-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LgXB+3S9S0h47C7LabuLmn+FPpKxwGIv/DtSbxFOv72jSSvR1g3Q27QYzA1IXEYf 3PvW2bbJHuEmOb99sJEM6w== 0000950124-97-001749.txt : 19970326 0000950124-97-001749.hdr.sgml : 19970326 ACCESSION NUMBER: 0000950124-97-001749 CONFORMED SUBMISSION TYPE: S-3 PUBLIC DOCUMENT COUNT: 5 FILED AS OF DATE: 19970325 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: ILLINOIS SUPERCONDUCTOR CORPORATION CENTRAL INDEX KEY: 0000888693 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH [8731] IRS NUMBER: 363688459 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-3 SEC ACT: 1933 Act SEC FILE NUMBER: 333-23863 FILM NUMBER: 97562000 BUSINESS ADDRESS: STREET 1: 451 KINGSTON COURT CITY: MOUNT PROSPECT STATE: IL ZIP: 60056 BUSINESS PHONE: 8473919400 MAIL ADDRESS: STREET 1: 451 KINGSTON COURT CITY: MT PROSPECT STATE: IL ZIP: 60056 S-3 1 FORM S-3 1 As filed with the Securities and Exchange Commission on March 25, 1997 Registration No. 333- ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------------ FORM S-3 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ ILLINOIS SUPERCONDUCTOR CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 36-3688459 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.)
451 KINGSTON COURT, MT. PROSPECT, ILLINOIS 60056, (847) 391-9400 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) ORA E. SMITH President and Chief Executive Officer Illinois Superconductor Corporation 451 Kingston Court, Mt. Prospect, Illinois 60056, (847) 391-9400 (Name, address, including zip code, and telephone number, including area code, of agent for service) ------------------------ COPIES TO: LAWRENCE D. LEVIN, ESQ. BRUCE A. ZIVIAN, ESQ. PATRICK A. POHLEN, ESQ. Katten Muchin & Zavis Eilenberg & Zivian Cooley Godward LLP 525 West Monroe Street 30 North LaSalle Street, Suite Five Palo Alto Square Chicago, Illinois 60661 2900 3000 El Camino Real (312) 902-5200 Chicago, Illinois 60602 Palo Alto, California 94306 (312) 917-9900 (415) 843-5000
------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT. ------------------------ If the only securities being registered on this Form are being offered pursuant to dividend or interest reinvestment plans, please check the following box: [ ]. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box: [ ]. If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box: [ ] ------------------------ CALCULATION OF REGISTRATION FEE
======================================================================================================================== TITLE OF EACH PROPOSED MAXIMUM PROPOSED MAXIMUM CLASS OF SECURITIES AMOUNT TO OFFERING PRICE AGGREGATE AMOUNT OF TO BE REGISTERED BE REGISTERED PER SHARE OFFERING PRICE REGISTRATION FEE - ------------------------------------------------------------------------------------------------------------------------ Common Stock, $0.001 par value (including preferred stock purchase rights)............. 1,150,000 $16.1875 $18,615,625 $5,642 ========================================================================================================================
(1) Includes 150,000 shares of Common Stock issuable upon exercise of the Underwriters' over-allotment option. (2) Estimated solely for purposes of calculating the amount of registration fee in accordance with Rule 457(a) under the Securities Act of 1933, as amended. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(A), MAY DETERMINE. ================================================================================ 2 Information contained herein is subject to completion or amendment. A registration statement relating to these securities has been filed with the Securities and Exchange Commission. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This prospectus shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any State in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such State. SUBJECT TO COMPLETION, DATED MARCH 25, 1997 1,000,000 SHARES ILLINOIS SUPERCONDUCTOR CORPORATION ISC LOGO COMMON STOCK ------------------------- All of the 1,000,000 shares of Common Stock offered hereby (the "Offering") are being sold by Illinois Superconductor Corporation (the "Company"). The Company's Common Stock is traded on the Nasdaq National Market under the symbol "ISCO." On March 20, 1997, the last reported sale price of the Company's Common Stock on the Nasdaq National Market was $16.50 per share. See "Price Range of Common Stock." ------------------------- THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR A DISCUSSION OF CERTAIN FACTORS TO BE CONSIDERED BY PROSPECTIVE INVESTORS IN PURCHASING THE SHARES OF COMMON STOCK OFFERED HEREBY. ------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
======================================================================================================== PRICE TO UNDERWRITING PROCEEDS TO PUBLIC DISCOUNT(1) COMPANY(2) - -------------------------------------------------------------------------------------------------------- Per Share................................ $ $ $ - -------------------------------------------------------------------------------------------------------- Total (3)................................ $ $ $ ========================================================================================================
(1) See "Underwriting" for information concerning indemnification of the Underwriters and other matters. (2) Before deducting expenses payable by the Company estimated at $500,000. (3) The Company has granted to the Underwriters a 30-day option to purchase up to 150,000 additional shares of Common Stock on the same terms and conditions as set forth above solely to cover over-allotments, if any. If the Underwriters exercise this option in full, the total Price to Public, Underwriting Discount and Proceeds to the Company will be $ , $ and $ , respectively. See "Underwriting." ------------------------- The shares of Common Stock are offered by the several Underwriters named herein subject to receipt and acceptance by them, and subject to their right to reject any order in whole or in part. It is expected that delivery of certificates representing such shares will be made against payment therefor at the offices of Gruntal & Co., Incorporated, 14 Wall Street, New York, New York 10005 on or about , 1997. ------------------------- GRUNTAL & CO., INCORPORATED THE DATE OF THIS PROSPECTUS IS , 1997 3 [SCHEMATIC OF WIRELESS NETWORK FROM PORTABLE TELEPHONE THROUGH BASE STATION TO PUBLICLY-SWITCHED TELEPHONE NETWORK] Illinois Superconductor Corporation's wireless telecommunications products are installed within a cellular or Personal Communications Services service provider's base station and improve the link between mobile and portable telephones and the base station. [PICTURE OF RADIO FREQUENCY FILTER UNIT] SpectrumMaster(TM) and RangeMaster(TM) filters are compact solutions to service providers' network, quality, coverage, capacity and flexibility needs. [PICTURE OF THE COMPANY'S RADIO FREQUENCY FILTER UNIT INSTALLED IN A RACK] Illinois Superconductor Corporation's radio frequency filter products are designed to be integrated into standard equipment racks within a service provider's base stations. ------------------------ SpectrumMaster(TM), RangeMaster(TM) and the Company's circle/sphere logo are trademarks of the Company. All other trade names and trademarks appearing in this Prospectus are the property of their respective holders. ------------------------ CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK INCLUDING BY ENTERING STABILIZING BIDS OR EFFECTING SYNDICATE COVERING TRANSACTIONS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP MEMBERS (IF ANY) OR THEIR RESPECTIVE AFFILIATES MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE "UNDERWRITING." 2 4 PROSPECTUS SUMMARY This Prospectus contains certain statements of a forward-looking nature relating to future events or the future financial performance of the Company. Prospective investors are cautioned that such statements are only predictions and that actual events or results may differ materially. In evaluating such statements, prospective investors should specifically consider the various factors identified in this Prospectus, including the matters set forth under the caption "Risk Factors," which could cause actual results to differ materially from those indicated in such forward-looking statements. The following summary is qualified in its entirety by the more detailed information and financial statements and notes thereto appearing elsewhere in this Prospectus or incorporated by reference herein. Unless otherwise indicated, the information in this Prospectus assumes no exercise of the Underwriters' over-allotment option. THE COMPANY Illinois Superconductor Corporation (the "Company") develops, manufactures and markets high performance products for wireless telecommunications markets based on its proprietary high temperature superconductor ("HTS") materials, radio frequency ("RF") filter design and cryogenic technologies. 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. The wireless telecommunications industry has experienced significant growth in recent years, which has led to increased competition among service providers, rapid growth in base station installations and significant increases in RF interference. By reducing the effects of this interference, the Company's RF filter products enable cellular and Personal Communications Services ("PCS") service providers to improve the quality and increase the coverage, capacity and flexibility of their networks in an economical manner. The Company's RF filter products, which are based on superconductor technology, offer the following performance benefits: - call quality is improved and the frequency of blocked or dropped calls is reduced because adjacent band interference from competing wireless service providers and other radio services is reduced; - coverage gaps between base stations are reduced because the radio range of these base stations is extended, thereby minimizing the number of base stations required in a wireless network; - network call carrying capacity is increased because channels which were previously unusable due to adjacent band interference now become available; and - flexibility in the location of base stations is improved because wireless service providers can locate base stations in areas where RF interference or other restrictions currently inhibit operations. The Company currently offers two product lines to address the needs of cellular and PCS service providers. The SpectrumMaster(TM) 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(TM) product line combines the interference rejection advantages of a SpectrumMaster(TM) filter with a cryogenically-cooled low-noise amplifier. RangeMaster(TM) is designed to serve the range extension needs of rural, suburban or small city cellular and PCS operators. In addition, the Company is developing other products based on its core technologies, including adapting current products to meet the specific needs of international wireless markets and developing RF transmitter products. The Company has completed 14 field trials with several major cellular service providers. As a result of these field trials and other marketing initiatives, the Company has received orders from certain of these service providers for commercial units. In the third quarter of 1996, the Company began shipping its first RF filter products to the cellular market, which were installed and accepted into customers' commercially operational base stations. In addition, the Company has received orders for its products from certain other customers who have not participated in field trials. 3 5 According to the Cellular Telecommunications Industry Association ("CTIA"), there are in excess of 30,000 cellular base stations in the U.S., and the Company believes that there are currently in excess of 60,000 cellular base stations worldwide. Furthermore, industry sources estimate that there were approximately 6,000 PCS base stations in service at the end of 1996 and forecast that over 100,000 PCS base stations will be built in the U.S. over the next four years. The Company's objective is to be the global leader in supplying high performance RF filter products to these growing markets. Key elements of the Company's strategy include: (i) offering the highest performance filter systems in the industry; (ii) pursuing cellular and PCS markets; (iii) focusing on key service provider relationships; (iv) developing original equipment manufacturer ("OEM") customer relationships; (v) developing manufacturing expertise and capacity; and (vi) building on its technology leadership position. The Company believes it is strongly positioned to execute its strategy and capitalize on the growth in the wireless telecommunications industry. The Company was founded in 1989 by ARCH Development Corporation ("ARCH"), an affiliate of the University of Chicago, to commercialize superconductor technologies initially developed by Argonne National Laboratory ("Argonne"). 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. THE OFFERING Common Stock to be offered........................ 1,000,000 shares Common Stock to be outstanding after the Offering........................................ 6,023,352 shares(1) Use of proceeds................................... For product development, expansion of sales and marketing efforts, working capital, acquisition of manufacturing equipment and general corporate purposes. See "Use of Proceeds." Nasdaq National Market symbol..................... ISCO
- ------------------------- (1) Excludes as of February 28, 1997 (i) 670,225 shares of Common Stock issuable upon the exercise of outstanding warrants, (ii) 796,258 shares of Common Stock issuable upon the exercise of previously granted options and (iii) 289,532 shares of Common Stock reserved for future issuance under the Company's Amended and Restated 1993 Stock Option Plan (the "1993 Stock Option Plan"). See "Description of Capital Stock" and Notes 6 and 7 of Notes to Financial Statements. 4 6 SUMMARY FINANCIAL INFORMATION
YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------- 1992 1993 1994 1995 1996 ---- ---- ---- ---- ---- STATEMENT OF OPERATIONS DATA: Revenues............................... $ 202,348 $ 251,977 $ 208,168 $ 27,830 $ 209,822 Costs and expenses: Cost of government contract revenue............................ 149,303 234,191 194,098 19,286 49,534 Research and development............. 230,895 608,373 1,962,678 4,554,946 6,422,921 Selling and marketing................ 87,943 48,587 454,968 469,600 1,834,640 General and administrative........... 718,789 1,102,576 2,199,597 2,763,615 3,290,810 --------- ----------- ----------- ----------- ------------ (984,582) (1,741,750) (4,603,173) (7,779,617) (11,388,083) Other income (expense): Investment income.................... 15,586 102,260 496,392 487,543 503,911 Interest expense..................... (25,182) (10,136) (8,582) (39,600) (29,602) --------- ----------- ----------- ----------- ------------ (9,596) 92,124 487,810 447,943 474,309 --------- ----------- ----------- ----------- ------------ Net loss............................... $(994,178) $(1,649,626) $(4,115,363) $(7,331,674) $(10,913,774) ========= =========== =========== =========== ============ Net loss per common share(1)........... $(1.15) $(2.01) $(2.41) Weighted average number of common shares outstanding(1)................ 3,578,485 3,641,196 4,536,034
DECEMBER 31, 1996 ----------------------------- ACTUAL AS ADJUSTED(2) ------ -------------- BALANCE SHEET DATA: Cash and cash equivalents................................... $ 5,188,047 $20,115,547 Working capital............................................. 5,207,923 20,135,423 Total assets................................................ 13,388,496 28,315,996 Long-term debt, less current portion........................ 91,618 91,618 Stockholders' equity........................................ 11,520,128 26,447,628
- ------------------------- (1) Excludes as of December 31, 1996 (i) 670,225 shares of Common Stock issuable upon the exercise of outstanding warrants, (ii) 796,258 shares of Common Stock issuable upon the exercise of previously granted options and (iii) 289,532 shares of Common Stock reserved for future issuance under the 1993 Stock Option Plan. See "Description of Capital Stock" and Notes 6 and 7 of Notes to Financial Statements. (2) As adjusted to give effect to the sale of the 1,000,000 shares of Common Stock offered hereby at an assumed public offering price of $16.50 per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by the Company. 5 7 RISK FACTORS Because the Company wants to provide investors with more meaningful and useful information, this Prospectus contains, and incorporates by reference, certain forward-looking statements (as such term is defined in the rules promulgated pursuant to the Securities Act of 1933, as amended (the "Securities Act")) that reflect the Company's current expectations regarding the future results of operations and performance and achievements of the Company. Such forward-looking statements are subject to the safe harbor created by 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 "anticipate," "believe," "estimate," "expect" 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 assumptions, including the factors set forth in the following Risk Factors, which could cause the Company's future results, performance or achievements to differ materially from those expressed in, or implied by, any of these statements. 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 Prospectus or to reflect the occurrence of unanticipated events. In addition to the other information in this Prospectus, prospective investors should carefully consider the following Risk Factors before purchasing any of the shares of Common Stock offered hereby. UNCERTAIN MARKET ACCEPTANCE OF SUPERCONDUCTING TELECOMMUNICATIONS PRODUCTS The Company's RF filter products have not been sold in significant quantities and there is no assurance that a substantial market will develop for the Company's products. The Company's customers require demanding specifications for performance and reliability. There can be no assurance that the Company's RF filter products will continue to pass product performance and reliability tests established by cellular and PCS service providers. There can also be no assurance that the Company's products will operate reliably on a long-term basis, that the Company will be able to manufacture adequate quantities of any products it develops at commercially acceptable costs or on a timely basis or that any of the Company's current or future products will achieve market acceptance. 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 to date has been engaged principally in research and development ("R&D"), product testing, manufacturing and marketing activities. Most of the Company's revenues to date have been derived from R&D contracts. The Company has not yet begun to generate significant revenues from the sale of its RF filter products and only recently recognized any revenues from the sale of such 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 development. The Company has incurred substantial net losses in each year since its inception and expects to continue to incur operating losses through at least early 1998 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 significant quantities of its RF filter products, there can be no assurance that the Company will ever achieve a profitable level of operations or, if profitability is achieved, that it can be sustained. 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 has produced limited quantities of products for its first orders and for use in development and customer field trial programs, production of large quantities 6 8 at competitive costs presents a number of technological and engineering challenges for the Company, and there can be no assurance that the Company will be able 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 substantial quantities of the Company's products. No assurance can be given that the Company will be able to make the transition to full commercial production successfully. In addition, 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's marketing and sales experience to date is very limited. 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. There can be no assurance that the Company will be able to establish adequate sales and distribution capabilities, that it will be able to enter into marketing agreements or relationships with third parties on financially acceptable terms or that any third parties with whom it enters into such arrangements will be successful in marketing the Company's products. 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 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, such as "smart" antennas, may also provide protection from RF interference and offer enhanced range to cellular and PCS service providers and may therefore compete with the Company's products. There can be no assurance that high performance RF filters will become a preferred technology to address these needs of cellular and PCS service providers. Failure of the Company's products to improve performance sufficiently or to do so at an acceptable price or to achieve commercial acceptance or otherwise compete with conventional 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 the field. In order to compete successfully, the Company must develop and maintain technologically advanced products, 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. There can be no assurance that the Company will be able to achieve these objectives. Failure to do so would have a material adverse effect on the Company's business, operating results and financial condition. 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 performance in the next several 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. 7 9 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. There can be no assurance that the Company's development efforts will not be rendered obsolete by the adoption of alternative solutions to current wireless operator problems or by technological advances made by others, or that other materials or processes, including other superconducting materials or fabrication processes, will not 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, there can be no assurance that the Company will not 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 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 available other alternatives to cellular or PCS service, thereby creating additional sources of competition. There can be no assurance that competition to cellular or PCS technologies will not 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 OEMs. 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 failure to attract new customers would have a material adverse effect on the Company's business, operating results and financial condition. 8 10 LENGTHY SALES CYCLES 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. Prior to selling its products to these customers, the Company must generally undergo lengthy approval and purchase processes. Technical and business evaluation can take up to a year or more for products based on new technologies such as HTS. Accordingly, the Company is continually submitting its current products as well as new products to its customers for approval. 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. There can be no assurance that the Company will obtain the necessary approvals or that ensuing sales of such products will occur. There can also be no assurance that the length of its customers' approval process or delays will not 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 and cryogenic refrigerators, are purchased from a single source or are only currently available from a limited number of sources. The Company's reliance on these sole or 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 not be able 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 sole or 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. Business disruption, production shortfalls or financial difficulties of a sole or limited source supplier could materially and adversely affect 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. FUTURE CAPITAL NEEDS To date, the Company has financed its operations primarily through public and private equity financings that have raised approximately $39 million, net of related expenses. Although the Company believes that its current funds, together with the net proceeds from the Offering, are sufficient to finance the Company's operations as planned for at least the next 12 months, the Company may require funds to finance its product development, manufacturing and marketing activities thereafter. There can be no assurance that such funds will be available, or available on terms satisfactory to the Company. If additional funds are raised by issuing equity securities, further dilution to existing or future stockholders is likely to result. If adequate funds are not available on acceptable terms when needed, or if the Offering is not completed, the Company may be required to delay, scale-back or eliminate the manufacturing, marketing or sales of one or more of its products or research and development programs, or 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. 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 transaction have been made at this time, and there can be no assurance that any such discussions will result in any such transaction being concluded. 9 11 INTELLECTUAL PROPERTY AND PATENTS 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 March 19, 1997, the Company has been issued six U.S. patents, purchased two U.S. patents from another company and has filed and is actively pursuing applications for 23 other U.S. patents, and is the exclusive or non-exclusive licensee of 11 patents and patent applications held by others. 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. No assurance can be given that the patent applications filed by the Company or by the Company's licensors will result in issued patents or that the scope and breadth of any claims allowed in any patents issued to the Company or its licensors will exclude competitors or provide competitive advantages to the Company. In addition, there can be no assurance that any patents issued to the Company or its licensors will be held valid if subsequently challenged or that others will not claim rights in the patents and other proprietary technologies owned or licensed by the Company or that others have not developed or will not 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 and 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. There can be no assurance that the Company will be able to obtain licenses to such technologies or that, if obtainable, such licenses would be available on terms acceptable to the Company or that the Company could successfully design around these third-party patents. 10 12 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. 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 Corporation ("IBM"), Lucent Technologies, Inc. ("Lucent"), formerly a subsidiary of AT&T, 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 will be 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 and therefore exportation of such RF filters to certain countries may be restricted or subject to export licenses. 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, there can be no assurance that the operations, business or assets of the Company will not 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. 11 13 DEPENDENCE ON KEY PERSONNEL The Company's success will depend in large part upon its ability to attract and retain highly qualified management, 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. VOLATILITY OF COMMON STOCK PRICE The market price of the Company's Common Stock, like that of many other high-technology companies, has fluctuated significantly and is likely to continue to fluctuate in the future. Announcements by the Company or others regarding the receipt of customer orders, timing of product shipments, 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. 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 Mount Prospect, Illinois. Any material disruption in the Company's operations, whether due to fire, natural disaster, power loss or otherwise, could have a material adverse effect on the Company's business, operating results and financial condition. SUBSTANTIAL NUMBER OF SHARES ELIGIBLE FOR FUTURE SALE The sale of a substantial number of shares of Common Stock by the Company or any of its significant stockholders, or the perception that such sales could occur, could adversely affect the prevailing market price of the Common Stock. The Company is unable to make any prediction as to the effect, if any, that future sales of Common Stock or the availability of Common Stock for sale may have on the market price of the Common Stock prevailing from time to time. 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. Upon completion of the Offering, the Company will have 6,023,352 shares of Common Stock outstanding, assuming no exercise of options or warrants after February 28, 1997. An aggregate of 5,954,379 of these shares of Common Stock, including the 1,000,000 shares of Common Stock offered hereby, will be either (i) freely tradable without restriction or further registration under the Securities Act, unless purchased by "affiliates" of the Company as that term is defined in Rule 144 of the Securities Act, which shares will be subject to the resale limitations of Rule 144, or (ii) eligible for resale in the public market without restriction, pursuant to a currently effective registration statement. In addition, 670,225 shares underlying currently exercisable warrants will also be eligible for resale in the public market upon exercise of the warrants, pursuant to such registration statement. The remaining 68,973 shares outstanding upon completion of the Offering will be "restricted securities" as that term is defined under Rule 144 (the "Restricted Shares"). Certain of the outstanding shares of Common Stock are, and for a period of 90 days following the Offering will be, subject to restrictions on transfer or sale. As of February 28, 1997, the Company had outstanding warrants to purchase 670,225 shares of Common Stock at a weighted average exercise price of $8.17 per share and options to purchase 796,258 shares of Common Stock at a weighted average exercise price of $13.40 per share (590,700 of which have not yet vested) issued to employees, directors and consultants pursuant to the 1993 Stock Option Plan and individual agreements with management and directors of the Company. The Company has previously filed a registration statement under the Securities Act covering shares of Common Stock underlying the options. As a result, shares of Common Stock underlying these options, other than shares held by affiliates, are immediately eligible for resale in the public market without restriction, subject to certain vesting provisions and the terms of lock-up agreements, if applicable. 12 14 The Company may issue additional capital stock, warrants and/or other securities to raise capital in the future. In order to attract and retain key personnel, the Company may also issue additional securities, including stock options, in connection with its employee benefit plans. During the terms of such options and warrants, the holders thereof are given the opportunity to benefit from a rise in the market price of the Common Stock. The exercise of such options and warrants, as well as the sale by the Company of additional securities and/or rights to purchase such securities, may have an adverse or dilutive effect on the market value of the Common Stock, including the shares of Common Stock being offered hereby. Also, the existence of such options and warrants may adversely affect the terms on which the Company can obtain additional equity financing. 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. 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 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. In addition, the Company's Certificate of Incorporation and Bylaws contain provisions that include (i) a requirement that stockholder action may be taken only at stockholder meetings; (ii) the authority of the Board of Directors to issue series of 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 (iv) the classification of the Board of Directors into three classes, each serving for staggered three year terms. 13 15 USE OF PROCEEDS The net proceeds to the Company from the sale of the 1,000,000 shares of Common Stock offered by the Company hereby are estimated to be approximately $14,927,500 ($17,241,625 if the Underwriters' over-allotment option is exercised in full), based on an assumed public offering price of $16.50 per share and after deducting estimated underwriting discounts and commissions and offering expenses payable by the Company. The Company intends to use the net proceeds primarily for funding of its product development programs, expansion of its sales and marketing efforts, working capital, capital expenditures, acquisition of manufacturing equipment and other general corporate purposes. The Company has not identified precisely the amounts it plans to spend for each purpose. The amounts actually expended for each purpose will vary significantly depending upon numerous factors, including the progress of the Company's product development and testing programs, and timing and extent of commercial orders for and shipments of the Company's products, and the status of competitive products. In addition, a portion of the net proceeds may be used to finance strategic acquisitions or corporate alliances. The Company considers such acquisitions on an ongoing basis, but has no current commitments for any acquisitions which would have a material impact on the Company's results of operations or financial condition. Pending such uses, the Company will invest the net proceeds in investment grade short or medium term interest bearing instruments. PRICE RANGE OF COMMON STOCK The Common Stock is traded on the Nasdaq National Market under the symbol "ISCO." The following table sets forth, for the periods indicated, the high and low sale prices for the Common Stock on the Nasdaq National Market.
HIGH LOW ---- --- 1995: First Quarter............................................. $ 8.50 $ 6.00 Second Quarter............................................ 11.50 7.00 Third Quarter............................................. 11.75 7.50 Fourth Quarter............................................ 21.25 10.00 1996: First Quarter............................................. $34.00 $15.50 Second Quarter............................................ 27.25 19.75 Third Quarter............................................. 27.25 15.75 Fourth Quarter............................................ 22.25 14.75 1997: First Quarter (through March 20, 1997).................... $19.25 $15.38
On March 20, 1997, the last reported sale price of the Common Stock on the Nasdaq National Market was $16.50, and the Common Stock was held by 220 holders of record. DIVIDEND POLICY The Company has never declared or paid any cash dividends on its Common Stock and does not anticipate paying cash dividends on its Common Stock in the foreseeable future, but intends instead to retain future earnings for reinvestment in its business. Any future determination to pay cash dividends will be at the discretion of the Board of Directors and will be dependent upon the Company's financial condition, results of operations, capital requirements and such other factors as the Board of Directors deems relevant. 14 16 CAPITALIZATION The following table sets forth, at December 31, 1996, the capitalization of the Company and the capitalization as adjusted to give effect to the issuance and sale by the Company of 1,000,000 shares of Common Stock offered hereby (at an assumed public offering price of $16.50 per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by the Company). This table should be read in conjunction with the Financial Statements of the Company and the Notes thereto included elsewhere in this Prospectus.
DECEMBER 31, 1996 ---------------------------- ACTUAL AS ADJUSTED ------ ----------- Long term debt, less current portion........................ $ 91,618 $ 91,618 Stockholders' equity: Preferred Stock, $.001 par value, 100,000 shares authorized, no shares issued or outstanding, actual; and no shares issued and outstanding, as adjusted...... -- -- Common Stock, $.001 par value, 15,000,000 shares authorized, 5,023,352 shares issued and outstanding, actual; and 6,023,352 shares issued and outstanding, as adjusted(1)............................................ 5,023 6,023 Additional paid-in capital................................ 39,019,421 53,945,921 Notes receivable from stockholders(2)..................... (1,142,754) (1,142,754) Deficit accumulated during the development stage.......... (26,361,562) (26,361,562) ------------ ------------ Total stockholders' equity............................. $ 11,520,128 $ 26,447,628 ------------ ------------ Total capitalization................................. $ 11,611,746 $ 26,539,246 ============ ============
- ------------------------- (1) Excludes as of December 31, 1996 (i) 670,225 shares of Common Stock issuable upon the exercise of outstanding warrants at a weighted average exercise price of $8.17 per share, (ii) 796,258 shares of Common Stock issuable upon the exercise of previously granted stock options at a weighted average exercise price of $13.40 per share, and (iii) 289,532 shares of Common Stock reserved for future issuance under the 1993 Stock Option Plan. See "Description of Capital Stock" and Notes 6 and 7 of Notes to Financial Statements. (2) As of March 20, 1997, the aggregate outstanding principal amount of these notes was $716,319. 15 17 SELECTED FINANCIAL DATA The following table sets forth selected financial data of the Company. The statement of operations data for each of the years ended December 31, 1994, 1995 and 1996, and the balance sheet data at December 31, 1995 and 1996, are derived from the Company's Financial Statements included elsewhere in this Prospectus which have been audited by Ernst & Young LLP, independent auditors. The statement of operations data for the years ended December 31, 1992 and 1993 and the balance sheet data at December 31, 1992, 1993 and 1994 are derived from the Company's financial statements not included herein. The data should be read in conjunction with the Financial Statements, related notes, and "Management's Discussion and Analysis of the Financial Condition and Results of Operations" included elsewhere in this Prospectus.
YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------- 1992 1993 1994 1995 1996 ---- ---- ---- ---- ---- STATEMENT OF OPERATIONS DATA: Revenues....................... $ 202,348 $ 251,977 $ 208,168 $ 27,830 $ 209,822 Costs and expenses: Cost of government contract revenue................... 149,303 234,191 194,098 19,286 49,534 Research and development..... 230,895 608,373 1,962,678 4,554,946 6,422,921 Selling and marketing........ 87,943 48,587 454,968 469,600 1,834,640 General and administrative... 718,789 1,102,576 2,199,597 2,763,615 3,290,810 --------- ----------- ----------- ----------- ------------ (984,582) (1,741,750) (4,603,173) (7,779,617) (11,388,083) Other income (expense): Investment income............ 15,586 102,260 496,392 487,543 503,911 Interest expense............. (25,182) (10,136) (8,582) (39,600) (29,602) --------- ----------- ----------- ----------- ------------ (9,596) 92,124 487,810 447,943 474,309 --------- ----------- ----------- ----------- ------------ Net loss....................... $(994,178) $(1,649,626) $(4,115,363) $(7,331,674) $(10,913,774) ========= =========== =========== =========== ============ Net loss per common share(1)... $(1.15) $(2.01) $(2.41) Weighted average number of common shares outstanding(1)............... 3,578,485 3,641,196 4,536,034 DECEMBER 31, ---------------------------------------------------------------------- 1992 1993 1994 1995 1996 --------- ----------- ----------- ----------- ------------ BALANCE SHEET DATA: Cash and cash equivalents...... $ 705,943 $16,739,861 $ 90,362 $ 953,093 $ 5,188,047 Working capital................ 687,484 16,597,042 9,806,670 5,458,474 5,207,923 Total assets................... 996,909 17,632,020 14,732,501 11,105,766 13,388,496 Long-term debt/capital lease obligations, less current portion...................... 40,101 47,971 8,355 509,079 91,618 Stockholders' equity........... 875,817 16,843,855 12,821,746 9,185,379 11,520,128
- ------------------------- (1) Excludes as of December 31, 1996 (i) 670,225 shares of Common Stock issuable upon the exercise of outstanding warrants, (ii) 796,258 shares of Common Stock issuable upon the exercise of previously granted options and (iii) 289,532 shares of Common Stock reserved for future issuance under the 1993 Stock Option Plan. See "Description of Capital Stock" and Notes 6 and 7 of Notes to Financial Statements. 16 18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The discussion below contains certain forward-looking statements that are based on the beliefs of the Company's management, as well as assumptions made by, and information currently available to, the Company's management. The Company's future results, performance or achievements could differ materially from those expressed in, or implied by, any such forward-looking statements. See "Risk Factors" for a discussion of factors that could cause or contribute to such material differences. The following presentation of management's discussion and analysis of the Company's financial condition and results of operations should be read in conjunction with the Company's Financial Statements and notes thereto and other financial information included herein. The Company was founded in 1989 by ARCH, an affiliate of The University of Chicago, to commercialize superconducting technologies developed initially at Argonne. Since its inception, the Company has been in the development stage, primarily engaging in research and product development activities, both internally funded and under government-funded contracts and cooperative agreements, recruiting technical and administrative personnel, and raising capital. Throughout its development stage, the Company's primary focus has been to use its proprietary HTS materials technologies to develop RF filter products designed to enhance the quality, coverage, capacity and flexibility of cellular and PCS wireless telecommunications services. To date, the Company has received a majority of its revenue from government research contracts. While these contracts have historically provided the Company's primary source of revenue, the Company believes that they will not be a significant source of revenue in the future. The Company has incurred cumulative losses of $26,361,562 from inception to December 31, 1996. During the second half of 1996, the Company made the first commercial sales of its RF filter products. The Company has received additional orders for its products which are scheduled for delivery during the first and second quarters of 1997. Product revenues have been derived from sales of the Company's RF filter products and to a lesser extent other development stage products. The Company expects sales of its RF filter products to increase. RESULTS OF OPERATIONS Years Ended December 31, 1996 and 1995 The Company's revenues increased in 1996 to $209,822 from $27,830 in 1995, primarily as a result of sales of the Company's RF filter products. A government research and development contract begun during the fourth quarter of 1995 generated $53,122 in revenues in 1996. 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 significant amount of its commercial products. Cost of government contract revenue was $49,534 in 1996, as compared to $19,286 for 1995. Cost of government contract revenue consists primarily of research and development expenses associated with government contracts, including engineering personnel, engineering materials and other overhead costs. The increase of these costs resulted from increased activity under government contracts. Costs associated with development stage product sales are reflected as research and development expenses. The Company's internally funded research and development expenses for 1996 were $6,422,921 compared to $4,554,946 for 1995. The Company incurred increased expenditures to expand its RF filter product lines, develop and implement its manufacturing processes and also to conduct advanced research and development activities. These expenditures consisted primarily of personnel costs, materials and supplies expenses and costs associated with the Company's product sales. Under the terms of a government contract entered into in March 1993 and amended in March 1994 and March 1995, the U.S. Government agreed to share costs of certain of the Company's research and development efforts. This contract was completed in March 1996. Funding of $200,445 for 1996 has been offset against the related research and development costs, as compared to $649,660 for 1995. The Company anticipates it will maintain a similar level of research and development expenses during 1997 to expand its existing product lines. 17 19 Selling and marketing expenses for 1996 were $1,834,640, as compared to $469,600 for 1995. This increase was attributable to the addition of sales, marketing and field service personnel, increases in expenditures to conduct customer field trials and expansion of product marketing and advertising efforts. General and administrative expenses for 1996 were $3,290,810, as compared to $2,763,615 for 1995. This increase was attributable to increased administrative expense necessary to support growth in Company personnel and higher outside service provider costs. Investment income increased to $503,911 in 1996 from $487,543 in 1995. This increase was primarily due to a larger average investment portfolio during 1996, which was attributable primarily to the Company's private placement completed in February 1996. Interest expense decreased to $29,602 in 1996 from $39,600 in 1995 primarily due to a lower average debt balance outstanding in 1996 as compared to 1995. Years Ended December 31, 1995 and 1994 The Company's revenues decreased in 1995 to $27,830 from $208,168 in 1994, primarily as a result of completing several government contracts in 1994. A new government contract begun during the fourth quarter of 1995 generated $21,832 in government contract revenue, and the balance of $5,998 in revenues was the result of development stage non-RF filter product sales. Cost of government contract revenue was $19,286 in 1995, as compared to $194,098 for 1994. Cost of government contract revenue consists primarily of research and development expenses associated with government contracts, including engineering personnel, engineering materials and other overhead costs. The decrease in these costs resulted from decreased activity under government contracts. Costs associated with development stage product sales are reflected as research and development expenses. The Company's internally funded research and development expenses for 1995 were $4,554,946 compared to $1,962,678 for 1994. This increase reflects the Company's increased commitment of resources to the commercialization of its RF filter product lines. To support field tests of these products, the Company continued to expand its internal research and development activities through the hiring of additional personnel and increasing expenditures for materials and services needed to produce field test units. Under the terms of a government contract entered into in March 1993, and amended in March 1994 and March 1995, the U.S. Government agreed to share costs of certain of the Company's research and development efforts. Funding of $649,660 for 1995 has been offset against the related research and development costs, as compared to $619,028 for 1994. Selling and marketing expenses for 1995 were $469,600, as compared to $454,968 for 1994. This increase was attributable to the hiring of additional marketing and administrative personnel, and increased expenditures for product marketing and advertising efforts. General and administrative expenses for 1995 were $2,763,615, as compared to $2,199,597 for 1994. This increase was primarily attributable to increased occupancy costs as a result of the Company's move to its new facility and additional Company personnel. Investment income decreased to $487,543 in 1995 from $496,392 in 1994. This decrease was primarily due to a smaller average investment portfolio in 1995. Interest expense increased to $39,600 in 1995 from $8,582 in 1994 primarily due to a higher average debt balance outstanding in 1995 as compared to 1994. LIQUIDITY AND CAPITAL RESOURCES To date, the Company has financed its operations primarily through public and private equity financings which have raised approximately $39,000,000, net of related expenses. In February 1996, the Company completed a private placement which raised approximately $8,334,000, net of expenses. At December 31, 1996, the Company's cash, cash equivalents and investments, including certain restricted investments, was 18 20 approximately $6,038,000, reflecting a decrease of approximately $861,000, from $6,899,000 at December 31, 1995. In December 1996, the Company received an aggregate of approximately $4,400,000 from the exercise of warrants that were issued in the Company's private placement completed in November 1995, approximately $1,100,000 of which was in the form of promissory notes. Approximately $716,000 in principal amount of these promissory notes is currently outstanding and is due on April 30, 1997. The Company had provided notice of its intent to redeem the warrants in November 1996. During 1995 and 1996, the Company financed a portion of its leasehold improvements and capital equipment additions through various borrowings approximating $743,000, approximately $172,000 of which was outstanding at December 31, 1996. The remaining balance is due in monthly installments through May 1999. The Company to date has generated limited revenues from product sales. The Company invested approximately $3,000,000 during 1996 in the build-out of its manufacturing facility and other manufacturing equipment. The development and expansion of the Company's RF filter product lines will require continued commitment of substantial funds to conduct product development and field trial activities to establish commercial-scale manufacturing and to market its RF filter products. The Company currently estimates that additional investments aggregating approximately $500,000 for machinery, equipment and improvements associated with expansion of its manufacturing operations will be made over the next 12 months. 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 needed to support the Company's commercialization efforts, the magnitude of its research and product development programs, the cost of additional plant and equipment for manufacturing and the costs involved in protecting the Company's patents or other intellectual property. Without consideration of any funds under new government contracts or cooperative agreements, or from the sale of its products, the Company believes that its available cash, cash equivalents and investments, together with the net proceeds from the Offering, provide sufficient funds to meet the Company's current operating plans and debt service requirements for at least the next 12 months. If adequate funds are not available on acceptable terms when needed, or if the Offering is not completed, the Company may be required to delay, scale-back or eliminate the manufacturing, marketing or sales of one or more of its products or research and development programs. The Company will continue to evaluate its needs for capital and may pursue additional sources of capital it considers appropriate based upon Company requirements and market conditions. 19 21 BUSINESS The discussion below contains certain forward-looking statements that are based on the beliefs of the Company's management, as well as assumptions made by, and information currently available to, the Company's management. The Company's actual results, performance or achievements could differ materially from those expressed in, or implied by, any such forward-looking statements. See "Risk Factors" for a discussion of factors that could cause or contribute to such material differences. GENERAL Illinois Superconductor Corporation develops, manufactures and markets high performance products for wireless telecommunications markets based on its proprietary HTS materials, RF filter design and cryogenic technologies. Superconductor materials, when cooled below a critical temperature, are able to transmit an electrical 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. The wireless telecommunications industry has experienced significant growth in recent years, which has led to increased competition among service providers, rapid growth in base station installations and significant increases in RF interference. By reducing the effects of this interference, the Company's RF filter products enable cellular and PCS service providers to improve the quality and increase the coverage, capacity and flexibility of their networks in an economical manner. The Company's RF filter products, which are based on superconductor technology, offer the following performance benefits: - call quality is improved and the frequency of blocked or dropped calls is reduced because adjacent band interference from competing wireless service providers and other radio services is reduced; - coverage gaps between base stations are reduced because the radio range of these base stations is extended, thereby minimizing the number of base stations required in a wireless network; - network call carrying capacity is increased because channels which were previously unusable due to adjacent band interference now become available; and - flexibility in the location of base stations is improved because wireless service providers can locate base stations in areas where RF interference or other restrictions currently inhibit operations. The Company currently offers two product lines to address the needs of cellular and PCS service providers. The SpectrumMaster(TM) 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(TM) product line combines the interference rejection advantages of a SpectrumMaster(TM) filter with a cryogenically-cooled low-noise amplifier. RangeMaster(TM) is designed to serve the range extension needs of rural, suburban or small city cellular and PCS operators. In addition, the Company is developing other products based on its core technologies, including adapting current products to meet the specific needs of international wireless markets and developing RF transmitter products. The Company has completed 14 field trials with several major cellular service providers. As a result of these field trials and other marketing initiatives, the Company has received orders from certain of these service providers for commercial units. In the third quarter of 1996, the Company began shipping its first RF filter products to the cellular market, which were installed and accepted into customers' commercially operational base stations. In addition, the Company has received orders for its products from certain other customers who have not participated in field trials. INDUSTRY BACKGROUND The wireless telecommunications industry has experienced significant growth, both domestically and internationally, in recent years. This growth has been attributable primarily to the widespread availability of wireless services, continued decreases in the price of service and equipment, deregulation, introduction of new technologies and increased RF spectrum availability. This growth in the popularity of wireless services has led to significant increases in competition among service providers, numbers of base stations and RF interference. 20 22 In addition to the growth of the wireless communications market, new digital technologies are rapidly being introduced into the marketplace, including Time Division Multiple Access, Global System for Mobile Telecommunications ("GSM") and Code Division Multiple Access ("CDMA"). Although analog technology represents the most widely deployed cellular protocol, it has several limitations, including inconsistent service quality and inefficient use of the radio spectrum. Digital cellular technologies are being implemented or deployed in cellular networks to address some of the shortcomings of analog technology. Digital technologies, however, do not fully resolve these shortcomings and have their own limitations. To date, cellular telephone has been the largest segment of the wireless communications market. According to the CTIA, as of December 1996, there were over 44 million cellular subscribers in the U.S. In addition, industry publications indicate that the current worldwide market for wireless services is in excess of 100 million subscribers. According to the CTIA, there are in excess of 30,000 cellular base stations in the U.S. The Company believes that there are currently in excess of 60,000 cellular base stations worldwide and that this number is increasing rapidly as cellular service providers increase capacity to meet subscriber growth. PCS represents the most significant new wireless service currently being deployed in the U.S. PCS is based on digital technologies and is designed to provide subscribers with additional choices of carriers, improved signal quality, increased services and greater data transmission capabilities. Industry sources estimate that there were approximately 6,000 PCS base stations in service at the end of 1996 and forecast that over 100,000 PCS base stations will be built in the U.S. over the next four years. PCS services are also being implemented in other countries around the world. The Company believes that competition for subscribers will continue to intensify as the U.S. and foreign governments continue deregulating the telecommunications industry, allocating more spectrum and allowing additional service providers to enter markets with new services. Increased competition is causing service providers to differentiate themselves on the basis of quality, price and coverage. The intensity of competition is evidenced by an ongoing movement of customers among carriers. This customer movement can reduce service providers' revenues while increasing their marketing costs. The rapid growth and increased competition experienced by the wireless telecommunications industry have increased the difficulty of providing quality wireless services. Wireless service providers face the challenge of providing quality services in this environment which is increasingly characterized by RF interference and congestion. In addition, the rapid rate of growth and community concerns have affected where service providers locate their base stations. Base stations provide the link between a wireless user and the telecommunications network and are being positioned closer together, often in the same location, which results in RF interference problems. There has also been an increase in the use of portable handheld phones which transmit weaker signals than mobile, or car-mounted, phones and therefore base stations do not receive their signals as well as those from mobile 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. Furthermore, in order to compete with these already broadly deployed cellular networks, PCS service providers need to deploy coverage quickly and with the lowest possible capital investment. The Company believes the resulting demands on system performance will lead service providers to invest in new infrastructure technologies, such as high performance RF filters, to address their growth and quality needs. RF filters are used in wireless networks to process radio signals received from a base station's antenna and provide as "clean" and strong a signal as possible to the other radio equipment in the wireless base station system. Conventional filters suffer substantial performance limitations due to electrical signal losses experienced by the types of materials used. Wireless service providers therefore have a need for RF filtering with much higher performance characteristics than are currently available using conventional technology. The Company believes that the changing market conditions, the drive to implement new technologies and the technical issues faced by wireless service providers create significant opportunities for new equipment suppliers. 21 23 THE COMPANY'S SOLUTION The Company's products are designed to address the high performance RF filter needs of domestic and international commercial wireless systems by providing the following advantages: - Improved Call Quality. The Company's RF filter products improve call quality by reducing dropped and blocked calls. During field trials in urban cellular locations, the Company's RF filter products have typically demonstrated a 20 to 40% reduction in dropped calls caused by out-of-band interference and base station front-end overloading. During these field trials, the Company's RF filter products have also demonstrated a reduction in blocked calls experienced in urban cellular locations. The Company believes that its RF filter products also improve audio fidelity by reducing noise and interference. - Increased Base Station Range. The Company's RF filter products extend the uplink range (the distance from which a base station can receive a signal from a portable unit) of cellular and PCS base stations. The Company believes that cellular service providers will be able to use its filters to fill coverage gaps without having to install additional base stations. The Company also believes that PCS service providers can lower capital costs by reducing the number of base stations required to build out new wireless networks. - Greater Network Capacity and Utilization. The Company's RF filter products increase the capacity and utilization of a wireless base station. In some cases, capacity increases because channels which were previously unusable due to interference are recovered. In other cases, system utilization increases result from reductions in the number of blocked and dropped calls and increases in the ability of the system to permit weak signals to be processed with acceptable call quality. - Improved Flexibility of Base Station Location. The Company's RF filter products allow wireless service providers to locate base stations in areas where RF interference or other restrictions currently inhibit operations. For example, the Company's RF filter products enable base stations to be located in close proximity to a number of other RF signal transmitters. Because of the performance characteristics of the Company's RF filter products, base stations can also be located in less than optimal sites due to zoning or other governmental restrictions. 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 Filter Systems in the Industry. The Company's proprietary HTS thick-film technology permits the Company to build filters with an extremely high level of adjacent band interference rejection coupled with a very low level of desired signal loss. The Company believes that product performance leadership is key to solving the broadest range of wireless service provider needs. - Pursuing Cellular and PCS Markets. Among the broad range of wireless telecommunications services, the Company believes that the most important markets for its products are cellular and PCS. The Company is developing relationships with several major cellular operators through its marketing efforts, completion of field trials and sales for retrofit applications. The Company has also begun testing its products for the PCS market. - Focusing on Key Service Provider Relationships. The Company currently markets its high performance RF filter products primarily to large domestic and international wireless service providers which deploy these systems in their networks. The Company targets existing cellular service providers for retrofit applications and new PCS wireless service providers for build out applications. For retrofit customers, the Company's strategy is to conduct field trials with service providers to confirm the benefits of its products, gain service provider acceptance, and then expand its sales effort to the service providers' regional operators. The Company works closely with these key customers to shorten the sales cycle. The Company also works closely with major PCS service providers to minimize infrastructure costs during build out. 22 24 - Developing OEM Customer Relationships. Wireless service providers typically engage an OEM infrastructure equipment provider to install new base stations. The Company is developing relationships with several major wireless infrastructure OEMs to integrate the Company's RF filter products into their product offerings and ensure that wireless service providers can install the Company's products in their new base stations. - Developing Manufacturing Expertise and Capacity. The Company has developed a scaleable product manufacturing process based on its thick-film HTS technology. Although the Company purchases certain components which are built to its detailed specifications, it retains control of the highest value-added portions of its manufacturing process, such as producing the HTS resonator elements for its filters. The Company believes that it has built, equipped and staffed a manufacturing facility which has sufficient capacity to satisfy near term market demand for its products. - Building on Its Technology Leadership Position. To date, the Company has devoted significant R&D resources to establish itself as a leading provider of superconductor-based products for the wireless telecommunications industry. The Company plans to build upon its strong technological foundation to capture an increasing share of the wireless equipment market. PRODUCTS The Company currently offers two product lines to address the multiple needs of cellular and PCS service providers. The SpectrumMaster(TM) 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(TM) product line combines the interference rejection advantages of a SpectrumMaster(TM) filter with a cryogenically-cooled low-noise amplifier. RangeMaster(TM) is designed to serve the range extension needs of rural, suburban or small city cellular and PCS operators. All of the Company's products are designed to be smoothly integrated into a service provider's base station equipment. Service requirements for its SpectrumMaster(TM) and RangeMaster(TM) products are minimal and can be performed by either a wireless service provider or the Company's personnel. The Company's products are currently being sold to U.S. cellular service providers, have been tested with a PCS service provider and are being adapted and marketed to international cellular and PCS service providers. See "Risk Factors -- Uncertain Market Acceptance of Superconducting Telecommunications Products." SpectrumMaster(TM). The Company currently markets three models of its SpectrumMaster(TM) filter for the cellular market. These products address the interference rejection needs of wireless service providers with U.S. A or B frequency band allocations and meet all analog and digital protocol specifications in the U.S. The Company shipped the first of these products in the third quarter of 1996. The Company has developed its first filter products specifically targeted to satisfy the needs of PCS service providers to increase call quality by reducing the RF signal noise in PCS systems due to interference and radio system noise. These products are intended to address the high performance filter needs of service providers with PCS frequency band allocations and will be compatible with all PCS digital protocol specifications in the U.S. RangeMaster(TM). The Company currently markets two models of its RangeMaster(TM) receiver front end for the cellular market. These products address the range extension needs of cellular service providers with U.S. A or B frequency band allocations and meet all analog and digital protocol specifications in the U.S. The RangeMaster(TM) products permit operators to fill coverage gaps in their networks caused by insufficient RF uplink range without adding new base stations. The first field trials using these products have been completed, and the Company received its first orders for these products in the first quarter of 1997. The Company also offers RangeMaster(TM) products specifically designed to enable PCS service providers to minimize their infrastructure costs and deployment times by lowering the number of base stations needed to provide continuous wireless coverage over a given area. These products address the need for greater base station range of service providers with PCS frequency band allocations and are compatible with all PCS digital protocol specifications in the U.S. The Company completed prototype testing of its RangeMaster(TM) receiver 23 25 front end products with a PCS service provider and expects to begin operational field trials during the second quarter of 1997. International Cellular Products Offerings. The Company is adapting its SpectrumMaster(TM) and RangeMaster(TM) products for international cellular markets to address their specific interference rejection and range extension needs. For example, along with the adaptation of its products for various Asian cellular and PCS markets, the Company is developing products for the Japanese Personal Digital Cellular market that will address its unique growing interference protection needs. In addition, the Company is developing products for European cellular and PCS markets, including GSM filters in various configurations. SUPERCONDUCTIVITY AND TECHNOLOGY Superconductor materials, when cooled below a critical temperature, are able to transmit an electrical current with either no or minimal loss of energy. Because of this extremely low energy loss, superconductors are attractive for a wide range of commercial applications. In the case of direct currents, superconductors are perfect conductors, with no energy loss at all. In the case of alternating currents, including RF currents, some slight energy losses occur due to the superconductor's interaction with changing magnetic fields. Until 1986, most known superconductors operated at temperatures very near absolute zero (0 degrees K or -459 degrees Fahrenheit). The difficulty and expense required to maintain these temperatures limited the commercial application of these low temperature superconductors. In 1986, researchers discovered a class of materials which become superconducting at temperatures greater than 77 degrees K (-320 degrees Fahrenheit). These high temperature superconductors can be cooled with economical and reliable mechanical refrigerators. The Company's products are based upon its proprietary and patented technologies, which provide several strategic advantages in the development, manufacturing and marketing of its products. The Company considers its technology strengths to include its thick-film HTS fabrication technology, its high performance RF filter design technology and its cryogenics technology. See "Risk Factors -- Rapid Technological Change; Possible Pursuit of Other Market Opportunities" and "-- Focus on Wireless Telecommunications Market; Current and Future Competitive Technologies." Thick-Film HTS Fabrication Technology. A number of HTS compounds have been discovered in the last ten years. The most significant of these compounds to the Company is YBCO. The Company focuses its product application efforts on this compound for two main reasons. First, YBCO materials are readily manufacturable using the Company's thick-film fabrication technology. Second, this material offers superior RF electrical performance at commercial wireless frequencies. The Company's exploitation of HTS materials is based on thick-film fabrication technology. The Company's technology position in thick-film HTS fabrication is based on owned and licensed patents, as well as extensive know-how and trade secrets. In addition, the Company has acquired HTS thick-film fabrication technology from other parties, primarily the University of Birmingham (UK). The Company believes that its HTS thick-film fabrication technology overcomes many of the drawbacks of using alternative HTS fabrication technologies (thin-film or bulk) to fabricate superconducting RF filters for cellular, PCS and other wireless markets. The Company's HTS thick-film fabrication process uses conventional ceramic deposition techniques. The simplicity of the HTS thick-film fabrication process and its reliance on proven industrial production techniques is expected to result in a reduction in processing and materials costs over those of thin-film and bulk HTS fabrication processes. For example, the Company has developed a patented technique to form superconducting thick-films on cost-effective substrates. The Company believes that its HTS thick-film fabrication technology presents the most feasible way to fabricate economical RF devices in the frequency range used in cellular, PCS and other wireless telecommunications systems when compared to other HTS fabrication technologies. The Company believes its HTS thick-film technology allows the design of higher performing RF filters, handles greater levels of RF power and introduces lower levels of RF distortion. The Company also believes its HTS thick-film technology permits greater flexibility in RF filter design due to the ability to economically manufacture the three-dimensional shapes required to produce very high levels of RF performance. In addition, the Company believes that RF 24 26 products produced by its HTS thick-film fabrication process cost less to manufacture. The Company's HTS thick-film process, unlike HTS thin-film processes which are based on semiconductor fabrication processes, do not require clean room facilities and require lower capital investments for a production facility. RF Filter Design Technology. The technology and tools for designing, constructing and testing conventional RF filters are well established. However, with the introduction of HTS materials, a new set of customized design tools and techniques has been developed by the Company to support filter product development. These customized design tools, which include electrical circuit design and analysis software, engineering design rules and filter assembly and testing procedures, are important competitive advantages to the Company and are protected mainly as trade secrets. They enable the rapid design and implementation of the Company's RF filter products. Cryogenics Technology. Since HTS materials have to be maintained at cryogenic temperatures (below -300 degrees Fahrenheit) in order to function, the Company must incorporate efficient and economical cryogenic technologies into its products. The cryocooling systems used in the Company's products consist of two parts: the cryostat or insulating vessel, which houses the superconducting electronic components, and the cryogenic refrigerator, which maintains the required temperatures within the cryostat package. The Company has created a substantial base of technology in the design, assembly and operation of these cryogenic systems. The Company works closely with the vendors of the refrigerator systems to design smaller, lower cost and more reliable components. In order for the Company to produce commercially successful products, it must design into its products cryogenic systems which offer long life, low maintenance, high reliability and low cost. SALES AND MARKETING To date, the Company's sales and marketing efforts have focused on major cellular service providers in retrofit applications. The Company expects to continue such efforts, as well as build on its experience to establish OEM channels and a PCS market presence. The Company currently uses a direct sales force to sell its products. The Company also makes selective use of consultants and agents to facilitate its sales efforts. See "Risk Factors -- Limited Experience in Manufacturing, Marketing and Sales," "-- Lengthy Sales Cycles" and "-- Dependence on Limited Number of Customers." Although the Company believes that with increasing market acceptance of its products it will be able to shorten the sales cycle, in general, sales of the Company's RF filter products to larger cellular service providers in retrofit applications have consisted of the following three steps: - Conduct an Operational Field Trial Program. The initial step in the Company's sales process consists of coordination with, and active involvement of, a service provider's central engineering organization and an appropriate regional service area. The process includes identifying candidate cell sites which suffer performance degradation due to high levels of RF interference and range limitation, measuring cell site performance before installation of the Company's RF filter products, installing the Company's RF filter products for a number of weeks while collecting cell site performance data, and then compiling and interpreting the data to measure the benefits provided by the Company's RF filter products. - Obtain Corporate Engineering Approval for Installation in Service Provider Sites. Upon review of the products' performance during the field trials, the wireless service provider's engineering staff provides an approval so that managers in regional service areas can purchase the Company's RF filter products for commercial deployment in their networks. - Sell Products Directly to Service Providers' Regional Service Areas. Once approval is obtained from the corporate organization, the Company sells its products directly to decision makers within a service provider's regional service area. Commercial field trials of the Company's cellular RF filter products in operational base stations began in November 1995. The Company has completed 14 trials in eight regional markets with five major cellular service providers. During field trials, the Company's RF filter products have demonstrated several benefits for 25 27 the cellular market, including reduced dropped calls, improved uplink range, improved call quality and increased capacity. Certain details of field trial experience to date are contained in the following table:
---------------------------------------------------------------------------------------------------- SERVICE PROVIDER CLASS CELL SITE ENVIRONMENT NUMBER OF TRIALS STATUS ---------------------------------------------------------------------------------------------------- SPECTRUMMASTER(TM) U.S. B-Band Cellular Urban High Interference 3 Completed U.S. A-Band Cellular Urban High Interference 2 Completed U.S. B-Band Cellular Adjacent to Airport 2 Completed U.S. A-Band Cellular Adjacent to Airport 2 Completed U.S. B-Band Cellular Antenna Farm 1 Completed ---------------------------------------------------------------------------------------------------- RANGEMASTER(TM) U.S. B-Band Cellular Rural Range Extension 1 Completed U.S. A-Band Cellular Rural Range Extension 2 Completed U.S. B-Band Cellular Suburban Range Extension 2 One Completed/ One Underway ----------------------------------------------------------------------------------------------------
Completed field trials have enabled the Company to begin shortening the sales cycle with its customers. As the Company's products have become more accepted, new customers are beginning to rely on the results of extensive testing that other service providers have conducted. Because these field trial results have demonstrated several benefits to the cellular market, some cellular service provider customers have elected not to engage in their own trials, but to purchase the units based on certain proven performance criteria. The Company has also established marketing efforts to begin qualification testing with OEM customers who serve as the major suppliers to cellular and PCS service providers. As part of its field trials with cellular service providers, the Company involves the staff of the OEM vendor that provided the cellular infrastructure system to the service provider. This allows the Company to demonstrate the benefits of its RF filter products to the OEM, to demonstrate the products' compatibility with the OEM's equipment and to cause the OEM to design the Company's products into their system product offerings. As a result, the Company's cellular products are beginning to undergo evaluation at a major OEM's test facilities. The Company began tests of its RF filter products with a PCS service provider in late 1996. The Company's marketing and sales personnel are working directly with both PCS service providers and PCS OEMs to enhance the probability of sales success in this market. The Company is undergoing technical discussions with a PCS OEM regarding integrating the Company's RF filter products into its PCS product line. MANUFACTURING 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, quality verification and shipping of the Company's products. All of these activities occur at the Company's manufacturing facility in Mount Prospect, Illinois, which began operations during the third quarter of 1996. The Company believes that manufacturing 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, except for superconducting components, for its filter products from third party suppliers. The Company believes it has access to adequate supplies of these purchased components, most of which are produced 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. See "Risk Factors -- Limited Experience in Manufacturing, Marketing and Sales" and "-- Dependence on Limited Sources of Supply." 26 28 RESEARCH AND DEVELOPMENT The Company's research and development efforts to date have been focused on developing and improving cellular and PCS RF filter products. These efforts have resulted in products with improved interference rejection, reduced desired signal loss, decreased size, lower cost and enhanced operational reliability. The Company plans to devote significant resources in the future to continue to develop and improve these products and expand its product lines. See "Risk Factors -- Rapid Technological Change; Possible Pursuit of Other Market Opportunities." The Company has evaluated and will continue to evaluate other markets for product opportunities using its HTS technology. The Company has conducted, and plans to continue, R&D into the technology for superconducting fault current limiters which would act in electrical power distribution applications much more rapidly than mechanical circuit breakers. The majority of the Company's development efforts devoted to this technology have to date been supported by R&D contracts from the U.S. Government. The Company has also entered into a cooperative development agreement with a major provider of electrical power distribution products. The goal of this program is to determine if superconducting fault current limiters have applications in commercial markets, including electrical grid protection, industrial machinery protection, and protection of electrical and electronic components such as high power radio amplifier tubes and transistors. A key component of the Company's R&D strategy is to develop relationships with domestic and international research groups to leverage its internal R&D investments. The Company believes it enjoys many benefits from these research relationships including accelerated introduction of new technologies into its product lines, early indications of new technology developments which could enhance or compete with its products, and high value improvements in its current key technologies. Another part of the Company's R&D strategy has been to contract with and receive funding under government contracts and cooperative agreements. Government programs under which the Company has received R&D funding include the Advanced Technology Program ("ATP") with the U.S. Department of Commerce and Small Business Innovation Research ("SBIR") contracts with a number of defense and non-defense government agencies. The Company has pursued, and will continue to pursue, government contract opportunities in areas which are directly applicable to its core technologies and offer attractive commercial opportunities. The Company believes that it receives benefits from these contracts through leveraging of its internal R&D investments, and also by developing longer range, more speculative technology areas. The Company's total R&D expenses during 1994, 1995 and 1996 were approximately $2,582,000, $5,205,000 and $6,623,000, respectively, with total R&D expenses from inception through December 31, 1996 of approximately $16,195,000. R&D costs reimbursed under government contracts and cooperative agreements during 1994, 1995 and 1996 were approximately $619,000, $650,000 and $200,000, respectively, and approximately $1,980,000 from inception through December 31, 1996. STRATEGIC RELATIONSHIPS In addition to its own research staff, the Company has from time to time entered into research relationships to leverage its internal resources by seeking assistance in solving specific problems and providing awareness of technical trends that influence its business. As a result, the Company has relationships with institutions which have significant superconductivity research programs. The Company's initial research relationship was with Argonne, which currently conducts one of the largest superconductivity R&D programs in the U.S. In addition to a number of formal joint R&D projects that the Company has had with Argonne in the past, it is currently engaged in a two year Collaborative Research and Development Agreement with Argonne aimed at the development of fault current limiters for utility applications. The Company has also entered into agreements with Lucent through which the Company and Lucent have jointly designed and developed technology for use in products for cellular, PCS and other wireless telecommunications applications. The development work with Lucent was funded from March 1993 through March 1996 primarily through an ATP cooperative agreement awarded to the Company by the U.S. Department of Commerce, which the Company used to offset R&D expenses. The Company's ATP 27 29 agreement with Lucent was completed in March 1996. The Company and Lucent entered into a joint development agreement to continue joint research efforts to further the development of superconducting filters for cellular and PCS communications systems using CDMA technology. The Company has also entered into a technology transfer agreement with the University of Birmingham (UK), by which the Company purchased certain intellectual property rights as well as design information relating to the production of HTS thick-films. The Company is currently funding research at the University of Birmingham's (UK) Interdisciplinary Research Centre over a four-year period and has procured additional consulting services from researchers involved in the program. The agreement covering these activities ends in December 1998 and is subject to renewal. The Company also participates in the Science and Technology Center for Superconductivity, a superconductivity R&D center which is operated by the University of Illinois under funding from the National Science Foundation, and the Company is currently funding superconductor research activities at the University of Illinois. 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 nondisclosure agreements. The Company also has obtained exclusive and non-exclusive licenses for technology developed with or by its research partners, 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. See "Risk Factors -- Intellectual Property and Patents." As of March 19, 1997, the Company has been issued six U.S. patents and has filed and is actively pursuing applications for 23 other U.S. patents, and is the licensee of 11 patents and patent applications held by others. Such patents and patent applications relate to various aspects of the Company's superconductor technology and to its current and proposed products. One of the Company's patent applications has been filed jointly with Lucent 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 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 U.S. 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 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 or is being funded in part by SBIR 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. 28 30 COMPETITION The market for wireless telecommunications products is very competitive. The Company views its competition as (i) conventional RF filter products, (ii) RF filters 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. In addition, other competitive RF filter products based on new technologies may provide competition in the future to the Company's RF filter products. In addition to competitive filter products, other companies including Hazeltine Corp., Metawave Communications Corporation, Allen Telecom Group, Inc., Repeater Technologies, Inc. and ArrayCom, Inc., among others, are developing products based on "smart" antenna, digital signal processing, microcell or repeater technologies which are also aimed at reducing interference problems or providing range extension by means other than RF filtering. The Company does not believe that these technologies pose a direct competitive threat at present, but cannot exclude them as competition to the Company's RF filter products at some point in the future. The existing market for high temperature superconductor-based products is very small and in the early stages of development. The Company believes that the market for superconducting products will become intensely competitive, especially if products with significant market potential are developed. In addition, the Company believes the superconducting products market will continue to be characterized by rapid technological change. A number of large multinational companies are engaged in R&D programs that could lead to the commercialization of superconducting products, including products for the wireless telecommunications market. These include, among others, E.I. DuPont de Nemours & Co., IBM, TRW Inc. and Westinghouse Electric Corp. in the U.S. and Fujitsu Ltd., Hitachi Ltd., NEC Corp., Siemens A.G., and Thomson S.A. in Japan and Europe. The Company also believes that a number of smaller companies are engaged in various aspects of the development and commercialization of superconducting electronics products, including products for the cellular, PCS and other wireless telecommunications markets. These include, among others, Conductus, Inc., Superconductor Technologies Inc., and Superconducting Core Technologies, Inc. The Company believes that it competes on the basis of product performance, cost, 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. See "Risk Factors -- Competition." GOVERNMENT REGULATIONS Although the Company believes that its wireless telecommunications products themselves are not licensed or governed by 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 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. See "Risk Factors -- Government Regulations." EMPLOYEES As of February 28, 1997, the Company had a total of 76 employees, 23 of whom hold advanced degrees. Of the employees, 19 are engaged in manufacturing and production, 36 are engaged in research, development 29 31 and engineering, and 21 are engaged in general management, marketing, finance and administration. The Company also employs a number of consultants and independent contractors. The Company considers its relations with its employees to be satisfactory. See "Risk Factors -- Dependence on Key Personnel." FACILITIES The Company maintains its corporate headquarters in a 35,000 square foot building located in Mount 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. See "Risk Factors -- Business Interruptions and Dependence on Single U.S. Facility." LEGAL PROCEEDINGS 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 Common Stock, plus warrants (immediately exercisable at $12.96 per share) to purchase an additional 370,370.37 shares of 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 9, 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 discovery has commenced. 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. 30 32 MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The executive officers and directors of the Company, their ages as of February 28, 1997 and their positions in the Company are as follows:
NAME AGE POSITION ---- --- -------- Ora E. Smith(1)........................... 49 President, Chief Executive Officer and Director Edward W. Laves, Ph.D..................... 49 Executive Vice President and Chief Operating Officer Stephen G. Wasko.......................... 37 Vice President, Chief Financial Officer, Treasurer and Secretary James D. Hodge, Ph.D...................... 43 Vice President and Chief Scientist Dennis M. Craig........................... 38 Vice President, Manufacturing James C. DeBelina......................... 45 Vice President, Sales and Marketing Benjamin Golant........................... 46 Vice President, Product Development James Pajcic.............................. 45 Vice President, Human Resources Steven Lazarus(1)(2)...................... 65 Chairman of the Board of Directors Leonard A. Batterson(1)(2)................ 52 Director Michael J. Friduss(3)..................... 54 Director Peter S. Fuss(3).......................... 63 Director Tom L. Powers(2).......................... 60 Director Paul G. Yovovich(1)(2).................... 43 Director
- ------------------------- (1) Member of Executive Committee (2) Member of Compensation Committee (3) Member of Audit Committee Mr. Smith has served as the President and Chief Executive Officer and a director of the Company since October 1990. From 1989 until joining the Company, Mr. Smith was the Vice President and Chief Marketing Officer of Conductus, Inc., a superconducting electronics company. From 1979 to 1989, Mr. Smith served in a number of executive positions with Rockwell International Corporation, including Corporate Director of External Technology Development. Between 1984 and 1985, Mr. Smith served as the Industrial Research Institute Fellow in The White House Science Office. Mr. Smith holds S.B. and S.M. degrees in Mechanical Engineering from the Massachusetts Institute of Technology and a J.D. degree from Harvard Law School. Dr. Laves joined the Company in December 1994 as its Executive Vice President and Chief Operating Officer. Dr. Laves is responsible for the Company's manufacturing functions, the continuing development of its high temperature superconducting products for the wireless telecommunications markets, other corporate research and development activities and the Company's marketing and sales activities. From 1985 until joining the Company, Dr. Laves was at Motorola, Inc. where he was Director of Wireless Local Loop Products. From 1991 to 1993, he served as General Manager of the Cellular Infrastructure Division of Nippon Motorola, Ltd. From 1988 to 1990, Dr. Laves managed the development and introduction to the market of Motorola, Inc.'s CoveragePLUS wide area Special Mobile Radio System (SMRS). Dr. Laves holds Ph.D. and M.B.A. degrees from the University of Chicago, and received his B.A. degree from Cornell University. Mr. Wasko joined the Company in November 1990, and has served as Vice President and Treasurer since 1992. He was elected Secretary of the Company in April 1993 and Chief Financial Officer in August 1993. Mr. Wasko is responsible for the Company's financial and administrative operations. Prior to joining the Company's management team, he was Manager of Commercial Development in the Space Station Division of McDonnell Douglas Corporation. Additionally, Mr. Wasko served as Program Manager for Technology Development on the Rockwell International Corporation National Aerospace Plane Program and managed external technology development activities for Rockwell from 1986 to 1988. Mr. Wasko holds a B.S. degree in 31 33 aerospace engineering from the University of Michigan, an M.S. in the same field from the University of Southern California and an M.B.A. degree from the Harvard Graduate School of Business Administration. Dr. Hodge joined the Company in December 1990 as its Vice President, Engineering and Chief Technical Officer. He has served as Vice President and Chief Scientist since June 1995. Dr. Hodge possesses experience in the synthesis and processing of a wide variety of ceramic materials. Additionally, he has expertise in commercial application of materials in areas such as electronics packaging, high intensity discharge lamps and certain fast-ion conductors. Dr. Hodge joined the Company after serving from 1988 to 1990 as Vice President of Engineering at CPS Superconductor Corporation, a superconducting electronics company, where he was Principal Investigator on CPS Superconductor Corporation's contract to produce high strength high temperature superconducting wire with the U.S. Government. Dr. Hodge was also a member of the technical staff at General Electric Company's Corporate Research and Development Center. He holds a B.S. degree from the University of Utah and a Ph.D. from the Massachusetts Institute of Technology, both in Materials Science. He currently holds nine patents and is the author of thirty papers in refereed journals. Mr. Craig joined the Company in December 1996 as Vice President, Manufacturing. Before joining the Company, Mr. Craig worked for eight years at Motorola, Inc., where he most recently served as manufacturing operations manager in the Component Products Group. During his career at Motorola, Inc., his responsibilities included production management, new product implementation, cost reduction and capacity analysis and planning. Prior to joining Motorola, Inc., Mr. Craig served as a manufacturing process development engineer at Northrop Corporation in its defense systems division. He received an M.B.A. degree from Lake Forest Graduate School of Management and a B.S. degree in mechanical engineering from the University of Illinois at Chicago. Mr. DeBelina joined the Company in October 1995 as Vice President, Sales and Marketing. Before joining the Company, Mr. DeBelina was North American Sales Director for DataTAC(R) network products for Motorola, Inc. From 1985 until joining the Company, Mr. DeBelina held several other sales and marketing management positions at Motorola, Inc. Previously, Mr. DeBelina served both as Product Manager and Planning Manager for FMC Corporation. He holds a B.S. degree in math and computer science from Illinois Institute of Technology and an M.B.A. degree from the Harvard Graduate School of Business Administration. Mr. Golant joined the Company in January 1996 as Vice President, Product Development. From 1989 until joining the Company, Mr. Golant was at E.F. Johnson Company where he served as Director of Engineering, Chief Engineer and Director of Product Marketing. His responsibilities included managing the development of mobile, portable and base station equipment for wireless land mobile radio systems. From 1976 to 1989, Mr. Golant was employed by Motorola, Inc.'s communications sector, leading teams to develop and commercialize a variety of radio component and system products. He received a B.S. degree in electrical engineering from Lehigh University. He holds one patent in the area of RF filter technology. Mr. Pajcic joined the Company in January 1995 as Human Resource Director. He has served as Vice President, Human Resources since January 1997. Before joining the Company, Mr. Pajcic spent 15 years at Morton International where he most recently served as Director Employment and Human Resource Development on the corporate staff. Prior to his employment with Morton International, Mr. Pajcic held Human Resource positions at General Foods Corporation and American Hospital Supply Corporation. He holds a B.S. degree in psychology from Northwestern University and a Masters Degree in Management from Northwestern University's Kellogg School of Management, with emphases in Industrial Relations, Organizational Behavior and Finance. Mr. Lazarus has served as a director of the Company since January 1992 and as Chairman of the Board since August 1993. He is a Managing General Partner of Arch Venture Fund L.P. and served previously as President and Chief Executive Officer of ARCH, an affiliate of the University of Chicago. The Company was founded by ARCH in 1989. As President of ARCH, he also served as Associate Dean of the University of Chicago's Graduate School of Business. Before joining ARCH in 1987, he was the Group Vice President of the Health Care Services Group of Baxter Travenol Laboratories, Inc., the predecessor of Baxter Healthcare Corporation. During his 13 years at Baxter, he was also Senior Vice President for Technology, with 32 34 responsibilities for manufacturing, materials management, R&D and engineering. Mr. Lazarus is a director of Amgen Corporation and Primark Corporation, both public companies. Mr. Batterson has served as a director of the Company since February 1990. He is the Chairman and Chief Executive Officer of Batterson Venture Partners, L.L.C., a venture capital management company founded in 1995. Since 1987, he has been the Managing General Partner of Batterson Johnson & Wang Venture Partners, a partnership formed with Donald Johnson and Sona Wang. The Batterson Johnson & Wang L.P. fund, a stockholder of the Company, invests in the following industries: publishing, communications, telecommunications, medical, biotechnology, materials, retailing, consumer products, manufacturing, computers and software. As Managing General Partner, Mr. Batterson manages its daily operations, investor relationships, reporting and investment strategy. Prior to co-founding Batterson Johnson & Wang Venture Partners, Mr. Batterson was director of the Venture Capital Division of the Allstate Insurance Companies. He is Chairman of the Board of LinksCorp, Inc., a golf course management company, as well as Nanophase Technologies Corporation, a material science company. Mr. Batterson holds a B.A. degree from Washington University (St. Louis), a J.D. degree from Washington University Law School and an M.B.A. degree from the Harvard Graduate School of Business Administration. Mr. Friduss has served as a director of the Company since October 1996. Mr. Friduss is president of MJ Friduss & Associates, telecommunications consultants to some of the largest carriers and suppliers in the telecommunications industry. From 1992 until 1993, Mr. Friduss served as vice president of customer service and information technology for Ameritech Corporation. From 1989 until joining Ameritech Corporation, he served as vice president of operations at Michigan Bell. In 1991, he founded the Telecommunications Industry Benchmarking Consortium, a collaboration of local, long distance and alternate access companies, whose mission is to identify and replicate the communications industry's best practices. Mr. Friduss received a B.S. degree in industrial engineering from Illinois Institute of Technology and a master's degree in management from Northwestern University. He currently serves on the Board of Trustees of Harris Associates Investment Trust (The Oakmark Funds) and is the editor of The Friduss Report, a newsletter focused on the purchasing practices of the Regional Bell Operating Companies. Mr. Fuss has served as a director of the Company since June 1995. Mr. Fuss is a management consultant, primarily for Tellabs, Inc. ("Tellabs") as a member of the International Executive Committee of Tellabs International, Inc. Prior to his retirement from Tellabs in 1993, Mr. Fuss was President of Tellabs International, Inc., which he founded in 1987 as a subsidiary. Tellabs International, Inc. is responsible for all Tellabs operations outside of North America. From 1986 to 1987, he was Senior Vice President, Technical Marketing and Business Development of Tellabs. Mr. Fuss joined Tellabs as Vice President, Engineering in 1979. From 1977 to 1979, he was Director of R&D at Teletype Corporation and from 1958 to 1977 he held engineering and management positions at AT&T Bell Laboratories. Mr. Fuss holds a B.S. degree in electrical engineering from the University of Michigan and an M.S.E.E. from New York University. He served two years as an officer in the U.S. Air Force. He holds ten patents, primarily in the area of digital signal processing. He is also a director of Clear Communications, Inc., NetEdge Systems, Inc., Process Control Technologies, Inc. and Batterson Venture Partners, LLC. Mr. Powers has served as a director of the Company since October 1996. Mr. Powers is a professor and associate director of the Advanced Manufacturing Center at New Mexico State University in Las Cruces, New Mexico, as well as a consultant to a number of companies. From 1989 to 1991, he was president of the cellular systems business unit of AT&T Network Systems Group, now known as Lucent. Under his leadership, the business unit became the market leader in wireless infrastructure equipment in the U.S., opened markets internationally and introduced the industry's first digital cellular system. In 1983, he became vice president of AT&T and Philips Telecommunications B.V., a joint venture located in the Netherlands. He joined AT&T in 1958 as a member of the technical staff of Bell Laboratories and went on to management positions in consumer products, customer switching systems engineering and network planning. Mr. Powers holds a B.S. degree in electrical engineering with high honors from the University of Arkansas and a master's degree in electrical engineering from New York University. He also is a graduate of the Wharton Advanced Marketing Program and the Stanford Executive Program. 33 35 Mr. Yovovich has served as a director of the Company since its initial public offering in October 1993. He is a private investor and corporate director. From 1993 until May 1996 he was President of Advance Ross Corporation, a public company, which through a merger in January 1996 became a wholly-owned subsidiary of CUC International, Inc., a public company. From 1982 through 1992, Mr. Yovovich held a number of executive positions at Centel Corporation, a major national telecommunications company, most recently serving as President of its Central Telephone Company subsidiary. He is also a director of U.S. Robotics Corporation, Comarco, Inc. and APAC TeleServices, Inc., each a public company. He holds B.A. and M.B.A. degrees from the University of Chicago and is a C.P.A. Mr. Yovovich has advised the Company that he will not stand for re-election when his term expires at the Company's 1997 annual meeting of stockholders. 34 36 PRINCIPAL STOCKHOLDERS The following table sets forth, as of February 28, 1997, certain information with respect to the beneficial ownership of Common Stock by (i) each person known by the Company to own beneficially more than 5% of the outstanding shares of Common Stock, (ii) each Company director, (iii) the chief executive officer and each of the four other most highly compensated (based on combined salary and bonus) executive officers of the Company whose total salary and bonus exceeded $100,000 during 1996 and (iv) all Company executive officers and directors as a group.
PERCENT OF SHARES NUMBER OF BENEFICIALLY OWNED SHARES ------------------- BENEFICIALLY PRIOR TO AFTER NAME AND ADDRESS OWNED(1) OFFERING OFFERING ---------------- ------------ -------- -------- Batterson Johnson & Wang L.P.(2)............................ 598,018 11.4% 9.6% Sheldon Drobny(3)........................................... 426,313 8.3 7.0 Aaron Fischer(4)............................................ 376,302 7.3 6.1 State of Illinois(5)........................................ 360,944 6.7 5.7 Stewart Shiman(6)........................................... 335,485 6.6 5.5 Ora E. Smith(7)............................................. 115,952 2.3 1.9 James D. Hodge, Ph.D.(8).................................... 52,249 1.0 * Stephen G. Wasko(9)......................................... 29,202 * * Edward W. Laves, Ph.D.(9)................................... 25,417 * * Paul G. Yovovich(10)........................................ 13,000 * * James C. DeBelina(11)....................................... 8,117 * * Peter S. Fuss(9)............................................ 3,333 * * Tom L. Powers............................................... 2,400 * * Leonard A. Batterson(12).................................... 2,000 * * Steven Lazarus(9)........................................... 2,000 * * Michael J. Friduss.......................................... 1,000 * * All executive officers and directors as a group (14 persons)(13).............................................. 266,477 5.1 4.3
- ------------------------- * Denotes beneficial ownership less than one percent. (1) Unless otherwise indicated below, the persons in the above table have sole voting and investment power with respect to all shares shown as beneficially owned by them. (2) Includes 221,515 shares issuable upon exercise of warrants presently exercisable. The address of the stockholder is 303 West Madison Street, Chicago, Illinois 60606. (3) Includes 84,603 shares issuable upon exercise of warrants presently exercisable. Includes 73,402 shares held by Drobny/Fischer General Partnership ("DFGP"). Mr. Drobny is a general partner of DFGP and in such capacity he shares voting and investment power with respect to shares held by DFGP and therefore may be deemed the beneficial owner of the shares of Common Stock directly held by DFGP. Includes 7,688 shares held by Paradigm Venture Investors, L.L.C. ("Paradigm"). Mr. Drobny is the managing director of Paradigm and in such capacity he shares voting and investment power with respect to shares held by Paradigm and therefore may be deemed the beneficial owner of the shares of Common Stock directly held by Paradigm. The address of the stockholder is 95 Revere Drive, Suite A, Northbrook, Illinois 60062. (4) Includes 117,149 shares issuable upon exercise of warrants presently exercisable. Includes 73,402 shares held by DFGP. Mr. Fischer is a general partner of DFGP and in such capacity he shares voting and investment power with respect to shares held by DFGP and therefore may be deemed the beneficial owner of the shares of Common Stock directly held by DFGP. Includes 7,688 shares held by Paradigm. Mr. Fischer shares voting and investment power with respect to shares held by Paradigm and therefore may be deemed the beneficial owner of the shares of Common Stock directly held by Paradigm. The address of the stockholder is 95 Revere Drive, Suite A, Northbrook, Illinois 60062. 35 37 (5) Includes 69,080 shares issuable upon exercise of warrants presently exercisable. The Company has been advised by the Illinois Department of Commerce and Community Affairs ("DCCA") that because of Illinois state law and regulations, DCCA cannot exercise its voting rights with respect to the shares of common stock it holds. As a result, pursuant to a written proxy dated June 8, 1994, DCCA has given its irrevocable proxy for all of the voting securities of the Company it now or hereafter owns to the individual who is the chief executive officer of the Company. The address of the stockholder is Illinois Department of Commerce and Community Affairs, 100 West Randolph, Chicago, Illinois 60601. (6) Includes 93,642 shares issuable upon exercise of warrants presently exercisable. Includes 7,688 shares held by Paradigm. Mr. Shiman shares voting and investment power with respect to shares held by Paradigm and therefore may be deemed the beneficial owner of the shares of Common Stock directly held by Paradigm. The address of the stockholder is 95 Revere Drive, Suite A, Northbrook, Illinois 60062. (7) Includes 46,979 shares issuable upon exercise of options exercisable currently or within 60 days of February 28, 1997. Excludes 291,864 shares held by the State of Illinois and 69,080 shares issuable upon exercise of warrants presently exercisable and held by the State of Illinois. Mr. Smith, as the chief executive officer of the Company, has an irrevocable proxy to vote these shares. Therefore, Mr. Smith may be deemed the beneficial owner of the shares of Common Stock directly owned by the State of Illinois. Mr. Smith disclaims this beneficial ownership. (8) Includes 52,224 shares issuable upon exercise of options exercisable currently or within 60 days of February 28, 1997. (9) Represents shares issuable upon exercise of options exercisable currently or within 60 days of February 28, 1997. (10) Includes 12,000 shares issuable upon exercise of options exercisable currently or within 60 days of February 28, 1997. (11) Includes 7,917 shares issuable upon exercise of options exercisable currently or within 60 days of February 28, 1997. (12) Represents shares issuable upon exercise of options exercisable currently or within 60 days of February 28, 1997. Excludes 376,503 shares held by Batterson Johnson & Wang L.P. ("BJ&W") and 221,515 shares issuable upon exercise of warrants presently exercisable and held by BJ&W. Mr. Batterson is the managing general partner of BJ&W and in such capacity he shares voting and investment power with respect to shares held by BJ&W and therefore may be deemed the beneficial owner of the shares of Common Stock directly owned by BJ&W. Mr. Batterson disclaims this beneficial ownership. (13) Includes 192,529 shares issuable upon exercise of options exercisable currently or within 60 days of February 28, 1997. 36 38 DESCRIPTION OF CAPITAL STOCK The authorized capital stock of the Company consists of 15,000,000 shares of Common Stock, $.001 par value per share, and 100,000 shares of Preferred Stock, $.001 par value per share. COMMON STOCK Of the 15,000,000 shares of Common Stock authorized, 5,023,352 shares were outstanding as of February 28, 1997, and 6,023,352 shares will be outstanding upon consummation of the Offering, assuming completion of the sale of 1,000,000 shares of Common Stock. Subject to the rights of holders of Preferred Stock, the holders of outstanding shares of Common Stock are entitled to share ratably in dividends declared out of assets legally available therefor at such time and in such amounts as the Board of Directors may from time to time lawfully determine. Each holder of Common Stock is entitled to one vote for each share held. Subject to the rights of holders of any outstanding Preferred Stock, upon liquidation, dissolution or winding up of the Company, any assets legally available for distribution to stockholders as such are to be distributed ratably among the holders of the Common Stock at that time outstanding. All shares of Common Stock currently outstanding are and all shares of Common Stock offered hereby, when duly issued and paid for will be, fully paid and nonassessable, not subject to redemption and assessment and without conversion, preemptive or other rights to subscribe for or purchase any proportionate part of any new or additional issues of any class or of securities convertible into stock of any class. Pursuant to the adoption of the Rights Plan by the Board of Directors, the holders of Common Stock, including the shares offered hereby, have certain rights to purchase Series A Junior Participating Preferred Stock or Common Stock under certain circumstances. See "-- Preferred Stock" and "-- Stockholder Rights Plan." PREFERRED 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. The rights, preferences, limitations and restrictions of different series of Preferred Stock may differ with respect to dividend rates, amounts payable on liquidation, voting rights, conversion rights, redemption provisions, sinking fund provisions and other matters. The Board of Directors may authorize the issuance of Preferred Stock which ranks senior to the Common Stock with respect to the payment of dividends and the distribution of assets on liquidation. In addition, the Board of Directors is authorized to fix the limitations and restrictions, if any, upon the payment of dividends on Common Stock to be effective while any shares of Preferred Stock are outstanding. The Board of Directors, without stockholder approval, can issue Preferred Stock with voting and conversion rights which could adversely affect the voting power of the holders of Common Stock. The issuance of Preferred Stock may have the effect of delaying, deferring or preventing a change in control of the Company. Upon consummation of the Offering, no shares of Preferred Stock will be outstanding. In connection with the adoption of the Rights Plan, the Board of Directors has created one series of Preferred Stock, consisting of 10,000 shares of Series A Junior Participating Preferred Stock (the "Series A Preferred"). No shares of Series A Preferred have been issued as of the date of this Registration Statement. Each share of the Series A Preferred, when and if issued, would entitle 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 would be entitled to exercise 1,000 votes per share on all matters submitted to a vote of stockholders and, except as otherwise required by law, would 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. Except as contemplated in connection with the Rights Plan 37 39 described below, the Company has no present plans to issue any of the Preferred Stock. See "-- Stockholder Rights Plan." WARRANTS The Company has issued and outstanding warrants to purchase a total of 670,225 shares of Common Stock, including warrants to purchase 61,313 shares of Common Stock exercisable at $1.47 per share, warrants to purchase 35,153 shares of Common Stock exercisable at $2.29 per share, warrants to purchase 35,153 shares of Common Stock exercisable at $2.75 per share, warrants to purchase 47,037 shares of Common Stock exercisable at $3.21 per share, warrants to purchase 401,569 shares of Common Stock exercisable at $9.56 per share and warrants to purchase 90,000 shares of Common Stock exercisable at $13.50 per share. The warrants expire on various dates between October 1998 and January 2002. The number of shares issuable upon exercise of the warrants is subject to proportionate adjustment in the event of stock splits, stock dividends and similar events. STOCKHOLDER RIGHTS PLAN In February 1996, the Board of Directors of the Company adopted the Rights Plan. 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 (including the shares offered hereby) 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. 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. See "Risk Factors -- Anti-Takeover Provisions." 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 stockholders. The Rights are not intended to prevent an acquisition of the Company on terms that are favorable and fair to all stockholders. 38 40 SHARES ELIGIBLE FOR FUTURE SALE Upon completion of the Offering, the Company will have 6,023,352 shares of Common Stock outstanding, assuming no exercise of options or warrants after February 28, 1997. An aggregate of 5,954,379 of these shares of Common Stock, including the 1,000,000 shares of Common Stock offered hereby, will be either (i) freely tradable without restriction or further registration under the Securities Act, unless purchased by "affiliates" of the Company as that term is defined in Rule 144 of the Securities Act, which shares will be subject to the resale limitations of Rule 144, or (ii) eligible for resale in the public market without restriction, pursuant to a currently effective registration statement. In addition, 670,225 shares underlying currently exercisable warrants will also be eligible for resale in the public market upon exercise of the warrants, pursuant to such registration statement. The remaining 68,973 shares outstanding upon completion of the Offering will be Restricted Shares. The availability or sales of such Restricted Shares in the public market, could adversely affect the market price of the Common Stock. All directors and executive officers, holding an aggregate of 73,948 shares and 192,529 shares issuable upon exercise of options exercisable currently or within 60 days of February 28, 1997, and certain other stockholders of the Company have agreed with the Underwriters that, for a period of 90 days after the date of this Prospectus, they will not directly or indirectly sell or otherwise transfer their shares of Common Stock, now owned by such holders or with respect to which they have the power of disposition, otherwise than with the prior written consent of Gruntal & Co., Incorporated. As a result of these contractual restrictions, notwithstanding possible earlier eligibility for sale, shares subject to lock-up agreements will not be salable until the agreements expire. See "Underwriting." Taking into account the lock-up agreements, all 68,973 additional Restricted Shares will be eligible for public sale beginning 90 days after the effective date of the registration statement, subject to certain volume limitations. Beginning 90 days after the effective date of the registration statement, certain shares issued or issuable upon exercise of options granted by the Company prior to the effective date of the registration statement will also be eligible for sale in the public market pursuant to Rule 701 under the Securities Act, subject to pre-existing lockup agreements. In general, Rule 701 permits resales of shares issued pursuant to certain compensatory benefit plans and contracts commencing 90 days after the issuer becomes subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, in reliance upon Rule 144 but without compliance with certain restrictions, including the holding period requirements, contained in Rule 144. In general, under Rule 144 as in effect after April 29, 1997, a person (or persons whose shares are aggregated) who has beneficially owned Restricted Shares for at least one year, including persons who may be deemed "affiliates" of the Company, would be entitled to sell within any three-month period a number of shares that does not exceed the greater of one percent of the number of shares of Common Stock then outstanding or the average weekly trading volume of the Common Stock during the four calendar weeks preceding the filing of a Form 144 with respect to such sale. Sales under Rule 144 are also subject to certain manner of sale provisions and notice requirements and to the availability of current public information about the Company. In addition, a person who is not deemed to have been an affiliate of the Company at any time during the 90 days preceding a sale, and who has beneficially owned for at least two years the shares proposed to be sold, would be entitled to sell such shares under Rule 144(k) without regard to the requirements described above. The Company is unable to estimate accurately the number of Restricted Shares that will be sold under Rule 144 since this will depend in part on the market price for the Common Stock, the personal circumstances of the seller and other factors. As of February 28, 1997, the Company had outstanding warrants to purchase 670,225 shares of Common Stock at a weighted average exercise price of $8.17 per share and options to purchase 796,258 shares of Common Stock at a weighted average exercise price of $13.40 per share (590,700 of which have not yet vested) issued to employees, directors and consultants pursuant to the 1993 Stock Option Plan and individual agreements with management and directors of the Company. The Company has previously filed a registration statement under the Securities Act covering shares of Common Stock underlying the options. As a result, shares of Common Stock underlying these options, other than shares held by affiliates, are immediately eligible for resale in the public market without restriction, subject to certain vesting provisions and the terms of lock-up agreements, if applicable. 39 41 UNDERWRITING The underwriters named below (the "Underwriters"), for whom Gruntal & Co., Incorporated is acting as Representative, have severally agreed, subject to the terms and conditions contained in the Underwriting Agreement, to purchase from the Company the number of shares of Common Stock indicated below opposite their respective names at the public offering price less the underwriting discount set forth on the cover page of this Prospectus. The Underwriting Agreement provides that the obligations of the Underwriters are subject to certain conditions precedent, and that the Underwriters are committed to purchase all of such shares if any are purchased.
NUMBER OF UNDERWRITERS SHARES ------------ --------- Gruntal & Co., Incorporated................................. --------- Total..................................................... 1,000,000 =========
The Underwriters have advised the Company that they propose initially to offer the Common Stock to the public on the terms set forth on the cover page of this Prospectus. The Underwriters may allow selected dealers a concession of not more than $ per share; and the Underwriters may allow, and such dealers may reallow, a concession of not more than $ per share to certain other dealers. After the public offering, the offering price and other selling terms may be changed by the Underwriters. The Common Stock is offered subject to receipt and acceptance by the Underwriters, and to certain other conditions, including the right to reject orders in whole or in part. The Company has granted an option to the Underwriters, exercisable during the 30-day period after the date of this Prospectus, to purchase up to 150,000 additional shares of Common Stock to cover over-allotments, if any, at the public offering price less the underwriting discount set forth on the cover page of this Prospectus. To the extent that this option is exercised, the Underwriters will be committed, subject to certain conditions, to purchase such additional shares in approximately the same proportion as set forth in the above table. The Underwriters may purchase such shares only to cover over-allotments made in connection with the Offering. The Underwriting Agreement provides that the Company will indemnify the Underwriters against certain liabilities, including civil liabilities under the Securities Act, or will contribute to payments the Underwriters may be required to make in respect thereof. All directors and executive officers and certain other stockholders of the Company have agreed that they will not, without the prior written consent of Gruntal & Co., Incorporated, directly or indirectly, sell, offer, contract or grant any option to sell (including without limitation any short sale) pledge, transfer, establish an open "put equivalent position" within the meaning of Rule 16a-1(h) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or otherwise dispose of any shares of Common Stock, options or warrants to acquire shares of Common Stock, or securities exchangeable or exercisable for or convertible into shares of Common Stock currently owned either of record or beneficially (as defined in Rule 13d-3 under the Exchange Act) by such party, or publicly announce such party's intention to do any of the foregoing, for a period commencing on the date hereof and continuing to a date 90 days after the date of this Prospectus. Gruntal & Co., Incorporated may, in its sole discretion, at any time without prior notice, release all or any 40 42 portion of the securities held by the Company's directors and executive officers from the aforementioned restrictions. The Company has agreed in the Underwriting Agreement that, without the prior written consent of Gruntal & Co., Incorporated, for a period of 90 days after the date of this Prospectus, the Company shall not issue, sell or register with the Commission (other than on Form S-8 or on any successor form), or otherwise dispose of, directly or indirectly, any equity securities of the Company (or any securities convertible into or exercisable or exchangeable for equity securities of the Company), except for the issuance of the shares offered hereby and the issuance of shares pursuant to the Company's 1993 Stock Option Plan. In connection with the Offering, certain Underwriters and selling group members (if any) and their respective affiliates may engage in transactions that stabilize, maintain or otherwise affect the market price of the Common Stock. Such transactions may include stabilization transactions effected in accordance with Rule 104 of Regulation M, pursuant to which such persons may bid for or purchase Common Stock for the purpose of stabilizing its market price. The Underwriters also may create a short position for the account of the Underwriters by selling more Common Stock in connection with the Offering then they are committed to purchase from the Company, and in such case may purchase Common Stock in the open market following completion of the Offering to cover all or a portion of such short position. The Underwriters may also cover all or a portion of such short position, up to 150,000 shares of Common Stock, by exercising the Underwriters' over-allotment option referred to above. In addition, Gruntal & Co., Incorporated, on behalf of the Underwriters, may impose "penalty bids" under contractual arrangements with the Underwriters whereby it may reclaim from an Underwriter (or dealer participating in the Offering) for the account of the other Underwriters, the selling concession with respect to Common Stock that is distributed in the Offering but subsequently purchased for the account of the Underwriters in the open market. Any of the transactions described in this paragraph may result in the maintenance of the price of the Common Stock at a level above that which might otherwise prevail in the open market. None of the transactions described in this paragraph is required, and, if they are undertaken, they may be discontinued at any time. LEGAL MATTERS Certain legal matters with respect to the validity of the Common Stock offered hereby will be passed upon for the Company by Katten Muchin & Zavis, Chicago, Illinois, a partnership including professional corporations. Certain legal matters in connection with patents and proprietary rights will be passed upon for the Company by Marshall, O'Toole, Gerstein, Murray & Borun, Chicago, Illinois. Certain legal matters in connection with the Offering will be passed upon for the Underwriters by Cooley Godward LLP, Palo Alto, California. EXPERTS The financial statements of the Company as of December 31, 1995 and 1996 and for each of the three years in the period ended December 31, 1996 and the cumulative period from October 18, 1989 (date of inception) to December 31, 1996, appearing in this Prospectus and Registration Statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. Certain matters dealing with patents and proprietary rights set forth under "Risk Factors -- Intellectual Property and Patents" and "Business -- Intellectual Property and Patents" have been included in this Prospectus in reliance upon the written opinion of Marshall, O'Toole, Gerstein, Murray & Borun, Chicago, Illinois, as experts in such matters. See "Legal Matters." 41 43 AVAILABLE INFORMATION The Company is subject to the informational requirements of the Exchange Act and in accordance therewith files reports, proxy statements and other information with the Securities and Exchange Commission (the "Commission"). Such reports, proxy statements and other information filed by the Company may be inspected and copied at the public reference facilities maintained by the Commission at the Commission's Public Reference Room, 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549, and at the Commission's Regional Offices at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and at 7 World Trade Center, Suite 1300, New York, New York 10048. Copies of such material can be obtained from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549 at prescribed rates. Copies of reports, proxy and information statements and other information regarding registrants that file electronically are available on the Commission's Web site at http://www.sec.gov. The Company's Common Stock is listed on the Nasdaq National Market, and such reports, proxy statements and other information can also be inspected at the offices of The Nasdaq Stock Market, 1735 K Street, N.W., Washington, D.C. 20006. The Company has filed with the Commission a Registration Statement on Form S-3 (the "Registration Statement") under the Securities Act, with respect to the shares offered hereby. This Prospectus, which constitutes a part of the Registration Statement, does not contain all of the information set forth in the Registration Statement, certain parts of which are omitted in accordance with the rules and regulations of the Commission. Any statements contained herein concerning the provisions of any document filed as an Exhibit to the Registration Statement or otherwise filed with the Commission are not necessarily complete and, in each instance, reference is made to the copy of such document so filed. Each such statement is qualified in its entirety by such reference. The Registration Statement, including the exhibits and schedules thereto, may be inspected without charge at the Commission's principal office at 450 Fifth Street, N.W., Washington, D.C. 20549 and copies of either of them or any part thereof may be obtained from such office, upon payment of the fees prescribed by the Commission. The Registration Statement, including the exhibits and schedules thereto, is also available on the Commission's Web site at http://www.sec.gov. INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE The following documents previously filed by the Company with the Commission pursuant to the Exchange Act are incorporated herein by reference: 1. The Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996; and 2. The description of the Common Stock contained in the Company's Registration Statement on Form 8-A filed August 23, 1993 pursuant to Section 12 of the Exchange Act and all amendments thereto and reports filed for the purpose of updating such description. All documents filed by the Company pursuant to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date of this Prospectus and prior to the termination of the offering made hereby shall be deemed to be incorporated by reference in this Prospectus and to be a part hereof from the date of filing of such documents. Any statement contained herein or in a document incorporated or deemed to be incorporated herein by reference shall be deemed to be modified or superseded for purposes of this prospectus to the extent that a statement contained in any subsequently filed document which is deemed to be incorporated by reference herein modifies or supersedes such statement. Any such statement so modified or superseded shall not be deemed, except as so modified or superseded, to constitute a part of this Prospectus. The Company will provide, without charge, to each person to whom a copy of this Prospectus is delivered, on the written or oral request of such person, a copy of any or all of the documents incorporated herein by reference (other than exhibits thereto, unless such exhibits are specifically incorporated by reference into the information that this Prospectus incorporates). Written or telephone requests for such copies should be directed to the Company's principal executive office: Illinois Superconductor Corporation, 451 Kingston Court, Mt. Prospect, Illinois 60056, Attention: Secretary (telephone: (847) 391-9400). 42 44 ILLINOIS SUPERCONDUCTOR CORPORATION INDEX TO FINANCIAL STATEMENTS Report of Independent Auditors.............................. F-2 Financial Statements Balance Sheets as of December 31, 1995 and 1996............. F-3 Statements of Operations for the Years Ended December 31, 1994, 1995, and 1996 and the Cumulative Period From October 18, 1989 (Date of Inception) to December 31, 1996...................................................... F-4 Statements of Stockholders' Equity for the Years Ended December 31, 1994, 1995, and 1996 and the Cumulative Period From October 18, 1989 (Date of Inception) to December 31, 1996......................................... F-5 Statements of Cash Flows for the Years Ended December 31, 1994, 1995, and 1996 and the Cumulative Period From October 18, 1989 (Date of Inception) to December 31, 1996...................................................... F-6 Notes to Financial Statements............................... F-7
F-1 45 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, 1995 and 1996, and the related statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996, and the cumulative period from October 18, 1989 (date of inception) to December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our 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, 1995 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, and the cumulative period from October 18, 1989 (date of inception) to December 31, 1996, in conformity with generally accepted accounting principles. ERNST & YOUNG LLP Chicago, Illinois January 29, 1997, except for paragraph 8 of Note 6, for which the date is March 7, 1997. F-2 46 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) BALANCE SHEETS
DECEMBER 31 -------------------------- 1995 1996 ---- ---- ASSETS Current assets: Cash and cash equivalents................................. $ 953,093 $ 5,188,047 Investments............................................... 5,083,809 500,313 Inventories............................................... -- 653,696 Accounts receivable....................................... 310,529 130,752 Prepaid expenses and other................................ 465,298 436,052 ----------- ----------- Total current assets........................................ 6,812,729 6,908,860 Property and equipment, net................................. 3,193,777 5,742,804 Restricted certificates of deposit.......................... 862,500 350,000 Patents and trademarks, net................................. 236,760 386,832 ----------- ----------- Total assets................................................ $11,105,766 $13,388,496 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 876,369 $ 1,126,009 Accrued liabilities....................................... 381,306 494,507 Current portion of long-term debt......................... 96,580 80,421 ----------- ----------- Total current liabilities................................... 1,354,255 1,700,937 Long-term debt, less current portion........................ 509,079 91,618 Deferred occupancy costs.................................... 57,053 75,813 Stockholders' equity: Capital stock: Preferred stock ($.001 par value); 100,000 shares authorized and none issued and outstanding............ -- -- Common stock ($.001 par value); 15,000,000 shares authorized and 3,998,952 and 5,023,352 shares issued and outstanding at December 31, 1995 and 1996, respectively.......................................... 3,999 5,023 Additional paid-in capital................................ 24,670,560 39,019,421 Deferred compensation..................................... (41,392) -- Notes receivable from stockholders........................ -- (1,142,754) Deficit accumulated during the development stage.......... (15,447,788) (26,361,562) ----------- ----------- Total stockholders' equity.................................. 9,185,379 11,520,128 ----------- ----------- Total liabilities and stockholders' equity.................. $11,105,766 $13,388,496 =========== ===========
See notes to financial statements. F-3 47 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF OPERATIONS
CUMULATIVE FROM YEARS ENDED DECEMBER 31 OCTOBER 18, 1989 ---------------------------------------- (DATE OF INCEPTION) TO 1994 1995 1996 DECEMBER 31, 1996 ---- ---- ---- ---------------------- Revenues: Development stage product sales... $ 2,787 $ 5,998 $ 156,700 $ 194,412 Government contracts.............. 205,381 21,832 53,122 800,215 ----------- ----------- ------------ ------------ Total revenues...................... 208,168 27,830 209,822 994,627 Costs and expenses: Cost of government contract revenue........................ 194,098 19,286 49,534 675,226 Research and development.......... 1,962,678 4,554,946 6,422,921 14,215,011 Selling and marketing............. 454,968 469,600 1,834,640 3,068,684 General and administrative........ 2,199,597 2,763,615 3,290,810 10,940,405 ----------- ----------- ------------ ------------ Total costs and expenses............ 4,811,341 7,807,447 11,597,905 28,899,326 ----------- ----------- ------------ ------------ (4,603,173) (7,779,617) (11,388,083) (27,904,699) Other income (expense): Investment income................. 496,392 487,543 503,911 1,658,250 Interest expense.................. (8,582) (39,600) (29,602) (115,113) ----------- ----------- ------------ ------------ 487,810 447,943 474,309 1,543,137 ----------- ----------- ------------ ------------ Net loss............................ $(4,115,363) $(7,331,674) $(10,913,774) $(26,361,562) =========== =========== ============ ============ Net loss per common share........... $ (1.15) $ (2.01) $ (2.41) =========== =========== ============ Weighted average number of common shares outstanding................ 3,578,485 3,641,196 4,536,034 =========== =========== ============
See notes to financial statements. F-4 48 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE PERIOD FROM INCEPTION (OCTOBER 18, 1989) TO DECEMBER 31, 1996
PREFERRED STOCK COMMON STOCK NOTES ----------------------- -------------------- ADDITIONAL RECEIVABLE NUMBER OF NUMBER OF PAID-IN DEFERRED FROM SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION STOCKHOLDERS ---------- ------ --------- ------ ---------- ------------ ------------ October 18, 1989 to December 31, 1990: Issuance of common stock; October 20, 1989 -- $.0007 per share.... -- $ -- 136,250 $ 100 $ -- $ -- $ -- Issuance of preferred stock -- Series A, $1.00 per share....... 1,000,000 1,000,000 -- -- -- -- -- Issuance of common shares; September 10, 1990; $.0184 per share........................... -- -- 105,973 1,944 -- -- -- Net loss.......................... -- -- -- -- -- -- -- ---------- ---------- ---------- -------- ----------- --------- ----------- Balance at December 31, 1990....... 1,000,000 1,000,000 242,223 2,044 -- -- -- Issuance of preferred stock -- Series A; $1.00 per share......... 500,000 500,000 -- -- -- -- -- Net loss........................... -- -- -- -- -- -- -- ---------- ---------- ---------- -------- ----------- --------- ----------- Balance as of December 31, 1991.... 1,500,000 1,500,000 242,223 2,044 -- -- -- Issuance of preferred stock -- Series B; $1.25 per share......... 926,000 1,157,500 -- -- -- -- -- Conversion of notes payable to stockholder into shares of preferred stock -- Series B; $1.25 per share......................... 440,000 550,000 -- -- -- -- -- Conversion of accrued interest to common stock: $1.4679 per share... -- -- 11,851 17,398 -- -- -- Net loss -- -- -- -- -- -- -- ---------- ---------- ---------- -------- ----------- --------- ----------- Balance as of December 31, 1992.... 2,866,000 3,207,500 254,074 19,442 -- -- -- Issuance of stock options.......... -- -- -- -- 488,600 (488,600) -- Exercise of stock options; $.0184 per share......................... -- -- 9,634 177 -- -- -- Issuance of preferred stock -- Series C; $1.50 per share......... 1,500,000 2,250,000 -- -- -- -- -- Stock split of .5450 to 1.......... -- -- -- (19,355) 19,355 -- -- Conversion of preferred stock into common shares..................... (4,366,000) (5,457,500) 1,761,971 1,762 5,455,738 -- -- Issuance of common stock -- Initial public offering, net of offering costs; $11.25 per share........... -- -- 1,350,000 1,350 13,083,011 -- -- Issuance of warrants............... -- -- -- -- 100 -- -- Issuance of common stock -- Exercise of underwriter's option on overallotment shares; $11.25 per share......................... -- -- 202,500 202 2,095,673 -- -- Amortization of deferred compensation...................... -- -- -- -- -- 187,151 -- Net loss........................... -- -- -- -- -- -- -- ---------- ---------- ---------- -------- ----------- --------- ----------- Balance as of December 31, 1993.... -- -- 3,578,179 3,578 21,142,477 (301,449) -- Additional costs of initial public offering.......................... -- -- -- -- (46,189) -- -- Exercise of stock options; $.229 per share......................... -- -- 545 1 124 -- -- Amortization of deferred compensation...................... -- -- -- -- -- 139,318 -- Net loss........................... -- -- -- -- -- -- -- ---------- ---------- ---------- -------- ----------- --------- ----------- Balance as of December 31, 1994.... -- -- 3,578,724 3,579 21,096,412 (162,131) -- Exercise of stock options; $.184 -- $11.25 per share.................. -- -- 50,130 50 105,536 -- -- Exercise of warrants; $1.4679 per share............................. -- -- 13,625 14 19,986 -- -- Forfeiture of stock options........ -- -- -- -- (132,300) 74,164 -- Issuance of common stock -- Private placement, net of offering costs; $10.80 per share.................. -- -- 356,473 356 3,580,926 -- -- Amortization of deferred compensation...................... -- -- -- -- -- 46,575 -- Net loss........................... -- -- -- -- -- -- -- ---------- ---------- ---------- -------- ----------- --------- ----------- Balance as of December 31, 1995.... -- -- 3,998,952 3,999 24,670,560 (41,392) -- Exercise of stock options; $.184 -- $15.25 per share.................. -- -- 49,881 50 282,903 -- -- Exercise of warrants; $1.4679 -- $13.50 per share.................. -- -- 565,993 566 5,738,150 -- (1,142,754) Forfeiture of stock options........ -- -- -- -- (5,438) 5,438 -- Issuance of common stock -- Private placement, net of offering costs; $21.80 per share.................. -- -- 408,526 408 8,333,246 -- -- Amortization of deferred compensation...................... -- -- -- -- -- 35,954 -- Net loss........................... -- -- -- -- -- -- -- ---------- ---------- --------- -------- ----------- --------- ----------- Balance as of December 31, 1996.... -- $ -- 5,023,352 $ 5,023 $39,019,421 $ -- $(1,142,754) ========== ========== ========= ======== =========== ========= =========== DEFICIT ACCUMULATED DURING DEVELOPMENT STAGE TOTAL ----------- ----- October 18, 1989 to December 31, 1990: Issuance of common stock; October 20, 1989 -- $.0007 per share.... $ -- $ 100 Issuance of preferred stock -- Series A, $1.00 per share....... -- 1,000,000 Issuance of common shares; September 10, 1990; $.0184 per share........................... -- 1,944 Net loss.......................... (469,177) (469,177) ------------ ----------- Balance at December 31, 1990....... (469,177) 532,867 Issuance of preferred stock -- Series A; $1.00 per share......... -- 500,000 Net loss........................... (887,770) (887,770) ------------ ----------- Balance as of December 31, 1991.... (1,356,947) 145,097 Issuance of preferred stock -- Series B; $1.25 per share......... -- 1,157,500 Conversion of notes payable to stockholder into shares of preferred stock -- Series B; $1.25 per share......................... -- 550,000 Conversion of accrued interest to common stock: $1.4679 per share... -- 17,398 Net loss (994,178) (994,178) ------------ ----------- Balance as of December 31, 1992.... (2,351,125) 875,817 Issuance of stock options.......... -- -- Exercise of stock options; $.0184 per share......................... -- 177 Issuance of preferred stock -- Series C; $1.50 per share......... -- 2,250,000 Stock split of .5450 to 1.......... -- -- Conversion of preferred stock into common shares..................... -- -- Issuance of common stock -- Initial public offering, net of offering costs; $11.25 per share........... -- 13,084,361 Issuance of warrants............... -- 100 Issuance of common stock -- Exercise of underwriter's option on overallotment shares; $11.25 per share......................... -- 2,095,875 Amortization of deferred compensation...................... -- 187,151 Net loss........................... (1,649,626) (1,649,626) ------------ ----------- Balance as of December 31, 1993.... (4,000,751) 16,843,855 Additional costs of initial public offering.......................... -- (46,189) Exercise of stock options; $.229 per share......................... -- 125 Amortization of deferred compensation...................... -- 139,318 Net loss........................... (4,115,363) (4,115,363) ------------ ----------- Balance as of December 31, 1994.... (8,116,114) 12,821,746 Exercise of stock options; $.184 -- $11.25 per share.................. -- 105,586 Exercise of warrants; $1.4679 per share............................. -- 20,000 Forfeiture of stock options........ -- (58,136) Issuance of common stock -- Private placement, net of offering costs; $10.80 per share.................. -- 3,581,282 Amortization of deferred compensation...................... -- 46,575 Net loss........................... (7,331,674) (7,331,674) ------------ ----------- Balance as of December 31, 1995.... (15,447,788) 9,185,379 Exercise of stock options; $.184 -- $15.25 per share.................. -- 282,953 Exercise of warrants; $1.4679 -- $13.50 per share.................. -- 4,595,962 Forfeiture of stock options........ -- -- Issuance of common stock -- Private placement, net of offering costs; $21.80 per share.................. -- 8,333,654 Amortization of deferred compensation...................... -- 35,954 Net loss........................... (10,913,774) (10,913,774) ------------ ----------- Balance as of December 31, 1996.... $(26,361,562) $11,520,128 ============ ===========
See notes to financial statements. F-5 49 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF CASH FLOWS
CUMULATIVE FROM OCTOBER 18, 1989 (DATE OF YEARS ENDED DECEMBER 31 INCEPTION) TO ----------------------------------------- DECEMBER 31, 1994 1995 1996 1996 ---- ---- ---- --------------- OPERATING ACTIVITIES Net loss............................................ $ (4,115,363) $(7,331,674) $(10,913,774) $(26,361,562) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation...................................... 202,525 668,859 1,157,561 2,234,786 Amortization...................................... 15,667 7,541 6,639 52,572 Loss on disposal of property and equipment........ 15,070 499 -- 15,569 Loss (gain) on available-for-sale securities...... 124,000 (54,065) (43,171) 26,764 Net (amortization) accretion of bond (premiums) discounts....................................... (7,963) (11,454) (939) (20,356) Note receivable from officer...................... -- -- -- 179,400 Provision for interest on notes payable........... -- -- -- 17,398 Payments of patent costs.......................... (91,141) (97,005) (156,711) (404,756) Stock compensation expense........................ 139,318 46,575 35,954 408,998 Cancellation of stock options..................... -- (58,136) -- (58,136) Changes in operating assets and liabilities: Accounts receivable............................. 65,345 (28,936) 179,777 (130,752) Inventories..................................... -- -- (653,696) (653,696) Prepaid expenses and other...................... (532,388) 306,527 29,246 (436,052) Accounts payable................................ 1,143,035 (818,844) 249,640 1,126,009 Accrued liabilities............................. (11,535) 252,159 113,201 494,507 Deferred occupancy costs........................ 38,567 18,486 18,760 75,813 ------------ ----------- ------------ ------------ Net cash used in operating activities............... (3,014,863) (7,099,468) (9,977,513) (23,433,494) INVESTING ACTIVITIES Purchases of available-for-sale securities.......... (15,691,459) (8,060,495) (30,945,246) (54,697,200) Sales of available-for-sale securities.............. 2,987,121 4,566,564 2,500,000 10,053,685 Maturities of available-for-sale securities......... 2,061,578 9,002,364 33,072,852 44,136,794 (Increase) decrease in certificates of deposit, net............................................... (989,000) 137,500 512,500 (350,000) Acquisitions of property and equipment.............. (1,912,835) (1,888,694) (3,706,588) (7,751,926) Decrease (increase) in notes receivable from officers.......................................... 3,500 -- -- (179,400) ------------ ----------- ------------ ------------ Net cash provided by (used in) investing activities........................................ (13,541,095) 3,757,239 1,433,518 (8,788,047) FINANCING ACTIVITIES Payments of organization costs...................... -- -- -- (64,495) Proceeds from notes payable to stockholders......... -- -- -- 550,000 Proceeds from issuance of preferred stock........... -- -- -- 4,907,500 Proceeds from issuance of common stock -- net of offering costs.................................... (46,189) 3,581,282 8,333,654 27,051,304 Exercise of stock options........................... 125 105,586 282,953 388,664 Exercise of warrants................................ -- 20,000 4,595,962 4,615,962 Proceeds from issuance of long-term debt............ -- 650,518 92,182 742,700 Payments on long-term debt.......................... -- (44,859) (525,802) (570,661) Payments under capital lease obligations............ (47,477) (107,567) -- (211,386) ------------ ----------- ------------ ------------ Net cash provided by (used in) financing activities........................................ (93,541) 4,204,960 12,778,949 37,409,588 ------------ ----------- ------------ ------------ Increase (decrease) in cash and cash equivalents.... (16,649,499) 862,731 4,234,954 5,188,047 Cash and cash equivalents at beginning of period.... 16,739,861 90,362 953,093 -- ------------ ----------- ------------ ------------ Cash and cash equivalents at end of period.......... $ 90,362 $ 953,093 $ 5,188,047 $ 5,188,047 ============ =========== ============ ============ Supplemental cash flow information: Cash paid for interest............................ $ 8,582 $ 39,600 $ 29,602 $ 96,369 ============ =========== ============ ============ Equipment capitalized under lease agreements...... $ -- $ 59,739 $ -- $ 211,386 ============ =========== ============ ============ Conversion of notes payable and accrued interest to preferred and common stock................... $ -- $ -- $ -- $ 567,398 ============ =========== ============ ============
See notes to financial statements. F-6 50 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS Illinois Superconductor Corporation (Company) was founded in 1989 to commercialize superconducting technologies primarily for the wireless telecommunications industry. Since its inception, the Company has been in the development stage, engaging in research and product development activities, both internally funded and under government-funded contracts and cooperative agreements, recruiting technical and administrative personnel, and raising capital. The Company's primary focus has been on developing radio frequency component products for the cellular and other wireless telecommunications markets located mainly in the United States. In the course of its development activities, the Company has experienced net losses and negative cash flows from operations. Historically, the Company has funded its operations primarily through the issuance of equity securities, government contracts and debt. The Company intends to offer additional equity securities during 1997. In the event the equity offering is not successful, the Company believes that it is capable of sustaining operations throughout 1997 under plans which could include a reduction in the Company's operating levels. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CASH, CASH EQUIVALENTS AND INVESTMENTS 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. Investments consist of U.S. corporate debt securities, U.S. Treasury securities, and other U.S. government obligations. 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. Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. All of the Company's investments are classified as available-for-sale. Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of tax, reported in a separate component of shareholders' equity. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion is included in investment income. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in investment income. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in investment income. INVENTORIES Inventories are stated at the lower of cost (determined on a first in, first out basis) or market. PROPERTY AND EQUIPMENT Property and equipment is stated at cost, less accumulated depreciation, and is 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 F-7 51 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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
PATENTS AND TRADEMARKS 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 a recurring basis. Patents and trademarks are net of accumulated amortization of $11,285 and $17,924 at December 31, 1995 and 1996, respectively. INCOME TAXES Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. REVENUE RECOGNITION Revenues from research and development contracts are recognized utilizing the percentage-of-completion method measured by the relationship of costs incurred to total contract costs. When the current contract estimate indicates a loss, provision is made for the total anticipated loss. Revenues from research-related activities are derived primarily from contracts and cost-sharing agreements with agencies of the U.S. government (see Note 8). All payments to the Company for work performed on contracts with agencies of the U.S. government are subject to adjustment upon audit by agencies of the U.S. government. Management believes that any such audits will not have a significant effect on the financial position or results of operations of the Company. Revenues from product sales are recognized at the time of shipment. ADVERTISING COSTS Advertising costs are charged to expense in the period incurred. Advertising expense for the years ended December 31, 1994, 1995, 1996, and the cumulative period from October 18, 1989 (date of inception) to December 31, 1996, was approximately $119,000, $87,000, $135,000, and $341,000, respectively. RESEARCH AND DEVELOPMENT COSTS Research and development costs related to both present and future products are charged to expense in the period incurred. F-8 52 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) NET LOSS PER COMMON SHARE Net loss per common share and pro forma net loss per common share (Note 7) are computed based upon the weighted-average number of common shares outstanding. Common equivalent shares are not included in the per share calculations since the effect of their inclusion would be antidilutive. 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. ADOPTION OF FASB 121 In March 1995, the Financial Accounting Standards Board issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (FASB 121), which requires impairment losses to be recorded 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. FASB 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company adopted FASB 121 in the first quarter of 1996. The effect of adoption was not material. RECLASSIFICATIONS Certain amounts in the 1995 financial statements have been reclassified to conform to the 1996 presentation. 3. INVENTORIES Inventories consist of the following:
DECEMBER 31 ------------------- 1995 1996 ---- ---- Raw materials............................................ $ -- $ 64,524 Work-in-process.......................................... -- 214,172 Finished product......................................... -- 375,000 -------- -------- $ -- $653,696 ======== ========
F-9 53 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 4. INVESTMENTS The following is a summary of available-for-sale debt securities at December 31, 1995 and 1996:
1995 1996 -------------------------- ------------------------ AVAILABLE-FOR-SALE AVAILABLE-FOR-SALE DEBT SECURITIES DEBT SECURITIES -------------------------- ------------------------ COST FAIR VALUE COST FAIR VALUE ---- ---------- ---- ---------- U.S. Treasury securities and obligations of U.S. government agencies.......... $3,456,281 $3,456,281 $500,313 $500,313 U.S. corporate debt securities................... 1,627,528 1,627,528 -- -- ---------- ---------- -------- -------- $5,083,809 $5,083,809 $500,313 $500,313 ========== ========== ======== ========
During the years ended December 31, 1995 and 1996, available-for-sale debt securities with a fair value at the date of sale of $4,566,564 and $2,500,000, respectively, were sold. The gross realized gains on such sales were $59,480 and $43,171 in 1995 and 1996, respectively, and the gross realized losses were $5,415 in 1995. The available-for-sale debt security held at December 31, 1996, is due after three years. 5. PROPERTY AND EQUIPMENT Property and equipment consists of the following:
DECEMBER 31 ----------------------- 1995 1996 ---- ---- Leasehold improvements................................ $1,959,276 $4,172,694 Lab equipment......................................... 1,352,786 1,606,594 Manufacturing equipment............................... -- 864,059 Office equipment...................................... 435,646 626,029 Furniture and fixtures................................ 409,041 593,961 ---------- ---------- 4,156,749 7,863,337 Less: Accumulated depreciation........................ 962,972 2,120,533 ---------- ---------- $3,193,777 $5,742,804 ========== ==========
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. In conjunction with the adoption of the Rights Plan (as discussed below), the Company has 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. F-10 54 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. CAPITAL STOCK (CONTINUED) On February 9, 1996, the board of directors adopted a shareholder rights plan (Rights Plan). Pursuant to such 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 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 1996. The remaining 340,773 warrants were called for redemption by the Company in November 1996 and were exercised in December 1996. In conjunction with the exercise, 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 February 21, 1997, and are guaranteed by an affiliate of a stockholder. On March 7, 1997, $716,319 of these notes were extended to April 30, 1997. If any of the balance remains outstanding after April 30, 1997, the interest rate defaults to 10.25% per annum. 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. F-11 55 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. CAPITAL STOCK (CONTINUED) At December 31, 1996, authorized but unissued shares of common stock have been reserved for future issuance as follows: Warrants.................................................... 670,225 Options outstanding......................................... 796,258 Options reserved for future issuance under the 1993 Stock Option Plan (Note 7)...................................... 289,532 --------- 1,756,015 =========
7. STOCK OPTIONS AND WARRANTS 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 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. 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 1996, is 1,055,000, of which 80,000 are reserved for issuance to outside directors. The Plan is administered by a committee (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 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 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. 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. 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, commencing with the 1994 meeting, each outside director who is elected, reelected, or continues to serve as a director, shall be granted 2,000 NSOs (3,000 NSOs for the 1996 meeting and all future annual meetings), 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. F-12 56 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. STOCK OPTIONS AND WARRANTS (CONTINUED) 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 are determined by the Board of Directors and, for options granted through December 31, 1992, represent estimated fair values of the Company's common stock at the grant date. For the year ended December 31, 1993, the Company recorded an increase to additional paid-in capital and a corresponding charge to deferred compensation of approximately $489,000 to recognize the difference between the estimated fair value of the Company's common stock at the date of grant and the exercise price for 107,638 options granted in the year ended December 31, 1993. The deferred compensation is being amortized over the five-year vesting period of the options. During 1995 and 1996, 29,430 and 1,090 of these options were forfeited, resulting in a reduction in compensation expense of $58,136 in 1995. Amortization of compensation expense of $139,318, $46,575 and $35,954 was recorded for the years ended December 31, 1994, 1995, and 1996, respectively. Pro forma information regarding net income and earnings per share is required under FASB 123, and has been determined as if the Company had accounted for its stock options granted subsequent to December 31, 1994, under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the years ended December 31, 1995 and 1996: risk-free interest rate of 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 .75; and expected life of the options of 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:
YEAR ENDED ------------------------- 1995 1996 ---- ---- Pro forma net loss................................... $7,428,018 $11,590,957 Pro forma net loss per common share.................. 2.04 2.56
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. F-13 57 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. STOCK OPTIONS AND WARRANTS (CONTINUED) The table below summarizes all option activity through December 31, 1996:
EXERCISE OPTIONS PRICE OUTSTANDING PER SHARE ----------- --------- Period October 18, 1989 (date of inception) to December 31, 1990: Granted................................................... 25,984 $ .0184 - .184 ------- Outstanding at December 31, 1990.......................... 25,984 .0184 - .184 Granted................................................... 2,725 .184 ------- Outstanding at December 31, 1991.......................... 28,709 .0184 - .184 Granted................................................... 39,513 .0184 - .229 ------- Outstanding at December 31, 1992.......................... 68,222 .0184 - .229 Granted................................................... 132,638 .229 - 11.25 Exercised................................................. (9,634) .0184 ------- Outstanding at December 31, 1993.......................... 191,226 .184 - 11.25 Granted................................................... 271,012 6.75 - 16.25 Exercised................................................. (545) .229 Forfeited................................................. (4,680) .229 - 16.25 ------- Outstanding at December 31, 1994.......................... 457,013 .184 - 16.25 Granted................................................... 190,360 6.75 - 19.25 Exercised................................................. (50,130) .184 - 11.25 Forfeited................................................. (71,975) .184 - 15.25 ------- Outstanding at December 31, 1995.......................... 525,268 .184 - 19.25 Granted................................................... 346,907 17.00 - 27.00 Exercised................................................. (49,881) .184 - 15.25 Forfeited................................................. (26,036) .229 - 26.50 ------- Outstanding at December 31, 1996.......................... 796,258 $ .184 - 27.00 =======
The weighted-average exercise price of options outstanding at December 31, 1995 and 1996, was $8.93 and $13.40, respectively. The weighted-average exercise price of options granted, exercised, and forfeited during 1996 was $18.93, $5.67, and $11.76, respectively. The weighted-average fair value of options granted during 1996 was $11.35. Following is additional information with respect to options outstanding at December 31, 1996:
EXERCISE EXERCISE EXERCISE EXERCISE EXERCISE PRICE FROM PRICE FROM PRICE FROM PRICE FROM PRICE FROM $0.18 TO $6.75 TO $10.50 TO $16.00 TO $23.50 TO $0.23 $9.13 $15.50 $22.13 $27.00 ---------- ---------- ---------- ---------- ---------- Outstanding at December 31, 1996: Number of options........................ 68,536 124,664 213,356 339,942 49,760 Weighted-average exercise price.......... $0.22 $7.37 $11.37 $17.83 $25.07 Weighted-average remaining contractual life in years......................... 6.0 8.0 7.7 9.6 9.3 Exercisable at December 31, 1996: Number of options........................ 39,380 41,916 109,068 14,825 -- Weighted-average exercise price.......... $0.22 $7.32 $11.84 $17.58 --
F-14 58 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. STOCK OPTIONS AND WARRANTS (CONTINUED) The total number of unvested options outstanding at December 31, 1996, was 591,069, of which 451,069 will vest based on employees' continued service to the Company and 140,000 will vest based on employees' continued service to the Company and the Company's attainment of certain performance objectives established by the Committee. 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 13,625 and 34,063 of these shares were exercised in 1995 and 1996, 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 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 in 1996. The Company also issued warrants to purchase 470,589 shares of common stock in connection with the July 1993 issuance of Series C preferred stock. The warrants are exercisable at $9.56 per share and expire in November 2000. Warrants for 69,020 of these shares were exercised in 1996. 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 are exercisable through October 26, 1998. Warrants for 10,000 of these shares were exercised in 1996. 8. RESEARCH AND DEVELOPMENT AGREEMENTS In March 1993, the Company entered into a three-year cost-sharing cooperative agreement with the U.S. government under the Department of Commerce Advanced Technology Program. Funding totaling $619,000, $650,000, $200,000, and $1,980,000 for the years ended December 31, 1994, 1995, and 1996, and for the period from March 1993 to December 31, 1996, respectively, has been offset against the related research and development expenses. The Company is party to a number of research and development contracts, generally short-term in nature, which provided approximately $205,000, $22,000, and $53,000 of revenues for the years ended December 31, 1994, 1995, and 1996, respectively. These contracts include cost-plus and fixed-price arrangements. Research and development expenses include the costs associated with development stage product sales. 9. INCOME TAXES The Company has net operating loss and research and development credit carryforwards for tax purposes of approximately $27,700,000 and $624,000, respectively, at December 31, 1996, which begin to expire in 2005. F-15 59 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. INCOME TAXES (CONTINUED) Significant components of the Company's deferred tax assets and liabilities are as follows:
DECEMBER 31 ------------------------- 1995 1996 ---- ---- Deferred tax assets: Net operating loss carryforward................... $ 5,716,000 $10,502,000 Research and development tax credit carryforwards.................................. 744,000 624,000 Deferred compensation............................. 120,000 94,000 Property and equipment............................ 19,000 -- Development stage losses.......................... 17,000 -- ----------- ----------- Total deferred tax assets........................... 6,616,000 11,220,000 Deferred tax liabilities: Patent costs...................................... (85,000) (142,000) Property and equipment............................ -- (68,000) ----------- ----------- (85,000) (210,000) ----------- ----------- Net deferred tax assets............................. 6,531,000 11,010,000 Valuation allowance................................. (6,531,000) (11,010,000) ----------- ----------- Net deferred tax assets............................. $ -- $ -- =========== ===========
The valuation allowance increased during 1996 by $4,479,000 due primarily to the increase in the net operating loss carryforward. Based on the Internal Revenue Code and changes in the ownership of the Company, utilization of the net operating loss carryforwards will be subject to annual limitations. 10. LONG-TERM DEBT The Company's long-term debt consists of two equipment financing notes with a bank that mature in October 1998 and May 1999, respectively. The notes bear interest at 8.5% per annum. Payments of principal plus accrued interest are due monthly in arrears. Borrowings are collateralized by the related equipment purchased, which has a carrying value of approximately $146,000 at December 31, 1996. The notes require the Company to maintain a minimum net worth and leverage ratio, as defined. The Company's outstanding obligations under these notes was $172,039 at December 31, 1996, with aggregate debt maturities of $80,421 in 1997, $78,074 in 1998, and $13,544 in 1999. 11. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of cash equivalents, the restricted certificates of deposit, and the shareholder notes receivable approximates fair value due to the short maturity of those instruments. The fair value of the Company's investments approximates the carrying value based on quoted market prices for those or similar investments. The fair value of the Company's long-term debt approximates the carrying value based on current rates available to the Company for debt with similar remaining maturities. 12. COMMITMENTS OPERATING 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 F-16 60 ILLINOIS SUPERCONDUCTOR CORPORATION (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 12. COMMITMENTS (CONTINUED) for a security deposit ($350,000 at December 31, 1996) 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, 1996:
YEAR AMOUNT ---- ------ 1997........................................................ $ 211,700 1998........................................................ 227,500 1999........................................................ 227,500 2000........................................................ 231,300 2001........................................................ 249,900 Thereafter.................................................. 699,900 ---------- $1,847,800 ==========
Rent expense totaled $174,994, $267,991, and $227,334, for the years ended December 31, 1994, 1995, and 1996, respectively. CONSULTING AND RESEARCH AGREEMENTS During 1994, the Company entered into consulting and research agreements related to the development of certain technology. The consulting agreement requires annual payments of $50,000 through 1998, while the research agreement provides for annual payments of $100,000 through 1997 with the right to renew for one additional year at the Company's option. 13. 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, 1994, 1995, and 1996. 14. LEGAL PROCEEDINGS In 1996, a stockholder filed a complaint against the Company alleging that, in connection with the Company's private placement of securities in November 1995, the Company breached and repudiated an oral contract with the stockholder for the issuance and sale by the Company of 370,370 shares of the Company's common stock at $10.80 per share, plus warrants (immediately exercisable at $12.96 per share) to purchase an additional 370,370 shares of the Company's common stock. The stockholder is seeking a jury trial and money damages equal to the difference between $8,800,000 (370,370 shares at $10.80 per share and 370,370 shares at $12.96 per share) and 740,740 shares multiplied by the highest price at which the Company's stock traded on the Nasdaq Stock Market between November 20, 1995 and the date of judgment. The Company believes that the suit is without merit and intends to continue to defend itself vigorously in this litigation. As such, the Company believes that the resolution of this matter will not have a material adverse effect on the financial condition or results of operations of the Company. F-17 61 [INSIDE BACK COVER] [PICTURE OF THE COMPANY'S CORPORATE HEADQUARTERS IN MT. PROSPECT, ILLINOIS] Illinois Superconductor Corporation's executive offices as well as its manufacturing, research and development and administrative operations are located in its Mt. Prospect, Illinois facility. 62 ====================================================== NO DEALER, SALES REPRESENTATIVE OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY OF THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SHARES OF COMMON STOCK TO WHICH IT RELATES OR AN OFFER TO, OR A SOLICITATION OF, ANY PERSON IN ANY JURISDICTION WHERE SUCH OFFER OR SOLICITATION WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF. ------------------------- TABLE OF CONTENTS
PAGE ---- Prospectus Summary.................... 3 Risk Factors.......................... 6 Use of Proceeds....................... 14 Price Range of Common Stock........... 14 Dividend Policy....................... 14 Capitalization........................ 15 Selected Financial Data............... 16 Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 17 Business.............................. 20 Management............................ 31 Principal Stockholders................ 35 Description of Capital Stock.......... 37 Shares Eligible for Future Sale....... 39 Underwriting.......................... 40 Legal Matters......................... 41 Experts............................... 41 Available Information................. 42 Incorporation of Certain Documents by Reference........................... 42 Index to Financial Statements......... F-1
====================================================== ====================================================== 1,000,000 SHARES ISC LOGO ILLINOIS SUPERCONDUCTOR CORPORATION COMMON STOCK ------------------------- PROSPECTUS ------------------------- GRUNTAL & CO., INCORPORATED , 1997 ====================================================== 63 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION Set forth below is the approximate amount of fees and expenses (other than underwriting commissions and discounts) payable by the Registrant in connection with the issuance and distribution of the Common Stock pursuant to the Prospectus contained in this Registration Statement. All amounts are estimates except the Securities and Exchange Commission registration fee, the NASD filing fee and the Nasdaq National Market listing fee.
APPROXIMATE AMOUNT ----------- Securities and Exchange Commission registration fee......... $ 5,642 NASD filing fee............................................. 2,362 Nasdaq National Market listing fee.......................... 17,500 Accountants' fees and expenses.............................. 75,000 Legal fees and expenses..................................... 250,000 Transfer Agent and Registrar fees and expenses.............. 10,000 Printing and engraving...................................... 100,000 Blue Sky fees and expenses.................................. 2,500 Miscellaneous expenses...................................... 36,996 -------- Total................................................ $500,000 ========
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS Article 9 of the Company's Certificate of Incorporation provides that the Company shall indemnify its directors to the full extent permitted by the General Corporation Law of the State of Delaware and may indemnify its officers and employees to such extent, except that the Company shall not be obligated to indemnify any such person (i) with respect to proceedings, claims or actions initiated or brought voluntarily by any such person and not by way of defense, or (ii) for any amounts paid in settlement of an action indemnified against by the Company without the prior written consent of the Company. The Company has entered into indemnity agreements with each of its directors. These agreements may require the Company, among other things, to indemnify such directors against certain liabilities that may arise by reason of their status or service as directors, to advance expenses to them as they are incurred, provided that they undertake to repay the amount advanced if it is ultimately determined by a court that they are not entitled to indemnification and to obtain directors' liability insurance if available on reasonable terms. In addition, Article 8 of the Company's Certificate of Incorporation provides that a director of the Company shall not be personally liable to the Company or its stockholders for monetary damages for breach of his or her fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the Company or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) for willful or negligent conduct in paying dividends or repurchasing stock out of other than lawfully available funds or (iv) for any transaction from which the director derives an improper personal benefit. Reference is made to Section 145 of the General Corporation Law of the State of Delaware which provides for indemnification of directors and officers in certain circumstances. The Company has obtained a directors' and officers' liability insurance policy which entitles the Company to be reimbursed for certain indemnity payments it is required or permitted to make to its directors and officers. II-1 64 ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 1 Form of Underwriting Agreement. 3.1* Certificate of Incorporation of the Company. 3.2* Bylaws of the Company. 3.3* Certificate of Amendment of Certificate of Incorporation of the Company. 4.1* Specimen stock certificate representing Common Stock. 4.2 Rights Agreement dated as of February 9, 1996 between the Company and LaSalle National Trust, N.A., filed as the Exhibit to the Company's Registration Statement on Form 8-A, filed February 12, 1996, incorporated herein by reference. 5 Opinion of Katten Muchin & Zavis as to the legality of the securities being registered (including consent). 23.1 Consent of Ernst & Young LLP. 23.2 Consent of Katten Muchin & Zavis (contained in its opinion filed as Exhibit 5 hereto). 23.3 Consent of Marshall, O'Toole, Gerstein, Murray & Borun. 24 Power of Attorney (included on the signature page hereto).
- ------------------------ * Incorporated by reference from the Company's Registration Statement on Form S-1 dated August 20, 1993, Reg. No. 33-67756, with the same exhibit number. ITEM 17. UNDERTAKINGS The undersigned registrant hereby undertakes: (1) For purposes of determining any liability under the Securities Act of 1933 (the "Securities Act"), each filing of the Company's annual report pursuant to Section 13(a) or Section 15(d) of the Exchange Act that is incorporated by reference in this Registration Statement shall be deemed to be a new registration statement relating to the securities offered herein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (2) Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Company pursuant to the foregoing provisions, or otherwise, the Company has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Company of expenses incurred or paid by a director, officer or controlling person of the Company in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Company will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. (3) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (4) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered herein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-2 65 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Company certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-3 and has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Mt. Prospect, State of Illinois on the 24th day of March, 1997. ILLINOIS SUPERCONDUCTOR CORPORATION By: /s/ ORA E. SMITH ------------------------------------ Ora E. Smith, President and Chief Executive Officer POWER OF ATTORNEY Each person whose signature appears below hereby constitutes and appoints Ora E. Smith and Stephen G. Wasko and each of them his true and lawful attorney-in-fact and agent, with full power of substitution, to sign on his behalf, individually and in each capacity stated below, all amendments and post- effective amendments to this Registration Statement on Form S-3 (including registration statements filed pursuant to Rule 462(b) under the Securities Act of 1933, and all amendments thereto) and to file the same, with all exhibits thereto and any other documents in connection therewith, with the Securities and Exchange Commission under the Securities Act of 1933, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as each might or could do in person, hereby ratifying and confirming each act that said attorneys-in-fact and agents may lawfully do or cause to be done by virtue thereof. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following persons on March 24, 1997 in the capacities indicated.
SIGNATURE TITLE --------- ----- /s/ ORA E. SMITH President, Chief Executive Officer - ----------------------------------------------------- (Principal Executive Officer) and a Director Ora E. Smith /s/ STEPHEN G. WASKO Vice President, Chief Financial Officer, - ----------------------------------------------------- Treasurer and Secretary (Principal Financial Stephen G. Wasko and Accounting Officer) /s/ LEONARD A. BATTERSON Director - ----------------------------------------------------- Leonard A. Batterson /s/ MICHAEL J. FRIDUSS Director - ----------------------------------------------------- Michael J. Friduss /s/ PETER S. FUSS Director - ----------------------------------------------------- Peter S. Fuss /s/ STEVEN LAZARUS Chairman of the Board and Director - ----------------------------------------------------- Steven Lazarus /s/ TOM L. POWERS Director - ----------------------------------------------------- Tom L. Powers /s/ PAUL G. YOVOVICH Director - ----------------------------------------------------- Paul G. Yovovich
II-3 66 INDEX TO EXHIBITS EXHIBIT NUMBER EXHIBIT - ------- ------- 1 Form of Underwriting Agreement. 5 Opinion of Katten Muchin & Zavis as to the legality of the securities being registered (including consent). 23.1 Consent of Ernst & Young LLP. 23.3 Consent of Marshall, O'Toole, Gerstein, Murray & Borun. EX-1 2 UNDERWRITING AGREEMENT 1 EXHIBIT 1 1,000,000 Shares ILLINOIS SUPERCONDUCTOR CORPORATION Common Stock UNDERWRITING AGREEMENT March __, 1997 Gruntal & Co., Incorporated 14 Wall Street New York, NY 10005 On behalf of the Several Underwriters named on Schedule I attached hereto. Ladies and Gentlemen: Illinois Superconductor Corporation, a Delaware corporation (the "Company"), proposes, subject to the terms and conditions contained herein, to sell to you and the other underwriters named on Schedule I to this Agreement (the "Underwriters"), for whom you are acting as Representative (the "Representative"), an aggregate of 1,000,000 shares (the "Firm Shares") of the Company's Common Stock, par value $.001 per share (including preferred stock purchase rights) (the "Common Stock"). The respective amounts of the Firm Shares to be so purchased by the several Underwriters are set forth opposite their names in Schedule I hereto. In addition, the Company proposes to grant to the Underwriters an option to purchase up to an additional 150,000 shares (the "Option Shares") of Common Stock for the purpose of covering over-allotments in connection with the sale of the Firm Shares. The Firm Shares and the Option Shares are together called the "Shares." 1. SALE AND PURCHASE OF THE SHARES. On the basis of the representations, warranties and agreements contained in, and subject to the terms and conditions of, this Agreement: (a) The Company agrees to sell to the Underwriters, and each of the Underwriters agrees, severally and not jointly, to purchase from the Company, at $____ per share (the "Initial Price"), the number of Firm Shares set forth opposite the name of such Underwriter on Schedule I to this Agreement. 2 (b) The Company grants to the several Underwriters an option to purchase, severally and not jointly, all or any part of the Option Shares at the Initial Price. The number of Option Shares to be purchased by each Underwriter shall be the same percentage (adjusted by the Representative to eliminate fractions) of the total number of Option Shares to be purchased by the Underwriters as such Underwriter is purchasing of the Firm Shares. Such option may be exercised only to cover over-allotments in the sales of the Firm Shares by the Underwriters and may be exercised in whole or in part at any time on or before 12:00 noon, New York City time, on the business day before the Firm Shares Closing Date (as defined below), and on one or more occasions thereafter within 30 days after the date of this Agreement, in each case upon written, facsimile or telegraphic notice, or oral or telephonic notice confirmed by written, facsimile or telegraphic notice, by the Representative to the Company no later than 12:00 noon, New York City time, on the business day before the Firm Shares Closing Date or at least two business days before the Option Shares Closing Date (as defined below), as the case may be, setting forth the number of Option Shares to be purchased and the time and date (if other than the Firm Shares Closing Date) of such purchase. 2. DELIVERY AND PAYMENT. Delivery by the Company of the Firm Shares to the Representative for the respective accounts of the Underwriters, and payment of the purchase price by wire transfer or by certified or official bank check or checks payable in same day funds to the Company, shall take place at the offices of Katten Muchin & Zavis, 525 West Monroe Street, Chicago, IL 60661, at 9:00 a.m., local time, on the [third] [fourth] business day following the date of this Agreement, or at such time on such other date, not later than 10 business days after the date of this Agreement, as shall be agreed upon by the Company and the Representative (such time and date of delivery and payment are called the "Firm Shares Closing Date"). In the event the option with respect to the Option Shares is exercised in whole or in part on one or more occasions, delivery by the Company of the Option Shares to the Representative for the respective accounts of the Underwriters and payment of the purchase price by wire transfer or by certified or official bank check or checks payable in same day funds to the Company shall take place at the offices of Katten Muchin & Zavis specified above, at the time and on the date (which may be the same date as, but in no event shall be earlier than, the Firm Shares Closing Date) specified in the notice referred to in Section 1(b) (such time and date of delivery and payment are called the "Option Shares Closing Date"). The Firm Shares Closing Date and the Option Shares Closing Date are called, individually, a "Closing Date" and, together, the "Closing Dates." Certificates evidencing the Shares shall be registered in such names and shall be in such denominations as the Representative shall request at least two full business days before the Firm Shares Closing Date or, in the case of Option Shares, on the day of notice of exercise of the 2. 3 option as described in Section 1(b) and shall be made available to the Representative for checking and packaging, at such place as is designated by the Representative, at least 24 hours prior to the Firm Shares Closing Date (or the Option Shares Closing Date in the case of the Option Shares). 3. REGISTRATION STATEMENT AND PROSPECTUS; PUBLIC OFFERING. The Company has prepared in conformity with the requirements of the Securities Act of 1933, as amended (the "Securities Act"), and the published rules and regulations thereunder (the "Rules") adopted by the Securities and Exchange Commission (the "Commission") a Registration Statement (as hereinafter defined) on Form S-3 (No. 333- ________), including a preliminary prospectus relating to the Shares, and has filed with the Commission the Registration Statement and such amendments thereof as may have been required to the date of this Agreement. Copies of such Registration Statement (including all amendments thereof) and of the related preliminary prospectus have previously been delivered by the Company to you as the representatives of the Underwriters. The term "preliminary prospectus" means any preliminary prospectus (as described in Rule 430 of the Rules) included at any time as a part of the Registration Statement and any preliminary prospectus filed by the Company with the consent of the Representative pursuant to Rule 424(a) of the Rules. The Registration Statement as amended at the time and on the date it becomes effective (the "Effective Date"), including all exhibits and information, if any, and all documents incorporated or deemed to be incorporated by reference therein or deemed to be part of the Registration Statement pursuant to Rule 424(b), Rule 434 and Rule 430A of the Rules or the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the rules and regulations promulgated thereunder, is called the "Registration Statement." The term "Prospectus" means the prospectus in the form first used to confirm sales of the Shares (whether such prospectus was included in the Registration Statement at the time of effectiveness or was subsequently filed with the Commission pursuant to Rule 424(b) of the Rules) or if the Company relies on Rule 434 under the Securities Act, the "Term Sheet" relating to the Shares, together with the preliminary prospectus that such Term Sheet supplements. "Term Sheet" means any term sheet that satisfies the requirements of Rule 434 under the Securities Act. All references in this Agreement to financial statements and schedules and other information which is contained, included or stated in the Registration Statement or the Prospectus (and all other references of like import) shall be deemed to mean and include all such financial statements and schedules and other information which is or is deemed to be incorporated by reference in the Registration Statement or the Prospectus, as the case may be; and all references in this Agreement to amendments or supplement to the Registration Statement or the Prospectus shall be deemed to mean and include the filing of any document under the Exchange Act which is or is deemed to be incorporated by reference in the Registration Statement or the Prospectus, as the case may be. The Company understands that the Underwriters propose to make a public offering of the Shares, as set forth in and pursuant to the Prospectus, as soon after the Effective Date and the date of this Agreement as the Representative deem advisable. The Company hereby 3. 4 confirms that the Underwriters and dealers have been authorized to distribute or cause to be distributed each preliminary prospectus and are authorized to distribute the Prospectus (as from time to time amended or supplemented if the Company furnishes amendments or supplements thereto to the Underwriters). 4. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company hereby represents and warrants to each Underwriter as follows: (a) On the Effective Date the Registration Statement complied, and on the date of the Prospectus, on the date any post-effective amendment to the Registration Statement shall become effective, on the date any supplement or amendment to the Prospectus is filed with the Commission and on each Closing Date, the Registration Statement and the Prospectus (and any amendment thereof or supplement thereto) will comply, in all material respects, with the applicable provisions of the Securities Act and the Rules and the Company's Registration Statement on Form 8-A under Exchange Act, will be effective and will comply in all material respects with the Exchange Act and the rules and regulations of the Commission thereunder; the Registration Statement did not, as of the Effective Date, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading; and on the other dates referred to above neither the Registration Statement nor the Prospectus, nor any amendment thereof or supplement thereto, will contain any untrue statement of a material fact or will omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. No order preventing or suspending the use of any preliminary prospectus has been issued by the Commission or any state of the United States or other United States or foreign regulatory body. When each related preliminary prospectus was filed with the Commission (whether filed as part of the Registration Statement or any amendment thereto or pursuant to Rule 424(a) of the Rules) and when any amendment thereof or supplement thereto was filed with the Commission, such preliminary prospectus or amendment thereof or supplement thereto complied in all material respects with the applicable provisions of the Securities Act and the Rules and did not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. Notwithstanding the foregoing, the Company makes no representation or warranty as to the paragraph with respect to stabilization on the inside front cover page of the Prospectus and the 4. 5 statements contained in the first, second and sixth paragraphs under the caption "Underwriting" in the Prospectus. The Company acknowledges that the statements referred to in the previous sentence constitute the only information furnished in writing by the Representative on behalf of the several Underwriters specifically for inclusion in the Registration Statement, any preliminary prospectus or the Prospectus. (b) The financial statements of the Company (including all notes and schedules thereto) included in the Registration Statement and Prospectus present fairly the financial position, the statements of operations, stockholders' equity, and cash flows and the other information purported to be shown therein of the Company; and such financial statements (including all notes and schedules thereto) have been prepared in conformity with generally accepted accounting principles, consistently applied throughout the periods involved, and all adjustments necessary for a fair presentation of the results for such periods have been made. The other financial and statistical information and data set forth in the Registration Statement and the Prospectus is accurately presented and, to the extent such information and data is derived from the financial statements and books and records of the Company, is prepared on a basis consistent with such financial statements and books and records. (c) Ernst & Young LLP, whose reports are filed with the Commission as a part of the Registration Statement, are and, during the periods covered by their reports, were independent public accountants with respect to the Company as required by the Securities Act and the Rules. (d) The Company has been duly incorporated and is a validly existing corporation in good standing under the laws of the jurisdictions in which each is incorporated. The Company has no subsidiaries and does not control, directly or indirectly, any corporation, partnership, joint venture, association or other business organization. The Company is duly qualified and in good standing as a foreign corporation in each jurisdiction in which the character or location of its assets or properties (owned, leased or licensed) or the nature of its business makes such qualification necessary, except for such jurisdictions where the failure to so qualify would not have a material adverse effect on the assets or properties, business, results of operations or condition (financial or otherwise) of the Company taken as a whole (a "Material Adverse Effect"). Except as disclosed in the Registration Statement and the Prospectus, the Company does not own, lease or license any material asset or property or conduct any material business outside the United States of America. The Company has all requisite corporate power and authority, and all necessary authorizations, 5. 6 approvals, consents, orders, licenses, certificates and permits of and from all governmental or regulatory bodies or any other person or entity, to own, lease and license its assets and properties and conduct its businesses as now being conducted and as described in the Registration Statement and the Prospectus except for such authorizations, approvals, consents, orders, licenses, certificates and permits the failure to so obtain would not have a Material Adverse Effect; no such authorization, approval, consent, order, license, certificate or permit contains a materially burdensome restriction other than as disclosed in the Registration Statement and the Prospectus; and the Company has all such corporate power and authority, and such authorizations, approvals, consents, orders, licenses, certificates and permits to enter into, deliver and perform this Agreement and to issue and sell the Shares (except as may be required under the Securities Act and state and foreign Blue sky laws). (e) The Company owns or possesses adequate and enforceable rights to use all patents, trademarks, trademark applications, trade names, service marks, copyrights, copyright applications, licenses, know-how (including trade secrets and other unpatented and/or unpatentable proprietary or confidential information, systems or procedures) and other similar rights and proprietary knowledge (collectively, "Intangibles") necessary for or incidental to the conduct of its business as described in the Registration Statement and the Prospectus. Except as disclosed in the Registration Statement and the Prospectus, the Company has not received any notice of, and to the best of its knowledge is not aware of, any infringement of or conflict with asserted rights of others with respect to any Intangibles which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, could have a Material Adverse Effect and the Company does not know of any reasonable basis therefor. Except as disclosed in the Registration Statement and the Prospectus, no Intangibles of the Company are in dispute or are in any conflict with the right of any other person or entity and the Company (i) has or will have the right (subject to applicable agreements, which agreements provide for use to the extent necessary and desirable for the conduct of its business as currently conducted and as proposed to be conducted) to use, free and clear of all liens, charges, claims, encumbrances, pledges, security interests, defects, restrictions or equities of any kind whatsoever all licenses and rights to the Intangibles used in the conduct of its business as now conducted or proposed to be conducted without infringing upon or otherwise acting adversely to the right or claimed right of any other person and (ii) is not or will not become, as the case may be, obligated or in any way liable for any payment by way of royalties, fees or otherwise to any owner or licensee of, or other claimant to, any 6. 7 Intangibles with respect to the use thereof or in connection with the conduct of its business or otherwise, except for any such payments, claims, uses, liens, charges, encumbrances, pledges, security interests, defects, restrictions and equities which would not have a Material Adverse Effect. (f) The Company does not own any real property. The Company has good and marketable title to each of the items of personal property which are reflected in the financial statements referred to in Section 4(b) or are referred to in the Registration Statement and the Prospectus as being owned by it and valid and enforceable leasehold interests in each of the items of real and personal property which are referred to in the Registration Statement and the Prospectus as being leased by it, in each case free and clear of all liens, encumbrances, claims, security interests and defects, other than those described in the Registration Statement and the Prospectus and those which would not have a Material Adverse Effect. (g) Except as described in the Registration Statement and the Prospectus there is no litigation or governmental or other proceeding or investigation before any court or before or by any public body or board pending or, to the Company's best knowledge, threatened (and the Company does not know of any reasonable basis therefor) against, or involving the assets, properties or business of, the Company which could have a Material Adverse Effect. (h) Subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, except as described therein, (i) there has not been any material adverse change in the assets or properties, business, results of operations, prospects or condition (financial or otherwise) of the Company, whether or not arising from transactions in the ordinary course of business; (ii) the Company has not sustained any material loss or interference with its assets, businesses or properties (whether owned, leased or licensed) from fire, explosion, earthquake, flood or other calamity, whether or not covered by insurance, or from any labor dispute or any court or legislative or other governmental action, order or decree; (iii) the inventories reflected in the financial statements of the Company filed with and as part of the Registration Statement and the Prospectus are currently and readily merchantable in all material respects, containing no material amount of slow moving, obsolete or damaged goods which have not been written down in conformity with generally accepted accounting principles applied on a basis consistent with prior periods; and (iv) the accounts receivables, net of allowances, reflected in the financial statements of the Company 7. 8 filed with and as a part of the Registration Statement and the Prospectus are, except to the extent heretofore collected, fully collectible and subject to no material counterclaims or set-offs; and since the date of the latest balance sheet included in the Registration Statement and the Prospectus, except as reflected therein, the Company has not (1) issued any securities (other than the grant of stock options and Common Stock issued upon exercise of stock options or warrants described in the Registration Statement and Prospectus) or incurred any liability or obligation, direct or contingent, for borrowed money, except such liabilities or obligations incurred in the ordinary course of business, (2) entered into any transaction not in the ordinary course of business or (3) declared or paid any dividend or made any distribution on any shares of its stock or redeemed, purchased or otherwise acquired or agreed to redeem, purchase or otherwise acquire any shares of its stock. (i) There is no document or contract of a character required to be described in the Registration Statement or Prospectus or to be filed as an exhibit to the Registration Statement which is not described or filed as required. Each agreement listed in the Exhibits to the Registration Statement is in full force and effect and is valid and enforceable by and against the Company in accordance with its terms, assuming the due authorization, execution and delivery thereof by each of the other parties thereto. Neither the Company nor, to the best of the Company's knowledge, any other party is in default in the observance or performance of any term or obligation to be performed by it under any such agreement, and no event has occurred which with notice or lapse of time or both would constitute such a default, in any such case which default or event could have a Material Adverse Effect. No default exists, and no event has occurred which with notice or lapse of time or both would constitute a default, in the due performance and observance of any term, covenant or condition, by the Company of any other agreement or instrument to which the Company is a party or by which it or its properties or business may be bound or affected which default or event could have a Material Adverse Effect. (j) The Company is not in violation of any term or provision of its charter or by-laws, in each case amended to the date hereof, or of any franchise, license, permit, judgment, decree, order, statute, rule or regulation, where the consequences of such violation could have a Material Adverse Effect. Except as described in the Registration Statement or Prospectus, the Company does not intend to amend its charter or by-laws. 8. 9 (k) Neither the execution, delivery and performance of this Agreement by the Company nor the consummation of any of the transactions contemplated hereby (including, without limitation, the issuance and sale by the Company of the Shares) will give rise to a right to terminate or accelerate the due date of any payment due under, or conflict with or result in the breach of any term or provision of, or constitute a default (or an event which with notice or lapse of time or both would constitute a default) under, or require any consent or waiver under, or result in the execution or imposition of any lien, charge or encumbrance upon any properties or assets of the Company pursuant to the terms of, any indenture, mortgage, deed of trust or other material agreement or instrument to which the Company is a party or by which it or any of its material properties or businesses is bound, or any material franchise, license, permit, judgment, decree, order, statute, rule or regulation applicable to the Company or violate any provision of the charter or by-laws of the Company, except for such consents or waivers which have already been obtained and are in full force and effect. No consent, approval, authorization, order, registration or qualification of or with any court or governmental agency or body is required for the issue and sale of the Shares or the consummation of the other transactions contemplated by this Agreement, except the registration under the Securities Act of the Shares, and such consents, approvals, authorizations, registrations or qualifications as may be required under state securities or Blue Sky laws in connection with the purchase and distribution of the Shares by the Underwriters. (l) The authorized, issued and outstanding capital stock of the Company and the capital stock reserved or committed for issuance is as set forth under the captions "Capitalization" and "Description of Capital Stock" in the Prospectus. All of the outstanding shares of Common Stock have been duly and validly issued and are fully paid and nonassessable and none of them was issued in violation of any preemptive or other similar right or any federal or state securities laws. The Shares, when issued and sold pursuant to this Agreement, will be duly and validly issued, fully paid and nonassessable and none of them will be issued in violation of any preemptive or other similar right or any federal or state securities laws. Except as disclosed in the Registration Statement and the Prospectus, there is no outstanding option, warrant or other right calling for the issuance of, and there is no commitment, plan or arrangement to issue, any share of stock of the Company or any security convertible into, or exercisable or exchangeable for, such stock. The Common Stock, the Shares and each other authorized class of capital stock of the Company and all warrants and securities convertible into classes of capital stock of the Company, 9. 10 conform in all material respects to all statements in relation thereto contained in the Registration Statement and the Prospectus. The Company has a sufficient number of authorized but unissued shares of Common Stock to enable the Company to issue, without further stockholder action, all the Shares to be sold by the Company. (m) Except as disclosed in the Prospectus, no holder of any security of the Company has the right to have any security owned by such holder included in the Registration Statement or to demand registration of any security owned by such holder during the period ending 90 days after the date of this Agreement. The provisions of all registration rights agreements described in the Prospectus have been fully complied with or waived and the sale of the Shares pursuant to this Agreement will not conflict with any such registration rights, except such as have been fully complied with or waived. Each director and officer of the Company has delivered to the Representative an enforceable written agreement (a "Lockup Agreement") that such person or entity will not, for a period of 90 days after the date of this Agreement, offer for sale, sell, distribute, grant any option for the sale of, or otherwise dispose of, directly or indirectly, or exercise any registration rights with respect to, any shares of Common Stock (or any securities convertible into, exercisable for, or exchangeable for any shares of Common Stock) owned by them, without the prior written consent of the Representative on behalf of the several Underwriters. The Company has used its best efforts to obtain a signed Lockup Agreement from each stockholder owning 5% or more of the Common Stock and has delivered all agreements so obtained to the Representative. (n) All necessary corporate action has been duly and validly taken by the Company to authorize the execution, delivery and performance of this Agreement and the issuance and sale of the Shares by the Company. This Agreement has been duly and validly authorized, executed and delivered by the Company and constitutes and will constitute a legal, valid and binding obligation of the Company enforceable against the Company in accordance with its respective terms, except (i) as the enforceability thereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the enforcement of creditors' rights generally and by general equitable principles and (ii) to the extent that rights to indemnity or contribution under this Agreement may be limited by federal and state securities laws or the public policy underlying such laws. 10. 11 (o) The Company is not involved in any labor dispute nor, to the best knowledge of the Company, is any such dispute threatened, which dispute could have a Material Adverse Effect. Except as set forth in the Registration Statement and Prospectus, the Company has not violated any applicable safety or similar law applicable to its business nor any federal or state law relating to discrimination in the hiring, promotion or pay of employees, nor any applicable federal or state wages and hours law, nor any provisions of the Employee Retirement Income Security Act or the rules and regulations promulgated thereunder, the violation of any of which could have a Material Adverse Effect. (p) No transaction has occurred between or among the Company and any of its officers or directors or any affiliate or affiliates of any such officer or director that is required to be described in and is not described in the Registration Statement and the Prospectus. (q) The Company has not taken, nor will it take, directly or indirectly, any action designed to or which might reasonably be expected to cause or result in, or which has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of the Common Stock to facilitate the sale or resale of any of the Shares. (r) The Company has not ever been denied a license, permit or authorization material to the operation of its business, and the operating practices and procedures of the Company is in material compliance with all applicable federal, state and local laws, rules and regulations. (s) Except for matters which, individually or in the aggregate, would not have a Material Adverse Effect, (i) the Company has obtained all permits, licenses and other authorizations which are required under the Environmental Laws (as defined below), (ii) the Company is in full compliance with all terms and conditions of all permits, licenses and authorizations required under the Environmental Laws, (iii) the Company is in full compliance with all limitations, restrictions, conditions, standards, prohibitions, requirements, obligations, schedules and timetables contained in the Environmental Laws or contained in any regulation, code, plan, consent or other order, decree, judgment, notice of violation or other notice, or demand letter issued, entered, promulgated or approved thereunder (collectively, the "Environmental Requirements"), (iv) no officer of the Company is aware of nor has he or she received (A) notice (written or oral) from a governmental authority, citizens group, employee or otherwise that alleges that the Company is not in full compliance with one or more Environmental Requirements, or (B) notice 11. 12 (written or oral) respecting the Company of any past, present or future events, conditions, circumstances, activities, practices, incidents, actions or plans that may interfere with or prevent continued compliance with all Environmental Requirements, or that may give rise to any common law or other legal liability or otherwise form the basis of any claim, action, suit proceeding, hearing or investigation (each, an "Action"), based on or related to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling, or the emission, discharge, release or threatened release, of any chemical, pollutant, contaminant, or hazardous or toxic material or waste or petroleum or petroleum products into ambient air, surface water, ground water or land, and (v) there is no Action relating to any Environmental Requirement pending or, to the best knowledge of the Company threatened against or affecting (A) the Company or its properties, or (B) any person or entity whose liability for such Action has or may have been retained or assumed either contractually or by operation of law by the Company. "Environmental Laws" shall mean federal, state and local laws relating to pollution or protection of human health or the environment, including, without limitation, laws (including the common law) relating to emissions, discharges, releases or threatened releases of chemicals, pollutants, contaminants or hazardous or toxic materials or wastes or petroleum or petroleum products into ambient air, surface water, ground water or land, or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of chemicals, pollutants, contaminants or hazardous or toxic materials or wastes or petroleum or petroleum products. (t) Except as described in the Registration Statement or the Prospectus, there is no action, suit, investigation or proceeding pending or to the knowledge of the Company threatened before or by any federal or state court, commission, regulatory body, administrative agency or other governmental body, domestic or foreign, or arbitrator to which the Company is or may become a party or of which any property of the Company is subject or affected that (i) could affect the consummation of the transactions contemplated under this Agreement, including the issuance or validity of the Shares, (ii) could have a Material Adverse Effect or (iii) is required to be disclosed in the Registration Statement or the Prospectus. All pending legal or governmental proceedings to which the Company is a party or of which any of its respective properties are subject or affected which are not described in the Prospectus, including ordinary routine litigation incidental to the business, would not have a Material Adverse Effect. 12. 13 (u) The Company has such licenses, permits and other approvals or authorizations of and from governmental or regulatory authorities ("Permits") as are materially necessary under applicable law to own its properties and to conduct its business in the manner now being conducted and as described in the Registration Statement and the Prospectus, except such Permits which individually or in the aggregate would not have a Material Adverse Effect; and the Company has fulfilled and performed all of its obligations with respect to such Permits, and no event has occurred which allows, or after notice or lapse of time or both would allow, revocation or termination thereof or result in any other material impairment of the rights of the holder of any such Permits except such Permits which individually or in the aggregate would not have a Material Adverse Effect. The Company has never been denied a Permit of the type referred to in this Section 4(u). (v) The Company has timely filed all federal, state, local and foreign tax returns which are required to be filed through the date hereof, or has received extensions thereof, and has paid all taxes shown on such returns and all assessments received by it to the extent that the same are material and have become due. The Company has no knowledge, nor any reasonable grounds to know, of any tax deficiencies which could have a Material Adverse Effect; the Company has paid all taxes which have become due, whether pursuant to any assessment, or otherwise, and there is no further liability (whether or not disclosed on such returns) or assessment for any such tax, and no interest or penalties accrued or accruing with respect thereto, except as may be set forth or adequately reserved for in the financial statements included in the Registration Statement and the Prospectus; the amounts currently set up as provisions for taxes or otherwise by the Company on its books and records are sufficient for the payment of all its unpaid federal, foreign, state, county and local taxes accrued through the dates as of which they speak, and for which the Company may be liable in its own right, or as a transferee of the assets of, or as successor to any other corporation, association, partnership, joint venture or other entity. (w) The Company is insured by insurers of recognized financial responsibility against such losses and risks and in such amounts as are customary in the businesses in which they are engaged; and the Company has no reason to believe that it will not be able to renew its existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business at a cost that would not have a Material Adverse Effect. 13. 14 (x) The books, records and accounts of the Company accurately and fairly reflect, in reasonable detail, the transactions in, and dispositions of, the assets of, and the results of operations of, the Company. The Company maintains a system of internal accounting controls sufficient to provide reasonable assurance that (A) transactions are executed in accordance with management's general or specific authorizations; (B) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain asset accountability; (C) access to assets is permitted only in accordance with management's general or specific authorization; and (D) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (y) The Shares have been duly authorized for quotation on the Nasdaq National Market. (z) The Company is not an "Investment Company" within the meaning of the Investment Company Act of 1940. (aa) Neither the Company nor, to the Company's knowledge, any employee or agent of the Company have made any payment of funds of the Company or received or retained any funds in violation of any law, rule or regulation, which payment, receipt or retention of funds is of a character required to be disclosed in the Registration Statement and Prospectus. (bb) The documents incorporated or deemed to be incorporated by reference in the Prospectus, at the time they were or hereafter are filed with the Commission, complied and will comply in all material respects with the requirements of the Exchange Act, and, when read together with the other information in the Prospectus, at the time the Registration Statement and any amendments thereto become effective and at each Closing Date will not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading. 5. CONDITIONS OF THE UNDERWRITERS' OBLIGATIONS. The obligations of the Underwriters under this Agreement are several and not joint. The respective obligations of the Underwriters to purchase the Shares are subject to each of the following terms and conditions: 14. 15 (a) The Prospectus shall have been timely filed with the Commission in accordance with Section 6(a) of this Agreement. (b) No order preventing or suspending the use of any preliminary prospectus or the Prospectus shall have been or shall be in effect and no order suspending the effectiveness of the Registration Statement shall be in effect and no proceedings for such purpose shall be pending before or threatened by the Commission, and any requests for additional information on the part of the Commission (to be included in the Registration Statement or the Prospectus or otherwise) shall have been complied with to the satisfaction of the Representative. (c) The representations and warranties of the Company contained in this Agreement and in the certificates delivered pursuant to Section 5(d) shall be true and correct when made and on and as of each Closing Date as if made on such date, and the Company shall have performed all covenants and agreements and satisfied all the conditions contained in this Agreement required to be performed or satisfied by it at or before such Closing Date. (d) The Representative shall have received on each Closing Date a certificate, addressed to the Representative and dated such Closing Date, of the chief executive officer and the chief financial officer of the Company to the effect that the signers of such certificate have carefully examined the Registration Statement, the Prospectus and this Agreement and that the representations and warranties of the Company in this Agreement are true and correct on and as of such Closing Date with the same effect as if made on such Closing Date and the Company has performed all covenants and agreements and satisfied all conditions contained in this Agreement required to be performed or satisfied by it at or prior to such Closing Date. (e) The Representative shall have received at the time this Agreement is executed and on each Closing Date a signed letter from Ernst & Young LLP addressed to the Representative and dated, respectively, the date of this Agreement and each such Closing Date, in form and substance satisfactory to the Representative and counsel to the Underwriters, containing statements and information of the type ordinarily inlcuded in accountant's "comfort letters" to underwriters with respect to audited financial statements and certain financial information contained in the Registration Statement and the Prospectus and confirming that they are independent public accountants with respect to the Company within the meaning of the Securities Act and the applicable published rules and regulations thereunder. The letters shall not disclose any change, or any development involving a prospective change, in or affecting the business or properties of the Company which, in the sole judgment of the Representative, makes it impractical or inadvisable to proceed with the public offering of the 15. 16 Firm Shares or the Option Shares as contemplated by the Prospectus. References to the Registration Statement and the Prospectus in this paragraph (e) are to such documents as amended and supplemented at the date of the letter. (f) The Representative shall have received on each Closing Date from Katten Muchin & Zavis, counsel for the Company, an opinion, addressed to the Representative and dated such Closing Date, and stating in effect that: (i) The Company is duly incorporated and is validly existing in good standing under the laws of the State of Delaware. To the best of such counsel's knowledge, the Company has no subsidiaries and does not control, directly or indirectly, any corporation, partnership, joint venture, association or other business organization. The Company is duly qualified and in good standing as a foreign corporation in each jurisdiction in which, to the best of such counsel's knowledge, the character or location of its assets or properties (owned, leased or licensed) or the nature of its businesses makes such qualification necessary, except for such jurisdictions where the failure to so qualify would not, independently or collectively, have a Material Adverse Effect. (ii) The Company has all requisite corporate power and authority to own, lease and license its assets and properties and conduct its business as now being conducted and as described in the Registration Statement and the Prospectus; and the Company has all requisite corporate power and authority and all necessary authorizations, approvals, consents, orders, licenses, certificates and permits to enter into, deliver and perform this Agreement and to issue and sell the Shares other than those required under the Securities Act and state and foreign Blue Sky laws and those which, if not obtained, would not have a Material Adverse Effect; (iii) The Company has authorized and issued capital stock as described in the Registration Statement and the Prospectus; the certificates evidencing the Shares are in due and proper legal form and have been duly authorized for issuance by the Company; all of the outstanding shares of Common Stock of the Company reflected in the Registration Statement and Prospectus have been duly and validly authorized and have been duly and validly issued and are fully paid and nonassessable and none of them was issued in violation of any statutory preemptive or other similar statutory right or, to the best of such counsel's knowledge, any right of first refusal. The Shares when issued and sold pursuant to this Agreement will be duly and validly issued, outstanding, fully paid and nonassessable and none of them will have been issued in violation of any statutory preemptive or other similar statutory right. The provisions of all registration rights, described in the Prospectus or otherwise, have been complied with or waived and the sale of the Shares pursuant to this Agreement will not 16. 17 conflict with any such registration rights. To the best of such counsel's knowledge, except as disclosed in the Registration Statement and the Prospectus, there is no outstanding option, warrant or other right calling for the issuance of, and no commitment, plan or arrangement to issue, any share of stock of the Company or any security convertible into, exercisable for, or exchangeable for stock of the Company. The Common Stock and the Shares conform in all material respects to the descriptions thereof contained in the Registration Statement and the Prospectus. The Company has a sufficient number of authorized but unissued shares of Common Stock to enable the Company to issue, without further stockholder action, all the Shares to be sold by the Company. (iv) The Company has all requisite corporate power and authority to execute and deliver this Agreement and to perform its obligations under this Agreement. All necessary corporate action has been duly and validly taken by the Company to authorize the execution, delivery and performance of this Agreement and the issuance and sale of the Shares by the Company. This Agreement has been duly and validly authorized, executed and delivered by the Company, and this Agreement constitutes the legal, valid and binding obligation of the Company enforceable against the Company in accordance with its terms except (A) as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the enforcement of creditors' rights generally and by general equitable principles and (B) to the extent that rights to indemnity or contribution under this Agreement may be limited by federal or state securities laws or the public policy underlying such laws. (v) Neither the execution, delivery and performance of this Agreement by the Company nor the consummation of any of the transactions contemplated hereby (including, without limitation, the issuance and sale by the Company of the Shares) will give rise to a right to terminate or accelerate the due date of any payment due under, or conflict with or result in the breach of any term or provision of, or constitute a default (or any event which with notice or lapse of time, or both, would constitute a default) under, or require consent or waiver under, or result in the execution or imposition of any lien, charge or encumbrance upon any properties or assets of the Company pursuant to the terms of any indenture, mortgage, deed of trust, note or other material agreement or instrument of which such counsel is aware and to which the Company is a party or by which it or any of its properties or businesses is bound, or any material franchise, license, permit, judgment, decree, order, statute, rule or regulation of which such counsel is aware or violate any provision of the charter or by-laws of the Company. 17. 18 (vi) The Common Stock, including the Shares, has been approved for quotation on the Nasdaq National Market subject to official notice of listing of the Shares. (viI) To the best of such counsel's knowledge, no default exists, and no event has occurred which with notice or lapse of time, or both, would constitute a default, in the due performance and observance of any term, covenant or condition by the Company of any indenture, mortgage, deed of trust, note or any other agreement or instrument to which the Company is a party or by which it or any of its assets or properties or businesses may be bound or affected, where the consequences of such default could have a Material Adverse Effect. (VIII) To the best of such counsel's knowledge, the Company is not in violation of any term or provision of its charter or by-laws. (ix) No consent, approval, authorization or order of any court or governmental agency or body is required for the performance of this Agreement by the Company or the consummation of the transactions contemplated hereby, except such as have been obtained under the Securities Act and such as may be required under state securities or Blue Sky laws in connection with the purchase and distribution of the Shares by the several Underwriters (as to which such counsel need express no opinion) and such as may be required under the rules of the National Association of Securities Dealers, Inc. with respect to the underwriting arrangements reflected in this Agreement (as to which such counsel need express no opinion). (X) Except as described in the Registration Statement and the Prospectus, to the best of such counsel's knowledge, there is no litigation or governmental or other proceeding or investigation, before any court or before or by any public body or board pending or threatened against, or involving the assets, properties or businesses of, the Company which could have a Material Adverse Effect. (xi) All contracts and other documents, statutes, legal or governmental proceedings required to be filed as exhibits to, or described in, the Registration Statement have been so filed with the Commission or are fairly described in the Registration Statement, as the case may be. (xii) The Registration Statement, all preliminary prospectuses and the Prospectus and each amendment or supplement thereto (except for the financial statements and schedules and other financial and accounting data included therein, as to which such counsel need expresses no opinion) comply as 18. 19 to form in all material respects with the requirements of the Securities Act and the Rules. (xiii) The Registration Statement has become effective under the Securities Act and, to the best of such counsel's knowledge, no stop order suspending the effectiveness of the Registration Statement has been issued and no proceedings for that purpose have been instituted or are threatened, pending or contemplated; and any required filing of the Prospectus, pursuant to Rule 424(b) of the Rules has been made in accordance with the provisions thereof. (xiv) The registration of the Common Stock under Section 12(g) of the Exchange Act has become effective. (xv) Each document filed pursuant to the Exchange Act (other than the financial statements and supporting schedules included therein, as to which no opinion need be rendered) and incorporated or deemed to be incorporated by reference in the Prospectus complied when so filed as to form in all material respects with the Exchange Act; and such counsel has no reason to believe that any of such documents, when they were so filed, contained an untrue statement of a material fact or omitted to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made when such documents were filed, not misleading." (xvi) The Company is not an "Investment Company" within the meaning of the Investment Company Act of 1940. To the extent deemed advisable by such counsel, they may rely as to matters of fact on certificates of responsible officers of the Company and public officials and on the opinions of other counsel reasonably satisfactory to the Representative as to matters which are governed by laws other than the laws of the States of Illinois and Delaware and the federal laws of the United States; provided that such counsel shall state that in their opinion they know of no reason why the Underwriters and they are not justified in relying on such other opinions. Copies of such certificates and other opinions shall be furnished to the Representative and counsel for the Underwriters. In addition, such counsel shall state that such counsel has participated in conferences with officers and other representatives of the Company, representatives of the Representative and representatives of the independent certified public accountants of the Company, at which conferences the contents of the Registration Statement and the Prospectus and related matters were discussed and, although such counsel is not passing upon and does not assume any responsibility for the accuracy, completeness or fairness of the statements contained in the Registration Statement and the Prospectus (except as specified in the foregoing opinion), on the basis of the foregoing, no facts have come to 19. 20 the attention of such counsel that have caused such counsel to believe that the Registration Statement at the time it became effective (except with respect to the financial statements and notes and schedules thereto and other financial data, as to which such counsel need express no belief) contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or that the Prospectus as amended or supplemented (except with respect to the financial statements and notes schedules thereto and other financial data, as to which such counsel need express no belief) on the date thereof contained or at the Closing Date contains any untrue statement of a material fact or omitted or omits to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. (g) The Representative shall have received on each Closing Date from Marshall, O'Toole, Gerstein, Murray & Borun, patent counsel for the Company, an opinion, addressed to the Representative and dated such Closing Date, in form and substance satisfactory to Cooley Godward LLP, counsel to the Underwriters, and stating in effect that: (i) The statements under the captions "Risk Factors- Intellectual Property and Patents" and "Business-Intellectual Property and Patents," in the Registration Statement and the Prospectus, to the extent that they reflect matters of law, summaries of law or regulations, or patent status, are correct in all material respects, subject to the qualifications set forth therein; and such counsel do not know of any statutes, legal and governmental proceedings, contracts and other documents relating to the Company's patents and patent applications required to be described in the Prospectus that are not described as required; (ii) The Company's patent applications prepared by such counsel have been properly prepared and filed on behalf of the Company and, to the best of such counsel's knowledge, the Company's other patent applications have been properly prepared and filed on behalf of the Company; except as set forth in the Prospectus, each of the patents issued therefrom and the applications are held by the Company and, except as set forth in the Prospectus, to the best of such counsel's knowledge, no other entity or individual has any right or claim in any of the Company's patents, patent applications or any patent to be issued therefrom and such counsel is unaware of any facts which form a basis for a finding of unenforceability or invalidity of any of the patents or patent rights owned by, licensed to or used by the Company; (iii) To the best of such counsel's knowledge, the Company owns or possesses sufficient rights to use all patents necessary for the conduct 20. 21 of its business now being or proposed to be conducted as described in the Prospectus; (iv) to the best of such counsel's knowledge, (A) the Company has conducted its business without infringement of any patents or patent rights of others and (B) there are no infringements by others of any of the Company's patent or patent rights which in the judgment of such counsel could affect materially the use thereof by the Company; (v) to the best of such counsel's knowledge, there is not pending or threatened any action, suit or proceeding to which the Company is a party, before or by any court or governmental agency or body relating to patents or patent rights or patent applications; (vi) Nothing has come to the attention of such counsel that would lead such counsel to believe that any of the representations and warranties of the Company contained in Section 4(e) of this Agreement are not true and correct as of the Closing Date; and (vii) Such counsel have reviewed the statements under the captions "Risk Factors-Intellectual Property and Patents" and "Business-Intellectual Property and Patents," in the Registration Statement and the Prospectus, and any further amendments or supplements thereto made by the Company prior to the Closing Date, and such counsel have no reason to believe that either such portions of the Registration Statement, when such portions became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading or that the such portions of the Prospectus and any amendment or supplement thereto, as of the date thereof, on the date of filing thereof with the Commission, and the Closing Date, included an untrue statement of a material fact or omitted to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading. (h) All proceedings taken in connection with the sale of the Firm Shares and the Option Shares as herein contemplated shall be reasonably satisfactory in form and substance to the Representative and their counsel and the Underwriters shall have received from Cooley Godward LLP a favorable opinion, addressed to the Representative and dated such Closing Date, with respect to the Shares, the Registration Statement and the Prospectus, and such other related matters, as the Representative may reasonably request, and the Company shall have furnished to Cooley Godward LLP such documents as they may reasonably request for the purpose of enabling them to pass upon such matters. 21. 22 (i) The Company shall have in place on the Closing Date an insurance policy which covers the Company as well as its directors and officers, covering potential liabilities under the Securities Act and the Exchange Act providing coverage of no less that $__,000,000 and a term of no less than one year from the date of this Agreement. (j) The Shares to be purchased on the Closing Date by the Underwriters shall have been approved for quotation on the Nasdaq National Market. (k) All directors and officers of the Company, shall have agreed in writing, in form and substance satisfactory to the Representative, that such person or entity will not, for a period 90 days after the date of this Agreement directly or indirectly, except with prior written consent of the Representative, offer, sell, grant any option to purchase, or otherwise dispose (or announce any offer, sale, grant of an option to purchase or other disposition) of any shares of Common Stock or any securities convertible into, or exchangeable or exercisable for, such shares of Common Stock. (l) The Representative shall have been furnished with such additional documents and certificates as the Representative or counsel for the Underwriters may reasonably request related to this Agreement and the transactions contemplated hereby. All such opinions, certificates, letters and documents shall be in compliance with the provisions hereof only if they are satisfactory in form and substance to the Representative and to counsel for the Underwriters, in each case in their reasonable judgment. The Company shall furnish to the Representative conformed copies of such opinions, certificates, letters and other documents in such number as the Representative shall reasonably request. 6. COVENANTS OF THE COMPANY. The Company covenants and agrees as follows: (a) The Company shall prepare the Prospectus in a form approved by the Representative and file such Prospectus pursuant to Rule 424(b) or Rule 434 under the Securities Act within the time period required thereby following the execution and delivery of this Agreement, or, if applicable, such earlier time as may be required by Rule 430A(a)(3) under the Securities Act, and shall promptly advise the Representative (i) when any amendment to the Registration Statement shall have become effective, (ii) of any request by the Commission for any amendment of the Registration Statement or the Prospectus or for any additional information, (iii) of the prevention or suspension of the use of any preliminary prospectus or the Prospectus or of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or the institution or threatening of any proceeding for that purpose and (iv) of the receipt by the 22. 23 Company of any notification with respect to the suspension of the qualification of the Shares for sale in any jurisdiction or the initiation or threatening of any proceeding for such purpose. The Company shall not file any amendment of the Registration Statement or supplement to the Prospectus unless the Company has furnished the Representative a copy for their review prior to filing and shall not file any such proposed amendment or supplement to which the Representative reasonably object. The Company shall use its best efforts to prevent the issuance of any such stop order and, if issued, to obtain as soon as possible the withdrawal thereof. (b) If, at any time when a prospectus relating to the Shares is required to be delivered under the Securities Act and the Rules, any event occurs as a result of which the Prospectus as then amended or supplemented would include any untrue statement of a material fact or omit to state any material fact necessary to make the statements therein in the light of the circumstances under which they were made not misleading, or if it shall be necessary to amend or supplement the Prospectus to comply with the Securities Act or the Rules, the Company promptly shall prepare and file with the Commission, subject to the second sentence of Section 6(a), an amendment or supplement which shall correct such statement or omission or an amendment which shall effect such compliance. (c) The Company shall make generally available to its security holders and to the Representative as soon as practicable, but not later than 45 days after the end of the 12-month period beginning at the end of the fiscal quarter of the Company during which the Effective Date occurs (or 90 days if such 12-month period coincides with the Company's fiscal year), an earnings statement (which need not be audited) of the Company, covering such 12-month period, which shall satisfy the provisions of Section 11(a) of the Securities Act or Rule 158 of the Rules. (d) The Company shall furnish to the Representative and counsel for the Underwriters, without charge, signed copies of the Registration Statement (including all exhibits thereto and amendments thereof) and to each other Underwriter a copy of the Registration Statement (without exhibits thereto) and all amendments thereof and, so long as delivery of a prospectus by an Underwriter or dealer may be required by the Securities Act or the Rules, as many copies of any preliminary prospectus and the Prospectus and any amendments thereof and supplements thereto as the Representative may reasonably request. (e) The Company shall cooperate with the Representative and its counsel in endeavoring to qualify the Shares for offer and sale under the laws of such jurisdictions as the Representative may designate and shall maintain such 23. 24 qualifications in effect so long as required for the distribution of the Shares; provided, however, that the Company shall not be required in connection therewith, as a condition thereof, to qualify as a foreign corporation or to execute a general consent to service of process in any jurisdiction or subject itself to taxation as doing business in any jurisdiction. (f) For a period of five years after the date of this Agreement, the Company shall supply to the Representative, and to each other Underwriter who may so request in writing, copies of (i) such financial statements and other periodic and special reports as the Company may from time to time distribute generally to the holders of any class of its capital stock and (ii) any information, documentation or report it shall file or shall be required to file with the Commission. (g) Without the prior written consent of the Representative, for a period of 90 days after the date of this Agreement, the Company shall not issue, sell or register with the Commission (other than on Form S-8 or on any successor form), or otherwise dispose of, directly or indirectly, any equity securities of the Company (or any securities convertible into or exercisable or exchangeable for equity securities of the Company), except for (i) the issuance of the Shares pursuant to the Registration Statement and, as described in footnote 1 to the table under the caption "Capitalization" in the Preliminary Prospectus, (ii) the issuance of Common Stock pursuant to the exercise of options granted under the Company's 1993 Stock Option Plan, (iii) the issuance of Common Stock pursuant to the exercise of warrants outstanding as of the date hereof and (iv) the grant of options to purchase Common Stock under the Company's 1993 Stock Option Plan. (h) On or before the Firm Shares Closing Date, the Company shall make all filings required under applicable securities laws and by the Nasdaq National Market (including any required registration under the Exchange Act) in order to permit the consummation of the transactions contemplated hereby. (i) The Company shall apply the net proceeds of the sale of the Shares issued and to be sold by it as set forth in the Prospectus. The Company shall take such steps as shall be necessary to ensure that for a period of three years from the Effective Date the Company will not become an "investment company" within the meaning of such term under the Investment Company Act of 1940, as amended, and the rules and regulations thereunder. (j) The Company agrees to pay, or reimburse if paid by the Representative, whether or not the transactions contemplated hereby are consummated or this Agreement is terminated, all costs and expenses incident to 24. 25 the public offering of the Shares and the performance of the obligations of the Company under this Agreement including those relating to: (i) the preparation, printing, filing and distribution of the Registration Statement including all exhibits thereto, each preliminary prospectus, the Prospectus, all amendments and supplements to the Registration Statement and the Prospectus, and the printing, filing and distribution of this Agreement; (ii) the preparation and delivery of certificates for the Shares to the Underwriters; (iii) the registration or qualification of the Shares for offer and sale under the securities or Blue Sky laws of the various jurisdictions referred to in Section 6(e), including the fees and disbursements of counsel for the Underwriters in connection with such registration and qualification; (iv) the furnishing (including costs of shipping and mailing) to the Representative and to the Underwriters of copies of each preliminary prospectus, the Prospectus and all amendments or supplements to the Prospectus, and of the several documents required by this Section to be so furnished, as may be reasonably requested for use in connection with the offering and sale of the Shares by the Underwriters or by dealers to whom Shares may be sold; (v) the filing fees of the National Association of Securities Dealers, Inc. in connection with its review of the terms of the public offering and the fees and disbursements of counsel for the Underwriters in connection with such review; (vi) the furnishing (including costs of shipping and mailing) to the Representative and to the Underwriters of copies of all reports and information required by Section 6(f); (vi) inclusion of the Shares for quotation on the Nasdaq National Market; and (viii) all transfer taxes, if any, with respect to the sale and delivery of the Shares by the Company to the Underwriters. (k) During the period beginning on the date hereof and ending no earlier than the date as in the opinion of counsel for the Underwriters the Prospectus is required by law to be delivered in connection with sales by an Underwriter or dealer, the Company will file all documents required to be filed with the Commission pursuant to Section 13, 14 or 15 of the Exchange Act in the manner and within the time periods required by the Exchange Act. 7. INDEMNIFICATION. (a) The Company agrees to indemnify and hold harmless each Underwriter and each person, if any, who controls any Underwriter within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act against any and all losses, claims, damages and liabilities, joint or several (including any reasonable investigation, legal and other expenses incurred in connection with, and any amount paid in settlement of, any action, suit or proceeding or any claim asserted), to which they, or any of them, may become subject under the Securities Act, the Exchange Act or other federal or state law or regulation, at common law or otherwise, insofar as such losses, claims, 25. 26 damages or liabilities arise out of or are based upon (i) any untrue statement or alleged untrue statement of a material fact contained in any preliminary prospectus, the Registration Statement or the Prospectus or any amendment thereof or supplement thereto, or in any Blue Sky application or other document executed by the Company filed in any state or other jurisdiction to quantify any or all of the Shares under the securities laws thereof (any such application document or information being hereinafter referred to as a "Blue Sky Application") or arise out of or are based upon any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading or (ii) any breach of the representations and warranties set forth in Section 4 hereof; provided, however, that such indemnity shall not inure to the benefit of any Underwriter (or any person controlling such Underwriter) on account of any losses, claims, damages or liabilities arising from the sale of the Shares to any person by such Underwriter if such untrue statement or omission or alleged untrue statement or omission was made in such preliminary prospectus, the Registration Statement or the Prospectus, or such amendment or supplement, or any Blue Sky Application in reliance upon and in conformity with information furnished in writing to the Company by the Representative on behalf of any Underwriter specifically for use therein. In addition to its other obligations under this Section 7(a), the Company agrees that, as an interim measure while any claim, action, suit, investigation, inquiry or other proceeding referred to in this Section 7(a) is pending, it will reimburse the Underwriters on a monthly basis for all reasonable legal fees or other out-of-pocket expenses reasonably incurred in connection with investigating or defending any such claim, action, suit, investigation, inquiry or other proceeding, notwithstanding the absence of a judicial determination as to the propriety and enforceability of the Company's obligation to reimburse the Underwriters for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. To the extent that any such interim reimbursement payment is so held to have been improper, the Underwriters shall promptly return it to the Company. This indemnity agreement will be in addition to any liability which the Company may otherwise have. (b) Each Underwriter agrees, severally and not jointly, to indemnify and hold harmless the Company, each person, if any, who controls the Company within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act, each director of the Company, and each officer of the Company who signs the Registration Statement, to the same extent as the foregoing indemnity from the Company to each Underwriter, but only insofar as such losses, claims, damages or liabilities arise out of or are based upon any untrue statement or omission or alleged untrue statement or omission which was made in any preliminary prospectus, the Registration Statement or the Prospectus, or any amendment thereof or supplement thereto, with respect to stabilization on the 26. 27 inside front cover page of the Prospectus and the statements contained in the first, second and sixth paragraphs under the caption "Underwriting" in the Prospectus; provided, however, that the obligation of each Underwriter (including any controlling person, director or officer thereof) shall be limited to the net underwriting commission received by such Underwriter in connection with the sale of the Shares. (c) Any party that proposes to assert the right to be indemnified under this Section 7 will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect of which a claim is to be made against an indemnifying party or parties under this Section, notify each such indemnifying party of the commencement of such action, suit or proceeding, enclosing a copy of all papers served. No indemnification provided for in Section 7(a) or 7(b) shall be available to any party who shall fail to give notice as provided in this Section 7(c) if the party to whom notice was not given was unaware of the proceeding to which such notice would have related and was prejudiced by the failure to give such notice but the omission so to notify such indemnifying party of any such action, suit or proceeding shall not relieve it from any liability that it may have to any indemnified party for contribution or otherwise than under this Section 7. In case any such action, suit or proceeding shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate in, and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel reasonably satisfactory to such indemnified party, and after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof and the approval by the indemnified party of such counsel, the indemnifying party shall not be liable to such indemnified party for any legal or other expenses, except as provided below and except for the reasonable costs of investigation subsequently incurred by such indemnified party in connection with the defense thereof. The indemnified party shall have the right to employ its counsel in any such action, but the fees and expenses of such counsel shall be at the expense of such indemnified party unless (i) the employment of counsel by such indemnified party has been authorized in writing by the indemnifying parties, (ii) the indemnified party shall have reasonably concluded that there may be a conflict of interest between the indemnifying parties and the indemnified party in the conduct of the defense of such action (in which case the indemnifying parties shall not have the right to direct the defense of such action on behalf of the indemnified party) or (iii) the indemnifying parties shall not have employed counsel to assume the defense of such action within a reasonable time after notice of the commencement thereof, in each of which cases the fees and expenses of counsel shall be at the expense of the indemnifying parties. An indemnifying 27. 28 party shall not be liable for any settlement of any action, suit, proceeding or claim effected without its written consent. 8. CONTRIBUTION. In order to provide for just and equitable contribution in circumstances in which the indemnification provided for in Section 7(a) is due in accordance with its terms but for any reason is held to be unavailable from the Company, the Company and the Underwriters shall contribute to the aggregate losses, claims, damages and liabilities (including any investigation, legal and other expenses reasonably incurred in connection with, and any amount paid in settlement of, any action, suit or proceeding or any claims asserted, but after deducting any contribution received by the Company from persons other than the Underwriters, such as persons who control the Company within the meaning of the Securities Act, officers of the Company who signed the Registration Statement and directors of the Company, who may also be liable for contribution) to which the Company and one or more of the Underwriters may be subject in such proportion as is appropriate to reflect the relative benefits received by the Company on the one hand and the Underwriters on the other from the offering of the Shares or, if such allocation is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to above but also the relative fault of the Company on the one hand and the Underwriters on the other in connection with the statements or omissions which resulted in such losses, claims, damages, liabilities or expenses, as well as any other relevant equitable considerations. The relative benefits received by the Company shall be deemed to be in the same proportion as (x) the total proceeds from the offering (net of underwriting discounts but before deducting expenses) received by the Company, as set forth in the table on the cover page of the Prospectus, bear to (y) the total price to the public of the offering as set forth in the table on the cover page of the Prospectus, and the relative benefits received by the Underwriters shall be deemed to be in the same proportion as (x) the underwriting discounts received by the Underwriters, as set forth in the table on the cover page of the Prospectus, bear to (y) the total price to the public of the offering as set forth in the table on the cover page of the Prospectus. The relative fault of the Company or the Underwriters shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact related to information supplied by the Company or the Underwriters and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and the Underwriters agree that it would not be just and equitable if contribution pursuant to this Section 8 were determined by pro rata allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above. Notwithstanding the provisions of this Section 8, (i) in no case shall any Underwriter (except as may be provided in the Agreement Among Underwriters) be liable or responsible for any amount in excess of the underwriting discount applicable to the Shares purchased by such Underwriter hereunder, and (ii) the Company shall be liable and responsible for any amount in excess of such underwriting discount; provided, however, that no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. For purposes of this Section 8, each person, if any, who 28. 29 controls an Underwriter within the meaning of Section 15 of the Securities Act or Section 20(a) of the Exchange Act shall have the same rights to contribution as such Underwriter, and each person, if any, who controls the Company within the meaning of the Section 15 of the Securities Act or Section 20(a) of the Exchange Act, each officer of the Company who shall have signed the Registration Statement and each director of the Company shall have the same rights to contribution as the Company, subject in each case to clauses (i) and (ii) in the immediately preceding sentence of this Section 8. Any party entitled to contribution will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect of which a claim for contribution may be made against another party or parties under this Section 8, notify such party or parties from whom contribution may be sought, but the omission so to notify such party or parties from whom contribution may be sought shall not relieve the party or parties from whom contribution may be sought from any other obligation it or they may have hereunder or otherwise than under this Section 8. No party shall be liable for contribution with respect to any action, suit, proceeding or claim settled without its written consent. The Underwriters' obligations to contribute pursuant to this Section 8 are several in proportion to their respective underwriting commitments and not joint. 9. TERMINATION. This Agreement may be terminated with respect to the Shares to be purchased on a Closing Date by the Representative by notifying the Company at any time (a) in the absolute discretion of the Representative at or before such Closing Date: (i) if on or prior to such date, any domestic or international event or act or occurrence has materially disrupted, or in the opinion of the Representative will in the future materially disrupt, the securities markets; (ii) if there has occurred any new outbreak or material escalation of hostilities or other calamity or crisis the effect of which on the financial markets of the United States is such as to make it, in the judgment of the Representative, inadvisable to proceed with the offering; (iii) if there shall be such a material adverse change in general financial, political or economic conditions or the effect of international conditions on the financial markets in the United States is such as to make it, in the judgment of the Representative, inadvisable or impracticable to market the Shares; (iv) if trading in the Common Stock has been suspended by the Commission or trading generally on the New York Stock Exchange, Inc., the American Stock Exchange, Inc. or the Nasdaq National Market has been suspended or limited, or minimum or maximum ranges for prices for securities shall have been fixed, or maximum ranges for prices for securities have been required, by said exchanges or by order of the Commission, the National Association of Securities Dealers, Inc., or any other governmental or regulatory authority; or (v) if a banking moratorium has been declared by any state or federal authority, or (b) at or before such Closing Date, that any of the conditions specified in Section 5 shall not have been fulfilled when and as required by this Agreement. 29. 30 If this Agreement is terminated pursuant to any of its provisions, the Company shall not be under any liability to any Underwriter, and no Underwriter shall be under any liability to the Company, except that (A) the Company will reimburse the Underwriters for all out-of-pocket expenses (including the reasonable fees and disbursements of their counsel) incurred by them in connection with the proposed purchase and sale of the Shares or in contemplation of performing their obligations hereunder and (B) no Underwriter who shall have failed or refused to purchase the Shares agreed to be purchased by it under this Agreement, without some reason sufficient hereunder to justify cancellation or termination of its obligations under this Agreement, shall be relieved of liability to the Company or to the other Underwriters for damages occasioned by its failure or refusal. 10. SUBSTITUTION OF UNDERWRITERS. If one or more of the Underwriters shall fail (other than for a reason sufficient to justify the cancellation or termination of this Agreement under Section 9) to purchase on a Closing Date the Shares agreed to be purchased on such Closing Date by such Underwriter or Underwriters, the Representative may find one or more substitute underwriters to purchase such Shares or make such other arrangements as the Representative may deem advisable or one or more of the remaining Underwriters may agree to purchase such Shares in such proportions as may be approved by the Representative, in each case upon the terms set forth in this Agreement. If no such arrangements have been made by the close of business on the business day following such Closing Date, (a) if the number of Shares to be purchased by the defaulting Underwriters on such Closing Date does not exceed 10% of the Shares that all the Underwriters are obligated to purchase on such Closing Date, then each of the nondefaulting Underwriters shall be obligated to purchase such Shares on the terms herein set forth in proportion to their respective obligations hereunder; provided, that in no event shall the maximum number of Shares that any Underwriter has agreed to purchase pursuant to Section 1 be increased pursuant to this Section 10 by more than one-ninth of such number of Shares without the written consent of such Underwriter, or (b) if the number of Shares to be purchased by the defaulting Underwriters on such Closing Date does not exceed 10% of the Shares that all the Underwriters are obligated to purchase on such Closing Date, then the Company shall be entitled to an additional business day within which it may, but is not obligated to, find one or more substitute underwriters reasonably satisfactory to the Representative to purchase such Shares upon the terms set forth in this Agreement. In any such case, either the Representative or the Company shall have the right to postpone the applicable Closing Date for a period of not more than five business days in order that necessary changes and arrangements (including any necessary amendments or supplements to the Registration Statement or Prospectus) may be effected by the Representative and the 30. 31 Company. If the number of Shares to be purchased on such Closing Date by such defaulting Underwriter or Underwriters shall exceed 10% of the Shares that all the Underwriters are obligated to purchase on such Closing Date, and none of the nondefaulting Underwriters or the Company shall make arrangements pursuant to this Section 10 within the period stated for the purchase of the Shares that the defaulting Underwriters agreed to purchase, this Agreement shall terminate with respect to the Shares to be purchased on such Closing Date without liability on the part of any nondefaulting Underwriter to the Company and without liability on the part of the Company, except in both cases as provided in Sections 6(j), 7, 8 and 9. The provisions of this Section 10 shall not in any way affect the liability of any defaulting Underwriter to the Company or the nondefaulting Underwriters arising out of such default. A substitute underwriter hereunder shall become an Underwriter for all purposes of this Agreement. 11. MISCELLANEOUS. The respective agreements, representations, warranties, indemnities and other statements of the Company or its officers and of the Underwriters set forth in or made pursuant to this Agreement shall remain in full force and effect, regardless of any investigation made by or on behalf of any Underwriter or the Company or any of the officers, directors or controlling persons referred to in Sections 7 and 8 hereof, and shall survive delivery of and payment for the Shares. The provisions of Sections 6(j), 7, 8 and 9 shall survive the termination or cancellation of this Agreement. This Agreement has been and is made for the benefit of the Underwriters and the Company and their respective heirs, executors, administrators, successors and assigns, and, to the extent expressed herein, for the benefit of persons controlling any of the Underwriters, or the Company, and directors and officers of the Company, and their respective heirs, executors, administrators, successors and assigns, and no other person shall acquire or have any right under or by virtue of this Agreement. The term "successors and assigns" shall not include 31. 32 any purchaser of Shares from any Underwriter merely because of such purchase. All notices and communications hereunder shall be in writing and mailed or delivered or by telephone or telegraph if subsequently confirmed in writing, (a) if to the Representative, to Gruntal & Co., Incorporated, 14 Wall Street, New York, NY 10005, Attention: Syndicate Department, or, (b) if to the Company, to its agent for service as such agent's address appears on the cover page of the Registration Statement. This Agreement shall be governed by and construed in accordance with the laws of the State of New York without regard to principles of conflict of laws. This Agreement (including the Schedules and Exhibits hereto) constitutes the full and entire understanding and agreement between the parties with regard to the subjects hereof and supersedes all other agreements relating to the subject matter hereof. 32. 33 This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. 33. 34 Please confirm that the foregoing correctly sets forth the agreement among us. Very truly yours, ILLINOIS SUPERCONDUCTOR CORPORATION By:___________________________________________ Ora E. Smith, President and Chief Executive Officer Confirmed: GRUNTAL & CO., INCORPORATED Acting on behalf on itself and as representative of the several Underwriters named in Schedule I annexed hereto. By: GRUNTAL & CO., INCORPORATED By: ______________________________________ Title 34. 35 SCHEDULE I Name Number of Firm Shares to be Purchased Gruntal & Co., Incorporated ---------------------- Total 1,000,000 EX-5 3 OPIN. OF KATTEN MUCHIN & ZAVIS (INCLUDING CONSENT) 1 [LETTERHEAD OF KATTEN MUCHIN & ZAVIS] EXHIBIT 5 March 24, 1997 Illinois Superconductor Corporation 451 Kingston Court Mt. Prospect, Illinois 60056 RE: REGISTRATION STATEMENT ON FORM S-3 Ladies and Gentlemen: We have acted as counsel for Illinois Superconductor Corporation, a Delaware corporation (the "Company"), in connection with the preparation and filing of a registration statement on Form S-3 (the "Registration Statement") with the Securities and Exchange Commission under the Securities Act of 1933, as amended. The Registration Statement relates to the Company's public offering (the "Offering") of 1,150,000 shares of the Company's Common Stock, $.001 par value per share (the "Common Stock"), including the 150,000 shares of Common Stock issuable upon exercise of the Underwriters' (as defined herein) over-allotment option (collectively, the "Shares"). In connection with this opinion, we have relied as to matters of fact, without investigation, upon certificates of public officials and others and upon affidavits, certificates and written statements of directors, officers and employees of, and the accountants and transfer agent for, the Company. We have also examined originals or copies, certified or otherwise identified to our satisfaction, of such instruments, documents and records as we have deemed relevant and necessary to examine for the purpose of this opinion, including (a) the Registration Statement, (b) the Certificate of Incorporation of the Company, (c) the By-Laws of the Company, (d) resolutions adopted by the Board of Directors of the Company in connection with the Offering and (e) the form of Underwriting Agreement (the "Underwriting Agreement") between the Company and Gruntal & Co., Incorporated, as representative of the several underwriters (collectively, the "Underwriters"). In connection with this opinion, we have assumed the accuracy and completeness of all documents and records that we have reviewed, the genuineness of all signatures, the authenticity of the documents submitted to us as originals and the conformity to authentic original documents of all documents submitted to us as certified, conformed or reproduced copies. We have further assumed that all natural persons involved in the Offering as contemplated by the Registration 2 Illinois Superconductor Corporation March 24,1997 Page 2 Statement have sufficient legal capacity to enter into and perform their respective obligations and to carry out their roles in the Offering. Based upon and subject to the foregoing, it is our opinion that the 1,150,000 Shares covered by the Registration Statement (including the 150,000 Shares issuable upon exercise of the Underwriters' over-allotment option), when issued by the Company pursuant to the Underwriting Agreement, will be validly issued, fully paid and non-assessable. Our opinion expressed above is limited to the General Corporation Law of the State of Delaware, and we do not express any opinion concerning any other laws. This opinion is given as of the date hereof and we assume no obligation to advise you of changes that may hereafter be brought to our attention. We hereby consent to use of our name under the heading "Legal Matters" in the Prospectus forming a part of the Registration Statement and to use of this opinion for filing as Exhibit 5 to the Registration Statement. Very truly yours, /s/ Katten Muchin & Zavis KATTEN MUCHIN & ZAVIS EX-23.1 4 CONSENT OF ERNST & YOUNG LLP. 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the reference to our firm under the captions "Selected Financial Data" and "Experts" and to the use of our report dated January 29, 1997, except for paragraph 8 of Note 6, for which the date is March 7, 1997, in the Registration Statement (Form S-3) and related Prospectus of Illinois Superconductor Corporation for the registration of 1,000,000 shares of its common stock. /s/ Ernst & Young LLP ------------------------ Ernst & Young LLP Chicago, Illinois March 24, 1997 EX-23.3 5 CON. OF MARSHALL O'TOOLE, GERSTEIN, MURRAY & BORUN 1 EXHIBIT 23.3 [MARSHALL, O'TOOLE, GERSTEIN, MURRAY & BORUN LETTERHEAD] March 21, 1997 We hereby consent to be named as an expert in the "Legal Matters" and "Experts" section of the Registration Statement on Form S-3 filed with the Securities and Exchange Commission by Illinois Superconductor Corporation. Very truly yours, MARSHALL, O'TOOLE, GERSTEIN MURRAY & BORUN By: /s/ Robert M. Gerstein ------------------------ Robert M. Gerstein RMG/mjm -----END PRIVACY-ENHANCED MESSAGE-----