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SPIR > SEC Filings for SPIR > Form 10-K on 31-Mar-2014All Recent SEC Filings

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Form 10-K for SPIRE CORP


31-Mar-2014

Annual Report


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

This Management's Discussion and Analysis of Financial Condition and Results of Operations section and other parts of this Report contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which statements involve risks and uncertainties. These statements relate to our future plans, objectives, expectations and intentions. These statements may be identified by the use of words such as "may", "could", "would", "should", "will", "expects", "anticipates", "intends", "plans", "believes", "estimates", and similar expressions, and includes statements regarding the expected growth of the solar market, the potential impact of pending litigation on our results, and the sufficiency of cash resources in 2014. Our actual results and the timing of certain events may differ significantly from the results and timing described in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those factors described below and above under "Item 1A. Risk Factors" and "Item 1. Business." Readers are encouraged to carefully review those risk factors. The following discussion and analysis of our financial condition and results of operations should be read in light of those factors and in conjunction with our accompanying Consolidated Financial Statements, including the Notes thereto.

Overview


We and our subsidiaries along with our variable interest entity develop, manufacture and market highly-engineered products and services in two principal business areas: (i) capital equipment and systems for the photovoltaic solar industry and (ii) biomedical, through our variable interest entity, N2 Biomedical LLC ("N2 Bio"), generally bringing to bear expertise in materials technologies, surface science and thin films across both business areas, as discussed below.

In the photovoltaic solar area, we develop, manufacture and market specialized equipment for the production of terrestrial photovoltaic modules from solar cells and provide photovoltaic systems for grid connected applications in the commercial markets. Our equipment has been installed in approximately 200 factories in 50 countries. The equipment market is very competitive with major competitors located in the U.S., Japan and Europe. Our flagship product is our Spi-Sun simulator which tests module performance. Our other product offerings include turn-key module lines and to a lesser extent other individual equipment. To compete we offer other services such as training and assistance with module certification. We also provide turn-key services to our customers to backward integrate to solar cell manufacturing.

In the biomedical area, through our variable interest entity, N2 Bio, we provide value-added surface treatments to manufacturers of orthopedic and other medical devices that enhance the durability, antimicrobial characteristics or other material characteristics of their products, and perform sponsored research programs into practical applications of advanced biomedical technologies.

Transactions

On September 18, 2013, we, Spire Biomedical, Inc. (the "Subsidiary" and together with us, "Spire Bio") entered into an Asset Purchase Agreement (the "Purchase Agreement") with N2 Bio pursuant to which N2 Bio agreed to (i) acquire substantially all of the assets of the Subsidiary's biomedical business (the "Bio Business Unit") and (ii) assume and pay certain liabilities related to the purchased assets as set forth in the Purchase Agreement (collectively, the "Transaction"). The Transaction closed on September 18, 2013. The purchase price for the Bio Business Unit was $10.5 million plus the assumption of liabilities of approximately $100 thousand, with $6.0 million paid in cash at closing, a $2.4 million subordinated convertible promissory note, and 310,549 Series A Convertible Preferred Units of N2 Bio valued at approximately $2.1 million ($6.72 per share). The assets and liabilities of the Subsidiary's biomedical business are under common control and were recorded at carryover basis for financial reporting. The difference between the consideration paid and the carrying value of the assets and liabilities acquired by N2 Bio was recorded as a deemed dividend by us in the amount of $9.5 million and has been eliminated in consolidation. Mark C. Little was the Chief Executive Officer of the Subsidiary, is a member of our Board of Directors and is the Chief Executive Officer of N2 Bio. Mark C. Little is the son of Roger G. Little, our Chairman of the Board. Roger G. Little is also a member of the Board of Directors of N2 Bio.

We have determined that N2 Bio is a VIE because the equity investment at risk from the majority shareholders of N2 Bio is not sufficient to permit N2 Bio to finance its activities without additional subordinated financial support. As discussed above, N2 Bio is subject to a subordinated convertible promissory note due to us. Additionally, Mark Little is the Chief Executive Officer of N2 Bio and also is a member of our Board of Directors. We have also determined that we have the obligation to absorb losses and the right to receive benefits from N2 Bio that could potentially be significant to it. Therefore, we have determined that N2 Bio is a VIE and that we are a primary beneficiary of the VIE and must consolidate the financial condition, results of operations and cash flows of N2 Bio with those of our own. See Note 19 to the consolidated financial statements.

The subordinated convertible promissory note (i) bears interest at 9% per annum until paid in full, (ii) is convertible, at our option, into Common Units of N2 Bio at a conversion price of $6.72 per share, (iii) has a seven year term, (iv) is unsecured and (v) is subordinate in right of payment to all senior bank indebtedness of N2 Bio.

The Series A Convertible Preferred Units (i) represent an equity ownership interest of 19.9% in N2 Bio, (ii) are governed by the terms of the Amended and Restated Limited Liability Company Agreement of N2 Bio dated September 18, 2013,
(iii) rank senior to the Common Units on liquidation, dissolution and winding up, and (iv) vote together with the Common Units on an as-converted basis. We have the right to appoint one director to the Board of Directors of N2 Bio. N2 Bio is subject to certain affirmative and negative operating covenants in favor of the holder of Series A Preferred Units.

On September 18, 2013, we and N2 Bio entered into a Shared Services Agreement whereby we will provide N2 Bio certain services (the "Shared Services") for a period of three years. It is the intent of the parties that the aggregate fees for the Shared Services shall equal approximately $500,000 during the first year. Following the first anniversary, N2 Bio may terminate any specific Shared Service with 20 days' written notice to us.


On September 18, 2013, the lease agreement between SPI-Trust, a related party, and us for the premises in Bedford, Massachusetts where the Business is located was amended, by reducing our leased space and annual base rent by approximately 19%. All other material terms and conditions related to the lease remain unchanged as of such date.

On September 18, 2013, N2 Bio entered into a Lease Agreement (the "N2 Bio Bedford Lease") with SPI-Trust with respect to 27,048 square feet of space in the premises in Bedford, Massachusetts. The term of the N2 Bio Bedford Lease commenced on September 18, 2013 and is set to expire on November 30, 2020. The annual rental rate prorated for September 18, 2013 to November 30, 2013 is $16.00 per square foot on a triple net basis, whereby the tenant is responsible for operating expenses, taxes and maintenance of the building. The annual rental rate increases on December 1, 2013 and each anniversary thereafter by $0.50 per square foot.

The Purchase Agreement includes a five-year commitment of (i) us not to compete with the Bio Business Unit services and (ii) N2 Bio not to compete with our consumer electronic products business. We and N2 Bio both agreed not to solicit the officers or employees of the other party for a one-year period.

On March 9, 2012, we completed the sale of our semiconductor business unit, which provided semiconductor foundry services, operated a semiconductor foundry and fabrication facility and was engaged in the business of wafer epitaxy, foundry services, and device fabrication for the defense, medical, telecommunications and consumer products markets (the "Semiconductor Business Unit"), to Masimo Corporation ("Masimo"). Accordingly, the results of operations and assets and liabilities of the Semiconductor Business Unit are being presented herein as discontinued operations. See Note 18 to the consolidated financial statements.

Results of Operations

The following discussions of our results of continuing operations exclude the results related to the Medical Products Business Unit and the Semiconductor Business Unit, which were sold on December 14, 2009 and March 9, 2012, respectively. The Medical Products Business Unit and the Semiconductor Business Unit have been segregated from continuing operations and are reflected as discontinued operations for all periods presented. See "Net income (loss) from discontinued operations, net of tax" below and Note 18 to the consolidated financial statements.


The following table sets forth certain items as a percentage of net sales and revenues for the periods presented:

                                                                Year Ended December 31,
                                                                  2013             2012

Net sales and revenues                                            100  %             100  %
Cost of sales and revenues                                        (83 )              (76 )
Gross margin                                                       17                 24
Selling, general and administrative expenses                      (74 )              (53 )
Internal research and development expenses                          -                 (1 )
Gain on termination of contracts                                    -                  -
Operating loss from continuing operations                         (57 )              (30 )
Other expense, net                                                 (1 )                -
Loss from continuing operations before income tax benefit         (58 )              (30 )
Income tax benefit - continuing operations                          -                  9
Net loss from continuing operations                               (58 )              (21 )
Net income from discontinued operations, net of tax                 -                 13
Net loss                                                          (58 )               (8 )
Less: Net loss attributable to noncontrolling interest              -                  -

Net loss attributable to common stockholders (58 )% (8 )%

Overall

Our total net sales and revenues for the year ended December 31, 2013 ("2013") decreased 34% to $14.6 million as compared to $22.1 million for the year ended December 31, 2012 ("2012"). The decrease was primarily attributable to a $7.6 million decrease in solar revenue, partially offset by a slight increase in biomedical revenue.

Solar Business Unit

Sales in our solar business unit decreased 50% to $7.7 million in 2013 as compared to $15.3 million in 2012. The decrease in solar business unit revenue is primarily the result of a decrease in solar module equipment revenue of $7.6 million and a decrease in solar research and development revenue of $1.0 million, partially offset by an increase in equipment research and development revenue of $689 thousand and an increase in solar systems revenue of $562 thousand. Lower government incentives in the photovoltaic market and the world-wide oversupply of photovoltaic modules relative to market demand has led to precipitously declining prices in the photovoltaic market. The oversupply has also resulted in reduced demand for photovoltaic manufacturing equipment that will not improve until the module supply/demand imbalance is rectified by growth in photovoltaic systems market. Our Solar Business Unit has been negatively impacted by this reduction in demand which is contributing to decreased revenue in our solar business unit.

Biomedical Business Unit

Revenues in our biomedical business unit, including the results of N2 Bio, our variable interest entity, subsequent to September 18, 2013, remained constant at $6.9 million in 2013 when compared to 2012. The increase was primarily attributable to an increase in orthopedics coating services revenue of $293 thousand, partially offset by a decrease in biomedical research and development revenue of $218 thousand.

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Net Sales and Revenues

The following table categorizes our net sales and revenues for the periods presented:


                                          Year Ended December 31,                Decrease
(in thousands)                              2013             2012            $              %

Sales of goods                         $       5,734     $   12,989     $   (7,255 )        (56 )%
Contract research and service revenues         8,847          9,121           (274 )         (3 )%
Net sales and revenues                 $      14,581     $   22,110     $   (7,529 )        (34 )%

The 56% decrease in sales of goods for 2013 as compared to 2012 was primarily due to a decrease of $7.6 million in solar module manufacturing equipment revenues and a decrease of $185 thousand in ATC Lab revenues, partially offset by an increase of $562 thousand in solar systems revenues. The decrease in solar module equipment sales of 61% in 2013 as compared to 2012 was primarily due to a decrease in individual module equipment units delivered in 2013. The decrease in ATC lab revenue of 39% in 2013 as compared to 2012 was primarily due to the completion of three large projects benefiting 2012. The increase in solar systems revenue of 752% in 2013 as compared to 2012 was primarily due to the completion of two solar system projects in 2013. Lower government incentives in the photovoltaic market and the world-wide oversupply of photovoltaic modules relative to market demand has led to precipitously declining prices in the photovoltaic market. The oversupply has also resulted in reduced demand for photovoltaic manufacturing equipment that will not improve until the module supply/demand imbalance is rectified by growth in the photovoltaic systems market. Our Solar Business Unit has been negatively impacted by this reduction in demand which is contributing to decreased sales of goods.

The 3% decrease in contract research and service revenues for 2013 as compared to 2012 was primarily attributable to an decrease of $1.0 million in solar research and development revenue and a decrease of $218 thousand in biomedical research and development revenue, partially offset by an increase of $689 thousand in equipment research and development revenue and an increase of $293 thousand in biomedical service revenue. The decrease in solar research and development revenue of 66% in 2013 as compared to 2012 was primarily due to the completion of three research and development projects in the first and third quarter of 2013 and the second quarter of 2012. The decrease in biomedical research and development revenue of 67% in 2013 as compared to 2012 was primarily due to the completion of two research and development projects in the second and forth quarter of 2012. The increase in equipment research and development revenue of 98% in 2013 as compared to 2012 was primarily due to new research and development projects starting in the end of the third quarter of 2012. Revenues from our biomedical services increased 5% in 2013 compared to 2012 as a result of an increase in revenue from two large customers in 2013.

Revenues from the delivery of biomedical services to Stryker Orthopedics and Biomet Inc. accounted for 20% and 12%, respectively, of total net sales and revenues for 2013.

Revenues from the delivery biomedical services to Stryker Orthopedics and revenues from the delivery of solar equipment to First Solar, Inc. accounted for 14% and 12%, respectively, of total net sales and revenues for 2012.

Cost of Sales and Revenues

The following table categorizes our cost of sales and revenues for the periods
presented, stated in dollars and as a percentage of related sales and revenues:

                                             Years Ended December 31,              Decrease
(in thousands)                           2013        %       2012       %         $          %

Cost of goods sold                     $  7,514    131 %   $ 11,943    92 %   $ (4,429 )   (37 )%
Cost of contract research and services    4,561     52 %      4,896    54 %       (335 )    (7 )%
Net cost of sales and revenues         $ 12,075     83 %   $ 16,839    76 %   $ (4,764 )   (28 )%

Cost of goods sold decreased 37% for 2013 as compared to 2012, primarily due to a decrease of $4.7 million in costs related to solar module equipment and a decrease of $110 thousand in costs related to the ATC lab, partially offset by an increase of $377 thousand in costs related to solar systems. The decrease in solar module equipment costs of 42% in 2013 as compared to 2012 was primarily due to a decrease in associated revenue. The decrease in ATC lab costs of 28% in 2013 as compared to 2012 was primarily due to a decrease in associated revenue. The increase in solar system costs of 142% in 2013 as compared to 2012 was primarily due to the delivery of two solar system projects in 2013. As a percentage of sales, cost of goods sold increased to 131% of sales of goods in 2013 as compared to 92% of sales of goods in 2012. This increase in the percentage of sales in 2013 is due


primarily to a decline in sales of higher margin equipment in 2013 and to a lesser extent, lower indirect costs not sufficient to offset the amount of overhead absorbed due to the reduction in sales volume, partially offset by the delivery of 2 high margin solar system projects in 2013.

Cost of contract research and services decreased 7% for 2013 as compared to 2012, primarily due to a decrease of $439 thousand in costs related to solar research and development services and $157 thousand in costs related to biomedical research and development services, partially offset by an increase of $227 thousand in costs related to equipment research and development services. The decrease in solar research and development services costs of 62% in 2013 as compared to 2012 was primarily due to a reduction in direct costs related to the completion of three projects. The decrease in biomedical research and development costs of 34% in 2013 as compared to 2012 was primarily due to reductions in indirect costs related to the completion of two projects and the reduction of indirect employee related costs. The increase in equipment research and development services costs in 2013 as compared to 2012 was primarily due to new equipment research and development projects starting in the end of the third quarter of 2012. Cost of contract research and services as a percentage of related revenue decreased to 52% of related revenues in 2013 from 54% in 2012. This decrease in the percentage of sales in 2013 is primarily due to higher margin from new equipment research and development projects starting in the end of the third quarter of 2012.

Cost of sales and revenues also includes approximately $18 thousand and $52 thousand of share-based compensation in 2013 and 2012, respectively.

Operating Expenses

The following table categorizes our operating expenses for the periods
presented, stated in dollars and as a percentage of net sales and revenues:

                                          Years Ended December 31,              Decrease
(in thousands)                         2013       %       2012       %         $          %
Selling, general and administrative $  10,851    74 %   $ 11,676    53 %   $   (825 )    (7 )%
Internal research and development          31     - %        233     1 %       (202 )   (87 )%
Operating expenses                  $  10,882    75 %   $ 11,909    54 %   $ (1,027 )    (9 )%

Selling, General and Administrative Expenses

Selling, general and administrative expense decreased 7% in 2013 as compared to 2012, primarily as a result of a decrease in employee related expenses due to a reduction in workforce and reduced marketing and agent commissions in the solar business unit, partially offset by transaction related costs associated with the N2 Biomedical transaction in the third quarter of 2013 (see Note 19 to the consolidated financial statements). In addition, a net expense was realized related to the change in value of the deferred compensation plan. Selling, general and administrative expense increased to 74% of sales and revenues in 2013 as compared to 53% in 2012. The increase was primarily due to the decrease in sales and revenues.

Selling, general and administrative expenses include approximately $82 thousand and $150 thousand of share-based compensation in 2013 and 2012, respectively.

Internal Research and Development Expenses

Internal research and development expense decreased 87% in 2013 as compared to 2012, primarily as a result of lower levels of research and development spent in the solar group. As a percentage of sales and revenue, internal research and development expenses decreased slightly in 2013 when compared to 2012.

Gains on Termination of Contracts

In the fourth quarter of 2012, we determined that a purchase and sale agreement, as amended, with Evergreen Solar Systems India (P) Ltd. ("Evergreen") related to a module manufacturing line expansion was terminated due to a breach of contract by Evergreen. Evergreen had failed to make payments as required by the agreement and has not responded to numerous communications by us. In the fourth quarter of 2012, we recognized a gain on termination of contracts of $35 thousand which relates to Evergreen's non-refundable deposit. See Note 17 to the consolidated financial statements.

Other Expense, Net

We incurred interest expense of $138 thousand and $120 thousand in 2013 and 2012, respectively. The increase in interest expense is due to increased debt related to the term note with Middlesex Savings Bank retained in the third quarter of 2013 (see


Note 7 to the consolidated financial statements). We had currency exchange
losses of $9 thousand and $7 thousand in 2013 and 2012, respectively.

Income Taxes

We recorded a state income tax benefit from continuing operations of $2 thousand in 2013. We recorded an income tax benefit on our loss from continuing operations of $2.0 million in 2012, which was offset by a provision on our income from discontinued operations of $1.9 million in 2012. Gross federal net operating loss carryforwards were approximately $13.9 million as of December 31, 2013 and expire at various times through 2033. We have a full valuation allowance recorded against the net deferred tax assets at December 31, 2013 due to uncertainty regarding realization of these assets in the future.

Income from Discontinued Operations

During the first quarter of 2012, we began pursuing an exclusive sales process of our Semiconductor Business Unit. On March 9, 2012, we completed the sale of the Semiconductor Business Unit to Masimo. Accordingly, the results of operations and assets and liabilities of the Semiconductor Business Unit are being presented herein as discontinued operations.

During the second quarter of 2009, we began pursuing an exclusive sales process of our Medical Products Business Unit. On December 14, 2009, we completed the sale of the Medical Products Business Unit to Bard Access Systems, Inc. Accordingly, the results and liabilities of the Medical Products Business Unit are being presented herein as discontinued operations.

We recorded net income from discontinued operations of $2.9 million in 2012. Included in discontinued operations for 2012 is a gain on sale of business unit to Masimo of $5.4 million and an income tax provision of $1.9 million. Included in the gain of $5.4 million is proceeds received from Masimo of $8.0 million, less assets and liabilities assumed by Masimo of $2.1 million and legal and professional fees related to complete the sale of $425 thousand. See Note 18 to the consolidated financial statements.

Net Loss

We reported a net loss of $8.5 million and $1.9 million for 2013 and 2012, respectively. Net loss increased approximately $6.7 million, primarily due to a $4.9 million decline in 2013 income from discontinued operations before tax and a $3.0 million decline in 2013 solar business unit margin, partially offset by a $1.0 million decline in 2013 operating expenses and improved margin in the biomedical business of $197 thousand.

Net Loss Attributable to Noncontrolling Interest

We reported a net loss attributable to noncontrolling interest of $44 thousand and zero for 2013 and 2012, respectively. Net loss attributable to noncontrolling interest represents 80.1% of N2 Bio's net loss for 2013 and all of N2 Bio's costs associated with the transaction. See Note 19 to the consolidated financial statements.

Net Loss Attributable to Common Stockholders

We reported net loss attributable to common stockholders of $8.5 million and $1.9 million for 2013 and 2012, respectively. Net loss attributable to common stockholders increased approximately $6.6 million, primarily due to a $4.9 million decline in 2013 income from discontinued operations before tax and a $3.0 million decline in 2013 solar business unit margin, partially offset by a $1.0 million decline in 2013 operating expenses, improved margin in the biomedical business of $197 thousand and a reduction in net loss attributable to noncontrolling interest of $44 thousand.

Liquidity and Capital Resources
December 31, December 31, Increase (Decrease) (in thousands) 2013 2012 $ % Cash and cash equivalents $ 3,986 $ 3,030 $ 956 32 % Working capital $ 3,704 $ 6,616 $ (2,912 ) (44 )%

Cash and cash equivalents increased due to cash provided by financing activities, partially offset by cash used in operating activities. The overall decrease in working capital is due to an increase in current liabilities, primarily accounts payable, current portion of term loan and advances on contracts in progress along with a decrease in inventories, accounts receivable and current assets of discontinued operations, partially offset by increased cash and cash equivalents and deferred cost of good sold. We have


historically funded our operating cash requirements using operating cash flow, . . .

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