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                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
                                 ---------------

                                    FORM 10-K
(Mark One)
 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                   For the fiscal year ended December 31, 1998

                                       OR

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

             For the transition period from __________ to __________

                         COMMISSION FILE NUMBER 0-22302

                       ILLINOIS SUPERCONDUCTOR CORPORATION
             (Exact name of registrant as specified in its charter)

          DELAWARE                                              36-3688459
(State or other jurisdiction                               (I.R.S. Employer 
of incorporation)                                          Identification No.)

                               451 KINGSTON COURT
                          MT. PROSPECT, ILLINOIS 60056
                                 (847) 391-9400
          (Address and telephone number of principal executive offices)

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

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

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

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

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

     On March 25, 1999, 12,557,344 shares of the registrant's Common Stock were
outstanding. The aggregate market value on March 25, 1999 of the registrant's
Common Stock held by non-affiliates of the registrant was $14,127,012.

                      DOCUMENTS INCORPORATED BY REFERENCE

     Certain portions of the registrant's definitive proxy statement for the
annual meeting of stockholders to be held on June 9, 1999 are incorporated by
reference in Part III of this Form 10-K.

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<TABLE>
<CAPTION>
                                               TABLE OF CONTENTS

                                                     PART I
<S>        <C>                                                                                                   <C>
Item 1.    Business...........................................................................................    1
Item 2.    Properties.........................................................................................   19
Item 3.    Legal Proceedings..................................................................................   19
Item 4.    Submission of Matters to a Vote of Security Holders................................................   21

                                                     PART II

Item 5.    Market for Registrant's Common Equity and Related Stockholder Matters..............................   22
Item 6.    Selected Financial Data............................................................................   24
Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations..............   25
Item 7a.   Quantitative and Qualitative Disclosures About Market Risk.........................................   28
Item 8.    Financial Statements and Supplementary Data........................................................   29
Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...............   49

                                                     PART III

Item 10.   Directors and Executive Officers of the Registrant.................................................   50
Item 11.   Executive Compensation.............................................................................   50
Item 12.   Security Ownership of Certain Beneficial Owners and Management.....................................   50
Item 13.   Certain Relationships and Related Transactions.....................................................   50

                                                      PART IV

Item 14.   Exhibits, Financial Statement Schedules and Reports on Form 8-K....................................   51
</TABLE>

Because the Company wants to provide investors with more meaningful and useful
information, this Annual Report on Form 10-K ("Form 10-K") contains, and
incorporates by reference, certain "forward-looking statements" (as such term is
defined in Section 21E of the Securities Exchange Act of 1934, as amended) that
reflect the Company's current expectations regarding the future results of
operations, performance and achievements of the Company. These forward-looking
statements are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. The Company has tried, wherever
possible, to identify these forward-looking statements by using words such as
"anticipates," "believes," "estimates," "expects," "plans," "intends" and
similar expressions. These statements reflect the Company's current beliefs and
are based on information currently available to it. Accordingly, these
statements are subject to certain risks, uncertainties and contingencies, which
could cause the Company's actual results, performance or achievements to differ
materially from those expressed in, or implied by, such statements. These
factors include, among others, the following: the Company's history of net
losses and the lack of assurance that the Company's earnings will be sufficient
to cover fixed charges in the future; the degree to which the Company is
leveraged and the restrictions imposed on the Company under its existing debt
instruments which may adversely affect the Company's ability to finance its
future operations, to compete effectively against better capitalized competitors
and to withstand downturns in its business or the economy generally; the
Company's current inability to satisfy the minimum maintenance requirements for
the continued listing of its shares of Common Stock for trading on the Nasdaq
National Market which may have a material adverse effect on the liquidity of the
Common Stock and the Company's ability to obtain additional funding as needed if
such shares are delisted; demand for, and acceptance of, the Company's products;
continued downward pressure on the prices charged for the Company's products due
to competition of rival manufacturers of filters for the wireless
telecommunications market; the timing and receipt of customer orders; the
Company's ability to attract and retain key personnel; the effects of legal
proceedings and other factors described in this Form 10-K, including those
described under the heading "Risk Factors," or in other filings of the Company
with the Securities and Exchange Commission. The Company undertakes no
obligation to release publicly the results of any revisions to any such
forward-looking statements that may be made to reflect events or circumstances
after the date of this Form 10-K or to reflect the occurrence of unanticipated
events.


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                                     PART I

ITEM 1.  BUSINESS

GENERAL

     Illinois Superconductor Corporation (the "Company") uses its patented and
proprietary high temperature superconductor ("HTS") materials, radio frequency
("RF") filter designs and cryogenic technologies to develop, manufacture and
market high performance products designed to enhance the quality, capacity,
coverage and flexibility of cellular, Personal Communications Services ("PCS")
and other wireless telecommunications services. Superconductor materials, when
cooled below a critical temperature, are able to transmit an electric current
with either no or minimal loss of energy. Because of this minimal energy loss,
superconductors are attractive for a wide range of commercial applications.

     RF filters refine the radio signals by passing radio waves through a series
of resonators (poles) which allow certain frequencies to pass while rejecting
other frequencies. The more poles in the RF filter, the more effective the RF
filter. Each pole, however, has electrical resistance which causes the loss
(insertion loss) of desired radio waves. Therefore, the more poles in a
conventional RF filter, the greater the insertion loss. The advantage of using
superconductors in RF filters is that more poles can be added without
significant increases in insertion loss. Adding superconductors does not,
however, change the fundamental fact that filter performance depends upon the
number of poles. The Company's highest performing RF filters have more than 30
poles which the Company believes is significantly greater than any other
commercially available filter.

     Filters can be designed with a variety of structures including stripline,
microstrip, cavity, dielectric, and waveguide. The Company is able to produce RF
filters using any of these technologies, but has primarily focused on cavity
filters because of their high performance and tuning flexibility. The Company
uses its proprietary thick-film superconducting technology for its RF filters.
The Company believes that relative to other superconducting materials
technologies, thick-film provides for higher RF filter performance and lower
distortion levels. The Company also believes that its thick-film superconductor
technology is unique in its ability to handle high-powered transmit applications
while maintaining very low levels of intermodulation distortion. In addition,
thick-film technology does not require "clean" rooms for manufacturing, which
reduces the cycle time and cost of production. Superconductors become
superconducting at temperatures of roughly -200(Degree) C. These temperature
levels can be maintained using commercially available mechanical cooling
systems. The Company has developed cryogenic packaging systems for its RF
filters which are highly reliable over longer durations and minimize operating
costs.

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

BUSINESS STRATEGY

     The Company's objective is to be the global leader in supplying high
performance RF filter products to the growing wireless telecommunications
market. Key elements of the Company's strategy include the following:

     -   Offering the Highest Performance RF Filter Systems in the Industry. The
         Company's proprietary thick-film and RF filter design technology
         permits the Company to build RF filters with a high level of adjacent
         band interference rejection coupled with a low level of desired signal
         loss. The Company believes that its success will depend upon
         maintaining its technological leadership.

     -   Supplying Price Competitive Products. The Company has been able to
         continually reduce its product cost, which has permitted the Company to
         competitively price its products. Currently, the price for the
         Company's superconducting filters is approaching that of conventional
         filters. The Company's lowest price product currently sells for less
         than $10,000 per cell site. The Company believes that with superior
         performance and competitive pricing it can become the dominant RF
         filter manufacturer in the world. In 1997, the Company reduced product
         costs by 50%, and in 1998 



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         the Company reduced product costs by an additional 40%. The Company
         believes that it can continue to achieve further cost reductions in the
         coming years.

     -   Providing Solutions for Different Market Needs. The Company has
         successfully expanded its product line in response to a wide variety of
         customer needs in a cost-effective manner. For rural markets, the
         Company currently offers a rural range extension product for under
         $10,000, while for urban markets, it offers a 24 pole brick wall RF
         filter which it believes is superior to the other RF filters currently
         available on the market. The Company has achieved this broad product
         portfolio through flexible designs which can quickly be adapted to
         different customer needs. By addressing the varied needs of the market
         at a reasonable price, the Company aims to provide real value to its
         customers.

     -   Superior Customer Support The Company strives to exceed its customers'
         expectations for quality and responsiveness by minimizing service
         interruptions. Because of its superior quality and customer support,
         the Company was awarded Motorola's superior quality award in 1998.

     -   Best in Class Reliability. To insure maximum customer retention, the
         Company aims to provide the highest level of reliability to its
         customers. To achieve this, the Company introduced its proprietary
         ATP(TM) technology which insures that its RF filters continue to
         operate even when there is a cooling system or power failure. In
         addition, the Company has chosen its cooler vendor based on superior
         reliability and offers such features as redundant alarms and remote
         diagnostics.

     -   Focusing on Fast Growing Commercial Markets. The Company has focused on
         the fast growing wireless telecommunications market and has deferred at
         this time pursuing other commercial applications of its proprietary
         technology. This focus has minimized overhead costs and allowed the
         Company to be first to market with new RF products and a broader
         product portfolio than its competitors.

     -   Building Long-Term Relationships with Customers. Becoming the preferred
         RF filter vendor with customers will allow the Company to focus on
         expanding its business with new customers and in new markets. To date,
         the Company has established strong relationships with six of the
         largest wireless operators in the United States. These customers have
         placed repeated orders in multiple markets. The Company's largest
         customer purchased equipment for over 50 cell sites in the fourth
         quarter of 1998.

     The Company has received orders from multiple wireless telecommunications
service providers located in the United States, Canada and Asia, including many
of the largest wireless operators in the United States. The Company's RF filters
are now installed in over 100 cell sites in market areas across the United
States. In 1997, commercial orders from wireless service providers were
generally for one or two operational cell sites, with the largest order having
been for five cell sites. In 1998, commercial orders significantly increased
with several wireless service providers deploying the Company's products in tens
of cell sites. The Company's newest product line, the PowerMaster(TM) line of
transmit filters, has generated interest from several major original equipment
manufacturers ("OEMs") that supply cellular and PCS systems equipment to the
wireless service providers.

     The Company is an approved vendor for one of the world's largest cellular
system equipment manufacturers and is pursuing similar relationships with other
OEMs. Being an approved vendor allows cellular and PCS service providers in the
U.S. and abroad to purchase the Company's products directly from the OEM, for
use in both new and existing cell sites.


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RISK FACTORS

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

Uncertain Market Acceptance of Superconducting Telecommunications Products

     The Company's RF filter products, which are based on the Company's HTS
technology, have not been sold in very large quantities and a sufficient market
may not develop for the Company's products. The Company's customers establish
demanding specifications for performance and reliability. The Company's RF
filter products may not continue to meet product performance and reliability
criteria set by cellular and PCS service providers. Also, the Company's products
may not operate reliably on a long-term basis, the Company may be unable to
manufacture adequate quantities of any products it develops at commercially
acceptable costs or on a timely basis, or the Company's current or future
products may not achieve market acceptance. The Company has experienced, and may
continue to experience, quarterly fluctuations in its results of operations as
its RF filter products attempt to gain market acceptance while being subject to
the lengthy purchase processes of customers. Failure to successfully develop,
manufacture and commercialize products on a timely and cost-effective basis will
have a material adverse effect on the Company's business, operating results and
financial condition.

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

     The Company was founded in October 1989 and through 1996 was engaged
principally in research and development ("R&D"), product testing, manufacturing,
marketing and sales activities. The Company has only recently begun to generate
significant revenues from the sale of its RF filter products. Prior to the
commencement of these sales, the majority of the Company's revenues were derived
from R&D contracts, primarily from the U.S. government. The Company does not
expect revenues to increase dramatically until it ships a significantly larger
amount of its RF products. Accordingly, the Company has only a limited operating
history upon which an evaluation of the Company and its prospects can be based.
The Company must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in their early stages of product
commercialization.

     The Company has incurred substantial net losses in each year since its
inception. The Company expects to continue to incur operating losses through at
least the end of 1999 as it continues to devote significant financial resources
to its product development, manufacturing, marketing and sales efforts. Even if
the Company is able to overcome the significant remaining manufacturing and
marketing hurdles necessary to sell large quantities of its RF filter products,
the Company may never achieve a profitable level of operations or, if
profitability is achieved, it may not be sustained.

     The Company's customers are highly concentrated. The loss of an individual
customer may have a material adverse effect on the Company's business. The
wireless telecommunications market is currently experiencing an increasing rate
of consolidation among the largest wireless operators which may cause a
significant disruption and/or delay in the sales of the Company's products. In
order to continue to grow revenues, the Company may be required to further
reduce the prices of its products. In the event of further price reductions, the
Company may not be able to reduce product costs sufficiently to achieve
acceptable product margins.

Future Capital Needs and Delisting of Common Stock

     To date, the Company has financed its operations primarily through public
and private equity and debt financings. Although the Company recently completed
a private placement of $3.3 million in aggregate initial principal amount of
convertible debt securities, the Company believes that it will require
substantial additional funds during the third quarter of 1999 to finance its
product development, manufacturing, marketing and sales activities. In addition,
the Company's outstanding debt instruments contain certain restrictions which
may adversely impair the Company's ability to obtain additional financing. See
"Substantial Leverage; Restrictions Contained in Debt Instruments" below. If
additional funds are raised by issuing other equity or convertible debt
securities, further dilution to existing or future stockholders is likely to
result. If adequate funds are not available on acceptable terms when needed, the
Company would be required to substantially delay, scale-back or eliminate the
manufacturing, marketing or sales of one or more of its products or research and
development programs, or may be required to obtain funds through arrangements
with collaborative partners or others that may require the Company to relinquish
rights to certain of its technologies,


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product candidates or potential products that the Company would not otherwise
relinquish. This would materially adversely affect the Company's business
operating results and financial condition. Inadequate funding also could impair
the Company's ability to compete in the marketplace.

     The Company regularly examines opportunities to expand its technology base
and product line through means such as licenses, joint ventures and acquisitions
of assets or ongoing businesses, and may issue securities in connection with
such transactions. However, no commitments to enter into or pursue any such
transactions have been made at this time, and any such discussions may not
result in any such transaction being concluded.

     In addition, the Company currently has a limited number of unreserved
authorized shares of its Common Stock, $.001 par value per share (the
"Common Stock"), available for future issuance in connection with financings.
The Company plans to request that its stockholders approve an increase in the
number of authorized shares at the next annual meeting of the Company's
stockholders. Failure to obtain this approval would limit the Company's ability
to raise sufficient funds to support its business plans.

     The Company is currently unable to maintain a level of net tangible assets
required to maintain the listing of the Common Stock for trading on the Nasdaq
National Market, and the Common Stock may be delisted for trading on the Nasdaq
National Market in the near future. Such delisting could have a material adverse
effect on the liquidity of the Common Stock and could have a material adverse
effect on the Company's ability to obtain additional funding as needed,
especially if the Company is unable to list the Common Stock for trading on
another securities market or exchange.

Substantial Leverage; Restrictions Contained in Debt Instruments

     The Company is substantially leveraged. The degree to which the Company is
leveraged may adversely affect the Company's ability to finance its future
operations, to compete effectively against better capitalized competitors and to
withstand downturns in its business or the economy generally. Although the
Company's outstanding Notes (as defined below under "Substantial Number of
Shares Eligible for Future Sale; Dilution") currently permit, subject to certain
restrictions, the Company to pay accrued interest on such securities in shares
of Common Stock, the Company may be unable to continue to be permitted to do so
in the future. If the Company is no longer permitted to pay accrued interest on
the Notes in shares of Common Stock, the Company may not be successful in
raising additional equity or debt financing sufficient to enable it to pay such
interest in cash. In addition, the Company's outstanding Notes contain
restrictions that may adversely affect the Company's ability to raise additional
equity or debt financing. Under the Notes, the Company is not permitted, without
the prior approval of the holders of the Notes, (i) to incur any additional
indebtedness (other than pursuant to a working capital line of credit in an
amount not to exceed $1 million or to trade creditors in the ordinary course of
business) or to create any lien, pledge, or encumbrance, subject to certain
exceptions, on any assets of the Company, (ii) for so long as a significant
portion of the Notes remain outstanding, to engage in certain sale or merger
transactions, or to engage in certain other transactions which require the
approval of the Company's stockholders, or (iii) to redeem, purchase or
otherwise acquire any equity or debt securities of the Company which are junior
in rights or preferences to the Notes, or to pay any dividend (other than in
shares of Common Stock) with respect to such securities. In addition, in the
event that the Company fails to achieve break-even or positive operating income
during the second quarter of 2000, the Notes may become immediately due and
payable unless the holders thereof agree to modify or waive such provision.
Furthermore, for so long as the amount of Common Stock issuable upon conversion
of the Notes represents 5% or more of the total then outstanding shares of the
Common Stock, the holders of the Notes have the right to designate two members
for election to the Company's Board of Directors.



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Volatility of Common Stock Price

     The market price of the Common Stock, like that of many other
high-technology companies, has fluctuated significantly and is likely to
continue to fluctuate in the future. Since January 1, 1998, the closing price of
the Common Stock has ranged from a low of $0.84 per share to a high of $3.31 per
share. Announcements by the Company or others regarding the receipt of customer
orders, quarterly variations in operating results, additional equity or debt
financings, changes in recommendations of securities analysts, results of
customer field trials, scientific discoveries, technological innovations,
litigation, product developments, patent or proprietary rights, government
regulation and general market conditions may have a significant impact on the
market price of the Common Stock. In addition, if in the future the closing
price of the Common Stock as reported on the Nasdaq National Market remains
below $1.00 per share for 30 consecutive days, the Common Stock could be
delisted for trading on the Nasdaq National Market. Such delisting could have a
material adverse effect on the liquidity of the Common Stock.

Limited Experience in Manufacturing, Marketing and Sales

     For the Company to be financially successful, it must manufacture its
products in substantial quantities, at acceptable costs and on a timely basis.
Although the Company to date has produced limited quantities of its products for
commercial installations and for use in development and customer field trial
programs, production of large quantities at competitive costs presents a number
of technological and engineering challenges for the Company. The Company may be
unable to manufacture such products in sufficient volume. The Company has
limited experience in manufacturing, and substantial costs and expenses may be
incurred in connection with attempts to manufacture larger quantities of the
Company's products. The Company may be unable to make the transition to large
scale commercial production successfully.

     The Company's marketing and sales experience to date is very limited. The
Company will be required to further develop its marketing and sales force in
order to effectively demonstrate the advantages of its products over more
traditional products, as well as competitive superconductive products. The
Company may also elect to enter into agreements or relationships with third
parties regarding the commercialization or marketing of its products. If the
Company enters into such agreements or relationships, it will be substantially
dependent upon the efforts of others in deriving commercial benefits from its
products. The Company may be unable to establish adequate sales and distribution
capabilities, it may be unable to enter into marketing agreements or
relationships with third parties on financially acceptable terms, and any third
parties with whom it enters into such arrangements may not be successful in
marketing the Company's products.

     To date, the Company's products have been installed in over 100 cell sites
with a wide geographic dispersion. Although the Company's products have not
experienced any significant reliability problems to date, the Company's products
may develop quality problems in the future. Repeated or widespread quality
problems could result in significant warranty expenses and/or the loss of
customer confidence. The occurrence of such quality problems could have a
material adverse effect on the Company's business, operating results and
financial condition.

Competition

     The wireless telecommunications equipment market is very competitive. The
Company's products compete directly with products which embody existing and
future competing commercial technologies. In particular, in cellular and PCS
telecommunications applications, the Company competes with conventional RF
component manufacturers whose products are currently in use by the Company's
potential customers. Many of these companies have substantially greater
financial resources, larger R&D staffs and greater manufacturing and marketing
capabilities than the Company. Other emerging wireless technologies, including
"smart antennas" and tower mounted amplifiers, may also provide protection from
RF interference and offer enhanced range to cellular and PCS service providers
at lower prices and/or superior performance, and may therefore compete with the
Company's products. High performance RF filters may not become a preferred
technology to address the needs of cellular and PCS service providers. Failure
of the Company's products to improve performance sufficiently, reliably, or at
an acceptable price or to achieve commercial acceptance or otherwise compete
with conventional and new technologies will have a material adverse effect on
the Company's business, operating results and financial condition.

     Although the market for superconductive electronics currently is small and
in the early stages of development, the Company believes it will become
intensely competitive, especially if products with significant market potential
are successfully developed. In addition, if the superconducting industry
develops, additional competitors with significantly greater resources are likely
to enter 


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the field. In order to compete successfully, the Company must continue
to develop and maintain technologically advanced products, reduce production
costs, attract and retain highly qualified personnel, obtain additional patent
or other protection for its technology and products and manufacture and market
its products, either alone or with third parties. The Company may be unable to
achieve these objectives. Failure to achieve these objectives would have a
material adverse effect on the Company's business, operating results and
financial condition.

     During the fourth quarter of 1998, the Company implemented a new pricing
strategy pursuant to which it reduced the prices for all of its products.
Although sales of the Company's products increased significantly during the
fourth quarter of 1998, such sales growth may not be sustained over subsequent
periods. Similarly, the Company may not be able to continue to reduce product
costs sufficiently to achieve and maintain acceptable product margins.

Management of Growth

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

Rapid Technological Change; Possible Pursuit of Other Market Opportunities

     The field of superconductivity is characterized by rapidly advancing
technology. The success of the Company will depend in large part upon its
ability to keep pace with advancing superconducting technology, high performance
RF filter design and efficient, low cost cryogenic technologies. Rapid changes
have occurred, and are likely to continue to occur, in the development of
superconducting materials and processes. The Company will have to continue to
improve its ability to fabricate thick-film HTS devices, design high performance
RF filters and efficient cryogenic subsystems and produce significant quantities
of products based on these improvements. The Company's development efforts may
be rendered obsolete by the adoption of alternative solutions to current
wireless operator problems or by technological advances made by others. In
addition, other materials or processes, including other superconducting
materials or fabrication processes, may prove more advantageous for the
commercialization of high performance wireless products than the materials and
processes selected by the Company.

     Because HTS product development is a new and emerging field, there may in
the future be new opportunities that are more attractive than those initially
identified by the Company for its targeted markets. As a result, the Company may
elect in the future to commit its resources to such other potentially more
attractive market opportunities. Such election may require the Company to limit
or abandon its current focus on developing, manufacturing, marketing and selling
HTS products for cellular, PCS and other telecommunications markets. The risks
associated with other markets may be different from the risks associated with
the cellular, PCS and other wireless telecommunications markets.

Focus on Wireless Telecommunications Market; Current and Future 
Competitive Technologies

     The Company has selected the wireless telecommunications market, in
particular the cellular and PCS markets, as the first principal target market
for its superconductor-based products. The devotion of substantial resources to
the wireless telecommunications market makes the Company vulnerable to adverse
changes in this market. Adverse developments in the wireless telecommunications
market, which could come from a variety of sources, including future
competition, new technologies or regulatory decisions, could affect the
competitive position of wireless systems. Any adverse developments in the
wireless telecommunications market during the foreseeable future would have a
material adverse effect on the Company's business, operating results and
financial condition.

     The Federal Communications Commission ("FCC") has adopted rules that
provide preferential licensing treatment for parties that develop new
communications services and technologies. These developments and further
technological advances may make 


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available other alternatives to cellular or PCS service, thereby creating
additional sources of competition. Competition to cellular or PCS technologies
could adversely affect the market for the Company's products, or result in
changes in the Company's development and manufacturing programs.

Dependence on a Limited Number of Customers

     To date, the Company's marketing and sales efforts have focused on major
cellular service providers in retrofit applications and, to a lesser extent, on
PCS operators and cellular and PCS original equipment manufacturers. During
1998, sales to three of the Company's customers accounted for over 88% of the
Company's total revenues for 1998. The Company expects that if its RF filter
products achieve market acceptance, a limited number of wireless service
providers and OEMs will account for a substantial portion of its revenue during
any period. Sales of many of the Company's RF filter products depend in
significant part upon the decision of prospective customers and current
customers to adopt and expand their use of the Company's products. Wireless
service providers and the Company's other customers are significantly larger
than, and are able to exert a high degree of influence over, the Company.
Customers' orders are affected by a variety of factors such as new product
introductions, regulatory approvals, end user demand for wireless services,
customer budgeting cycles, inventory levels, customer integration requirements,
competitive conditions and general economic conditions. The loss of one or more
of the Company's customers or the failure to attract new customers would have a
material adverse effect on the Company's business, operating results and
financial condition.

Lengthy Sales Cycles

     Wireless service providers, wireless equipment OEMs and the Company's other
customers are significantly larger than, and are able to exert a high degree of
influence over, the Company. Prior to selling its products to these customers,
the Company must generally undergo lengthy approval and purchase processes.
Technical and business evaluation by potential customers can take up to a year
or more for products based on new technologies such as HTS. The length of the
approval process is affected by a number of factors, including, among others,
the complexity of the product involved, priorities of the customers, budgets and
regulatory issues affecting customers. The Company may not obtain the necessary
approvals or ensuing sales of such products may not occur. The length of the
Company's customers' approval process or delays could have a material adverse
effect on the Company's business, operating results and financial condition.

Dependence on Limited Sources of Supply

     Certain parts and components used in the Company's RF filter products,
including substrates, vacuum components, and cryogenic refrigerators, are only
available from a limited number of sources. The Company's reliance on these
limited source suppliers exposes the Company to certain risks and uncertainties,
including the possibility of a shortage or discontinuation of certain key
components and reduced control over delivery schedules, manufacturing
capabilities, quality and costs. Any reduced availability of such parts or
components when required could materially impair the Company's ability to
manufacture and deliver its products on a timely basis and result in the
cancellation of orders, which could have material adverse effect on the
Company's business, operating results and financial condition. In addition, the
purchase of certain key components involves long lead times and, in the event of
unanticipated increases in demand for the Company's products, the Company may be
unable to manufacture products in a quantity sufficient to meet its customers'
demand in any particular period. The Company has no guaranteed supply
arrangements with its limited source suppliers, does not maintain an extensive
inventory of parts or components, and customarily purchases parts and components
pursuant to purchase orders placed from time to time in the ordinary course of
business.

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

Intellectual Property and Patents



                                       7



<PAGE>   10



     The Company's success will depend in part on its ability to obtain patent
protection for its products and processes, to preserve its trade secrets and to
operate without infringing upon the patent or other proprietary rights of others
and without breaching or otherwise losing rights in the technology licenses upon
which any Company products are based. As of December 31, 1998, the Company has
been issued 20 U.S. patents, has filed and is actively pursuing applications for
16 other U.S. patents, and is the licensee of 10 U.S. patents and patent
applications held by others. One of the Company's patents is jointly owned with
Lucent Technologies, Inc. The Company believes that, since the discovery of HTS
materials in 1986, a large number of patent applications have been filed
worldwide and many patents have been granted in the U.S. relating to HTS
materials. The claims in those patents often appear to overlap and there are
interference proceedings pending in the United States Patent and Trademark
Office (not currently involving the Company) regarding rights to inventions
claimed in some of the HTS materials patent applications. The Company also
believes there are a large number of patents and patent applications covering RF
filter products and other products and technologies that the Company is
pursuing. Accordingly, the patent positions of companies using HTS materials
technologies and RF technologies, including the Company, are uncertain and
involve complex legal and factual questions. The patent applications filed by
the Company or by the Company's licensors may not result in issued patents or
the scope and breadth of any claims allowed in any patents issued to the Company
or its licensors may not exclude competitors or provide competitive advantages
to the Company. In addition, patents issued to the Company or its licensors may
not be held valid if subsequently challenged or others may claim rights in the
patents and other proprietary technologies owned or licensed by the Company.
Others may have developed or may in the future develop similar products or
technologies without violating any of the Company's proprietary rights.
Furthermore, the Company's loss of any license to technology that it now has or
acquires in the future may have a material adverse effect on the Company's
business, operating results and financial condition.

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

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

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

     The Company believes that a number of patent applications, including
applications filed by International Business Machines 



                                       8


<PAGE>   11



Corporation, Lucent Technologies, Inc., and other potential competitors of the
Company are pending that may cover the useful compositions and uses of certain
HTS materials including yttrium barium copper oxide ("YBCO"), the principal HTS
material used by the Company in its present and currently proposed products.
Therefore, there is a substantial risk that one or more third parties may be
granted patents covering YBCO and other HTS materials and their uses, in which
case the Company could not use these materials without an appropriate license.
As with other patents, the Company has no assurance that it will be able to
obtain licenses to any such patents for YBCO or other HTS materials or their
uses or that such licenses would be available on commercially reasonable terms.
Any of these problems would have a material adverse effect on the Company's
business, operating results and financial condition.

Government Regulations

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

     The Company is subject to governmental labor, safety and discrimination
laws and regulations with substantial penalties for violations. In addition,
employees and others may bring suit against the Company for perceived violations
of such laws and regulations. Defense against such complaints could result in
significant legal costs for the Company. Although the Company endeavors to
comply with all applicable laws and regulations, it may be the subject of
complaints in the future which could have material adverse effect on the
Company's business, operating results and financial condition.

     The Company uses certain hazardous materials in its research, development
and manufacturing operations. As a result, the Company is subject to stringent
federal, state and local regulations governing the storage, use and disposal of
such materials. It is possible that current or future laws and regulations could
require the Company to make substantial expenditures for preventive or remedial
action, reduction of chemical exposure, or waste treatment or disposal. The
Company believes it is in material compliance with all environmental regulations
and to date the Company has not had to incur significant expenditures for
preventive or remedial action with respect to the use of hazardous materials.
However, the operations, business or assets of the Company could be materially
and adversely affected by the interpretation and enforcement of current or
future environmental laws and regulations. In addition, although the Company
believes that its safety procedures for handling and disposing of such materials
comply with the standards prescribed by state and federal regulations, there is
the risk of accidental contamination or injury from these materials. In the
event of an accident, the Company could be held liable for any damages that
result. Furthermore, the use and disposal of hazardous materials involves the
risk that the Company could incur substantial expenditures for such preventive
or remedial actions. The liability in the event of an accident or the costs of
such actions could exceed the Company's resources or otherwise have a material
adverse effect on the Company's business, results of operations and financial
condition.

Dependence on Key Personnel

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



                                       9



<PAGE>   12



Business Interruptions and Dependence on a Single U.S. Facility

     The Company's primary operations, including engineering, manufacturing,
research, distribution and general administration, are housed in a single
facility in Mt. Prospect, Illinois. Any material disruption in the Company's
operations, whether due to fire, flooding, natural disaster, power loss or
otherwise, would have a material adverse effect on the Company's business,
operating results and financial condition.

Substantial Number of Shares Eligible for Future Sale; Dilution

     On March 31, 1999, the Company privately issued an aggregate of $3.3
million initial principal amount of senior convertible notes due May 15, 2002
(the "New Notes"). The New Notes accrue interest at the rate of 6% per annum,
payable in cash or shares of Common Stock at the Company's option, and are
convertible into an aggregate of 2,933,334 shares of Common Stock. In connection
with the issuance of the New Notes, warrants exercisable for an aggregate of
1,320,000 shares of Common Stock at an exercise price of $1.4625 per share (the
"New Warrants") were also issued. The New Warrants expire on March 31, 2002.
Concurrently with the issuance of the New Notes, the Company amended certain
terms of $5.5 million in aggregate principal amount of the Company's senior
convertible notes due May 15, 2002 (the "Amended Notes") and the warrants
exercisable for an aggregate of 2,200,000 shares of Common Stock (the "Amended
Warrants") issued in connection therewith. The Amended Notes accrue interest at
the rate of 6% per annum, payable in cash or shares of Common Stock at the
Company's option, and are convertible into an aggregate of 4,888,889 shares of
Common Stock. The Amended Warrants expire on May 15, 2001 and are exercisable at
an exercise price of $1.4625 per share. In addition, as of March 31, 1999, $4.85
million in aggregate principal amount of the Company's senior convertible notes
due May 15, 2002 issued in May 1998 (the "1998 Notes," and together with the New
Notes and the Amended Notes, the "Notes"), and the warrants exercisable for an
aggregate of 1,940,000 shares of Common Stock issued in connection therewith
(the "1998 Warrants," and together with the New Warrants and the Amended
Warrants, the "Warrants"), remain outstanding. The 1998 Notes accrue interest at
the rate of 2% per annum, which interest is payable in cash or Common Stock at
the Company's option, and are convertible into an aggregate of 3,233,333 shares
of Common Stock. The 1998 Warrants expire on May 15, 2001 and are exercisable at
an exercise price of $3.75 per share. An aggregate of 16,515,556 shares of
Common Stock are issuable upon conversion of the Notes and exercise of the
Warrants which is equal to approximately 132% of the Common Stock outstanding as
of March 31, 1999.

     The sale of a substantial number of shares of Common Stock by the Company
or any of its significant stockholders upon the conversion of a substantial
portion of the Notes or the exercise of a substantial portion of the Warrants,
or the perception that such sales could occur, could adversely affect the
prevailing market price of the Common Stock. In addition, any such sale or such
perception could make it more difficult for the Company to sell equity
securities in the future at a time and price that the Company deems appropriate.

     As of December 31, 1998, the Company had, including to the 1998 Warrants
and the Amended Warrants, outstanding warrants to purchase 4,678,688 shares of
Common Stock at a weighted average exercise price of $4.33 per share and options
to purchase 1,193,977 shares of Common Stock at a weighted average exercise
price of $6.71 per share (827,321 of which have not yet vested) issued to
employees, directors and consultants pursuant to the Company's Amended and
Restated 1993 Stock Option Plan, as amended, and individual agreements with
management and directors of the Company. In order to attract and retain key
personnel, the Company may issue additional securities, including stock options,
in connection with its employee benefit plans. During the terms of the Notes and
such options and warrants (including the Warrants), the holders thereof are
given the opportunity to benefit from a rise in the market price of the Common
Stock.

     The conversion of the Notes into, or the exercise of options and warrants
(including the Warrants) for, Common Stock, as well as the sale or issuance by
the Company of additional shares of Common Stock and/or rights to purchase
Common Stock, would likely have an adverse or dilutive effect on the market
value of the Common Stock. The Company also may in the future offer equity
participation in connection with the obtaining of non-equity financing, such as
debt or leasing arrangements accompanied by warrants to purchase equity
securities of the Company. This could also have a dilutive effect upon the
holders of Common Stock.

Anti-Takeover Provisions

     The Company has certain provisions which may be deemed to have a potential
"anti-takeover" effect in that such provisions


                                       10


<PAGE>   13



may delay, defer or prevent a change of control of the Company. In February
1996, the Board of Directors of the Company (the "Board of Directors") adopted a
stockholders rights plan (the "Rights Plan"). By causing substantial dilution to
a person or group that attempts to acquire the Company on terms not approved by
the Board of Directors, the Series A Rights and Series B Rights of the Rights
Plan may interfere with certain acquisitions, including acquisitions that may
offer a premium over market price to some or all of the Company's stockholders.
Further discussion of the Rights Plan is set forth herein under the heading
"Market for Registrant's Common Equity and Related Stockholder Matters-Rights
Plan." In addition, the Company's Certificate of Incorporation and By-Laws
contain provisions that include (i) a requirement that stockholder action may be
taken only at stockholders meetings; (ii) the authority of the Board of
Directors to issue series of the Company's preferred stock with such voting
rights and other powers as the Board of Directors may determine; (iii) notice
requirements in the Bylaws relating to nominations to the Board of Directors and
to the raising of business matters at stockholders meetings; and (d) the
classification of the Board of Directors into three classes, each serving for
staggered three-year terms. In addition, the Company's outstanding debt
instruments contain provisions which may be deemed to have a potential
"anti-takeover" effect. The interests of the holders of such debt instruments
could conflict with the interests of the Company's stockholders. See
"Substantial Leverage; Restrictions Contained in Debt Instruments" above.

WIRELESS TELECOMMUNICATIONS INDUSTRY BACKGROUND

     The wireless telecommunications industry has experienced significant
growth, both domestically and internationally, in recent years. This growth
appears to be due to the increasing popularity of wireless telecommunications,
the entry of new service providers into the market as governments open up new RF
spectrum, the continuing decline in the price of service and wireless
telephones, and the introduction of new service features. Rapid growth has
intensified RF interference while increasing wireless operators' demand for
improved system quality, lower capital expenditures per customer, and
co-location of multiple antennas with other RF transmitters at a single cell
site.

     In the United States, wireless telecommunications services customers now
frequently have a choice of at least four wireless service providers. Digital
technologies such as Global System for Mobile Telecommunications ("GSM"), Code
Division Multiple Access ("CDMA"), and Time Division Multiple Access ("TDMA")
allow operators to offer such advanced features as short message service, fax,
three-way conferencing and call waiting. Wireless systems are also marketed as a
convenient and economical substitute for regular wireline telephone service. In
addition, service providers are also trying to differentiate themselves on the
basis of quality, price, coverage, and advanced service features. The rapid
growth in competition in wireless telecommunications services is forcing
operators to reduce costs and to seek out new cost effective solutions such as
high performance filters which can reduce capital costs while increasing network
capacity. Already, manufacturers and operators are beginning to plan a new and
more advanced form of wireless telecommunications called Third Generation
cellular or "3G." 3G is expected to provide full Internet access and video
teleconferencing services. The first 3G network is expected to become commercial
in Japan in 2001 and in Europe soon thereafter.

     Industry statistics demonstrate the rapid growth of the wireless
telecommunications industry. The Cellular Telecommunications Industry
Association ("CTIA") reports that as of June 1998 there were over 60 million
wireless customers in the United States. Industry publications, as well as other
industry sources, have estimated a total worldwide wireless customer base of
approximately 207 million at the end of 1997. Several industry sources have
estimated the customer base will exceed 830 million by the end of 2003. CTIA
reports that there were over 57,000 base stations in the United States as of
June 1998 and, based on industry sources, the Company believes that there are
approximately 205,000 base stations worldwide. The Company further believes that
this worldwide number is growing at a rate of over 35% per year. The Company
anticipates that the need to provide improved service on a cost effective basis
in an increasingly congested environment will lead wireless service providers to
invest in new infrastructure technologies such as high performance RF filters.

     The rapid growth and increased competition experienced by the wireless
telecommunications industry has increased the difficulty of providing quality
wireless services. Wireless service providers face the challenge of providing
quality services in an environment increasingly characterized by RF interference
and congestion. In addition, the rapid rate of growth and community concerns
have affected the manner in which service providers locate their base stations.
Many communities are objecting to the proliferation of new towers to provide
wireless services. Base stations which provide the link between a wireless user
and the telecommunications network are being positioned closer together and
often in the same location, which results in RF interference problems. There has
also been a dramatic proliferation in the use of portable hand held phones 



                                       11


<PAGE>   14



which transmit weaker signals than mobile or car-mounted phones. As a result,
cellular networks which were laid out based on mobile phone power levels have,
in many areas, developed coverage gaps which operators must fill in to satisfy
their goals of providing seamless coverage. To lower costs, many cellular and
PCS operators are sharing antenna sites with other cellular and PCS operators,
and with television stations, paging operators and two-way radio transmitters.
Such close proximity of radio transmitters can cause RF interference problems
which degrade the quality and capacity of wireless telecommunications systems.
Furthermore, in order to compete with these already broadly deployed cellular
networks, new PCS service providers need to deploy coverage quickly and with the
lowest possible capital investment.

     Recently, several wireless system operators have sold their antenna towers
to third party management companies which then lease space for base stations and
their antennas back to the system operator. In addition to managing the site for
the existing system operator, these management companies lease additional space
at the tower site to other wireless providers, including television stations,
paging operators and two-way radio transmitters. The Company believes that the
activities of these management companies will facilitate an increase in the
co-location of multiple wireless providers over time. The Company believes that
this trend may lead to an increase in the demand for high performance filters as
concerns over RF interference and congestion increase.

THE COMPANY'S SOLUTION

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

     -   GREATER NETWORK CAPACITY AND UTILIZATION. The Company's RF front-end
         products can increase the capacity and utilization of a wireless base
         station by up to 18%. In some cases, capacity increases because
         channels which were previously unusable due to interference are
         recovered. In other cases, system utilization increases because of
         lower levels of blocked and dropped calls, and increases in the ability
         of the system to permit weak signals to be processed with acceptable
         call quality. In CDMA systems, increased capacity frequently results
         from lowering the system's noise floor.

     -   REDUCED CDMA CELL SITE BREATHING. Coverage for CDMA digital systems
         decreases as the number of users increases. To maintain network
         coverage, an operator can increase the number of cell sites, add radio
         carriers, or use the Company's high performance RF filters with cooled
         low noise amplifiers ("LNAs").

     -   IMPROVED BASE STATION RANGE. Based upon comparative field trials in
         multiple rural locations in the United States, and as confirmed by
         computer propogation models conducted by customers of the Company, the
         Company's RF front-end systems (high performance filter and
         cryogenically-cooled LNA) can extend the uplink range of a wireless
         system by up to 30%. Greater range can reduce a service operator's
         capital expenditure per customer in lower density areas by filling in
         coverage gaps in existing systems or by reducing the number of required
         cell sites for new system deployments. This is true for both analog and
         digital systems.

     -   IMPROVED FLEXIBILITY IN LOCATING BASE STATIONS. The Company's RF
         front-end products can allow wireless telecommunications service
         providers to co-locate base stations near other RF transmitters. The
         Company's products allow the base station radio to better tolerate RF
         interference while reducing out-of-band signals that could interfere
         with other nearby wireless telecommunications operators.

     -   IMPROVED CALL QUALITY. The Company's RF filter products improve call
         quality by reducing dropped and blocked calls. During commercial
         installations and field trials, the Company's RF filter products have
         frequently demonstrated a 20 to 40 percent reduction in dropped calls
         caused by out-of-band interference and base station front-end
         overloading. During these commercial installations and field trials,
         the Company's RF filter products have also demonstrated a similar
         reduction in blocked calls experienced in urban cellular locations. The
         Company's RF filter products also frequently improve audio fidelity by
         reducing noise and interference.

     -   SIMPLER TRANSMITTER SYSTEM DESIGNS. The Company believes that its line
         of RF transmit filters can allow for simpler, less costly transmitters,
         particularly for digital systems. These RF transmit filters should
         improve system performance while diminishing system costs.


                                       12


<PAGE>   15



     -   IMPROVED DIGITAL SYSTEM CAPACITY. The Company believes that its
         recently introduced line of transmit combiners allow increased capacity
         and range in CDMA systems as system loading increases. CDMA systems
         appear unable to offer multi-carrier systems without the use of a
         combiner, but traditional combiners reduce the power transmitted from
         the base station antenna. The Company's filter technology allows
         operators to use combiners with lower loss of desired signals.

PRODUCTS

     The Company currently offers three product lines to address the needs of
cellular and PCS service providers. The SpectrumMaster(R) product line is
designed primarily to improve the RF performance of cellular and PCS systems in
high interference environments, including urban areas and near airports. The
RangeMaster(R) product line combines the interference rejection advantages of a
superconducting filter with a cooled LNA. RangeMaster(R) is designed to serve
the range extension needs of rural, suburban, or small city cellular and PCS
operators. The PowerMaster(TM) product line incorporates the Company's filter
technologies into RF transmitter products. The PowerMaster(TM) duplexer is
designed to improve and allow the co-location of multiple wireless service
providers at a single cell site. The PowerMaster(TM) combiner is designed to
improve the range and capacity of multi-carrier CDMA systems. Each product line
is available in a variety of performance levels to meet the varying needs of
different operators and in several mounting configurations to fit specific
customer situations. All of the Company's currently offered products can be
supplied in domestic and international frequencies for both cellular (800 MHz)
and PCS (1.9 Ghz) applications. The Company's proprietary RF filter designs
allow the Company to quickly provide new product offerings with minimal
additional engineering and limited manufacturing complexity.

     The Company believes that SpectrumMaster(R) is the world's highest
performance commercial receive pre-select RF filter for wireless
telecommunications cell sites. SpectrumMaster(R) improves the performance of
cellular and PCS systems in high interference environments such as urban areas
and airport properties. SpectrumMaster(R) is available in two models.
SpectrumMaster(R) Ultra is a high performance filter with 24 filter poles for
extremely congested RF environments. SpectrumMaster(R) Ultra provides 10,000
times better rejection of unwanted signals than conventional filters, while
losing very little of the desired signal. SpectrumMaster(R) Classic is a 16 pole
filter and provides 1,000 times better rejection of unwanted signals than
conventional filters while having very low loss of desired signals and extremely
linear filter response. Both SpectrumMaster(R) models meet all analog and
digital protocol specifications for cellular and PCS systems in the United
States. In addition, the Company has developed an even higher performance filter
for Third Generation (3G) systems and has shipped a prototype of this product
for testing in Japan. This new product, the SpectrumMaster(R) Extreme filter,
provides 10,000 times better performance than the SpectrumMaster(R) Ultra. The
SpectrumMaster(R)'s modular design allows rapid design modification to meet
other customer requirements. The Company sold its first SpectrumMaster(R)
product to cellular service providers in the second half of 1996 and sales of
SpectrumMaster(R) have continued to grow in 1997 and 1998.

     RangeMaster(R) combines a high performance superconducting cavity filter
with a high performance cryogenically-cooled LNA to lower noise resulting from
interference and thermal noise. RangeMaster(R) is available in four models, from
the economical RangeMaster(R) Omega 150 which is targeted at low interference
rural environments to the 16 pole RangeMaster(R) Classic which provides superior
interference protection for more congested locations. The Company has also
developed a prototype RangeMaster(R) Extreme for Third Generation (3G) systems.

     In late 1998, the Company introduced All Temperature Performance (ATP(TM)),
a new function for the RangeMaster(R) product line. This series of
superconducting filters provide HTS high performance front-end functions when
cryogenically cooled. However, in the event of power or cooling system failure,
these products continue to provide the filtering of good quality filters using
conventional technology. In addition, these products resume superconducting
performance automatically when power is restored which eliminates the need for
bypass circuitry.

     PowerMaster(TM) is a family of high performance transmit filter systems for
use in the base stations of wireless telecommunications operators. The Company
began marketing two models of PowerMaster(TM) products, a transmitter filter and
a duplexer, in February 1997. These products, which incorporate the Company's
new power handling technology, are used in transmit applications. Unique to the
Company, this technology extends the Company's filter applications to include
transmit, in addition to the receive applications already in commercial use. The
PowerMaster(TM) duplexer improves system quality,


                                       13


<PAGE>   16



extends range and simplifies the location of cell sites for both cellular and
PCS systems. PowerMaster(TM) technology provides an ultra-high performance
duplexer, which handles continuous power levels of up to 70 watts at 800 Mhz.
The PowerMaster(TM) duplexer allows an operator to obtain the benefits of very
high performance filtering on both the forward and reverse paths in a system.
These benefits include improved call quality, extended range, improved
transmit/receive isolation, and a reduction in the transmit amplifier output
power required to achieve forward path coverage. The PowerMaster(TM) combiner,
which is a low-loss transmit combiner with superior separation, improves
downlink coverage, and minimizes the number of required antennas and feedlines,
thereby lowering a system operator's capital expense.

     International Cellular Products Offerings. The Company is adapting its
SpectrumMaster(R), RangeMaster(R), and PowerMaster(TM) product lines for
international wireless markets to address their specific interference rejection
and range extension needs. The Company is developing products for both Asian and
European cellular and PCS markets, including GSM filters in various
configurations. In December 1997, the Company leased two SpectrumMaster(R) units
to a major Asian cellular operator for testing as a basis for potential system
deployment in the operator's Third Generation (3G) networks. A third unit, a
SpectrumMaster(R) Ultra, was leased to this operator in September 1998. In
addition, the Company has leased a RangeMaster(R) unit to a major European
OEM for testing in May 1999.

TECHNOLOGY

     The Company possesses proprietary technology in three areas: the design of
high performance RF cavity filters, thick-film superconducting materials
fabrication and cryogenic packaging.

     The Company's products are based on its proprietary RF cavity filter
designs. The Company believes that cavity filter technology provides superior
filter performance with low intermodulation distortion when compared with
alternative technologies, such as RF stripline filter technology (which the
Company is also capable of using). The Company has been able to use its cavity
filter technology to offer filters with over 30 poles. The more poles in a
filter, the better its rejection of unwanted signals. The Company believes its
products are superior to other RF filters with regard to rejection of unwanted
signals.

     The Company is able to offer RF cavity filters with superior filtering, low
loss of unwanted signals, and high power handling because of its proprietary
thick-film superconducting fabrication technology. The Company's thick-film
fabrication technology allows the Company to utilize a variety of filter
technologies including cavity and strip line designs. The Company's
superconducting technology is simple and relatively inexpensive to manufacture
and offers superconducting yields consistently above 96%. The Company believes
the electrical performance of the Company's products are superior to any
alternative superconducting technology currently available for RF filters. The
Company's thick-film superconducting technology can handle up to 70 watts of
continuous power at 800 Mhz.

     High-temperature superconductors become superconducting at -200(Degree) C.
This temperature can be attained using widely available mechanical
refrigerators. The Company has developed proprietary technologies which provide
an efficient, low cost cryogenic package with a long life cycle and minimum
power consumption. Together, the Company believes that its technological
excellence in filter design, superconducting materials and cryogenic packaging
provide it with a unique and well-protected technology advantage over its
competitors.

SALES AND MARKETING

     The Company has focused its sales and marketing effort on U.S. wireless
service providers for retrofit applications. To date, the Company has sold its
products to many of the largest cellular operators in the United States as well
as to numerous mid-size and smaller U.S. wireless operators. The Company has
also sold or leased filters to two major international operators and has
successfully tested its PCS RangeMaster(R) product with two of the largest U.S.
PCS operators. The Company has also tested its PowerMaster(TM) line with two 
major OEMs and is discussing specifications with others. The Company has been
named as an approved vendor to one of the largest OEMs, allowing cellular and
PCS operators throughout the world the opportunity to purchase the Company's
products directly from the OEM. The Company primarily uses a direct sales force
to sell its products.


                                       14


<PAGE>   17



     The Company believes that it has reached the stage of volume deployment
with certain of its customers placing larger orders for the Company's products
than before. For example, one of the Company's largest customers purchased
equipment for over 50 cell sites in the fourth quarter of 1998. The Company's
success has been facilitated by the establishment of corporate purchase
agreements with two of the largest operators in the United States under which
the separate operating regions of the operators can place orders directly with
the Company. In the fourth quarter of 1998, the Company implemented a new
pricing structure pursuant to which it reduced and simplified pricing on all of
its products.

     The Company's marketing and sales personnel work directly with both PCS
service providers and PCS OEMs to enhance the probability of sales success in
this rapidly growing market. The Company has continued technical discussions
with multiple PCS OEM's regarding integrating the Company's RF filter products
into such OEM's PCS product line. To date, the Company's PowerMaster(TM) PCS
transmit filter/duplexer has been tested in the laboratories of two PCS
equipment OEMs.

     During 1998, sales to three of the Company's customers, ALLTEL Corporation,
Bell Atlantic Mobile and Southwestern Bell Corporation, accounted for
approximately 59%, 15% and 14% of the Company's total revenues, respectively,
for the year ended December 31, 1998.

MANUFACTURING

     The Company's state-of-the-art manufacturing process provides predictable
product yields and can be easily expanded to meet increased customer demand.
Superconducting component yields are now consistently above 96%, with low scrap
levels. Manufacturing costs were reduced by 50% during 1997 due to volume,
design and yield efficiencies, and reduced by another 40% in 1998 due to
redesign and resourcing efforts. The Company expects further cost reductions in
1999. The Company has focused its manufacturing efforts on maintaining control
of key technologies while avoiding the cost and complexities of vertical
integration. The Company's manufacturing operations consist primarily of the
manufacture of superconducting components from raw materials, and the assembly,
tuning, testing and quality verification of the Company's products. All of these
activities occur at the Company's manufacturing facility in Mt. Prospect,
Illinois, which began operations during 1996. The Company believes that the
manufacture of its RF filter products requires only moderate capital investments
and is scaleable. The Company also believes that capacity can be rapidly
expanded to meet growing demand without the need for large, upfront capital
investments. The Company purchases all of the components for its filter
products, except for superconducting components, from third party suppliers. The
Company believes it has access to adequate supplies of these purchased
components, most of which are produced according to the Company's proprietary
designs and specifications. The Company is using its just-in-time manufacturing
capability to maximize quality, insure flexibility, limit management complexity
and minimize inventory cost.

RESEARCH AND DEVELOPMENT

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

     The Company's total R&D expenses during 1996, 1997 and 1998 were
approximately $6,423,000, $4,132,000, and $2,935,000, respectively. R&D costs
reimbursed under government contracts and cooperative agreements during 1996,
1997 and 1998 were approximately $200,000, $0, and $0, respectively.


                                       15


<PAGE>   18



INTELLECTUAL PROPERTY AND PATENTS

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

     As of December 31, 1998, the Company has been issued 20 U.S. patents, has
filed and is actively pursuing applications for 16 other U.S. patents, and is
the licensee of 10 patents and patent applications held by others. Such patents
and patent applications relate to various aspects of the Company's
superconductor technology, the design of HTS filters, methods for packaging and
cooling, and system implementation techniques. One of the Company's patent
applications has been filed jointly with Lucent Technologies, Inc. and relates
to superconducting filters. Additional inventions are the subject of a group of
patent applications currently under preparation. Furthermore, the Company
expects to pursue foreign patent rights on certain of its inventions and
technologies critical to its products.

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

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

COMPETITION

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

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

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


                                       16


<PAGE>   19



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

     Two other companies, Conductus, Inc. and Superconducting Technologies,
Inc., are currently marketing superconducting filters to the wireless
telecommunications marketplace. In addition, a number of large multinational
companies are engaged in R&D programs that could lead to the commercialization
of superconducting filters for the wireless telecommunications marketplace.
These companies include, among others, E.I. DuPont de Nemours & Co., Fujitsu
Corporation, NEC Corporation, Kyocera Corporation, and Matsushita Electric
Industrial Co., Ltd. The Company believes that all of these companies are
working on RF stripline filters using epitaxial thin-film superconducting
technology. None of these filters are expected to be commercially implemented in
the near future. The Company believes that RF stripline superconducting filters,
while smaller, are technically unable to provide equivalent rejection of
unwanted signals, competitively low levels of intermodulation distortion, as
large a number of filter poles, or similar levels of power handling.

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

GOVERNMENT REGULATIONS

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

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

EMPLOYEES

     As of March 10, 1999, the Company had a total of 63 employees, 14 of whom
hold advanced degrees. Of the employees, 26 are engaged in manufacturing and
production, 16 are engaged in research, development and engineering, and 21 are
engaged in general management, marketing, sales, finance and administration. The
Company also periodically employs a number of consultants and independent
contractors. The Company considers its relations with its employees to be
satisfactory.

ITEM 2.  PROPERTIES

     The Company maintains its corporate headquarters in a 35,000 square foot
building located in Mt. Prospect, Illinois under a lease which expires in
October 2004. This facility also houses the Company's manufacturing, research,
development, engineering and marketing activities. The Company believes that
this facility is adequate and suitable for its current needs and that additional
space would be available on commercial terms as necessary to meet any future
needs.


                                       17


<PAGE>   20



ITEM 3.  LEGAL PROCEEDINGS

Siegler Litigation

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

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

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

Note Litigation

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

     On September 30, 1997, the Borrowers and the Guarantor responded to the
Company's complaint. Concurrently, the Borrowers filed a counterclaim alleging
that they exercised the warrants in reliance on the Company's alleged fraudulent
representations to certain Borrowers concerning a third-party's future
underwriting of a secondary public offering of the Common Stock. The
counterclaim sought an amount of damages which the Borrowers allege "cannot
currently be determined." On December 10, 1997, the Company's motion to strike
the Borrowers' fraud defense and dismiss their counterclaim was granted with
leave to amend.

     On January 14, 1998, the Borrowers filed amended defenses and counterclaims
based on substantially similar allegations of supposed fraud by the Company. The
Company's answer was filed on April 30, 1998, and the parties are proceeding
with discovery. The Company regards the amended fraud claim as without factual
or legal merit. Effective July 23, 1998, one of the Borrowers, Merrill Weber &
Co., Inc., and the Company reached a settlement of their respective claims. The
Company intends to vigorously pursue recovery of the moneys owed by the other
Borrowers and the Guarantor under the promissory notes and the guarantee.

Lipman Litigation

     On January 6, 1998, Jerome H. Lipman, individually and on behalf of all
others similarly situated, filed a complaint 


                                       18



<PAGE>   21



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

     The Company and the Named Directors regard the suit as without factual or
legal merit. Accordingly, on February 17, 1998, the Company and the Named
Directors filed a motion to dismiss Mr. Lipman's complaint. The motion presented
arguments that the claims of Mr. Lipman and the putative class are barred by the
business judgment rule and the plaintiff's failure to fulfill the legal
prerequisites for filing an action against the Named Directors. Prior to a
hearing on the Company's and the Named Directors' motion to dismiss, Mr. Lipman
filed a motion on March 16, 1998, seeking both to amend his proposed putative
class to include Mr. Drobny and to certify the class.

     On June 1, 1998, the court granted the Company's and the Named Directors'
motion to dismiss the complaint. Concurrently, Mr. Lipman withdrew his motion to
amend the proposed putative class and certify the class. On June 30, 1998, Mr.
Lipman filed an amended complaint against the Named Directors but excluding the
Company itself as a defendant. The amended complaint alleges that the Named
Directors breached their duties of loyalty and due care to the putative class of
stockholders by selecting financing for the Company in June 1997 and thereafter
drawing two tranches of the financing. The amended complaint seeks certification
of a class consisting of all owners of the Common Stock during the period from
May 15, 1997 through December 31, 1997, excluding the Named Directors. Mr.
Lipman's amended complaint alleges that the stock owned by the putative class
lost $61 million due to the financing the Named Directors selected, and seeks an
unspecified amount of compensatory and punitive damages. The Company and the
Named Directors regard the amended complaint as without factual or legal merit.
Accordingly, the Named Directors filed a motion to dismiss Mr. Lipman's amended
complaint on July 29, 1998. The court granted the motion to dismiss in December
1998, finding that Mr. Lipman still had failed to fulfill the prerequisites for
maintaining a shareholder derivative action against the Named Directors. On
January 12, 1999, Mr. Lipman and two added former stockholders filed a second
amended complaint against the Named Directors and again including the Company
itself as a defendant.

     The second amended complaint alleges that the Named Directors breached
their duties of loyalty and due care to the putative class and further alleges
that the purported devaluation of the plaintiff's stock resulting from the June
1997 financing was an improper "assessment" on the plaintiffs' shares for which
they seek an unspecified amount of compensatory and punitive damages. In
February 1999, the Company and the Named Directors filed a motion to dismiss the
second amended complaint. A hearing on the motion is scheduled for April 1999.

Greenwald Litigation

     On June 24, 1998, Jonathan Greenwald, derivatively on behalf of the
Company, filed a complaint against the Company and the Named Directors in the
court of Chancery of the State of Delaware in and for New Castle County. Mr.
Greenwald's complaint alleges that the Named Directors breached their duties of
good faith, loyalty, due care, and candor by selecting financing for the Company
in 1997 which purportedly reduced the stock price and was supposedly accepted to
entrench the Named Directors. The complaint seeks an unspecified amount of
compensatory damages, various equitable relief and attorney's fees.

     The Company and the Named Directors regard the suit as without factual or
legal merit. Accordingly, in January 1999, the Company and the Named Directors
filed a motion to dismiss the complaint arguing that the complaint is barred by
the business judgment rule and the plaintiffs' failure to fulfill the
prerequisites for maintaining a shareholder derivative action against the Named
Directors. A hearing on the motion has not been scheduled.


                                       19


<PAGE>   22




ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters were submitted to a vote of security holders during the quarter
ended December 31, 1998.







                                       20



<PAGE>   23





                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     The outstanding shares of the Company's Common Stock are listed on the
Nasdaq National Market and trade under the symbol ISCO. The following table sets
forth for the periods indicated the range of high and low closing sale prices
for the Common Stock:

<TABLE>
<CAPTION>
                                                           HIGH         LOW
                                                           ----         ---
<S>                                                        <C>         <C> 
FISCAL YEAR ENDING DECEMBER 31, 1997
  First Quarter.................................           $ 18.24     $15.48
  Second Quarter................................           $ 12.40     $ 8.00
  Third Quarter.................................           $  9.48     $ 7.24
  Fourth Quarter................................           $  3.32     $ 1.24
FISCAL YEAR ENDING DECEMBER 31, 1998
  First Quarter.................................            $ 3.31     $ 0.88
  Second Quarter................................            $ 3.25     $ 1.25
  Third Quarter.................................            $ 1.94     $ 1.00
  Fourth Quarter................................            $ 1.66     $ 0.84
</TABLE>

     On March 25, 1999, there were approximately 284 holders of record of the
Common Stock.

     The Company has never paid cash dividends on the Common Stock and the
Company does not expect to pay any dividends on its Common Stock in the
foreseeable future. In addition, the Company's existing debt instruments limit
the Company's ability to pay dividends. See "Risk Factors - Substantial
Leverage; Restrictions Contained in Debt Instruments."

RIGHTS PLAN

     In February 1996, the Board of Directors of the Company adopted a
stockholders rights plan (the "Rights Plan"). In connection with the adoption of
the Rights Plan, the Board of Directors created one series of Preferred Stock,
consisting of 10,000 shares of Series A Junior Participating Preferred Stock
(the "Series A Preferred"). Each share of the Series A Preferred, when and if
issued, entitles the holder thereof to receive dividends equal to 1,000 times
the dividends per share declared with respect to the Common Stock. Holders of
the Series A Preferred are entitled to exercise 1,000 votes per share on all
matters submitted to a vote of stockholders and, except as otherwise required by
law, vote together with the holders of Common Stock as a single class. In the
event of liquidation, such holders would receive a preference of 1,000 times the
aggregate amount to be distributed per share to the holders of Common Stock. In
general, each share of the Series A Preferred is intended to have a value and
voting rights equal to 1,000 shares of Common Stock, and appropriate
anti-dilutive adjustments will be made in accordance with the terms of such
Series A Preferred in the event of certain changes in Common Stock.

     Pursuant to the Rights Plan, a Series A Right is associated with, and
trades with, each share of Common Stock outstanding. The record date for
distribution of such Series A Rights was February 22, 1996 (the "Record Date")
and, for so long as the Series A Rights are associated with the Common Stock,
each new share of Common Stock issued by the Company will include one Series A
Right.

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


                                       21



<PAGE>   24



     If any person or group acquires 15% or more of the Common Stock outstanding
(the "Shares Acquisition Date"), each holder of a Series A Right (except the
acquiring party) has the right to receive, upon exercise, (i) shares of Common
Stock of the Company having a market value of two times the exercise price of
the Series A Right and (ii) one Series B Right (Series A Rights and Series B
Rights are hereinafter collectively referred to as the "Rights"). The Board of
Directors has the option, after the Shares Acquisition Date but before there has
been a 50% acquisition of the Company, to exchange both (i) one share of Common
Stock (or one-thousandth of a share of preferred stock) and (ii) one Series B
Right, for each Series A Right (other than Series A Rights held by an acquiring
party). If, after the Series A Rights become exercisable, the Company is
involved in a merger or other business combination, or if the Company sells or
transfers more than 50% of its assets or earning power, or if an acquiring party
engages in certain "self-dealing" transactions with the Company, each Series A
Right and Series B Right then outstanding (other than Rights held by an
acquiring party) will be exercisable for common stock of the other party to such
transaction having a market value of two times the exercise price of the Right.
The Company has the right to redeem the Series A Rights for $.01 per Series A
Right (the "Redemption Price") prior to the Shares Acquisition Date. The Series
B Rights, once issued, are not redeemable. The Rights expire on February 9,
2006.

     The Rights have certain anti-takeover effects. The Rights should not
interfere with any merger or business combination approved by the Board of
Directors since the Series A Rights may be redeemed by the Company at the
Redemption Price prior to the time that a person or group has acquired
beneficial ownership of 15% or more of the Common Stock. However, by causing
substantial dilution to a person or group that attempts to acquire the Company
on terms not approved by the Board of Directors, the Rights may interfere with
certain acquisitions, including acquisitions that may offer a premium over
market price to some or all of the Company's shareholders. The Rights are not
intended to prevent an acquisition of the Company on terms that are favorable
and fair to all shareholders. See "Risk Factors - Anti-Takeover Provisions."




                                       22


<PAGE>   25

ITEM 6.  SELECTED FINANCIAL DATA

     The following table presents selected financial data with respect to the
Company as of and for the years ended December 31, 1994, 1995, 1996, 1997 and
1998. The selected financial data for each of the years in the audited five-year
period ended December 31, 1998 have been derived from the financial statements
of the Company. The information set forth below should be read in conjunction
with "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations", and the financial statements, related notes and other
financial information included elsewhere in this Form 10-K.

<TABLE>
<CAPTION>
                                            -----------     -----------      ------------     ------------        ------------
                                               1994            1995              1996             1997                1998
                                            -----------     -----------      ------------     ------------        ------------
<S>                                         <C>             <C>              <C>              <C>                 <C>
STATEMENT OF OPERATIONS DATA:
  Net Revenues..........................    $   208,168     $    27,830      $    209,822     $  1,038,134        $  3,242,930
  Costs and expenses:
    Cost of revenues....................        194,098          19,286            49,534        4,401,077           7,047,347
      Research and development..........      1,962,678       4,554,946         6,422,921        4,132,019           2,934,784
    Selling and marketing...............        454,968         469,600         1,834,640        1,918,044           1,847,680
    General and administrative..........      2,199,597       2,763,615         3,290,810        2,772,274           3,370,058
                                            -----------     -----------      ------------     ------------        ------------

                                             (4,603,173)     (7,779,617)      (11,388,083)     (12,185,280)        (11,956,939)
  Other income (expense):
    Investment income ..................        496,392         487,543           503,911          254,781             354,738
    Interest expense....................         (8,582)        (39,600)          (29,602)         (17,969)        (10,247,919)
                                            -----------     -----------      ------------     ------------        ------------
                                                487,810         447,943           474,309          236,812          (9,893,181)
                                            -----------     -----------      ------------     ------------        ------------

Net loss................................    $(4,115,363)    $(7,331,674)     $(10,913,774)    $(11,948,468)       $(21,850,120)

Preferred Stock dividends...............              -               -                 -         (143,302)            (61,834)
                                            -----------     -----------      ------------     ------------        ------------
Net loss plus Preferred Stock dividends.    $(4,115,363)    $(7,331,674)     $(10,913,774)    $(12,091,770)       $(21,911,954)
                                            ===========     ===========      ============     ============        ============

Basic and diluted loss per common share.    $     (1.15)    $     (2.01)     $      (2.41)    $      (2.34)       $      (1.93)
                                                           

Weighted average number of
    common shares outstanding...........      3,578,485       3,641,196         4,536,034        5,156,663          11,345,540


<CAPTION>
                                            -----------     -----------      ------------     ------------        ------------
                                               1994            1995              1996             1997                1998
                                            -----------     -----------      ------------     ------------        ------------
<S>                                         <C>             <C>              <C>              <C>                 <C>
BALANCE SHEET  DATA:
Cash and cash equivalents.............      $     90,362    $   953,093      $  5,188,047     $  2,766,886        $  2,152,595
Working capital.......................         9,806,670      5,458,474         5,207,923        4,668,982           4,143,558
Total assets..........................        14,732,501     11,105,766        13,388,496       11,534,309          10,028,088
Long-term debt/capital lease
   obligations, less current portion..             8,355        509,079            91,618           13,541           9,302,651
Stockholders' equity (net capital
   deficiency)........................        12,821,746      9,185,379        11,520,128       10,046,569            (772,968)

</TABLE>

                                       23



<PAGE>   26




ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
         RESULTS OF OPERATIONS

     The information contained in this Form 10-K contains forward-looking
statements which involve certain risks, uncertainties and contingencies which
could cause the Company's actual results, performance or achievements to differ
materially from those expressed, or implied, by such statements. See the
italicized language on the introductory page of this Form 10-K.

RESULTS OF OPERATIONS

Years Ended December 31, 1998 and 1997

     The Company's net revenues increased $2,204,796 from $1,038,134 in 1997 to
$3,242,930 in 1998, as a result of increased sales of the Company's radio
frequency ("RF") front-end products. Net revenues in the fourth quarter of 1998
were $1,504,497, as compared to $282,384 for the fourth quarter of 1997. This
revenue growth was the result of the increased acceptance of the Company's
products by operators, price reductions that the Company implemented in October
1998 and a large scale deployment of the Company's products by one of the
largest cellular operators in the U.S. However, the Company anticipates
significantly lower revenues in the first quarter of 1999 as compared to the
fourth quarter of 1998. Net revenues from product sales represent gross product
shipments less reserves for potential returns. Such reserves are based on the
Company's historical product return rates. All of the net revenues in 1997 and
1998 were from commercial product sales. The Company has concentrated its
efforts on its commercial product development programs and does not expect
revenues to increase dramatically unless and until it ships a significantly
larger amount of its commercial products.

     Cost of product sales was $7,047,347 for the year ended December 31, 1998,
as compared to $4,401,077 for the year ended December 31, 1997. The cost of net
product sales for 1998 and 1997 consisted of direct material, labor and overhead
costs associated with the products that were shipped during the year, plus
approximately $375,000 and $529,000, respectively, of costs, which consisted
primarily of allocated overhead costs, incurred to produce units in ending
finished goods inventory that exceed net realizable value. Due to low
utilization levels and excess capacity in the Company's manufacturing facility,
cost of net product sales exceeded net revenues for the years ended December 31,
1998 and 1997. The Company expects the cost of net product sales to exceed net
revenues until it manufactures and ships a significantly higher amount of its
commercial products.

     The Company's internally funded research and development expenses decreased
$1,197,235 from $4,132,019 in 1997 to $2,934,784 in 1998. Research and
development costs were reduced during 1998, as compared to 1997, primarily due
to a reduction in personnel and operating costs during 1998. The Company expects
to continue reducing its research and development expenses during 1999.

     Selling and marketing expenses decreased to $1,847,680 in 1998 from
$1,918,044 in 1997. This decrease was due to lower advertising, recruiting and
consulting expenses during 1998 as compared to 1997. The decrease was partially
offset by increased salary and freight expenses in 1998.

     General and administrative expenses increased $597,784 from $2,772,274 in
1997 to $3,370,058 in 1998. The increase in general and administrative expenses
was due primarily to higher consultant, legal and office expenses during 1998 as
compared to 1997.

     Investment income increased $99,957 from $254,781 in 1997 to $354,738 in
1998. This increase was due to a higher average cash, cash equivalent and
investment balance during 1998.

     Interest expense increased $10,229,950 from $17,969 in 1997 to $10,247,919
in 1998. This increase was primarily due to $10,101,401 of non-cash interest
charges related to the Company's Senior Convertible Notes due May 15, 2002,
issued in May 1998.


                                       24



<PAGE>   27



Years Ended December 31, 1997 and 1996

     The Company's net revenues increased $828,312 from $209,822 in 1996 to
$1,038,134 in 1997, as a result of increased sales of the Company's RF front-end
products. Net revenues from product sales represent gross product shipments less
reserves for potential returns. Such reserves are based on the Company's
historical product return rates. A government contract accounted for $53,122 of
the Company's net revenues in 1996, while all of the net revenues in 1997 were
from commercial product sales.

     Cost of net product sales was $4,401,077 for the year ended 1997, as
compared to $0 for the year ended 1996. The cost of net product sales for 1997
consisted of direct material, labor and overhead costs associated with the
products that were shipped during the year, plus approximately $529,000 of
costs, which consist primarily of allocated overhead costs, incurred to produce
units in ending finished goods inventory that exceed net realizable value. With
the introduction of the SpectrumMaster(R) Ultra product into the Company's
product line, management determined that there was little marketability for an
early SpectrumMaster(R) filter product model. Management decided, therefore, to
write down the costs associated with this early SpectrumMaster(R) inventory.
Consequently, a total of $309,000 was charged to cost of net product sales in
the fourth quarter of 1997. Due to low utilization levels and excess capacity in
the Company's manufacturing facility, cost of net product sales exceeded net
revenues for the year ended December 31, 1997.

     The Company's internally funded research and development expenses decreased
$2,290,902 from $6,422,921 in 1996 to $4,132,019 in 1997. Research and
development costs were reduced during 1997, as compared to 1996, primarily due
to the initiation of full-scale manufacturing activities during 1997. Costs
associated with manufacturing activities during 1997 were recorded as
manufacturing overhead expenses and were charged as cost of product sales. Costs
associated with the development of manufacturing activities and processes during
1996 were recorded as research and development expenses during that period.
Additional reductions of research and development costs in 1997 as compared to
1996 are due to reductions in personnel, materials and other operating costs.

     Selling and marketing expenses increased to $1,918,044 in 1997 from
$1,834,640 in 1996. This increase was due to the addition of sales personnel and
expanded product marketing and advertising efforts during 1997 as compared to
1996. The increase was partially offset by reduced consulting costs during 1997.

     General and administrative expenses decreased $518,536 from $3,290,810 in
1996, to $2,772,274 in 1997. The decrease in general and administrative expenses
was due primarily to lower administrative personnel, consultant and legal
expenses during 1997 as compared to 1996.

     Investment income decreased $249,130 from $503,911 in 1996 to $254,781 in
1997. This decrease was due to a lower average cash equivalent and investment
balance during 1997.

     Interest expense decreased $11,633 from $29,602 in 1996, to $17,969 in
1997. The decrease is primarily due to a lower average outstanding debt balance
during 1997.

IMPACT OF YEAR 2000

     The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Computer programs
that have time-sensitive software may recognize a date using "00" as the year
1990 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.

     The Company has established a task force comprised of several employees to
evaluate the Company's status with respect to the Year 2000 Issue. The task
force has identified the following areas as possibly being affected by the Year
2000 issue: (1) IT and non-IT systems, (2) manufacturing applications and (3)
third-party relationships. For each of these areas, the Company is in the
process of identifying and assessing specific software, equipment and systems
which are potentially susceptible to the Year 2000 Issue. The Company expects to
develop and implement corrective actions to ensure that by September 30, 1999
its software, equipment and systems will function properly with respect to dates
in the year 2000 and thereafter. The Company believes the total cost of such
year 2000 compliance activities will not be material. The Company believes that
it has no material exposure to contingencies related to the Year 2000 Issue for
the products that it has sold to date.


                                       25



<PAGE>   28



     The Company processes its transactions and applications utilizing a network
of personal computers. In addition, the Company's telephone system, fax
machines, payroll, alarm systems and other miscellaneous systems utilize
computer equipment and software. The Company is identifying which software and
equipment needs to be upgraded. Based on its assessment to date, the Company
does not believe that significant modifications or replacement of its software
systems will be required to be year 2000 compliant. Most of the software used by
the Company in operational applications has been acquired within the past 18
months and is year 2000 compliant.

     The Company's manufacturing activities rely on machine tools and test
stations, each of which contain embedded technology. The Company has identified
the particular hardware and software systems used in such manufacturing
applications. The Company is communicating orally and in writing with suppliers
of these systems and based on such conversations believes the manufacturing
applications are year 2000 compliant.

     The Company relies on third party suppliers for raw materials, utilities
and other key supplies and services. The Company, therefore, recognizes that it
is vulnerable to third party suppliers that fail to remediate their own Year
2000 Issues. The Company is communicating orally and in writing with its
significant suppliers to determine their year 2000 compliance status. The
Company is also dependent upon its customers for sales and cash flow. The
Company does not currently have any formal information concerning the year 2000
compliance status of its customers, but has received indications that most of
the Company's customers are working on year 2000 compliance.

     The Company's most reasonably likely worst case scenario with respect to
the Year 2000 Issue is that (1) its manufacturing applications may malfunction
and (2) third party suppliers of raw materials and utilities and customers may
be unable to remediate their own Year 2000 Issues. In such scenario, the Company
could experience manufacturing interruptions, delays in distribution of its
products and reduced sales. This would have a material adverse effect on the
Company's operations. The Company currently has no contingency plan in event
such reasonably likely worst case scenario occurs.

     The Company currently believes that the Year 2000 Issue will not pose
significant operational problems for the Company. However, if all Year 2000
Issues are not properly identified or remediated on a timely basis, the
Company's results of operations or relationships with customers and suppliers
may be materially adversely affected. There can be no guarantee that the systems
of other companies on which the Company relies will be timely converted or that
their failure to do so would not have a material adverse effect on the Company's
operations.

LIQUIDITY AND CAPITAL RESOURCES
     At December 31, 1998, the Company's cash, cash equivalents and investments,
including certain restricted investments, were $2,489,942, reflecting a decrease
of $1,157,257 from $3,647,199 at December 31, 1997. $680,696 in principal amount
of promissory notes, plus $138,355 of accrued interest thereon, from certain
stockholders is outstanding as of December 31, 1998. These notes were due on
April 30, 1997. The Company has filed a lawsuit to collect on the outstanding
balance, but there can be no assurance when and if such promissory notes will be
repaid. See "Item 3. Legal Proceedings."

     The continuing development of and expansion in sales of the Company's RF
filter product lines will require continued commitment of substantial funds to
undertake continued product development and manufacturing activities 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 cost of additional plant and equipment for manufacturing and the
costs involved in protecting the Company's patents or other intellectual
property.

     On May 15, 1998 the Company entered into a Securities Purchase Agreement
(the "Agreement") with various parties. Under the terms of the Agreement, the
Company issued and sold $10,350,000 in aggregate principal amount of Senior
Convertible Notes due May 15, 2002 (the "Notes") and issued warrants to purchase
4,140,000 shares of the Company's Common Stock (the "Warrants"). The Notes bear
interest at 2% per annum, payable in cash or in shares of the Company's Common
Stock at the Company's option, and mature on May 15, 2002. Holders of the Notes
may convert 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. Conversions were not permitted during the first 90 days following the
issuance of the Notes and were limited to one-half of the original principal
amount during the period from 91 to 180 days after the issuance of the Notes. On
and after 


                                       26


<PAGE>   29



May 15, 2000, the Company may redeem all or a portion of the Notes at
a redemption price equal to the principal amount plus accrued interest thereon,
if any, under certain conditions. The Warrants have an exercise price of $3.75
per share and expire on May 15, 2001. The Agreement contains several covenants
which limit the Company's ability to incur additional indebtedness and to create
any lien, pledge, or encumbrance on any assets of the Company.

     On March 31, 1999, the Company privately issued an aggregate of $3.3
million initial principal amount of Senior Convertible Notes due May 15, 2002
(the "New Notes") and issued warrants to purchase 1,320,000 shares of the
Company's Common Stock (the "New Warrants"). The New Notes bear interest at the
rate of 6% per annum, payable in cash or shares of Common Stock at the Company's
option, and mature on May 15, 2002. Holders of the New Notes may convert the
principal amount, plus accrued and unpaid interest, if any, into shares of the
Company's Common Stock at a fixed conversion price of $1.125 per share. On and
after May 15, 2000, the Company may redeem all or a portion of the New Notes at
a redemption price equal to the principal amount plus accrued interest thereon,
if any, under certain conditions. The New Warrants have an exercise price of
$1.4625 per share and expire on March 31, 2002. In the event that the Company
fails to achieve break-even or positive operating income during the second
quarter of 2000, the New Notes, together with the Notes, may become immediately
due and payable unless the holders thereof agree to modify or waive such
provision. Concurrently with the issuance of the New Notes, the Company amended
certain terms of $5.5 million in aggregate principal amount of the Notes (the
"Amended Notes") and the Warrants exercisable for an aggregate of 2,200,000
shares of the Company's Common Stock (the "Amended Warrants") issued in
connection therewith. The Amended Notes were amended to 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, 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.

     Despite the recently completed issuance and sale of New Notes, the Company
believes that during the third quarter of 1999 it will require substantial
additional funds to finance its product development, manufacturing and marketing
activities. The Company's strategy to generate sufficient working capital to
fund its operations and cash requirements in the future includes advancing
market penetration with OEMs and customers in overseas markets, building strong
and enduring relationships with existing customers and expanding product
offerings to meet varying customer needs, reducing product costs through
economies of scale in material purchases, refinement of the manufacturing
processes, and the further implementation of an overhead reduction program. The
Company is actively seeking financing in order to obtain working capital to
continue its operations according to its current operating plan through the
third quarter of 1999 and beyond. If the Company is unable to obtain adequate
funds when needed in the future, the Company would be required to substantially
delay, scale-back or eliminate the manufacturing, marketing or sales of one or
more of its products or research and development programs, or may be required to
obtain funds through arrangements with collaborative partners or others that may
require the Company to relinquish rights to certain of its technologies, product
candidates or potential products that the Company would not otherwise
relinquish.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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




                                       27



<PAGE>   30




ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                         REPORT OF INDEPENDENT AUDITORS


The Board of Directors
Illinois Superconductor Corporation

We have audited the accompanying balance sheets of Illinois Superconductor
Corporation as of December 31, 1998 and 1997, and the related statements of
operations, stockholders' equity (net capital deficiency), and cash flows for
each of the three years in the period ended December 31, 1998. 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 generally accepted auditing
standards. 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 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, 1998 and 1997, and the results of its operations and
its cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles. 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. As more fully
described in Note 3, Illinois Superconductor Corporation has incurred ongoing
operating losses and does not currently have financing commitments in place to
meet expected cash requirements through 1999. These conditions raise substantial
doubt about Illinois Superconductor Corporation's ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note 3. 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 26, 1999, except
  for Note 3, as to which
  the date is March 31, 1999




                                       28



<PAGE>   31

                      ILLINOIS SUPERCONDUCTOR CORPORATION
                                        
                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                          DECEMBER 31,
                                                                     1998              1997
                                                                 -----------       -----------
<S>                                                              <C>               <C>       
ASSETS                                                           
Current assets:                                                  
 Cash and cash equivalents                                       $ 2,152,595       $ 2,766,886
 Investments                                                               -           500,313
 Inventories                                                       1,424,427         1,726,141
 Accounts receivable, net of allowance for doubtful              
   accounts of $87,990 and $68,775 at December 31, 1998 and      
   1997, respectively                                              1,494,418           586,501
 Prepaid expenses and other                                          479,311           471,928
                                                                 -----------       -----------
Total current assets                                               5,550,751         6,051,769
                                                                 
Property and equipment:                                          
 Leasehold improvements                                            4,218,511         4,215,011
 Lab equipment                                                     1,694,840         1,689,381
 Manufacturing equipment                                             983,426           945,081
 Office equipment                                                    759,443           709,324
 Furniture and fixtures                                              629,490           618,496
                                                                 -----------       -----------
                                                                   8,285,710         8,177,293
 Less: Accumulated depreciation                                   (4,761,599)       (3,654,239)
                                                                 -----------       -----------
                                                                   3,524,111         4,523,054
                                                                 
Restricted certificates of deposit                                   337,347           380,000
Patents and trademarks, net                                          615,879           579,486
                                                                 
                                                                 -----------       -----------
Total assets                                                     $10,028,088       $11,534,309
                                                                 ===========       =========== 
</TABLE>                                                         


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


                                       29
<PAGE>   32

                       ILLINOIS SUPERCONDUCTOR CORPORATION

                                 BALANCE SHEETS

                                   (CONTINUED)

<TABLE>
<CAPTION>
                                                                                      DECEMBER 31,
                                                                                 1998              1997
                                                                            ------------       ------------
<S>                                                                         <C>                <C>      
LIABILITIES AND STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY) 
Current liabilities:                                                                   
 Accounts payable                                                           $    464,752       $    717,425
 Accrued liabilities                                                             799,569            587,285
 Accrued interest                                                                129,375                  -
 Current portion of other long-term debt                                          13,497             78,077
                                                                            -------------      ------------
Total current liabilities                                                      1,407,193          1,382,787
                                                                               
Senior convertible notes, net of discount                                      9,302,651                  -
Other long-term debt, less current portion                                             -             13,541
Deferred occupancy costs                                                          91,212             91,412

Stockholders' equity (net capital deficiency):
 Preferred Stock:
   Series B Convertible  Preferred Stock at liquidation  value: 95
     shares issued and  outstanding  at December  31,1997 (none at
     December 31, 1998)                                                                -            488,534
   Series C Convertible  Preferred Stock at liquidation value: 600
     shares issued and  outstanding  at December  31,1997 (none at
     December 31, 1998)                                                                -          3,038,424
   Series G Convertible  Preferred Stock at liquidation value: 700
     shares issued and  outstanding  at December  31,1997 (none at
     December 31, 1998)                                                                -          3,530,206
   Common stock  ($.001 par value);  30,000,000  and  15,000,000
     shares  authorized  and  12,557,045  and  6,001,925  shares
     issued  and  outstanding  at  December  31,  1998 and 1997,
     respectively                                                                 12,557              6,002
 Additional paid-in capital                                                   60,055,321         41,991,941
 Notes receivable from stockholders                                             (680,696)          (698,508)
 Accumulated deficit                                                         (60,160,150)       (38,310,030)
                                                                            ------------       ------------ 
Total stockholders' equity (net capital deficiency)                             (772,968)        10,046,569
                                                                            ------------       ------------ 
Total liabilities and stockholders' equity (net capital deficiency)                             
                                                                            $ 10,028,088       $ 11,534,309
                                                                            ============       ============ 
</TABLE>

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


                                       30
<PAGE>   33

                       ILLINOIS SUPERCONDUCTOR CORPORATION

                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                        YEAR ENDED DECEMBER 31,
                                                               1998               1997               1996
                                                          -------------       ------------       -----------  
<S>                                                       <C>                 <C>               <C>        
Net revenues:                                                                                                  
  Net product sales                                       $   3,242,930       $  1,038,134      $    156,700  
  Government contracts                                                -                  -            53,122  
                                                          -------------       ------------      -------------  
Total net revenues                                            3,242,930          1,038,134           209,822
                                                                                                  
Costs and expenses:                                                                               
  Cost of product sales                                       7,047,347          4,401,077                 -
  Cost of government contract revenue                                 -                  -            49,534
  Research and development                                    2,934,784          4,132,019         6,422,921
  Selling and marketing                                       1,847,680          1,918,044         1,834,640
  General and administrative                                  3,370,058          2,772,274         3,290,810
                                                          -------------       ------------      -------------  
Total costs and expenses                                     15,199,869         13,223,414        11,597,905  
                                                          -------------       ------------      -------------  
                                                            (11,956,939)       (12,185,280)      (11,388,083)  
                                                                                                               
Other income and (expense):                                                                                    
  Investment income                                             354,738            254,781           503,911  
  Non-cash interest expense on Senior                                                                          
   convertible notes (Note 8)                               (10,101,401)                 -                 -  
  Other interest expense                                       (146,518)           (17,969)          (29,602)  
                                                          -------------       ------------      -------------  
                                                             (9,893,181)           236,812           474,309  
                                                          -------------       ------------      -------------  
Net loss                                                    (21,850,120)       (11,948,468)      (10,913,774)  
                                                                                                               
Preferred Stock dividends                                       (61,834)          (143,302)                -  
                                                          -------------       ------------      -------------  

Net loss plus Preferred Stock dividends                   $( 21,911,954)      $(12,091,770)     $(10,913,774)  
                                                          =============       ============      =============  

Basic and diluted loss per common share                   $       (1.93)      $      (2.34)     $      (2.41)
                                                          =============       ============      =============  
Weighted average number of common shares                                                    
 outstanding                                                 11,345,540          5,156,663         4,536,034
                                                          =============       ============      =============
</TABLE>                                                  

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


                                       31
<PAGE>   34

                       ILLINOIS SUPERCONDUCTOR CORPORATION

           STATEMENTS OF STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)

                  YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996

<TABLE>
<CAPTION>
                                            SERIES B CONVERTIBLE   SERIES C CONVERTIBLE    SERIES G CONVERTIBLE
                                              PREFERRED STOCK         PREFERRED STOCK        PREFERRED STOCK       COMMON STOCK
                                            ----------------------------------------------------------------------------------------
                                                 NUMBER               NUMBER               NUMBER                NUMBER
                                                OF SHARES    AMOUNT  OF SHARES   AMOUNT   OF SHARES  AMOUNT    OF SHARES   AMOUNT
                                            ----------------------------------------------------------------------------------------
<S>                                            <C>       <C>          <C>       <C>          <C>    <C>         <C>          <C> 
Balance as of December 31, 1995                    -     $         -     -      $       -       -   $        -   3,998,952   $ 3,999
                                                                                          
   Exercise of stock options; $.184 - $15.25                                              
     per share                                     -               -     -              -       -            -      49,881        50
   Exercise of warrants; $1.4679 - $13.50          -               -     -              -       -            -     565,993       566
     per share                                                                            
   Forfeiture of stock options                     -               -     -              -       -            -           -         -
   Issuance of common stock - Private                                                     
     placement, net of offering costs;             -               -     -              -       -            -     408,526       408
     $21.80 per share                                                                     
   Amortization of deferred compensation           -               -     -              -       -            -           -         -
   Net loss                                        -               -     -              -       -            -           -         -
                                            ----------------------------------------------------------------------------------------
Balance as of December 31, 1996                    -               -     -              -       -            -   5,023,352     5,023
   Exercise of stock options; $.184 - $18.25       -               -     -              -       -            -      17,821        18
     per share
   Exercise of warrants; $1.4679 - $13.50          -               -     -              -       -            -     138,820       139
     per share
   Payment of stockholder notes receivable         -               -     -              -       -            -           -         -
   Issuance of  preferred  stock,  net of        600       3,000,000   600      3,000,000     700    3,500,000           -         -
     offering costs
   Preferred stock dividends                       -          13,534     -         38,424       -       30,206      19,940        20
   Conversion of preferred stock to             
    common stock                                (505)     (2,525,000)    -              -       -            -     801,992       802
   Net loss                                        -               -     -              -       -            -           -         -
                                            ----------------------------------------------------------------------------------------
Balance as of December 31, 1997                   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         -               -     -              -       -            -      33,942        34
     per share
   Payment of stockholder notes                    -               -     -              -       -            -           -         -
     receivable
   Preferred stock dividends                       -             260     -         24,377       -       37,197           -         -
   Conversion of preferred stock to              (95)       (488,794) (600)    (3,062,801)   (700)  (3,567,403)   6,521,178    6,521
     common stock
   Discount on senior convertible notes            -               -     -              -       -            -           -         -
     (Note 8)
   Net loss                                        -               -     -              -       -            -           -         -
                                            ========================================================================================
Balance as of December 31, 1998                    -       $       -     -     $        -       -   $        -  12,557,045   $12,557
                                            ========================================================================================
</TABLE>

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


                                       32
<PAGE>   35

                      ILLINOIS SUPERCONDUCTOR CORPORATION
                                        
          STATEMENTS OF STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)

                 YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996

                                  (CONTINUED)

<TABLE>
<CAPTION>
                                                     ADDITIONAL        DEFERRED    NOTES RECEIVABLE    ACCUMULATED                 
                                                  PAID-IN CAPITAL    COMPENSATION  FROM STOCKHOLDERS     DEFICIT           TOTAL   
                                                  ---------------------------------------------------------------------------------
<S>                                                 <C>                <C>          <C>              <C>             <C>           
Balance as of December 31, 1995                     $24,670,560        $(41,392)    $          -     $(15,447,788)   $   9,185,379 
   Exercise of stock options; $.184 -                                                                                              
     $15.25 per share                                   282,903               -                -                -          282,953 
   Exercise of warrants; $1.4679  -                   5,738,150               -       (1,142,754)               -        4,595,962 
     $13.50 per share                                                                                                              
   Forfeiture of stock options                           (5,438)          5,438                -                -                - 
   Issuance of common stock - Private                                                                                              
     placement, net of offering costs;                8,333,246               -                -                -        8,333,654 
     $21.80 per share                                                                                                              
   Amortization of deferred compensation                      -          35,954                -                -           35,954 
   Net loss                                                   -               -                -      (10,913,774)     (10,913,774)
                                                  ---------------------------------------------------------------------------------
Balance as of December 31, 1996                      39,019,421               -      (1,142,754)      (26,361,562)      11,520,128 
   Exercise of stock options; $.184 -                    70,170               -               -                 -           70,188 
     $18.25 per share                                                                                                              
   Exercise  of warrants; $1.4679  -                    796,908               -               -                 -          797,047 
     $13.50 per share                                                                                                              
   Payment of stockholder notes                               -               -         444,246                 -          444,246 
     receivable                                                                                                                    
   Issuance of preferred stock, net of                 (336,572)              -               -                 -        9,163,428 
     offering costs                                                                                                                
   Preferred stock dividends                            (82,184)              -               -                 -                - 
   Conversion of preferred stock to                   2,524,178               -               -                 -                - 
     common stock                                                                                                                  
   Net loss                                                   -               -               -       (11,948,468)     (11,948,468)
                                                  ---------------------------------------------------------------------------------
Balance as of December 31, 1997                      41,991,941               -        (698,508)      (38,310,030)      10,046,569 
   Additional offering costs related to                (143,400)              -               -                 -         (143,400)
     issuance of preferred stock                                                                                                   
   Exercise of stock options;  $. 18 -                    7,387               -               -                 -            7,421 
     $.23 per share                                                                                                                
   Payment of stockholder notes                               -               -          17,812                 -           17,812 
     receivable                                                                                                                    
   Preferred stock dividends                            (61,834)              -               -                 -                - 
   Conversion of preferred stock to                   7,112,477               -               -                 -                - 
     common stock                                                                                                                  
   Discount on senior convertible notes              11,148,750               -               -                 -       11,148,750 
     (Note 8)                                                                                                                      
   Net loss                                                   -               -               -       (21,850,120)     (21,850,120)
                                                  ---------------------------------------------------------------------------------
Balance as of December 31, 1998                     $60,055,321        $      -     $  (680,696)     $(60,160,150)   $    (772,968)
                                                  =================================================================================
</TABLE>

          See the accompanying Notes which are an integral part of the
                             financial statements.
                                        
                                       33
<PAGE>   36

                       ILLINOIS SUPERCONDUCTOR CORPORATION
                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                   YEARS ENDED DECEMBER 31,
                                                            1998               1997               1996
                                                       -------------       -------------      ------------- 
<S>                                                    <C>                 <C>                <C>          
OPERATING ACTIVITIES                                   
Net loss                                               $(21,850,120)       $(11,948,468)      $(10,913,774)
Adjustments to reconcile net loss to net cash          
 used in operating activities:                         
   Depreciation                                           1,107,360           1,533,705          1,157,561
   Amortization                                              76,214               6,994              6,639
   Non-cash interest expense on senior                 
    convertible notes (Note 8)                           10,101,401                   -                  -
   Loss (gain) on available-for-sale securities               4,963                   -            (43,171)
   Other                                                          -                   -               (939)
   Stock compensation expense                                     -                   -             35,954
   Changes in operating assets and liabilities:        
       Accounts receivable                                 (907,917)           (455,749)           179,777
       Inventories                                          301,714          (1,072,445)          (653,696)
       Prepaid expenses and other                            (7,383)            (35,876)            29,246
       Accounts payable                                    (252,673)           (411,584)           249,640
       Accrued liabilities                                  341,659               92,778           113,201
       Deferred occupancy costs                                (200)              15,599            18,760
                                                       -------------       -------------      ------------- 
Net cash used in operating activities                   (11,084,982)        (12,275,046)        (9,820,802)
                                                                            
INVESTING ACTIVITIES                                                        
Purchases of available-for-sale securities                        -                   -        (30,945,246)
Sales of available-for-sale securities                      495,350                   -          2,500,000
Maturities of available-for-sale securities                       -                   -         33,072,852
(Increase) decrease in restricted  certificates of                          
 deposit                                                     42,653             (30,000)           512,500
Payments of patent costs                                   (112,607)           (199,647)          (156,711)
Acquisitions of property and equipment                     (108,417)           (310,956)        (3,706,588)
                                                       -------------       -------------      -------------
Net cash provided by (used in) investing                    316,979            (540,603)         1,276,807
 activities                                                                 
                                                         
FINANCING ACTIVITIES                                      
Proceeds  from  issuance of preferred  stock - net        
 of offering costs                                         (143,400)          9,163,428                  -
Proceeds  from  issuance of common  stock - net of        
 offering costs                                                   -                   -          8,333,654
Exercise of stock options                                     7,421              70,188            282,953
Exercise of warrants                                              -             797,047          4,595,962
Payments on stockholder notes receivable                     17,812             444,246                  -
Proceeds from issuance of senior convertible notes       10,350,000                   -                  -
Proceeds from issuance of other long-term debt                    -                   -             92,182
Payments on other long-term debt                            (78,121)            (80,421)          (525,802)
                                                       -------------       -------------      -------------
Net cash provided by financing activities                10,153,712          10,394,488         12,778,949
                                                       -------------       -------------      -------------
Increase (decrease) in cash and cash equivalents           (614,291)         (2,421,161)         4,234,954
Cash and cash equivalents at beginning of period          2,766,886           5,188,047            953,093
                                                       -------------       -------------      -------------
Cash and cash equivalents at end of period             $  2,152,595        $  2,766,886       $  5,188,047
                                                       =============       =============      =============
                                                                                                 
Supplemental cash flow information:                                                              
Cash paid for interest                                 $      8,994        $     17,969       $     29,602
                                                       =============       =============      =============
</TABLE>

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

                                       34
<PAGE>   37



                       ILLINOIS SUPERCONDUCTOR CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

1.  DESCRIPTION OF BUSINESS

     Illinois Superconductor Corporation (the "Company") was founded in 1989 by
ARCH Development Corporation, an affiliate of The University of Chicago, to
commercialize superconducting technologies developed initially at Argonne
National Laboratory. The Company uses its patented and proprietary
high-temperature superconducting materials 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 located primarily in the United States.

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 1998, the Company wrote-off $61,333 of
patent-related costs. Total capitalized patent and trademark costs are $655,678
and $604,404 at December 31, 1998 and 1997, respectively. Capitalized patent
costs related to pending patents are $315,177 and $471,933 at December 31, 1998
and 1997, respectively. Patents and trademarks are net of accumulated
amortization of $39,799 and $24,918 at December 31, 1998 and 1997, 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


2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Income Taxes




                                       35



<PAGE>   38



     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.

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 is
recognized upon customer acceptance of the products. The Company warrants its
products against defects in materials and workmanship typically for a one year
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. A
provision for estimated future costs related to warranty expenses is recorded
when revenues are recognized. Returns and allowances and warranty costs 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, 1998, 1997 and 1996, was
approximately $18,000, $176,000 and $135,000, 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. Common shares issuable
upon the exercise of options and warrants are not included in the per share
calculations since the effect of their inclusion would be antidilutive. All
earnings per share amounts for all periods have been presented and, where
appropriate, restated to conform to the Statement 128 requirements.

Use of Estimates

     The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
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.



                                       36



<PAGE>   39




2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Long Lived Assets

     The Company records impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount.

3.  GOING CONCERN AND MANAGEMENT'S PLANS

     The Company has incurred, and continues to incur, losses from operations
and the Company's available resources are not presently sufficient to fund its
expected cash requirements through the end of 1999. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.

     The Company's strategy to generate sufficient working capital to fund its
operations and cash requirements in the future includes advancing market
penetration with original equipment manufacturers ("OEMs") and customers in
overseas markets, building strong and enduring relationships with existing
customers, expanding product offerings to meet varying customer needs, and
reducing product costs through economies of scale in material purchases,
refinement of the manufacturing processes, and further implementation of an
overhead reduction program.

     As a result of its funding requirements, on March 31, 1999, the Company
privately issued an aggregate of $3.3 million initial principal amount of Senior
Convertible Notes due May 15, 2002 (the "New Notes") and issued warrants to
purchase 1,320,000 shares of the Company's Common Stock (the "New Warrants").
The New Notes bear interest at the rate of 6% per annum, payable in cash or
shares of Common Stock at the Company's option, and mature on May 15, 2002.
Holders of the New Notes may convert the principal amount, plus accrued and
unpaid interest, if any, into shares of the Company's Common Stock at a fixed
conversion price of $1.125 per share. On and after May 15, 2000, the Company may
redeem all or a portion of the New Notes at a redemption price equal to the
principal amount plus accrued interest thereon, if any, under certain
conditions. The New Warrants have an exercise price of $1.4625 per share and
expire on March 31, 2002. In the event that the Company fails to achieve
break-even or positive operating income during the second quarter of 2000, the
New Notes, together with the Notes (See Note 8), may become immediately due and
payable unless the holders thereof agree to modify or waive such provision.
Concurrently with the issuance of the New Notes, the Company amended certain
terms of $5.5 million in aggregate principal amount of the Notes (the "Amended
Notes") and the Warrants exercisable for an aggregate of 2,200,000 shares of the
Company's Common Stock (the "Amended Warrants") issued in connection therewith.
The Amended Notes were amended to 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,
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.

     Despite the recently completed issuance and sale of New Notes, the Company
believes that during the third quarter of 1999 it will require substantial
additional funds to finance its product development, manufacturing and marketing
activities. The Company is actively seeking financing in order to obtain working
capital to continue its operations according to its current operating plan
through the third quarter of 1999 and beyond.

     If the Company is unable to obtain adequate funds when needed in the
future, the Company would be required to substantially delay, scale-back or
eliminate the manufacturing, marketing, or sales of one or more of its products
or research and development programs, or may be required to obtain funds through
arrangements with collaborative partners or others that may require the Company
to relinquish rights to certain of its technologies, product candidates or
potential products that the Company would not otherwise relinquish. This would
materially and adversely affect the Company's business, financial condition,
results of operations and cash flows.



                                       37



<PAGE>   40

4.  INVENTORIES

     Inventories consist of the following:

<TABLE>
<CAPTION>
                                                             DECEMBER 31,
                                                         1998           1997
                                                     ----------     ----------
<S>                                                  <C>            <C>        
    Raw materials                                    $1,083,605     $  704,626
    Work-in-process                                      60,456        345,956
    Finished product                                    280,366        675,559
                                                     ==========     ==========
                                                     $1,424,427     $1,726,141
                                                     ==========     ==========
</TABLE>

     Cost of product sales for the years ending December 31, 1998 and 1997
     includes approximately $375,000 and $529,000, respectively, of costs in
     excess of the net realizable value of finished goods inventory.


5.  INVESTMENTS

     Investments at December 31, 1997 consisted of a U.S. government security,
due March 2001, with a cost and fair value of $500,313. During 1998, this
security was sold. The gross realized loss on such sale was $4,963.

6.  CAPITAL STOCK

     The Company has an authorized class of undesignated preferred stock
consisting of 100,000 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
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 


                                       38
<PAGE>   41
6.  CAPITAL STOCK (CONTINUED)

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 consists 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
bear interest at 8.25% per annum, were due on April 30, 1997, and are 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 is currently being disputed by the issuers and is in
litigation (Note 12).

     On February 23, 1996 the Company completed the private placement and
issuance of 408,526 shares of its common stock at $21.80 per share. Proceeds,
net of related expenses, were $8,333,654.

     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 a warrant 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 $10.0625 per share, expiring on October 29, 2001. 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 the fourth quarter of 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 the first quarter of 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, $2,475,000 (495 shares) of Series C Convertible
Preferred Stock were converted into 2,133,331 shares of common stock. Accrued
dividends thereon of $50,885 were also converted into 43,797 shares of common
stock. In addition, $3,240,000 (648 shares) of Series G Convertible Preferred
Stock were converted into 3,248,447 shares of common stock. Accrued dividends
thereon of $61,913 were also converted into 62,075 shares of common stock.

     During the second quarter of 1998 $525,000 (105 shares) of Series C
Convertible Preferred Stock were converted into 477,968 shares of common stock.
Accrued dividends thereon of $11,916 were also converted into 10,849 shares of
common stock. In addition, $260,000 (52 shares) of Series G Convertible
Preferred Stock were converted into 260,678 shares of common stock. Accrued
dividends of $5,490 were also converted into 5,502 shares of common stock.

     On April 22, 1998, the stockholders of the Company approved an increase in
the number of shares of authorized common stock from 15,000,000 to 30,000,000.

     At December 31, 1998, authorized but unissued shares of common stock have
been reserved for future issuance as 


                                       39

<PAGE>   42


follows:

<TABLE>
<CAPTION>
          <S>                                                         <C>
          Warrants outstanding (Note 7)                                4,678,688
          Options outstanding (Note 7)                                 1,193,977
          Options reserved for future  issuance under the 1993 
           Stock Option Plan (Note 7)                                    485,145
          Shares issuance upon conversion of senior
           convertible notes (Note 8)                                  6,900,000
                                                                      ----------
                                                                      13,257,810
                                                                      ==========
</TABLE>


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 1997, is 1,705,000, of which 80,000 are
reserved for issuance to outside directors. 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 on or before May 31,
1995 generally vest over a five year period (one-fifth of options granted vest
after one year from the grant date and the remaining options vest ratably each
month thereafter). Options granted under the Plan subsequent to May 31, 1995,
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 3,000 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 seven
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 generally
become exercisable over a five-year period, commencing from the date of grant,
and expire 10 years from the date of grant. Exercise prices were determined by
the Board of Directors and, for options granted through December 31, 1992,
represented estimated fair values of the Company's common stock at the grant
date.

      The Company has elected to follow Accounting Principals 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, no compensation
expense is recognized.

      Pro forma information regarding net income and earnings per share is
required under FASB 123, and has been 


                                       40

<PAGE>   43


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, 1998, 1997 and 1996: risk-free
interest rate of 5.6%, 6.3% and 6.2%, respectively; a dividend yield of 0%;
volatility factor of the expected market price of the Company's common stock of
 .96, .74 and .75, respectively; and expected life of the options of 4.0, 4.0 and
4.1 years, respectively.

     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:

<TABLE>
<CAPTION>
                                                                         YEAR ENDED DECEMBER 31,
                                                                  1998             1997           1996
                                                             --------------   ------------    ------------
          <S>                                                <C>              <C>             <C>  
          Pro forma net loss                                 $(22,863,252)    $(13,063,962)   $(11,590,957)
          Pro forma  basic  and  diluted  loss per  common  
            share                                            $      (2.02)    $      (2.53)   $      (2.56)
</TABLE>

     Because FASB 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1999.


                                       41

<PAGE>   44
7. STOCK OPTIONS AND WARRANTS (CONTINUED)

     The table below summarizes all option activity during the period from
January 1, 1996 to December 31, 1998:

<TABLE>
<CAPTION>
                                                                  EXERCISE
                                                     OPTIONS        PRICE
                                                   OUTSTANDING    PER SHARE
                                                -------------------------------
<S>                                                   <C>        <C> 
     Outstanding at December 31, 1995                 525,268    $ .18 - 19.25
     Granted                                          346,907    17.00 - 27.00
     Exercised                                        (49,881)     .18 - 15.25
     Forfeited                                        (26,036)     .23 - 26.50
                                                --------------
     Outstanding at December 31, 1996                 796,258      .18 - 27.00
     Granted                                          121,000     2.00 - 19.00
     Exercised                                        (17,821)     .18 - 18.25
     Forfeited                                       (216,104)    6.75 - 27.00
                                                --------------
     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
                                                ==============
</TABLE>

     The weighted-average exercise price of options outstanding at December 31,
1998, 1997 and 1996, was $6.71, $12.92 and $13.40, respectively. The
weighted-average exercise price of options granted, exercised, and forfeited
during 1998 was $1.55, $0.22 and $6.69, respectively. The weighted-average fair
value of options granted during 1998, 1997 and 1996 was $1.09, $7.94, $11.35,
respectively.

     Following is additional information with respect to options outstanding at
December 31, 1998:

<TABLE>
<CAPTION>
                                            EXERCISE     EXERCISE    EXERCISE     EXERCISE     EXERCISE
                                           PRICE FROM   PRICE FROM  PRICE FROM   PRICE FROM   PRICE FROM
                                            $0.18 TO     $1.03 TO   $10.125 TO    $15.50 TO    $19.00 TO
                                              $0.23       $9.75       $14.75       $18.50       $26.50
                                          ---------------------------------------------------------------
     <S>                                     <C>         <C>          <C>          <C>           <C>
     OUTSTANDING AT DECEMBER 31, 1998:
        Number of options                    18,975      808,250      102,189      211,548       53,015
        Weighted-average exercise price      $ 0.22       $ 2.48      $ 10.92      $ 17.56      $ 22.07
        Weighted-average remaining
          contractual life in years            3.77         8.73         5.62         7.40         7.23

     EXERCISABLE AT DECEMBER 31, 1998:
        Number of options                    18,975       84,769       93,185      133,185       36,542
        Weighted-average exercise price      $ 0.22        $7.40      $ 10.93       $17.47      $ 21.99
</TABLE>

     The total number of unvested options outstanding at December 31, 1998 was
827,321, all of which will vest based on employees' continued service to the
Company.

     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 19,869, 34,063 and 13,625 of these shares were exercised
during 1997, 1996, and 1995, respectively.

     In connection with the July 1992 issuance of Series B convertible preferred
stock, the Company issued common stock purchase warrants for 213,780 shares to
the Series B convertible preferred stockholders. These warrants have an exercise
price of $2.29 (71,260 shares), $2.75 (71,260 shares), and $3.21 (71,260 shares)
per share and expire 



                                       42




<PAGE>   45
7.  STOCK OPTIONS AND WARRANTS (CONTINUED)

upon the seventh anniversary of issuance. Warrants for 96,437 of these shares
(36,107 shares at $2.29 per share, 36,107 shares at $2.75 per share and 24,223
shares at $3.21 per share) were exercised during 1996. Warrants for 54,337 of
these shares (17,779 shares at $2.29 per share, 17,779 shares at $2.75 per
share, and 18,779 shares at $3.21 per share) were exercised during 1997.

     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 and expire in November 2000.
Warrants for 64,614 and 69,020 of these shares were exercised during 1997 and
1996, respectively.

     In conjunction with the Company's initial public offering in October 1993,
warrants to purchase an aggregate of 100,000 shares of common stock at an
exercise price of $13.50 (120% of the initial public offering price) per share
were issued for $100 to the managing underwriter of the initial public offering.
The warrants were exercisable through October 26, 1998. Warrants for 10,000 of
these shares were exercised in 1996. The remaining 90,000 warrants expired
unexercised on October 26, 1998.

     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 6). These warrants have 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 6). These warrants have an exercise price of $10.0625 per
share and expire on October 29, 2001.

     On May 15, 1998, the Company issued warrants to purchase 4,140,000 shares
of common stock in connection with the issuance of Senior Convertible Notes
(Note 8). These warrants have an exercise price of $3.75 per share and expire on
May 15, 2001.

8.  LONG-TERM DEBT

     On May 15, 1998, the Company entered into a Securities Purchase Agreement
(the "Agreement") with various parties. Under the terms of the Agreement, the
Company issued and sold $10,350,000 in aggregate principal amount of Senior
Convertible Notes due May 15, 2002 (the "Notes") and issued warrants to purchase
4,140,000 shares of the Company's Common Stock (the "Warrants"). The Notes bear
interest at 2% per annum, payable in cash or in shares of the Company's Common
Stock at the Company's option, and mature on May 15, 2002. Holders of the Notes
may convert 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. Conversions were not permitted during the first 90 days following the
issuance of the Notes and were limited to one-half of the original principal
amount during the period from 91 to 180 days after the issuance of the Notes.
The Company may redeem all or a portion of the Notes at a redemption price equal
to the principal amount plus accrued interest thereon, if any, under certain
conditions. The Warrants have an exercise price of $3.75 per share and expire on
May 15, 2001. The Agreement contains several covenants which limit the Company's
ability to incur additional indebtedness and to create any lien, pledge, or
encumbrance on any assets of the Company.

     Since the 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 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 the 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 Warrants issued in
conjunction with the Notes (equal to $1,230,000, and calculated using the
Black-Scholes Approximation Formula) 

8. LONG-TERM DEBT (CONTINUED)

was allocated to additional paid-in capital, thus creating an additional
discount to the debt. This discount will be recognized as a charge to interest
expense using the effective interest method over the four year term of the
Notes. The Company recognized 


                                       43
<PAGE>   46


$10,101,401 of non-cash interest charges during 1998 as a result of the
amortization of the discount on the Notes. As a result of the additional
interest expense from amortization of the debt discount described above, the
effective interest rate on the Notes is approximately 73.9%.

     It is not practicable to estimate the fair value of the Notes at December
31, 1998 because a quoted market price for such securities is not available, the
Company has not yet developed a valuation model necessary to make such an
estimate, and the cost of obtaining an independent valuation would be
prohibitive.

9.  INCOME TAXES

     The Company has net operating loss and research and development credit
carryforwards for tax purposes of approximately $50,369,000 and $1,050,000,
respectively, at December 31, 1998. The net operating loss carryforwards expire
in the following years:

              YEAR                                                  AMOUNT
            -----------------------------------------------------------------
              2005                                               $     7,000
              2006                                                   638,000
              2007                                                   974,000
              2008                                                 1,659,000
              2009                                                 3,973,000
              2010                                                 8,199,000
              2011                                                11,953,000
              2012                                                11,922,000
              2013                                                11,044,000
                                                                 ------------
                                                                 $50,369,000
                                                                 ============

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

<TABLE>
<CAPTION>
                                                          DECEMBER 31,
                                                   1998                 1997
                                             -----------------------------------
     <S>                                     <C>                    <C>  
     Deferred tax assets:                    
      Net operating loss carryforward        $ 19,140,000           $15,210,000
      Research and development tax credit    
       carryforwards                            1,050,000               881,000
      Deferred compensation                        27,000                79,000
      Accounts receivable                          33,000                     -
      Inventories                                 223,000                     -
                                             -----------------------------------
     Total deferred tax assets                 20,473,000            16,170,000
                                             
     Deferred tax liabilities:               
      Patent costs                               (234,000)             (215,000)
      Property and equipment                     (101,000)             (130,000)
                                             -----------------------------------
                                                 (335,000)             (345,000)
                                             -----------------------------------
     Net deferred tax assets                   20,138,000            15,825,000
     Valuation allowance                      (20,138,000)          (15,825,000)
                                             -----------------------------------
     Net deferred tax assets                 $          -           $         -
                                             ===================================
</TABLE>

9.  INCOME TAXES (CONTINUED)

     The valuation allowance increased during 1998 and 1997 by $4,313,000 and
$4,815,000, 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 

                                       44

<PAGE>   47


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, which expires October 2004, the Company is responsible for all real
estate taxes and operating expenses. The lease provides for a security deposit
($250,000 at December 31, 1998) 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, 1998:

           YEAR                                                      AMOUNT
          ------------------------------------------------------------------

          1999                                                    $  227,500
          2000                                                       231,300
          2001                                                       249,900
          2002                                                       249,900
          2003                                                       249,900
          Thereafter                                                 208,300
                                                                  ----------
                                                                  $1,416,800
                                                                  ==========

     Rent expense totaled $229,786, $226,938 and $227,334, for the years ended
December 31, 1998, 1997, and 1996, 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, 1998, 1997, and 1996.

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
12.  LITIGATION (CONTINUED)

trial and money damages equal to the difference between $8,800,000 (370,370.37
shares at $10.80 per share and

370,370.37 shares at $12.96 per share) and 740,740.74 multiplied by the highest
price at which the Common Stock traded on The Nasdaq Stock Market between
November 20, 1995 and the date of judgment. Mr. Siegler also preserved his claim
for specific performance for purposes of appeal. On November 1, 1996, the case
was transferred to the Circuit Court of Cook County, Illinois, County
Department, Law Division. The Company's Answer was filed on November 21, 1996
and the parties are in the midst of discovery.


                                       45

<PAGE>   48

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

Note Litigation

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

     On September 30, 1997, the Borrowers and the Guarantor responded to the
Company's complaint. Concurrently, the Borrowers filed a counterclaim alleging
that they exercised the warrants in reliance on the Company's alleged fraudulent
representations to certain Borrowers concerning a third-party's future
underwriting of a secondary public offering of the Common Stock. The
counterclaim sought an amount of damages which the Borrowers allege "cannot
currently be determined." On December 10, 1997, the Company's motion to strike
the Borrowers' fraud defense and dismiss their counterclaim was granted with
leave to amend.

     On January 14, 1998, the Borrowers filed amended defenses and counterclaims
based on substantially similar allegations of supposed fraud by the Company. The
Company's answer was filed on April 30, 1998, and the parties are proceeding
with discovery. The Company regards the amended fraud claim as without factual
or legal merit. Effective July 23, 1998, one of the Borrowers, Merrill Weber &
Co., Inc., and the Company reached a settlement of their respective claims. The
Company intends to vigorously pursue recovery of the moneys owed by the other
Borrowers and the Guarantor under the promissory notes and the guarantee.

Lipman Litigation

     On January 6, 1998, Jerome H. Lipman, individually and on behalf of all
others similarly situated, filed a complaint 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 

12. LITIGATION (CONTINUED)

Drobny. The complaint also seeks an unspecified amount of compensatory and
punitive damages, and attorneys' fees.

     The Company and the Named Directors regard the suit as without factual or
legal merit. Accordingly, on February 17, 1998, the Company and the Named
Directors filed a motion to dismiss Mr. Lipman's complaint. The motion presented
arguments that the claims of Mr. Lipman and the putative class are barred by the
business judgment rule and the plaintiff's failure to fulfill the legal
prerequisites for filing an action against the Named Directors. Prior to a
hearing on the Company's and the Named Directors' motion to dismiss, Mr. Lipman
filed a motion on March 16, 1998, seeking both to amend his proposed putative
class to include Mr. Drobny and to certify the class.


                                       46
<PAGE>   49

     On June 1, 1998, the court granted the Company's and the Named Directors'
motion to dismiss the complaint. Concurrently, Mr. Lipman withdrew his motion to
amend the proposed putative class and certify the class. On June 30, 1998, Mr.
Lipman filed an amended complaint against the Named Directors but excluding the
Company itself as a defendant. The amended complaint alleges that the Named
Directors breached their duties of loyalty and due care to the putative class of
stockholders by selecting financing for the Company in June 1997 and thereafter
drawing two tranches of the financing. The amended complaint seeks certification
of a class consisting of all owners of the Common Stock during the period from
May 15, 1997 through December 31, 1997, excluding the Named Directors. Mr.
Lipman's amended complaint alleges that the stock owned by the putative class
lost $61 million due to the financing the Named Directors selected, and seeks an
unspecified amount of compensatory and punitive damages. The Company and the
Named Directors regard the amended complaint as without factual or legal merit.
Accordingly, the Named Directors filed a motion to dismiss Mr. Lipman's amended
complaint on July 29, 1998. The court granted the motion to dismiss in December
1998, finding that Mr. Lipman still had failed to fulfill the prerequisites for
maintaining a shareholder derivative action against the Named Directors. On
January 12, 1999, Mr. Lipman and two added former stockholders filed a second
amended complaint against the Named Directors and again including the Company
itself as a defendant.

     The second amended complaint alleges that the Named Directors breached
their duties of loyalty and due care to the putative class and further alleges
that the purported devaluation of the plaintiff's stock resulting from the June
1997 financing was an improper "assessment" on the plaintiffs' shares for which
they seek an unspecified amount of compensatory and punitive damages. In
February 1999, the Company and the Named Directors filed a motion to dismiss the
second amended complaint. A hearing on the motion is scheduled for April 1999.

Greenwald Litigation

     On June 24, 1998, Jonathan Greenwald, derivatively on behalf of the
Company, filed a complaint against the Company and the Named Directors in the
court of Chancery of the State of Delaware in and for New Castle County. Mr.
Greenwald's complaint alleges that the Named Directors breached their duties of
good faith, loyalty, due care, and candor by selecting financing for the Company
in 1997 which purportedly reduced the stock price and was supposedly accepted to
entrench the Named Directors. The complaint seeks an unspecified amount of
compensatory damages, various equitable relief and attorney's fees.

     The Company and the Named Directors regard the suit as without factual or
legal merit. Accordingly, in January 1999, the Company and the Named Directors
filed a motion to dismiss the complaint arguing that the complaint is barred by
the business judgment rule and the plaintiffs' failure to fulfill the
prerequisites for maintaining a shareholder derivative action against the Named
Directors. A hearing on the motion has not been scheduled.

     The Company intends to defend itself vigorously in the matters described
above and believes that the resolution of these matters will not have a material
adverse effect on the financial condition, results of operations, or cash flows
of the Company.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE
         None.

                                       47
<PAGE>   50

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         Information in response to this item is incorporated by reference from
the "Election of Directors," "Executive Officers," and "Section 16(a) Beneficial
Ownership Compliance" sections of the Company's definitive proxy statement to be
filed with Securities and Exchange Commission in connection with the Company's
1999 Annual Meeting of Stockholders, scheduled to be held on June 9, 1999 (the
"1999 Proxy Statement").

ITEM 11.  EXECUTIVE COMPENSATION

         Information in response to this item is incorporated by reference from
the section of the 1999 Proxy Statement captioned "Executive Compensation and
Certain Transactions."

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         Information in response to this item is incorporated by reference from
the section of the 1999 Proxy Statement captioned "Security Ownership of
Management and Principal Stockholders."

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Information in response to this item is incorporated by reference from
the section of the 1999 Proxy Statement captioned "Executive Compensation and
Certain Transactions."


                                       48

<PAGE>   51

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K 

(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:

         Report of Independent Auditors
         Balance Sheets as of December 31, 1998 and 1997
         Statements of Operations for the Years Ended December 31, 1998, 1997, 
               and 1996 
         Statements of Stockholders' Equity (Net Capital Deficiency) for the 
              Years Ended December 31, 1998, 1997, and 1996
         Statements of Cash Flows for the Years Ended December 31, 1998, 1997 
              and 1996 
         Notes to Financial Statements

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

                Schedule II       N        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.

(b)  Reports on Form 8-K:

     None.


                                       49



<PAGE>   52

                                   SIGNATURES


     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 31st day of
March, 1999.

                      ILLINOIS SUPERCONDUCTOR CORPORATION


                                       By: /s/ EDWARD W. LAVES
                                          -------------------------------------
                                          Edward W. Laves, Ph.D.
                                          President and Chief 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 31st day of March, 1999.

<TABLE>
<CAPTION>

           SIGNATURE                                                 TITLE
------------------------------------      ---------------------------------------------------------
<S>                                       <C>
                                          Chairman of the Board, President, Chief Executive Officer
          /s/ EDWARD W. LAVES             (Principal Executive Officer)
------------------------------------      
              Edward W. Laves             
                                          
                                          Controller and Treasurer
          /s/ KENNETH E. WOLF             (Principal Financial and Accounting Officer)
------------------------------------      
              Kenneth E. Wolf             
                                          
          /s/ HOWARD HOFFMANN             Director
------------------------------------      
              Howard Hoffmann             
                                          
           /s/ ROBERT D. MITCHUM          Director
------------------------------------      
               Robert D. Mitchum          
                                          
          /s/ TERRY S. PARKER             Director
------------------------------------      
              Terry S. Parker             
                                          
          /s/ THOMAS L. POWERS            Director
------------------------------------      
              Thomas L. Powers            

</TABLE>

                                       50

<PAGE>   53

                       ILLINOIS SUPERCONDUCTOR CORPORATION

                                   SCHEDULE II

                        VALUATION AND QUALIFYING ACCOUNTS
              FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

<TABLE>
<CAPTION>
                                                         Balance at
                                                        beginning of      Additions    Deductions   Balance at end
                                                            year                                       of year
                                                      ---------------   ------------   ----------   --------------
<S>                                                      <C>            <C>            <C>             <C>             
YEAR ENDED DECEMBER 31, 1998: 
 Deducted from asset accounts:
    Valuation allowance on deferred tax assets......     $15,825,000      $4,580,000   $      0        $20,405,000


    Allowance for doubtful accounts                      $    68,775      $   19,215   $      0        $    87,990      


    Reserve for obsolete inventory                       $         0      $  587,000   $               $   587,000


YEAR ENDED DECEMBER 31, 1997: 
 Deducted from asset accounts:
    Valuation allowance on deferred tax assets.....      $11,010,000      $4,815,000   $      0        $15,825,000
                                                                                              

    Allowance for doubtful accounts                      $         0      $   68,775   $      0        $    68,775

YEAR ENDED DECEMBER 31, 1996: 
 Deducted from asset accounts:
    Valuation allowance on deferred tax assets.....      $ 6,531,000      $4,479,000   $      0        $11,010,000
</TABLE>

<PAGE>   54

                                  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.

     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 B 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., 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
              June 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 
<PAGE>   55

              December 1997 S-3.

     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.

     4.18     Form of 6% Senior Convertible Note due May 15, 2002.

     4.19     Form of Warrant dated March 31, 1999.

     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.

     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.

     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.

     10.1     1993 Amended and Restated Stock Option Plan, as amended,
              incorporated by reference to Exhibit B to the Company's Proxy
              Statement filed with the SEC on May 6, 1997.*

     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. *

     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.

     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.
<PAGE>   56


     10.10    License Agreement dated January 31, 1990 between the Company and
              Northwestern University, incorporated by reference to Exhibit
              10.13 to the IPO Registration Statement.

     10.11    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.

     10.12    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.

     10.13    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.

     10.14    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.

     10.16    Form of Officer Indemnification Agreement.*

     10.17    Employment Agreement dated July 1, 1998 between the Company and
              Edward W. Laves, Ph.D.*

     10.18    Employment Agreement dated November 9, 1998 between the Company
              and Dennis Craig.*

     10.19    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.

     23.      Consent of Ernst & Young LLP.

     27.      Financial Data Schedule.

__________________
* Management contract or compensatory plan or arrangement required to be filed
  as an exhibit on this Form 10-K.