UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 AMENDMENT NO. 1 TO FORM 10-SB GENERAL FORM FOR REGISTRATION OF SECURITIES OF SMALL BUSINESS ISSUERS UNDER SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 SUPERCONDUCTIVE COMPONENTS, INC. (Name of Small Business Issuer in its charter) Ohio 31-121318 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1145 Chesapeake Avenue Columbus, Ohio 43212 (Address, including zip code, of principal executive offices) (614) 486-0261 (Issuer's telephone number) Securities to be registered pursuant to Section 12(b) of the Act: None Securities to be registered pursuant to Section 12(g) of the Act: common stock, without par value TABLE OF CONTENTS Part I Forward Looking Statements.................................................................. I-1 Item 1. Description of Business........................................................... I-1 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ...................................................... I-19 Item 3. Description of Property........................................................... I-23 Item 4. Security Ownership of Beneficial Owners and Management............................ I-24 Item 5. Directors and Executive Officers, Promoters and Control Persons................... I-27 Item 6. Executive Compensation............................................................ I-29 Item 7. Certain Relationships and Related Transactions.................................... I-31 Item 8. Description of Securities......................................................... I-32 Part II Item 1. Market Price of and Dividends on the Registrant's Common Equity and Related Shareholder Matters.......................................... II-1 Item 2. Legal Proceedings................................................................. II-2 Item 3. Changes in and Disagreements with Accountants..................................... II-2 Item 4. Recent Sales of Unregistered Securities........................................... II-3 Item 5. Indemnification of Officers and Directors......................................... II-3 Part F/S Financial Statements........................................................................ F-1 Part III Item 1. Index to and Description of Exhibits.............................................. III-1 Signatures.................................................................................. III-2 PART I FORWARD-LOOKING STATEMENTS This document contains forward-looking statements that reflect the views of management with respect to future events and financial performance. These forward-looking statements are subject to certain uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors include, but are not limited to, the words "anticipates", "believes", "estimates", "expects", "plans", "projects", "targets" and similar expressions which identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which speak only as of the date the statements were made. ITEM 1. DESCRIPTION OF BUSINESS INTRODUCTION Superconductive Components, Inc. ("SCI" or the "Company"), an Ohio corporation, was incorporated on May 29, 1987, to develop, manufacture and market products based on or incorporating high temperature superconductive ("HTS") materials. HTS materials are complex metal oxides - ceramics - of certain stoichiometries (chemical mixture ratios) which exhibit superconducting phenomena when cooled to at least 196DEG. Centigrade. These complex metal oxides are identified as members of the Perovskite family of ceramic materials. Perovskites are a large family of crystalline ceramics that derive their name from the perovskite mineral. The perovskite minerals are the most abundant minerals on earth and have approximately a 2:3 metal-to-oxygen ratio. Copper-oxide superconductors are layered perovskites. The strategy of the Company has been to find commercially viable applications for HTS materials and, subsequently, other ceramic and metal materials. The Company's objective has been to stay intellectually current with the advancing technology in HTS materials, and search out commercially viable applications by being in the market place. This objective has been widened to include other perovskites, as well as other metals and alloys, in materials other than HTS materials. Until 1998, the Company relied primarily on its own resources for the research and development necessary to stay current with HTS technology and also to develop products for other applications. In 1998, the Company engaged in sponsored research for Nanophase Technology Corporation, Inc. and also received several awards for research from two United States government agencies, the National Aeronautics and Space Administration and the National Science Foundation. The Company's sponsored research programs are discussed more fully at Pages I-10 and I-11 with respect to their revenues and time lines. The following table summarizes this information: SPONSOR PROGRAM TYPE AWARD START DATE END DATE ------- ------------ ----- ---------- -------- National Aeronautics and SBIR Phase II $ 585,000 4/1/99 3/31/01 Space Administration National Science Foundation SBIR Phase II $ 399,000 9/1/99 8/31/01 National Science Foundation STTR Phase I $ 100,000 7/1/99 6/30/00 Cambridge Research Institute Private Contract $ 25,000 9/1/99 12/31/00 Ceramphysics, Inc. Private Contract $ 20,500 9/1/99 12/31/00 TOTAL: $1,129,500 The Company intends to continue to seek such funding because this funding maintains and expands the technical understanding within the Company. I-1 With the exception of processes and devices being developed under federal or private research grants (which are discussed more fully in "The SCI Division - Sensors in Development" and "- Sponsored Product Development Programs within the SCI Division"), the Company's products are fully developed and currently are being sold in the marketplace. The Company supplies materials to customers who are engaged in product or process development themselves, but such customers purchase the Company's products based on clear specifications for a fixed price. The Company currently does not have any export restrictions on foreign sales of its products. Since the Company was formed in 1987, the total amount of accumulated deficit it has generated is $6,009,192. BACKGROUND OF SUPERCONDUCTIVITY AND ADVANTAGES OF HIGH TEMPERATURE SUPERCONDUCTIVITY A superconductor is an element, inert-metallic alloy, or compound that will conduct electricity without resistance when cooled below a certain critical temperature. For the types of superconductors that the Company manufactures, this critical temperature is -196DEG. Centigrade. This phenomenon was discovered in 1911 in the metal Mercury when it was cooled with liquid Helium to -273DEG. Centigrade. This cooling enables the material to carry electrical currents without loss of energy and, due to the increased current the metals can carry, be used to generate very large magnetic fields. Scientists realized that the phenomenon of superconductivity raised the possibility of less expensive electrical generation and transmission, powerful magnets and levitation. In the past, the only way to achieve this phenomenon was to submerge the metals in liquid Helium. Because of Helium's inherent instability in liquid form and cost issues, the wide spread use of superconductors in commercial applications was impractical. These metals, now known as Low Temperature Superconductors ("LTS"), are superconductive at temperatures from absolute zero up to as high as +23DEG. Kelvin. Kelvin is the temperature scale used to identify the extremely cold conditions required for superconductivity. The Kelvin scale starts at "absolute zero," which is the equivalent of -273DEG. Centigrade, and is the coldest theoretical temperature attainable. The unit of measure on this temperature scale is called a Kelvin ("K") and is equal to a single degree on the Centigrade scale. With the discovery of new ceramic compounds in 1986, superconductivity can now be accomplished at higher temperatures by using liquid Nitrogen for cooling. The boiling point of Liquid Nitrogen is 77DEG. K, which is equivalent to -196DEG.C. These new ceramics bring superconductivity into the realm of the practical since liquid Nitrogen is inexpensive, stable, long-lasting, and the largest component in our atmosphere and environmentally friendly. These materials are known as HTS. HTS materials provide the potential for significant increases in performance of electrical systems. Every electrical application delivers electricity from its source to a user through the use of "conductors." However, conventional conductors, such as Copper, exhibit some performance disadvantages. These performance disadvantages include resistance to electric current, causing power loss, heat generation, interference and noise, each of which can significantly decrease the performance of electrical systems. Additionally, the ceramic superconductors manufactured by the Company must overcome several hurdles if they are to gain wide spread commercial application. These include problems associated with making flexible structures such as wire from brittle materials such as ceramics, the limited performance of these materials at what are considered practical temperatures, such as the boiling point of liquid Nitrogen (77DEG. K), and the cost of any device based on these materials. The scientific community has been working on these and other difficulties with HTS materials since 1987. There is no assurance that all of these difficulties can be overcome. Superconductors have the ability to conduct electrical current with zero resistance, no power loss, and no generation of heat below some critical current. The performance advantages of HTS materials in electronics applications include reduced component size and weight, increased operating speeds and, in transmission applications, include lower on-line losses. HTS materials exhibit these properties when cooled to 77DEG. K, a process easily obtainable with inexpensive liquid Nitrogen. LTS materials require cooling to as cold as 4DEG. K or -269DEG. C , with the use of the more expensive liquid Helium. The problem of system-wide cooling is being addressed by various of the Company's customers and others. I-2 While this problem must be solved for the success of large area applications, such as power transmission lines, high performance applications such as superconductive magnets for medical applications have been widely demonstrated. The required use of liquid Helium has made wide spread applications of LTS superconductors impractical in many applications. The higher operating temperatures of HTS superconductors have reduced the operating costs for HTS products since the required liquid Nitrogen is inexpensive and readily available. However, the HTS material itself, as a ceramic, is more difficult to form into products than the metallic LTS materials. For example, with wire and cables, the HTS material requires considerably more processing steps and possibly a higher degree of processing precision, in order to manufacture a useful product. In many respects these processes are still in development by the Company's customers and others. Because of these difficulties, it has been necessary to develop a number of new or modified processes to achieve satisfactory results with the HTS material. The Company's process development in this area is being sponsored by the National Science Foundation through a Phase II SBIR grant. This two year program is intended to produce a fine grained superconductive powder which can be manufactured in large batches. The Company is on schedule with its development plans and continues to make sales based on the enhanced powder products that have resulted from this research. HISTORY OF THE COMPANY The Company was founded in 1987 by Dr. Edward R. Funk and his wife Ingeborg Funk to develop, manufacture, and market HTS materials for commercial applications of the newly-discovered superconducting ceramics. The Company's initial efforts were directed toward mastering the manufacturing process for making high temperature superconducting ceramic powders, as discussed in further detail below. During this period, the market for high temperature superconductors was very small, estimated at $1 million a year or less, consisting primarily of demonstration kits and small amounts of HTS powder for research purposes. Sales, though relatively small, covered a wide range of superconducting products, including ceramic powders. The Company sold ceramic powders as finished products and in other forms such as pressed pills or pellets, which were achieved by sintering the ceramic powders, and solid shapes. Ceramic powders sold in such forms were used primarily in research applications. Subsequently, the Company began to develop other forms of HTS materials. A broad commercial market for products using HTS superconducting materials has not yet developed, although small niche markets had emerged for some products. In the second half of 1989, the Company began to focus on the market for superconducting thin-film materials, made from the Company's sputtering targets. A sputtering target is a pressed and sintered ceramic pellet which has been sized to fit into a special coating device called a sputtering system. These HTS sputtering targets are used by customers of the Company in a vapor deposition process to make thin films of the target material. This process operates in vacuum, hence, the frequently heard term, vacuum deposition or Physical Vapor Deposition, ("PVD"). HTS thin films are then patterned, using techniques similar to those in the semiconductor industry, to manufacture sensors, circuits and other devices, which in turn can be used in medical diagnostics, geological exploration, advanced radar, wireless communication and other niche applications. The Company's HTS products are produced and marketed by its SCI Division. Additionally, the Target Markets, Inc. ("TMI") Division of the Company is marketing some of the non-superconducting products that the Company has developed. The Company established the TMI Division in 1992 and began to market sputtering targets of materials other than superconductors for thin film deposition. This division is located within the headquarters of the Company in Columbus, Ohio and shares facilities and staff with the SCI Division. For additional information, see "The TMI Division." The following chart summarizes the annual revenues and percentage of total consolidated sales for the fiscal years ended December 31, 1997, 1998, and 1999, respectively, and for the nine months ended September 30, 2000, for each class of products that the Company produces. I-3 ANNUAL REVENUE BY PRODUCT CLASS 12/31/97 12/31/98 12/31/99 9/30/00 -------- -------- -------- ------- % of % of % of % of Annual Total Annual Total Annual Total Annual Total PRODUCT CLASS Revenue Sales Revenue Sales Revenue Sales Revenue Sales ------------- ------- ----- ------- ----- ------- ----- ------- ----- Superconductive Powders $ 126,780 5.78% $ 73,959 2.96% $ 107,277 4.01% $ 43,916 1.91% Nonsuperconductive Powders 9,870 0.45% 8,456 0.34% 18,003 0.67% 29,343 1.28% Superconductive Targets 105,649 4.82% 52,899 2.12% 85,386 3.19% 42,223 1.84% Nonsuperconductive Targets(1) 1,074,410 49.01% 1,035,725 41.46% 1,079,133 40.29% 947,041 41.28% Buy & Resell(2) 469,349 21.41% 435,119 17.42% 552,663 20.63% 525,338 22.90% Bonding and Backing Plates(3) 188,152 8.58% 142,161 5.69% 163,200 6.09% 154,298 6.73% Demonstration Kits 26,537 1.21% 21,644 0.87% 15,141 0.57% 14,026 0.61% Levitators 33,330 1.52% 21,182 0.85% 11,245 0.42% 17,290 0.75% Contract Research 4,300 0.20% 470,552 18.84% 425,153 15.87% 417,079 18.18% Other 153,628 7.02% 236,465 9.45% 221,161 8.26% 103,838 4.52% ---------- ---------- ---------- ---------- $2,192,005 $2,498,162 $2,678,362 $2,294,392 ========== ========== ========== ========== ---------- (1) Includes nonsuperconductive targets from the SCI division and ceramic and metal targets from the TMI Division. (2) Includes buy and resell of precious metals, buy/resell targets and other miscellaneous items. (3) Includes sales from the SCI and TMI divisions. ORIGINAL COMPANY FOCUS IN HTS PRODUCTS The Company's original focus was to offer HTS powders in various chemical mixture ratios and bulk solid state forms of HTS materials, including: - sputtering targets; - Levitators-TM-, which produce a large oriented grain useful for its high levitation forces, ability to trap magnetic flux, and carry large currents; - magnetic shields; and - various kits, support equipment and other materials. Superconductors can be used as magnetic shields because of their unique diamagnetic properties. Diamagnetism is the ability of a material to repel a magnetic field. Many naturally-occurring substances, such as water, wood, and paraffin, exhibit weak diamagnetism. Superconductors exhibit strong diamagnetism below their T(c), which represents the critical transition temperature below which a material begins to superconduct. The sudden loss of resistance in a superconductive medium may occur across a range as small as twenty millionths of a degree Centigrade. I-4 The market for all HTS products, although small, has historically been represented by groups seeking to establish a fundamental understanding of the properties, principles and theory of these materials and also groups focused on applications of high temperature superconductivity. The ratio of fundamental to applications research continues to shift toward commercialization of the technology as demonstrated by the increasing number of "beta prototype" programs in the industry. A beta prototype is a device or system in a pre-commercial stage of development, which has been tested in a laboratory as an alpha prototype, and then further developed to be tested in an actual customer site in a typical operating environment. Operating experience and customer feedback in the beta test phase can be used in the design of an initial commercial product. The Company provides the basic building blocks for many HTS products, since nearly all applications of HTS start with powder that is subsequently processed into products such as wire, sputtering targets, or large single crystals, which, in turn, can be used to manufacture transmission cables, superconductive magnets, sensors, radio frequency ("Rf") filters for wireless communications, and frictionless bearing systems for linear or rotating system applications. A frictionless bearing system is a non-contact device that utilizes the diamagnetic characteristics of a superconductor to stably levitate or suspend a load which may be in rotational or linear motion. The system overcomes normal frictions which limit conventional mechanical bearings by eliminating physical contact between the components. This bearing design has been used in energy storage systems under development by Boeing, among others. The Company has a suite of proprietary processes that are utilized in the production of its products. As discussed later, the Company also has licenses of patents and its own patent and patent applications in this field. See the section of this document entitled "Intellectual Property" for additional information. The Company's proprietary ceramic powder and powder densification processes have been successfully adapted to other electronic ceramics that exhibit unique, non-superconductive, characteristics. Some of these materials are also in transition from fundamental to applications oriented development and may be the source of significant revenues in the Company's future. These materials can be categorized as ionic or electronic conductors and materials with unique magnetic properties such as the ceramics used in non-volatile computer memories. EXPANSION INTO OTHER MATERIALS AND THE CREATION OF THE TMI DIVISION By early 1990, it was clear to the Company that the market for HTS superconducting powder, targets and other HTS products was still too small (about $1 to $2 million annually) to assure survival and growth of the Company. Accordingly, the Company expanded its product line to include sputtering targets made of non-superconducting ceramics, metals and metal alloys. As the demand for these products grew it became evident that this new product line could expand more rapidly if it were managed as a focused, non-superconductive, effort. The metal, metals alloy and simple ceramic sputtering targets were then packaged into the newly created TMI Division. The Company's products are marketed and identified under the TMI name. The total market for non-superconducting metal, metal alloy and simple ceramic targets for the thin film industry is estimated at $720 million globally based on a Business Communications Company ("BCC") report dated August 26, 1999. The Company, through its TMI Division, also embarked on a program to move selected products developed for research and development applications into production applications. Through continuing relationships with equipment manufacturers and potential customers, TMI is able to compete in the production markets with existing products both on a technical and price basis. There are new materials being continuously investigated, and these new ceramics and metal alloys sometimes develop rapidly into significant markets. The Company believes that it has positioned itself well in the marketplace to move quickly as these materials move from research and development into production usage. In 1999, approximately 60.0% of the Company's target shipments were classified by the Company as production, and 40.0% were classified as research and development. This is a marked change from 100.0% classification as research and development shipments in 1995. The Company's objective is to achieve an 80.0% to 20.0% ratio of production to research and development shipments. The Company has continually added production processes and testing equipment for the many product compositions that can be used as sputtering targets. The TMI Division standard products, as listed in its catalogue, now I-5 include nearly 200 items of ceramic materials and metals and alloys available in various sizes and shapes. TMI shipments were 66.4% of total Company shipments in 1999. The Company offers a wide range of HTS products to the marketplace. The Company has competitors for all of its various products. In general, the Company's HTS products are distinct in the marketplace due to the molecular level mixing achieved through the Company's patented and proprietary chemical precipitation processes for ceramic powders, the chemical purity achievable by these processes, and the high level of characterization and customization the Company performs for each client. Accordingly, the Company intends to be price competitive on its products but not the low price leader. THE SCI DIVISION The SCI Division primarily produces and markets the Company's various HTS products, which include both superconducting and non-superconducting products. The most significant of the Company's HTS products are discussed below. SUPERCONDUCTING PRODUCTS HIGH TEMPERATURE SUPERCONDUCTIVE POWDERS. HTS powders are the building blocks for most applications of high temperature superconductivity. The Company offers a wide variety of HTS powders. Powders are manufactured using conventional solid state and wet chemistry, as well as proprietary processes developed or licensed by the Company. Wet chemistry refers to a mixing technique using liquid precursors from the Company's processes which utilize dry blending of chemical precursors. Superconducting powders represented approximately 4.0% of Company revenues in 1999, 3.0% in 1998, and 5.8% in 1997. The Company's HTS powder production is also used internally to make Levitators-TM-, HTS sputtering targets and other ceramic components. Customers in the SCI Division have included several manufacturers of superconducting wire, wherein the powder is put into a tube and drawn and redrawn to very fine size. Such wire is now available from our customers and others in lengths sufficient to make superconducting magnets, motors, and power transmission lines. This market for the Company's HTS powder is expected to grow as these applications transition from research to prototype to production use. Some of these applications are now in the engineering-prototype stage, and are being evaluated with respect to their conventional counterparts. There currently are several highly-publicized prototype devices or systems based on HTS materials, most of which in the United States are sponsored by the Department of Energy through its Strategic Partnership Initiatives ("SPI"), including: - Fault Current Limiter - Transformer - Transmission Line - Flywheel Energy Storage system The purpose of the engineering prototypes now in evaluation is to determine the technical and economic feasibility of the specific applications. Although it is unlikely that all of the initially configured prototypes now in testing will be economically viable, there are a number of applications being tested, and the Company believes that some of these will move into production in the next several years, although in most cases the time lines for development are unclear. Specifically, the development of YBCO wires based on the coated conductor approach still has several technical and financial hurdles to overcome, and at this time it is unclear when such wires will move into production phase. The Company is particularly optimistic about cables, where the use of superconductors may reduce power transmission losses. In addition, because much higher currents can be carried in HTS cables for a given volume, there may be savings realized through the minimization of the disruption to dense cityscapes as the transmission and distribution grid is refitted to accommodate the increase in demand for electric power. Encouraging results are also being shown by companies other than SCI that make superconductive Rf filters for the distributed base stations which support the national wireless communication network. Rf filters are used in wireless communication systems to enable the selection of desired radio frequencies and the exclusion of undesired signals. Such I-6 applications of HTS promise to reduce noise level, decrease signal interference, and reduce the number of dropped calls. Additionally, some HTS equipped cellular base stations extend the range of the station. Another promising application of HTS is fast response fuses, sometimes called fault current limiters. In this case, the very short (fraction of a cycle) response time of HTS material to voltage surges on electric transmission and distribution networks may reduce downtime and capital expenditures for utilities. HTS fault current limiters are self-resetting and, unlike conventional fuses, are not destroyed by a voltage surge. The Company currently has an alliance with Argonne National Laboratory in the development of this device. This product has not yet reached the prototype test stage. It is well-known that the major market for LTS superconducting wire is in magnets for medical Magnetic Resonance Imaging ("MRI") systems. Recent tests conducted by Siemens show that HTS wire may have an economic and technical advantage for this application. Cost advantages may be achieved in new systems by the elimination of liquid Helium cooling. Technical advantages may be achieved through the higher fields obtainable by using HTS materials at very low temperatures. The Siemens tests were not conducted with wire containing the Company's HTS materials, but with wire of similar composition produced by the Company's competitors. At this time, the Company's HTS products have not been tested in an MRI system. The Company makes the raw materials that are used by the manufacturers of the above mentioned products, and actively solicits the business of those making such products. SUPERCONDUCTING SPUTTERING TARGETS. The Company converts its powders into dense, precisely machined ceramic components which are used as sputtering targets by its customers for the manufacture of superconductive thin films. These thin films can then be etched in patterns to produce electrical devices such as superconductive quantum interference devices ("SQUIDS") that are extremely sensitive to small electric and magnet fields, such as brain waves, a passing submarine, or certain electric and magnetic signatures of ore or oil deposits. This market was 3.2% of Company revenues in 1999, 2.1% in 1998, and 4.8% in 1997. HTS materials, as thin and thick films both as sputtering targets and powder are currently used in Rf filters microwave applications such as in cellular base stations. At this time, there are several companies whose superconductive Rf filters are going into limited production. These companies include: Superconductor Technologies, Inc., Conductus, Inc., and Illinois Superconductor Corp. Other companies are thought to be developing such products based on HTS materials. The Company is a potential supplier to these producers for both HTS powder and sputtering targets, although it has not sold these products to such producers as of yet. The "next generation" of HTS wires and cables is expected to be based on a structure called a "coated conductor." In this case the conductor, Ittrium Barium Copper Oxide ("YBCO"), is deposited using a thin film technique onto a metal tape or foil which has been modified so that the area receiving the superconductor is specifically aligned or "textured" to promote optimal performance of the coating. Thin film deposition is a method of fabricating ceramic superconductors to more precisely control the growth of the crystalline structure to eliminate grain boundaries and achieve a desired T(c). The deposition of the YBCO conductor is being pursued in the United States and Japan by use of the Company's sputtering targets. While this application is expected to take several years to develop, for now it enables the Company to participate in near term applications of HTS wire through its Bismuth, Strontium, Calcium, Copper and Oxygen ("BSCCO") materials, and future requirements through its YBCO ceramic components. "LEVITATORS-TM-". The Company has a non-exclusive license from Argonne National Laboratories for producing seeded and melt textured YBCO large single domains for which the Company has been issued the trademark "Levitators-TM-." In a typical melt processing method, YBCO is heated above its peritectic point where it melts incongruently into Y(2)BaCuO(5) and a Ba-and Cu- rich liquid. The semi-solid melt is cooled slowly to obtain aligned grains of YBCO or domains. In order to achieve high levitation forces, large domain size and high critical current density, J(c), are desirable. One way to increase the domain size is by initiating grain growth by using a seed crystal. In the presence of a favorable temperature gradient, the seed not only ensures a single nucleation site but also permits controlled orientation of the grains. The seeding technique along with a controlled temperature gradient enable growth of YBCO domains as large as that of the sample size. I-7 A superconducting Levitator-TM- is a compact of the Company's superconductive powders which have been processed to form a large C-axis oriented grain that exhibits a high critical current density and considerable diamagnetism. The Company has advanced its technology well beyond the original Argonne licenses and expects to be issued a patent for its own proprietary processes to manufacture Levitators.-TM- At this time, the Company's large domain Levitators-TM- ("LDL"), made from its superconducting powders, exceed 30 Newtons of separating force when used with certain magnets. This value is high enough to make practical several applications, including near frictionless bearing systems, flywheels energy storage devices (so called frictionless flywheels), and linear transportation devices (i.e. Maglev trains). In 1996 the Company supplied approximately 1,600 Levitators-TM- to a major utility for a prototype frictionless flywheel energy storage ("FFES") device. The FFES device is a flywheel that rotates in an evacuated chamber and is supported by HTS Levitators-TM- so that there are no mechanical bearings. The friction factor is more than 1,000,000 times less than the best mechanical bearings. Under these conditions, very little energy is lost to friction. Energy is applied to the flywheel to spin it up, and energy is withdrawn at nearly 90.0% efficiency as needed. At this time, Commonwealth Edison, through Commonwealth Research Corporation, has placed the development of FFES units on hold pending further funding from Commonwealth Edison. The prototype for which the Company supplied for the Levitators-TM- is said to have demonstrated the feasibility of HTS levitated frictionless bearings for this application. The Levitators-TM- supplied by the Company for this program were tested by Argonne National Laboratory. The Company has engaged in further research and development on its Levitators-TM-, with a view toward enhancing their performance capability and reducing the costs of production. The Company has focused its efforts on identifying a suitable replacement for Platinum Oxide, which is one of the most expensive components of its basic powder mix for Levitators-TM-. If successful, levitator production costs will be substantially reduced. Currently the Company is exploring the use of Cerium as a substitute for Platinum Oxide with some success. The Company continues to collaborate with Argonne National Laboratory through a Creative Research and Development Agreement in order to advance the technology and broaden the range of applications for which Levitators-TM- are applicable. Improvements in performance, combined with a significant reduction in manufacturing costs, are expected to result from this multi-year, cost sharing, program. The United States electric power industry is scheduled for deregulation in the very near future. This will force competition to occur between power providers well beyond their current regional boundaries. Commonwealth Edison, which purchased the Company's LDL in 1996, at that time supplied approximately 5% of the electrical power used in the United States. Officials at the utility have advised the Company that they view the development of the FFES system as a key component of their competitive strategy. Other utilities may also use these systems in their competitive strategies. There are also programs to develop similar energy storage devices in Japan, the United Kingdom, Korea and Germany. Currently the Boeing Corporation, which is one of the Company's competitors, is developing a competitive FFES system that uses HTS materials as an enabling component of the bearing system. SUPERCONDUCTING ACCESSORIES. The Company provides certain accessory superconducting products that are needed, in addition to the Company's core HTS materials, to support its customers' research or manufacturing programs. The Company does not manufacture accessory superconducting products, but rather it purchases such products for resale to the Company's customers. DEMONSTRATION KITS, INSTRUMENTATION ACCESSORIES FOR SUPERCONDUCTIVITY EDUCATION. Demonstration kits were the first products sold by the Company in significant volume. Packaged for the educational community, the Company continues to manufacture a family of laboratory demonstration kits designed to exhibit the key features of perfect conduction, diamagnetism and flux trapping that are unique to HTS materials. These kits are marketed directly by the Company and also through a network of educational product distributors which include Edmund Scientific, Arbor Scientifiy, Beckly Cardy and others. The instrumentation and accessories offered by the Company include a wide range of discs, dies, rare earth magnets, vacuum jars, box furnaces, digital volt meters, dewars and flasks, and related items. I-8 These combined categories represented approximately 0.6% of Company revenues in 1999, 0.9% in 1998 and 1.1% in 1997. NON-SUPERCONDUCTING PRODUCTS Beginning in 1996, the SCI Division of the Company manufactured and sold non-superconducting, as well as HTS products for commercial use which can be categorized as engineered powders, engineered parts, and engineered components. ENGINEERED CERAMIC POWDERS. The Company has adapted its proprietary Ceramic Oxide powder production processes for the manufacture of fine, ultra-fine and nano-crystalline powders of non-superconductive materials to support a variety of expanding applications requiring electronic ceramics. These powders are used by customers of the Company in the development or manufacture of: - Solid Oxide Fuel Cells ("SOFC"); - Ceramic Membranes for the separation of natural gas from its contaminants; - Lithium ion batteries; - Ceramic electrodes for harsh environments; - Ceramic electrodes as a replacement for precious metals; and - Capacitors. Engineered ceramic powders were 0.07% of Company revenues in 1999, 0.3% in 1998, and 0.5% in 1997. CERAMIC SPUTTERING TARGETS. The Company has adapted its proprietary ceramic powder densification processes to manufacture a variety of sputtering targets from its line of electronic ceramic powders. The energy storage and optical industries are working to utilize the unique properties of electronic ceramics to enhance the performance or reduce the cost of their products. Sputtering targets composed of complex Ceramic Oxides for applications such as non-volatile memory, thin film capacitors, thin film electrodes, and transparent electronic conductors are an emerging product line for the SCI Division, comprising 5.9% of the SCI Division's revenues in 1999, 5.8% in 1998 and 6.6% in 1997. The hope of the Company is that materials developed to supply customers' research requirements will grow into large scale production orders with the commercial success of the next generation of thin-film-based electronic devices. The Company has certain proprietary knowledge and trade secrets related to the manufacturing of these non-superconductive Ceramic Oxides sputtering targets. SENSORS IN DEVELOPMENT BY SCI DIVISION The SCI Division was awarded a Phase I SBIR contract by the National Science Foundation to develop a sensor for NO(x) and to be used in harsh environments. The Company has also been given a purchase order by Cambridge Research Instruments to develop a temperature sensor, based on a thin film superconductor, for use at or slightly above the boiling point of liquid Nitrogen. These two development contracts were 1.2% of Company revenues in 1999. The Company was not in this field of sensors prior to 1999. SENSORS FOR HARSH ENVIRONMENTS- GASEOUS OXIDES OF NITROGEN. For automobiles, public utilities, and other generators of oxides of Nitrogen gas ("NO(x)"), currently no low cost detection system exists. The harmful effects of NO(x) are a well known component of the green house gases that are damaging to the environment. The United States and other foreign governments continue to fund the development of solutions to reduce green house gasses in which sensors are a part of the detection and correction system. Once developed, these solutions may be legislated upon the market place. The low-cost NO(x) sensor market is global and may be expected to exceed several million dollars in the next decade. I-9 The Company has recently completed a Phase I feasibility study of the design, development and manufacture of a sensor for NO(x) to be used in harsh environments, such as the exhaust stream of internal combustion engines. This Small Business Innovative Research grant ("SBIR") program consists of three phases: (1) Phase I, which is the feasibility study, (2) Phase II, in which a prototype is developed, and (3) Phase III, which includes the realization of a commercial product, backed by private funds. The Company is currently preparing a Phase II proposal for this sensor. The goal of the program, funded through a competitive award in the amount of $399,000 by the National Science Foundation, is to build on the Company's strengths in ceramic fabrication and to devise a device that is both low in cost and also highly sensitive to NO(x) in the range required for future automobiles. The development of a NO(x) sensor, suitable for use in next generation spark-ignition direct injection engines, or SIDI, has been given the highest priority by stakeholders in the industry, including major automobile and engine manufacturers. New, lean-burn engine technologies are nearing commercial reality, but they lack adequate sensors to monitor and control the quality of exhaust in order to operate within federally mandated pollution guidelines. SENSORS FOR CRYOGENIC TEMPERATURES - YBCO BASED. Sensors based on the superconductor YBCO are being developed for the temperature range of 77-92DEG. K. The skill set developed to perfect these devices will serve the Company in the manufacture of all of its planned sensors. While temperature sensors for the broad range of 4.2DEG. K to 300DEG. K are well understood, and available from reputable commercial enterprises, a greater accuracy over a limited temperature range may be a competitive advantage for YBCO based sensors in new and dynamic applications such as magnetic levitation ("MAGLEV") and flywheel energy storage, where very small temperature excursions may be used as the predictors of system disruptions or failure. In this effort the Company currently has an alliance with CRI, Inc. of Cambridge, Massachusetts. STRATEGIC ALLIANCES, MAJOR SUPPLIERS AND CUSTOMERS The Company attempts to do most development work in the SCI Division in cooperation with partners who will ultimately consume, or may serve as a channel to market, the Company's products and technology. In this way, the Company remains focused on providing value-added materials solutions for a range of commercial applications. Most of the Company's products are manufactured from component chemicals and metals supplied by various vendors. The SCI Division is dependent upon ultra high purity Yttrium to manufacture its superconducting products. Several suppliers currently satisfy the Company's requirements for this material. If the Company suddenly lost the services of such suppliers, there could be a disruption in its manufacturing process until the suppliers were replaced, but the Company has identified several other firms as potential back-up suppliers who would be capable of supplying this material to the Company as necessary. To date, the Company has not experienced an interruption of raw material supplies. The top 5 suppliers to the SCI Division in 1999 were, in descending order: Argonne National Laboratories, Noah Technology Corp., MTI Corp., Cerac Corp., and Praxair Corp. In every case, the Company believes that suitable substitute vendors could be found. Also, as the Company's volume grows, the Company may make alliances or purchasing contracts with these or other vendors. No customers in the SCI Division accounted for 10.0% or more of the total SCI revenue in 1999. RESEARCH AND DEVELOPMENT The Company focuses its research and development efforts in areas that build on its expertise in multi-component ceramic oxides. These efforts currently include optimization and scale up efforts for BSCCO 2-2-1-2 powders sponsored by the National Science Foundation, large and specially formulated YBCO discs and rotation/levitation apparatus for gravity modification research sponsored by NASA, and a sensing device based on the Company's ceramic products which identify the presence of NO(x) gases in harsh environments which is also sponsored by the National Science Foundation. I-10 The Company's initial focus on HTS was shifted upon the realization that the market for that technology would take several years to develop, and that the Company's talents and capital base could also be used to provide materials solutions in a wide range of other industries. While according to a study commissioned by the United States Department of Energy, HTS is expected to develop into a multi-billion dollar industry in the first decade of this century, the Company has diversified its efforts to concurrently participate in other materials markets. The emphasis of the SCI Division's research has been broadened to include engineered ceramic oxide materials. The SCI Division of the Company remains focused on the development of materials, processes and devices based on its core skills in: - ceramic powder fabrication; - powder densification; - thin film technology, a device fabrication technique where individual layers of the device are less than one micron thick and are typically constructed using specialized coating techniques that can utilize the Company's sputtering targets; and - thick film technology, a device fabrication technique where individual layers of the device are more than one micron thick and are typically constructed using specialized coating processes like tape casting, which can utilize the Company's ceramic powders. These developments are realized through partnerships with the Company's many customer collaborators. The Company's reliance on a commercial customer collaborator optimizes its development expenditures by focusing on the projects where customers have identified markets and agree to provide future revenue streams based on the successful completion of the project. COMPANY SPONSORED RESEARCH AND DEVELOPMENT. The Company often undertakes commitments in the ordinary course of business that require the Company to develop methods or processes that expand the Company's skill set. In general, the Company does not initiate a formal development program to accomplish these tasks, but does absorb any expenses which may exceed the revenues provided by clients, as part of its internal development costs. SPONSORED PRODUCT DEVELOPMENT PROGRAMS WITHIN THE SCI DIVISION The Company has a number of research programs, including two Phase II SBIR's that are sponsored by government agencies. These programs are being conducted within the SCI Division. These programs are all believed to have significant commercial potential if the respective technologies can be fully developed. The research program sponsored by NASA involved various experiments to determine the proper composition and crystal structure of a specialized ceramic material which, when used in conjunction with a superconductive YBCO layer, and the assembly is both cooled and rotated at high speeds, may shield the effects of gravity. Another research program sponsored by the National Science Foundation as a Phase II SBIR involves the automation of the chemical precipitation and also the scale up and automation of the low pressure calcination process for the Company's BSCCO 2-2-1-2 superconductor powder. Experiments are being performed to determine the reliability of the automated process, and the effects of the larger batch size on quality in the calcination step. The Company's subcontractor, IGC Advanced Superconductor, was also using selected powder samples to make multi-filament superconductive wire and also developing a process for the continuous heat treatment of long lengths of HTS wire. The Phase I STTR program, also sponsored by NSF, included experiments using various combinations of the Company's ceramic substrates and powders to determine which pairing showed the most sensitivity to NO(x) gases at temperatures in the range of 700-1000DEG. C. SBIRs and sponsored research and development contracts accounted for 15.9% of Company revenues in 1999, 18.8% in 1998, and 0.2% in 1997. Several public and privately funded programs currently support continued product, process and component development within the SCI Division. Sponsored programs include: - National Aeronautics and Space Administration ("NASA"), beginning on April 1, 1999, funded a Phase II SBIR for a $580,000 program over 2 years to demonstrate the feasibility of manufacturing a large, bi- I-11 layered superconductive toroid (ring) and related levitation/rotation system for gravity modification experiment in cooperation with Argonne National Laboratories and Wright State University. The Company's share for in-house work on this project is $310,000 over 2 years. The contract may be cancelled at any time and the 24 month duration expires on May, 2001. - THE NATIONAL SCIENCE FOUNDATION ("NSF"), beginning on September 1, 1999, funded a Phase II SBIR program over 2 years for $400,000 for advanced manufacturing of BSCCO superconductive powders for low cost, continuous HTS wire fabrication, with partner Intermagnetics General Corporation, Advanced Superconductor Division. The Company's share of this funding is $200,000 over 2 years and the contract may be cancelled at any time. This program expires on August 31, 2001. - NSF, beginning on July 1, 1999, funded a Phase I STTR (Small Business Technology Transfer Program) for $100,000 for the development and technology transfer of a sensor for oxides of Nitrogen gas to be used in harsh environments, i.e. an automobile exhaust stream, with partner the Center for Industrial Sensors and Measurement at The Ohio State University. The Company's in-house share of this funding is $50,000. This program expired on June 30, 2000 although work continues on the device in preparation of a Phase II grant application which will be submitted in January 2001. - THE CAMBRIDGE RESEARCH INSTRUMENT CORP., funded by a Phase II SBIR subcontracted with the Company for $25,000 for the development of a superconductive temperature sensor tunable for a specific 2DEG. K region around the boiling point of liquid Nitrogen (77DEG. K) for use in a unique geological instrument. This program began on September 1, 1999, and ended on September 30, 2000. - CERAMPHYSICS, INC., which has a funded Phase II SBIR subcontracted with the Company for the development of HTS electrodes to replace Platinum in a Department of Defense application of cryogenic capacitance energy storage. This program is for $20,500 and ends on September 1, 2001. A second phase of the program has been funded outside the government for a 13 month period beginning October 1, 2000. All of the sponsored research and development contracts can be cancelled at the sponsor's option, with accrued costs being paid. As of December 1, 2000, the Company had $1,129,500 of funding from government sponsored research and development programs that could be cancelled at any time. To date, federal funding has been directly or indirectly responsible for an estimated 80.0% of the developmental funding of the HTS industry. Such funding plummeted in 1992 and 1993 when the Supercollider project was terminated. Federal funding has rebounded somewhat in recent years. Management of the Company anticipates that any increase in funding for superconductivity research may benefit the Company indirectly, since many of its customers' research and development efforts receive government funding. However, while the Company continues to submit proposals to federal and private funding organizations, there is no assurance that the Company will be awarded similar contracts in the future. COMPETITION IN THE HTS INDUSTRY The Company has a number of domestic and international competitors in the HTS field, many of whom have resources far in excess of the Company's resources. After more than a decade of intensive development work, commercial prototypes of various large scale HTS applications are now reaching prototype test stage. It is anticipated that as commercial devices based on HTS technology begin to gain wide spread acceptance, and the attractiveness of the industry improves, new competitors for powders, sputtering targets and large superconductive single crystals will emerge. A major United States competitor of the SCI Division is The Surface Science Division of Praxair Corporation. In Europe, the SCI Division competes principally with a spin-off of Herchst Chemical Company, now named Adventis, a division of Aliatec Corporation of France. In Japan, the SCI Division's principal competitor is the DOWA Chemical Company. Some of the developers of HTS based products, such as American Superconductor Corporation, have also chosen to internally manufacture the HTS powders that they require, and therefore compete with the Company in some cases, or foreclose themselves as potential customers of the Company. I-12 MARKETING AND SALES The SCI Division markets its products by direct sale in the United States. Most of the Division's orders are in response to requests for quotations. The SCI Division distributes a catalogue of its products, exhibits at the several relevant shows, and engages in direct mailings. The Company also has an operating website: www.superconductivecomp.com. The Company intends to intensify its marketing efforts in the future. The SCI Division also sells its products to distributors in some foreign markets. On March 2, 2000, the Company announced that Earth Chemicals in Japan was selected as the exclusive distributor for Japan. The Company has non-exclusive distributors in Europe, Korea, Taiwan, Israel and Singapore. The global acceptance of the Internet has greatly increased the SCI Division's ability to promote itself to the entire scientific community, and thereby facilitated direct sales, engineering and customer support from the Company's Columbus, Ohio facility. Notwithstanding an increasing number of distributors, more than 75.0% of the SCI Division's international sales are handled directly by the Company's in-house sales staff. In addition to distributors and representatives around the world and its Internet website, the Company maintains a modest print advertising program, which includes the magazines PHYSICS TODAY, SUPERCONDUCTOR, CRYO-ELECTRONICS and the THOMAS REGISTER OF MANUFACTURERS. The Company publishes technical articles in scientific journals and presents technical papers at technology-based conferences, workshops and symposia. The Company has sold HTS products to customers in 42 countries worldwide. The total number of customers served by the Company was 185 in 1999, 129 in 1998, and 95 in 1997. No single customer accounts for more than 10.0% of total SCI Division sales. PRODUCTION CAPACITY The SCI Division has a current HTS powder production capacity of approximately 700 kilograms per year, but is expected to increase to 1,200 kilograms per year in the year 2001. The Company was able to increase its production capacity in the year 2000 to keep pace with customer demand. The cost of this expansion was supported by grants from NSF and by additional investment in equipment by the Company. Currently, the Company is on track to meet future demand. Generally, the Company has not had instances where it was unable to meet demand, although delivery times have been extended by a few weeks in some cases without any loss of sales. Increasingly, however, the customers of the SCI Division are inquiring about the production capacity of the Company for their future production requirements. Based on this experience and occasional loss of customers to larger competitors, management views the expansion of HTS capacity in the SCI Division as a primary objective in the near future. QUALITY CONTROL The Company's quality program uses a network of trusted and qualified suppliers, backed up by the Company's internal and contracted analytical capabilities. Incoming raw materials are tested, when required, for suitability using techniques such as X-ray diffraction, Inductivity Coupled Plasma spectrometry, Particle Size Analysis, and other methods. In addition to these tests, sample lots of the Company's complex ceramics are often fabricated to determine if a new supplier and/or new lot of input materials can be used to make a product to specification. The quality assurance processes for Company products include Critical Temperature, carbon content, or packing density. The Company certifies its products for phase purity by X-ray Diffraction ("XRD"), for major and trace elemental composition by Inductively Couples Plasma ("ICP"), and mechanical tolerances using certified calipers and micrometers. The amount of rejected product during internal processing was 4.5% of revenues in 1999, 3.0% in 1998, and 4.3% in 1997. Customer returns of SCI Division products were 0.1% of revenues in 1999, 0.5% in 1998, and 0.7% in 1997. I-13 The Company owns its quality control equipment and also selectively contracts with a network of domestic vendors for additional analytical capabilities. The Company's in-house analytical instruments include: - ICP manufactured by Leeman Laboratories, Inc.; - Particle Size Analyzer ("PSA") manufactured by Toshiba Corporation.; - XRD manufactured by Rigaku Corporation; - Electronic Dispersive X-Ray Spectrometer ("EDS") manufactured by EDAX; - Differential Thermal Analyzer ("DTA") manufactured by Perkin Elmer Corporation; - Scanning Electron Microscope ("SEM") manufactured by ISI Corporation; - Various digital calipers, analog calipers, digital and analog micrometers, routinely calibrated against National Institute of Standards ("NIST") traceable standards; and - Various digital weight scales that are routinely calibrated against NIST traccable standards. INTELLECTUAL PROPERTY The Company has developed or acquired intellectual property in the form of patents, patent applications, and licenses on patents. The Company currently is not aware of any litigation involving its products or processes, nor has the Company been contacted by any potential litigants regarding the same. PATENTS. The Company has applied for and received from the United States Patent and Trademark Office patent # 5,863,867 dated January 26, 1999, for Fine-Particle Bi-Sr-Ca-Cu-O Having High Phase Purity made by a Chemical Precipitation and Low-Pressure Calcination method. This patent was issued in January 1999 and will expire on October 28, 2016. This material is used to make HTS powder at this time. Several other patents have been or will be filed covering all aspects of the HTS field, including the basic concepts, the powder composition, processing, and products. Currently, the Company has also received notice of allowance from the United States Patent and Trademark Office on a patent application submitted for the joining of large single domains of YBCO. Industry wide, it has been reported that over 4,000 applications exist for HTS materials, processes and applications. The Company does not have a license or patents covering all products that it makes and markets in the HTS field. The issue of ownership of basic patents for HTS materials and processes is not yet determined, and is in contention. The Company anticipates that it will be several years before these patent ownership issues are settled. The Company may not be able to obtain licenses for manufacturing from the patent holders. Furthermore, the Company may have a liability, which cannot be determined at this time, for products produced prior to the issuance of the patents. The Company may not have the resources to defend itself in the event of a patent lawsuit (although the Company knows of no such lawsuits pending at this time). The Company's patent attorneys are Hudak and Shunk of Akron, Ohio. Ms. Laura Shunk, a partner in that firm, is the daughter of Dr. Edward R. Funk, President and Chief Executive Officer of the Company. PATENT APPLICATIONS. The Company has applied to the United States Patent and Trademark Office for a patent number covering Large Weld-Connected Superconducting Monoliths and Process for Making Same. The application date is July 1, 1998. The patent is assigned to the Company. Notice of allowance for this patent application has been received and the Company expects a patent to issue in the near future. TRADEMARKS. The Company owns a trademark on the word "Levitator-TM-", which is used to describe the SCI Division's line of large domain YBCO seeded and melt-textured monoliths. NON-EXCLUSIVE LICENSES. The Company has the following non-exclusive licenses: - Sandia National Laboratories - Sandia Chemical Prep Process for line YBCO superconductive powders, license #95-000131, based on U.S. patent #4,839,339, dated June 13, 1989. I-14 - Argonne National Laboratory Low Pressure Calcination process for low Carbon HTS material. License # ANL-IN-89-030, based on U.S. patent # 5,086,034. - Argonne National Laboratory Levitator Package. Licenses # ANL-IN-93-008, ANL-IN-93-130, ANL-IN-93-134 based on U.S. patents # 5,504,060 (Method of Harvesting Rare Earth Barium Copper Oxide Single Crystals), #5,549,748 (Method of Harvesting Single Crystals from a Peritectic Melt), and # 5776,864 (Large Domain 123 Material Produced by Seeding with Single Crystal Rare Earth Barium Copper Oxide Single Crystals). The Company's license agreements with Argonne and Sandia National Laboratories form the core of its technology base in HTS powder and device fabrication. The Company acquired these licenses for less cost than it could have developed similar technology internally, and was able, based on the speed at which the Company was able to commercialize the resulting HTS products, to create a revenue stream within a few months of license acquisition dates. Subsequently, the Company has built on these licenses to create its own intellectual property in the form of patents, patent applications, and industrial knowledge. LICENSED POWDER PROCESSING TECHNOLOGIES. The processes used by the Company to manufacture high temperature ceramic (superconductive) powder were invented at various national research laboratories operated by the Department of Energy. The Company has licensed these processes from the Department of Energy, which gives the Company the legal right to practice the technology in exchange for a small royalty on sales. The powders are then used to make pressed shapes which can become sputtering targets or Levitators-TM- or they can be sold without further processing to customers who will combine them with other materials to make superconductive wire and cable. TRADE SECRETS. The Company uses the following trade secrets in the manufacture of its SCI Division products: - Powder fabrication in non-SC powders; - Powder densification in YBCO and Non-SC material; - Fabrication of BI-layer structure of YBCO for use in Gravity Modification; and - Fabrication of nano-materials. THE TMI DIVISION The TMI Division manufactures and markets source materials, both ceramics and metals, for the thin film vacuum deposition industry (PVD - Physical Vacuum Deposition Industry). The TMI Division has served over 900 customers worldwide in 40 foreign countries over the past five years. While serving as critical raw materials for the fabrication of a variety of highly engineered thin film products -- from integrated circuits to window coatings -- sputtering targets are themselves high-value-added advanced materials. THE SPUTTERING TARGETS INDUSTRY A number of technological changes are occurring within the sputtering industry. For example, higher purity sputtering targets and new target materials are emerging to improve the performance of thin film products for certain applications. Also, sputtering target fabrication methods and cathode designs are being refined and optimized to improve target material utilization and process efficiency. A Business Communications, Inc. Report, dated August 26, 1999, summarizes sputtering target consumption as follows: I-15 SPUTTERED FILMS AND SPUTTERING TARGETS ------------------------------------------------------------------------------------------------ AAGR* WORLD MARKET 1999 2004 (%) EST'D EST'D EST'D ------------------------------------------------------------------------------------------------ Total film area (million m2) 363 764 16.0 Target consumption (million kg) 2.9 3.9 6.0 Target consumption (million lb) 6.4 8.5 6.0 Approx. target units consumed (000) 374 510 6.4 Value of material consumed (MM$) 720 1100 8.8 Source: Business Communications Co. Inc., Norwalk, Connecticut * Average Annual Growth Rate An estimated 2.9 million kilograms (6.4 million pounds) of sputtering target material will be consumed in 1999 to sputter-deposit 363 million square meters of thin films for microelectronics, data storage, advanced display and optical coating applications. This projection shows that, worldwide, the production of sputtered films will increase at an average annual growth rate ("AAGR") of 16.0% from 1999 to 2004, reaching 764 million square meters of sputter-deposited films in 2004. Application of sputtering targets include the following industries: Optical Filters, Flat Panel Displays; Photovoltaic Cells; Electronic Switches; Thin Film Resistors; Decorative Coatings; Thin Film Batteries; and Tool Coating for Wear Resistance, non-glare glass and mirrors and semi-conductors. TMI DIVISION PRODUCTS SPUTTERING TARGETS. The Company has chosen to focus on production applications in industries other than the semi-conductor industry. Thus, the focus of the Company is on the use of sputtering targets in industrial applications. Sputtering targets are offered in an extensive line of materials, including most ceramic materials and various metals and alloys. Customers in the solar panel, tool coating, decorative coating, electronic, optical and research industries use these targets. Non-superconducting targets represented approximately 66.4% of Company revenues during 1999, 66.3% in 1998 and 77.0% in 1997. In addition to the TMI Division, the SCI Division of the Company also makes and markets sputtering targets. The SCI Division sputtering targets, however, are made of more complex ceramics which require specialized processing. The SCI Division has greater scientific expertise to bring to bear on the manufacture of these sputtering targets. The TMI and SCI divisions have an agreed list of items that each division quotes on and manufactures. BONDING AND BACKING PLATES. Bonding is the process of adhering a sputtering target to a backing plate to prepare the target for use in the physical vapor deposition process. Physical vapor deposition processes are coating techniques that deposit thin metal, ceramic or other materials onto a substrate, and include sputtering, laser ablation, evaporation, and iron bea0m deposition. The Company offers bonding on its own, or customer supplied, backing plates with metallic solder or silver epoxy. High purity copper backing plates can also be used in thicknesses ranging from .125" to 1" on sizes from 1" to 12" and rectangles to 72" long. Bonding services generated approximately 5.5% of Company revenues in 1999. In earlier years, TMI had the bonding done though an outside source. PROCESS KNOWLEDGE Since its inception, the TMI Division has invested heavily in practical in-house research and development. Each item of the nearly 200 items now offered in the TMI Division's catalogue has required some degree of development, including finding vendors, developing the manufacturing processes and methods of control and standardization. The process knowledge is captured in written specifications, process set cards, logs, operating I-16 procedures and other means. COMPETITION The market for sputtering targets is very competitive. The Company has numerous competitors, most of which are larger and have greater financial resources than the Company. Domestically, the Company views Puretech, Inc., a division of Williams Advanced Materials, itself a division of Wellman Corporation, and Cerac Corporation as primary competitors over the entire line of manufactured products, although as many as 30 competitors exist and compete for different portions of the sputtering target market. Further, some primary metal suppliers also produce sputtering targets. Additionally, there are a number of foreign competitors producing sputtering targets and thin-film deposition materials throughout the world. Management believes that Tosoh Corp. has the largest worldwide market share, followed by MRC Corporation (a division of Praxair Corp.), VMC Corporation, Johnson Mathey Corporation, Nippon Mining Corporation, Puretech Inc., and Cerac Inc. All enjoy vastly superior resources than those possessed by the Company. However, few of these competitors focus their marketing efforts on the research segment of the market, due to the low volumes that characterize this market niche. The Company believes that the principal competitive factors in this market are price, service, quality, reliability, reproductability, availability of technical information, and timely deliveries. The Company strives to differentiate itself from its competitors by providing a full line of manufacturing capabilities, maintaining an excellent quality rating by achieving quick turnaround on manufactured orders, and by providing personalized customer service. Although TMI's objective is to achieve an 80.0% to 20.0% ratio of shipments for production to research and development, at this time, the ratio is approximately 60.0% production to 40.0% research and development. Obtaining production business requires submitting samples, meeting the customer specifications, and developing the confidence of the customer for reliability and reproductability. Management believes that the needs of its customers generally progress from research and development quantities to pilot production to full scale production. The length of time this cycle requires varies widely. The TMI Division now has the equipment and capacity to supply production quantities to customers who have moved out of the development phase to the production of any new product. Management believes that it will be able to capture a proportion of larger production type orders in the future from these customers based on on-going sales and marketing programs and long-term relationships that have been developed with current and prospective customers. MARKETING AND SALES The TMI Division markets and sells its products worldwide, concentrating on the Research & Development and Industrial Production markets. Domestic sales account for approximately 70.0% of the Company's sales, compared to 30.0% export sales. All sales are conducted in United States dollars. In the United States, the TMI Division markets and sells through its internal sales staff, and through independent manufacturer's representative groups located strategically around the country. Either party may terminate the Company's contracts with its representatives within 60 days. Commission rates vary according to materials and other factors. A typical commission rate is 8.0% of gross sales dollars. In Asia, the TMI division markets and sells through several non-exclusive distributors. Sales in this region consist primarily of research & development accounts. TMI currently is seeking representation in the European market. PRODUCTION CAPACITY In the TMI Division, the production equipment currently on hand will accommodate a throughput of $4.0 million or greater per year, depending on product mix and the addition of a second shift operation. In order to enter production accounts requiring larger, more complex targets, the Company intends to acquire a larger machine center in I-17 2001. The new center will cost approximately $150,000 and will be financed through a leasing program. This additional center will increase the TMI Division production capacity by approximately 25%. With those measures taken, the production capability of the TMI Division is expected to be approximately $6.0 million per year revenue. MAJOR SUPPLIERS AND CUSTOMERS The TMI Division buys raw materials, components and chemicals used in the manufacture and assembly of the Company's products. If these materials are not received in a timely manner, it may seriously affect the Company's production schedule. The Company, however, has designed its products using widely-available standard items and components, and has identified alternative vendors it may use in order to avoid production delays. The Company is not experiencing difficulty in maintaining its inventory of such components, although purchase commitments are, at times, limited by cash flow. The TMI Division purchases various types of ceramic powder as well as metal for the production of ceramic or metal sputtering targets. These materials are purchased to Company specifications. In such cases, the price per unit of weight of the material depends strongly on the amount purchased. In some cases, the materials are very costly. The quantities purchased and price per unit weight paid by the Company varies widely, based upon cash flow considerations and inventory levels. The Company has established supplier relations with a number of companies, some of which are importers of metals from other countries, including China and Russia. Delivery schedules are often unpredictable for these supplies, requiring the Company to maintain considerable inventory levels to avoid shortages. The Company does not manufacture sputtering targets made from gold, platinum, palladium or other materials considered in the market as precious metals. As a service to its customers who require such materials, TMI buys finished targets from one of several suppliers and resells these targets at a markup. The approximate percent of the Company's overall revenues consisting of precious metals was 5.3% in 1998 and 7.9% in 1999. The Company maintains a letter of credit with one precious metal supplier to cover the purchases. The Company sells precious metals on a net-10 day basis, while all other sales are net-30 days. The Company also purchases other finished sputtering targets made with unique compositions of common materials from outside sources for resale at a markup to its customers as a service. The approximate percent of the Company's overall revenues consisting of these "buy/re-sell" items was 12.1% in 1998 and 12.7% in 1999. The Company has appropriate purchase specifications, and performs its own receiving inspection and quality control on these products prior to shipment to its customers. The top 5 suppliers to the TMI Division in 1999 were, in descending order: Williams Advanced Materials, Inc., Standard Resources, Inc., ACI Alloys Inc., Noah, Inc. and Alta, Inc. In every case, the Company believes that suitable substitute vendors could be found. The Company buys primarily based on quality, price and delivery to its specifications factors. No customers in the TMI Division accounted for 10.0% or more of the total TMI revenue in 1999. RESEARCH AND DEVELOPMENT The TMI Division has no government support, preferring to invest in and control its research and development program in a commercial market-oriented customer-driven manner. QUALITY CONTROL The Company strives for world class quality in its products. The Company has experienced quality control problems in the past. Consequently, the Company in recent years has invested funds in the development and implementation of a quality assurance program to insure that each process in the manufacturing, materials purchasing and order-entry functions are more tightly controlled. I-18 The Company has also invested in quality control equipment. The Company is currently able to perform in-house testing of its ceramic products and metals and alloys via Scanning Electron Microscopy, Edax, Differential Thermal Analysis, Electrical Resistivity, and Particle Size Analysis, Inductively Coupled Plasma, Spectagraph Equipment and X-ray Diffraction. The quality control efforts have included preparation for certification for ISO 9000, the international standard of quality performance, as well as investment in training of personnel, preparation of specifications, purchasing and installation of equipment, purchasing of software, on-going calibration and maintenance of advanced measuring and composition analysis equipment. These efforts have produced a significant improvement in the product produced by the Company, as shown by customer returns, which were under 1.7% over-all in 1999, 2.0% in 1998 and 2.3% in 1997. The Company has not requested the required examination by the controlling authorities for ISO 9000 and does not plan to do so in fiscal year 2001. EMPLOYEES The Company currently has 21 full-time and 2 part-time employees. Three of the Company's employees have a Ph.D. in Chemistry or Materials Science. Ten employees work primarily for the TMI Division of the Company, while the remainder work primarily for the SCI Division. In the case of shared employees, charges are assigned in accordance with the ratio of shipped dollars. The Company has never experienced work stoppage and considers its relations with employees to be good. The employees do not have a bargaining unit. ENVIRONMENTAL MATTERS The Company generates small quantities of ceramic dust from grinding or machining and has approval from the Ohio EPA for the emission of the exhaust from these materials, which are primarily Zinc Oxide. The Company maintains filters and dust collectors that it believes are in accordance with all EPA regulations. The Company has been inspected from time to time by local EPA authorities and the few noted deficiencies have been corrected. To date, the Company is not under any EPA strictures. The Company does not handle "hazardous materials" as defined on the Materials Safety and Data Sheets ("MSDS"). The Company supplies MSDS sheets to its customers with all shipments as a routine procedure. The TMI Division also does not offer products made from "hazardous materials" (as defined by the MSDS, for the materials). COLLECTIONS AND WRITE-OFFS The Company collected its receivables in an average of 55 days in 1999. The Company has occasionally been forced to write-off a few small invoices as uncollectible. The Company considers credit management critical to its success. SEASONAL TRENDS The Company has not experienced and does not in the future expect to experience seasonal trends in its business operations. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS To date, the Company has received revenue predominantly from commercial sales and also government research contracts and non-government research contracts. The Company has incurred cumulative losses of $6,009,192 from inception to September 30, 2000. I-19 NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999 Revenue for the nine months ended September 30, 2000, was $2,294,392, an increase of $323,583 or 16.4% from the year earlier period when sales totaled $1,970,809. For the nine months ended September 20, 2000, and 1999, product sales totaled $1,405,427 and $1,302,755, respectively, for the TMI division, or an increase of 7.9%. For these same periods, SCI Division sales totaled $888,965 and $668,054, or an increase of 33.1%. The increase was primarily attributable to additional research contracts in 2000 versus 1999 in the SCI Division and higher sales volume in commercial products in the TMI Division. The gross margin on sales of products was $392,606 or 20.9% for the nine months ended September 30, 2000 compared to $354,753 or 20.8% for the earlier period. For the nine months ended September 30, 2000, and 1999, gross margin on product sales for the TMI Division represented 22.8% and 23.8%, respectively, and for the SCI Division represented 15.3% and 11.2%, respectively. The increase in margin in the SCI Division for product sales is due to increased sales as the gross margin is impacted by utilization of production capacity. The gross margin on contract research revenue reported in the SCI Division in segment reporting was 22.8% in 2000 versus 18.2% in 1999. The increase in gross margin for the contract research revenue is due to higher sales volume in 2000. Gross margins on the Company's various products vary widely and the gross margins are impacted from period to period by sales mix and utilization of production capacity. The gross margins on the contract research is generally lower than on other products. The Company expects that gross margins on product sales will improve as sales grow. General and administrative expenses were $357,018 or 10.6% of total revenue for the nine months ended September 30, 2000, and $221,909 or 11.3% of total revenue for the earlier period. The increase in these costs related to the expansion of the Company's infrastructure, including the addition of executive management. Wages and related benefits increased $82,000 related to additional corporate staff and cost-of-living raises, legal and accounting increased $26,000 related to the audit of financial statements and preparation for regulatory filings and bad debt expense increased $27,000 due to an increase in the allowance for doubtful accounts for related parties. The related party receivable is due from a Diamond Fiber Composites, Inc., a company owned jointly by Dr. Funk and a non-affiliate of the Company. See "Certain Relationships and Related Transactions" for additional information. Sales expense of $219,131 or 9.6% in the nine months ended September 30, 2000, was up from the $192,161 or 9.7% for the nine months ended September 30, 1999. The increase included expenditures for the development of foreign market opportunities. The increase of interest expense from $32,035 or 1.4% in 1999 to $50,073 or 2.2% for the nine months ended September 30, 2000, relates to interest on both the subordinated notes payable and on the bank borrowings. The Company's net loss for the nine months ended September 30, 2000, totaled $(137,271), or $(.14) per share, compared to a loss of $(19,822), or $(.07) per share for the previous year. The 2000 period was impacted by the increase in general and administrative expenses in comparison to the prior period. FISCAL YEAR 1999 AS COMPARED TO FISCAL YEAR 1998 REVENUES Revenues in fiscal 1999 increased by 7.2% to $2,678,362 from the fiscal 1998 level of $2,498,162. Contract research revenue in fiscal 1999 was $425,153 compared to $470,552 in fiscal 1998, a decrease of 9.6%. TMI Division sales increased to $1,779,519 in 1999 from $1,655,178 in 1998 or an increase of 7.5%. SCI Division sales for product sales increased to $473,690 from $372,432 or an increase of 27.1%. Increase in sales is credited to increased sales of existing customers and efforts by management to expand into additional markets creating new customers. I-20 In 1999, total contract research revenues were $425,153 as compared to $470,552 in 1998. Government development contract revenue was $392,617, or 14.7% of total revenues in 1999 and $167,252 or 6.7% of total revenues in 1998. NASA has been, and is expected in the near term to continue to be, the Company's largest customer, accounting for 8.9% of the Company's revenues in fiscal 1999. Significant loss of government funding would have a material adverse effect on the Company's financial condition and results of operations. GROSS MARGIN Total gross margin in 1999 was $477,179 or 17.8% of total revenue as compared to $438,223 or 17.5% in 1998. Gross margin on sales revenue for the TMI Division was 23.3% in 1999 versus 18.3% in 1998. The improvement in gross margin is due primarily to increased sales as the gross margin is impacted by utilization of production capacity. Gross margin on sales revenue for the SCI Division product sales was 0.7% for 1999 compared to 0.9% in 1998. The gross margin on product sales is reasonable between years. Inventory reserves are established for obsolete inventory and excess inventory quantities based on management's estimate of net realizable value. Changes in this reserve are expensed to cost of goods sold and approximated $9,000 and $28,000 for the years ended December 31, 1999, and 1998, respectively. The TMI Division was charged $6,000 and $20,000 and the SCI Division was charged $3,000 and $8,000 for the years ended December 31, 1999, and 1998, respectively. The decrease in inventory reserves between years is due to better inventory control by management. Gross margin on contract research revenue reported in the SCI Division in segment reporting was 13.9% for 1999 compared to 28.2%. The decrease in gross margin on contract research revenue of 14.3% was due primarily to a $300,000 non-government contract obtained in 1998 which resulted in higher margins. SELLING EXPENSE Selling expense in fiscal 1999 decreased to $265,631 from $301,618 in fiscal 1998, a decrease of $35,987, or 11.9%. This decrease is primarily a result of a reduction in the sales staff of the SCI Division at the end of fiscal 1998. GENERAL AND ADMINISTRATIVE EXPENSE General and Administrative expense in fiscal 1999 decreased to $332,709, from $359,751 in fiscal 1998, a decrease of $27,042, or 7.5%, primarily due to decreased legal expenses. RESEARCH AND DEVELOPMENT EXPENSES. Internal research and development costs are expensed as incurred. Research and development costs, including testing, for 1999 was $15,392 compared to $41,421 in 1998. Internal research and development costs decrease when government funded projects are available. INTEREST EXPENSE. Interest expense was $44,473, or 1.7% of Company revenues in fiscal 1999, up 54.2% from $28,847, or 1.5% in fiscal 1998. The increase in interest expense was attributable to the increased capital lease obligations during 1998 and 1999. Subordinated notes payable to shareholders increased by $205,125 during 1999. LIQUIDITY AND WORKING CAPITAL The working capital of the Company at September 30, 2000, was $165,798 compared to $168,167 at September 30, 1999. The Company provided cash from operations for the nine months ended September 30, 2000, and 1999 of approximately $88,000 and $34,000, respectively. Significant non-cash expenses including I-21 depreciation and an inventory reserve on excess and obsolete inventory were approximately $271,000 and $261,000, respectively, for the nine months ended September 30, 2000, and 1999. Overall, accounts receivable, inventory and prepaids increased in excess of increases in accounts payable and accrued expenses by approximately $169,000 and $183,000, respectively, as a result of timing of receipt of inventory versus required scheduled payments on this inventory. At December 31, 1999, working capital was $57,991 compared to $13,055 at December 31, 1998. The increase in working capital of $44,936 was due mainly to accounts payable paid by a shareholder which increased long-term subordinated notes payable. The Company provided cash from operations for the years ended December 31, 1999, and 1998 of $107,633 and $42,520, respectively. Significant non-cash expenses included depreciation and inventory reserve on excess and obsolete inventory approximate $281,000 and $292,000, respectively, for the years ended December 31, 1999, and 1998. Overall, accounts receivable, inventory and prepaids increased in excess of increases in accounts payable and accrued expenses by approximately $29,000 and $9,000, respectively, or insignificant amounts. For investing activities, the Company used cash of approximately $66,000, $207,000, $62,000 and $42,000 for the years ended December 31, 1999, and 1998 and nine months ended September 30, 2000, and 1999, respectively. The amount invested in 1998 was used to purchase machinery and equipment for increased production capacity. For financing activities for the year ended December 31, 1999, the Company used cash of approximately $46,000. Due to tight cash flow, cash was overdrawn by approximately $31,000. Cash payments to third parties for debt and capital lease obligations approximated $73,000. Proceeds from issuance of subordinated notes payable of approximately $80,000 to a shareholder were used to pay accrued cumulative dividends approximating $84,000 on Series A and B preferred stock. For financing activities for the year ended December 31, 1998, the Company provided cash of approximately $163,000. Cash payments to third parties for debt and capital lease obligations approximated $54,000. Proceeds from subordinated notes payable to a shareholder totaling $155,000, sales of common stock of $50,000 and the exercise of stock options of $11,500 was used to reduce accounts payable and fund operations. For financing activities for the nine months ended September 30, 2000, the Company utilized cash of approximately $12,000. Due to tight cash flow, $31,000 was overdrawn with the bank. Cash payments to third parties for debt and capital lease obligations approximated $155,000. Proceeds from a bank promissory note totaled $75,000. Proceeds from subordinated notes payable from shareholders totaled $89,000. The proceeds from these were used to redeem $70,000 of Series A preferred stock and accrued dividends. For financing activity for the nine months ended September 30, 1999, the Company provided cash of approximately $6,000. Cash payments to third parties for debt and capital lease obligations approximated $64,000. Proceeds from subordinated notes payable from shareholders totaled $89,000 and was used by the Company to redeem $70,000 of Series A preferred stock and accrued dividends and to fund operations. Subsequent to September 30, 2000, the Company received proceeds from the sale of common stock totaling $500,000 for 200,000 shares of common stock and $28,000 for the sale of warrants to purchase 140,000 shares of common stock at $3.50 per share. Additionally, the Company has available $25,000 on bank debt. In conjunction with the sale of common stock and common stock warrants, Dr. and Mrs. Funk converted approximately $506,000 to common stock. See "Recent Sales of Unregistered Securities" for additional information. While officers of the Company have advanced funds in the form of subordinated debt, accounts payable and guaranteeing bank debt in the past, there is no commitment by these individuals to continue funding the Company or guaranteeing bank debt in the future. However, the Company believes the combination of increased capital from these two common stock transactions and the reduction of debt by the conversion to equity allows management to pursue its current plans. The Company will continue to seek new financing or equity financing arrangements. However, the Company cannot be certain that it will be successful in efforts to raise additional new I-22 funds. INFLATION The Company believes that there has not been a significant impact from inflation on the Company's operations during the past three fiscal years. FUTURE OPERATING RESULTS The Company has improved cash provided from operations in 1999 and 2000. The Company is currently looking to relocate from its present facilities in the second quarter of 2001. The relocation will provide the Company with the space to expand its production facilities. The Company has improved its equity and debt position in 2000. Series A preferred stock has been reduced by $79,000 through redemption by the Company. Dr. and Mrs. Funk hold the remaining 71 outstanding shares of Series A preferred stock. Series B preferred stock was converted to equity during 2000 with 26,648 shares of Series B preferred stock outstanding as of December 1, 2000. Effective October 10, 2000, the Company sold 200,000 shares of common stock for total proceeds of $500,000 and subordinated notes payable to Dr. and Mrs. Funk approximating $506,000 was converted to common stock. These debt and equity transactions improve the Company's cash and equity position to allow for future relocation, plant expansion and increasing employees as management deems necessary to provide for a business strategy being developed. This business strategy anticipates material and device development using the Company's core skills in the area of electronic ceramics, spinning off the SCI Division and offering a minority interest to the public and cooperation with its investors to establish the necessary relationships for the capitalization of the various projects. The Company will continue its emphasis on inventory control and reducing excess inventory levels. The Company has recently implemented purchasing strategies to reduce the amount of excess inventory. These purchasing strategies examine both price and quantity, therefore, inventory purchases are more representative of current inventory quantity requirements versus making purchasing decisions using only pricing. Additionally, the Company is posting excess inventory on its web site in an effort to sell slow moving inventory. The Company plans to place some of its larger purchase commitments on an annualized basis for raw materials which can be purchased in larger quantities at reduced prices. In general, the Company attempts to limit inventory price increases by making an annual commitment, but drawing the material either as required, or on a monthly or quarterly basis. Such annual commitments may reach $500,000 in 2000 and greater in 2001 depending on sales volume increases. The terms of payment for such commitments are worked out with the vendor on a case-by-case basis, but in all cases are cancelable at the Company's discretion without penalty to the Company. DEVELOPMENT STAGE OF THE COMPANY'S PRODUCTS AND UNCERTAINTY REGARDING DEVELOPMENT OF MARKETS Some of the Company's products are in the early stages of commercialization and the Company believes that it will be several years before products will have significant commercial end-use applications, and that significant additional development work may be necessary to improve the commercial feasibility and acceptance of its products. There can be no assurance that the Company will be able to commercialize any of the products currently under development. To date, there has been no widespread commercial use of HTS products. ITEM 3. DESCRIPTION OF PROPERTY The Company's office and manufacturing facilities are located at 1145 Chesapeake Avenue, Columbus, Ohio, where it occupies about 20,000 square feet. Additional space of 10,000 square feet is currently sub-leased by the Company and can be reclaimed for Company use on three months notice. The Company has a lease on the property at $3.15 per square foot until March 1, 2001, with an option to renew. I-23 There is adequate power running to several locations in the building and other utilities are adequate for the projected growth. The Company is current on all operating lease liabilities. ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT COMMON STOCK The following tables set forth certain information as of December 1, 2000, with respect to the beneficial ownership of the Company's common stock by the following individuals and groups: - each of the Company's directors; - each of the Company's executive officers; - each person known by the Company to beneficially own five percent (5%) or more of our outstanding common stock; and - all of the Company's directors and executive officers as a group. Unless otherwise indicated, we believe that each person listed below has sole voting and investment power over his or her shares. NAME AND ADDRESS NUMBER OF SHARES OF BENEFICIAL OWNER BENEFICIALLY OWNED(1) PERCENTAGE OF CLASS (2) ------------------- --------------------- ----------------------- Edward R. Funk 1145 Chesapeake Avenue 842,327(3) 41.3% Columbus, OH 43212 Ingeborg V. Funk 1145 Chesapeake Avenue 842,327(3) 41.3% Columbus, OH 43212 Mangart Global Fund Limited P.O. Box 309 170,000(4) 9.0% George Town, Cayman Islands British West Indies Windcom Investment SA Corso Elvezia 25 170,000(5) 9.0% 6900 Lugan, CH Curtis A. Loveland 41 South High Street 154,198(6) 8.5% Columbus, OH 43215 Diego Ratti Via Antonietti 7 122,300 6.7% 6900 Paradiso Switzerland Edward W. Ungar 929 Harrison Avenue 9,310(7) * Columbus, OH 43215 I-24 Robert J. Baker 1145 Chesapeake Avenue 5,350(8) * Columbus, OH 43212 Lloyd E. Hackman 15508 Fiddlesticks Blvd., S.E. 60,507(9) 3.3% Ft. Myers, FL 33912 Charles E. Washbush 1233 Langeston Dr. 4,750(10) * Columbus, OH 43220 Don Raifsnider 1145 Chesapeake Avenue 16,000(11) * Columbus, OH 43212 James R. Gaines 1145 Chesapeake Avenue 29,532(12) 1.6% Columbus, OH 43212 Robert H. Peitz 43 Little St. 2,000(13) * Matawan, NJ 07747 Dr. Suvankar Sengupta 5692 Hillcrest Dr. 30,040(14) 1.6% Hilliard, OH 43026 All executive officers and directors as a group (11 persons)(15) 1,154,014 54.9% ------------------ * Less than 1% (1) For purposes of the above table, a person is considered to "beneficially own" any common shares with respect to which he or she exercises sole or shared voting or investment power, or of which he or she has the right to acquire the beneficial ownership within 60 days of December 1, 2000. Unless otherwise indicated, voting power and investment power are exercised solely by the person named above, or shared with members of his or her household. (2) "Percentage of Class" is calculated on the basis of the number of outstanding shares, plus the number of common shares a person has the right to acquire within 60 days of December 1, 2000. As of December 1, 2000, the Company had 1,816,977 shares of common stock outstanding. (3) Edward R. Funk and Ingeborg V. Funk are husband and wife. Under the rules of the Securities and Exchange Commission, they are deemed to beneficially own the shares of the other. Consequently the number reported above for each includes 99,702 and 185,145 common shares held of record by Dr. Funk and Mrs. Funk, respectively, 31,926 common shares held of record by Dr. and Mrs. Funk as tenants in common; options, warrants and convertible notes for 225,337 common shares, which can be acquired by Dr. Funk and Mrs. Funk, respectively, under stock options and warrants and convertible notes exercisable within 60 days of December 1, 2000. This number also includes 96,904 common shares which are owned by Funk I-25 Metallurgical Corporation, a corporation wholly owned by Dr. and Mrs. Funk. (4) Includes 70,000 common shares which can be acquired by Mangart Global Fund Limited under warrants exercisable within 60 days of December 1, 2000. (5) Includes 70,000 common shares which can be acquired by Windcom Investments SA under warrants exercisable within 60 days of December 1, 2000. (6) Includes options to exercise 1,000 common shares of the Company, 200 shares held by Mr. Loveland in a Keough account, and 153,198 common shares held of record by Mr. Loveland for various irrevocable trusts for the benefit of Dr. and Mrs. Funk's children and grandchildren. (7) Includes 4,260 common shares, owned by Taratec Corp., a company controlled by Mr. Ungar, 3,500 common shares, which can be acquired by Mr. Ungar under stock options exercisable within 60 days of December 1, 2000, and 1,550 shares owned by Mr. Ungar directly. (8) Includes 2,000 common shares which can be acquired by Mr. Baker under stock options exercisable within 60 days of December 1, 2000. (9) Includes 4,250 common shares which can be acquired by Mr. Hackman under stock options exercisable within 60 days of December 1, 2000, and 56,257 shares owned by Mr. Hackman directly. (10) Includes 1,000 common shares which can be acquired by Mr. Washbush under stock options exercisable within 60 days of December 1, 2000. (11) Includes 10,000 common shares which can be acquired by Mr. Raifsnider under stock options exercisable within 60 days of December 1, 2000. (12) Includes 17,300 common shares which can be acquired by Mr. Gaines under stock options exercisable within 60 days of December 1, 2000. (13) Includes 2,000 common shares which can be acquired by Mr. Peitz under stock options exercisable within 60 days of December 1, 2000. (14) Includes 20,040 common shares which can be acquired by Dr. Sengupta under stock options exercisable within 60 days of December 1, 2000. (15) Includes 286,427 vested options, warrants, subordinated debt, and Series A preferred stock which are exercisable within 60 days of December 1, 2000, for all directors and executive officers listed. SERIES A 10% PREFERRED SHARES The following tables set forth certain information as of December 1, 2000 with respect to the beneficial ownership of the Company's Series A 10% Preferred Shares by the following individuals and groups: - each of the Company's directors; - each of the Company's executive officers; - each person known by the Company to beneficially own five percent (5%) or more of our outstanding common stock; and - all of the Company's directors and executive officers as a group. Unless otherwise indicated, we believe that each person listed below has sole voting and investment power over his or her shares. I-26 NAME AND ADDRESS NUMBER OF SHARES OF BENEFICIAL OWNER BENEFICIALLY OWNED(1) PERCENTAGE OF CLASS (2) ------------------- --------------------- ----------------------- Edward R. Funk 1145 Chesapeake Avenue 71 100% Columbus, OH 43212 --------- (1) For purposes of the above table, a person is considered to "beneficially own" any Series A 10% Preferred Shares with respect to which he or she exercises sole or shared voting or investment power. Unless otherwise indicated, voting power and investment power are exercised solely by the person named above, or shared with members of his or her household. (2) "Percentage of Class" is calculated on the basis of the number of outstanding Series A 10% Preferred Shares as of December 1, 2000, which was 71 shares. ITEM 5. DIRECTORS AND EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY The Company has a Board of Directors that is currently comprised of eight members. Each director holds office until the next annual meeting of shareholders or until a successor is elected or appointed. The members of the Board of Directors and the executive officers of the Company and their respective age and position are as follows: Officer or Name Age Position with the Company Director Since ---- --- ------------------------- -------------- Edward R. Funk 75 President, Chief Executive 1987 Officer, Treasurer and Director Ingeborg V. Funk 76 Vice President 1987 Donald D. Raifsnider 52 Vice President and General Manager 1997 of the TMI Division Suvankar Sengupta 36 Chief Scientist 1994 Curtis A. Loveland 54 Secretary and Director 1987 Edward W. Ungar 64 Director 1990 Robert J. Baker, Jr. 60 Director 1992 Lloyd E. Hackman 70 Director 1993 Charles E. Washbush 71 Director 1994 James R. Gaines, Jr. 44 Director 1997 Robert H. Peitz 42 Director 1997 I-27 EDWARD R. FUNK, SC.D., is a founder of the Company and has served as President, Chief Executive Officer, Treasurer, and a Director of the Company since its inception in 1987. Dr. Funk was the founder and was Chairman of the Board of Cross Medical Products, Inc. ("Cross"), a Columbus, Ohio publicly held company which manufactured electromechanical orthopedic devices and related medical products. Dr. Funk resigned as Chairman in May, 1998, at which time Cross merged with Interpore International to form Interpore/Cross International. In 1970, Dr. Funk also founded Funk Metallurgical Corporation, a Columbus, Ohio corporation, and served as that company's President from its inception until June 1986 and as Chairman of the Board from its inception until the business was sold in September 1988. Dr. Funk also was a founder of Astro Metallurgical Corp. of Wooster, Ohio. Dr. Funk is the husband of Ingeborg V. Funk, a Vice President of the Company. INGEBORG V. FUNK is a founder of the Company and has served as Vice President of the Company since its inception in 1987. Mrs. Funk was also a Director of the Company from its inception until December 1, 1993. In addition, Mrs. Funk co-founded Cross. Mrs. Funk also co-founded Funk Metallurgical Corporation, and served as that company's Vice President from its inception until June 1986, and thereafter as its President until the business was sold in September 1988. DONALD D. RAIFSNIDER has been with the Company since 1997, and serves as Vice President and General Manager of the TMI Division of the Company. Prior to joining the Company, Mr. Raifsnider's career encompassed Production and Material Management with Anchor Swan Corporation, along with Sales and Marketing management at Mirro Corporation and his own manufacturers representative organization. SUVANKAR SENGUPTA, PH.D.,has served as Chief Scientist of the Company since April, 1994. Prior to joining the Company, Dr. Sengupta was a Guest Graduate Student at the Argonne National Laboratory (1991-1994) and served as a Research Assistant at the Center of Materials Science and Engineering at the University of Notre Dame (1991-1994). Dr. Sengupta is the holder of three patents in the field of high temperature superconductor technology. CURTIS A. LOVELAND has served as Secretary and as a Director of the Company since 1987. Mr. Loveland has been a practicing attorney since 1973 and has been a partner in the law firm of Porter, Wright, Morris and Arthur LLP since 1979. Mr. Loveland's practice is concentrated in the areas of corporate law and finance. Mr. Loveland also serves on the Board of Directors of several other central Ohio companies, including Applied Innovation Inc. and Rocky Shoes & Boots, Inc. The law firm of Porter, Wright, Morris & Arthur LLP serves as legal counsel for the Company. EDWARD W. UNGAR has been a Director of the Company since 1990. Mr. Ungar is the President and founder of Taratec Corporation, a technological consulting firm in Columbus, Ohio. Prior to forming Taratec Corporation in 1986, Mr. Ungar was an executive with Battelle Memorial Institute. ROBERT J. BAKER, JR., PH.D., has served as a Director of the Company since 1992. Dr. Baker is the founder of Venture Resources International and the co-founder of Business Owners Consulting Group, which assist companies in the development of growth strategies, including marketing position and competitive strategies. Dr. Baker is currently a visiting member of the Capital University faculty serving the MBA program. LLOYD E. HACKMAN has been a Director of the Company since 1993. Mr. Hackman is the former President and Chairman of Ribbon Technology, Inc., a company he founded. Ribbon Technology, Inc. produces wire products directly from molten metal for use in concrete reinforcement. CHARLES E. WASHBUSH has been a director of the Company since 1994 and is a founding partner, owner, and board member of Corporate Finance Associates Worldwide ("CFAW"), the successor company to Corporate Finance Associates, and President of Corporate Finance Associates of Columbus, Inc. CFAW is an investment banking firm, founded in 1956, with 40 offices in the United States and Canada and 10 affiliate offices in Europe. JAMES R. GAINES, JR. has served in various capacities with the Company since 1987 and now serves as Vice President and General Manager of the SCI Division of the Company. Mr. Gaines became a Director of the Company in June 1997. Prior to joining the Company, Mr. Gaines was in management at several small companies in cryogenics and other related fields for over ten years. I-28 ROBERT H. PEITZ became a Director of the Company in June 1997 and is Managing Director and Head of Financial Markets for BHF-Capital Corporation in New York. Mr. Peitz is on the Board of BHF Structured Finance and BHF Realty. Previously, Mr. Peitz held positions as Chief Dealer and Vice President in charge of Interest Rate Risk Management. Mr. Peitz has been with BHF since 1988. Prior to joining BHF, Mr. Peitz was in the Management Training program at Morgan Stanley in 1987 and 1988. FAMILY RELATIONSHIPS Dr. Funk, who is President, Chief Executive Officer, Treasurer and a director of the Company, and Mrs. Funk, who is Vice President of the Company, are husband and wife. Mr. Peitz, who is a director of the Company, is the son of Mrs. Funk and the stepson of Dr. Funk. There are no other family relationships among the directors and executive officers of the Company. INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS None. ITEM 6. EXECUTIVE COMPENSATION The following table sets forth certain information regarding compensation paid during our fiscal years ended December 31, 1997, 1998 and 1999 to our Chief Executive Officer and each of our three other highest compensated executive officers (collectively, the "Named Executive Officers"). SUMMARY COMPENSATION TABLE ANNUAL COMPENSATION LONG-TERM COMPENSATION ------------------- ---------------------- AWARDS ---------------------- RESTRICTED SECURITIES STOCK UNDERLYING ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS AWARD OPTIONS COMPENSATION ($) ($) ($) (#) ($) --------------------------- ---- ------ ----- ---------- ---------- ------------ EDWARD R. FUNK 1999 $ 5,538 $0 $0 10,000 $0 President and Chief Executive 1998 $ 0 $0 $0 0 $0 Officer 1997 $ 0 $0 $0 0 $0 JAMES R. GAINES 1999 $75,385 $0 $0 15,000 $0 Vice President and General 1998 $76,716 $0 $0 0 $0 Manager of the SCI Division 1997 $58,701 $0 $0 28,000 $0 DON RAIFSNIDER 1999 $56,000 $0 $0 15,000 $0 Vice President and General 1998 $54,738 $0 $0 0 $0 Manager of the TMI Division 1997 $0 $0 20,000 $0 SUVANKAR SENGUPTA 1999 $70,000 $0 $0 15,000 $0 Chief Scientist 1998 $74,985 $0 $0 0 $0 1997 $58,781 $0 $0 12,400 $0 I-29 OPTION/SAR GRANTS IN LAST FISCAL YEAR The following table sets forth certain information concerning the grant of stock options to the Named Executive Officers for the fiscal year ended December 31, 1999. The Company did not grant any stock appreciation rights for the fiscal year 1999. NUMBER OF SECURITIES % OF TOTAL OPTIONS UNDERLYING OPTIONS GRANTED TO EMPLOYEES IN EXERCISE PRICE NAME GRANTED (#) FISCAL YEAR(2) ($/SHARE) EXPIRATION DATE --------------------------------------------------------------------------------------------------------- Edward R. Funk 10,000 11.8% $2.00 1/13/05 James R. Gaines 15,000 17.6% $2.00 1/13/05 Don Raifsnider 15,000 17.6% $2.00 1/13/05 Suvankar Sengupta 15,000 17.6% $2.00 1/13/05 ---------------------- (1) This table covers the period from January 1, 1999 to December 31, 1999. (2) Percentage is based upon 85,000 options granted to employees in fiscal year 1999. AGGREGATED OPTION/SAR EXERCISES IN FISCAL 1999 AND FISCAL YEAR-END OPTION/SAR VALUES The following table provides certain information regarding the number and value of stock options held by our Named Executive Officers at December 31, 1999. NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT OPTIONS AT FISCAL YEAR-END (#) FISCAL YEAR-END ($)(2) ------------------------------ ----------------------- SHARES ACQUIRED ON VALUE EXERCISE REALIZED NAME (#) ($)(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE --------------------- ---------- -------- ----------- ------------- ----------- ------------- Edward R. Funk 0 $0 3,000 10,000 $0 $1,250 James R. Gaines 0 $0 13,200 31,800 $0 $1,875 Don Raifsnider 0 $0 8,000 27,000 $0 $1,875 Suvankar Sengupta 0 $0 9,960 22,400 $0 $1,875 -------------------- (1) Value realized represents the difference between the exercise price of the option shares and the market price of the option shares on the date the option was exercised. The value realized was determined without consideration for any taxes or brokerage expenses that may have been owed. I-30 (2) Represents the total gain which would be realized if all in-the-money options held at year end were exercised, determined by multiplying the number of shares underlying the options by the difference between the per share option exercise price and the per share fair market value at year end ($2.125 at December 31, 1999). An option is in-the-money if the fair market value of the underlying shares exceeds the exercise price of the option. COMPENSATION OF DIRECTORS The Company has no standard arrangement for the compensation of members of its Board of Directors. During fiscal 1999, however, each director received a non-statutory option to purchase 500 shares of the Company's common stock at an exercise price of $2.00 per share for services performed as a director of the Company. Additionally, on January 1, 2000, and October 23, 2000, each director received a non-statutory option to purchase 1,000 common shares of the Company at an option price of $2.125 per share, and 5,000 common shares at an option price of $2.00 per share, respectively. The options generally are exercisable one year from the grant date and expire on the sixth anniversary of the grant date, except for the options granted on October 23, 2000, which expire on the tenth anniversary of the grant date. ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS RIBBON TECHNOLOGY, INC. On July 20, 1993, the Company entered into an agreement with Ribbon Technology Corporation, an Ohio corporation ("Ribtec") to sell to Ribtec 50,000 common shares for $300,000 ($6.00 per share) and a convertible subordinated debenture for $200,000 (the "Debenture"). Lloyd Hackman, a director of the Company, is the President and majority shareholder of Ribtec. In June 1995, the Company issued 119,003 unregistered common shares to Ribtec in exchange for the cancellation of the Debenture. Ribtec obtained piggyback registration rights in the event of the registration and sale of the Company's common shares under the 1933 Act on a form permitting registration of primary or secondary offerings, for the common shares received pursuant to the Debenture. DIAMOND FIBER COMPOSITES, INC. The Company has trade and other receivables from Diamond Fiber Composites, Inc. ("DFC"), a company jointly owned by Dr. Funk and Peter Williams, who is not affiliated with the Company. DFC rents space from SCI and also uses utilities for which DFC is billed monthly. SCI has also supplied tools to DFC in the past. The Company has trade and other receivables due from DFC totaling $44,607 at December 31, 1999, in which the Company had written off the entire outstanding balance. The receivables relate to the sale of inventory, rent for warehouse space and reimbursement of expenses. FOURTH QUARTER 1999 ISSUANCE OF SUBORDINATED NOTES AND WARRANTS Through December 31, 1999, Dr. Funk had advanced the Company $256,125 and Mrs. Funk had advanced the Company $161,000. Effective December 31, 1999, the Company documented these loans through the issuance of Subordinated Promissory Notes to Dr. and Mrs. Funk in the amounts of $256,125 and $161,000 respectively. These notes bear interest at an annual rate of 10% and interest is payable monthly. The notes mature on December 31, 2009 and are convertible into common stock of the Company at $2.50 per share. On January 7, 2000, the Company issued common stock purchase warrants at $2.50 per share for 150,000 shares of common stock related to the subordinated notes payable to Dr. and Mrs. Funk. The warrants are 100% vested and expire ten years from the date of grant. In conjunction with a sale of common stock and common stock warrants by the Company on October 10, 2000, Dr. and Mrs. Funk converted their Subordinated Promissory Notes to 202,613 shares of common stock of the Company at the $2.50 per share conversion rate. NOTES PAYABLE The Company has a note payable to a bank in the amount of $95,025 at December 31, 1999, due June 30, 2000 I-31 interest only payable monthly at prime (8.5% at December 31, 1999) plus .75% until maturity. In addition, the Company is contingently liable under a standby letter of credit issued in favor of a vendor at $20,000 until June 30, 2001. No collateral, other than the personal guarantee by Dr. Funk, collateralizes the note or letter of credit. On February 28, 2000, Dr. Funk paid the bank note payable totaling $89,408 in full. The Company increased the amount of Dr. Funk's subordinated note payable as reimbursement for payment on the bank note payable. TARATEC CORPORATION On January 31, 1999, the Company issued 1,920 shares of common stock of the Company to Taratec Corporation for consulting services in lieu of making a cash payment of $2,400to Taratec Corporation for the services rendered. Mr. Ungar, who is a director of the Company, is the President of Taratec Corporation. LEGAL SERVICES Curtis A. Loveland is an officer, director and shareholder of the Company. Mr. Loveland is also a partner with Porter, Wright, Morris & Arthur LLP, the Company's legal counsel. OTHER The Company also has a note receivable from an Mr. Gaines, who is the Vice President and General Manager of the SCI Division of the Company, in the amount of $4,283. The note bears interest at a rate of 4% per annum. ITEM 8. DESCRIPTION OF SECURITIES The Company's authorized capital stock is 15,260,000 shares, consisting of 15,000,000 shares of common stock, without par value, 125,000 shares of Voting Preferred Shares, without par value and 125,000 shares of Non-Voting Preferred Shares, without par value (collectively, the "Preferred Shares"), of which 700 shares are designated Series A Preferred Shares and 100,000 shares are designated as Series B Preferred Shares and 10,000 shares of 10% Cumulative Convertible Preferred Shares, without par value (the "10% Preferred Shares"). COMMON STOCK Holders of the common shares have no redemption or conversion rights, participate ratably in any distribution of assets to shareholders in liquidation and have no preemptive or other subscription rights. Holders of common shares are entitled to receive such dividends as may be declared by the board of directors. Holders of common shares are entitled to one vote for each share held on all members on which shareholders are entitled to vote, and are not entitled to vote cumulatively for the elec