M. Craig                                              |  |                    | 216,542    | (4)        |  |  | *    |  
|                                                            
|                                                            
|                                                            
|                                                            
|Tom L. Powers                                                |  |                    | 115,400    | (5)        |  |  | *    |  
|                                                            
|                                                            
|                                                            
|                                                            
|Howard S. Hoffmann                                           |  |                    | 104,666    | (6)        |  |  | *    |  
|                                                            
|                                                            
|                                                            
|                                                            
|Amr Abdelmonem                                               |  |                    | 95,025     | (7)        |  |  | *    |  
|                                                            
|                                                            
|                                                            
|                                                            
|Mark D. Brodsky                                              |  |                    | 50,000     | (8)        |  |  | *    |  
|                                                            
|                                                            
|                                                            
|                                                            
|Cynthia Quigley                                              |  |                    | 30,000     | (6)        |  |  | *    |  
|                                                            
|                                                            
|                                                            
|                                                            
|Daniel Spoor                                                 |  |                    | 10,000     | (9)        |  |  | *    |  
|                                                            
|                                                            
|                                                            
|                                                            
|Charles F. Willes                                            |  |                    | 8,000      |            |  |  | *    |  
|                                                            
|                                                            
|                                                            
|                                                            
|Norbert Lou                                                  |  |                    |           | (8)        |  |  |     |  
|                                                            
|                                                            
|                                                            
|                                                            
|All directors and executive officers as a group (13 persons) |  |                    | 1,098,625  | (10)       |  |  | 1.0  | %



---

|*   |  | Less than 1%.                                                                                                                                                                                                                 
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(1) |  | The address for Alexander Finance, L.P. is 1560 Sherman Avenue Evanston,
IL 60201.                                                                                                                                            
|   
|   
|   
|   
|(2) |  | As reflected in a Schedule 13D/A dated January 26, 2001. The address of
Elliott Associates L.P. and Elliott International, L.P. is c/o Elliot
International Capital Advisors, Inc. 712 Fifth Avenue New York, New York
10019. 
|   
|   
|   
|   
|(3) |  | Includes outstanding options to purchase 150,000 shares, which were
exercisable as of April 1, 2001, or within 60 days from such date.                                                                                        
|   
|   
|   
|   
|(4) |  | Includes 13,000 shares of Common Stock of which Mr. Craig shares
investment and voting power and outstanding options to purchase 191,542
shares, which were exercisable as of April 1, 2001, or within 60 days from
such date.
|   
|   
|   
|   
|(5) |  | Includes outstanding options to purchase 113,000 shares, which were
exercisable as of April 1, 2001, or within 60 days from such date.                                                                                        
|   
|   
|   
|   
|(6) |  | Represents the total number of outstanding options to purchase shares,
which were exercisable as of April 1, 2001, or within 60 days from such
date.                                                                          
|   
|   
|   
|   
|(7) |  | Includes outstanding options to purchase 83,025 shares, which were
exercisable as of April 1, 2001, or within 60 days from such date.                                                                                         
|   
|   
|   
|   
|(8) |  | Messrs. Brodsky and Lou provide management services to Elliott
Associates, L.P. and Elliott International, L.P., each of whom
beneficially own 19,900,979 and 19,900,974, respectively. See note 2
above.                     

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---



##### Table of Contents



|(9)  |  | Does not include 2,500,000 shares of Common Stock held by Mr. Spoors
employer, Lockheed Martin Canada Inc. Mr. Spoor does not having voting
and or dispositive control over such shares held by Lockheed Martin Canada
Inc. and Mr. Spoor disclaims beneficial ownership of such shares.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|    
|    
|    
|(10) |  | Includes outstanding options to purchase 735,790 shares, which were
exercisable as of April 1, 2001, or within 60 days from such date.                                                                                                                                                   




Item 13. Certain Relationships and Related Transactions.

On October 20, 2000,
Elliott Associates, L.P. and Elliot International, L.P.
purchased, for an aggregate price of $5 million, an aggregate of 1,818,182
shares of Common Stock. The price paid was 10% above the closing price of
Common Stock on that date. In addition, the Company agreed to register these
shares with the Securities and Exchange Commission for resale by Elliott
Associates, L.P. and Elliot International, L.P. On such date, Messrs. Brodsky and Perlman
were directors of the Company and affiliated with Elliott Associates, L.P. and Elliot
International, L.P.

On December 29, 2000,
Alexander Finance L.P., Elliot Associates, L.P. and Elliott
International, L.P., holders of our senior convertible notes, converted $14,354,778
in principal amount of their notes plus accrued interest into 63,283,309 shares
of Common Stock.

On February 23, 2001, the Company secured a short-term bridge loan from
Elliott Associates, L.P. for up to $3.5 million to fund the Companys working capital
needs. The purpose of the short-term bridge loan was to fund the Companys
working capital needs. The Company accessed the first $2 million of the loan
at closing and accessed the balance of $1.5 million on April 2, 2001. Both
loans, plus accrued interest thereon, were repaid in full on April 6, 2001, the
date the first of the two settlement funds (as described above) was received.

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##### Table of Contents






PART IV




Item 14. Exhibits, Financial Statement Schedules and Reports.

(a) The following documents are filed as part of this Form 10-K:



| |                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------
| | 1. The following financial statements of the Company, with the report of
independent auditors, are filed as part of this Form 10-K:



| |                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------
| | Reports of Independent Certified Public Accountants                                                                           
| | Consolidated Balance Sheets as of December 31, 2000 and 1999                                                                  
| | Consolidated Statements of Operations for the Years Ended
December 31, 2000, 1999, and 1998                                   
| | Consolidated Statements of Stockholders Equity (Net Capital Deficiency)
for the Years Ended December 31, 2000, 1999, and 1998
| | Consolidated Statements of Cash Flows for the Years Ended
December 31, 2000, 1999, and 1998                                   
| | Notes to Consolidated Financial Statements                                                                                    



| |                                                                                                   
| | --------------------------------------------------------------------------------------------------
| | 2. The following financial statement schedules of the Company are filed
as part of this Form 10-K:



| |                                                 
| | ------------------------------------------------
| | Schedule II    Valuation and Qualifying Accounts



| |                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | All other financial schedules are omitted because such schedules are not
required or the information required has been presented in the
aforementioned financial statements.



| |                                                               
| | --------------------------------------------------------------
| | 3. Exhibits are listed in the Exhibit Index to this Form 10-K.

The following current reports on Form 8-K were filed during the quarterly period
ended December 31, 2000:

1. On October 20, 2000, the Company filed with the SEC an amended Current
Report on Form 8-K/A setting forth the financial statements for the acquisition
of Spectral Solutions, Inc., which amended the Current Report on Form 8-K filed
with the SEC on August 23, 2000.

2. On October 26, 2000, the Company filed with the SEC a Current Report on
Form 8-K reporting on an additional $5 million investment in the Company by
Elliott Associates, L.P. and an affiliated investment firm.

3. On November 2, 2000, the Company filed with the SEC a Current Report on
Form 8-K announcing that the Company had entered into an agreement to acquire
Lockheed Martin Canadas Adaptive Notch Filtering business unit.

4. On December 18, 2000, the Company filed with the SEC a Current Report on
Form 8-K reporting on the Companys change in certifying accountants.

5. On December 27, 2000, the Company filed with the SEC a Current Report on
Form 8-K reporting on the acquisition of Lockheed Martin Canada Inc.s Adaptive
Notch Filtering business unit and the appointment of Daniel Spoor, President and
CEO of Lockheed Martin Canada Inc., to the Companys Board of Directors.

Page 69



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##### Table of Contents



Signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amendment to report
to be signed on its behalf by the undersigned, thereunto duly authorized on the
30th day of April, 2001.

| |                                    
| | -----------------------------------
| | Illinois Superconductor Corporation
|
|
| | By: /s/ George M. Calhoun          
| | George M. Calhoun                  
| | Chief Executive Officer (Principal 
| | Executive Officer)                 

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 30th day of April, 2001.

|                       |  |                                        | 
|---------------------- |  | -------------------------------------- | 
|Signature              |  | Title                                  | 
|                       |  |                                        | 
|/s/ George M. Calhoun  |  | Chief Executive Officer and            | 
|                      
|                      
|                      
|                      
|George M. Calhoun      |  | Director (Principal Executive Officer) | 
|                      
|/s/ Charles F. Willes  |  | Chief Financial Officer (Principal     | 
|                      
|                      
|                      
|                      
|Charles F. Willes      |  | and Accounting Officer)                | 
|                      
|/s/ Howard S. Hoffmann |  | Director                               | 
|                      
|                      
|                      
|                      
|Howard S. Hoffmann     |  |                                        | 
|                      
|/s/ Thomas L. Powers   |  | Director                               | 
|                      
|                      
|                      
|                      
|Thomas L. Powers       |  |                                        | 
|                      
|/s/ Norbert Lou        |  | Director                               | 
|                      
|                      
|                      
|                      
|Norbert Lou            |  |                                        | 

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##### Table of Contents



ILLINOIS SUPERCONDUCTOR CORPORATION

SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

|                              |                               |                                            |  |              |            |           |  |            |           |         |  |   |         |                |  |   |            | 
|----------------------------- | ----------------------------- | ------------------------------------------ |  | ------------ | ---------- | --------- |  | ---------- | --------- | ------- |  | - | ------- | -------------- |  | - | ---------- | 
|                              |                               |                                            |  | Balance at  
|                              |                               |                                            |  | beginning of |            |           |  |            |           |         |  |   |         | Balance at end
|                              |                               |                                            |  | Year         |            | Additions |  | Deductions |           | of year
|                              |                               |                                            |  |              |            |           |  |            |           |        
|YEAR ENDED DECEMBER 31, 2000:
|                             
|                              | Deducted from asset accounts:
|                             
|                             
|                             
|                             
|                              |                               | Valuation allowance on deferred tax assets |  | $            | 24,314,000 |           |  | $          | 6,119,000 |         |  | $ | 0       |                |  | $ | 30,433,000 | 
|                             
|                             
|                             
|                             
|                              |                               | Allowance for doubtful accounts            |  | $            | 35,340     |           |  | $          | 0         |         |  | $ | 22,986  |                |  | $ | 12,354     | 
|                             
|                             
|                             
|                             
|                              |                               | Reserve of obsolete inventory              |  | $            | 853,724    |           |  | $          | 0         |         |  | $ | 238,493 |                |  | $ | 615,231    | 
|                             
|YEAR ENDED DECEMBER 31, 1999:
|                             
|                              | Deducted from asset accounts:
|                             
|                             
|                             
|                             
|                              |                               | Valuation allowance on deferred tax assets |  | $            | 20,138,000 |           |  | $          | 4,176,000 |         |  | $ | 0       |                |  | $ | 24,314,000 | 
|                             
|                             
|                             
|                             
|                              |                               | Allowance for doubtful accounts            |  | $            | 87,990     |           |  | $          | 0         |         |  | $ | 52,650  |                |  | $ | 35,340     | 
|                             
|                             
|                             
|                             
|                              |                               | Reserve of obsolete inventory              |  | $            | 587,000    |           |  | $          | 266,724   |         |  | $ | 0       |                |  | $ | 853,724    | 
|                             
|YEAR ENDED DECEMBER 31, 1998:
|                             
|                              | Deducted from asset accounts:
|                             
|                             
|                             
|                             
|                              |                               | Valuation allowance on deferred tax assets |  | $            | 15,825,000 |           |  | $          | 4,313,000 |         |  | $ | 0       |                |  | $ | 20,138,000 | 
|                             
|                             
|                             
|                             
|                              |                               | Allowance for doubtful accounts            |  | $            | 68,775     |           |  | $          | 19,215    |         |  | $ | 0       |                |  | $ | 87,990     | 
|                             
|                             
|                             
|                             
|                              |                               | Reserve for obsolete inventory             |  | $            | 0          |           |  | $          | 587,000   |         |  | $ | 0       |                |  | $ |           

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##### Table of Contents



EXHIBIT INDEX

|        |  |                                                                                                                                                                                                                                                                                                                                        
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT
|NUMBER  |  | DESCRIPTION OF EXHIBITS                                                                                                                                                                                                                                                                                                                
|        |  |                                                                                                                                                                                                                                                                                                                                        
|3.1     |  | Certificate of Incorporation of the Company, incorporated by reference
to Exhibit 3.1 to the Companys Registration Statement on Form S-3/A,
filed with the Securities and Exchange Commission (SEC) on August
13, 1998, Registration No. 333-56601 (the August 1998 S-3).                                                         
|       
|       
|       
|       
|3.2     |  | By-Laws of the Company, incorporated by reference to Exhibit 3.2 to
Amendment No. 3 to the Companys Registration Statement on Form S-1,
filed with the SEC on October 26, 1993, Registration No. 33-67756 (the
IPO Registration Statement).                                                                                         
|       
|       
|       
|       
|3.3     |  | Certificate of Amendment of Certificate of Incorporation of the
Company, incorporated by reference to Exhibit 3.3 to the IPO
Registration Statement.                                                                                                                                                                                   
|       
|       
|       
|       
|3.4     |  | Certificate of Amendment of Certificate of Incorporation of the
Company, incorporated by reference to Exhibit 4.3 to the Companys
Registration Statement on Form S-3/A, filed with the SEC on July 1,
1999, Registration No. 333-77337.                                                                                               
|       
|       
|       
|       
|3.5     |  | Certificate of Amendment of Certificate of Incorporation of the
Company filed July 18, 2000, incorporated by reference to the
Companys registration statement                                                                                                                                                                         
|        |  | on Form S-8 filed August 7, 2000 (the August 2000 S-8).                                                                                                                                                                                                                                                                               
|       
|       
|       
|       
|4.1     |  | Specimen stock certificate representing Common Stock, incorporated by
reference to Exhibit 4.1 to the IPO Registration Statement.                                                                                                                                                                                                      
|       
|       
|       
|       
|4.2     |  | Form of Series B Warrants, incorporated by reference to Exhibit 4.2 to
the IPO Registration Statement.                                                                                                                                                                                                                                 
|       
|       
|       
|       
|4.3     |  | Form of Series C Warrants, incorporated by reference to Exhibit 4.3 to
the IPO Registration Statement.                                                                                                                                                                                                                                 
|       
|       
|       
|       
|4.4     |  | Form of Representative Warrant, incorporated by reference to Exhibit
4.4 to the IPO Registration Statement.                                                                                                                                                                                                                            
|       
|       
|       
|       
|4.5     |  | Rights Agreement dated as of February 9, 1996 between the Company and
LaSalle National Trust, N.A., incorporated by reference to the Exhibit
to the Companys Registration Statement on Form 8-A, filed with the
SEC on February 12, 1996.                                                                                             
|       
|       
|       
|       
|4.6     |  | Convertible Preferred Stock Purchase Agreement dated as of June 6,
1997, by and between the Company and Southbrook International
Investments, Ltd., incorporated by reference to Exhibit 4.3 to the
Companys Registration Statement on Form S-3, filed with the SEC on
June 23, 1997, Registration No. 333-29797(the June 1997 S-3).
|       
|       
|       
|       
|4.7     |  | Registration Rights Agreement dated as of June 6, 1997, by and between
the Company and Southbrook International Investments, Ltd.,
incorporated by reference to Exhibit 4.5 to the June 1997 S-3.                                                                                                                                      
|       
|       
|       
|       
|4.8     |  | Warrant dated June 6, 1997 issued to Southbrook International
Investments, Ltd., incorporated by reference to Exhibit 4.5 to the
June 1997 S-3.                                                                                                                                                                                        
|       
|       
|       
|       
|4.9     |  | Certificate of Designation, Preferences and Rights relating to the
Companys Series C Convertible Preferred Stock, incorporated by
reference to Exhibit 4.9 to the Companys Registration Statement on
Form S-3, filed with the SEC on September 22, 1997, Registration No.
333-36089.                                                 
|       
|       
|       
|       
|4.10    |  | Certificate of Designation, Preferences and Rights relating to the
Companys Series G Convertible Preferred Stock, incorporated by
reference to Exhibit 4.8 to the Companys Registration Statement on
Form S-3, filed with the SEC on December 8, 1997, Registration No.
333-41731 (the December 1997 S-3).                         
|       
|       
|       
|       
|4.11    |  | Convertible Preferred Stock Purchase Agreement dated as of October 29,
1997, by and between the Company and Elliott Associates, L.P. and
Westgate International, L.P., incorporated by reference to Exhibit 4.9
to the December 1997 S-3.                                                                                              
|       
|       
|       
|       
|4.12    |  | Registration Rights Agreement dated as of October 29, 1997, by and
between the Company and Elliott Associates, L.P. and Westgate
International, L.P., incorporated by reference to Exhibit 4.10 to the
December 1997 S-3.                                                                                                              
|       
|       
|       
|       
|4.13    |  | Agreement dated as of October 29, 1997, by and between the Company and
Brown Simpson Strategic Growth Fund, L.P. and Southbrook International
Investments, Ltd., incorporated by reference to Exhibit 4.11 to the
December 1997 S-3.                                                                                                   

Page 72



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##### Table of Contents



|     |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4.14 |  | Form of 2% Senior Convertible Note due May 15, 2002, incorporated by
reference to Exhibit 4.2 to the August 1998 S-3.                                                                                                                                                                                                                                                                                                       
|    
|    
|    
|    
|4.15 |  | Form of Warrant dated May 15, 1998, incorporated by reference to
Exhibit 4.3 to the August 1998 S-3.                                                                                                                                                                                                                                                                                                                        
|    
|    
|    
|    
|4.16 |  | Securities Purchase Agreement dated as of May 15, 1998, by and between
the Company and Elliott Associates, L.P., Westgate International,
L.P., Alexander Finance, LP, State Farm Mutual Automobile Insurance
Company, Spring Point Partners, L.P. and Spring Point Offshore Fund,
incorporated by reference to Exhibit 4.5 to the August 1998 S-3.                                                                          
|    
|    
|    
|    
|4.17 |  | Registration Rights Agreement dated as of May 15, 1998, by and between
the Company and Elliott Associates, L.P., Westgate International,
L.P., Alexander Finance, LP, State Farm Mutual Automobile Insurance
Company, Spring Point Partners, L.P. and Spring Point Offshore Fund,
incorporated by reference to Exhibit 4.6 to the August 1998 S-3.                                                                          
|    
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|4.18 |  | Form of 6% Senior Convertible Note due May 15, 2002 incorporated by
reference to Exhibit 4.18 to the Companys Annual Report on Form 10-K
for the year ended December 31, 1998.                                                                                                                                                                                                                                             
|    
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|4.19 |  | Form of Warrant dated March 31, 1999 incorporated by reference to
Exhibit 4.19 to the Companys Annual Report on Form 10-K for the year
ended December 31, 1998.                                                                                                                                                                                                                                                            
|    
|    
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|4.20 |  | Securities Purchase Agreement dated as of March 31, 1999, by and
between the Company and Elliott Associates, L.P., Westgate
International, L.P., Alexander Finance, LP and State Farm Mutual
Automobile Insurance Company, incorporated by reference to Exhibit
4.20 to the Companys Annual Report on Form 10-K for the year ended
December 31, 1998.                                                                      
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|4.21 |  | Registration Rights Agreement dated as of March 31, 1999, by and
between the Company and Elliott Associates, L.P., Westgate
International, L.P., Alexander Finance, LP and State Farm Mutual
Automobile Insurance Company, incorporated by reference to Exhibit
4.21 to the Companys Annual Report on Form 10-K for the year ended
December 31, 1998.                                                                      
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|4.22 |  | Amendment to Securities Purchase Agreement dated as of March 31, 1999,
by and between the Company and Elliott Associates, L.P., Westgate
International, L.P., Alexander Finance, LP, State Farm Mutual
Automobile Insurance Company, Spring Point Partners, L.P. and Spring
Point Offshore Fund, incorporated by reference to Exhibit 4.22 to the
Companys Annual Report on Form 10-K for the year ended December 31,
1998.
|    
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|4.23 |  | The SSI Replacement Nonqualified Stock Option Plan, incorporated by
reference to Exhibit 4.1 to the Companys Registration Statement on
Form S-8, filed with the SEC on November 3, 2000, Registration No.
333-49268.*                                                                                                                                                                                                      
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|4.24 |  | Letter Agreement dated October 20, 2000 by and between the Company and
Elliott Associates, L.P. and Westgate International, incorporated by
reference to Exhibit B to the Schedule 13D filed with the SEC by
Elliott Associates, L.P. on November 13, 2000.                                                                                                                                                                 
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|10.1 |  | 1993 Amended and Restated Stock Option Plan, as amended, incorporated
by reference to Exhibit 4.6 to the August 2000 S-8.                                                                                                                                                                                                                                                                                                   

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|      |  |                                                                                                                                                                                                                                      
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.2  |  | Form of Amended and Restated Director Indemnification Agreement,
incorporated by reference to Exhibit 10 to the Companys Quarterly
Report on Form 10-Q for the quarterly period ended September 30, 1998.                           
|     
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|     
|10.3  |  | Third Amended and Restated Registration Rights Agreement dated as of
July 14, 1993, as amended, incorporated by reference to Exhibit 10.4
to the IPO Registration Statement.                                                         
|     
|     
|     
|     
|10.4  |  | Public Law Agreement dated February 2, 1990 between Illinois
Department of Commerce and Community Affairs and the Company,
incorporated by reference to Exhibit 10.5 to the IPO Registration
Statement.                              
|     
|     
|     
|     
|10.5  |  | Public Law Agreement dated December 30, 1991 between Illinois
Department of Commerce and Community Affairs and the Company, amended
as of June 30, 1992, incorporated by reference to Exhibit 10.6 to the
IPO Registration Statement.
|     
|     
|     
|     
|10.6  |  | Representative Warrant Agreement, incorporated by reference to Exhibit
10.7 to the IPO Registration Statement.                                                                                                                       
|     
|     
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|     
|10.7  |  | Subcontract and Cooperative Development Agreement dated as of June 1,
1993 between American Telephone and Telegraph Company and the Company,
incorporated by reference to Exhibit 10.9 to the IPO Registration
Statement.            
|     
|     
|     
|     
|10.8  |  | Intellectual Property Agreement dated as of June 1, 1993 between
American Telephone and Telegraph Company and the Company, incorporated
by reference to Exhibit 10.10 to the IPO Registration Statement.                             
|     
|     
|     
|     
|10.9  |  | License Agreement dated January 31, 1990 between the Company and
Northwestern University, incorporated by reference to Exhibit 10.13 to
the IPO Registration Statement.                                                              
|     
|     
|     
|     
|10.10 |  | License Agreement dated February 2, 1990 between the Company and ARCH
Development Corporation, incorporated by reference to Exhibit 10.14 to
the IPO Registration Statement.                                                         
|     
|     
|     
|     
|10.11 |  | License Agreement dated August 9, 1991 between the Company and ARCH
Development Corporation, incorporated by reference to Exhibit 10.15 to
the IPO Registration Statement.                                                           
|     
|     
|     
|     
|10.12 |  | License Agreement dated October 11, 1991 between the Company and ARCH
Development Corporation, incorporated by reference to Exhibit 10.16 to
the IPO Registration Statement.                                                         
|     
|     
|     
|     
|10.13 |  | Public Law Agreement dated August 18, 1993 between Illinois
Department of Commerce and Community Affairs and the Company,
incorporated by reference to Exhibit 10.17 to the IPO Registration
Statement.                              
|     
|     
|     
|     
|10.14 |  | Form of Officer Indemnification Agreement incorporated by reference
to Exhibit 10.17 to the Companys Annual Report on Form 10-K for the
year ended December 31, 1998.                                                               
|     
|     
|     
|     
|10.15 |  | Employment Agreement dated November 9, 1998 between the Company and
Dennis Craig incorporated by reference to Exhibit 10.18 to the
Companys Annual Report on Form 10-K for the year ended December 31,
1998.                        

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|      |  |                                                                                                                                                                                                                                                                                                                                                     
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.16 |  | Employment Agreement dated April 12, 1999 between the Company and Amr
Abdelmonem, incorporated by reference to the Companys Registration
Statement on Form S-2A, filed with the SEC on July 9, 1999,
Registration Number 333-77337.                                                                                                                
|     
|     
|     
|     
|10.17 |  | Single-Tenant Industrial building Lease between Teachers Retirement
System of the State of Illinois, landlord, and Illinois Superconductor
Corporation, tenant, dated June 24, 1994, incorporated by reference to
Exhibit 10.1 to the Companys Form 10-Q for the quarterly period
ending June 30, 1994.                                           
|     
|     
|     
|     
|10.18 |  | Letter Agreement, dated November 5, 1999, by and among the Company
and the Investors, incorporated by reference to Exhibit 10(a) to the
Companys Current Report on Form 8-K filed with the SEC on November
15, 1999.                                                                                                                               
|     
|     
|     
|     
|10.19 |  | Letter Agreement re Modification of Covenants, dated November 5,
1999, by and among the Company and the Investors, incorporated by
reference to Exhibit 10(b) to the Companys Current Report on Form 8-K
filed with the SEC on November 15, 1999.                                                                                                  
|     
|     
|     
|     
|10.20 |  | Security Agreement, dated November 5, 1999, by and among the Company
and the Investors, incorporated by reference to Exhibit 10(c) to the
Companys Current Report on Form 8-K filed with the SEC on November
15, 1999.                                                                                                                             
|     
|     
|     
|     
|10.21 |  | Letter Agreement dated November 12, 1999, amending the Letter
Agreement filed as Exhibit 10.18, incorporated by reference to Exhibit
4.26 to the Companys Quarterly Report on Form 10-Q for the quarter
ended March 31, 2000, filed with the SEC on May 12, 2000 (the First
Quarter 2000 10-Q).                                                  
|     
|     
|     
|     
|10.22 |  | Securities Purchase Letter Agreement dated December 28, 1999, by and
among the Company, Elliott Associates, Westgate and Alexander,
incorporated by reference to Exhibit 4.27 to the First Quarter 2000
10-Q.                                                                                                                                       
|     
|     
|     
|     
|10.23 |  | Securities Purchase Letter Agreement dated March 27, 2000, by and
among the Company, Elliott Associates, Westgate and Alexander,
incorporated by reference to Exhibit 4.28 to the First Quarter 2000
10-Q.                                                                                                                                          
|     
|     
|     
|     
|10.24 |  | Agreement and Plan of Merger, dated May 17, 2000 among the Company,
SSI Acquisition, Corp., Spectral Solutions, Inc., Russell Scott III,
and Certain Other Stockholders of Spectral Solutions, Inc.,
incorporated by reference to Annex A to the Companys definitive
additional proxy materials filed June 9, 2000.                                
|     
|     
|     
|     
|10.25 |  | Escrow Agreement dated August 8, 2000 among the Company, Russell
Scott, III, as stockholder representative, and American National Bank
and Trust Company, as escrow agent, incorporated by reference to
Exhibit 10.25 to the Companys registration statement on Form S-2
filed September 7, 2000, Registration No. 333-45406 (the September
S-2).
|     
|     
|     
|     
|10.26 |  | Employment Agreement dated August 2, 2000 between the Company and
Richard Herring, incorporated by reference to Exhibit 10.26 to the
September S-2.                                                                                                                                                                                                 
|     
|     
|     
|     
|10.27 |  | Management Services Agreement, dated July 17, 2000, by and between
the Company and CTR Ventures, K.K., incorporated by reference to
Exhibit 10.27 to the September S-2.                                                                                                                                                                             
|     
|     
|     
|     
|10.28 |  | Transaction Agreement, dated November 1, 2000, by and among the
Company, Illinois Superconductor Canada Corporation and Lockheed Martin Canada,
Inc., incorporated by reference to Exhibit 2.1 to the Company's
Current Report on Form 8-K filed on January 4, 2001.                                                                                
|     
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|23.1  |  | Consent of Grant Thornton LLP.                                                                                                                                                                                                                                                                                                                      
|     
|     
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|     
|23.2  |  | Consent of Ernst & Young LLP.                                                                                                                                                                                                                                                                                                                       



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