**United States**

**Securities and Exchange Commission**

**Washington,DC 20549**

 

**FORM 10–Q**

**(MarkOne)**

 
| **ý** | **Quarterly  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|------------|----------------------------------------------------------------------------------------------|

 

**Forthe period ended June 30, 2002 or**

 
| **o** | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**Forthe transition period from         to**

 

**Commissionfile number 0-11915**

 

**Conductus, Inc.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                                        |   | **77-0162388**                       |
|-------------------------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of Incorporation or  organization)                     |   | (I.R.S. Employer Identification No.) |
|                                                                                |   |                                 |
| **969 W. Maude Ave., Sunnyvale,  California**                                       |   | **94085**                            |
| (Address of principal executive offices)                                            |   | (Zip Code)                           |
|                                                                                |   |                                 |
| **(408) 523-9950**                                                                  |
| (Registrant’s Telephone Number, including area code)                           |
|                                                                                |
| **Not  Applicable**                                                                 |
| (Former name, former address and former fiscal year,  if changed since last report) |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySections 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days Yes   ý    No  o

 

As of July 31, 2002,there were 22,510,401 shares of the registrant’s common stock outstanding

 

Total pages: Index to Exhibits to be found on page

 

 

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**Conductus,Inc**

**Index**

 
| **Part I: Financial  Information** |
|------------------------------------|
|                               |   |
|                               | *Item 1: Financial  Statements* |
|                               |   |
|                               |   | Unaudited  Condensed Balance Sheets – June 30, 2002 and December 31, 2001 |
|                               |   |   |
|                               |   | Unaudited Condensed  Statements of Operations – Three and Six months ended June 30, 2002 and 2001 |
|                               |   |   |
|                               |   | Unaudited Condensed  Statements of Cash Flows – Six months ended June 30, 2002 and 2001 |
|                               |   |   |
|                               |   | Notes To  Unaudited Condensed Financial Statements |
|                               |   |   |
|                               | *Item  2: Management’s Discussion and Analysis of Financial Condition and Results of  Operations* |
|                               |   |   |
|                               | *Item  3: Quantitative and Qualitative Disclosures About Market Risk* |
|                               |   |   |
| **Part II: Other  Information**    |
|                               |   |   |
|                               | *Item 1: Legal Proceedings* |
|                               |   |   |
|                               | *Item  2: Changes in Securities* |
|                               |   |   |
|                               | *Item 3:  Default Upon Senior Securities* |
|                               |   |   |
|                               | *Item  4: Submission of Matters to a Vote of Security Holders* |
|                               |   |   |
|                               | *Item 5: Other Information* |
|                               |   |   |
|                               | *Item 6:  Exhibits and Reports on Form 8-K* |
|                               |   |   |
| **Signatures**                     |   |   |

 

2

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**PartI:  Financial Information**

*ItemI:  Financial Statements*

**Conductus,Inc.**

**Condensed Balance Sheets**

 

(In thousands)

(Unaudited)

 
|                                                                  |   | **June 30, 2002** |   | **December 31, 2001** |   |
|-----------------------------------------------------------------------|--------|-------------------|--------|-----------------------|--------|
| ASSETS                                                                |   |              |   |                  |   |
| Current assets:                                                       |   |              |   |                  |   |
| Cash and cash  equivalents                                            |   | $                 | 6,376  |                  | $      | 4,201 |   |
| Short-term investments                                                |   | 450               |   | 2,696                 |   |
| Accounts receivable,  net                                             |   | 1,114             |   | 1,151                 |   |
| Inventories                                                           |   | 2,996             |   | 3,835                 |   |
| Prepaid expenses and  other current assets                            |   | 362               |   | 349                   |   |
| Total current assets                                                  |   | 11,298            |   | 12,232                |   |
| Property and equipment,  net                                          |   | 2,740             |   | 3,033                 |   |
| Restricted cash                                                       |   | 374               |   | 374                   |   |
| Other assets                                                          |   | 530               |   | 587                   |   |
| Total assets                                                          |   | $                 | 14,942 |                  | $      | 16,226 |   |
|                                                                  |   |              |   |                  |   |
| LIABILITIES                                                           |   |              |   |                  |   |
| Current liabilities:                                                  |   |              |   |                  |   |
| Accounts payable                                                      |   | $                 | 1,522  |                  | $      | 725 |   |
| Other accrued  liabilities                                            |   | 2,146             |   | 1,909                 |   |
| Capital lease  obligations                                            |   | 179               |   | 169                   |   |
| Total current  liabilities                                            |   | 3,847             |   | 2,803                 |   |
| Capital lease  obligations and long-term debt, net of current portion |   | 113               |   | 205                   |   |
| Total liabilities                                                     |   | 3,960             |   | 3,008                 |   |
|                                                                  |   |              |   |                  |   |
| STOCKHOLDERS’ EQUITY                                             |   |              |   |                  |   |
| Common stock                                                          |   | 2                 |   | 2                     |   |
| Additional paid-in capital                                            |   | 110,591           |   | 103,590               |   |
| Receivable from  stockholder                                          |   | (460              | )      | (460                  | )      |
| Accumulated deficit                                                   |   | (99,151           | )      | (89,914               | )      |
| Total stockholders’  equity                                      |   | 10,982            |   | 13,218                |   |
| Total liabilities and  stockholders’ equity                      |   | $                 | 14,942 |                  | $      | 16,226 |   |

 

The accompanying notes are an integral part of these condensedfinancial statements.

 

3

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**Conductus,Inc.**

**Condensed Statements Of Operations**

 

(In thousands, except per share amounts)

(Unaudited)

 
|                                    |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|-----------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                    |   | **2002**                        |   | **2001**                      |   | **2002** |   | **2001** |   |
| Revenues:                               |   |                            |   |                          |   |   |   |   |   |
| Product                                 |   | $                               | 955    |                          | $      | 752 |   | $ | 1,979 |   | $ | 1,294 |   |
| Contract                                |   | 639                             |   | 954                           |   | 1,582 |   | 1,684 |   |
|                                    |   |                            |   |                          |   |   |   |   |   |
| Total revenues                          |   | 1,594                           |   | 1,706                         |   | 3,561 |   | 2,978 |   |
| Operating costs and  expenses:          |   |                            |   |                          |   |   |   |   |   |
| Cost of product  revenues               |   | 2,597                           |   | 2,671                         |   | 4,257 |   | 4,705 |   |
| Research and  development               |   | 2,067                           |   | 2,195                         |   | 4,128 |   | 4,456 |   |
| Selling, general and  administrative    |   | 2,344                           |   | 1,821                         |   | 4,491 |   | 3,483 |   |
|                                    |   |                            |   |                          |   |   |   |   |   |
| Total operating costs  and expense      |   | 7,008                           |   | 6,687                         |   | 12,876 |   | 12,644 |   |
|                                    |   |                            |   |                          |   |   |   |   |   |
| Loss from operations                    |   | (5,414                          | )      | (4,981                        | )      | (9,315 | ) | (9,666 | ) |
| Interest and other  income              |   | 71                              |   | 197                           |   | 127 |   | 425 |   |
| Interest expense                        |   | (25                             | )      | (32                           | )      | (50 | ) | (72 | ) |
|                                    |   |                            |   |                          |   |   |   |   |   |
| Net loss                                |   | (5,368                          | )      | (4,816                        | )      | (9,238 | ) | (9,313 | ) |
|                                    |   |                            |   |                          |   |   |   |   |   |
| Net loss per share:                     |   |                            |   |                          |   |   |   |   |   |
| Basic and diluted                       |   | $                               | (0.24  | )                             | $      | (0.29 | ) | $ | (0.44 | ) | $ | (0.57 | ) |
|                                    |   |                            |   |                          |   |   |   |   |   |
| Shares used in per  share calculations: |   |                            |   |                          |   |   |   |   |   |
| Basic and diluted                       |   | 22,468                          |   | 16,626                        |   | 20,763 |   | 16,358 |   |

 

The accompanying notes are an integral part of these condensedfinancial statements.

 

4

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**CONDUCTUS,INC.**

**Condensed Statements of Cash Flows**

 

(In thousands)

(Unaudited)
|                                                                         |   | **Six Months Ended June 30,** |   |
|------------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                         |   | **2002**                      |   | **2001** |   |
| Cash flows from  operating activities:                                       |   |                          |   |   |   |
| Net loss                                                                     |   | $                             | (9,238 | ) | $ | (9,313 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |   |                          |   |   |   |
| Depreciation and  amortization                                               |   | 493                           |   | 378 |   |
| Amortization of  discount on long term debt                                  |   | 46                            |   | 14 |   |
| Loss (gain) on disposal  of equipment                                        |   | 4                             |   | (80 | ) |
| Non-cash charge for  warrants vesting upon commercial product sales          |   | 5                             |   | 110 |   |
| Changes in operating  assets and liabilities:                                |   |                          |   |   |   |
| Accounts receivable                                                          |   | 37                            |   | (766 | ) |
| Inventories                                                                  |   | 839                           |   | (1,581 | ) |
| Prepaid expenses and  other current assets                                   |   | (1                            | )      | 44 |   |
| Accounts payable and  other accrued liabilities                              |   | 1,034                         |   | 2,177 |   |
|                                                                         |   |                          |   |   |   |
| Net cash used in  operating activities                                       |   | (6,781                        | )      | (9,017 | ) |
| Cash flows from  investing activities:                                       |   |                          |   |   |   |
| Maturities of  short-term investments                                        |   | 2,251                         |   | 8,027 |   |
| Purchases of short-term  investments                                         |   | (5                            | )      | (3,750 | ) |
| Acquisition of property  and equipment                                       |   | (204                          | )      | (852 | ) |
| Net proceeds from  disposal of property and equipment                        |   | —                        |   | 80 |   |
|                                                                         |   |                          |   |   |   |
| Net cash provided by  investing activities                                   |   | 2,042                         |   | 3,505 |   |
| Cash flows from  financing activities:                                       |   |                          |   |   |   |
| Net proceeds from  issuance of common stock                                  |   | 6,996                         |   | 12,044 |   |
| Principal payments on  long-term debt and capital leases                     |   | (82                           | )      | (674 | ) |
|                                                                         |   |                          |   |   |   |
| Net cash provided by  financing activities                                   |   | 6,914                         |   | 11,370 |   |
| Net increase in cash  and cash equivalents                                   |   | 2,175                         |   | 5,858 |   |
| Cash and cash  equivalents at beginning of period                            |   | 4,201                         |   | 7,202 |   |
|                                                                         |   |                          |   |   |   |
| Cash and cash  equivalents at end of period                                  |   | $                             | 6,376  |   | $ | 13,060 |   |

 

The accompanying notes are an integral part of these condensedfinancial statements.

 

5

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**Conductus,Inc.**

 

**NotesTo Condensed Financial Statements**

**(Unaudited)**

 

**1.          Summaryof Significant Accounting Policies:**

 

**UNAUDITED FINANCIAL INFORMATION:**

 

The accompanyingunaudited condensed financial statements have been prepared pursuant to therules and regulations of the Securities and Exchange Commission. Certaininformation and footnote disclosures normally included in the financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America have been condensed or omitted pursuant to suchrules and regulations. These unaudited condensed financial statements should beread in conjunction with the audited financial statements and notes theretoincluded in our Report on Form 10-K for the year ended December 31, 2001, andfiled with the Securities and Exchange Commission. The unaudited condensedfinancial statements as of June 30, 2002, and for the three and six monthsended June 30, 2002 and 2001, include, in the opinion of management, alladjustments, consisting of normal recurring adjustments, necessary to presentfairly the financial information set forth herein. The unaudited condensedresults of operations for the interim periods are not necessarily indicative ofthe results to be expected for an entire year. The December 31, 2001 balancesheet included in this unaudited interim report was derived from auditedfinancial statements, but does not include all disclosures required byaccounting principles generally accepted in the United States of America.

 

**Substantial Future Capital Needs**

 

The Company’sfuture capital requirements will depend, generally, on future levels ofrevenues and spending. The Company believes that its cash balance at June 30,2002, together with its $2 million bank credit facility, based on a limitationof 80% of certain eligible receivables, should be sufficient to fundanticipated cash requirements through December 2002.

 

Based on currentrevenues, cost and expense expectations, the Company believes it will need toraise additional capital through equity or other financing transactions priorto December 31, 2002 in order to fund operations beyond 2002.  The Company currently expects to raise additionalcapital through equity financing.  Theterms of any future equity financing are presently uncertain, as they dependupon the financial performance of the Company through the time of thefinancing, as well as the general condition of the market for equity financingfor companies such as Conductus.

 

Should the termsof a prospective equity financing be unattractive, or should equity financingbe unavailable on any terms, the Company has several options designed toforestall its inability to continue as a going concern and, it hopes, allow itto complete an equity financing at a later date on more attractive terms.   These options include reducing currentoperating costs, deferring planned discretionary expenditures, such as capitalexpenditures, sales of assets or a strategic transaction involving itsintellectual property.

 

Because theCompany’s future needs for cash and future ability to raise financing involvesignificant uncertainties regarding future events, including its level ofoperating performance and the general condition of the market for equityfinancing, the Company’s planned course of action could change rapidly.  The Company is continually evaluating itsplans and expects to be prepared to take action promptly when appropriate.  However, there can be no assurance thatunforeseen events will not deplete its cash resources sooner than it expects orthat additional financing will become available on acceptable terms or atall.  Unless the Company is able toraise significant additional funds through the issuance of new equity or debt,it may be required to obtain funds through a strategic transaction onunfavorable terms or to delay, reduce or eliminate one or more of its researchand development programs.

 

The unauditedcondensed financial statements have been prepared assuming that the Companywill continue as a going concern. The financial statements do not include anyadjustments that might be necessary if it is unable to continue as a goingconcern or that may result from the outcome of any of these uncertainties.

 

6

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**2.          SupplementalSchedule of Non-Cash Investing and Financing Activities:**

 
|                                    |   | **Six Months Ended   June 30,** |   |
|-----------------------------------------|--------|---------------------------------|--------|
|                                    |   | **2002**                        |   | **2001** |   |
|                                    |   |                            |   |   |   |
| Equipment acquired  under capital lease |   | $                               | — |   | 514 |   |
|                                         |        |                                 |        |  |  |  |

 

**3.          Basicand Diluted Net Loss Per Share:**

 

A reconciliationof the numerator and denominator of the basic and diluted net loss per share isprovided as follows (in thousands, except per share data):

 
|                                                      |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|-----------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                      |   | **2002**                         |   | **2001**                       |   | **2002** |   | **2001** |   |
| Numerator - basic and  diluted net loss per share:        |   |                             |   |                           |   |   |   |   |   |
| Net loss                                                  |   | $                                | (5,368 | )                              | $      | (4,816 | ) | $ | (9,238 | ) | $ | (9,313 | ) |
| Denominator – basic and  diluted net loss per share: |   |                             |   |                           |   |   |   |   |   |
| Weighted average common  shares outstanding               |   | 22,468                           |   | 16,626                         |   | 20,763 |   | 16,358 |   |
| Net loss per share:                                       |   |                             |   |                           |   |   |   |   |   |
| Basic and diluted                                         |   | $                                | (0.24  | )                              | $      | (0.29 | ) | $ | (0.44 | ) | $ | (0.57 | ) |

 

In the abovecomputations, common equivalent shares are excluded from the diluted net lossper share calculations, as their effect is anti-dilutive.  Common equivalent shares, including commonstock options and warrants, that could potentially dilute basic earnings pershare in the future and that were not included in the computations of dilutedloss per share because of anti-dilution were approximately 115,000 and 925,000for the three months ended June 30, 2002 and 2001, respectively, and 160,000and 1,016,000 for the six months ended June 30, 2002 and 2001, respectively.

 

**4.          Inventories:**

 

Inventoriesconsist of the following (in thousands):

 
|            |   | **June 30,** **2002** |   | **December 31,   2001** |   |
|-----------------|--------|----------------------------|--------|-------------------------|--------|
|            |   |                       |   |                    |   |
| Raw materials   |   | $                          | 968    |                    | $      | 2,349 |   |
| Work in process |   | 1,142                      |   | 888                     |   |
| Finished goods  |   | 886                        |   | 598                     |   |
| Total           |   | $                          | 2,996  |                    | $      | 3,835 |   |

 

7

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**5.          LegalProceedings:**

 

On July 17,2001, ISCO International, Inc. (“ISCO”) filed a complaint in the UnitedStates District Court for the District of Delaware against the Company,alleging that its current base station front-end systems containingcryogenically cooled superconducting filters infringe ISCO’s U.S. PatentNo. 6,263,215, entitled “Cryoelectronically Cooled Receiver Front End forMobile Radio Systems,” which was issued on July 17, 2001. OnSeptember 17, 2001, ISCO amended its complaint to allege willfulinfringement and to seek treble damages for the alleged infringement. Thecomplaint seeks injunctive relief and damages for infringement. The Companydenied infringement, denied that the patent is valid and alleged that thepatent was procured through inequitable conduct. The Company filed counterclaimsseeking declarations of invalidity and non-infringement and damages for unfaircompetition. The Company believes that ISCO’s claims are without merit and aredefending ourselves vigorously.

 

On March 26,2002, ISCO attempted to add claims of infringement of two additional patents toits complaint by way of an amended Answer and Counterclaim. U.S. PatentNo. 6,203,340 for “Cryoelectronic Receiver Front End For Mobile RadioSystems,” issued March 20, 2001, and U.S. Patent No. 6,104,934 for“Cryogenic Receiver Front End,” issued August 15, 2000, direct theirclaims to tower-mounted applications of cryogenic receiver front-end systems.Both the Company and the co-defendant, Superconductor Technologies, Inc.,objected to the addition of the new claims and asked the court to strike ordismiss them.

 

On April 17,2002, the court dismissed the additional claims. The effect of this dismissalis that the litigation will proceed on its original schedule, and will notaddress claims directed to the additional patents.

 

An adverse outcomein the pending litigation, or in litigation of other intellectual propertyclaims could subject the Company to significant liabilities or require it tocease using such technology. The cost of defending a patent lawsuit will likelyconstitute a major financial burden for the Company.  As the litigation is in an initial stage, the Company is not ableat this time to estimate the possibility of loss or range of loss, if any thatmight result. While the outcome of this claim cannot be predicted withcertainty, the Company does not believe that the outcome will have a materialadverse effect on its financial position, results of operations or cash flows.

 

*Item 2: Management’s Discussion and Analysis of FinancialCondition and Results of Operations.*

 

THIS REPORT ONFORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS ANDUNCERTAINTIES. CONDUCTUS, INC.’S (THE “COMPANY” OR “CONDUCTUS” OR “OUR”) ACTUALRESULTS MAY DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKINGSTATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOTLIMITED TO, THOSE DISCUSSED IN “RISK FACTORS” IN PART 1 OF OUR ANNUAL REPORT ONFORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2002 AS SUPPLEMENTED BY AMENDMENT 2TO OUR REGISTRATION STATEMENT ON FORM S-3 FILED JUNE 6, 2002. THE FOLLOWINGDISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE UNAUDITED CONDENSED FINANCIALSTATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN THIS REPORT ON FORM 10-Q.

 

**Overview**

 

We develop,manufacture and market electronic components and systems based onsuperconductors for applications in the worldwide wireless telecommunicationsmarket. Our products use high-temperature superconductor technology, which hassignificant potential performance advantages over products based on competingmaterials such as copper. These advantages include enhanced sensitivity,efficiency, speed and operating frequency, as well as reduced powerconsumption, size, weight and cost. Our primary commercial product is our lineof ClearSite® front-end receiver systems for cellular and personalcommunication services cell sites. These products may significantly enhance theservices provided by wireless network operators. Taking advantage of the uniqueproperties of high-temperature superconductor materials, ClearSite products canprovide significant benefits in base station performance, including coverageenhancement, reduced interference, increased capacity and enhanced bandwidth.They can also reduce the size of the filter components required and enablenetwork service providers and original equipment manufacturers to deploy new,and enhance existing, analog and digital cellular systems for increasinglydemanding carrier network environments.

 

Our ClearSiteproducts are designed for use with TDMA, CDMA, GSM and analog base stations.They may be installed as part of a new base station, or as a retrofit forexisting base stations. In 2001, we introduced our ClearSite 2100 line offront-end receiver systems. ClearSite 2100 systems are available in both omniand three-sector configurations, and can be retrofitted into existing cellsites resulting in immediate performance improvements, or can be deployed innew network build outs. In 2002, we introduced our ClearSite 2300 Metro line offront-end receiver systems, which incorporates higher performance filteringcapabilities specifically designed to address the needs of the urban market.

 

8

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In addition to ourproducts for the wireless communications infrastructure market, we design,manufacture and sell products for the government market. These specializedproducts use many of the same technologies used in our commercial products and,thus, complement our commercial product line.

 

A significant partof our revenues are derived from government research and development contracts.Many of these contracts are under programs calling for basic research ofpotentially broad application. We expect that this research may result inimprovement of existing products (for example, with materials improvement,cryogenic technology or improved filter design or tuning performance) orpossibly provide the basis for future products. We retain ownership oftechnology developed under these government contracts. The government obtains aperpetual, royalty-free license to use the technology for government purposes.Typically under these contracts, the government has the right to terminate thecontract for convenience.

 

As of June 30, 2002, wehad accumulated losses of approximately $99,151,000 and we expect to incursignificant additional losses during the remainder of 2002. We, alone or withcollaborative partners, must successfully develop, manufacture, introduce andmarket our potential products in order to achieve profitability. Though ourproduct line is commercially available and generates material sales, we do notexpect to recognize revenues equal to or greater than our costs and expensesuntil we achieve significantly larger sales volume and successfully reduce costsof the products.

 

### **CriticalAccounting Policies and Estimates**

## ** **

**General**

 

Discussion andanalysis of our financial condition and results of operations are based uponour financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof these financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses, andrelated disclosure of contingent assets and liabilities. On an on-going basis,we evaluate estimates, including those related to revenues, contracts,inventories, contingencies and litigation. Estimates are based on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results may differ materially fromthese estimates under different assumptions or conditions.

 

We believe thefollowing critical accounting policies affect the more significant judgmentsand estimates used in the preparation of our financial statements:

 

## **RevenueRecognition**

 

Our revenuerecognition policy is significant because our revenues are a key component ofour results of operations. We follow very specific and detailed guidelines inmeasuring revenues; however, certain judgments affect the application of ourrevenue policy.  Revenue results aredifficult to predict, and any shortfall in revenues or delay in recognizingrevenues could cause our operating results to vary significantly from quarterto quarter.

 

We recognizerevenue upon the shipment of our products to the customer provided that we havereceived a purchase order, the price is fixed or determinable, title hastransferred, collection of the resulting receivable is reasonably assured andthere are no remaining obligations. We provide for future returns and warrantyclaims based on historical experience at the time revenue is recognized.

 

When we issuewarrants or other equity instruments in connection with sales transactions, thefair value of the equity instrument, as calculated using the Black–Scholesoption pricing model, is treated as a reduction in the amount of revenuesrecognized in the period, unless the reduction results in negative revenues forthat specific customer on a cumulative basis, in which case the remainder, ifany, increases cost of goods sold in our financial statements.

 

## **Research andDevelopment Contracts**

 

We have enteredinto contracts to perform research and development for the U.S. government.Revenue from these contracts is recognized utilizing thepercentage-of-completion method measured by the relationship of costs incurredto total contract costs. Estimates of costs-to-complete on contracts are basedon significant management judgments including assessing the progress of thecontract and estimating remaining tasks and associated costs. We haveexperienced managers who prepare these estimates, which are subject to review.Management assessments of costs to complete determine the amount of revenue andprofit (or loss) that we recognize in an accounting period. Accordingly, actualrevenue may differ materially from our estimates with different conditions orassumptions. Historically, we have not incurred significant unexpected contractlosses.

 

9

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Cost of U.S.government contract revenues for the three and six months ended June 30, 2002,were $1,543,000 and $3,301,000, respectively, allocated between research anddevelopment, and selling, general and administrative expenses. Costs includedirect engineering and development costs and applicable overhead. The companyaccrues contract losses when they become reasonably estimable.

 

## **Inventories**

 

Inventories arestated at the lower of cost (determined on a first-in, first-out basis) ormarket value. We validate our perpetual inventory balances against a quarterlyphysical count making adjustments to the perpetual balance as necessary. Wewrite down our inventory for estimated obsolescence or unmarketable inventoryequal to the difference between the cost of inventory and the estimated marketvalue based upon assumptions about future demand and market conditions. Ifactual market conditions are less favorable than those projected by management,additional inventory write-downs may be required. Appropriate consideration isgiven to obsolescence, excessive levels, deterioration and other factors inevaluating net realizable value.

 

**Results of Operations**

 

Total revenuesconsist of contract and product revenues. Substantially all product sales comprise sales of superconductiveproducts.  Our total revenues decreasedby 7% to $1,594,000 for the quarter ended June 30, 2002, from $1,706,000 in thecomparable period of 2001. Total revenues for the six months ended June 30,2002 were $3,561,000, which represents a 20% increase from $2,978,000 in thecomparable period of 2001.  Productrevenues for the quarter ended June 30, 2002 increased by 27% to $955,000,compared to product revenues of $752,000 for the comparable period of 2001. Forthe six months ended June 30, 2002, product revenues increased by 53% to$1,979,000 from $1,294,000 for the comparable period of 2001.  The increase in product revenues isprimarily due to increased commercial unit shipments under one major contractduring the comparison periods.  Product revenues for the quarter endedJune 30, 2002 and 2001 were offset by non-cash sales discounts in theamount of $1,000 and $70,000, respectively. The non-cash sales discounts related to the fair market value of 32,520and 26,820 warrants, which vested during the second quarter of 2002 and 2001, respectively.Product revenues for the six months ended June 30, 2002 and 2001 wereoffset by non-cash sales discounts in the amount of $5,000 and $110,000,respectively.  The non-cash salesdiscounts related to the fair market value of 55,980 and 42,580 warrants, whichvested during the first half of 2002 and 2001, respectively. Contractrevenues decreased by 33% to $639,000, compared to $954,000 for the secondquarter of 2001.  For the six months ended June 30, 2002, contractrevenues decreased by 6% to $1,582,000, compared to $1,684,000 for the comparableperiod of 2001.  The decrease incontract revenues during the comparison periods is due primarily to delays inthe start dates of anticipated new contracts.

 

Cost of productrevenues was primarily composed of costs of products related to our wirelesstelecommunications products. Cost of product revenues decreased by 3% or$74,000 to $2,597,000 for the quarter ended June 30, 2002, compared to$2,671,000 for the comparable period of 2001 and represented 272% and 355% ofproduct revenues, respectively.  Cost of product revenues decreased 10% to$4,257,000 for the first six months of 2002, compared to $4,705,000 for thecomparable period of 2001 and represented 215% and 364% of product revenues,respectively. The decrease in the cost of product revenues as a percentage ofproduct revenues was primarily due to a decrease in indirect manufacturingspending.  This decrease was partiallyoffset by charges of approximately $557,000 recorded for the quarter ended June 30,2002, related to a write-off of excess and obsolete inventory and directmaterial purchases.  We expect productcosts, as a percentage of product revenues, to decrease and margins to improveas the volume of shipments of our wireless communications products grows.  In addition, we expect both our direct andindirect manufacturing costs to decline as a result of various cost cuttingmeasures we have implemented, including a reduction in headcount, supplypurchases and travel expense.  However,we cannot assure you that margins will improve in the future.

 

Research anddevelopment expenses include both externally and internally funded projects.Research and development expenses decreased by 6% to $2,067,000 in the quarterended June 30, 2002, compared to $2,195,000 in the comparable period of theprior year.  Research and developmentrepresented 130% and 129% of total revenues in the quarters ended June 30, 2002and 2001, respectively.   For the sixmonths ended June 30, 2002 research and development expenses decreased by 7% to$4,128,000 from  $4,456,000 in the sixmonths ended June 30, 2001.  Researchand development expenses as a percentage of total revenues for the six monthsended June 30, 2002 and 2001 were 116% and 150%, respectively.  The decrease in research and developmentexpenses for the quarter ended June 30, 2002 when compared to the quarter endedJune 30, 2001 was due to a decrease in spending on recruiting and relocation of$86,000, and on sub-contractors for externally funded research and developmentcontracts of $138,000.  These decreaseswere partially offset by increased spending on materials for externally fundedresearch and development contracts of $164,000.  The increase in research and development expenses as a percentageof total revenues for the three months ended June 30, 2002, when compared tothe three months ended June 30, 2001, was primarily due to the decrease inrevenues during the comparison periods, partially offset by the decrease inresearch and development spending.   Thedecrease in research and development expenses for the six months ended June 30,2002, when compared to the six months ended June 30, 2001, was primarily due toa decrease in spending on recruiting and relocation of $231,000 and a decreasein spending on sub-contractors for externally funded research and developmentcontracts of $242,000, partially offset by increases in personnel costs of$222,000, due to increased headcount. The 

 

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decrease in research anddevelopment expenses as a percentage of total revenues for the six months endedJune 30, 2002, when compared to 2001, was primarily due to the increase inrevenues during the comparison periods and to a lesser extent, the decrease inresearch and development spending.  Weexpect to reduce our research and development spending during the remainder of2002 as a result of various cost cutting measures we have implemented,including a reduction in headcount, supply purchases and travel expense, and,as a result, anticipate decreases in research and development expenses comparedto the prior year.  However, there canbe no assurance that we will be successful in our research and development costreduction efforts.

 

Selling, generaland administrative expenses include costs associated with marketing, sales, andvarious administrative activities. Selling, general and administrative expenses increased by 29% to$2,344,000 from $1,821,000 in the quarters ended June 30, 2002 and 2001,respectively, and by 29% to $4,491,000 from $3,483,000 for the six months endedJune 30, 2002 and 2001, respectively. Selling, general and administrative expenses as a percentage of totalrevenues for the quarters ended June 30, 2002 and 2001 were 147% and 107%,respectively, and 126% and 117% for the six months ended June 30, 2002 and2001, respectively.  The increase inspending for the three and six months ended June 30, 2002, compared to the sameperiods in the prior year, both as a percent of revenues and in dollars, wasprimarily due to  $780,000 and$1,300,000 in legal expenses related to the ISCO International litigationincurred in the three and six months ended June 30, 2002, respectively. Theincrease in legal expenses when compared to the same periods in the prior yearwas partially offset by decreases in recruiting and relocation expenses of$70,000 and $181,000, and personnel related expenses of $81,000 and $115,000for three and six months ended June 30, 2002, respectively. We expect tocontinue to incur increased legal costs related to the ISCO International, Inc.patent litigation during the remainder of 2002 and, with the exception of legalspending, we expect to reduce sales, marketing, general and administrativespending as a result of various cost cutting measures we have implemented,including a reduction in headcount, supply purchases and travel expense duringthe remainder of 2002 when compared to the prior year.  However, there can be no assurance that wewill be successful in our selling, general and administrative cost reductionefforts.

 

Interest and otherincome was $71,000 and $197,000 for the three months ended June 30, 2002 and2001, respectively. For the six months ended June 30, 2002 and 2001, interestand other income was $127,000 and $425,000, respectively.  The decrease in interest income was primarilythe result of lower average cash balances in 2002 compared to 2001.

 

Interest expensewas $25,000 and $32,000 for the three months ended June 30, 2002 and 2001,respectively. For the six months ended June 30, 2002 and 2001, interest expensewas $50,000 and $72,000, respectively. Interest expense related primarily to our loan from a leasing company.The decrease in interest expense was primarily the result of lower average debtlevels during the comparison periods.

 

We do not believethat inflation has had a material effect on our financial condition or resultsof operations during the past two fiscal years. However, we cannot assure youthat our business will not be affected by inflation in the future.

 

**Liquidity and Capital Resources**

 

As of June 30,2002, our aggregate cash, cash equivalents and short-term investments,excluding $374,000 of restricted cash, totaled $6,826,000, compared to$6,897,000 as of December 31, 2001.  Additionally, we have a bankline of credit facility.  The bank line of credit is subject to renewal inNovember 2002.  We may borrow up to amaximum of $2,000,000 under the bank line of credit based on a limitation of80% of certain eligible receivables.

 

Net cash used inoperations was $6,781,000 during the six months ended June 30, 2002. Net cashused in operations was primarily the result of the net loss of $9,238,000,partially offset by a decrease in inventories and an increase in accountspayable and other accrued liabilities of $839,000 and $1,034,000, respectively,and the effect of non-cash charges of $548,000 for depreciation, amortization,loss on the disposal of equipment and warrants vesting upon commercial productsales during the first six months of 2002. We anticipate that we will incursignificant additional net losses during the remainder of 2002 and anticipatethat our accounts receivable may increase during the remainder of 2002. As aresult, we anticipate the use of additional cash in operating activities duringthe remainder of 2002.  We have purchased inventory during the first sixmonths of 2002 to support our projected sales during 2002.  The increasein accounts payable and other accrued liabilities is principally a result oflegal expenses related to the ISCO International, Inc. patent litigation and,to a lesser extent, inventory purchases.  Should actual sales for theremainder of 2002 be less than our projections, the carrying value of inventorymay be adversely affected.

 

Net cash providedby investing activities was $2,042,000 during the six months ended June 30,2002. The balance was primarily related to the proceeds from sales ofshort-term investments during the period of $2,251,000, partially offset byinvestments 

 

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in additional propertyand equipment of $204,000. We do not anticipate significant spending on capitalexpenditures during the remainder of 2002.

 

Net cash providedby financing activities was $6,914,000 during the six months ended June 30,2002, and was primarily the result of an equity financing of $7,300,000, lessoffering expenses of approximately $422,000, received from the issuance of3,650,000 shares of common stock at $2.00 per share in March 2002, partiallyoffset by principal payments on long-term debt of $82,000.  In connection with the equity financing, wealso issued warrants to purchase an additional 1,825,000 shares of our commonstock at an exercise price of $2.75 per share.

 

All of our creditfacilities contain financial, reporting and other covenants, which we are requiredto satisfy. We were in compliance with all such covenants at June 30,2002. We cannot assure you that we will continue to satisfy all such covenantsin the future. We cannot assure you that if we were to default on any of suchcovenants, we would be able to obtain a waiver of the default from the lender.In the event of default on any of these covenants, the party providing thefinancing under the applicable credit facility would not be obligated toadvance further amounts to us under that facility.  The entire amount outstanding, if any, under that facility couldbe declared to be immediately due and payable and the party providing thefinancing under the applicable credit facility could exercise its legalremedies against those assets that are collateral for that facility.

 

Our line ofClearsite products currently generates material revenues and we expect theserevenues to increase in the future. However, we do not expect to recognizerevenues equal to or greater than our costs and expenses until we reduce ouroverall product costs and produce in volumes sufficient to reduce the total ofour direct product costs, manufacturing overhead and operating expenses enoughto equal or be less than our revenue.  The continued development of ourproducts will require a commitment of substantial funds to conduct furtherresearch and development and testing, to establish high volume commercial scalemanufacturing and to market these products. We expect to use significantamounts of cash for these purposes and to support losses from operations untilproduct revenues increase.

 

Our projections ofproduct revenues are uncertain.  While we believe our products will becommercially successful, the timing of increases in product revenues willdepend on many factors, including:

 

•                  Continued progress in our researchand development programs;

•                  The magnitude of these programs;

•                  The time and cost involved inobtaining any required regulatory approvals;

•                  The costs involved in preparing,filing, prosecuting, maintaining and enforcing patents;

•                  Successful completion oftechnological, manufacturing and market requirements;

•                  Changes in existing researchrelationships;

•                  The availability of funding undergovernment contracts;

•                  Our ability to establishcollaborative arrangements; and

•                  The cost of manufacturing scale-upand the amount and timing of future revenues.

 

Our future capitalrequirements will depend, generally, on our levels of revenues and spending. Webelieve our cash balance at June 30, 2002, together with our $2 million bankcredit facility, based on a limitation of 80% of certain eligible receivables,should be sufficient to fund anticipated cash requirements through December2002.

 

Based on currentrevenue, cost and expense expectations, we believe we will need to raiseadditional capital through equity or other financing transactions prior toDecember 31, 2002, in order to fund operations beyond 2002.  We currentlyexpect to raise additional capital through equity financing.  The terms ofany future equity financing are presently uncertain, as they depend upon ourfinancial performance through the time of the financing, as well as the generalcondition of the market for equity financing for companies such as ours, but weexpect that they may be similar to the terms of the March 2002 transaction.

 

Should the termsof a prospective equity financing be unattractive, or should equity financingbe unavailable on any terms, we have several options designed to forestall ourinability to continue as a going concern and, we hope, allow us to complete anequity financing at a later date on more attractive terms.   Theseoptions include reducing current operating costs and deferring planneddiscretionary expenditures, such as capital expenditures, sales of assets, or astrategic transaction involving our intellectual property.

 

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Because our futureneeds for cash and our future ability to raise financing involve significantuncertainties regarding future events, including our level of operatingperformance and the general condition of the market for equity financing, ourplanned course of action could change rapidly.  We are continuallyevaluating our plans and expect to be prepared to take action promptly whenappropriate.  However, there can be no assurance that unforeseen eventswill not deplete our cash resources sooner than we expect or that additionalfinancing will become available on acceptable terms or at all.  Unless weare able to raise significant additional funds through issuance of new equityor debt, we may be required to obtain funds through a strategic transaction onunfavorable terms or to delay, reduce or eliminate one or more of our researchand development programs.

 

Our unauditedcondensed financial statements have been prepared assuming that we willcontinue as a going concern. The financial statements do not include anyadjustments that might be necessary if we are unable to continue as a goingconcern or that may result from the outcome of any of these uncertainties.

 

*Item3: Quantitative and Qualitative Disclosures About Market Risk*

 

Our general policyis to limit the risk of principal loss and ensure the safety of invested fundsby limiting market and credit risk.  Our exposure to financial marketrisks relates primarily to our exposure to the impact of changes in interestrates on our fixed income investment portfolio and long-term debt obligations.

 

*FixedIncome Investments*

 

The primaryobjective of our investment activities is to preserve our principal whilemaximizing yields without significantly increasing risk.  To achieve thisobjective, we maintain a portfolio that consists primarily of short-term,high-quality commercial paper and foreign debt.  All of our fixed incomeinvestments have maturities of less than one year.  Hence, our exposurerelated to changes in interest rates is somewhat limited due to the short-termnature of our portfolio.  We do not use derivative financial instrumentsin our investment portfolio.

 

*DebtObligations*

 

Our outstanding debtconsists of term loan obligations that are primarily based on fixedrates.  Therefore, our exposure to changes in interest rates is limitedbecause any increase or decrease in interest rates would not significantlyincrease or decrease interest expense on our debt obligations.

 

 

**Part II:  Other Information**

 

*Item1:              Legal Proceedings.*

 

On July 17,2001, ISCO International, Inc. (“ISCO”) filed a complaint in the UnitedStates District Court for the District of Delaware against us alleging ourcurrent base station front-end systems containing cryogenically cooledsuperconducting filters infringe ISCO’s U.S. Patent No. 6,263,215,entitled “Cryoelectronically Cooled Receiver Front End for Mobile RadioSystems,” which was issued on July 17, 2001.  On September 17, 2001,ISCO amended its complaint to allege willful infringement and to seek trebledamages for the alleged infringement.  The complaint seeks injunctiverelief and damages for infringement.  We have denied infringement, deniedthat the patent is valid and alleged that the patent was procured throughinequitable conduct.  We have filed counterclaims seeking declarations ofinvalidity and non-infringement and damages for unfair competition.  Webelieve that ISCO’s claims are without merit and are defending ourselvesvigorously.

 

On March 26,2002, ISCO attempted to add claims of infringement of two additional patents toits complaint by way of an amended Answer and Counterclaim. U.S. PatentNo. 6,203,340 for “Cryoelectronic Receiver Front End For Mobile RadioSystems,” issued March 20, 2001, and U.S. Patent No. 6,104,934 for“Cryogenic Receiver Front End,” issued August 15, 2000, direct theirclaims to tower-mounted applications of cryogenic receiver front-end systems.Both we and co-defendant Superconductor Technologies, Inc. objected to theaddition of the new claims and asked the court to strike or dismiss them.

 

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On April 17,2002, the court dismissed the additional claims. The effect of this dismissalis that the litigation will proceed on its original schedule, and will notaddress claims directed to the additional patents.

 

An adverse outcomein the pending litigation, or in litigation of other intellectual propertyclaims could subject us to significant liabilities or require us to cease usingsuch technology. The cost of defending a patent lawsuit will likely constitutea major financial burden for us. We are not able at this time to estimate thepossibility of loss or range of loss, if any that might result. While theoutcome of this claim cannot be predicted with certainty, we do not believethat the outcome will have a material adverse effect on our financial position,results of operations or cash flows.

 

*Item2:              Changes in Securities andUse of Proceeds.*

 

Not Applicable.

 

*Item 3:*             *Default Upon Senior Securities*.

 

Not Applicable.

 

*Item4:*             *Submission of Matters to a Vote of Security Holders.*

 

The Annual Meetingof Stockholders was held on May 30, 2002.

 

(a)  Themeeting included the election of the Board of Directors, submitted as ProposalNo. 1, whose names are as follows:

 

John F. Shoch, Ph.D.Robert M. JanowiakMartin A. KaplanCharles E. ShalvoyDavid L. Short

 

(b)  Othermatters voted upon at the stockholders meeting were:

 

Proposal No. 2: Approval of amendment to and restatement of the Company’s RestatedCertificate of Incorporation to increase the number of shares of Common Stockauthorized to be issued from 40,000,000 to 75,000,000;

 

Proposal No. 3: Ratification of the selection of PricewaterhouseCoopers LLP as theCompany’s independent accountants for the year ending December 31, 2002.

 

Shares of common stock voted as follows:

 
|                              |   | **Votes For** |   | **Votes Against** |   |
|-----------------------------------|--------|---------------|--------|-------------------|--------|
| Proposal  No. 1                   |   |          |   |              |   |
| (Election of Board of  Directors) |   |          |   |              |   |
| John F. Shoch                     |   | 15,241,114    |   | 155,679           |   |
| Robert M. Janowiak                |   | 15,239,514    |   | 157,279           |   |
| Martin A. Kaplan                  |   | 15,238,079    |   | 158,714           |   |
| Charles E. Shalvoy                |   | 15,207,088    |   | 189,705           |   |
| David L. Short                    |   | 15,235,124    |   | 161,669           |   |

 

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|                                                                                                                                                                                              |   | **Votes For** |   | **Votes Against** |   | **Abstaining** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|--------|-------------------|--------|----------------|--------|
| Proposal  No. 2                                                                                                                                                                                   |   |          |   |              |   |           |   |
| (Amendment and  restatement of the Company’s Restated Certificate of Incorporation to  increase the number of shares of common stock authorized to be issued from  40,000,000 to 75,000,000) |   | 15,085,456    |   | 289,940           |   | 21,397         |   |
|                                                                                                                                                                                              |   |          |   |              |   |           |   |
| Proposal  No. 3                                                                                                                                                                                   |   |          |   |              |   |           |   |
| (Approval of the  selection of PricewaterhouseCoopers LLP to serve as the Company’s independent  accountants for the fiscal year ending December 31, 2002)                                   |   | 15,361,079    |   | 22,984            |   | 12,730         |   |

 

*Item5:              Other Information*.

 

Not Applicable.

 

*Item6:*             *Exhibits and Reports on Form 8-K*

 

(A)  Exhibits 

 

3.1        Amended and Restated Certificate ofIncorporation of Conductus, Inc. dated June 19, 2002.

 

99.1                   CertificationPursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

99.2                   CertificationPursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

(B) Reports on Form 8-K.

 

On April 22, 2002, wefiled a current report on form 8-K reporting that on April 17, 2002, theFederal Court for the District of Delaware had dismissed the additional claimsthat ISCO International had attempted to add to the pending patent litigation.The effect of this dismissal is that the litigation will proceed on itsoriginal schedule, and will not address claims directed to the additionalpatents.

 

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, as amended, the Registranthas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 
|   |   | CONDUCTUS, INC. |
|--------|--------|-----------------|
|   |   |            |
|   |   |            |
|   |   |            |
|   |   | Registrant      |

 

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|                                |   |                                                                  |
|-------------------------------------|--------|-----------------------------------------------------------------------|
| Dated:  August  14,  2002 |   | /s/ Ron Wilderink                                                     |
|                                |   |                                                                  |
|                                |   | Ron Wilderink                                                         |
|                                |   | Vice President of  Finance  Chief Financial Officer and Secretary     |
|                                |   |                                                                  |
|                                |   | /s/ Charles E. Shalvoy                                                |
|                                |   |                                                                  |
|                                |   | Charles E. Shalvoy                                                    |
|                                |   | President and Chief  Executive Officer 

and Duly Authorized  Officer |

 

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