TMCnet News
LUNA INNOVATIONS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) 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 sensing and test & measurement products and are focused on bringing new and innovative technology solutions to measure, monitor, protect and improve critical processes in the aerospace, automotive, energy, composite, telecommunications and defense industries. In addition, we provide applied research services, typically under research programs funded by the U.S. government, in areas of advance materials, sensing and healthcare applications. 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 growth strategy is focused on becoming the leading provider of fiber optic strain & temperature sensing solutions and standard test methods for composite, as well as non-composite materials, structures and systems. We are organized into two main business segments, our Products and Licensing segment and our Technology Development segment. Our Products and Licensing segment develops, manufactures and markets our fiber optic sensing, as well as test and measurement products and also conducts applied research in the fiber optic sensing area for both corporate and government customers. We are continuing to develop and commercialize our fiber optic technology for strain and temperature sensing applications for the aerospace, automotive, and energy industries. Our Products and Licensing segment revenues represented approximately 40% and 36% of our total revenues for the three months ended March 31, 2014 and 2013, respectively. Our Technology Development segment performs applied research principally in the areas of sensing and instrumentation, advanced materials and health sciences. Our Technology Development segment comprised approximately 60% and 64% of our total revenues for the three months ended March 31, 2014 and 2013, respectively. Our Technology Development segment predominantly performs applied research in the areas of sensing and materials. 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. 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 increased from $2.6 million in the three 14 -------------------------------------------------------------------------------- Table of Contents months ended March 31, 2013 to $2.7 million for the three months ended March 31, 2014. 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 $7.8 million at March 31, 2014 and $8.7 million at December 31, 2013. Revenues from product sales are mostly derived from the sales of our sensing systems and products that make use of light-transmitting optical fibers, or fiber optics. 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 in Note 2 to our condensed consolidated financial statements included in this report, during the quarter ended March 31, 2014, we sold our shape sensing business in the medical field to affiliates of Intuitive Surgical, Inc., or Intuitive. As a part of this transaction, we entered into a revocable license agreement with Intuitive pursuant to which we have the right to use all of our transferred technology outside the field of medicine and in respect of our existing non-shape sensing products in certain non-robotic medical fields. Furthermore, in March 2013 we sold the assets associated with our secure computing and communications group, or SCC to MacAulay-Brown, Inc., or Mac-B, another defense contractor. As a result of these sales, we have reported the results of operations from medical shape sensing and SCC as discontinued operations in our condensed consolidated financial statements included elsewhere in this report. Net loss from continuing operations was $1.1 million for the quarter ended March 31, 2014, compared to $1.3 million for the quarter ended March 31, 2013. After giving effect to the results of discontinued operations, including the recognition of a $9.7 million gain, net of taxes, we recognized on the sale of medical shape sensing to Intuitive, we recorded net income attributable to common stockholders of approximately $8.5 million for the quarter ended March 31, 2014. For the quarter ended March 31, 2013, we recorded a net income attributable to common stockholders of approximately $2.8 million, including an after-tax gain of $4.0 million recognized on the sale of SCC. We expect to continue to incur increasing expenses as we seek to 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. In recent years, economic conditions around the world deteriorated, and the outlook for 2014 and beyond remains uncertain. This slowing of the economy, both in the United States and globally, reduced the financial capacities of some of our customers and potential customers, thereby slowing spending on the products and services we provide. Furthermore, reductions in government spending may impact the availability of new program awards in 2014. For example, the Budget Control Act commits the U.S. Government to reduce the federal deficit by $1.2 trillion over ten years through a combination of automatic, across-the-board spending cuts and caps on discretionary spending, or sequestration. Automatic across-the-board cuts required by sequestration could have a material adverse effect on our technology development revenue and, consequently, our results of operations. While the exact manner in which sequestration will impact our business is unclear, funding for programs in which we participate could be reduced, delayed or canceled. Our ability to obtain new contract awards also could be negatively affected. Our sales of SCC in 2013 and our medical shape sensing business in 2014 are expected to result in lower revenues until we can increase revenues significantly, primarily from product sales. As a result, we may incur greater net losses than we have in prior years. 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 15 -------------------------------------------------------------------------------- Table of Contents 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 60% and 64% of our total revenues for the three months ended March 31, 2014 and 2013, respectively. Our Products and Licensing 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 40% and 36% of our total revenues for the three months ended March 31, 2014 and 2013, 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 as well as overhead allocated to each of these activities. 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, 2013, as filed with the Securities and Exchange Commission on April 10, 2014 and amended on April 15, 2014. There have been no material changes to the descriptions therein. Results of Operations Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013 Revenues 16 -------------------------------------------------------------------------------- Table of Contents Three months ended March 31, 2014 2013 Change Revenues: Technology development revenues $ 2,675,452 $ 2,627,241 $ 48,211 2 % Products and licensing revenues 1,796,429 1,478,127 $ 318,302 22 % Total revenues $ 4,471,881 $ 4,105,368 $ 366,513 9 % Revenues from our Technology Development segment remained virtually unchanged from the three months ended March 31, 2013 compared to the three months ended March 31, 2014. Revenues from our Products and Licensing segment increased by $0.3 million from $1.5 million in the three months ended March 31, 2013 to $1.8 million for the same period in 2014. This increase in our Products and Licensing revenues was primarily attributable to increased sales of our OVA product line. Cost of Revenues and Gross Profit Three months ended March 31, 2014 2013 Change Cost of revenues: Technology development costs $ 2,025,155 $ 2,184,914 $ (159,759 ) (7 )% Products and licensing costs 894,640 785,728 $ 108,912 14 % Total cost of revenues $ 2,919,795 $ 2,970,642 $ (50,847 ) (2 )% Gross Profit $ 1,552,086 $ 1,134,726 $ 417,360 37 % The cost of our Technology Development segment revenues decreased primarily due to the payment of $0.1 million in severance related expenses associated with a reduction in the headcount in our optical systems group in the first quarter of 2013. The increase in cost of revenues in our Products and Licensing segment resulted from the increase in product sales noted above. Because of the overall increase in revenues of 9% in the three months ended March 31, 2014 compared to the three months ended March 31, 2013, with essentially no change in the associated cost of revenues, our gross profit increased to $1.6 million for the three months ended March 31, 2014, compared to $1.1 million for the three months ended March 31, 2013. Operating Expense Three months ended March 31, 2014 2013 Change Operating expense: Selling, general and administrative $ 2,755,078 $ 2,663,108 $ 91,970 3 % Research, development and engineering 749,154 712,952 $ 36,202 5 % Total operating expense $ 3,504,232 $ 3,376,060 $ 128,172 4 % Our selling, general and administrative expense increased 3% during the three months ended March 31, 2014, as compared to the same period in 2013. The increase was primarily due to increase in bids and proposal expenses in our Technology Development segment. Research, development and engineering expense remained virtually unchanged. Other Income 17 -------------------------------------------------------------------------------- Table of Contents During the three months ended March 31, 2014 and 2013, we recognized approximately $80,000 and $27,000, respectively, of rent from Mac-B for the partial sublease of our Roanoke facility. During the three months ended March 31, 2013, we also recognized other income of approximately $23,000 resulting from the amortization of the discount on the Hansen debt and approximately $48,000 in an insurance policy profit share. Interest Expense Interest expense for the three months ended March 31, 2014 was approximately $32,000 compared to interest expense of approximately $58,000 during the same period in 2013. The monthly average loan balance during the three months ended March 31, 2014 was $1.9 million compared to $3.5 million for the same period in 2013. The lower average loan balance accounted for the decrease in interest expense. Net Loss from Continuing Operations As a result of the foregoing, during the three months ended March 31, 2014, we incurred a net loss from continuing operations before income taxes of approximately $1.9 million, compared to a net loss from continuing operations before income taxes of approximately $2.2 million for the three months ended March 31, 2013. We also recorded an income tax benefit from utilization of our available net operating loss carryforwards of $0.8 million and $0.9 million for the three months ended March 31, 2014 and 2013, respectively. After recognition of the tax benefit, our loss from continuing operations was $1.1 million for the three months ended March 31, 2014 compared to a loss from continuing operations of $1.3 million for the three months ended March 31, 2013. Net Income from Discontinued Operations, Net of Income Taxes For the three months ended March 31, 2014, we recognized net income from discontinued operations of $9.7 million, compared to net income from discontinued operations of $4.1 million for the same period in 2013. For the three months ended March 31, 2014, this income resulted from the sale of our medical shape sensing business that occurred during this quarter. For the three months ended March 31, 2013, net income from discontinued operations consisted of $4.0 million gain on the sale of our SCC business, net of tax, in addition to an operating income from our medical shape sensing business of $0.2 million, partially offset by an operating loss of $0.1 million from our SCC business for the two months prior to the sale on March 1, 2013. Liquidity and Capital Resources At March 31, 2014, our total cash and cash equivalents were $10.9 million. We have a term loan with SVB which at March 31, 2014 had a balance of $1.8 million. This term loan matures on May 1, 2015. We also maintain a revolving line of credit of up to $1.0 million with SVB, under which no amounts are outstanding and the full borrowing capacity of $1.0 million remains available. The line of credit is currently scheduled to expire on May 18, 2014, and we are contemplating its renewal. The terms and conditions of our term loan and line of credit are described in Note 5 of our condensed consolidated financial statements included in this report. We believe that our cash balance as of March 31, 2014, in addition to a $6.0 million payment received from Intuitive in April 2014 as part of the sale of our medical shape sensing business, our expected operating cash flows and the funds available to us under the line of credit with SVB, provide adequate liquidity for us to meet our working capital needs over the next twelve months. Discussion of Cash Flows Recent Activity 18-------------------------------------------------------------------------------- Table of Contents Three months ended 2014 2013 Change Net cash used in operating activities $ (1,435,135 ) $ (272,352 ) $ (1,162,783 ) Net cash provided by investing activities 4,764,856 4,460,428 $ 304,428 Net cash used in financing activities (222,247 ) (261,539 ) $ 39,292 Net change in cash $ 3,107,474 $ 3,926,537 $ (819,063 ) During the first three months of 2014, operations used $1.4 million of net cash, as compared to the same period in 2013 in which operations used $0.3 million of net cash. During the first three months of 2014, our net income of $8.5 million was primarily the result of the after-tax gain on the sale of our medical shape sensing business of $9.7 million and a tax benefit of $0.8 million. Without the effects of that gain and tax benefit, our pre-tax loss from continuing operations was approximately $1.9 million. The pre-tax loss from continuing operations included charges for depreciation and amortization of $0.2 million and share-based compensation of $0.2 million both of which are non-cash items that do not impact cash flow for the period. Additionally, working capital remained virtually unchanged, and consisted of a $0.9 million decrease in accounts receivable due to improved collection efforts, which was offset by a $0.8 million decrease in accounts payable. During the three months ended March 31, 2013, operations used $0.3 million of net cash. Our net income of $2.8 million was primarily the result of the gain on the sale of SCC of $4.0 million and a tax benefit of $0.9 million. Without the effects of that gain and tax benefit, our pre-tax loss from continuing operations was $2.2 million. The pre-tax loss from continuing operations included charges for depreciation and amortization of $0.2 million and share-based compensation of $0.3 million, both of which are non-cash items that do not impact cash flow for the period. Additionally, changes in working capital provided net cash inflow of $1.3 million, consisting of a $2.0 million decrease in accounts receivable due to improved collection efforts, partially offset by a $0.2 million decrease in accounts payable and accrued liabilities and $0.3 million decrease in deferred credits. Our cash provided by investing activities is composed of purchases of equipment and capitalized costs associated with the prosecution of patents and the net cash proceeds from our sales of our medical shape sensing business and SCC. During the three months ended March 31, 2014, we had a net cash inflow of $5.0 million due to the sale of our medical shape sensing business. Also, during the period, we used $0.1 million for equipment purchases and $0.1 million in patent costs associated with certain intangible assets. During the three months ended March 31, 2013, we had a net cash inflow of $4.5 million due to the sale of SCC and used $0.1 million for equipment purchases. Net cash used in financing activities during the three months ended March 31, 2014 included the scheduled repayments of principal for our debt and lease obligations, which in the aggregate resulted in net cash outflows of $0.4 million partially offset by our receipt of $0.2 million upon the exercise of stock options during the period. Net cash used in financing activities during the three months ended March 31, 2013 included the scheduled repayments of principal for our debt and lease obligations, which in the aggregate resulted in net cash outflows of $0.3 million. Off-Balance Sheet Arrangements We have no material off-balance sheet arrangements as defined in Regulation S-K Item 303(a)(4)(ii). |