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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: June 30, 1998
Commission File Number: 0-22303
ILLINOIS SUPERCONDUCTOR CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 36-3688459
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
451 KINGSTON COURT, MOUNT PROSPECT, IL 60056
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (847) 391-9400
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 ____
As of August 7, 1998 there were outstanding 12,557,344 shares of common
stock, par value $.001, of the registrant.
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ILLINOIS SUPERCONDUCTOR CORPORATION
QUARTER ENDED JUNE 30, 1998
INDEX
PAGE
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements .................................................................... 3
Condensed Balance Sheets as of June 30, 1998 (unaudited) and December 31, 1997 ............. 3
Condensed Statements Of Operations (unaudited) for the three months ended June 30, 1998
and 1997, and the six months ended June 30, 1998 and 1997................................. 4
Condensed Statements Of Cash Flows (unaudited) for the six months ended June 30, 1998
and 1997.................................................................................. 5
Notes To Condensed Financial Statements .................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ................................................................... 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk .............................. 10
PART II - OTHER INFORMATION
Item 2. Legal Proceedings ....................................................................... 10
Item 3. Changes in Securities ................................................................... 12
Item 4. Submission of Matters to a Vote of Security Holders ..................................... 12
Item 6. Exhibits and Reports on Form 8-K ........................................................ 12
SIGNATURES ...................................................................................... 14
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PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ILLINOIS SUPERCONDUCTOR CORPORATION
CONDENSED BALANCE SHEETS
JUNE 30, 1998 AND DECEMBER 31, 1997
DECEMBER 31,
JUNE 30, 1998 1997
------------- -------------
(Unaudited)
ASSETS:
Current assets:
Cash and cash equivalents $8,465,835 $2,766,886
Investments 500,067 500,313
Inventories 1,550,154 1,726,141
Accounts receivable 1,086,160 586,501
Prepaid expenses and other 270,164 471,928
------------ ------------
Total current assets 11,872,380 6,051,769
Property and equipment:
Property and equipment 8,199,622 8,177,293
Less: accumulated depreciation 4,204,424 3,654,239
------------ ------------
Net property and equipment 3,995,198 4,523,054
Other assets:
Restricted certificates of deposit 380,000 380,000
Deferred financing costs, net 69,247 -
Patents and trademarks, net 605,490 579,486
------------ ------------
1,054,737 959,486
------------ ------------
Total assets $16,922,315 $11,534,309
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable $669,565 $717,425
Accrued liabilities 366,572 587,285
Current portion of other long-term debt 48,773 78,077
------------ ------------
Total current liabilities 1,084,910 1,382,787
Other long term debt, less current portion - 13,541
Senior Convertible Notes 10,350,000 -
Discount on Senior Convertible Notes (7,993,459) -
Deferred occupancy costs 91,312 91,412
Stockholders' equity:
Series B Convertible Preferred Stock at liquidation value: 0 and 95 shares issued and
outstanding at June 30, 1998 and December 31, 1997, respectively - 488,534
Series C Convertible Preferred Stock at liquidation value: 0 and 600 shares issued and
outstanding at June 30, 1998 and December 31, 1997, respectively - 3,038,424
Series G Convertible Preferred Stock at liquidation value: 0 and 700 shares issued and
outstanding at June 30, 1998 and December 31, 1997, respectively - 3,530,206
Common stock ($.001 par value); 30,000,000 and 15,000,000 shares authorized and 12,557,072 and
6,001,925 issued and outstanding at June 30, 1998 and December 31, 1997, respectively 12,557 6,002
Additional paid-in capital 60,078,035 41,991,941
Notes receivable from stockholders (698,508) (698,508)
Accumulated deficit (46,002,532) (38,310,030)
------------ ------------
Total stockholders' equity 13,389,552 10,046,569
------------ ------------
Total liabilities and stockholders' equity $16,922,315 $11,534,309
============ ============
NOTE: The condensed balance sheet at December 31, 1997 has been derived from
the audited financial statements at that date but does not not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements.
See accompanying notes to Condensed Financial Statements.
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ILLINOIS SUPERCONDUCTOR CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------- ------------------------------
1998 1997 1998 1997
------------- ------------ ------------ -----------
Net revenues $ 814,532 $ 89,000 $ 1,511,701 $ 539,000
Costs and expenses:
Cost of revenues 1,402,896 899,003 2,448,093 2,074,760
Research and development 587,343 1,136,888 1,338,383 2,401,422
Selling and marketing 461,834 455,141 829,588 1,021,643
General and administrative 813,608 821,398 1,494,825 1,479,957
------------- ------------ ------------ -----------
Total costs and expenses 3,265,681 3,312,430 6,110,889 6,977,782
------------- ------------ ------------ -----------
Operating income (loss) (2,451,149) (3,223,430) (4,599,188) (6,438,782)
Other income (expense):
Investment income 60,604 55,308 67,986 138,322
Interest expense (3,157,267) (4,334) (3,161,300) (10,762)
------------- ------------ ------------ -----------
(3,096,663) 50,974 (3,093,314) 127,560
------------- ------------ ------------ -----------
Net loss ($5,547,812) ($3,172,456) ($7,692,502) ($6,311,222)
============= ============ ============ ===========
Preferred Stock dividends (94) - (61,834) -
Net loss plus Preferred Stock dividends ($5,547,906) ($3,172,456) ($7,754,336) ($6,311,222)
============= ============ ============ ===========
Basic and diluted loss per common share ($0.44) ($0.63) ($0.77) ($1.25)
============= ============ ============ ===========
Weighted average number of
common shares outstanding 12,481,244 5,050,227 10,113,927 5,036,942
============= ============ ============ ===========
See accompanying notes to Condensed Financial Statements
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ILLINOIS SUPERCONDUCTOR CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
SIX MONTHS ENDED JUNE 30,
----------------------------------
1998 1997
------------- -------------
OPERATING ACTIVITIES:
Net loss $ (7,692,502) $ (6,311,222)
Adjustment to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 554,727 761,986
Noncash interest expense on Senior Convertible Notes 3,155,291 -
Changes in operating assets and liabilities (390,339) (756,366)
------------- -------------
Net cash used in operating activities (4,372,823) (6,305,602)
------------- -------------
INVESTING ACTIVITIES:
Payment of patent costs (30,545) (85,344)
Acquisition of property and equipment (22,329) (178,578)
------------- -------------
Net cash used in investing activities (52,874) (263,922)
------------- -------------
FINANCING ACTIVITIES:
Payments of financing costs (69,247) -
Proceeds from Senior Convertible Notes 10,350,000 -
Proceeds from issuance of preferred stock - net
of offering costs (120,587) 2,762,682
Proceeds from issuance of common stock - net of
offering costs - (8,537)
Exercise of stock options 7,325 56,594
Exercise of warrants - 67,364
Collection of notes receivable from stockholders - 444,246
Payments on other long-term debt (42,845) (40,005)
------------- -------------
Net cash provided by financing activities 10,124,646 3,282,344
------------- -------------
Increase (decrease) in cash and cash equivalents 5,698,949 (3,287,180)
Cash and cash equivalents at beginning of period 2,766,886 5,188,047
------------- -------------
Cash and cash equivalents at end of period $ 8,465,835 $ 1,900,867
============= =============
See accompanying notes to condensed financial statements
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ILLINOIS SUPERCONDUCTOR CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and six months ended June 30,
1998 are not necessarily indicative of the results that may be expected for the
year ending December 31, 1998. For further information, refer to the financial
statements and footnotes thereto included in Illinois Superconductor
Corporation's Annual Report on Form 10-K for the year ended December 31, 1997.
NOTE 2 - NET LOSS PER COMMON SHARE
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings per Share, which replaced the calculation of primary and fully diluted
earnings per share with basic and diluted earnings per share. Basic and diluted
net loss per common share is computed based on 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 the earnings per share amounts for
all periods have been presented and, where appropriate, restated to conform to
the Statement 128 requirements.
NOTE 3 - COMPREHENSIVE INCOME
As of January 1, 1998 the Company adopted Financial Accounting Standards
Board's Statement No.130, Reporting Comprehensive Income . Statement 130
establishes new rules for the reporting and display of comprehensive income and
its components; however, the adoption of this Statement had no impact on the
Company's net income or stockholders' equity.
During the three and six months ended June 30, 1998, total comprehensive
income (loss) amounted to $(5,547,812) and ($7,692,502), respectively, compared
to ($3,172,456) and ($6,311,222) for the same respective periods in 1997.
NOTE 4 - CAPITAL STOCK
During the first quarter of 1998, $475,000 (95 shares) of Series B
Convertible Preferred Stock were converted into 270,671 shares of the Company's
Common Stock ("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 thereon of $5,490 were also converted into 5,504 shares of Common
Stock. Currently, no shares of Series B, Series C or Series G Convertible
Preferred Stock remain outstanding.
On April 22, 1998, the shareholders of the Company approved an increase in
the number of shares of authorized Common Stock from 15,000,000 to 30,000,000.
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NOTE 5 - INVENTORIES
Inventories at June 30, 1998 consist of the following:
Raw materials $ 747,183
Work in process 178,717
Finished product 624,254
------------
$ 1,550,154
============
NOTE 6 - SECURITIES PURCHASE AGREEMENT
On May 15, 1998, the Company entered into a Securities Purchase Agreement
("Agreement") with various parties. Under the terms of the Agreement, the
Company issued and sold $10,350,000 aggregate principal amount of Senior
Convertible Notes ("Notes") and issued warrants to purchase 4,140,000 shares of
Common Stock (Warrants). The Notes bear interest at 2% per annum, payable in
cash or in shares of Common Stock at the Company's option, and are due on May
15, 2002. Holders of the Notes may convert the principal amount, plus accrued
and unpaid interest, if any, into shares of Common Stock at a conversion price
of $1.50 per share. Conversions are not permitted the first 90 days following
the issuance of the Notes and are 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
will be 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, resulting in a $3,118,542 charge in the second quarter of
1998.
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) was allocated to
additional paid-in capital, thus creating a 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, resulting in a $36,749 charge in
the second quarter of 1998.
NOTES 7 - LEGAL PROCEEDINGS
See "Part II - Other Information, Item 1. Legal Proceedings" for a complete
description of outstanding legal matters. The Company believes that the
resolution of the matters discussed therein will not have a material adverse
effect on the financial condition, results of operations or cash flows of the
Company.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Because ILLINOIS SUPERCONDUCTOR Corporation ("the Company") wants to provide
investors with more meaningful and useful information, this Quarterly Report on
Form 10-Q contains certain "forward-looking statements" (as such term is defined
in Section 21E of the Securities and 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. Such 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 for 1998
and beyond to differ materially from those expressed in, or implied by, such
statements. These important factors include, without limitation, demand for, and
acceptance of, the Company's products; the Company's ability to manufacture
commercial quantities of the Company's products on a timely, efficient and
cost-effective basis; competition by rival manufacturers of filters for the
wireless telecommunications market; the Company's ability to obtain additional
financing if and when needed; changes in technology; the Company's ability to
attract and retain key personnel; costs and other effects of legal proceedings
and claims; general business conditions of, and growth in, the wireless
telecophony industry; and general economic conditions. A more complete
description of these risks, uncertainties and assumptions, are included in the
Company's filings with the Securities and Exchange Commission, including those
described under the heading "Risk Factors" in the Company's Registration
Statement on Form S-3, as amended, initially filed in June 1998. The Company
undertakes no obligation to update or revise these forward-looking statements to
reflect new events or uncertainties.
The Company was founded in 1989 by ARCH Development Corporation, an
affiliate of the University of Chicago, to commercialize superconducting
technologies primarily for the wireless telecommunications industry. The
Company uses its patented and proprietary high temperature superconductor
(HTS) materials technologies to develop and manufacture radio frequency (RF)
front-end products which are designed to enhance the quality, capacity,
coverage and flexibility of cellular, personal communications services (PCS),
and other wireless telephony services.
The Company began commercial sales of its RF filter products in 1996. All
products revenues during the first six months of 1998 and 1997 were from
commercial sales of the Company's RF front-end products. The Company expects
sales of its RF front-end products to continue to increase during 1998 from 1997
levels.
RESULTS OF OPERATIONS
The Company's net revenues increased $725,532 and $972,701 to $814,532 and
$1,511,701 for the three and six months, respectively, ended June 30, 1998
compared to the same prior year periods. These increases were a result of
increased sales of the Company's RF front-end products.
Cost of revenues increased to $1,402,896 and $2,448,093 for the three
and six months, respectively, ended June 30, 1998 from $899,003 and $2,074,760
in the comparable prior year periods. The reduction in cost of revenues as a
percentage of net revenues was due to improvements in direct materials cost per
unit, greater labor efficiencies, and reduced manufacturing overhead costs. The
Company expects such improvements to continue during the rest of 1998. The
Company, however, expects the cost of revenues to exceed the revenues realized
until it manufactures and ships a more significant amount of its commercial
products.
The Company's net research and development expenses decreased to $587,343
and $1,338,383 for the three and six month periods, respectively, ended June 30,
1998, from $1,136,888 and $2,401,422 for the same periods in 1997. These
decreases were due to a reduction in personnel, engineering material, and other
operating costs. The Company expects that its research and development expenses
during 1998 will continue to be reduced from 1997 levels.
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Selling and marketing expenses increased to $461,834 for the three months
ended June 30, 1998 from $455,141 for the same period in 1997, and decreased to
$829,588 for the six months ended June 30, 1998 from $1,021,643 for the same
period in 1997. The increase in the three month period was primarily due to
additional staffing, while the decrease for the six month period was due to
reduced marketing personnel costs and related expenses, reduction in field trial
consulting services, and lower advertising costs.
General and administrative expenses decreased to $813,608 for the three
months ended June 30, 1998 from $821,398 for the same period in 1997, and
increased to $1,494,825 for the six months ended June 30, 1998 from $1,479,957
for the same period in 1997. The decrease for the three month period was due to
reduced personnel costs, while the increase for the six month period was
primarily attributable to increased legal expenses, and was partially offset by
reduced financial services expense and personnel costs.
Interest expense, net of interest income increased to $3,096,663 and
$3,093,314 for the three and six month periods, respectively, ended June 30,
1998 from $50,974 and $127,560 of investment income, net of interest expense for
the same periods in 1997. The increases in interest expense was primarily due to
a $3,115,291 charge in the second quarter to amortize the discount on the
Senior Convertible Notes issued on May 15, 1998.
IMPACT OF YEAR 2000
Based on a recent assessment, the Company has determined that it will
require very little modification to its software to comply with Year 2000
transition requirements. Most of the software used by the Company in operational
applications has been acquired within the past 18 months and such software
already address Year 2000 issues. The Company expects to complete any other
modifications that may be necessary by December 31, 1998, which is prior to any
anticipated impact to the Company's operating systems. The Company realizes,
however, that the failure by it or those with which it transacts business to
address the Year 2000 issue could adversely affect the Company.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1998, the Company's cash, cash equivalents and investments,
including certain restricted investments, was approximately $9,345,902,
reflecting an increase of approximately $5,698,703 from $3,647,199 at December
31, 1997.
During 1995 and 1996, the Company financed a portion of its leasehold
improvements and capital equipment additions through various borrowings
approximating $743,000, of which $59,000 was outstanding at June 30, 1998. This
remaining balance is due in monthly installments through May 1999 and bears
interest at 8.5% per annum. Approximately $699,000 in principal amount of
promissory notes, plus approximately $106,000 of accrued interest thereon from
certain stockholders was outstanding as of June 30, 1998. This receivable was
due on April 30, 1997. The Company has filed a lawsuit to collect the
outstanding balance, but there can be no assurance when and if such promissory
notes will be repaid. (See "Part II - Other Information, Item 1. Legal
Proceedings")
The Company to date has generated limited revenues from product sales. The
continuing development and expansion in the 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 cost of additional plant and equipment for
manufacturing and the costs involved in protecting the Company's patents or
other intellectual property. As a result of these factors and the Company's
recent funding requirements, on May 15, 1998, the Company entered into a
Securities Purchase Agreement with a group of investors whereby the Company
issued $10.35 million principal amount of Senior Convertible Notes which accrue
interest payable in cash or Common stock, at 2% per annum. In connection with
the Securities Purchase Agreement, the Company also issued warrants to purchase
4,140,000 shares of the Company's Common Stock at an exercise price of $3.75 per
share. (See "Part II - Other Information, Item 2. Changes in Securities").
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Without consideration of proceeds from additional financings, the Company
believes that its available cash, cash equivalents and investments is sufficient
to finance the Company's current operating plans through at least December 31,
1998. The Company's strategy to generate sufficient working capital to fund its
operations and cash requirements in the future includes advancing market
penetration with OEM's 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 the
implementation of an overhead reduction program . In addition, the Company has
strengthened its Board of Directors and management team by adding several
industry veterans and experienced businessmen to assist in implementing the
Company's plans.
While continuously evaluating its needs for capital, the Company may in the
future pursue additional sources of capital it considers appropriate based upon
Company requirements and market conditions. If the Company is unable to
successfully implement its business plan on a timely basis or cannot obtain
adequate funds when needed in the future, the Company may be required to delay,
scale back or eliminate the manufacturing, marketing or sales of one or more of
its products or some or all of its research and development programs. This could
substantially impair the Company's ability to compete in the marketplace.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - Not
Applicable
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On June 5, 1996, Craig M. Siegler filed a complaint against the Company in
the Circuit Court of Cook County, Illinois, County Department, Chancery
Division. The complaint alleged that, in connection with the Company's private
placement of securities in November 1995, the Company breached and repudiated an
oral contract with Mr. Siegler for the issuance and sale by the Company to Mr.
Siegler of 370,370.37 shares of the Company's 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 9, 1996, Mr. Siegler filed his First Amended Verified Complaint
and Jury Demand, seeking a jury trial and money damages equal to the difference
between $8,800,000 (370,370.37 shares at $10.80 per share and 370,370.37 shares
at $12.96 per share) and 740,740.74 multiplied by the highest price at which the
Common Stock traded on The Nasdaq Stock Market between November 20, 1995 and the
date of judgment. Mr. Siegler also preserved his claim for specific performance
for purposes of appeal. On November 1, 1996, the case was transferred to the
Circuit Court of Cook County, Illinois, County Department, Law Division. The
Company's Answer was filed on November 21, 1996 and 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.
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' obligation 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 Company's Common Stock in December 1996.
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On September 30, 1997, the Borrowers and the Guarantor responded to the
Company's complaint. Concurrently, the Borrowers filed a counterclaim alleging
that they exercised the warrants in reliance on the Company's alleged fraudulent
representations to certain of the 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 recently began
discovery. The Company regards the amended fraud defense and counterclaim 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 remaining Borrowers and the Guarantor under the promissory
notes and the guarantee.
On November 21, 1997, a stockholder, Sheldon Drobny, sued the Company and
seven of its former or current directors: Edward W. Laves, Leonard A. Batterson,
Paul G. Yovovich, Peter S. Fuss, Steven Lazarus, Tom L. Powers and Ora E. Smith
(collectively, the "Directors") in the Circuit Court of Cook County, Illinois,
County Department, Law Division. The complaint alleged that the Directors
breached their duties of loyalty and due care to Mr. Drobny by selecting
financing for the Company in June 1997 which supposedly entrenched the
Directors, eroded the Common Stock price and diluted Mr. Drobny's equity in the
Company. Mr. Drobny's complaint sought an unspecified amount of compensatory
damages in excess of $50,000.
The Company and the Directors regard the suit as without factual or legal
merit. Accordingly, on January 16, 1988 the Company and the Directors filed a
motion to dismiss Mr. Drobny's complaint. The motion presented arguments that
Mr. Drobny's claims are barred by the business judgment rule, Mr. Drobny lacks
standing to assert his claims against the Directors and the complaint has
various technical pleading defects. To date Mr.Drobny has not responded to the
Company's and the Directors' motion to dismiss. Instead, Mr. Drobny filed a
motion seeking voluntary dismissal of his complaint on February 25, 1998. Mr.
Drobny's motion alleges that he "wishes to become part of the class action"
filed by Mr. Lipman (as described below), "instead of prosecuting (his) separate
but parallel case." On July 20, 1998, the court granted Mr. Drobny's motion for
voluntary dismissal and the case was dismissed without prejudice.
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 Yovovich (collectively, the "Board") in the Circuit Court of Cook County,
Illinois, County Department, Chancery Division. The complaint alleged that the
Board breached its duty of loyalty and due care to the putative class of
stockholders by selecting financing for the Company in June 1997 which
supposedly entrenched the Board and reduced the Common Stock price. The
complaint also alleged that the Board breached its 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 Company's Common Stock during the period from June 6, 1997
through November 21, 1997, excluding the Board and Sheldon Drobny. The complaint
also seeks an unspecified amount of compensatory and punitive damages, and
attorneys' fees.
The Company and the Board regard the suit as without factual or legal
merit. Accordingly, on February 17, 1998, the Company and the Board 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
judgement rule and the plaintiff's failure to fulfill the legal prerequisites
for filing an action against the Board. Prior to a hearing on the Company's and
the Board's 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 Board's 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 Company's eight former or current
directors but no longer included the Company itself as a defendant. The amended
complaint alleges that the 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 that financing. The
amended complaint seeks certification of a class consisting of all
11
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owners of the Company's Common Stock during the period from May 15, 1997 through
December 31, 1997, excluding the directors. Mr. Lipman's amended complaint
alleges that the stock owned by the putative class lost $61 million due to the
financing the directors selected, and seeks an unspecified amount of
compensatory and punitive damages. The Company and the Board regard the amended
complaint as without factual or legal merit. Accordingly, the Board filed a
motion to dismiss Mr. Lipton's amended complaint on July 29, 1998.
On June 24, 1998, Jonathan Greenwald, derivatively on behalf of the
Company, filed a complaint against the Company and the Board in the Court of
Chancery of the State of Delaware in and for New Castle County. The Company was
served with the complaint on July 31, 1998. To date, service of the complaint
upon the Board has not yet been completed. Mr. Greenwald's complaint alleges
that the Board breached its duties of good faith, loyalty, due care, and candor
by selecting financing for the Company in 1997 which reduced the Common Stock
price and was accepted to entrench the Board. The complaint seeks an
unspecified amount of compensatory damages, various equitable relief and
attorney's fees.
The Company and the Board regard the suit as without factual or legal
merit. Accordingly, following completion of service upon the Board and at such
time as response to Mr. Greenwald's complaint is required under Delaware law,
the Company and the Board anticipate filing an appropriate motion contesting the
complaint.
ITEM 2. CHANGES IN SECURITIES
On May 15, 1998, the Company issued $10,350,000 aggregate principal amount
of Senior Convertible Notes (the "Notes") to a group of institutional investors.
Interest on the Notes is payable, in cash or shares of Common stock at the
option of the Company, at the rate of 2% per annum. The Notes, exclusive of
interest, are convertible into 6,900,002 shares of Common Stock. One half of the
principle amount of the Notes is convertible into shares of Common Stock as of
August 13,1998 and the remaining principal amount of the Notes will be
convertible into shares of Common Stock beginning on November 11, 1998. In
connection with the issuance of the Notes, the Company also issued to the
investors warrants to purchase 4,140,000 shares of Common Stock at an exercise
price of $3.75 per share (the "Warrants").
The sale of the Notes and Warrants was exempt from the registration
requirements of the Securities Act of 1993, as amended (the "Act"), pursuant to
Section 4(2) of the Act and/or Regulation D promulgated thereunder as a
transaction by an issuer not involving a public offering, in that the
transaction involved the issuance and sale by the Company of its securities to
financially sophisticated institutions which represented that they were aware of
the Company's activities and business and financial condition, and which
represented that they acquired such securities for investment purposes for their
own account and not for distribution. All securities representing the Notes and
Warrants have been legended. The Company has registered for public resale under
the Act the shares of Common Stock into which the Notes and Warrants are
convertible or exercisable, as applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
a) A Special Meeting of Stockholders of the Company was held on April 22,
1998.
b) The stockholders voted to increase the authorized shares of Common Stock
from 15,000,000 to 30,000,000. Results of voting were as follows:
For Against Abstentions Brokers Non-Voters
- --------- ----------- ----------- ------------------
8,570,899 1,610,184 65,727 0
(c) The 1998 Annual Meeting of Stockholders of the Company was held on
June 11, 1998.
(d) The stockholders voted to re-elect two Class II directors to the
Company's Board of Directors. Results of the voting were as follows:
Directors For Authority Abstentions Broker Non-
--------- --- --------- ----------- -----------
Withheld Votes
-------- -----
Peter S. Fuss 10,046,257 482,203 0 0
Tom L. Powers 10,047,982 480,478 0 0
Steven Lazarus, Edward W. Laves, Robert D. Mitchum and Terry S. Parker
continued their terms of office as directors of the Company after the 1998
Annual Meeting of Stockholders. Ora E. Smith resigned as a director of the
Company and the Company's Board of Directors elected Mark D. Brodsky to
replace him as a director of the Company.
(e) The Stockholders also voted to ratify the appointment by the Company's
Board of Directors of Ernst & Young LLP as the independent auditors
of the Company's financial statements for the year ended December 31,
1998. Results of the voting were as follows:
For Against Abstentions Broker Non-Votes
--- ------- ----------- ----------------
10,210,042 230,657 87,761 0
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS -
Exhibit 27 - Financial Data Schedule
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B. REPORTS ON FORM 8-K
Reports on Form 8-K filed by the Company during the quarter ended
June 30, 1998 were filed by the Company on the following dates:
April 22, 1998, reporting Item 5
May 15, 1998, reporting Items 5 and 7
June 15, 1998, reporting Items 5 and 7
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SIGNATURES
Pursuant to the requirements 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.
ILLINOIS SUPERCONDUCTOR CORPORATION
Registrant
Date: August 14, 1998 By: /s/ Edward W. Laves
-------------------------------------
Edward W. Laves
President and Chief Executive Officer
Date: August 14, 1998 By: /s/ Kenneth Edward Wolf
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Kenneth E. Wolf
Controller