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LUNA > SEC Filings for LUNA > Form 10-Q on 8-Aug-2013All Recent SEC Filings

Show all filings for LUNA INNOVATIONS INC

Form 10-Q for LUNA INNOVATIONS INC


8-Aug-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes to those statements included elsewhere in this report. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under "Risk Factors" and elsewhere in this report.

Overview

We develop, manufacture and market fiber optic test & measurement, sensing, and instrumentation products and are focused on bringing new and innovative technology solutions to measure, monitor, protect and improve critical processes in the telecommunications, medical, composite and defense industries. Our business model is designed to accelerate the process of bringing new and innovative products to market. We use our in-house technical expertise across a range of technologies to perform applied research services for companies and government-funded projects. We continue to invest in product development and commercialization, which we anticipate will lead to increased product sales growth.

Our corporate strategy focuses on two key objectives for growth as we seek to commercialize our technologies:

Develop and become the leading supplier of fiber optic shape sensing technology for robotic and minimally invasive surgical systems.

Become the leading provider of fiber optic sensing systems and standard test methods for composite materials.

We are organized into two main business segments, our Products and Licensing segment and our Technology Development segment. A breakdown of our operating loss by segment, as well as our total assets by segment, is provided in footnote 6 to our condensed consolidated financial statements included in this report.

Our Products and Licensing segment develops, manufactures and markets our fiber optic test and measurement, sensing, and instrumentation products and also conducts applied research in the fiber optic sensing area for both corporate and government customers. Revenues in this segment are currently largely derived from sales of test and measurement equipment for optical components and networks and equipment for measuring strain and temperature using optical fiber. Our Products and Licensing segment is also focused on our two key strategic objectives. We are working to develop and commercialize our fiber optic shape sensing technology in the medical industry with the goal of supplying fiber optic shape sensing components for use in robotic and minimally invasive surgical systems. We are also working to increase the sales of our fiber optic technology for strain and temperature sensing applications for the composite materials industry. Our Products and Licensing segment revenues represented approximately 53% and 42% of our total revenues for the quarters ended June 30, 2013 and 2012, respectively, and approximately 48% and 41% for the six months ended June 30, 2013 and 2012, respectively.


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Our Technology Development segment performs applied research for government funded projects and previously included our secure computing and communications group, or SCC. Our Technology Development segment, excluding SCC, represented approximately 47% and 58% of our total revenues for the quarters ended June 30, 2013 and 2012, respectively and approximately 52% and 59% for the six months ended June 30, 2013 and 2012, respectively. Our Technology Development segment predominantly performs applied research in the various areas of sensing applications and technologies, innovative materials and biomedical activities. Most of the government funding for our Technology Development segment is derived from the Small Business Innovation Research, or SBIR, program coordinated by the U.S. Small Business Administration, or SBA.

We generate revenues through technology development services provided under contractual arrangements, product sales, product development under contractual relationships and license fees. Our Technology Development segment revenues have historically accounted for a large portion of our total revenues, and we expect that they will continue to represent a significant portion of our total revenues for the foreseeable future. Our Technology Development segment revenues decreased to $2.8 million for the three months ended June 30, 2013 as compared to $3.9 million for the same period in 2012 and they decreased to $5.4 million for the six months ended June 30, 2013 as compared to $7.8 million for the same period in 2012, due primarily to our Optical Systems group completing certain large contracts in 2012 that were not renewed or replaced in 2013.

Within the Technology Development segment, we have historically had a backlog of contracts for which work has been scheduled, but for which a specified portion of work has not yet been completed. We define backlog as the dollar amount of obligations payable to us under negotiated contracts upon completion of a specified portion of work that has not yet been completed, exclusive of revenues previously recognized for work already performed under these contracts, if any. Total backlog includes funded backlog, which is the amount for which money has been directly authorized by the U.S. Congress and for which a purchase order has been received by a commercial customer, and unfunded backlog, representing firm orders for which funding has not yet been appropriated. Indefinite delivery and quantity contracts and unexercised options are not reported in total backlog. The approximate value of our Technology Development segment backlog was $11.3 million at June 30, 2013, compared to $10.3 million at December 31, 2012, excluding a backlog of $3.3 million related to discontinued operations and $15.2 million at June 30, 2012, excluding a backlog of $2.5 million related to discontinued operations.

Our product and licensing segment includes primarily sales of our sensing systems and products that make use of light-transmitting optical fibers, or fiber optics and revenues earned from the funded development of our fiber optic shape sensing systems for medical applications. We continue to invest in product development and commercialization, which we anticipate will lead to increased product sales growth. Although we have been successful in licensing certain technology in past years, we do not expect license revenues to represent a significant portion of future revenues. Over time, however, we do intend to gradually increase such revenues. In the near term, we expect revenues from product sales and product development to be primarily in areas associated with our fiber optic instrumentation, test and measurement and sensing platforms. In the long term, we expect that revenues from product sales will represent a larger portion of our total revenues and that, as we develop and commercialize new products, these revenues will reflect a broader and more diversified mix of products.

As described below, on March 1, 2013, we sold our SCC business. As a result of the sale, we have reported the results of operations from SCC as discontinued operations in our condensed consolidated financial statements included elsewhere in this report. Net loss from continuing operations was $0.8 million for the three months ended June 30, 2013, compared to $0.4 million for the three months ended June 30, 2012. Net loss from continuing operations was $1.9 million for the six months ended June 30, 2013, compared to $1.1 million for the six months ended June 30, 2012. After giving effect to the results of discontinued operations, including the $3.9 million gain, net of taxes, we recognized on the sale of SCC, we recorded net income attributable to common stockholders of approximately $1.8 million for the six months ended June 30, 2013, compared to a net loss attributable to common stockholders of approximately $0.6 million for the six months ended June 30, 2012, and a net loss attributable to common stockholders of approximately $1.0 million for the three months ended June 30, 2013, compared to a net loss attributable to common stockholders of approximately $0.3 million for the three months ended June 30, 2012.


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We expect to continue to incur increasing expenses as we expand our business, including expenses for research and development, sales and marketing and manufacturing capabilities. We may also grow our business in part through acquisitions of additional companies and complementary technologies, which could cause us to incur transaction expenses, amortization or write-offs of intangible assets and other acquisition-related expenses. As a result, we expect to incur net losses for the foreseeable future, and these losses could be substantial.

Global economic conditions have experienced a significant prolonged downturn and remain uncertain. This slowing of the economy has reduced the financial capacities of our customers and possibly our potential customers, thereby slowing spending on the products and services we provide. The outlook for the economy for 2013 and beyond remains uncertain.

Sale of Secured Computing and Communications Group

On March 1, 2013, we entered into an Asset Purchase Agreement with MacAulay-Brown, Inc. ("Mac-B") under which we sold SCC to Mac-B for $6.1 million in cash. Of the purchase price, $0.1 million will be payable on December 31, 2013 and an additional $0.6 million was placed in escrow to be released in tranches over 18 months, subject to certain events and dates and to any indemnification claims of Mac-B. Mac-B acquired all of the assets of SCC, including SCC's intellectual property, in the transaction. We estimate that the net proceeds received upon the closing of the transaction, after the payment of our transaction expenses and assuming our receipt of the $0.7 million of aggregate purchase price payable in the future as described above, will be approximately $5.2 million. In connection with the transaction, Mac-B also entered into a sublease with us that will permit Mac-B to continue operating the SCC business in our Roanoke, Virginia headquarters through December 31, 2013. During 2013, we expect to collect approximately $0.3 million in sublease payments from Mac-B.

In light of the significance of SCC to our business, we expect the sale of SCC will have a significant impact on our financial results. SCC accounted for 18.5% of our revenues, and 20.7% of our cost of revenues for the year ended December 31, 2012. Additionally, we expect the sale of SCC to result in a reduction in annual operating expenses of approximately $0.8 million, including the effects of the sublease described above.

Description of Our Revenues, Costs and Expenses

Revenues

We generate revenues from technology development, product sales and commercial product development and licensing activities. We derive Technology Development segment revenues from providing research and development services to third parties, including government entities, academic institutions and corporations, and from achieving milestones established by some of these contracts and in collaboration agreements. In general, we complete contracted research over periods ranging from six months to three years, and recognize these revenues over the life of the contract as costs are incurred or upon the achievement of certain milestones built into the contracts. Our Technology Development segment revenues represented approximately 47% and 58% of our total revenues for the quarters ended June 30, 2013 and 2012, respectively, and approximately 52% and 59% for the six months ended June 30, 2013 and 2012, respectively.

Our Product and License segment revenues reflect amounts that we receive from sales of our products or development of products for third parties, as well as fees paid to us in connection with licenses or sublicenses of certain patents and other intellectual property, and represented approximately 53% and 42% of our total revenues for the quarters ended June 30, 2013 and 2012, respectively, and approximately 48% and 41% for the six months ended June 30, 2013 and 2012, respectively.

Cost of Revenues

Cost of revenues associated with Technology Development segment revenues consists of costs associated with performing the related research activities including direct labor, amounts paid to subcontractors and overhead allocated to Technology Development segment activities.

Cost of revenues associated with our Products and Licensing segment revenues consists of: license fees for use of certain technologies; product manufacturing costs including all direct material and direct labor costs; amounts paid to our contract manufacturers; manufacturing, shipping and handling; provisions for product warranties; and inventory obsolescence and overhead allocated to each of these activities.


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Operating Expense

Operating expense consists of selling, general and administrative expenses, as well as expenses related to research, development and engineering, depreciation of fixed assets and amortization of intangible assets. These expenses also include: compensation for employees in executive and operational functions including certain non-cash charges related to expenses from option grants, facilities costs, professional fees, salaries, commissions, travel expense and related benefits of personnel engaged in sales, product management and marketing activities; costs of marketing programs and promotional materials; salaries, bonuses and related benefits of personnel engaged in our own research and development beyond the scope and activities of our Technology Development segment; product development activities not provided under contracts with third parties; and overhead costs related to these activities.

Interest Expense

Interest expense is composed of interest paid under our bank loans as well as interest accrued on our capital lease obligations.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates, assumptions and judgments that affect the amounts reported in our financial statements and the accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or judgments. Our critical accounting policies are described in the Management's Discussion and Analysis section and the notes to our audited consolidated financial statements previously included in our Annual Report on Form 10-K for the period ended December 31, 2012, as filed with the Securities and Exchange Commission on March 29, 2013. There have been no material changes to the descriptions therein.

Results of Operations

Three Months Ended June 30, 2013 Compared to Three Months Ended June 30, 2012

Revenues



                                               Three months ended June 30,
                                                 2013                2012                   Change

Revenues:
Technology development revenues             $     2,807,296       $ 3,894,846      $ (1,087,550 )       (28 )%
Products and licensing revenues                   3,165,764         2,845,864           319,900          11 %


Total revenues                              $     5,973,060       $ 6,740,710      $   (767,650 )       (11 )%

Revenues from our Technology Development segment decreased by $1.1 million from $3.9 million in the quarter ended June 30, 2012 to $ 2.8 million for the same period in 2013. This was due primarily to a decrease in our research revenues from our Optical Systems group caused by a reduced amount of contract work.

Our Products and Licensing segment revenues increased due in part to a $0.1 million increase in sales of our fiber optic test and measurement equipment in the second quarter of 2013 as compared to the second quarter of 2012, resulting primarily from increased orders of our ODiSI products. We also experienced a $0.2 million increase in product development work in the second quarter of 2013 as compared to the second quarter of 2012.


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Cost of Revenues and Gross Profit



                                   Three months ended June 30,
                                      2013               2012                Change

  Cost of revenues:
  Technology development costs   $     2,209,158      $ 2,729,108     $ (519,950 )      (19 )%
  Products and licensing costs         1,355,643        1,267,201         88,442          7 %


  Total cost of revenues         $     3,564,801      $ 3,996,309     $ (431,508 )      (11 )%

  Gross Profit                   $     2,408,259      $ 2,744,401     $ (336,142 )      (12 )%

The cost of our Technology Development segment revenues decreased primarily due to a reduction of $0.2 million in direct labor due to staff reductions in our Optical Systems group earlier this year, a reduction of $0.2 million in direct subcontractor cost and a reduction of $0.1 million in other direct costs.

The slight increase in cost of revenues in our Products and Licensing segment was primarily the result of the $0.1 million increase in revenue from product sales described above, which resulted in a corresponding increase in cost of revenue. While our revenue from product development work increased, the costs associated with this work decreased slightly, thereby positively affecting our gross margins, as described below.

Because of the overall decrease in revenues of 11% compared to the quarter ended June 30, 2012, which was partially offset by a decrease in costs of revenue of 11%, our resulting gross profit was $2.4 million for the quarter ended June 30, 2013, compared to $2.7 million for the corresponding quarter in 2012.

Operating Expense



                                                  Three months ended June 30,
                                                    2013                2012                Change
Operating expense:
Selling, general and administrative            $     2,658,605       $ 2,526,638      $ 131,967         5 %
Research, development, and engineering                 666,632           608,459         58,173        10 %


Total operating expense                        $     3,325,237       $ 3,135,097      $ 190,140         6 %

Our selling, general and administrative costs increased 5% during the second quarter of 2013, as compared to the same period in 2012. The increase was primarily due to an increase in bad debt expense of approximately $125,000 and consulting fees of approximately $107,000, partially offset by a decrease in share-based compensation expense of approximately $170,000.

Research, development, and engineering expense increased by 10% during the second quarter of 2013 as compared to the same period in 2012, primarily due to increased engineering expenses in our Products and Licensing segment due to internal product development.

Other Income

During the three months ended June 30, 2013, we recognized other income of approximately $15,000, which consisted primarily of the amortization of the discount on the Hansen debt, which was fully amortized during the second quarter of 2013.

During the three months ended June 30, 2012, we recognized $23,000 of other income as a result of the amortization of the discount on the Hansen debt.

Interest Expense

Interest expense for the three months ended June 30, 2013 was approximately $50,000 compared to interest expense of approximately $74,000 during the same period in 2012. The monthly average loan balance during the second quarter of 2013 was $3.0 million compared to $4.5 million for the same period in 2012. The lower average loan balance accounted for the decrease in interest expense.


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Loss from Continuing Operations

As a result of the foregoing, during the three months ended June 30, 2013, we incurred a net loss from continuing operations of approximately $0.8 million, compared to a net loss of approximately $0.4 million for the three months ended June 30, 2012.

Loss/Income from Discontinued Operations

For the three months ended June 30, 2013, we recognized a net loss from discontinued operations of $0.2 million, due to the allocation of the alternative minimum income tax calculation. For the three months ended June 30, 2012, we recognized net income from discontinued operations of $0.2 million.

Six Months Ended June 30, 2013 Compared to Six Months Ended June 30, 2012

Revenues



                                     Six months ended June 30,
                                       2013              2012                 Change

 Revenues:
 Technology development revenues   $   5,434,537     $  7,837,546     $ (2,403,009 )     (31 )%
 Products and licensing revenues       5,035,439        5,559,677         (524,238 )      (9 )%


 Total revenues                    $  10,469,976     $ 13,397,223     $ (2,927,247 )     (22 )%

Revenues from our Technology Development segment decreased by $2.4 million from $7.8 million in the six months ended June 30, 2012 to $5.4 million for the same period in 2013. This decrease was due primarily to a decline in revenues from our optical systems group of $1.9 million due to the completion of certain large contracts during the second half of 2012, which contracts were not renewed or replaced in 2013.

Our Products and Licensing segment revenues decreased primarily due to a $0.8 million decrease in sales of our fiber optic test and measurement equipment in the first half of 2013 as compared to the first half of 2012. This decrease resulted primarily from fewer orders of our OBR and OVA products in 2013 as compared to 2012, which was partially offset by an increase of $0.3 million in revenues from ODiSI sales during the first half of 2013, as compared to the same period in 2012. Revenue for product development was virtually unchanged for the first half of 2013 as compared to the same period in 2012.

Cost of Revenues and Gross Profit



                                   Six months ended June 30,
                                      2013             2012                 Change

  Cost of revenues:
  Technology development costs   $    4,381,135     $ 5,428,304     $ (1,047,169 )      (19 )%
  Products and licensing costs        2,288,062       2,514,696         (226,634 )       (9 )%


  Total cost of revenues         $    6,669,197     $ 7,943,000     $ (1,273,803 )      (16 )%

  Gross Profit                   $    3,800,779     $ 5,454,223     $ (1,653,444 )      (30 )%

The cost of our Technology Development segment revenues decreased due to a reduction of $0.4 million in each of direct labor and direct subcontractor costs and a reduction of $0.3 million in other direct costs.

The cost of revenues in our Products and Licensing segment decreased due to the decrease in product sales described above in addition to decreased cost of our commercial development projects. The decrease in costs of products sold was less than the decrease in the corresponding revenues due to the higher cost of the lasers utilized in products in the first quarter of 2013. The decreased cost of our commercial development work was primarily the result of cost overruns we experienced in completing a fixed price contract in 2012.


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Our resulting gross profit was $3.8 million for the six months ended June 30, 2013 compared to $5.5 million for the corresponding six months in 2012. The decline in gross profit was primarily the result of the smaller decrease in cost of revenues than the decrease in revenue, in connection with the declining product sales described above. In addition, we also experienced a decrease in revenue and cost of revenues in our Technology Development segment for the six months ended June 30, 2013 compared to the same period in 2012.

Operating Expense



                                                   Six months ended June 30,
                                                     2013              2012                Change
Operating expense:
Selling, general and administrative             $    5,167,251      $ 5,183,614      $ (16,363 )      <1 %
Research, development, and engineering               1,507,124        1,293,240        213,884        17 %


Total operating expense                         $    6,674,375      $ 6,476,854      $ 197,121         3 %

Our selling, general and administrative costs were virtually unchanged during the first six months of 2013 compared to the same period in 2012.

Research, development, and engineering expense increased by 17% during the first six months of 2013 as compared to the same period in 2012, primarily due to increased engineering expenses in our Products and Licensing segment due primarily to increased work on internal product development.

Other Income

During the six months ended June 30, 2013, we recognized other income of approximately $87,000, which consisted primarily of the amortization of the discount on the Hansen debt of approximately $38,000, which was fully amortized during the second quarter of 2013, and an insurance policy profit share of approximately $48,000.

During the six months ended June 30, 2012, we recognized approximately $47,000 of other income as a result of the amortization of the discount on the Hansen debt.

Interest Expense

Interest expense for the six months ended June 30, 2013 was approximately $108,000 compared to interest expense of approximately $154,000 during the same period in 2012. The monthly average loan balance during the first six months of 2013 was $3.3 million compared to $4.7 million for the same period in 2012. The lower average loan balance accounted for the decrease in interest expense.

Loss from Continuing Operations

As a result of the foregoing, during the six months ended June 30, 2013, we incurred a net loss from continuing operations of approximately $1.9 million, compared to a net loss of approximately $1.1 million for the six months ended June 30, 2012.

Income from Discontinued Operations

For the six months ended June 30, 2013, we recognized net income from discontinued operations of $3.8 million, compared to net income from discontinued operations of $0.6 million for the same period in 2012. For the six months ended June 30, 2013, this income consisted of the $3.9 million gain on the sale of SCC business, net of taxes, which occurred during the quarter ended March 31, 2013, which gain was partially offset by an operating loss $0.1 million from the SCC business for the two months prior to the sale on March 1, . . .

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