-----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, F+avf6nBhtzqtb5EbiTQYrGo+tyeP0uOb8dFeOuenf716GuG6lhHwHdClqnFH2Po nhMwjvkfreEHc2OMRUwbIg== 0000950137-99-000768.txt : 19990402 0000950137-99-000768.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950137-99-000768 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ILLINOIS SUPERCONDUCTOR CORPORATION CENTRAL INDEX KEY: 0000888693 STANDARD INDUSTRIAL CLASSIFICATION: INSTRUMENTS FOR MEAS & TESTING OF ELECTRICITY & ELEC SIGNALS [3825] IRS NUMBER: 363688459 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22302 FILM NUMBER: 99582950 BUSINESS ADDRESS: STREET 1: 451 KINGSTON CT CITY: MOUNT PROSPECT STATE: IL ZIP: 60056 BUSINESS PHONE: 8473919400 MAIL ADDRESS: STREET 1: 451 KINGSTON COURT CITY: MT PROSPECT STATE: IL ZIP: 60056 10-K 1 FORM 10-K 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 --------------- FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ COMMISSION FILE NUMBER 0-22302 ILLINOIS SUPERCONDUCTOR CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 36-3688459 (State or other jurisdiction (I.R.S. Employer of incorporation) Identification No.) 451 KINGSTON COURT MT. PROSPECT, ILLINOIS 60056 (847) 391-9400 (Address and telephone number of principal executive offices) Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Title of each class ------------------- Common Stock, par value $0.001 per share Preferred Stock Purchase Rights Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No ____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] On March 25, 1999, 12,557,344 shares of the registrant's Common Stock were outstanding. The aggregate market value on March 25, 1999 of the registrant's Common Stock held by non-affiliates of the registrant was $14,127,012. DOCUMENTS INCORPORATED BY REFERENCE Certain portions of the registrant's definitive proxy statement for the annual meeting of stockholders to be held on June 9, 1999 are incorporated by reference in Part III of this Form 10-K. ================================================================================ 2
TABLE OF CONTENTS PART I Item 1. Business........................................................................................... 1 Item 2. Properties......................................................................................... 19 Item 3. Legal Proceedings.................................................................................. 19 Item 4. Submission of Matters to a Vote of Security Holders................................................ 21 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.............................. 22 Item 6. Selected Financial Data............................................................................ 24 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.............. 25 Item 7a. Quantitative and Qualitative Disclosures About Market Risk......................................... 28 Item 8. Financial Statements and Supplementary Data........................................................ 29 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............... 49 PART III Item 10. Directors and Executive Officers of the Registrant................................................. 50 Item 11. Executive Compensation............................................................................. 50 Item 12. Security Ownership of Certain Beneficial Owners and Management..................................... 50 Item 13. Certain Relationships and Related Transactions..................................................... 50 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.................................... 51
Because the Company wants to provide investors with more meaningful and useful information, this Annual Report on Form 10-K ("Form 10-K") contains, and incorporates by reference, certain "forward-looking statements" (as such term is defined in Section 21E of the Securities Exchange Act of 1934, as amended) that reflect the Company's current expectations regarding the future results of operations, performance and achievements of the Company. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company has tried, wherever possible, to identify these forward-looking statements by using words such as "anticipates," "believes," "estimates," "expects," "plans," "intends" and similar expressions. These statements reflect the Company's current beliefs and are based on information currently available to it. Accordingly, these statements are subject to certain risks, uncertainties and contingencies, which could cause the Company's actual results, performance or achievements to differ materially from those expressed in, or implied by, such statements. These factors include, among others, the following: the Company's history of net losses and the lack of assurance that the Company's earnings will be sufficient to cover fixed charges in the future; the degree to which the Company is leveraged and the restrictions imposed on the Company under its existing debt instruments which may adversely affect the Company's ability to finance its future operations, to compete effectively against better capitalized competitors and to withstand downturns in its business or the economy generally; the Company's current inability to satisfy the minimum maintenance requirements for the continued listing of its shares of Common Stock for trading on the Nasdaq National Market which may have a material adverse effect on the liquidity of the Common Stock and the Company's ability to obtain additional funding as needed if such shares are delisted; demand for, and acceptance of, the Company's products; continued downward pressure on the prices charged for the Company's products due to competition of rival manufacturers of filters for the wireless telecommunications market; the timing and receipt of customer orders; the Company's ability to attract and retain key personnel; the effects of legal proceedings and other factors described in this Form 10-K, including those described under the heading "Risk Factors," or in other filings of the Company with the Securities and Exchange Commission. The Company undertakes no obligation to release publicly the results of any revisions to any such forward-looking statements that may be made to reflect events or circumstances after the date of this Form 10-K or to reflect the occurrence of unanticipated events. i 3 PART I ITEM 1. BUSINESS GENERAL Illinois Superconductor Corporation (the "Company") uses its patented and proprietary high temperature superconductor ("HTS") materials, radio frequency ("RF") filter designs and cryogenic technologies to develop, manufacture and market high performance products designed to enhance the quality, capacity, coverage and flexibility of cellular, Personal Communications Services ("PCS") and other wireless telecommunications services. Superconductor materials, when cooled below a critical temperature, are able to transmit an electric current with either no or minimal loss of energy. Because of this minimal energy loss, superconductors are attractive for a wide range of commercial applications. RF filters refine the radio signals by passing radio waves through a series of resonators (poles) which allow certain frequencies to pass while rejecting other frequencies. The more poles in the RF filter, the more effective the RF filter. Each pole, however, has electrical resistance which causes the loss (insertion loss) of desired radio waves. Therefore, the more poles in a conventional RF filter, the greater the insertion loss. The advantage of using superconductors in RF filters is that more poles can be added without significant increases in insertion loss. Adding superconductors does not, however, change the fundamental fact that filter performance depends upon the number of poles. The Company's highest performing RF filters have more than 30 poles which the Company believes is significantly greater than any other commercially available filter. Filters can be designed with a variety of structures including stripline, microstrip, cavity, dielectric, and waveguide. The Company is able to produce RF filters using any of these technologies, but has primarily focused on cavity filters because of their high performance and tuning flexibility. The Company uses its proprietary thick-film superconducting technology for its RF filters. The Company believes that relative to other superconducting materials technologies, thick-film provides for higher RF filter performance and lower distortion levels. The Company also believes that its thick-film superconductor technology is unique in its ability to handle high-powered transmit applications while maintaining very low levels of intermodulation distortion. In addition, thick-film technology does not require "clean" rooms for manufacturing, which reduces the cycle time and cost of production. Superconductors become superconducting at temperatures of roughly -200(Degree) C. These temperature levels can be maintained using commercially available mechanical cooling systems. The Company has developed cryogenic packaging systems for its RF filters which are highly reliable over longer durations and minimize operating costs. The Company was founded in 1989 by ARCH Development Corporation, an affiliate of the University of Chicago, to commercialize superconductor technologies initially developed by Argonne National Laboratory. The Company was incorporated in Illinois on October 18, 1989 and reincorporated in Delaware on September 24, 1993. The Company's facilities and principal executive offices are located at 451 Kingston Court, Mt. Prospect, Illinois 60056 and its telephone number is (847) 391-9400. BUSINESS STRATEGY The Company's objective is to be the global leader in supplying high performance RF filter products to the growing wireless telecommunications market. Key elements of the Company's strategy include the following: - Offering the Highest Performance RF Filter Systems in the Industry. The Company's proprietary thick-film and RF filter design technology permits the Company to build RF filters with a high level of adjacent band interference rejection coupled with a low level of desired signal loss. The Company believes that its success will depend upon maintaining its technological leadership. - Supplying Price Competitive Products. The Company has been able to continually reduce its product cost, which has permitted the Company to competitively price its products. Currently, the price for the Company's superconducting filters is approaching that of conventional filters. The Company's lowest price product currently sells for less than $10,000 per cell site. The Company believes that with superior performance and competitive pricing it can become the dominant RF filter manufacturer in the world. In 1997, the Company reduced product costs by 50%, and in 1998 1 4 the Company reduced product costs by an additional 40%. The Company believes that it can continue to achieve further cost reductions in the coming years. - Providing Solutions for Different Market Needs. The Company has successfully expanded its product line in response to a wide variety of customer needs in a cost-effective manner. For rural markets, the Company currently offers a rural range extension product for under $10,000, while for urban markets, it offers a 24 pole brick wall RF filter which it believes is superior to the other RF filters currently available on the market. The Company has achieved this broad product portfolio through flexible designs which can quickly be adapted to different customer needs. By addressing the varied needs of the market at a reasonable price, the Company aims to provide real value to its customers. - Superior Customer Support The Company strives to exceed its customers' expectations for quality and responsiveness by minimizing service interruptions. Because of its superior quality and customer support, the Company was awarded Motorola's superior quality award in 1998. - Best in Class Reliability. To insure maximum customer retention, the Company aims to provide the highest level of reliability to its customers. To achieve this, the Company introduced its proprietary ATP(TM) technology which insures that its RF filters continue to operate even when there is a cooling system or power failure. In addition, the Company has chosen its cooler vendor based on superior reliability and offers such features as redundant alarms and remote diagnostics. - Focusing on Fast Growing Commercial Markets. The Company has focused on the fast growing wireless telecommunications market and has deferred at this time pursuing other commercial applications of its proprietary technology. This focus has minimized overhead costs and allowed the Company to be first to market with new RF products and a broader product portfolio than its competitors. - Building Long-Term Relationships with Customers. Becoming the preferred RF filter vendor with customers will allow the Company to focus on expanding its business with new customers and in new markets. To date, the Company has established strong relationships with six of the largest wireless operators in the United States. These customers have placed repeated orders in multiple markets. The Company's largest customer purchased equipment for over 50 cell sites in the fourth quarter of 1998. The Company has received orders from multiple wireless telecommunications service providers located in the United States, Canada and Asia, including many of the largest wireless operators in the United States. The Company's RF filters are now installed in over 100 cell sites in market areas across the United States. In 1997, commercial orders from wireless service providers were generally for one or two operational cell sites, with the largest order having been for five cell sites. In 1998, commercial orders significantly increased with several wireless service providers deploying the Company's products in tens of cell sites. The Company's newest product line, the PowerMaster(TM) line of transmit filters, has generated interest from several major original equipment manufacturers ("OEMs") that supply cellular and PCS systems equipment to the wireless service providers. The Company is an approved vendor for one of the world's largest cellular system equipment manufacturers and is pursuing similar relationships with other OEMs. Being an approved vendor allows cellular and PCS service providers in the U.S. and abroad to purchase the Company's products directly from the OEM, for use in both new and existing cell sites. 2 5 RISK FACTORS The following factors, in addition to the other information contained elsewhere herein, should be considered carefully in evaluating the Company and its business. Uncertain Market Acceptance of Superconducting Telecommunications Products The Company's RF filter products, which are based on the Company's HTS technology, have not been sold in very large quantities and a sufficient market may not develop for the Company's products. The Company's customers establish demanding specifications for performance and reliability. The Company's RF filter products may not continue to meet product performance and reliability criteria set by cellular and PCS service providers. Also, the Company's products may not operate reliably on a long-term basis, the Company may be unable to manufacture adequate quantities of any products it develops at commercially acceptable costs or on a timely basis, or the Company's current or future products may not achieve market acceptance. The Company has experienced, and may continue to experience, quarterly fluctuations in its results of operations as its RF filter products attempt to gain market acceptance while being subject to the lengthy purchase processes of customers. Failure to successfully develop, manufacture and commercialize products on a timely and cost-effective basis will have a material adverse effect on the Company's business, operating results and financial condition. Limited Operating History; History of Losses; and Uncertainty of Financial Results The Company was founded in October 1989 and through 1996 was engaged principally in research and development ("R&D"), product testing, manufacturing, marketing and sales activities. The Company has only recently begun to generate significant revenues from the sale of its RF filter products. Prior to the commencement of these sales, the majority of the Company's revenues were derived from R&D contracts, primarily from the U.S. government. The Company does not expect revenues to increase dramatically until it ships a significantly larger amount of its RF products. Accordingly, the Company has only a limited operating history upon which an evaluation of the Company and its prospects can be based. The Company must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early stages of product commercialization. The Company has incurred substantial net losses in each year since its inception. The Company expects to continue to incur operating losses through at least the end of 1999 as it continues to devote significant financial resources to its product development, manufacturing, marketing and sales efforts. Even if the Company is able to overcome the significant remaining manufacturing and marketing hurdles necessary to sell large quantities of its RF filter products, the Company may never achieve a profitable level of operations or, if profitability is achieved, it may not be sustained. The Company's customers are highly concentrated. The loss of an individual customer may have a material adverse effect on the Company's business. The wireless telecommunications market is currently experiencing an increasing rate of consolidation among the largest wireless operators which may cause a significant disruption and/or delay in the sales of the Company's products. In order to continue to grow revenues, the Company may be required to further reduce the prices of its products. In the event of further price reductions, the Company may not be able to reduce product costs sufficiently to achieve acceptable product margins. Future Capital Needs and Delisting of Common Stock To date, the Company has financed its operations primarily through public and private equity and debt financings. Although the Company recently completed a private placement of $3.3 million in aggregate initial principal amount of convertible debt securities, the Company believes that it will require substantial additional funds during the third quarter of 1999 to finance its product development, manufacturing, marketing and sales activities. In addition, the Company's outstanding debt instruments contain certain restrictions which may adversely impair the Company's ability to obtain additional financing. See "Substantial Leverage; Restrictions Contained in Debt Instruments" below. If additional funds are raised by issuing other equity or convertible debt securities, further dilution to existing or future stockholders is likely to result. If adequate funds are not available on acceptable terms when needed, the Company would be required to substantially delay, scale-back or eliminate the manufacturing, marketing or sales of one or more of its products or research and development programs, or may be required to obtain funds through arrangements with collaborative partners or others that may require the Company to relinquish rights to certain of its technologies, 3 6 product candidates or potential products that the Company would not otherwise relinquish. This would materially adversely affect the Company's business operating results and financial condition. Inadequate funding also could impair the Company's ability to compete in the marketplace. The Company regularly examines opportunities to expand its technology base and product line through means such as licenses, joint ventures and acquisitions of assets or ongoing businesses, and may issue securities in connection with such transactions. However, no commitments to enter into or pursue any such transactions have been made at this time, and any such discussions may not result in any such transaction being concluded. In addition, the Company currently has a limited number of unreserved authorized shares of its Common Stock, $.001 par value per share (the "Common Stock"), available for future issuance in connection with financings. The Company plans to request that its stockholders approve an increase in the number of authorized shares at the next annual meeting of the Company's stockholders. Failure to obtain this approval would limit the Company's ability to raise sufficient funds to support its business plans. The Company is currently unable to maintain a level of net tangible assets required to maintain the listing of the Common Stock for trading on the Nasdaq National Market, and the Common Stock may be delisted for trading on the Nasdaq National Market in the near future. Such delisting could have a material adverse effect on the liquidity of the Common Stock and could have a material adverse effect on the Company's ability to obtain additional funding as needed, especially if the Company is unable to list the Common Stock for trading on another securities market or exchange. Substantial Leverage; Restrictions Contained in Debt Instruments The Company is substantially leveraged. The degree to which the Company is leveraged may adversely affect the Company's ability to finance its future operations, to compete effectively against better capitalized competitors and to withstand downturns in its business or the economy generally. Although the Company's outstanding Notes (as defined below under "Substantial Number of Shares Eligible for Future Sale; Dilution") currently permit, subject to certain restrictions, the Company to pay accrued interest on such securities in shares of Common Stock, the Company may be unable to continue to be permitted to do so in the future. If the Company is no longer permitted to pay accrued interest on the Notes in shares of Common Stock, the Company may not be successful in raising additional equity or debt financing sufficient to enable it to pay such interest in cash. In addition, the Company's outstanding Notes contain restrictions that may adversely affect the Company's ability to raise additional equity or debt financing. Under the Notes, the Company is not permitted, without the prior approval of the holders of the Notes, (i) to incur any additional indebtedness (other than pursuant to a working capital line of credit in an amount not to exceed $1 million or to trade creditors in the ordinary course of business) or to create any lien, pledge, or encumbrance, subject to certain exceptions, on any assets of the Company, (ii) for so long as a significant portion of the Notes remain outstanding, to engage in certain sale or merger transactions, or to engage in certain other transactions which require the approval of the Company's stockholders, or (iii) to redeem, purchase or otherwise acquire any equity or debt securities of the Company which are junior in rights or preferences to the Notes, or to pay any dividend (other than in shares of Common Stock) with respect to such securities. In addition, in the event that the Company fails to achieve break-even or positive operating income during the second quarter of 2000, the Notes may become immediately due and payable unless the holders thereof agree to modify or waive such provision. Furthermore, for so long as the amount of Common Stock issuable upon conversion of the Notes represents 5% or more of the total then outstanding shares of the Common Stock, the holders of the Notes have the right to designate two members for election to the Company's Board of Directors. 4 7 Volatility of Common Stock Price The market price of the Common Stock, like that of many other high-technology companies, has fluctuated significantly and is likely to continue to fluctuate in the future. Since January 1, 1998, the closing price of the Common Stock has ranged from a low of $0.84 per share to a high of $3.31 per share. Announcements by the Company or others regarding the receipt of customer orders, quarterly variations in operating results, additional equity or debt financings, changes in recommendations of securities analysts, results of customer field trials, scientific discoveries, technological innovations, litigation, product developments, patent or proprietary rights, government regulation and general market conditions may have a significant impact on the market price of the Common Stock. In addition, if in the future the closing price of the Common Stock as reported on the Nasdaq National Market remains below $1.00 per share for 30 consecutive days, the Common Stock could be delisted for trading on the Nasdaq National Market. Such delisting could have a material adverse effect on the liquidity of the Common Stock. Limited Experience in Manufacturing, Marketing and Sales For the Company to be financially successful, it must manufacture its products in substantial quantities, at acceptable costs and on a timely basis. Although the Company to date has produced limited quantities of its products for commercial installations and for use in development and customer field trial programs, production of large quantities at competitive costs presents a number of technological and engineering challenges for the Company. The Company may be unable to manufacture such products in sufficient volume. The Company has limited experience in manufacturing, and substantial costs and expenses may be incurred in connection with attempts to manufacture larger quantities of the Company's products. The Company may be unable to make the transition to large scale commercial production successfully. The Company's marketing and sales experience to date is very limited. The Company will be required to further develop its marketing and sales force in order to effectively demonstrate the advantages of its products over more traditional products, as well as competitive superconductive products. The Company may also elect to enter into agreements or relationships with third parties regarding the commercialization or marketing of its products. If the Company enters into such agreements or relationships, it will be substantially dependent upon the efforts of others in deriving commercial benefits from its products. The Company may be unable to establish adequate sales and distribution capabilities, it may be unable to enter into marketing agreements or relationships with third parties on financially acceptable terms, and any third parties with whom it enters into such arrangements may not be successful in marketing the Company's products. To date, the Company's products have been installed in over 100 cell sites with a wide geographic dispersion. Although the Company's products have not experienced any significant reliability problems to date, the Company's products may develop quality problems in the future. Repeated or widespread quality problems could result in significant warranty expenses and/or the loss of customer confidence. The occurrence of such quality problems could have a material adverse effect on the Company's business, operating results and financial condition. Competition The wireless telecommunications equipment market is very competitive. The Company's products compete directly with products which embody existing and future competing commercial technologies. In particular, in cellular and PCS telecommunications applications, the Company competes with conventional RF component manufacturers whose products are currently in use by the Company's potential customers. Many of these companies have substantially greater financial resources, larger R&D staffs and greater manufacturing and marketing capabilities than the Company. Other emerging wireless technologies, including "smart antennas" and tower mounted amplifiers, may also provide protection from RF interference and offer enhanced range to cellular and PCS service providers at lower prices and/or superior performance, and may therefore compete with the Company's products. High performance RF filters may not become a preferred technology to address the needs of cellular and PCS service providers. Failure of the Company's products to improve performance sufficiently, reliably, or at an acceptable price or to achieve commercial acceptance or otherwise compete with conventional and new technologies will have a material adverse effect on the Company's business, operating results and financial condition. Although the market for superconductive electronics currently is small and in the early stages of development, the Company believes it will become intensely competitive, especially if products with significant market potential are successfully developed. In addition, if the superconducting industry develops, additional competitors with significantly greater resources are likely to enter 5 8 the field. In order to compete successfully, the Company must continue to develop and maintain technologically advanced products, reduce production costs, attract and retain highly qualified personnel, obtain additional patent or other protection for its technology and products and manufacture and market its products, either alone or with third parties. The Company may be unable to achieve these objectives. Failure to achieve these objectives would have a material adverse effect on the Company's business, operating results and financial condition. During the fourth quarter of 1998, the Company implemented a new pricing strategy pursuant to which it reduced the prices for all of its products. Although sales of the Company's products increased significantly during the fourth quarter of 1998, such sales growth may not be sustained over subsequent periods. Similarly, the Company may not be able to continue to reduce product costs sufficiently to achieve and maintain acceptable product margins. Management of Growth The Company's growth to date has caused, and will continue to cause, a significant strain on its management, operational, financial and other resources. The Company's ability to manage its growth effectively will require it to implement and improve its operational, financial, manufacturing and management information systems and expand, train, manage and motivate its employees. These demands may require the addition of new management personnel and the development of additional expertise by management. Any increase in resources devoted to product development and marketing and sales efforts could have an adverse effect on the Company's financial performance in the next several fiscal quarters. If the Company were to receive substantial orders, the Company may have to expand its current facility, which could cause an additional strain on the Company's management personnel and development resources. The failure of the Company's management team to effectively manage growth could have a material adverse effect on the Company's business, operating results and financial condition. Rapid Technological Change; Possible Pursuit of Other Market Opportunities The field of superconductivity is characterized by rapidly advancing technology. The success of the Company will depend in large part upon its ability to keep pace with advancing superconducting technology, high performance RF filter design and efficient, low cost cryogenic technologies. Rapid changes have occurred, and are likely to continue to occur, in the development of superconducting materials and processes. The Company will have to continue to improve its ability to fabricate thick-film HTS devices, design high performance RF filters and efficient cryogenic subsystems and produce significant quantities of products based on these improvements. The Company's development efforts may be rendered obsolete by the adoption of alternative solutions to current wireless operator problems or by technological advances made by others. In addition, other materials or processes, including other superconducting materials or fabrication processes, may prove more advantageous for the commercialization of high performance wireless products than the materials and processes selected by the Company. Because HTS product development is a new and emerging field, there may in the future be new opportunities that are more attractive than those initially identified by the Company for its targeted markets. As a result, the Company may elect in the future to commit its resources to such other potentially more attractive market opportunities. Such election may require the Company to limit or abandon its current focus on developing, manufacturing, marketing and selling HTS products for cellular, PCS and other telecommunications markets. The risks associated with other markets may be different from the risks associated with the cellular, PCS and other wireless telecommunications markets. Focus on Wireless Telecommunications Market; Current and Future Competitive Technologies The Company has selected the wireless telecommunications market, in particular the cellular and PCS markets, as the first principal target market for its superconductor-based products. The devotion of substantial resources to the wireless telecommunications market makes the Company vulnerable to adverse changes in this market. Adverse developments in the wireless telecommunications market, which could come from a variety of sources, including future competition, new technologies or regulatory decisions, could affect the competitive position of wireless systems. Any adverse developments in the wireless telecommunications market during the foreseeable future would have a material adverse effect on the Company's business, operating results and financial condition. The Federal Communications Commission ("FCC") has adopted rules that provide preferential licensing treatment for parties that develop new communications services and technologies. These developments and further technological advances may make 6 9 available other alternatives to cellular or PCS service, thereby creating additional sources of competition. Competition to cellular or PCS technologies could adversely affect the market for the Company's products, or result in changes in the Company's development and manufacturing programs. Dependence on a Limited Number of Customers To date, the Company's marketing and sales efforts have focused on major cellular service providers in retrofit applications and, to a lesser extent, on PCS operators and cellular and PCS original equipment manufacturers. During 1998, sales to three of the Company's customers accounted for over 88% of the Company's total revenues for 1998. The Company expects that if its RF filter products achieve market acceptance, a limited number of wireless service providers and OEMs will account for a substantial portion of its revenue during any period. Sales of many of the Company's RF filter products depend in significant part upon the decision of prospective customers and current customers to adopt and expand their use of the Company's products. Wireless service providers and the Company's other customers are significantly larger than, and are able to exert a high degree of influence over, the Company. Customers' orders are affected by a variety of factors such as new product introductions, regulatory approvals, end user demand for wireless services, customer budgeting cycles, inventory levels, customer integration requirements, competitive conditions and general economic conditions. The loss of one or more of the Company's customers or the failure to attract new customers would have a material adverse effect on the Company's business, operating results and financial condition. Lengthy Sales Cycles Wireless service providers, wireless equipment OEMs and the Company's other customers are significantly larger than, and are able to exert a high degree of influence over, the Company. Prior to selling its products to these customers, the Company must generally undergo lengthy approval and purchase processes. Technical and business evaluation by potential customers can take up to a year or more for products based on new technologies such as HTS. The length of the approval process is affected by a number of factors, including, among others, the complexity of the product involved, priorities of the customers, budgets and regulatory issues affecting customers. The Company may not obtain the necessary approvals or ensuing sales of such products may not occur. The length of the Company's customers' approval process or delays could have a material adverse effect on the Company's business, operating results and financial condition. Dependence on Limited Sources of Supply Certain parts and components used in the Company's RF filter products, including substrates, vacuum components, and cryogenic refrigerators, are only available from a limited number of sources. The Company's reliance on these limited source suppliers exposes the Company to certain risks and uncertainties, including the possibility of a shortage or discontinuation of certain key components and reduced control over delivery schedules, manufacturing capabilities, quality and costs. Any reduced availability of such parts or components when required could materially impair the Company's ability to manufacture and deliver its products on a timely basis and result in the cancellation of orders, which could have material adverse effect on the Company's business, operating results and financial condition. In addition, the purchase of certain key components involves long lead times and, in the event of unanticipated increases in demand for the Company's products, the Company may be unable to manufacture products in a quantity sufficient to meet its customers' demand in any particular period. The Company has no guaranteed supply arrangements with its limited source suppliers, does not maintain an extensive inventory of parts or components, and customarily purchases parts and components pursuant to purchase orders placed from time to time in the ordinary course of business. To satisfy customer requirements, the Company may be required to stock certain long lead time parts in anticipation of future orders. The failure of such orders to materialize as forecasted could limit resources available for other important purposes or accelerate the Company's requirement for additional funds. In addition, such excess inventory could become obsolete which would adversely affect the Company's financial performance. Business disruption, production shortfalls or financial difficulties of a limited source supplier could materially and adversely effect the Company by increasing product costs or reducing or eliminating the availability of such parts or components. In such events, the inability of the Company to develop alternative sources of supply quickly and on a cost-effective basis could materially impair the Company's ability to manufacture and deliver its products on a timely basis and could have a material adverse effect on its business, operating results and financial condition. Intellectual Property and Patents 7 10 The Company's success will depend in part on its ability to obtain patent protection for its products and processes, to preserve its trade secrets and to operate without infringing upon the patent or other proprietary rights of others and without breaching or otherwise losing rights in the technology licenses upon which any Company products are based. As of December 31, 1998, the Company has been issued 20 U.S. patents, has filed and is actively pursuing applications for 16 other U.S. patents, and is the licensee of 10 U.S. patents and patent applications held by others. One of the Company's patents is jointly owned with Lucent Technologies, Inc. The Company believes that, since the discovery of HTS materials in 1986, a large number of patent applications have been filed worldwide and many patents have been granted in the U.S. relating to HTS materials. The claims in those patents often appear to overlap and there are interference proceedings pending in the United States Patent and Trademark Office (not currently involving the Company) regarding rights to inventions claimed in some of the HTS materials patent applications. The Company also believes there are a large number of patents and patent applications covering RF filter products and other products and technologies that the Company is pursuing. Accordingly, the patent positions of companies using HTS materials technologies and RF technologies, including the Company, are uncertain and involve complex legal and factual questions. The patent applications filed by the Company or by the Company's licensors may not result in issued patents or the scope and breadth of any claims allowed in any patents issued to the Company or its licensors may not exclude competitors or provide competitive advantages to the Company. In addition, patents issued to the Company or its licensors may not be held valid if subsequently challenged or others may claim rights in the patents and other proprietary technologies owned or licensed by the Company. Others may have developed or may in the future develop similar products or technologies without violating any of the Company's proprietary rights. Furthermore, the Company's loss of any license to technology that it now has or acquires in the future may have a material adverse effect on the Company's business, operating results and financial condition. Some of the patents and patent applications owned or licensed by the Company are subject to non-exclusive, royalty-free licenses held by various governmental units. These licenses permit these U.S. government units to select vendors other than the Company to produce products for the U.S. Government which would otherwise infringe the Company's patent rights which are subject to the royalty-free licenses. In addition, the U.S. Government has the right to require the Company to grant licenses (including exclusive licenses) under such patents and patent applications or other inventions to third parties in certain instances. Patent applications in the U.S. are currently maintained in secrecy until patents are issued. In foreign countries, this secrecy is maintained for a period of time after filing. Accordingly, publication of discoveries in the scientific literature or of patents themselves or laying open of patent applications in foreign countries tends to lag behind actual discoveries and filing of related patent applications. Due to this factor and the large number of patents and patent applications related to HTS materials, RF technologies and other products and technologies that the Company is pursuing, comprehensive patent searches and analyses associated with HTS materials, RF technologies and other products and technologies that the Company is pursuing are often impractical or not cost-effective. As a result, the Company's patent and literature searches cannot fully evaluate the patentability of the claims in the Company's patent applications or whether materials or processes used by the Company for its planned products infringe or will infringe upon existing technologies described in U.S. patents or may infringe upon claims in patent applications made available in the future. Because of the volume of patents issued and patent applications filed relating to HTS materials, RF technologies and other products and technologies that the Company is pursuing, the Company believes there is a significant risk that current and potential competitors and other third-parties have filed or will file patent applications for, or have obtained or will obtain, patents or other proprietary rights relating to materials, products or processes used or proposed to be used by the Company. In any such case, to avoid infringement, the Company would have to either license such technologies or design around any such patents. The Company may be unable to obtain licenses to such technologies or, if obtainable, such licenses may not be available on terms acceptable to the Company or the Company may be unable to successfully design around these third-party patents. Participation in litigation or patent office proceedings in the U.S. or other countries, which could result in substantial cost to and diversion of effort by the Company, may be necessary to enforce patents issued or licensed to the Company, to defend the Company against infringement claims made by others or to determine the ownership, scope or validity of the proprietary rights of the Company and others. The parties to such litigation may be larger, better capitalized than the Company and better able to support the cost of litigation. An adverse outcome in any such proceedings could subject the Company to significant liabilities to third parties, require the Company to seek licenses from third parties and/or require the Company to cease using certain technologies, any of which could have a material adverse effect on the Company's business, operating results and financial condition. The Company believes that a number of patent applications, including applications filed by International Business Machines 8 11 Corporation, Lucent Technologies, Inc., and other potential competitors of the Company are pending that may cover the useful compositions and uses of certain HTS materials including yttrium barium copper oxide ("YBCO"), the principal HTS material used by the Company in its present and currently proposed products. Therefore, there is a substantial risk that one or more third parties may be granted patents covering YBCO and other HTS materials and their uses, in which case the Company could not use these materials without an appropriate license. As with other patents, the Company has no assurance that it will be able to obtain licenses to any such patents for YBCO or other HTS materials or their uses or that such licenses would be available on commercially reasonable terms. Any of these problems would have a material adverse effect on the Company's business, operating results and financial condition. Government Regulations Although the Company believes that its wireless telecommunications products themselves would not be subject to licensing by, or approval requirements of, the FCC, the operation of base stations is subject to FCC licensing and the radio equipment into which the Company's products would be incorporated is subject to FCC approval. Base stations and the equipment marketed for use therein must meet specified technical standards. The Company's ability to sell its wireless telecommunications products is dependent on the ability of wireless base station equipment manufacturers and wireless base station operators to obtain and retain the necessary FCC approvals and licenses. In order for them to be acceptable to base station equipment manufacturers and to base station operators, the characteristics, quality and reliability of the Company's base station products must enable them to meet FCC technical standards. Any failure to meet such standards or delays by base station equipment manufacturers and wireless base station operators in obtaining the necessary approvals or licenses could have a material adverse effect on the Company's business, operating results and financial condition. In addition, HTS RF filters are on the U.S. Department of Commerce's export regulation list. Therefore, exportation of such RF filters to certain countries may be restricted or subject to export licenses. The Company is subject to governmental labor, safety and discrimination laws and regulations with substantial penalties for violations. In addition, employees and others may bring suit against the Company for perceived violations of such laws and regulations. Defense against such complaints could result in significant legal costs for the Company. Although the Company endeavors to comply with all applicable laws and regulations, it may be the subject of complaints in the future which could have material adverse effect on the Company's business, operating results and financial condition. The Company uses certain hazardous materials in its research, development and manufacturing operations. As a result, the Company is subject to stringent federal, state and local regulations governing the storage, use and disposal of such materials. It is possible that current or future laws and regulations could require the Company to make substantial expenditures for preventive or remedial action, reduction of chemical exposure, or waste treatment or disposal. The Company believes it is in material compliance with all environmental regulations and to date the Company has not had to incur significant expenditures for preventive or remedial action with respect to the use of hazardous materials. However, the operations, business or assets of the Company could be materially and adversely affected by the interpretation and enforcement of current or future environmental laws and regulations. In addition, although the Company believes that its safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, there is the risk of accidental contamination or injury from these materials. In the event of an accident, the Company could be held liable for any damages that result. Furthermore, the use and disposal of hazardous materials involves the risk that the Company could incur substantial expenditures for such preventive or remedial actions. The liability in the event of an accident or the costs of such actions could exceed the Company's resources or otherwise have a material adverse effect on the Company's business, results of operations and financial condition. Dependence on Key Personnel The Company's success will depend in large part upon its ability to attract and retain highly qualified management, administrative, manufacturing, marketing, sales and R&D personnel. Due to the specialized nature of the Company's business, it may be difficult to locate and hire qualified personnel. The loss of services of one of its executive officers or other key personnel, or the failure of the Company to attract and retain other executive officers or key personnel, could have a material adverse effect on the Company's business, operating results and financial condition. 9 12 Business Interruptions and Dependence on a Single U.S. Facility The Company's primary operations, including engineering, manufacturing, research, distribution and general administration, are housed in a single facility in Mt. Prospect, Illinois. Any material disruption in the Company's operations, whether due to fire, flooding, natural disaster, power loss or otherwise, would have a material adverse effect on the Company's business, operating results and financial condition. Substantial Number of Shares Eligible for Future Sale; Dilution On March 31, 1999, the Company privately issued an aggregate of $3.3 million initial principal amount of senior convertible notes due May 15, 2002 (the "New Notes"). The New Notes accrue interest at the rate of 6% per annum, payable in cash or shares of Common Stock at the Company's option, and are convertible into an aggregate of 2,933,334 shares of Common Stock. In connection with the issuance of the New Notes, warrants exercisable for an aggregate of 1,320,000 shares of Common Stock at an exercise price of $1.4625 per share (the "New Warrants") were also issued. The New Warrants expire on March 31, 2002. Concurrently with the issuance of the New Notes, the Company amended certain terms of $5.5 million in aggregate principal amount of the Company's senior convertible notes due May 15, 2002 (the "Amended Notes") and the warrants exercisable for an aggregate of 2,200,000 shares of Common Stock (the "Amended Warrants") issued in connection therewith. The Amended Notes accrue interest at the rate of 6% per annum, payable in cash or shares of Common Stock at the Company's option, and are convertible into an aggregate of 4,888,889 shares of Common Stock. The Amended Warrants expire on May 15, 2001 and are exercisable at an exercise price of $1.4625 per share. In addition, as of March 31, 1999, $4.85 million in aggregate principal amount of the Company's senior convertible notes due May 15, 2002 issued in May 1998 (the "1998 Notes," and together with the New Notes and the Amended Notes, the "Notes"), and the warrants exercisable for an aggregate of 1,940,000 shares of Common Stock issued in connection therewith (the "1998 Warrants," and together with the New Warrants and the Amended Warrants, the "Warrants"), remain outstanding. The 1998 Notes accrue interest at the rate of 2% per annum, which interest is payable in cash or Common Stock at the Company's option, and are convertible into an aggregate of 3,233,333 shares of Common Stock. The 1998 Warrants expire on May 15, 2001 and are exercisable at an exercise price of $3.75 per share. An aggregate of 16,515,556 shares of Common Stock are issuable upon conversion of the Notes and exercise of the Warrants which is equal to approximately 132% of the Common Stock outstanding as of March 31, 1999. The sale of a substantial number of shares of Common Stock by the Company or any of its significant stockholders upon the conversion of a substantial portion of the Notes or the exercise of a substantial portion of the Warrants, or the perception that such sales could occur, could adversely affect the prevailing market price of the Common Stock. In addition, any such sale or such perception could make it more difficult for the Company to sell equity securities in the future at a time and price that the Company deems appropriate. As of December 31, 1998, the Company had, including to the 1998 Warrants and the Amended Warrants, outstanding warrants to purchase 4,678,688 shares of Common Stock at a weighted average exercise price of $4.33 per share and options to purchase 1,193,977 shares of Common Stock at a weighted average exercise price of $6.71 per share (827,321 of which have not yet vested) issued to employees, directors and consultants pursuant to the Company's Amended and Restated 1993 Stock Option Plan, as amended, and individual agreements with management and directors of the Company. In order to attract and retain key personnel, the Company may issue additional securities, including stock options, in connection with its employee benefit plans. During the terms of the Notes and such options and warrants (including the Warrants), the holders thereof are given the opportunity to benefit from a rise in the market price of the Common Stock. The conversion of the Notes into, or the exercise of options and warrants (including the Warrants) for, Common Stock, as well as the sale or issuance by the Company of additional shares of Common Stock and/or rights to purchase Common Stock, would likely have an adverse or dilutive effect on the market value of the Common Stock. The Company also may in the future offer equity participation in connection with the obtaining of non-equity financing, such as debt or leasing arrangements accompanied by warrants to purchase equity securities of the Company. This could also have a dilutive effect upon the holders of Common Stock. Anti-Takeover Provisions The Company has certain provisions which may be deemed to have a potential "anti-takeover" effect in that such provisions 10 13 may delay, defer or prevent a change of control of the Company. In February 1996, the Board of Directors of the Company (the "Board of Directors") adopted a stockholders rights plan (the "Rights Plan"). By causing substantial dilution to a person or group that attempts to acquire the Company on terms not approved by the Board of Directors, the Series A Rights and Series B Rights of the Rights Plan may interfere with certain acquisitions, including acquisitions that may offer a premium over market price to some or all of the Company's stockholders. Further discussion of the Rights Plan is set forth herein under the heading "Market for Registrant's Common Equity and Related Stockholder Matters-Rights Plan." In addition, the Company's Certificate of Incorporation and By-Laws contain provisions that include (i) a requirement that stockholder action may be taken only at stockholders meetings; (ii) the authority of the Board of Directors to issue series of the Company's preferred stock with such voting rights and other powers as the Board of Directors may determine; (iii) notice requirements in the Bylaws relating to nominations to the Board of Directors and to the raising of business matters at stockholders meetings; and (d) the classification of the Board of Directors into three classes, each serving for staggered three-year terms. In addition, the Company's outstanding debt instruments contain provisions which may be deemed to have a potential "anti-takeover" effect. The interests of the holders of such debt instruments could conflict with the interests of the Company's stockholders. See "Substantial Leverage; Restrictions Contained in Debt Instruments" above. WIRELESS TELECOMMUNICATIONS INDUSTRY BACKGROUND The wireless telecommunications industry has experienced significant growth, both domestically and internationally, in recent years. This growth appears to be due to the increasing popularity of wireless telecommunications, the entry of new service providers into the market as governments open up new RF spectrum, the continuing decline in the price of service and wireless telephones, and the introduction of new service features. Rapid growth has intensified RF interference while increasing wireless operators' demand for improved system quality, lower capital expenditures per customer, and co-location of multiple antennas with other RF transmitters at a single cell site. In the United States, wireless telecommunications services customers now frequently have a choice of at least four wireless service providers. Digital technologies such as Global System for Mobile Telecommunications ("GSM"), Code Division Multiple Access ("CDMA"), and Time Division Multiple Access ("TDMA") allow operators to offer such advanced features as short message service, fax, three-way conferencing and call waiting. Wireless systems are also marketed as a convenient and economical substitute for regular wireline telephone service. In addition, service providers are also trying to differentiate themselves on the basis of quality, price, coverage, and advanced service features. The rapid growth in competition in wireless telecommunications services is forcing operators to reduce costs and to seek out new cost effective solutions such as high performance filters which can reduce capital costs while increasing network capacity. Already, manufacturers and operators are beginning to plan a new and more advanced form of wireless telecommunications called Third Generation cellular or "3G." 3G is expected to provide full Internet access and video teleconferencing services. The first 3G network is expected to become commercial in Japan in 2001 and in Europe soon thereafter. Industry statistics demonstrate the rapid growth of the wireless telecommunications industry. The Cellular Telecommunications Industry Association ("CTIA") reports that as of June 1998 there were over 60 million wireless customers in the United States. Industry publications, as well as other industry sources, have estimated a total worldwide wireless customer base of approximately 207 million at the end of 1997. Several industry sources have estimated the customer base will exceed 830 million by the end of 2003. CTIA reports that there were over 57,000 base stations in the United States as of June 1998 and, based on industry sources, the Company believes that there are approximately 205,000 base stations worldwide. The Company further believes that this worldwide number is growing at a rate of over 35% per year. The Company anticipates that the need to provide improved service on a cost effective basis in an increasingly congested environment will lead wireless service providers to invest in new infrastructure technologies such as high performance RF filters. The rapid growth and increased competition experienced by the wireless telecommunications industry has increased the difficulty of providing quality wireless services. Wireless service providers face the challenge of providing quality services in an environment increasingly characterized by RF interference and congestion. In addition, the rapid rate of growth and community concerns have affected the manner in which service providers locate their base stations. Many communities are objecting to the proliferation of new towers to provide wireless services. Base stations which provide the link between a wireless user and the telecommunications network are being positioned closer together and often in the same location, which results in RF interference problems. There has also been a dramatic proliferation in the use of portable hand held phones 11 14 which transmit weaker signals than mobile or car-mounted phones. As a result, cellular networks which were laid out based on mobile phone power levels have, in many areas, developed coverage gaps which operators must fill in to satisfy their goals of providing seamless coverage. To lower costs, many cellular and PCS operators are sharing antenna sites with other cellular and PCS operators, and with television stations, paging operators and two-way radio transmitters. Such close proximity of radio transmitters can cause RF interference problems which degrade the quality and capacity of wireless telecommunications systems. Furthermore, in order to compete with these already broadly deployed cellular networks, new PCS service providers need to deploy coverage quickly and with the lowest possible capital investment. Recently, several wireless system operators have sold their antenna towers to third party management companies which then lease space for base stations and their antennas back to the system operator. In addition to managing the site for the existing system operator, these management companies lease additional space at the tower site to other wireless providers, including television stations, paging operators and two-way radio transmitters. The Company believes that the activities of these management companies will facilitate an increase in the co-location of multiple wireless providers over time. The Company believes that this trend may lead to an increase in the demand for high performance filters as concerns over RF interference and congestion increase. THE COMPANY'S SOLUTION The Company's products are designed to address the high performance RF front-end needs of domestic and international commercial wireless telecommunication systems by providing the following advantages: - GREATER NETWORK CAPACITY AND UTILIZATION. The Company's RF front-end products can increase the capacity and utilization of a wireless base station by up to 18%. In some cases, capacity increases because channels which were previously unusable due to interference are recovered. In other cases, system utilization increases because of lower levels of blocked and dropped calls, and increases in the ability of the system to permit weak signals to be processed with acceptable call quality. In CDMA systems, increased capacity frequently results from lowering the system's noise floor. - REDUCED CDMA CELL SITE BREATHING. Coverage for CDMA digital systems decreases as the number of users increases. To maintain network coverage, an operator can increase the number of cell sites, add radio carriers, or use the Company's high performance RF filters with cooled low noise amplifiers ("LNAs"). - IMPROVED BASE STATION RANGE. Based upon comparative field trials in multiple rural locations in the United States, and as confirmed by computer propogation models conducted by customers of the Company, the Company's RF front-end systems (high performance filter and cryogenically-cooled LNA) can extend the uplink range of a wireless system by up to 30%. Greater range can reduce a service operator's capital expenditure per customer in lower density areas by filling in coverage gaps in existing systems or by reducing the number of required cell sites for new system deployments. This is true for both analog and digital systems. - IMPROVED FLEXIBILITY IN LOCATING BASE STATIONS. The Company's RF front-end products can allow wireless telecommunications service providers to co-locate base stations near other RF transmitters. The Company's products allow the base station radio to better tolerate RF interference while reducing out-of-band signals that could interfere with other nearby wireless telecommunications operators. - IMPROVED CALL QUALITY. The Company's RF filter products improve call quality by reducing dropped and blocked calls. During commercial installations and field trials, the Company's RF filter products have frequently demonstrated a 20 to 40 percent reduction in dropped calls caused by out-of-band interference and base station front-end overloading. During these commercial installations and field trials, the Company's RF filter products have also demonstrated a similar reduction in blocked calls experienced in urban cellular locations. The Company's RF filter products also frequently improve audio fidelity by reducing noise and interference. - SIMPLER TRANSMITTER SYSTEM DESIGNS. The Company believes that its line of RF transmit filters can allow for simpler, less costly transmitters, particularly for digital systems. These RF transmit filters should improve system performance while diminishing system costs. 12 15 - IMPROVED DIGITAL SYSTEM CAPACITY. The Company believes that its recently introduced line of transmit combiners allow increased capacity and range in CDMA systems as system loading increases. CDMA systems appear unable to offer multi-carrier systems without the use of a combiner, but traditional combiners reduce the power transmitted from the base station antenna. The Company's filter technology allows operators to use combiners with lower loss of desired signals. PRODUCTS The Company currently offers three product lines to address the needs of cellular and PCS service providers. The SpectrumMaster(R) product line is designed primarily to improve the RF performance of cellular and PCS systems in high interference environments, including urban areas and near airports. The RangeMaster(R) product line combines the interference rejection advantages of a superconducting filter with a cooled LNA. RangeMaster(R) is designed to serve the range extension needs of rural, suburban, or small city cellular and PCS operators. The PowerMaster(TM) product line incorporates the Company's filter technologies into RF transmitter products. The PowerMaster(TM) duplexer is designed to improve and allow the co-location of multiple wireless service providers at a single cell site. The PowerMaster(TM) combiner is designed to improve the range and capacity of multi-carrier CDMA systems. Each product line is available in a variety of performance levels to meet the varying needs of different operators and in several mounting configurations to fit specific customer situations. All of the Company's currently offered products can be supplied in domestic and international frequencies for both cellular (800 MHz) and PCS (1.9 Ghz) applications. The Company's proprietary RF filter designs allow the Company to quickly provide new product offerings with minimal additional engineering and limited manufacturing complexity. The Company believes that SpectrumMaster(R) is the world's highest performance commercial receive pre-select RF filter for wireless telecommunications cell sites. SpectrumMaster(R) improves the performance of cellular and PCS systems in high interference environments such as urban areas and airport properties. SpectrumMaster(R) is available in two models. SpectrumMaster(R) Ultra is a high performance filter with 24 filter poles for extremely congested RF environments. SpectrumMaster(R) Ultra provides 10,000 times better rejection of unwanted signals than conventional filters, while losing very little of the desired signal. SpectrumMaster(R) Classic is a 16 pole filter and provides 1,000 times better rejection of unwanted signals than conventional filters while having very low loss of desired signals and extremely linear filter response. Both SpectrumMaster(R) models meet all analog and digital protocol specifications for cellular and PCS systems in the United States. In addition, the Company has developed an even higher performance filter for Third Generation (3G) systems and has shipped a prototype of this product for testing in Japan. This new product, the SpectrumMaster(R) Extreme filter, provides 10,000 times better performance than the SpectrumMaster(R) Ultra. The SpectrumMaster(R)'s modular design allows rapid design modification to meet other customer requirements. The Company sold its first SpectrumMaster(R) product to cellular service providers in the second half of 1996 and sales of SpectrumMaster(R) have continued to grow in 1997 and 1998. RangeMaster(R) combines a high performance superconducting cavity filter with a high performance cryogenically-cooled LNA to lower noise resulting from interference and thermal noise. RangeMaster(R) is available in four models, from the economical RangeMaster(R) Omega 150 which is targeted at low interference rural environments to the 16 pole RangeMaster(R) Classic which provides superior interference protection for more congested locations. The Company has also developed a prototype RangeMaster(R) Extreme for Third Generation (3G) systems. In late 1998, the Company introduced All Temperature Performance (ATP(TM)), a new function for the RangeMaster(R) product line. This series of superconducting filters provide HTS high performance front-end functions when cryogenically cooled. However, in the event of power or cooling system failure, these products continue to provide the filtering of good quality filters using conventional technology. In addition, these products resume superconducting performance automatically when power is restored which eliminates the need for bypass circuitry. PowerMaster(TM) is a family of high performance transmit filter systems for use in the base stations of wireless telecommunications operators. The Company began marketing two models of PowerMaster(TM) products, a transmitter filter and a duplexer, in February 1997. These products, which incorporate the Company's new power handling technology, are used in transmit applications. Unique to the Company, this technology extends the Company's filter applications to include transmit, in addition to the receive applications already in commercial use. The PowerMaster(TM) duplexer improves system quality, 13 16 extends range and simplifies the location of cell sites for both cellular and PCS systems. PowerMaster(TM) technology provides an ultra-high performance duplexer, which handles continuous power levels of up to 70 watts at 800 Mhz. The PowerMaster(TM) duplexer allows an operator to obtain the benefits of very high performance filtering on both the forward and reverse paths in a system. These benefits include improved call quality, extended range, improved transmit/receive isolation, and a reduction in the transmit amplifier output power required to achieve forward path coverage. The PowerMaster(TM) combiner, which is a low-loss transmit combiner with superior separation, improves downlink coverage, and minimizes the number of required antennas and feedlines, thereby lowering a system operator's capital expense. International Cellular Products Offerings. The Company is adapting its SpectrumMaster(R), RangeMaster(R), and PowerMaster(TM) product lines for international wireless markets to address their specific interference rejection and range extension needs. The Company is developing products for both Asian and European cellular and PCS markets, including GSM filters in various configurations. In December 1997, the Company leased two SpectrumMaster(R) units to a major Asian cellular operator for testing as a basis for potential system deployment in the operator's Third Generation (3G) networks. A third unit, a SpectrumMaster(R) Ultra, was leased to this operator in September 1998. In addition, the Company has leased a RangeMaster(R) unit to a major European OEM for testing in May 1999. TECHNOLOGY The Company possesses proprietary technology in three areas: the design of high performance RF cavity filters, thick-film superconducting materials fabrication and cryogenic packaging. The Company's products are based on its proprietary RF cavity filter designs. The Company believes that cavity filter technology provides superior filter performance with low intermodulation distortion when compared with alternative technologies, such as RF stripline filter technology (which the Company is also capable of using). The Company has been able to use its cavity filter technology to offer filters with over 30 poles. The more poles in a filter, the better its rejection of unwanted signals. The Company believes its products are superior to other RF filters with regard to rejection of unwanted signals. The Company is able to offer RF cavity filters with superior filtering, low loss of unwanted signals, and high power handling because of its proprietary thick-film superconducting fabrication technology. The Company's thick-film fabrication technology allows the Company to utilize a variety of filter technologies including cavity and strip line designs. The Company's superconducting technology is simple and relatively inexpensive to manufacture and offers superconducting yields consistently above 96%. The Company believes the electrical performance of the Company's products are superior to any alternative superconducting technology currently available for RF filters. The Company's thick-film superconducting technology can handle up to 70 watts of continuous power at 800 Mhz. High-temperature superconductors become superconducting at -200(Degree) C. This temperature can be attained using widely available mechanical refrigerators. The Company has developed proprietary technologies which provide an efficient, low cost cryogenic package with a long life cycle and minimum power consumption. Together, the Company believes that its technological excellence in filter design, superconducting materials and cryogenic packaging provide it with a unique and well-protected technology advantage over its competitors. SALES AND MARKETING The Company has focused its sales and marketing effort on U.S. wireless service providers for retrofit applications. To date, the Company has sold its products to many of the largest cellular operators in the United States as well as to numerous mid-size and smaller U.S. wireless operators. The Company has also sold or leased filters to two major international operators and has successfully tested its PCS RangeMaster(R) product with two of the largest U.S. PCS operators. The Company has also tested its PowerMaster(TM) line with two major OEMs and is discussing specifications with others. The Company has been named as an approved vendor to one of the largest OEMs, allowing cellular and PCS operators throughout the world the opportunity to purchase the Company's products directly from the OEM. The Company primarily uses a direct sales force to sell its products. 14 17 The Company believes that it has reached the stage of volume deployment with certain of its customers placing larger orders for the Company's products than before. For example, one of the Company's largest customers purchased equipment for over 50 cell sites in the fourth quarter of 1998. The Company's success has been facilitated by the establishment of corporate purchase agreements with two of the largest operators in the United States under which the separate operating regions of the operators can place orders directly with the Company. In the fourth quarter of 1998, the Company implemented a new pricing structure pursuant to which it reduced and simplified pricing on all of its products. The Company's marketing and sales personnel work directly with both PCS service providers and PCS OEMs to enhance the probability of sales success in this rapidly growing market. The Company has continued technical discussions with multiple PCS OEM's regarding integrating the Company's RF filter products into such OEM's PCS product line. To date, the Company's PowerMaster(TM) PCS transmit filter/duplexer has been tested in the laboratories of two PCS equipment OEMs. During 1998, sales to three of the Company's customers, ALLTEL Corporation, Bell Atlantic Mobile and Southwestern Bell Corporation, accounted for approximately 59%, 15% and 14% of the Company's total revenues, respectively, for the year ended December 31, 1998. MANUFACTURING The Company's state-of-the-art manufacturing process provides predictable product yields and can be easily expanded to meet increased customer demand. Superconducting component yields are now consistently above 96%, with low scrap levels. Manufacturing costs were reduced by 50% during 1997 due to volume, design and yield efficiencies, and reduced by another 40% in 1998 due to redesign and resourcing efforts. The Company expects further cost reductions in 1999. The Company has focused its manufacturing efforts on maintaining control of key technologies while avoiding the cost and complexities of vertical integration. The Company's manufacturing operations consist primarily of the manufacture of superconducting components from raw materials, and the assembly, tuning, testing and quality verification of the Company's products. All of these activities occur at the Company's manufacturing facility in Mt. Prospect, Illinois, which began operations during 1996. The Company believes that the manufacture of its RF filter products requires only moderate capital investments and is scaleable. The Company also believes that capacity can be rapidly expanded to meet growing demand without the need for large, upfront capital investments. The Company purchases all of the components for its filter products, except for superconducting components, from third party suppliers. The Company believes it has access to adequate supplies of these purchased components, most of which are produced according to the Company's proprietary designs and specifications. The Company is using its just-in-time manufacturing capability to maximize quality, insure flexibility, limit management complexity and minimize inventory cost. RESEARCH AND DEVELOPMENT The Company's R&D efforts have been focused on developing and improving RF filter products for wireless telecommunications systems. As a result of such efforts, filter performance has been improved, product size has been reduced, production costs have been lowered, product reliability has been increased, and product packaging has been streamlined. The Company expects to continue to invest in R&D to further improve and adapt its filter products to meet and exceed market expectations. The Company also intends to develop related products that are synergistic with its core filter offerings and which utilize the Company's core technical competencies in RF filter design, superconducting materials, and cryogenic cooling systems. The Company's total R&D expenses during 1996, 1997 and 1998 were approximately $6,423,000, $4,132,000, and $2,935,000, respectively. R&D costs reimbursed under government contracts and cooperative agreements during 1996, 1997 and 1998 were approximately $200,000, $0, and $0, respectively. 15 18 INTELLECTUAL PROPERTY AND PATENTS The Company regards certain elements of its product design, fabrication technology and manufacturing process as proprietary and protects its rights in them through a combination of patents, trade secrets and non-disclosure agreements. The Company also has obtained exclusive and non-exclusive licenses for technology developed with or by its research partners, Argonne National Laboratory ("Argonne") and Northwestern University, and expects to continue to obtain licenses from such research partners and others. The Company believes that its success will depend in part upon the protection of its proprietary information, its patents and licenses of key technologies from third parties, and its ability to operate without infringing on the proprietary rights of others. As of December 31, 1998, the Company has been issued 20 U.S. patents, has filed and is actively pursuing applications for 16 other U.S. patents, and is the licensee of 10 patents and patent applications held by others. Such patents and patent applications relate to various aspects of the Company's superconductor technology, the design of HTS filters, methods for packaging and cooling, and system implementation techniques. One of the Company's patent applications has been filed jointly with Lucent Technologies, Inc. and relates to superconducting filters. Additional inventions are the subject of a group of patent applications currently under preparation. Furthermore, the Company expects to pursue foreign patent rights on certain of its inventions and technologies critical to its products. In 1994, the Company purchased from Ceramic Process Systems two additional patents and the related technical know-how covering a process for producing yttrium barium copper oxide ("YBCO") powder and manufacturing YBCO electrical fibers. In 1994, the Company also purchased technology relating to the fabrication of HTS thick-film components from the University of Birmingham (UK). This thick-film technology complements the Company's existing patented processes for making thick-film superconducting components. Through collaborative relationships with Argonne and Northwestern University, the Company has licensed patents and patent applications issued or filed in the United States and in certain foreign countries arising under or related to such collaborative relationships. These licenses primarily relate to the processing and composition of HTS materials, including the preferential orientation of HTS materials and the processing of YBCO on a variety of metals, as well as design technology for some of the Company's current and proposed products. The Company's licenses from ARCH Development Corporation and Northwestern University continue for the lives of the patent rights licensed thereby, subject to termination on certain events, and permit the Company to retain rights to its patentable improvements to the licensed technology. Certain of the Company's research has been funded in part by Small Business Innovation Research and other government contracts. Although the U.S. Government has or will have certain rights in the technology developed with this funding, the Company does not believe that these rights will have a material impact on the Company's current RF filter products. COMPETITION The market for wireless telecommunications products is very competitive. The Company views its competition as (i) conventional RF filter products, (ii) RF products based on new technologies and (iii) other superconductor-based RF products. The Company's RF filter products compete against conventional RF filter products produced by such companies as Celwave, certain divisions of the Allen Telecom Group, Inc., Filtronic Comtek, Sinclair Radio Labs, Inc., K&L Microwave, Inc., Wacom Technology Corp., EMR Corp. and TX-RX Systems, Inc., among others. Although these conventional RF filter products are generally less expensive than the Company's products, the Company believes its RF filter products are superior on a cost/benefit basis. Other competitive RF products based on other technologies may provide competition in the future to the Company's RF filter products. In addition to competitive RF filter products, other companies including, Hazeltine Corp., Metawave Communications Corporation, Allen Telecom Group, Inc., Repeater Technologies, Inc. and Array Com, Inc., among others, are developing products based on "smart antenna," digital signal processing technologies, microcells and repeaters which are also aimed at reducing interference problems or providing range extension by means other than RF filtering. Furthermore, various vendors are offering tower mounted amplifiers ("TMAs") which provide similar range extension benefits to the Company's filters with cooled LNAs. TMAs are generally less expensive than the Company's products but require greater maintenance costs due to their location on top of the operator's antenna tower. 16 19 Various filter companies appear to be experimenting with cooled dielectric filters or with filters that combine dielectric materials and superconducting technology. K&L Microwave, Inc. has been experimenting with a cooled dielectric filter design. In addition, COM DEV International, Ltd., a Canadian corporation, has published research in which a dielectric material is mounted on a superconducting ground plane. The Company does not believe that either of these efforts currently pose a competitive threat but cannot exclude them as competition to the Company's product lines at some point in the future. Two other companies, Conductus, Inc. and Superconducting Technologies, Inc., are currently marketing superconducting filters to the wireless telecommunications marketplace. In addition, a number of large multinational companies are engaged in R&D programs that could lead to the commercialization of superconducting filters for the wireless telecommunications marketplace. These companies include, among others, E.I. DuPont de Nemours & Co., Fujitsu Corporation, NEC Corporation, Kyocera Corporation, and Matsushita Electric Industrial Co., Ltd. The Company believes that all of these companies are working on RF stripline filters using epitaxial thin-film superconducting technology. None of these filters are expected to be commercially implemented in the near future. The Company believes that RF stripline superconducting filters, while smaller, are technically unable to provide equivalent rejection of unwanted signals, competitively low levels of intermodulation distortion, as large a number of filter poles, or similar levels of power handling. The Company believes that it competes on the basis of product performance, price, breadth of product portfolio, customer support, quality, reliability and focus on the wireless telecommunications market. Many of the Company's competitors have substantially greater financial resources, larger R&D staffs and greater manufacturing and marketing capabilities than the Company. GOVERNMENT REGULATIONS Although the Company believes that its wireless telecommunications products themselves are not licensed or governed by approval requirements of the Federal Communications Commission ("FCC"), the operation of base stations is subject to FCC licensing and the radio equipment into which the Company's products would be incorporated is subject to FCC approval. Base stations and the equipment marketed for use therein must meet specified technical standards. The Company's ability to sell its RF filter products is dependent on the ability of wireless base station equipment manufacturers and of wireless base station operators to obtain and retain the necessary FCC approvals and licenses. In order to be acceptable to base station equipment manufacturers and to base station operators, the characteristics, quality, and reliability of the Company's base station products must enable them to meet FCC technical standards. The Company uses certain hazardous materials in its research, development and manufacturing operations. As a result, the Company is subject to stringent federal, state and local regulations governing the storage, use and disposal of such materials. It is possible that current or future laws and regulations could require the Company to make substantial expenditures for preventive or remedial action, reduction of chemical exposure, or waste treatment or disposal. The Company believes it is in material compliance with all environmental regulations and to date the Company has not had to incur significant expenditures for preventive or remedial action with respect to the use of hazardous materials. EMPLOYEES As of March 10, 1999, the Company had a total of 63 employees, 14 of whom hold advanced degrees. Of the employees, 26 are engaged in manufacturing and production, 16 are engaged in research, development and engineering, and 21 are engaged in general management, marketing, sales, finance and administration. The Company also periodically employs a number of consultants and independent contractors. The Company considers its relations with its employees to be satisfactory. ITEM 2. PROPERTIES The Company maintains its corporate headquarters in a 35,000 square foot building located in Mt. Prospect, Illinois under a lease which expires in October 2004. This facility also houses the Company's manufacturing, research, development, engineering and marketing activities. The Company believes that this facility is adequate and suitable for its current needs and that additional space would be available on commercial terms as necessary to meet any future needs. 17 20 ITEM 3. LEGAL PROCEEDINGS Siegler Litigation On June 5, 1996, Craig M. Siegler filed a complaint against the Company in the Circuit Court of Cook County, Illinois, County Department, Chancery Division. The complaint alleged that, in connection with the Company's private placement of securities in November 1995, the Company breached and repudiated an oral contract with Mr. Siegler for the issuance and sale by the Company to Mr. Siegler of 370,370.37 shares of the Common Stock, plus warrants (immediately exercisable at $12.96 per share) to purchase an additional 370,370.37 shares of the Common Stock, for a total price of $4,000,000. The remedy sought by Mr. Siegler was a sale to him of such securities on the terms of the November 1995 private placement. On August 16, 1996, the Company's motion to dismiss Mr. Siegler's complaint was granted with leave to amend. On September 19, 1996, Mr. Siegler's motion for reconsideration was denied. On October 10, 1996, Mr. Siegler filed his First Amended Verified Complaint and Jury Demand, seeking a jury trial and money damages equal to the difference between $8,800,000 (370,370.37 shares at $10.80 per share and 370,370.37 shares at $12.96 per share) and 740,740.74 multiplied by the highest price at which the Common Stock traded on The Nasdaq Stock Market between November 20, 1995 and the date of judgment. Mr. Siegler also preserved his claim for specific performance for purposes of appeal. On November 1, 1996, the case was transferred to the Circuit Court of Cook County, Illinois, County Department, Law Division. The Company's Answer was filed on November 21, 1996 and the parties are in the midst of discovery. The Company believes that the suit is without merit and intends to continue to defend itself vigorously in this litigation. However, if Mr. Siegler prevails in this litigation and is awarded damages in accordance with the formula described above, such judgment would have a material adverse effect on the Company's operating results and financial condition. Note Litigation On July 10, 1997, the Company filed a complaint against Sheldon Drobny; Howard L. "Buzz" Simons, joint tenant with Aric and Corey Simons; Aaron Fischer; Stewart Shiman; Sharon D. Gonsky, d/b/a SDG Associates; Gregg Rosenberg; Stacey Rosenberg; Merrill Weber & Co., Inc.; Drobny/Fischer Partnership, an Illinois general partnership; and Ruben Rosenberg (collectively, the "Borrowers"), and Paradigm Venture Investors, L.L.C. (the "Guarantor") in the Circuit Court of Cook County, Illinois, County Department, Law Division. The complaint seeks to enforce the terms of loans made to the Borrowers by the Company and evidenced by promissory notes dated December 13, 1996, in the aggregate principal amount of $698,508 and the guarantee by the Guarantor of the Borrowers' obligations under these promissory notes. The Borrowers' notes were issued to the Company in connection with the Borrowers' exercise of warrants to purchase shares of the Common Stock in December 1996. On September 30, 1997, the Borrowers and the Guarantor responded to the Company's complaint. Concurrently, the Borrowers filed a counterclaim alleging that they exercised the warrants in reliance on the Company's alleged fraudulent representations to certain Borrowers concerning a third-party's future underwriting of a secondary public offering of the Common Stock. The counterclaim sought an amount of damages which the Borrowers allege "cannot currently be determined." On December 10, 1997, the Company's motion to strike the Borrowers' fraud defense and dismiss their counterclaim was granted with leave to amend. On January 14, 1998, the Borrowers filed amended defenses and counterclaims based on substantially similar allegations of supposed fraud by the Company. The Company's answer was filed on April 30, 1998, and the parties are proceeding with discovery. The Company regards the amended fraud claim as without factual or legal merit. Effective July 23, 1998, one of the Borrowers, Merrill Weber & Co., Inc., and the Company reached a settlement of their respective claims. The Company intends to vigorously pursue recovery of the moneys owed by the other Borrowers and the Guarantor under the promissory notes and the guarantee. Lipman Litigation On January 6, 1998, Jerome H. Lipman, individually and on behalf of all others similarly situated, filed a complaint 18 21 against the Company and eight of its former or current directors: Leonard A. Batterson, Michael J. Friduss, Peter S. Fuss, Edward W. Laves, Steven L. Lazarus, Tom L. Powers, Ora E. Smith and Paul G. Yovovich (collectively, the "Named Directors") in the Circuit Court of Cook County, Illinois, County Department, Chancery Division. The complaint alleged that the Named Directors breached their duties of loyalty and due care to the putative class of stockholders by selecting financing for the Company in June 1997 which supposedly entrenched the Directors and reduced the Common Stock price. The complaint also alleged that the Named Directors breached their duty of disclosure by not informing the stockholders that the selected financing would erode the Common Stock price. Mr. Lipman's complaint sought certification of a class consisting of all owners of the Common Stock during the period from June 6, 1997 through November 21, 1997, excluding the Named Directors and Sheldon Drobny. The complaint also seeks an unspecified amount of compensatory and punitive damages, and attorneys' fees. The Company and the Named Directors regard the suit as without factual or legal merit. Accordingly, on February 17, 1998, the Company and the Named Directors filed a motion to dismiss Mr. Lipman's complaint. The motion presented arguments that the claims of Mr. Lipman and the putative class are barred by the business judgment rule and the plaintiff's failure to fulfill the legal prerequisites for filing an action against the Named Directors. Prior to a hearing on the Company's and the Named Directors' motion to dismiss, Mr. Lipman filed a motion on March 16, 1998, seeking both to amend his proposed putative class to include Mr. Drobny and to certify the class. On June 1, 1998, the court granted the Company's and the Named Directors' motion to dismiss the complaint. Concurrently, Mr. Lipman withdrew his motion to amend the proposed putative class and certify the class. On June 30, 1998, Mr. Lipman filed an amended complaint against the Named Directors but excluding the Company itself as a defendant. The amended complaint alleges that the Named Directors breached their duties of loyalty and due care to the putative class of stockholders by selecting financing for the Company in June 1997 and thereafter drawing two tranches of the financing. The amended complaint seeks certification of a class consisting of all owners of the Common Stock during the period from May 15, 1997 through December 31, 1997, excluding the Named Directors. Mr. Lipman's amended complaint alleges that the stock owned by the putative class lost $61 million due to the financing the Named Directors selected, and seeks an unspecified amount of compensatory and punitive damages. The Company and the Named Directors regard the amended complaint as without factual or legal merit. Accordingly, the Named Directors filed a motion to dismiss Mr. Lipman's amended complaint on July 29, 1998. The court granted the motion to dismiss in December 1998, finding that Mr. Lipman still had failed to fulfill the prerequisites for maintaining a shareholder derivative action against the Named Directors. On January 12, 1999, Mr. Lipman and two added former stockholders filed a second amended complaint against the Named Directors and again including the Company itself as a defendant. The second amended complaint alleges that the Named Directors breached their duties of loyalty and due care to the putative class and further alleges that the purported devaluation of the plaintiff's stock resulting from the June 1997 financing was an improper "assessment" on the plaintiffs' shares for which they seek an unspecified amount of compensatory and punitive damages. In February 1999, the Company and the Named Directors filed a motion to dismiss the second amended complaint. A hearing on the motion is scheduled for April 1999. Greenwald Litigation On June 24, 1998, Jonathan Greenwald, derivatively on behalf of the Company, filed a complaint against the Company and the Named Directors in the court of Chancery of the State of Delaware in and for New Castle County. Mr. Greenwald's complaint alleges that the Named Directors breached their duties of good faith, loyalty, due care, and candor by selecting financing for the Company in 1997 which purportedly reduced the stock price and was supposedly accepted to entrench the Named Directors. The complaint seeks an unspecified amount of compensatory damages, various equitable relief and attorney's fees. The Company and the Named Directors regard the suit as without factual or legal merit. Accordingly, in January 1999, the Company and the Named Directors filed a motion to dismiss the complaint arguing that the complaint is barred by the business judgment rule and the plaintiffs' failure to fulfill the prerequisites for maintaining a shareholder derivative action against the Named Directors. A hearing on the motion has not been scheduled. 19 22 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the quarter ended December 31, 1998. 20 23 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The outstanding shares of the Company's Common Stock are listed on the Nasdaq National Market and trade under the symbol ISCO. The following table sets forth for the periods indicated the range of high and low closing sale prices for the Common Stock:
HIGH LOW ---- --- FISCAL YEAR ENDING DECEMBER 31, 1997 First Quarter................................. $ 18.24 $15.48 Second Quarter................................ $ 12.40 $ 8.00 Third Quarter................................. $ 9.48 $ 7.24 Fourth Quarter................................ $ 3.32 $ 1.24 FISCAL YEAR ENDING DECEMBER 31, 1998 First Quarter................................. $ 3.31 $ 0.88 Second Quarter................................ $ 3.25 $ 1.25 Third Quarter................................. $ 1.94 $ 1.00 Fourth Quarter................................ $ 1.66 $ 0.84
On March 25, 1999, there were approximately 284 holders of record of the Common Stock. The Company has never paid cash dividends on the Common Stock and the Company does not expect to pay any dividends on its Common Stock in the foreseeable future. In addition, the Company's existing debt instruments limit the Company's ability to pay dividends. See "Risk Factors - Substantial Leverage; Restrictions Contained in Debt Instruments." RIGHTS PLAN In February 1996, the Board of Directors of the Company adopted a stockholders rights plan (the "Rights Plan"). In connection with the adoption of the Rights Plan, the Board of Directors created one series of Preferred Stock, consisting of 10,000 shares of Series A Junior Participating Preferred Stock (the "Series A Preferred"). Each share of the Series A Preferred, when and if issued, entitles the holder thereof to receive dividends equal to 1,000 times the dividends per share declared with respect to the Common Stock. Holders of the Series A Preferred are entitled to exercise 1,000 votes per share on all matters submitted to a vote of stockholders and, except as otherwise required by law, vote together with the holders of Common Stock as a single class. In the event of liquidation, such holders would receive a preference of 1,000 times the aggregate amount to be distributed per share to the holders of Common Stock. In general, each share of the Series A Preferred is intended to have a value and voting rights equal to 1,000 shares of Common Stock, and appropriate anti-dilutive adjustments will be made in accordance with the terms of such Series A Preferred in the event of certain changes in Common Stock. Pursuant to the Rights Plan, a Series A Right is associated with, and trades with, each share of Common Stock outstanding. The record date for distribution of such Series A Rights was February 22, 1996 (the "Record Date") and, for so long as the Series A Rights are associated with the Common Stock, each new share of Common Stock issued by the Company will include one Series A Right. Each Series A Right will entitle its holder to purchase one-thousandth of a share of Series A Preferred of the Company for $200 (subject to adjustment). The Series A Rights are not exercisable until the earlier of (i) ten days after any person or group becomes the beneficial owner of 15% or more of the outstanding Common Stock or (ii) 10 business days (unless extended by the Board of Directors) after the commencement of a tender offer or exchange offer that would result in a person or group beneficially owning 15% or more of the Common Stock. 21 24 If any person or group acquires 15% or more of the Common Stock outstanding (the "Shares Acquisition Date"), each holder of a Series A Right (except the acquiring party) has the right to receive, upon exercise, (i) shares of Common Stock of the Company having a market value of two times the exercise price of the Series A Right and (ii) one Series B Right (Series A Rights and Series B Rights are hereinafter collectively referred to as the "Rights"). The Board of Directors has the option, after the Shares Acquisition Date but before there has been a 50% acquisition of the Company, to exchange both (i) one share of Common Stock (or one-thousandth of a share of preferred stock) and (ii) one Series B Right, for each Series A Right (other than Series A Rights held by an acquiring party). If, after the Series A Rights become exercisable, the Company is involved in a merger or other business combination, or if the Company sells or transfers more than 50% of its assets or earning power, or if an acquiring party engages in certain "self-dealing" transactions with the Company, each Series A Right and Series B Right then outstanding (other than Rights held by an acquiring party) will be exercisable for common stock of the other party to such transaction having a market value of two times the exercise price of the Right. The Company has the right to redeem the Series A Rights for $.01 per Series A Right (the "Redemption Price") prior to the Shares Acquisition Date. The Series B Rights, once issued, are not redeemable. The Rights expire on February 9, 2006. The Rights have certain anti-takeover effects. The Rights should not interfere with any merger or business combination approved by the Board of Directors since the Series A Rights may be redeemed by the Company at the Redemption Price prior to the time that a person or group has acquired beneficial ownership of 15% or more of the Common Stock. However, by causing substantial dilution to a person or group that attempts to acquire the Company on terms not approved by the Board of Directors, the Rights may interfere with certain acquisitions, including acquisitions that may offer a premium over market price to some or all of the Company's shareholders. The Rights are not intended to prevent an acquisition of the Company on terms that are favorable and fair to all shareholders. See "Risk Factors - Anti-Takeover Provisions." 22 25 ITEM 6. SELECTED FINANCIAL DATA The following table presents selected financial data with respect to the Company as of and for the years ended December 31, 1994, 1995, 1996, 1997 and 1998. The selected financial data for each of the years in the audited five-year period ended December 31, 1998 have been derived from the financial statements of the Company. The information set forth below should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations", and the financial statements, related notes and other financial information included elsewhere in this Form 10-K.
----------- ----------- ------------ ------------ ------------ 1994 1995 1996 1997 1998 ----------- ----------- ------------ ------------ ------------ STATEMENT OF OPERATIONS DATA: Net Revenues.......................... $ 208,168 $ 27,830 $ 209,822 $ 1,038,134 $ 3,242,930 Costs and expenses: Cost of revenues.................... 194,098 19,286 49,534 4,401,077 7,047,347 Research and development.......... 1,962,678 4,554,946 6,422,921 4,132,019 2,934,784 Selling and marketing............... 454,968 469,600 1,834,640 1,918,044 1,847,680 General and administrative.......... 2,199,597 2,763,615 3,290,810 2,772,274 3,370,058 ----------- ----------- ------------ ------------ ------------ (4,603,173) (7,779,617) (11,388,083) (12,185,280) (11,956,939) Other income (expense): Investment income .................. 496,392 487,543 503,911 254,781 354,738 Interest expense.................... (8,582) (39,600) (29,602) (17,969) (10,247,919) ----------- ----------- ------------ ------------ ------------ 487,810 447,943 474,309 236,812 (9,893,181) ----------- ----------- ------------ ------------ ------------ Net loss................................ $(4,115,363) $(7,331,674) $(10,913,774) $(11,948,468) $(21,850,120) Preferred Stock dividends............... - - - (143,302) (61,834) ----------- ----------- ------------ ------------ ------------ Net loss plus Preferred Stock dividends. $(4,115,363) $(7,331,674) $(10,913,774) $(12,091,770) $(21,911,954) =========== =========== ============ ============ ============ Basic and diluted loss per common share. $ (1.15) $ (2.01) $ (2.41) $ (2.34) $ (1.93) Weighted average number of common shares outstanding........... 3,578,485 3,641,196 4,536,034 5,156,663 11,345,540 ----------- ----------- ------------ ------------ ------------ 1994 1995 1996 1997 1998 ----------- ----------- ------------ ------------ ------------ BALANCE SHEET DATA: Cash and cash equivalents............. $ 90,362 $ 953,093 $ 5,188,047 $ 2,766,886 $ 2,152,595 Working capital....................... 9,806,670 5,458,474 5,207,923 4,668,982 4,143,558 Total assets.......................... 14,732,501 11,105,766 13,388,496 11,534,309 10,028,088 Long-term debt/capital lease obligations, less current portion.. 8,355 509,079 91,618 13,541 9,302,651 Stockholders' equity (net capital deficiency)........................ 12,821,746 9,185,379 11,520,128 10,046,569 (772,968)
23 26 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information contained in this Form 10-K contains forward-looking statements which involve certain risks, uncertainties and contingencies which could cause the Company's actual results, performance or achievements to differ materially from those expressed, or implied, by such statements. See the italicized language on the introductory page of this Form 10-K. RESULTS OF OPERATIONS Years Ended December 31, 1998 and 1997 The Company's net revenues increased $2,204,796 from $1,038,134 in 1997 to $3,242,930 in 1998, as a result of increased sales of the Company's radio frequency ("RF") front-end products. Net revenues in the fourth quarter of 1998 were $1,504,497, as compared to $282,384 for the fourth quarter of 1997. This revenue growth was the result of the increased acceptance of the Company's products by operators, price reductions that the Company implemented in October 1998 and a large scale deployment of the Company's products by one of the largest cellular operators in the U.S. However, the Company anticipates significantly lower revenues in the first quarter of 1999 as compared to the fourth quarter of 1998. Net revenues from product sales represent gross product shipments less reserves for potential returns. Such reserves are based on the Company's historical product return rates. All of the net revenues in 1997 and 1998 were from commercial product sales. The Company has concentrated its efforts on its commercial product development programs and does not expect revenues to increase dramatically unless and until it ships a significantly larger amount of its commercial products. Cost of product sales was $7,047,347 for the year ended December 31, 1998, as compared to $4,401,077 for the year ended December 31, 1997. The cost of net product sales for 1998 and 1997 consisted of direct material, labor and overhead costs associated with the products that were shipped during the year, plus approximately $375,000 and $529,000, respectively, of costs, which consisted primarily of allocated overhead costs, incurred to produce units in ending finished goods inventory that exceed net realizable value. Due to low utilization levels and excess capacity in the Company's manufacturing facility, cost of net product sales exceeded net revenues for the years ended December 31, 1998 and 1997. The Company expects the cost of net product sales to exceed net revenues until it manufactures and ships a significantly higher amount of its commercial products. The Company's internally funded research and development expenses decreased $1,197,235 from $4,132,019 in 1997 to $2,934,784 in 1998. Research and development costs were reduced during 1998, as compared to 1997, primarily due to a reduction in personnel and operating costs during 1998. The Company expects to continue reducing its research and development expenses during 1999. Selling and marketing expenses decreased to $1,847,680 in 1998 from $1,918,044 in 1997. This decrease was due to lower advertising, recruiting and consulting expenses during 1998 as compared to 1997. The decrease was partially offset by increased salary and freight expenses in 1998. General and administrative expenses increased $597,784 from $2,772,274 in 1997 to $3,370,058 in 1998. The increase in general and administrative expenses was due primarily to higher consultant, legal and office expenses during 1998 as compared to 1997. Investment income increased $99,957 from $254,781 in 1997 to $354,738 in 1998. This increase was due to a higher average cash, cash equivalent and investment balance during 1998. Interest expense increased $10,229,950 from $17,969 in 1997 to $10,247,919 in 1998. This increase was primarily due to $10,101,401 of non-cash interest charges related to the Company's Senior Convertible Notes due May 15, 2002, issued in May 1998. 24 27 Years Ended December 31, 1997 and 1996 The Company's net revenues increased $828,312 from $209,822 in 1996 to $1,038,134 in 1997, as a result of increased sales of the Company's RF front-end products. Net revenues from product sales represent gross product shipments less reserves for potential returns. Such reserves are based on the Company's historical product return rates. A government contract accounted for $53,122 of the Company's net revenues in 1996, while all of the net revenues in 1997 were from commercial product sales. Cost of net product sales was $4,401,077 for the year ended 1997, as compared to $0 for the year ended 1996. The cost of net product sales for 1997 consisted of direct material, labor and overhead costs associated with the products that were shipped during the year, plus approximately $529,000 of costs, which consist primarily of allocated overhead costs, incurred to produce units in ending finished goods inventory that exceed net realizable value. With the introduction of the SpectrumMaster(R) Ultra product into the Company's product line, management determined that there was little marketability for an early SpectrumMaster(R) filter product model. Management decided, therefore, to write down the costs associated with this early SpectrumMaster(R) inventory. Consequently, a total of $309,000 was charged to cost of net product sales in the fourth quarter of 1997. Due to low utilization levels and excess capacity in the Company's manufacturing facility, cost of net product sales exceeded net revenues for the year ended December 31, 1997. The Company's internally funded research and development expenses decreased $2,290,902 from $6,422,921 in 1996 to $4,132,019 in 1997. Research and development costs were reduced during 1997, as compared to 1996, primarily due to the initiation of full-scale manufacturing activities during 1997. Costs associated with manufacturing activities during 1997 were recorded as manufacturing overhead expenses and were charged as cost of product sales. Costs associated with the development of manufacturing activities and processes during 1996 were recorded as research and development expenses during that period. Additional reductions of research and development costs in 1997 as compared to 1996 are due to reductions in personnel, materials and other operating costs. Selling and marketing expenses increased to $1,918,044 in 1997 from $1,834,640 in 1996. This increase was due to the addition of sales personnel and expanded product marketing and advertising efforts during 1997 as compared to 1996. The increase was partially offset by reduced consulting costs during 1997. General and administrative expenses decreased $518,536 from $3,290,810 in 1996, to $2,772,274 in 1997. The decrease in general and administrative expenses was due primarily to lower administrative personnel, consultant and legal expenses during 1997 as compared to 1996. Investment income decreased $249,130 from $503,911 in 1996 to $254,781 in 1997. This decrease was due to a lower average cash equivalent and investment balance during 1997. Interest expense decreased $11,633 from $29,602 in 1996, to $17,969 in 1997. The decrease is primarily due to a lower average outstanding debt balance during 1997. IMPACT OF YEAR 2000 The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Computer programs that have time-sensitive software may recognize a date using "00" as the year 1990 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business activities. The Company has established a task force comprised of several employees to evaluate the Company's status with respect to the Year 2000 Issue. The task force has identified the following areas as possibly being affected by the Year 2000 issue: (1) IT and non-IT systems, (2) manufacturing applications and (3) third-party relationships. For each of these areas, the Company is in the process of identifying and assessing specific software, equipment and systems which are potentially susceptible to the Year 2000 Issue. The Company expects to develop and implement corrective actions to ensure that by September 30, 1999 its software, equipment and systems will function properly with respect to dates in the year 2000 and thereafter. The Company believes the total cost of such year 2000 compliance activities will not be material. The Company believes that it has no material exposure to contingencies related to the Year 2000 Issue for the products that it has sold to date. 25 28 The Company processes its transactions and applications utilizing a network of personal computers. In addition, the Company's telephone system, fax machines, payroll, alarm systems and other miscellaneous systems utilize computer equipment and software. The Company is identifying which software and equipment needs to be upgraded. Based on its assessment to date, the Company does not believe that significant modifications or replacement of its software systems will be required to be year 2000 compliant. Most of the software used by the Company in operational applications has been acquired within the past 18 months and is year 2000 compliant. The Company's manufacturing activities rely on machine tools and test stations, each of which contain embedded technology. The Company has identified the particular hardware and software systems used in such manufacturing applications. The Company is communicating orally and in writing with suppliers of these systems and based on such conversations believes the manufacturing applications are year 2000 compliant. The Company relies on third party suppliers for raw materials, utilities and other key supplies and services. The Company, therefore, recognizes that it is vulnerable to third party suppliers that fail to remediate their own Year 2000 Issues. The Company is communicating orally and in writing with its significant suppliers to determine their year 2000 compliance status. The Company is also dependent upon its customers for sales and cash flow. The Company does not currently have any formal information concerning the year 2000 compliance status of its customers, but has received indications that most of the Company's customers are working on year 2000 compliance. The Company's most reasonably likely worst case scenario with respect to the Year 2000 Issue is that (1) its manufacturing applications may malfunction and (2) third party suppliers of raw materials and utilities and customers may be unable to remediate their own Year 2000 Issues. In such scenario, the Company could experience manufacturing interruptions, delays in distribution of its products and reduced sales. This would have a material adverse effect on the Company's operations. The Company currently has no contingency plan in event such reasonably likely worst case scenario occurs. The Company currently believes that the Year 2000 Issue will not pose significant operational problems for the Company. However, if all Year 2000 Issues are not properly identified or remediated on a timely basis, the Company's results of operations or relationships with customers and suppliers may be materially adversely affected. There can be no guarantee that the systems of other companies on which the Company relies will be timely converted or that their failure to do so would not have a material adverse effect on the Company's operations. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1998, the Company's cash, cash equivalents and investments, including certain restricted investments, were $2,489,942, reflecting a decrease of $1,157,257 from $3,647,199 at December 31, 1997. $680,696 in principal amount of promissory notes, plus $138,355 of accrued interest thereon, from certain stockholders is outstanding as of December 31, 1998. These notes were due on April 30, 1997. The Company has filed a lawsuit to collect on the outstanding balance, but there can be no assurance when and if such promissory notes will be repaid. See "Item 3. Legal Proceedings." The continuing development of and expansion in sales of the Company's RF filter product lines will require continued commitment of substantial funds to undertake continued product development and manufacturing activities and to market and sell its RF front-end products. The actual amount of the Company's future funding requirements will depend on many factors, including: the amount and timing of future revenues, the level of product marketing and sales efforts to support the Company's commercialization plans, the magnitude of its research and product development programs, the ability of the Company to improve product margins, the cost of additional plant and equipment for manufacturing and the costs involved in protecting the Company's patents or other intellectual property. On May 15, 1998 the Company entered into a Securities Purchase Agreement (the "Agreement") with various parties. Under the terms of the Agreement, the Company issued and sold $10,350,000 in aggregate principal amount of Senior Convertible Notes due May 15, 2002 (the "Notes") and issued warrants to purchase 4,140,000 shares of the Company's Common Stock (the "Warrants"). The Notes bear interest at 2% per annum, payable in cash or in shares of the Company's Common Stock at the Company's option, and mature on May 15, 2002. Holders of the Notes may convert the principal amount, plus accrued and unpaid interest, if any, into shares of the Company's Common Stock at a fixed conversion price of $1.50 per share. Conversions were not permitted during the first 90 days following the issuance of the Notes and were limited to one-half of the original principal amount during the period from 91 to 180 days after the issuance of the Notes. On and after 26 29 May 15, 2000, the Company may redeem all or a portion of the Notes at a redemption price equal to the principal amount plus accrued interest thereon, if any, under certain conditions. The Warrants have an exercise price of $3.75 per share and expire on May 15, 2001. The Agreement contains several covenants which limit the Company's ability to incur additional indebtedness and to create any lien, pledge, or encumbrance on any assets of the Company. On March 31, 1999, the Company privately issued an aggregate of $3.3 million initial principal amount of Senior Convertible Notes due May 15, 2002 (the "New Notes") and issued warrants to purchase 1,320,000 shares of the Company's Common Stock (the "New Warrants"). The New Notes bear interest at the rate of 6% per annum, payable in cash or shares of Common Stock at the Company's option, and mature on May 15, 2002. Holders of the New Notes may convert the principal amount, plus accrued and unpaid interest, if any, into shares of the Company's Common Stock at a fixed conversion price of $1.125 per share. On and after May 15, 2000, the Company may redeem all or a portion of the New Notes at a redemption price equal to the principal amount plus accrued interest thereon, if any, under certain conditions. The New Warrants have an exercise price of $1.4625 per share and expire on March 31, 2002. In the event that the Company fails to achieve break-even or positive operating income during the second quarter of 2000, the New Notes, together with the Notes, may become immediately due and payable unless the holders thereof agree to modify or waive such provision. Concurrently with the issuance of the New Notes, the Company amended certain terms of $5.5 million in aggregate principal amount of the Notes (the "Amended Notes") and the Warrants exercisable for an aggregate of 2,200,000 shares of the Company's Common Stock (the "Amended Warrants") issued in connection therewith. The Amended Notes were amended to bear interest at the rate of 6% per annum, payable in cash or shares of the Company's Common Stock at the Company's option, and the fixed conversion price for the Amended Notes was reduced from $1.50 to $1.125 per share. The exercise price of the Amended Warrants was reduced from $3.75 to $1.4625 per share. Despite the recently completed issuance and sale of New Notes, the Company believes that during the third quarter of 1999 it will require substantial additional funds to finance its product development, manufacturing and marketing activities. The Company's strategy to generate sufficient working capital to fund its operations and cash requirements in the future includes advancing market penetration with OEMs and customers in overseas markets, building strong and enduring relationships with existing customers and expanding product offerings to meet varying customer needs, reducing product costs through economies of scale in material purchases, refinement of the manufacturing processes, and the further implementation of an overhead reduction program. The Company is actively seeking financing in order to obtain working capital to continue its operations according to its current operating plan through the third quarter of 1999 and beyond. If the Company is unable to obtain adequate funds when needed in the future, the Company would be required to substantially delay, scale-back or eliminate the manufacturing, marketing or sales of one or more of its products or research and development programs, or may be required to obtain funds through arrangements with collaborative partners or others that may require the Company to relinquish rights to certain of its technologies, product candidates or potential products that the Company would not otherwise relinquish. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company does not have any material market risk sensitive instruments. 27 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT AUDITORS The Board of Directors Illinois Superconductor Corporation We have audited the accompanying balance sheets of Illinois Superconductor Corporation as of December 31, 1998 and 1997, and the related statements of operations, stockholders' equity (net capital deficiency), and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedule listed in the index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Illinois Superconductor Corporation at December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. The accompanying financial statements have been prepared assuming that Illinois Superconductor Corporation will continue as a going concern. As more fully described in Note 3, Illinois Superconductor Corporation has incurred ongoing operating losses and does not currently have financing commitments in place to meet expected cash requirements through 1999. These conditions raise substantial doubt about Illinois Superconductor Corporation's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 3. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. Ernst & Young LLP Chicago, Illinois February 26, 1999, except for Note 3, as to which the date is March 31, 1999 28 31 ILLINOIS SUPERCONDUCTOR CORPORATION BALANCE SHEETS
DECEMBER 31, 1998 1997 ----------- ----------- ASSETS Current assets: Cash and cash equivalents $ 2,152,595 $ 2,766,886 Investments - 500,313 Inventories 1,424,427 1,726,141 Accounts receivable, net of allowance for doubtful accounts of $87,990 and $68,775 at December 31, 1998 and 1997, respectively 1,494,418 586,501 Prepaid expenses and other 479,311 471,928 ----------- ----------- Total current assets 5,550,751 6,051,769 Property and equipment: Leasehold improvements 4,218,511 4,215,011 Lab equipment 1,694,840 1,689,381 Manufacturing equipment 983,426 945,081 Office equipment 759,443 709,324 Furniture and fixtures 629,490 618,496 ----------- ----------- 8,285,710 8,177,293 Less: Accumulated depreciation (4,761,599) (3,654,239) ----------- ----------- 3,524,111 4,523,054 Restricted certificates of deposit 337,347 380,000 Patents and trademarks, net 615,879 579,486 ----------- ----------- Total assets $10,028,088 $11,534,309 =========== ===========
See the accompanying Notes which are an integral part of the financial statements. 29 32 ILLINOIS SUPERCONDUCTOR CORPORATION BALANCE SHEETS (CONTINUED)
DECEMBER 31, 1998 1997 ------------ ------------ LIABILITIES AND STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY) Current liabilities: Accounts payable $ 464,752 $ 717,425 Accrued liabilities 799,569 587,285 Accrued interest 129,375 - Current portion of other long-term debt 13,497 78,077 ------------- ------------ Total current liabilities 1,407,193 1,382,787 Senior convertible notes, net of discount 9,302,651 - Other long-term debt, less current portion - 13,541 Deferred occupancy costs 91,212 91,412 Stockholders' equity (net capital deficiency): Preferred Stock: Series B Convertible Preferred Stock at liquidation value: 95 shares issued and outstanding at December 31,1997 (none at December 31, 1998) - 488,534 Series C Convertible Preferred Stock at liquidation value: 600 shares issued and outstanding at December 31,1997 (none at December 31, 1998) - 3,038,424 Series G Convertible Preferred Stock at liquidation value: 700 shares issued and outstanding at December 31,1997 (none at December 31, 1998) - 3,530,206 Common stock ($.001 par value); 30,000,000 and 15,000,000 shares authorized and 12,557,045 and 6,001,925 shares issued and outstanding at December 31, 1998 and 1997, respectively 12,557 6,002 Additional paid-in capital 60,055,321 41,991,941 Notes receivable from stockholders (680,696) (698,508) Accumulated deficit (60,160,150) (38,310,030) ------------ ------------ Total stockholders' equity (net capital deficiency) (772,968) 10,046,569 ------------ ------------ Total liabilities and stockholders' equity (net capital deficiency) $ 10,028,088 $ 11,534,309 ============ ============
See the accompanying Notes which are an integral part of the financial statements. 30 33 ILLINOIS SUPERCONDUCTOR CORPORATION STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 1997 1996 ------------- ------------ ----------- Net revenues: Net product sales $ 3,242,930 $ 1,038,134 $ 156,700 Government contracts - - 53,122 ------------- ------------ ------------- Total net revenues 3,242,930 1,038,134 209,822 Costs and expenses: Cost of product sales 7,047,347 4,401,077 - Cost of government contract revenue - - 49,534 Research and development 2,934,784 4,132,019 6,422,921 Selling and marketing 1,847,680 1,918,044 1,834,640 General and administrative 3,370,058 2,772,274 3,290,810 ------------- ------------ ------------- Total costs and expenses 15,199,869 13,223,414 11,597,905 ------------- ------------ ------------- (11,956,939) (12,185,280) (11,388,083) Other income and (expense): Investment income 354,738 254,781 503,911 Non-cash interest expense on Senior convertible notes (Note 8) (10,101,401) - - Other interest expense (146,518) (17,969) (29,602) ------------- ------------ ------------- (9,893,181) 236,812 474,309 ------------- ------------ ------------- Net loss (21,850,120) (11,948,468) (10,913,774) Preferred Stock dividends (61,834) (143,302) - ------------- ------------ ------------- Net loss plus Preferred Stock dividends $( 21,911,954) $(12,091,770) $(10,913,774) ============= ============ ============= Basic and diluted loss per common share $ (1.93) $ (2.34) $ (2.41) ============= ============ ============= Weighted average number of common shares outstanding 11,345,540 5,156,663 4,536,034 ============= ============ =============
See the accompanying Notes which are an integral part of the financial statements. 31 34 ILLINOIS SUPERCONDUCTOR CORPORATION STATEMENTS OF STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY) YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
SERIES B CONVERTIBLE SERIES C CONVERTIBLE SERIES G CONVERTIBLE PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK COMMON STOCK ---------------------------------------------------------------------------------------- NUMBER NUMBER NUMBER NUMBER OF SHARES AMOUNT OF SHARES AMOUNT OF SHARES AMOUNT OF SHARES AMOUNT ---------------------------------------------------------------------------------------- Balance as of December 31, 1995 - $ - - $ - - $ - 3,998,952 $ 3,999 Exercise of stock options; $.184 - $15.25 per share - - - - - - 49,881 50 Exercise of warrants; $1.4679 - $13.50 - - - - - - 565,993 566 per share Forfeiture of stock options - - - - - - - - Issuance of common stock - Private placement, net of offering costs; - - - - - - 408,526 408 $21.80 per share Amortization of deferred compensation - - - - - - - - Net loss - - - - - - - - ---------------------------------------------------------------------------------------- Balance as of December 31, 1996 - - - - - - 5,023,352 5,023 Exercise of stock options; $.184 - $18.25 - - - - - - 17,821 18 per share Exercise of warrants; $1.4679 - $13.50 - - - - - - 138,820 139 per share Payment of stockholder notes receivable - - - - - - - - Issuance of preferred stock, net of 600 3,000,000 600 3,000,000 700 3,500,000 - - offering costs Preferred stock dividends - 13,534 - 38,424 - 30,206 19,940 20 Conversion of preferred stock to common stock (505) (2,525,000) - - - - 801,992 802 Net loss - - - - - - - - ---------------------------------------------------------------------------------------- Balance as of December 31, 1997 95 488,534 600 3,038,424 700 3,530,206 6,001,925 6,002 Additional offering costs related to - - - - - - - - issuance of preferred stock Exercise of stock options; $. 18 - $.23 - - - - - - 33,942 34 per share Payment of stockholder notes - - - - - - - - receivable Preferred stock dividends - 260 - 24,377 - 37,197 - - Conversion of preferred stock to (95) (488,794) (600) (3,062,801) (700) (3,567,403) 6,521,178 6,521 common stock Discount on senior convertible notes - - - - - - - - (Note 8) Net loss - - - - - - - - ======================================================================================== Balance as of December 31, 1998 - $ - - $ - - $ - 12,557,045 $12,557 ========================================================================================
See the accompanying Notes which are an integral part of the financial statements. 32 35 ILLINOIS SUPERCONDUCTOR CORPORATION STATEMENTS OF STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY) YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (CONTINUED)
ADDITIONAL DEFERRED NOTES RECEIVABLE ACCUMULATED PAID-IN CAPITAL COMPENSATION FROM STOCKHOLDERS DEFICIT TOTAL --------------------------------------------------------------------------------- Balance as of December 31, 1995 $24,670,560 $(41,392) $ - $(15,447,788) $ 9,185,379 Exercise of stock options; $.184 - $15.25 per share 282,903 - - - 282,953 Exercise of warrants; $1.4679 - 5,738,150 - (1,142,754) - 4,595,962 $13.50 per share Forfeiture of stock options (5,438) 5,438 - - - Issuance of common stock - Private placement, net of offering costs; 8,333,246 - - - 8,333,654 $21.80 per share Amortization of deferred compensation - 35,954 - - 35,954 Net loss - - - (10,913,774) (10,913,774) --------------------------------------------------------------------------------- Balance as of December 31, 1996 39,019,421 - (1,142,754) (26,361,562) 11,520,128 Exercise of stock options; $.184 - 70,170 - - - 70,188 $18.25 per share Exercise of warrants; $1.4679 - 796,908 - - - 797,047 $13.50 per share Payment of stockholder notes - - 444,246 - 444,246 receivable Issuance of preferred stock, net of (336,572) - - - 9,163,428 offering costs Preferred stock dividends (82,184) - - - - Conversion of preferred stock to 2,524,178 - - - - common stock Net loss - - - (11,948,468) (11,948,468) --------------------------------------------------------------------------------- Balance as of December 31, 1997 41,991,941 - (698,508) (38,310,030) 10,046,569 Additional offering costs related to (143,400) - - - (143,400) issuance of preferred stock Exercise of stock options; $. 18 - 7,387 - - - 7,421 $.23 per share Payment of stockholder notes - - 17,812 - 17,812 receivable Preferred stock dividends (61,834) - - - - Conversion of preferred stock to 7,112,477 - - - - common stock Discount on senior convertible notes 11,148,750 - - - 11,148,750 (Note 8) Net loss - - - (21,850,120) (21,850,120) --------------------------------------------------------------------------------- Balance as of December 31, 1998 $60,055,321 $ - $ (680,696) $(60,160,150) $ (772,968) =================================================================================
See the accompanying Notes which are an integral part of the financial statements. 33 36 ILLINOIS SUPERCONDUCTOR CORPORATION STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998 1997 1996 ------------- ------------- ------------- OPERATING ACTIVITIES Net loss $(21,850,120) $(11,948,468) $(10,913,774) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 1,107,360 1,533,705 1,157,561 Amortization 76,214 6,994 6,639 Non-cash interest expense on senior convertible notes (Note 8) 10,101,401 - - Loss (gain) on available-for-sale securities 4,963 - (43,171) Other - - (939) Stock compensation expense - - 35,954 Changes in operating assets and liabilities: Accounts receivable (907,917) (455,749) 179,777 Inventories 301,714 (1,072,445) (653,696) Prepaid expenses and other (7,383) (35,876) 29,246 Accounts payable (252,673) (411,584) 249,640 Accrued liabilities 341,659 92,778 113,201 Deferred occupancy costs (200) 15,599 18,760 ------------- ------------- ------------- Net cash used in operating activities (11,084,982) (12,275,046) (9,820,802) INVESTING ACTIVITIES Purchases of available-for-sale securities - - (30,945,246) Sales of available-for-sale securities 495,350 - 2,500,000 Maturities of available-for-sale securities - - 33,072,852 (Increase) decrease in restricted certificates of deposit 42,653 (30,000) 512,500 Payments of patent costs (112,607) (199,647) (156,711) Acquisitions of property and equipment (108,417) (310,956) (3,706,588) ------------- ------------- ------------- Net cash provided by (used in) investing 316,979 (540,603) 1,276,807 activities FINANCING ACTIVITIES Proceeds from issuance of preferred stock - net of offering costs (143,400) 9,163,428 - Proceeds from issuance of common stock - net of offering costs - - 8,333,654 Exercise of stock options 7,421 70,188 282,953 Exercise of warrants - 797,047 4,595,962 Payments on stockholder notes receivable 17,812 444,246 - Proceeds from issuance of senior convertible notes 10,350,000 - - Proceeds from issuance of other long-term debt - - 92,182 Payments on other long-term debt (78,121) (80,421) (525,802) ------------- ------------- ------------- Net cash provided by financing activities 10,153,712 10,394,488 12,778,949 ------------- ------------- ------------- Increase (decrease) in cash and cash equivalents (614,291) (2,421,161) 4,234,954 Cash and cash equivalents at beginning of period 2,766,886 5,188,047 953,093 ------------- ------------- ------------- Cash and cash equivalents at end of period $ 2,152,595 $ 2,766,886 $ 5,188,047 ============= ============= ============= Supplemental cash flow information: Cash paid for interest $ 8,994 $ 17,969 $ 29,602 ============= ============= =============
See the accompanying Notes which are an integral part of the financial statements. 34 37 ILLINOIS SUPERCONDUCTOR CORPORATION NOTES TO FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS Illinois Superconductor Corporation (the "Company") was founded in 1989 by ARCH Development Corporation, an affiliate of The University of Chicago, to commercialize superconducting technologies developed initially at Argonne National Laboratory. The Company uses its patented and proprietary high-temperature superconducting materials technologies to develop and manufacture radio frequency front-end products designed to enhance the quality, capacity, coverage and flexibility of cellular, PCS and other wireless telecommunications services located primarily in the United States. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Cash and Cash Equivalents Cash and cash equivalents consist of demand deposits, time deposits, money market funds, and commercial paper which have maturities of three months or less from the date of purchase. Management believes that the financial institutions in which it maintains such deposits are financially sound and, accordingly, minimal credit risk exists with respect to these deposits. Inventories Inventories are stated at the lower of cost (determined on a first in, first out basis) or market. Patents and Trademarks Patents and trademarks represent costs, primarily legal fees and expenses, incurred in order to prepare and file patent applications related to various aspects of the Company's superconductor technology and to its current and proposed products. Patents and trademarks are recorded at cost and are amortized using the straight-line method over the shorter of their estimated useful lives or 17 years. The recoverability of the carrying values of patents and trademarks is evaluated on an ongoing basis. During 1998, the Company wrote-off $61,333 of patent-related costs. Total capitalized patent and trademark costs are $655,678 and $604,404 at December 31, 1998 and 1997, respectively. Capitalized patent costs related to pending patents are $315,177 and $471,933 at December 31, 1998 and 1997, respectively. Patents and trademarks are net of accumulated amortization of $39,799 and $24,918 at December 31, 1998 and 1997, respectively. Property and Equipment Property and equipment are stated at cost, less accumulated depreciation, and are depreciated over the estimated useful lives of the assets using accelerated methods. Leasehold improvements are amortized using the straight-line method over the shorter of the useful life of the asset or the term of the lease. Amortization of leasehold improvements is included in depreciation expense. The useful lives assigned to property and equipment for the purpose of computing book depreciation are as follows: Lab equipment 5 years Manufacturing equipment 3 to 5 years Office equipment 3 to 5 years Furniture and fixtures 5 years Leasehold improvements Life of lease 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Income Taxes 35 38 Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Revenue Recognition and Product Warranty Revenues from product sales are generally recognized at the time of shipment and are recorded net of estimated returns and allowances. The Company has, under certain conditions, granted customers the right to return product during a specified period of time after shipment. In these situations, the Company establishes a liability for estimated returns and allowances at the time of shipment. The Company has established a program which, in certain situations, allows customers or prospective customers to field test the Company's products for a specified period of time. Revenues from field test arrangements is recognized upon customer acceptance of the products. The Company warrants its products against defects in materials and workmanship typically for a one year period from the date of shipment, except for superconducting materials contained in the products, which are warranted for ten years from the date of shipment. A provision for estimated future costs related to warranty expenses is recorded when revenues are recognized. Returns and allowances and warranty costs were not significant in any period reported. Advertising Costs Advertising costs are charged to expense in the period incurred. Advertising expense for the years ended December 31, 1998, 1997 and 1996, was approximately $18,000, $176,000 and $135,000, respectively. Research and Development Costs Research and development costs related to both present and future products are charged to expense in the period incurred. Net Loss Per Common Share Basic and diluted net loss per common share are computed based upon the weighted average number of common shares outstanding. Common shares issuable upon the exercise of options and warrants are not included in the per share calculations since the effect of their inclusion would be antidilutive. All earnings per share amounts for all periods have been presented and, where appropriate, restated to conform to the Statement 128 requirements. Use of Estimates The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Description of Certain Concentrations and Risks The Company operates in a highly competitive and rapidly changing industry. Product revenues are currently concentrated with a limited number of customers and the supply of certain materials is concentrated among a few providers. The development and commercialization of new technologies by any competitor could adversely affect the Company's results of operations. 36 39 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Long Lived Assets The Company records impairment losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. 3. GOING CONCERN AND MANAGEMENT'S PLANS The Company has incurred, and continues to incur, losses from operations and the Company's available resources are not presently sufficient to fund its expected cash requirements through the end of 1999. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The Company's strategy to generate sufficient working capital to fund its operations and cash requirements in the future includes advancing market penetration with original equipment manufacturers ("OEMs") and customers in overseas markets, building strong and enduring relationships with existing customers, expanding product offerings to meet varying customer needs, and reducing product costs through economies of scale in material purchases, refinement of the manufacturing processes, and further implementation of an overhead reduction program. As a result of its funding requirements, on March 31, 1999, the Company privately issued an aggregate of $3.3 million initial principal amount of Senior Convertible Notes due May 15, 2002 (the "New Notes") and issued warrants to purchase 1,320,000 shares of the Company's Common Stock (the "New Warrants"). The New Notes bear interest at the rate of 6% per annum, payable in cash or shares of Common Stock at the Company's option, and mature on May 15, 2002. Holders of the New Notes may convert the principal amount, plus accrued and unpaid interest, if any, into shares of the Company's Common Stock at a fixed conversion price of $1.125 per share. On and after May 15, 2000, the Company may redeem all or a portion of the New Notes at a redemption price equal to the principal amount plus accrued interest thereon, if any, under certain conditions. The New Warrants have an exercise price of $1.4625 per share and expire on March 31, 2002. In the event that the Company fails to achieve break-even or positive operating income during the second quarter of 2000, the New Notes, together with the Notes (See Note 8), may become immediately due and payable unless the holders thereof agree to modify or waive such provision. Concurrently with the issuance of the New Notes, the Company amended certain terms of $5.5 million in aggregate principal amount of the Notes (the "Amended Notes") and the Warrants exercisable for an aggregate of 2,200,000 shares of the Company's Common Stock (the "Amended Warrants") issued in connection therewith. The Amended Notes were amended to bear interest at the rate of 6% per annum, payable in cash or shares of the Company's Common Stock at the Company's option, and the fixed conversion price for the Amended Notes was reduced from $1.50 to $1.125 per share. The exercise price of the Amended Warrants was reduced from $3.75 to $1.4625 per share. Despite the recently completed issuance and sale of New Notes, the Company believes that during the third quarter of 1999 it will require substantial additional funds to finance its product development, manufacturing and marketing activities. The Company is actively seeking financing in order to obtain working capital to continue its operations according to its current operating plan through the third quarter of 1999 and beyond. If the Company is unable to obtain adequate funds when needed in the future, the Company would be required to substantially delay, scale-back or eliminate the manufacturing, marketing, or sales of one or more of its products or research and development programs, or may be required to obtain funds through arrangements with collaborative partners or others that may require the Company to relinquish rights to certain of its technologies, product candidates or potential products that the Company would not otherwise relinquish. This would materially and adversely affect the Company's business, financial condition, results of operations and cash flows. 37 40 4. INVENTORIES Inventories consist of the following:
DECEMBER 31, 1998 1997 ---------- ---------- Raw materials $1,083,605 $ 704,626 Work-in-process 60,456 345,956 Finished product 280,366 675,559 ========== ========== $1,424,427 $1,726,141 ========== ==========
Cost of product sales for the years ending December 31, 1998 and 1997 includes approximately $375,000 and $529,000, respectively, of costs in excess of the net realizable value of finished goods inventory. 5. INVESTMENTS Investments at December 31, 1997 consisted of a U.S. government security, due March 2001, with a cost and fair value of $500,313. During 1998, this security was sold. The gross realized loss on such sale was $4,963. 6. CAPITAL STOCK The Company has an authorized class of undesignated preferred stock consisting of 100,000 shares. Preferred stock may be issued in series from time to time with such designations, relative rights, priorities, preferences, qualifications, limitations and restrictions thereof, to the extent that such are not fixed in the Company's certificate of incorporation, as the board of directors determines. On February 9, 1996, the board of directors adopted a shareholder rights plan (the "Rights Plan"). In conjunction with the adoption of the Rights Plan, the Company created one series of preferred stock, consisting of 10,000 shares of Series A Junior Participating Preferred Stock ("Series A Preferred"). Each share of Series A Preferred would entitle the holder to receive dividends equal to 1,000 times the dividends per share declared with respect to the Company's common stock and, in the event of liquidation, such holders would receive a preference of 1,000 times the aggregate amount to be distributed per share to the holders of the Company's common stock. Pursuant to the Rights Plan, a Series A Right is associated with, and trades with, each share of common stock outstanding. The record date for distribution of such Series A Rights was February 22, 1996, and for so long as the Series A Rights are associated with the common stock, each new share of common stock issued by the Company will include a Series A Right. Each Series A Right will entitle its holder to purchase one one-thousandth of a share of Series A Preferred for $200, subject to adjustment as defined in the Rights Plan. The Series A Rights are not exercisable until the earlier of (i) 10 days after any person or group becomes the beneficial owner of 15% or more of the Company's outstanding common stock, or (ii) 10 business days (unless extended by the board of directors) after the commencement of a tender offer or exchange offer that would result in a person or group beneficially owning 15% or more of the Company's outstanding common stock. If any person or group ("Acquiring Party") acquires 15% or more of the Company's outstanding common stock ("Shares Acquisition Date"), each holder of a Series A Right, except the Acquiring Party, has the right to receive upon exercise (i) shares of the Company's common stock having a market value equal to two times the exercise price of the Series A Right, and (ii) one Series B Right (Series A Rights and Series B Rights are hereinafter collectively referred to as the "Rights"). The board of directors has the option, after the Shares Acquisition Date but before there has been a 50% acquisition of the Company, to exchange one share of common stock (or one one-thousandth of a share of preferred stock) and one Series B Right for each Series A Right (other than Series A Rights held by the Acquiring Party). If, after the Series A Rights become exercisable, the Company is involved in a merger or other business combination, or if the Company sells or transfers more than 50% of its assets or earning power, or if an acquiring party engages in certain "self-dealing" transactions with the Company, as defined in the Rights Plan, each Right then outstanding (other than Rights held by the Acquiring Party) will be exercisable for common stock of the other party to such transaction having a market value 38 41 6. CAPITAL STOCK (CONTINUED) of two times the exercise price of the Right. The Company has the right to redeem each Series A Right for $0.01 prior to the Shares Acquisition Date. The Series B Rights, once issued, are not redeemable. The Rights expire on February 9, 2006. On November 14, 1995, the Company completed the private placement and issuance of 356,473 Units, which raised $3,581,282, net of related expenses. Each Unit consists of one share of common stock and one detachable common stock purchase warrant. Each warrant had a term of two years and was exercisable for the purchase of one share of common stock at $13.00 per share. Warrants for 15,700 of these shares were exercised prior to December 23, 1996. The remaining 340,773 warrants were redeemed by the Company on December 23, 1996. In conjunction with the redemption, the Company issued 340,773 shares of its common stock in exchange for $3,287,304 in cash plus $1,142,754 of notes. The notes bear interest at 8.25% per annum, were due on April 30, 1997, and are guaranteed by an affiliate of a stockholder. Payments made during 1998 and 1997 on the notes receivable totaled $17,812 and $444,246, respectively. The remaining balance due of $680,696 is currently being disputed by the issuers and is in litigation (Note 12). On February 23, 1996 the Company completed the private placement and issuance of 408,526 shares of its common stock at $21.80 per share. Proceeds, net of related expenses, were $8,333,654. On June 6, 1997, the Company issued 600 shares of Series B Convertible Preferred Stock ("Series B Stock") for $5,000 per share, or $3,000,000. In connection with the sale, the Company issued a warrant to purchase 62,500 shares of common stock at $14.8125 per share expiring on June 6, 2001. On each of August 29, 1997 and October 29, 1997, the Company issued 300 shares of Series C Convertible Preferred Stock ("Series C Stock") for $5,000 per share, or $3,000,000 in aggregate. In addition, on October 29, 1997, the Company issued 700 shares of Series G Convertible Preferred Stock ("Series G Stock") for $5,000 per share, or $3,500,000. In connection with the sale of Series G Stock, the Company issued warrants to purchase an aggregate of 34,782 shares of common stock at $10.0625 per share, expiring on October 29, 2001. Total proceeds for the above issuances, net of related expenses, was $9,020,028. None of the Preferred Stock has voting rights. The Series B Stock was convertible into common stock at a conversion price equal to the lessor of (a) $11.85, or (b) 101% of the average of the lowest per share market value for the five consecutive trading days during the 60 trading days immediately preceding the date of the conversion. The Series C Stock and Series G Stock was convertible into common stock at a conversion price equal to the lessor of (a) $8.05 or (b) 101% of the average of the lowest per share market value for the five consecutive trading days during the 60 trading days immediately proceeding the date of conversion. The conversion ratio was subject to adjustment. Dividends on the Series B, Series C and Series G Convertible Preferred Stock were payable at the rate of 5% per annum, and were payable in cash or shares of common stock, at the option of the Company. During the fourth quarter of 1997, $2,525,000 (505 shares) of Series B Convertible Preferred Stock were converted into 801,992 shares of common stock. Accrued dividends thereon of $61,138 were also converted into 19,940 shares of common stock. During the first quarter of 1998, $475,000 (95 shares) of Series B Convertible Preferred Stock were converted into 270,671 shares of common stock. Accrued dividends thereon of $13,794 were also converted into 7,860 shares of common stock. In addition, $2,475,000 (495 shares) of Series C Convertible Preferred Stock were converted into 2,133,331 shares of common stock. Accrued dividends thereon of $50,885 were also converted into 43,797 shares of common stock. In addition, $3,240,000 (648 shares) of Series G Convertible Preferred Stock were converted into 3,248,447 shares of common stock. Accrued dividends thereon of $61,913 were also converted into 62,075 shares of common stock. During the second quarter of 1998 $525,000 (105 shares) of Series C Convertible Preferred Stock were converted into 477,968 shares of common stock. Accrued dividends thereon of $11,916 were also converted into 10,849 shares of common stock. In addition, $260,000 (52 shares) of Series G Convertible Preferred Stock were converted into 260,678 shares of common stock. Accrued dividends of $5,490 were also converted into 5,502 shares of common stock. On April 22, 1998, the stockholders of the Company approved an increase in the number of shares of authorized common stock from 15,000,000 to 30,000,000. At December 31, 1998, authorized but unissued shares of common stock have been reserved for future issuance as 39 42 follows:
Warrants outstanding (Note 7) 4,678,688 Options outstanding (Note 7) 1,193,977 Options reserved for future issuance under the 1993 Stock Option Plan (Note 7) 485,145 Shares issuance upon conversion of senior convertible notes (Note 8) 6,900,000 ---------- 13,257,810 ==========
7. STOCK OPTIONS AND WARRANTS On August 19, 1993, the Board of Directors adopted the 1993 Stock Option Plan (the "Plan") for employees, consultants, and directors who are not also employees of the Company (outside directors). The maximum number of shares issuable under the Plan, as amended in 1997, is 1,705,000, of which 80,000 are reserved for issuance to outside directors. The Plan is administered by a committee (the "Committee") consisting of two or more outside directors appointed by the board of directors of the Company. For employees and consultants, the Plan provides for granting of Incentive Stock Options (ISOs) and Nonstatutory Stock Options (NSOs). In the case of ISOs, the exercise price shall not be less than 100% (110% in certain cases) of the fair value of the Company's common stock, as determined by the Committee, on the date of grant. In the case of NSOs, the exercise price shall not be less than 85% (110% in certain cases) of the fair value of the Company's common stock, as determined by the Committee, on the date of grant. The term of options granted to employees and consultants will be for a period not to exceed 10 years (five years in certain cases). Options granted under the Plan on or before May 31, 1995 generally vest over a five year period (one-fifth of options granted vest after one year from the grant date and the remaining options vest ratably each month thereafter). Options granted under the Plan subsequent to May 31, 1995, generally vest over a four year period (one-fourth of options granted vest after one year from the grant date and the remaining options vest ratably each month thereafter). In addition, the Committee may authorize option grants with vesting provisions that are not based solely on employees' rendering of additional service to the Company. For outside directors, NSOs only will be granted with an exercise price of 100% of the fair value of the stock, as determined by the Committee, on the date of grant. The Plan provides that each outside director will be automatically granted 10,000 NSOs on the date of their initial election to the board of directors. On the date of the annual meeting of the stockholders of the Company, each outside director who is elected, reelected, or continues to serve as a director, shall be granted 3,000 NSOs, except for those outside directors who are first elected to the Board of Directors at the meeting or three months prior. The options granted vest ratably over three years and expire after seven years from the grant date. The Company entered into stock option agreements with certain employees and a consultant prior to the adoption of the Plan. These stock options generally become exercisable over a five-year period, commencing from the date of grant, and expire 10 years from the date of grant. Exercise prices were determined by the Board of Directors and, for options granted through December 31, 1992, represented estimated fair values of the Company's common stock at the grant date. The Company has elected to follow Accounting Principals Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB 25) and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under Financial Accounting Standards Board No. 123, Accounting for Stock-Based Compensation, (FASB 123) requires the use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, since the exercise price of the Company's employee stock option grants has equaled the market price of the underlying stock on the date of grant, no compensation expense is recognized. Pro forma information regarding net income and earnings per share is required under FASB 123, and has been 40 43 determined as if the Company had accounted for its stock options granted subsequent to December 31, 1994, under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the years ended December 31, 1998, 1997 and 1996: risk-free interest rate of 5.6%, 6.3% and 6.2%, respectively; a dividend yield of 0%; volatility factor of the expected market price of the Company's common stock of .96, .74 and .75, respectively; and expected life of the options of 4.0, 4.0 and 4.1 years, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information is as follows:
YEAR ENDED DECEMBER 31, 1998 1997 1996 -------------- ------------ ------------ Pro forma net loss $(22,863,252) $(13,063,962) $(11,590,957) Pro forma basic and diluted loss per common share $ (2.02) $ (2.53) $ (2.56)
Because FASB 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect will not be fully reflected until 1999. 41 44 7. STOCK OPTIONS AND WARRANTS (CONTINUED) The table below summarizes all option activity during the period from January 1, 1996 to December 31, 1998:
EXERCISE OPTIONS PRICE OUTSTANDING PER SHARE ------------------------------- Outstanding at December 31, 1995 525,268 $ .18 - 19.25 Granted 346,907 17.00 - 27.00 Exercised (49,881) .18 - 15.25 Forfeited (26,036) .23 - 26.50 -------------- Outstanding at December 31, 1996 796,258 .18 - 27.00 Granted 121,000 2.00 - 19.00 Exercised (17,821) .18 - 18.25 Forfeited (216,104) 6.75 - 27.00 -------------- Outstanding at December 31, 1997 683,333 .18 - 26.50 Granted 780,900 1.03 - 2.00 Exercised (33,942) .18 - .23 Forfeited (236,314) .23 - 26.50 -------------- Outstanding at December 31, 1998 1,193,977 $ .18 - 26.50 ==============
The weighted-average exercise price of options outstanding at December 31, 1998, 1997 and 1996, was $6.71, $12.92 and $13.40, respectively. The weighted-average exercise price of options granted, exercised, and forfeited during 1998 was $1.55, $0.22 and $6.69, respectively. The weighted-average fair value of options granted during 1998, 1997 and 1996 was $1.09, $7.94, $11.35, respectively. Following is additional information with respect to options outstanding at December 31, 1998:
EXERCISE EXERCISE EXERCISE EXERCISE EXERCISE PRICE FROM PRICE FROM PRICE FROM PRICE FROM PRICE FROM $0.18 TO $1.03 TO $10.125 TO $15.50 TO $19.00 TO $0.23 $9.75 $14.75 $18.50 $26.50 --------------------------------------------------------------- OUTSTANDING AT DECEMBER 31, 1998: Number of options 18,975 808,250 102,189 211,548 53,015 Weighted-average exercise price $ 0.22 $ 2.48 $ 10.92 $ 17.56 $ 22.07 Weighted-average remaining contractual life in years 3.77 8.73 5.62 7.40 7.23 EXERCISABLE AT DECEMBER 31, 1998: Number of options 18,975 84,769 93,185 133,185 36,542 Weighted-average exercise price $ 0.22 $7.40 $ 10.93 $17.47 $ 21.99
The total number of unvested options outstanding at December 31, 1998 was 827,321, all of which will vest based on employees' continued service to the Company. In December 1991 and January 1992, the Company issued common stock purchase warrants for 34,063 and 74,938 shares, respectively, to preferred stockholders in conjunction with short-term loans from the stockholders. These warrants have an exercise price of $1.4679 per share and expire 10 years from the date of issue. Warrants for 19,869, 34,063 and 13,625 of these shares were exercised during 1997, 1996, and 1995, respectively. In connection with the July 1992 issuance of Series B convertible preferred stock, the Company issued common stock purchase warrants for 213,780 shares to the Series B convertible preferred stockholders. These warrants have an exercise price of $2.29 (71,260 shares), $2.75 (71,260 shares), and $3.21 (71,260 shares) per share and expire 42 45 7. STOCK OPTIONS AND WARRANTS (CONTINUED) upon the seventh anniversary of issuance. Warrants for 96,437 of these shares (36,107 shares at $2.29 per share, 36,107 shares at $2.75 per share and 24,223 shares at $3.21 per share) were exercised during 1996. Warrants for 54,337 of these shares (17,779 shares at $2.29 per share, 17,779 shares at $2.75 per share, and 18,779 shares at $3.21 per share) were exercised during 1997. The Company issued warrants to purchase 470,589 shares of common stock in connection with the July 1993 issuance of Series C Preferred Stock. These warrants are exercisable at $9.56 per share and expire in November 2000. Warrants for 64,614 and 69,020 of these shares were exercised during 1997 and 1996, respectively. In conjunction with the Company's initial public offering in October 1993, warrants to purchase an aggregate of 100,000 shares of common stock at an exercise price of $13.50 (120% of the initial public offering price) per share were issued for $100 to the managing underwriter of the initial public offering. The warrants were exercisable through October 26, 1998. Warrants for 10,000 of these shares were exercised in 1996. The remaining 90,000 warrants expired unexercised on October 26, 1998. On June 6, 1997, the Company issued warrants to purchase 62,500 shares of common stock in connection with the issuance of Series B Convertible Preferred Stock (Note 6). These warrants have an exercise price of $14.8125 per share and expire on June 6, 2001. On October 29, 1997, the Company issued warrants to purchase 34,782 shares of common stock in connection with the issuance of Series G Convertible Preferred Stock (Note 6). These warrants have an exercise price of $10.0625 per share and expire on October 29, 2001. On May 15, 1998, the Company issued warrants to purchase 4,140,000 shares of common stock in connection with the issuance of Senior Convertible Notes (Note 8). These warrants have an exercise price of $3.75 per share and expire on May 15, 2001. 8. LONG-TERM DEBT On May 15, 1998, the Company entered into a Securities Purchase Agreement (the "Agreement") with various parties. Under the terms of the Agreement, the Company issued and sold $10,350,000 in aggregate principal amount of Senior Convertible Notes due May 15, 2002 (the "Notes") and issued warrants to purchase 4,140,000 shares of the Company's Common Stock (the "Warrants"). The Notes bear interest at 2% per annum, payable in cash or in shares of the Company's Common Stock at the Company's option, and mature on May 15, 2002. Holders of the Notes may convert the principal amount, plus accrued and unpaid interest, if any, into shares of the Company's Common Stock at a fixed conversion price of $1.50 per share. Conversions were not permitted during the first 90 days following the issuance of the Notes and were limited to one-half of the original principal amount during the period from 91 to 180 days after the issuance of the Notes. The Company may redeem all or a portion of the Notes at a redemption price equal to the principal amount plus accrued interest thereon, if any, under certain conditions. The Warrants have an exercise price of $3.75 per share and expire on May 15, 2001. The Agreement contains several covenants which limit the Company's ability to incur additional indebtedness and to create any lien, pledge, or encumbrance on any assets of the Company. Since the Notes were issued with a non-detachable conversion feature that was "in-the-money" at the date of issuance, a portion of the proceeds equal to the intrinsic value of the conversion feature (equal to $9,918,750, and calculated as the difference between the conversion price and the quoted market price of the Company's Common stock on the date of issuance multiplied by the number of shares into which the Notes are convertible) was allocated to additional paid-in capital, thus creating a discount to the debt. This discount was recognized as a charge to interest expense using the effective interest method over the period from the date of issuance to the date the Notes first became convertible (August 15, 1998 for up to one-half of the original principal amount and November 15, 1998 for the remaining principal amount). In addition, a portion of the proceeds equal to the fair value of the Warrants issued in conjunction with the Notes (equal to $1,230,000, and calculated using the Black-Scholes Approximation Formula) 8. LONG-TERM DEBT (CONTINUED) was allocated to additional paid-in capital, thus creating an additional discount to the debt. This discount will be recognized as a charge to interest expense using the effective interest method over the four year term of the Notes. The Company recognized 43 46 $10,101,401 of non-cash interest charges during 1998 as a result of the amortization of the discount on the Notes. As a result of the additional interest expense from amortization of the debt discount described above, the effective interest rate on the Notes is approximately 73.9%. It is not practicable to estimate the fair value of the Notes at December 31, 1998 because a quoted market price for such securities is not available, the Company has not yet developed a valuation model necessary to make such an estimate, and the cost of obtaining an independent valuation would be prohibitive. 9. INCOME TAXES The Company has net operating loss and research and development credit carryforwards for tax purposes of approximately $50,369,000 and $1,050,000, respectively, at December 31, 1998. The net operating loss carryforwards expire in the following years: YEAR AMOUNT ----------------------------------------------------------------- 2005 $ 7,000 2006 638,000 2007 974,000 2008 1,659,000 2009 3,973,000 2010 8,199,000 2011 11,953,000 2012 11,922,000 2013 11,044,000 ------------ $50,369,000 ============ Significant components of the Company's deferred tax assets and liabilities are as follows:
DECEMBER 31, 1998 1997 ----------------------------------- Deferred tax assets: Net operating loss carryforward $ 19,140,000 $15,210,000 Research and development tax credit carryforwards 1,050,000 881,000 Deferred compensation 27,000 79,000 Accounts receivable 33,000 - Inventories 223,000 - ----------------------------------- Total deferred tax assets 20,473,000 16,170,000 Deferred tax liabilities: Patent costs (234,000) (215,000) Property and equipment (101,000) (130,000) ----------------------------------- (335,000) (345,000) ----------------------------------- Net deferred tax assets 20,138,000 15,825,000 Valuation allowance (20,138,000) (15,825,000) ----------------------------------- Net deferred tax assets $ - $ - ===================================
9. INCOME TAXES (CONTINUED) The valuation allowance increased during 1998 and 1997 by $4,313,000 and $4,815,000, respectively, due primarily to the increase in the net operating loss carryforward. Based on the Internal Revenue Code and changes in the ownership of the 44 47 Company, utilization of the net operating loss carryforwards will be subject to annual limitations. 10. LEASES The Company leases its manufacturing and office space. Under the terms of the lease, which expires October 2004, the Company is responsible for all real estate taxes and operating expenses. The lease provides for a security deposit ($250,000 at December 31, 1998) that is secured by a certificate of deposit owned by the Company. Future minimum payments under the operating lease consist of the following at December 31, 1998: YEAR AMOUNT ------------------------------------------------------------------ 1999 $ 227,500 2000 231,300 2001 249,900 2002 249,900 2003 249,900 Thereafter 208,300 ---------- $1,416,800 ========== Rent expense totaled $229,786, $226,938 and $227,334, for the years ended December 31, 1998, 1997, and 1996, respectively. 11. 401(K) PLAN The Company has a 401(k) plan covering all employees who meet prescribed service requirements. The plan provides for deferred salary contributions by the plan participants and a Company contribution. Company contributions, if any, are at the discretion of the Board of Directors and are not to exceed the amount deductible under applicable income tax laws. No Company contribution was made for the years ended December 31, 1998, 1997, and 1996. 12. LITIGATION Siegler Litigation On June 5, 1996, Craig M. Siegler filed a complaint against the Company in the Circuit Court of Cook County, Illinois, County Department, Chancery Division. The complaint alleged that, in connection with the Company's private placement of securities in November 1995, the Company breached and repudiated an oral contract with Mr. Siegler for the issuance and sale by the Company to Mr. Siegler of 370,370.37 shares of the Common Stock, plus warrants (immediately exercisable at $12.96 per share) to purchase an additional 370,370.37 shares of the Common Stock, for a total price of $4,000,000. The remedy sought by Mr. Siegler was a sale to him of such securities on the terms of the November 1995 private placement. On August 16, 1996, the Company's motion to dismiss Mr. Siegler's complaint was granted with leave to amend. On September 19, 1996, Mr. Siegler's motion for reconsideration was denied. On October 10, 1996, Mr. Siegler filed his First Amended Verified Complaint and Jury Demand, seeking a jury 12. LITIGATION (CONTINUED) trial and money damages equal to the difference between $8,800,000 (370,370.37 shares at $10.80 per share and 370,370.37 shares at $12.96 per share) and 740,740.74 multiplied by the highest price at which the Common Stock traded on The Nasdaq Stock Market between November 20, 1995 and the date of judgment. Mr. Siegler also preserved his claim for specific performance for purposes of appeal. On November 1, 1996, the case was transferred to the Circuit Court of Cook County, Illinois, County Department, Law Division. The Company's Answer was filed on November 21, 1996 and the parties are in the midst of discovery. 45 48 The Company believes that the suit is without merit and intends to continue to defend itself vigorously in this litigation. However, if Mr. Siegler prevails in this litigation and is awarded damages in accordance with the formula described above, such judgment would have a material adverse effect on the Company's operating results and financial condition. Note Litigation On July 10, 1997, the Company filed a complaint against Sheldon Drobny; Howard L. "Buzz" Simons, joint tenant with Aric and Corey Simons; Aaron Fischer; Stewart Shiman; Sharon D. Gonsky, d/b/a SDG Associates; Gregg Rosenberg; Stacey Rosenberg; Merrill Weber & Co., Inc.; Drobny/Fischer Partnership, an Illinois general partnership; and Ruben Rosenberg (collectively, the "Borrowers"), and Paradigm Venture Investors, L.L.C. (the "Guarantor") in the Circuit Court of Cook County, Illinois, County Department, Law Division. The complaint seeks to enforce the terms of loans made to the Borrowers by the Company and evidenced by promissory notes dated December 13, 1996, in the aggregate principal amount of $698,508 and the guarantee by the Guarantor of the Borrowers' obligations under these promissory notes. The Borrowers' notes were issued to the Company in connection with the Borrowers' exercise of warrants to purchase shares of the Common Stock in December 1996. On September 30, 1997, the Borrowers and the Guarantor responded to the Company's complaint. Concurrently, the Borrowers filed a counterclaim alleging that they exercised the warrants in reliance on the Company's alleged fraudulent representations to certain Borrowers concerning a third-party's future underwriting of a secondary public offering of the Common Stock. The counterclaim sought an amount of damages which the Borrowers allege "cannot currently be determined." On December 10, 1997, the Company's motion to strike the Borrowers' fraud defense and dismiss their counterclaim was granted with leave to amend. On January 14, 1998, the Borrowers filed amended defenses and counterclaims based on substantially similar allegations of supposed fraud by the Company. The Company's answer was filed on April 30, 1998, and the parties are proceeding with discovery. The Company regards the amended fraud claim as without factual or legal merit. Effective July 23, 1998, one of the Borrowers, Merrill Weber & Co., Inc., and the Company reached a settlement of their respective claims. The Company intends to vigorously pursue recovery of the moneys owed by the other Borrowers and the Guarantor under the promissory notes and the guarantee. Lipman Litigation On January 6, 1998, Jerome H. Lipman, individually and on behalf of all others similarly situated, filed a complaint against the Company and eight of its former or current directors: Leonard A. Batterson, Michael J. Friduss, Peter S. Fuss, Edward W. Laves, Steven L. Lazarus, Tom L. Powers, Ora E. Smith and Paul G. Yovovich (collectively, the "Named Directors") in the Circuit Court of Cook County, Illinois, County Department, Chancery Division. The complaint alleged that the Named Directors breached their duties of loyalty and due care to the putative class of stockholders by selecting financing for the Company in June 1997 which supposedly entrenched the Directors and reduced the Common Stock price. The complaint also alleged that the Named Directors breached their duty of disclosure by not informing the stockholders that the selected financing would erode the Common Stock price. Mr. Lipman's complaint sought certification of a class consisting of all owners of the Common Stock during the period from June 6, 1997 through November 21, 1997, excluding the Named Directors and Sheldon 12. LITIGATION (CONTINUED) Drobny. The complaint also seeks an unspecified amount of compensatory and punitive damages, and attorneys' fees. The Company and the Named Directors regard the suit as without factual or legal merit. Accordingly, on February 17, 1998, the Company and the Named Directors filed a motion to dismiss Mr. Lipman's complaint. The motion presented arguments that the claims of Mr. Lipman and the putative class are barred by the business judgment rule and the plaintiff's failure to fulfill the legal prerequisites for filing an action against the Named Directors. Prior to a hearing on the Company's and the Named Directors' motion to dismiss, Mr. Lipman filed a motion on March 16, 1998, seeking both to amend his proposed putative class to include Mr. Drobny and to certify the class. 46 49 On June 1, 1998, the court granted the Company's and the Named Directors' motion to dismiss the complaint. Concurrently, Mr. Lipman withdrew his motion to amend the proposed putative class and certify the class. On June 30, 1998, Mr. Lipman filed an amended complaint against the Named Directors but excluding the Company itself as a defendant. The amended complaint alleges that the Named Directors breached their duties of loyalty and due care to the putative class of stockholders by selecting financing for the Company in June 1997 and thereafter drawing two tranches of the financing. The amended complaint seeks certification of a class consisting of all owners of the Common Stock during the period from May 15, 1997 through December 31, 1997, excluding the Named Directors. Mr. Lipman's amended complaint alleges that the stock owned by the putative class lost $61 million due to the financing the Named Directors selected, and seeks an unspecified amount of compensatory and punitive damages. The Company and the Named Directors regard the amended complaint as without factual or legal merit. Accordingly, the Named Directors filed a motion to dismiss Mr. Lipman's amended complaint on July 29, 1998. The court granted the motion to dismiss in December 1998, finding that Mr. Lipman still had failed to fulfill the prerequisites for maintaining a shareholder derivative action against the Named Directors. On January 12, 1999, Mr. Lipman and two added former stockholders filed a second amended complaint against the Named Directors and again including the Company itself as a defendant. The second amended complaint alleges that the Named Directors breached their duties of loyalty and due care to the putative class and further alleges that the purported devaluation of the plaintiff's stock resulting from the June 1997 financing was an improper "assessment" on the plaintiffs' shares for which they seek an unspecified amount of compensatory and punitive damages. In February 1999, the Company and the Named Directors filed a motion to dismiss the second amended complaint. A hearing on the motion is scheduled for April 1999. Greenwald Litigation On June 24, 1998, Jonathan Greenwald, derivatively on behalf of the Company, filed a complaint against the Company and the Named Directors in the court of Chancery of the State of Delaware in and for New Castle County. Mr. Greenwald's complaint alleges that the Named Directors breached their duties of good faith, loyalty, due care, and candor by selecting financing for the Company in 1997 which purportedly reduced the stock price and was supposedly accepted to entrench the Named Directors. The complaint seeks an unspecified amount of compensatory damages, various equitable relief and attorney's fees. The Company and the Named Directors regard the suit as without factual or legal merit. Accordingly, in January 1999, the Company and the Named Directors filed a motion to dismiss the complaint arguing that the complaint is barred by the business judgment rule and the plaintiffs' failure to fulfill the prerequisites for maintaining a shareholder derivative action against the Named Directors. A hearing on the motion has not been scheduled. The Company intends to defend itself vigorously in the matters described above and believes that the resolution of these matters will not have a material adverse effect on the financial condition, results of operations, or cash flows of the Company. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 47 50 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information in response to this item is incorporated by reference from the "Election of Directors," "Executive Officers," and "Section 16(a) Beneficial Ownership Compliance" sections of the Company's definitive proxy statement to be filed with Securities and Exchange Commission in connection with the Company's 1999 Annual Meeting of Stockholders, scheduled to be held on June 9, 1999 (the "1999 Proxy Statement"). ITEM 11. EXECUTIVE COMPENSATION Information in response to this item is incorporated by reference from the section of the 1999 Proxy Statement captioned "Executive Compensation and Certain Transactions." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information in response to this item is incorporated by reference from the section of the 1999 Proxy Statement captioned "Security Ownership of Management and Principal Stockholders." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information in response to this item is incorporated by reference from the section of the 1999 Proxy Statement captioned "Executive Compensation and Certain Transactions." 48 51 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Form 10-K: 1. The following financial statements of the Company, with the report of independent auditors, are filed as part of this Form 10-K: Report of Independent Auditors Balance Sheets as of December 31, 1998 and 1997 Statements of Operations for the Years Ended December 31, 1998, 1997, and 1996 Statements of Stockholders' Equity (Net Capital Deficiency) for the Years Ended December 31, 1998, 1997, and 1996 Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 Notes to Financial Statements 2. The following financial statement schedules of the Company are filed as part of this Form 10-K: Schedule II N Valuation and Qualifying Accounts All other financial schedules are omitted because such schedules are not required or the information required has been presented in the aforementioned financial statements. 3. Exhibits are listed in the Exhibit Index to this Form 10-K. (b) Reports on Form 8-K: None. 49 52 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 31st day of March, 1999. ILLINOIS SUPERCONDUCTOR CORPORATION By: /s/ EDWARD W. LAVES ------------------------------------- Edward W. Laves, Ph.D. President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 31st day of March, 1999.
SIGNATURE TITLE - ------------------------------------ --------------------------------------------------------- Chairman of the Board, President, Chief Executive Officer /s/ EDWARD W. LAVES (Principal Executive Officer) - ------------------------------------ Edward W. Laves Controller and Treasurer /s/ KENNETH E. WOLF (Principal Financial and Accounting Officer) - ------------------------------------ Kenneth E. Wolf /s/ HOWARD HOFFMANN Director - ------------------------------------ Howard Hoffmann /s/ ROBERT D. MITCHUM Director - ------------------------------------ Robert D. Mitchum /s/ TERRY S. PARKER Director - ------------------------------------ Terry S. Parker /s/ THOMAS L. POWERS Director - ------------------------------------ Thomas L. Powers
50 53 ILLINOIS SUPERCONDUCTOR CORPORATION SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Balance at beginning of Additions Deductions Balance at end year of year --------------- ------------ ---------- -------------- YEAR ENDED DECEMBER 31, 1998: Deducted from asset accounts: Valuation allowance on deferred tax assets...... $15,825,000 $4,580,000 $ 0 $20,405,000 Allowance for doubtful accounts $ 68,775 $ 19,215 $ 0 $ 87,990 Reserve for obsolete inventory $ 0 $ 587,000 $ $ 587,000 YEAR ENDED DECEMBER 31, 1997: Deducted from asset accounts: Valuation allowance on deferred tax assets..... $11,010,000 $4,815,000 $ 0 $15,825,000 Allowance for doubtful accounts $ 0 $ 68,775 $ 0 $ 68,775 YEAR ENDED DECEMBER 31, 1996: Deducted from asset accounts: Valuation allowance on deferred tax assets..... $ 6,531,000 $4,479,000 $ 0 $11,010,000
54 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION OF EXHIBITS 3.1 Certificate of Incorporation of the Company, incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-3/A, filed with the Securities and Exchange Commission ("SEC") on August 13, 1998, Registration No. 333-56601 (the "August 1998 S-3"). 3.2 By-Laws of the Company, incorporated by reference to Exhibit 3.2 to Amendment No. 3 to the Company's Registration Statement on Form S-1, filed with the SEC on October 26, 1993, Registration No. 33-67756 (the "IPO Registration Statement"). 3.3 Certificate of Amendment of Certificate of Incorporation of the Company, incorporated by reference to Exhibit 3.3 to the IPO Registration Statement. 4.1 Specimen stock certificate representing Common Stock, incorporated by reference to Exhibit 4.1 to the IPO Registration Statement. 4.2 Form of Series B Warrants, incorporated by reference to Exhibit 4.2 to the IPO Registration Statement. 4.3 Form of Series B Warrants, incorporated by reference to Exhibit 4.3 to the IPO Registration Statement. 4.4 Form of Representative Warrant, incorporated by reference to Exhibit 4.4 to the IPO Registration Statement. 4.5 Rights Agreement dated as of February 9, 1996 between the Company and LaSalle National Trust, N.A., to the Exhibit to the Company's Registration Statement on Form 8-A, filed with the SEC on February 12, 1996. 4.6 Convertible Preferred Stock Purchase Agreement dated as of June 6, 1997, by and between the Company and Southbrook International Investments, Ltd., incorporated by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-3, filed with the SEC on June 23, 1997, Registration No. 333-29797 (the "June 1997 S-3"). 4.7 Registration Rights Agreement dated as of June 6, 1997, by and between the Company and Southbrook International Investments, Ltd., incorporated by reference to Exhibit 4.5 to the June 1997 S-3. 4.8 Warrant dated June 6, 1997 issued to Southbrook International Investments, Ltd., incorporated by reference to Exhibit 4.5 to June S-3. 4.9 Certificate of Designation, Preferences and Rights relating to the Company's Series C Convertible Preferred Stock, incorporated by reference to Exhibit 4.9 to the Company's Registration Statement on Form S-3, filed with the SEC on September 22, 1997, Registration No. 333-36089. 4.10 Certificate of Designation, Preferences and Rights relating to the Company's Series G Convertible Preferred Stock, incorporated by reference to Exhibit 4.8 to the Company's Registration Statement on Form S-3, filed with the SEC on December 8, 1997, Registration No. 333-41731 (the "December 1997 S-3"). 4.11 Convertible Preferred Stock Purchase Agreement dated as of October 29, 1997, by and between the Company and Elliott Associates, L.P. and Westgate International, L.P., incorporated by reference to Exhibit 4.9 to the December 1997 S-3. 4.12 Registration Rights Agreement dated as of October 29, 1997, by and between the Company and Elliott Associates, L.P. and Westgate International, L.P., incorporated by reference to Exhibit 4.10 to the December 1997 S-3. 4.13 Agreement dated as of October 29, 1997, by and between the Company and Brown Simpson Strategic Growth Fund, L.P. and Southbrook International Investments, Ltd., incorporated by reference to Exhibit 4.11 to the 55 December 1997 S-3. 4.14 Form of 2% Senior Convertible Note due May 15, 2002, incorporated by reference to Exhibit 4.2 to the August 1998 S-3. 4.15 Form of Warrant dated May 15, 1998, incorporated by reference to Exhibit 4.3 to the August 1998 S-3. 4.16 Securities Purchase Agreement dated as of May 15, 1998, by and between the Company and Elliott Associates, L.P., Westgate International, L.P., Alexander Finance, LP, State Farm Mutual Automobile Insurance Company, Spring Point Partners, L.P. and Spring Point Offshore Fund, incorporated by reference to Exhibit 4.5 to the August 1998 S-3. 4.17 Registration Rights Agreement dated as of May 15, 1998, by and between the Company and Elliott Associates, L.P., Westgate International, L.P., Alexander Finance, LP, State Farm Mutual Automobile Insurance Company, Spring Point Partners, L.P. and Spring Point Offshore Fund, incorporated by reference to Exhibit 4.6 to the August 1998 S-3. 4.18 Form of 6% Senior Convertible Note due May 15, 2002. 4.19 Form of Warrant dated March 31, 1999. 4.20 Securities Purchase Agreement dated as of March 31, 1999, by and between the Company and Elliott Associates, L.P., Westgate International, L.P., Alexander Finance, LP and State Farm Mutual Automobile Insurance Company. 4.21 Registration Rights Agreement dated as of March 31, 1999, by and between the Company and Elliott Associates, L.P., Westgate International, L.P., Alexander Finance, LP and State Farm Mutual Automobile Insurance Company. 4.22 Amendment to Securities Purchase Agreement dated as of March 31, 1999, by and between the Company and Elliott Associates, L.P., Westgate International, L.P., Alexander Finance, LP, State Farm Mutual Automobile Insurance Company, Spring Point Partners, L.P. and Spring Point Offshore Fund. 10.1 1993 Amended and Restated Stock Option Plan, as amended, incorporated by reference to Exhibit B to the Company's Proxy Statement filed with the SEC on May 6, 1997.* 10.2 Form of Amended and Restated Director Indemnification Agreement, incorporated by reference to Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1998. * 10.3 Third Amended and Restated Registration Rights Agreement dated as of July 14, 1993, as amended, incorporated by reference to Exhibit 10.4 to the IPO Registration Statement. 10.4 Public Law Agreement dated February 2, 1990 between Illinois Department of Commerce and Community Affairs and the Company, incorporated by reference to Exhibit 10.5 to the IPO Registration Statement. 10.5 Public Law Agreement dated December 30, 1991 between Illinois Department of Commerce and Community Affairs and the Company, amended as of June 30, 1992, incorporated by reference to Exhibit 10.6 to the IPO Registration Statement. 10.6 Representative Warrant Agreement, incorporated by reference to Exhibit 10.7 to the IPO Registration Statement. 10.7 Subcontract and Cooperative Development Agreement dated as of June 1, 1993 between American Telephone and Telegraph Company and the Company, incorporated by reference to Exhibit 10.9 to the IPO Registration Statement. 10.8 Intellectual Property Agreement dated as of June 1, 1993 between American Telephone and Telegraph Company and the Company, incorporated by reference to Exhibit 10.10 to the IPO Registration Statement. 56 10.10 License Agreement dated January 31, 1990 between the Company and Northwestern University, incorporated by reference to Exhibit 10.13 to the IPO Registration Statement. 10.11 License Agreement dated February 2, 1990 between the Company and ARCH Development Corporation, incorporated by reference to Exhibit 10.14 to the IPO Registration Statement. 10.12 License Agreement dated August 9, 1991 between the Company and ARCH Development Corporation, incorporated by reference to Exhibit 10.15 to the IPO Registration Statement. 10.13 License Agreement dated October 11, 1991 between the Company and ARCH Development Corporation, incorporated by reference to Exhibit 10.16 to the IPO Registration Statement. 10.14 Public Law Agreement dated August 18, 1993 between Illinois Department of Commerce and Community Affairs and the Company, incorporated by reference to Exhibit 10.17 to the IPO Registration Statement. 10.16 Form of Officer Indemnification Agreement.* 10.17 Employment Agreement dated July 1, 1998 between the Company and Edward W. Laves, Ph.D.* 10.18 Employment Agreement dated November 9, 1998 between the Company and Dennis Craig.* 10.19 Single-Tenant Industrial building Lease between Teachers' Retirement System of the State of Illinois, landlord, and Illinois Superconductor Corporation, tenant, dated June 24, 1994, incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarterly period ending June 30, 1994. 23. Consent of Ernst & Young LLP. 27. Financial Data Schedule. __________________ * Management contract or compensatory plan or arrangement required to be filed as an exhibit on this Form 10-K. EX-4.18 2 FORM OF 6% SENIOR CONVERTIBLE NOTE 1 EXHIBIT 4.18 NEITHER THESE SECURITIES NOR THE SECURITIES INTO WHICH THESE SECURITIES ARE CONVERTIBLE HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE, IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS. THE SECURITIES REPRESENTED BY THIS NOTE ARE SUBJECT TO CERTAIN RESTRICTIONS ON TRANSFER SET FORTH IN SECTION 3.1 OF A SECURITIES PURCHASE AGREEMENT, DATED AS OF MARCH 31, 1999, BETWEEN ILLINOIS SUPERCONDUCTOR CORPORATION (THE "COMPANY") AND THE PURCHASERS LISTED THEREIN, INCLUDING THE ORIGINAL HOLDER HEREOF. A COPY OF THAT AGREEMENT IS ON FILE AT THE PRINCIPAL OFFICE OF THE COMPANY. 6% SENIOR CONVERTIBLE NOTE -------------------------- Mt. Prospect, Illinois Note No.:___ March 31, 1999 Original Principal Amount: $______ FOR VALUE RECEIVED, ILLINOIS SUPERCONDUCTOR CORPORATION, a Delaware corporation (the "Company"), hereby promises to pay to the order of [NAME OF HOLDER] or its registered assigns ("Holder") the Principal Amount (as defined in Section 3(a)(i) below), together with all accrued but unpaid cash interest thereon, if any, on May 15, 2002 (the "Maturity Date") to the extent such Principal Amount and cash interest has not been converted into the Company's Common Stock, $.001 par value per share (the "Common Stock"), in accordance with the terms hereof, and to pay interest on the unpaid principal balance hereof at the rate of 6% per annum from March 31, 1999 (the "Issuance Date") until the same becomes due and payable on the Maturity Date, or such earlier date upon acceleration or by conversion or redemption in accordance with the terms hereof. Interest on this Note shall commence accruing on the Issuance Date and shall be computed on the basis of a 360-day year, 30-day months and actual days elapsed and shall be payable in accordance with Section 3(a)(ii) hereof. Notwithstanding anything contained herein, this Note shall bear interest from and after the occurrence and during the continuance of a default pursuant to Section 5(a), at the rate equal to the lower of fifteen percent (15%) per annum or the highest rate permitted by law. Unless otherwise agreed or required by applicable law, payments will be applied first to any unpaid collection costs, then to unpaid interest and fees and any remaining amount to principal. All payments of principal and interest on this Note (to the extent such principal and/or interest is not converted into Common Stock or interest is not paid in-kind in accordance with the terms hereof) shall be made in lawful money of the United States of America by wire transfer of immediately available funds to 2 such account as the Holder may from time to time designate by written notice in accordance with the provisions of this Note or by Company check. Whenever any amount expressed to be due by the terms of this Note is due on any day which is not a Business Day (as defined below), the same shall instead be due on the next succeeding day which is a Business Day. For purposes of this Note, "Business Day" shall mean any day other than a Saturday, Sunday or a day on which commercial banks in the City of New York are authorized or required by law or executive order to remain closed. Each capitalized term used herein, and not otherwise defined, shall have the meaning ascribed thereto in the Securities Purchase Agreement, dated March 31, 1999, pursuant to which this Note was originally issued (the "Purchase Agreement"). This Note and the other senior convertible notes issued or amended by the Company on the Issuance Date pursuant to the Purchase Agreement are collectively referred to in this Note as the "Notes." The following terms and conditions shall apply to this Note: Section 1. Voting Rights. The rights of holders of Notes to elect or designate directors to the Company's Board of Directors is limited to the provisions of Section 1 of the Amendment to Note Purchase Agreement, dated as of the date hereof, by and among the Company, the Holder and the other holders of Notes (the "Amendment to Note Agreement"). So long as any principal amount of Notes is outstanding, the Company shall not, without the affirmative vote of the holders of at least 75% of the principal amount of the Notes then outstanding, authorize or create any class of debt securities or capital stock ranking as to dividends, interest or distribution of assets upon a Liquidation payment at maturity, if applicable, (as defined in Section 2 hereof) senior to, prior to or pari passu with the Notes. Section 2. Liquidation. Upon any liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary (a "Liquidation"), the holders of Notes shall be entitled to receive in cash out of the assets of the Company, whether such assets are capital or surplus, an amount equal to the outstanding principal thereon plus all accrued but unpaid interest thereon before any distribution or payment shall be made to the holders of any Junior Securities (as defined in Section 6 hereof), and if the assets of the Company shall be insufficient to pay in full the amounts due to the holders of the Notes and holders of other classes or series of debt securities of the Company that rank pari passu with the Notes as to distributions of assets, then the entire assets to be distributed to the holders of Notes and the holders of such debt securities ranking pari passu shall be distributed among the holders of Notes and the holders of such debt securities ranking pari passu ratably in accordance with the respective amounts that would be payable on the Notes and such debt securities if all amounts payable thereon were paid in full. A sale, conveyance or disposition (either singly or in the aggregate) of all or substantially all of the assets of the Company or the effectuation by the Company or a third party of a transaction or series of related transactions in which more than 50% of the voting power of the Company is disposed of, or a consolidation or merger of the Company with or into any other company or companies shall not be treated as a Liquidation, but instead shall be subject to the provisions of Section 3 hereof. The Company shall mail written notice of any such Liquidation, not less than 45 days prior to the payment date stated therein, to each record holder of Notes. Section 3. Conversion. The Holder shall have the right, at the Holder's option, to convert this Note into shares of Common Stock on the following terms and conditions: (a)(i) Any part of the Principal Amount (as defined below) of this Note shall be convertible into shares of Common Stock (subject to reduction pursuant to Section 3(i) below) at the Conversion Ratio at the option of the Holder in whole or in part at any time following the Issuance Date up to and including the day that all of the Principal Amount and cash interest accrued but unpaid thereon, if any, are paid in full. -2- 3 Each conversion by the Holder shall be for at least $10,000 in Principal Amount, or such lesser Principal Amount as shall remain unpaid and outstanding at the time of conversion. The Holder shall effect conversions by surrendering to the Company a fully executed notice of conversion in the form of conversion notice attached hereto as Exhibit A (the "Conversion Notice"), which may be transmitted by facsimile, and this Note. Each Conversion Notice shall specify the outstanding Principal Amount of this Note to be converted and the date on which such conversion is to be effected, which date may not be prior to the date such Conversion Notice is received by the Company hereunder (the "Conversion Date"); provided, however, that if this Note is not received by the Company (other than by facsimile) within two (2) Trading Days of the date specified in the Conversion Notice as the date on which such conversion is to be effected, then the Conversion Date shall be the date on which this Note is received by the Company (other than by facsimile). If no Conversion Date is specified in a Conversion Notice, the Conversion Date shall be the date that the Conversion Notice is deemed delivered pursuant to Section 3(h) hereof; provided, however, that if this Note is not received (other than by facsimile) by the Company within two (2) Trading Days of such date, then the Conversion Date shall be the date on which this Note is received by the Company (other than by facsimile). Subject to Section 3(b) hereof and Section 3(i) hereof, each Conversion Notice, once given, shall be irrevocable. If the Holder is converting less than all of the outstanding Principal Amount tendered by the Holder with the Conversion Notice, or if a conversion hereunder cannot be effected in full for any reason, the Company shall promptly deliver to the Holder (in the manner and within the time set forth in Section 3(b) hereof) a Note for such Principal Amount as has not been converted. As used herein, "Principal Amount" shall refer to the sum of (i) the original principal amount of $__________; (ii) all accrued but unpaid in-kind interest payments added thereto as provided in paragraph 3(a)(ii) below; and (iii) any payments which Holder has elected to add to the Principal Amount following the occurrence of an "Event," pursuant to paragraph 3(c)(i) below. (ii) Interest. Interest on this Note shall be payable in-kind, unless the Company shall, on thirty (30) days' irrevocable prior written notice, have informed the holders of the Notes of its election to pay cash interest. If paid in-kind, then interest on this Note shall accrue on, and be automatically added to the Principal Amount on a daily basis and shall compound quarterly on each March 31, June 30, September 30 and December 31. Following notice of payment of cash interest by the Company, all payments of interest on this Note shall be made in cash, until such time as the Company provides thirty (30) days' irrevocable prior written notice to the Holder of its election to pay interest on this Note in-kind. If the Company elects to pay accrued interest in cash, interest shall be paid quarterly in arrears on each March 31, June 30, September 30 and December 31 and shall compound quarterly. Notwithstanding the foregoing, accrued but unpaid cash interest on any portion of the Principal Amount which is converted into Common Stock hereunder shall be converted at the same time as such Principal Amount. Accrued but unpaid cash interest on any portion of the Principal Amount which is redeemed or repurchased hereunder shall be paid in cash concurrently with such redemption or repurchase. Notwithstanding anything to the contrary contained herein, the Company may not pay interest in-kind (and must deliver cash in respect thereof) on the Notes if: (i) the number of shares of Common Stock at the time authorized, unissued and unreserved for all purposes, or held as treasury stock, is insufficient to issue such interest upon conversion of all Notes; (ii) such shares are not registered for resale pursuant to an effective registration statement and covered by a current related prospectus, the use of which has not been suspended (except during periods, permitted by the Registration Rights Agreement (as defined in Section 6 below), that such -3- 4 registration statement is not required to be effective or such prospectus is not required to be available pursuant to the Registration Rights Agreement), that names the recipient of such dividend as a selling stockholder thereunder and may not be sold without restrictions pursuant to Rule 144 promulgated under the Securities Act of 1933, as amended (the "Securities Act"), as determined by counsel to the Company pursuant to a written opinion letter, addressed to the Company's transfer agent, in the form and substance reasonably acceptable to the holder; (iii) such shares are not listed on the Nasdaq National Market, The Nasdaq SmallCap Market, the New York Stock Exchange, the American Stock Exchange or any other exchange or quotation system on which the Common Stock is then listed for trading; or (iv) the Company shall have failed to pay any cash interest payments when due (unless waived by holders of 75% in outstanding principal amount of the Notes). (b) Not later than three (3) Trading Days after the Conversion Date, the Company will deliver to the Holder (i) a certificate or certificates which shall be free of restrictive legends and trading restrictions (other than those required by Section 3.1(b) of the Purchase Agreement) representing the number of shares of Common Stock being acquired upon the conversion of this Note, and (ii) a Note representing the remaining Principal Amount of this Note not converted, if any, provided, however, that the Company shall not be obligated to issue certificates evidencing the shares of Common Stock issuable upon conversion of this Note until this Note is either delivered for conversion (other than by facsimile) to the Company, or the Holder notifies the Company that such Note has been lost, stolen or destroyed and provides a bond (or other adequate security reasonably acceptable to the Company) reasonably satisfactory to the Company to indemnify the Company from any loss incurred by it in connection therewith. The Company shall, upon request of the Holder, use its best efforts to deliver any certificate or certificates required to be delivered by the Company under this Section 3(b) electronically through The Depository Trust Corporation or another established clearing corporation performing similar functions. If in the case of any Conversion Notice, such certificate or certificates, including for purposes hereof, any shares of Common Stock to be issued on the Conversion Date on account of accrued interest hereunder, are not delivered to or as directed by the Holder by the third Trading Day after the Conversion Date, the Holder shall be entitled by written notice to the Company at any time on or before its receipt of such certificate or certificates thereafter, to rescind such conversion, in which event the Company shall immediately return this Note tendered for conversion. If the Company fails to deliver to the Holder such certificate or certificates pursuant to this Section 3(b), including for purposes hereof, any shares of Common Stock to be issued on the Conversion Date on account of accrued interest hereunder, prior to the fifth Trading Day after the Conversion Date, the Company shall pay to the Holder, in cash, an amount equal to the actual damages which the Holder can prove it has suffered as a direct result of the Company's failure to deliver to the Holder such certificate or certificates prior to the fifth Trading Day after the Conversion Date. If the Company fails to deliver to the Holder such certificate or certificates pursuant to this Section prior to the 20th day after the Conversion Date, the Company shall (i) deliver notice of such failure to all holders of the Notes and (ii) at the option of any holder of the Notes, and upon such holder's written notice to the Company, redeem all or a portion of the outstanding Principal Amount of the Notes held by such holder, as requested by such holder. The aggregate redemption price shall be equal to the greater of (i) the outstanding Principal Amount being redeemed plus accrued and unpaid cash interest thereon, if any, and (ii) the product of (x) the average of the Per Share Market Value for the five (5) Trading Days preceding the Conversion Date and (y) the Conversion Ratio. If a holder has requested that the Company redeem such holder's Notes pursuant to this Section 3(b) and the Company fails for any reason to pay the redemption price above within seven (7) days after such notice is deemed delivered pursuant to Section 3(b), the -4- 5 Company will pay interest on the redemption price at a rate of 15% per annum, in cash to such holder, accruing from such seventh day until the redemption price and any accrued interest thereon is paid in full; provided, however, if any portion of the redemption price under this Section 3(b) shall not be paid by the Company within seven (7) days of such notice of redemption being delivered, the applicable holder by written notice given to the Company within 30 days of such 7th day, may elect to invalidate ab initio such redemption and the Company shall, within three (3) Trading Days of receipt of such notice, return to such holder that portion of this Note for which the redemption price has not been paid. (c) (i) The conversion price ("Conversion Price") applicable to conversions of the Principal Amount of this Note into Common Stock hereunder shall be $1.125, subject to adjustment as provided herein. Notwithstanding the foregoing, if (a) the registration statement contemplated by the Registration Rights Agreement, which among other things, requires the Company to register the resale of the shares of Common Stock issuable upon conversion of the Notes, including a registration statement covering additional shares of Common Stock issuable upon conversion of the Notes but not included in a prior registration statement (the "Underlying Shares Registration Statement") is not filed on or prior to the 30th day after the Issuance Date in the case of the initial Underlying Shares Registration Statement, and with respect to any other Underlying Shares Registration Statement, the 30th day following the date additional shares of Common Stock became issuable upon conversion of the Notes, or (b) the Company fails to file with the Commission a request for acceleration in accordance with Rule 12d1-2 promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), within five (5) days of the date that the Company is notified (orally or in writing, whichever is earlier) by the Commission that an Underlying Shares Registration Statement will not be "reviewed" or is advised that such Registration Statement is not subject to further review or comment, or (c) if the Underlying Shares Registration Statement is not declared effective by the Commission on or prior to the 90th day after the Issuance Date, in the case of the initial Underlying Shares Registration Statement, and with respect to the other Underlying Shares Registration Statements, the 60th day following the date additional shares of Common Stock became issuable upon conversion of the Notes, or (d) if such Underlying Shares Registration Statement is filed with and declared effective by the Commission but thereafter ceases to be effective as to all Registrable Securities (as such term is defined in the Registration Rights Agreement) at any time prior to the expiration of the "Effectiveness Period" (as such term as defined in the Registration Rights Agreement), without being succeeded within ten (10) Business Days by a subsequent Underlying Shares Registration Statement filed with and declared effective by the Commission, or (e) if trading in the Common Stock shall be suspended for any reason for more than three (3) consecutive Trading Days or five (5) Trading Days in the aggregate or if the Common Stock shall be delisted from the Nasdaq National Market (unless such delisting shall be due to failure comply with the maintenance criteria set forth in NASD Rule 4450 (or any successor rule) with respect to: (i) minimum bid price or (ii) net tangible assets, or unless the Common Stock is listed for trading on The Nasdaq SmallCap Market, the New York Stock Exchange or the American Stock Exchange within three (3) Trading Days), or (f) if the conversion rights of the Holder are suspended for any reason, or (g) the Company postpones or suspends the filing or effectiveness of any Registration Statement in excess of 20 consecutive days or 60 days in the aggregate during any twelve month period, or (h) a holder of Registrable Securities must discontinue disposition of its Registrable Securities pursuant to the fourth paragraph of Section 3(o) of the Registration Rights Agreement, or (i) if during the Effectiveness Period (as defined in the Registration Rights Agreement), the Registrable Securities shall not be exempt from qualification under the state securities laws of all 50 states and the District of Columbia and (1) the Company shall not have, within 14 days of such occurrence, applied to have the Registrable Securities qualified under all such laws; or (2) within 45 days of such occurrence, such Registrable Securities shall not be so qualified (any such occurrence in clauses (a) through (i) above being referred to as an "Event," and for purposes of clauses (a), (c), (f) and (h) the date on which such Event occurs, or for purposes of clause (b) -5- 6 the date on which such five (5) day period is exceeded, or for purposes of clause (d) the date which such 10 Business Day-period is exceeded, or for purposes of clause (e) the date on which such three Trading Day period is exceeded, or for purposes of clause (g) the date on which such 20 consecutive day or 60 aggregate day period is exceeded, or for purposes of clause (i) the date on which such14 or 45 day period is exceeded being referred to as an "Event Date"), the Conversion Price for all of the Notes shall be decreased by 2.5% for each monthly anniversary of an Event Date until the earlier to occur of the second month anniversary after the Event Date and such time as the applicable Event is cured (e.g. if an Event has not been cured on the first month anniversary of its Event Date, the Conversion Price for all of the Notes shall be reduced to $1.096875; if the Event has not been cured on the second month anniversary of its Event Date, the Conversion Price for all of the Notes in effect on a Conversion Date shall be further reduced to $1.0694532). Commencing the second month anniversary after the Event Date, at the option of any holder of the Notes, to be exercised by written notice, for each applicable monthly period either (a) the Company shall pay to such holder 2.5% of the outstanding Principal Amount of such holder's Notes, which amount such holder may elect by written notice to the Company delivered at least 5 Trading Days prior to the date such amount is payable to have added to the Principal Amount or (b) the Conversion Price for such Notes shall be decreased by 2.5% for each such additional month (to be effective in full on the monthly anniversary of an applicable Event Date) as liquidated damages, and not as a penalty, on the first day of each monthly anniversary of the Event Date, in either case until such time as the applicable Event is cured. Any decreased Conversion Price in effect pursuant to this Section 3(c)(i) shall continue notwithstanding the fact that the Event causing such decrease has been subsequently cured. If an Event is not cured by the third month anniversary of an Event Date (or the second week anniversary of an Event Date for the purpose of clause (f)), then each holder of Notes shall have the option by written notice to require the Company to redeem such holder's Notes, in whole or in part, at an aggregate redemption price equal to the greater of (i) the Principal Amount (plus accrued and unpaid cash interest thereon, if any) and (ii) the product of (x) the average of the Per Share Market Value for the five (5) Trading Days immediately preceding such holder's redemption notice and (y) the Conversion Ratio. If the Holder has requested that the Company redeem this Note pursuant to this Section 3.1(c)(i) and the Company fails for any reason to pay the redemption price within seven (7) days after the notice of redemption is deemed delivered pursuant to Section 3(h), the Company will pay interest on such redemption price in cash at a rate of 15% per annum to the applicable holder, accruing from the date the notice of redemption is deemed delivered until the redemption price plus any accrued interest thereon is paid in full; provided, however, if any portion of the redemption price under this Section 3.1(c)(i) shall not be paid by the Company within seven (7) days of such notice of redemption being delivered, such holder by written notice given to the Company within 30 days of such 7th day, may elect to invalidate ab initio such redemption and the Company shall, within three (3) Trading Days of receipt of such notice, return to such holder the portion of this Note for which the redemption price has not been paid. The provisions of this Section 3(c)(i) are not exclusive and shall in no way limit the Company's obligations under the Registration Rights Agreement. (ii) If the Company, at any time while any Principal Amount of this Note is outstanding, (a) shall pay a stock dividend or otherwise make a distribution or distributions on shares of its Junior Securities payable in shares of Common Stock, (b) subdivide outstanding shares of Common Stock into a larger number of shares, (c) combine outstanding shares of Common Stock into a smaller number of shares, or (d) issue by reclassification of shares of Common Stock any shares of capital stock of the Company, the Conversion Price shall be multiplied by a fraction of which the numerator shall be the number of shares of Common Stock (excluding treasury shares, if any) outstanding before such event and of which the denominator shall be the number of shares of Common Stock outstanding after such event. Any adjustment made pursuant to this Section 3(c)(ii) shall become effective immediately after the record -6- 7 date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision, combination or re-classification. (iii) If the Company, at any time while any Principal Amount of this Note is outstanding, shall distribute to all holders of Common Stock evidences of its indebtedness or assets or rights or warrants to subscribe for or purchase any security (excluding those referred to in Section 3(c)(ii) above), then in each such case the Conversion Price shall be determined by multiplying the Conversion Price in effect immediately prior to the record date fixed for determination of stockholders entitled to receive such distribution by a fraction of which the denominator shall be the Per Share Market Value of Common Stock determined as of the record date mentioned above, and of which the numerator shall be such Per Share Market Value of the Common Stock on such record date less the then fair market value at such record date of the portion of such assets or evidence of indebtedness so distributed applicable to one outstanding share of Common Stock as determined by the Company's Board of Directors in good faith; provided, however, that if the holders of a majority of the outstanding principal of the Notes dispute such amount, such holders may select a nationally recognized or major regional investment banking firm or firm of independent certified public accountants of recognized standing (an "Appraiser") paid for by the holders of the outstanding principal of the Notes then outstanding, in which case the fair market value shall be equal to the average of the determinations by the Company's Board of Directors and such Appraiser. In either case the adjustments shall be described in a statement provided to the holders of the Notes of the portion of assets or evidences of indebtedness so distributed or such subscription rights applicable to one share of Common Stock. Such adjustment shall be made whenever any such distribution is made and shall become effective immediately after the record date mentioned above. (iv) All calculations under this Section 3 shall be made to the nearest cent or the nearest 1/100th of a share, as the case may be. (v) Whenever the Conversion Price is adjusted pursuant to Section 3(c)(ii) or (iii) above, the Company shall promptly mail to each holder of the Notes, a notice setting forth the Conversion Price after such adjustment and setting forth a brief statement of the facts requiring such adjustment. (vi) In case of (i) an acquisition after the date hereof by an individual, legal entity or "group" within the meaning of Section 13(d) under the Exchange Act of voting securities of the Company pursuant to which, after giving effect to such acquisition, such individual, legal entity or group will beneficially own in excess of 50% of the issued and outstanding voting securities of the Company, (ii) a replacement of more than one-half of the members of the Company's Board of Directors which is not approved by those individuals who are members of the Company's Board of Directors on the date thereof in one or a series of related transactions, (iii) the merger of the Company with or into another entity, consolidation or sale, transfer or disposition of all or substantially all of the assets of the Company in one or a series of transactions or (iv) the execution by the Company of an agreement to which the Company is a party or which it is bound providing for an event set forth in (i), (ii) or (iii) above, pursuant to which the Common Stock is converted into other securities, cash or property (each, a "Business Combination"), the Holder shall have the right thereafter to, at its option, (A) convert this Note, in whole or in part, only into the shares of stock and other securities, cash and/or property receivable upon or deemed to be held by holders of Common Stock following such Business Combination, and the Holder shall be entitled upon such event to receive such amount of securities, cash or property as the shares of the Common Stock of the Company into which this Note could have been converted immediately prior to such Business Combination would have been entitled, subject to such further applicable adjustments set forth in this Section 3 or (B) -7- 8 require the Company to redeem this Note, in whole or in part, at a redemption price equal to the greater of (i) the outstanding Principal Amount being redeemed plus any accrued and unpaid cash interest thereon and (ii) the product of (x) the average of the Per Share Market Value for the five (5) Trading Days immediately preceding the Purchaser's election to have its Notes redeemed and (y) the Conversion Ratio. If any portion of the applicable redemption price under this Section 3.1(c)(vi) shall not be paid by the Company within seven (7) days after the date due, interest shall accrue thereon at the rate of 15% per annum until the redemption price plus all such interest is paid in full (which amount shall be paid as liquidated damages and not as a penalty). In addition, if any portion of such redemption price remains unpaid for more than seven (7) days after the date due, the Holder of this Note being subject to such redemption may elect, by written notice to the Company given within 30 days after the date due, to either (i) demand conversion in accordance with the formula and the time frame therefor set forth in Section 3 of the portion of this Note for which such redemption price, plus accrued liquidated damages thereof, has not been paid in full (the "Unpaid Redemption Notes") or (ii) invalidate ab initio such redemption, notwithstanding anything herein contained to the contrary. If the Holder elects option (i) above, the Company shall within three (3) Trading Days of its receipt of such election deliver to the holder the shares of Common Stock issuable upon conversion of the Unpaid Redemption Notes subject to the Holder's conversion demand and otherwise perform its obligations hereunder with respect thereto; or, if the Holder elects option (ii) above, the Company shall promptly, and in any event not later than three (3) Trading Days from receipt of the Holder's notice of such election, return to the Holder all of the Unpaid Redemption Notes. The terms of any such Business Combination shall include such terms so as to continue to give to the Holders the right to receive the amount of securities, cash and/or property upon any conversion or redemption following such Business Combination to which a holder of the number of shares of Common Stock deliverable upon such conversion would have been entitled in such Business Combination. This provision shall similarly apply to successive reclassifications, consolidations, mergers, sales, transfers or share exchanges. (vii) If: A. the Company shall declare a dividend (or any other distribution) on its Common Stock; or B. the Company shall declare a special nonrecurring cash dividend on or a redemption of its Common Stock; or C. the Company shall authorize the granting to all holders of the Common Stock rights or warrants to subscribe for or purchase any shares of capital stock of any class or of any rights; or D. the approval of any stockholders of the Company shall be required in connection with any reclassification of the Common Stock of the Company, any consolidation or merger to which the Company is a party, any sale or transfer of all or substantially all of the assets of the Company, of any compulsory share of exchange whereby the Common Stock is converted into other securities, cash or property; or E. the Company shall authorize the voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company. then the Company shall cause to be filed at each office or agency maintained for the purpose of conversion -8- 9 of this Note, and shall cause to be mailed to the Holder at its last address as it shall appear upon the books of the Company, at least 30 calendar days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, redemption, rights or warrants, or if a record is not to be taken, the date as of which the holders of Common Stock of record to be entitled to such dividend, distributions, redemption, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer or share exchange is expected to become effective or close, and the date as of which it is expected that holders of Common Stock of record shall be entitled to exchange their shares of Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer or share exchange; provided, however, that the failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of the corporate action required to be specified in such notice. (d) The Company covenants that it will at all times reserve and keep available out of its authorized and unissued Common Stock solely for the purpose of issuance upon conversion of this Note, free from preemptive rights or any other actual contingent purchase rights of persons other than the holders of the Notes, not less than such number of shares of Common Stock as shall (subject to any additional requirements of the Company as to reservation of such shares set forth in the Purchase Agreement) be issuable (taking into account the adjustments and restrictions of Section 3(c) above) upon the conversion of this Note hereunder. The Company covenants that all shares of Common Stock that shall be so issuable shall, upon issue, be duly authorized, validly issued, fully paid, nonassessable and freely tradeable. (e) Upon a conversion hereunder the Company shall not be required to issue stock certificates representing fractions of shares of Common Stock, but may if otherwise permitted, make a cash payment in respect of any final fraction of a share based on the Per Share Market Value at such time. If the Company elects not, or is unable, to make such a cash payment, the Holder shall be entitled to receive, in lieu of the final fraction of a share, one whole share of Common Stock. (f) The issuance of certificates for shares of Common Stock on conversion of this Note shall be made without charge to the Holder for any documentary stamp or similar taxes that may be payable in respect of any transfer involved in the issuance and delivery of any such certificate upon conversion in a name other than that of the Holder and the Company shall not be required to issue or deliver such certificates unless or until the person or persons requesting the issuance thereof shall have paid to the Company the amount of such tax or shall have established to the satisfaction of the Company that such tax has been paid. (g) After all of the Principal Amount and accrued but unpaid cash interest at any time owed on this Note have been paid in full or converted into Common Stock, this Note shall automatically be deemed be canceled. (h) Any and all notices or other communications or deliveries to be provided by the Holder hereunder, including, without limitation, any Conversion Notice, shall be in writing and delivered personally, by facsimile, or by a nationally recognized overnight courier service to the attention of the General Counsel of the Company at the facsimile telephone number or address of the principal place of business of the Company as set forth in the Purchase Agreement. Any and all notices or other communications or deliveries to be provided by the Company hereunder shall be in writing and delivered personally, by facsimile, or by a nationally recognized overnight courier service addressed to the Holder at the facsimile telephone number or address of the Holder appearing on the books of the Company, or if no such facsimile telephone number or address appears, at the principal place of business of the Holder. Any -9- 10 notice or other communication or deliveries hereunder shall be deemed delivered (i) upon receipt, when delivered personally, (ii) when sent by facsimile, upon receipt if received on a Business Day prior to 5:00 p.m. (Central Time), or on the first Business Day following such receipt if received on a Business Day after 5:00 p.m. (Central Time) or (iii) upon receipt, when deposited with a nationally recognized overnight courier service. (i) Notwithstanding anything to the contrary herein, the Holder may not use its ability to convert this Note if such conversion would result in the total number of shares of Common Stock deemed beneficially owned by the Holder (other than by virtue of the ownership of this Note or ownership of other securities that have limitations on a holder's right to convert or exercise similar to those limitations set forth herein), together with all shares of Common Stock deemed beneficially owned by the Holder's Affiliates (as defined in the Purchase Agreement) that would be aggregated for purposes of determining a group under Section 13(d) of the Exchange Act, exceeding 9.9% of the total issued and outstanding shares of the Company's Common Stock (the "Restricted Ownership Percentage"); provided that (w) the Holder shall have the right, at any time and from time to time, to reduce the Restricted Ownership Percentage applicable to it immediately upon written notice to the Company, (x) the Holder shall have the right at any time and from time to time, to increase its Restricted Ownership Percentage and otherwise waive in whole or in part the restrictions of this Section 3(i) immediately upon written notice to the Company in the event of an occurrence or notice of an intended or pending Change of Control (as defined in the Purchase Agreement)(a "Change of Control Notice") or the delivery by the Company of a notice of a redemption of the Notes or the Company's 2% Senior Convertible Notes (the "2% Notes") by the Company (a "Redemption Notice") and, (y) the Holder can make subsequent adjustments pursuant to (w) or (x) any number of times (which adjustment shall be effective immediately). The delivery of a Conversion Notice by the Holder shall be deemed a representation by the Holder that it is in compliance with this Section 3(i). Section 4. Redemption. (a) The Company shall have the right, exercisable at any time upon thirty (30) days' notice to the holders of the Notes given at any time on or after May 15, 2000 to redeem all or any portion of the Notes which have not previously been converted or redeemed, at a redemption price equal to the outstanding Principal Amount (plus accrued and unpaid cash interest thereon), provided the Per Share Market Value for the Common Stock has been at least $3.375 per share for each of the twenty (20) consecutive Trading Days preceding the date on which the Company delivers a redemption notice pursuant to this Section 4(a). The entire redemption price plus all interest accrued thereon (as set forth below) shall be paid in cash. Holders of the Notes may convert the Notes, including those subject to a redemption notice given under this Section 4(a), during the period from the date of such redemption notice through the date on which the redemption price for such Notes is paid by the Company and the Company shall honor all properly tendered Conversion Notices during such period. Any redemption notice under this Section 4(a) shall indicate the Principal Amount of Notes to be redeemed and the date (subject to the terms hereof) on which such redemption is to occur. The holders of the Notes to be redeemed shall tender by overnight mail, the Notes subject to such redemption on the date prior to the redemption date. If the Company intends to redeem less than all of the then outstanding Notes, it shall do so on a pro rata basis among such holders in accordance with this Section 4(a). If any portion of the applicable redemption price under this Section shall not be paid by the Company within seven (7) days after the date due, interest shall accrue thereon at the rate of 15% per annum until the redemption price plus all such interest is paid in full (which amount shall be paid as liquidated damages and not as a penalty). In addition, if any portion of such redemption price remains unpaid for more than seven (7) days after the date due, the holder of this Note subject to such redemption may elect, by written notice to the Company given within 30 days after the date due, to either (i) demand conversion of the Unpaid Redemption Notes in accordance with the formula and the time frame therefor set forth in Section 3 or (ii) invalidate ab initio -10- 11 such redemption, notwithstanding anything herein contained to the contrary. If the Holder elects option (i) above, the Company shall within three (3) Trading Days of its receipt of such election deliver to the Holder the shares of Common Stock issuable upon conversion of the Unpaid Redemption Notes subject to such holder conversion demand and otherwise perform its obligations hereunder with respect thereto; or, if the Holder elects option (ii) above, the Company shall promptly, and in any event not later than three (3) Trading Days from receipt of the Holder's notice of such election, return to the Holder all of the Unpaid Redemption Notes. Failure by the Company to redeem this Note on a timely basis after notifying the holders of its intent to redeem the Notes pursuant to this Section 4(a) shall result in the Company being prohibited from exercising such right pursuant to this Section 4(a) again. (b) Notwithstanding anything to the contrary herein, the Company shall be prohibited from exercising its right to redeem the Notes pursuant to Section 4(a) if at the time of such redemption and for the 30 days preceding the Company's notice of such redemption and at all times between the date of such notice and the redemption (i) an Underlying Shares Registration Statement is not effective, (ii) the Common Stock is not listed on the Nasdaq National Market, The Nasdaq SmallCap Market, the New York Stock Exchange or the American Stock Exchange or trading on such market or exchange is suspended (other than for a period of not more than one Trading Day to allow for dissemination of material information regarding the Company) or (iii) the use of a Prospectus (as defined in the Registration Rights Agreement) is suspended. Section 5. Defaults and Remedies. (a) Events of Default. An "Event of Default" is: (i) default in payment of the Principal Amount or accrued but unpaid cash interest thereon of any of the Notes on or after the date such payment is due (to the extent such principal and/or amount has not been converted into Common Stock in accordance with the terms hereof or thereof, as applicable); (ii) any principal payment under the 2% Notes shall have been accelerated, (iii) failure by the Company for ten (10) days after notice to it to comply with any other material provision of any of the Notes, the Purchase Agreement, the Amendment to Note Agreement, the Registration Rights Agreement (other than an Event) or the common stock purchase warrants of the Company issued to the Holder pursuant to the Purchase Agreement; (iv) a material breach by the Company of its representations or warranties in the Purchase Agreement or Registration Rights Agreement; (v) any event identified as an "Event of Default" shall have occurred pursuant to Section 3.22 of the Purchase Agreement; (vi) any default under or acceleration prior to maturity of any mortgage, indenture or instrument under which there may be issued or by which there may be secured or evidenced any indebtedness for money borrowed by the Company or for money borrowed the repayment of which is guaranteed by the Company, whether such indebtedness or guarantee now exists or shall be created hereafter, provided that the Company's obligation with respect to any such borrowed or accelerated amount exceeds, in the aggregate, $500,000; (vii) if the Company pursuant to or within the meaning of any Bankruptcy Law; (A) commences a voluntary case; (B) consents to the entry of an order for relief against it in an involuntary case; (C) consents to the appointment of a Custodian of it or for all or substantially all of its property; (D) makes a general assignment for the benefit of its creditors; or (E) admits in writing that it is generally unable to pay its debts as the same become due; or (viii) a court of competent jurisdiction enters an order or decree under any Bankruptcy Law that: (1) is for relief against the Company in an involuntary case; (2) appoints a Custodian of the Company or for all or substantially all of its property; or (3) orders the liquidation of the Company or any subsidiary, and the order or decree remains unstayed and in effect for ninety (90) days. The Term "Bankruptcy Law" means Title 11, U.S. Code, or any similar Federal or State Law for the relief of debtors. The term "Custodian" means any receiver, trustee, assignee, liquidator or similar official under any Bankruptcy Law. -11- 12 (b) Remedies. If an Event of Default occurs and is continuing with respect to any of the Notes, the Holder may declare all of the then outstanding Principal Amount of this Note and all other Notes held by the Holder, including any interest due thereon, to be due and payable immediately, except that in the case of an Event of Default arising from events described in clauses (vii) and (viii) of Section 5(a), this Note shall become due and payable without further action or notice. In the event of such acceleration, the amount due and owing to the Holder shall be the greater of (1) the outstanding Principal Amount of the Notes held by the Holder (plus all accrued and unpaid cash interest, if any) and (2) the product of (A) the product of the average of Per Share Market Value for the five (5) Trading days immediately preceding the Holder's redemption notice and (B) the Conversion Ratio. In either case the Company shall pay interest on such redemption price in cash at a rate of 15% per annum to the Holder if such redemption price is not paid within 7 days of receipt of the Holder's written notice. The remedies under this Note shall be cumulative. Section 6. Definitions. For the purposes hereof, the following terms shall have the following meanings: "Conversion Ratio" means, at any time, a fraction, of which the numerator is the Principal Amount of this Note (and any accrued but unpaid cash interest thereon, if any) to be converted in such conversion, and of which the denominator is the Conversion Price at such time. "Junior Securities" means the Company's capital stock and all other equity securities and all debt securities of the Company which are junior in rights and liquidation preference to the Notes. "Per Share Market Value" means on any particular date (a) the closing bid price per share of the Common Stock on such date on the Nasdaq National Market or other stock exchange or quotation system on which the Common Stock is then listed or if there is no such price on such date, then the closing bid price on such exchange or quotation system on the date nearest preceding such date, or (b) if the Common Stock is not listed then on the Nasdaq National Market or any stock exchange or quotation system, the closing bid price for a share of Common Stock in the over-the-counter market, as reported by The Nasdaq Stock Market, Inc. or by the National Quotation Bureau Incorporated or similar organization or agency succeeding to its functions of reporting prices at the close of business on such date, or (c) if the Common Stock is not then reported by the National Quotation Bureau Incorporated (or similar organization or agency succeeding to its functions of reporting prices), then the average of the "Pink Sheet" quotes for the relevant conversion period, as determined in good faith by the holder, or (d) if the Common Stock is not then publicly traded the fair market value of a share of Common Stock as determined by an Appraiser selected in good faith and paid for by the holders of a majority in Principal Amount of the Notes; provided, however, that the Company, after receipt of the determination by such appraiser, shall have the right to select an additional Appraiser (which may be the firm of independent accountants that regularly reviews the Company's financial statements), in which case, the fair market value shall be equal to the average of the determinations by each such Appraiser. "Person" means a corporation, an association, a partnership, a limited liability company, an organization, a business, an individual, a government or political subdivision thereof or a governmental agency. "Registration Rights Agreement" means the Registration Rights Agreement, dated as of March 31, 1999, between the Company and the original holders of the Notes. -12- 13 "Trading Day" means a day on which the Common Stock is traded on The Nasdaq National Market or other stock exchange or market on which the Common Stock has been listed. "Underlying Shares" means the number of shares of Common Stock into which the Notes are convertible in accordance with the terms hereof and the Purchase Agreement. Section 7. General (a) Payment of Expenses. The Company agrees to pay all reasonable debts and expenses, including attorneys' fees and expenses, which may be incurred by the Holder in successfully enforcing this Note and/or collecting any amount due under this Note. (b) Savings Clause. In case any provision of this Note is held by a court of competent jurisdiction to be excessive in scope or otherwise invalid or unenforceable, such provision shall be adjusted rather than voided, if possible, so that it is enforceable to the maximum extent possible, and the validity and enforceability of the remaining provisions of this Note will not in any way be affected or impaired thereby. In no event shall the amount of interest paid hereunder exceed the maximum rate of interest on the unpaid principal balance hereof allowable by applicable law. If any sum is collected in excess of the applicable maximum rate, the excess collected shall be applied to reduce the principal debt. If the interest actually collected hereunder is still in excess of the applicable maximum rate, the interest rate shall be reduced so as not to exceed the maximum allowable under law. (c) Amendment. Neither this Note nor any term hereof may be amended, waived, discharged or terminated other than by a written instrument signed by the Company and Holder. (d) Assignment, Etc. The Holder may assign or transfer this Note to any transferee; provided, however, that if such transferee is not already a holder of the Notes or the 2% Notes or an Affiliate of any holder of the Notes or the 2% Notes then such transferee shall not have the ability to participate in the nomination of directors pursuant to Section 1 of the Amendment to Note Agreement. This Note shall be binding upon the Company and its successors and shall inure to the benefit of the Holder and its successors and assigns. (e) No Waiver. No failure on the part of the Holder to exercise, and no delay in exercising any right, remedy or power hereunder shall operate as a waiver thereof, nor shall any single or partial exercise by the Holder of any right, remedy or power hereunder preclude any other or future exercise of any other right, remedy or power. Each and every right, remedy or power hereby granted to the Holder or allowed it by law or other agreement shall be cumulative and not exclusive of any other, and may be exercised by the Holder from time to time. (f) Governing Law; Jurisdiction. (i) THIS NOTE WILL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK WITHOUT REGARD TO ANY CONFLICTS OF LAWS PROVISIONS THEREOF THAT WOULD OTHERWISE REQUIRE THE APPLICATION OF THE LAW OF ANY OTHER JURISDICTION. (ii) The Company irrevocable submits to the exclusive jurisdiction of any State -13- 14 or Federal Court sitting in the State of New York over any suit, action, or proceeding arising out of or relating to this agreement. The Company irrevocably waives, to the fullest extent permitted by law, any objection which it may now or hereafter have to the laying of the venue of any such suit, action, or proceeding brought in such a court and any claim that suit, action, or proceeding has been brought in an inconvenient forum. The Company agrees that the service of process upon it mailed by certified or registered mail (and service so made shall be deemed complete five days after the same has been posed as aforesaid) or by personal service shall be deemed in every respect effective service of process upon it in any such suit or proceeding. Nothing herein shall affect Holder's right to serve process in any other manner permitted by law. The Company agrees that a final non-appealable judgement in any such suit or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on such judgment or in any other lawful manner. (iii) The Company hereto knowingly and voluntarily waives any and all rights it may have to a trial by jury with respect to any litigation based on, or arising out of, under, or in connection with, this Note. (g) Replacement Notes. This Note may be exchanged by Holder at any time and from time to time for a Note or Notes with different denominations representing an equal aggregate Principal Amount, as reasonably requested by Holder, upon surrendering the same. No service charge will be made for such registration or exchange. In the event that Holder notifies the Company that this Note has been lost, stolen or destroyed, a replacement Note identical in all respects to the original Note (except for registration number and Principal Amount, if different than that shown on the original Note), shall be issued to the Holder, provided that the Holder executes and delivers to the Company an agreement reasonably satisfactory to the Company to indemnify the Company from any loss incurred by it in connection with the Note. 15 IN WITNESS WHEREOF, the Company has caused this Note to be signed by Edward W. Laves, its President and Chief Executive Officer, on the day and in the year first above written. ILLINOIS SUPERCONDUCTOR CORPORATION By: /S/ Edward W. Laves ----------------------------------------- Name: Edward W. Laves Title: President and Chief Executive Officer 16 EXHIBIT A --------- FORM OF NOTICE OF CONVERSION (To be Executed by the Holder in order to Convert a Note) The undersigned hereby elects to convert the aggregate Principal Amount (as defined in the Note), together with any accrued but unpaid cash interest thereon indicated below of Note No. ___, into shares of Common Stock, par value $.001 per share (the "Common Stock"), of Illinois Superconductor Corporation (the "Company") according to the conditions hereof, as of the date written below. If shares are to be issued in the name of a person other than undersigned, the undersigned will pay all transfer taxes payable with respect thereto and is delivering herewith such certificates and opinions as reasonably requested by the Company in accordance therewith. No fee will be charged to the holder for any conversion, except for such transfer taxes, if any. The undersigned hereby represents that the number of shares of Common Stock issuable pursuant to this Notice of Conversion does not violate or breach the restrictions on conversions contained in Section 3(i) of the Note. Conversion calculations: --------------------------------------------------- Date to Effect Conversion Note No.: --------------------------------------------------- Aggregate Principal Amount of Note Being Converted --------------------------------------------------- Number of shares of Common Stock to be Issued --------------------------------------------------- Applicable Conversion Price --------------------------------------------------- Signature --------------------------------------------------- Name --------------------------------------------------- Address 17 EXHIBIT A --------- FORM OF NOTICE OF CONVERSION (To be Executed by the Holder in order to Convert a Note) The undersigned hereby elects to convert the aggregate Principal Amount (as defined in the Note), together with any accrued but unpaid cash interest thereon indicated below of Note No. ___, into shares of Common Stock, par value $.001 per share (the "Common Stock"), of Illinois Superconductor Corporation (the "Company") according to the conditions hereof, as of the date written below. If shares are to be issued in the name of a person other than undersigned, the undersigned will pay all transfer taxes payable with respect thereto and is delivering herewith such certificates and opinions as reasonably requested by the Company in accordance therewith. No fee will be charged to the holder for any conversion, except for such transfer taxes, if any. The undersigned hereby represents that the number of shares of Common Stock issuable pursuant to this Notice of Conversion does not violate or breach the restrictions on conversions contained in Section 3(i) of the Note. Conversion calculations: --------------------------------------------------- Date to Effect Conversion Note No.: --------------------------------------------------- Aggregate Principal Amount of Note Being Converted --------------------------------------------------- Number of shares of Common Stock to be Issued --------------------------------------------------- Applicable Conversion Price --------------------------------------------------- Signature --------------------------------------------------- Name --------------------------------------------------- Address EX-4.19 3 FORM OF WARRANT 1 EXHIBIT 4.19 NEITHER THIS WARRANT NOR THE SECURITIES INTO WHICH THIS WARRANT IS EXERCISABLE HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM THE REGISTRATION REQUIREMENTS THEREUNDER AND IN COMPLIANCE WITH APPLICABLE STATE SECURITIES OR BLUE SKY LAWS. ILLINOIS SUPERCONDUCTOR CORPORATION WARRANT ------- Warrant No. WCN-00_ Dated March 31, 1999 Illinois Superconductor Corporation, a Delaware corporation (the "Company"), hereby certifies that, for value received, __________________________, or its registered assigns (the "Holder"), is entitled, subject to the terms set forth below, to purchase from the Company up to a total of _______ shares of Common Stock, $.001 par value per share (the "Common Stock"), of the Company (each such share, a "Warrant Share" and all such shares, the "Warrant Shares") at an exercise price equal to $1.4625 per share (as adjusted from time to time as provided in Section 8, the "Exercise Price"), at any time and from time to time from the date hereof through and including March 31, 2002 (the "Expiration Date"), and subject to the following terms and conditions: 1. Registration of Warrant. The Company shall register this Warrant, upon records to be maintained by the Company for that purpose (the "Warrant Register"), in the name of the record Holder hereof from time to time. The Company may deem and treat the registered Holder of this Warrant as the absolute owner hereof for the purpose of any exercise hereof or any distribution to the Holder, and for all other purposes, and the Company shall not be affected by notice to the contrary. 2. Registration of Transfers and Exchanges. (a) The Company shall register the transfer of any portion of this Warrant in the Warrant Register, upon surrender of this Warrant, with the Form of Assignment attached hereto duly completed and signed and a written opinion of Holder's counsel that such transfer is exempt from registration under the Securities Act, to the Company at the office specified in or 2 pursuant to Section 3(b); provided, however that the Holder shall not make any transfers to any transferee pursuant to this Section for the right to acquire less than 1,000 Warrant Shares. Upon any such registration or transfer, a new warrant to purchase Common Stock, in substantially the form of this Warrant (any such new warrant, a "New Warrant"), evidencing the portion of this Warrant so transferred shall be issued to the transferee and a New Warrant evidencing the remaining portion of this Warrant not so transferred, if any, shall be issued to the transferring Holder. The acceptance of the New Warrant by the transferee thereof shall be deemed the acceptance of such transferee of all of the rights and obligations of a holder of a Warrant. If this Warrant is duly assigned in accordance with the terms hereof, then the Company agrees, upon the request of the assignee, to amend or supplement promptly any effective registration statement covering the Warrant Shares so that the direct assignee of the original Holder is added as a selling stockholder thereunder. (b) This Warrant is exchangeable, upon the surrender hereof by the Holder to the office of the Company specified in or pursuant to Section 3(b) for one or more New Warrants in the name of such Holder, evidencing in the aggregate the right to purchase the number of Warrant Shares which may then be purchased hereunder. Any such New Warrant will be dated the date of such exchange. 3. Duration and Exercise of Warrants. (a) This Warrant shall be exercisable by the registered Holder on any business day before 5:30 P.M., New York time, at any time and from time to time up to and including the Expiration Date. At 5:30 P.M., New York time on the Expiration Date, the portion of this Warrant not exercised prior thereto shall be and become void and of no value. (b) Upon surrender of this Warrant, with the Form of Election to Purchase attached hereto duly completed and signed, to the Company at its office at 451 Kingston Court, Mt. Prospect, Illinois 60056, Attention: General Counsel, or at such other address as the Company may specify in writing to the then registered Holder, and upon payment of the Exercise Price multiplied by the number of Warrant Shares that the Holder intends to purchase hereunder, in lawful money of the United States of America, in cash or by certified or official bank check or checks or wire transfer of immediately available funds, all as specified by the Holder in the Form of Election to Purchase, the Company shall promptly (but in no event later than three (3) trading days after the Date of Exercise (as defined herein)) issue or cause to be issued and cause to be delivered to or upon the written order of the Holder and in such name or names as the Holder may designate, a certificate for the Warrant Shares issuable upon such exercise, free of restrictive legends other than as required by the Securities Purchase Agreement, dated as of March 31, 1999, between the Company and the Purchasers listed therein, including the initial Holder of this Warrant (the "Purchase Agreement"). Any person so designated by the Holder to receive Warrant Shares shall be deemed to have become holder of record of such Warrant Shares as of the Date of Exercise of this Warrant. A "Date of Exercise" means the date on which the Company shall have received (i) this Warrant (or any New Warrant, as applicable), with the Form of Election to Purchase attached hereto (or attached to such New Warrant) appropriately completed and duly signed, and (ii) -2- 3 payment of the Exercise Price for the number of Warrant Shares so indicated by the Holder hereof to be purchased. (c) This Warrant shall be exercisable, either in its entirety or, from time to time, for a portion of the number of Warrant Shares so long as at least 1,000 Warrant Shares are purchased in any one exercise, unless such exercise would result in the Holder holding less than 1,000 Warrant Shares. If less than all of the Warrant Shares which may be purchased under this Warrant are exercised at any time, the Company shall issue or cause to be issued to the Holder, at its expense, a New Warrant evidencing the right to purchase the remaining number of Warrant Shares for which no exercise has been evidenced by this Warrant. (d) If and while the Warrant Shares issuable upon the exercise of this Warrant are not registered for public resale pursuant to an effective registration statement with a current available prospectus, then upon exercise of this Warrant the aggregate Exercise Price may be paid by the Holder notifying the Company that it should subtract from the number of Warrant Shares issuable to the Holder upon such exercise an amount of Warrant Shares, the aggregate Per Share Market Value (as defined in the Purchase Agreement) of which, as determined on the date immediately preceding the date of the Form of Election to Purchase, equals such aggregate Exercise Price of the Warrant Shares for which this Warrant is being exercised. (e) Notwithstanding anything to the contrary herein, the Holder may not use its ability to exercise this Warrant if such exercise would result in the total number of shares of Common Stock deemed beneficially owned by the Holder (other than by virtue of the ownership of this Warrant or ownership of other securities that have limitations on a holder's right to convert or exercise similar to those limitations set forth herein), together with all shares of Common Stock deemed beneficially owned by the Holder's Affiliates (as defined in the Purchase Agreement) that would be aggregated for purposes of determining a group under Section 13(d) of the Exchange Act, exceeding 9.9% of the total issued and outstanding shares of the Company's Common Stock (the "Restricted Ownership Percentage"); provided that (w) the Holder shall have the right, at any time and from time to time, to reduce the Restricted Ownership Percentage applicable to it immediately upon written notice to the Company, (x) the Holder shall have the right to increase its Restricted Ownership Percentage and otherwise waive in whole or in part the restrictions of this Section 3(e) immediately upon written notice to the Company in the event of an occurrence or notice of an intended or pending Change of Control (as defined in the Purchase Agreement)(a "Change of Control Notice") or the delivery by the Company of a notice of a redemption of the Company's 6% Convertible Notes or the Company's 2% Senior Convertible Notes by the Company (a "Redemption Notice") and, (y) the Holder can make subsequent adjustments pursuant to (w) or (x) any number of times (which adjustment shall be effective immediately). The delivery of an exercise notice by the Holder shall be deemed a representation by the Holder that it is in compliance with this paragraph. 4. [INTENTIONALLY OMITTED] 5. Payment of Taxes. The Company will pay all documentary stamp taxes attributable to the issuance of Warrant Shares upon the exercise of this Warrant; provided, -3- 4 however, that the Company shall not be required to pay any tax which may be payable in respect of any transfer involved in the registration of any certificates for Warrant Shares or Warrants in a name other than that of the Holder, and the Company shall not be required to issue or cause to be issued or deliver or cause to be delivered the certificates for Warrant Shares unless or until the person or persons requesting the issuance thereof shall have paid to the Company the amount of such tax or shall have established to the satisfaction of the Company that such tax has been paid. The Holder shall be responsible for all other tax liability that may arise as a result of holding or transferring this Warrant or receiving Warrant Shares upon exercise hereof. 6. Replacement of Warrant. If this Warrant is mutilated, lost, stolen or destroyed, the Company may in its discretion issue or cause to be issued in exchange and substitution for and upon cancellation hereof, or in lieu of and substitution for this Warrant, a New Warrant, but only upon receipt of evidence reasonably satisfactory to the Company of such loss, theft or destruction and indemnity. Applicants for a New Warrant under such circumstances shall also comply with such other reasonable regulations and procedures and pay such other reasonable charges as the Company may prescribe. 7. Reservation of Warrant Shares. The Company covenants that it shall comply with the provisions of Section 3.13 of the Purchase Agreement. Subject to Section 3.13 of the Purchase Agreement, the Company covenants that, following its June 9, 1999 stockholder meeting, it will at all times reserve and keep available out of the aggregate of its authorized but unissued Common Stock, solely for the purpose of enabling it to issue Warrant Shares upon exercise of this Warrant as herein provided, the number of Warrant Shares which are then issuable and deliverable upon the exercise of this entire Warrant, free from preemptive rights or any other actual contingent purchase rights of persons other than the Holders (taking into account the adjustments and restrictions of Section 8). The Company covenants that all Warrant Shares that shall be so issuable and deliverable shall, upon issuance and the payment of the applicable Exercise Price in accordance with the terms hereof, be duly authorized, validly issued, fully paid and nonassessable. 8. Certain Adjustments. The Exercise Price and number of Warrant Shares issuable upon exercise of this Warrant are subject to adjustment from time to time as set forth in this Section 8. Upon each such adjustment of the Exercise Price pursuant to this Section 8, the Holder shall thereafter prior to the Expiration Date be entitled to purchase, at the Exercise Price resulting from such adjustment, the number of Warrant Shares obtained by multiplying the Exercise Price in effect immediately prior to such adjustment by the number of Warrant Shares issuable upon exercise of this Warrant immediately prior to such adjustment and dividing the product thereof by the Exercise Price resulting from such adjustment. (a) If the Company, at any time while this Warrant is outstanding, (i) shall pay a stock dividend (except scheduled dividends paid on outstanding preferred stock as of the date hereof which contain a stated divided rate) or otherwise make a distribution or distributions on shares of its Common Stock (as defined below) (or on any other class of capital stock and not the Common Stock) payable in shares of Common Stock, (ii) subdivide outstanding shares of Common Stock into a larger number of shares, or (iii) combine outstanding shares of Common -4- 5 Stock into a smaller number of shares, the Exercise Price shall be multiplied by a fraction of which the numerator shall be the number of shares of Common Stock (excluding treasury shares, if any) outstanding before such event and of which the denominator shall be the number of shares of Common Stock (excluding treasury shares, if any) outstanding after such event. Any adjustment made pursuant to this Section shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision or combination, and shall apply to successive subdivisions and combinations. (b) In case of any reclassification of the Common Stock, any consolidation or merger of the Company with or into another person, the sale or transfer of all or substantially all of the assets of the Company or any compulsory share exchange pursuant to which the Common Stock is converted into other securities, cash or property, then the Holder shall have the right thereafter to exercise this Warrant only into the shares of stock and other securities and property receivable upon or deemed to be held by holders of Common Stock following such reclassification, consolidation, merger, sale, transfer or share exchange, and the Holder shall be entitled upon such event to receive such amount of securities or property equal to the amount of Warrant Shares such Holder would have been entitled to had such Holder exercised this Warrant immediately prior to such reclassification, consolidation, merger, sale, transfer or share exchange, subject to such further adjustments as set forth in this Section 8. The terms of any such consolidation, merger, sale, transfer or share exchange shall include such terms so as to continue to give to the Holder the right to receive the securities or property set forth in this Section 8(b) upon any exercise following any such reclassification, consolidation, merger, sale, transfer or share exchange. (c) If the Company, at any time while this Warrant is outstanding, shall distribute to all holders of Common Stock evidences of its indebtedness or assets or rights or warrants to subscribe for or purchase any security (excluding those referred to in Section 8(a) and (b)), then in each such case the Exercise Price shall be determined by multiplying the Exercise Price in effect immediately prior to the record date fixed for determination of stockholders entitled to receive such distribution by a fraction of which the denominator shall be the Exercise Price determined as of the record date mentioned above, and of which the numerator shall be such Exercise Price on such record date less the then fair market value at such record date of the portion of such assets or evidence of indebtedness so distributed applicable to one outstanding share of Common Stock as determined by the Board of Directors of the Company acting in good faith. (d) For the purposes of this Section 8, the following clauses shall also be applicable: (i) Record Date. In case the Company shall take a record of the holders of its Common Stock for the purpose of entitling them (A) to receive a dividend or other distribution payable in Common Stock or in securities convertible or exchangeable into shares of Common Stock, or (B) to subscribe for or purchase Common Stock or securities convertible or exchangeable into shares -5- 6 of Common Stock, then such record date shall be deemed to be the date of the issue or sale of the shares of Common Stock deemed to have been issued or sold upon the declaration of such dividend or the making of such other distribution or the date of the granting of such right of subscription or purchase, as the case may be. (ii) Treasury Shares. The number of shares of Common Stock outstanding at any given time shall not include shares owned or held by or for the account of the Company, and the disposition of any such shares shall be considered an issue or sale of Common Stock. (e) All calculations under this Section 8 shall be made to the nearest cent or the nearest 1/100th of a share, as the case may be. (f) Whenever the Exercise Price is adjusted pursuant to Section 8(c) above, the Holders of Warrants representing a majority in interest of the Warrant Shares, after receipt of the determination by the Company's Board of Directors (the "Board"), shall have the right to select an appraiser at the Holder's cost and expense (which shall be a nationally recognized accounting firm), in which case the adjustment shall be equal to the average of the adjustments recommended by each of the Board and such appraiser. The Holders shall promptly mail or cause to be mailed to the Company, a notice setting forth the Exercise Price after such adjustment and setting forth a brief statement of the facts requiring such adjustment. Such adjustment shall become effective immediately after the record date mentioned above. (g) If: (i) the Company shall declare a dividend (or any other distribution) on its Common Stock; or (ii) the Company shall declare a special nonrecurring cash dividend on or a redemption of its Common Stock; or (iii) the Company shall authorize the granting to all holders of the Common Stock rights or warrants to subscribe for or purchase any shares of capital stock of any class or of any rights; or (iv) the approval of any stockholders of the Company shall be required in connection with any reclassification of the Common Stock of the Company, any consolidation or merger to which the Company is a party, any sale or transfer of all or substantially all of the assets of the Company, or any compulsory share exchange whereby the Common Stock is converted into other securities, cash or property; or (v) the Company shall authorize the voluntary dissolution, liquidation or winding up of the affairs of the Company, -6- 7 then the Company shall cause to be mailed to each Holder at their last addresses as they shall appear upon the Warrant Register, at least 30 calendar days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, redemption, rights or warrants, or if a record is not to be taken, the date as of which the holders of Common Stock of record to be entitled to such dividend, distributions, redemption, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer or share exchange is expected to become effective or close, and the date as of which it is expected that holders of Common Stock of record shall be entitled to exchange their shares of Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer, share exchange, dissolution, liquidation or winding up; provided, however, that the failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of the corporate action required to be specified in such notice. 9. Fractional Shares. The Company shall not be required to issue or cause to be issued fractional Warrant Shares on the exercise of this Warrant. The number of full Warrant Shares which shall be issuable upon the exercise of this Warrant shall be computed on the basis of the aggregate number of Warrant Shares purchasable on exercise of this Warrant so presented. If any fraction of a Warrant Share would, except for the provisions of this Section 9, be issuable on the exercise of this Warrant, the Company shall, at its option, (i) pay an amount in cash equal to the Exercise Price multiplied by such fraction or (ii) round the number of Warrant Shares issuable, up to the next whole number. 10. Notices. Any and all notices or other communications or deliveries hereunder shall be in writing and shall be deemed to have been delivered (i) upon receipt, when delivered personally; (ii) when sent by facsimile, upon receipt if received on a Business Day prior to 5:00 p.m. (Central Time), or the first Business Day following such receipt if received on a Business Day after 5:00 p.m. (Central Time); or (iii) upon receipt, when deposited with a nationally recognized overnight express courier service, fully prepaid, in each case properly addressed to the party to receive the same. The addresses and facsimile number for such communications shall be: (1) if to the Company, to Illinois Superconductor Corporation, 451 Kingston Court, Mt. Prospect, Illinois 60056, Attention: General Counsel, or to facsimile no. (847) 391-5015, or (ii) if to the Holder, to the Holder at the address or facsimile number appearing on the Warrant Register or such other address or facsimile number as the Holder may provide to the Company in accordance with this Section 10. 11. Warrant Agent. (a) The Company shall serve as warrant agent under this Warrant. Upon thirty (30) days' notice to the Holder, the Company may appoint a new warrant agent. (b) Any corporation into which the Company or any new warrant agent may be merged or any corporation resulting from any consolidation to which the Company or any new warrant agent shall be a party or any corporation to which the Company or any new warrant agent transfers substantially all of its corporate trust or shareholders services business shall be a successor warrant agent under this Warrant without any further act. Any such -7- 8 successor warrant agent shall promptly cause notice of its succession as warrant agent to be mailed (by first class mail, postage prepaid) to the Holder at the Holder's last address as shown on the Warrant Register. 12. Miscellaneous. (a) This Warrant shall be binding on and inure to the benefit of the parties hereto and their respective successors and permitted assigns. This Warrant may be amended only in writing signed by the Company and the Holder. (b) Subject to Section 12(a), above, nothing in this Warrant shall be construed to give to any person or corporation other than the Company and the Holder any legal or equitable right, remedy or cause under this Warrant; this Warrant shall be for the sole and exclusive benefit of the Company and the Holder. (c) This Warrant shall be governed by and construed and enforced in accordance with the internal laws of the State of New York without regard to the principles of conflicts of law thereof. (d) The headings herein are for convenience only, do not constitute a part of this Warrant and shall not be deemed to limit or affect any of the provisions hereof. (e) In case any one or more of the provisions of this Warrant shall be invalid or unenforceable in any respect, the validity and enforceability of the remaining terms and provisions of this Warrant shall not in any way be affected or impaired thereby and the parties will attempt in good faith to agree upon a valid and enforceable provision which shall be a commercially reasonable substitute therefor, and upon so agreeing, shall incorporate such substitute provision in this Warrant. -8- 9 IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed by its authorized officer as of the date first indicated above. ILLINOIS SUPERCONDUCTOR CORPORATION By: /s/ Edward W. Laves -------------------------------------- Name: Edward W. Laves Title: President 10 FORM OF ELECTION TO PURCHASE (To be executed by the Holder to exercise the right to purchase shares of Common Stock under the foregoing Warrant) To Illinois Superconductor Corporation: In accordance with the Warrant enclosed with this Form of Election to Purchase, the undersigned hereby irrevocably elects to purchase _____________ shares of Common Stock ("Common Stock"), $.001 par value per share, of Illinois Superconductor Corporation (the "Company") and encloses herewith $________ in cash or certified or official bank check or checks or by wire transfer of immediately available funds or (to the extent permitted by the terms of the Warrant) hereby notifies the Company to effect a "cashless" exercise by subtracting ___________ shares of Common Stock valued at $________ per share from the shares of Common Stock issuable hereby, which sum represents the aggregate Exercise Price (as defined in the Warrant) for the number of shares of Common Stock to which this Form of Election to Purchase relates, together with any applicable taxes payable by the undersigned pursuant to the Warrant. The undersigned represents that the number of shares of Common Stock issuable pursuant to this Form of Election to Purchase does not violate or breach the restrictions on exercise contained in Section 3(e) of the Warrant. The undersigned requests that certificates for the shares of Common Stock issuable upon this exercise be issued in the name of PLEASE INSERT SOCIAL SECURITY OR TAX IDENTIFICATION NUMBER -------------------------------- - -------------------------------------------------------------------------------- (Please print name and address) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- If the number of shares of Common Stock issuable upon this exercise shall not be all of the shares of Common Stock which the undersigned is entitled to purchase in accordance with the enclosed Warrant, the undersigned requests that a New Warrant (as defined in the Warrant) evidencing the right to purchase the shares of Common Stock not issuable pursuant to the exercise evidenced hereby be issued in the name of and delivered to: - -------------------------------------------------------------------------------- (Please print name and address) - -------------------------------------------------------------------------------- 11 - -------------------------------------------------------------------------------- Dated: Name of Holder: ----------------- (Print) -------------------------- (By:) -------------------------- (Name:) (Title:) (Signature must conform in all respects to name of holder as specified on the face of the Warrant) -11- 12 [To be completed and signed only upon transfer of Warrant] FOR VALUE RECEIVED, the undersigned hereby sells, assigns and transfers unto ________________________________ the right represented by the within Warrant to purchase ____________ shares of Common Stock of Illinois Superconductor Corporation to which the within Warrant relates and appoints ________________ attorney to transfer said right on the books of Illinois Superconductor Corporation with full power of substitution in the premises. Dated: - ---------------, ---- --------------------------------------- (Signature must conform in all respects to name of holder as specified on the face of the Warrant) --------------------------------------- Address of Transferee --------------------------------------- --------------------------------------- In the presence of: - -------------------------- -12- EX-4.20 4 SECURITIES PURCHASE AGREEMENT 1 Exhibit 4.20 SECURITIES PURCHASE AGREEMENT by and among ILLINOIS SUPERCONDUCTOR CORPORATION and ELLIOTT ASSOCIATES, L.P., WESTGATE INTERNATIONAL, L.P., ALEXANDER FINANCE, LP and STATE FARM MUTUAL AUTOMOBILE INSURANCE COMPANY Dated as of March 31, 1999 ______________________________ 2 SECURITIES PURCHASE AGREEMENT (this "Agreement"), dated as of March 31, 1999, by and among Elliott Associates, L.P., a limited partnership organized and existing under the laws of Delaware, Westgate International, L.P., a limited partnership organized and existing under the laws of the Cayman Islands, Alexander Finance, LP, a limited partnership organized and existing under the laws of the State of Illinois , and State Farm Mutual Automobile Insurance Company, an insurance company organized and existing under the laws of the State of Illinois (each, a "Purchaser" and collectively, the "Purchasers"), and Illinois Superconductor Corporation, a corporation organized and existing under the laws of Delaware (the "Company"). WHEREAS, subject to the terms and conditions set forth in this Agreement, the Company desires to issue and sell to the Purchasers, and the Purchasers desires to acquire from the Company, $3,300,000 principal amount of the Company's 6% Senior Convertible Notes due May 15, 2002 (the "6% Notes"), in the form of Exhibit A attached hereto, on the terms and conditions set forth herein; WHEREAS, subject to the terms and conditions set forth in this Agreement, the Purchasers and the Company desire that the terms and provisions of $5,500,000 principal amount of the Company's 2% Senior Convertible Notes due May 15, 2002, which were issued on May 15, 1998 and which are held by the Purchasers (the "2% Notes"), be amended, as set forth below; and WHEREAS, subject to the terms and conditions set forth in this Agreement, in connection with the transactions set forth above, the Purchasers and the Company desire that the Purchasers: (i) acquire warrants, substantially in the form of Exhibit B attached hereto ("6% Note Warrants") to purchase an aggregate of 1,320,000 shares of the Company's Common Stock, par value $ .001 per share (the "Common Stock"), at an exercise price of $1.4625 per share; and (ii) amend the terms of certain existing warrants issued to the Purchasers to purchase 2,200,000 shares of Common Stock at $3.75 per share and expiring on May 15, 2001 (the "2% Note Warrants"), as set forth below. IN CONSIDERATION of the mutual covenants contained in this Agreement, the Company and the Purchasers agree as follows: ARTICLE I PURCHASE AND SALE OF NOTES AND WARRANTS; AMENDMENT 1.1 Purchase and Sale. Subject to the terms and conditions set forth herein, the Company shall issue and sell to the Purchasers, and the Purchasers shall purchase from the Company, (i) $3,300,000 in aggregate principal amount of 6% Notes, in the respective amounts set forth opposite each Purchaser's name on the Schedule of Purchasers attached hereto, and (ii) 6% Note Warrants to purchase an aggregate of 1,320,000 shares of Common Stock, at an exercise price of $1.4625 per share, subject to adjustment as therein provided, at any time during the period beginning on the Closing Date (as hereinafter defined) and ending on the third 2 3 anniversary of the Closing Date, in the respective amounts set forth opposite each Purchaser's name on the Schedule of Purchasers. For purposes of this Agreement, "Conversion Ratio", "Trading Day, "Business Day" and "Per Share Market Value" shall have the meanings set forth in the 6% Notes. 1.2 Amendment of 2% Notes and 2% Note Warrants. (a) Subject to the terms and conditions set forth herein, the terms and provisions of $5,500,000 principal amount of 2% Notes held by the Purchasers shall be amended as set forth in the Amendment, in the form of Exhibit C attached hereto (the "Amendment to Note Agreement"), to the Securities Purchase Agreement, dated as of May 15, 1998, by and among the Company, the Purchasers, Spring Point Partners, L.P. and Spring Point Offshore Fund (the "2% Note Agreement"). The 2% Notes amended pursuant to the terms of the Amendment to Note Agreement shall hereinafter be referred to as the "Amended 2% Notes." (b) Subject to the terms and provisions herein, the terms and provisions of 2% Note Warrants to purchase 2,200,000 shares of Common Stock shall be amended, as set forth in the Amendment to Note Agreement. The 2% Note Warrants amended pursuant to the terms of the Amendment to Note Agreement shall hereinafter be referred to as the "Amended 2% Note Warrants." 1.3 Purchase Price and Amendment Amount. The purchase price of the 6% Notes and 6% Note Warrants purchased herein and the amounts of 2% Notes and 2% Note Warrants to be amended shall be set forth opposite each Purchaser's name on the Schedule of Purchasers. 1.4 The Closing. (a) Time and Place. The closing of the purchase and sale of the 6% Notes and the 6% Note Warrants and the amendment of the 2% Notes and the 2% Note Warrants (the "Closing") shall take place at the offices of Kleinberg, Kaplan, Wolff & Cohen, P.C., 551 Fifth Avenue, New York, New York on March 31, 1999, or such later date as the parties shall agree, but not prior to the date that the conditions set forth in Section 4 have been satisfied or waived by the appropriate party. The date of the Closing is hereinafter referred to as the "Closing Date." At the Closing, the Company shall sell and issue to the Purchasers, and the Purchasers shall purchase, 6% Notes and 6% Note Warrants for an aggregate purchase price of $3,300,000 and the Company shall also amend the amount of 2% Notes and 2% Note Warrants with respect to each Purchaser, all as set forth in the Schedule of Purchasers. (b) Closing Deliveries. At the Closing, (i) the Company shall deliver to each Purchaser, in such denominations as are requested by such Purchaser, (A) (1) 6% Notes in the principal amount which such Purchaser is then buying (as indicated opposite such Purchaser's name on the Schedule of Purchasers) and (2) Amended 2% Notes in the principal amount indicated opposite such Purchaser's name on the Schedule of Purchasers) and (B) (1) 6% Note Warrants to purchase such number of shares of Common Stock as indicated opposite such 3 4 Purchaser's name on the Schedule of Purchasers and (2) Amended 2% Note Warrants to purchase such number of shares of Common Stock as indicated opposite such Purchaser's name on the Schedule of Purchasers, each registered in the name of such Purchaser, and (C) all other documents, instruments and writings required to have been delivered at or prior to the Closing by the Company pursuant to this Agreement, including the Amendment to Note Agreement and the Registration Rights Agreement by and between the Company and the Purchasers, substantially in the form of Exhibit D attached hereto (the "Registration Rights Agreement"), and (ii) each Purchaser shall deliver to the Company (A) that portion of $3,300,000 which represents the purchase price for the 6% Notes and 6% Note Warrants to be issued and sold to such Purchaser (as indicated opposite such Purchaser's name on the Schedule of Purchasers), in United States dollars in immediately available funds by wire transfer to an account designated in writing by the Company and (B) those 2% Notes and 2% Note Warrants to be amended (as indicated opposite such Purchaser's name on the Schedule of Purchasers), and (C) all documents, instruments and writings required to have been delivered at or prior to the Closing by such Purchaser pursuant to this Agreement, including the Amendment to Note Agreement and the Registration Rights Agreement. ARTICLE II REPRESENTATIONS AND WARRANTIES 2.1 Representations, Warranties and Agreements of the Company. The Company hereby makes the following representations and warranties to each Purchaser: (a) Organization and Qualification. The Company is a corporation, duly incorporated, validly existing and in good standing under the laws of the State of Delaware, with the requisite corporate power and authority to own and use its properties and assets and to carry on its business as currently conducted. The Company has no subsidiaries. The Company is duly qualified to do business and is in good standing as a foreign corporation in each jurisdiction in which the nature of the business conducted or property owned by it makes such qualification necessary, except where the failure to be so qualified or in good standing, as the case may be, could not, individually or in the aggregate, (x) adversely affect the legality, validity or enforceability of any of the Transaction Documents (as defined below) in any material respect, (y) have a material adverse effect on the results of operations, assets, prospects, or financial condition of the Company or (z) adversely impair in any material respect the Company's ability to perform fully on a timely basis its obligations under the Transaction Documents (a "Material Adverse Effect"). (b) Authorization; Enforcement. The Company has the requisite corporate power and authority to enter into and to consummate the transactions contemplated hereby and by the 6% Notes, the 6% Note Warrants, the Amendment to Note Agreement, the Registration Rights Agreement, the Amended 2% Notes and the Amended 2% Note Warrant, and otherwise to carry out its obligations hereunder and thereunder. This Agreement, the 6% Notes, the Amendment to Note Agreement, the Registration Rights Agreement, the 6% Note Warrants, the Amended 2% Notes and the Amended 2% Note Warrants are collectively referred to as the 4 5 "Transaction Documents." The execution and delivery of each of the Transaction Documents by the Company and the consummation by it of the transactions contemplated thereby have been duly authorized by all requisite corporate action on the part of the Company. At the Closing, each of the Transaction Documents will be duly executed and delivered by the Company and when delivered in accordance with the terms hereof, will constitute the valid and binding obligation of the Company enforceable against the Company in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, liquidation or similar laws relating to, or affecting generally the enforcement of, creditors' rights and remedies or by other equitable principles of general application. The Company is not in violation of any of the provisions of its Certificate of Incorporation, as amended (the "Certificate of Incorporation"), or By-Laws (the "By-Laws"). Attached as Exhibit 2.1(b) are copies of the Company's Certificate of Incorporation and By-laws. (c) Capitalization. The authorized, issued and outstanding capital stock of the Company is set forth in Schedule 2.1(c). No shares of Common Stock are entitled to preemptive or similar rights, nor is any holder of the Common Stock entitled to preemptive or similar rights arising out of any agreement or understanding with the Company by virtue of any of the Transaction Documents. Except as disclosed in Schedule 2.1(c), there are no outstanding options, warrants, script rights to subscribe to, calls or commitments of any character whatsoever relating to, or, except as a result of the issuance of the 6% Notes and the 6% Note Warrants and the amendment of the 2% Notes and 2% Note Warrants hereunder, securities, rights or obligations convertible into or exchangeable for, or giving any person any right to subscribe for or acquire any shares of Common Stock, or contracts, commitments, understandings, or arrangements by which the Company is or may become bound to issue additional shares of Common Stock, or securities or rights convertible or exchangeable into shares of Common Stock. To the knowledge of the Company, except as specifically disclosed in the SEC Documents (as defined below) or Schedule 2.1(c), no Person beneficially owns (as determined pursuant to Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act") or has the right to acquire by agreement with or by obligation binding upon the Company beneficial ownership of in excess of 5% of the Common Stock currently issued and outstanding. (d) Underlying Shares. As of the date hereof, the Company has a sufficient number of shares of Common Stock authorized and duly reserved for issuance upon conversion of the 6% Notes and the 2% Amended Notes (collectively, the "Transaction Notes"). As of the date hereof, the Company has a sufficient number of shares of Common Stock authorized and duly reserved for exercise of the 6% Note Warrants and the Amended 2% Warrants (collectively, the "Transaction Warrants") except for a shortfall of 1,320,000 shares of Common Stock underlying the 6% Note Warrants (the "Shortfall"). The Shortfall can be reduced to zero shares of Common Stock upon consent of the holders of warrants to purchase shares of Common Stock at exercise prices in excess of $1.4625 on the date hereof to waive the Company's representation and obligation to reserve shares of Common Stock issuable upon exercise thereof; provided, however, that with respect to any such waiver, the shares of Common Stock thereby released may only be authorized and reserved for issuance upon exercise of Transaction Warrants held by the holder granting the waiver. Upon obtaining stockholder approval to amend its Certificate of Incorporation pursuant to Section 3.13 below, the Company will have, and at all times thereafter 5 6 while the Transaction Notes and Transaction Warrants are outstanding will maintain, an adequate reserve of duly authorized shares of Common Stock to enable it to perform its obligations under this Agreement, and with respect to the Transaction Notes and Transaction Warrants issued and outstanding at the Closing Date and in no circumstances shall such reserved and available shares of Common Stock be less than the sum of (i) the number of shares of Common Stock which would be issuable upon conversion of the Transaction Notes issued pursuant to the terms hereof (the "Underlying Shares"), and (ii) the number of shares of Common Stock which would be issuable upon exercise in full of the Transaction Warrants (the "Warrant Shares"). When issued in accordance with the terms hereof and the Transaction Notes, the Underlying Shares will be duly authorized, validly issued, fully paid and nonassessable. When issued upon exercise of the Transaction Warrants in accordance with the terms thereof, the Warrant Shares will be duly authorized, validly issued, fully paid and nonassessable. (e) No Conflicts. The execution, delivery and performance of the Transaction Documents by the Company and the consummation by the Company of the transactions contemplated thereby do not and will not (i) subject to obtaining the approval referred to in Section 3.13 below, conflict with or violate any provision of its Certificate of Incorporation or By-laws or (ii) subject to obtaining the consents referred to in Section 2.1(f) below, conflict with, constitute a default (or an event which with notice or lapse of time or both would become a default) under, or give to others any rights of termination, amendment, acceleration or cancellation of, any agreement, indenture or instrument to which the Company is a party, or (iii) result in a violation of any law, rule, regulation, order, judgment, injunction, decree or other restriction of any court or governmental authority to which the Company is subject (including Federal and state securities laws and regulations), or by which any material property or asset of the Company is bound or affected, except in the case of each of clauses (ii) and (iii), such conflicts, defaults, terminations, amendments, accelerations, cancellations and violations as could not, individually or in the aggregate, have or result in a Material Adverse Effect. The business of the Company is not being conducted in violation of any law, ordinance or regulation of any governmental authority, except for violations which, individually or in the aggregate, do not have a Material Adverse Effect. (f) Consents and Approvals. Except as specifically set forth in Schedule 2.1(f), the Company is not required to obtain any consent, waiver, authorization or order of, or make any filing or registration with, any court or other federal, state, local or other governmental authority or other person in connection with the execution, delivery and performance by the Company of the Transaction Documents, except for (i) the filing of the registration statement(s) contemplated by the Registration Rights Agreement (the "Underlying Shares Registration Statement(s)") with the Securities and Exchange Commission (the "Commission"), which shall be filed in the time periods set forth in the Registration Rights Agreement, (ii) the application(s) for the listing of the Underlying Shares and the Warrant Shares with the Nasdaq National Market, which shall be filed in accordance with Section 3.7 hereof (and with any other national securities exchange or market on which the Common Stock is then listed), (iii) any filings, notices or registrations under applicable state securities laws, and (iv) in all other cases, where the failure to obtain such consent, waiver, authorization or order, or to give or make such notice or filing, would not materially impair or delay the ability of the Company to effect the Closing and to 6 7 deliver to the Purchasers the Transaction Notes (and, upon conversion of the Transaction Notes thereunder, the Underlying Shares) or the Transaction Warrants (and, upon exercise of the Transaction Warrants, the Warrant Shares) in the manner contemplated hereby and by the Registration Rights Agreement free and clear of all liens and encumbrances of any nature whatsoever (the approvals referred to in clauses (i) through (iii) above, together with the consents, waivers, authorizations, orders, notices and filings referred to in Schedule 2.1(f), are hereinafter referred to as the "Required Approvals"). The Company has no reason to believe that it will be unable to obtain the Required Approvals. (g) Litigation; Proceedings. Except as specifically disclosed in the Disclosure Materials (as defined below) or set forth in Schedule 2.1(g), there is no action, suit, notice of violation, proceeding or investigation pending or, to the knowledge of the Company, threatened against or affecting the Company or any of its properties before or by any court, governmental or administrative agency or regulatory authority (Federal, state, county, local or foreign) which (i) adversely affects the legality, validity or enforceability of any of the Transaction Documents, (ii) could, individually or in the aggregate, have a Material Adverse Effect or (iii) could, individually or in the aggregate, materially impair the ability of the Company to perform fully on a timely basis its obligations under the Transaction Documents. (h) No Default or Violation. The Company (i) is not in default under or in violation of any indenture, loan or credit agreement or any other agreement or instrument to which it is a party or by which it or any of its properties is bound, (ii) is not in violation of any order of any court, arbitrator or governmental body, and (iii) is not in violation of any statute, rule or regulation of any governmental authority, except as could not, in any such case (individually or in the aggregate), (x) adversely affect the legality, validity or enforceability of any of the Transaction Documents, (y) have a Material Adverse Effect or (z) adversely impair the Company's ability or obligation to perform fully on a timely basis its obligations under any of the Transaction Documents. (i) Schedules. The information contained in the Schedules to this Agreement furnished by or on behalf of the Company is true and correct in all material respects and does not omit to state any material fact necessary in order to make the statements made therein, in light of the circumstances under which they were made, not misleading. (j) Private Offering. Assuming (without any independent investigation or verification by or on behalf of the Company) the accuracy of the representations and warranties of the Purchasers set forth in Section 2.2, the offer and sale of the 6% Notes, the 6% Note Warrants, the Underlying Shares and the Warrant Shares and the amendment of the 2% Notes and the 2% Note Warrants are exempt from registration under Section 5 of the Securities Act of 1933, as amended (the "Securities Act"). Neither the Company nor any person acting on its behalf has taken or will take any action which might subject the offering, issuance or sale of such 6% Notes, the 6% Note Warrants, the Underlying Shares or the Warrant Shares to the registration requirements of Section 5 of the Securities Act. (k) SEC Documents. The Company has filed all reports required to be filed by it under the Exchange Act, including pursuant to Section 13(a) or 15(d) thereof, for the three 7 8 years preceding the date hereof (or such shorter period as the Company was required by law to file such material) (the foregoing materials being collectively referred to herein as the "SEC Documents" and, together with the Schedules to this Agreement furnished by or on behalf of the Company, the Company's Registration Statement on Form S-3 (File No. 333-56601) declared effective by the Commission on August 13, 1998, and any press releases, copies of which are attached as Exhibit 2.1(k), issued by the Company subsequent to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997, the "Disclosure Materials") on a timely basis, or has received a valid extension of such time of filing. As of their respective dates, the SEC Documents complied in all material respects with the requirements of the Securities Act and the Exchange Act and the rules and regulations of the Commission promulgated thereunder, and none of the SEC Documents, when filed, contained any untrue statement of a material fact or omitted to state a 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. The financial statements of the Company included in the SEC Documents comply in all material respects with applicable accounting requirements and the published rules and regulations of the Commission with respect thereto. Such financial statements have been prepared in accordance with generally accepted accounting principles applied on a consistent basis during the periods involved, except as may be otherwise indicated in such financial statements or the notes thereto, and fairly present in all material respects the financial position of the Company as of and for the dates thereof and the results of operations and cash flows for the periods then ended, subject, in the case of unaudited statements, to normal year-end audit adjustments. Since the date of the financial statements included in the Company's last filed Annual Report on Form 10-K, there has been no event, occurrence or development that has had a Material Adverse Effect which is not specifically disclosed in any of the Disclosure Materials. (l) Seniority. No obligations of the Company are senior to the 6% Notes in right of payment, whether upon liquidation, dissolution or otherwise. Except for the indebtedness described in Schedule 2.1(s), no obligations of the Company are pari passu with the 6% Notes in right of payment, whether upon liquidation or otherwise. (m) [Intentionally Left Blank] (n) Certain Fees. No fees or commissions will be payable by the Company to any broker, financial advisor, finder, investment banker, or bank with respect to the transactions contemplated by this Agreement, except for such fees to be paid to the firm retained by the Company to render the fairness opinion with respect to the transactions contemplated hereby, which will not exceed $80,000. (o) Solicitation Materials. The Company has not (i) distributed any offering materials in connection with the offering and sale of the 6% Notes, the 6% Note Warrants, the Underlying Shares or the Warrant Shares or the amendment to 2% Notes and 2% Note Warrants other than the Disclosure Materials and other filings by the Company pursuant to the Exchange Act prior to the date hereof, or (ii) solicited any offer to buy or sell the Transaction Notes, the Transaction Warrants, the Underlying Shares or the Warrant Shares by means of any form of general solicitation or advertising. 8 9 (p) Form S-3 Eligibility. The Company is, and at the Closing Date will be, eligible to register securities of selling stockholders for resale with the Commission under Form S-3 promulgated under the Securities Act. (q) Intellectual Property. Except as disclosed in its filings pursuant to the Exchange Act or Securities Act, the Company (i) is aware of no patents or trademarks ("Intellectual Property") to which the Company does not possess rights or licenses to use, which are necessary to conduct its business as now conducted; (ii) has no knowledge or reason to believe of infringement by the Company of the Intellectual Property rights of others and is unaware of any proceeding involving such infringement being brought or threatened against the Company; (iii) has no knowledge of the material infringement of its Intellectual Property by third parties; and (iv) has no reason to believe that any of its Intellectual Property is unenforceable. (r) Stockholder Rights Plan. The issuance of the 6% Notes and the 6% Note Warrants directly from the Company to the Purchasers and the amendment of the 2% Notes and the 2% Note Warrants pursuant to the terms hereunder do not, and the issuance of the Underlying Shares and the Warrant Shares directly from the Company to the Purchasers, will not (together with other shares of Common Stock deemed to be beneficially owned by such Purchasers pursuant to the Company's issuance of convertible preferred stock and warrants under that certain Convertible Preferred Stock Purchase Agreement dated October 29, 1997 and the Company's issuance of senior convertible notes and warrants (including the 2% Notes and 2% Note Warrants) pursuant to the Securities Purchase Agreement, dated May 15, 1998) in and of itself cause a Purchaser to become an Acquiring Person as such term is defined in the Rights Agreement, dated as of February 9, 1996, by and between the Company and LaSalle National Trust, N.A., as Rights Agent, or any amendment thereof or successor thereto. (s) Outstanding Indebtedness. The outstanding indebtedness of the Company as of March 25, 1999 is set forth in Schedule 2.1(s). Since March 25, 1999, the Company has not incurred any further indebtedness, other than trade debt in the ordinary course of business. 2.2 Representations and Warranties of the Purchaser. Each Purchaser severally hereby represents and warrants to the Company as to itself as follows: (a) Organization; Authority. Such Purchaser is a limited partnership, corporation or other entity, duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization with the requisite legal power and authority to enter into and to consummate the transactions contemplated hereby and by the Registration Rights Agreement and otherwise to carry out its obligations hereunder and thereunder. The purchase by the Purchaser of the 6% Notes and 6% Note Warrants and the amendment of the 2% Notes and 2% Note Warrants hereunder has been duly authorized by all necessary action on the part of such Purchaser. Each of this Agreement, the Amendment to Note Agreement and the Registration Rights Agreement has been duly executed and delivered by such Purchaser or on its behalf and constitutes the valid and legally binding obligation of such Purchaser, enforceable against the Purchaser in accordance with its terms, subject to bankruptcy, insolvency, fraudulent transfer, 9 10 reorganization, moratorium and similar laws of general applicability relating to or affecting creditors' rights generally and to general principles of equity. (b) Investment Intent. Such Purchaser is acquiring the 6% Notes, the 6% Note Warrants, the Underlying Shares and the Warrant Shares for its own account for investment purposes and without a present intention to distribute or resell such 6% Notes, 6% Note Warrants, Underlying Shares or Warrant Shares or any part thereof or interest therein; without prejudice, however, to such Purchaser's right, subject to the provisions of this Agreement and the Registration Rights Agreement, at all times to sell or otherwise dispose of all or any part of such 6% Notes, Underlying Shares, 6% Note Warrants or Warrant Shares pursuant to an effective registration statement under the Securities Act under an exemption from such registration. (c) Purchaser Status. At the time such Purchaser was offered the 6% Notes and the 6% Note Warrants, it was, and at the date hereof, it is, and at the Closing Date and each exercise date under the 6% Note Warrants it will be, an "accredited investor" as defined in Rule 501 under the Securities Act. (d) Experience of Purchaser. Such Purchaser, either alone or together with its representatives, has such knowledge, sophistication and experience in business and financial matters so as to be capable of evaluating the merits and risks of the prospective investment in the 6% Notes, the 6% Warrants, the Underlying Shares and the Warrant Shares, and has so evaluated the merits and risks of such investment. (e) Ability of Purchaser to Bear Risk of Investment. Such Purchaser is able to bear the economic risk of an investment in the 6% Notes and the 6% Warrants, the Underlying Shares and the Warrant Shares, and, at the present time, is able to afford a complete loss of such investment. (f) Access to Information. Such Purchaser acknowledges receipt of the Disclosure Materials and further acknowledges that it has been afforded (i) the opportunity to ask such questions as it has deemed necessary of, and to receive answers from, representatives of the Company concerning the terms and conditions of the offering of the 6% Notes and the 6% Note Warrants, and the merits and risks of investing in the 6% Notes and the 6% Warrants; (ii) access to information about the Company and the Company's financial condition, results of operations, business, properties, management and prospects sufficient to enable it to evaluate its investment; and (iii) the opportunity to obtain such additional information which the Company possesses or can acquire without unreasonable effort or expense that is necessary to make an informed investment decision with respect to the investment and to verify the accuracy and completeness of the information contained in the Disclosure Materials. (g) Prohibited Transactions. The 6% Notes and the 6% Note Warrants being purchased by such Purchaser are not being acquired, directly or indirectly, with the assets of any "employee benefit plan" within the meaning of Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended. 10 11 (h) Reliance. Such Purchaser understands and acknowledges that (i) the 6% Notes and the 6% Note Warrants are being offered and sold to such Purchaser without registration under the Securities Act in a private placement that is exempt from the registration provisions of the Securities Act under Section 4(2) of the Securities Act or Regulation D promulgated thereunder and (ii) the availability of such exemption, depends in part on, and the Company will rely upon the accuracy and truthfulness of, the foregoing representations and such Purchaser hereby consents to such reliance. (i) Title. Such Purchaser is the legal and beneficial owner of the 2% Notes and 2% Note Warrants being amended pursuant to this Agreement and the Amendment to Note Agreement, free and clear of all liens, claims and encumbrances. The Company acknowledges and agrees that the Purchasers make no representations or warranties with respect to the transactions contemplated hereby other than those specifically set forth in this Section 2.2. ARTICLE III OTHER AGREEMENTS OF THE PARTIES 3.1 Transfer Restrictions. (a) If a Purchaser should decide to dispose of 6% Notes or any portion of the 6% Note Warrants (and upon conversion or exercise thereof, as the case may be, any of the Underlying Shares or Warrant Shares) held by it, the Purchaser understands and agrees that it may do so only pursuant to an effective registration statement under the Securities Act, to the Company or pursuant to an available exemption from the registration requirements of the Securities Act. In connection with any transfer of any 6% Notes, any portion of the 6% Note Warrants or any Underlying Shares or Warrant Shares other than pursuant to an effective registration statement or to the Company, the Company may require the transferor thereof to provide to the Company a written opinion of counsel experienced in the area of United States securities laws selected by the transferor, the form and substance of which opinion shall be reasonably satisfactory to the Company, to the effect that such transfer does not require registration of such transferred securities under the Securities Act. (b) Each Purchaser agrees to the imprinting, so long as is required by this Section 3.1(b), of the following legend on its 6% Notes, 6% Note Warrants, Underlying Shares and Warrant Shares: [NEITHER THESE SECURITIES NOR THE SECURITIES INTO WHICH THESE SECURITIES ARE [CONVERTIBLE] [EXERCISABLE]] [THE SECURITIES REPRESENTED HEREBY] HAVE [NOT] BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, 11 12 ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS. [FOR 6% NOTES ONLY] THE SECURITIES REPRESENTED BY THIS NOTE ARE SUBJECT TO CERTAIN RESTRICTIONS ON TRANSFER SET FORTH IN SECTION 3.1 OF A SECURITIES PURCHASE AGREEMENT, DATED AS OF MARCH 31, 1999, BETWEEN ILLINOIS SUPERCONDUCTOR CORPORATION (THE "COMPANY") AND THE PURCHASERS LISTED THEREIN, INCLUDING THE ORIGINAL HOLDER HEREOF. A COPY OF THAT AGREEMENT IS ON FILE AT THE PRINCIPAL OFFICE OF THE COMPANY. The Underlying Shares issuable upon conversion of the 6% Notes and the Warrant Shares issuable upon exercise of the 6% Note Warrants, as the case may be, shall not contain the legend set forth above if the conversion of such 6% Notes or exercise of the Warrants, as the case may be, occurs at any time while the Underlying Shares Registration Statement is effective under the Securities Act or in the event there is not an effective Underlying Shares Registration Statement at such time, if in a written opinion of counsel reasonably acceptable to the Company and experienced in the area of United States securities laws, such counsel determines that such legend is not required under applicable requirements of the Securities Act (including judicial interpretations and pronouncements issued by the staff of the Commission). The Company agrees that it will provide each Purchaser, upon request, with a certificate or certificates representing Underlying Shares and Warrant Shares, free from such legend at such time as such legend is no longer required hereunder. Each Purchaser agrees that, in connection with any transfer of Underlying Shares or Warrant Shares by it pursuant to an effective registration statement under the Securities Act, it will comply with the prospectus delivery requirements of the Securities Act provided copies of a current prospectus relating to such effective registration statement are or have been supplied to such Purchaser. The Company makes no representation, warranty or agreement as to the availability of any exemption from registration under the Securities Act with respect to any resale of 6% Notes, 6% Note Warrants, Underlying Shares or Warrant Shares. 3.2 Stop Transfer Instruction. The Company may not make any notation on its records or give instructions to any transfer agent of the Company which enlarge the restrictions of transfer set forth in Section 3.1. 3.3 Furnishing of Information. As long as a Purchaser owns 6% Notes, Underlying Shares, 6% Note Warrants or Warrant Shares, the Company covenants to timely file (or obtain extensions in respect thereof) all reports required to be filed by the Company after the date hereof pursuant to Section 13(a) or 15(d) of the Exchange Act and to promptly furnish the Purchaser with true and complete copies of all such filings. If the Company or a successor to the Company is not at the time required to file reports pursuant to such sections, the Company will prepare and furnish to each Purchaser annual and quarterly financial statements, together with a discussion and analysis of such financial statements in form and substance substantially similar to those that 12 13 would otherwise be required to be included in reports required by Section 13(a) or 15(d) of the Exchange Act in the time period that such filings would have been required to have been made under the Exchange Act. The Company shall use its best efforts to at all times comply with Rule 144(c) promulgated under the Securities Act. 3.4 Copies and Use of Disclosure Materials. The Company shall furnish each Purchaser, without charge, as many copies of the Disclosure Materials, as amended or supplemented, as such Purchaser may reasonably request. The Company consents to the use of the SEC Documents, as amended and supplemented, by each Purchaser in connection with resales of the Underlying Shares or the Warrant Shares. 3.5 Blue Sky Laws. In accordance with the Registration Rights Agreement, the Company shall qualify the Underlying Shares and the Warrant Shares under the securities or Blue Sky laws of all states and the District of Columbia and shall continue such qualification at all times through the third anniversary of the Closing Date; provided, however, that the Company shall not be required in connection therewith to qualify as a foreign corporation where they are not now so qualified or to take any action that would subject the Company to general service of process in any such jurisdiction where it is not then so subject. 3.6 Integration. The Company shall not and shall use its best efforts to ensure that no Affiliate (as defined in Rule 405 under the Securities Act) of the Company shall sell, offer for sale or solicit offers to buy or otherwise negotiate in respect of any security (as such term is defined in Section 2 of the Securities Act) that would be integrated with the offer or sale of the 6% Notes, the 6% Note Warrants, the Underlying Shares or the Warrant Shares in a manner that would (i) require the registration under the Securities Act of the sale of the 6% Notes, the 6% Note Warrants, the Underlying Shares or the Warrant Shares to the Purchaser or (ii) would violate any rule of a securities exchange or market upon which the Common Stock is listed, which limits the amount of capital stock that may be issued without stockholder approval. 3.7 Listing of Underlying Shares and Warrant Shares. The Company shall (a) not later than the fifth Business Day following the Closing Date prepare and file with the Nasdaq National Market (as well as any other national securities exchange or market on which the Common Stock is then listed) an additional shares listing application covering and listing (i) such number of shares of Common Stock as are issuable upon conversion of the 6% Notes, together with any additional shares of Common Stock issuable upon the conversion of the Amended 2% Notes which are not covered by the prior listing application filed by the Company with Nasdaq National Market for shares of Common Stock issuable upon conversion of the 2% Notes; and (ii) the Warrant Shares underlying the 6% Note Warrants, (b) take all steps necessary to cause such shares to be approved for listing on the Nasdaq National Market (as well as on any other national securities exchange or market on which the Common Stock is then listed) as soon as possible thereafter and in no event later than ten (10) Business Days after the Closing Date, and (c) provide to the Purchasers evidence of such listing. The Company shall use its best efforts to maintain the listing of the Common Stock on the Nasdaq National Market. If the Common Stock is de-listed from the Nasdaq National Market, the Company shall use its best efforts to have the Common Stock listed (and to maintain such listing) on the Nasdaq Small Cap Market or the American Stock 13 14 Exchange or the New York Stock Exchange. If the Common Stock is subsequently de-listed, from, or never listed on, the Nasdaq Small Cap Market or the American Stock Exchange or New York Stock Exchange, then the Company shall use its best efforts to have the Common Stock listed (and to maintain such listing) on the Nasdaq OTC Bulletin Board. 3.8 Conversion Procedures. Exhibit E attached hereto sets forth the form of legal opinion, if necessary, that shall be rendered to the Company's transfer agent as may be reasonably necessary to enable each Purchaser to exercise its right of conversion in a timely and expeditious manner. 3.9 Redemption Restrictions. As of the date hereof, except as disclosed on Schedule 3.9, the Company is not a party to any agreement which prohibits the redemption or payment of the Transaction Notes, Transaction Warrants, Underlying Shares or Warrant Shares otherwise required or permitted under the Transaction Notes or the Registration Rights Agreement. The Company shall not enter into any agreement which restricts its ability to redeem the Transaction Notes, the Transaction Warrants, the Underlying Shares or the Warrant Shares, without the prior written consent of the Purchasers. 3.10 Notice of Breaches. Each of the Company and the Purchasers shall give prompt written notice to the other of any breach of any representation, warranty or other agreement contained in this Agreement, the Amendment to Note Agreement or in the Registration Rights Agreement, as well as any events or occurrences arising after the date hereof and prior to the Closing Date to which would reasonably be likely to cause any representation or warranty or other agreement of such party, as the case may be, contained herein to be incorrect or breached as of the Closing Date. However, no disclosure by either party pursuant to this Section 3.10 shall be deemed to cure any breach of any representation, warranty or other agreement contained herein, the Amendment to Note Agreement or in the Registration Rights Agreement. Notwithstanding the generality of the foregoing, the Company shall promptly notify the Purchasers of any notice or claim (written or oral) that it receives from any lender of the Company to the effect that the consummation of the transactions contemplated hereby, by the Amendment to Note Agreement and by the Registration Rights Agreement violates or would violate any written agreement or understanding between such lender and the Company, and the Company shall promptly furnish by facsimile to the Purchasers a copy of any written statement in support of or relating to such claim or notice. 3.11 Conversion Obligations of the Company. Subject to Section 3(i) of the Transaction Notes and Section 3(e) of the Transaction Warrants, the Company covenants to convert the Transaction Notes and to deliver Underlying Shares in accordance with the terms and conditions and time period set forth in the Transaction Notes, and to deliver Warrant Shares in accordance with the terms and conditions and time period set forth in the Transaction Warrants. Subject to Section 3(i) of the Transaction Notes and Section 3(e) of the Transaction Warrants, this is an independent covenant which is not subject to any offset or other defense for any reason based upon any claim that the Company may have against a Purchaser. 14 15 3.12 Board Seats. The Purchasers shall have, with respect to designation of directors to the Company's Board of Directors, the rights set forth in Section 1 of the Amendment to Note Agreement. 3.13 Increase of Authorized Capital. The Company shall use its best efforts to obtain stockholder approval, on or before June 9, 1999, of an amendment to the Certificate of Incorporation increasing the number of authorized shares of Common Stock such that the Company shall have a sufficient number of shares of Common Stock to reserve for issuance upon exercise of all Transaction Warrants. In the event that such amendment has not been effected by June 11, 1999, the Company shall immediately send notices of such failure to amend to all holders of Transaction Notes, and unless the Company shall have received by the earlier of 5 Trading Days of the date of such notice or June 17, 1999, a written objection from the holders of at least 75% in principal amount of the outstanding Transaction Notes, it shall repurchase from the holders of Transaction Notes, on the 10th Trading Day following such failure to amend, on a pro-rata basis, such principal amount of Transaction Notes as are convertible into the number of shares of Common Stock representing the shortfall in the Company's authorized capital with respect to the number of shares of Common Stock issuable upon exercise of the Transaction Warrants. The purchase price of such redemption shall be equal to the greater of: (i) the aggregate principal amount of Transaction Notes to be redeemed plus any accrued and unpaid interest thereon and (ii) the product of the average Per Share Market Value for the 5 Trading Days preceding such holder's redemption notice and the Conversion Ratio. In addition to the foregoing, in the event that the Company fails to effect the foregoing amendment to the Certificate of Incorporation, any Purchaser may, at its option, decrease the shortfall of authorized shares (and therefore decrease the principal amount of Transaction Notes to be repurchased by the Company pursuant to this Section 3.13) by waiving its rights to have shares of Common Stock reserved to cover the exercise of other warrants held by such Purchaser to purchase shares of Common Stock and instead designate that such shares be reserved for issuance upon exercise of Transaction Warrants held by such Purchaser. 3.14 Purchaser's Rights if Trading in Common Stock is Suspended or Delisted. In the event that at any time while the Transaction Notes are outstanding the trading in the shares of the Common Stock is suspended on (other than as a result of the suspension of trading in securities on such market generally or temporary suspensions pending the release of material information) or delisted from the Nasdaq National Market (unless such delisting shall be due to failure to comply with the maintenance criteria set forth in NASD Rule 4450 (or any successor rule) with respect to: (i) minimum bid price or (ii) net tangible assets or unless the Common Stock is listed for trading on The Nasdaq Small CapMarket, the New York Stock Exchange or the American Stock Exchange within three Trading Days), for more than three (3) consecutive Trading Days or five (5) Trading Days in the aggregate, at each Purchaser's option exercisable by written notice to the Company and tender of such Purchaser's Transaction Notes, the Company shall redeem, within seven (7) days of receipt of such written notice, all Transaction Notes owned by such Purchaser at an aggregate purchase price equal to (A) the outstanding aggregate principal amount and all accrued but unpaid interest thereon and (B) interest on such amount accruing from the 7th day after the Company's receipt of such notice and the Transaction Notes to be redeemed until 15 16 paid at the rate of 15% per annum; provided, however, that at any time prior to the redemption of all or any portion of such Purchaser's Transaction Notes, such Purchaser, by written notice to the Company delivered prior to such redemption, may elect to invalidate ab initio the redemption of any or all of such Purchaser's unredeemed Transaction Notes and the Company shall, within three (3) Trading Days of receipt of such notice, return to the Purchaser the Transaction Notes for which the redemption has been rescinded as provided herein. 3.15 Certain Negative Covenants of the Company. The Company covenants that from the date hereof and for so long as at least $450,000 in principal amount of the Transaction Notes (or any amendment thereto or instrument issued in exchange therefor) remain outstanding, it will not, without the prior written approval of holders of at least 75% in principal amount of the then outstanding Transaction Notes: (a) Directly or indirectly create, incur, assume, guarantee, or otherwise become or remain directly or indirectly liable with respect to, any indebtedness of any kind, other than (i) indebtedness under the 6% Notes and the 2% Notes, (ii) indebtedness pursuant to a working capital line of credit, in an amount not to exceed $1,000,000; or (iii) indebtedness to trade creditors in the ordinary course of business. (b) Directly or indirectly create, incur, assume or permit to exist any lien, pledge, charge or encumbrance on or with respect to any of its property or assets (including any document or instrument in respect of goods or accounts receivable) whether now owned or held or hereafter acquired, or any income or profits therefrom, except for Permitted Liens. As used herein, "Permitted Liens" means (i) liens on the Company's inventory and accounts receivable to secure a working capital line of credit, in an amount not to exceed $1,000,000; (ii) liens imposed by mandatory provisions of law such as materialmen's, mechanic's or warehousemen's; (iii) liens for taxes, assessments and governmental charges or levies imposed upon the Company or any subsidiaries or their income, profits or property, if the same are not yet due and payable or if the same are contested in good faith and as to which adequate reserves have been provided; (iv) pledges or deposits made to secure payment of worker's compensation insurance, unemployment insurance, pensions or social security programs or to secure the performance of letters of credits, bids, tenders, public or statutory obligations, surety, performance bonds and other similar obligations; and (v) encumbrances consisting of zoning restrictions, easements, or other restrictions on the use of real property, provided that such do not impair the use of such property for the uses intended and none of which is violated by existing or proposed structures or land use. (c) Directly or indirectly, issue any note, capital stock, option, warrant, right or other instrument which is convertible into, exchangeable for, or confers the right to subscribe for or purchase, shares of Common Stock where the price at which such conversion, exchange, subscription or purchase is to occur cannot be determined at the time such instrument is issued because it is based, in whole or in part, on the future market trading prices of the Common Stock. 16 17 3.16 Dividends and Distributions on Junior Securities. So long as any Transaction Notes shall remain outstanding, the Company shall not redeem, purchase or otherwise acquire directly or indirectly any Junior Securities (as defined in the 6% Notes), nor shall the Company directly or indirectly pay or declare any dividend or make any distribution (other than a dividend or distribution described in Section 3(c)(ii) of the 6% Notes or a dividend paid in shares of equity securities) with respect to Junior Securities. 3.17 Future Financings. The holders of Transaction Notes and Transaction Warrants shall have the benefit of the provisions of Section 2 of the Amendment to Note Agreement. 3.18 Certain Additional Negative Covenants. The holders of Transaction Notes shall have the benefit of certain additional negative covenants set for in Section 3 of the Amendment to Note Agreement. 3.19 Certain Affirmative Covenants of the Company. The Company covenants that from the date hereof and for so long as any portion of the Transaction Notes (or any amendment thereto or instrument issued in exchange therefor) shall remain outstanding, it will (and will cause any subsidiaries to) observe or perform the following: (a) Corporate Existence. It will maintain its corporate existence in good standing and remain qualified to do business as a foreign corporation in each jurisdiction in which the nature of its activities or the character of the properties it owns or leases makes such qualification necessary. (b) Continuation of Business. It will continue to conduct its business in compliance with all applicable rules and regulations of applicable governmental authorities, except for such non-compliance which would not have a Material Adverse Effect. 3.20 Future Rights Plans. None of the acquisitions of 6% Notes or 6% Note Warrants or the amendment of 2% Notes or 2% Note Warrants nor the deemed beneficial ownership of shares of Common Stock issuable upon, or the acquisition of such shares pursuant to, the conversion of Transaction Notes or the exercise of Transaction Warrants will in any event under any circumstances in and of itself trigger the poison pill provisions of any stockholders' rights or similar agreements, or plan having a similar effect, to which the Company is a party. 3.21 Access to Management. The Company shall, for so long as at least $450,000 in principal amount of Transaction Notes shall remain outstanding, upon reasonable notice, make available to holders of the Transaction Notes, members of the Company's senior management and/or the Company's auditors to discuss issues relating to the Company's business and financial matters, provided that as a condition to such access, such holders and the Company shall have entered into a confidentiality agreement in the Form of Exhibit F hereto. 3.22 Operating Income. 17 18 (a) Not later than July 15, 2000, the Chief Financial Officer ( or if there is no Chief Financial Officer, the Principal Accounting Officer) of the Company shall deliver a certificate to all holders of Transaction Notes indicating whether or not such officer has a good faith reasonable belief that the Company's Operating Income (as defined below) for the fiscal quarter ended June 30, 2000 is zero or greater. Such certificate shall include the officer's calculation of Operating Income. Failure of such officer of the Company to deliver such a certificate by July 15, 2000 indicating a good faith reasonable belief that the Company's Operating Income for the quarter ended June 30, 2000 will be zero or greater shall constitute an immediate Event of Default under the Transaction Notes. (b) Not later than July 31, 2000, Ernst & Young LLP, the Company's independent auditors, or such other firm as has been retained by the Company's Board of Directors to audit the Company's financial statements filed with the Commission (the "Independent Auditors"), shall deliver a letter to all holders of Transaction Notes indicating whether or not the Independent Auditors can confirm that, after a review (but not an audit) of the Company's financial statements for the fiscal quarter ended June 30, 2000, in accordance with generally accepted auditing standards, (i) the Company's Operating Income for such quarter was zero or greater and (ii) the Company's calculation of Operating Income is correct. Failure of the Independent Auditors to deliver such a letter by July 31, 2000 confirming Operating Income for the Company of zero or greater for the quarter ended June 30, 2000 shall constitute an immediate Event of Default under the Transaction Notes. (c) As used herein, "Operating Income" shall mean (a) operating income as reported in the Company's quarterly financial statements for the quarter ended June 30, 2000, prepared in accordance with generally accepted accounting principles applied on a basis consistent with historic practice, but (b) adjusted to disregard any depreciation of physical plant and equipment and amortization of intellectual property, and (c) adjusted to disregard each non-recurring item, and each credit or other adjustment relating to prior periods , in either case to the extent that such item, credit or other adjustment had the effect of increasing operating income as so reported. ARTICLE IV CONDITIONS 4.1 Conditions Precedent to the Obligation of the Company to Issue the 6% Notes and 6% Note Warrants and to Amend 2% Notes and 2% Note Warrants. The obligation of the Company to issue the 6% Notes and the 6% Note Warrants hereunder to each Purchaser and to amend certain 2% Notes and 2% Note Warrants of such Purchaser is subject to the satisfaction, or waiver by the Company, at or before the Closing Date, of each of the following conditions: (i) Accuracy of such Purchaser's Representations and Warranties. The representations and warranties of such Purchaser shall be true and correct in all 18 19 material respects as of the date when made and as of the Closing Date, as though made on and as of such date (except for representations and warranties that speak as of a specific date); (ii) Performance by such Purchaser. Such Purchaser shall have performed, satisfied and complied in all material respects with all covenants, agreements and conditions required by this Agreement to be performed, satisfied or complied with by the Purchaser at or prior to the Closing; (iii) No Injunction. No statute, rule, regulation, executive order, decree, ruling or injunction shall have been enacted, entered, promulgated or endorsed by any court or governmental authority of competent jurisdiction which prohibits the consummation of any of the transactions contemplated by this Agreement, the Amendment to Note Agreement or the Registration Rights Agreement; and (iv) Required Approvals. All Required Approvals shall have been obtained. 4.2 Conditions Precedent to the Obligation of Each Purchaser to Acquire the 6% Notes and the 6% Note Warrants and to have 2% Notes and 2% Note Warrants amended. The obligation of such Purchaser hereunder to acquire and pay for the 6% Notes and the 6% Note Warrants and to have certain of its 2% Notes and 2% Note Warrants amended is subject to the satisfaction or waiver by such Purchaser, at or before the Closing Date, of each of the following conditions: (i) Accuracy of the Company's Representations and Warranties. The representations and warranties of the Company set forth herein and in the Registration Rights Agreement shall be true and correct in all material respects as of the date when made and as of the Closing Date, as though made on and as of such date (except for representations and warranties that speak as of a specific date); (ii) Performance by the Company. The Company shall have performed, satisfied and complied in all material respects with all covenants, agreements and conditions required by this Agreement and the Amendment to Note Agreement to be performed, satisfied or complied with by the Company at or prior to the Closing; (iii) No Injunction. No statute, rule, regulation, executive order, decree, ruling or injunction shall have been enacted, entered, promulgated or endorsed by any court or governmental authority of competent jurisdiction which prohibits the consummation of any of the transactions contemplated by this Agreement, the Amendment to Note Agreement, the Transaction Notes, the Transaction Warrants or the Registration Rights Agreement; (iv) Adverse Changes. Since the date hereof, no event which had or could reasonably be expected to have a Material Adverse Effect, and no material adverse change in the financial condition or prospects of the Company, shall have occurred which is not disclosed in the Disclosure Materials; 19 20 (v) No Suspensions of Trading in Common Stock. The trading in the Common Stock shall not have been suspended by the Commission or on the Nasdaq National Market (except for any suspension of trading of not more than one Trading Day solely to permit dissemination of material information regarding the Company and other than a suspension of trading on the Nasdaq National Market if the Common Stock is listed for trading, and not suspended, on The Nasdaq SmallCap Market within one business day after such suspension); (vi) Listing of Common Stock. The Common Stock shall have at all times between the date hereof and the Closing Date been, and on the Closing Date be, listed for trading on the Nasdaq National Market, The Nasdaq SmallCap Market, the New York Stock Exchange or the American Stock Exchange; (vii) Legal Opinion. The Company shall have delivered to such Purchaser the opinion of Katten Muchin & Zavis, counsel to the Company, in substantially the form of Exhibit G attached hereto; (viii) Required Approvals. All Required Approvals (other than those referred to in clauses (i) through (iii) of Section 2.1(f) and stockholder approval referenced in Schedule 2.1(f)) shall have been obtained; (ix) [intentionally omitted] (x) Delivery of Transaction Notes. The Company shall have delivered to Katten Muchin & Zavis in escrow, pending the Closing Date, the 6% Notes being acquired by such Purchaser hereunder and the Amended 2% Notes being issued to Purchaser hereunder, registered in the name of such Purchaser and in the denominations requested by such Purchaser; (xi) Registration Rights Agreement. The Company shall have executed and delivered the Registration Rights Agreement; (xii) Amendment to Note Agreement. The Company shall have executed and delivered the Amendment to Note Agreement; (x) Transaction Warrants. The Company shall have executed and delivered the 6% Note Warrants being acquired by such Purchaser hereunder, and the Amended 2% Warrants of such Purchaser being issued to Purchaser hereunder, registered in the name of such Purchaser in accordance with the terms of the Agreement; (xi) Company Certificates. Such Purchaser shall have received a certificate, dated the Closing Date, signed by the Secretary or an Assistant Secretary of the Company and certifying (i) that attached thereto is a true, correct and complete copy of (A) the Certificate of Incorporation, (B) the Company's By-laws, and (C) resolutions duly adopted by the Board of Directors of the Company authorizing the execution, delivery and (where appropriate) 20 21 filing of the Transaction Documents and the issuance and sale of the 6% Notes, the 6% Note Warrants, the Underlying Shares and the Warrant Shares and the amendment of the 2% Notes and 2% Note Warrants and (ii) the incumbency of the officers executing the Transactions Documents; and (xv) Change of Control. No Change of Control shall have occurred between the date hereof and the Closing Date. "Change of Control" means the occurrence of any of (i) an acquisition after the date hereof by an individual, legal entity or "group" within the meaning of Section 13(d) of the Exchange Act of voting securities of the Company pursuant to which, after giving effect to such acquisition, such individual, legal entity or group will beneficially own in excess of 50% of the issued and outstanding voting securities of the Company, (ii) a replacement of more than one-half of the members of the Company's Board of Directors which is not approved by those individuals who are members of the Company's Board of Directors on the date thereof in one or a series of related transactions, (iii) the merger of the Company with or into another entity, consolidation or sale of all or substantially all of the assets of the Company in one or a series of related transactions or (iv) the execution by the Company of an agreement to which the Company is a party or by which it is bound, providing for any of the events set forth above in (i), (ii) or (iii). (xvi) Registration of Shares Underlying Amended 2% Notes and 2% Amended Note Warrants. (a) The legal opinion referred to in paragraph (vii) shall include an opinion that, with the exception of additional shares of Common Stock issuable due to the decrease in the conversion price of the Amended 2% Notes from the 2% Notes, the shares of Common Stock issuable upon conversion of the Amended 2% Notes and upon exercise of the Amended 2% Warrants are: (i) duly registered pursuant to the Company's Registration Statement on Form S-3 (Reg 333-56601) declared effective by the Commission on August 13, 1998 (the "2% Note Share Registration Statement"); (ii) may be resold pursuant to the prospectus included therein, as amended and supplemented (the "2% Note Share Prospectus") and (iii) are duly listed, subject to issuance, on the Nasdaq National Market. (b) The Company shall have taken such step as may be required, including, without limitation, amending the 2% Note Share Registration Statement, the 2% Note Share Prospectus, or filing a prospectus supplement thereto, in order for Company's counsel to issue the opinion referred to in Section (xvi)(a) above. ARTICLE V MISCELLANEOUS 5.1 Fees and Expenses. Except as provided in the Registration Rights Agreement, the Company shall pay (i) upon submission of an itemized statement, the reasonable fees and expenses of one legal counsel for the Purchasers, and (ii) the expenses incurred by the Company incident to the negotiation, preparation, execution, delivery and performance of this Agreement. Each 21 22 Purchaser shall be responsible for its own tax liability that may arise as a result of the investment hereunder or the transactions contemplated by this Agreement. 5.2 Entire Agreement; Amendments. This Agreement, together with the Exhibits and Schedules hereto and the other Transaction Documents contain the entire understanding of the parties with respect to the subject matter hereof and supersede all prior agreements and understandings, oral or written, with respect to such matters. 5.3 Notices. Any notice or other communication required or permitted to be given hereunder shall be in writing and shall be deemed to have been delivered (i) upon receipt, when delivered personally; (ii) when sent by facsimile, upon receipt if received on a Business Day prior to 5:00 p.m. (Central Time), or the first Business Day following such receipt if received on a Business Day after 5:00 p.m. (Central Time); or (iii) upon receipt, when deposited with a nationally recognized overnight express courier service, fully prepaid, in each case properly addressed to the party to receive the same. The addresses and facsimile numbers for such communications shall be: If to the Company: Illinois Superconductor Corporation 451 Kingston Court Mt. Prospect, Illinois 60056 Attn: General Counsel Fax: (847) 391-5015 With copies to: Katten Muchin & Zavis 525 W. Monroe St. Suite 1600 Chicago, Illinois 60661 Attn: Lawrence D. Levin Fax: (312) 902-1061 If to a Purchaser: Elliott Associates, L.P. 712 Fifth Avenue, 36th Floor New York, New York 10019 Attn: Mark Brodsky Fax: (212) 974-2092 Westgate International, L.P. c/o Stonington Management Corp. 712 Fifth Avenue, 36th Floor New York, New York 10019 Attn: Mark Brodsky Fax: (212) 974-2092 22 23 Alexander Finance, LP 1560 Sherman Avenue Suite 900 Evanston, Illinois 60201 Attn: Brian D. Brookover Fax: (847) 733-0339 State Farm Mutual Automobile Insurance Company One State Farm Plaza Bloomington, Illinois 61710 Attn: Common Stocks, E-9 Fax:(309) 766-7423 With copies to: Kleinberg, Kaplan, Wolff & Cohen, P.C. 551 Fifth Avenue New York, NY 10176 Attn: Stephen M. Schultz Fax: (212) 986-8866 or such other address or facsimile number as may be designated in writing hereafter, in the same manner, by such person. 5.4 Amendments; Waivers. No provision of this Agreement may be waived or amended except in a written instrument signed, in the case of an amendment, by both the Company and the Purchasers representing at least 75% of the then outstanding principal amount of the Transaction Notes; or, in the case of a waiver, by the party against whom enforcement of any such waiver is sought. No waiver of any default with respect to any provision, condition or requirement of this Agreement shall be deemed to be a continuing waiver in the future or a waiver of any other provision, condition or requirement hereof, nor shall any delay or omission of any party to exercise any right hereunder in any manner impair the exercise of any such right accruing to it thereafter. 5.5 Headings. The headings herein are for convenience only, do not constitute a part of this Agreement and shall not be deemed to limit or affect any of the provisions hereof. 5.6 Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the parties and their successors and permitted assigns. Neither the Company nor any Purchaser may assign this Agreement or any rights or obligations hereunder without the prior written consent of the other, except that, in connection with a transfer, in whole or in part, of the Transaction Notes or the Transaction Warrants as provided therein, a Purchaser may assign its rights hereunder to any such transferee of the Transaction Notes or the Transaction Warrants. The assignment by a party of this Agreement or any rights hereunder shall not affect the obligations of such party under this Agreement. 23 24 5.7 No Third-Party Beneficiaries. This Agreement is intended for the benefit of the parties hereto and their respective permitted successors and assigns and is not for the benefit of, nor may any provision hereof be enforced by, any other person. 5.8 Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the internal laws of the State of New York without regard to the principles of conflicts of law thereof. 5.9 Survival. The agreements and covenants contained in Article III and this Article V shall survive the delivery and conversion of the Transaction Notes pursuant to this Agreement and the representations and warranties of the Company and the Purchasers contained in Article II shall survive until a date that is two years after the Closing Date. 5.10 Execution. This Agreement may be executed in two or more counterparts, all of which when taken together shall be considered one and the same agreement and shall become effective when counterparts have been signed by each party and delivered to the other parties, it being understood that all parties need not sign the same counterpart. In the event that any signature is delivered by facsimile transmission, such signature shall create a valid and binding obligation of the executing party with the same force and effect as if such facsimile signature page were an original thereof. 5.11 Publicity. The Company and the Purchasers shall consult with each other in issuing any press releases or otherwise making public statements with respect to the transactions contemplated hereby and neither the Company nor the Purchasers shall issue any such press release or otherwise make any such public statement without the prior consent of the other, which consent shall not be unreasonably withheld or delayed, except that no prior consent shall be required if such disclosure is required by law, in which such case the disclosing party shall provide the other parties with prior notice of such public statement. 5.12 Severability. In case any one or more of the provisions of this Agreement shall be invalid or unenforceable in any respect, the validity and enforceability of the remaining terms and provisions of this Agreement shall not in any way be affecting or impaired thereby and the parties will attempt to agree upon a valid and enforceable provision which shall be a reasonable substitute therefor, and upon so agreeing, shall incorporate such substitute provision in this Agreement. 5.13 Like Treatment of Purchasers. Neither the Company nor any of its Affiliates shall, directly or indirectly, pay or cause to be paid any consideration, whether by way of interest, fee, payment for the redemptions or exchange of the Transaction Notes, or otherwise, to any holder of Transaction Notes, for or as an inducement to, or in connection with the solicitation of, any consent, waiver or amendment of any terms or provisions of the Transaction Notes or this Agreement, the Amendment to Note Agreement or the Registration Rights Agreement or the Transaction Warrants, unless such consideration is required to be paid to all holders of Transaction Notes bound by such consent, waiver or amendment whether or not such holders so consent, waive or agree to amend and whether or not such holders tender their Transaction Notes for redemption or exchange. The Company shall not, directly or indirectly, redeem any 24 25 Transaction Notes unless such offer of redemption is made pro rata to all holders on identical terms. 5.14 Obligation of Purchasers Several, not Joint. The obligations of the Purchasers under this Agreement, or under any other Transaction Document are several and not joint. 5.15 Payment of Expenses. The Company agrees to pay all costs and expenses, including reasonable attorneys' fees and expenses, which may be incurred by the Purchasers in successfully enforcing this Agreement or any other Transaction Document. 5.16 Indemnification. The Company hereby agrees to indemnify, defend and hold harmless each Purchaser and such Purchaser's partners, directors, officers, employees or agents ("Indemnified Parties"), from and against any and all losses, claims, damages, liabilities and costs, including reasonable legal fees (collectively "Losses"), as incurred, involving a third-party claim and arising out of or relating to the acquisition by such Purchaser of the 6% Notes and 6% Note Warrants issued and sold to it by the Company pursuant to this Agreement or arising out of the amendment of such Purchaser's 2% Notes and 2% Warrants pursuant to this Agreement; provided, that any Indemnified Party shall reimburse the Company for any amount paid pursuant to this Section 5.16 to the extent a final judgment by a court or body of proper jurisdiction, which has been fully appealed, determines that such Indemnified Party was at fault in connection with the claim or action pursuant to which such Losses were incurred. In connection with the foregoing, the Company may elect to assume the defense of a claim made against an Indemnified Party, provided that if the Company does not notify an Indemnified Party that it is assuming such defense within ten (10) days of receipt from Indemnified Party of the notice of Loss, it shall reimburse such Indemnified Party for its reasonable legal fees and expenses, as incurred, on a monthly basis. 5.17 Rescission Right. (a) Notwithstanding anything to the contrary contained herein or in any other Transaction Document, whenever a Purchaser, pursuant to the provisions of this Agreement or any other Transaction Document, exercises its right to have its Transaction Notes repurchased or redeemed by the Company, whether pursuant to a put right, acceleration or otherwise, and such repurchase or redemption is not effected in full within the time period provided in the relevant provision, then, except where such right is otherwise provided in such provision, such Purchaser shall have the right to, by written notice, rescind the redemption or repurchase of any portion of such Purchaser's Transaction Notes which have not been repurchased or redeemed in a timely manner, and the Company shall, within three (3) Trading Days of receipt of such notice, return to such Purchaser the Transaction Notes for which redemption or repurchase has been rescinded as provided herein. (b) Notwithstanding anything to contrary contained herein or in any other Transaction Document, whenever a Purchaser exercises its right, pursuant to the provisions of this Agreement or any other Transaction Document, to (i) convert Transaction Notes into Common Stock or other securities or consideration; or (ii) exercise the Transaction Warrants for 25 26 Common Stock or other securities or consideration, and the delivery of the Common Stock, securities or other consideration issuable upon such conversion or exercise has not been effected within the time period provided in the relevant provision, then, except were such right is otherwise provided in such provision, such Purchaser still have the right to, upon written notice, rescind such conversion or exercise, as the case may be, and the Company shall, within three (3) Trading Days of receipt of such notice, return to Purchaser, any conversion notices, Transaction Notes, exercise notices or consideration tendered in connection with such conversion or exercise. 26 27 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their respective authorized persons as of the date first indicated above. Company: ILLINOIS SUPERCONDUCTOR CORPORATION /s/ Edward W. Laves By:_______________________________________ Name: Edward W. Laves Title: President and Chief Executive Officer Purchasers: ELLIOTT ASSOCIATES, L.P. /s/ Authorized Signatory By:_______________________________________ Name: Title: WESTGATE INTERNATIONAL, L.P. By: Martley International, L.P. As Attorney-in-fact /s/ Authorized Signatory By:________________________________________ Name: Title: ALEXANDER FINANCE, LP /s/ Authorized Signatory By:________________________________________ Name: Title: STATE FARM MUTUAL AUTOMOBILE INSURANCE COMPANY /s/ Authorized Signatory By:_________________________________________ Name: Title: 27 28 SCHEDULE OF PURCHASERS
Purchaser's Name Purchase Price Principal Amount Number of Warrants Principal Amount Amount of 2% Note of 6% Notes 6% Note of 2% Notes Warrants Purchased Warrants Purchased to be Amended to be Amended Elliott Associates .$833,334 $833,334 333,334 $1,388,889 555,556 Westgate $833,333 $833,333 333,333 $1,388,889 555,555 Alexander $1,333,333 $1,333,333 533,333 $2,222,222 888,889 State Farm $300,000 $300,000 120,000 $500,000 200,000
28 29 SCHEDULE 2.1(C) CAPITALIZATION The authorized, issued and outstanding capital stock of the Company consists of the following: Preferred Stock, $.001 par value, 100,000 shares authorized, no shares issued and outstanding: Series A Preferred Stock, 10,000 shares authorized, no shares issued and outstanding Series B Convertible Preferred Stock, 600 shares authorized, no shares issued and outstanding Series C Convertible Preferred Stock, 600 shares authorized, no shares issued and outstanding Series G Convertible Preferred Stock, 700 shares authorized, no shares issued and outstanding Common Stock, $.001 par value, 30,000,000 shares authorized, 12,557,344 shares of which were issued and outstanding as of March 25, 1999. As of March 25, 1999, the Company also has outstanding warrants (including the 2% Note Warrants) to purchase 4,678,686 shares of Common Stock and options to purchase 1,208,665 shares of Common Stock. The Company also has 496,335 additional shares of Common Stock reserved for issuance upon the exercise of options which may be granted under the Company's Amended and Restated 1993 Stock Option Plan as amended. The Company has reserved for issuance upon conversion of the 2% Notes, 6,900,000 shares of Common Stock. Holders of the 2% Notes have the right to covert such Notes (plus accrued interest payable in shares in Common Stock) into shares of Common Stock at a conversion price equal to $1.50 per share, subject to adjustment. As of March 25, 1999, $10,350,000 in aggregate principal amount of the 2% Notes, plus accrued interest, remain outstanding and subject to conversion. The Company has a stockholders rights plan (the "Rights Plan") pursuant to which a Series A Right is associated and trades with each share of Common Stock outstanding. Each Series A Right will entitle its holder, under certain circumstances described in the Rights Plan, to purchase one one-thousandth of a share of the Company's Series A Junior Participating Preferred Stock, $.001 par value per share, for $200 (subject to adjustment) or receive shares of Common Stock having a market value of two times the exercise of the Series A Right and one Series B Right. 29 30 The Company is obligated to issue a warrant to Southbrook Investments, Ltd. exercisable for 31,250 shares of Common Stock, which warrant has not yet been issued. 30 31 SCHEDULE 2.1(F) REQUIRED CONSENTS 1. The approval of the Company's stockholders referred to in Section 3.13 of the Agreement to increase the number of shares of Common Stock authorized for issuance. 2. The consent of the holders of the 2% Notes evidenced by their execution and delivery of the Amendment to Note Agreement. 31 32 SCHEDULE 2.1(G) LITIGATION See Part II "Item 1. Legal Proceedings" in the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1998. 32 33 SCHEDULE 2.1(S) OUTSTANDING INDEBTEDNESS The outstanding indebtedness of the Company as of March 25, 1999 consisted of the following: nstallment Loan Note from NBD Bank, secured by certain engineering test equipment: Account Number 0030188, $5,120.79 in principal outstanding as of March 25, 1999, interest rate = 8.5% annually, monthly installment payments of $2,915.61, due through May 1999 $10,350,000 in aggregate principal amount of Senior Convertible Notes due May 15, 2002, plus accrued interest. Equipment Lease Installment Agreement from Hewlett - Packard Company, 36 monthly installment payments of $891.85, commencing February 1999, secured by certain engineering test equipment. Trade debt incurred in the ordinary course of business, which equaled $1,149,343 as of March 25, 1999. 33 EX-4.21 5 REGISTRATION RIGHTS AGREEMENT 1 EXHIBIT 4.21 REGISTRATION RIGHTS AGREEMENT ----------------------------- This Registration Rights Agreement (this "Agreement") is made and entered into as of March 31, 1999, by and among Illinois Superconductor Corporation, a Delaware corporation (the "Company"), and Elliott Associates, L.P., a limited partnership organized and existing under the laws of Delaware, Westgate International, L.P., a limited partnership existing under the laws of the Cayman Islands, Alexander Finance, LP, a limited partnership existing under the laws of Illinois and State Farm Mutual Automobile Insurance Company, an insurance company organized and existing under the laws of the State of Illinois (each, a "Purchaser" and collectively, the "Purchasers"). This Agreement is made pursuant to the Securities Purchase Agreement, dated as of March 31, 1999, between the Company and the Purchasers (the "Purchase Agreement"). The Company and the Purchasers hereby agree as follows: 1. Definitions Capitalized terms used and not otherwise defined herein shall have the meanings given such terms in the Purchase Agreement. As used in this Agreement, the following terms shall have the following meanings: "Advice" shall have meaning set forth in Section 3(o). "Affiliate" means, with respect to any Person, any other Person that directly or indirectly controls or is controlled by or under common control with such Person. For the purposes of this definition, "control," when used with respect to any Person, means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities, by contract or otherwise; and the terms of "affiliated," "controlling" and "controlled" have meanings correlative to the foregoing. "Business Day" means any day except Saturday, Sunday and any day which shall be a legal holiday or a day on which banking institutions in the state of New York generally are authorized or required by law or other government actions to close. "Closing Date" shall have the meaning set forth in the Purchase Agreement. "Commission" means the Securities and Exchange Commission. "Common Stock" means the Company's Common Stock, par value $.001 per share. "Effectiveness Date" means the 90th day following the Closing Date. "Effectiveness Period" shall have the meaning set forth in Section 2(a). "Exchange Act" means the Securities Exchange Act of 1934, as amended. 2 "Filing Date" means the 30th day following the Closing Date. "Holder" or "Holders" means the record holder or holders, as the case may be, from time to time of Registrable Securities as reflected on the books of the Company. "Indemnified Party" shall have the meaning set forth in Section 5(c). "Indemnifying Party" shall have the meaning set forth in Section 5(c). "Losses" shall have the meaning set forth in Section 5(a). "Notes" means the 6% Senior Convertible Notes due May 15, 2002 originally issued pursuant to to the Purchase Agreement. "Person" means an individual or a corporation, partnership, trust, incorporated or unincorporated association, joint venture, limited liability company, joint stock company, government (or an agency or political subdivision thereof) or other entity of any kind. "Proceeding" means an action, claim, suit, investigation or proceeding (including, without limitation, an investigation or partial proceeding, such as a deposition), whether commenced or threatened. "Prospectus" means the prospectus included in the Registration Statement (including, without limitation, a prospectus that includes any information previously omitted from a prospectus filed as part of an effective registration statement in reliance upon Rule 430A promulgated under the Securities Act), as amended or supplemented by any prospectus supplement, with respect to the terms of the offering of any portion of the Registrable Securities covered by the Registration Statement, and all other amendments and supplements to the Prospectus, including post-effective amendments, and all material incorporated by reference or deemed to be incorporated by reference in such Prospectus. "Registrable Securities" means (i) the shares of Common Stock or other securities of the Company issuable upon (A) conversion of the Notes and (B) exercise of the Warrants and (ii) any securities of the Company received in exchange for, or as a distribution with respect to, the Notes or Warrants and any securities received upon conversion or exercise of such securities received in exchange for, or as a distribution with respect to, the Notes or Warrants; provided that so long as the Company has securities which are registered under the Exchange Act or publicly traded, such securities are of a class of securities of the Company which is registered under the Exchange Act or otherwise publicly traded. "Registration Statement" means the registration statements contemplated by Sections 2(a), 2(b) or 2(p) for the public resale of the Registrable Securities including (in each case) the Prospectus, amendments and supplements to such registration statement or Prospectus, including pre- and post-effective amendments, all exhibits thereto, and all material incorporated by reference or deemed to be incorporated by reference in such registration statement. "Rule 144" means Rule 144 promulgated by the Commission pursuant to the Securities Act, as such Rule may be amended from time to time, or any similar rule or regulation -2- 3 hereafter adopted by the Commission having substantially the same effect as such Rule. "Rule 158" means Rule 158 promulgated by the Commission pursuant to the Securities Act, as such Rule may be amended from time to time, or any similar rule or regulation hereafter adopted by the Commission having substantially the same effect as such Rule. "Rule 415" means Rule 415 promulgated by the Commission pursuant to the Securities Act, as such Rule may be amended from time to time, or any similar rule or regulation hereafter adopted by the Commission having substantially the same effect as such Rule. "Securities Act" means the Securities Act of 1933, as amended. "Special Counsel" means a single special counsel selected by the Holders of a majority of the Registrable Securities to be covered by a Registration Statement, for which the Holders will be reimbursed by the Company pursuant to Section 4. "Underwritten Registration or Underwritten Offering" means a registration in connection with which securities of the Company are sold to an underwriter for reoffering to the public pursuant to an effective registration statement. "Warrants" means the common stock purchase warrants of the Company originally issued to the Purchasers pursuant to the Purchase Agreement. 2. Shelf Registration (a) On or prior to the applicable Filing Date the Company shall prepare and file with the Commission a "Shelf" Registration Statement covering all Registrable Securities for an offering to be made on a continuous basis pursuant to Rule 415. The Registration Statement shall be on Form S-3 (except if otherwise directed by the Holders of a majority in interest of the applicable Registrable Securities in accordance herewith or if the Company is not then eligible to register for resale the Registrable Securities on Form S-3, in which case such registration shall be on another appropriate form in accordance herewith). The Company shall (i) not permit any securities other than the Registrable Securities to be included in the Registration Statement and (ii) use its best efforts to cause the Registration Statement to be declared effective under the Securities Act as promptly as possible after the filing thereof, but in any event shall use its best efforts to cause such Registration Statement to be declared effective prior to the Effectiveness Date, and the Company shall keep such Registration Statement continuously effective under the Securities Act until the date which is four years after the date that such Registration Statement is declared effective by the Commission or such earlier date when all Registrable Securities covered by such Registration Statement have been sold or may be sold without restrictions pursuant to Rule 144 as determined by the counsel to the Company pursuant to a written opinion letter, in form and substance reasonably satisfactory to the Purchasers, addressed to the Company's transfer agent to such effect (the "Effectiveness Period"); provided, however, that, subject to the last paragraph of Section 3(o), the Company shall not be deemed to have used its best efforts to keep the Registration Statement effective during the Effectiveness Period if it voluntarily takes any action that would result in the Holders not being able to sell the Registrable Securities covered by such Registration Statement during the Effectiveness Period, unless such -3- 4 action is required under applicable law or the Company has filed a post-effective amendment to the Registration Statement and the Commission has not declared it effective. (b) At any time when there is not an effective Registration Statement, if the Holders of a majority of the Registrable Securities so elect, an offering of Registrable Securities may be effected on no more than two occasions in the form of an Underwritten Offering. In such event, and if the managing underwriters advise the Company and such Holders in writing that in their opinion the amount of Registrable Securities proposed to be sold in such Underwritten Offering exceeds the amount of Registrable Securities which can be sold in such Underwritten Offering, there shall be included in such Underwritten Offering the amount of such Registrable Securities which in the opinion of such managing underwriters can be sold, and such amount shall be allocated pro rata among the Holders proposing to sell Registrable Securities in such Underwritten Offering. (c) If any of the Registrable Securities are to be sold in an Underwritten Offering, the investment banker that will administer the offering will be selected by the Holders of a majority of the Registrable Securities included in such offering upon consultation with the Company. No Holder may participate in any Underwritten Offering hereunder unless such Person (i) agrees to sell its Registrable Securities on the basis provided in any underwriting agreements approved by the Persons entitled hereunder to approve such arrangements and (ii) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements and other documents required under the terms of such arrangements. 3. Registration Procedures In connection with the Company's registration obligations hereunder, the Company shall: (a) Prepare and file with the Commission on or prior to the applicable Filing Date, a Registration Statement on Form S-3 (or such other form if directed by the Holders in connection with an Underwritten Offering hereunder or if the Company is not then eligible to register for resale the Registrable Securities on Form S-3, in which case such registration shall be on another appropriate form in accordance herewith) in accordance with the method or methods of distribution thereof as specified by the Holders, and cause the Registration Statement to become effective and remain effective as provided herein; provided, however, that, not less than five (5) Business Days prior to the filing of the Registration Statement or any related Prospectus or any amendment or supplement thereto, the Company shall (i) furnish to the Holders whose Registrable Securities are covered by such Registration Statement, their Special Counsel and any managing underwriters, copies of all such documents proposed to be filed, which documents (other than those incorporated or deemed to be incorporated by reference) will be subject to the review of such Holders, their Special Counsel and such managing underwriters, and (ii) cause its officers and directors, counsel and independent certified public accountants to respond to such inquiries as shall be necessary, in the reasonable opinion of Special Counsel to such Holders and counsel to such underwriters, to conduct a reasonable investigation within the meaning of the Securities Act. The Company shall not file the Registration Statement or any such Prospectus or any amendments or supplements thereto to which the Holders of a majority of the Registrable Securities covered by such Registration Statement, their Special Counsel, or any managing -4- 5 underwriters, shall reasonably object in writing within three (3) Business Days of their receipt thereof. (b) (i) Prepare and file with the Commission such amendments, including post-effective amendments, to the Registration Statement as may be necessary to keep the Registration Statement continuously effective as to the applicable Registrable Securities for the Effectiveness Period and prepare and file with the Commission such additional Registration Statements in order to register for resale under the Securities Act all of the Registrable Securities; (ii) cause the related Prospectus to be amended or supplemented by any required Prospectus supplement, and as so supplemented or amended to be filed pursuant to Rule 424 (or any similar provisions then in force) promulgated under the Securities Act; (iii) respond as promptly as practicable to any comments received from the Commission with respect to the Registration Statement or any amendment thereto and promptly provide the Holders true and complete copies of all correspondence from and to the Commission relating to the Registration Statement; and (iv) comply with the provisions of the Securities Act and the Exchange Act with respect to the disposition of all Registrable Securities covered by the Registration Statement during the applicable period in accordance with the intended methods of disposition by the Holders thereof set forth in the Registration Statement as so amended or in such Prospectus as so supplemented. (c) Notify the Holders of Registrable Securities to be sold, their Special Counsel and any managing underwriters immediately (and, in the case of (i)(A) below, not less than five (5) days prior to such filing) and (if requested by any such Person) confirm such notice in writing no later than one (1) Business Day following the day (i)(A) when a Prospectus or any Prospectus supplement or post-effective amendment to the Registration Statement is proposed to be filed (which for purposes of this subparagraph (A) shall not include the filings of the Company made under the Exchange Act and incorporated by reference in the Registration Statement); (B) when the Commission notifies the Company whether there will be a "review" of such Registration Statement and whenever the Commission comments in writing on such Registration Statement and (C) with respect to the Registration Statement or any post-effective amendment, when the same has become effective; (ii) of any request by the Commission or any other Federal or state governmental authority for amendments or supplements to the Registration Statement or Prospectus or for additional information; (iii) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement covering any or all of the Registrable Securities or the initiation of any Proceedings for that purpose; (iv) if at any time any of the representations and warranties of the Company contained in any agreement (including any underwriting agreement) contemplated hereby ceases to be true and correct in all material respects; (v) of the receipt by the Company of any notification with respect to the suspension of the qualification or exemption from qualification of any of the Registrable Securities for sale in any jurisdiction, or the initiation or threatening of any Proceeding for such purpose; and (vi) of the occurrence of any event that makes any statement made in the Registration Statement or Prospectus or any document incorporated or deemed to be incorporated therein by reference untrue in any material respect or that requires any revisions to the Registration Statement, Prospectus or other documents so that, in the case of the Registration Statement or the Prospectus, as the case may be, it will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. -5- 6 (d) Use its best efforts to avoid the issuance of, or, if issued, obtain the withdrawal of (i) any order suspending the effectiveness of the Registration Statement or (ii) any suspension of the qualification (or exemption from qualification) of any of the Registrable Securities for sale in any jurisdiction, at the earliest practicable moment. (e) If requested by any managing underwriter or the Holders of a majority in interest of the Registrable Securities to be sold in connection with an Underwritten Offering, (i) promptly incorporate in a Prospectus supplement or post-effective amendment to the Registration Statement such information as such managing underwriters and such Holders reasonably agree should be included therein and (ii) make all required filings of such Prospectus supplement or such post-effective amendment as soon as practicable after the Company has received notification of the matters to be incorporated in such Prospectus supplement or post-effective amendment; provided, however, that the Company shall not be required to take any action pursuant to this Section 3(e) that would, in the opinion of counsel for the Company, violate applicable law or be materially detrimental to the business prospects of the Company. (f) Furnish to each Holder, their Special Counsel and any managing underwriters, without charge, at least one conformed copy of each Registration Statement and each amendment thereto, including financial statements and schedules, all documents incorporated or deemed to be incorporated therein by reference, and all exhibits to the extent requested by such Person (including those previously furnished or incorporated by reference) promptly after the filing of such documents with the Commission. (g) Promptly deliver to each Holder, their Special Counsel, and any underwriters, within two business days after a Registration Statement is declared effective by the Commission, without charge, as many copies of the Prospectus or Prospectuses (including each form of prospectus) and, within two business days after being filed with the Commission, each amendment or supplement thereto as such Holder may reasonably request; and the Company hereby consents to the use of such Prospectus and each amendment or supplement thereto by each of the selling Holders and any underwriters in connection with the offering and sale of the Registrable Securities covered by such Prospectus and any amendment or supplement thereto. (h) Prior to any public offering of Registrable Securities, use its best efforts to register or qualify or cooperate with the selling Holders, any underwriters and their Special Counsel in connection with the registration or qualification (or exemption from such registration or qualification) of such Registrable Securities for offer and sale under the securities or Blue Sky laws of such jurisdictions within the United States as any Holder or underwriter requests in writing, to keep each such registration or qualification (or exemption therefrom) effective during the Effectiveness Period and to do any and all other acts or things necessary or advisable to enable the disposition in such jurisdictions of the Registrable Securities covered by a Registration Statement; provided, however, that the Company shall not be required to qualify generally to do business in any jurisdiction where it is not then so qualified or to take any action that would subject it to general service of process in any such jurisdiction where it is not then so subject or subject the Company to any material tax in any such jurisdiction where it is not then so subject. -6- 7 (i) Cooperate with the Holders and any managing underwriters to facilitate the timely preparation and delivery of certificates representing Registrable Securities to be sold pursuant to a Registration Statement, which certificates shall be free of all restrictive legends, and to enable such Registrable Securities to be in such denominations and registered in such names as any such managing underwriters or Holders may request at least two Business Days prior to any sale of Registrable Securities. (j) Upon the occurrence of any event contemplated by Section 3(c)(vi), as promptly as practicable, prepare a supplement or amendment, including a post-effective amendment, to the Registration Statement or a supplement to the related Prospectus or any document incorporated or deemed to be incorporated therein by reference, and file any other required document so that, as thereafter delivered, neither the Registration Statement nor such Prospectus will 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 statements therein, in light of the circumstances under which they were made, not misleading. Such supplement or amendment may take the form of a document filed by the Company under the Exchange Act and incorporated by reference into the Registration Statement. (k) Use its best efforts to cause all Registrable Securities relating to such Registration Statement to be listed on the Nasdaq National Market or any other securities exchange, quotation system, market or over-the-counter bulletin board, if any, on which similar securities issued by the Company are then listed as and when required pursuant to the Purchase Agreement. (l) Enter into such agreements (including an underwriting agreement in form, scope and substance as is customary in underwritten public offerings) and take all such other actions in connection therewith (including those reasonably requested by any managing underwriters and the Holders of a majority of the Registrable Securities being sold) in order to expedite or facilitate the disposition of such Registrable Securities, and whether or not an underwriting agreement is entered into, (i) make such representations and warranties to such Holders and such underwriters as are customarily made by issuers to underwriters in underwritten public offerings, and confirm the same if and when requested; (ii) in the case of an Underwritten Offering obtain and deliver copies thereof to the managing underwriters, if any, of opinions of counsel to the Company and updates thereof addressed to each such underwriter, in form, scope and substance reasonably satisfactory to any such managing underwriters covering the matters customarily covered in opinions requested in Underwritten Offerings and such other matters as may be reasonably requested by such underwriters; (iii) immediately prior to the effectiveness of the Registration Statement, and, in the case of an Underwritten Offering, at the time of delivery of any Registrable Securities sold pursuant thereto, obtain and deliver copies to the Holders and the managing underwriters, if any, of "cold comfort" letters and updates thereof from the independent certified public accountants of the Company (and, if necessary, any other independent certified public accountants of any subsidiary of the Company or of any business acquired by the Company for which financial statements and financial data is, or is required to be, included in the Registration Statement), addressed to each selling Holder and each of the underwriters, if any, in form and substance as are customary in connection with Underwritten Offerings; (iv) if an underwriting agreement is entered into, the same shall contain indemnification provisions and procedures no less favorable to the selling Holders and the under- -7- 8 writers, if any, than those set forth in Section 6 (or such other provisions and procedures acceptable to the managing underwriters, if any, and holders of a majority of Registrable Securities participating in such Underwritten Offering); and (v) deliver such documents and certificates as may be reasonably requested by the Holders of a majority of the Registrable Securities being sold, their Special Counsel and any managing underwriters to evidence the continued validity of the representations and warranties made pursuant to clause 3(l)(i) above and to evidence compliance with any customary conditions contained in the underwriting agreement or other agreement entered into by the Company. (m) In the event that (i) Holders of at least a majority of the Registrable Securities or (ii) their Special Counsel, determine in good faith that it is necessary or highly advisable to establish a due diligence defense because such Holders may be deemed to be underwriters with respect to the resale of Registrable Securities, make available for inspection by the selling Holders, a representative of such Holders, an underwriter participating in any disposition of Registrable Securities, and an attorney or accountant retained by such selling Holders or underwriters, at the offices where normally kept, during reasonable business hours, all financial and other records, pertinent corporate documents and properties of the Company and its subsidiaries, if any, and cause the officers, directors, agents and employees of the Company and its subsidiaries, if any, to supply all information in each case reasonably requested by any such Holder, representative, underwriter, attorney or accountant in connection with the Registration Statement; provided, however, that any information that is determined in good faith by the Company in writing to be of a confidential nature at the time of delivery of such information shall be kept confidential by such Persons, unless (i) disclosure of such information is required by court or administrative order or is necessary to respond to inquiries of regulatory authorities; (ii) disclosure of such information, in the opinion of counsel to such Person, is required by law; (iii) such information becomes generally available to the public other than as a result of a disclosure or failure to safeguard by such Person; or (iv) such information becomes available to such Person from a source other than the Company and such source is not known by such Person to be bound by a confidentiality agreement with the Company. (n) Comply with all applicable rules and regulations of the Commission and make generally available to its security holders earning statements satisfying the provisions of Section 11(a) of the Securities Act and Rule 158 not later than 45 days after the end of any 12-month period (or 90 days after the end of any 12-month period if such period is a fiscal year) (i) commencing at the end of any fiscal quarter in which Registrable Securities are sold to underwriters in a firm commitment or best efforts Underwritten Offering and (ii) if not sold to underwriters in such an offering, commencing on the first day of the first fiscal quarter of the Company after the effective date of the Registration Statement, which statement shall cover said 12-month period, or end shorter periods as is consistent with the requirements of Rule 158. (o) The Company may require each selling Holder to furnish to the Company such information regarding such Holder and the distribution of such Registrable Securities as is required by law to be disclosed in the Registration Statement and the Company may exclude from such registration the Registrable Securities of any such Holder who unreasonably fails to furnish such information within a reasonable time after receiving such request. The Company shall also disclose in the Registration Statement such other information regarding each Holder -8- 9 and its plan of distribution of the Registrable Securities as such Holder shall reasonably request, except where such inclusion of information would violate applicable law. If the Registration Statement refers to any Holder by name or otherwise as the holder of any securities of the Company, then such Holder shall have the right to require (if such reference to such Holder by name or otherwise is not required by the Securities Act or any similar Federal statute then in force) the deletion of the reference to such Holder in any amendment or supplement to the Registration Statement filed or prepared subsequent to the time that such reference ceases to be required. Each Holder by its acquisition of the Registrable Securities covenants and agrees that (i) such Holder will not offer or sell any Registrable Securities under the Registration Statement until it has received copies of the Prospectus as then amended or supplemented as contemplated in Section 3(g) and notice from the Company that such Registration Statement and any post-effective amendments thereto have become effective as contemplated by Section 3(c) and (ii) such Holder and its officers, directors or Affiliates, if any, will comply with the prospectus delivery requirements of the Securities Act as applicable to them in connection with sales of Registrable Securities pursuant to the Registration Statement. Each Holder agrees by its acquisition of such Registrable Securities that, upon receipt of a notice from the Company of the occurrence of any event of the kind described in Section 3(c)(ii), 3(c)(iii), 3(c)(v) or 3(c)(vi), such Holder will forthwith discontinue disposition of such Registrable Securities until such Holder's receipt of the copies of the supplemented Prospectus and/or amended Registration Statement contemplated by Section 3(j), or until it is advised in writing (the "Advice") by the Company that the use of the applicable Prospectus may be resumed, and, in either case, has received copies of any additional or supplemental filings that are incorporated or deemed to be incorporated by reference in such Prospectus or Registration Statement. If (a) there is material non-public information regarding the Company which the Company's Board of Directors (the "Board") reasonably determines not to be in the Company's best interest to disclose and which the Company is not otherwise required to disclose, or (b) there is a significant business opportunity (including but not limited to the acquisition or disposition of assets (other than in the ordinary course of business) or any merger, consolidation, tender offer or other similar transaction) available to the Company which the Board reasonably determines not to be in the Company's best interest to disclose, then the Company may postpone or suspend filing or effectiveness of a Registration Statement for a period not to exceed 20 consecutive days, provided that the Company may not postpone or suspend its obligation under this Section for more than 60 days in the aggregate during any 12 month period; provided, however, that no such postponement of suspension shall be permitted for consecutive 20 day periods, arising out of the same set as of facts, circumstances or transactions. (p) If, whether pursuant to a decrease in the conversion price of the Notes, a decrease in the exercise price of the Warrants or otherwise, the Holders are entitled to additional shares of Common Stock or other Registrable Securities not covered in the initial Registration Statement when declared effective by the Commission, the Company shall, within 30 days of the event resulting in such increase in Registrable Securities, file a Registration Statement with -9- 10 respect to such additional Registrable Securities and shall use its best efforts to cause such Registration Statement to become effective within (60) days of such event. 4. Registration Expenses (a) All fees and expenses incident to the performance of or compliance with this Agreement by the Company shall, except as and to the extent specified in Section 4(b), be borne by the Company whether or not pursuant to an Underwritten Offering and whether or not the Registration Statement is filed or becomes effective and whether or not any Registrable Securities are sold pursuant to the Registration Statement. The fees and expenses referred to in the foregoing sentence shall include, without limitation, (i) all registration and filing fees (including, without limitation, fees and expenses (A) with respect to filings required to be made with the Nasdaq National Market and each other securities exchange or market on which Registrable Securities are required hereunder to be listed and (B) in compliance with state securities or Blue Sky laws (including, without limitation, fees and disbursements of counsel for the Holders in connection with Blue Sky qualifications of the Registrable Securities and determination of the eligibility of the Registrable Securities for investment under the laws of such jurisdictions as the managing underwriters, if any, or the Holders of a majority of the applicable Registrable Securities may designate)), (ii) printing expenses (including, without limitation, expenses of printing certificates for Registrable Securities and of printing prospectuses if the printing of prospectuses is requested by the managing underwriters, if any, or by the holders of a majority of the Registrable Securities included in the Registration Statement), (iii) messenger, telephone and delivery expenses, (iv) fees and disbursements of counsel for the Company and Special Counsel for the Holders, in the case of the Special Counsel, to a maximum amount of $5,000, (v) Securities Act liability insurance, if the Company so desires such insurance, and (vi) fees and expenses of all other Persons retained by the Company in connection with the consummation of the transactions contemplated by this Agreement. In addition, the Company shall be responsible for all of its internal expenses incurred in connection with the consummation of the transactions contemplated by this Agreement (including, without limitation, all salaries and expenses of its officers and employees performing legal or accounting duties), the expense of any annual audit, the fees and expenses incurred in connection with the listing of the Registrable Securities on any securities exchange as required hereunder. (b) If the Holders require an Underwritten Offering pursuant to the terms hereof, the Company shall be responsible for all costs, fees and expenses in connection therewith, except for the fees and disbursements of the underwriters (including any underwriting commissions and discounts) and their legal counsel and accountants (which shall be borne by the Holders). Therefore, in such circumstances the Holders or the underwriters shall bear the expenses of the fees and disbursements of any legal counsel or accounting firm retained by the underwriters in connection with such Underwritten Offering and the costs of any determination (but not filing) by the underwriters of the eligibility of the Registrable Securities for investment under the applicable state securities laws. By way of illustration which is not intended to diminish from the provisions of Section 4(a), the Holders shall not be responsible for, and the Company shall be required to pay the fees or disbursements incurred by the Company (including by its legal counsel and accountants) in connection with, the preparation and filing of a Registration Statement and related Prospectus for such offering, the maintenance of such Registration Statement in accordance with the terms hereof, the listing of the Registrable -10- 11 Securities in accordance with the requirements hereof, and printing expenses incurred to comply with the requirements hereof. 5. Indemnification (a) Indemnification by the Company. The Company shall, notwithstanding any termination of this Agreement, indemnify and hold harmless each Holder, the officers, directors, agents (including any underwriters retained by such Holder in connection with the offer and sale of Registrable Securities), brokers (including brokers who offer and sell Registrable Securities as principal as a result of a pledge or any failure to perform under a margin call of Common Stock), investment advisors and employees of each of them, each Person who controls any such Holder (within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act) and the officers, directors, agents and employees of each such controlling Person, to the fullest extent permitted by applicable law, from and against any and all losses, claims, damages, liabilities, costs (including, without limitation, costs of preparation and attorneys' fees) and expenses (collectively, "Losses"), as incurred, arising out of or relating to any untrue or alleged untrue statement of a material fact contained in the Registration Statement, any Prospectus or any form of prospectus or in any amendment or supplement thereto or in any preliminary prospectus, or arising out of or relating to any omission or alleged omission of a material fact required to be stated therein or necessary to make the statements therein (in the case of any Prospectus or form of prospectus or supplement thereto, in light of the circumstances under which they were made) not misleading, except to the extent, but only to the extent, that such untrue statements or omissions are based solely upon information regarding such Holder furnished in writing to the Company by or on behalf of such Holder expressly for use therein, or to the extent that such information relates to such Holder or such Holder's proposed method of distribution of Registrable Securities and was reviewed and expressly approved in writing by such Holder expressly for use in the Registration Statement, such Prospectus or such form of Prospectus or in any amendment or supplement thereto. The Company shall notify the Holders promptly of the institution, threat or assertion of any Proceeding of which the Company is aware in connection with the transactions contemplated by this Agreement, and provided, however, that, with respect to any untrue statement or alleged untrue statement or omission or alleged omission made in a preliminary prospectus or Prospectus, the foregoing indemnity agreement shall not inure to the benefit of any selling Holder, brokers, investment advisors or employees thereof, from whom the Person asserting any such Losses purchased the Registrable Securities concerned, or any Person controlling such Holder, to the extent that any such Loss results from the fact that a copy of the Prospectus or Prospectus as amended or supplemented was not sent or given to such Person, if required by the Securities Act so to have been delivered, at or prior to the written confirmation of the sale of such Registrable Securities to such Person and the untrue statement or alleged untrue statement or omission or alleged omission was corrected in such Prospectus or Prospectus as amended or supplemented, if the Company had previously furnished copies of such Prospectus or Prospectus as amended or supplemented to such Holder. (b) Indemnification by Holders. Each Holder shall, severally and not jointly, indemnify and hold harmless the Company, the directors, officers, agents and employees, each Person who controls the Company (within the meaning of Section 15 of the Securities Act and Section 20 of the Exchange Act), and the directors, officers, agents or employees of such controlling Persons, to the fullest extent permitted by applicable law, from and against all Losses -11- 12 (as determined by a court of competent jurisdiction in a final judgment not subject to appeal or review) arising solely out of or based solely upon any untrue statement of a material fact contained in the Registration Statement, any Prospectus, or any form of prospectus, or arising solely out of or based solely upon any omission of a material fact required to be stated therein or necessary to make the statements therein not misleading to the extent, but only to the extent, that such untrue statement or omission is contained in any information so furnished in writing by such Holder to the Company specifically for inclusion in the Registration Statement or such Prospectus or to the extent that such information relates to such Holder or such Holder's proposed method of distribution of Registrable Securities and was reviewed and expressly approved in writing by such Holder expressly for use in the Registration Statement, such Prospectus or such form of Prospectus. In no event shall the liability of any selling Holder hereunder be greater in amount than the dollar amount of the net proceeds received by such Holder upon the sale of the Registrable Securities giving rise to such indemnification obligation. (c) Conduct of Indemnification Proceedings. If any Proceeding shall be brought or asserted against any Person entitled to indemnity hereunder (an "Indemnified Party"), such Indemnified Party promptly shall notify the Person from whom indemnity is sought (the "Indemnifying Party") in writing, and the Indemnifying Party shall assume the defense thereof, including the employment of counsel reasonably satisfactory to the Indemnified Party and the payment of all fees and expenses incurred in connection with defense thereof; provided, that the failure of any Indemnified Party to give such notice shall not relieve the Indemnifying Party of its obligations or liabilities pursuant to this Agreement, except (and only) to the extent that it shall be finally determined by a court of competent jurisdiction (which determination is not subject to appeal or further review) that such failure shall have proximately and materially adversely prejudiced the Indemnifying Party. An Indemnified Party shall have the right to employ separate counsel in any such Proceeding and to participate in the defense thereof, but the fees and expenses of such counsel shall be at the expense of such Indemnified Party or Parties unless: (1) the Indemnifying Party has agreed in writing to pay such fees and expenses; or (2) the Indemnifying Party shall have failed promptly to assume the defense of such Proceeding and to employ counsel reasonably satisfactory to such Indemnified Party in any such Proceeding; or (3) the named parties to any such Proceeding (including any impleaded parties) include both such Indemnified Party and the Indemnifying Party, and such Indemnified Party shall have been advised by counsel that a conflict of interest is likely to exist if the same counsel were to represent such Indemnified Party and the Indemnifying Party (in which case, if such Indemnified Party notifies the Indemnifying Party in writing that it elects to employ separate counsel at the expense of the Indemnifying Party, the Indemnifying Party shall not have the right to assume the defense thereof and such counsel shall be at the expense of the Indemnifying Party). The Indemnifying Party shall not be liable for any settlement of any such Proceeding effected without its written consent, which consent shall not be unreasonably withheld. No Indemnifying Party shall, without the prior written consent of the Indemnified Party, effect any settlement or compromise of, or consent to the entry of any judgment with respect to, any pending or threatened Proceeding in respect of which any Indemnified Party is a party, unless such settlement, compromise or judgment (i) includes an unconditional release of such Indemnified Party from all liability on claims that are the subject matter of such Proceeding and (ii) does not include a statement as to, or an admission of, fault, culpability or a failure to act by or on behalf of such Indemnified Party. -12- 13 All fees and expenses of the Indemnified Party (including reasonable fees and expenses to the extent incurred in connection with investigating or preparing to defend such Proceeding in a manner not inconsistent with this Section) shall be paid to the Indemnified Party, as incurred, within 10 Business Days of written notice thereof to the Indemnifying Party (regardless of whether it is ultimately determined that an Indemnified Party is not entitled to indemnification hereunder; provided, that the Indemnifying Party may require such Indemnified Party to undertake to reimburse all such fees and expenses to the extent it is finally judicially determined that such Indemnified Party is not entitled to indemnification hereunder). (d) Contribution. If a claim for indemnification under Section 5(a) or 5(b) is unavailable to an Indemnified Party because of a failure or refusal of a governmental authority to enforce such indemnification in accordance with its terms (by reason of public policy or otherwise), then each Indemnifying Party, in lieu of indemnifying such Indemnified Party, shall contribute to the amount paid or payable by such Indemnified Party as a result of such Losses, in such proportion as is appropriate to reflect the relative fault of the Indemnifying Party and Indemnified Party in connection with the actions, statements or omissions that resulted in such Losses as well as any other relevant equitable considerations. The relative fault of such Indemnifying Party and Indemnified Party shall be determined by reference to, among other things, whether any action in question, including any untrue or alleged untrue statement of a material fact or omission or alleged omission of a material fact, has been taken or made by, or relates to information supplied by, such Indemnifying Party or Indemnified Party, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such action, statement or omission. The amount paid or payable by a party as a result of any Losses shall be deemed to include, subject to the limitations set forth in Section 5(c), any reasonable attorneys' or other reasonable fees or expenses incurred by such party in connection with any Proceeding to the extent such party would have been indemnified for such fees or expenses if the indemnification provided for in this Section was available to such party in accordance with its terms. The parties hereto agree that it would not be just and equitable if contribution pursuant to this Section 5(d) were determined by pro rata allocation or by any other method of allocation that does not take into account the equitable considerations referred to in the immediately preceding paragraph. Notwithstanding the provisions of this Section 5(d), no Holder shall be required to contribute, in the aggregate, any amount in excess of the amount by which the proceeds actually received by such Holder from the sale of the Registrable Securities subject to the Proceeding exceeds the amount of any damages that such Holder has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. 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. The indemnity and contribution agreements contained in this Section are in addition to any liability that the Indemnifying Parties may have to the Indemnified Parties. 6. Rule 144 The Company shall file the reports required to be filed by it under the Securities -13- 14 Act and the Exchange Act in a timely manner and, if at any time the Company is not required to file such reports, the Company will, upon the request of any Holder, make publicly available other information so long as necessary to permit sales of its securities pursuant to Rule 144. The Company further covenants that it will take such further action as any Holder may reasonably request, all to the extent required from time to time to enable such Holder to sell Registrable Securities without registration under the Securities Act within the limitation of the exemptions provided by Rule 144; provided, however, that the Company shall not be obligated to provide an opinion to any Holder regarding the sale of Registrable Securities pursuant to exemptions provided by Rule 144. Upon the request of any Holder, the Company shall deliver to such Holder a written certification of a duly authorized officer as to whether it has complied with such requirements. 7. Miscellaneous (a) Remedies. In the event of a breach by the Company or by a Holder, of any of their obligations under this Agreement, each Holder or the Company, as the case may be, in addition to being entitled to exercise all rights granted by law and under this Agreement, including recovery of damages, will be entitled to specific performance of its rights under this Agreement. The Company and each Holder agree that monetary damages would not provide adequate compensation for any losses incurred by reason of a breach by it of any of the provisions of this Agreement and hereby further agrees that, in the event of any action for specific performance in respect of such breach, it shall waive the defense that a remedy at law would be adequate. (b) No Registration Rights Agreements. Except and to the extent specifically set forth on Schedule 7(b) attached hereto, the Company has not previously entered into any agreement granting any registration rights with respect to any of its securities to any Person. Without limiting the generality of the foregoing, without the written consent of the Holders of at least 75% of the then underlying and outstanding Registrable Securities, the Company shall not grant to any Person the right to request the Company to register any securities of the Company under the Securities Act unless the rights so granted are subject in all respects to the prior rights in full of the Holders set forth herein, and are not otherwise in conflict or inconsistent with the provisions of this Agreement. (c) No Piggyback on Registrations. Except as and to the extent specifically set forth on Schedule 7(c) attached hereto, neither the Company nor any of its securityholders (other than the Holders in such capacity pursuant hereto) may include securities of the Company in the Registration Statement other than the Registrable Securities, and the Company shall not enter into any agreement providing any such right to any of its securityholders. (d) Piggy-Back Registrations. If at any time when there is not an effective Registration Statement the Company shall determine to prepare and file with the Commission a registration statement relating to an offering for its own account or the account of others under the Securities Act of any of its equity securities, other than on Form S-4 or Form S-8 (each as promulgated under the Securities Act) or their then equivalents relating to equity securities to be issued solely in connection with any acquisition of any entity or business or equity securities issuable in connection with stock option or other employee benefit plans, the Company shall -14- 15 send to each Holder written notice of such determination and, if within twenty (20) days after receipt of such notice, any such Holder shall so request in writing, the Company shall include in such registration statement all or any part of the Registrable Securities such Holder requests to be registered, except that if, in connection with any Underwritten Offering for the account of the Company the managing underwriter(s) thereof shall impose a limitation on the number of shares of Common Stock which may be included in the registration statement because, in such underwriter(s)' judgment, such limitation is necessary to effect an orderly public distribution of securities covered thereby, then the Company shall be obligated to include in such registration statement only such limited amount of the Registrable Securities which in the opinion of such managing underwriter(s) can be sold. Any exclusion of Registrable Securities shall be made pro rata among the Holders seeking to include Registrable Securities, in proportion to the number of Registrable Securities sought to be included by such Holders; provided, however, that the Company shall not exclude any Registrable Securities unless the Company has first excluded all outstanding securities the holders of which are not entitled by right to inclusion of securities in such registration statement; and provided, further, however, that, after giving effect to the immediately preceding proviso, any exclusion of Registrable Securities shall be made pro rata with holders of other securities having the right to include such securities in such registration statement. No right to registration of Registrable Securities under this Section shall be construed to limit any registration otherwise required hereunder. (e) Amendments and Waivers. The provisions of this Agreement, including the provisions of this sentence, may not be amended, modified or supplemented, and waivers or consents to departures from the provisions hereof may not be given, unless the same shall be in writing and signed by the Company and the Holders of at least a majority of the then outstanding Notes, Warrants and Registrable Securities; provided, however, that, for the purposes of this sentence, Registrable Securities that are owned, directly or indirectly, by the Company, or an Affiliate of the Company are not deemed outstanding. Notwithstanding the foregoing, a waiver or consent to depart from the provisions hereof with respect to a matter that relates exclusively to the rights of certain Holders and that does not directly or indirectly affect the rights of other Holders may be given by Holders of at least 75% of the underlying and outstanding Registrable Securities to which such waiver or consent relates; provided, however, that the provisions of this sentence may not be amended, modified, or supplemented except in accordance with the provisions of the immediately preceding sentence. (f) Notices. Any and all notices or other communications or deliveries required or permitted to be provided hereunder shall be in writing and shall be deemed delivered (i) upon receipt, when delivered personally; (ii) when sent by facsimile, upon receipt if received on a Business Day prior to 5:00 p.m. (Central Time), or the first Business Day following such receipt if received on a Business Day after 5:00 p.m. (Central Time); or (iii) upon receipt, when deposited with a nationally recognized overnight express courier service, fully prepaid, in each case properly addressed to the party to receive the same. The addresses and facsimile numbers for such communications shall be: -15- 16 If to the Company: Illinois Superconductor Corporation 451 Kingston Court Mt. Prospect, Illinois 60056 Attn: William M. Kochlefl Fax: (847) 391-5015 With copies to: Katten Muchin & Zavis 525 W. Monroe St. Suite 1600 Chicago, Illinois 60661 Attn: Lawrence D. Levin Fax: (312) 902-1061 If to a Purchaser: Elliott Associates, L.P. 712 Fifth Avenue, 36th Floor New York, New York 10019 Attn: Mark Brodsky Fax: (212) 974-2092 Westgate International, L.P. c/o Stonington Management Corp. 712 Fifth Avenue, 36th Floor New York, New York 10019 Attn: Mark Brodsky Fax: (212) 974-2092 Alexander Finance, LP 1560 Sherman Avenue Suite 900 Evanston, Illinois 60201 Attn: Brian D. Brookover Fax: (847) 733-0339 State Farm Mutual Automobile Insurance Company One State Farm Plaza Bloomington, Illinois 16701 Attn: Common Stocks E-9 Fax: (309) 766-7423 With copies to: Kleinberg, Kaplan, Wolff & Cohen, P.C. 551 Fifth Avenue New York, New York 10176 Attn: Stephen M. Schultz Fax: (212) 986-8866 -16- 17 If to any other Person who is then the registered Holder: To the address or facsimile number of such Holder as it appears in the stock transfer books of the Company or such other address as may be designated in writing hereafter, in the same manner, by such Person. (g) Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the successors and permitted assigns of each of the parties and shall inure to the benefit of each Holder. The Company may not assign its rights or obligations hereunder without the prior written consent of each Holder. The Purchasers may assign its rights hereunder in the manner and to the Persons as permitted under the Purchase Agreement. (h) Assignment of Registration Rights. The rights of each Purchaser hereunder, including the right to have the Company register for resale Registrable Securities in accordance with the terms of this Agreement, shall be automatically assignable by such Purchaser to any assignee or transferee of all or a portion of the Notes, the Warrants or the Registrable Securities if: (i) such Purchaser agrees in writing with the transferee or assignee to assign such rights, and a copy of such agreement is furnished to the Company within a reasonable time after such assignment, (ii) the Company is, within a reasonable time after such transfer or assignment, furnished with written notice of (a) the name and address of such transferee or assignee, and (b) the securities with respect to such registration rights are being transferred or assigned, (iii) following such transfer or assignment the further disposition of such securities by the transferee or assignees is restricted under the Securities Act and applicable state securities laws, (iv) at or before the time the Company receives the written notice contemplated by clause (ii) of this Section, the transferee or assignee agrees in writing with the Company to be bound by all of the provisions of this Agreement, and (v) such transfer shall have been made in accordance with the applicable requirements of the Purchase Agreement. The rights to assignment shall apply to such Purchaser's (and to subsequent) successors and assigns. (i) Counterparts. This Agreement may be executed in any number of counterparts, each of which when so executed shall be deemed to be an original and, all of which taken together shall constitute one and the same agreement. In the event that any signature is delivered by facsimile transmission, such signature shall create a valid binding obligation of the party executing (or on whose behalf such signature is executed) the same with the same force and effect as if such facsimile signature were the original thereof. (j) Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New York, without regard to principles of conflicts of law. (k) Cumulative Remedies. The remedies provided herein are cumulative and not exclusive of any remedies provided by law. -17- 18 (l) Severability. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction to be invalid, illegal, void or unenforceable, the remainder of the terms, provisions, covenants and restrictions set forth herein shall remain in full force and effect and shall in no way be affected, impaired or invalidated, and the parties hereto shall use their reasonable efforts to find and employ an alternative means to achieve the same or substantially the same result as that contemplated by such term, provision, covenant or restriction. It is hereby stipulated and declared to be the intention of the parties that they would have executed the remaining terms, provisions, covenants and restrictions without including any of such that may be hereafter declared invalid, illegal, void or unenforceable. (m) Headings. The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. (n) Shares Held by the Company and its Affiliates. Whenever the consent or approval of Holders of a specified percentage of Registrable Securities is required hereunder, Registrable Securities held by the Company or its Affiliates (other than the Purchaser or transferees or successors or assigns thereof if such Persons are deemed to be Affiliates solely by reason of their holdings of such Registrable Securities) shall not be counted in determining whether such consent or approval was given by the Holders of such required percentage. -18- 19 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. ILLINOIS SUPERCONDUCTOR CORPORATION By: /s/ Edward W. Laves Name: Edward W. Laves Title: Chief Executive Officer and President ELLIOTT ASSOCIATES, L.P. By: /s/ Authorized Signatory Name: Title: WESTGATE INTERNATIONAL, L.P. By: Martley International, L.P., Attorney-in-fact By: /s/ Authorized Signatory Name: Title: 20 ALEXANDER FINANCE, LP By: /s/ Authorized Signatory Name: Title: STATE FARM MUTUAL AUTOMOBILE INSURANCE COMPANY By: /s/ James Freytag Name: James Freytag Title:Vice President - Common Stocks By: /s/ John Gordon Name: John Gordon Title:Investment Officer 21 Schedule 7(b) ------------- Third Amended and Restated Registration Rights Agreement, dated as of July 14, 1993 between the Company and the persons named therein. Representative's Warrant Agreement, dated October 23, 1993, between the Company and Gruntal & Co., Incorporated. Registration Rights Agreement, dated June 6, 1997, between the Company and Southbrook International Investments, Ltd. Registration Rights Agreement, dated October 29, 1997, between the Company and Elliott Associates, L.P. and Westgate International, L.P. Registration Rights Agreement, dated May 15, 1998, by and among the Company, the Purchasers, State Farm Mutual Automobile Insurance Company, Spring Point Partners, L.P. and Spring Point Offshore Fund. 22 Schedule 7(c) ------------- Third Amended and Restated Registration Rights Agreement, dated as of July 14, 1993 between the Company and the persons named therein. Representative's Warrant Agreement, dated October 23, 1993, between the Company and Gruntal & Co., Incorporated. Registration Rights Agreement, dated June 6, 1997, between the Company and Southbrook International Investments, Ltd. Registration Rights Agreement, dated October 29, 1997, between the Company and Elliott Associates, L.P. and Westgate International, L.P. EX-4.22 6 AMENDMENT TO SECURITIES 1 EXHIBIT 4.22 AMENDMENT TO SECURITIES PURCHASE AGREEMENT (this "AMENDMENT TO NOTE AGREEMENT") dated as of March 31, 1999, by and among Elliott Associates, L.P., a limited partnership organized and existing under the laws of Delaware ("ELLIOTT"), Westgate International, L.P., a limited partnership organized and existing under the laws of the Cayman Islands ("WESTGATE"), Alexander Finance, LP, a limited partnership organized and existing under the laws of Illinois ("ALEXANDER"), State Farm Mutual Automobile Insurance Company, an insurance company organized and existing under the laws of Illinois ("State Farm"), Spring Point Partners, L.P., a limited partnership organized and existing under the laws of California and Spring Point Offshore Fund, a corporation organized and existing under the laws of the Cayman Islands (each, a "2% NOTE PURCHASER" and collectively, the "2% NOTE PURCHASERS"), and Illinois Superconductor Corporation, a corporation organized and existing under the laws of Delaware (the "COMPANY"). W I T N E S S E T H WHEREAS, as of May 15, 1998, the Company and the Purchasers entered into a Securities Purchase Agreement (the "2% NOTE AGREEMENT"), pursuant to which the Purchasers purchased from the Company: (i) $10,350,000 in aggregate principal amount of 2% Senior Convertible Notes of the Company due May 15, 2002 (the "2% NOTES") and (ii) warrants (the "2% NOTE WARRANTS") to purchase an aggregate of 4,140,000 shares of the Company's common stock, par value $.001 per share ("COMMON STOCK"), at an exercise price of $3.75 per share; WHEREAS, pursuant to a Securities Purchase Agreement, dated as of March 31, 1999 (the "6% NOTE Agreement"), Elliott, Westgate, Alexander and State Farm (the "6% NOTE PURCHASERS"), are purchasing: (i) $3,300,000 in principal amount of 6% Senior Convertible Notes of the Company due May 15, 2002 (the "6% NOTES"); and (ii) warrants to purchase an aggregate of 1,320,000 shares of Common Stock at $1.4625 per share (the "6% NOTE WARRANTS"); WHEREAS, in connection with the 6% Note Agreement, the Company, the 2% Note Purchasers and the 6% Note Purchasers (collectively, the "INVESTORS") desire that the terms of the 2% Note Agreement, the 2% Notes and the 2% Note Warrants be amended to reflect the exercise of certain rights thereunder from the date hereof going forward; and WHEREAS, pursuant to the terms of the 6% Note Agreement, the Company and the 6% Note Purchasers desire that certain of the 2% Notes and 2% Note Warrants held by the 6% Note Purchasers and set forth in the Schedule of Purchasers to the 6% Note Agreement (the "DESIGNATED 2% NOTES" and the "DESIGNATED 2% NOTE WARRANTS", respectively) be amended to reflect certain terms contained herein. NOW, THEREFORE, in consideration of the mutual covenants in this Agreement, the Company and the Investors hereby agree as follows: 1. BOARD SEATS. That portion of Section 3.12 of the 2% Note Agreement following the first two sentences thereof is hereby amended to read in its entirety as follows: 2 "Until such time as the amount of Common Stock issuable upon conversion of the then outstanding 2% Notes (including the Designated 2% Notes) and 6% Notes is less than 5% of then outstanding Common Stock (the "MINIMUM AMOUNT"), the Company shall cause the individuals originally designated hereunder by holders of the 2% Notes (or such other individual(s) designated by a plurality of the Investment Amount (as defined below) as replacement(s), and acceptable to a majority of the members of the Board of Directors (not including the Investors' designees), such acceptance not to be unreasonably withheld) to be nominated to the Board of Director(s) of the Company and will solicit proxies from stockholders voting in favor of such nominees. For so long as the Investors have the right to appoint members to the Company's Board of Directors pursuant to this Section 3.12, the Company covenants not to increase the size of its Board of Directors above nine (9) members. Notwithstanding the foregoing, any holder of 2% Notes (including the Designated 2% Notes) or 6% Notes may elect, upon notice to the Company , which notice may be rescinded by a subsequent notice received no earlier than 61 days following the date the prior notice is received, to waive its right to participate in the foregoing selection of members of the Company's Board of Directors, provided that for purposes of the Minimum Amount, the amount of Common Stock issuable upon conversion of such holder's 6% Notes and 2% Notes (including Designated 2% Notes) shall be counted. As used herein, "Investment Amount" shall refer to the sum of the principal amount outstanding on (i) the 6% Notes; and (ii) the 2% Notes (including the Designated 2% Notes.) 2. FUTURE FINANCINGS. Section 3.13 of the 2% Note Agreement is hereby deleted in its entirety and replaced with the following provision: "For so long as any 6% Notes, 6% Note Warrants, 2% Notes (including Designated 2% Notes) and 2% Note Warrants (including Designated 2% Note Warrants) shall be outstanding, in the event that the Company shall seek any financing (excluding a firm commitment underwritten public offering or the issuance of the Company's securities in connection 2 3 with a strategic partnership or joint venture), it shall: (i) provide reasonable notice to the Investors holding such securities of its intention to seek financing and (ii) provide such Investors with a reasonable opportunity to submit a proposal for financing. 3. FURTHER COVENANT OF THE COMPANY. Section 3.17A of the 2% Note Agreement is hereby amended to read in its entirety as follows: "Furthermore, the Company covenants that for as long as the amount outstanding of the Investment Amount is at least $5,625,000, the Company, will not, without the prior written approval of at least $5,625,000 of the Investment Amount: (i) consolidate with or merge into any other person, or permit any other person to consolidate or merge into it; (ii) sell, lease or otherwise dispose of all or substantially all of its assets; (iii) amend its certificate of incorporation (other than to effect an increase in the authorized capital stock of the Company); (iv) adopt any plan pursuant to which capital stock of the Company or rights to purchase capital stock of the Company are issued, except for (A) a director compensation plan to be implemented during 1999; and (B) for the adoption and amendment of employee benefit plans, if any, only if such adoption or amendment does not authorize shares of Common Stock equaling more than 20% of the then outstanding shares of Common Stock and does not provide for options having a exercise price less than the market price of Common Stock; or (v) engage in any transaction, which pursuant to the rules of any securities market or exchange on which the Common Stock is traded, requires approval of holders of the Common Stock. 3 4 The Company covenants that within ten (10) days of (i) the applicable holders of the 6% Notes, and 2% Notes (including Designated 2% Notes) notifying the Company that they do or do not object to the Company engaging in the action for which their approval has been sought or (ii) the lapse of the 10 Business Day period without the Company being notified by the applicable holders as to whether or not they object to the Company engaging in such action, each pursuant to this Section 3.17A, the Company will either (x) publicly disclose the information disclosed to the holders of the 6% Notes and 2% Notes (including Designated 2% Notes) pursuant to this Section 3.17A which it deems to be material, non-public information and with respect to the balance of such information, if any, notify such holders in writing that it does not deem such information to be material, non-public information and that it will not deem such information to have been misappropriated if such holders trade in the Common Stock while in possession of such information, or (y) notify such holders in writing that it does not deem the information disclosed to the holders of the 6% Notes and 2% Notes (including Designated 2% Notes) pursuant to this Section 3.17A to be material, non-public information and that it will not deem such information to have been misappropriated if such holders trade in the Common Stock while in possession of such information; provided that the Company acknowledges that if, and only if, it fails to do either (x) or (y) within the applicable ten (10) day period, the holders of the 6% Notes and 2% Notes (including Designated 2% Notes) may publicly disclose such information. 4. PURCHASER OWNERSHIP OF COMMON STOCK. Section 3.15 of the 2% Note Agreement is hereby deleted in its entirety. 5. RIGHTS IF TRADING IN COMMON STOCK IS SUSPENDED OR DILUTED. Section 3.16 of the 2% Note Agreement is hereby amended to insert the following on the fifth line thereof after "Nasdaq National Market (" but before "unless...": "unless such delisting shall be due to failure to comply with the maintenance criteria set forth in NASD Rule 4450 (or any successor rule) with respect to "(i) minimum bid price or (ii) net tangible assets or" 6. CONSENT TO ISSUANCE OF 6% NOTES AS PARI PASSU OBLIGATIONS. The 2% Note Purchasers hereby consent to the issuance of the 6% Notes as obligations which are pari passu with the 2% Notes. 7. AMENDMENTS TO ALL 2% NOTES. (a) Events of Default. Section 5(a) "Events of Default" of each of the 2% Notes is hereby amended to add at the end of the sentence beginning `An "Event of Default" is. . .', the following clause: "; or (vii) if any principal payments under any of the Company's 6% Senior Convertible Notes due May 15, 2002 are accelerated." 4 5 (b) Limitation on Beneficial Ownership of Common Stock. Each of the 2% Notes is hereby amended to add the following paragraph (j) to Section 3 thereof: "(j) Notwithstanding anything to the contrary herein, the Holder may not use its ability to convert this Note if such conversion would result in the total number of shares of Common Stock deemed beneficially owned by the Holder (other than by virtue of the ownership of this Note or ownership of other securities that have limitations on a holder's right to convert or exercise similar to those limitations set forth herein), together with all shares of Common Stock deemed beneficially owned by the Holder's Affiliates (as defined in the Purchase Agreement) that would be aggregated for purposes of determining a group under Section 13(d) of the Exchange Act, exceeding 9.9% of the total issued and outstanding shares of the Company's Common Stock (the "Restricted Ownership Percentage"); provided that (w) the Holder shall have the right, at any time and from time to time, to reduce the Restricted Ownership Percentage applicable to it immediately upon written notice to the Company, (x) the Holder shall have the right to increase its Restricted Ownership Percentage and otherwise waive in whole or in part the restrictions of this Section 3(j) immediately upon written notice to the Company in the event of an occurrence or notice of an intended or pending Change of Control (as defined in the Purchase Agreement) (a "Change of Control Notice") or the delivery by the Company of a notice of a redemption of the Notes or the Company's 6% Senior Convertible Notes by the Company (a "Redemption Notice"), and (y) the Holder can make subsequent adjustments pursuant to (w) or (x) any number of times (which adjustment shall be effective immediately). The delivery of a Conversion Notice by the Holder shall be deemed a representation by the Holder that it is in compliance with this Section 3(j). (c) Amendments to Events. Section 3(c)(i) of each of the 2% Notes is hereby amended to insert the following in clause (e) thereof after "delisted from the Nasdaq National Market (" but before "unless": "unless such delisting shall be due to failure to comply with the maintenance criteria set forth in 5 6 NASD Rule 4450 (or any successor rule) with respect to (i) minimum bid price or (ii) net tangible assets or" 8. AMENDMENT OF 2% NOTE WARRANTS. Each of the 2% Note Warrants is hereby amended to add the following paragraph (f) to Section 3 thereof: "(f) Notwithstanding anything to the contrary herein, the Holder may not use its ability to exercise this Warrant if such exercise would result in the total number of shares of Common Stock deemed beneficially owned by the Holder (other than by virtue of the ownership of this Warrant or ownership of other securities that have limitations on a holder's right to convert or exercise similar to those limitations set forth herein), together with all shares of Common Stock deemed beneficially owned by the Holder's Affiliates (as defined in the Purchase Agreement) that would be aggregated for purposes of determining a group under Section 13(d) of the Exchange Act, exceeding 9.9% of the total issued and outstanding shares of the Company's Common Stock (the "Restricted Ownership Percentage"); provided that (w) the Holder shall have the right, at any time and from time to time, to reduce the Restricted Ownership Percentage applicable to it immediately upon written notice to the Company, (x) the Holder shall have the right to increase its Restricted Ownership Percentage and otherwise waive in whole or in part the restrictions of this Section 3(f) immediately upon written notice to the Company in the event of an occurrence or notice of an intended or pending Change of Control (as defined in the Purchase Agreement) (a "Change of Control Notice") or the delivery by the Company of a notice of a redemption of the Company's 6% Senior Convertible Notes or the Company's 2% Senior Convertible Notes by the Company (a "Redemption Notice") and (y) the Holder can make subsequent adjustments pursuant to (w) or (x) any number of times (which adjustment shall be effective immediately). The delivery of an exercise notice by the Holder shall be deemed a representation by the Holder that it is in compliance with this paragraph. 6 7 9. AMENDMENT TO THE DESIGNATED 2% NOTES. In addition to the changes set forth in Section 6 herein, each of the Designated 2% Notes is hereby amended, effective the date hereof, as follows: (a) Interest Rate. The interest on the Designated 2% Notes shall be increased from 2% to 6% per annum. (b) Payment and Calculation of Interest. The existing accrued interest on the Designated 2% Notes on the date hereof shall be paid in the manner set forth in Section 3(a)(ii) in the form of Amended Designated 2% Notes referred to in paragraph (e) below. (c) Conversion Price. The Conversion Price shall be reduced from $1.50 to $1.125, subject to further adjustments pursuant to the terms of the Designated 2% Notes. (d) Benefits of 6% Note Agreement. The Designated 2% Notes shall be entitled to the benefits of the provisions contained in the 6% Note Agreement which apply to them. (e) Other Changes. The Designated 2% Notes shall be further amended, as provided in the form of Amended Designated 2% Notes, attached as Exhibit A hereto. (f) Amended Designated 2% Notes. Concurrently with the execution of this Amendment to Note Agreement, the 6% Note Purchasers shall exchange their existing Designated 2% Notes for amended Designated 2% Notes in the Form of Exhibit A, reflecting the amendment set forth in paragraphs (a) through (e) above and the amendments in Section 6 herein. 10. AMENDMENT TO THE DESIGNATED 2% NOTE WARRANTS. In addition to the changes set forth in Section 7 herein, each of the Designated 2% Note Warrants is hereby amended, effective the date hereof, as follows: (a) Exercise Price. The Exercise Price shall be reduced from $3.75 to $1.4625 per share (subject to further adjustment set forth in the Designated 2% Note Warrants). (b) Expiration Date. The Expiration Date shall be March 31, 2002. (c) Amended Designated 2% Note Warrants. Concurrently with the execution of this Amendment to Note Agreement, the 6% Note Purchasers shall exchange their existing certificates representing the Designated 2% Note Warrants for certificates, in the Form of Exhibit B hereto, reflecting the changes, set forth in paragraphs (a) and (b) above and the amendments in Section 7 herein. 11. EFFECT OF AMENDMENT. As amended herein, the 2% Note Agreement, the 2% Notes, the Designated 2% Notes, the 2% Note Warrants and the Designated 2% Note Warrants shall remain in full force and effect. 7 8 IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed by their respective authorized persons as of the date first indicated above. Company: ILLINOIS SUPERCONDUCTOR CORPORATION By: /s/ Edward W. Laves Name: Edward W. Laves Title: President and Chief Executive Officer Purchasers: ELLIOTT ASSOCIATES, L.P. By: /s/ Authorized Signatory Name: Title: WESTGATE INTERNATIONAL, L.P. By: Martley International, L.P. As Attorney-in-fact By: /s/ Authorized Signatory Name: Title: ALEXANDER FINANCE, LP By: /s/ Authorized Signatory Name: Title: 9 STATE FARM MUTUAL AUTOMOBILE INSURANCE COMPANY By: /s/ James Freytag Name: James Freytag Title: Vice President - Common Stocks By: /s/ John Gordon Name: John Gordon Title: Investment Officer SPRING POINT PARTNERS, L.P. By: Name: Title: SPRING POINT OFFSHORE FUND By: Name: Title: EX-10.16 7 FORM OF OFFICER INDEMNIFICATION 1 EXHIBIT 10.16 INDEMNIFICATION AGREEMENT THIS INDEMNIFICATION AGREEMENT (the "Agreement") is entered into as of the [insert day]th day of [insert month], [insert year], by and between Illinois Superconductor Corporation, a Delaware corporation (the "Company"), and [insert name of officer] ("Indemnitee"). RECITALS Indemnitee has been asked to serve as an officer of the Company (service in such a capacity shall hereafter be described as service as an "Agent"). Section 145 of the General Corporation Law of Delaware ("Section 145") empowers the Company to indemnify its Agents and expressly provides that the indemnification that it authorizes is not exclusive. The Company now maintains Directors' and Officers' Liability Insurance ("D & O Insurance") covering certain liabilities that may be incurred by certain of its Agents and others in the performance of their duties for the Company. Developments with respect to the terms and availability of D & O Insurance, however, have raised questions concerning the adequacy and reliability of the protection afforded thereby. The Company is aware that, as a result, competent and experienced persons have become increasingly reluctant to serve as directors or officers of corporations. To induce Indemnitee to continue to serve as an Agent, the Company is prepared to provide Indemnitee with the protections described in this Agreement. NOW, THEREFORE, in consideration of the willingness of Indemnitee to continue to serve as an Agent, the Company hereby agrees as follows: 1. INDEMNIFICATION GENERALLY. The Company agrees to hold harmless and to indemnify Indemnitee to the fullest extent authorized or permitted by Section 145, or, to the extent that any amendment to Section 145 or to other applicable law may expand indemnification rights, to the fullest extent authorized or permitted by Section 145 or such other applicable law as may be in effect. However, such indemnification shall not apply to expenses that Indemnitee has incurred in a suit brought by Indemnitee against the Company, except for expenses that Indemnitee has incurred in an action brought to enforce rights or to collect sums due under this Agreement in which Indemnitee is the prevailing party. 2. MAINTENANCE OF LIABILITY INSURANCE. 2.1 The Company agrees that, so long as Indemnitee shall continue to serve as an Agent and, thereafter, for so long as Indemnitee shall potentially be subject to any threatened, pending, or completed action, suit, or proceeding, whether civil, criminal, administrative, or investigative (a "Proceeding"), by reason of the fact that Indemnitee is or was an Agent of the Company, the Company, subject to Section 3 of this Agreement, shall maintain in amounts reasonably available to the Company D & O Insurance from established and reputable insurers. 2.2 Notwithstanding the Company's agreement in Section 2.1 above, the Company shall have no obligation to maintain D & O Insurance if the Company determines in good faith and in its reasonable business judgment that such insurance is not reasonably available, the premium costs for such insurance are disproportionate to the amount of coverage provided, or the coverage provided by such insurance is limited by exclusions so as to provide an insufficient benefit, or Indemnitee is covered adequately by similar insurance maintained by an affiliate of the Company. 3. SELF INSURANCE. If the Company does not maintain D & O Insurance in accordance with Section 2.1 of this Agreement, or if the coverage provided by such insurance is less than that provided by the D & O Insurance maintained by the Company at the time that this Agreement is signed or the D & O Insurance first 2 procured by the Company after this Agreement is signed, the Company, subject only to the exclusions contained in Section 5 of this Agreement, agrees to hold harmless and to indemnify Indemnitee to the fullest extent of the coverage that otherwise would have been provided to Indemnitee under the D & O Insurance that the Company currently maintains or ultimately procures. 4. ADDITIONAL INDEMNITY. Subject only to the exclusions set forth in Section 5 of this Agreement, the Company agrees to hold harmless and to indemnify Indemnitee against any and all expenses (including attorneys' fees and expenses), judgments, fines, and amounts paid in settlement that Indemnitee actually and reasonably has incurred in connection with any Proceeding to which Indemnitee is or was a party, or at any time either becomes a party or is threatened to be made a party by reason of the fact that Indemnitee is or was an Agent, subject to the same exclusion provided in the last sentence of Section 1 of this Agreement. 5. LIMITATIONS ON SELF INSURANCE AND ADDITIONAL INDEMNITY. The Company shall not pay any indemnity under Sections 3 or 4 of this Agreement: 5.1 to the extent that Indemnitee is indemnified in full under Sections 1 or 2 of this Agreement or under any D & O Insurance or any other insurance; or 5.2 with respect to (a) remuneration paid to Indemnitee if it shall be determined by a final adjudication that such remuneration was in violation of law or (b) expenses (including attorneys' fees) incurred by Indemnitee in connection with any Proceeding relating to such remuneration, unless Indemnitee is the prevailing party therein; or 5.3 either (a) on account of any suit in which a final, non-appealable judgment is rendered against Indemnitee under the provisions of Section 16 of the Securities Exchange Act of 1934 and amendments thereto or under similar provisions of any federal or state law or (b) on account of amounts paid in settlement of any litigation instituted or threatened under Section 16 or such law as a result of Indemnitee's purchase or sale of securities of the Company or of any affiliate of the Company; or 5.4 on account of Indemnitee's conduct, which finally and non-appealably has been adjudged to have been knowingly fraudulent or deliberately dishonest or to have involved willful misconduct; or 5.5 for expenses or other losses incurred in connection with Indemnitee's having in fact gained any personal profit or advantage to which Indemnitee was not legally entitled; or 5.6 if a court having jurisdiction in the matter shall finally and non-appealably determine that such indemnification would violate public policy or be otherwise unlawful. 6. PARTIAL INDEMNIFICATION. If Indemnitee is entitled under any provision of this Agreement to indemnification by the Company for a portion of any expenses or liabilities incurred by Indemnitee in the investigation, defense, settlement, or appeal of a Proceeding, but is not entitled to indemnification for the total amount of the expenses or liabilities, the Company shall indemnify Indemnitee for the portion of such expenses or liabilities to which Indemnitee is entitled. 7. DETERMINATION OF INDEMNIFICATION. 7.1 Notwithstanding any other provision of this Agreement (i) the obligations of the Company under Section 1 of this Agreement shall be subject to the condition that the Reviewing Party (as defined in Section 7.6 below) shall have determined (in a written opinion, in any case in which the Independent Legal Counsel referred to in Section 7.3 below is involved) that the Indemnitee would be permitted to be indemnified under this Agreement and (ii) the obligation of the Company to make an expense advance pursuant to Section 9 of this Agreement shall be subject to the condition that the Reviewing Party shall not have determined, in good faith, that the Indemnitee has failed to cooperate with any internal Company inquiry of any alleged misconduct committed by the Indemnitee. 7.2 The Reviewing Party shall be selected by the Company's Board of Directors; provided, 3 however, that if there has been a Change in Control (other than a Change in Control which has been approved by a majority of the Company's Board of Directors who were directors immediately prior to such Change in Control) the Reviewing Party shall be the Independent Legal Counsel referred to in Section 7.3 below. If there has been no determination by the Reviewing Party within the fifteen (15) day period referred to in Section 9 of this Agreement, the Reviewing Party shall be deemed to have made a determination that it is permissible to indemnify the Indemnitee under this Agreement. 7.3 The Company agrees that if there is a Change in Control (other than a Change in Control which has been approved by a majority of the Company's Board of Directors who were directors immediately prior to such Change in Control) then the Independent Legal Counsel (as defined in Section 7.7 below) shall be selected by the Indemnitee and approved by the Company (which approval shall not be unreasonably withheld) and such Independent Legal Counsel shall determine whether the officer is entitled to indemnification for expenses, judgments, fines, penalties and amounts paid in settlement (including, without limitation, all interest, assessments and other charges paid or payable in connection therewith) under this Agreement. Such Independent Legal Counsel shall render its written opinion to the Company and the Indemnitee as to whether and to what extent the Indemnitee will be permitted to be indemnified for expenses, judgments, fines, penalties and amounts paid in settlement (including, without limitation, all interest, assessments and other charges paid or payable in connection therewith). The Company agrees to pay the reasonable fees of the Independent Legal Counsel and to indemnify fully such Independent Legal Counsel against any and all expenses (including reasonable attorneys' fees), claims, liabilities and damages arising out of or relating to this Agreement or the engagement of such Independent Legal Counsel pursuant hereto. 7.4 If a determination denying the Indemnitee's claim is made by the Reviewing Party (other than the Independent Legal Counsel), notice of such determination shall disclose with particularity the reasons for such determination. If a determination denying the Indemnitee's claim is made by the Independent Legal Counsel, the notice shall include a copy of the related legal opinion of such counsel. 7.5 For purposes of this Agreement, a "Change in Control" shall be deemed to have occurred if (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company or a corporation owned directly or indirectly by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Securities Exchange Act of 1934), directly or indirectly, of securities of the Company representing 15% or more of the total voting power represented by the Company's then outstanding Voting Securities (as defined in Section 7.8 below), or (ii) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board of Directors of the Company and any new director whose election by the Company's Board of Directors or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority thereof, or (iii) the stockholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the Voting Securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into Voting Securities of the surviving entity) at least 85% of the total voting power represented by the Voting Securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or the stockholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company (in one transaction or a series of transactions) of all or substantially all of the assets of the Company. 7.6 For purposes of this Agreement, the "Reviewing Party" shall mean any appropriate person or body consisting of a member or members of the Board of Directors of the Company or any other person or body appointed by the Board who is not a party to the particular action, suit or proceeding with respect to which the Indemnitee is seeking indemnification, or the Independent Legal Counsel. 7.7 For purposes of this Agreement, the "Independent Legal Counsel" shall mean an attorney, selected in accordance with the provisions of Section 7.3 above, who shall not have otherwise performed services for the Company or the Indemnitee within the five years preceding such selection (other than in 4 connection with seeking indemnification under this Agreement). The Independent Legal Counsel shall not be any person who, under the applicable standards of professional conduct then prevailing, would have a conflict of interest in representing either the Company or the Indemnitee in an action to determine the Indemnitee's rights under this Agreement, nor shall the Independent Legal Counsel be any person who has been sanctioned or censured for ethical violations of applicable standards of professional conduct. 7.8 For purposes of this Agreement, "Voting Securities" shall mean any securities of the Company or another entity which vote generally in the election of directors of the Company or such other entity. 8. INDEMNIFICATION PROCEDURES. 8.1 Promptly after the receipt by Indemnitee of notice of the commencement or the threat of commencement of any Proceeding, Indemnitee shall, if Indemnitee believes that indemnification with respect to the Proceeding may be sought from the Company under this Agreement, notify the Company, consistent with Section 14 of this Agreement of the commencement or the threat of commencement of the Proceeding, but the failure of the Indemnitee to so notify the Company shall not relieve the Company from any liability it may have under this Agreement except to the extent that it has been prejudiced in any material extent by such failure, or from any liability which it may have otherwise. 8.2 If, at the time that the Company receives notice under Section 8.1 of this Agreement of the commencement or the threat of commencement of any Proceeding, the Company has D & O Insurance in effect, the Company shall give prompt notice of the commencement or the threat of commencement of such Proceeding to the insurer(s) in accordance with the procedures set forth in its insurance policy or policies. The Company then shall take all appropriate action to cause such insurer(s) immediately to pay all amounts payable as a result of such Proceeding or threatened Proceeding in accordance with the terms of such policy or policies, provided that the Company shall remain liable to pay any such amount in the event the insurer(s) fail to pay such amount. 8.3 If the Company is obligated to pay to Indemnitee the expenses of any Proceeding or threatened Proceeding, the Company, upon the delivery to Indemnitee of written notice of its election to do so, shall be entitled to assume Indemnitee's defense. The Company's assumption of Indemnitee's defense shall be subject to Indemnitee's approval of the counsel who is to conduct the defense. Counsel shall be approved or disapproved by Indemnitee within seven (7) days after the Company notifies Indemnitee of counsel's identity and shall be deemed approved unless Indemnitee provides the Company with notice to the contrary. After the approval of counsel selected by the Company, the Company will not be liable to Indemnitee under this Agreement for any attorneys' fees that Indemnitee subsequently incurs with respect to the same Proceeding, provided that (a) Indemnitee shall have the right to employ Indemnitee's own counsel in any such Proceeding at Indemnitee's own expense, and (b) Indemnitee may retain Indemnitee's own counsel, the fees and expenses of whom shall be paid by the Company, if (i) Indemnitee shall reasonably have concluded that a conflict or potential conflict exists between the Company and Indemnitee in the conduct of any such defense or (ii) the Company shall not, in fact, have employed counsel to assume the defense of such Proceeding. 9. ADVANCES OF EXPENSES. Prior to a determination that this Agreement in fact entitles Indemnitee to indemnification, expenses that Indemnitee has incurred or for which Indemnitee might be entitled to indemnity under this Agreement shall be advanced to Indemnitee by the Company within fifteen (15) days after the Company's receipt of Indemnitee's written request for such an advance, provided that Indemnitee undertakes in writing to repay such advance(s) to the extent that Indemnitee ultimately is determined not to be entitled to indemnification under the provisions of Section 145, this Agreement, or otherwise. 10. NON-EXCLUSIVITY. The provisions for indemnification and advancement of expenses contained in this Agreement shall not be deemed exclusive of any other rights that Indemnitee may have under any provision of law, the Company's Certificate of Incorporation or Bylaws, the vote of the Company's stockholders or disinterested directors, other agreements, or otherwise. Indemnitee's rights hereunder shall continue after Indemnitee has ceased acting as an Agent of the Company and shall inure to the benefit of Indemnitee's heirs, executors, and administrators. 5 11. SEVERABILITY. If any provision or provisions of this Agreement shall for any reason be held to be invalid, illegal, or unenforceable, (i) the validity, legality, and enforceability of the remaining provisions of this Agreement (including, without limitation, all portions of any paragraphs of the Agreement containing the provision or provisions held to be invalid, illegal, or unenforceable) shall not in any way be affected or impaired, and (ii) to the fullest extent possible, the provisions of this Agreement (including, without limitation, all portions of any paragraph of this Agreement held to be invalid, illegal, or unenforceable) shall be construed so as to give effect to the intent manifested by the provision or provisions that have been held to be invalid, illegal, or unenforceable to the maximum extent permitted by law. 12. MODIFICATION AND WAIVER. No supplement, modification, or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provision hereof (whether or not similar), and no such waiver shall constitute a continuing waiver. 13. SUCCESSORS AND ASSIGNS. The terms of this Agreement shall bind, and shall inure to the benefit of, the successors, assigns, heirs, executors, and administrators of the parties hereto. 14. NOTICE. All notices, consents, requests, approvals, and other communications required or permitted under this Agreement shall be in writing and shall be deemed to have been properly given if hand delivered or if sent by a courier freight prepaid (in either case, effective upon receipt or when refused), in the case of the Company, at the addresses listed below, and in the case of Indemnitee, at Indemnitee's address of record with the Company, or to such other addresses of which the parties may notify one another in writing. To the Company: Illinois Superconductor Corporation 451 Kingston Court Mount Prospect, IL 60056 Attn: General Counsel with a copy to: Katten Muchin & Zavis 525 West Monroe Street Suite 1600 Chicago, IL 60661-3693 Attn: Lawrence Levin, Esq. 15. GOVERNING LAW. This Agreement shall be governed exclusively by and construed according to the laws of the State of Delaware, as applied to contracts between Delaware residents entered into and to be performed entirely within Delaware. 16. THIRD PARTIES. This Agreement is entered into solely for the benefit of the Company and its successors and assigns, on the one hand, and of Indemnitee and Indemnitee's heirs, executors, and administrators, on the other hand, and no third party shall have any rights hereunder. 17. DURATION. This Agreement shall terminate upon the expiration of all statutes of limitations that would be applicable to any cause of action that could arise out of Indemnitee's service as an Agent. IN WITNESS WHEREOF, the parties to this Agreement have entered into this Indemnification Agreement effective as of the date first above written. ILLINOIS SUPERCONDUCTOR CORPORATION By: ______________________________________ Edward W. Laves President and Chief Executive Officer ------------------------------------------ (Signature) [NAME OF OFFICER] ----------------------- ----------------------- (Print Address) EX-10.17 8 EMPLOYMENT AGREEMENT DATED 7/1/98 1 EXHIBIT 10.17 EMPLOYMENT AGREEMENT Employment Agreement dated and effective as of July 1, 1998 (this "AGREEMENT"), between ILLINOIS SUPERCONDUCTOR CORPORATION, a Delaware corporation (with its successors and assigns, referred to as the "COMPANY"), and EDWARD W. LAVES ("LAVES"). PRELIMINARY STATEMENT Laves is currently employed by the Company pursuant to an Amended and Restated Employment Agreement between the Company and Laves dated and effective as of July 1, 1997 (the "PRIOR AGREEMENT"). The Company desires to continue to employ Laves, and Laves wishes to continue to be employed by the Company, upon certain terms and conditions not contained in the Prior Agreement, including an extension of the term of Laves' employment. In order to specify such terms and conditions, and extend the term of Laves' employment with the Company, Laves and the Company agree as follows: AGREEMENT 1. EMPLOYMENT FOR TERM. The Company hereby employs Laves and Laves hereby accepts employment with the Company for the period beginning on July 1, 1998 and ending on December 31, 1999 (the "TERM"), or upon the earlier termination of the Term pursuant to Section 6 below. The end of the Term for any reason shall end Laves' employment under this Agreement, but shall not terminate Laves' or the Company's other obligations in this Agreement. 2. POSITION AND DUTIES. During the Term, Laves shall continue to serve as the Chairman of the Board, President and Chief Executive Officer of the Company. During the Term, Laves shall also hold such additional positions and titles as the Board of Directors of the Company (the "BOARD") may determine from time to time. During the Term, Laves shall devote substantially all of his business time and best efforts to his duties as an employee of the Company. 3. COMPENSATION. (a) BASE SALARY. Effective as of June 11, 1998 and ending on December 31, 1999, the Company shall pay Laves a base salary at a rate of $200,000 per annum, payable at least monthly on the Company's regular pay cycle for professional employees. (b) BONUSES. Laves shall be eligible to receive bonuses of up to fifty percent (50%) of his base salary during Term as determined in the sole discretion of the Board. (c) OTHER AND ADDITIONAL COMPENSATION. Sections 3(a) and 3(b) establish minimum salary and bonus grant levels for Laves during the Term, and shall not preclude the Board from awarding Laves a higher salary or stock options at any time, nor shall they preclude the Board from awarding Laves bonuses or other compensation in the discretion of the Board. 4. EMPLOYEE BENEFITS. During the Term, Laves shall be entitled to the employee benefits, including vacation, health and other insurance benefits, and deferred compensation arrangements, made available by the Company to any other employee of the Company. 5. EXPENSES. The Company shall reimburse Laves for actual out-of-pocket expenses incurred by him in the performance of his services for the Company (in accordance with the Company's policy for such reimbursements applicable to the Company's executive officers on the same terms generally offered to such officers), upon the receipt of appropriate documentation of such expenses. 6. TERMINATION. 2 (a) GENERAL. The Term shall end immediately upon Laves' death. The Company may end the Term at any time for any reason or no reason, with or without "Cause" (as defined in Section 7(a) below) in the absolute discretion of the Board (but subject to the Company's obligations under this Agreement). (b) NOTICE OF TERMINATION. Promptly after it ends the Term, the Company shall give Laves notice of termination, including a statement of whether the termination was for Cause. The Company's failure to give notice under this Section shall not, however, affect the validity of the Company's termination of the Term. 7. SEVERANCE BENEFITS. (a) "CAUSE" DEFINED. "Cause" means willful malfeasance or willful misconduct by Laves in connection with his employment; Laves' gross negligence in performing any of his duties under this Agreement; Laves' conviction of, or entry of a plea of guilty to, or entry of a plea of nolo contendere with respect to, any crime other than a traffic violation or infraction which is a misdemeanor; Laves' willful and continuing breach of any written policy applicable to all employees adopted by the Company concerning conflicts of interest, political contributions, standards of business conduct or fair employment practices, procedures with respect to compliance with securities laws or any similar matters, or adopted pursuant to the requirements of any government contract or regulation; or material and continuing breach by Laves of any of his agreements in this Agreement. (b) TERMINATION WITHOUT CAUSE. If the Company ends the Term prior to December 31, 1999, other than for Cause, then the Company shall make the "Severance Payment" (as defined below) to Laves for and during the "Severance Period" (as defined below). The Severance Payment shall be payable in proportionate amounts at least monthly on the Company's regular pay cycle for professional employees and (if the last day of the Severance Period is not the last day of a pay period) on the last day of the Severance Period. Regardless of anything in this Agreement to the contrary, if Laves resigns as a result of a material change, or a related series of changes taken as a whole, in the scope or nature of his responsibilities as President and Chief Executive Officer of the Company, such change or changes shall be deemed to be a constructive termination of Laves' employment by the Company without Cause for all purposes of this Agreement, including without limitation the obligation of the Company to make the Severance Payments during the Severance Period. For purposes of this Agreement: (i) the term "SEVERANCE PAYMENT" means, for the period of 180 days from the commencement of the Severance Period, an amount equal to Laves' base salary in effect on the day prior to the date on which the Severance Period commences, and thereafter during the Severance Period an amount equal to 50% of Laves' base salary in effect at the time the Severance Period commenced; and (ii) the term "SEVERANCE PERIOD" means the period commencing on the day following the date of termination of Laves' employment with the Company and ending on the first anniversary of the date of termination, subject to earlier termination as of the date that Laves commences full time employment with any other person or entity. Laves agrees that during the Severance Period he shall endeavor to render reasonable advisory and consulting services to the Company with respect to matters pertaining to the business of the Company as the Board of Directors or the then Chairman of the Board may reasonably request in writing, provided that the Company acknowledges and agrees that Laves shall be obligated to perform such services only to the extent that Laves determines in his discretion that such services shall not interfere with the conduct of Laves' then current business and personal affairs at the time of any such request. The Company shall pay all reasonable out-of-pocket expenses incurred by Laves in the performance of such advisory and consulting services. (c) TERMINATION FOR ANY OTHER REASON. If the Company ends the Term for Cause, or, subject to the first paragraph of Section 7(b) above, if Laves resigns as an employee or officer of the Company, or if Laves dies, then the Company shall have no obligation to pay Laves any amount, whether for salary, benefits, bonuses, or other compensation or expense reimbursements of any kind, accruing after the end of the Term, and such rights shall, except as otherwise required by law, be forfeited immediately upon the end of the Term. (d) OPTION MATTERS. If the Company ends the Term without Cause, the Company and 3 Laves agree that notwithstanding any term or provision of any agreement between Laves and the Company to the contrary, (i) all options held by Laves to acquire shares of the common stock of the Company at the time of termination shall immediately become vested, and shall be immediately exercisable by Laves or his personal representative, and (ii) Laves (or his personal representative, as the case may be) shall have the right to exercise such vested options, and all other options previously vested in Laves prior to the date of termination, for a period of 365 days following such end of the Term. Laves and the Company agree that except as set forth above, all option agreements referred to above shall remain in full force and effect in accordance with their terms. 8. CONFIDENTIALITY, OWNERSHIP, AND COVENANTS OF NON-COMPETITION AND NON-SOLICITATION. (a) "COMPANY INFORMATION" AND "INVENTIONS" DEFINED. "COMPANY INFORMATION" means all information, knowledge or data of or pertaining to (i) the Company, and (ii) any other person, firm, corporation or business organization with which the Company may do business during the Term, that is not in the public domain (and whether relating to methods, processes, techniques, discoveries, pricing, marketing or any other matters). "INVENTIONS" collectively refers to any and all inventions, trade secrets, ideas, processes, formulas, source and object codes, data, programs, other works of authorship, know-how, improvements, discoveries, developments, designs, and techniques regarding any of the foregoing. (b) CONFIDENTIALITY. Except as provided in the next two sentences, Laves covenants and agrees that all Company Information shall be kept secret and confidential at all times during and after the end of the Term and shall not be used or divulged by him outside the scope of his employment as contemplated by this Agreement, except as the Company may otherwise expressly authorize by action of the Board. In the event that Laves is requested in a judicial, administrative or governmental proceeding to disclose any of the Company Information, Laves will promptly so notify the Company so that the Company may seek a protective order or other appropriate remedy and/or waive compliance with this Agreement. If disclosure of any of the Company Information is required, Laves may furnish the material so required to be furnished, but Laves will furnish only that portion of the Company Information that legally is required. (c) OWNERSHIP. Laves hereby assigns to the Company all of Laves' right (including patent rights, copyrights, trade secret rights, and all other rights throughout the world), title and interest in and to Inventions, whether or not patentable or registrable under copyright or similar statutes, made or conceived or reduced to practice or learned by Laves, either alone or jointly with others, during the course of the performance of services for the Company. Laves shall also assign to, or as directed by, the Company, all of Laves' right, title and interest in and to any and all Inventions, the full title to which is required to be in the United States government by a contract between the Company and the United States government or any of its agencies. The provisions of Sections 8(a), 8(b) and this Section 8(c) are not intended to supersede or limit the effect of any prior confidentiality or proprietary rights agreements previously executed by Laves. (d) PERIODS DEFINED. "NON-COMPETITION PERIOD" means the period beginning on the day following the date of termination of Laves' employment with the Company and ending on the first anniversary of the day following the date of termination of Laves' employment with the Company. "NON-SOLICITATION PERIOD" means the period beginning on the day following the date of termination of Laves' employment with the Company and ending on the second anniversary of the day following the date of termination of Laves' employment with the Company. (e) COVENANTS OF NON-COMPETITION AND NON-SOLICITATION. Laves acknowledges that his services pursuant to this Agreement are unique and extraordinary, that the Company will be dependent upon Laves for the development and growth of its business and related functions, and that he will continue to develop personal relationships with significant customers of the Company and to have control of confidential information concerning, and lists of customers of, the Company. Laves further acknowledges that the business of the Company is international in scope and cannot be confined to any particular geographic area of the United States. For the foregoing reasons, Laves covenants and agrees that during the Non-Competition Period Laves shall not, directly or indirectly, engage in, be financially interested in, represent, render any advice or services to, or be employed by, any other business (conducted for profit or not for profit) that is engaged in the development or production of (i) high temperature superconducting materials, (ii) radio frequency filter devices, or 4 (iii) fault current limiter devices, in any such case for or related to uses which are or could reasonably deemed to be competitive with the current or currently contemplated business of the Company in the world. For the reasons acknowledged by Laves at the beginning of this Section, Laves additionally acknowledges, covenants, and agrees that, during the Non-Solicitation Period, Laves shall not, directly or indirectly, whether on his own behalf or on behalf of any other person or entity, in any manner (A) solicit the business of or otherwise contact in any commercial capacity any person or entity that is, or is reasonably anticipated to become, at the date of termination to become, a customer, supplier, or contractor of the Company for the purpose of obtaining business of the type performed by the Company, or (B) solicit for employment any persons who were officers or employees of the Company upon the date of termination of his employment hereunder, or at any time during a ninety-day period preceding such date, or aid any competitive business organization in any attempt to hire any such officers or employees of the Company. Notwithstanding the foregoing, this Section (e) shall terminate and be of no further force or effect if the Company fails to make any payment or otherwise perform any obligation owed to Laves pursuant to Sections 3, 4, 5 and 7(b) above. (f) EQUITABLE REMEDIES. Laves acknowledges, covenants and agrees that, in the event he shall violate any provisions of this Section 8, the Company will not have an adequate remedy at law and will therefore be entitled to enforce each such provision by temporary or permanent injunctive or mandatory relief obtained in an action or proceeding without the necessity of posting any bond of any kind whatsoever, and without prejudice to any other remedies that may be available at law or in equity. The foregoing restrictions shall not preclude Laves from the ownership of not more than three percent (3%) of the voting securities of any corporation whose voting securities are registered under Section 12(g) of the Securities Exchange Act of 1934, even if its business competes with that of the Company. 9. SUCCESSORS AND ASSIGNS. (a) LAVES. This Agreement is a personal contract, and the rights and interests that the Agreement accords to Laves may not be sold, transferred, assigned, pledged, encumbered, or hypothecated by him. Except as contemplated in Section 7(d) above, Laves shall not have any power of anticipation, alienation or assignment of the payments contemplated by this Agreement, all rights and benefits of Laves shall be for the sole personal benefit of Laves, and no other person shall acquire any right, title or interest under this Agreement by reason of any sale, assignment, transfer, claim or judgment or bankruptcy proceedings against Laves. Except as so provided, this Agreement shall inure to the benefit of and be binding upon Laves and his personal representatives, distributees and legatees. (b) THE COMPANY. This Agreement shall be binding upon the Company and inure to the benefit of the Company and of its successors and assigns, including (but not limited to) any corporation that may acquire all or substantially all of the Company's assets or business or into or with which the Company may be consolidated or merged. This Agreement shall continue in full force and effect in the event that the Company sells all or substantially all of its assets, merges or consolidates, otherwise combines or affiliates with another business, dissolves and liquidates, or otherwise sells or disposes of substantially all of its assets. The Company's obligations under this Agreement shall cease, however, if the successor to, the purchaser or acquiror either of the Company or of all or substantially all of its assets, or the entity with which the Company has affiliated, shall assume in writing the Company's obligations under this Agreement (and deliver an executed copy of such assumption to Laves), in which case such successor or purchaser, but not the Company, shall thereafter be the only party obligated to perform the obligations that remain to be performed on the part of the Company under this Agreement. 10. ENTIRE AGREEMENT. This Agreement represents the entire agreement between the parties concerning Laves' employment with the Company and supersedes all prior negotiations, discussions, understandings and agreements, whether written or oral, between Laves and the Company relating to the subject matter of this Agreement. All prior employment agreements, including the Prior Agreement, between the Company and Laves shall remain in full force and effect with respect all matters addressed in such prior employment agreements occurring on or before the effective date of this Agreement. 11. AMENDMENT OR MODIFICATION, WAIVER. No provision of this Agreement may be amended or waived unless such amendment or waiver is agreed to in writing signed by Laves and by a duly authorized officer of the Company other that Laves. No waiver by any party to this Agreement of any breach by another party 5 of any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of a similar or dissimilar condition or provision at the same time, any prior time or any subsequent time. 12. NOTICES. All notices, demands or other communications of any kind to be given or delivered under this Agreement shall be in writing and shall be deemed to have been properly given if (a) delivered by hand, (b) delivered by a nationally recognized overnight courier service, (c) sent by registered or certified United States Mail, return receipt requested and first class postage prepaid, or (d) facsimile transmission followed by a confirmation copy delivered by a nationally recognized overnight courier service. Such communications shall be sent to the parties at their respective addresses as follows: If to Laves: Edward Laves If to the Company: Illinois Superconductor Corporation 451 Kingston Court Mount Prospect, Illinois 60056 Attention: Vice President of Human Resources with a copy to: Lawrence D. Levin Katten Muchin & Zavis 525 West Monroe Street, Suite 1600 Chicago, Illinois 60661-3693 Either party may change such address for delivery to the other party by delivery of a notice in conformity with the provisions of this section specifying such change. Notice shall be deemed to have been properly given (i) on the date of delivery, if delivery is by hand, (ii) three (3) days after the date of mailing if sent by certified or registered mail, (iii) one (1) day after date of delivery to the overnight courier if sent by overnight courier, or (iv) the next business day after the date of transmission by facsimile. 13. SEVERABILITY. If any provision of this Agreement or the application of any such provision to any party or circumstances shall be determined by any court of competent jurisdiction to be invalid and unenforceable to any extent, the remainder of this Agreement or the application of such provision to such person or circumstances other than those to which it is so determined to be invalid and unenforceable shall not be affected, and each provision of this Agreement shall be validated and shall be enforced to the fullest extent permitted by law. If for any reason any provision of this Agreement containing restrictions is held to cover an area or to be for a length of time that is unreasonable or in any other way is construed to be too broad or to any extent invalid, such provision shall not be determined to be entirely null, void and of no effect; instead, it is the intention and desire of both the Company and Laves that, to the extent that the provision is or would be valid or enforceable under applicable law, any court of competent jurisdiction shall construe and interpret or reform this Agreement to provide for a restriction having the maximum enforceable area, time period and such other constraints or conditions (although not greater than those currently contained in this Agreement) as shall be valid and enforceable under the applicable law. 14. SURVIVORSHIP. The respective rights and obligations of the parties hereunder shall survive any termination of this Agreement to the extent necessary to the intended preservation of such rights and obligations. 15. HEADINGS. All descriptive headings of sections and paragraphs in this Agreement are intended solely for convenience of reference, and no provision of this Agreement is to be construed by reference to the heading of any section or paragraph. 16. WITHHOLDING TAXES. All salary, benefits, reimbursements and any other payments to Laves under this Agreement shall be subject to all applicable payroll and withholding taxes and deductions required by any law, rule or regulation of and federal, state or local authority. 17. APPLICABLE LAW: JURISDICTION. The laws of the State of Illinois shall govern the 6 interpretation, validity and performance of the terms of this Agreement, without reference to rules relating to conflicts of law. Any suit, action or proceeding against Laves with respect to this Agreement, or any judgment entered by any court in respect thereof, may be brought in any court of competent jurisdiction in the State of Illinois, as the Company may elect in its sole discretion, and Laves hereby submits to the nonexclusive jurisdiction of such courts for the purpose of any such suit, action, proceeding or judgment. 18. INTERPRETATION AND CONSTRUCTION. Each of the parties to this Agreement has been represented by their own counsel, each has reviewed and approved this Agreement as executed, and neither party shall be charged with the responsibility of having drafted any provision of this Agreement so as to cause any rule of strict construction to be applied against such party. IN WITNESS WHEREOF, the parties hereto have executed this Employment Agreement as of the date first above written. ILLINOIS SUPERCONDUCTOR CORPORATION By: ------------------------------------ JAMES PAJCIC Vice-President Human Resources, Treasurer and Secretary ------------------------------------------- EDWARD W. LAVES EX-10.18 9 EMPLOYMENT AGREEMENT DATED 11/9/98 1 EXHIBIT 10.18 EMPLOYMENT AGREEMENT Employment Agreement dated and effective as of November 9, 1998 (this "AGREEMENT"), between ILLINOIS SUPERCONDUCTOR CORPORATION, a Delaware corporation (with its successors and assigns, referred to as the "COMPANY"), and DENNIS CRAIG ("CRAIG"). PRELIMINARY STATEMENT Craig is now employed as the Vice President - Engineering and Manufacturing of the Company. The Company desires to continue to employ Craig, and Craig wishes to continue to be employed by the Company, upon the terms and conditions set forth in this agreement. AGREEMENT 1. EMPLOYMENT FOR TERM. The Company hereby employs Craig and Craig hereby accepts employment with the Company for the period beginning on the date of this agreement and ending on December 31, 1999 (the "TERM"), or upon the earlier termination of the Term pursuant to Section 6 below. The end of the Term for any reason shall end Craig's employment under this Agreement, but shall not terminate Craig's or the Company's other obligations in this Agreement. 2. POSITION AND DUTIES. During the Term, Craig shall continue to serve as the Vice President Engineering and Manufacturing of the Company. During the Term, Craig shall also hold such additional positions and titles as the Board of Directors of the Company (the "BOARD") or the President may determine from time to time. During the Term, Craig shall devote substantially all of his business time and best efforts to his duties as an employee of the Company. 3. COMPENSATION. (a) BASE SALARY. Effective as of June 11, 1998 and ending on December 31, 1999, the Company shall pay Craig a base salary at a rate of $150,000 per annum, payable at least monthly on the Company's regular pay cycle for professional employees. (b) BONUSES. Craig shall be eligible to receive bonuses during the Term as determined in the sole discretion of the Board. (c) OTHER AND ADDITIONAL COMPENSATION. Sections 3(a) and 3(b) establish minimum salary and bonus grant levels for Craig during the Term, and shall not preclude the Board from awarding Craig a higher salary or stock options at any time, nor shall they preclude the Board from awarding Craig bonuses or other compensation in the discretion of the Board. 4. EMPLOYEE BENEFITS. During the Term, Craig shall be entitled to the employee benefits, including vacation, health and other insurance benefits, and deferred compensation arrangements, made available by the Company to any other employee of the Company. 5. EXPENSES. The Company shall reimburse Craig for actual out-of-pocket expenses incurred by him in the performance of his services for the Company (in accordance with the Company's policy for such reimbursements applicable to the Company's executive officers on the same terms generally offered to such officers), upon the receipt of appropriate documentation of such expenses. 6. TERMINATION. (a) GENERAL. The Term shall end immediately upon Craig's death. The Company may end the Term at any time for any reason or no reason, with or without "Cause" (as defined in Section 7(a) below) in the absolute discretion of the Board (but subject to the Company's obligations under this Agreement). 2 (b) NOTICE OF TERMINATION. Promptly after it ends the Term, the Company shall give Craig notice of termination, including a statement of whether the termination was for Cause. The Company's failure to give notice under this Section shall not, however, affect the validity of the Company's termination of the Term. 7. SEVERANCE BENEFITS. (a) "CAUSE" DEFINED. "Cause" means willful malfeasance or willful misconduct by Craig in connection with his employment; Craig's gross negligence in performing any of his duties under this Agreement; Craig's conviction of, or entry of a plea of guilty to, or entry of a plea of nolo contendere with respect to, any crime other than a traffic violation or infraction which is a misdemeanor; Craig's willful and continuing breach of any written policy applicable to all employees adopted by the Company concerning conflicts of interest, political contributions, standards of business conduct or fair employment practices, procedures with respect to compliance with securities laws or any similar matters, or adopted pursuant to the requirements of any government contract or regulation; or (v) material and continuing breach by Craig of any of his agreements in this Agreement. (b) TERMINATION WITHOUT CAUSE. If the Company ends the Term prior to December 31, 1999, other than for Cause, then the Company shall make the "Severance Payment" (as defined below) to Craig for and during the "Severance Period" (as defined below). The Severance Payment shall be payable in proportionate amounts at least monthly on the Company's regular pay cycle for professional employees and (if the last day of the Severance Period is not the last day of a pay period) on the last day of the Severance Period. Regardless of anything in this Agreement to the contrary, if Craig resigns as a result of a material change, or a related series of changes taken as a whole, in the scope or nature of his responsibilities as Vice President - Engineering and Manufacturing of the Company, such change or changes shall be deemed to be a constructive termination of Craig's employment by the Company without Cause for all purposes of this Agreement, including without limitation the obligation of the Company to make the Severance Payments during the Severance Period. For purposes of this Agreement: (i) the term "SEVERANCE PAYMENT" means, for the period of 180 days from the commencement of the Severance Period, an amount equal to Craig's base salary in effect on the day prior to the date on which the Severance Period commences; and (ii) the term "SEVERANCE PERIOD" means the period commencing on the day following the date of termination of Craig's employment with the Company and ending on the six-month anniversary of the date of termination, subject to earlier termination as of the date that Craig commences full time employment with any other person or entity. Craig agrees that during the Severance Period he shall endeavor to render reasonable advisory and consulting services to the Company with respect to matters pertaining to the business of the Company as the Board of Directors or the then Chairman of the Board may reasonably request in writing, provided that the Company acknowledges and agrees that Craig shall be obligated to perform such services only to the extent that Craig determines in his discretion that such services shall not interfere with the conduct of Craig's then current business and personal affairs at the time of any such request. The Company shall pay all reasonable out-of-pocket expenses incurred by Craig in the performance of such advisory and consulting services. (c) TERMINATION FOR ANY OTHER REASON. If the Company ends the Term for Cause, or, subject to the first paragraph of Section 7(b) above, if Craig resigns as an employee or officer of the Company, or if Craig dies, then the Company shall have no obligation to pay Craig any amount, whether for salary, benefits, bonuses, or other compensation or expense reimbursements of any kind, accruing after the end of the Term, and such rights shall, except as otherwise required by law, be forfeited immediately upon the end of the Term. (d) OPTION MATTERS. If the Company ends the Term without Cause, the Company and Craig agree that notwithstanding any term or provision of any agreement between Craig and the Company to the contrary, (i) all options held by Craig to acquire shares of the common stock of the Company at the time of termination shall immediately become vested, and shall be immediately exercisable by Craig or his personal representative, and (ii) Craig (or his personal representative, as the case may be) shall have the right to exercise such vested options, and all other 3 options previously vested in Craig prior to the date of termination, for a period of 365 days following such end of the Term. Craig and the Company agree that except as set forth above, all option agreements referred to above shall remain in full force and effect in accordance with their terms. 8. CONFIDENTIALITY, OWNERSHIP, AND COVENANTS OF NON-COMPETITION AND NON-SOLICITATION. (a) "COMPANY INFORMATION" AND "INVENTIONS" DEFINED. "COMPANY INFORMATION" means all information, knowledge or data of or pertaining to (i) the Company, and (ii) any other person, firm, corporation or business organization with which the Company may do business during the Term, that is not in the public domain (and whether relating to methods, processes, techniques, discoveries, pricing, marketing or any other matters). "INVENTIONS" collectively refers to any and all inventions, trade secrets, ideas, processes, formulas, source and object codes, data, programs, other works of authorship, know-how, improvements, discoveries, developments, designs, and techniques regarding any of the foregoing. (b) CONFIDENTIALITY. Except as provided in the next two sentences, Craig covenants and agrees that all Company Information shall be kept secret and confidential at all times during and after the end of the Term and shall not be used or divulged by him outside the scope of his employment as contemplated by this Agreement, except as the Company may otherwise expressly authorize by action of the Board. In the event that Craig is requested in a judicial, administrative or governmental proceeding to disclose any of the Company Information, Craig will promptly so notify the Company so that the Company may seek a protective order or other appropriate remedy and/or waive compliance with this Agreement. If disclosure of any of the Company Information is required, Craig may furnish the material so required to be furnished, but Craig will furnish only that portion of the Company Information that legally is required. (c) OWNERSHIP. Craig hereby assigns to the Company all of Craig's right (including patent rights, copyrights, trade secret rights, and all other rights throughout the world), title and interest in and to Inventions, whether or not patentable or registrable under copyright or similar statutes, made or conceived or reduced to practice or learned by Craig, either alone or jointly with others, during the course of the performance of services for the Company. Craig shall also assign to, or as directed by, the Company, all of Craig's right, title and interest in and to any and all Inventions, the full title to which is required to be in the United States government by a contract between the Company and the United States government or any of its agencies. The provisions of Sections 8(a), 8(b) and this Section 8(c) are not intended to supersede or limit the effect of any prior confidentiality or proprietary rights agreements previously executed by Craig. (d) PERIODS DEFINED. "NON-COMPETITION PERIOD" means the period beginning on the day following the date of termination of Craig's employment with the Company and ending on the first anniversary of the day following the date of termination of Craig's employment with the Company. "NON-SOLICITATION PERIOD" means the period beginning on the day following the date of termination of Craig's employment with the Company and ending on the second anniversary of the day following the date of termination of Craig's employment with the Company. (e) COVENANTS OF NON-COMPETITION AND NON-SOLICITATION. Craig acknowledges that his services pursuant to this Agreement are unique and extraordinary, that the Company will be dependent upon Craig for the development and growth of its business and related functions, and that he will continue to develop personal relationships with significant customers of the Company and to have control of confidential information concerning, and lists of customers of, the Company. Craig further acknowledges that the business of the Company is international in scope and cannot be confined to any particular geographic area of the United States. For the foregoing reasons, Craig covenants and agrees that during the Non-Competition Period Craig shall not, directly or indirectly, engage in, be financially interested in, represent, render any advice or services to, or be employed by, any other business (conducted for profit or not for profit) that is engaged in the development or production of (i) high temperature superconducting materials, (ii) radio frequency filter devices, or (iii) fault current limiter devices, in any such case for or related to uses which are or could reasonably deemed to be competitive with the current or currently contemplated business of the Company in the world. For the reasons acknowledged by Craig at the beginning of this Section, Craig additionally acknowledges, covenants, and agrees that, during the Non-Solicitation Period, Craig shall not, directly or indirectly, whether on his own behalf or on 4 behalf of any other person or entity, in any manner (A) solicit the business of or otherwise contact in any commercial capacity any person or entity that is, or is reasonably anticipated to become, at the date of termination to become, a customer, supplier, or contractor of the Company for the purpose of obtaining business of the type performed by the Company, or (B) solicit for employment any persons who were officers or employees of the Company upon the date of termination of his employment hereunder, or at any time during a ninety-day period preceding such date, or aid any competitive business organization in any attempt to hire any such officers or employees of the Company. Notwithstanding the foregoing, this Section (e) shall terminate and be of no further force or effect if the Company fails to make any payment or otherwise perform any obligation owed to Craig pursuant to Sections 3, 4, 5 and 7(b) above. (f) EQUITABLE REMEDIES. Craig acknowledges, covenants and agrees that, in the event he shall violate any provisions of this Section 8, the Company will not have an adequate remedy at law and will therefore be entitled to enforce each such provision by temporary or permanent injunctive or mandatory relief obtained in an action or proceeding without the necessity of posting any bond of any kind whatsoever, and without prejudice to any other remedies that may be available at law or in equity. The foregoing restrictions shall not preclude Craig from the ownership of not more than three percent (3%) of the voting securities of any corporation whose voting securities are registered under Section 12(g) of the Securities Exchange Act of 1934, even if its business competes with that of the Company. 9. SUCCESSORS AND ASSIGNS. (a) CRAIG. This Agreement is a personal contract, and the rights and interests that the Agreement accords to Craig may not be sold, transferred, assigned, pledged, encumbered, or hypothecated by him. Except as contemplated in Section 7(d) above, Craig shall not have any power of anticipation, alienation or assignment of the payments contemplated by this Agreement, all rights and benefits of Craig shall be for the sole personal benefit of Craig, and no other person shall acquire any right, title or interest under this Agreement by reason of any sale, assignment, transfer, claim or judgment or bankruptcy proceedings against Craig. Except as so provided, this Agreement shall inure to the benefit of and be binding upon Craig and his personal representatives, distributees and legatees. (b) THE COMPANY. This Agreement shall be binding upon the Company and inure to the benefit of the Company and of its successors and assigns, including (but not limited to) any corporation that may acquire all or substantially all of the Company's assets or business or into or with which the Company may be consolidated or merged. This Agreement shall continue in full force and effect in the event that the Company sells all or substantially all of its assets, merges or consolidates, otherwise combines or affiliates with another business, dissolves and liquidates, or otherwise sells or disposes of substantially all of its assets. The Company's obligations under this Agreement shall cease, however, if the successor to, the purchaser or acquiror either of the Company or of all or substantially all of its assets, or the entity with which the Company has affiliated, shall assume in writing the Company's obligations under this Agreement (and deliver an executed copy of such assumption to Craig), in which case such successor or purchaser, but not the Company, shall thereafter be the only party obligated to perform the obligations that remain to be performed on the part of the Company under this Agreement. 10. ENTIRE AGREEMENT. This Agreement represents the entire agreement between the parties concerning Craig's employment with the Company and supersedes all prior negotiations, discussions, understandings and agreements, whether written or oral, between Craig and the Company relating to the subject matter of this Agreement. All prior employment agreements, including the Prior Agreement, between the Company and Craig shall remain in full force and effect with respect all matters addressed in such prior employment agreements occurring on or before the effective date of this Agreement. 11. AMENDMENT OR MODIFICATION, WAIVER. No provision of this Agreement may be amended or waived unless such amendment or waiver is agreed to in writing signed by Craig and by a duly authorized officer of the Company other that Craig. No waiver by any party to this Agreement of any breach by another party of any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of a similar or dissimilar condition or provision at the same time, any prior time or any subsequent time. 12. NOTICES. All notices, demands or other communications of any kind to be given or delivered under 5 this Agreement shall be in writing and shall be deemed to have been properly given if (a) delivered by hand, (b) delivered by a nationally recognized overnight courier service, (c) sent by registered or certified United States Mail, return receipt requested and first class postage prepaid, or (d) facsimile transmission followed by a confirmation copy delivered by a nationally recognized overnight courier service. Such communications shall be sent to the parties at their respective addresses as follows: If to Craig: Dennis Craig Illinois Superconductor Corporation 451 Kingston Court Mt. Prospect, IL 60056 If to the Company: Illinois Superconductor Corporation 451 Kingston Court Mount Prospect, Illinois 60056 Attention: Vice President of Human Resources with a copy to: Lawrence D. Levin Katten Muchin & Zavis 525 West Monroe Street, Suite 1600 Chicago, Illinois 60661-3693 Either party may change such address for delivery to the other party by delivery of a notice in conformity with the provisions of this section specifying such change. Notice shall be deemed to have been properly given (i) on the date of delivery, if delivery is by hand, (ii) three (3) days after the date of mailing if sent by certified or registered mail, (iii) one (1) day after date of delivery to the overnight courier if sent by overnight courier, or (iv) the next business day after the date of transmission by facsimile. 13. SEVERABILITY. If any provision of this Agreement or the application of any such provision to any party or circumstances shall be determined by any court of competent jurisdiction to be invalid and unenforceable to any extent, the remainder of this Agreement or the application of such provision to such person or circumstances other than those to which it is so determined to be invalid and unenforceable shall not be affected, and each provision of this Agreement shall be validated and shall be enforced to the fullest extent permitted by law. If for any reason any provision of this Agreement containing restrictions is held to cover an area or to be for a length of time that is unreasonable or in any other way is construed to be too broad or to any extent invalid, such provision shall not be determined to be entirely null, void and of no effect; instead, it is the intention and desire of both the Company and Craig that, to the extent that the provision is or would be valid or enforceable under applicable law, any court of competent jurisdiction shall construe and interpret or reform this Agreement to provide for a restriction having the maximum enforceable area, time period and such other constraints or conditions (although not greater than those contained currently contained in this Agreement) as shall be valid and enforceable under the applicable law. 14. SURVIVORSHIP. The respective rights and obligations of the parties hereunder shall survive any termination of this Agreement to the extent necessary to the intended preservation of such rights and obligations. 15. HEADINGS. All descriptive headings of sections and paragraphs in this Agreement are intended solely for convenience of reference, and no provision of this Agreement is to be construed by reference to the heading of any section or paragraph. 16. WITHHOLDING TAXES. All salary, benefits, reimbursements and any other payments to Craig under this Agreement shall be subject to all applicable payroll and withholding taxes and deductions required by any law, rule or regulation of and federal, state or local authority. 17. APPLICABLE LAW: JURISDICTION. The laws of the State of Illinois shall govern the interpretation, validity and performance of the terms of this Agreement, without reference to rules relating to conflicts of law. Any suit, action or proceeding against Craig with respect to this Agreement, or any judgment entered by any court in respect thereof, may be brought in any court of competent jurisdiction in the State of Illinois, as the Company may elect in its sole discretion, and Craig hereby submits to the nonexclusive jurisdiction 6 of such courts for the purpose of any such suit, action, proceeding or judgment. 18. INTERPRETATION AND CONSTRUCTION. Each of the parties to this Agreement has been represented by their own counsel, each has reviewed and approved this Agreement as executed, and neither party shall be charged with the responsibility of having drafted any provision of this Agreement so as to cause any rule of strict construction to be applied against such party. IN WITNESS WHEREOF, the parties hereto have executed this Employment Agreement as of the date first above written. ILLINOIS SUPERCONDUCTOR CORPORATION By: ---------------------------------------- EDWARD W. LAVES President and Chief Executive Officer ---------------------------------------------- DENNIS CRAIG EX-23 10 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements Form S-8 No. 33-88716, Form S-8 No. 333-06003, Form S-3 No. 333-02846, Form S-3 No. 333-29797, Form S-3 No. 333-36089, Form S-3 No. 333-41731 and Form S-3 No. 333-56601 of our report dated February 26, 1999 (except Note 3, as to which the date is March 31, 1999), with respect to the financial statements and schedule of Illinois Superconductor Corporation included in the Annual Report on Form 10-K for the year ended December 31, 1998. /s/ Ernst & Young LLP ---------------------- Ernst & Young LLP Chicago, Illinois March 31, 1999 EX-27 11 FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 2,152,595 0 1,582,408 87,990 1,424,427 5,550,751 8,285,710 4,761,599 10,028,088 1,407,193 0 0 0 12,557 (785,525) 10,028,088 3,242,930 3,242,930 7,047,347 7,047,347 8,133,307 19,215 10,247,919 (21,911,954) 0 (21,911,954) 0 0 0 (21,911,954) (1.93) (1.93)
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