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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)

~~/x/~~ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended December 31, ~~2000~~2001

/o / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 0-11915

CONDUCTUS, INC.
(Exact name of registrant as specified in its charter)

Delaware		77-0162388
(State of incorporation)		(I.R.S. Employer Identification No.)

Delaware (State of incorporation)		77-0162388 (I.R.S. Employer Identification No.)
969 W. Maude Avenue Sunnyvale, California 94085 (Address of principal executive offices, including zip code)

969 W. Maude Avenue Sunnyvale, California 94085 (Address of principal executive offices, including zip code)

Registrant's telephone number, including area code: (408) 523-9950

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: ~~Common Stock, $0.0001 par value Preferred Share Purchase Right, $0.0001 par value~~

~~Indicate~~Common by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports)Stock, ~~and (2) has been subject to such filing requirements for the past 90 days~~$0. ~~Yes /x/ No / /~~0001 par value

~~Indicate by~~ aPreferred ~~check~~Share ~~mark~~Purchase ~~if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein~~Right, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K$0. ~~/ /~~0001 par value

~~The aggregate~~ Indicate ~~market value of voting stock held~~ by ~~non-affiliates~~check ofmark whether the ~~Registrant,~~registrant: ~~as of January~~(1) ~~31,~~has ~~2001,~~filed ~~was~~all ~~approximately~~reports ~~$112.8 million~~required ~~based~~to onbe ~~the closing~~filed ~~sale price of Conductus' Common Stock, as reported~~ by ~~the Nasdaq National Market on January~~Section ~~31,~~13 ~~2001.~~or ~~Shares~~15(d) of ~~Common~~the ~~Stock~~Securities ~~held~~Exchange ~~by each officer, director and holder~~ Act of 5%1934 orduring ~~more of~~ the ~~outstanding~~preceding ~~Common~~12 months ~~Stock~~(or ~~have~~for ~~been~~such ~~excluded~~shorter inperiod that ~~such~~the ~~persons~~registrant ~~may~~was berequired ~~deemed~~ to befile ~~affiliates.~~such ~~This~~reports), ~~determination~~and of(2) has ~~affiliate~~been ~~status~~subject isto ~~not~~such ~~necessarily~~filing arequirements ~~conclusive determination~~ for ~~other~~the ~~purposes.~~past ~~On January~~90 ~~31, 2001, approximately 16~~days.1 ~~million~~Yes ý No o ~~shares of the Registrant's Common Stock, $0.0001 par value, were outstanding.~~

Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

The aggregate market value of voting stock held by non-affiliates of the Registrant, as of February 28, 2002, was approximately $25.3 million based on the closing sale price of Conductus' Common Stock, as reported by the Nasdaq National Market on February 28, 2002. Shares of Common Stock held by each officer, director and holder of 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. On February 28, 2002, approximately 18.8 million shares of the Registrant's Common Stock, $0.0001 par value, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The following documents are incorporated by reference in those parts of this Annual Report on Form 10-K as set forth below, but only to the extent specifically stated in such parts hereof:

(1): Portions of the Registrant's Proxy Statement for the 2002 Annual Meeting of Stockholders scheduled to be held on May 30, 2002, are incorporated by reference into Part III.

TABLE OF CONTENTS

		~~Page Number~~	Page Number
PART I		1	3
	ITEM 1. BUSINESS	1
	ITEM 1.	BUSINESS	3
	ITEM 2. PROPERTIES	20
	ITEM 2.	PROPERTIES	24
	ITEM 3. LEGAL PROCEEDINGS	20
	ITEM 3.	LEGAL PROCEEDINGS	24
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS	20
	ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS	25
	ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS	20
	ITEM 5.	MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS	25
	ITEM 6. SELECTED FINANCIAL DATA	21
	ITEM 6.	SELECTED FINANCIAL DATA	26
	ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	23
	ITEM 7.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	27
	ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK	28
	ITEM 7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK	33
	ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	28
	ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	34
	ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	30
	ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	60
PART III		30	60
	ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT	30
	ITEM 10.	DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT	60
	ITEM 11. EXECUTIVE COMPENSATION	30
	ITEM 11.	EXECUTIVE COMPENSATION	60
	ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT	30
	ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT	60
	ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS	30
	ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS	60
PART IV		31	60
	ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K	31
	ITEM 14.	EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K	60

PART I

ITEM 1. BUSINESS

THE STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K AND IN REPORTS INCORPORATED BY REFERENCE THAT ARE NOT PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS THAT REFLECT OUR CURRENT EXPECTATIONS REGARDING OUR COMPANY'S FUTURE RESULTS OF OPERATIONS AND PERFORMANCE AND ACHIEVEMENTS. WE HAVE TRIED, WHEREVER POSSIBLE, TO IDENTIFY THESE FORWARD-LOOKING STATEMENTS BY USING WORDS SUCH AS "ANTICIPATE," "BELIEVE," "ESTIMATE," "EXPECT" AND SIMILAR EXPRESSIONS. THESE STATEMENTS REFLECT OUR CURRENT BELIEFS AND ARE BASED ON INFORMATION CURRENTLY AVAILABLE TO US. ACCORDINGLY, THESE STATEMENTS ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS, SUCH AS THOSE SET FORTH UNDER "RISK FACTORS" AND "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, WHICH COULD CAUSE OUR FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN, OR IMPLIED BY, ANY OF THESE STATEMENTS. WE UNDERTAKE NO OBLIGATION TO REVISE OR UPDATE TO ANY SUCH FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS FORM 10-K OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS.

Overview

~~THE~~ We ~~STATEMENTS~~develop, ~~CONTAINED~~manufacture INand ~~THIS~~market ~~ANNUAL~~electronic ~~REPORT~~components ONand ~~FORM~~systems ~~10-K~~based ~~AND~~on INsuperconductors ~~REPORTS~~for ~~INCORPORATED~~applications BYin ~~REFERENCE~~the ~~THAT~~worldwide ~~ARE~~wireless ~~NOT~~telecommunications market. ~~PURELY~~From ~~HISTORICAL~~our ~~ARE FORWARD-LOOKING~~incorporation ~~STATEMENTS~~in ~~THAT~~1987 ~~REFLECT~~to ~~CONDUCTUS~~1997, ~~INC.'S~~ ~~CURRENT~~we ~~EXPECTATIONS~~developed ~~REGARDING~~materials ~~ITS~~and ~~FUTURE~~processes ~~RESULTS~~for OFhigh-temperature ~~OPERATIONS~~superconductor ~~AND~~technology ~~PERFORMANCE~~and ~~AND~~researched ~~ACHIEVEMENTS.~~potential WEapplications ~~HAVE~~for ~~TRIED, WHEREVER POSSIBLE, TO~~the ~~IDENTIFY~~technology. ~~THESE~~These ~~FORWARD-LOOKING~~efforts ~~STATEMENTS~~were BYsponsored ~~USING~~in ~~WORDS~~part ~~SUCH~~by ASgovernment ~~"ANTICIPATE,"~~research ~~"BELIEVE,"~~and ~~"ESTIMATE,"~~development ~~"EXPECT"~~contract ~~AND SIMILAR EXPRESSIONS~~funding. ~~THESE~~We ~~STATEMENTS~~initiated ~~REFLECT~~commercial ~~OUR~~product ~~CURRENT~~shipments ~~BELIEFS~~in ~~AND~~1992 ~~ARE~~addressing ~~BASED~~multiple ~~ON INFORMATION~~markets, ~~CURRENTLY~~including ~~AVAILABLE TO US. ACCORDINGLY~~the communications, ~~THESE~~health ~~STATEMENTS~~care ~~ARE~~and ~~SUBJECT~~instrumentation TOmarkets. ~~CERTAIN~~In ~~RISKS,~~late ~~UNCERTAINTIES AND ASSUMPTIONS~~1996, ~~SUCH~~we ASmade ~~THOSE~~the ~~SET~~strategic ~~FORTH~~decision ~~UNDER~~to ~~"RISK~~focus ~~FACTORS"~~on ~~AND~~the ~~"MANAGEMENT'S DISCUSSION~~rapidly ~~AND~~growing ~~ANALYSIS~~telecommunications OFmarket. ~~FINANCIAL~~In ~~CONDITION~~the ~~AND~~third ~~RESULTS~~quarter OFof ~~OPERATIONS~~1997, ~~WHICH~~we completed ~~COULD~~two ~~CAUSE~~organizational ~~OUR~~changes ~~FUTURE~~aimed ~~RESULTS,~~at ~~PERFORMANCE~~focusing ORon ~~ACHIEVEMENTS~~wireless TOcommunications. ~~DIFFER~~We ~~MATERIALLY~~closed ~~FROM~~our ~~THOSE~~Instrument ~~EXPRESSED~~and ~~IN,~~Systems ORdivision ~~IMPLIED~~and ~~BY,~~sold ~~ANY~~our OFnuclear ~~THESE~~magnetic ~~STATEMENTS.~~resonance WE("NMR") ~~UNDERTAKE~~spectroscopy NOprobe ~~OBLIGATION~~business. TOIn ~~RELEASE~~mid-1999, ~~PUBLICLY~~we ~~THE~~licensed ~~RESULTS~~our OFremaining ~~ANY~~instrumentation ~~REVISIONS~~business TOto ~~ANY~~another ~~SUCH~~firm. ~~FORWARD-LOOKING~~Research ~~STATEMENTS~~and ~~THAT~~development ~~MAY~~efforts ~~BE MADE TO REFLECT EVENTS OR CIRCUMSTANCES AFTER~~are ~~THE~~now ~~DATE~~focused OFon ~~THIS~~developing ~~FORM~~applications ~~10-K~~for ORthe TOcommunications ~~REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS~~market.

~~BUSINESS~~ Our products use high-temperature superconductor technology, which has significant potential performance advantages over products based on competing materials such as copper. These advantages include enhanced sensitivity, efficiency, speed and operating frequency, as well as reduced power consumption, size, weight and cost. Our primary commercial product is our line of ClearSite front-end receiver systems for cellular and personal communication services cell sites that may significantly enhance the services provided by wireless network operators. Taking advantage of the unique properties of high-temperature superconductor materials, ClearSite products can provide significant benefits in base station performance, including coverage enhancement, reduced interference, increased capacity and enhanced bandwidth. They can also reduce the size of the filter components required and enable network services providers and original equipment manufacturers to deploy new, and enhance existing, analog and digital cellular systems for increasingly demanding carrier network environments.

We Our ClearSite ~~design,~~products ~~manufacture~~are ~~and~~designed ~~sell high-performance products~~ for ~~the wireless communications infrastructure market. Our products~~ use ~~high-temperature~~ ~~superconductor~~with ~~technology~~TDMA, ~~which~~CDMA, ~~has~~GSM ~~significant~~and ~~potential~~analog ~~performance~~base ~~advantages~~stations. ~~over~~They ~~products~~may ~~based~~be oninstalled ~~competing materials such~~ as ~~copper.~~ ~~These~~part ~~advantages~~of ~~include~~a ~~enhanced~~new ~~sensitivity,~~base ~~efficiency~~station, ~~speed~~or ~~and~~as ~~operating~~a ~~frequency,~~retrofit asfor ~~well~~existing asbase stations. ~~reduced~~In ~~power consumption~~2001, ~~size,~~we ~~weight~~introduced ~~and~~our ~~cost.~~ClearSite ~~Our~~2100 ~~primary commercial product is our~~ line of ~~ClearSite~~ front-end receiver systems ~~for cellular and personal communication services cell sites that may significantly enhance the services provided by wireless network operators~~. ~~Taking~~ ~~advantage of the unique properties of high-temperature superconductor materials,~~ ClearSite ~~products~~2100 can provide significant benefits in base station performance, including coverage enhancement, reduced interference, increased capacity and enhanced bandwidth. They can also reduce the size of the filter components required and enable network services providers and original equipment manufacturers to deploy new, and enhance existing, analog and digital cellular systems ~~for~~are ~~increasingly demanding carrier network environments.~~

available in both omni and three-sector configurations, and can be retrofitted in existing cell sites resulting in immediate performance improvements, or can be deployed in new network build outs.

In addition to our products for the wireless communications infrastructure market, we design, manufacture and sell products for the government market. These specialized products use many of the same technologies used in our commercial products and, thus, complement our commercial product line.

Industry Background

The wireless communications market is both global and growing. According to the Cellular Telecommunications Industry Association and analyst reports, at the ~~end~~ end of ~~1999~~2001 there were over ~~400~~940 million wireless subscribers worldwide and this number is expected to exceed 1.76 billion subscribers by ~~2005~~2006. In addition, the volume of traffic, as ~~measured~~ measured in ~~gigabytes~~minutes of ~~traffic~~use per day, is expected to grow from a level of less than 1~~,000~~.6 billion ~~gigabytes~~ per day at the end of ~~1999~~2001 to approximately ~~7,000~~4.5 billion ~~gigabytes~~ per day by the end of ~~2005~~2006. To support this growth in wireless traffic, industry experts estimate ~~that~~approximately ~~more than~~ 1,~~600~~890,000 cellular and personal communication services base stations will be in operation throughout the world by the end of ~~2005~~2006, compared to ~~350~~615,000 at the end of ~~1999~~2001.

As cell phone use expands, changes in technology are placing increased demands on wireless network operators. Portable handsets that transmitted only 0.2 to 0.6 watts have ~~increasingly~~ largely replaced higher-power mobile phones, which transmit up to 3 watts, thereby decreasing the effective receiving range of existing base stations. In addition, as carriers have moved from analog to digital (2G) technology, many have found that the range of the base station has decreased. As a result, in rural and suburban areas where base stations are widely separated, current wireless customers can experience dropped calls due to "dead zones" in coverage. At the same time, service providers are utilizing a greater number of channels within their allotted frequency bands in order to keep up with demand, particularly in urban areas, thereby increasing the incidence of interference.

1 The evolution of wireless networks to carry data traffic as well as voice traffic is one of the defining elements of the unfolding Information Age. Developing the necessary technology presents a great challenge to wireless network operators and their suppliers, because it involves a merging of two industries. New markets for wireless data services are developing as information technology and telecommunications converge, bringing the Internet and the wireless networks together. To date, wireless data applications have been dominated by relatively undemanding services such as electronic mail and fax services, Short Message Services ("SMS") and 9.6 Kbps data speeds. According to an industry report, in 1999 data accounted for less than 2% of mobile traffic. While there is currently uncertainty as to the rate of adoption, one industry report suggests that data will account for 13% of minutes of use in North America by 2006.

higher-power mobile phones, which transmit up to 3 watts, thereby decreasing the effective receiving range of existing base stations. In addition, as carriers have moved from analog to digital (2G) technology, many have found that the range of the base station decreases. As a result, in rural and suburban areas where base stations are widely separated, current wireless customers can experience dropped calls due to "dead zones" in coverage. At the same time, service providers are utilizing a greater number of channels within their allotted frequency bands in order to keep up with demand, particularly in urban areas, thereby increasing the incidence of interference.

The evolution of wireless networks to carry data traffic as well as voice traffic is one of the defining elements of the unfolding Information Age. Developing the necessary technology presents a great challenge to wireless network operators and their suppliers because it involves a merging of two industries. New markets for wireless data services are developing as information technology and telecommunications converge, which bring the Internet and the wireless networks together. To date, wireless data applications have been dominated by relatively undemanding services such as electronic mail and fax services, Short Message Services ("SMS") and 9.6 kbit/s data speeds. According to an industry report, in 1999 data accounted for less than 2% of mobile traffic; by 2003, data is expected to account for 45% of mobile traffic.

As succeeding generations of wireless services emerge, new applications such as smart messaging, file transfer, corporate groupware, videophony, wireless imaging, e-commerce, remote healthcare and others will become increasingly important and place higher demands upon the infrastructure. Other protocols and technologies being adopted include HSCSD (High-Speed Circuit-Switched Data), GPRS (General Packet Radio Service), EDGE (Enhanced Data Rates for Global Evolution), a 2.5G standard for Time Division Multiple Access (TDMA) wireless networks and 1XRTT, a 2.5G standard for Code Division Multiple Access (CDMA) wireless networks, are all leading up to the third generation of wireless technology (3G). The anticipated use of 3G wireless networks to carry video traffic will require over a one hundred-fold increase in bandwidth.

In the expanding and increasingly complex wireless communications infrastructure, wireless network operators are seeking cost-effective solutions that overcome problems of limited capacity, insufficient coverage, and increasing interference. Problems associated with interference, poor coverage and limited capacity are leading to decreased customer satisfaction and increased customer turnover. These problems decrease a wireless network operator's ability to compete effectively and adversely affect their ability to maximize billable minutes. The requirement for increased bandwidth imposed by wireless data communications adds additional problems for wireless network operators to solve.

These problems decrease a wireless network operator's ability to compete effectively and adversely affect their ability to maximize billable minutes. The requirement for increased bandwidth imposed by wireless data communications adds additional problems for wireless network operators to solve.

These trends are causing a number of operating problems involving wireless base stations. These include signal interference caused by multiple communications channels, poor signal quality resulting from lower-power, hand-held telephones and strained capacity due to the growing demand for service. These problems can lead to increased customer turnover and decreased billable minutes.

Wireless operators are seeking cost-effective solutions to address these problems. We believe that superconductive filters used in conjunction with super-cooled amplifiers have the potential to offer a solution to current problems, as well as to provide solutions to anticipated problems in the growing network of cellular and personal communication services base stations.

Technology

Superconductors

Superconductors are materials that have the ability to transport electrical energy with little or no loss when cooled to a "critical" temperature. The ~~intrinsic~~ intrinsic properties of superconductors include reliable signal transmission, extreme magnetic sensitivity and efficient high-speed switching. When electrical currents flow through ~~ordinary~~ ordinary materials, they encounter resistance, which consumes energy by converting electrical energy into heat energy. Depending on whether direct or alternating current is applied, superconductors have the ability to transport electrical current with no resistance at all or with only a tiny fraction of what is found in the best conventional conductors. This property is extremely beneficial in electronic components. Other intrinsic properties of superconductors enable the fabrication of unique electronic devices, including high-speed electronic switches and ultra-sensitive magnetic sensors.

2 Superconductors must be cooled to low temperatures or they do not exhibit the superconducting state. Our products are based on high-temperature superconductors, which were discovered in 1986. These high critical temperatures allow some materials to be cooled to a superconducting state using commercially available refrigeration systems or liquid nitrogen, which is inexpensive and relatively easy to use. We utilize yttrium barium copper oxide in our products. Yttrium barium copper oxide has a high critical temperature that is about 90 Kelvin. Low temperature superconductors do not become superconducting until their temperature is reduced to about 23 Kelvin or lower. We believe that this ability to obtain the benefits of superconducting technology at more easily achieved temperatures enables much broader commercial applications. While many electronic technologies exhibit enhanced performance at reduced temperatures, the most compelling performance improvements are enabled by superconductive electronics. When the unique advantages of superconductive electronics are complemented by the advantages of other cryogenic (super-cooled) technologies, the result is a hybrid system whose overall performance can justify the additional expense associated with maintaining low temperatures.

by converting electrical energy into heat energy. Depending on whether direct or alternating current is applied, superconductors have the ability to transport electrical current with no resistance at all or with only a tiny fraction of what is found in the best conventional conductors. This property is extremely beneficial in electronic components. Other intrinsic properties of superconductors enable the fabrication of unique electronic devices, including high-speed electronic switches and ultra-sensitive magnetic sensors.

From 1911, when superconductivity was first discovered, until 1986, the critical temperatures (the highest temperature at which they exhibit superconductive properties) for all known superconductors did not exceed 23 Kelvin (-418 DEG. F). As a result, superconductivity was not widely used in commercial applications because of the high cost and complexities associated with reaching and maintaining such low temperatures. In 1986, a new class of superconducting materials, referred to as high-temperature superconductors, was discovered having critical temperatures above 77 Kelvin (-320 DEG. F), the boiling point of liquid nitrogen. These high critical temperatures allow some materials to be cooled to a superconducting state using commercially available refrigeration systems or liquid nitrogen, which is inexpensive and relatively easy to use. The science and technology of extremely low temperatures is known as "cryogenics." We believe that this ability to obtain the benefits of superconducting technology at more easily achieved temperatures enables much broader commercial applications. While many electronic technologies exhibit enhanced performance at reduced temperatures, the most compelling performance improvements are enabled by superconductive electronics. When the unique advantages of superconductive electronics are complemented by the advantages of other cryogenic (super-cooled) technologies, the result is a hybrid system whose overall performance can justify the additional expense associated with maintaining low temperatures.

Benefits of Superconductive Technology in Wireless Base Stations

Our ClearSite products can offer significant benefits in base station receivers. Base stations are communication stations that are typically found at the base of of antenna towers or, in an urban environment, on top of buildings. Each specific coverage area, or "cell," in a wireless telephone network, has a base station for sending and receiving voice and data within the cell. In setting up a base station, the service provider seeks to install equipment with sufficient sensitivity within the frequency band assigned to it to handle communications with the lowest power handsets over its entire geographical area and with sufficient selectivity to avoid interfering signals from adjacent frequency bands. Filters within these base stations select frequencies within the operator's assigned bands and reject unwanted frequencies. Amplifiers boost the strength of signals coming into the base station. The operator's assigned frequency range is then allocated using one of several schemes to provide telephone service to multiple subscribers. The capacity of the system depends upon the number of effective channels; that is, channels whose signal quality is sufficient to satisfy customer demands for clear communications.

The unique characteristics of superconducting materials can be exploited to create filters that simultaneously deliver superior performance with respect to adjacent-band interference rejection and with respect to "insertion loss," reduction of the desired signal because of the filter. Because of their low-loss property, superconductors provide the closest physically-attainable approximation to a perfect filter, which would allow 100% of the desired signals to pass through and screen out 100% of the unwanted signals. 5

An ~~immediate~~reject ~~benefit~~unwanted offrequencies. ~~superconductor~~Amplifiers ~~technology~~boost ~~in base station applications is~~ the ~~ability~~strength toof ~~provide~~signals ~~superior~~coming ~~interference~~into ~~rejection~~the bybase ~~making~~station. ~~practical~~The ~~filters~~operator's ~~with~~assigned afrequency ~~large number~~range ofis ~~poles~~then ~~(filtering~~allocated ~~stages.)~~using Aone ~~second benefit~~ of ~~superconducting~~several ~~filters~~schemes isto ~~the~~provide telephone ~~potential~~service ~~ability~~ to ~~fully~~multiple ~~utilize~~subscribers. ~~the~~The ~~available~~capacity ~~spectrum~~of ~~without~~the ~~introducing~~system ~~guard~~depends ~~bands~~upon ~~or blocked channels at~~ the ~~band~~number ~~edge. A third benefit~~ of ~~superconductor~~effective ~~and,~~channels; ~~more~~that ~~generally~~is, ~~cryoelectronic~~channels ~~technology~~whose insignal ~~base~~quality ~~stations~~ is ~~the~~sufficient ~~potential~~to ~~for~~satisfy ~~providing~~customer ~~extended coverage by virtue of reducing the noise floor~~demands infor ~~the~~clear ~~receiver~~communications. ~~front end of the base~~

3 The unique characteristics of superconducting materials can be exploited to create filters that simultaneously deliver superior adjacent-band interference rejection while minimizing "insertion loss," reduction of the desired signal by the filter. Because of their low-loss property, superconductors provide the closest physically attainable approximation to a perfect filter, which would allow 100% of the desired signals to pass through and screen out 100% of the unwanted signals.

An immediate benefit of superconductor technology in base station applications is the ability to provide superior interference rejection by making practical filters with a large number of poles (filtering stages.) A second benefit of superconducting filters is the potential ability to fully utilize the available spectrum without introducing guard bands or blocked channels at the band edge. A third benefit of superconductor and, more generally, cryoelectronic technology in base stations is the potential for providing extended coverage by virtue of reducing the noise floor in the receiver front end of the base station. A fourth benefit offered by superconductor technology utilizing thin-film superconductor components is the potential for reducing the size and weight of filter subsystems.

Our Expertise

We develop electronic devices and components using thin-film technology based upon yttrium barium copper oxide. We believe yttrium barium copper oxide is the high-temperature superconductor best suited for electronic applications. We combine an advanced yttrium barium copper oxide thin-film technology with expertise in electronic device and component design, analog and digital electronic engineering, super-cooling, mechanical engineering and system integration. We believe that systems containing superconductive electronic technology offer superior performance and reduce the costs of performing desired functions.

Thin-film. We use a thin-film fabrication approach, in which a very thin film of superconductor is is deposited on a small wafer (typically 2~~-inch~~ inches in diameter) of a dielectric material and then etched to give two filters, each with the equivalent of as ~~many~~much as 1950 poles, on a single wafer. Compared to "thick-film" approaches and ceramic fabrication techniques, we believe the thin-film approach is more versatile, enables more compact components and provides superior ~~superconducting~~ properties. The fabrication of our components and circuits involves specialized processes, which are the subject of our proprietary know-how. We have performed advanced work in materials, processes and structures based on thin-film ~~superconductive~~ technology, and have developed processes we believe are capable of routinely producing a variety of high quality films for several applications.

Yttrium barium copper oxide. Although a number of high-temperature superconductors have been identified, we ~~have~~ have focused upon the development of yttrium barium copper oxide. Yttrium barium copper oxide is the only high-temperature superconductor for which there has been both significant ~~development~~ development and successful demonstration of ~~multilayer~~multi-layer technology. We believe that ~~multilayer~~multi-layer structures can be used for better film quality and stability and enhanced device functionality. We have ~~developed~~ developed several proprietary processes embodied in patent applications and trade secrets for producing yttrium barium copper oxide and other thin-film materials as well as for fabricating superconducting components and devices.

RF design. We have developed a substantial capability for designing high-temperature superconductor ~~microstrip~~ microstrip filters over a wide range of frequencies and with a wide range of characteristics. In particular, this technology provides the capability of realizing filters with large numbers of poles (filtering stages) in very compact packages. We have fabricated filters with sixteen and nineteen poles on 2-inch wafers and delivered such filters as part of systems. We have been advancing our filter design technology over a number of years and it has gained a fair measure of maturity in terms of design tools, simulation techniques and available topologies. The need for narrow-band filters, specialized filters and the desirability of very compact designs in the thin-film arena has led to a series of advances embodied in patent applications and trade secrets. Apart from the ability to meet increasingly demanding performance specifications, we are also now able to design high-temperature superconductor filters far more rapidly than in the past.

numbers of poles (filtering stages) in very compact packages. We have fabricated filters with the equivalent of up to 50 poles on 2-inch wafers and delivered such filters as part of systems. We have been advancing our filter design technology over a number of years and it has gained a fair measure of maturity in terms of design tools, simulation techniques and available topologies. The need for narrow-band filters, specialized filters and the desirability of very compact designs in the thin-film arena has led to a series of advances embodied in patent applications and trade secrets. Apart from the ability to meet increasingly demanding performance specifications, we are also now able to design high-temperature superconductor filters far more rapidly than in the past.

Product design. We have developed significant expertise and know-how in electronic device and component design, analog and digital electronic engineering, super-cooling, mechanical engineering and system integration. We seek to make the presence of superconductive and super-cooled components an entirely integral feature of our products. By skillfully integrating the refrigeration system into our communications filter subsystems, for example, and by selecting a refrigeration approach with proven durability, we believe that our products can be easily accommodated and well accepted by end users. Furthermore, we believe that providing our technology at the subsystem level to system manufacturers in specific markets will allow us to rapidly and efficiently expand both our product line and our customer base.

The Conductus Solution

Our ClearSite products incorporate superconducting filters and cryogenic low-noise amplifiers to enhance receiver sensitivity and reduce ~~interference~~ interference from the growing number of competing wireless services. We believe that our technology can improve the performance of the basic elements of the communication system, such as the interference filters and preamplifiers in the base stations. The products, which feature a compact form factor and rugged housing, effectively improve coverage, reduce interference, increase network capacity and enhance bandwidth, thus improving the wireless network ~~operators~~operator's ability to compete effectively and increase billable airtime. The products incorporate built-in radio frequency ("RF") diagnostics, alarm systems, remote monitoring capabilities and system failure bypass circuitry.

~~Clearsite~~ ClearSite ~~provides~~products provide benefits in all types of wireless environments. In current cellular systems, the needs of urban and rural operators are quite different. Urban base stations ~~are~~ are typically high-capacity cells in harsh or otherwise congested environments. Key issues are interference and capacity. In contrast, rural base stations see relatively low call volumes ~~but~~ but struggle with problems with ~~the~~ handset to base station transmissions because of the lower power levels transmitted by hand-held phones and the long distances between base stations. In this environment, range extension and coverage improvement are the key issues.

The growing wireless infrastructure with increasing numbers of carriers and increasing ~~uses~~use of wireless technology for data communications present a variety of opportunities for superconductive filter technology. With multiple bands, large numbers of base stations, new interference sources and tight space constraints, all the virtues of superconductive filter technology may be needed to solve problems.

~~The following chart summarizes ClearSite's benefits for various generations of wireless networks.~~ 7

		1G	2G	2.5/3G
ClearSite Benefit	Reason
Reduced interference	Sharp filters		•	•
Increased capacity	Sharp filters		•	•
Improved coverage/extended range	Reduced system noise	•	•	•
Increased bandwidth for data	Sharp filters, low noise			•
Compact form-factor	Thin-film technology	•	•	•

The following chart summarizes the benefits of ClearSite products for various generations of wireless networks.

We have had several recent validations of the advantages offered by ClearSite products. In 2000, we completed and documented six comprehensive field trials, including four TDMA trials, one CDMA trial and one W-CDMA (wideband-CDMA) or 3G trial. These validations included the following:

ClearSite Benefit	Reason	1G	2G	2.5/3G
Reduced interference	Sharp filters		•	•
Increased capacity	Sharp filters		•	•
Improved coverage/extended range	Reduced system noise	•	•	•
Increased bandwidth for data	Sharp filters, low noise			•
Compact form-factor	Thin-film technology	•	•	•

5 During the last year, we made significant progress in our efforts to build a commercial market for ClearSite products.

•: In March 2001, we announced our new generation of ClearSite products, which include optional features such as remote variable gain adjustment;
•: In May 2001, we announced a follow-on order from one of the nation's ten leading carriers;
•: In May 2001, we announced the hiring of a new vice president of sales to expand and strengthen our sales organization and to help us win additional major accounts in the United States and abroad;
•: In June 2001, we announced that we had developed a new, ultra-selective filter that we believe has the best performance available to date;
•: In August 2001, we announced completion of a modification of our manufacturing facilities increasing our production capacity using lean manufacturing processes;
•: We successfully conducted corporate-sponsored field trials with two of the top five carriers and with one of the second five largest carriers in the U.S;
•: Our field trial results consistently demonstrated average improvement in mobile transmit power of approximately 3dB due to the deployment of ClearSite systems;
•: Conductus' ClearSite systems obtained qualification for system-wide sales to four of the top ten carriers in the U.S. We believe that these successful trials will result in deployment orders during 2002;
•: We received purchase orders from two additional major base station equipment manufacturers in Japan for next-generation ClearSite 3G systems specifically designed for OEM use; and
•: We won a number of new government programs during the year, and more than tripled our overall government business in 2001.

placed orders for more than 50 additional systems, which are expected to be delivered during the second and third quarters of 2001.

Business and Development Strategy

Our objective is to become a leading worldwide provider of wireless telecommunications components based on superconductors. Our strategy for developing, manufacturing and marketing superconductive electronics products includes the following key elements:

Focus on Complete Solutions. We believe that superconductive component technology can best be provided to customers in the form of integrated subsystems that incorporate the superconductive components, additional electronic circuits and devices, and the self-contained refrigeration equipment and packaging required to maintain the reduced temperatures necessary to sustain superconductivity.

Conduct Additional Field Trials to Prove Our Technology. In ~~2000~~2001, we completed ~~and~~two ~~documented six comprehensive field trials~~corporate-sponsored, ~~including four TDMA trials, one CDMA trial and one W~~ multi-~~CDMA or 3G trial. During 2001~~site, ~~we intend to conduct additional~~ field trials toin ~~further~~urban ~~document the benefits of our technology, focusing on trials for~~ CDMA systems. WeThese ~~believe~~two ~~that well-documented field~~ trials ~~can~~have ~~provide~~shown ~~data~~that ~~useful~~ClearSite ~~to our understanding of the full benefits to our customers, and assist our customers in evaluating the price/performance benefits of our technology.~~

Expand Sales and Marketing Capabilities. We plan to expand our sales and marketing activities by hiring employees with significant experience in key product areas and by engaging distributors and representatives in target markets, particularly internationally. During 2000, we increased our business development activities in Asia by adding exclusive distributors or representatives in both Taiwan and Korea. We believe the most significant international opportunity is the introduction of 2.5G and 3G wireless technology, with initial deployments taking place this year in Japan. In 2001, we plan to expand our business development activities in other areas of Asia as well as Europe and Latin America, where significant opportunities exist to create a growing market presence. Many European countries have among the highest wireless penetration rates in the world. In addition, heavily-populated countries in Latin America utilize wireless standards similar to that of the United States, and are experiencing rapid growth in wireless subscribers due to the limited availability and high cost of fixed lines. 8

~~Expand~~ systems ~~Manufacturing~~not ~~Capabilities. A~~only ~~key~~increase tocoverage, ~~our~~but ~~success~~also ~~will~~increase becapacity ~~our~~and ~~ability~~quality toof ~~build~~service ~~the~~at ~~manufacturing~~busy ~~infrastructure~~ urban cell sites in demanding environments. During 2002, we ~~believe~~intend ~~are~~to ~~necessary~~conduct additional field trials to further ~~support~~document the ~~commercialization~~benefits of our ~~products~~technology. inWe ~~our~~believe ~~target~~that ~~markets.~~well-documented ~~This~~field ~~includes~~trials ~~the~~can ~~development~~provide data useful to our understanding of ~~thin-film~~the ~~deposition~~full ~~techniques~~benefits ~~suitable~~to ~~for high-volume~~our ~~manufacturing~~customers, and ~~the~~assist our ~~acquisition~~customers ~~and~~in ~~build-out~~evaluating ofthe ~~manufacturing~~price/performance ~~and~~benefits ~~assembly~~of ~~areas~~our technology.

~~Maintain~~ Expand ~~Technological~~Sales ~~Leadership. We have devoted significant resources to developing proprietary high-temperature superconductor thin-film manufacturing~~ and ~~process~~Marketing ~~technologies~~Capabilities. During ~~In addition~~2001, we ~~have~~expanded ~~developed~~our ~~technologies~~marketing ~~related~~and tosales ~~superconductive~~activities ~~filter~~by ~~subsystem~~hiring ~~design~~a Vice President of Sales and ~~manufacture.~~additional ~~Government-supported~~account ~~research~~management and ~~development~~field ~~has~~service ~~supported~~personnel. ~~our~~We ~~advances~~believe ~~not~~the ~~only~~most insignificant ~~thin-film~~international ~~processing,~~opportunity ~~but~~is ~~also~~the inintroduction ~~filter~~of ~~design,~~2.5G ~~tuning~~ and ~~packaging.~~3G Wewireless ~~have~~technology, ~~three~~with ~~patents~~initial ~~and~~deployments ~~eight~~taking ~~pending~~place ~~patent~~in ~~applications~~Japan. ~~related~~In to2001, ~~various~~we ~~aspects~~expanded of our ~~current~~business ~~ClearSite~~development ~~product~~activities ~~design~~in ~~and manufacture or potential future versions of ClearSite products~~Japan. ~~International counterparts of several of~~

6 Expand Manufacturing Capabilities. A key to our success will be our ability to build the manufacturing infrastructure we believe is necessary to support the commercialization of our products in our target markets. This includes the development of thin-film deposition techniques suitable for high-volume manufacturing, and the acquisition and build-out of manufacturing and assembly areas.

Maintain Technological Leadership. We have devoted significant resources to developing proprietary ~~these~~high-temperature ~~pending~~superconductor ~~applications~~thin-film ormanufacturing ~~issued~~and ~~patents~~process technologies. We use proprietary processes for production of superconductive films and for filter design. In addition, we have ~~been~~developed ~~filed~~technologies ~~under~~related ~~the~~to ~~Patent~~superconductive ~~Cooperation~~filter ~~Treaty~~subsystem ~~with~~design aand ~~number~~manufacture. ofGovernment-supported ~~applications~~research ~~currently~~and ~~pending~~development has supported our advances not only in thin-film ~~various~~processing, ~~countries~~but ~~worldwide~~also in filter design, tuning and packaging. We ~~have~~protect ~~also~~our ~~licensed from~~technology ~~Lucent~~through ~~Technologies~~of patent, ~~Inc.~~ ~~certain~~trademarks, ~~rights~~copyright toand ~~Lucent's~~trade ~~patents~~secret law. We also use nondisclosure and ~~patent~~proprietary ~~applications~~information ~~for~~agreements ~~yttrium~~to ~~barium~~protect ~~copper~~our ~~oxide~~proprietary technology.

Sales and Marketing

In order to successfully commercialize our products, we are expanding the staffing and related activities of our sales, marketing and distribution organizations. Our current sales and marketing strategy relies primarily on direct sales for our communications products in the United States and distributors abroad. During ~~2000~~2001, we ~~added~~hired ~~sales~~a ~~and sales~~new ~~support~~Vice ~~personnel~~President of Sales and ~~appointed~~significantly aincreased ~~distributor~~the ~~for~~number ~~the~~of ~~Taiwanese~~account ~~market~~managers to expand and astrengthen ~~representative~~our ~~for~~sales organization and to help us win additional major accounts in the ~~Korean~~United ~~market~~States and abroad.

We intend to add additional personnel to support our sales and marketing efforts. These employees will be actively engaged in direct marketing to customers, as well as in sales and marketing support. We actively market our products through ~~direct~~quarterly ~~mail~~email ~~advertisements~~customer newsletters, as well as through demonstrations at industry trade shows. Our employees have published the results of ~~their~~ their research at our company widely in trade and technical journals. Additionally, our employees have frequently presented our technology as invited speakers at conferences worldwide.

Strategic Relationships

In May 1999, we entered into a definitive agreement with General Dynamics Information Systems, Inc. ("GDIS") to license our high-temperature superconductor electronics and cryoelectronics technology. Under the license agreement, GDIS acquired rights to our high-temperature superconductor thin-film technology and other intellectual property for $5,000,000 plus future royalties and has certain ~~exclusive~~ rights to use and sell this technology for use in U.S. government or state, local and foreign government markets, as defined under the agreement. We also entered into a Cross-License, Supply and Training Agreement with GDIS under which both parties agreed to cross-license updates, if any, to the licensed technology developed by either party. Additionally, we agreed to provide product and training to GDIS in exchange for payment at standard commercial rates from GDIS. Subsequent ~~to the original transaction, the~~ ~~General Dynamics business unit with whom we work was transferred~~ to ~~General Dynamics Electronic Systems ("GDES") and the agreement was assigned to the successor organization.~~

We believe that GDES may help us in our efforts to further penetrate the government market for high-temperature superconductor products. GDES has strong relationships in the military and intelligence community. In addition, GDES had developed its own technology to address needs of government customers that can be combined with our technology to provide unique system-level solutions to specific applications problems. GDES can benefit from the agreement by gaining exclusive access to what it has assessed as an enabling technology for a number of applications. 9

the original transaction, the General Dynamics business unit with whom we work was transferred to General Dynamics Electronic Systems ("GDES") and the agreement was assigned to the successor organization.

We believe that GDES may help us in our efforts to further penetrate the government market for high-temperature superconductor products. GDES has strong relationships in the military and intelligence community. In addition, GDES has developed its own technology to address needs of government customers. We believe that GDES technology can be combined with our technology to provide unique system-level solutions to specific applications problems. GDES can benefit from the agreement by gaining exclusive access to what it has assessed as an enabling technology for a number of applications.

Research and Development

We expect that future ClearSite products will include versions designed for outdoor installation as well as tower mounting. We are also exploring the application of superconductive and cryoelectronic technologies to a variety of applications in the broader communications market. Among these are subsystems for communications satellites, antenna components and various elements of high-speed and/or high-bandwidth communications equipment.

Government Contracts

Our research and development expense in the fiscal years ~~1998~~1999, ~~1999~~2000 and ~~2000~~2001 was approximately $54,~~621~~430,000, $45,~~430~~507,000 and $58,~~507~~666,000, respectively. Externally funded research and development programs, primarily under contracts with the U.S. government, accounted for approximately $52,~~661~~477,000, $21,~~477~~920,000 and $16,~~920~~939,000 of total operating expense in the fiscal years, ~~1998~~1999, ~~1999~~2000 and ~~2000~~2001, respectively. Our revenue from government-related contracts represented approximately, 7925%, 2574% and 7461% of total revenue for fiscal years ~~1998~~1999, ~~1999~~2000 and ~~2000~~2001, respectively.

We believe that we will continue to be heavily dependent on U.S. government contracts to fund a significant portion of our research and development programs. Our strategy is to fund a significant portion of our research and development, particularly for wireless communications and digital electronics applications, through contracts with agencies of the U.S. government.

Our contracts involving the U.S. government are, or may be, subject to numerous risks, including the risk that the government will reduce, modify, terminate or fail to exercise future options on the contracts.

Patents, Proprietary Technology and Trademarks

We ~~have~~own ~~three~~23 ~~issued~~patents ~~U.S.~~alone ~~patents~~or with others, and ~~eight~~have fourteen pending ~~patent~~ applications ~~that~~in ~~address~~the ~~various~~United ~~aspects~~States. ofOur ~~our~~patents ~~current~~have ~~and~~useful ~~future~~lives ~~ClearSite~~ranging ~~products. International~~from ~~counterparts~~5 ofto 15 years. ~~several~~We ofhave ~~these~~fourteen ~~pending~~international ~~applications~~patents orand ~~issued~~a ~~patents~~number ~~have~~of ~~been~~international ~~filed~~applications pending under the Patent Cooperation Treaty ~~with a number of applications currently issued~~ or ~~pending~~ in various countries worldwide. ~~These~~Several ~~patents~~of our patents and patent applications ~~address~~relate to a various aspects of our communications products, including thin-film processing, filter design and tuning, and other aspects of our products. Other patents relate to various technologies, such as superconductive quantum interference devices or digital electronics and are licensed to one or more entities. We will continue to file other U.S. and key international patent applications as part of our business strategy to protect technology we consider important to providing a competitive market advantage for our technologies. ~~Additionally,~~ ~~we have issued patents that we have licensed to others.~~ We have also licensed from Lucent Technologies, Inc., certain rights to Lucent's patents and patent applications for yttrium barium copper oxide.

We also rely upon trade secrets, unpatented know-how, continuing technological innovation, employee and third-party nondisclosure agreements and the pursuit of licensing opportunities in order to develop and maintain our competitive position. 10

We also rely upon copyrights, trademarks, trade secrets, unpatented know-how, continuing technological innovation, employee and third-party nondisclosure agreements and the pursuit of licensing opportunities in order to develop and maintain our competitive position.

We believe that, since the discovery of high-temperature superconductors in 1986, several thousand patent applications have been filed worldwide and over 600 patents have been granted in the U.S. relating to high temperature superconductivity. In some cases, these patents and applications may be overlapping. There are interference proceedings pending regarding rights to inventions claimed in some of the applications. Accordingly, the patent positions of companies using high-temperature superconductor technology, including our company, are uncertain and involve both complex legal and factual questions. Consequently, there is significant risk that others have obtained or will obtain patents relating to our planned products or technology and that we will be unable to obtain licenses on commercially reasonable bases or at all.

A patent issue of particular importance to us relates to copper oxides, including yttrium barium copper oxide. We have neither obtained any issued patents nor have we filed any patent applications covering the composition of any copper oxides. However, several U.S. and foreign patent applications are pending that would, if issued, cover compositions of yttrium barium copper oxide. We understand that at least several U.S. applications, including that of Lucent Technologies, were the subject of interference proceedings. We have obtained a license from Lucent Technologies to use yttrium barium copper oxide in our products. Lucent has reported to us that they have prevailed in the interference proceeding, but no patent has yet been issued. We believe that other interference proceedings in the United States addressed to various compositions of yttrium barium copper oxide may be pending. Should another party prevail in any of these proceedings, we may need to obtain a license from that party in order to continue to develop and sell products based on yttrium barium copper oxide. Additionally, we are aware of patents issued in other countries that cover certain compositions and methods of making or using yttrium barium copper oxide and other superconducting oxides. We may be required to obtain a license for these patents to sell our products in those countries.

another party prevail in any of these proceedings, we may need to obtain a license from that party in order to continue to develop and sell products based on yttrium barium copper oxide. Additionally, we are aware of patents issued in other countries that cover certain compositions and methods of making or using yttrium barium copper oxide and other superconducting oxides. We may be required to obtain a license for these patents to sell our products in those countries.

Through our strategic relationships, we have received rights to certain intellectual property developed by our partners, as well as commitments from those partners to offer licenses to certain background technology. We cannot assure you that the terms of these licenses will allow us to compete effectively.

Additionally, successful marketing of a material portion of our ClearSite products depends in part on nonexclusive licenses obtained from various licensors. There can be no assurance that such licenses will not be terminated by licensors or that we will be able to develop alternate products that do not require these or other licenses.

We On ~~own~~July 17, 2001, ISCO International, Inc. ("ISCO") filed a complaint in the United District Court for the District of Delaware against Conductus, alleging that our current base station front-end systems containing cryogenically cooled superconducting filters infringe ISCO's U.S. ~~registered~~Patent ~~trademarks~~No. 6,263,215, entitled "~~CONDUCTUS®~~Cryoelectronically Cooled Receiver Front End for Mobile Radio Systems," which was issued on July 17, 2001. On September 17, 2001, ISCO amended its complaint to allege willful infringement and ~~"ClearSite®~~to seek treble damages for the alleged infringement. The complaint seeks injunctive relief and damages for infringement. We have denied infringement," denied that the patent is valid and alleged that the patent was procured through inequitable conduct. We have filed ancounterclaims ~~application~~seeking todeclarations ~~register~~of ~~the~~invalidity ~~trademark~~and ~~"Clearing~~non-infringement ~~the~~and ~~Way~~damages for unfair competition." We believe that ISCO's claims are without merit and are defending ourselves vigorously.

that might result. While the outcome of this claim cannot be predicted with certainty, we do not believe that the outcome will have a material adverse effect on our financial position, results of operations or cash flows.

We own the U.S. registered trademarks "CONDUCTUS®" and "ClearSite®," and "Clearing the Way®."

Manufacturing

We have established a ~~pilot~~ production facility at our headquarters in Sunnyvale, California, to fabricate, test and assemble thin films and components. We ~~fabricate~~ fabricate two-, three- and four-inch wafers in two ~~cleanroom~~clean room areas that consist, in total, of approximately 2,600 square feet. Additionally, we assemble systems in a 35,~~250~~ 576 square foot manufacturing facility, which includes ~~cleanrooms~~clean rooms of approximately 1,250 square feet. We combine advanced yttrium barium copper oxide thin-film technology with expertise in electronic and device component design, analog and digital electronic engineering, low temperature packaging, mechanical engineering and system integration.

The primary materials and equipment used in our ClearSite products include substrates, yttrium barium copper oxide precursors and processing equipment. We procure our substrates from several suppliers. We primarily utilize yttrium, barium and copper to produce yttrium barium copper oxide. These metals are available from numerous vendors. In limited cases, we use yttrium barium copper oxide purchased from two sources. Our processing equipment is assembled from off-the-shelf components that we can obtain from multiple sources.

We believe that most of our products will be in the form of subsystems that incorporate superconducting and cryoelectronic components with super-cooling refrigerators and conventional electronic assemblies. We anticipate continuing to manufacture the superconducting components, and purchasing most of the other components from commercial vendors. These other components include super-cooling refrigerators, printed circuit boards, product cases and housings and vacuum vessels. We currently obtain certain components, including cryocoolers, from a single source or a limited number of suppliers. Although we do not believe that we are ultimately dependent upon any supplier as a sole source or limited source for any critical components, our inability to develop alternative sources, a prolonged interruption in supply or a significant increase in price of one or more components would harm our business, operating results and financial condition.

We are focusing on the development of our production processes and are manufacturing limited quantities of superconducting components and products incorporating those components at our facility in Sunnyvale, California~~, facility~~. Apart from the production of superconducting components, we expect that our manufacturing activities generally will be limited to cleaning, final assembly, vacuum bakeout and testing. We are producing these products in limited commercial quantities and are continuing to expand our capabilities.

Competition

Our ClearSite products compete with a number of alternative approaches and technologies that increase the capacity and improve the quality of wireless networks, some of which may be less expensive or offer better performance. These approaches include increasing the numbers of transmission stations, increasing tower heights, locating filters and amplifiers at the top of antennas and using advanced antenna technology.

Although the market for superconductive electronics currently is small and in the early stages of development, we believe this market will become intensely competitive if products with significant market potential are successfully developed.

A number of large American, Japanese and European companies are engaged in research and development programs that we believe could lead to the development and/or commercialization of superconductive electronic products. These include, among others: DuPont, IBM, TRW, and Northrop-Grumman Corporation in the U.S.; and Fujitsu Ltd., Hitachi Ltd., NEC Corp., and Sumitomo Electric Industries, Ltd. in Japan. 12

We A number of large American, Japanese and European companies are engaged in research and development programs that we believe could lead to the development and/or commercialization of superconductive electronic products. We also believe that a number of smaller companies are engaged in various aspects of the development and commercialization of superconductive electronics products. These include, among others, ~~Hypres,~~Superconductor Technologies Inc. ~~in digital circuits; and Illinois Superconductor Corp.~~, ~~Superconductor~~ISCO ~~Technologies~~International, Inc. and CryoDevices, Inc. in wireless communications. Furthermore, academic institutions, governmental agencies, and other public and private research organizations are engaged in development programs which may lead to competitive arrangements for commercializing superconductive electronics products. In addition, if the superconductor industry does develop further, new competitors with significantly greater resources are likely to enter the field.

Several of our existing collaborative arrangements permit, and future arrangements may also permit, both us and our partner(s) to use the technology developed under these arrangements. Accordingly, we may compete with our partners for commercial sales of any products developed under these arrangements.

We believe that the principal competitive factors in the market for superconductive electronics will be the following:

•: The ability to develop commercial applications of superconductive technology;
•: Product performance, including speed, sensitivity, size and power dissipation;
•: Price; and
•: Product quality and reputation.

We believe that we are competitive with regard to these factors. Nonetheless, because the market for superconductive electronics is at an early stage, our relative competitive position in the future is difficult to predict.

Environmental Matters

We use certain hazardous materials in our research and manufacturing operations. As a result, we are subject to federal, state and local governmental regulations. We believe that we have complied with all regulations and have all permits necessary to conduct our business.

Employees

As of December 31, ~~2000~~2001, we had a total of 9399 full-time equivalent employees of which 2839 hold advanced degrees. Of the total full-time employees, 4245 were engaged in research and product development, 29 in manufacturing, 11 in sales and marketing and 14 in administration and finance. None of our employees are represented by a labor union. We have not experienced any work stoppages and consider our relations with our employees to be good.

1013

development, 26 in manufacturing, 9 in sales and marketing, and 16 in administration and finance. None of our employees are represented by a labor union. We have not experienced any work stoppages and consider our relations with our employees to be good.

Our executive officers are as follows:

Name	Age	Position
Charles E. Shalvoy	5354	President, Chief Executive Officer and Director
Ron Wilderink	42	Vice President of Finance, Chief Financial Officer and Secretary
Hank Scherf	54	Vice President of Sales
James P. Simmons, Jr.	5152	Vice President, ~~Sales~~of ~~and~~ Marketing
Randy W. Simon, Ph.D.	4748	Vice President, ~~Technology~~of Government Programs and Chief Technology Officer
Syed I. Zaidi	45	Vice President, Operations
Richard E. Weiss	47	Vice President of Engineering
Ron Wilderink	43	Vice President of Finance, Chief Financial Officer and Secretary
Syed I. Zaidi	46	Vice President of Operations

Mr. Shalvoy joined us in June 1994 as President, Chief Executive Officer and Director. From 1988 to 1994, he was President and Chief Operating Officer of Therma-Wave, Inc., a manufacturer of semiconductor production equipment. Prior to that he was employed by Aehr Test Systems, Emerson Electric Corp. and Raychem Corporation in a variety of senior management positions. Mr. Shalvoy holds a B.S. in Mechanical Engineering from the University of Notre Dame and an M.B.A. from Stanford University.

Mr. ~~Wilderink~~ Scherf joined us in ~~November~~May ~~1998~~2001 as Vice President of ~~Finance~~Worldwide ~~and Chief Financial Officer~~Sales. HeFrom ~~was~~December 2000 ~~appointed~~until ~~Secretary in January~~February ~~2000.~~2001 ~~From~~he ~~1995~~was ~~until~~Vice ~~1998,~~President heof ~~was~~Sales ~~with~~at ~~Oak~~Villa ~~Technology~~Montage, Inc., aFrom ~~multinational~~April 1998 ~~semiconductor~~until ~~manufacturer~~December 2000 ~~where~~ he was Vice President, ~~Corporate~~of ~~Controller.~~Sales ~~His prior experience includes various management~~ and ~~staff~~Product ~~positions~~Marketing at ~~Bell Microproducts~~GoDigital Networks, Inc., aFrom ~~distributor~~October 1993 ofuntil ~~high~~April 1998 ~~technology~~he ~~products;~~was ~~VMX, Inc.,~~Regional aVice ~~manufacturer~~President of ~~integrated~~Sales ~~voice processing systems~~for ~~and~~ADC ~~KPMG LLP, an accounting and consulting firm~~Kentrox. Mr. ~~Wilderink~~Scherf holds a BBS in Aerospace Engineering from the U.S. Naval ~~degree~~Academy, and M.S. in ~~Accounting~~Mechanical ~~from~~Engineering ~~San~~form ~~Jose~~North Carolina State University and isan aM.B.A. ~~Certified~~from ~~Public~~Stanford ~~Accountant in California~~University.

Mr. Simmons joined us in November 1998 as Vice President Sales and Marketing. In May 2001, he was appointed Vice President of Marketing. From 1994 to 1998 he was Vice President, Marketing and Sales of Superconductor Technologies, Inc., a manufacturer of high-temperature superconducting wireless subsystems. His prior experience includes senior management positions at Therma-Wave, Inc., Nanometrics, Inc. and KLA Instruments Corporation and various management positions at Hewlett-Packard. Mr. Simmons holds a B.S. degree in Applied Physics from California Institute of Technology and an M.B.A. from Harvard Business School.

Dr. Simon joined us in October 1990. asHe ~~Senior~~has ~~Scientist~~held ~~and~~a ~~served~~number ~~as Director~~ of ~~Research~~senior ~~and~~management ~~Development~~positions ~~from March 1991~~with ~~to January 1993 and as Vice President~~Conductus, ~~Marketing~~ and has ~~Development~~been ~~from January 1993 to November 1994 and~~ Vice President, ~~Technology~~of Government Programs and ~~Investor Relations~~Chief ~~from November 1994 to November 1995 and Vice President,~~ Technology ~~Programs~~Officer since ~~November~~April ~~1995~~17, 2001. From January 1985 to October 1990, he held a variety of scientific and managerial positions at TRW, where he headed TRW's Superconductivity Research Department's high-temperature superconductivity program and managed TRW's internal research and development program on high-temperature superconductive electronics. Dr. Simon holds a B.S. in Physics from Pomona College and an M.S. and a Ph.D. in Physics from the University of California, Los Angeles.

Mr. ~~Zaidi~~ Weiss joined us in May ~~2000~~2001 as ~~Director~~Vice President of ~~Quality Assurance~~Engineering. InFrom ~~October~~July ~~2000~~1995 until April 2001, he was ~~appointed~~employed ~~Vice President,~~by ~~Operations~~Ericsson, Inc. ~~Prior~~in tovarious ~~joining~~management ~~Conductus~~positions, ~~Mr. Zaidi~~the ~~worked~~last ~~for~~as ~~Lam~~Vice ~~Research,~~President. aPrior ~~leading~~to ~~semiconductor~~Ericsson ~~capital~~Mobile ~~equipment~~Phone, ~~company~~Mr. Weiss inworked ~~Fremont,~~for ~~California,~~nine inyears ~~various~~at Stanford ~~senior~~Telecom ~~management positions.~~where Hehe ~~has~~designed ~~also~~communications ~~worked~~products for ~~Gemini~~both ~~Research~~commercial asand agovernment ~~Quality & Reliability Engineer~~customers. Mr. ~~Zaidi~~Weiss ~~holds~~earned ahis ~~B.S.~~BS in ~~Metallurgical~~Meteorology ~~Engineering~~ from ~~N.E.D.~~Pennsylvania State University ~~of Engineering~~ and ~~Technology~~ ~~in Karachi, Pakistan, and~~ an ~~M.S. in Mechanical Engineering~~ MSEE from ~~the~~George ~~University~~Washington ~~of Cincinnati in Cincinnati, Ohio~~University.

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Mr. Wilderink joined us in November 1998 as Vice President of Finance and Chief Financial Officer. He was appointed Secretary in January 2000. From 1995 until 1998, he was with Oak Technology, Inc., a multinational semiconductor manufacturer where he was Vice President and Corporate Controller. His prior experience includes various management and staff positions at Bell Microproducts, Inc., a distributor of high technology products; VMX, Inc., a manufacturer of integrated voice processing systems and KPMG LLP, an accounting and consulting firm. Mr. Wilderink holds a B.S. degree in Accounting from San Jose State University and is a Certified Public Accountant in California.

Mr. Zaidi joined us in May 2000 as Director of Quality Assurance. In October 2000, he was appointed Vice President, Operations. Prior to joining Conductus, Mr. Zaidi held various senior management positions for Lam Research, a leading semiconductor capital equipment company in Fremont, California. He has also worked for Gemini Research as a Quality & Reliability Engineer. Mr. Zaidi holds a B.S. in Metallurgical Engineering from N.E.D. University of Engineering and Technology in Karachi, Pakistan, and an M.S. in Mechanical Engineering from the University of Cincinnati in Cincinnati, Ohio.

RISK FACTORS

Conductus' business, financial condition and results of operations have been, and in the future may be, affected by a variety of factors, including those set forth below and elsewhere in this report. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us, or that we currently consider immaterial, may also impair our business operations.

Risks Related to our Business

We have a history of losses and may never become profitable.

Our ~~net~~financial ~~loss~~statements ~~for~~have ~~the~~been ~~year~~prepared ~~ended~~assuming ~~December 31,~~that ~~2000,~~we ~~excluding~~will ~~the~~continue ~~impact~~as ofa ~~non-cash~~going ~~charges~~concern. ~~related~~The tofinancial ~~the~~statements ~~beneficial~~do ~~conversion~~not ~~features~~include ofany adjustments that might be necessary if the ~~Series C~~Company ~~stock,~~is ~~was~~unable ~~$12~~to continue as a going concern.~~9 million.~~ AsWe ofhave ~~December 31,~~incurred ~~2000~~significant losses since inception. In 2001, we ~~had~~incurred ~~accumulated~~losses ~~net~~from ~~losses~~operations of ~~approximately~~$17,997,000 and used cash totalling $7118,730,000 in our operating activities.~~9 million.~~ We expect tothat ~~incur~~operating ~~substantial additional~~ losses ~~through~~and negative cash flows will continue at least ~~2001~~through 2002 as we ~~expand~~continue to market our ~~operations.~~ClearSite Weproduct ~~expect~~and increase toits ~~commit~~customer base. These factors raise substantial ~~resources~~doubt about our ability to: continue as a going concern.

In We ~~order~~are toseeking ~~become~~additional ~~profitable,~~equity weand ~~must~~debt ~~successfully~~financing ~~develop,~~from ~~manufacture,~~external ~~introduce~~investors ~~and~~to ~~market~~fund ~~our~~operations, ~~potential~~however, ~~products.~~there Weis ~~cannot~~no ~~assure~~assurance ~~you~~ that we will ~~ever~~ be ~~profitable~~able ~~or,~~to ifobtain ~~we become~~additional ~~profitable,~~financing with terms that weare ~~will~~acceptable ~~continue~~ to ~~be profitable thereafter~~us. ~~Our~~The ~~failure~~financial tostatements ~~become~~do ~~profitable~~not orinclude ~~maintain~~any ~~our~~adjustments ~~profitability~~that ~~could~~may ~~significantly~~result ~~harm~~from the ~~value~~outcome of ~~our~~these ~~common stock~~uncertainties.

The value of our common stock is difficult to evaluate because our future operating results are unpredictable and likely to fluctuate significantly.

We focus our efforts on developing superconductive products for the wireless telecommunications industry. Our operating history in that market is limited and our operating results are susceptible to significant fluctuations. Thus, we cannot reliably predict future operating results, making it difficult for you to assess the value of our common stock. We believe that period-to-period comparisons of our operating results are not necessarily meaningful, and you should not rely upon period-to-period comparisons as indications of future performance.

Our future operating results may vary significantly due to factors including:

•: Our ClearSite products have not yet achieved market acceptance, making future demand uncertain;
•: The size and timing of significant orders, and their fulfillment;
•: The size and timing of government funded contracts;
•: Our products may have a long development cycle, which may affect our ability to change our product offering quickly and compete effectively;
•: Limited life cycle of our products due to factors outside of our control, such as changing needs of service providers and the emergence of competing products;
•: Changes in our pricing policies, or those of our competitors;
•: Changes in our operating expense and our ability to control costs;
•: Our customers' budget cycles;
•: Product quality problems;

1216

•: Our ability, and our subcontractors' ability, to obtain sufficient supplies of limited or sole-source components for our products;
•: Consolidation by competitors and indirect channel partners; and
•: Regulatory changes affecting the wireless telecommunications industry or our products.

Another factor making our future operating results difficult to predict is that we currently have a limited backlog of unshipped orders. Accordingly, future quarterly revenue is difficult to predict since it depends substantially upon orders that are yet to be booked. Product revenue is also difficult to forecast because our sales cycle, which may increase in the future, varies substantially from customer to customer and by distribution channel.

We base our expense levels and expansion plans, including our plan to significantly increase our research and development efforts, manufacturing capacity and sales and marketing, in large part on our expectations of future revenue. This expense is relatively fixed in the short-term. Consequently, our operating results in any given period are likely to be disproportionately harmed if revenue in that period falls below our expectations.

We cannot predict whether our products will be commercially accepted, because commercial application of superconductive electronics technology has been limited to date.

Although we have introduced a number of superconductive electronic products, most of our revenue to date has been derived from government research and development contracts. We may not successfully develop, introduce and market new products or product enhancements. Any new products or product enhancements that we do market may not be well received in the marketplace or achieve any significant degree of commercial acceptance.

~~Changes~~Our inability to protect our ~~sales~~patents ~~channel~~and ~~mix~~other ~~could~~proprietary ~~cause~~rights ~~fluctuations~~is inuncertain, ~~future~~exposing ~~operating~~us ~~results~~to possible losses of competitive advantage.

We Our ~~currently~~efforts ~~sell~~to ~~most~~protect of our ~~products~~proprietary ~~directly~~rights tomay ~~wireless~~not ~~network~~succeed ~~operators~~ in ~~the~~preventing ~~United~~their ~~States~~infringement by others or ensure that these rights will provide us with a competitive advantage. WeOur ~~plan,~~pending ~~however,~~patent toapplications ~~expand~~may ~~our~~not ~~business~~result in ~~international markets~~issued bypatents ~~increasing~~and the validity of our ~~direct~~issued ~~sales~~patents ~~force~~may ~~and~~be ~~selling~~subject ~~through~~to ~~resellers~~challenge. orThird ~~directly~~parties ~~through~~may ~~original~~also ~~equipment~~be ~~manufacturers~~able to design around the patented aspects of our products. IfAdditionally, we ~~experience~~own ~~changes~~certain inof the ~~mix~~issued patents and patent applications jointly with third parties. Because any owner or co-owner of ~~our~~a patent ~~sales~~can ~~channels~~license its rights under jointly-owned patents or applications, we do not exclusively control our ~~gross profit~~inventions ~~and~~made ~~operating~~jointly ~~margins~~with ~~may~~others. ~~fluctuate~~These ~~significantly~~events could result in losses of competitive advantage.

Intellectual property infringement claims against us could materially harm our results of operations.

Our products incorporate a number of technologies, including high temperature superconductor technology, technology related to other materials, and electronics technologies. Our patent position, and that of other companies using high-temperature superconductor technology, is uncertain and there is significant risk that others, including our competitors, have obtained or will obtain patents relating to our planned products or technology.

While we have obtained a license to Lucent Technologies' patent applications covering certain yttrium barium copper oxide compositions, we believe that other patents have been issued or applications may be pending claiming various compositions for which we may also need a license. We cannot assure you that we will obtain licenses to other patents covering yttrium barium copper oxide compositions, if these patents are issued, or to any other patents applicable to our business, on commercially reasonable terms. We may be required to expend significant resources to develop alternatives that would not infringe such patents or to obtain licenses to the related technology. We

may not be able to successfully design around these patents or obtain licenses to them and may have to defend ourselves at substantial cost against allegations of infringement of third party patents.

On July 17, 2001, ISCO International, Inc. ("ISCO") filed a complaint in the United District Court for the District of Delaware against Conductus, alleging that our current base station front-end systems containing cryogenically cooled superconducting filters infringe ISCO's U.S. Patent No. 6,263,215, entitled "Cryoelectronically Cooled Receiver Front End for Mobile Radio Systems," which was issued on July 17, 2001. On September 17, 2001, ISCO amended its complaint to allege willful infringement and to seek treble damages for the alleged infringement. The complaint seeks injunctive relief and damages for infringement. We have denied infringement, denied that the patent is valid and alleged that the patent was procured through inequitable conduct. We have filed counterclaims seeking declarations of invalidity and non-infringement and damages for unfair competition. We believe that ISCO's claims are without merit and are defending ourselves vigorously.

An adverse outcome in the pending litigation, or in litigation of other intellectual property claims could subject us to significant liabilities or require us to cease using such technology. The cost of defending a patent lawsuit will likely constitute a major financial burden for us. As the litigation is in an initial stage, we are not able at this time to estimate the possibility of loss or range of loss, if any that might result. While the outcome of this claim cannot be predicted with certainty, we do not believe that the outcome will have a material adverse effect on our financial position, results of operations or cash flows

Our failure to anticipate and respond to developments in the wireless telecommunications market could substantially harm our business.

We are focusing our efforts on the wireless telecommunications market, including the 2G, 2.5G and 3G markets. The concentration of our resources on the wireless telecommunications market makes us potentially vulnerable to changes in this market, such as new technologies, future competition, changes in availability of capital resources or regulatory changes that could affect the competitive position and rate of growth of the wireless industry.

We may not be able to compete effectively in the superconductive electronics industry or against alternative technologies.

~~Our~~ ClearSite products compete with a number of alternative approaches and technologies that increase the capacity and improve the quality of wireless networks. Some of these alternatives may be more cost effective or offer better performance than our products. Wireless network operators may opt to increase the number of transmission stations, increase tower heights, install filters and amplifiers at the top of antennas or use advanced antenna technology in lieu of purchasing our products. We may not succeed in competing with these alternatives.

13 The market for superconductive electronics currently is small and in the early stages of development. We anticipate that as superconductive electronics emerge as a viable alternative to current solutions, the market will become intensively competitive. A number of large companies with substantially greater financial resources and capabilities are engaged in programs to develop and commercialize products that may compete with ours, or promote alternative solutions to meet the needs of the wireless network operators. Small companies, including ISCO International, Superconductor Technologies, Inc., and CryoDevices, Inc., are also developing and commercializing superconductive electronic products for the telecommunications industry. Furthermore, academic institutions, governmental agencies and other public and private research organizations are engaged in development programs that may lead to commercial superconductive electronic products. Our success will depend on our ability to develop and maintain our technological leadership while managing the various risks described in this document.

~~antennas or use advanced antenna technology in lieu of purchasing our products. We may not succeed in competing with these alternatives.~~ 18

~~The market~~Changes ~~for superconductive electronics currently is small and~~ in the early stages of development. We anticipate that as superconductive electronics emerge as a viable alternative to current solutions, the market will become intensively competitive. A number of large companies with substantially greater financial resources and capabilities are engaged in programs to develop and commercialize products that may compete with ours, or promote alternative solutions to meet the needs of the wireless network operators. Small companies, including Illinois Superconductor Corporation, Superconductor Technologies, Inc., and CryoDevices, Inc., are also developing and commercializing superconductive electronic products for the telecommunications industry. Furthermore, academic institutions, governmental agencies and other public and private research organizations are engaged in development programs that may lead to commercial superconductive electronic products. Our success will depend on our ~~ability~~sales tochannel ~~develop~~mix ~~and~~could ~~maintain~~cause ~~our~~fluctuations ~~technological leadership while managing the various risks described~~ in ~~this~~future ~~document.~~operating results.

We currently sell most of our products directly to wireless network operators in the United States. We plan, however, to expand our business in international markets by increasing our direct sales force and selling through resellers or directly through original equipment manufacturers. If we experience changes in the mix of our sales channels, our gross profit and operating margins may fluctuate significantly.

We depend heavily upon government contracts for a substantial portion of our revenue, and our business would suffer if, among other things, any of these contracts are terminated or adversely modified.

We have derived a significant portion of our revenue from contracts with the U.S. government. Our government contracts include both research and development contracts and government product sales. Our revenue from government-related contracts represented approximately 7925%, 2574% and 7461% of total revenue for fiscal years ~~1998~~1999, ~~1999~~2000 and ~~2000~~2001, respectively. Although we anticipate that government contract revenue will grow in ~~2001~~2002 compared to ~~2000~~2001, revenue from government contracts may decrease. Our government contract revenue is derived primarily from a few large contracts. As a result, a reduction in, or discontinuance of, the government's commitment to or our participation in current or future programs could significantly reduce our government contract revenue and harm our business. Our contracts involving the U.S. government may include various risks, including:

•: Termination by the government;
•: Reduction or modification in the event of changes in the government's requirements or budgetary constraints;
•: Increased or unexpected costs causing losses or reduced profits under contracts where our prices are fixed or unallowable costs under contracts where the government reimburses us for costs and pays an additional premium;
•: Risks of potential disclosure of our confidential information to third parties;
•: The failure or inability of the main contractor to perform its contract in circumstances where we are a subcontractor;
•: The failure of the government to exercise options for additional work provided for in the contracts; and
•: The government's right in certain circumstances to freely use technology developed under these contracts.

The programs in which we participate may extend for several years, but are normally funded on an annual basis. The U.S. government may not continue to fund programs to which our development projects apply. Even if funding is continued, we may fail to compete successfully to obtain funding pursuant to such programs.

Harm to, or the loss of our relationship with any one of our small number of customers could significantly harm our business.

A relatively small number of customers have accounted for a significant portion of our total revenue to date, and we expect that this trend will continue for ~~the~~ the foreseeable future. For example, one non-government customer accounted for 15% and 21% of our total net revenue for the ~~year~~years ended December 31, 2001 and 2000., respectively. Accordingly, our future operating results will continue to substantially depend on the success of a few customers and our relationships with them. Any reduction or delay in sales of our products to one or more of these key customers could significantly harm our business. Our operating results will also depend on our ability to successfully develop relationships with additional key customers. We cannot assure you that we will retain our largest customers or that we will be able to recruit additional key customers.

harm our business. Our operating results will also depend on our ability to successfully develop relationships with additional key customers. We cannot assure you that we will retain our largest customers or that we will be able to recruit additional key customers.

Most of our customers can cease doing business with us with limited notice and with little or no penalty. Our customer agreements typically do not require minimum purchases. Further, our customers may also have relationships with our competitors. These relationships may affect the purchasing decisions of such customers. We cannot assure you that our customers will not choose to direct their business to our competitors.

We currently rely on specific superconductive materials and may not successfully adjust to the rapidly changing superconductive electronics market.

The field of superconductivity is characterized by rapidly advancing technology. Our success depends upon our ability to keep pace with advancing superconductive technology, including materials, processes and industry standards. We have focused our development efforts to date principally on yttrium barium copper oxide, a high-temperature superconductor. However, yttrium barium copper oxide may not ultimately prove commercially competitive against other currently known materials or materials that may be discovered in the future.

We will have to continue to develop and integrate advances in technology for the fabrication of electronic circuits and devices and manufacture of commercial quantities of our products. We will also need to continue to develop and integrate advances in complementary technologies. We cannot assure you that our development efforts will not be rendered obsolete by research efforts and technological advances made by others or that materials other than those currently used by us will not prove more advantageous for the commercialization of superconductive electronic products.

Our sales cycles are unpredictable and may be long, making our future performance unpredictable.

Our focus on developing products for the telecommunications market began in 1996, and our experience with the sales cycle for telecommunications products is limited. The sales cycle includes identification of decision makers within the customers' organizations, development of an understanding of customer-specific performance and economic issues, convincing the customer through field trial reports of the benefits of ClearSite systems, negotiation of purchase orders and deployment.

Because customers who purchase our systems must commit a significant amount of capital and other resources, sales to our customers are subject to delays beyond our control. Our customers must consider budgetary constraints, comply with internal procedures for approving large expenditures and complete whatever testing is necessary for them to integrate new technologies that will affect their key operations. While the sales cycle for an initial order of our products is typically 6 to 12 months, we may experience longer sales cycles in the future. Such delays or lengthened sales cycles could have a material adverse effect on our business.

Our dependence on a small number of suppliers makes us particularly vulnerable to events that impact our suppliers, most of which are beyond our control.

We currently obtain certain components of our ~~subsystems~~products, including cryocoolers, from a single source or a limited number of suppliers. Our business could be significantly harmed by:

•: An inability to develop alternative sources for components to meet customer demand;
•: A prolonged interruption in supply; or
•: A significant increase in price of one or more components.

Our failure to successfully develop collaborative relationships with government agencies, research institutions and other companies could harm our business.

We have established and continue to seek collaborative arrangements with corporate partners, government agencies and public and private research institutions to develop, manufacture and market superconductive electronic products. Our success depends on the development and success of these collaborative arrangements. However, we may not be able to enter into collaborative arrangements on commercially reasonable terms, and even if established, these arrangements may not succeed. If these programs are successful, our collaborative partners may seek to manufacture jointly developed products themselves or obtain them from alternative sources, rather than purchase them from us. Finally, these programs:

•: May require us to share control over our development, manufacturing and marketing programs and relinquish rights to our technology;
•: May be subject to termination at the discretion of our collaborative partners; and
•: May restrict our ability to engage in certain areas of product development, manufacturing and marketing.

Our ability to protect our patents and other proprietary rights is uncertain, exposing us to possible losses of competitive advantage.

Our efforts to protect our proprietary rights may not succeed in preventing their infringement by others or ensure that these rights will provide us with a competitive advantage. Our pending patent applications may not result in issued patents and the validity of our issued patents may be subject to challenge. Third parties may also be able to design around the patented aspects of our products. Additionally, we own certain of the issued patents and patent applications jointly with third parties. Because any owner or co-owner of a patent can license its rights under jointly-owned patents or applications, we do not exclusively control our inventions made jointly with others. These events could result in losses of competitive advantage.

Intellectual property infringement claims against us could materially harm our results of operations.

compositions, if these patents are issued, or to any other patents applicable to our business, on commercially reasonable terms. We may be required to expend significant resources to develop alternatives that would not infringe such patents or to obtain licenses to the related technology. We may not be able to successfully design around these patents or obtain licenses to them and may have to defend ourselves at substantial cost against allegations of infringement of third party patents. An adverse outcome in such litigation could subject us to significant liabilities or require us to cease using such technology. The cost of defending a patent lawsuit will likely constitute a major financial burden for us.

Our limited commercial manufacturing experience and capabilities could hamper our success.

Our failure to develop adequate manufacturing capabilities would significantly harm our business. Currently, we have only limited production facilities. To date, we have focused primarily on developing fabrication processes and producing limited quantities of products. Although our processing technology derives principally from semiconductor manufacturing technology, the fabrication of high-temperature superconductor components is especially difficult because of specific properties unique to high-temperature superconductor materials.

We cannot assure you that we can develop the necessary manufacturing capability to attain yields sufficient to meet the demand for our products at a cost that will allow us to provide a price/performance advantage to our customers. While we have established limited production facilities for our electronics products, we may not be able to expand our processing, production control, assembly, testing and quality assurance capabilities to produce existing or planned superconductive electronic products in adequate commercial quantities.

Even if our products meet performance standards acceptable to the superconductive electronics market, we cannot assure you that any such products will offer price/performance advantages sufficient to achieve market acceptance, or that our costs will be low enough for us to continue to operate.

Our success depends on the attraction and retention of senior management and technical personnel with relevant expertise.

As a competitor in a highly technical market, we depend heavily upon the efforts of our existing senior management and technical teams. The loss of the services of one or more members of these teams could slow our product development and commercialization objectives. Due to the specialized nature of high-temperature superconductors, we also depend upon our ability to attract and retain qualified technical personnel with substantial industry knowledge and expertise. Competition for qualified personnel is intense and we may not be able to continue to attract and retain qualified personnel necessary for the development of our business.

Regulatory changes negatively affecting wireless communications companies could substantially harm our business.

The Federal Communications Commission strictly regulates the operation of wireless base stations in the United States. Other countries also regulate the operation of base stations within their territories. Base stations and equipment marketed for use in base stations must meet specific technical standards. Our ability to sell our high-temperature superconductor filter subsystems will depend upon the rate of deployment of and other new wireless digital services, the ability of base station equipment manufacturers and of base station operators to obtain and retain the necessary approvals and licenses, and changes in regulations that may impact the requirements for our products. Any failure or delay of base station manufacturers or operators in obtaining necessary approvals could significantly harm our business.

We derive a portion of our revenue from sales outside the United States, and our international business activities subject us to risks that could reduce the demand for our products and increase our operating expense.

A significant part of our strategy involves our continued pursuit of growth opportunities in a number of international markets, including Japan, Korea and Taiwan. We also anticipate expanding our efforts into Europe, Latin America and other Asian markets. In many international markets, barriers to entry are the result of long-standing relationships between our potential customers and their local suppliers and protective regulations, including local content and service requirements. In addition, our pursuit of international growth opportunities may require significant investments for an extended period before we realize returns, if any, on our investments.

Our business in international markets could be adversely affected by:

•: Different technology standards and design requirements;
•: Difficulty in attracting qualified personnel;
•: Longer payment cycles for and greater difficulties collecting accounts receivable;
•: Export controls, tariffs and other barriers;
•: Fluctuations in currency exchange rates;
•: Nationalization, expropriation and limitations on repatriation of cash;
•: Social, economic, banking and political risks;
•: Taxation;
•: Changes in U.S. laws and policies affecting trade, foreign investment and loans; and
•: Cultural differences in the conduct of business.

We may depend heavily on the successful development and sale of complementary technologies for future products developed by third parties, and we may not succeed if certain other products and technologies are not available to us.

Continued successful improvement of our products depends on the commercial availability of a number of other technologies, such as specialized mechanical refrigeration systems (cryocoolers), super-cooled semiconductor technology and specialized microchip materials. There are also complementary technologies in the development stage that could improve the performance of our products. We do not intend to devote significant efforts or resources to developing these technologies. We anticipate depending on the development activities of third parties in these areas. We cannot assure you that ~~these technologies will be successfully developed and commercialized, or that they will achieve market acceptance.~~

these technologies will be successfully developed and commercialized, or that they will achieve market acceptance.

We may acquire or make investments in companies or technologies that could cause loss of value to our stockholders and disruption of our business.

We intend to explore opportunities to acquire companies or technologies in the future. Entering into an acquisition entails many risks, any of which could adversely affect our business, including:

•: Failure to integrate the acquired assets and/or companies with our current business;
•: The price we pay may exceed the value we eventually realize;
•: Loss of share value to our existing stockholders as a result of issuing equity securities as part or the entire purchase price;
•: Potential loss of key employees from either our current business or the acquired business;
•: Entering into markets in which we have little or no prior experience;
•: Diversion of financial resources and management's attention from other business concerns;
•: Assumption of unanticipated liabilities related to the acquired assets; and
•: The business or technologies we acquire or in which we invest may have limited operating histories and may be subjected to many of the same risks to which we are exposed.

Compliance with environmental regulations could be especially costly due to the hazardous materials we must use in manufacturing our products.

We are subject to a number of federal, state and local governmental regulations related to the use, storage, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in our business. Any failure to comply with present or future regulations could result in fines being imposed, suspension of production or interruption of our operations. In addition, these regulations could restrict our ability to expand or require us to acquire costly equipment or incur other significant expense to comply with environmental regulations or to clean up prior discharges.

Terrorism and the declaration of war by the United States against terrorism may adversely affect our business.

The recent terrorist attacks in the United States and the declaration of war by the United States against terrorism has created significant instability and uncertainty in the world, which may continue to have a material adverse effect on world financial markets, including financial markets in the United States. In addition, such adverse political events may have an adverse impact on economic conditions in the United States. Unfavorable economic conditions in the United States may have an adverse affect on our financial operations including, but not limited to, our ability to expand the market for our products, obtain financing as needed, enter into strategic relationships and effectively compete in the information exchange and knowledge exchange markets.

Risks Related to our Common Stock

Our common stock may continue to be volatile and we may be exposed to costly securities class action lawsuits.

The market price of our common stock has been and is likely to continue to be highly volatile. Our common stock may be significantly affected by the following factors:

•: Actual or anticipated fluctuations in our operating results;

•: Announcements of technological innovations;
•: Announcements of new products or new contracts by us or our competitors;
•: Conditions and trends in the telecommunications and other technology industries; and
•: Changes in financial estimates of our future results or recommendations by securities analysts.

In addition, the stock market has from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for the securities of technology companies. In the past, securities class action lawsuits have often been brought against such companies following periods of stock price volatility. We may be affected by similar litigation in the future, which could result in substantial costs and cause a diversion of management's attention and resources. These events could significantly harm our business, operating results and financial condition.

Our corporate governance structure may prevent our acquisition by another company at a premium over the public trading price for your shares.

It is possible that the acquisition of a majority of our outstanding voting stock by another company could result in our stockholders receiving a premium over ~~the~~ the public trading price for their shares. However, we have adopted a stockholder rights plan which, if triggered, could make it more difficult for a third party to acquire a majority of our ~~outstanding~~ outstanding voting stock, even if doing so would create an immediate benefit to our stockholders. Further, provisions of our restated certificate of incorporation and bylaws and of Delaware corporate law could delay or make more difficult an acquisition of our company by merger, tender offer or proxy contest, even if it would create an immediate benefit to our stockholders. For example, our restated certificate of incorporation does not permit stockholders to act by written consent and our bylaws require advance notice of any matters to be brought before the stockholders at the annual meeting.

by written consent and our bylaws require advance notice of any matters to be brought before the stockholders at the annual meeting.

In addition, our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the terms, rights and preferences of this preferred stock, including voting rights of those shares, without any further vote or action by the stockholders. The rights of the holders of common stock may be subordinate to, and adversely affected by, the rights of holders of preferred stock that may be issued in the future. The issuance of preferred stock could also make it more difficult for a third party to acquire a majority of our outstanding voting stock, even at a premium over our public trading price.

ITEM 2. PROPERTIES

Our principal facility, including our pilot production facility, is located in two buildings providing approximately 40,000 square feet of available space in Sunnyvale, California, with leases ~~which~~that ~~were due to~~ expire ~~in August 2000 and 2001. In January 2000, we exercised our option to extend the lease~~ on ~~both buildings through~~ February 28, 2006.

ITEM 3. LEGAL PROCEEDINGS

We On ~~are~~July 17, ~~not~~2001, ISCO International, Inc. ("ISCO") filed a ~~party~~complaint in the United District Court for the District of Delaware against Conductus, alleging that our current base station front-end systems containing cryogenically cooled superconducting filters infringe ISCO's U.S. Patent No. 6,263,215, entitled "Cryoelectronically Cooled Receiver Front End for Mobile Radio Systems," which was issued on July 17, 2001. On September 17, 2001, ISCO amended its complaint to ~~any~~allege ~~material~~willful infringement ~~litigation~~and to seek treble damages for the alleged infringement. The complaint seeks injunctive relief and ~~are~~damages ~~not~~for ~~aware~~infringement. ofWe ~~any~~have ~~pending~~denied orinfringement, ~~threatened~~denied ~~litigation~~that ~~against~~the uspatent is valid and alleged that ~~could~~the patent was procured through inequitable conduct. We have afiled ~~material~~counterclaims ~~adverse~~seeking ~~effect~~declarations of invalidity and non-infringement and damages for unfair ~~upon~~competition. ~~our~~We ~~business,~~believe ~~operating~~that ~~results~~ISCO's orclaims ~~financial~~are ~~condition~~without merit and are defending ourselves vigorously.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS

No matters were submitted to our stockholders during our fourth quarter of ~~2000~~2001.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock began trading on the Nasdaq National Market under the trading symbol "CDTS" on August 5, 1993, moved to the Nasdaq SmallCap Market on November 10, 1998, and moved back to the Nasdaq National Market on January 5, 2001. We have never declared or paid any cash dividends on our common stock and do not expect to do so in the foreseeable future. We anticipate that all future earnings generated from operations will be retained to develop and expand our business. Our board of directors, at their discretion, will determine whether we will pay dividends on the common stock in the future. In addition, our line of credit prohibits us from paying cash dividends without the lender's consent.

The following table presents quarterly information on the high and low closing sales prices for shares of our common stock for the periods indicated, as reported by the Nasdaq National Market.

	High		Low
1998
First Quarter	$	5	$	231/32
Second Quarter		43/8		27/8
Third Quarter		41/2		21/16
Fourth Quarter		21/4		11/64
1999
First Quarter	$	~~21/16~~2.06	$	~~31/32~~0.97
Second Quarter		~~27/16~~2.48		~~11/4~~1.25
Third Quarter		2.00		~~17/8~~1.88
Fourth Quarter		~~113/4~~11.75		2.00
2000
First Quarter	$	~~815/8~~81.63	$	~~711/16~~7.69
Second Quarter		~~261/2~~26.50		~~81/4~~8.25
Third Quarter		2.00		~~129/16~~12.56
Fourth Quarter		14.00		~~49/16~~4.56
2001
First Quarter	$	10.44	$	3.88
Second Quarter		7.70		3.06
Third Quarter		5.02		3.25
Fourth Quarter		3.58		2.01

As of ~~January~~February 3128, ~~2001~~2002, the closing sale price of our common stock was $~~101/8~~2.32 per share.

On ~~January~~February 3128, ~~2001~~2002, we had ~~104~~126 holders of record of our common stock.

ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data should be read in conjunction with both the Financial Statements and accompanying notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations." The statement of operations data for the years ended December 31, ~~1998~~1999, ~~1999~~2000 and ~~2000~~2001, and the balance sheet data at December 31, ~~1999~~2000 and ~~2000~~2001 are derived from and are qualified by reference to, the audited financial statements included elsewhere in this Annual Report on Form 10-K. The statement of operations data for the years ended December 31, ~~1996~~1997 and ~~1997~~1998 and the balance sheet data at December 31, ~~1996~~1997, ~~1997~~1998 and ~~1998~~1999 are derived from audited financial statements not included in this Annual Report on Form 10-K. The net loss attributable to common stockholders for the year ended December 31, 2000, includes a cumulative effect adjustment to record an additional deemed dividend on preferred stock of $2,239,000 relating to Series C preferred stock. Additionally, the basic and diluted loss per common share and the shares used in loss per share calculations ~~information~~were ~~was~~ computed on the basis described ~~for net loss per share~~ in ~~note~~Note 2 of Notes to Financial Statements attached hereto. The results of operations for the year ended December 31, ~~2000~~ ~~attached~~2001, ~~hereto.~~or ~~The~~any other period, are not necessarily indicative of future results.

			Years Ended December 31,
			1997			1998			1999			2000			2001
			(in thousands, except per share data)
Statement of Operations Data:
Revenue:
	Product		$	2,188		$	991		$	872		$	522		$	2,595
	Contract			7,266			3,698			1,915			1,496			4,029
	License and other			—			—			5,011			—			—

		Total revenue		9,454			4,689			7,798			2,018			6,624
Cost of product sales				1,845			2,685			2,508			4,993			9,394
Research and development expenses				10,626			5,621			4,430			5,507			8,666
Selling, general and administrative expenses				4,330			3,515			3,976			5,679			7,076
Write off of property and equipment and other expenses				152			—			—			—			—

Loss from operations				(7,499	)		(7,132	)		(3,116	)		(14,161	)		(18,512	)

Net loss attributable to common stockholders			$	(7,543	)	$	(7,829	)	$	(4,070	)	$	(23,248	)	$	(17,997	)

Basic and diluted net loss per common share attributable to common stockholders			$	(1.09	)	$	(1.10	)	$	(0.57	)	$	(1.75	)	$	(1.03	)

Shares used in per share calculations				6,897			7,088			7,155			13,283			17,552

results of operations for the year ended December 31, 2000, or any other period, are not necessarily indicative of future results.

		December 31, 1999
		1997		1998			1999		2000		2001
		(in thousands)
Balance Sheet Data:
	Cash and investments	$	3,168	$	2,888		$	14,078	$	15,167	$	6,897
	Working capital		1,822		2,656			13,684		15,747		9,429
	Total assets		8,762		7,035			18,597		22,383		16,226
	Long-term debt, less current portion		310		1,341			596		—		205
	Total liabilities		4,460		3,671			3,944		3,597		3,008
	Redeemable preferred stock		—		5,683			10,778		—		—
	Stockholders' equity (deficit)		4,301		(2,320	)		3,875		18,786		13,218

			Years Ended December 31,
			1996			1997			1998			1999			2000
			(in thousands, except per share data)
Statement of Operations Data:
Revenues:
	Product		$	2,852		$	2,188		$	991		$	872		$	522
	Contract			9,691			7,266			3,698			1,915			1,496
	License and other			—			—			—			5,011			—
		Total net revenues		12,543			9,454			4,689			7,798			2,018
Cost of product sales				1,824			1,845			2,685			2,508			4,993
Research and development expenses				11,774			10,626			5,621			4,430			5,507
Selling, general and administrative expenses				4,054			4,330			3,515			3,976			5,679
Write-off of property and equipment and other expenses				—			152			—			—			—
Loss from operations				(5,109	)		(7,499	)		(7,132	)		(3,116	)		(14,161	)
Net loss attributable to common stockholders			$	(5,004	)	$	(7,543	)	$	(7,829	)	$	(4,070	)	$	(23,248	)
Basic and diluted net loss per common share attributable to common stockholders			$	(0.80	)	$	(1.09	)	$	(1.10	)	$	(0.57	)	$	(1.75	)
Shares used in per share calculations				6,263			6,897			7,088			7,155			13,283

		December 31,
		1996		1997		1998			1999		2000
		(in thousands)
Balance Sheet Data:
	Cash and investments	$	7,636	$	3,168	$	2,888		$	14,078	$	15,167
	Working capital		9,135		1,822		2,656			13,684		15,747
	Total assets		16,081		8,762		7,035			18,597		22,383
	Long-term debt, less current portion		1,022		310		1,341			596		—
	Total liabilities		4,898		4,460		3,671			3,944		3,597
	Redeemable preferred stock		—		—		5,683			10,778		—
	Stockholders' equity (deficit)		11,183		4,301		(2,320	)		3,875		18,786

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

~~Overview~~Critical Accounting Policies and Estimates

We develop, manufacture and market electronic components and systems based on superconductors for applications in the worldwide wireless telecommunications market. From our incorporation in 1987 to 1997, we developed materials and processes for high-temperature superconductor technology and researched potential applications for the technology. These efforts were sponsored in part by government research and development contract funding. We initiated commercial product shipments in 1992 addressing multiple markets, including the communications, health care and instrumentation markets. In late 1996, we made the strategic decision to focus on the rapidly growing telecommunications market. In the third quarter of 1997, we completed two organizational changes aimed at focusing on wireless communications. We closed our Instrument and Systems division and sold our nuclear magnetic resonance ("NMR") spectroscopy probe business. In mid-1999, we licensed our remaining instrumentation business to another firm. Research and development efforts are now focused on developing applications in the communications market. General

~~Our net~~ Discussion ~~loss~~and ~~for~~analysis ~~the~~of ~~year~~our ~~ended~~financial ~~December 31,~~condition ~~2000,~~and ~~excluding~~results ~~the~~of ~~impact~~operations ofare ~~non-cash~~based ~~charges~~upon ~~related~~our tofinancial ~~the~~statements, ~~beneficial~~which ~~conversion~~have ~~features~~been ofprepared ~~the~~in ~~Series C~~accordance with ~~stock,~~accounting ~~was~~principles ~~$12,900,000~~generally accepted in the United States. AsThe preparation of ~~December 31,~~these ~~2000,~~financial westatements ~~had~~requires ~~accumulated~~us ~~losses~~make ofestimates ~~approximately~~and ~~$71~~judgments that affect the reported amounts of assets,~~917~~ liabilities,~~000~~ revenue and weexpenses, ~~expect~~and torelated ~~incur~~disclosure ~~significant~~of ~~additional~~contingent ~~losses~~assets ~~during~~and ~~2001~~liabilities. ~~We,~~On ~~alone~~an oron-going ~~with collaborative~~basis, ~~partners~~we evaluate estimates, ~~must~~including ~~successfully~~those ~~develop~~related to revenue, ~~manufacture~~contracts, inventories, ~~introduce~~contingencies and ~~market~~litigation. ~~our~~Estimates ~~potential~~are ~~products~~based inon ~~order~~historical toexperience ~~achieve~~and ~~profitability.~~on Wevarious doother ~~not~~assumptions ~~expect~~that are believed to ~~recognize~~be ~~significant~~reasonable ~~product~~under ~~sales~~the circumstances, the results of ~~until~~which weform ~~successfully~~the ~~commercialize~~basis ~~systems~~for making judgments about the carrying values of assets and ~~subsystems~~liabilities that ~~address~~are ~~market~~not ~~needs~~readily ~~for~~apparent ~~the~~from ~~wireless~~other ~~telecommunications~~sources. ~~market~~Actual results may differ materially from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements:

Revenue Recognition

Our revenue recognition policy is significant because our revenue is a key component of our results of operations. We follow very specific and detailed guidelines in measuring revenue; however, certain judgments affect the application of our revenue policy. Revenue results are difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter.

We recognize revenue upon the shipment of our products to the customer provided that we have received a purchase order, the price is fixed, title has transferred, collection of the resulting receivable is probable and there are no remaining obligations. We provide for future returns and warranty claims based on historical experience at the time revenue is recognized.

When we issue warrants or other equity instruments in connection with sales transactions, the fair value of the equity instrument, as calculated using the Black-Scholes option pricing model, is treated as a reduction in the amount of revenue recognized in the period, unless the reduction results in negative revenue for that specific customer on a cumulative basis, in which case the remainder, if any, increases cost of goods sold in our financial statements.

Research and Development Contracts

We have entered into contracts to perform research and development for the U.S. government. Revenues from these contracts are recognized utilizing the percentage-of-completion method measured by the relationship of costs incurred to total contract costs. Cost of U.S. government contract revenues for the years ended December 31, 1999, 2000 and 2001 was $2,477,000, $1,920,000 and $6,939,000, respectively, allocated between research and development, and selling, general and administrative expenses. Costs include direct engineering and development costs and applicable overhead. The company accrues contract losses when they become reasonably estimable.

Inventories

Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market. Conductus validates its perpetual inventory balances against a quarterly physical count making adjustments to the perpetual balance as necessary. Conductus writes down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-

downs may be required. Appropriate consideration is given to obsolescence, excessive levels, deterioration and other factors in evaluating net realizable value.

Litigation

Results of Operations

Years Ended December 31, ~~1998,~~ 1999, 2000 and ~~2000~~2001

Total ~~net~~ revenue for ~~1998~~1999, ~~1999~~2000 and ~~2000~~2001, was $47,~~689~~798,000, $72,~~798~~018,000 and $26,~~018~~624,000, respectively, and consisted primarily of contract revenue and product revenue. except Infor 1999, when we also recognized $5,000,000 of license revenue. The ~~increase~~decrease in total net revenue in ~~1999~~2000 compared to ~~1998~~1999 was primarily related to the ~~recognition~~impact of ~~$5,000,000~~the in license revenue in 1999, ~~partially~~and, ~~offset~~to bya ~~decreases~~lesser inextent, ~~both~~a ~~product~~$769,000 ~~and~~decrease ~~contract~~in revenue ~~during~~from the ~~comparison~~sale ~~periods~~of products and government contract activities. The ~~decrease~~increase in total ~~net~~ revenue in ~~2000~~2001 compared to ~~1999~~2000 was ~~primarily related to~~ the ~~impact~~result of ~~the~~an ~~license~~increase ~~revenue~~of in$2,533,000 ~~1999~~ and, ~~to a lesser extent~~$2,073,000 ~~decreases~~ in ~~revenue~~government ~~from~~contract ~~the~~revenue ~~sale of products~~ and ~~government~~product ~~contract~~revenue, ~~activities~~respectively.

Product revenue primarily consists of revenue related to the sale of our commercial and government wireless products. We recognize revenue upon the shipment of these products to our customers provided that we have received a purchase order, the price is fixed, title has transferred, collection of the resulting receivable is reasonably assured, product returns are reasonably estimable and there are no remaining obligations. Product revenue as a percentage of total net revenue was approximately 2111%, 1126% and 2639% in ~~1998~~1999, ~~1999~~2000 and ~~2000~~2001, respectively. Product revenue ~~decreased~~ increased to $~~522~~2,595,000 in ~~2000~~2001 from $~~872~~522,000 in ~~1999~~2000. ~~and~~This ~~$991,000~~increase was due to an increase in ~~1998~~both government and commercial product shipments during 2001 compared to 2000. The decrease in product revenue to $522,000 in 2000 from $872,000 in 1999 ~~relates~~was related primarily to a decrease in revenue from the shipment of ~~government~~ government wireless products and, to a lesser extent, a decrease in revenue from shipments of discontinued products that dodid not relate to our target market, including sales of magnetic sensing systems and other ~~products.~~ ~~The decrease in product revenue in 1999 from 1998 relates primarily to a decrease in revenue from shipments of the~~ products ~~that do not relate to our target market~~.

Product revenue in 2001 and 2000 was offset by non-cash sales discounts inof ~~the~~$115,000 ~~amount~~and of $138,000 related to the fair value of ~~the~~45,380 and 17,660 warrants, which vested during 2001 and 2000, respectively. These warrants were issued to Dobson Communications as part of a two-year purchase agreement. Under the terms of the agreement, we issued a warrant to purchase up to 500,000 shares of common stock at $13.43 per share which vests based on the amount of product purchased by Dobson. The fair value of the warrants, as calculated using the Black-Scholes option pricing model, is treated as a reduction in the amount of revenue recognized in the period, unless the reduction results in negative revenue for that specific customer on a cumulative basis, in which case the remainder, if any, increases cost of goods sold in our financial statements.

2328

Contract werevenue ~~issued~~consists aof ~~warrant~~revenue pursuant to ~~purchase~~U.S. upgovernment research and development contracts. Contract revenue increased to ~~500~~$4,029,000 ~~shares~~in of2001 ~~common~~from ~~stock~~$1,496,000 atin 2000 and from $131,915,000 in 1999.43 ~~per~~The ~~share~~increase ~~based~~in oncontract ~~the~~revenue ~~amount~~in of2001 ~~product~~was ~~purchased~~primarily bydue ~~Dobson.~~to ~~The~~an ~~fair~~increase ~~value~~in ofactivity ~~the~~related ~~warrants~~to ~~issued~~new iscontracts, ~~treated~~which aswere aawarded in late 2000 and early 2001. The decrease in ~~payment~~contract ~~for~~revenue ~~the~~during ~~warrant,~~2000 ~~reducing~~and 1999 was primarily the ~~amount~~result of ~~revenue~~a ~~recognized~~change in ~~the~~our ~~period~~business strategy to focus exclusively on contracts relating to our wireless telecommunications business and, therefore, ~~the~~beginning ~~remainder~~in 1998, ifwe ~~any~~did not continue to seek additional contracts related to superconductive technologies outside of the wireless telecommunications market. Additionally, ~~increasing~~the ~~cost~~decrease in 2000 compared to 1999 was the result of ~~goods~~the ~~sold~~completion of several contracts and delays in ~~our~~the ~~financial~~anticipated ~~statements~~start date of new contracts in 2000.

~~Contract~~ The ~~revenue,~~cost ~~consisting~~of product sales is primarily composed of ~~revenue~~costs ~~pursuant~~of products related to Uour wireless telecommunications products.S. ~~government~~Cost ~~research~~of product sales were $2,508,000, $4,993,000 and ~~development~~$9,394,000 for ~~contracts~~1999, ~~represented~~2000 ~~approximately~~and ~~79%~~2001, ~~25%~~respectively, and ~~74%~~resulted ofin ~~total~~negative ~~net~~product ~~revenue~~margins inof ~~1998~~(188%), ~~1999~~ (857%) and (262%) for 1999, 2000 and 2001, respectively. ~~Revenue~~These ~~from~~negative ~~these~~product ~~contracts~~margins isresult ~~recognized~~primarily ~~utilizing~~ from the ~~percentage-of-completion~~relatively ~~method~~low ~~measured~~volume byof ~~the~~product ~~relationship~~sales ofcompared ~~costs~~to ~~incurred~~overhead toand ~~total contract~~other period costs. ~~Contract~~The ~~revenue~~improvement ~~decreased~~in 2001 product margins when compared to ~~$1,496,000~~2000 was primarily due to the increased volume of shipments in 2001 when compared to 2000 ~~from~~partially offset by a $1996,~~915,~~000 inwrite ~~1999~~down ~~and~~of ~~from~~excess ~~$3,698,000~~and inobsolete ~~1998.~~inventory ~~The~~and ~~decrease~~an increase in ~~contract~~costs ~~revenue~~and ~~during~~expenses ~~the~~related ~~comparison~~to ~~periods~~the ~~was~~development ~~primarily~~of the Company's ~~result~~infrastructure ofnecessary ato ~~change~~meet infuture ~~our~~demand. ~~business~~During ~~strategy~~2001, ~~to focus~~we ~~exclusively~~purchased onapproximately ~~contracts~~$4,527,000 ~~relating~~of inventory to support our ~~wireless~~projected ~~telecommunications~~sales ~~business~~during 2001 and, ~~therefore,~~2002 ~~beginning~~and into ~~1998,~~secure wevolume ~~did~~discounts. Should ~~not~~actual ~~continue~~sales tofor ~~seek~~2001 ~~additional~~be ~~contracts~~less ~~related~~than toour ~~superconductive technologies~~projections, ~~outside~~the carrying value of ~~the~~inventory ~~wireless~~may ~~telecommunications~~be ~~market~~adversely affected. ~~Additionally,~~The ~~the~~ decrease in product margins during 2000 compared to 1999 was ~~the~~primarily ~~result~~due to ofincreases ~~the~~in ~~completion~~overhead and other period costs associated with our efforts to increase manufacturing capacity for our wireless communications products. We expect product costs, as a percentage of product ~~several~~sales, ~~contracts~~to decrease and ~~delays~~margins into improve as the ~~anticipated start~~volume ~~date~~of shipments of ~~new~~our ~~contracts~~wireless communications products grows, however we cannot assure you that margins will improve in ~~2000~~the future.

~~The~~ Research ~~cost~~and ofdevelopment ~~product~~expense ~~sales~~includes isthe ~~primarily~~cost ~~composed~~ of ~~costs~~both ofresearch ~~products~~and ~~related~~development tofunded ~~our~~through ~~wireless~~government ~~telecommunications~~contracts ~~products.~~and ~~Cost~~research ofand ~~product~~development ~~sales~~funded ~~for~~by ~~1998,~~Conductus. ~~1999~~Research and development ~~2000~~expense was $24,~~685~~430,000, $25,~~508~~507,000 and $48,~~993~~666,000, and ~~resulted~~represented in57%, ~~negative~~273% ~~product~~and ~~margins~~131% of ~~(171%),~~our ~~(188%)~~total ~~and~~net ~~(857%)~~revenue ~~for~~in ~~1998~~1999, ~~1999~~2000 and ~~2000~~2001, respectively. ~~These~~The ~~negative~~increase ~~product~~from ~~margins~~2000 ~~result~~to 2001 was primarily ~~from~~related ~~the relatively~~to ~~low~~an ~~volume~~increase ofin ~~product~~spending ~~sales~~on ~~compared~~externally tofunded ~~overhead~~research and ~~other~~development ~~period~~contracts ~~costs.~~as ~~The~~well ~~decrease~~as an increase in headcount and other costs to support internally funded project related to new product ~~margins~~development. ~~during~~The ~~the~~increase ~~comparison~~from ~~periods~~1999 to 2000 was primarily ~~due~~related to ~~increases~~the inimpact ~~overhead~~of ~~and~~increased ~~other period~~spending ~~costs~~on ~~associated~~new ~~with~~wireless ~~our~~communication ~~efforts~~and todevelopment ~~increase~~activities ~~manufacturing~~partially ~~capacity~~offset ~~for~~by ~~our~~decreases in ~~wireless~~spending ~~communications~~on ~~products~~contract-related activities during the comparison periods. We expect ~~product~~to ~~costs~~continue to incur significant research and ~~margins~~development asexpense aon ~~percentage~~internally offunded ~~product~~programs ~~sales~~as ~~will~~we ~~improve~~seek to asdevelop ~~the~~additional ~~volume~~commercial ofproducts, ~~shipments~~particularly ofin ~~our~~the wireless communications ~~products~~area. ~~grows,~~As ~~however~~a result, we ~~cannot~~anticipate ~~assure~~moderate ~~you~~increases ~~that~~in ~~margins~~research ~~will~~and ~~improve~~development inexpense compared to the ~~future~~prior year.

~~Research~~ Selling, general and ~~development~~administrative expense includes ~~the~~costs ~~cost~~associated ofwith ~~both~~marketing, ~~research~~sales, and ~~development~~various ~~funded~~administrative ~~through~~activities. ~~government~~Selling, ~~contracts~~general and ~~research~~administrative ~~and development funded by us. Research and development~~ expense was $53,~~621~~976,000, $45,~~430~~679,000 and $57,~~507~~076,000, and represented ~~120~~51%, 57281% and ~~273~~107% of our total net revenue in ~~1998~~1999, ~~1999~~2000 and ~~2000~~2001, respectively. The increase ~~from~~in ~~1999~~spending in 2001 when compared to 2000 was ~~primarily~~ ~~related~~primarily to the ~~impact~~result of ~~increased~~an ~~spending~~increase onin ~~new~~personnel ~~wireless~~related ~~communication~~costs, ~~and~~legal ~~development~~expense ~~activities~~associated ~~partially~~with ~~offset~~the byISCO ~~decreases~~International, Inc. inpatent ~~spending~~suit onand ~~contract-related~~to ~~activities~~a ~~during~~lesser ~~the~~extent ~~comparison~~recruiting, travel, tradeshow, and ~~periods~~insurance expenses. The ~~decrease~~increase in ~~research~~spending ~~and~~in ~~development~~2000 ~~expense~~compared ~~from 1998~~ to 1999 was primarily the result of ~~decreases~~an increase in ~~spending~~sales ~~related~~and tosales ~~government~~support ~~contract~~personnel ~~activities~~and ~~partially~~the ~~offset~~appointments byof ~~increased~~a ~~spending~~distributor ~~on new~~for ~~wireless~~the ~~communication~~Taiwan market and ~~development~~a ~~activities.~~representative Wefor ~~expect~~the toKorean ~~continue~~markets, toas ~~incur~~well ~~significant~~as ~~research~~increases in sales, marketing, legal and ~~development~~other ~~expense~~administrative oncosts. ~~internally~~The ~~funded~~changes ~~programs~~in asthe welevel ~~seek~~of tosales ~~develop~~expense ~~additional commercial~~as ~~products,~~a ~~particularly~~percentage inof ~~the~~revenue was ~~wireless~~primarily ~~communications~~related ~~area.~~to Asthe achange ~~result,~~in wetotal ~~anticipate~~revenue ~~moderate~~during ~~increases~~the incomparison ~~research~~periods and, ~~development~~to ~~expense~~a ~~compared~~lesser toextent, the ~~prior~~increase ~~year.~~in the level of

Selling, general and administrative expense includes costs associated with marketing, sales, and various administrative activities. Selling, general and administrative expense was $3,515,000, $3,976,000 and $5,679,000, and represented 75%, 51% and 281% of our revenue in 1998, 1999 and 2000, respectively. The increase in spending during the comparison periods is primarily the result of an increase in sales and sales support personnel and the appointments of a distributor for the Taiwan market and a representative for the Korean markets, as well as increases in sales, marketing, legal and other administrative costs. The changes in the level of sales expense as a percentage of revenue was primarily related to the change in total revenue during the comparison periods and, to a lesser extent, the increase in the level of spending. We expect to continue to incur increasing sales, general and other administrative expense to the extent we increase sales of commercial products, particularly in the communications markets. 29

24 spending. We expect to continue to incur increasing sales, general and other administrative expense to the extent we increase sales of commercial products, particularly in the communications markets.

Interest income was $9789,000, $891,361,000 and $1575,~~361,~~000 in ~~1998~~1999, ~~1999~~2000 and ~~2000~~2001, respectively. The changes in the levels of interest income during the comparison periods were primarily due to changes in average cash balances and, to a lesser extent, interest rate movements during the comparison periods.

~~Interest~~ Other ~~charges~~income ~~related primarily to our loan from a leasing company as well as our bank term loans. Interest expense~~ was $~~530~~30,000, $~~339~~112,000 and $~~231~~82,000 in ~~1998~~1999, ~~1999~~2000 and ~~2000~~2001, respectively. ~~The~~This ~~decrease in interest expense in each period was~~ primarily ~~the result of lower average debt levels during the comparison periods. Interest expense in 1998 includes interest payments on the bridge loan facility we entered into with our bank, payments~~ related to the ~~outstanding~~sale ~~loan from a leasing company and the amortization~~ of ~~the~~equipment ~~value~~that ~~of warrants issued to~~ the ~~bank~~Company ~~and~~no ~~leasing companies~~longer needed.

Interest charges related primarily to our loan from a leasing company. Interest expense was $339,000, $231,000 and $142,000 in 1999, 2000 and 2001, respectively. The decrease in interest expense in each period was primarily the result of lower average debt levels and, to a lesser extent, interest rate movements during the comparison periods. Interest expense includes payments related to the outstanding loan from a leasing company and the amortization of the value of warrants issued to the leasing companies.

As a result of incurring losses, we have not incurred any income tax liability. We have established a valuation allowance against our deferred tax assets and review this allowance on a periodic basis. At such time that we believe that it is more likely than not that the deferred tax asset will be realized, the valuation allowance will be reduced.

We do not believe that inflation has had a material effect on our financial condition or results of operations during the past three fiscal years. However, we cannot assure you that our business will not be affected by inflation in the future.

Liquidity and Capital Resources

We have financed our operations since 1998 primarily through equity transactions and commercial arrangements. These transactions include the following:

In September 1998, we issued a total of 2,461,227 shares of Series B preferred stock convertible into the same number of shares of common stock, and issued warrants to purchase 492,242 shares of common stock, for a total proceeds, net of issuance costs, of $6,344,000. We allocated the net proceeds based on their relative fair value. Accordingly, we allocated $5,572,000 to preferred stock, $772,000 to warrants and $222,000 to the beneficial conversion feature. The beneficial conversion feature was amortized over six months, which is the minimum beneficial ~~conversion~~ conversion period. As of December 31, 2000, all of the Series B preferred shares had been converted to common stock. See Note 8 of "Notes to Financial Statements."

In January and February 2000, the Series B preferred stock and accrued dividends were converted into common stock. During the year ended December 31, 2000, 358,535 Series B warrants were exercised for 358,535 shares of our common stock for net proceeds of approximately $~~200~~260,000.

In May 1999, we entered into a definitive agreement with General Dynamics Information Systems, Inc. ("GDIS") to license our high-temperature superconductor electronics and cryoelectronics technology. Under the license agreement, GDIS acquired rights to our high-temperature superconductor thin-film technology and other intellectual property for $5,000,000 plus future royalties and has certain rights to use and sell this technology for use in the U.S. government or state, local and foreign government markets, as defined under the agreement. We also entered into a Cross-License, Supply and Training Agreement with GDIS under which we agreed to cross-license updates, if any, to the licensed technology developed by either party. Additionally, we agreed to provide product and training to GDIS in exchange for payment at standard commercial rates from GDIS. As a result of this transaction, we recognized revenue of $5,000,000 for the year ended December 31, 1999. Upon execution of the agreement, GDIS made an immediate payment to us of $2,900,000. In addition, GDIS paid us 12 monthly payments of $175,000 beginning in July 1999. Subsequent to the original ~~transaction, the General Dynamics business unit with whom we work was transferred to General Dynamics Electronic Systems ("GDES") and the agreement was assigned to the successor organization.~~

~~In December 1999, we issued a total of 375,000 shares of Series C preferred stock convertible into 3,750,000 shares of common stock, and issued warrants to purchase 750,000 shares of common stock,~~ 30

25 transaction, the General Dynamics business unit with whom we work was transferred to General Dynamics Electronic Systems ("GDES") and the agreement was assigned to the successor organization.

In December 1999, we issued a total of 375,000 shares of Series C preferred stock convertible into 3,750,000 shares of common stock, and issued warrants to purchase 750,000 shares of common stock, for a total, net of issuance costs, of $14,906,000. We allocated the net proceeds based on their relative fair value. Accordingly we allocated $4,856,000 to preferred stock, $2,239,000 to warrants and $7,812,000 to the beneficial conversion feature. The beneficial conversion feature was amortized over six months, which is the minimum beneficial conversion period. We recorded as a deemed dividend an expense of $2,790,000 and $4,836,000, in the quarters ended March 31, 2000 and June 30, 2000, respectively. We also recorded an additional deemed dividend of $2,239,000 relating to Series C preferred stock as a cumulative effect adjustment in the fourth quarter of 2000 to account for a change in accounting guidance. ~~As of December 31, 2000, all of the Series C preferred shares had been converted to common stock. See Note 8 of "Notes to Financial Statements."~~

In July 2000, all of the Series C preferred stock was converted into common stock. A total of $502,000 in accrued dividends was paid during the year ended December 31, 2000. During the year ended December 31, 2000, 331,793 Series C warrants were exercised for 331,793 shares of our common stock for net proceeds of approximately $1,311,000. See Note 8 of "Notes to Financial Statements."

In January 2000, we issued 1,000,000 shares of common stock in a private placement for net proceeds of $13,629,000.

As In ~~of December~~June 312001, ~~2000,~~we ~~our~~completed ~~aggregate~~a ~~cash,~~private ~~cash~~placement ~~equivalents and short-term investments, excluding $514,000~~ of ~~restricted cash~~2, ~~totaled $15~~556,~~167,~~000 ~~compared~~shares ~~to $14,078,000 as~~ of ~~December 31,~~common ~~1999.~~stock ~~Additionally,~~at ~~we have entered into~~ a ~~bank~~price ~~line~~ of ~~credit~~$5.00 ~~facility~~per ~~and an equipment lease line~~share. ~~The~~After ~~bank~~deducting ~~line~~commissions ~~of credit is subject to renewal in 2001~~ and ~~the equipment~~expenses ~~lease~~we ~~lines~~received ~~expire~~proceeds ~~in 2001 and 2004. We may borrow up to a maximum~~ of ~~$2,000,000 under the bank line of credit based on a limitation of 80% of certain eligible receivables and we may~~ ~~purchase up to~~ $211,~~000~~941,000 ~~in capital equipment under the equipment line~~. ~~As of December 31, 2000, there were no amounts outstanding under either the bank line of credit facility or the equipment line of credit.~~

~~Net~~ As ~~cash~~of ~~used~~December 31, in2001, ~~operations~~our ~~was~~aggregate $7cash,~~258,000,~~ ~~$2,634,000~~cash equivalents and ~~$12,429,000~~short-term ~~for 1998~~investments, ~~1999~~excluding ~~and 2000~~$374,000 ~~respectively.~~of ~~The~~restricted ~~decrease in~~ cash, ~~used~~totaled in$6,897,000 ~~1999~~ compared to $15,167,000 ~~1998~~as ~~was the result~~ of ~~a decrease~~December 31, in2000. ~~our~~Additionally, ~~operating~~we ~~loss~~have ~~primarily~~a ~~due~~bank tocredit ~~the~~facility ~~General Dynamics license agreement~~available. ~~The~~Under ~~increase~~this infacility, ~~cash~~we ~~used~~are inpermitted ~~operations in 2000 compared~~ to ~~1999~~borrow ~~was~~an ~~primarily~~amount ~~the~~equal ~~result~~to 80% of ~~the~~certain ~~increase in net~~eligible ~~loss during the comparison periods and~~receivables, up to a ~~lesser~~maximum ~~extent, increases in the levels~~ of ~~inventory.~~$2,000,000 Weoutstanding ~~anticipate~~at ~~that~~any wetime, ~~will~~subject ~~incur~~to ~~significant~~a ~~additional~~$10,000,000 tangible net ~~losses~~worth ~~during~~covenant. ~~2001~~As ~~and~~of ~~anticipate~~December 31, ~~that our accounts receivable and inventories may increase during~~ 2001, asthere awere ~~result~~no ofamounts ~~increased~~outstanding ~~working~~under ~~capital requirements to support wireless telecommunications products. As a result~~this facility, wewhich ~~anticipate~~is ~~the~~subject ~~use of~~to ~~additional~~renewal ~~cash~~ in ~~operating activities during 2001~~November 2002.

Net cash used in ~~investing~~operations ~~activities~~ was $12,~~035~~634,000 ~~in 1998~~, ~~compared to~~ $112,~~081~~429,000 ~~in 1999~~ and $718,~~721~~730,000 infor 1999, 2000 and 2001, respectively. The ~~year-to-year~~increase ~~changes,~~in ~~during~~cash used in operations in the comparison periods ~~were~~ was primarily ~~due~~the toresult ~~higher purchases~~ of ~~short-term~~the ~~investments~~increase in ~~each~~net ~~succeeding~~loss ~~year.~~during Inthe ~~addition~~comparison periods and, ~~capital~~to ~~expenditures~~a ~~increased~~lesser ~~significantly~~extent, increases in ~~2000~~the ~~compared to~~levels ~~1999~~of ~~and~~inventory. ~~1998~~We ~~levels~~anticipate ~~due~~that ~~primarily~~we towill ~~the~~incur ~~purchase~~significant ofadditional ~~manufacturing~~net ~~and~~losses ~~engineering~~during ~~equipment.~~2002 Weand anticipate that our ~~capital~~accounts ~~expenditures~~receivable ~~will~~and inventories may increase induring ~~2001~~2002 as a result of increased working capital requirements to ~~approximately~~support ~~$2,500,000~~wireless astelecommunications products. As a result, we ~~continue~~ ~~our~~anticipate ~~transition~~an toincrease in the ~~manufacture~~use of ~~greater~~cash ~~volumes~~in ofoperating ~~commercial~~activities ~~products~~during 2002.

Net cash ~~provided~~used byin ~~financing~~investing activities was $71,~~229~~081,000, ~~$14,125,000~~in 1999 and $157,~~395~~721,000 ~~for~~in ~~1998, 1999 and~~ 2000~~, respectively~~. The change in net cash ~~provided~~used byduring ~~financing~~2000 ~~activities in 1998~~ was primarily due to ~~the~~higher ~~issuance~~purchases of short-term ~~Series B~~investments. ~~preferred~~In ~~stock~~addition, ~~and~~capital ~~related~~expenditures ~~warrants~~increased assignificantly ~~well as proceeds from borrowings~~ in ~~excess~~2000 ofcompared ~~debt~~to ~~payments during the year. Net cash provided by financing activities in~~ 1999 ~~was~~levels due primarily ~~attributable~~ to the ~~issuance~~purchase of ~~Series C~~manufacturing ~~preferred~~and ~~stock~~engineering ~~and~~equipment. In ~~related~~2001 ~~warrants~~net ~~partially~~cash ~~offset~~provided by ~~principal~~investing ~~payments~~activities onwas ~~long term debt of~~ $~~938~~4,167,000. The ~~net~~change in cash provided by ~~financing~~investing activities ~~in 2000~~ was primarily ~~the~~due ~~result~~to of the ~~issuance~~maturity of ~~1,000,000~~short ~~shares~~term ofinvestments ~~common~~partially ~~stock~~offset inby the aacquisition ~~financing~~of ~~transaction~~equipment infor ~~January 2000~~ and tothe abuild ~~lesser~~out ~~extent,~~of ~~the receipt~~our ofmanufacturing ~~proceeds~~facility. ~~related~~We toanticipate ~~the~~that ~~exercise~~our ofcapital ~~Series B~~expenditures ~~and~~will ~~Series C~~increase ~~warrants~~in ~~partially~~2002 ~~offset~~to byapproximately ~~dividend~~$1,700,000 ~~payments~~as onwe ~~Series C~~continue ~~preferred~~our transition ~~stock~~to asthe ~~well~~manufacture asof ~~principal~~greater ~~payments~~volumes ~~on long-term~~of ~~debt~~commercial products.

26 Net cash provided by financing activities was $14,125,000, $15,395,000 and $11,562,000 for 1999, 2000 and 2001, respectively. Net cash provided by financing activities in 1999 was primarily attributable to the issuance of Series C preferred stock and related warrants, partially offset by principal payments on long term debt. The net cash provided by financing activities in 2000 was primarily the result of the issuance of 1,000,000 shares of common stock in a financing transaction in January 2000 and to a lesser extent, the receipt of proceeds related to the exercise of Series B and Series C warrants, partially offset

All of our credit arrangements contain reporting and financial covenants, which we are required to satisfy. We cannot assure you that we will satisfy all such covenants in the future. We cannot assure you that if we default on any of the covenants, we could obtain a waiver of the default from the lender. In the event of default on any of these covenants, no further amounts would be advanced to us under any facility, the entire amounts outstanding, if any, could become due and payable immediately upon default, and those assets that are collateral could be seized, unless the lender waives such default. 31

by dividend payments on Series C preferred stock as well as principal payments on long-term debt. The net cash provided by financing activities in 2001 was primarily the result of the issuance of 2,556,000 shares of common stock in a private placement in June, partially offset by payments on long-term debt.

All of our credit facilities contain financial, reporting and other covenants which we are required to satisfy. We were in compliance with all such covenants at December 31, 2001 and are currently in compliance with all such covenants. We cannot assure you that we will continue to satisfy all such covenants in the future. We cannot assure you that if we default on any of such covenants, we could obtain a waiver of the default from the lender. In the event of default on any of these covenants, the party providing the financing under the applicable credit facility would not be obligated to advance further amounts to us under that facility, the entire amount outstanding, if any, under that facility could be declared to be immediately due and payable, and the party providing the financing under the applicable credit facility could exercise its legal remedies against those assets that are collateral for that facility.

To date we have received limited revenue from product sales. The continued development of our products will require a commitment of substantial funds to conduct further research and development and testing, to establish commercial-scale manufacturing and to market these products. We expect to use significant amounts of cash for capital equipment and to support operations until product revenue increases. Our future capital requirements will depend on many factors, including:

•: Continued progress in our research and development programs;
•: The magnitude of these programs;
•: The time and cost involved in obtaining any required regulatory approvals;
•: The costs involved in preparing, filing, prosecuting, maintaining and enforcing patents;
•: Successful completion of technological, manufacturing and market requirements;
•: Changes in existing research relationships;
•: The availability of funding under government contracts;
•: Our ability to establish collaborative arrangements; and
•: The cost of manufacturing scale-up and the amount and timing of future revenue.

We ~~anticipate~~have ~~that~~incurred ~~existing~~significant ~~sources~~losses ofsince ~~liquidity,~~inception. ~~bank~~In ~~credit lines~~2001, ~~equipment~~we ~~lease~~incurred ~~lines~~losses ~~and anticipated revenue~~ from ~~product~~operations ~~sales~~of ~~and government contracts~~$17,997,000 ~~will satisfy our projected working capital~~ and ~~other~~used cash ~~requirements~~totalling ~~through at least the next twelve months. However~~$18,730,000 ~~there can be no assurance that changes~~ in our ~~plans~~operating oractivities. ~~other~~We ~~events affecting us will not result~~expect inthat ~~the~~operating ~~expenditure~~losses ofand ~~our~~negative ~~resources~~cash ~~before~~flows ~~such~~will ~~time.~~continue Weat ~~may~~least ~~raise~~through ~~additional~~2002 ~~financing~~as inwe ~~the~~continue ~~future~~to ~~through~~market ~~the~~our ~~issuance~~ClearSite ofproduct ~~debt~~and ~~securities,~~seek ~~equity~~to ~~securities,~~increase orour acustomer ~~combination of both~~base.

In March 2002, we received gross proceeds of $7.3 million upon the completion of a private placement of 3,650,000 shares of common stock at a price of $2.00 per share. In connection with the transaction, we also issued to the purchasers, warrants to purchase an additional 1,825,000 shares of our common stock at an exercise price of $2.75 per share. After deducting commissions and expenses, we received proceeds of approximately $6.9 million from this transaction.

We believe our cash balance at December 31, 2001, together with the cash received from the private placement we completed in March 2002 and our $2 million bank credit facility should, be sufficient to fund operations through December 2002. However, there can be no assurance that changes in our plans or other events affecting Conductus will not result in the expenditure of our resources before then. Additionally, we can give no assurance that additional financing will be available on acceptable terms or at all. Unless we are able to raise significant additional funds, through debt or equity issuances, asset sales, or otherwise, we will be required to delay, reduce or eliminate one or more of our research and development programs or obtain funds from collaborative partners or others that may require us to relinquish rights to our technologies or potential products that we would not otherwise relinquish. Our financial statements have been prepared assuming that we will continue as a going concern. The financial statements do not include any adjustments that might be necessary if we

are unable to continue as a going concern or that may result from the outcome of any of these other uncertainties.

Recent Accounting Pronouncements

In ~~June~~August ~~1998~~2001, the ~~Financial Accounting Standards Board ("~~FASB") issued Statement of Financial Accounting Standards ("SFAS") No. ~~133~~143, Accounting for ~~Derivative Instruments and~~Asset ~~Hedging~~Retirement ~~Activities.~~Obligations, ~~SFAS~~which ~~No. 133~~is ~~establishes~~effective ~~a new model~~ for ~~accounting~~fiscal ~~for~~years ~~derivatives~~beginning ~~and~~after ~~hedging activities~~June 15, ~~and~~2002. ~~supercedes~~This ~~and~~statement ~~amends~~addresses afinancial ~~number of existing~~ accounting ~~standards.~~and ~~SFAS~~reporting ~~No. 133~~for ~~requires that all derivatives be recognized in the balance sheet at their fair market value and the~~obligations ~~corresponding~~associated ~~derivative~~with ~~gains or losses be either reported in~~ the ~~statement~~retirement of ~~operations~~tangible orlong-lived asassets aand ~~deferred item, depending on~~ the ~~type~~associated ofasset ~~hedge~~retirement ~~relationship that exists with respect of such derivatives~~costs. ~~In July 1999, the FASB issued~~ SFAS No. ~~137~~143 requires, ~~Accounting~~among ~~for~~other ~~Derivative~~things, ~~Instruments~~that ~~and Hedging Activities—Deferral of~~ the ~~Effective~~retirement ~~Date~~obligations be ofrecognized ~~FASB~~when ~~Statement~~they ~~No. 133.~~are ~~SFAS~~incurred ~~No. 137~~and ~~deferred~~displayed ~~the~~as ~~effective~~liabilities ~~date~~on ~~until~~ the ~~year~~balance ~~beginning after June 30, 2000~~sheet. In ~~June 2000~~addition, the ~~FASB~~asset's ~~issued~~retirement ~~SFAS No. 138,~~costs ~~Accounting~~are ~~for~~to ~~Derivative~~be ~~Instruments~~capitalized ~~and~~as ~~Hedging~~part ~~Activities—An Amendment~~ of ~~FASB Statement No. 133. SFAS No. 138 amends~~ the ~~accounting~~asset's ~~and~~carrying ~~reporting~~amount ~~standards for certain derivatives~~ and subsequently ~~hedging~~allocated ~~activities~~to ~~such~~expense asover ~~net~~the ~~settlement~~asset's ~~contracts,~~useful ~~foreign~~life. ~~currency~~The ~~transactions~~Company ~~and~~believes ~~intercompany derivatives.~~that Wethe ~~will~~adoption ~~adopt~~of SFAS No. ~~133~~143 inwill ~~our quarter ending March 31, 2001. To date, we do~~ not ~~believe that we~~ have ~~engaged~~a insignificant ~~derivative~~impact oron ~~hedging~~its ~~activities~~financial ~~that fall within the scope of the standard~~statements.

27 In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The statement develops one accounting model for long-lived assets that are to be disposed of by sale, as well as addressing the principal implementation issues. The Company believes that the adoption of SFAS No. 144 will not have a significant impact on its financial statements.

In January 2002, ~~various~~EITF ~~areas~~Topic No. D-103, ~~including~~Income ~~revenue~~Statement ~~recognition~~Characterization ~~and~~of ~~stock~~Reimbursements Received for "Out-~~based~~of-Pocket" ~~compensation~~Expenses Incurred, ~~accounting~~was ~~standards~~issued, and ~~practices~~considered ~~continue~~whether toreimbursements ~~evolve.~~received ~~The~~for ~~SEC~~"out-of-pocket" ~~has~~expenses incurred ~~issued~~should ~~interpretative~~be ~~guidance relating~~characterized toin ~~Staff~~the ~~Accounting~~income ~~Bulletin~~statement Noas revenue or as a reduction of expenses incurred. ~~101~~ ~~("SAB~~The ~~101"),~~FASB ~~and~~staff believes that the ~~FASB~~reimbursements ~~continues~~received toshould ~~address~~be characterized as revenue. It ~~and~~is ~~other~~not ~~related~~expected ~~accounting~~that ~~issues~~this issue will have a significant effect on total net revenue for the Company.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Conductus' general policy is to limit the risk of principal loss and ensure the safety of invested funds by limiting market and credit risk. Our exposure to financial market risks relates primarily to our exposure to the impact of changes in interest rates on our fixed income investment portfolio and long-term debt obligations.

Fixed Income Investments

The primary objective of our investment activities is to preserve our principal while maximizing yields without significantly increasing risk. To achieve this objective, we maintain a portfolio that consists primarily of short-term, high-quality commercial paper and foreign debt. ~~All~~The majority of our fixed income investments have maturities of less than one year, and all have maturities of less than two years. Hence, our exposure related to changes in interest rates is somewhat limited due to the short-term nature of our portfolio. We do not use derivative financial instruments in our investment portfolio.

Debt Obligations

Conductus' outstanding debt consists of term loan obligations that are primarily based on fixed rates. Therefore, our exposure to changes in interest rates is limited because any increase or decrease in interest rates would not significantly increase or decrease interest expense on our debt obligations.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following financial statements of the Registrant and Independent Accountant's report are included in pages 35-55:

Report of Independent Accountants

Balance Sheets—as of December 31, 1999 and 2000

Statements of Operations—years ended December 31, 1998, 1999 and 2000

Statements of Stockholders' Equity and Redeemable Preferred Stock—years ended December 31, 1998, 1999 and 2000

Statements of Cash Flows—years ended December 31, 1998, 1999 and 2000

Notes to Financial Statements

The following table presents the selected quarterly unaudited financial data for Conductus:

		Three months ended
		March 31, 1999			June 30, 1999		September 30, 1999			December 31, 1999			March 31, 2000			June 30, 2000			September 30, 2000			December 31, 2000
		(In thousands, except per share amounts)
Revenues:
	Product	$	397		$	142	$	196		$	137		$	88		$	46		$	192		$	196
	Contract		917			431		294			273			251			191			397			657
	License and other		—			5,000		11			—			—			—			—			—
	Total net revenues		1,314			5,573		501			410			339			237			589			853
Cost of Product Sales			570			597		733			608			701			1,352			1,467			1,473
Research and development expenses			1,121			1,033		996			1,280			1,081			1,207			1,490			1,729
Selling, general and administrative expenses			834			1,276		964			902			1,210			1,520			1,335			1,614
Income (loss) from operations		$	(1,211	)	$	2,667	$	(2,192	)	$	(2,380	)	$	(2,653	)	$	(3,842	)	$	(3,703	)	$	(3,963	)
Net income (loss) attributable to common stockholders		$	(1,491	)	$	2,507	$	(2,339	)	$	(2,747	)	$	(5,373	)	$	(8,519	)	$	(3,377	)	$	(5,979	)
Net income (loss) per common share attributable to common stockholders:
	Basic	$	(0.21	)	$	0.35	$	(0.33	)	$	(0.38	)	$	(0.56	)	$	(0.70	)	$	(0.22	)	$	(0.38	)
	Diluted	$	(0.21	)	$	0.26	$	(0.33	)	$	(0.38	)	$	(0.56	)	$	(0.70	)	$	(0.22	)	$	(0.38	)
Shares used in per share calculations:
	Basic		7,144			7,148		7,157			7,169			9,535			12,126			15,656			15,810
	Diluted		7,144			9,749		7,157			7,169			9,535			12,126			15,656			15,810

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not Applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Incorporated herein by reference is the information required by this item relating to our directors and nominees and disclosure relating to compliance with Section 16(a) of the Securities Exchange Act of 1934 that is included under the captions "Election of Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the Proxy Statement for the 2001 Annual Meeting of Stockholders to be held on May 24, 2001.

ITEM 11. EXECUTIVE COMPENSATION

Incorporated herein by reference is the information required by this item that is included under the caption "Executive Compensation and Related Information" in our 2001 Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Incorporated herein by reference is the information required by this item that is included under the caption "Ownership of Securities" in our 2001 Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Incorporated herein by reference is the information required by this item that is included under the caption "Certain Transactions" in our 2001 Proxy Statement.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

		Page Number
1.	Financial Statements
	Report of Independent Accountants	35
	Balance Sheets—as of December 31, 1999 and 2000	36
	Statements of Operations—years ended December 31, 1998, 1999 and 2000	37
	Statements of Stockholders' Equity and Redeemable Preferred Stock—years ended December 31, 1998, 1999 and 2000	38
	Statements of Cash Flows—years ended December 31, 1998, 1999 and 2000	39
	Notes to Financial Statements	40
2.	Financial Statement Schedule
	Report of Independent Accountants	S-1
	Schedule II—Valuation and Qualifying Accounts	S-2
3.	See Exhibits

Exhibit No		Description
3.1(1)		Restated Certificate of Incorporation.
3.2(2)		Restated Bylaws.
4.1(3)		Stockholder Rights Plan.
10.1(1)*		1992 Stock Option/Stock Purchase Plan, as amended.
10.2(1)*		1994 Employee Stock Purchase Plan, as amended.
10.3(4)		Form of Series B Preferred Stock and Warrant Purchase Agreement, dated September, 1998, and September 22, 1998, between Conductus and Series B Investors.
10.4(4)		Form of Warrant to Purchase Common Stock between Conductus and Series B Investors.
10.5(5)		Employment Agreement dated May 3, 1994, between Registrant and Mr. Charles E. Shalvoy.
10.6(6)		Form of Indemnification Agreement between the Registrant and each of its directors and officers.
10.7(7)		High Temperature Superconductor Thin-Film Manufacturing Alliance Agreement among Registrant, Superconductor Technologies, Inc., Stanford University, Georgia Research Corporation, Microelectronic Control and Sensing Incorporated, IBIS, Focused Research and BDM Federal dated November 17, 1995.
10.8(8)†		Superconducting Filter Technology Joint Development Agreement dated April 25, 1996 between the Registrant and Lucent Technologies Inc.
10.9(4)		Master Lease Agreement between Conductus and Leasing Technologies International, Inc., dated June 15, 1998.
10.10(6)		Lease Agreement dated May 3, 1993, between the Registrant and Mozart-McKee Limited Partnership for Sunnyvale facilities.
10.11(5)		Lease Agreement dated December 8, 1994, between Registrant and Mozart-McKee Limited Partnership for Sunnyvale facilities.
10.12(4)†		Master Loan and Security Agreement between Conductus and Transamerica Business Credit Corporation, dated June 26, 1998.

10.13(9)		Silicon Valley Bank Loan and Security Agreement dated April 23, 1998.
10.14(9)		Collateral Assignment, Patent Mortgage and Security Agreement between Conductus and Silicon Valley Bank.
10.15(10)†		Asset Purchase Agreement dated July 9, 1997, between Registrant and Bruker Instruments, Inc. for sale of assets of Registrant's NMR Probe business.
10.16(11)†		License Agreement with General Dynamics, dated May 4, 1999.
10.17(12)		Cross-License, Supply and Training Agreement with General Dynamics, dated May 4, 1999.
10.18(13)		Form of Series C Preferred Stock and Warrant Purchase Agreement, dated December 10, 1999, between Conductus and Series C Investors.
10.19(13)		Form of Warrant to Purchase Common Stock between Conductus and Series C Investors.
10.20(14)		Common Stock Purchase Agreement dated January 18, 2000, between Conductus and the Investors named therein.
10.21(14)		Building Leases Amendment Letter dated January 31, 2000, between Conductus and the Mozart Development Company.
10.22(15)†		Purchase Contract, dated as of August 7, 2000, between Conductus and Dobson Cellular Systems, Inc.
10.23(15)†		Warrant to Purchase Common Stock, dated August 7, 2000, issued by Conductus to Dobson Communications Corporation.
10.24(15)		Master Equipment Lease Commitment, dated as of September 1, 2000, between Pentech Financial Services, Inc. and Conductus.
10.25(15)		Master Equipment Lease, dated as of September 1, 2000, between Pentech Financial Services, Inc. and Conductus.
10.26(15)		Warrant to Purchase Common Stock, dated as of September 1, 2000, issued by Conductus to Pentech Financial Services, Inc.
10.27		Loan Modification Agreement dated as of October 30, 2000, between Conductus and Silicon Valley Bank modifying the Loan and Security Agreement dated as of April 23, 1998.
10.28		Loan Modification Agreement dated as of November 29, 2000, between Conductus and Silicon Valley Bank modifying the Loan and Security Agreement dated as of April 23, 1998.
10.29		Promissory Note between Charles E. Shalvoy and Conductus dated December 28, 2000.
10.30		Security Agreement between Charles E. Shalvoy and Conductus dated December 28, 2000.
23.1		Consent of Independent Accountants.
24.1		Power of Attorney (See Page 34).

No reports on Form 8-K were filed during the last quarter of the fiscal year covered by this Form 10-K Annual Report.

See responses to Item 14(a)(3) above.

None required, except as indicated in response to Item 14(a)(2) above.

~~SIGNATURES~~ ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 30, 2000.

			Page
Index to Financial Statement and Supplementary Data:
	Financial Statements:
		Report of Independent Accountants	35
		Balance Sheets—at December 31, 2000 and 2001	36
		Statements of Operations—for the years ended December 31, 1999, 2000 and 2001	37
		Statements of Stockholders' Equity (Deficit) and Redeemable Preferred Stock—for the years ended December 31, 1999, 2000 and 2001	38
		Statements of Cash Flows—for the years ended December 31, 1999, 2000 and 2001	39
		Notes to Financial Statements	40
	Financial Statement Schedule:
		Report of Independent Accountants	57
		Schedule II—Valuation and Qualifying Accounts	58
	Supplementary Financial Data:

		Quarterly Financial Data (unaudited) for the two years ended December 31, 2001.	59

CONDUCTUS, INC. By: /s/ CHARLES E. SHALVOY Charles E. Shalvoy President and Chief Executive Officer

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Charles E. Shalvoy and Ronald Wilderink, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/ CHARLES E. SHALVOY Charles E. Shalvoy	President, Chief Executive Officer and Director (Principal Executive Officer)	April 2, 2001
/s/ RON WILDERINK Ron Wilderink	Vice President of Finance, Chief Financial Officer and Secretary (Principal Accounting Officer)	April 2, 2001
/s/ JOHN F. SHOCH John F. Shoch, Ph.D.	Chairman of the Board of Directors	April 2, 2001
/s/ MARTIN COOPER Martin Cooper	Director	April 2, 2001
/s/ ROBERT M. JANOWIAK Robert M. Janowiak	Director	April 2, 2001
/s/ MARTIN A. KAPLAN Martin A. Kaplan	Director	April 2, 2001
/s/ DAVID L. SHORT David L. Short	Director	April 2, 2001

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and
Stockholders of Conductus, Inc.:

In our opinion, the accompanying balance sheets and the related statements of operations, of stockholders' equity (deficit) and redeemable preferred stock and of cash flows, present fairly, in all material respects, the financial position of Conductus, Inc. at December 31, ~~1999~~2000 and ~~2000~~2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, ~~2000~~2001, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of Conductus' management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards ~~generally~~ generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As The accompanying financial statements have been prepared assuming Conductus will continue as a going concern. As discussed in Note 82 to the financial statements, Conductus has incurred ~~adopted~~significant ~~the~~losses ~~provisions~~from ofinception ~~Emerging~~that ~~Issues~~raise ~~Task~~substantial ~~Force~~doubt ~~issue~~about ~~No. 00-27~~its ~~and~~ability ~~recorded~~to continue as a ~~cumulative~~ ~~effect~~going ~~adjustment~~concern. Management's plans in ~~the~~regard ~~fourth~~to ~~quarter~~these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of ~~2000~~this uncertainty.

~~PricewaterhouseCoopers~~/s/ PricewaterhouseCoopers LLP

San Jose, California February 915, ~~2001~~2002

CONDUCTUS, INC. BALANCE SHEETS (IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS)

BALANCE SHEETS (IN THOUSANDS EXCEPT FOR SHARE AND PER SHARE AMOUNTS)

			December 31,
			2000			2001
ASSETS
Current assets:
	Cash and cash equivalents		$	7,202		$	4,201
	Short-term investments			7,965			2,696
	Accounts receivable, net			563			1,151
	Inventories			3,273			3,835
	Prepaid expenses and other current assets			341			349

		Total current assets		19,344			12,232
Property and equipment, net				2,135			3,033
Restricted cash				514			374
Other assets				390			587

		Total assets	$	22,383		$	16,226

LIABILITIES
Current liabilities:
	Capital lease obligations and long-term debt, current portion		$	597		$	169
	Accounts payable			1,477			725
	Other accrued liabilities			1,523			1,909

		Total current liabilities		3,597			2,803
	Capital lease obligations and long-term debt, net of current portion			—			205

		Total liabilities		3,597			3,008

Commitments and contingencies (Note 6)
STOCKHOLDERS' EQUITY
Common stock, $0.0001 par value: Authorized: 40,000,000 shares; Issued and outstanding: 16,073,019 and 18,792,968 in 2000 and 2001				2			2
Additional paid-in capital				91,161			103,590
Receivable from stockholder				(460	)		(460	)
Accumulated deficit				(71,917	)		(89,914	)

		Total stockholders' equity		18,786			13,218

		Total liabilities and stockholders' equity	$	22,383		$	16,226

			December 31,
			1999			2000
ASSETS
Current assets:
	Cash and cash equivalents		$	11,957		$	7,202
	Short-term investments			2,121			7,965
	Accounts receivable, net			1,382			563
	Inventories			1,266			3,273
	Prepaid expenses and other current assets			306			341
		Total current assets		17,032			19,344
Property and equipment, net				1,374			2,135
Restricted cash				—			514
Other assets				191			390
		Total assets	$	18,597		$	22,383
LIABILITIES
Current liabilities:
	Current portion of long-term debt		$	752		$	597
	Accounts payable			1,023			1,477
	Other accrued liabilities			1,573			1,523
		Total current liabilities		3,348			3,597
	Long-term debt, net of current portion			596			—
		Total liabilities		3,944			3,597
Commitments (Note 6)
REDEEMABLE PREFERRED STOCK
Preferred stock, no par value:
	Authorized: 5,000,000 shares
	Series B, no par value; Designated: 4,500,000; Issued and outstanding: 2,461,227 in 1999 and none in 2000 (Liquidation value: $7,162 at December 31, 1999)			5,736			—
	Series C, no par value; Designated: 400,000; Issued and outstanding: 375,000 in 1999 and none in 2000 (Liquidation value: $15,039 at December 31, 1999)			5,042			—
STOCKHOLDERS' EQUITY
Common stock, $0.0001 par value:
	Authorized: 25,000,000 shares;
	Issued and outstanding: 7,256,518 and 16,073,019 in 1999 and 2000			1			2
Additional paid-in capital				52,543			91,161
Receivable from stockholder				—			(460	)
Accumulated deficit				(48,669	)		(71,917	)
		Total stockholders' equity		3,875			18,786
		Total liabilities, redeemable equity and stockholders' equity	$	18,597		$	22,383

The accompanying notes are an integral part of these financial statements.

CONDUCTUS, INC. STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

STATEMENTS OF OPERATIONS (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

			For the Years Ended December 31,
			1999			2000			2001
Revenue:
	Product		$	872		$	522		$	2,595
	Contract			1,915			1,496			4,029
	Other			5,011			—			—

		Total revenue		7,798			2,018			6,624

Costs and expenses:
	Cost of product sales			2,508			4,993			9,394
	Research and development			4,430			5,507			8,666
	Selling, general and administrative			3,976			5,679			7,076

		Total costs and expenses		10,914			16,179			25,136

Loss from operations				(3,116	)		(14,161	)		(18,512	)
Interest income				89			1,361			575
Other income				30			112			82
Interest expense				(339	)		(231	)		(142	)

	Net loss			(3,336	)		(12,919	)		(17,997	)
Dividend accretion and deemed dividend on preferred stock				(734	)		(8,090	)		—

Net loss attributable to common stockholders before cumulative effect of accounting change				(4,070	)		(21,009	)		(17,997	)
Cumulative effect of accounting change on deemed dividend on preferred stock				—			(2,239	)		—

	Net loss attributable to common stockholders		$	(4,070	)	$	(23,248	)	$	(17,997	)

Basic and diluted net loss per share:
	Net loss per share attributable to common stockholders before cumulative effect of accounting change		$	(0.57	)	$	(1.58	)	$	(1.03	)
	Cumulative effect of accounting change on deemed dividend on preferred stock			—			(0.17	)		—

	Net loss per share attributable to common stockholders		$	(0.57	)	$	(1.75	)	$	(1.03	)

Shares used in loss per share calculations				7,155			13,283			17,552

			For the Years Ended December 31,
			1998			1999			2000
Revenues:
	Product		$	991		$	872		$	522
	Contract			3,698			1,915			1,496
	Other			—			5,011			—
		Total revenues		4,689			7,798			2,018
Costs and expenses:
	Cost of product sales			2,685			2,508			4,993
	Research and development			5,621			4,430			5,507
	Selling, general and administrative			3,515			3,976			5,679
		Total costs and expenses		11,821			10,914			16,179
Loss from operations				(7,132	)		(3,116	)		(14,161	)
Interest income				97			89			1,361
Other income (expense)				(36	)		30			112
Interest expense				(530	)		(339	)		(231	)
	Net loss			(7,601	)		(3,336	)		(12,919	)
Dividend accretion and deemed dividend on preferred stock				(228	)		(734	)		(8,090	)
Net loss attributable to common stockholders before cumulative effect of accounting change				(7,829	)		(4,070	)		(21,009	)
Cumulative effect of accounting change on deemed dividend on preferred stock				—			—			(2,239	)
	Net loss attributable to common stockholders		$	(7,829	)	$	(4,070	)	$	(23,248	)
Basic and diluted net loss per share:
	Net loss per share attributable to common stockholders before cumulative effect of accounting change		$	(1.10	)	$	(0.57	)	$	(1.58	)
	Cumulative effect of accounting change on deemed dividend on preferred stock			—			—			(0.17	)
	Net loss per share attributable to common stockholders		$	(1.10	)	$	(0.57	)	$	(1.75	)
Shares used in per share calculations				7,088			7,155			13,283

The accompanying notes are an integral part of these financial statements.

CONDUCTUS, INC. STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) AND REDEEMABLE PREFERRED STOCK (IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS)

	Redeemable Preferred Stock
									Additional Paid-In Capital
							Common Stock		Additional Paid-In Capital		Receivable from Stockholder			Accumulated Deficit
							Common Stock				Receivable from Stockholder			Accumulated Deficit
	Series B			Series C													Total
Balances, December 31, 1997	$	—		$	—		$	1	$	41,070	$	—		$	(36,770	)	$	4,301
Issuance of 2,461,227 shares of preferred stock net of $301 issuance costs		5,572			—			—		—		—			—			—
Issuance of common stock warrants		—			—			—		1,041		—			—			1,041
Issuance of 111,955 shares of common stock to employees		—			—			—		66		—			—			66
Issuance of 28,070 shares of common stock to employees under the employee stock purchase plan		—			—			—		65		—			—			65
Compensation associated with stock options granted		—			—			—		36		—			—			36
Dividend accretion and deemed dividend on preferred stock		111			—			—		—		—			(228	)		(228	)
Net loss		—			—			—		—		—			(7,601	)		(7,601	)
Balances, December 31, 1998		5,683			—			1		42,278		—			(44,599	)		(2,320	)
Issuance of 29,387 shares of common stock to employees under the employee stock purchase plan		—			—			—		48		—			—			48
Preferred B issuance costs		(58	)		—			—		—		—			—			—
Issuance of 375,000 shares of preferred stock net of $94 issuance costs		—			4,856			—		7,812		—			—			7,812
Issuance of common stock warrants		—			—			—		2,239		—			—			2,239
Issuance of 30,136 shares of common stock upon exercise of warrants		—			—			—		—		—			—			—
Issuance of 52,875 shares of common stock to employees		—			—			—		166		—			—			166
Dividend accretion and deemed dividend on preferred stock		111			186			—		—		—			(734	)		(734	)
Net loss		—			—			—		—		—			(3,336	)		(3,336	)
Balances, December 31, 1999		5,736			5,042			1	$	52,543		—			(48,669	)		3,875
Issuance of 57,798 shares of common stock to employees under the employee stock purchase plan		—			—			—		197		—			—			197
Issuance of 1,000,000 shares of common stock upon private placement, net of $40 issuance costs		—			—			—		13,629		—			—			13,629
Issuance of 1,000,000 shares of common stock in a private placement, net of $40 issuance costs		—			—			—		13,629		—			—			13,629
Issuance of 812,881 shares of common stock upon exercise of warrants		—			—			—		1,571		—			—			1,571
Issuance of 713,203 shares of common stock upon exercise of warrants		—			—			—		1,571		—			—			1,571
Issuance of 187,843 shares of common stock upon conversion of Preferred B dividends		—			—			—		516		—			—			516
Issuance of 411,451 shares of common stock to employees for cash		—			—			—		1,291		—			—			1,291
Issuance of 135,301 shares of common stock for note receivable upon exercise of stock options		—			—			—		460		(460	)		—			—
Issuance of common stock warrants to customer		—			—			—		138		—			—			138
Vesting of common stock warrants issued to customer		—			—			—		138		—			—			138
Dividend accretion and deemed dividend on preferred stock		—			7,625			—		2,239		—			(10,329	)		(8,090	)
Conversion of preferred stock to 6,211,227 shares of common stock		(5,736	)		(12,667	)		1		18,402		—			—			18,403
Issuance of common stock warrants in connection with capital lease		—			—			—		175		—			—			175
Net loss		—			—			—		—		—			(12,919	)		(12,919	)
Balances, December 31, 2000	$	—		$	—		$	2	$	91,161	$	(460	)	$	(71,917	)	$	18,786
Issuance of 35,962 shares of common stock to employees for cash		—			—			—		65		—			—			373
Issuance of 105,109 shares of common stock to employees under the employee stock purchase plan		—			—			—		308		—			—			—
Issuance of 2,556,000 shares of common stock in a private placement, net of issuance costs of $839		—			—			—		11,941		—			—			11,941
Vesting of common stock warrants issued to customer		—			—			—		115		—			—			115
Net loss		—			—			—		—		—			(17,997	)		(17,997	)
Balances, December 31, 2001	$	—		$	—		$	2	$	103,590	$	(460	)	$	(89,914	)	$	13,218

The accompanying notes are an integral part of these financial statements.

CONDUCTUS, INC. STATEMENTS OF CASH FLOWS (IN THOUSANDS)

STATEMENTS OF CASH FLOWS (IN THOUSANDS)

			For the Years Ended December 31,
			1999			2000			2001
Cash flows from operating activities:
	Net loss		$	(3,336	)	$	(12,919	)	$	(17,997	)
	Adjustments to reconcile net loss to net cash used in operating activities:
	Depreciation and amortization			813			742			974
	Amortization of discount on long term debt			52			40			69
	Gain on sales of equipment			—			(107	)		(82	)
	Non-cash charge for warrants vesting upon commercial product sales			—			138			115
Changes in operating assets and liabilities:
	Accounts receivable			(272	)		819			(588	)
	Inventories			(423	)		(2,007	)		(562	)
	Prepaid expenses and other current assets			(161	)		(35	)		(42	)
	Other assets			(28	)		(57	)		(251	)
	Accounts payable and other accrued liabilities			721			957			(366	)

		Net cash used in operating activities		(2,634	)		(12,429	)		(18,730	)

Cash flows from investing activities:
	Maturities of short-term investments			1,350			2,150			9,026
	Purchases of short-term investments			(2,130	)		(7,994	)		(3,757	)
	Acquisition of property and equipment			(151	)		(1,476	)		(1,324	)
	Acquisition of license			(150	)		—			—
	Net proceeds from sales of equipment			—			113			82
	Release of previously restricted cash			—			—			140
	Purchase of certificate of deposit (restricted cash)			—			(514	)		—

		Net cash provided by (used) in investing activities		(1,081	)		(7,721	)		4,167

Cash flows from financing activities:
	Net proceeds from issuance of common stock			214			15,117			12,314
	Net proceeds from issuance of preferred stock			12,609			—			—
	Net proceeds from issuance of common stock upon exercise of warrants			2,239			1,571			—
	Preferred dividend payments			—			(502	)		—
	Principal payments on long-term debt			(937	)		(791	)		(612	)
	Principal payments under capital lease obligations			—			—			(140	)

		Net cash provided by financing activities		14,125			15,395			11,562

	Net increase (decrease) in cash and cash equivalents			10,410			(4,755	)		(3,001	)
Cash and cash equivalents at beginning of period				1,547			11,957			7,202

Cash and cash equivalents at end of period			$	11,957		$	7,202		$	4,201

			For the Years Ended December 31,
			1998			1999			2000
Cash flows from operating activities:
	Net loss		$	(7,601	)	$	(3,336	)	$	(12,919	)
	Adjustments to reconcile net loss to net cash used in operating activities:
		Depreciation and amortization		931			813			742
		Compensation associated with stock options granted		36			—			—
		Amortization of discount on long term debt		(108	)		52			40
		Gain on disposal of equipment		—			—			(107	)
		Non-cash charge for warrants vesting upon commercial product sales		—			—			138
Changes in operating assets and liabilities:
	Accounts receivable			945			(272	)		819
	Inventories			(232	)		(423	)		(2,007	)
	Prepaid expenses and other current assets			(6	)		(161	)		(35	)
	Other assets			59			(28	)		(57	)
	Accounts payable and other accrued liabilities			(1,282	)		721			957
		Net cash used in operating activities		(7,258	)		(2,634	)		(12,429	)
Cash flows from investing activities:
	Maturities of short-term investments			557			1,350			2,150
	Purchases of short-term investments			(1,341	)		(2,130	)		(7,994	)
	Acquisition of property and equipment			(251	)		(151	)		(1,476	)
	Acquisition of license			—			(150	)		—
	Net proceeds from sales of assets			—			—			113
	Purchase of certificate of deposit (restricted cash)			—			—			(514	)
		Net cash used in investing activities		(1,035	)		(1,081	)		(7,721	)
Cash flows from financing activities:
	Proceeds from borrowings			4,500			—			—
	Net proceeds from issuance of common stock			132			214			15,117
	Net proceeds from issuance of preferred stock			5,572			12,609			—
	Net proceeds from issuance of common stock upon exercise of warrants			772			2,239			1,571
	Preferred dividend payments			—			—			(502	)
	Principal payments on long-term debt			(3,747	)		(937	)		(791	)
		Net cash provided by financing activities		7,229			14,125			15,395
	Net increase (decrease) in cash and cash equivalents			(1,064	)		10,410			(4,755	)
Cash and cash equivalents at beginning of period				2,611			1,547			11,957
Cash and cash equivalents at end of period			$	1,547		$	11,957		$	7,202

The accompanying notes are an integral part of these financial statements.

CONDUCTUS, INC. NOTES TO FINANCIAL STATEMENTS

NOTES TO FINANCIAL STATEMENTS

1. FORMATION AND BUSINESS OF THE COMPANY:

Conductus, Inc. ("Conductus" or the "Company"), was incorporated in Delaware in 1987 and was formed to develop, manufacture and market superconductive electronic devices, circuits and systems for sensor, communications, test and instrumentation and digital electronics applications. In 1997, Conductus discontinued operation of its Instrument and System Division and is now focused on development, manufacturing and marketing electronic components and subsystems based on high-temperature superconductor ("HTS") technology for applications in the worldwide telecommunications market. Conductus' ClearSite® product family integrates superior HTS technology to enhance the sensitivity and selectivity of wireless base station receivers, leading to reduced interference, enhanced coverage, increased capacity and higher bandwidth.

SUBSTANTIAL FUTURE CAPITAL NEEDS:

Conductus has recognized limited revenues from product sales to date and has cash, cash equivalents and short-term investments of $15,167,000 as of December 31, 2000. Conductus anticipates that existing sources of liquidity and anticipated revenue will satisfy projected working capital and other cash requirements through at least the next twelve months. Management plans to raise additional financing in the future through the issuance of debt securities, equity securities or a combination of both. However, there can be no assurance that changes in Conductus' plans or other events affecting Conductus will not result in the expenditure of our resources before such time.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

SUBSTANTIAL FUTURE CAPITAL NEEDS:

Conductus has incurred significant losses since inception. In 2001, the Company incurred losses from operations of $17,997,000 and used cash totalling $18,730,000 in its operating activities. The Company expects that operating losses and negative cash flows will continue at least through 2002 as it continues to market the ClearSite product and seeks to increase its customer base.

In March 2002, the Company received gross proceeds of $7.3 million upon the completion of a private placement of 3,650,000 shares of common stock at a price of $2.00 per share. In connection with the transaction, the Company also issued warrants to purchase an additional 1,825,000 shares of its common stock at an exercise price of $2.75 per share. After deducting commissions and expenses, the Company received proceeds of approximately $6.9 million from this transaction.

The Company believes its cash balance at December 31, 2001, together with the cash received from the private placement completed in March 2002 and the $2 million bank credit facility, should be sufficient to fund operations through December 2002. However, there can be no assurance that changes in its plans or other events affecting the Company will not result in the expenditure of its resources before then. Additionally, the Company can give no assurance that additional financing will be available on acceptable terms or at all. Unless the Company is able to raise significant additional funds, through debt or equity issuances, asset sales, or otherwise, it will be required to delay, reduce or eliminate one or more of its research and development programs or obtain funds from collaborative partners or others that may require it to relinquish rights to its technologies or potential products that it would not otherwise relinquish. The Company's financial statements have been prepared assuming that it will continue as a going concern. The financial statements do not include any adjustments that might be necessary if it is unable to continue as a going concern or that may result from the outcome of any other uncertainties.

FISCAL YEAR:

Conductus uses a 52-week calendar year ending on the last day of the month for its financial presentations.

USE OF ESTIMATES:

The preparation of financial statements in conformity with ~~generally accepted~~ accounting principles ~~requires~~generally ~~management~~accepted toin ~~make estimates and assumptions that affect~~ the ~~reported~~United ~~amounts~~States of ~~assets~~America ~~and~~requires ~~liabilities~~management ~~and~~to ~~disclosure~~make estimates ~~of contingent assets~~ and ~~liabilities~~assumptions atthat ~~the~~affect ~~date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.~~

CERTAIN RISKS AND CONCENTRATIONS:

Conductus' superconducting products are concentrated in the electronic component industry, which is highly competitive and rapidly changing. Revenues for its products are concentrated with a relatively limited number of customers and suppliers for certain components are concentrated among a few providers. In addition, approximately 79%, 25% and 74% of total revenues for each of the fiscal years 1998, 1999 and 2000 were from government-related contracts. The development of new technologies or commercialization of superconductive products by any competitor, or the conclusion of one or more government contracts could affect operating results adversely.

In August 2000, Conductus entered into a transaction with Dobson Cellular Systems, Inc., to sell a minimum of 200 ClearSite systems to be deployed nationwide over the next two years.

the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

CERTAIN RISKS AND CONCENTRATIONS:

Conductus' superconducting products are concentrated in the electronic component industry, which is highly competitive and rapidly changing. Revenues for its products are concentrated with a relatively limited number of customers and suppliers for certain components are concentrated among a few providers. In addition, approximately 25%, 74% and 61% of total revenues for each of the fiscal years 1999, 2000 and 2001, respectively, were from government-related contracts. The development of new technologies or commercialization of superconductive products by any competitor, or the conclusion of one or more government contracts could affect operating results adversely.

In August 2000, Conductus entered into a transaction with Dobson Cellular Systems, Inc., to sell a minimum of 200 ClearSite systems to be deployed nationwide over the following two years, and this customer accounted for 15% and 21% of total net revenue for the years ended December 31, 2001 and 2000, respectively.

CASH AND CASH EQUIVALENTS:

Conductus considers all highly liquid investments purchased with an original maturity date of three months or less to be cash equivalents. Investments, which consist ~~primarily~~ of ~~foreign~~commercial ~~debt,~~paper and ~~commercial~~United ~~paper~~States government agency debt, are stated at fair market value. Management believes that the financial institutions in which it maintains such deposits are financially sound and, accordingly, minimal credit risk exists with respect to these deposits. ~~Additionally,~~Cash ~~cash~~ and cash equivalents are held by two U.S. banks.

FAIR VALUE OF FINANCIAL INSTRUMENTS:

Other financial instruments, principally accounts receivable, long -term debt and other borrowings, are considered to approximate fair value based upon comparable market information available at respective balance sheet dates.

INVESTMENTS:

Investments are deemed by management to be available-for-sale and are reported at fair market value with net unrealized gains or losses reported as a separate component of stockholders' equity. Available-for-sale marketable securities with maturities less than one year from the balance sheet date are classified as short-term and those with maturities greater than one year from the balance sheet date are classified as long -term, except when management has the intention and ability to redeem within one year from the balance sheet date, when they are included within current assets. As of December 31, ~~2000~~2001, no unrealized gains or losses on investments had been incurred. Realized gains and losses, which are calculated based on the specific identification method, are recorded in operations as incurred.

INVENTORIES:

Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market. ~~Appropriate~~Conductus ~~consideration~~validates isits ~~given~~perpetual toinventory ~~obsolescence,~~balances ~~excessive~~against ~~levels,~~a ~~deterioration~~quarterly ~~and~~physical ~~other~~count ~~factors~~making ~~in evaluating net realizable value.~~

adjustments to the perpetual balance as necessary. Conductus writes down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Appropriate consideration is given to obsolescence, excessive levels, deterioration and other factors in evaluating net realizable value.

PROPERTY AND EQUIPMENT:

Property and equipment are stated at cost and depreciated on the straight-line method over estimated useful lives of five years for equipment and furniture and fixtures. Repairs and maintenance are charged to expense as incurred, and improvements are capitalized. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the useful life of the assets or the related lease term. When assets are disposed of, the cost and related accumulated depreciation are removed from the accounts and the resulting gains and losses are included in results of operations.

LONG-LIVED ASSETS:

Conductus evaluates the recoverability of its long-lived assets in accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed ofOf, which requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. In that event, a loss is recognized based on the amount by which the carrying value exceeds the estimated fair value of the long-lived asset. Estimated fair value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair values are reduced for the cost of disposal. No losses from impairment have been recognized in the financial statements.

involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair values are reduced for the cost of disposal. No losses from impairment have been recognized in the financial statements.

REVENUE RECOGNITION:

Conductus recognizes revenues upon the shipment of its products to the customer provided that it has received a purchase order, the price is fixed, title has transferred, collection of the resulting receivable is ~~reasonably~~probable ~~assured, product returns are reasonably estimable~~ and there are no remaining obligations. The Company provides for future returns and warranty claims based on historical experience at the time revenue is recognized.

In When ~~December 1999,~~Conductus ~~the~~issues ~~Securities~~warrants ~~and~~or ~~Exchange~~other ~~Commission~~equity ~~("SEC")~~instruments ~~issued~~in ~~Staff~~connection ~~Accounting~~with ~~Bulletin~~sales ~~No. 101~~transactions, ~~("SAB~~the ~~101"),~~portion ~~Revenue~~of ~~Recognition~~the inpayments from the ~~Financial~~ ~~Statements,~~customer ~~which~~equal ~~provides~~to ~~guidance~~the onfair value of the ~~recognition~~equity instrument, ~~presentation~~as ~~and~~calculated ~~disclosure~~using ofthe ~~revenue~~Black-Scholes inoption ~~financial~~pricing ~~statements~~model ~~filed~~is ~~with~~treated as a reduction of the ~~SEC.~~amount ~~SAB~~of ~~101~~revenue ~~outlines~~recognized in the ~~basic criteria~~period, ~~that~~unless ~~must~~the bereduction ~~met~~results toin ~~recognize~~negative revenue ~~and~~for that ~~provides~~specific ~~guidance~~customer ~~for~~on ~~disclosures~~a ~~related~~cumulative tobasis, ~~revenue~~in ~~recognition~~which ~~policies.~~case ~~Conductus~~the ~~has~~remainder, ~~complied~~if ~~with~~any, ~~the~~increases ~~guidance~~cost inof ~~SAB~~goods ~~101~~sold ~~for~~in ~~all~~our ~~periods presented~~financial statements.

When Conductus issues warrants or other equity instruments in connection with sales transactions, the portion of the payments from the customer equal to the fair value of the equity instrument is treated as a payment for the equity instrument.

ADVERTISING:

Conductus does not engage in general advertising through print, radio, television or such other media, and as such, does not incur advertising expenses.

RESEARCH AND DEVELOPMENT CONTRACTS:

Conductus has entered into contracts to perform research and development for the U.S. government. Revenues from these contracts are recognized utilizing the percentage-of-completion method measured by the relationship of costs incurred to total contract costs. Cost of contract revenues for the years ended December 31, ~~1998,~~ 1999, 2000 and ~~2000~~2001 was $52,~~661~~477,000, $21,~~478~~920,000 and $16,~~920~~939,000, respectively, allocated between research and development, and selling, general and administrative expenses. Costs include direct engineering and development costs and applicable overhead. The ~~company~~Company accrues contract losses when they become reasonably estimable.

RESEARCH AND DEVELOPMENT:

Internally funded research and development expenditures are charged to operations as incurred.

INCOME TAXES:

Conductus utilizes the liability method of accounting for income taxes, as set forth in ~~Statement of Financial Accounting Standards ("~~SFAS") No. 109, Accounting for Income Taxes. Under the liability method, deferred taxes are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to amounts expected to be realized.

COMPREHENSIVE LOSS

Conductus adopted the provisions of SFAS No. 130, Reporting Comprehensive Income. This statement requires companies to classify items of other comprehensive income by their nature in the financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the balance sheet. There has been no difference between Conductus' net loss and its total comprehensive loss through December 31, ~~2000~~2001.

ACCOUNTING FOR STOCK-BASED COMPENSATION:

As permitted by SFAS No. 123, Accounting for Stock-Based Compensation, Conductus accounts for grants of equity instruments to employees using the intrinsic value method described in Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, as modified under FASB Interpretation No. 44 ("FIN No. 44") Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25). All other grants are accounted for using the fair value method described in SFAS No. 123 with appropriate compensation expense recognition in the statement of operations.

Conductus accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force ("EITF") 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services.

In March 2000, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 44 ("FIN 44") Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25. FIN 44 clarifies the application of Opinion No. 25 for (a) the definition of employee for purposes of applying Opinion No. 25, (b) the criteria for determining whether a plan qualifies as a noncompensatory plan, (c) the accounting consequences of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 is effective July 1, 2000, but certain conclusions cover specific events that occur either after December 15, 1998, or January 12, 2000. The adoption of the provisions of FIN 44 did not have a material impact on the financial statements.

BASIC AND DILUTED LOSS PER SHARE:

A reconciliation of the numerator and denominator of the basic and diluted net loss per share is provided as follows:

		Years Ended December 31,
		1998			1999			2000
		1999			2000			2001
		(in thousands, except per share data)
Numerator-basic and diluted net loss per share:
	Net loss	$	(73,~~601~~336	)	$	(312,~~336~~919	)	$	(1217,~~919~~997	)
	Dividend accretion and deemed dividend on preferred stock		(~~228~~734	)		(~~734~~8,090	)		~~(8,090~~—	)
	Cumulative effect of accounting change on deemed dividend on preferred stock		—			—(2,239	)		~~(2,239~~—	)
	Net loss attributable to common shareholders	$	(7,829	)	$	(4,070	)	$	(23,248	)
	Net loss attributable to common stockholders	$	(4,070	)	$	(23,248	)	$	(17,997	)
Denominator-basic and diluted net loss per share:
Denominator-basic and diluted net loss attributable to common stockholders per share:
	Weighted average common shares		7,~~088~~155			713,~~155~~283			1317,~~283~~552
	Basic and diluted net loss per share	$	(1.10	)	$	(0.57	)	$	(1.75	)
Basic and diluted net loss attributable to common stockholders per share		$	(0.57	)	$	(1.75	)	$	(1.03	)

In the ~~1998~~1999, ~~1999~~2000 and ~~2000~~2001 computations, common equivalent shares are excluded from the diluted loss per share, as their effect is antidilutive. Common equivalent shares, including common stock options, warrants and preferred stock, that could potentially dilute basic earnings per share in the future and that were not included in the computation of diluted loss per share because of antidilution were approximately 410,~~074~~889,000, 2553,~~797,~~000 and 4558,~~100,~~000 ~~for~~at ~~the years ended 1998~~December 31, 1999, 2000 and ~~2000~~2001, respectively.

RECENT PRONOUNCEMENTS:

In ~~June~~August ~~1998~~2001, the FASB issued SFAS No. ~~133~~143, Accounting for ~~Derivative~~Asset ~~Instruments~~Retirement ~~and~~Obligations, ~~Hedging~~which is ~~Activities.~~effective ~~SFAS No. 133 establishes a new model~~ for ~~accounting~~fiscal ~~for~~years ~~derivatives~~beginning ~~and~~after ~~hedging~~June 15, ~~activities~~2002. ~~and~~This ~~supercedes~~statement ~~and~~addresses ~~amends~~financial ~~a number of existing~~ accounting ~~standards.~~ ~~SFAS~~and ~~No. 133~~reporting ~~requires~~for ~~that~~obligations ~~all~~associated ~~derivatives~~with ~~be recognized in~~ the ~~balance~~retirement ~~sheet~~of attangible long-lived ~~their~~assets ~~fair market value~~ and the ~~corresponding~~associated ~~derivative~~asset ~~gains~~retirement ~~or losses be either reported in the statement of operations or as a deferred item depending on the type of hedge relationship that exists with respect to such derivatives~~costs. ~~In July 1999, the FASB issued~~ SFAS No. ~~137~~143 requires, ~~Accounting~~ ~~for~~among ~~Derivative Instruments~~other ~~and~~things, ~~Hedging~~that ~~Activities—Deferral~~the ofretirement ~~the~~obligations ~~Effective~~be ~~Date~~recognized ofwhen ~~FASB~~they ~~Statement~~are ~~No. 133.~~incurred ~~SFAS~~and ~~No. 137~~displayed ~~deferred~~as ~~the~~liabilities ~~effective~~on ~~date until~~ the ~~year~~balance ~~beginning after June 30, 2000~~sheet. In ~~June 2000~~addition, the ~~FASB~~asset's ~~issued~~retirement ~~SFAS~~costs ~~No. 138,~~are ~~Accounting~~to ~~for Derivative~~be ~~Instruments~~capitalized ~~and~~as ~~Hedging~~part ~~Activities—An Amendment~~ of ~~FASB Statement No. 133. SFAS No. 138 amends~~ the ~~accounting~~asset's ~~and~~carrying ~~reporting~~amount ~~standards for~~and ~~certain~~subsequently ~~derivatives~~allocated ~~and~~to ~~hedging~~expense ~~activities~~over ~~such~~the asasset's ~~net~~useful ~~settlement~~life. ~~contracts,~~The ~~foreign~~Company ~~currency~~believes ~~transactions~~that ~~and~~the ~~intercompany~~adoption ~~derivatives.~~of ~~Conductus will adopt~~ SFAS No. ~~133~~143 inwill ~~its quarter ending March 31, 2001. To date, Conductus does~~ not ~~believe~~have ~~that~~a itsignificant ~~has~~impact ~~engaged~~on inits ~~derivative~~financial ~~or hedging activities that fall within the scope of the standard~~statements.

In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The statement develops one accounting model for long-lived assets that are to be disposed of by sale, as well as addressing the principal implementation issues. The Company believes that the adoption of SFAS No. 144 will not have a significant impact on its financial statements.

In ~~various~~January 2002, ~~areas~~EITF Topic No. D-103, ~~including~~Income ~~revenue~~Statement ~~recognition~~Characterization ~~and~~of ~~stock~~Reimbursements Received for "Out-~~based~~of-Pocket" ~~compensation~~Expenses Incurred, ~~accounting~~was ~~standards~~issued, and ~~practices~~considered ~~continue~~whether toreimbursements ~~evolve~~received for "out-of-pocket" expenses incurred should be characterized in the income statement as revenue or as a reduction of expenses incurred. The ~~SEC~~FASB ~~has~~staff ~~issued~~believes ~~interpretative~~that ~~guidance~~the reimbursements received should be characterized as revenue. ~~relating~~It tois ~~SAB~~not ~~101,~~expected ~~and~~that ~~the~~this ~~FASB~~issue ~~continues~~will tohave ~~address~~a ~~revenue~~significant ~~and~~effect ~~other~~on ~~related~~total ~~accounting~~net ~~issues~~revenue for the Company.

3. SUPPLEMENTAL CASH FLOW DISCLOSURE:

		For The Years Ended December 31,
		1998		1999		2000
		1999		2000		2001
		(in thousands)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
	Cash paid during the year for interest	$	~~375~~297	$	~~297~~211	$	~~211~~97
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
	Conversion of preferred shares to common stock	$	—	$	—18,403	$	~~18,403~~—
	Conversion of preferred dividend to common stock	$	—	$	—516	$	~~516~~—
	Dividend accretion and deemed dividend on preferred stock	$	~~228~~734	$	~~734~~10,329	$	~~10,329~~—
	Value of warrants issued in association with capital lease line	$	~~269~~—	$	—175	$	~~175~~—
	Equipment acquired under capital lease	$	—	$	—	$	514

4. BALANCE SHEET COMPONENTS (in thousands):

SHORT-TERM INVESTMENTS:

Short-term investments, all of which are classified as available-for-sale, are summarized below:

		Cost and Market Value
		December 31,
		1999		2000
		2000		2001
Debt securities:
	Commercial paper	$	~~295~~2,057	$	~~2,057~~—
	Other		15,~~823~~880		52,~~880~~686
	Accrued interest		328		2810
	Total	$	27,~~121~~965	$	72,~~965~~696

At December 31, ~~2000~~2001, ~~all~~ scheduled maturities on $2,245,000 of investments are within one year and scheduled maturities on $451,000 are more than one year, classified within current assets due to management's intention and ability to redeem during 2002 to fund operations. Investments consisted primarily of United States government agencies debt and commercial paper bearing interest between 64.1144% and 6.8029% per annum, which are due to mature in ~~May~~February ~~2001~~2003.

ACCOUNTS RECEIVABLE:

Accounts receivable, net, consists of the following:

			December 31,
			1999			2000
			2000			2001
U.S. government contracts:
	Unbilled
		Recoverable costs and accrued profit on progress completed—not billed	$	~~148~~—		$	—258
	Billed			~~192~~620			~~620~~505
Commercial				9557			57406
License Fee Receivable				1,050			—
Allowance for doubtful accounts				(114	)		(18	)
Allowance for doubtful accounts				(103	)		(114	)
			$	563		$	1,151
			$	1,382		$	563

At December 31, 1999, recoverable costs and accrued profit and unrecovered costs and estimated profits not billed were comprised principally of amounts of revenue recognized on contracts for which billings had not been presented to the contract owners because the amounts were not billable at the balance sheet date. There were no such amounts at December 31, 2000.

INVENTORIES:

Inventories consist of the following:

	December 31,
	1999		2000
	2000		2001
Raw materials	$	~~574~~2,156	$	2,~~156~~349
Work in process		~~401~~640		~~640~~888
Finished goods		~~291~~477		~~477~~598
	$	13,~~266~~273	$	3,~~273~~835

PROPERTY AND EQUIPMENT:

Property and equipment, net, consists of the following:

	December 31,
	1999			2000
	2000			2001
Equipment	$	7,~~397~~910		$	79,~~910~~761
Leasehold improvements		1,~~715~~722			12,~~722~~525
Furniture and fixtures		~~432~~425			425
Construction in process		40884			~~884~~22
		9,584			10,941
		10,941			12,733
Accumulated depreciation and amortization		(8,~~210~~806	)		(89,~~806~~700	)
	$	12,~~374~~135		$	23,~~135~~033

At December 31, 2001, the Company held equipment under capital leases with a cost and accumulated amortization of $514,000 and $140,000, respectively. The Company held no equipment under capital leases at December 31, 2000.

Depreciation expense for the years ended December 31, 1999, 2000 and 2001 was $785,000, $711,000 and $940,000, respectively.

OTHER ACCRUED LIABILITIES:

Other accrued liabilities consist of the following:

	December 31,
	1999		2000
	2000		2001
Accrued consulting and professional	$	~~194~~182	$	~~182~~334
Accrued compensation		697		1,037
Accrued warranty costs		51		202
Preferred dividend payable		554		—
Deferred rent		106		313
Other accrued liabilities		128		304
Accrued compensation		1,037		874
	$	1,573	$	1,523
Other accrued liabilities		147		186
	$	1,523	$	1,909

5. ~~LONG-TERM~~ ~~DEBT~~CAPITAL LEASE OBLIGATIONS AND ~~OTHER~~LONG-TERM ~~BORROWINGS~~DEBT:

Credit facilities consist of a ~~loan~~capital ~~from~~lease aline ~~leasing~~of ~~company~~credit and a bank ~~and~~line ~~lease lines~~ of credit. Obligations related to credit facilities as of December 31, ~~1999~~2000 and 2001 ~~2000~~were ~~are~~ as follows (in thousands):

		December 31,
		1999			2000
		2000			2001
Loan payable to leasing company		$	~~1,348~~612		$	~~597~~—
Less: current portion			752			597
Capital lease obligation			—			374
	Long term debt	$	596		$	—
Unamortized discount			(15	)		—
			597			374
Less: current portion			(597	)		(169	)
	Non current portion	$	—		$	205

In April 1998, Conductus entered into a ~~$2,500,000~~bank ~~loan~~line ~~agreement~~of ~~with~~credit aagreement, ~~leasing~~which ~~company~~provides ~~collateralized~~for byborrowings ~~substantially~~of ~~all~~up ofto the ~~assets~~lesser of ~~Conductus. In connection with the loan agreement~~$2,000,000 ~~Conductus~~or ~~granted~~80% ~~warrants~~of toeligible ~~purchase~~receivables upsubject to a $~~125~~10,000,000 oftangible ~~Conductus'~~net ~~common~~worth ~~stock at $4~~covenant.~~11,~~ aBorrowings ~~price~~under ~~equal~~this tofacility ~~the~~bear ~~average~~interest ~~closing~~at ~~bid price for~~ the ~~five~~bank's ~~days~~prime ~~immediately preceding and including April 22, 1998. The effective interest~~ rate, ~~including~~plus ~~the effect of the warrants, is 13~~2.980%. ~~The~~and ~~warrants~~are ~~were~~collateralized ~~valued~~by ~~using~~accounts ~~the~~receivable, ~~Black-Scholes~~equipment ~~option~~and ~~pricing~~other ~~model~~assets ~~and~~of Conductus. asAs of December 31, 2001 and 2000, ~~had~~there ~~been~~were ~~exercised~~no ~~and~~amounts ~~converted~~outstanding ~~into~~under ~~Conductus~~this ~~common stock~~facility. The ~~value~~line of ~~$102,000~~credit ~~assigned to the warrants~~ is ~~being~~subject ~~amortized~~ to ~~interest~~renewal ~~expense~~on ~~using~~November 30, ~~the effective interest method over the term of the agreement~~2002.

~~Also~~ In ~~in April~~June ~~1998~~2000, Conductus entered into a ~~bank~~36-month ~~line~~master ofleasing ~~credit~~ agreement, ~~which provides~~ for ~~borrowings~~the purchase of up to ~~the lesser of~~ $2514,000~~,000~~ ~~or 80%~~ of ~~eligible~~capital ~~receivables~~equipment. ~~Borrowings~~ Payments for draw downs under ~~this~~the lease ~~facility~~began ~~bear~~on ~~interest~~February 8, at2001 with the ~~bank's~~final ~~prime~~payment due on January 8, 2004. The effective interest rate ~~plus~~on 2the lease is 11.046%. ~~and~~This ~~are~~lease is collateralized by ~~accounts~~a ~~receivable~~bank letter of credit that expires on February 28, ~~equipment~~2004 and ~~other~~requires ~~assets~~Conductus ofto ~~Conductus~~maintain a balance equal to the principal amount owed under the master lease agreement as a 90-day Certificate of Deposit. AsThe Certificate of ~~December 31,~~Deposit ~~2000 and~~has ~~1999,~~been ~~there~~classified ~~were~~on nothe ~~amounts~~balance ~~outstanding~~sheet ~~under~~as ~~this~~"Restricted ~~facility~~Cash". ~~The~~Total ~~line~~borrowings under the lease agreement, net of ~~credit~~principal ispayments ~~subject~~in to2001, ~~renewal~~were on$374,000. ~~November~~There were no amounts outstanding as of December 3031, 2001.

In June 2000, Conductus entered into a 36-month equipment lease providing for borrowing of up to $514,000. This transaction has lease payments commencing on February 8, 2001, expires on January 8, 2004, and has an effective interest rate of 11.46%. This lease is collateralized by a bank letter of credit that expires on February 28, 2004 that requires Conductus to maintain a balance of $514,000 as a Certificate of Deposit, which is classified in the balance sheet as "Restricted Cash." As of December 31, 2000, there were no amounts outstanding under this facility.

At ~~In October~~December ~~2000~~31, ~~Conductus entered into a lease line of credit which provided for borrowings of up to $2~~2001,~~000,000~~ ~~for~~ the ~~purchase~~future ofminimum ~~capital~~lease ~~equipment.~~payments ~~This~~under transaction has an effective date of September 1, 2000. This line of credit is collateralized by equipment purchases and has an effective interest rate of 9.31%. Conductus also granted the leasing company warrants to purchase up to 10,000 shares of its common stock at $18.75 per share. Conductus valued the warrants using the Blacknon-~~Scholes~~cancelable ~~option~~capital ~~pricing~~leases ~~model~~are ~~applying an expected life of 7 years, a risk free interest rate of 5.91%, a dividend yield of 0% and a volatility of 129%. The fair value of the warrants was recorded~~ as ~~$175,000~~follows ~~and will be amortized over the term of the line of credit to interest expense. This line of credit expires~~ (in ~~June 2001,~~thousands): ~~with final payment obligations due 36 months after the final borrowing. As of December 31, 2000, there were no amounts outstanding under this facility.~~

All of the credit facilities contain reporting and financial covenants. In the event of default on any of these covenants, no further amounts would be advanced to Conductus under any facility. Additionally, the entire amounts outstanding could become due and payable immediately upon default and those assets that are collateralized could be seized, unless the lender waives such default. At December 31, 2000, Conductus was in compliance with all financial covenants.

Fiscal year ending December 31,
2002	$	202
2003		202
2004		17

Total minimum lease payments		421
Less: Amount representing interest		(47	)

Present value of capital lease obligations		374
Less: Current Portion		(169	)

Long-term portion of capital lease obligations	$	205

6 All of the Company's credit facilities contain financial, reporting and other covenants, such as minimum tangible net worth, which the Company is required to satisfy. ~~COMMITMENTS:~~ The Company was in compliance with all such covenants at December 31, 2001. In the event of default on any of these covenants, the party providing the financing under the applicable credit facility would not be obligated to advance further amounts to us under that facility, the entire amount outstanding, if any, under that facility could be declared to be immediately due and payable, and the party providing the financing under the applicable credit facility could exercise its legal remedies against those assets that are collateral for that facility.

6. COMMITMENTS AND CONTINGENCIES:

In October 2000, Conductus entered into an operating lease line of credit, which provided for borrowings of up to $2,000,000 for the purchase of capital equipment. This transaction has an effective date of September 1, 2000. This line of credit is collateralized by equipment purchased and has an effective interest rate of 9.31%.

Conductus also granted the leasing company warrants to purchase up to 10,000 shares of its common stock at $18.75 per share. Conductus valued the warrants using the Black-Scholes option pricing model applying an expected life of 7 years, a risk free interest rate of 5.91%, a dividend yield of 0% and a volatility of 129%. The fair value of the warrants was recorded as $175,000 and will be amortized over the term of the line of credit to interest expense. The amortization expense for the year ended December 31, 2001 was $54,000. This line of credit expired in June 2001, with final payment obligations due October 1, 2004.

Conductus leases its administrative, sales, marketing, manufacturing, research and development facilities under noncancelable operating leases which are due to expire in February 2006.

~~Conductus also has equipment leases that expire at different dates over the next four years.~~ 48

~~Future minimum~~ Conductus ~~payments~~also ~~under~~has ~~these~~equipment ~~noncancelable~~ leases ~~are~~that asexpire ~~follows:~~at different dates over the next three years.

	Facilities		Equipment		Total
	(in thousands)
2001	$	775	$	912	$	1,687
2002		1,007		240		1,247
2003		1,038		202		1,240
2004		1,070		17		1,087
2005		1,101		—		1,101
Thereafter		187		—		187
	$	5,178	$	1,371	$	6,549

Future minimum payments under these noncancelable operating leases are as follows:

Rent expense was $316,000, $353,000 and $576,000 for the years ending December 31, 1998, 1999 and 2000, respectively.

Fiscal year ending December 31,	Facilities		Equipment		Total
			(in thousands)
2002		1,014		232		1,246
2003		1,038		193		1,231
2004		1,070		87		1,157
2005		1,101		—		1,101
2006		187		—		187

	$	4,410	$	512	$	4,922

Rent expense was $353,000, $576,000 and $1,022,000 for the years ending December 31, 1999, 2000 and 2001, respectively.

On July 17, 2001, ISCO International, Inc. ("ISCO") filed a complaint in the United District Court for the District of Delaware against Conductus, alleging that the Company's current base station front-end systems containing cryogenically cooled superconducting filters infringe ISCO's U.S. Patent No. 6,263,215, entitled "Cryoelectronically Cooled Receiver Front End for Mobile Radio Systems," which was issued on July 17, 2001. On September 17, 2001, ISCO amended its complaint to allege willful infringement and to seek treble damages for the alleged infringement. The complaint seeks injunctive relief and damages for infringement. Conductus has denied infringement, denied that the patent is valid and alleged that the patent was procured through inequitable conduct. The Company has filed counterclaims seeking declarations of invalidity and non-infringement and damages for unfair competition. The Company believes that ISCO's claims are without merit and is defending itself vigorously.

An adverse outcome in the pending litigation, or in litigation of other intellectual property claims could subject the Company to significant liabilities or require it to cease using such technology. The cost of defending a patent lawsuit will likely constitute a major financial burden for the Company. As the litigation is in an initial stage, Conductus is not able at this time to estimate the possibility of loss or range of loss, if any that might result. While the outcome of this claim cannot be predicted with certainty, the Company does not believe that the outcome will have a material adverse effect on its financial position, results of operations or cash flows.

7. RECEIVABLE FROM STOCKHOLDER:

In conjunction with the exercise of 135,301 stock options in December 2000 by an officer of Conductus, Conductus received a full recourse promissory note for $460,000. The note bears interest at a rate of 5.87% and is due and payable in full no later than December 28, 2005.

48 In August 2001, the Company received a full recourse note receivable for $360,000 from an officer of Conductus which is included in Other Assets in the Balance Sheet at December 31, 2001. The note bears interest at 4.99% and is due and payable in full no later than August 22, 2006.

8. STOCKHOLDERS' EQUITY AND REDEEMABLE PREFERRED STOCK:

CAPITAL STOCK:

Under the terms of Conductus' Certificate of Incorporation, the Board of Directors may determine the rights, preferences and terms of its authorized but ~~unissued~~un-issued preferred stock.

Series B Preferred Stock

In September 1998, Conductus ~~sold and~~ issued 2,461,227 shares of its Series B preferred stock at ~~a price per share of~~ $2.70 per share and issued warrants to purchase 492,242 shares of common stock at an exercise price of $2.70 per share in a private placement of its equity securities. The value of the warrants was determined to be $772,000 using the Black-Scholes option pricing model. The allocation of proceeds between preferred stock and warrants resulted in a beneficial conversion feature in the amount of $222,000. The value of the beneficial conversion feature was accreted as preferred dividends over six months.

In January and February 2000, the Series B preferred stock was converted into 2,461,277 shares of common stock. The accrued dividends were converted into 187,843 shares of of common stock. During the year ended December 31, 2000, warrants ~~were~~to ~~exercised~~purchase ~~for 358~~96,~~535~~302 shares of Conductus' common stock were exercised for net proceeds of approximately $260,000. In addition, 277,106 warrants were exercised in a cashless transaction, in exchange for 262,233 shares of common stock.

Series C Preferred Stock

In December 1999, Conductus sold and issued 375,000 shares of its Series C preferred stock at ~~a price per share of~~ $40.00 per share and issued warrants to ~~purchase~~ purchase 750,000 shares of common stock at an exercise price of $4.00 per share in a private placement of its equity securities. Each preferred share is convertible into ten shares of common stock and has a cumulative dividend at ~~a rate of~~ $2.40 per year. The value of the warrants was determined to be $2,239,000 using the Black-Scholes option pricing model. The warrants have a term of 5 years and were exercisable beginning in June 2000.

In 1999, Conductus recorded a deemed dividend on preferred stock relating to the beneficial conversion feature on Series C preferred stock of $7,812,000, calculated in ~~accordance~~ accordance with the guidance contained in ~~Emerging Issues Task Force (~~EITF) No. 98-5 "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustment Conversion Ratios" that existed at that time.

The beneficial conversion feature was recognized as a deemed dividend to the preferred stockholders over the six-month period prior to the earliest date at which the preferred shareholders can realize that return. As a result, using the effective interest method, $7,625,000 of the beneficial conversion feature was recognized in the year ended December 31, 2000.

At the November 2000 meeting of the EITF, a further consensus was reached regarding the accounting for securities with beneficial conversion features that amended prior guidance. The EITF determined that the conversion price used to calculate the intrinsic value should be based on the "effective conversion price," which is based on the proceeds allocated to the convertible instrument. This guidance was further explained in EITF Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments.

At the November 2000 meeting, the SEC Observer stated that, for public companies, the transition adjustment to record the beneficial conversion feature using the effective conversion price, for all ~~convertibles~~convertible instruments issued after May 21, 1999, would be to record a cumulative effect adjustment. ~~Accordingly, Conductus recorded a cumulative effect adjustment in the fourth quarter of 2000 to account for the~~

4950

Accordingly, Conductus recorded a cumulative effect adjustment in the fourth quarter of 2000 to account for the adoption of EITF No. 00-27, and as a result, Conductus recorded an additional deemed dividend on preferred stock of $2,239,000 relating to Series C preferred stock.

Had Conductus recorded the cumulative effect adjustment in the fourth quarter of 1999, when the Series C preferred stock was issued, the pro forma net loss attributable to common stockholders would have been $4,123,000 and $23,195,000 for 1999 and 2000, respectively. The pro forma net loss per share attributable to common stockholders would have been $(0.58) and $(1.75) per share for 1999 and 2000, respectively.

In July 2000, the Series C preferred stock was converted into 3,750,000 shares of common stock. A total of $502,000 in accrued dividends was paid during the year ended December 31, 2000. During the year ended December 31, 2000, warrants ~~were~~to ~~exercised~~purchase ~~for 331~~327,~~793~~850 shares of Conductus' common stock were exercised for net proceeds of approximately $1,311,000. In addition, during the years ended December 31, 2000 and 2001, 6,000 and 50,000 warrants, respectively, were exercised in a cashless transaction, in exchange for 3,943 and 22,875 shares of common stock, respectively.

WARRANTS:

In connection with certain financing arrangements and a commercial transaction, Conductus has issued warrants to purchase shares of its common stock. The following warrants were outstanding as of December 31, ~~2000~~2001:

Transactions	Fiscal Year of Grant	Number Issued	Number Outstanding	Number Exercisable	Exercise Price		Fiscal Year of Expiration
Preferred B financing	1998	492,242	118,837	118,837	$	2.70	2003
Preferred C financing	1999	750,000	~~416~~366,150	~~416~~366,150	$	4.00	2004
Commercial product sale	2000	500,000	500,000	1763,~~660~~040	$	13.43	2005
Lease line of credit	2000	10,000	10,000	10,000	$	18.75	2007

In August 2000, Conductus entered into a transaction with Dobson Cellular Systems, Inc. to sell a minimum of 200 ClearSite systems to be deployed nationwide over the ~~next~~ next two years. Under the terms of the contract, Conductus issued a warrant to Dobson, to purchase up to 500,000 shares of common stock at $13.43 per share, which expires in August 2005. The number of warrants ~~issued~~that vest is based on the amount of products purchased by Dobson. AsIn of2000 ~~December 31,~~and ~~2000~~2001, ~~Conductus had issued~~ 17,660 ~~warrants.~~ ~~The~~and ~~fair~~45,380 ~~value~~warrants, ofrespectively, ~~the~~vested. The warrants, were valued using the Black-Scholes option pricing model applying an expected life of 5 years, a risk free rate of 5.00% to 5.92%, a dividend yield of 0% and a volatility of 129%~~, was $138,000~~. The ~~portion~~fair value of the ~~payment~~warrants ~~for~~was ~~the~~$138,000 ~~ClearSite~~and $115,000 ~~systems~~in ~~equal~~2000 toand ~~$138~~2001,~~000~~ respectively, and has been ~~treated~~deducted asfrom athe ~~payment~~total ~~for~~revenue ~~the warrants~~recognized.

~~1992~~2001 STOCK OPTION/STOCK ISSUANCE PLAN:

In May 2001, the stockholders approved the 2001 Stock Option/Stock Issuance Plan, which serves as a successor to the 1987, 1989 and 1992 Stock Option/Stock Issuance Plans. Under Conductus' stock option/stock issuance plan, as amended, a total of 4,580,000 shares of common stock are authorized for issuance under the plan as of December 31, ~~2000~~2001. The plan is divided into three separate components: the discretionary option grant program, the automatic option plan program and the stock issuance program.

The plan is divided into three separate components: the discretionary option grant program, the automatic option plan program and the stock issuance program. Under the discretionary option grant program, eligible individuals may be granted incentive options or nonstatutory options. The exercise price of incentive stock options granted under the plan must be at least equal to the fair market value of the common stock on the date of grant. The exercise price of nonstatutory options granted under 51

50 Under the discretionary option grant program, eligible individuals may be granted incentive options or non-statutory options. The exercise price of incentive stock options granted under the plan must be at least equal to the fair market value of the common stock on the date of grant. The exercise price of non-statutory options granted under the plan must be not less than 85% of the fair market value of the common stock on date of grant.

Under the ~~plan~~Automatic ~~must~~Grant beProgram, ~~not~~each ~~less~~non-employee ~~than~~board ~~85%~~member ofis ~~the~~automatically ~~fair~~granted, ~~market~~at ~~value of~~ the ~~common~~time ~~stock on date~~ of ~~grant.~~initial ~~Under~~election ~~the~~or ~~automatic option grant program~~appointment, ~~non-employee~~a ~~board members automatically receive~~ non-statutory ~~options~~ option to purchase 24,000 shares of common stock. ~~Each~~Additionally ~~non-employee~~each ~~board~~year ~~member~~the ~~who first becomes a~~ non-employee board ~~member~~members atreceive ~~any time on or after January 23, 1995 is automatically granted, at the time of such initial election or appointment,~~ an additional option to purchase 158,000 -shares ~~of common stock~~. The options are immediately exercisable, subject to Conductus' repurchase right, which lapses with respect to ~~twenty percent (20~~25%) of the optioned shares upon completion of ~~twelve (~~12) months of board service from the date of grant, and the remainder of the optioned shares in ~~forty-eight~~36 ~~(48)~~ equal monthly installments. Additionally each year the non-employee board members receive a 3,000-share grant that vests over three years. On May 25, 2000, the stockholders approved an amendment to the plan increasing the initial grant to 24,000 shares and the annual grant to 8,000 shares, each vesting over four years. Under the stock issuance program, eligible individuals are allowed to purchase shares of Conductus' common stock at fair market value or for such consideration as the compensation committee deems advisable.

Under the stock issuance program, eligible individuals are allowed to purchase shares of Conductus' common stock at fair market value or for such consideration as the compensation committee deems advisable.

Options granted under the plan may be immediately exercisable for all the option shares, on either a vested or unvested basis, or may become exercisable for fully vested shares in one or more installments over the participant's period of service. Shares issued under the stock issuance program may either be vested upon issuance or subject to a vesting schedule tied to the participant's period of future service or to the attainment of designated performance goals.

No option may be granted with a term exceeding ten years. However, each such option may be subject to earlier termination within a designated period following the optionee's cessation of service with Conductus.

A summary of the status of Conductus' stock option plans as of December 31, 1998, 1999 and 2000 and changes during the periods ending on these dates is presented below:

			Options Outstanding
	Available for Grant Under Option Plan
			Shares		Weighted Avg. Exercise Price
Balance, January 1,1998	521,348		1,100,687		$	4.68
Granted	(919,296	)	919,296			3.26
Exercised	—		(111,955	)		0.59
Canceled	887,938		(887,938	)		5.53
Balance, December 31, 1998	489,990		1,020,090		$	3.55
Additional shares authorized	500,000		—			—
Granted	(1,012,489	)	1,012,489			3.52
Exercised	—		(52,875	)		3.42
Canceled	180,207		(180,207	)		3.72
Balance, December 31, 1999	157,708		1,799,497		$	3.52
Additional shares authorized	2,000,000		—			—
Granted	(795,850	)	795,850			9.15
Exercised	—		(546,752	)		3.20
Canceled	119,194		(119,194	)		7.62
Balance, December 31, 2000	1,481,052		1,929,401		$	5.70

At December 31, 1998, 1999 and 2000, options to purchase 221,521, 550,423 and 371,846 shares, respectively, were exercisable and the weighted average prices for the exercisable options were $4.23, $3.81 and $4.17, respectively.

The following table summarizes information with respect to stock options outstanding at December 31, 2000:

	Options Exercisable
		Weighted Average Remaining Contractual Life (Years)			Options Outstanding
Range of Exercise Prices	Number Outstanding		Weighted Average Exercise Price		Number Exercisable	Weighted Average Exercise Price
$0.56-$1.25	195,248	7.67	$	1.20	50,048	$	1.06
$1.44-$1.69	223,290	8.09	$	1.54	50,942	$	1.55
$1.72-$4.63	213,011	7.91	$	3.10	73,557	$	3.17
$4.75-$5.25	44,050	4.05	$	4.92	43,775	$	4.92
$5.50	442,193	8.97	$	5.50	88,455	$	5.50
$5.69	502,500	9.95	$	5.69	—		—
$5.75-$15.75	202,234	8.31	$	9.44	65,069	$	7.01
$15.81-$23.38	70,625	9.35	$	17.29	—		—
$24.75	29,000	9.25	$	24.75	—		—
$55.50	7,250	9.16	$	55.50	—		—
$0.56-$55.50	1,929,401	8.71	$	5.70	371,846	$	4.17

The following information concerning Conductus' stock issuance plans is provided in accordance with SFAS No. 123. Conductus, however, continues to apply APB 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its plan.

The fair value of each option grant and purchase right has been estimated on the date of grant using the Black-Scholes option pricing and valuation model with the following weighted average assumptions used for grants and purchase rights in 1998, 1999 and 2000.

					1999
	1998								2000
					Group A
	Group A		Group B				Group B		Group A		Group B
Risk-free interest rates	5.36	%	5.17	%	5.92	%	5.47	%	6.15	%	6.15	%
Expected life	3.9 years		6 months		5 years		6 months		4.53 years		6 months
Volatility	1.05		1.05		1.04		1.04		1.29		1.29
Dividend yield	—		—		—		—		—		—

The weighted average expected life was calculated based on the exercise behavior of each group. Group A represents all grants of options to employees, officers, and directors. Group B represents the employees with purchase rights under the Employee Stock Purchase Plan.

The weighted average fair value of those options granted in 1998, 1999 and 2000 was $3.26, $2.75 and $8.50, respectively. The weighted average fair value of those purchase rights granted in 1998, 1999 and 2000 was $2.34, $0.73 and $3.60, respectively.

A ~~Had~~summary ~~compensation cost for these plans been determined based on fair value~~ of the ~~options~~status ~~at that grant date in 1998, 1999 and 2000 consistent with the provisions~~ of ~~SFAS No. 123,~~ Conductus' ~~net~~stock ~~loss~~option ~~and~~plans ~~net~~is ~~loss~~presented ~~per share would have been as follows~~below:

			1998			1999			2000
			Options Outstanding
Net loss attributable to common stockholders (in thousands)
	Available for Grant Under Option Plan
	—As reported		$	(7,829	)	$	(4,070	)	$	(23,248	)
			Shares		Weighted Avg. Exercise Price
	—Proforma		$	(9,067	)	$	(4,651	)	$	(25,449	)
Balance, December 31, 1998	489,990		1,020,090		$	3.55
Basic and diluted net loss per share
Additional shares authorized	500,000		—			—
	—As reported		$	(1.10	)	$	(0.57	)	$	(1.75	)
Granted	(1,012,489	)	1,012,489			3.52
	—Proforma		$	(1.28	)	$	(0.65	)	$	(1.92	)
Exercised	—		(52,875	)		3.42
Canceled	180,207		(180,207	)		3.72
Balance, December 31, 1999	157,708		1,799,497		$	3.52
Additional shares authorized	2,000,000		—			—
Granted	(795,850	)	795,850			9.15
Exercised	—		(546,752	)		3.20
Canceled	119,194		(119,194	)		7.62
Balance, December 31, 2000	1,481,052		1,929,401		$	5.70
Granted	(450,750	)	450,750			4.89
Exercised	—		(35,962	)		1.81
Canceled	185,279		(185,279	)		5.71
Balance, December 31, 2001	1,215,581		2,158,910		$	5.48

The ~~above~~following ~~proforma~~table ~~effect~~summarizes ~~may~~information ~~not~~with berespect ~~representative of the effects on reported net income for future years as the proforma numbers presented do not take into account the effect of equity grants made prior~~ to ~~1996~~stock oroptions ~~additional~~outstanding ~~future~~at ~~grants.~~December 31, 2001:

		Options Outstanding
			Weighted Average Remaining Contractual Life (Years)			Options Exercisable
Range of Exercise Prices		Number Outstanding	Weighted Average Remaining Contractual Life (Years)	Weighted Average Exercise Price		Number Exercisable	Weighted Average Exercise Price
$	0.56—$ 1.44	269,998	6.72	$	1.28	266,398	$	1.28
$	1.50—$ 3.63	262,893	7.10	$	2.28	143,056	$	2.45
$	3.72—$ 4.63	234,252	9.05	$	4.08	26,353	$	4.06
$	4.75—$ 5.25	34,250	4.02	$	4.95	28,625	$	4.91
	$5.50	426,398	7.97	$	5.50	342,878	$	5.50
$	5.63—$ 5.64	114,000	9.38	$	5.64	—		—
	$5.69	502,500	8.95	$	5.69	125,625	$	5.69
$	5.75—$13.75	218,824	7.71	$	8.29	155,679	$	7.88
$	15.75—$24.75	88,885	8.31	$	19.23	36,145	$	20.32
	$55.50	7,250	8.16	$	55.50	2,659	$	55.50

$	0.56—$55.50	2,158,910	8.05	$	5.48	1,127,418	$	5.01

At December 31, 1999 and 2000, options to purchase 1,232,214 and 922,673 shares, respectively, were exercisable and the weighted average prices for the exercisable options were $3.55 and $4.26, respectively.

At December 31, 1999, 2000 and 2001, options to purchase 550,423, 371,846 and 729,092 shares, respectively, were vested and the weighted average prices for the vested options were $3.81, $4.17 and $5.24, respectively.

The following information concerning Conductus' stock issuance plans is provided in accordance with SFAS No. 123. The fair value of each option grant and purchase right has been estimated on the date of grant using the Black-Scholes option pricing and valuation model with the following weighted average assumptions used for grants and purchase rights in 1999, 2000 and 2001.

	1999				2000				2001
	Group A		Group B		Group A		Group B		Group A		Group B
Risk-free interest rates	5.92	%	5.47	%	6.15	%	6.15	%	4.70	%	4.70	%
Expected life	5 years		6 months		4.53 years		6 months		4.52 years		6 months
Volatility	104	%	104	%	129	%	129	%	126	%	126	%
Dividend yield	—		—		—		—		—		—

The weighted average fair value of those options granted in 1999, 2000 and 2001 was $2.75, $8.50 and $3.69 respectively. The weighted average fair value of those purchase rights granted in 1999, 2000 and 2001 was $0.73, $3.60 and $3.09, respectively.

Had compensation cost for these plans been determined based on fair value of the options at that grant date in 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123, Conductus' net loss and net loss per share would have been as follows:

		1999			2000			2001
Net loss attributable to common stockholders (in thousands)
	—As reported	$	(4,070	)	$	(23,248	)	$	(17,997	)
	—Proforma	$	(4,651	)	$	(25,449	)	$	(21,474	)
Basic and diluted net loss attributable to common stockholders per share
	—As reported	$	(0.57	)	$	(1.75	)	$	(1.03	)
	—Proforma	$	(0.65	)	$	(1.92	)	$	(1.22	)

The above proforma effect may not be representative of the effects on reported net income for future years as the proforma numbers presented do not take into account the effect of additional future grants.

EMPLOYEE STOCK PURCHASE PLAN:

The board of directors adopted the Employee Stock Purchase Plan in July 1994. A total of 750,000 shares of common stock are authorized for issuance ~~under~~ under the plan as of December 31, ~~2000~~2001. The purpose of the plan is to provide employees of Conductus with a means of acquiring common stock of Conductus through payroll deductions. The purchase ~~price~~ price of such stock under the plan cannot be less than 85% of the lower of the fair market values on the specified purchase date and the beginning of the offering period. During 1998, 1999, and 2000, employees purchased 28,070, 29,387, and 57,798 shares for a total of approximately $66,000, $48,000 and $197,000, respectively. At December 31, 2000, 424,421 shares were available for future grants under the plan.

~~STOCKHOLDER RIGHTS PLAN:~~ 54

~~On January 22, 1998,~~ the ~~board~~offering ofperiod. ~~directors~~During ~~declared~~1999, a2000 ~~dividend~~and ~~of one preferred share purchase right for each outstanding share of common stock~~2001, ~~par value~~employees ~~$0.0001~~purchased ~~per share outstanding on February 16~~29,387, ~~1998~~57,798 toand ~~the~~105,109 ~~stockholders~~shares offor ~~record on that date. Each right entitles the registered holder to purchase from Conductus one one-thousandth of~~ a ~~share~~total of ~~Series A~~approximately ~~Junior participating preferred stock~~$48,000, ~~par value~~ $~~0.0001 per share~~197,000 atand ~~a price of~~ $29307,000 respectively.00 ~~per~~At ~~one one-thousandth of a preferred~~December 31, ~~share~~2001, ~~subject~~319,312 toshares ~~adjustment.~~were ~~The~~available ~~description~~for ~~and~~future ~~terms~~grants ofunder the ~~rights are set forth in a stockholders' rights agreement~~plan.

9. 401(k) PROFIT SHARING PLAN:

Conductus has a 401(k) profit sharing plan, which covers substantially all employees. Under the plan, employees are permitted to contribute up to 1525% of gross compensation not to exceed the annual 402(g) limitation for any plan year. Conductus may make discretionary contributions whether or not it has net profits. Conductus made no contributions during the years ~~1994~~1995 through ~~2000~~2001.

10. INCOME TAXES:

The components of deferred tax assets are as follows:

	December 31,
	1999			2000
	2000			2001
	(in thousands)
Property and equipment, principally due to differences in depreciation	$	~~366~~397		$	~~397~~683
Accrued liabilities and other nondeductible expenses		~~565~~639			~~639~~1,334
Tax credit carryforwards		1,~~531~~460			1,~~460~~258
Capitalized research and development costs		~~691~~849			~~849~~923
Net operating loss carryforward		1519,~~621~~954			1925,~~954~~603
Valuation allowance		(1823,~~774~~299	)		(2329,~~299~~801	)
Net deferred tax asset	$	—		$	—

Due to the uncertainty surrounding the realization of the deferred tax assets in future tax years, Conductus has placed a valuation allowance against its otherwise recognizable net deferred tax assets.

As of December 31, ~~2000~~2001, wethe ~~have~~Company has federal and California net operating loss carryforwards of approximately $5872,~~300~~100,000 and $1318,~~600~~900,000 available to reduce future federal ~~and~~ and California taxable income, respectively. These federal and California carryforwards ~~begin~~will to expire commencing in 2002 ~~and~~through ~~2001, respectively~~2021. Conductus also has approximately $866,000 and $471,000 in research and development tax ~~credit~~credits available to offset future federal and state income taxes, respectively. The federal tax credits will expire commencing in years 2004 through 2017. The state tax credits ~~may~~ may be carried forward to succeeding years until exhausted.

Conductus' ability to use its federal and state net operating loss carryforwards and federal and state tax credit carryforwards to ~~affect~~offset future taxable income and future taxes, respectively, may be subject to restrictions attributable to equity transactions that result in changes in ownership as defined by Internal Revenue Code Section 382. In the event Conductus has had such a change in ownership, utilization of the carryforwards could be severely restricted.

11. BUSINESS SEGMENT AND MAJOR CUSTOMERS:

Conductus has one reporting segment. Conductus markets its products primarily to customers in the United States ~~and Japan~~ in the wireless industry. Management uses one measurement of profitability and does not disaggregate its business for internal reporting.

During 1998, 1999 and 2000, all long-lived assets are held in the United States. All contract revenue for 1998, 1999 and 2000 was generated from the United States government. In addition, one customer accounted for 21% of revenue for the year ended December 31, 2000, and another customer accounted for 64% of revenue for the year ended December 31, 1999. No other customers accounted for more than 10% of revenue in the year ended December 31, 1998.

At December 31, 1999 and 2000, Conductus had accounts receivable from one customer representing 94% and 92% of total accounts receivable, respectively.

On May 4, 1999, Conductus entered into a definitive agreement with General Dynamics Information Systems, Inc. ("GDIS") to license its high temperature superconductive ("HTS") electronics and cryoelectronics technology. Under the license agreement, GDIS acquired rights to

Conductus' HTS thin-film technology and other intellectual property for $5,000,000 plus future royalties and will have rights to use and sell this technology for use in U.S. government or state, local and foreign government markets, as defined under the agreement. Upon execution of the agreement, GDIS made an immediate payment to Conductus of $2,900,000. In addition, GDIS began paying Conductus $175,000 on the first day of each month for 12 months beginning on July 1, 1999. Conductus and GDIS also entered into a Cross-License, Supply and Training Agreement under which Conductus and GDIS agreed to cross-license updates, if any, to the licensed technology developed by either party. Additionally, Conductus agreed to provide product and training to GDIS in exchange for payment at standard commercial rates from GDIS. As a result of this transaction, Conductus recognized revenues of $5,000,000 for the year ended December 31, 1999.

Conductus' revenues by geographic area are summarized as follows:

	1998		1999		2000
	(in thousands)
USA	$	4,485	$	7,526	$	2,151
Japan		146		272		—
Rest of the world		58		—		5
	$	4,689	$	7,798	$	2,156

During 1999, 2000 and 2001, all long-lived assets are held in the United States. All contract revenue for 1999, 2000 and 2001 was generated from the United States government. In addition, one customer accounted for 15% and 21% of total net revenue for the years ended December 31, 2001 and 2000, respectively, and another customer accounted for 64% of revenue for the year ended December 31, 1999.

At December 31, 2000 and 2001, Conductus had accounts receivable from one customer representing 92% and 66% of total accounts receivable, respectively.

12. SUBSEQUENT EVENT (unaudited)

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders
of Conductus, Inc.:

Our audits of the financial statements referred to in our report dated February 915, ~~2001~~2002, appearing on page ~~35,~~34 also included an audit of the financial statement schedule listed in in Item 14(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements.

/s/ PricewaterhouseCoopers LLP

San Jose, California February 915, ~~2001~~2002

~~S-1~~57

SCHEDULE II
CONDUCTUS, INC. VALUATION AND QUALIFYING ACCOUNTS

													Column E
Description		Balance at Beginning of Period		Charged (credited) to costs and expenses			Deductions			Balance at End of Period
		Column B		Column C
Year ended December 31, 1999:
Column A										Column D
	Allowance for doubtful accounts	$	293	$	(53	)	$	(137	)	$	103
		Balance at Beginning of Period		Charged to Cost and Expenses			Other Accounts						Balance at End of Period
Year ended December 31, 2000:
Description										Deductions
	Allowance for doubtful accounts	$	103	$	13		$	(2	)	$	114
Year ended December 31, 1998:
Year ended December 31, 2001:
	Allowance for doubtful accounts	$	~~248~~114	$	54(96	)	$	—		$	(918	)	$	~~293~~
Year ended December 31, 1999:
	Allowance for doubtful accounts	$	293	$	(53	)	$	—		$	(137	)	$	103
Year ended December 31, 2000:
	Allowance for doubtful accounts	$	103	$	(13	)	$	—		$	(2	)	$	104

~~S-2~~58

Quarterly Financial Data (unaudited)

The following table sets forth unaudited statements of operations data for the eight quarters ended December 31, 2001. This data has been derived from audited interim financial statements prepared on the same basis as our audited financial statements contained in this report and, in our opinion, include all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of such information when read in conjunction with our financial statements and notes to our statements appearing elsewhere in this report.

		Three months ended
		March 31, 2000			June 30, 2000			September 30, 2000			December 31, 2000			March 31, 2001			June 30, 2001			September 30, 2001			December 31, 2001
		(in thousands, except per share amounts)
Revenue:
	Product	$	88		$	46		$	192		$	196		$	542		$	752		$	703		$	598
	Contract		251			191			397			657			730			954			1,170			1,175

	Total revenue		339			237			589			853			1,272			1,706			1,873			1,773
Cost of product sales			701			1,352			1,467			1,473			2,034			2,671			3,049			1,640
Research and development expenses			1,081			1,207			1,490			1,729			2,261			2,195			2,212			1,998
Selling, general and administrative expenses			1,210			1,520			1,335			1,614			1,662			1,821			1,901			1,692

Loss from operations		$	(2,653	)	$	(3,842	)	$	(3,703	)	$	(3,963	)	$	(4,685	)	$	(4,981	)	$	(5,289	)	$	(3,557	)

Net loss attributable to common stockholders		$	(5,373	)	$	(8,519	)	$	(3,377	)	$	(5,979	)	$	(4,497	)	$	(4,816	)	$	(5,175	)	$	(3,509	)

Net loss per common share attributable to common stockholders:
	Basic and diluted	$	(0.56	)	$	(0.70	)	$	(0.22	)	$	(0.38	)	$	(0.28	)	$	(0.29	)	$	(0.28	)	$	(0.19	)

Shares used in per share calculations:
	Basic and diluted		9,535			12,126			15,656			15,810			16,087			16,626			18,710			18,742

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not Applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Incorporated herein by reference is the information required by this item relating to our directors and nominees and disclosure relating to compliance with Section 16(a) of the Securities Exchange Act of 1934 that is included under the captions "Election of Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the Proxy Statement for the 2002 Annual Meeting of Stockholders to be held on May 30, 2002.

ITEM 11. EXECUTIVE COMPENSATION

Incorporated herein by reference is the information required by this item that is included under the caption "Executive Compensation and Related Information" in our 2002 Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Incorporated herein by reference is the information required by this item that is included under the caption "Ownership of Securities" in our 2002 Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Incorporated herein by reference is the information required by this item that is included under the caption "Certain Transactions" in our 2002 Proxy Statement.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(A) Financial Statements, Financial Statement Schedule and Exhibits

(1) Financial Statements—See Index to Financial Statements and Financial Statement Schedule at page 34 of this Form 10-K.

(2) Financial Statement Schedule—See Index to Financial Statements and Financial Statement Schedule at page 34 of this Form 10-K.

All other financial statement schedules have been omitted as they are either not required, not applicable, or the information is otherwise included.

(3) Exhibits—See Exhibit Index at page 62 of this Form 10-K.

(B) Reports on Form 8-K

The Company filed no reports on Form 8-K during the fourth quarter of 2001.

SIGNATURES

		CONDUCTUS, INC.
		By:		/s/ CHARLES E. SHALVOY Charles E. Shalvoy President and Chief Executive Officer

POWER OF ATTORNEY

Signature	Title	Date
/s/ CHARLES E. SHALVOY Charles E. Shalvoy	President, Chief Executive Officer and Director (Principal Executive Officer)	March 28, 2002
/s/ RON WILDERINK Ron Wilderink	Vice President of Finance, Chief Financial Officer and Secretary (Principal Accounting Officer)	March 28, 2002
/s/ JOHN F. SHOCH John F. Shoch, Ph.D.	Chairman of the Board of Directors	March 28, 2002
/s/ ROBERT M. JANOWIAK Robert M. Janowiak	Director	March 28, 2002
/s/ MARTIN A. KAPLAN Martin A. Kaplan	Director	March 28, 2002
/s/ DAVID L. SHORT David L. Short	Director	March 28, 2002

EXHIBIT INDEX

Exhibit No		Description
Exhibit No.		Description
3.1(1)		Restated Certificate of Incorporation.
3.2(2)		Restated Bylaws.
4.1(3)		Stockholder Rights Plan.
10.1(1)*		1992 Stock Option/Stock Purchase Plan, as amended.
10.2(1)*		1994 Employee Stock Purchase Plan, as amended.
10.3(4)		Form of Series B Preferred Stock and Warrant Purchase Agreement, dated September, 1998, and September 22, 1998, between Conductus and Series B Investors.
10.4(4)		Form of Warrant to Purchase Common Stock between Conductus and Series B Investors.
10.5(5)		Employment Agreement dated May 3, 1994, between Registrant and Mr. Charles E. Shalvoy.
10.6(6)		Form of Indemnification Agreement between the Registrant and each of its directors and officers.
10.7(7)		High Temperature Superconductor Thin-Film Manufacturing Alliance Agreement among Registrant, Superconductor Technologies, Inc., Stanford University, Georgia Research Corporation, Microelectronic Control and Sensing Incorporated, IBIS, Focused Research and BDM Federal dated November 17, 1995.
10.8(8)†		Superconducting Filter Technology Joint Development Agreement dated April 25, 1996 between the Registrant and Lucent Technologies Inc.
10.9(4)		Master Lease Agreement between Conductus and Leasing Technologies International, Inc., dated June 15, 1998.
10.10(6)		Lease Agreement dated May 3, 1993, between the Registrant and Mozart-McKee Limited Partnership for Sunnyvale facilities.
10.11(5)		Lease Agreement dated December 8, 1994, between Registrant and Mozart-McKee Limited Partnership for Sunnyvale facilities.
10.12(4)†		Master Loan and Security Agreement between Conductus and Transamerica Business Credit Corporation, dated June 26, 1998.
10.13(9)		Silicon Valley Bank Loan and Security Agreement dated April 23, 1998.
10.14(9)		Collateral Assignment, Patent Mortgage and Security Agreement between Conductus and Silicon Valley Bank.
10.15(10)†		Asset Purchase Agreement dated July 9, 1997, between Registrant and Bruker Instruments, Inc. for sale of assets of Registrant's NMR Probe business.
10.16(11)†		License Agreement with General Dynamics, dated May 4, 1999.
10.17(12)		Cross-License, Supply and Training Agreement with General Dynamics, dated May 4, 1999.
10.18(13)		Form of Series C Preferred Stock and Warrant Purchase Agreement, dated December 10, 1999, between Conductus and Series C Investors.
10.19(13)		Form of Warrant to Purchase Common Stock between Conductus and Series C Investors.
10.20(14)		Common Stock Purchase Agreement dated January 18, 2000, between Conductus and the Investors named therein.
10.21(14)		Building Leases Amendment Letter dated January 31, 2000, between Conductus and the Mozart Development Company.
10.22(15)†		Purchase Contract, dated as of August 7, 2000, between Conductus and Dobson Cellular Systems, Inc.
10.23(15)†		Warrant to Purchase Common Stock, dated August 7, 2000, issued by Conductus to Dobson Communications Corporation.
10.24(15)		Master Equipment Lease Commitment, dated as of September 1, 2000, between Pentech Financial Services, Inc. and Conductus.
10.25(15)		Master Equipment Lease, dated as of September 1, 2000, between Pentech Financial Services, Inc. and Conductus.

10.26(15)		Warrant to Purchase Common Stock, dated as of September 1, 2000, issued by Conductus to Pentech Financial Services, Inc.
10.27		Loan Modification Agreement dated as of October 30, 2000, between Conductus and Silicon Valley Bank modifying the Loan and Security Agreement dated as of April 23, 1998.
10.28		Loan Modification Agreement dated as of November 29, 2000, between Conductus and Silicon Valley Bank modifying the Loan and Security Agreement dated as of April 23, 1998.
10.29		Promissory Note between Charles E. Shalvoy and Conductus dated December 28, 2000.
10.30		Security Agreement between Charles E. Shalvoy and Conductus dated December 28, 2000.
23.1		Consent of Independent Accountants.
24.1		Power of Attorney (See Page 34).

10.22(15)†		Purchase Contract, dated as of August 7, 2000, between Conductus and Dobson Cellular Systems, Inc.
10.23(15)†		Warrant to Purchase Common Stock, dated August 7, 2000, issued by Conductus to Dobson Communications Corporation.
10.24(15)		Master Equipment Lease Commitment, dated as of September 1, 2000, between Pentech Financial Services, Inc. and Conductus.
10.25(15)		Master Equipment Lease, dated as of September 1, 2000, between Pentech Financial Services, Inc. and Conductus.
10.26(15)		Warrant to Purchase Common Stock, dated as of September 1, 2000, issued by Conductus to Pentech Financial Services, Inc.
10.27(16)		Loan Modification Agreement dated as of October 30, 2000, between Conductus and Silicon Valley Bank modifying the Loan and Security Agreement dated as of April 23, 1998.
10.28(16)		Loan Modification Agreement dated as of November 29, 2000, between Conductus and Silicon Valley Bank modifying the Loan and Security Agreement dated as of April 23, 1998.
10.29(16)		Promissory Note between Charles E. Shalvoy and Conductus dated December 28, 2000.
10.30(16)		Security Agreement between Charles E. Shalvoy and Conductus dated December 28, 2000.
10.31(17)		Form of Common Stock Purchase Agreement, dated as of June 13, 2001, between the Company and the investors set forth on the signature page thereto.
10.32		Promissory Note between Charles E. Shalvoy and Conductus dated August 21, 2001.
10.33		Security Agreement between Charles E. Shalvoy and Conductus dated August 21, 2001.
23.1		Consent of Independent Accountants.
24.1		Power of Attorney (See Page 61).

*: Management compensatory plan or arrangement.
†: Confidential treatment granted as to certain portions of these exhibits.
(1): Incorporated herein by reference to Conductus' 1993 Annual Report on Form 10-K.
(2): Incorporated herein by reference to Conductus' Report on Form 8-K, filed with the SEC on January 22, 1998.
(3): Incorporated herein by reference to Conductus' Registration Statement on Form 8-A (Number 000-19915), filed with the SEC on January 29, 1998.
(4): Incorporated herein by reference to Conductus' Form 10-Q, filed with the SEC on November 16, 1998.
(5): Incorporated herein by reference to Conductus' 1994 Annual Report on Form 10-K.
(6): Incorporated herein by reference to Conductus' Registration Statement on Form S-1 (Number 33-64020), filed with the SEC on May 15, 1996, as amended.
(7): Incorporated herein by reference to Amendment No. 2 to Conductus' Registration Statement on Form S-1 (Number 333-3815), filed with the SEC on June 17, 1996.
(8): Incorporated herein by reference to Conductus' Registration Statement on Form S-1 (Number 333-3815), filed with the SEC on May 15, 1996, as amended.
(9): Incorporated herein by reference to Conductus' Form 10-Q, filed with the SEC on May 14, 1998.

(10): Incorporated herein by reference to Conductus' 1998 Annual Report on Form 10-K.
(11): Incorporated herein by reference to Conductus' Form 10-Q/A, filed with the SEC on May 27, 1999.
(12): Incorporated herein by reference to Conductus' Form 10-Q, filed with the SEC on May 17, 1999.
(13): Incorporated herein by reference to Conductus' 1999 Annual Report on Form 10-K.
(14): Incorporated herein by reference to Conductus' Form 10-Q, filed with the SEC on May 12, 2000.
(15): Incorporated herein by reference to Conductus' Form 10-Q, filed with the SEC on November 14, 2000.
(16): Incorporated herein by reference to Conductus' 2000 Annual Report on Form 10-K.
(17): Incorporated herein by reference to Conductus' Report on Form 8-K, filed with the SEC on July 3, 2001.

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