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LCDX > SEC Filings for LCDX > Form 10-K on 29-Mar-2013All Recent SEC Filings

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Form 10-K for LUCID INC


29-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and related notes. In addition to historical information, some of the information in this discussion and analysis contains forward-looking statements reflecting our current expectations and involves risk and uncertainties. For example, statements regarding our expectations as to our plans and strategy for our business, future financial performance, expense levels and liquidity sources are forward-looking statements. Our actual results and the timing of events could differ materially from those discussed in our forward-looking statements as a result of many factors, including those set forth under the "Risk Factors" in

Part I, Item 1A of this Annual Report on Form 10-K.

Overview

We are a medical device company that designs, manufactures and sells non-invasive cellular imaging systems enabling physicians to image and diagnose skin disease in real time with an optical biopsy versus an invasive or surgical biopsy. Devices using our Rapid Cell ID technology allow physicians to detect and diagnose skin disease, including basal cell carcinoma, melanoma, and inflammatory and pigmentary disorders. Rapid Cell ID technology offers physicians the option to non-invasively diagnose, monitor and follow-up the non-invasive treatment of basal cell carcinoma, and includes the capacity to visualize the margins of the disease prior to surgery, improving patient outcomes. We have developed an integrated platform of tools, including the VivaScope® 1500 and VivaScope® 3000 Rapid Cell ID Imagers along with our telepathology service that can be used by doctors, surgeons, and research laboratories. Our tools are already in use by doctors and researchers in major academic hospitals as well at pharmaceutical and large cosmetic companies.

Our telepathology server, when connected to a physician's VivaScope imager, transfers images from a physician's office or operating room to another physician, pathologist or other diagnostic reader for near real-time diagnosis and reporting. In addition, the telepathology server stores images and pathology reports as a part of a patient's HIPAA compliant permanent, electronic, medical record increasing efficiency and reducing costs for medical institutions compared to current histology record retention processes.

We have devoted substantially all of our resources to the development of our Rapid Cell ID technology and telepathology service, which expenses have included research and development, conducting clinical investigation for our product candidates, protecting our intellectual property and the general and administrative support of these operations. While we have generated revenue through product sales, we have funded our operations largely through multiple rounds of private debt and equity financings. We have never been profitable and we reported net losses of approximately $9.8 million and $9.1 million in 2012 and 2011, respectively. As of December 31, 2012, we had an accumulated deficit of approximately $46.5 million. We expect to incur operating losses for the foreseeable future as we invest substantial resources to promote the commercialization, and attempt to achieve widespread adoption, of our products. We will require additional financing to support these and other operating activities, as our current assets are insufficient to meet our operating costs. Adequate additional funding may not be available to us on acceptable terms, or at all. We expect that research and development expenses and sales and marketing expenses will increase along with general and administrative costs, as we grow and operate as a public company. We will need to generate significant revenues to achieve profitability and we may never do so.

Our revenues consist of product revenue and non-product revenue. Product revenues consist of revenues derived from the sale of our products and services, primarily VivaScopes, as well as an immaterial amount of revenue from maintenance and support services. We recognize product revenue when evidence of an agreement exists, title has passed (generally upon shipment) or services have been rendered. When product sales do not include installation or training, such as for all distributor sales and many direct sales, revenue is recognized upon shipment. Certain direct sales contracts require installation at the customer's location prior to acceptance. As such, revenue recognition on these contracts is delayed until all aspects of delivery, including installation, are complete. In addition, should the contract include training, revenue recognition is delayed until training is complete. Non-product revenue, which to date has been in the form of a payment from a European distributor for certain rights including a license to use certain technology in defined geographic areas, is recognized as earned.

Results of Operations

Years Ended December 31, 2012 and 2011

We reported a consolidated net loss of $9.8 million or $(1.23) per share for the year ended December 31, 2012 as compared to a consolidated net loss of $9.1 million or $(7.37) per share for the year ended December 31, 2011. The increase in net losses in 2012 resulted from increased operating costs primarily related to the 2012 Enhancement Program, employee related termination costs, an increase in warranty costs, and an overall decrease in sales over the year ended December 21, 2011.

The following presents a more detailed discussion of our consolidated operating results:

Product sales. For the years ended December 31, 2012 and 2011, we recorded sales of our products of $2.4 million and $3.2 million, respectively. The decrease was primarily attributed to a decrease in distributor sales in Asia of $0.4 million combined with decreased distributor sales in Europe of $0.3 million. Percentages of total sales by geographic region are as follows:

                                                Year Ended
                                                December 31,
                                   2012                              2011
                        Product Sales       Percent       Product Sales       Percent
                        (in millions)                     (in millions)
       North America   $           0.5            23 %   $           0.6            16 %
       Europe                      1.0            39 %               1.3            41 %
       Asia                        0.6            25 %               1.0            32 %
       Latin America               0.2             8 %               0.2             7 %
       Australia                   0.1             5 %               0.1             4 %
       Total           $           2.4           100 %   $           3.2           100 %

During the year ended December 31, 2012, we began a significant enhancement program to increase the speed and functionality of our VivaScope confocal imagers. We believe the sales of our existing products were negatively impacted during 2012 primarily because we informed our key distributors at the end of 2011 about the 2012 Enhancement Program. The 2012 Enhancement Program was substantially completed by September 31, 2012, and sales in the fourth quarter were $1.1 million.

Cost of revenue. For the year ended December 31, 2012 and 2011, we incurred cost of revenue of $2.4 million and $1.9 million, respectively. As a percentage of product sales, cost of revenue was 99% and 59% for the years ended December 31, 2012 and 2011, respectively. The increase in cost of sales as a percentage of product sales reflects an increase in warranty repairs as well as charges to increase our warranty reserves.

General and administrative expenses. General and administrative expenses consist primarily of salaries and benefits, professional fees (including legal and accounting incurred during the year ended December 31, 2011 in connection with becoming a public company), occupancy costs for our office, insurance costs and general corporate expenses. For the year ended December 31, 2012, general and administrative expenses totaled $4.0 million and had decreased $1.4 million from the prior year resulting primarily from decreases in professional fees of $0.7 million in connection with our 2011 IPO. There was an additional decrease of $0.2 million resulting from a decrease in fees to affiliates. For the year ended December 31, 2012 as compared to the prior year, benefits increased significantly due to severance expenses incurred throughout the year. For the years ended December 31, 2012 and 2011, general and administrative expenses included non-cash stock-based compensation expenses of $1.0 million and $1.5 million, respectively.

Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries and benefits and general marketing expenses. For the year ended December 31, 2012, sales and marketing expenses totaled $1.8 million, an increase of $0.4 million from the prior year. The increase in sales and marketing expenses primarily resulted from an increase of $0.5 million in expenses related to increased sales and marketing efforts. The increase was offset by a decrease in stock-based compensation expenses of $0.3 million. For the years ended December 31, 2012 and 2011, sales and marketing expenses included non-cash stock-based compensation expenses of $0.1 million and $0.4 million, respectively.

Engineering, research and development expenses. Engineering, research and development expenses consist primarily of salaries and benefits and material costs used in the development of new products and product improvements. For the year ended December 31, 2012, engineering, research and development expenses totaled $3.8 million, an increase of $2.3 million from the prior year. The increase in engineering, research and development expenses primarily resulted from an increase of $0.5 million due to severance benefits incurred during the year, combined with an increase in stock-based compensation charges of $0.4 million. Additionally, the 2012 Enhancement Program resulted in increased costs of $0.8 million over the prior year. For the years ended December 31, 2012 and 2011, engineering, research and development expenses included non-cash stock-based compensation expenses of $0.7 million and $0.3 million, respectively.

Interest expense. Interest expense decreased $1.9 million from $2.3 million for the year ended December 31, 2011 to $0.4 million for the year ended December 31, 2012. The decrease in interest expense was a result of the conversion to equity of the debt underlying our 2010/2011 and July 2011 Convertible Debt Offerings upon the completion of our IPO.

Loss on Extinguishment of Debt. Loss on extinguishment of debt decreased $2.3 million from $2.7 million for the year ended December 31, 2011 to $0.4 million for the year ended December 31, 2012. The decrease in the loss was a result of the conversion in connection with the 2011 IPO of the 2010/2011 Convertible Debt Offering, July 2011 Convertible Debt Offering and the fee arrangement with an affiliate.

Fair value adjustment of warrants expense. For the years ended December 31, 2012 and 2011, we recognized income of $0.6 million and $2.5 million, respectively, to record changes in the fair value of certain of our outstanding warrants not indexed to our own stock.

Liquidity and Capital Resources

As of December 31, 2012, we had $2.5 million in current assets and $3.1 million in current liabilities, resulting in a working capital deficit of $0.6 million. As of December 31, 2011, we had $6.1 million in current assets and $5.9 million in current liabilities, respectively, resulting in working capital of $0.2 million. Our working capital decreased during the year ended December 31, 2012 primarily as a result of continued operating losses. Our current assets consist of cash, accounts receivable, inventories, prepaid expenses and other. Our current liabilities consist of the current portion of our long-term debt, accounts payable, accrued expenses, and deferred revenue.

We anticipate that we will continue to generate losses for the at least the next year as we develop and expand our product offerings and seek to commercialize our products and expand our corporate infrastructure. We believe that our current assets are insufficient to meet our operating costs.

We will require significant amounts of additional capital in the future, and such capital may not be available when we need it on terms that we find favorable, if at all. We may seek to raise these funds through public or private equity offerings, debt financings, credit facilities, or partnering or other corporate collaborations and licensing arrangements. If adequate funds are not available or are not available on acceptable terms, our ability to fund our operations, take advantage of opportunities, develop products and technologies, and otherwise respond to competitive pressures could be significantly delayed or limited, and we may need to downsize or halt our operations. Prevailing market conditions may not allow for such a fundraising or new investors may not be prepared to purchase our securities at prices that are greater than the purchase price of shares sold in our initial public offering.

Because of the numerous risks and uncertainties associated with research, development and commercialization of medical devices, we are unable to estimate the exact amounts of our working capital requirements. Our future funding requirements will depend on many factors, including, but not limited to:

• the cost of development and growth of our VivaScope business;

• the cost of commercialization activities of our products, and of our future product candidates, including marketing, sales and distribution costs;

• the number and characteristics of any future product candidates we pursue or acquire;

• the scope, progress, results and costs of researching and developing our future product candidates, and conducting clinical trials;

• the timing of, and the costs involved in, obtaining regulatory approvals for our future product candidates;

• the cost of manufacturing our existing VivaScope products and maintaining our telepathology server, as well as such costs associated with any future product candidates we successfully commercialize;

• our ability to establish and maintain strategic partnerships, licensing or other arrangements and the financial terms of such agreements;

• the costs involved in preparing, filing, prosecuting, maintaining, defending and enforcing patent claims, including litigation costs and the outcome of such litigation; and

• the timing, receipt and amount of sales of, or royalties on, our future products, if any.

Summary of Cash Flows



                                                       For the Year Ended
                                                           December 31,
                                                      2012             2011
      Operating activities                        $ (7,704,665 )   $ (4,500,760 )
      Investing activities                             (79,493 )       (123,684 )
      Financing activities                           3,814,464        8,681,510
      Net decrease in cash and cash equivalents     (3,969,694 )      4,057,066

Net cash used in operating activities. Cash used in operating activities was $7.7 million and $4.5 million for the years ended December 31, 2012 and 2011, respectively. The increase in cash used in operating activities resulted from the increase in net loss of $0.8 million, combined with a net decrease in non-cash amounts in 2012 of $2.3 million. The change in non-cash amounts included an increase of $2.3 million and $1.1 million for loss on extinguishment of debt and accretion of debt discount, respectively, and an increase of $1.9 million for the fair value adjustment of warrants.

Net cash used in investing activities. Cash used in investing activities was $0.1 million for the years ended December 31, 2012 and 2011, and represents the purchases of fixed assets during these periods.

Net cash provided by financing activities. Cash provided by financing activities was $3.8 million and $8.7 million for the years ended December 31, 2012 and 2011, respectively. The decrease during the year ended December 31, 2012 as compared to the year ended December 31 2011 was a result of the net proceeds from our IPO, the sale of our July 2011 and 2010/2011 Convertible Debt Offerings and cash received from exercises of warrants that took place in the prior year offset by the proceeds from the 2012 Demand Note and 2012 Term Note in Q2 2012 and Q3 2012, respectively.

Term Loan. In July 2012, we borrowed $7.0 million from an affiliate pursuant to a Loan and Security Agreement (the "2012 Term Loan"), which refinanced a previous loan in the amount of $3.0 million. The 2012 Term Loan matures in July 2017 although we may prepay the note at any time, subject to certain notice requirements. The 2012 Term Loan bears interest at a rate of 7% per annum, payable quarterly commencing in July 2014 and is secured by all of the Company's assets.

The 2012 Term Loan contains customary affirmative and negative covenants, including covenants restricting the incurrence of debt, imposition of liens, the payment of dividends, and entering into affiliate transactions. The 2012 Term Loan also contains customary events of default, including among others, nonpayment of principal or interest, material inaccuracy of representations and failure to comply with covenants. If an event of default occurs and is continuing under the 2012 Term Loan, the entire outstanding balance may become immediately due and payable.

Promissory Notes. As of December 31, 2012 and December 31, 2011, we had $0.4 million and $0.6 million, respectively, outstanding under outstanding promissory notes. As of December 31, 2012, two notes that do not accrue interest remained outstanding with a combined principal of $0.4 million.

Trade Payables and Receivables. As of December 31, 2012 and December 31, 2011, we had approximately $0.2 million and $0.4 million, respectively, of accounts payable which were aged over 180 days. Management has reached agreements with certain of these vendors to pay overdue amounts over time. Generally, the terms for our trade payables are 30 days from the date of receipt. Certain vendors require partial or full prepayment, especially for parts unique to Lucid orders.

As of December 31, 2012 and December 31, 2011, we had accounts receivable of approximately $0.6 million and $0.4 million, respectively. We generally request 50% prepayment from all direct sales customers, with the balance due 30 days after shipment, although in certain circumstances we require the full balance prior to shipment. Amounts collected prior to the recognition of revenue are recognized as customer deposits and are included in "accrued expenses and other current liabilities." We characterize our relationships with our distributors as excellent and we generally require full payment within 30 days of shipment to our distributors.

Warrants. At December 31, 2012, we had 1,981,661 warrants outstanding at a weighted average exercise price of $5.75. These warrants were issued primarily with historical convertible debt offerings, as well as in the common units sold in our recent initial public offering.

2011 Reverse Stock Split. All shares, stock options, warrants to purchase common stock and per share information presented in this report, including the consolidated financial statements, have been adjusted to reflect the 2 for 1 reverse stock split of our common stock effective December 6, 2011 on a retroactive basis for all periods presented. We made a cash payment to shareholders for all fractional shares which would otherwise be required to be issued as a result of the stock split. There was no change in the par value of our common stock.

Off-Balance Sheet Arrangements

We had no off-balance sheet arrangements as of December 31, 2012 and as of the date of this report.

Recently Issued Accounting Pronouncements

In the normal course of business, management evaluates all new accounting pronouncements issued by the Financial Accounting Standards Board, SEC, Emerging Issues Task Force, American Institute of Certified Public Accountants and other authoritative accounting bodies to determine the potential impact they may have on our consolidated financial statements. Based upon this review, we do not expect any of the recently issued accounting pronouncements to have a material impact on our consolidated financial statements.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition, liquidity and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect amounts reported therein. The following lists our current accounting policies involving significant management judgment and provides a brief description of these policies:

Fair Value. Certain elements of our financial statements require us to make estimates regarding the fair market value of our common stock. Our management determines this value from time to time utilizing a variety of factors, including the report of a third party valuation consultant, the general performance of the Nasdaq composite, and our financial results and condition. The Company uses Black-Scholes for financial option modeling. We believe that the results we have calculated using the Black-Scholes option pricing model approximate the results of the Binomial Options Pricing Model and has yielded a reasonable estimate of fair value for all assessed dates. However, it is likely that these results may have been different than our fair market value if our stock had been listed and traded on an exchange.

Historically, we have used estimates of the fair value of our common stock at various dates for the purpose of:

• Determining the fair value of our common stock on the date of grant of a stock-based compensation award to our employees and non-employees as one of the inputs into determining the grant date fair value of the award.

• Determining the fair value of our common stock on the date of grant of a restricted stock award to determine the amount of compensation expense to be recorded over the requisite service period.

• Determining the fair value of our common stock to be issued at the date of conversion of convertible debt instruments into our common stock.

• Determining the intrinsic value of certain debt features, such as beneficial conversion features, on the date of issuance of convertible instruments.

• Determining the fair value of our common stock at each reporting period as an input into our model to value warrants classified as liabilities.

Management has estimated the fair value of our common stock during 2011 and 2012 as follows:

                        Estimate of
Date of Valuation       Fair Value                         Purpose
April 1, 2011          $      8.60      Grants of stock-based awards
April 8, 2011          $      8.62      Grants of stock-based awards
June 28, 2011          $      8.88      Grants of stock-based awards
August 10, 2011        $      8.62      Grants of stock-based awards
December 30, 2011      $      3.35      Issuance of common stock upon conversions in
                                        connection with the IPO
October 1, 2012        $      2.00      Grants of stock-based awards
November 8, 2012       $      2.00      Grants of stock-based awards
December 18, 2012                       Issuance of common stock in a private
                       $      1.40      transaction

In 2012, the Company estimated fair market value of our common stock based largely on recent trading history and volumes on the OTCBB. Because the trading in our stock has been thin and sporadic, exclusive use of the most recent trading price could, at times yield an amount which was not the best indication of fair value.

In 2011, prior to the Company's initial public offering, we relied in part on a valuation report retrospectively prepared by an independent valuation consultant based on data we provided. The valuation report provided us with guidelines in determining the fair value, but the determination was made by our management. We obtained a retrospective valuation by a third- party valuation specialist because, as an emerging company, we have not had the resources at our disposal to gather all of the necessary inputs, including information regarding comparable companies. We applied the income approach/ discounted cash flow analysis based on our projected cash flow using management's best estimate as of the valuation date. The determination of the fair value of our common stock required complex and subjective judgments to be made regarding our projected financial and operating results, our unique business risks, complex features of our outstanding debt and equity instruments, the liquidity of our shares and our operating history and prospects at the time of valuation.

In determining the fair value of our common stock we made estimates in 2011 surrounding our weighted average cost of capital of 21.90% based on a number of inputs, including the risk-free rate, an equity risk premium based on forward looking equity risk premium studies multiplied by a Beta derived from Bloomberg of firms in a comparable line of business, a small stock premium from a Duff &Phelps study that reflects expectations of equity holders, a company-specific risk premium based on revenue projections relative to comparable firms, plus the Company's cost of debt. We used an option-pricing method to allocate enterprise value to preferred and common shares, taking into account the guidance prescribed by the AICPA Audit and Accounting Practice Aid, "Valuation of Privately-Held Company Equity Securities Issued as Compensation." The method treats common stock and preferred stock as call options on the enterprise's value, with exercise prices based on the liquidation preference of the preferred stock. We also used an option-pricing method which involves making estimates of the anticipated timing of a potential liquidity event, such as a sale of our Company or an initial public offering, and estimates of the volatility of our equity securities. The anticipated timing is based on the plans of our Board of Directors and management. Estimating the volatility of the share price of a privately held company is complex because there is no readily available market for the shares. We estimated the volatility of our shares at 70% based on the historical volatilities of comparable public companies engaged in similar lines of business. Had we used different estimates of volatility, the allocations between preferred and ordinary shares may have been different.

Subsequent to the listing of our common units on the OTCBB on December 28, 2011 and prior to the splitting of our common units into their common stock and common warrant components, we used a binomial lattice model to allocate the fair market value of the common unit between the common stock and common warrant which comprise the unit.

Stock-Based Compensation. We measure compensation cost for stock-based compensation at fair value and recognize compensation over the service period for awards expected to vest. The fair value of each restricted stock award is based on management's estimate of the fair value of our common stock on the date of grant and is recognized as compensation expense using straight-line amortization over the requisite service period. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes pricing model and is recognized as compensation expense using straight-line amortization over the requisite service period.

Management has estimated the fair value of our stock option awards during 2011 and 2012 as follows:

                                              Weighted
                           Type of             Average
. . .
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