UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 29, 2007

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

For the transition period from                      to                     

Commission File Number 0-21074

460 Ward Drive,
Santa Barbara, California 93111-2356
(Address of principal executive offices & zip code)

(805) 690-4500
(Registrant’s telephone number including area code)

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o            Accelerated Filer o            Non-Accelerated Filer þ

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o or No  þ

     The registrant had 12,483,367 shares of the common stock outstanding as of the close of business on October 1, 2007.

 

 

SUPERCONDUCTOR TECHNOLOGIES INC.

INDEX TO FORM 10-Q

Three Months Ended September 29, 2007

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS			1
WHERE YOU CAN FIND MORE INFORMATION			1
PART I — FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Statement of Operations			2
Condensed Consolidated Balance Sheets			3
Condensed Consolidated Statement of Cash Flows			4
Notes to Unaudited Interim Condensed Consolidated Financial Statements			5
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			15
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk			21
ITEM 4. Disclosure Controls and Procedures			21
PART II — OTHER INFORMATION
ITEM 1. Legal Proceedings			22
ITEM 1A. Risk Factors			22
ITEM 2. Unregistered Sales of Equity Securities			22
ITEM 4. Submission of Matters to a Vote of Security Holders			22
ITEM 5. Other Information			22
ITEM 6. Exhibits			22
SIGNATURE			23
EXHIBIT 10.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

 i

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

      This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. You can find many (but not all) of these statements by looking for words such as “approximates,” “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans” “would,” “may” or other similar expressions in this Report. Our forward-looking statements relate to future events or our future performance and include, but are not limited to, statements concerning our business strategy, future commercial revenues, market growth, capital requirements, new product introductions, expansion plans and the adequacy of our funding. Other statements contained in this report that are not historical facts are also forward-looking statements.

      We claim the protection of the safe harbor contained in the Private Securities Litigation Reform Act of 1995. We caution investors that any forward-looking statements presented in this Report, or which we may make orally or in writing from time to time, are based on the beliefs of, assumptions made by, and information currently available to, us. Such statements are based on assumptions and the actual outcome will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance and some will inevitably prove to be incorrect. As a result, our actual future results can be expected to differ from our expectations, and those differences may be material. Accordingly, investors should use caution in relying on past forward-looking statements, which are based on known results and trends at the time they are made, to anticipate future results or trends.

      Some of the risks and uncertainties that may cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include the following: limited assets and a history of losses; needs for additional capital; limited number of potential customers; limited number of suppliers for some of our components; no significant backlog from quarter to quarter; significant fluctuations in product demand from quarter to quarter; and rapidly advancing technology. For further discussion of these and other factors see Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part II, Item 1A.” Risk Factors” in this Report and in our 2006 Annual Report on Form 10-K .

      This Report and all subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We do not undertake any obligation to release publicly any revisions to our forward-looking statements to reflect events or circumstances after the date of this Report.

WHERE YOU CAN FIND MORE INFORMATION

          As a public company, we are required to file annually, quarterly and special reports, proxy statements and other information with the SEC. You may read and copy any of our materials on file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Judiciary Plaza, Washington, DC 20549, as well as at the SEC’s regional office at 5757 Wilshire Boulevard, Suite 500, Los Angeles, California 90036. Our filings are available to the public over the Internet at the SEC’s website at http://www.sec.gov. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room. We also provide copies of our Forms 8-K, 10-K, 10-Q, Proxy and Annual Report at no charge to investors upon request and make electronic copies of our most recently filed reports available through our website at www.suptech.com as soon as reasonably practicable after filing such material with the SEC.

PART I
FINANCIAL INFORMATION

See accompanying notes to the unaudited interim condensed consolidated financial statements

Note-December 31, 2006 balances were derived from audited financial statements

See accompanying notes to the unaudited interim condensed consolidated financial statements.

SUPERCONDUCTOR TECHNOLOGIES INC.

shares will be issued until the full amount is received.

Principles of Consolidation

     The interim condensed consolidated financial statements include the accounts of Superconductor Technologies Inc. and our wholly owned subsidiaries. All significant intercompany transactions have been eliminated from the consolidated financial statements.

Cash and Cash Equivalents

     Cash and cash equivalents consist of highly liquid investments with original maturities of three months or less. Cash and cash equivalents are maintained with quality financial institutions and from time to time exceed FDIC limits.

Accounts Receivable

     We sell predominantly to entities in the wireless communications industry and to entities of the United States Government. We grant uncollateralized credit to our customers. We perform ongoing credit evaluations of our customers before granting credit. Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We determine the allowance based on historical write-off experience. Past due balances are reviewed for collectability. Accounts balances are charged off against the allowance when we deem it is probable the receivable will not be recovered. We do not have any off balance sheet credit exposure related to our customers.

Revenue Recognition

     Commercial revenues are principally derived from the sale of our SuperLink, AmpLink, and SuperPlex products and are recognized once all of the following conditions have been met: a) an authorized purchase order has been received in writing, b) customer‘s credit worthiness has been established, c) shipment of the product has occurred, d) title has transferred, and e) if stipulated by the contract, customer acceptance has occurred and all significant vendor obligations, if any, have been satisfied.

     Contract revenues are principally generated under research and development contracts. Contract revenues are recognized utilizing the percentage-of-completion method measured by the relationship of costs incurred to total estimated contract costs. If the current contract estimate were to indicate a loss, utilizing the funded amount of the contract, a provision would be made for the total anticipated loss. Revenues from research related activities are derived primarily from contracts with agencies of the United States Government. Credit risk related to accounts receivable arising from such contracts is considered minimal. These contracts include cost-plus, fixed price and cost sharing arrangements and are generally short-term in nature.

     All payments to us for work performed on contracts with agencies of the U.S. Government are subject to adjustment upon audit by the Defense Contract Audit Agency. Based on historical experience and review of current projects in process, we believe that the audits will not have a significant effect on our financial position, results of operations or cash flows. The Defense Contract Audit Agency has completed audits of us through 2003.

Warranties

     We offer warranties generally ranging from one to five years, depending on the product and negotiated terms of purchase agreements with our customers. Such warranties may require us to repair or replace defective product returned to us during such warranty period at no cost to the customer. An estimate by us for warranty related costs is recorded by us at the time of sale based on our actual historical product return rates and expected repair costs. Such costs have been within our expectations. See “ Use of Estimates” in this note.

Guarantees

     In connection with the sales and manufacturing of our commercial products, we indemnify, without limit or term, our customers and contract manufacturers against all claims, suits, demands, damages, liabilities, expenses, judgments, settlements and penalties arising from actual or alleged infringement or misappropriation of any intellectual property relating to our products or other claims arising from our products. We cannot reasonably develop an estimate of the maximum potential amount of payments that might be made under our guarantees because of the uncertainty as to whether a claim might arise and how much it might total. Historically, we have not incurred any expenses related to these guarantees.

Research and Development Costs

     Research and development costs are expensed as incurred and include salary, facility, depreciation and material expenses. Research and development costs incurred solely in connection with research and development contracts are charged to contract research and development expense. Other research and development costs are charged to other research and development expense.

Inventories

     Inventories are stated at the lower of cost or market, with costs primarily determined using standard costs, which approximate actual costs utilizing the first-in, first-out method. Provision for potentially obsolete or slow moving inventory is made based on our analysis of inventory levels and sales forecasts. Costs associated with idle capacity are expensed immediately.

Property and Equipment

     Property and equipment are recorded at cost. Equipment is depreciated using the straight-line method over their estimated useful lives ranging from three to five years. Leasehold improvements and assets financed under capital leases are amortized over the shorter of their useful lives or the lease term. Furniture and fixtures are depreciated over seven years. Expenditures for additions and major improvements are capitalized. Expenditures for minor tooling, repairs and maintenance and minor improvements are charged to expense as incurred. When property or equipment is retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the accounts. Gains or losses from retirements and disposals are recorded in selling, general and administration expenses. For the most recent quarter and year to date, we disposed of $1.3 million of older, fully depreciated equipment. There was no gain or loss on said disposition.

Patents, Licenses and Purchased Technology

     Patents and licenses are recorded at cost and are amortized using the straight-line method over the shorter of their estimated useful lives or approximately seventeen years. Purchased technology acquired through the acquisition of Conductus, Inc. is recorded at our estimated fair value and is amortized using the straight-line method over seven years.

Long-Lived Assets

     The realizability of long-lived assets is evaluated periodically as events or circumstances indicate a possible inability to recover the carrying amount. Long-lived assets that will no longer be used in business are written off in the period identified since they will no longer generate any positive cash flows for us. Periodically, long-lived assets that will continue to be used by us need to be evaluated for recoverability. Such evaluation is based on various analyses, including cash flow and profitability projections. The analyses necessarily involve significant management judgment. In the event the projected undiscounted cash flows are less than net book value of the assets, the carrying value of the assets will be written down to their estimated fair value. We completed such an analysis the fourth quarter of 2006 and determined that no write down was necessary.

Loss Contingencies

     In the normal course of business, we are subject to claims and litigation, including allegations of patent infringement. Liabilities relating to these claims are recorded when it is determined that a loss is probable and the amount of the loss can be reasonably estimated. The costs of defense in such matters are expensed as incurred. Insurance proceeds recoverable are recorded when deemed probable.

Income Taxes

     In July 2006, the FASB issued Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 provides detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise’s financial statements in accordance with SFAS 109. Income tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption of FIN 48 and in subsequent periods. We adopted FIN 48 effective January 1, 2007, and the provisions of FIN 48 have been applied to all income tax positions commencing from that date. There was no material impact from this adoption. As of December 31, 2006, we had net operating loss carryforwards for federal and state

income tax purposes of approximately $275.1 million and $143.4 million, respectively. We are currently evaluating the potential limitations on our ability to utilize our net operating loss carryforwards as a result of our recent financing transaction with BAOLI. Due to the uncertainty surrounding their realization, we recorded a full valuation allowance against our net deferred tax assets. Accordingly, no deferred tax asset has been recorded in the accompanying balance sheet.

Marketing Costs

     All costs related to marketing and advertising our products are expensed as incurred or at the time the advertising takes place. Advertising costs were not material in each of the three and nine month periods ended September 29, 2007 and September 30, 2006.

Net Loss per Share

     Basic and diluted net loss per share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding in each period. Potentially dilutive shares are not included in the calculation of diluted loss per share because their effect is anti-dilutive.

Stock-based Compensation

     Effective January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”).

     For the three and nine months ended September 29, 2007 and September 30, 2006 the weighted average fair values have been estimated at the date of the grant using the Black-Scholes option-pricing model. The following are the significant weighted average assumptions used for estimating the fair value under our stock option plans:

     The expected life was based on the contractual term of the options and the historical employee exercise behavior. Typically, options to our employees have a 4 year vesting term and a 10 year contractual term. The risk-free interest rate is based on the U. S. Treasury zero-coupon issues with a remaining term equal to the expected option life assumed at the grant date. The future volatility is based on our 4 year historical volatility. We used an expected dividend yield of 0% because we has never paid a dividend and do not anticipate paying dividends. We assumed a 10% forfeiture rate based on historical stock option cancellation rates over the last 4 years.

Use of Estimates

     The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect 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 periods. The significant estimates in the preparation of the financial statements relate to the assessment of the carrying amount of accounts receivable, inventory, intangibles, goodwill, estimated provisions for warranty costs, accruals for restructuring and lease abandonment costs, income taxes and litigation. Actual results could differ from those estimates and such differences may be material to the financial statements. For the quarter and year to date, we reversed none and $319,000, respectively, of product line exit cost accruals. This accrual was established in 2002 in the amount of $1,042,000 and represented the estimated costs to be incurred with a customer to support commercial product units previously purchased from Conductus for a period of five years.

Fair Value of Financial Instruments

     The carrying amount of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value due to the short-term nature of these instruments. We estimate that the carrying amount of the debt

approximates fair value based on our current incremental borrowing rates for similar types of borrowing arrangements.

Comprehensive Income (Loss)

     We have no items of other comprehensive income (loss) in any period other than our net loss.

Segment Information

     We operate in a single business segment, the research, development, manufacture and marketing of high performance products used in cellular base stations to maximize the performance of wireless telecommunications networks by improving the quality of uplink signals from mobile wireless devices. Net commercial product revenues are primarily derived from the sales of our SuperLink, AmpLink and SuperPlex products. We currently sell most of our product directly to wireless network operators in the United States. Net revenues derived principally from government research and development contracts are presented separately on the statement of operations for all periods presented.

Certain Risks and Uncertainties

     We have continued to incur operating losses. Our long-term prospects and execution of our business plan are dependent upon the continued and increased market acceptance for our products.

     We currently sell most of our products directly to wireless network operators in the United States and our product sales have historically been concentrated in a small number of customers. In the nine months ended September 29, 2007, we had two customers that represented 56% of total net revenues. At September 29, 2007, these customers represented 42% of accounts receivable. In 2006, we had three customers that represented 44%, 20% and 16% of total net revenues. At December 31, 2006, these three customers represented 66% of accounts receivable. The loss of or reduction in sales, or the inability to collect outstanding accounts receivable, from any of these customers could have a material adverse effect on our business, financial condition, results of operations and cash flows.

     We currently rely on a limited number of suppliers for key components of our products. The loss of any of these suppliers could have a material adverse effect on our business, financial condition, results of operations and cash flows.

     In connection with the sales of our commercial products, we indemnify, without limit or term, our customers against all claims, suits, demands, damages, liabilities, expenses, judgments, settlements and penalties arising from actual or alleged infringement or misappropriation of any intellectual property relating to our products or other claims arising from our products. We cannot reasonably develop an estimate of the maximum potential amount of payments that might be made under our indemnity because of the uncertainty as to whether a claim might arise and how much it might total.

Recent Accounting Pronouncements

     In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for using fair value to measure assets and liabilities, and expands disclosures about fair value measurements.  The Statement applies whenever other statements require or permit assets or liabilities to be measured at fair value.  SFAS 157 is effective for fiscal years beginning after November 15, 2007.  We are currently evaluating the impact this Statement will have on our consolidated financial statements.

     In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115” (“SFAS 159”).  SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value, with unrealized gains and losses related to these financial instruments reported in earnings at each subsequent reporting date.  SFAS 159 is effective for fiscal years beginning after November 15, 2007.  We are currently evaluating the impact this Statement will have on our consolidated financial statements.

3. Short Term Borrowings

     We have a line of credit with a bank. The line of credit was renewed in July 2007 for a term of one year. The line of credit expires July 15, 2008 and is structured as a sale of accounts receivable. The agreement provides for the sale of up to $5 million of eligible accounts receivable, with advances to us totaling 80% of the receivables sold. Advances under the agreement are collateralized by all our assets. Under the terms of the agreement, we continue to service the sold receivables and are subject to

recourse provisions. Advances bear interest at the prime rate (7.75% at September 29, 2007) plus 2.50% subject to a minimum monthly charge. There was no amount outstanding under this borrowing facility at September 29, 2007.

     The agreement relating to this line of credit contains representations and warranties, affirmative and negative covenants and events of default customary for financings of this type. The failure to comply with these provisions, or the occurrence of any one of the events of default, would prevent any further borrowings and would generally require the repayment of any outstanding borrowings. Such representations, warranties and events of default include (a) non-payment of debt and interest hereunder, (b) non-compliance with terms of the agreement covenants, (c) insolvency or bankruptcy, (d) material adverse change, (e) merger or consolidation where our shareholders do not hold a majority of the voting rights of the surviving entity, (f) transactions outside the normal course of business, or (g) payment of dividends.

4. Stockholders’ Equity

Stock Options

     We currently have one active stock option plan, the 2003 Equity Incentive Plan. Under the 2003 Equity Incentive Plan, stock awards may consist of stock options, stock appreciation rights, restricted stock awards, performance awards, and performance share awards. Stock awards may be made to our key employees, consultants, and non-employee directors. Stock options granted under these plans must be granted at prices no less than 100% of the market value on the date of grant. Generally, stock options become exercisable in installments over a minimum of four years, beginning one year after the date of grant, and expire not more than ten years from the date of grant, with the exception of 10% or greater stockholders which may have options granted at prices no less than the market value on the date of grant, and expire not more than five years from the date of grant. We expect to issue new shares to cover stock option exercises and have no plans to repurchase shares. There were no stock option exercises in 2006 or in the nine months ended September 29, 2007.

     As a result of adopting SFAS 123R, the impact to the Consolidated Statement of Operations for the three months ended September 29, 2007 and September 30, 2006 was (i) $25,000 and $45,000 on net income and (ii) zero and zero on both basic and diluted earnings per share, respectively, and for the nine months ended September 29, 2007 and September 30, 2006 was (ii) $90,000 and $145,000 on net income and (ii) $0.01 and $0.01 on both basic and diluted earnings per share, respectively. No stock compensation cost was capitalized during either period. The weighted-average fair value at the grant date for options issued in the first nine months of 2007 was $1.12 per share versus $3.47 per share in the first nine months of 2006. The total compensation cost related to non-vested awards not yet recognized is $163,000 and the weighted-average period over which the cost is expected to be recognized is 1.4 years in the first nine months of 2007 versus $296,000 and 1.4 years in the first nine months of 2006.

     The following is a summary of stock option transactions under our stock option plans at September 29, 2007:

     The outstanding options expire by the end of July 2017. The weighted-average contractual term of options outstanding is 5.6 years and the weighted-average contractual term of stock options currently exercisable is slightly less than 5.6 years. The exercise prices for these options range from $1.43 to $493.75 per share, for an aggregate exercise price of approximately $30.7 million. At September 29, 2007, 354,300 shares, with an intrinsic value of $459,000, of outstanding stock options had an exercise price less than the current market value. At September 29, 2007, 271,000 of these shares were exercisable, with an intrinsic value of $118,000.

     In July 2007, certain of our employees and directors voluntarily surrendered options to purchase 307,374 shares with an average exercise price of $38.95 per share. These options are included in the year to date options canceled. Because all of these options had been previously expensed, there was no additional expense as a result of this surrender.

Restricted Stock Awards

     In July 2006, we issued restricted stock awards for the first time. A total of 331,000 shares were granted and will fully vest in one single installment on the second anniversary of the grant date in July 2008. The per share weighted average grant-date fair value was $1.50. A 10% forfeiture rate was assumed. At September 29, 2007, 318,000 of these shares were outstanding.

     The impact to the Consolidated Statement of Operations for the three and nine months ended September 29, 2007 was an expense of $56,000 and $168,000 and zero and $0.01 on both basic and diluted earnings per share. No stock compensation cost was capitalized during the period. The total compensation cost related to non-vested awards not yet recognized is $186,000 and the weighted-average period over which the cost is expected to be recognized is 10 months. For the three and nine months ended September 30, 2006 the expense was $37,000 and zero on both basic and diluted earnings per share.

Warrants

     The following is a summary of our outstanding warrants at September 29, 2007:

5. Earnings Per Share

     The computation of per share amounts for the three month periods ended September 30, 2006 and September 29, 2007 is based on the average number of common shares outstanding for the period. Options, stock awards and warrants to purchase 2,335,318 and 1,864,336 shares of common stock during the three and nine month periods ended September 30, 2006 and September 29, 2007, respectively, were not considered in the computation of diluted earnings per share because their inclusion would be anti-dilutive.

6. Commitments and Contingencies

Operating Leases

     We lease our offices and production facilities under non-cancelable operating leases that expire at various times over the next six years. Generally, these leases contain escalation clauses for increases in annual renewal options and require us to pay utilities, insurance, taxes and other operating expenses.

     Rent expense totaled $275,000 and $823,000 for the three and nine month periods ended September 29, 2007, and $297,000 and $870,000 for the three and nine month periods ended September 30, 2006, respectively.

Capital Leases

     We had no capital leases at September 29, 2007 and $15,000 in capital leases at December 31, 2006.

Patents and Licenses

     We have entered into various licensing agreements requiring royalty payments ranging from 0.13% to 2.5% of specified product sales. Certain of these agreements contain provisions for the payment of guaranteed or minimum royalty amounts. In the event that we fail to pay minimum annual royalties, these licenses may automatically become non-exclusive or be terminated. These royalty obligations terminate in 2009 to 2020. For the three and nine months ended September 29, 2007, royalty expense totaled $43,000 and $129,000, respectively. For the three and nine months ended September 30, 2006, royalty expense totaled $40,000 and $117,000, respectively. Under the terms of certain royalty agreements, royalty payments made may be subject to audit. There have been no audits to date and we do not expect any possible future audit adjustments to be significant.

     The minimum lease payments under operating leases and license obligations are as follows:

7. Contractual Guarantees and Indemnities

     During our normal course of business, we make certain contractual guarantees and indemnities pursuant to which we may be required to make future payments under specific circumstances. We have not recorded any liability for these contractual guarantees and indemnities in the accompanying consolidated financial statements.

Warranties

     We establish reserves for future product warranty costs that are expected to be incurred pursuant to specific warranty provisions with our customers. Our warranty reserves are established at the time of sale and updated throughout the warranty period based upon numerous factors including historical warranty return rates and expenses over various warranty periods.

Intellectual Property Indemnities

     We indemnify certain customers and our contract manufacturers against liability arising from third-party claims of intellectual property rights infringement related to our products. These indemnities appear in development and supply agreements with our customers as well as manufacturing service agreements with our contract manufacturers, are not limited in amount or duration and generally survive the expiration of the contract. Given that the amount of any potential liabilities related to such indemnities cannot be determined until an infringement claim has been made, we are unable to determine the maximum amount of losses that it could incur related to such indemnifications.

Director and Officer Indemnities and Contractual Guarantees

     We have entered into indemnification agreements with our directors and executive officers which require us to indemnify such individuals to the fullest extent permitted by Delaware law. Our indemnification obligations under such agreements are not limited in amount or duration. Certain costs incurred in connection with such indemnifications may be recovered under certain circumstances under various insurance policies. Given that the amount of any potential liabilities related to such indemnities cannot be determined until a lawsuit has been filed against a director or executive officer, we are unable to determine the maximum amount of losses that we could incur relating to such indemnifications. Historically, any amounts payable pursuant to such director and officer indemnifications have not had a material negative effect on our business, financial condition or results of operations.

     We have also entered into severance and change in control agreements with certain of our executives. These agreements provide for the payment of specific compensation benefits to such executives upon the termination of their employment with us.

General Contractual Indemnities/Products Liability

     In connection with the sales of our commercial products, we indemnify, without limit or term, our customers against all claims, suits, demands, damages, liabilities, expenses, judgments, settlements and penalties arising from actual or alleged infringement or misappropriation of any intellectual property relating to our products or other claims arising from our products. We cannot reasonably develop an estimate of the maximum potential amount of payments that might be made under our indemnity because of the uncertainty as to whether a claim might arise and how much it might total.

Short Term Borrowings

     Advances under our line of credit with the bank are collateralized by all our assets. Under the terms of the agreement, we continue to service the sold receivables and are subject to recourse provisions. Under the terms of the agreement, if the bank determines that there is a material adverse change in our business, they can exercise all their rights and remedies under the agreement. There was no amount outstanding under this facility at September 29, 2007.

Contractual Contingency

     We have a contract to deliver several custom products to a government contractor. We are unable to manufacture the products for technical reasons. We have discussed the problem with the contractor and our government customer. They are considering the problem, and further discussions are expected. We do not believe that a loss, if any, is reasonably estimable at this time and therefore has not recorded any liability relating to this matter. We will periodically reassess our potential liability as additional information becomes available. If we later determine that a loss is probable and the amount reasonably estimable, we will record a liability for the potential loss. All costs have been expensed and no revenues recognized on this contract.

8. Details of Certain Financial Statement Components and Supplemental Disclosures of Cash Flow Information and Non-Cash Activities

      Balance Sheet Data :

     At December 31, 2006 equipment includes $237,000 of assets financed under capital lease arrangements, net of $223,000 of accumulated amortization. There were no assets under capital lease arrangements at September 29, 2007. Depreciation expense amounted to $534,000 and $1,738,000 for the three and nine month periods ended September 30, 2006 and $501,000 and $1,548,000 for the three and nine month periods ended September 29, 2007, respectively.

     Amortization expense related to these items totaled $82,000 and $244,000 for the three and nine month periods ended September 30, 2006 and $82,000 and $248,000 for the three and nine month periods ended September 29, 2007, respectively. Amortization expenses are expected to total $82,000 for the remainder of 2007, $220,000 in each of the years 2008 and 2009 and $96,000 in each of the years 2010 and 2011.

9. Subsequent Events

New Sales Agreement

     On October 30, 2007, we announced a sales agreement with China Corporate Credit Assurance Co. Ltd. (CCAC) for our SuperLink solution, thereby establishing a mechanism for us to supply our products to China while the process of forming the BAOLI joint venture proceeds.

New Financing Agreement

     As of November 9, 2007, we had received an aggregate of $4.0 million of the total of $15.0 million due under our financing arrangement with BAOLI. See “Note 2 — Summary of Sig nificant Accounting Practices — Basis of Presentation” as well as “Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Recent developments — New Financing Agreement. Some of the payments have been somewhat delayed from their original schedule by Chinese currency control regulations, but all are expected before the end of 2007. On November 9, 2007, we revised the terms of the transaction. As revised the transaction will involve the issuance of only 2,148,296 shares of common stock, with BAOLI receiving the remainder of its investment in non voting preferred stock with essentially the same economics as, and convertible into, 7,068,290 shares of common stock. Under the amended agreement, BAOLI can only convert shares of the preferred stock if it will not result in BAOLI holding more than 9.9% of our outstanding stock. In addition, we agreed to register BAOLI’s common stock under the Securities Act of 1993 in June, 2008. The preferred stock and the common stock issuable on conversion of that preferred stock will not be registered. This restructuring is not intended to change the substantive economic terms of the transaction.

Results of Shareholder Meeting

     On October 23, 2007, at our annual shareholder meeting, the shareholders approved an increase in the number of shares authorized to be issued under our 2003 Equity Incentive Plan from 1,200,000 shares to 2,500,000. The selection of Stonefield Josephson, Inc as independent auditors as well as the election of all Class 3 Directors were also approved.

Joint Venture

     On November 9, 2007, we signed a binding definitive agreement for a joint venture with Hunchun BaoLi Communications Co. Ltd. (BAOLI) to manufacture and market our SuperLink interference elimination solution for the China market. Under the terms of the agreement, we will provide an exclusive license in the China market of the enabling

technology and BAOLI will provide the manufacturing expertise and financing. BAOLI holds 55 percent of the equity in the joint venture. We hold 45 percent and will receive a royalty on sales. The joint venture still needs to obtain certain governmental approvals before it can become operational.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

     We develop, manufacture and market high performance infrastructure products for wireless voice and data applications. Wireless carriers face many challenges in today’s competitive marketplace. Minutes of use are skyrocketing, and wireless users now expect the same quality of service from their mobile devices as from their landline phones. We help wireless carriers meet these challenges by “doing more with less.”

     Our products help maximize the performance of wireless telecommunications networks by improving the quality of uplink signals from mobile wireless devices. Our products increase capacity utilization, lower dropped and blocked calls, extend coverage, and enable higher wireless data throughput — all while reducing capital and operating costs. SuperLink incorporates patented high-temperature superconductor (HTS) technology to create a receiver front-end that enhances network performance. Today, we are leveraging our expertise and proprietary technology in radio frequency (RF) engineering to expand our product line beyond HTS technology. We believe our RF engineering expertise provides us with a significant competitive advantage in the development of high performance, cost-effective solutions for the front end of wireless telecommunications networks.

          We have three product offerings:

           • SuperLink . In order to receive uplink signals from wireless handsets, base stations require a wireless filter system to eliminate, or filter out, out-of-band interference. SuperLink combines HTS filters with a proprietary cryogenic cooler and a cooled low-noise amplifier. The result is a highly compact and reliable receiver front-end that can simultaneously deliver both high selectivity (interference rejection) and high sensitivity (detection of low level signals). SuperLink delivers significant performance advantages over conventional filter systems.

           • AmpLink . AmpLink is designed specifically to address the sensitivity requirements of wireless base stations. AmpLink is a ground-mounted unit which includes a high-performance amplifier and up to six dual duplexers. The enhanced uplink provided by AmpLink improves network coverage immediately and avoids the installation and maintenance costs associated with tower mounted alternatives.

           • SuperPlex . SuperPlex is our line of multiplexers that provides extremely low insertion loss and excellent cross-band isolation. SuperPlex high-performance multiplexers are designed to eliminate the need for additional base station antennas and reduce infrastructure costs. Relative to competing technologies, these products offer increased transmit power delivered to the base station antenna, higher sensitivity to subscriber handset signals, and fast and cost-effective network overlays.

     We currently sell most of our commercial products directly to wireless network operators in the United States. Our primary customers to date include ALLTEL, AT&T, Sprint Nextel, T-Mobile, U.S. Cellular and Verizon Wireless. We have a concentrated customer base. Verizon Wireless and AT&T each accounted for more than 10% of our commercial revenues in 2007 and Verizon Wireless, ALLTEL and T-Mobile each accounted for more than 10% of our commercial revenues in 2006. We plan to expand our customer base by selling directly to other wireless network operators and manufacturers of base station equipment, but we cannot assure that this effort will be successful.

     We also generate significant revenues from government contracts. We primarily pursue government research and development contracts which compliment our commercial product development. We undertake government contract work which has the potential to add to or improve our commercial product line. These contracts often yield valuable intellectual property relevant to our commercial business. We typically own the intellectual property developed under these contracts, and the Federal Government receives a royalty-free, non-exclusive and nontransferable license to use the intellectual property for the United States.

     We sell most of our products to a small number of wireless carriers, and their demand for wireless communications equipment fluctuates dramatically and unpredictably. We expect these trends to continue and may cause significant fluctuations in our quarterly and annual revenues.

     The wireless communications infrastructure equipment market is extremely competitive and is characterized by rapid technological change, new product development, product obsolescence, evolving industry standards and price erosion over the life of a product. We face constant pressures to reduce prices. Consequently, we expect the average selling prices of our products will continue decreasing over time. We have responded in the past by successfully reducing our product costs, and

expect further cost reductions over the next twelve months. However, we cannot predict whether our costs will decline at a rate sufficient to keep pace with the competitive pricing pressures.

Recent Developments

New Financing Agreement

     On August 17, 2007, we entered into an agreement with Hunchun BaoLi Communication Co. Ltd. (“BAOLI”) under which BAOLI has agreed to invest $15.0 million in exchange for 9,216,590 shares of our common stock. The purchase price is $1.6275 per share, based on a five percent premium over the average closing price of our common stock on the NASDAQ stock exchange for the 30 days ending August 17, 2007. The investment is scheduled to be made in several installments through the end of 2007; as of November 9, 2007, we had received an aggregate of $4.0 million of the total of $15.0 million. Some of the payments have been somewhat delayed from their original schedule by Chinese currency control regulations, but all are expected before the end of 2007. On November 9, 2007, we revised the terms of the transaction. As revised the transaction will involve the issuance of only 2,148,296 shares of common stock, with BAOLI receiving the remainder of its investment in non voting preferred stock with essentially the same economics as, and convertible into, 7,068,290 shares of common stock. This restructuring is not intended to change the substantive economic terms of the transaction. We are also currently evaluating the potential limitations on our ability to utilize our net operating loss carryforwards as a result of this transaction.

Joint Venture

     On November 9, 2007, we signed a binding definitive agreement for a joint venture with Hunchun BaoLi Communications Co. Ltd. (BAOLI) to manufacture and market our SuperLink interference elimination solution for the China market. Under the terms of the agreement, we will provide an exclusive license in the China market of the enabling technology and BAOLI will provide the manufacturing expertise and financing. BAOLI holds 55 percent of the equity in the joint venture. We hold 45 percent and will receive a royalty on sales. The joint venture still needs to obtain certain governmental approvals before it can become operational.

New Sales Agreement

     On October 30, 2007, we announced a sales agreement with China Corporate Credit Assurance Co. Ltd. (CCAC) for our SuperLink solution, thereby establishing a mechanism for us to supply our products to China while the process of forming the BAOLI joint venture proceeds.

Critical Accounting Policies and Estimates

     Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, inventories, recovery of long-lived assets, including intangible assets, income taxes, warranty obligations, and contingencies. We base our estimates on historical experience and on various other assumptions, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. While we believe that our estimates are based on reasonable assumptions and judgments at the time they are made, some of our assumptions, estimates and judgments will inevitably prove to be incorrect. As a result, actual outcomes will likely differ from our accruals, and those differences—positive or negative—could be material. Some of our accruals are subject to adjustment as we believe appropriate based on revised estimates and reconciliation to the actual results when available.

     We identified certain critical accounting policies which affect certain of our more significant estimates and assumptions used in preparing our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2006. We have not made any material changes to these policies as disclosed in that report.

Backlog

     Our commercial backlog consists of accepted product purchase orders with scheduled delivery dates during the next twelve months. We had commercial backlog of $647,000 at September 29, 2007, as compared to $75,000 at December 31, 2006.

Results of Operations

Quarter and nine months ended September 29, 2007 as compared to the quarter and nine months ended September 30, 2006

     Total net revenues decreased by $1.8, or 30%, to $4.1 million in the third quarter of 2007 from $5.9 million in the third quarter of 2006. Total net revenues decreased by $2.8 million, or 18%, to $13.0 million in the first nine months of 2007 from $15.8 million in the same period last year. Total net revenues consist primarily of commercial product revenues and government contract revenues. We also generate some additional revenues from sublicensing our technology.

     Net commercial product revenues decreased to $2.3 million in the third quarter of 2007 from $4.9 million in the third quarter of 2006, a decrease of $2.6 million, or 54%. For the first nine months of 2007, net commercial product revenues decreased $3.8 million to $9.5 million from $13.3 million in the same period last year, a decrease of 29%. The decrease is primarily the result of lower sales of our SuperPlex products. Our three largest customers accounted for 63% of our total net revenues in the first nine months of 2007. These customers generally purchase products through non-binding commitments with minimal lead-times. Consequently, our commercial product revenues can fluctuate dramatically from quarter to quarter based on changes in our customers’ capital spending patterns.

     Government contract revenues increased to $1.8 million in the third quarter of 2007 from $1.0 million in the third quarter of 2006, an increase of $842,000, or 84%. For the first nine months of 2007, government contract revenues increased to $3.5 million from $2.4 million in the same period last year, an increase of $1.1 million, or 45%. The increase is attributable to the addition of new and larger contracts in 2007.

     Cost of commercial product revenues includes all direct costs, manufacturing overhead, provision for excess and obsolete inventories and restructuring and impairment charges relating to the manufacturing operations. The cost of commercial product revenue totaled $2.7 million for the third quarter of 2007 compared to $4.2 million for the third quarter of 2006, a decrease of $1.5 million, or 36%. For the first nine months of 2007, the cost of commercial product revenues totaled $9.8 million as compared to $11.7 million for the first nine months of 2006, a decrease of $1.9 million or 16%. For the year to date, decreased costs resulted primarily from lower production as a result of lower sales. There was also a reversal of a $319,000 product line exit cost accrual year to date. This accrual was established in 2002 in the amount of $1,042,000 and represented the estimated costs to be incurred with a customer to support commercial product units previously purchased from Conductus for a period of five years.

     Our cost of sales includes both variable and fixed cost components. The variable component consists primarily of materials, assembly and test labor, overhead, which includes equipment and facility depreciation, transportation costs and warranty costs. The fixed component includes test equipment and facility depreciation, purchasing and procurement expenses and quality assurance costs. Given the fixed nature of such costs, the absorption of our production overhead costs into inventory decreases and the amount of production overhead variances expensed to cost of sales increases as production volumes decline since we have fewer units to absorb our overhead costs against. Conversely, the absorption of our production overhead costs into inventory increases and the amount of production overhead variances expensed to cost of sales decreases as production volumes increase since we have more units to absorb our overhead costs against. As a result, our gross profit margins generally decrease as revenue and production volumes decline due to lower sales volume and higher amounts of production overhead variances expensed to cost of sales; and our gross profit margins generally increase as our revenue and production volumes increase due to higher sales volume and lower amounts of production overhead variances expensed to cost of sales.

     The following is an analysis of our commercial product gross profit and margins:

     We had a gross loss of $420,000 in the third quarter of 2007 from the sale of our commercial products as compared to a gross profit of $677,000 in the third quarter of 2006. For the nine months ended September 29, 2007, we had a gross loss of $364,000 from the sale of our commercial products as compared to a gross profit of $1.6 million in the nine months ended September 30, 2006. Our gross margins were adversely impacted by lower sales volume as well as charges for excess and obsolete inventory of approximately $160,000 and $270,000 in the first nine months of 2007 and 2006, respectively. We regularly review inventory quantities on hand and provide an allowance for excess and obsolete inventory based on numerous

factors including sales backlog, historical inventory usage, forecasted product demand and production requirements for the next twelve months.

     Contract research and development expenses totaled $963,000 in the third quarter of 2007 as compared to $651,000 in the third quarter of 2006 and represented 52% and 65% of government revenue, respectively. These expenses totaled $2.0 million in the first nine months of 2007 and $1.7 million in the first nine months of 2006 and represented 57% and 68% of government revenue, respectively. The expense increase was the result of higher expenses associated with performing our government contracts in the first quarter and two new contracts added in the second quarter. The expenses in 2007 represented a lower percent of government revenue for both the quarter and year to date due to greater overhead absorption associated with increased government revenues.

     Other research and development expenses relate to development of new wireless commercial products. We also incur design expenses associated with reducing the cost and improving the manufacturability of our existing products. These expenses totaled $528,000 in the third quarter of 2007 as compared to $767,000 in the same quarter of the prior year and totaled $2.3 million in the first nine months of 2007 and $2.7 million in the first nine months of 2006. The decrease in the third quarter expenses was due to increased efforts on new government contracts consuming more of our engineering resources, which were included in contract research and development expenses.

     Selling, general and administrative expenses totaled $2.0 million in the third quarter of 2007, as compared to $2.4 million in the third quarter of the prior year. In the first nine months of 2007, these expenses totaled $5.9 million as compared to $7.8 million in the same period last year. The lower expenses in 2007 for the quarter resulted primarily from lower insurance premiums and lower selling costs. The lower expenses in 2007 year to date resulted primarily from lower insurance premiums and lower selling costs combined with the second quarter reversal of a $610,000 reserve (see “ Settlement of Litigation” under Legal Proceedings Note to the Financial Statements).

     Interest expense in the three months and nine months ended September 29, 2007 amounted to $9,000 and $30,000, as compared to $11,000 and $35,000 in the three months and nine months ended September 30, 2006.

     We had a net loss of $2.0 million for the quarter ended September 29, 2007, as compared to a net loss of $2.1 million in the same period last year. For the nine months ended September 29, 2007, our loss totaled $6.9 million as compared to a net loss of $28.0 million in the same period last year.

     The net loss available to common shareholders totaled $0.16 per common share in the third quarter of 2007, as compared to a net loss of $0.17 per common share in the same period last year. The net loss available to common shareholders totaled $0.56 per common share in the first nine months of 2007, as compared to a net loss of $2.24 per common share in the same period last year.

Liquidity and Capital Resources

Cash Flow Analysis

     As of September 29, 2007, we had working capital of $5.0 million, including $2.5 million in cash and cash equivalents, as compared to working capital of $10.2 million at December 31, 2006, which included $5.5 million in cash and cash equivalents. In August 2007 our cash position was increased by the first installment of $1.0 million from BAOLI. An additional $3.0 million was received in October, 2007 and is not included in these third quarter financials. We currently invest our excess cash in short-term, investment-grade, money-market instruments with maturities of three months or less. We believe that all of our cash investments would be readily available to us should the need arise.

     Cash and cash equivalents decreased by $3.0 million to $2.5 million at September 29, 2007 from $5.5 million at December 31, 2006. Cash during this period was used primarily in operations and to a lesser extent for the purchase of property and equipment and for the payment of long-term borrowings.

     Cash used in operations totaled $3.9 million in the first nine months of 2007. We used $4.9 million to fund the cash portion of our net loss. We also used cash to fund a $1.0 million increase in accounts receivable and accounts payable payments. These uses were offset by cash generated from the sale of inventory, prepaid expenses and other assets totaling $2.0 million. Cash used in operations totaled $7.4 million in the first nine months of 2006. We used $5.6 million to fund the cash portion of our net loss. We also used cash to fund a $2.1 million increase in inventory, accounts receivable and accounts payable payments. These uses were partially offset by cash generated from the reduction of prepaid expenses and other assets totaling $259,000.

     Net cash provided by investing activities totaled $935,000 in the first nine months of 2007 as compared to $211,000 used in investing activities in the first nine months of last year. We received the first $1.0 million from our financing with BAOLI on August 31, 2007. The financing payment was partially off set by $91,000 expenditures related primarily to purchases of manufacturing equipment and facilities improvements to increase our production capacity. The first nine months 2007 investing activity is net of $26,000 in equipment sales.

     Net cash used in financing activities totaled $14,000 in the first nine months of 2007 and 2006, and was used to pay down our long term debt.

Financing Activities

     We have historically financed our operations through a combination of cash on hand, cash provided from operations, equipment lease financings, available borrowings under bank lines of credit and both private and public equity offerings. We have effective registration statements on file with the SEC covering the public resale by investors of all the common stock issued in our private placements, as well as any common stock acquired upon exercise of their warrants.

     As noted above, we have an agreement with BAOLI under which BAOLI has agreed to invest $15.0 million in exchange for equity. The investment is scheduled to be made in several installments through the end of 2007; as of November 7, 2007, we had received an aggregate of $4.0 million of the total of $15.0 million.

     We have an existing line of credit from a bank. It is a material source of funds for our business. The line of credit was renewed in July 2007 for a term of one year. The line of credit expires July 15, 2008. The loan agreement is structured as a sale of our accounts receivable and provides for the sale of up to $5.0 million of eligible accounts receivable, with advances to us totaling 80% of the receivables sold. Advances bear interest at the prime rate (7.75% at September 29, 2007) plus 2.50% per annum subject to a minimum monthly charge. There was no amount outstanding under this borrowing facility at September 29, 2007. Advances are collateralized by a lien on all of our assets. Under the terms of the agreement, we continue to service the sold receivables and are subject to recourse provisions.

Contractual Obligations and Commercial Commitments

     During the third quarter of 2007, there were no material changes outside the ordinary course of our business in the information regarding specified contractual obligations contained in our Annual Report on Form 10-K for the year ended December 31, 2006.

Capital Expenditures

     We plan to invest less than $100,000 in fixed assets during the remainder of 2007.

Future Liquidity

     Our principal sources of liquidity consist of existing cash balances and funds expected to be generated from future operations. We believe one of the key factors to our liquidity will be our ability to successfully execute on our plans to increase sales levels in a highly concentrated industry where we experience significant fluctuations in sales from quarter to quarter. Our cash requirements will also depend on numerous other variable factors, including the rate of growth of sales, the timing and levels of products purchased, payment terms and credit limits from manufacturers, and the timing and level of accounts receivable collections.

     Our independent registered public accounting firm has included in their audit report for fiscal 2006 an explanatory paragraph expressing doubt about our ability to continue as a going concern. Our prior firm included a similar explanatory paragraph in their audit report for 2004 and 2005. In the first nine months of 2007, we incurred a net loss of $6.9 million and had negative cash flows from operations of $3.9 million. In 2006, we incurred a net loss of $29.6 million and had negative cash flows from operations of $7.4 million

     As noted above, we have an agreement with BAOLI under which BAOLI has agreed to invest $15.0 million in exchange for equity. We expect to be able to satisfy our expected liquidity needs for at least the next twelve months from the proceeds of this transaction and cash flow from operations.

Net Operating Loss Carryforward

     As of December 31, 2006, we had net operating loss carryforwards for federal and state income tax purposes of approximately $275.1 million and $143.4 million, respectively, which expire in the years 2007 through 2026. Of these amounts $91.2 million and $23.5 million, respectively resulted from the acquisition of Conductus. Included in the net operating loss carryforwards are deductions related to stock options of approximately $24.1 million and $13.1 million for federal and California income tax purposes, respectively. To the extent net operating loss carryforwards are recognized for accounting purposes the resulting benefits related to the stock options will be credited to stockholders’ equity. In addition, we have research and development and other tax credits for federal and state income tax purposes of approximately $2.4 million and $983,000, respectively, which expire in the years 2007 through 2026. Of these amounts $661,000 and $736,000, respectively resulted from the acquisition of Conductus.

     Due to the uncertainty surrounding their realization, we have recorded a full valuation allowance against our net deferred tax assets. Accordingly, no deferred tax asset has been recorded in the accompanying balance sheet.

     Section 382 of the Internal Revenue Code imposes an annual limitation on the utilization of net operating loss carryforwards based on a statutory rate of return (usually the “applicable federal funds rate”, as defined in the Internal Revenue Code) and the value of the corporation at the time of a “change of ownership” as defined by Section 382. We completed an analysis of our equity transactions and determined that we had a change in ownership in August 1999 and December 2002. Therefore, the ability to utilize net operating loss carryforwards incurred prior to the change of ownership totaling $98 million will be subject in future periods to an annual limitation of $1.3 million. In addition, we acquired the right to Conductus’ net operating losses, which are also subject to the limitations imposed by Section 382. Conductus underwent three ownership changes, which occurred in February 1999, February 2001 and December 2002. Therefore, the ability to utilize Conductus’ net operating loss carryforwards of $91.2 million incurred prior to the ownership changes will be subject in future periods to annual limitation of $700,000. Net operating losses incurred by us subsequent to the ownership changes totaled $86.4 million and are not subject to this limitation. We are currently evaluating the potential limitations on our ability to utilize our net operating loss carryforwards as a result of the BOALI transaction.

Recent Accounting Requirements

     In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for using fair value to measure assets and liabilities, and expands disclosures about fair value measurements.  The Statement applies whenever other statements require or permit assets or liabilities to be measured at fair value.  SFAS 157 is effective for fiscal years beginning after November 15, 2007.  We are currently evaluating the impact this Statement will have on our consolidated financial statements.

     In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115” (“SFAS 159”).  SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value, with unrealized gains and losses related to these financial instruments reported in earnings at each subsequent reporting date.  SFAS 159 is effective for fiscal years beginning after November 15, 2007.  We are currently evaluating the impact this Statement will have on our consolidated financial statements.

Forward-Looking Statements

          Please read the section in our 2006 Annual Report on Form 10-K entitled Item 1A “ Risk Factors ” for a description of additional uncertainties and factors that may affect our forward-looking statements. We are not aware of any material adverse changes to those risk factors.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

     We are not aware of any material change in our exposure to market risk at September 29, 2007 as compared with our market risk exposure on December 31, 2006. See “ Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Risk ” in our 2006 Annual Report on Form 10-K.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

     Disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit, is recorded, processed, summarized and reported, within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms, and such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosures.

     Our Chief Executive Officer and Controller have evaluated our disclosure controls and procedures and have concluded, as of September 29, 2007, that they are effective as described above.

Changes in Internal Controls

     There have been no changes in our internal control over financial reporting during the third quarter of 2007 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

     Because of our inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

PART II
OTHER INFORMATION

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.