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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
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)
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
----- -----
On May 6, 1999, 12,557,344 shares of the registrant's Common Stock, par
value $0.001 per share, were outstanding.
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TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements...................................................................................... 1
Condensed Balance Sheets as of March 31, 1999 (unaudited) and December 31, 1998......................... 1
Condensed Statements of Operations (unaudited) for the three months ended
March 31, 1999 and 1998................................................................................. 2
Condensed Statements of Cash Flows (unaudited) for the three months ended
March 31, 1999 and 1998................................................................................. 3
Notes to Condensed Financial Statements................................................................. 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................... 6
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................................ 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................................................................... 9
Item 2. Changes in Securities and Use of Proceeds................................................................. 12
Item 3. Defaults Upon Senior Securities........................................................................... *
Item 4. Submission of Matters to a Vote of Security Holders....................................................... *
Item 5. Other Information......................................................................................... 12
Item 6. Exhibits and Reports on Form 8-K.......................................................................... 12
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* No reportable information under this item.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ILLINOIS SUPERCONDUCTOR CORPORATION
CONDENSED BALANCE SHEETS
MARCH 31, DECEMBER 31,
1999 1998
------------ -------------
(UNAUDITED)
ASSETS:
Current assets:
Cash and cash equivalents $ 3,962,862 $ 2,152,595
Inventories 2,981,198 1,424,427
Accounts receivable, net 527,313 1,494,418
Prepaid expenses and other 475,283 479,311
------------ -------------
Total current assets 7,946,656 5,550,751
Property and equipment:
Property and equipment 8,314,348 8,285,710
Less: accumulated depreciation 4,982,639 4,761,599
------------ -------------
Net property and equipment 3,331,709 3,524,111
Other assets:
Restricted certificates of deposit 341,307 337,347
Patents and trademarks, net 632,440 615,879
------------ -------------
973,747 953,226
------------ -------------
Total assets $ 12,252,112 $ 10,028,088
============ =============
LIABILITIES AND STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY):
Current liabilities:
Accounts payable $ 1,705,037 $ 464,752
Accrued liabilities 615,366 799,569
Accrued interest 181,125 129,375
Current portion of other long-term debt 13,259 13,497
------------ -------------
Total current liabilities 2,514,787 1,407,193
Other long term debt, less current portion 16,919 -
Senior Convertible Notes 13,650,000 10,350,000
Discount on Senior Convertible Notes (1,241,528) (1,047,349)
Deferred occupancy costs 91,162 91,212
Stockholders' equity (net capital deficiency):
Common stock ($.001 par value); 30,000,000 shares 12,557 12,557
authorized and 12,557,344 shares issued and outstanding at
March 31, 1999 and December 31, 1998
Additional paid-in capital 60,396,321 60,055,321
Notes receivable from stockholders (680,696) (680,696)
Accumulated deficit (62,507,410) (60,160,150)
------------ -------------
Total stockholders' equity (net capital deficiency) (2,779,228) (772,968)
------------ -------------
Total liabilities and stockholders' equity (net capital
deficiency) $ 12,252,112 $ 10,028,088
============ =============
NOTE: The condensed balance sheet as of December 31, 1998 has been derived from
the audited financial statements for that date but does not include all of the
information and accompanying notes required by generally accepted accounting
principles for complete financial statements.
See the accompanying Notes which are an integral part of the Condensed Financial
Statements.
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ILLINOIS SUPERCONDUCTOR CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
1999 1998
----------------------- ------------------------
Net revenues $ 511,900 $ 697,169
Costs and expenses:
Cost of revenues 1,009,026 1,045,197
Research and development 521,563 751,040
Selling and marketing 456,515 367,754
General and administrative 708,519 681,217
----------------------- ------------------------
Total costs and expenses 2,695,623 2,845,208
----------------------- ------------------------
Operating income (loss) (2,183,723) (2,148,039)
Other income (expense):
Interest income 38,356 7,382
Interest expense (129,417) (4,033)
----------------------- ------------------------
(91,061) 3,349
----------------------- ------------------------
Loss before extraordinary item (2,274,784) (2,144,690)
Extraordinary item - debt extinguishment (73,000) -
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Net loss (2,347,784) (2,144,690)
Preferred Stock dividends - (61,740)
----------------------- ------------------------
Net loss plus Preferred Stock dividends $ (2,347,784) $ (2,206,430)
======================= ========================
Basic and diluted loss per common share $ (0.19) $ (0.29)
======================= ========================
Weighted average number of common shares
outstanding 12,557,344 7,714,379
======================= ========================
See the accompanying Notes which are an integral part of the Condensed Financial
Statements.
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ILLINOIS SUPERCONDUCTOR CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
1999 1998
---------------------- -----------------------
OPERATING ACTIVITIES:
Net loss $ (2,347,784) $ (2,144,690)
Adjustment to reconcile net loss to net cash used in
operating activities:
Extraordinary item 73,000 -
Depreciation and amortization 230,756 233,831
Non-cash interest expense on Senior Convertible Notes 125,570 -
Changes in operating assets and liabilities 462,246 (431,681)
---------------------- -----------------------
Net cash used in operating activities (1,456,212) (2,342,540)
---------------------- -----------------------
INVESTING ACTIVITIES:
Payment of patent costs (21,564) (17,387)
Acquisition of property and equipment (11,957) (14,443)
---------------------- -----------------------
Net cash used in investing activities (33,521) (31,830)
---------------------- -----------------------
FINANCING ACTIVITIES:
Proceeds from issuance of Senior Convertible Notes 3,300,000 -
Additional offering costs from issuance of Preferred
Stock - (39,896)
Exercise of stock options - 7,359
Increase (decrease) in other long-term debt - (21,201)
---------------------- -----------------------
Net cash provided by financing activities 3,300,000 (53,738)
---------------------- -----------------------
Increase (decrease) in cash and cash equivalents 1,810,267 (2,428,108)
Cash and cash equivalents at beginning of period 2,152,595 2,766,886
---------------------- -----------------------
Cash and cash equivalents at end of period $ 3,962,862 $ 338,778
====================== =======================
See the accompanying Notes which are an integral part of the 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
notes 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 months ended March 31, 1999 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1999. For further information, refer to the financial
statements, including the notes thereto, included in Illinois Superconductor
Corporation's (the "Company") Annual Report on Form 10-K for the fiscal year
ended December 31, 1998.
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 for 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 first quarter of 1999 and 1998, total comprehensive income
(loss) amounted to $(2,347,784) and $(2,206,430), respectively.
NOTE 4 - INVENTORIES
Inventories consisted of the following:
MARCH 31, 1999 DECEMBER 31, 1998
-------------- -----------------
Raw materials.............. $2,510,575 $1,083,605
Work in process............ 288,101 60,456
Finished product........... 182,522 280,366
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Total inventory............ $2,981,198 $1,424,427
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NOTE 5 - LONG TERM DEBT
On May 15, 1998, the Company issued and sold $10,350,000 in aggregate
principal amount of senior convertible notes due May 15, 2002 (the "1998 Notes")
and issued warrants (the "1998 Warrants") to purchase 4,140,000 shares of the
Company's common stock, par value $0.001 per share ("Common Stock"). The 1998
Notes bear interest at 2% per annum, payable in cash or shares of Common Stock
at the Company's option, and mature on
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May 15, 2002. Holders of the 1998 Notes may convert the principal amount, plus
accrued and unpaid interest, if any, into shares of 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 1998 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 1998 Notes. On and after May 15, 2000, the Company may
redeem all or a portion of the 1998 Notes at a redemption price equal to the
principal amount plus accrued interest thereon, if any, under certain
conditions. The 1998 Warrants have an exercise price of $3.75 per share and
expire on May 15, 2001.
Since the 1998 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 Common Stock on the date of issuance multiplied by the number of
shares into which the 1998 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 1998 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 1998 Warrants issued in
conjunction with the 1998 Notes (equal to $1,230,000, and calculated using the
Black-Scholes Approximation Formula) 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 1998 Notes. The Company recognized $125,570 of
non-cash interest charges during the first quarter of 1999 as a result of the
amortization of the discount on the 1998 Notes.
On March 31, 1999, the Company issued and sold $3.3 million in aggregate
initial principal amount of senior convertible notes due May 15, 2002 (the "New
Notes") and issued warrants (the "New Warrants") to purchase 1,320,000 shares of
Common Stock. 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 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. Concurrently with the issuance of the New Notes, the Company amended
certain terms of $5.5 million in aggregate principal amount of the 1998 Notes
(the "Amended Notes") and the 1998 Warrants exercisable for an aggregate of
2,200,000 shares of the 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 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. A portion of the proceeds of the New
Notes equal to the fair value of the New Warrants issued in conjunction with the
New Notes (equal to $300,000 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 three year term
of the New Notes. In addition, the increase in fair value of the Amended
Warrants as a result of the decrease in exercise price (equal to $41,000 and
calculated using the Black-Scholes Approximation Formula) was allocated to
additional paid-in capital, thus creating an additional discount on the Amended
Notes. This discount will be recognized as a charge to interest expense using
the effective interest method over the remaining three year term of the Amended
Notes.
These amendments resulted in a $73,000 charge in the first quarter of 1999
which is shown as an extraordinary item in the Company's Statement of
Operations.
As of March 31, 1999, the effective interest rate on the 1998 Notes is
approximately 74%, the effective interest rate on the Amended Notes is
approximately 81%, and the effective interest rate on the New Notes is
approximately 9%.
NOTE 6 - LEGAL PROCEEDINGS
See "Part II. - Other Information, Item 1. Legal Proceedings" for a
complete description of outstanding legal proceedings involving the Company.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Because the Company wants to provide investors with more meaningful and
useful information, this Report 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 ability to obtain additional financing in the near
future; 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; and
the effects of legal proceedings. A more complete description of these risks,
uncertainties and assumptions is included in the Company's filings with the
Securities and Exchange Commission, including those described under the heading
"Risk Factors" in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1998. 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
Report or to reflect the occurrence of unanticipated events.
GENERAL
The following is a discussion and analysis of the historical results of
operations and financial condition of the Company and factors affecting the
Company's financial resources. This discussion should be read in conjunction
with the financial statements, including the notes thereto, set forth herein
under "Part I. - Financial Information, Item 1. Financial Statements" and in the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
1998. This discussion 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 forward-looking statements. Such forward-looking statements
are qualified by reference to, and should be read in conjunction with, the
italicized language set forth above.
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 ("RF") front-end
products which are designed to enhance the quality, capacity, coverage, and
flexibility of cellular, personal communications services ("PCS") and other
wireless telecommunications services.
RESULTS OF OPERATIONS
The Company's net revenues decreased $185,269, or 26.6%, from $697,169 for
the three months ended March 31, 1998 to $511,900 for the three months ended
March 31, 1999, primarily as a result of lower prices of the Company's RF
front-end products. The Company reduced the prices of its products in late 1998
to better compete with products using conventional technologies. Net revenues
from product sales represented gross product
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shipments less a reserve for potential returns. Such reserves are based on the
Company's historical product return rates.
Cost of revenues decreased to $1,009,026 for the three months ended March
31, 1999, from $1,045,197 for the same period in 1998. The reduction in cost of
revenues was due to the decrease in sales and the mix of products sold. The
Company expects improvements in gross margins during 1999 as unit costs continue
to decrease. 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 research and development expenses decreased 30.6% from
$751,040 for the period ended March 31, 1998, to $521,563 for the same period in
1999. Research and development costs were reduced in the 1999 period due to a
reduction in personnel, improved management of engineering material, and other
reductions in operating costs. The Company expects that its research and
development expenses during 1999 will continue to be reduced from 1998 levels.
Selling and marketing expenses increased 24.1% from $367,754 for the three
months ended March 31, 1998, to $456,515 for the same period in 1999. The
increase in expenses was due to increased personnel and trade show costs, which
were only partially offset by lower travel and delivery costs.
General and administrative expenses increased 4.0% from $681,217 for the
three months ended March 31, 1998, to $708,519 for the same period in 1999. The
increase was primarily attributable to increased legal and accounting expenses
associated with litigation and financing transactions. The increase in expenses
was only partially offset by reduced personnel costs.
Interest expense, net of interest income, increased to $91,061 for the
three months ended March 31, 1999 from $3,349 of interest income, net of
interest expense, for the same period in 1998. The increase was primarily due to
a $125,570 charge in the first quarter of 1999 to amortize the discount on the
senior convertible notes issued on May 15, 1998.
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
1900 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.
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.
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The Company's manufacturing activities rely on 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 March 31, 1999, the Company's cash and cash equivalents were $4,304,169,
an increase of $1,814,227 from $2,489,942 at December 31, 1998. Inventory
balances increased by $1,556,771 over December 31, 1998 levels in anticipation
of increased sales. $680,696 in principal amount of promissory notes, plus
$138,355 of accrued interest thereon, from certain stockholders is outstanding
as of March 31, 1999. 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 "Part II. -
Other Information, Item 1. Legal Proceedings - Note Litigation."
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 March 31, 1999, the Company issued and sold $3.3 million in aggregate
initial principal amount of senior convertible notes due May 15, 2002 (the "New
Notes") and issued warrants (the "New Warrants") to purchase 1,320,000 shares of
Common Stock. 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 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. Concurrently with the issuance of the New Notes, the Company amended
certain terms of $5.5 million in aggregate principal amount of the 1998 Notes
(the "Amended Notes") and the 1998 Warrants exercisable for an aggregate of
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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 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 fourth 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 original equipment manufacturers 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 fourth quarter of 1999 and beyond.
The outstanding 1998 Notes, the Amended Notes and the New Notes
(collectively, the "Notes") contain restrictions limiting the Company's ability
to incur additional indebtedness or to pay dividends (other than in shares of
Common Stock) that may adversely affect the Company's ability to raise
additional equity or debt financing. 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. In addition, 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 materially adversely affect the liquidity
of the Common Stock and may adversely affect 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. See "Item 5.
Other Information."
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. In
particular, if the Company does not secure adequate financing prior to or during
the fourth quarter of 1999, the Company believes that it will have to
substantially reduce its operating plans in order to continue its operations
beyond such date. Such a reduction would materially adversely affect the
Company's business, operating results and financial condition and impair the
Company's ability to compete in the marketplace.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not have any material market risk sensitive instruments.
PART II. OTHER INFORMATION
ITEM 1. 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 Common Stock, plus warrants (immediately
exercisable at $12.96 per share) to purchase an additional 370,370.37 shares of
Common
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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 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
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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 excluded the
Company itself as a defendant. The amended 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 and thereafter
drawing two branches of the financing. The amended complaint sought
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 alleged that the stock owned by the
putative class lost $61 million due to the financing the Named Directors
selected, and sought 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 included the Company itself as a defendant.
The second amended complaint alleged that the Named Directors breached
their duties of loyalty and due care to the putative class and further alleged
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 sought 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. The court granted the motion to dismiss in April 1999,
finding that (i) the plaintiffs could not assert their stock devaluation claims,
except derivatively, and (ii) the plaintiffs still had failed to fulfill the
prerequisites for maintaining a shareholder derivative action against the Named
Directors. The court, however, allowed the plaintiffs leave to file a third
amended complaint.
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 been scheduled for June 1999.
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ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On March 31, 1999, the Company issued and sold an aggregate of $3.3 million
initial principal amount of New Notes and New Warrants to purchase 1,320,000
shares of Common Stock to a group of institutional investors. 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 Common Stock at a fixed conversion price of $1.125 per share. The New
Warrants have an exercise price of $1.4625 per share and 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 1998 Notes
and the 1998 Warrants exercisable for an aggregate of 2,200,000 shares of the
Common Stock issued to such purchasers 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 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. The New Notes and the Amended Notes contain restrictions which limit the
Company's ability to pay cash dividends on the Common Stock. See "Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
The sale of the New Notes and the New Warrants was exempt from the
registration requirements of the Securities Act of 1933, as amended (the "Act"),
pursuant to Section 4(2) of the Act and/or Regulation D promulgates 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
accredited investors 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 New Notes and the New Warrants have been legended.
The Company has filed a registration statement with the Securities and Exchange
Commission relating to the public resale under the Act of the shares of Common
Stock into which the New Notes and the New Warrants are convertible or
exercisable, as the case may be.
ITEM 5. OTHER INFORMATION
On April 23, 1999, the Company was notified that The Nasdaq Stock Market
("Nasdaq") had determined to delist the Common Stock for trading on the Nasdaq
National Market due to the Company's current inability to meet the minimum net
tangible assets requirement for continued listing. On April 27, 1999, the
Company requested an oral hearing to appeal Nasdaq's determination. The
delisting action has been stayed pending the results of such hearing.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibits are listed in the Exhibit Index.
(b) Reports on Form 8-K:
On Current Report on Form 8-K, dated March 31, 1999, under "Item 5. Other
Events," the Company filed a press release announcing the Company's financial
results for the fourth quarter and year ended December 31, 1998, the Company's
completion of a $3.3 million fixed price convertible debt financing, and changes
to the Company's Board of Directors.
On Current Report on Form 8-K/A, dated March 31, 1999, under "Item 5. Other
Events," the Company filed a revised press release announcing the Company's
financial results for the fourth quarter and year ended December 31, 1998, the
Company's completion of a $3.3 million fixed price convertible debt financing,
and changes to the Company's Board of Directors.
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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
Date: May 14, 1999 By: /s/ EDWARD W. LAVES
--------------------------------------------
Edward W. Laves, Ph.D.
President and Chief Executive Officer
Date: May 14, 1999 By: /s/ KENNETH E. WOLF
--------------------------------------------
Kenneth E. Wolf
Controller and Treasurer
(Principal Financial and Accounting Officer)
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------ -----------------------
3.1 Certificate of Incorporation of the Company, as amended,
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").
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 C 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.
4.8 Warrant dated June 6, 1997 issued to Southbrook International
Investments, Ltd., incorporated by reference to Exhibit 4.5 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").
4.14 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, incorporated
by reference to Exhibit 4.18 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1998 (the "1998
Form 10-K").
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4.19 Form of Warrant dated March 31, 1999, incorporated by reference to
Exhibit 4.19 to the 1998 Form 10-K.
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, incorporated by reference to Exhibit
4.20 to the 1998 Form 10-K.
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, incorporated by reference to Exhibit
4.21 to the 1998 Form 10-K.
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, incorporated by reference to
Exhibit 4.22 to the 1998 Form 10-K.
27. Financial Data Schedule.
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