Company Background
We research, develop and commercialize innovative technologies in two primary areas of focus:
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Test & measurement, sensing, and instrumentation products; and
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We have a
disciplined and integrated business model that is designed to accelerate the process of bringing new and innovative products to market. We identify technologies that can fulfill large and unmet market needs and then take these technologies from the
applied research stage through commercialization. Although revenues from product sales currently represent less than half of our total revenues, we continue to invest in product development and commercialization, which we anticipate will lead to
increased product sales growth. In the future, we expect that revenues from product sales will represent a larger proportion of our total revenues. In addition, we anticipate that these revenues will reflect a broader and more diversified mix of
products as we develop and commercialize new products.
Our Business Model
We have developed a disciplined and integrated process to accelerate the development and commercialization of innovative technologies. Our business model
employs a market-driven approach and provides the infrastructure, resources and know-how throughout the process of developing and commercializing
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new products. To manage a diverse set of products effectively across a range of development stages, we are organized into two main groups: our Technology
Development Division and our Products Division. These groups work together through all product development stages, including:
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Searching for emerging technologies based on market needs;
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Conducting applied research;
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Developing and commercializing innovative products; and
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Applying proven technologies and products to new market opportunities.
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The strength of our business model is exemplified by our track record in taking innovative technologies from the applied research stage through product
development and ultimately to the creation of independent businesses. For example, we have created five companies in our areas of focus, two of which were sold to industry leaders in their fields and two of which were financed by private venture
capital. In addition, we have developed more than a dozen products serving several industries including energy, telecommunications, life sciences and defense.
Our commercialization strategy leverages opportunity teams which are cross-staffed with professionals from both our Products Division and our Technology Development Division. The objective of these opportunity teams
is to identify technologies that have demonstrated proof of concept and that are ready for further development. Each opportunity team includes personnel with a mix of intellectual property, technical and business backgrounds, including individuals
who have experience with venture capital-backed companies and others who have successfully run major divisions of large corporations. In addition, we plan to consult with members of our advisory board with respect to product development matters from
time to time. We believe that this combination of skills and experience is critical to the success of the product development process.
To
this end, we have rigorous processes to evaluate the merits of further developing any given technology. Investment proposals to develop technologies that have demonstrated proof-of-concept are submitted for consideration to our internal investment
committee. These proposals have the basic elements of a business plan, including market, competition, distribution, financing and intellectual property analyses. Our internal investment committee, which is composed of key members of our senior
management team, evaluates the merits of each proposal and makes investment decisions. It is at this stage that we first consider investing our own funds to finance continued development. Once qualified opportunities are approved, our internal
investment committee regularly reviews progress and evaluates whether or not to continue funding development of individual projects.
Products and
Services
Our principal products and product candidates are organized into two broad classestest & measurement, sensing,
and instrumentation products and health care products, all of which are managed by our Products Division. Our Products Division is supported by our Technology Development Division, which provides applied research services to our government and
corporate customers. The Technology Development Division seeks to continuously supply our Products Division with new opportunities. Our primary product lines and technology development services are described in more detail below.
Test & Measurement, Sensing, and Instrumentation Products
Luna Technologies Division
The cornerstone of our test & measurement, sensing and instrumentation business is our
Luna Technologies division, which we reacquired in September 2005. Our acquisition of Luna Technologies has significantly enhanced our development and production of optical fiber test & measurement and instrumentation products, as described
more fully below.
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Test and Measurement Equipment for Fiber Optic Components and Sub-Assemblies
Our test and measurement products monitor the integrity of fiber optic network components and subassemblies. These products are designed for manufacturers
and suppliers of optical components and sub-assemblies and allow them to reduce costs and improve the quality of their products. Most manufacturers and suppliers of optical components and modules currently use a combination of different types of
optical test equipment to identify and measure failures in optical networks, such as bad splices, bends, crimps and other reflective and non-reflective events. Our optical test equipment products replace the need for these multiple test products and
address all stages of the end users product development life cycle including: design verification, component qualification, assembly process verification and failure analysis.
Our Luna Technologies Division has two flagship product linesour Optical Vector Analyzer, or OVA, and our Optical Backscattering Reflectometer, or
OBR. Our award winning OVA platform allows manufacturers and suppliers of optical components and sub-assemblies to reduce costs and time-to-market by replacing multiple, time consuming and expensive measurement platforms with a single, integrated
and easy-to-use instrument. Our most recent version of OVA operating software provides customers with faster testing times, advanced data analysis options and an extended dynamic range relative to previous versions.
Our OBR is a highly sensitive diagnostic device that allows data and telecommunications companies and the service providers who maintain their own fiber
optic networks to reduce test time and improve product quality. Our OBR introduces the ability to inspect metropolitan fiber networks with higher resolution and better sensitivity than previously possible. Its user-friendly graphical user interface
also makes the OBR product suitable for both research and manufacturing applications. The OBR gives end users a very high resolution view that is similar to an X-Ray into the inner workings of a fiber optic network. The OBR also has a
feature that allows users to turn standard optical fiber into a continuous thermometer that could be used in a variety of applications including power generation, civil structure monitoring and industrial process control. We expect to increase sales
of our optical test equipment products by expanding our customer base beyond the telecommunications industry into avionics, defense and academic research laboratories. In July 2007, the OBR with distributed sensing received a 2007 R&D 100 Award
from the editors of R&D Magazine as one of the 100 most technologically significant new products introduced into the marketplace in the last year.
An upgraded version of the instrument, the OBR 4400, was announced in March 2007 and further enhanced the capabilities of the ultra-high resolution optical time domain reflectometer (OTDR) in a more compact design and
more powerful platform. With an increased range and millimeters of resolution, users can monitor the effects from component-level heating in optical amplifiers to strain and load redistribution in aircraft harnesses. Other applications include
temperature monitoring inside telecommunications cabinets and enclosures, and a feature that allows users to identify the location in fiber assemblies simply by touching the fiber.
Integrated Sensing
We have
significant knowledge and experience in distributed sensing systems, or DSS, which are products comprised of multiple sensors whose input is integrated through a fiber optic network and software. Our DSS products use fiber optic sensing technology
with an innovative monitoring system that allows several thousand sensors to be networked along a single optical fiber. Some key applications, markets and technical advantages of our DSS are described below.
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Distributed Strain
.
Potential markets for our DSS products include the airframe industry, integrated structural monitoring on civil structures and
space applications. For example, a major air frame manufacturer deployed our DSS products during fatigue tests to measure strain through a network of sensors distributed throughout an aircraft.
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Distributed Temperature
.
Our DSS product also enables the direct monitoring of temperature. Potential markets include industrial process control and
electrical system monitoring. For example, we
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have sold a network of distributed temperature sensors to a major manufacturer of electrical generators, which use our sensors to increase operational
efficiency and prolong generator life. We have also sold our DSS temperature sensors to NASA for both ultra-cold and extremely high-temperature measurements.
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Distributed Shape
.
A derivation of our distributed strain measurement technology is being utilized to enable three-dimensional shape and position
measurement. We are developing this technology for use in robotic tethers, flexible structures used by the US Navy for undersea systems, and other applications. We have also previously sold shape-sensing probes to a major aircraft manufacturer for
measuring shape on an aerodynamic surface.
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Tunable Lasers
In December 2006, we acquired the rights to manufacture an existing line of swept tunable lasers from a major laser manufacturer. We acquired this
technology and related manufacturing assets to allow us to compete more effectively in our existing fiber optic test and measurement as well as sensing markets. This laser went into initial production in October 2007. We are integrating this
technology into current and new products to help us provide our customers with faster and more flexible and cost-effective test and measurement products. With this technology in hand, we have been aggressively pursuing business opportunities in new
markets such as industrial and medical sensing.
Test and Measurement Equipment for Non-Destructive Industrial Testing
In addition to our fiber optic based products described above, we are developing a number of new devices that use high frequency sound, or ultrasonic,
waves to evaluate the physical properties of materials. In general, our devices can determine the physical condition of an object by analyzing numerical measurements taken from ultrasonic waves that interact with the object. Our quantitative
ultrasonic signal processing technology is designed to be extremely sensitive, detecting changes in the physical properties of the object studied. Our instruments report a numerical signature, not an image that is subject to interpretation and
sometimes requires an expert consultant. Our technology thus provides information that cannot be obtained by traditional non-quantitative ultrasonic methodologies. Our quantitative ultrasonic technology has applications in non-destructive industrial
testing.
Health Care Products
Medical Devices for Non-Invasive Monitoring and Diagnosis
Ultrasound is an important, non-invasive tool for diagnosis of
some medical conditions. All of our ultrasound medical products are built around a common platform, yet have customized processing and interfaces specific to each application. The pathway to market for medical diagnostic devices requires
pre-clearance by government agencies, for example, certification for safety through international standards as well as approval from the Food and Drug Administration, or FDA, through a 510(k) registration.
Our lead product in this field is our Emboli Detection and Classification (EDAC
®
) QUANTIFIER product. The EDAC
®
QUANTIFIER is a noninvasive medical device that uses quantitative ultrasound technology to count
emboli in ex-vivo blood circuits in real-time. Emboli can be air bubbles or solid matter (lipids or blood clots) and can enter the blood circuit during critical and invasive medical procedures such as cardio-pulmonary bypass surgery. Emboli can be
dangerous and are believed to be the cause of neurological or neuropsychological post-operative deficits and, in some cases, fatalities. The EDAC
®
system uses advanced ultrasound technology
to detect individual microemboli at rates up to 1000 per second. Employing complex algorithms originally developed for the defense industry, the system is designed to provide cardiothoracic surgeons, perfusionists and anesthesiologists with an
accurate rate of emboli in the blood circuit during heart-lung bypass and other operations.
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We launched the EDAC
®
QUANTIFIER in May 2006. We received FDA clearance of our 510(k) application for this product in May 2007.
In September 2007, we entered into a joint marketing alliance agreement with Terumo Cardiovascular
Systems Corporation (Terumo CVS). Under the terms of this agreement, Luna and Terumo CVS will market Lunas EDAC
®
; QUANTIFIER for clinical use in the United States. Terumo CVS is the
one of world's leading suppliers of products for cardiopulmonary bypass.
Medical Devices for Minimally Invasive Diagnostics, Surgery,
and Therapy
During 2007, we made significant progress in applying our award winning distributed fiber optic sensing technology to
enhance medical devices used for minimally invasive procedures for diagnostics, surgery, or therapy. This technology can be applied to measure the position and shape of an instrument inside the body, as well as pressure and temperature. It is
particularly beneficial to aid the navigation of robotic surgical devices in that it can provide real-time feedback of the shape, position, and location of the device. Similarly, it can provide the same benefits to non-robotic devices such as
endoscopes.
In June 2007, we announced that we had entered into an intellectual
property licensing, development, and supply agreement with Intuitive Surgical, Inc., a technology leader in robotic-assisted minimally invasive surgery. Under the terms of the multi-year agreement, we will develop and supply a fiber optic-based
shape sensing and position tracking system for integration into Intuitive Surgicals products, which includes the da Vinci
®
Surgical System.
We expect that this agreement with Intuitive Surgical will allow us to expand our presence within the medical devices market. Our shape sensing and
position tracking system promises to provide real-time position measurements to help surgeons navigate through the body. The system consists of software, instrumentation and disposable optical sensing fiber. Our technology is unique and designed to
provide the user with an accurate, direct and continuous measurement of device location with no adverse effect from line of sight limitations and without introducing electrical signals or radiation into the body.
Nanomaterial-based Medical Products
Our nanomaterial manufacturing and research and development team is developing advanced carbon
nanomaterials, which are molecular structures consisting of carbon atoms in distinctive geometric shapes. Such materials include Trimetasphere
®
nanomaterials, a new class of materials that
we describe in more detail below; fullerenes, which are carbon spheres that resemble a soccer ball; and carbon nanotubes, which are carbon rings shaped like a cylinder.
A Trimetasphere
®
nanomaterial is a
carbon sphere with three metal atoms and a nitrogen atom enclosed inside. Using different combinations of a group of 17 rare earth metals, we can develop thousands of different types of Trimetasphere
®
nanomaterials, each with distinctive properties and performance characteristics and each potentially marketable as a separate product. Each type of Trimetasphere
®
nanomaterial has distinctive chemical, physical or biological properties due to the properties of the metals enclosed in its carbon cage. We can further customize Trimetasphere
®
nanomaterials for specific applications by attaching different atoms or molecules to the surface of their carbon spheres. In some cases, the knowledge we gain from customizing Trimetasphere
®
nanomaterials for specific applications may provide us with new intellectual property covering Trimetasphere nanomaterials and may also provide us with new intellectual property covering carbon nanomaterials other
than Trimetasphere
®
nanomaterials, further expanding our inventory of potential new products. Through our collaborative relationship with Virginia Tech, we have obtained an exclusive
license to commercialize Trimetasphere
®
nanomaterials under an issued U.S. patent and pending U.S. applications.
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To date, we have won a number of government contracts funding new applications of nanotechnology. These
contracts have a value of approximately $9.9 million, of which approximately $3.0 million in revenue resulted from contracts entered into since January 2007. These contracts are partially funding our development of manufacturing processes to produce
nanomaterials in commercial quantities. Furthermore, we are researching and developing new applications exploring the physical properties of nanomaterials. We plan to continue to invest our own funds in these activities as well as competing for
additional research contracts to support these programs.
Medical Imaging
A potential market application of our nanomaterial technology is magnetic resonance imaging, or
MRI. MRI has been established as the imaging technology of choice for a broad range of applications, including the identification and diagnosis of a variety of medical disorders. MRI provides three-dimensional images that enable physicians to
diagnose and manage disease in a minimally invasive manner. MRI contrast agents, used in about 30% of MRI procedures, improve the resolution of images by enhancing the contrast in the organ or tissue in the body where the contrast agent circulates.
We anticipate that our Trimetasphere
®
nanomaterial contrast agents will offer two primary advantages over existing contrast agents: lower risk of toxicity and higher image contrast.
Most of the contrast agents approved by the FDA use gadolinium, a toxic metal. To neutralize gadoliniums toxicity, contrast agents
use organic compounds called chelates that wrap around the gadolinium, shielding the patient from its toxicity. However, chelates cannot neutralize the gadolinium if it escapes from the chelate. The longer the agent circulates, the greater the risk
of gadolinium escaping from the chelate and causing toxicity. As a result, the contrast agents currently in use need to be eliminated from the body quickly, making it difficult to produce high quality images. The FDA has also recently released a
black box warning to the radiology community regarding the dangers of all current gadolinium-based contrast agents to patients with impaired kidney function, noting that there have been at least 90 fatal outcomes within 18 months after the patient
received such contrast agents in an MRI procedure.
To solve this problem, our
Trimetasphere
®
nanomaterial MRI contrast agents utilize a completely new approach to preventing toxicity. Due to the strength of the Trimetasphere
®
nanomaterials carbon cage enclosing the gadolinium, we believe that our Trimetasphere
®
nanomaterial-based contrast agent can encapsulate gadolinium
for a longer period of time, and therefore allow the contrast agent to remain safely in the body longer. Experiments have also shown that our Trimetasphere
®
nanomaterials provide a stronger
contrast effect than the other contrast agents currently on the market. The first compound in this program is currently in preclinical development.
In addition to use as a general blood pooling agent, we are developing various modifications to
the Trimetasphere
®
nanomaterials to target them for specific tissues or physiological conditions. We believe that, using the Trimetasphere
®
nanomaterials, additional disease-targeting diagnostic agents can be created to enhance the capabilities of MRI and significantly expand its applications.
Medical contrast agents for human use must be approved by the FDA or similar foreign regulatory agencies before they can be marketed, which we do not
expect for several years. Please see the section titled Government Regulation below for more information about the regulatory approval process for our medical products.
We are also actively researching other applications for nanomaterial-based drugs based on the anti-oxidative characteristics of these materials. Such
products are in the early stages of development, but if successful, would offer new market opportunities for us.
During 2007, our
scientists, together with a team at Virginia Commonwealth University, published the discovery that carbon nanomaterials are effective at blocking allergic response in cultured human cells and
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laboratory animals. This published study used commercially available nanomaterials to reveal a previously unknown pathway to modulating the immune system. We
have an ongoing therapeutic program studying proprietary compounds in a number of different therapeutic areas, including immunology. We have filed two new patent applications to protect our recent discoveries in therapeutics.
Technology Development Division
Our
Technology Development Division provides applied research to customers in our primary areas of focus. Our Technology Development Division competes to win contracts in these areas on a fee-for-service basis. This group has a successful track record
of evaluating innovative technologies to address the needs of our customers. We identify these needs by utilizing our knowledge of the markets in our areas of focus and by consulting with major government entities, leading research universities and
large corporations. We also use this network to obtain favorable technology transfer agreements, contract research revenues and strategic partnerships for the products that we develop based on our applied research.
We are working or have worked with over 60 corporate, academic and government collaborators, including:
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Universities.
The College of William and Mary, Duke University, Georgia Institute of Technology, North Dakota State University, The Ohio State University,
The Pennsylvania State University, University of California, San Diego, University of Pittsburgh, University of Virginia, Washington University in St. Louis, University of Wyoming, and Virginia Polytechnic Institute and State University, or Virginia
Tech;
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Government entities.
Defense Advanced Research Projects Agency, Defense Threat Reduction Agency, Environmental Protection Agency, National Aeronautics and
Space Administration, National Institutes of Health, National Institute of Standards and Technology, National Science Foundation, United States Air Force, United States Army, United States Department of Agriculture, United States Department of
Commerce, United States Department of Defense, United States Department of Energy, United States Department of Transportation and United States Navy; and
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Corporations.
Anteon International Corporation, Applied Research Associates, Inc., Dana Corporation, Northrop Grumman Corporation, Boeing, Raytheon, Lockheed
Martin, General Dynamics, Sherwin-Williams and International Paint.
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We seek to continue to maximize the benefits we
derive from our contract research business, including revenue generation and identification of promising technologies for further development. We focus primarily on opportunities where we can retain partial or full rights to the intellectual
property developed and proactively target projects that we believe have the highest commercialization potential. Also, we take a disciplined approach to contract research to try to ensure that the costs of any contract we undertake are fully
covered. This approach enables us to cover the costs of riskier stage technology development with third-party funding. We believe that this model is cost efficient and reduces our risk significantly.
As of December 31, 2007, our Technology Development Division was engaged in 106 separate active contracts. Such contracts typically last from six
months to three years. These projects span a wide range of applications across our areas of focus.
Although we conduct our applied research
on a fee-for-service basis for third parties, we seek to retain full or partial rights to the technologies and patents developed under those contracts and to continuously enlarge and strengthen our intellectual property portfolio. Often, a new
technology that we develop complements existing technologies and enables us to develop applications and products that were not previously possible. In addition, the technologies we develop are often applicable to commercial markets beyond what was
originally contemplated in the contract research of such technologies and we endeavor to capture the value of those opportunities.
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As of December 31, 2007, our Technology Development Division team consisted of 125 full time
employees, including 42 with Ph.D.s and 63 with other advanced degrees. Our Technology Development Division also utilizes the knowledge and experience of researchers employed through the academic institutions, corporations and government agencies
with which we subcontract. The Technology Development Division is organized into subgroups according to the area of technology, with each subgroup managed by its own director responsible for its financial performance. In addition, our Technology
Development Division has in place disciplined processes designed to ensure quality control of proposal preparation, program reviews, pipeline reviews, revenue tracking and financial reporting.
Our Technology Development Division has a high historical success rate in winning bids for U.S. Government SBIR contracts, and we have won three National
Tibbetts Awards from the Small Business Administration for outstanding SBIR performance. SBIR contracts include Phase I feasibility contracts of up to $100,000 and Phase II proof-of-concept contracts, which can be as high as $750,000. We also
have been successful at winning contracts outside the SBIR program from corporations and government entities. Such contracts have no financial limit and typically have a longer duration, ranging from 12 to 24 months. As we continue to grow, one of
our goals is to derive a larger portion of our contract research revenues from contracts outside the SBIR program.
Other Technologies in Development
Through our Technology Development Division, we have also developed expertise with advanced materials for industrial, commercial and
military applications. Examples of product candidates in our pipeline that have demonstrated proof-of-concept include multi-functional protective coating systems and blast and ballistic resistant materials.
Multi-Functional Protective Coating Systems
We are exploring developing a family of multi-functional protective coating products to meet numerous market opportunities. Our approach involves the combination of innovative resin systems with commercially available and proprietary
additives to create high performance primers and topcoats. Our engineered coating systems are designed to have a variety of key performance attributes, including anti-corrosion, self-healing, rapid cure, non-skid, and tailored dielectric
properties. In addition to coatings, we are also developing other complementary products, such as surface cleaners and pretreatments that will improve the performance of the entire coating system.
Blast and Ballistic Resistant Materials
We are developing a variety of blast and ballistic resistant coatings, materials and composites for critical defense and homeland security applications. We combine resins, polymers, fibers, fabrics and composites that we have developed
with commercially-available components to create high strength, lightweight and flexible materials that range in application from soldiers to ships. Specific examples of potential applications include a new ammunition packaging system to
protect both ordnance and soldiers; a flexible blast resistant polymer to improve the integrity of ship deck coating systems and to prevent interior shrapnel in the event of an explosive blast; and lightweight, transparent, ballistic resistant
polymers for use in next generation military visors.
Our Growth Strategy
We have the following key strategies to achieve our goal of accelerating the development and commercialization of innovative technologies and to create
successful products in our areas of focus:
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Continue to expand our portfolio of innovative products.
We intend to build and commercialize a growing portfolio of high value-added products using
innovative technologies and utilize our existing relationships to identify, prioritize and allocate resources to respond rapidly to market needs and shorten the time to market for new products.
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Transition our mix of revenues to a higher percentage of product and license revenues.
We plan to commercialize a growing number of products in order to
increase the amount of revenues that we generate from product sales and license payments. To this end, we will seek to expand our distribution network and our ability to service our customers. We will also seek to allocate resources to improve our
ability to manufacture and shorten the cycle time from idea to market and to monetize our intellectual property portfolio by licensing our technologies. As a result, we believe that product sales and license revenues will comprise a greater portion
of our total revenues in the future.
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Continue to strengthen our Technology Development Division and actively pursue non-SBIR contracts.
We will seek to strengthen our Technology Development
Division through increased resource allocation and hiring and by expanding our network of relationships with federal laboratories, major research universities and industry leaders. These steps will provide us the opportunity to grow our applied
research business, remain informed of the latest technological advances and increase the quality and volume of high potential technologies that will support our product pipeline. We are also actively bidding on new non-SBIR contracts to increase our
backlog of non-SBIR contract revenue.
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Expand our intellectual property portfolio in our areas of focus.
We will seek to expand our intellectual property portfolio by applying our disciplined
processes to generate know-how and intellectual property through our network of relationships and our own research and development efforts. By continuing to expand our intellectual property portfolio, we will seek to enhance our competitive position
and develop additional products in these areas.
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Intellectual Property
We seek patent protection on inventions that we consider important to the development of our business. We rely on a combination of patent, trademark,
copyright and trade secret laws in the United States and other jurisdictions, as well as confidentiality procedures and contractual provisions to protect our proprietary technology and our brand. We control access to our proprietary technology and
enter into confidentiality and invention assignment agreements with our employees and consultants and confidentiality agreements with other third parties.
Our success depends in part on our ability to develop patentable products and obtain, maintain and enforce patent and trade secret protection for our products, as well as successfully defend these patents against
third party challenges both in the United States and in other countries. We will only be able to protect our technologies from unauthorized use by third parties to the extent that we own or have licensed valid and enforceable patents or trade
secrets that cover them. Furthermore, the degree of future protection of our proprietary rights is uncertain because legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep our competitive
advantage.
Currently, we own or license numerous U.S. patents and patent applications, and we intend to file, or request that our
licensors file, additional patent applications for patents covering our products. However, patents may not be issued for any pending or future pending patent applications owned by or licensed to us. Claims allowed under any issued patent or future
issued patent owned or licensed by us may not be valid or sufficiently broad to protect our technologies. Any issued patents owned by or licensed to us now or in the future may be challenged, invalidated or circumvented, and, in addition, the rights
under such patents may not provide us with competitive advantages. In addition, competitors may design around our technology or develop competing technologies. Intellectual property rights may also be unavailable or limited in some foreign
countries, which could make it easier for competitors to capture or increase their market share with respect to related technologies.
We
could incur substantial costs to defend ourselves in suits brought against us or in suits in which we may assert our patent rights against others. An unfavorable outcome of any such litigation could have a material adverse effect on our business and
results of operations.
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Executive Officers of the Registrant
The following table sets forth certain summary information concerning our senior executive officers. Additional information concerning our executive officers and directors may be found in our 2008 Proxy Statement,
which is incorporated by reference in Item 10 of Part II in this Annual Report on Form 10-K.
Kent A. Murphy, Ph.D.
, our
founder, has served as our President, Chief Executive Officer and Chairman of the Board since 1992. Dr. Murphy received his Ph.D. in Electrical Engineering from Virginia Polytechnic Institute and State University and is formerly a tenured
professor in Virginia Techs Bradley Department of Engineering, where he filed for over 35 patents. In 2001, he was named SBIR Entrepreneur of the Year and in 2004 was named Outstanding Industrialist of the Year by Virginias Governor
Warner. Dr. Murphy is the founding member of The Accelerating Innovation Foundation, a non-profit organization whose goal is to promote and facilitate development of a technology innovation cluster in the Mid-Atlantic region. Dr. Murphy is
not related to Edward G. Murphy, M.D., a member of our board of directors.
Dale E. Messick
has served as our Chief Financial
Officer since August 2006. Prior to joining the company, Mr. Messick served in various capacities, including Chief Financial Officer at Worldspan, a provider of transaction processing and information technology services to the global travel
industry. At Worldspan, Mr. Messick managed a staff of 160 throughout the United States, Mexico, and Europe and was responsible for accounting, financial reporting, budgeting, financial planning and analysis, and internal audit operations.
Mr. Messick received a B.B.A. in Accounting from The College of William and Mary and is a certified public accountant.
Scott A.
Graeff
has served as our Chief Commercialization Officer since August 2006 and previously served as our Chief Financial Officer since July 2005. Mr. Graeff was also a member of our Board of Directors from August 2005 until March 2006. From
December 1999 to June 2001, Mr. Graeff served as Chief Financial Officer of Liquidity Link, a software development company. From June 2001 to August 2002, Mr. Graeff served as President and Chief Financial Officer of Autumn Investments.
From August 2002 until July 2005, Mr. Graeff served as a Managing Director for Gryphon Capital Partners, a venture capital investment group. From August 2003 until July 2005, Mr. Graeff also served as the Acting Chief Financial Officer of
Luna Technologies, Inc. Mr. Graeff is presently a member of the Board of Directors of Provox Technologies Corporation, a provider of speech recognition-based medical documentation and workflow management systems, a position he has held since
June 2004. Mr. Graeff holds a B.S. in Commerce from the University of Virginia.
Scott A. Meller
has served as our President,
Contract Research Group, since September 2005. From May 2004 to September 2005, Mr. Meller served as our Chief Operating Officer. From October 2002 to May 2004, Mr. Meller served as our Vice President of Research and Development and
previously served as Director of Engineering from September 2000 to October 2002. Mr. Meller joined Luna Innovations in 1996 and was a major contributor to early research that led to spin-offs and new products, including Luna Technologies,
Inc. Mr. Meller holds a B.S. in Electrical Engineering from Clemson University, a M.S. in Electrical Engineering from Virginia Tech, and is a licensed Professional Engineer. He also holds three patents in optical fiber sensors and devices.
Kenneth D. Ferris
has served as President of Advanced Systems (part of our Products Division) since December 2005. Ken previously
worked with one of our spin-out ventures, Luna i-Monitoring. Prior to joining i-Monitoring in 2002, Ken worked for Carrier Access, where as VP and General Manger of Broadband Terminal Products, he was responsible for product development and product
management activities. Ken joined Carrier Access in August of 2000 when Carrier acquired Millennia Systems, a company he co-founded. Prior to 1998, Ken was a Vice President for FiberCom, as part of the team who developed the company from infancy to
maturity. Mr. Ferris holds a B.S. in Electrical Engineering from VirginiaTech.
Brian J. Soller, PhD
has served as President of
the Products Division since January 2008. Prior to this position, Dr. Soller served as Vice-President and General Manager of the Luna Technologies Division since 2001. Dr. Soller is a Goldwater Scholar who conducted his doctoral studies as
a National Defense Science and Engineering Graduate Fellow in optical science at the University of Rochester.
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Robert P. Lenk, Ph.D.
has served as President of our Luna nanoWorks Division since August 2005.
Prior to joining Luna Innovations, Dr. Lenk served as President of Oncovector Inc., a biopharmaceutical company since December 2003 and a member of its board of directors since May 2003. From July 1999 to September 2003, Dr. Lenk was
President and Chief Executive Officer of Therapeutics 2000, an inhalation pharmaceutical research company. Lenk holds a Ph.D. in Cell Biology from the Massachusetts Institute of Technology.
Other Key Employees
In addition to our executive
officers described above, the following is a summary of some of our other key technical personnel.
Mark Froggatt, Ph.D.
has been
our Chief Technology Officer since September 2005. He co-founded Luna Technologies in the fall of 2000 to develop instrumentation for fiber optic devices. Dr. Froggatt is the primary inventor of the technology used in the OVA and a leading
expert in the field of interferometric measurement. Before joining Luna Technologies, Dr. Froggatt worked at the NASA Langley Research Center developing ultrasonic and optical instrumentation for which he received eight patents. He received his
B.S. and M.S. degrees in Electrical Engineering from Virginia Tech and a Ph.D. from the University of Rochester Institute of Optics.
Joseph S. Heyman, Ph.D.
has served as our Chief Scientific Officer since May 2003. Dr. Heyman has over 30 patents and the distinction of winning four international IR-100 awards as one of the 100 most significant technology
developments of the year. Dr. Heyman served as Vice President and Chief Technology Officer of Nascent Technology Solutions from July 2001 to May 2003. He had a 36 year career at the NASA Langley Research Center, retiring as the Langley Chief
Technologist for the Director. Dr Heyman is an Adjunct Professor of Physics and Applied Science at The College of William and Mary. He received his B.A. in Physics from Northeastern University and his M.A. in Solid State Physics and Physical
Acoustics and his Ph.D. in Solid State Physics and Ultrasonics at Washington University.
Kenneth L. Walker, Ph.D.
has served as
Executive Vice President of our nanomanufacturing group since May 2005. Dr. Walker founded a specialty photonic devices business within Lucent Technologies Inc. which grew from a concept to a business with over $200 million in revenues. Upon
the divestiture of this business to Furukawa Co., Ltd., Dr. Walker continued as President of the division. Dr. Walker received his undergraduate degree from the California Institute of Technology and his Ph.D. degree from Stanford
University.
Competition
Our
Technology Development Division competes for government, university and corporate research contracts relating to a broad range of technologies. Competition for contract research is intense and the industry has few barriers to entry. We compete
against a number of in-house research and development departments of major corporations, as well as a number of small, limited-service contract research providers. The contract research industry continues to experience consolidation, which has
resulted in greater competition for clients. Increased competition might lead to price and other forms of competition that could harm our operating results. We compete for contract research on the basis of a number of factors, including reliability,
past performance, expertise and experience in specific areas, scope of service offerings, technological capabilities and price.
We also
compete, or will compete, with a variety of companies in several different product markets. The products that we have developed or are currently developing will compete with other technologically innovative products, as well as products
incorporating conventional materials and technologies. We expect that our products will compete with companies in a wide range of industries, including semiconductors, electronics, biotechnology, textiles, alternative energy, military, defense,
healthcare, telecommunications, industrial measurement, security applications and consumer electronics. Although there can be no assurance that we will continue to do so, we believe that we compete favorably in these areas. If we are unable to
effectively compete in these areas in the future, we could lose business to our competitors, which could harm our operating results.
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Government Regulation
Qualification for Small Business Innovation Research Grants
We presently derive a significant portion of our revenue from
the U.S. Governments Small Business Innovation Research, or SBIR, program administered by the U.S. Small Business Administration, or SBA. SBIR is a highly competitive program that encourages small businesses to explore their technological
potential and provides them incentive to profit from the commercialization of technologies. Each year, U.S. government federal agencies and departments are required to set aside a portion of their grant awards for SBIR-qualified organizations. SBIR
contracts include Phase I feasibility contracts of up to $100,000 and Phase II proof-of-concept contracts, which can be as high as $750,000. Several of our research contracts have used this program as a key source of project funding to develop new
technologies.
We must continue to qualify for the SBIR program in order to be eligible to receive future SBIR awards. The eligibility
requirements are:
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Ownership.
The company must be at least 51 percent owned and controlled by U.S. citizens or permanent resident aliens, or owned by an entity that is itself
at least 51 percent owned and controlled by U.S. citizens or permanent resident aliens; and
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Size.
The company, including its affiliates, cannot have more than 500 employees.
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These requirements are set forth in the SBAs regulations and are interpreted by the SBAs Office of Hearings and Appeals. In determining
whether we satisfy the 51% equity ownership requirement, agreements to merge, stock options, convertible debt and other similar instruments are given present effect by the SBA as though the underlying security were actually issued unless
the exercisability or conversion of such securities is speculative, remote or beyond the control of the security holder. We therefore believe our outstanding options and warrants held by eligible individuals may be counted as outstanding equity for
purposes of meeting the 51% equity ownership requirement. As of December 31, 2007, giving present effect to our outstanding options, we estimate that at least 60% of our equity is owned by U.S. citizens or permanent residents.
In addition, to be eligible for SBIR contracts, the number of our employees, including those of any entities that are considered to be affiliated with
us, cannot exceed 500. As of December 31, 2007, we, including all of our divisions, had 217 full and part-time employees. In determining whether we have 500 or fewer employees, the SBA may count the number of employees of entities that are
large stockholders who are affiliated, or have the power to control us. In determining whether two or more firms are affiliated, the SBA will look at factors such as stock ownership or common management, but ultimately will make its
determination based on the totality of the circumstances. The SBA presumes that a large stockholder of ours has the power to control us absent evidence rebutting that presumption. With respect to Carilion Clinic (formerly Carilion Health
System), our largest institutional stockholder, we believe we would not be required to count the employees of Carilion Clinic. We believe the relative beneficial ownership of our individual stockholders rebuts the presumption of control by Carilion
Clinic because the shares held by our officers and directors constitute the controlling voting interest in us. Eligibility protests can be raised to the SBA by a competitor or by the awarding contracting agency. Accordingly, a company can be
declared ineligible for a contract award as a result of a competitors protest to the SBA or as a result of questioning by the awarding contracting agency. We believe that we are currently in compliance with the SBIR eligibility criteria, but
we cannot provide assurance that the SBA will interpret its regulations in our favor. As we grow larger, and as our ownership becomes more diversified, we may no longer qualify for the SBIR program, and we may be required to seek alternative sources
and partnerships to fund some of our research and development costs. Additional information regarding these risks may be found in Part I, Item 1A of this Annual Report on Form 10-KRisk Factors
FDA Regulation of Products
Some of the products that we are developing are subject to regulation under the Food Drug and Cosmetic (FDC) Act. In particular, our Trimetasphere
®
nanomaterial-based MRI contrast agent and our ultrasound
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diagnostic devices for measuring certain medical conditions will be considered a drug and medical devices, respectively, under the FDC Act. Both the statutes
and regulations promulgated under the FDC Act govern, among other things, the testing, manufacturing, safety efficacy, labeling, storage, recordkeeping, advertising and other promotional practices involving the regulation of drug and devices.
Medical Devices
Our existing and future health care products, including our EDAC
®
product, are regulated by the FDA as medical devices. The nature of the requirements applicable to devices depends on their classification by the FDA. A device developed by us would be automatically
classified as a Class III device, requiring pre-market approval, unless the device is substantially equivalent to an existing device that has been classified in Class I or Class II or to a pre-1976 device that has not yet been classified or we
convince the FDA. Class I or Class II devices require registration through the 510(k) exemption. If we were unable to demonstrate such substantial equivalence and unable to obtain reclassification, we would be required to undertake the costly
and time-consuming process, comparable to that for new drugs, of conducting preclinical studies, obtaining an investigational device exemption to conduct clinical tests, filing a pre-market approval application, and obtaining FDA approval.
If the device were a Class I product, the general controls of the Federal Food, Drug, and Cosmetic Act, chiefly adulteration, misbranding
and good manufacturing practice requirements, would nevertheless apply. If substantial equivalence to a Class II device could be shown, the general controls plus special controls, such as performance standards, guidelines for safety and
effectiveness, and post-market surveillance, would apply. While demonstrating substantial equivalence to a Class I or Class II product is not as costly or time-consuming as the pre-market approval process for Class III devices, it can in some
cases also involve conducting clinical tests to demonstrate that any differences between the new device and devices already on the market do no affect safety or effectiveness. If substantial equivalence to a pre-1976 device that has not yet
been classified has been shown, it is possible that the FDA would subsequently classify the device as a Class III device and call for the filing of pre-market approval applications at that time. If the FDA took that step, then filing an
application acceptable to the FDA would be a prerequisite to remaining on the market.
New Drug Development
Our nanomaterial based drug candidates, including our MRI contrast agent product candidates, are regulated by the FDA as pharmaceuticals. Obtaining FDA
approval for a new drug has historically been a costly and time consuming process. Generally, in order to gain FDA premarket approval, a developer first must conduct preclinical studies in the laboratory and in animal model systems to gain
preliminary information on an agents efficacy and to identify any safety problems. The results of these studies are submitted as a part of an investigational new drug, or IND, application which the FDA must review before human clinical trials
of an investigational drug can start. The IND application includes a detailed description of the clinical investigations to be undertaken. In order to commercialize any drug, we must sponsor and file an IND application and be responsible for
initiating and overseeing the clinical studies to demonstrate the safety, efficacy and potency that are necessary to obtain FDA approval of any of the products. We will be required to select qualified investigators to supervise the administration of
the products and ensure that the investigations are conducted and monitored in accordance with FDA regulations. Clinical trials are normally done in three phases, although the phases may overlap. Phase I trials are concerned primarily with the
safety and preliminary effectiveness of the drug, involve fewer than 100 subjects and may take from six months to over one year. Phase II trials typically involve a few hundred patients and are designed primarily to demonstrate effectiveness in
treating or diagnosing the disease or condition for which the drug is intended, although short-term side effects and risks in people whose health is impaired may also be examined. Phase III trials are expanded clinical trials with larger numbers of
patients which are intended to evaluate the overall benefit-risk relationship of the drug and to gather additional information for proper dosage and labeling of the drug. The process of clinical trials generally takes two to five years to complete,
but may take longer. The FDA receives reports on the progress of each phase of clinical testing, and it may require the modification, suspension or termination of clinical trials if it concludes that an unwarranted risk is presented to patients.
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If clinical trials of a new product are completed successfully, the sponsor of the product may seek FDA
marketing approval. If the product is regulated as a drug, the FDA will require the submission and approval of a new drug application, or NDA, before commercial marketing of the drug. The NDA must include detailed information about the drug and its
manufacture and the results of product development, preclinical studies and clinical trials. The testing and approval processes require substantial time and effort, and we cannot guarantee that any approval will be granted on a timely basis, if at
all. If questions arise during the FDA review process, approval can take more than five years. Even with the submissions of relevant data, the FDA may ultimately decide that the NDA does not satisfy its regulatory criteria for approval and deny
approval or require additional clinical studies. In addition, the FDA may condition marketing approval on the conduct of specific post-marketing studies to further evaluate safety and effectiveness. Even if FDA regulatory clearances are obtained, a
marketed product is subject to continual review. Later discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the marketing of a product or withdrawal of the product
from the market as well as possible civil or criminal sanctions.
Environmental Regulation
Our facilities and current and proposed activities involve the use of a broad range of materials that are considered hazardous under applicable laws and
regulations. Accordingly, we are subject to a number of foreign and domestic laws and regulations relating to health and safety, protection of the environment, product labeling and product take back, and the storage, use, disposal of, and exposure
to, hazardous materials and wastes. We could incur costs, fines and civil and criminal penalties, personal injury and third party property damage claims, or we could be required to incur substantial investigation or remediation costs if we were to
violate or become liable under environmental, health and safety laws. Moreover, a failure to comply with environmental laws could result in fines and the revocation of environmental permits, which could prevent us from conducting our business.
Liability under environmental laws can be joint and several and without regard to fault. There can be no assurance that violations of environmental health and safety laws will not occur in the future as a result of the inability to obtain permits,
human error, equipment failure or other causes. Environmental laws could become more stringent over time, imposing greater compliance costs and increasing risks and penalties associated with violations, which could harm our business. Further,
violations of present and future environmental laws could restrict our ability to expand facilities, pursue certain technologies, and could require us to acquire costly equipment, or to incur potentially significant costs to comply with
environmental regulations.
The European Union Directive 2002/96/EC on Waste Electrical and Electronic Equipment, known as the WEEE
Directive, requires producers of certain electrical and electronic equipment, including monitoring instruments, to be financially responsible for specified collection, recycling, treatment and disposal of past and present covered products
placed on the market in the European Union. As a manufacturer of covered products, we may be required to register as a producer in some European Union countries, and we may incur some financial responsibility for the collection, recycling, treatment
and disposal of both new products sold, and products already sold prior to the WEEE Directives enforcement date, including the products of other manufacturers where these are replaced by our own products. European Union Directive 2002/95/EC on
the Restriction of the Use of Hazardous Substances in electrical and electronic equipment, known as the RoHS Directive, restricts the use of certain hazardous substances, including mercury, lead and cadmium in specified covered products;
however, the RoHS Directive currently exempts monitoring instruments from its requirements. If the European Commission were to remove this exemption in the future, we would be required to change our manufacturing processes, and redesign products
regulated under the RoHS Directive in order to be able to continue to offer them for sale within the European Union. For some products, substituting certain components containing regulated hazardous substances may be difficult or costly, or result
in production delays. We will continue to review the applicability and impact of both directives on the sale of our products within the European Union. Although we cannot currently estimate the extent of such impact, they are likely to result in
additional costs, and could require us to redesign or change how we manufacture our products, any of which could adversely affect our operating results. Failure to comply with the directives could result in the imposition of fines and penalties,
inability to sell covered products in the European Union and loss of revenues.
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We have made, and will continue to make, expenditures to comply with current and future environmental
laws. We anticipate that we could incur additional capital and operating costs in the future to comply with existing environmental laws and new requirements arising from new or amended statutes and regulations. In addition, because the applicable
regulatory agencies have not yet promulgated final standards for some existing environmental programs, we cannot at this time reasonably estimate the cost for compliance with these additional requirements. The amount of any such compliance costs
could be material. We cannot predict the impact that future regulations will impose upon our business.
Employees
As of December 31, 2007, we had 200 full time employees, 53 of which hold Ph.D.s and 90 of which hold other advanced degrees. None of our employees
are covered by a collective bargaining agreement, and we consider our relationship with our employees to be good.
Geographic Areas
For segment information with respect to our geographic markers, see Note 14 to our Consolidated Financial Statements in Part II, Item 8 of
this Annual Report on Form 10-K
Advisory Board
To assist us in executing our commercialization business model, we have assembled an advisory board of leaders with backgrounds in government, academia and industry with which we consult on a formal and informal basis regarding strategic
and technical matters. In connection with their appointment to and as consideration for their service on the advisory board, each advisor receives a stock option grant to purchase shares of our common stock.
Our advisory board members currently include the following:
Frank Bonsal, Jr.
is co-founder of the venture capital firm New Enterprise Associates, or NEA, where he has focused on the development of its early stage companies. He is also a co-founder of Red Abbey Venture
Partners in Lutherville, Maryland and he is a special limited partner of Amadeus Capital Partners, Boulder Ventures, Novak Biddle Venture Partners, Trellis Ventures and Windward Ventures. Mr. Bonsals current board memberships include
Advertising.com, Inc., CeraTech and Cibernet Corporation. Mr. Bonsal is also a member on the Johns Hopkins Hospital Endowment Board. Prior to founding NEA, Mr. Bonsal was a general partner of Alex. Brown & Sons Inc.
Terry Brady
was most recently employed by Oridion Systems Ltd. to launch a new division in the United States. Prior to joining Oridion Systems
Ltd., Mr. Brady founded Array Medical, Inc., where he served as President and Chief Executive Officer. Before founding Array Medical, Inc., Mr. Brady was President of International Technidyne Corporation Commercial Group.
Ronald E. Carrier, Ph.D.
is currently president emeritus of James Madison University, where he served previously as President for 27 years. During
his presidency, James Madison University changed from a teachers college to a major comprehensive university. Dr. Carrier has been active on a number of national and state commissions and has been a board member of several companies that
have been acquired by Fortune 200 companies.
John F. Hay
is currently a principal with P3 Consulting, LLC in Washington, D.C.
Mr. Hay has over 40 years of experience in the national security arena having served twelve years as an industry executive and thirty one years in uniform with the Department of the Navy. In 2000, Mr. Hay was appointed to the Bush-Cheney
Transition Advisory Committee and subsequently served as an advisor to the Secretary of Defense and the
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NASA Administrator. He currently serves as an advisor to the Secretary of the Army and is a member of the Army Science Board. During his time in industry,
Mr. Hay was Senior Vice President, Corporate and International Affairs for Westinghouse Electric and CBS Corporation. Before joining Westinghouse, Mr. Hay spent five years as a Congressional Affairs Officer in the Office of the Secretary
of the Army. During the previous twenty-six years, his military service included serving in the Chief of Staff of the Armys Office and a series of command and staff assignments in Infantry, Special Operations, Intelligence and Military Police
units. Mr. Hay received his bachelors degree from the University of Nebraska, his masters degree from Wichita State University and is a graduate of the U.S. Army Command and Staff College and the FBI National Academy.
Charles Edward Hamner, Jr. DVM, Ph.D.
is currently the President and CEO of Hamner Advisory Service; he specializes in management in the
pharmaceutical and health care industries and academic administration. From 1988-2002 Dr. Hamner served as President and CEO of the North Carolina Biotechnology Center, and was a Research Professor in the OB/GYN Department at the University of
North Carolina at Chapel Hill. He has also worked as Associate Vice President for Health Affairs at the University of Virginia Medical Center (1978-1988), and served as Interim Executive Director for the Center in 1981. Dr. Hamner received
his bachelors degree in Animal Science from Virginia Tech and his masters degree in Chemistry, DVM in Veterinary Medicine and Ph.D. in Bio-Chemistry from the University of Georgia.
Sir Harold W. Kroto
is one of the co-recipients of the 1996 Nobel Prize in Chemistry. Dr. Krotos Nobel Prize was based on his
co-discovery of buckminsterfullerene, a form of pure carbon better known as buckyballs. Dr. Kroto earned his Doctorate in chemistry from the University of Sheffield. He started his academic career at the University of Sussex at
Brighton in 1967, where he became a professor in 1985 and, in 1991 was made a Royal Society Research Professor.
The Honorable John O.
Marsh Jr.
is currently a Senior Fellow at the National Center for Technology and Law and a Distinguished Adjunct Professor at the George Mason University School of Law. Prior to that, Mr. Marsh served in the U.S. House of Representatives
for Virginia, as Secretary of the Army for eight years, and as National Security Advisor to Vice President and, later, President Gerald R. Ford. Mr. Marsh is also the former Chairman and interim Chief Executive Officer of Novavax, Inc., a
specialty biopharmaceutical company. Mr. Marsh received his law degree from Washington and Lee University.
John B.
Noftsinger, Jr., Ph.D.
is currently the Associate Vice President of Academic Affairs for Research and Program Innovation, the Executive Director of the Institute for Infrastructure and Information Assurance, and an Associate Professor of
Integrated Science and Technology and Education at James Madison University, where he specializes in interdisciplinary program and grant development. Dr. Noftsinger is also the Co-Chair of the Virginia Research and Technology Advisory
Committee and the Chair of the Virginia Technology Alliance.
Jerre Stead
is currently Chairman of IHS, Inc. and is the former
Chairman and Chief Executive Officer of Ingram Micro Inc. He previously served as Chief Executive Officer of Legent Corporation, Chairman and Chief Executive Officer of AT&T Global Information Solutions, and Chairman, President, and Chief
Executive Officer of Square D Company. Mr. Stead also serves on the board of directors of TBG, Armstrong World Industries, Inc., Brightpoint, Inc., Conexant Systems, Inc., Mindspeed Technologies, Inc., and Mobility Electronics, Inc.
G. Kim Wincup
is senior vice president of Science Applications International Corporation. Mr. Wincup previously served as counsel to the
U.S. House of Representatives Armed Services Committee and U.S. House of Representatives Veterans Affairs Committee, as staff director of the U.S. House of Representatives Armed Services Committee and the Joint Committee on the Organization of
Congress, and as Assistant Secretary of both the Air Force and the Army. Mr. Wincup has a bachelors degree in Political Science from DePauw University, and received a law degree from the University of Illinois School of Law.
General Larry D. Welch
was formally the U.S. Air Force Chief of Staff. As Chief, he served as the senior uniformed Air Force Officer
responsible for the organization, training and equipage of a combined active duty,
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Guard, Reserve and civilian force serving at locations in the United States and overseas. As a member of the Joint Chiefs of Staff, he and the other service
chiefs functioned as the principal military advisers to the secretary of defense, National Security Council and the President. General Welch received a bachelors degree in Business Administration from the University of Maryland and a Masters
Degree in International Relations from the George Washington University. General Welch completed Armed Forces Staff College at Norfolk, Va., in 1967, and National War College at Fort Lesley J. McNair, Washington, D.C., in 1972.
Website Access to Reports
We make our periodic and
current reports available, free of charge, on our website as soon as practicable after such material is electronically filed with the Securities and Exchange Commission. Our website address is
www.lunainnovations.com
and such reports are
filed under SEC Filings on the Investor Relations portion of our website. Further, a copy of this annual report as well as our other periodic and current reports may be obtained from the SEC, located at the SECs public reference
room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information
statements, and other information regarding our filings at www.sec.gov.
You should carefully consider the
risks described below before deciding whether to invest in our common stock. The risks described below are not the only ones we face. Additional risks not presently known to us or that we currently believe are immaterial may also impair our business
operations and financial results. If any of the following risks actually occurs, our business, financial condition or results of operations could be adversely affected. In such case, the trading price of our common stock could decline and you could
lose all or part of your investment. Our filings with Securities and Exchange Commission also contain forward-looking statements that involve risks or uncertainties. Our actual results could differ materially from those anticipated in these
forward-looking statements as a result of certain factors, including the risks we face described below.
RISKS RELATING TO OUR BUSINESS
If we are unable to manage our growth effectively, our revenue and net loss could be adversely affected.
While historically we have developed and commercialized only a few products at a time, we plan to grow by developing and commercializing multiple products
concurrently across many industries, technologies and markets. Our ability to grow by developing and commercializing multiple products simultaneously requires that we manage a diverse range of projects, and expand our personnel resources. Our
inability to do any of these could prevent us from successfully implementing our growth strategy, and our revenues and profits could be adversely affected.
To advance the development of multiple promising potential products concurrently, we need to manage effectively the logistics of maintaining the requisite corporate, operational, administrative and financing functions
for each of these product opportunities. Potentially expanding our operations into new geographic areas and relying on multiple facilities to develop and manufacture different products concurrently pose additional challenges. We have little
experience in managing these functions simultaneously for multiple projects in development or in building new infrastructure and integrating the operations of various facilities. If we cannot manage this process successfully, we may be subject to
operating difficulties, additional expenditures and limited revenue growth.
We need to expand our personnel resources to grow our business
effectively. We believe that sustained growth at a higher rate will place a strain on our management, as well as on our other human resources. To manage this growth, we must continue to attract and retain qualified management, professional,
scientific and technical and operating personnel. During 2007, the labor market, particularly for highly-specialized scientists
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and engineers remained tight. If we are unable to recruit a sufficient number of qualified personnel, we may be unable to staff and manage projects
adequately, which may slow the rate of growth of our contract research revenue or our product development efforts.
If we cannot successfully
transition our revenue mix from contract research revenues to product sales and license revenues, we may not be able to fully execute our business model or grow our business.
Our business model and future growth depend on our ability to transition to a revenues mix that contains significantly larger product sales and
license revenues components. Product sales and license revenues potentially offer greater scalability than services-based contract research revenues. Our current plan is to increase our portfolio of commercial products and, accordingly, we
expect that our future product sales and license revenues will represent a larger percentage of total revenues. However, if we are unable to develop and grow our product sales and license revenues to augment our contract research
revenues, our ability to execute our business model or grow our business could suffer.
We may not be successful in identifying market
needs for new technologies and developing new products to meet those needs.
The success of our business model depends on our
ability to identify correctly market needs for new technologies. We intend to identify new market needs, but we may not always have success in doing so, in part, because our contract research largely centers on identification and development of
unproven technologies, often for new or emerging markets. Furthermore, we must identify the most promising technologies from a sizable pool of projects. If our commercialization strategy process fails to identify projects with commercial potential
or if management does not ensure that such projects advance to the commercialization stage, we may not successfully commercialize new products and grow our revenues.
Our growth strategy requires that we not only identify new technologies that meet market needs,
but that we also develop successful commercial products that address those needs. We face several challenges in developing successful new products. Many of our existing products and those currently under developmentincluding our
Trimetasphere
®
carbon nanomaterials, which are nanomaterials in the form of a carbon sphere with three metal atoms enclosed insideare technologically innovative and require
significant and lengthy product development efforts. These efforts include planning, designing, developing and testing at the technological, product and manufacturing-process levels. These activities require us to make significant investments.
Although there are many potential applications for our technologies, our resource constraints require us to focus on specific products and to forgo other opportunities. We expect that one or more of the potential products we choose to develop will
not be technologically feasible or will not achieve commercial acceptance, and we cannot predict which, if any, of our products we will successfully develop or commercialize. The technologies we research and develop are new and steadily changing and
advancing. The products that are derived from these technologies may not be applicable or compatible with the state of technology or demands in existing markets. Our existing products and technologies may become uncompetitive or obsolete if our
competitors adapt more quickly than we do to new technologies and changes in customers requirements. Furthermore, we may not be able to identify if and when new markets will open for our products given that future applications of any given
product may not be readily determinable, and we cannot reasonably estimate the size of any markets that may develop. If we are not able to successfully develop new products, we may be unable to increase our product revenues.
We have incurred recent losses, and because our strategy for expansion may be costly to implement, we may experience continuing losses which may be significant.
We incurred consolidated net losses of approximately $9.4 million and $7.8 million for the years ended December 31, 2006
and 2007, respectively. We expect to continue to incur significant additional expenses as we expand our business, including increased expenses for research and development, sales and marketing, manufacturing, finance and accounting personnel and
expenses associated with being a public company. We may
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also grow our business in part through acquisitions of additional companies and complementary technologies which could cause us to incur greater than
anticipated transaction expenses, amortization or write-offs of intangible assets and other acquisition-related expenses. As a result, we expect that we may likely continue to incur losses for the foreseeable future, and these losses could be
substantial.
Because of the numerous risks and uncertainties associated with our business and our expansion strategy, we are unable to
predict when or if we will be able to achieve profitability again. If our revenues do not increase, or if our expenses increase at a greater rate than our revenues, we will continue to experience losses. Even if we do achieve profitability, we may
not be able to sustain or increase our profitability on a quarterly or annual basis.
Our failure to attract, train and retain skilled employees
would adversely affect our business and operating results.
The availability of highly trained and skilled technical and
professional personnel is critical to our future growth and profitability. Competition for scientists, engineers, technicians and professional personnel is intense and competitors aggressively recruit key employees. We have recently experienced
difficulties in recruiting and hiring these personnel as a result of the tight labor market in certain fields. This fact, combined with our growth strategy and future needs for additional experienced personnel, particularly in highly specialized
areas such as nanomaterial manufacturing and innovative ultrasound technologies, may make it more difficult to meet all of our needs for these employees in a timely manner. Although we intend to continue to devote significant resources to recruit,
train and retain qualified employees, we may not be able to attract and retain these employees, especially in technical fields where the supply of experienced qualified candidates is limited. Any failure to do so would have an adverse effect on our
business.
In addition, our future success depends in a large part upon the continued service of key members of our senior management team.
In particular, our Chairman, CEO and founder, Kent A. Murphy, Ph.D., is essential to our overall management as well as the development of our technologies, our culture and our strategic direction. All of our executive officers and key employees are
at-will employees, and, except with respect to Kent A. Murphy, Ph.D., we do not maintain any key-person life insurance policies. The loss of any of our management or key personnel could seriously harm our business.
We rely and will continue to rely on contract research, including government-funded research contracts, for a significant portion of our revenues. A decline in
government funding of existing or future government research contracts, including Small Business Innovation Research (or SBIR) revenues, could adversely affect our revenues and cash flows and our ability to fund our growth.
Technology development revenue, which consists primarily of government-funded research, accounted for approximately 79.8% and 69.3% of our total
consolidated total revenues for the years ended December 31, 2006 and 2007, respectively. As a result, we are vulnerable to adverse changes in our revenues and cash flows if a significant number of our government research contracts and
subcontracts are simultaneously delayed or canceled for budgetary, performance or other reasons. The U.S. government may cancel these contracts at any time without cause and without penalty or may change its requirements, programs or contract
budget, any of which could reduce our revenues and cash flows from U.S. government research contracts. Our revenues and cash flows from U.S. government research contracts could also be reduced by declines or other changes in U.S. defense,
homeland security and other federal agency budgets. In addition, we compete as a small business for some of these contracts, and in order to maintain our eligibility to compete as a small business, we (together with any affiliates) must continue to
meet size and revenue limitations established by the U.S. government.
In addition to contract cancellations and changes in agency budgets,
our future financial results may be adversely affected by curtailment of the U.S. governments use of contract research providers, including curtailment due to government budget reductions and related fiscal matters. These or other
factors could cause U.S. defense and other federal agencies to conduct research internally rather than through commercial research
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organizations, to reduce their overall contract research requirements or to exercise their rights to terminate contracts. Any of these actions
could limit our ability to obtain new contract awards and adversely affect our revenues and cash flows and our ability to fund our growth.
We also derive a significant portion of our technology development revenues from SBIR contracts. SBIR revenues accounted for approximately 61% and 47% of our consolidated total revenues for the year ended December 31, 2006 and 2007,
respectively. Contract research, including SBIR, may or may not remain a significant portion of our consolidated total revenues, depending on the success of our products and our ability to qualify for SBIR programs. Our strategy for developing
innovative technologies and products depends in large part on our ability to continue to enter into and generate revenues from non-SBIR contract research.
Our contract research customer base includes government agencies, corporations and academic institutions. Our customers are not obligated to extend their agreements with us. In addition, we may not be successful in
securing future contracts. Our customers priorities regarding funding for certain projects may change and funding resources may no longer be available at previous levels.
We rely and will continue to rely on contracts and grants awarded under the SBIR program for a significant portion of our revenues. A finding by the Small Business Administration, or SBA, that we no longer
qualify to receive SBIR funding could adversely affect our business.
We may not qualify to participate in the Small Business
Administrations, or SBAs, SBIR program or receive new SBIR awards from federal agencies in the future. In order to qualify for SBIR contracts and grants, at least 51% of our equity must be owned and controlled by U.S. citizens or
permanent resident aliens, or by another entity that is at least 51% owned or controlled by U.S. citizens or permanent resident aliens, and we must have 500 or fewer employees. These eligibility criteria are applied as of the time of the award of a
contract or grant. In determining whether we satisfy the 51% equity ownership requirement, agreements to merge, stock options, convertible debt and other similar instruments are given present effect by the SBA, as though the underlying
securities were actually issued unless the exercisability or conversion of such securities is speculative, remote or beyond the control of the security holder. We therefore believe our outstanding options and warrants held by eligible individuals
may be counted as, and our convertible debt may be excluded from, outstanding equity for purposes of meeting the 51% equity ownership requirement.
We believe that we are currently in compliance with the SBIR eligibility criteria but we cannot provide assurance that the SBA will interpret its regulations in our favor. We believe that over 60% of our equity is owned or controlled by
U.S. citizens, and that we currently have fewer than 500 employees. We must be able to certify that we meet the SBIR ownership and size requirements as of the time we enter into each SBIR contract or grant, and SBA may review our size status in
connection with each SBIR contract or grant. As we grow our business, it is foreseeable that we will eventually exceed the SBIR eligibility limitations and we may need to find other sources to fund our research and development efforts. If we are
unsuccessful in obtaining additional contracts or funding grants because we cannot meet the eligibility requirements or if our customers decide to reduce or discontinue support of our products, we may be required to seek alternative sources of
revenues or capital.
The SBA could determine that, as a result of Carilion Clinics equity ownership, the number of our employees exceeds the
size limitation placed on SBA contract and SBIR grant recipients, and therefore we will not be eligible to receive future SBA contracts and SBIR grants.
In addition to the U.S. ownership eligibility criteria discussed above, to be eligible for SBA contracts and SBIR grants, the number of our employees including those of any entities that are considered to be
affiliated with us, cannot exceed 500. As of December 31, 2007, including all of our divisions, we had 200 full time employees. However, in determining whether we are affiliated with any other entity, the SBA analyzes whether another entity
controls or has the power to control us. If the SBA determines that another entity controls or has the power to control us, it will aggregate that entitys employees (and the employees of its subsidiaries and affiliates) with our own for
purposes of applying the 500 employee test.
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The SBA may make an affiliation determination based on stock ownership. For example, the SBA may presume
that two or more entities have the power to control a company if the entities each own, control or has the power to control, less than 50 percent of the companys stock, such minority holdings are equal or approximately equal in size, and the
aggregate of the minority holdings is large as compared to any other stock holding. However, this presumption may be rebutted by showing that such control or power to control does not in fact exist. As of December 31, 2007, Carilion Clinic held
approximately 20.8% of our common stock, and Dr. Kent Murphy held approximately 24.6% of our common stock
.
Thus, applying the criteria stated above, the SBA could find that both Carilion Clinic and Dr. Murphy own less than 50% of
the stock, their percentages are roughly equal, and their respective percentages are large compared to any other stock holding. We believe that the relative beneficial ownership of our individual stockholders rebuts the presumption of control by
Carilion Clinic because the shares held by our officers and directors constitute the controlling interest in us. However, if the SBA were to make a determination that we are affiliated with Carilion Clinic, we would exceed the size limitations as
Carilion Clinic has over 500 employees, and we therefore would lose eligibility for new SBA contracts, public contracts, grants and other awards that are set aside for small businesses, including SBIR grants.
We might require additional capital to support business growth, and this capital might not be available.
We intend to continue to make investments to support our business growth and may require additional funds to respond to business challenges, including the
need to develop new products or enhance our existing products, enhance our operating infrastructure, complete our development activities, build our commercial scale manufacturing facilities and acquire complementary businesses and technologies.
Accordingly, we may need to engage in equity or debt financings to secure additional funds for these investments.
If we raise additional
funds through issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our
common stock, including shares of common stock sold in our initial public offering. Furthermore, such financings may jeopardize our ability to apply for SBIR grants or qualify for SBIR contracts or grants, and our dependence on SBIR grants may
restrict our ability to raise additional outside capital. In addition, we may not be able to obtain continued SBIR funding, or other additional financing on terms favorable to us, if at all. In order to retain SBIR eligibility, we may be restricted
in our ability to raise certain forms of equity capital from institutional investors. For example, in connection with the closing of our financing with Carilion Clinic on December 30, 2005, we were not able to raise all proceeds through the
issuance of equity without potentially jeopardizing our SBIR eligibility. We therefore elected to issue debt in the amount of $5.0 million of the total $8.0 million raised in such financing to maintain SBIR eligibility. Under the terms of these
notes, we agreed that we will not draw down any amount under our existing senior secured credit facility with First National Bank or incur additional indebtedness other than under certain limited conditions. If we are unable to obtain adequate
financing or financing on terms satisfactory to us, when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly limited.
If we are unable to secure third-party reimbursement for our health care products, including our EDAC
®
QUANTIFIER, our revenue and net loss could be adversely affected.
In both
the United States and foreign markets where we intend to sell our medical products, third-party payors such as the government and health insurance companies are generally responsible for hospital and doctor reimbursement for medical products and
services. Governments and insurance companies carefully review and increasingly challenge the prices charged for medical products and services. Reimbursement rates from private insurance companies vary depending on the procedure performed, the third
party involved, the insurance plan involved, and other factors. In the United States, reimbursement for medical procedures under the Medicare and Medicaid programs is administered by Centers for Medicare & Medicaid Services. Medicare
reimburses both hospitals and physicians a pre-determined, fixed amount based on the procedure performed. This fixed amount is paid regardless of the actual costs incurred by the hospital or physician in furnishing the care and is often
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unrelated to the specific devices used in that procedure. Thus, any reimbursements that hospitals or physicians obtain for using our medical products will
generally have to cover any additional costs that hospitals incur in purchasing such products.
Hospitals and medical centers to which we intend to sell our EDAC
®
QUANTIFIER product typically bill the services performed with our products to various
third-party payors, such as Medicare, Medicaid and other government programs and private insurance plans. If hospitals do not obtain sufficient reimbursement from third-party payors for procedures performed with our products, or if governmental and
private payors policies do not permit reimbursement for services performed using our products, demand for our product may be negatively impacted.
In countries outside the United States, reimbursement is obtained from various sources, including governmental authorities, private health insurance plans and labor unions. To sell our product in foreign markets, we
may need to seek international reimbursement approvals. We cannot be certain whether such required approvals will be obtained in a timely manner or at all.
Furthermore, any regulatory or legislative developments in domestic or foreign markets that eliminate or reduce reimbursement rates for procedures performed with our products could harm our ability to sell our
products or cause downward pressure on the prices of our products, either of which would have a negative effect on our product revenue and net loss.
We face and will face substantial competition in several different markets that may adversely affect our results of operations.
We face or will face substantial competition from a variety of companies in several different markets. Our competitors in contract research include, but are not limited to, companies such as General Dynamics
Corporation, Lockheed Martin Corporation, SAIC, Inc. and SRA International, Inc. In the molecular technology solutions products market, our competitors include, but are not limited to, large public manufacturers such as The Dow Chemical Company,
E.I. du Pont de Nemours and Company, Rohm and Haas Company and 3M Company, as well as emerging companies. In addition, in the MRI contrast agent market our competitors include Amersham Plc, Berlex Laboratories, Inc., Bracco Diagnostics, Inc., and
Mallinckrodt Inc. In the sensor solutions products market, our competitors include, but are not limited to, large companies such as Agilent Technologies, Inc., Analog Devices, Inc., Freescale Semiconductor, Inc., JDS Uniphase Corp., Robert Bosch
GmbH and Silicon Sensing, as well as emerging companies.
The products that we have developed or are currently developing will compete with
other technologically innovative products as well as products incorporating conventional materials and technologies. We expect that our products will compete with companies in a wide range of industries, including semiconductors, electronics,
biotechnology, textiles, alternative energy, military, defense, healthcare, telecommunications, industrial measurement, security applications and consumer electronics.
Many of our competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other
resources than we do. These competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements. In addition, current and potential competitors have established or may establish financial or strategic
relationships among themselves or with existing or potential customers or other third parties. Accordingly, new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We cannot assure you that we will
be able to compete successfully against current or new competitors, in which case our net revenues may fail to increase or may decline.
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We may be obligated to repay part of the proceeds received in connection with a grant from the City of Danville,
Virginia, for failing to make certain agreed upon expenditures and failing to meet certain employment obligations.
In March 2004,
we received a grant of $900,000 from the City of Danville, Virginia under a Grant Agreement to support the expansion of economic and commercial growth within the City. Under the Grant Agreement, we agreed to locate a nanomaterials manufacturing and
research facility and maintain its operations in Danville until March 25, 2009. Our obligations under this Grant Agreement require us to incur significant expenditures in order to retain such proceeds from the grant. Specifically, we agreed
under the Grant Agreement to invest at least $5.2 million in capital equipment expenditures and $1.2 million in certain facilities by September 25, 2006 and to maintain such investments in our Danville facility until March 25, 2009. We
also agreed to create by September 25, 2006 at least 54 new full-time jobs at the Danville facility at an average annual wage of at least $39,000 plus benefits, and to maintain these jobs at such facility until March 25, 2009. These
contractual requirements obligate us to an annual payroll obligation exceeding $2.0 million until March 25, 2009. To the extent such hiring results in salaries in excess of the required minimum wages, our annual payroll obligation could be
substantially greater than $2.0 million. As of September 25, 2006, and as of December 31, 2007, we had not fully met these capital expenditures and job milestones, and, as a result, we may be asked to repay the City of Danville a portion
of the $900,000 in funds based on a formula of the pro rata shortfall of such expenditures and jobs falling below such required levels. Because of the failure to meet these milestones and the continuing obligation to maintain our investment and
employees at this location through March 25, 2009, we currently have classified the full amount of the grant as a liability on our balance sheet in anticipation of potentially returning the funds.
We have limited experience manufacturing our products in commercial quantities in a cost-effective manner, which could adversely impact our business.
We have produced most of our products on a custom order basis rather than
pursuant to large contracts that require production on a large volume basis. Accordingly, other than the commercial manufacture of products by our Luna Technologies Division, we have no experience manufacturing products in large volume. Because our
experience in large scale manufacturing is limited, we may encounter unforeseen difficulties in our efforts to manufacture other products or materials in commercial quantities. For example, we may need to develop or in-license Trimetasphere
®
nanomaterial purification and isolation technology, which would result in manufacturing delays or shortfalls. We may also encounter difficulties and delays in manufacturing our products for the
following reasons:
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we plan to expand our manufacturing operations, and our production processes may have to change to accommodate this growth;
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to increase our manufacturing output significantly, we will have to attract and retain qualified employees, who are in short supply, for the assembly and testing
operations;
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we might have to sub-contract to outside manufacturers which might limit our control of costs and processes; and
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our manufacturing operations may have to comply with government specifications.
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If we are unable to keep up with demand for our products, our revenues could be impaired, market acceptance for our products could be adversely affected
and our customers might instead purchase our competitors products. Moreover, failure to develop and maintain a U.S. market for goods developed with U.S. government-licensed technology may result in the cancellation of the relevant U.S.
government licenses. Our inability to manufacture our products successfully would have a material adverse effect on our revenues.
Even if
we are able to manufacture our products on a commercial scale, the cost of manufacturing our products may be higher than we expect. If the costs associated with manufacturing are not significantly less than the prices at which we can sell our
products, we may not be able to operate at a profit.
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We depend on third-party vendors for specialized components in our manufacturing operations, making us vulnerable
to supply shortages and price fluctuations that could harm our business.
We primarily rely on third-party vendors for the
manufacture of the specialized components used in our products. Although we do not have any sole source suppliers of materials, the highly specialized nature of our supply requirements poses risks that we may not be able to locate additional sources
of the specialized components required in our business. For example, there are few manufacturers who produce the special lasers used in our optical test equipment. Moreover, none of these third-party vendors is obligated to continue to supply us
with components. Our reliance on these vendors subjects us to a number of risks that could impact our ability to manufacture our products and harm our business, including interruption of supply. Although we are now manufacturing tunable lasers in
low rate initial production, we expect our overall reliance on third-party vendors to continue.
Any significant delay or interruption in
the supply of components, or our inability to obtain substitute components or materials from alternate sources at acceptable prices in a timely manner, could impair our ability to meet the demand of our customers and harm our business.
Our nanotechnology-enabled products are new and may be, or may be perceived as being, harmful to human health or the environment.
While we believe that none of our current products contain chemicals known by us to be hazardous or subject to environmental regulation, it is possible
our current or future products, particularly carbon-based nanomaterials, may become subject to environmental regulation. We intend to develop and sell carbon-based nanomaterials as well as nanotechnology-enabled products, which are products that
include nanomaterials as a component to enhance those products performance. Nanomaterials and nanotechnology-enabled products have a limited historical safety record. Because of their size or shape or because they may contain harmful elements,
such as gadolinium and other rare-earth metals, our products could pose a safety risk to human health or the environment. These characteristics may also cause countries to adopt regulations in the future prohibiting or limiting the manufacture,
distribution or use of nanomaterials or nanotechnology-enabled products. Such regulations may inhibit our ability to sell some products containing those materials and thereby harm our business or impair our ability to develop commercially viable
products.
The subject of nanotechnology has received negative publicity and has aroused public debate. Government authorities could, for
social or other purposes, prohibit or regulate the use of nanotechnology. Ethical and other concerns about nanotechnology could adversely affect acceptance of our potential products or lead to government regulation of nanotechnology-enabled
products.
We face risks associated with our international business.
Our Luna Technologies Division and our Luna nanoWorks Division currently conduct business internationally and we might considerably expand our
international activities in the future. Our international business operations are subject to a variety of risks associated with conducting business internationally, including:
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having to comply with U.S. export control regulations and policies that restrict our ability to communicate with non-U.S. employees and supply foreign affiliates
and customers;
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changes in or interpretations of foreign regulations that may adversely affect our ability to sell our products, perform services or repatriate profits to the
United States;
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the imposition of tariffs;
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hyperinflation or economic or political instability in foreign countries;
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imposition of limitations on or increase of withholding and other taxes on remittances and other payments by foreign subsidiaries or joint ventures;
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conducting business in places where business practices and customs are unfamiliar and unknown;
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the imposition of restrictive trade policies;
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the imposition of inconsistent laws or regulations;
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the imposition or increase of investment and other restrictions or requirements by foreign governments;
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uncertainties relating to foreign laws and legal proceedings;
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having to comply with a variety of U.S. laws, including the Foreign Corrupt Practices Act; and
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having to comply with licensing requirements.
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We do
not know the impact that these regulatory, geopolitical and other factors may have on our international business in the future.
If we are
unsuccessful in our litigation with Hansen Medical, Inc., our business may be materially harmed.
On June 22, 2007, Hansen Medical
Inc., a company for whom we had conducted certain research, filed a complaint against us in the Superior Court of the State of California, County of Santa Clara alleging misappropriation of trade secrets, unfair competition, breach of contract,
breach of implied covenant of good faith and fair dealing and declaratory judgment. In addition to money damages in an unspecified amount, the plaintiff company seeks, among other things, equitable relief, including an injunction against our using
the allegedly misappropriated trade secrets in connection with another project of ours. We have answered the complaint and intend to defend ourselves vigorously in this matter. We also filed a counterclaim asserting claims for misappropriation of
trade secrets, unfair competition under the California Business and Professional Code, breach of contract, breach of implied covenant of good faith and fair dealing and declaratory judgment. We seek money damages from the counterclaim defendant in
an amount to be proven at trial and equitable, including declaratory, relief. While we believe the plaintiffs claims are without merit, we cannot predict the ultimate outcome of this litigation.
If we do not succeed in prosecuting our claims against Hansen Medical, Inc. or if Hansen Medical, Inc. prevails on one or more of its claims, we may not
recover our damages. In addition, if Hansen Medical, Inc. is successful, we may be required to pay substantial damages, and we may lose the ability to freely use certain of our intellectual property, any or all of which could materially harm our
business.
RISKS RELATING TO OUR REGULATORY ENVIRONMENT
As a provider of contract research to the U.S. government, we are subject to federal rules, regulations, audits and investigations, the violation or failure of which could adversely affect our business.
We must comply with and are affected by laws and regulations relating to the award, administration and performance of U.S. government
contracts. Government contract laws and regulations affect how we do business with our government customers and, in some instances, impose added costs on our business. A violation of specific laws and regulations could result in the
imposition of fines and penalties or the termination of our contracts or debarment from bidding on contracts. In some instances, these laws and regulations impose terms or rights that are more favorable to the government than those typically
available to commercial parties in negotiated transactions. For example, the U.S. government may terminate any of our government contracts and, in general, subcontracts, at their convenience, as well as for default based on performance.
In addition, U.S. government agencies, including the Defense Contract Audit Agency and the Department of Labor, routinely audit and
investigate government contractors. These agencies review a contractors performance under its contracts, cost structure and compliance with applicable laws, regulations and standards. The U.S. government also may review the adequacy of,
and a contractors compliance with, its internal control systems and policies, including the contractors purchasing, property, estimating, compensation and management
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information systems. Any costs found to be improperly allocated to a specific contract will not be reimbursed, while such costs already reimbursed must
be refunded. If an audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension
or prohibition from doing business with the U.S. government. In addition, our reputation could suffer serious harm if allegations of impropriety were made against us.
In addition to the risk of government audits and investigations, U.S. government contracts and grants impose requirements on contractors and grantees
relating to ethics and business practices, which carry civil and criminal penalties ranging from monetary fines, assessments, loss of the ability to do business with the U.S. government and certain other criminal penalties.
We may also be prohibited from commercially selling certain products that we develop under our Contract Research Group or related products based on the
same core technologies if the U.S. government determines that the commercial availability of those products could pose a risk to national security. For example, certain of our wireless technologies have been classified as secret by the U.S.
government and as a result we cannot sell them commercially. Any of these determinations would limit our ability to generate product sales and license revenues.
Our health care and medical products are subject to a lengthy and uncertain domestic regulatory approval process. If we do not obtain and maintain the necessary domestic regulatory approvals or clearances, we will not be able to
market and sell our products for clinical use in the United States.
Certain
of our current and potential products will require regulatory clearances or approvals prior to commercialization. In particular, our Trimetasphere
®
nanomaterial-based MRI contrast agent and
our EDAC
®
ultrasound diagnostic devices for measuring certain medical conditions will be considered a drug and medical devices, respectively, under the Federal Food, Drug &
Cosmetic Act, or FDC Act. Drugs and some medical devices are subject to rigorous preclinical testing and other approval requirements by the Food and Drug Administration, or FDA, pursuant to the FDC Act, and regulations under the FDC Act, as well as
by similar health authorities in foreign countries. Various federal statutes and regulations also govern or influence the testing, manufacturing, safety, labeling, packaging, advertising, storage, registration, listing and recordkeeping related to
marketing of these products. The process of obtaining these clearances or approvals and the subsequent compliance with appropriate federal statutes and regulations require the expenditure of substantial resources. We cannot be certain that any
required FDA or other regulatory approval will be granted or, if granted, will not be withdrawn. Our failure to obtain the necessary regulatory approvals, or our failure to obtain them in a timely manner, will prevent or delay our commercialization
of new products and our business or our stock price could be adversely affected.
In
general, the FDA regulates the research, testing, manufacturing, safety, labeling, storage, record keeping, promotion, distribution and production of medical devices in the United States to ensure that medical products distributed domestically are
safe and effective for their intended uses. In order for us to market our EDAC
®
or other products for clinical use in the United States, we generally must first obtain clearance from the
FDA pursuant to Section 510(k) of the Food, Drug, and Cosmetic Act, which has occurred in the case of the EDAC
®
. Clearance under Section 510(k) requires demonstration that a new
device is substantially equivalent to another device with 510(k) clearance or grandfather status. If we significantly modify our products after they receive FDA clearance, the FDA may require us to submit a separate 510(k) or premarket approval
application, or PMA, for the modified product before we are permitted to market the products in the U.S. In addition, if we develop products in the future that are not considered to be substantially equivalent to a device with 510(k) clearance or
grandfather status, we will be required to obtain FDA approval by submitting a PMA.
The FDA may not act favorably or quickly in its review
of our 510(k) or PMA submissions, or we may encounter significant difficulties and costs in our efforts to obtain FDA clearance or approval, all of which could
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delay or preclude sale of new products for clinical use in the United States. Furthermore, the FDA may request additional data or require us to conduct
further testing, or compile more data, including clinical data and clinical studies, in support of a 510(k) submission. The FDA may also, instead of accepting a 510(k) submission, require us to submit a PMA, which is typically a much more complex
and burdensome application than a 510(k). To support a PMA, the FDA would likely require that we conduct one or more clinical studies to demonstrate that the device is safe and effective. We may not be able to meet the requirements to obtain 510(k)
clearance or PMA approval, or the FDA may not grant any necessary clearances or approvals. In addition, the FDA may place significant limitations upon the intended use of our products as a condition to a 510(k) clearance or PMA approval. Product
applications can also be denied or withdrawn due to failure to comply with regulatory requirements or the occurrence of unforeseen problems following clearance or approval. Any delays or failure to obtain FDA clearance or approvals of new products
we develop, any limitations imposed by the FDA on new product use, or the costs of obtaining FDA clearance or approvals could have a material adverse effect on our business, financial condition and results of operations.
Complying with FDA regulations is an expensive and time-consuming process. Our failure to comply fully with such regulations could subject us to enforcement
actions.
Our commercially distributed medical device products will be subject to numerous post-market regulatory requirements,
including the following:
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Quality System Regulation, or QSR, which requires manufacturers to follow elaborate design, testing, control, documentation and other quality assurance procedures
during the manufacturing process;
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the FDAs general prohibition against false or misleading statements in the labeling or promotion of products for unapproved or off-label uses;
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the Reports of Corrections and Removals regulation, which requires that manufacturers report to the FDA recalls and field corrective actions taken to reduce a risk
to health or to remedy a violation of the FFDCA that may pose a risk to health; and
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the Medical Device Reporting regulation, which requires that manufacturers report to the FDA if their device may have caused or contributed to a death or serious
injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur.
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We will also become subject to inspection and marketing surveillance by the FDA to determine our compliance with regulatory requirements. If the FDA finds that we have failed to comply, it can institute a wide variety of enforcement
actions, ranging from a regulatory letter to a public warning letter to more severe civil and criminal sanctions. Our failure to comply with applicable requirements could lead to an enforcement action that may have an adverse effect on our financial
condition and results of operations.
If our manufacturing facilities do not meet Federal, State or foreign country manufacturing standards, we may
be required to temporarily cease all or part of our manufacturing operations, which would result in product delivery delays and negatively impact revenue.
Our manufacturing facilities are subject to periodic inspection by regulatory authorities and our operations will continue to be regulated by the FDA for compliance with Good Manufacturing Practice requirements
contained in the FDAs Quality System Regulations, or QSR. We are also required to comply with International Organization for Standardization, or ISO, quality system standards in order to produce products for sale in Europe. If we fail to
continue to comply with Good Manufacturing Practice requirements or ISO standards, we may be required to cease all or part of our operations until we comply with these regulations. Obtaining and maintaining such compliance is difficult and costly.
We cannot be certain that our facilities will be found to comply with Good Manufacturing Practice requirements or ISO standards in future inspections and audits by regulatory authorities.
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Our medical products are subject to various international regulatory processes and approval requirements. If we do
not obtain and maintain the necessary international regulatory approvals, we may not be able to market and sell our medical products in foreign countries.
To be able to market and sell our products in other countries, we must obtain regulatory approvals and comply with the regulations of those countries. These regulations, including the requirements for approvals and
the time required for regulatory review, vary from country to country. Obtaining and maintaining foreign regulatory approvals are expensive, and we cannot be certain that we will receive regulatory approvals in any foreign country in which we plan
to market our products. If we fail to obtain regulatory approval in any foreign country in which we plan to market our products, our ability to generate revenue will be harmed.
The European Union requires that manufacturers of medical products obtain the right to affix the CE mark to their products before selling them in member
countries of the European Union. The CE mark is an international symbol of adherence to quality assurance standards and compliance with applicable European medical device directives. In order to obtain the right to affix the CE mark to products, a
manufacturer must obtain certification that its processes meet certain European quality standards.
We have not yet received permission to
affix the CE mark to our medical products. We do not know whether we will be able to obtain permission to affix the CE mark for new or modified products. If we are unable to obtain permission to affix the CE mark to our products, we will not be able
to sell our products in member countries of the European Union.
We are subject to significant foreign and domestic government regulations, including
environmental and health and safety regulations, and failure to comply with these regulations could harm our business.
Our
facilities and current and proposed activities involve the use of a broad range of materials that are considered hazardous under applicable laws and regulations. Accordingly, we are subject to a number of foreign, federal, state, and local laws and
regulations relating to health and safety, protection of the environment, and the storage, use, disposal of, and exposure to, hazardous materials and wastes. We could incur costs, fines and civil and criminal penalties, personal injury and third
party property damage claims, or could be required to incur substantial investigation or remediation costs if we were to violate or become liable under environmental, health and safety laws. Moreover, a failure to comply with environmental laws
could result in fines and the revocation of environmental permits, which could prevent us from conducting our business. Liability under environmental laws can be joint and several and without regard to fault. There can be no assurance that
violations of environmental health and safety laws will not occur in the future as a result of the inability to obtain permits, human error, equipment failure or other causes. Environmental laws could become more stringent over time, imposing
greater compliance costs and increasing risks and penalties associated with violations, which could harm our business. Accordingly, violations of present and future environmental laws could restrict our ability to expand facilities, pursue certain
technologies, and could require us to acquire costly equipment, or to incur potentially significant costs to comply with environmental regulations.
The European Union Directive 2002/96/EC on Waste Electrical and Electronic Equipment, known as the WEEE Directive, requires producers of certain electrical and electronic equipment, including monitoring instruments, to be
financially responsible for specified collection, recycling, treatment and disposal of past and present covered products placed on the market in the European Union. As a manufacturer of covered products, we may be required to register as a producer
in some European Union countries, and we may incur some financial responsibility for the collection, recycling, treatment and disposal of both new product sold, and product already sold prior to the WEEE Directives enforcement date, including
the products of other manufacturers where these are replaced by our own products. European Union Directive 2002/95/EC on the Restriction of the use of Hazardous Substances in electrical and electronic equipment, known as the RoHS
Directive, restricts the use of certain hazardous substances, including mercury, lead and cadmium in specified covered products; however, the RoHS Directive currently exempts monitoring instruments from its requirements. If the European
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Commission were to remove this exemption in the future, we would be required to change our manufacturing processes and redesign products regulated under the
RoHS Directive in order to be able to continue to offer them for sale within the European Union. For some products, substituting certain components containing regulated hazardous substances may be difficult, costly or result in production delays. We
will continue to review the applicability and impact of both directives on the sale of our products within the European Union, and although we cannot currently estimate the extent of such impact, they are likely to result in additional costs and
could require us to redesign or change how we manufacture our products, any of which could adversely affect our operating results. Failure to comply with the directives could result in the imposition of fines and penalties, inability to sell covered
products in the European Union and loss of revenues.
Compliance with foreign, federal, state and local environmental laws and regulations
represents a small part of our present budget. If we fail to comply with any such laws or regulations, however, a government entity may levy a fine on us or require us to take costly measures to ensure compliance. Any such fine or expenditure may
adversely affect our development. We are committed to complying with and, to our knowledge, are in compliance with, all governmental regulations. We cannot predict the extent to which future legislation and regulation could cause us to incur
additional operating expenses, capital expenditures, or restrictions and delays in the development of our products and properties.
RISKS RELATING TO
OUR INTELLECTUAL PROPERTY
Our proprietary rights may not adequately protect our technologies.
Our commercial success will depend in part on our obtaining and maintaining patent, trade secret,
copyright and trademark protection of our technologies in the United States and other jurisdictions as well as successfully enforcing this intellectual property and defending this intellectual property against third-party challenges. We will only be
able to protect our technologies from unauthorized use by third parties to the extent that valid and enforceable intellectual property protections, such as patents or trade secrets, cover them. In particular, we place considerable emphasis on
obtaining patent and trade secret protection for significant new technologies, products and processes. Furthermore, the degree of future protection of our proprietary rights is uncertain because legal means afford only limited protection and may not
adequately protect our rights or permit us to gain or keep our competitive advantage. The degree of future protection of our proprietary rights is also uncertain for products that are currently in the early stages of developmentsuch as the
Trimetasphere
®
carbon nanomaterials productsbecause we cannot predict which of these products will ultimately reach the commercial market or whether the commercial versions of these
products will incorporate proprietary technologies.
Our patent position is highly uncertain and involves complex legal and factual
questions. Accordingly, we cannot predict the breadth of claims that may be allowed or enforced in our patents or in third-party patents. For example:
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we or our licensors might not have been the first to make the inventions covered by each of our pending patent applications and issued patents;
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we or our licensors might not have been the first to file patent applications for these inventions;
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others may independently develop similar or alternative technologies or duplicate any of our technologies;
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it is possible that none of our pending patent applications or the pending patent applications of our licensors will result in issued patents;
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our issued patents and issued patents of our licensors may not provide a basis for commercially viable technologies, may not provide us with any competitive
advantages, or may be challenged and invalidated by third parties; and
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we may not develop additional proprietary technologies that are patentable.
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Patents may not be issued for any pending or
future pending patent applications owned by or licensed to us, and claims allowed under any issued patent or future issued patent owned or licensed by us may not be valid or sufficiently broad to protect our technologies. Moreover, protection of
certain of our intellectual property may be unavailable or limited in the United States or in foreign countries, and certain of our productsincluding our Trimetasphere
®
carbon
nanomaterials productsdo not have foreign patent protection. Any issued patents owned by or licensed to us now or in the future may be challenged, invalidated, or circumvented, and the rights under such patents may not provide us with
competitive advantages. In addition, competitors may design around our technology or develop competing technologies. Intellectual property rights may also be unavailable or limited in some foreign countries, and in the case of certain products no
foreign patents were filed or can be filed. This could make it easier for competitors to capture or increase their market share with respect to related technologies. Although we are not currently involved in any legal proceedings related to
intellectual property, we could incur substantial costs to bring suits in which we may assert our patent rights against others or defend ourselves in suits brought against us. An unfavorable outcome of any such litigation could have a material
adverse effect on our business and results of operations.
We also rely on trade secrets to protect our technology, especially where we
believe patent protection is not appropriate or obtainable. However, trade secrets are difficult to protect. We vigorously pursue confidentiality agreements and contractual provisions with our collaborators, employees, and consultants to protect our
trade secrets and proprietary know-how. These agreements may be breached and or may not have adequate remedies for such breach. While we use reasonable efforts to protect our trade secrets, our employees, consultants, contractors or scientific and
other advisors, or those of our strategic partners, may unintentionally or willfully disclose our information to competitors. If we were to enforce a claim that a third party had illegally obtained and was using our trade secrets, our enforcement
efforts would be expensive and time consuming, and the outcome would be unpredictable. In addition, courts outside the United States are sometimes unwilling to protect trade secrets. Moreover, if our competitors independently develop equivalent
knowledge, methods and know-how, it will be more difficult for us to enforce our rights and our business could be harmed.
If we are not
able to defend the patent or trade secret protection position of our technologies, then we will not be able to exclude competitors from developing or marketing competing technologies, and we may not generate enough revenues from product sales to
justify the cost of development of our technologies and to achieve or maintain profitability.
We also rely on trademarks to establish a
market identity for Luna and Luna products. To maintain the value of our trademarks, we might have to file lawsuits against third parties to prevent them from using trademarks confusingly similar to or dilutive of our registered or unregistered
trademarks. Also, we might not obtain registrations for our pending trademark applications, and might have to defend our registered trademark and pending trademark applications from challenge by third parties. Enforcing or defending our registered
and unregistered trademarks might result in significant litigation costs and damages, including the inability to continue using certain trademarks.
Third parties may claim that we infringe their intellectual property, and we could suffer significant litigation or licensing expense as a result.
Various U.S. and foreign issued patents and pending patent applications, which are owned by third parties, exist in our technology areas. Such third parties may claim that we infringe their patents. Because patent
applications can take several years to result in a patent issuance, there may be currently pending applications, unknown to us, which may later result in issued patents that our technologies may infringe. For example, we are aware of competitors
with patents in technology areas applicable to our optical test equipment products. Such competitors may allege that we infringe these patents. There could also be existing patents of which we are not aware that our technologies may inadvertently
infringe. If third parties assert claims against us alleging that we infringe their patents or other intellectual property rightsincluding third parties that have asserted claims against businesses that we have acquired prior to our
acquisition of these businesseswe could incur substantial
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costs and diversion of management resources in defending these claims, and the defense of these claims could have a material adverse effect on our business,
financial condition, and results of operations. In addition, if third parties assert claims against us and we are unsuccessful in defending against these claims, these third parties may be awarded substantial damages, as well as injunctive or other
equitable relief against us, which could effectively block our ability to make, use, sell, distribute, or market our products and services in the United States or abroad.
Commercial application of nanotechnologies in particular, or technologies involving nanomaterials, is new and the scope and breadth of patent protection is uncertain. Consequently, the patent positions of companies
involved in nanotechnologies have not been tested and complex legal and factual questions for which important legal principles will be developed or may remain unresolved. In addition, it is not clear whether such patents will be subject to
interpretations or legal doctrines that differ from conventional patent law principles. Changes in either the patent laws or in interpretations of patent laws in the United States and other countries may diminish the value of our
nanotechnology-related intellectual property. Accordingly, we cannot predict the breadth of claims that may be allowed or enforced in our nanotechnology-related patents or in third party patents.
In the event that a claim relating to intellectual property is asserted against us, or third parties not affiliated with us hold pending or issued
patents that relate to our products or technology, we may seek licenses to such intellectual property or challenge those patents. However, we may be unable to obtain these licenses on commercially reasonable terms, if at all, and our challenge of
the patents may be unsuccessful. Our failure to obtain the necessary licenses or other rights could prevent the sale, manufacture, or distribution of our products and, therefore, could have a material adverse effect on our business, financial
condition, and results of operations.
A substantial portion of our technology is subject to retained rights of our licensors, and we may not be able
to prevent the loss of those rights or the grant of similar rights to third parties.
A substantial portion of our technology is
licensed from academic institutions, corporations and government agencies. Under these licensing arrangements, a licensor may obtain rights over the technology, including the right to require us to grant a license to one or more third parties
selected by the licensor or that we provide licensed technology or material to third parties for non-commercial research. The grant of a license for any of our core technologies to a third party could have a material and adverse effect on our
business. In addition, some of our licensors retain certain rights under the licenses, including the right to grant additional licenses to a substantial portion of our core technology to third parties for noncommercial academic and research use. It
is difficult to monitor and enforce such noncommercial academic and research uses, and we cannot predict whether the third party licensees would comply with the use restrictions of such licenses. We could incur substantial expenses to enforce our
rights against them. We also may not fully control the ability to assert or defend those patents or other intellectual property which we have licensed from other entities, or which we have licensed to other entities.
In addition, some of our licenses with academic institutions give us the right to use certain technology previously developed by researchers at these
institutions. In certain cases we also have the right to practice improvements on the licensed technology to the extent they are encompassed by the licensed patents and within our field of use. Our licensors may currently own and may in the future
obtain additional patents and patent applications that are necessary for the development, manufacture and commercial sale of our anticipated products. We may be unable to agree with one or more academic institutions from which we have obtained
licenses that certain intellectual property developed by researchers at these academic institutions is covered by our existing licenses. In the event that the new intellectual property is not covered by our existing licenses, we would be required to
negotiate a new license agreement. We may not be able to reach agreement with current or future licensors on commercially reasonable terms, if at all, or the terms may not permit us to sell our products at a profit after payment of royalties, which
could harm our business.
Some of our patents may cover inventions that were conceived or first reduced to practice under, or in connection
with, U.S. government contracts or other federal funding agreements. With respect to inventions
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conceived or first reduced to practice under a federal funding agreement, the U.S. government may retain a nonexclusive, non-transferable, irrevocable,
paid-up license to practice or have practiced for or on behalf of the United States the invention throughout the world. We may not have succeeded in our efforts to retain title in patents, maintain ownership of intellectual property or in limiting
the U.S. governments rights in our proprietary technologies and intellectual property whether such intellectual property was developed in the performance of a federal funding agreement or developed at private expense.
RISKS RELATING TO OUR COMMON STOCK
Our common stock
price has been volatile and we expect that the price of our common stock will fluctuate substantially in the future.
Before our
initial public offering, there was no public market for our common stock, and in the future, an active public trading market may not be sustained. The public trading price for our common stock will continue to be affected by a number of factors,
including:
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changes in earnings estimates, investors perceptions, recommendations by securities analysts or our failure to achieve analysts earning estimates;
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changes in our status as an entity eligible to receive SBIR contracts and grants;
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quarterly variations in our or our competitors results of operations;
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general market conditions and other factors unrelated to our operating performance or the operating performance of our competitors;
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announcements by us, or our competitors, of acquisitions, new products, significant contracts, commercial relationships or capital commitments;
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commencement of, or involvement in, litigation;
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any major change in our board of directors or management;
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changes in governmental regulations or in the status of our regulatory approvals;
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announcements related to patents issued to us or our competitors and to litigation;
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a lack of, limited or negative industry or security analyst coverage; and
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developments in our industry.
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addition, the stock prices of many technology companies have experienced wide fluctuations that have often been unrelated to the operating performance of those companies. These factors may materially and adversely affect the market price of our
common stock.
If there are substantial sales of our common stock, our stock price could decline.
If our existing stockholders sell a large number of shares of our common stock or the public market perceives that these sales may occur, the market price
of our common stock could decline.
As of the date of our initial public offering, employees and former employees holding approximately
1.8 million shares of our common stock or options exercisable for our common stock had entered into an agreement to not sell more than 20.0% of such shares in any year during the five years following the effective date of our initial
public offering, provided that if any shares subject to such annual limit are not sold in a given year then such shares may be sold in subsequent years. In addition, certain members of our management holding options exercisable
for approximately 2.2 million shares of our common stock had entered into an agreement not to sell more than 15.0% of such shares in any year during the five years following the effective date of such
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initial public offering. On January 23, 2007, certain members of our management team entered into amended and restated stock sale restriction agreements
whereby such officers agreed not to sell more than a fixed number of beneficially held shares of our common stock for a two year period ending December 31, 2008. On February 27, 2008, certain members of our management team entered into a
second amended and restated stock sale restriction agreement whereby such officers agreed not to sell more than a fixed number of beneficially held shares of our common stock for a two year period ending December 31, 2010. As of
December 31, 2007, such officers beneficially owned an aggregate of 4,541,021 shares of our common stock, including vested and unvested options to purchase common stock, which are subject to the sale restriction agreements. We have the right to
waive any of these resale restrictions for employees and management at our discretion, and in such instance, the shares would become freely tradable.
If our internal controls over financial reporting are found not to be effective or if we make disclosure of existing or potential significant deficiencies or material weaknesses in those controls, Investors could lose confidence in
our financial reports, and our stock price may be adversely affected.
Beginning with this Annual Report on Form 10-K,
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to include an internal control report with our Annual Report on Form 10-K. That report includes managements assessment of the effectiveness of our internal control over financial
reporting as of the end of the fiscal year. Additionally, our independent registered public accounting firm will be required to issue a report on managements assessment of our internal control over financial reporting and a report on their
evaluation of the operating effectiveness of our internal control over financial reporting beginning with our Annual Report for the year ending December 31, 2008.
We continue to evaluate our existing internal control over financial reporting against the standards adopted by the Public Company Accounting Oversight Board, or PCAOB. During the course of our ongoing evaluation of
the internal controls, we may identify areas requiring improvement, and may have to design enhanced processes and controls to address issues identified through this review. Remedying any deficiencies, significant deficiencies or material weaknesses
that we or our independent registered public accounting firm may identify, may require us to incur significant costs and expend significant time and management resources. We cannot assure you that any of the measures we implement to remedy any such
deficiencies will effectively mitigate or remedy such deficiencies. Investors could lose confidence in our financial reports, and our stock price may be adversely affected, if our internal controls over financial reporting are found not to be
effective by management or by an independent registered public accounting firm or if we make disclosure of existing or potential significant deficiencies or material weaknesses in those controls.
We have previously identified material weaknesses and significant deficiencies in our internal controls, and if we are unable to develop, implement and maintain
appropriate controls we will not be able to comply with applicable regulatory requirements imposed on reporting companies.
Although
we do not believe we have material weaknesses or significant deficiencies related to our policies and procedures, we continue to perform specific tests to determine the effectiveness of key controls within these policies and procedures. We intend to
monitor those policies and procedures in connection with our formally documented system of internal control.
Our maintenance of
appropriate internal controls will depend materially both on our successful hiring and retention of key senior accounting personnel If we are unable to retain and attract qualified personnel, to maintain financial reporting and accounting systems or
if we are unable to scale these systems to our growth, we may not have adequate, accurate or timely financial information, and we may be unable to meet our reporting obligations or comply with the requirements of the SEC, the NASDAQ Global Market or
the Sarbanes-Oxley Act of 2002, which could result in the imposition of sanctions, including the suspension or delisting of our common stock from the NASDAQ Global Market and the inability of registered broker dealers to make a market in our common
stock, or investigation by regulatory authorities. Any such action or other negative results caused by our inability
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to meet our reporting requirements or comply with legal and regulatory requirements or by disclosure of an accounting, reporting or control issue could
adversely affect the price of our common stock. Future determinations that there are significant deficiencies or material weaknesses in the effectiveness of our internal control over financial reporting could also reduce our ability to obtain
financing or could increase the cost of any financing we obtain and require additional expenditures to comply with applicable requirements.
Our
financial results may vary significantly from period to period, which may reduce our stock price.
Historically, our financial
results have exhibited significant seasonality. For example, we typically have lower product and license revenue in the first half of the year and higher product revenue in the second half of the year. We expect such seasonality to continue. In
addition, our financial results may fluctuate as a result of a number of factors, many of which are outside of our control, which may cause the market price of our common stock to fall. For these reasons, comparing our operating results on a
period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our financial results may be negatively affected by any of the risk factors listed in this Risk factors
section and, in particular, the following risks:
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a reduction of contract research funding;
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decisions by government agencies, academic institutions or corporations not to exercise contract options or to modify, curtail or terminate our major contracts;
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failure to estimate or control contract costs;
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adverse judgments or settlements in legal disputes;
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expenses related to acquisitions, mergers or joint ventures;
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declines in market demand for sensing and instrumentation products; and
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other one-time financial charges.
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As of
December 31, 2007, our directors and executive officers collectively controlled approximately 50 % of our outstanding common stock.
As of December 31, 2007, our directors and executive officers and their affiliates collectively controlled approximately 50% of our outstanding common stock. As a result, these stockholders, if they act together,
will be able to influence our management and affairs and all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. You and other stockholders will have minimal influence over
these actions. This concentration of ownership may have the effect of delaying or preventing a change in control of our company and might adversely affect the market price of our common stock.
Anti-takeover provisions in our amended and restated certificate of incorporation and bylaws and Delaware law could discourage a takeover.
Our amended and restated certificate of incorporation and bylaws and Delaware law contain provisions that might enable our management to resist a
takeover. These provisions include:
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a classified board of directors;
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advance notice requirements to stockholders for matters to be brought at stockholder meetings;
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a supermajority stockholder vote requirement for amending certain provisions of our amended and restated certificate of incorporation and bylaws; and
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the right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer.
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These provisions might discourage, delay or prevent a change in control of our company or a change in our
management. The existence of these provisions could adversely affect the voting power of holders of common stock and limit the price that investors might be willing to pay in the future for shares of our common stock.