Lumera 10-K 2005
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 31, 2004
Commission File Number 000-50862
(Exact Name of Registrant as Specified in Its Charter)
19910 North Creek Parkway
Bothell, Washington 98011-3008
(Address, including zip code, of principal executive offices And telephone number, including area code)
Securities registered under Section 12(b) of the Exchange Act: none
Securities registered under Section 12(g) of the Exchange Act: Common Stock, $0.001 par value
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Act of 1933). Yes ¨ No x
The registrants Common Stock was not publicly traded as of the last business day of the registrants most recently completed second fiscal quarter. The aggregate market value of the common stock held by non-affiliates of the registrant as of December 31, 2004 was approximately $82,228,246 (based on the closing price for the registrants Common Stock on the NASDAQ National Market of $7.70 per share).
The number of shares of the registrants Common Stock outstanding as of March 1, 2005 was 16,571,930.
Documents Incorporated by Reference
Portions of the registrants definitive Proxy Statement to be filed with the Commission pursuant to Regulation 14A in connection with the Registrants Annual Meeting of Shareholders to be held on June 2, 2005 are incorporated herein by reference into Part III of this report.
Preliminary Note Regarding Forward-Looking Statements
The information set forth in this report in Item 1 Description of Business and in Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations includes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), and is subject to the safe harbor created by that section. Such statements may include, but are not limited to, projections of revenues, income or loss, capital expenditures, plans for product development and cooperative arrangements, future operations, financing needs or plans of the Company, as well as assumptions relating to the foregoing. The words believe, expect, will, anticipate, estimate, target, project, plan, and similar expressions identify forward-looking statements, which speak only as of the date the statement was made. Certain factors that realistically could cause actual results to differ materially from those projected in the forward-looking statements are set forth in Item 1 Description of BusinessRisk Factors Related to the Companys Business.
We develop proprietary polymer materials and are developing products based on these materials for a broad range of applications. Using our expertise in nanotechnology, we design and synthesize polymer materials at the molecular levelto optimize their electrical, optical and surface properties. We are developing products for three distinct markets that we believe provide significant market opportunities, including biotechnology diagnostics and disposables, electro-optic devices and wireless antennas and systems. We believe we have developed a proprietary intellectual property position based on a combination of patents, licenses and trade secrets relating to the design and characterization of polymer materials, methods of polymer synthesis and production of polymers in commercial quantities, as well as device design, characterization, fabrication, testing and packaging technology.
We are developing products in the following key areas:
We have the ability to engineer, analyze and test polymer materials and related devices and the ability to fabricate advanced products, including the use of clean room manufacturing technology and processes. By controlling key manufacturing processes, we seek to accelerate the product design and development cycle for our potential products.
We have strategic relationships with universities, government agencies and corporate partners, which provide us access to important technology. We describe a number of our most important research relationships below.
Nanotechnology: Polymer Materials, Engineering and Process Development
Polymers are large carbon-based molecules that bond many small molecules together to form a long chain. Polymer materials can be engineered and optimized using nanotechnology to create a system in which unique surface, electrical, chemical and electro-optic characteristics can be controlled. Nanotechnology refers to the development of products and production processes at a scale smaller than 100 nanometers (a nanometer is one-billionth of a meter).
Materials based on polymers are used in a multitude of industrial and consumer products, from automotive parts to home appliances and furniture, as well as scientific and medical equipment. We believe that polymer materials engineered at the molecular level can have a significant role in the future development of commercially significant biotechnology and electro-optic related products. In addition, polymers, polymer-based devices and the processes used to create them are often patentable, which can provide the developers of such technology with a significant competitive advantage.
Markets and Lumera Products
The following table summarizes our target markets, our current and potential products and the initial applications for these products.
We believe that a substantial opportunity in biotechnology markets exists in designing, manufacturing and selling biotechnology disposables, including biochips (also known as microarrays). Biochips are small glass or silicon chips, usually one inch by three inches in size, which are used to hold DNA or protein samples for analysis and diagnostic testing. Polymer coatings can be used on biochips to define the microwells in which the DNA or protein samples are placed. These coatings are effective in keeping the samples separate from each other on the surface of the chips due to unique surface properties of the polymers.
We anticipate that the market for biotechnology disposables will continue to grow as the field of proteomics develops. Proteomics is the study of proteins, including their location, structure and function. Specific protein levels have been shown to be effective indicators of a number of diseases, including heart disease and several forms of cancer. A Global Industry Analysts, Inc. report states that the addressable world-wide market for proteomic research for diagnostics and disposables will surpass $1.2 billion in 2005, and is growing at a nearly 24 percent compound annual rate. We believe that there is a substantial market opportunity within this broader market for our tools and technology. In particular, we anticipate that as proteomics evolves, there will be an increasing demand for low-cost disposable diagnostic biochips and other devices for detecting disease.
We anticipate that a number of current and emerging diagnostic technologies related to genomics and proteomics will evolve from primarily a research tools to diagnostic tools, leading to increased demand for disposable biochips used in analysis for biologic molecules.
Lumera Product Opportunity
Our NanoCapture Arrays are biochips that are coated with our proprietary hydrophobic polymers. These water-resistant polymers surround the microwells on the biochips, better containing the DNA samples in the microwells and reducing cross-contamination between wells. Unlike most other currently available biochips that use Teflon to produce microwells, we use a very thin layer of polymer coating on our NanoCapture Arrays, providing a cost-effective alternative to Teflon. Because our polymer coatings are applied to our NanoCapture Arrays in very thin layers, these biochips provide the ability to isolate and contain extremely small amounts of samples for testing. This allows the production of biochips that can hold large numbers of samples on the same biochip, providing high throughput with minimal sample volumes. In addition, the polymers we use on our NanoCapture Arrays are compatible with silicon, glass, metal, plastic or other materials that provide the base layer for biochips, allowing for a wide range of additional applications.
Although we have designed our NanoCapture Arrays specifically for genetic analysis, they can be used in a broad range of biotechnology applications. We intend these arrays to be among the first disposable biochips used in mass spectrometry analysis for biologic molecules. Currently our NanoCapture Arrays are being tested by a prospective customer. In addition, we are developing other disposable low-cost diagnostic devices based on our ability to design and produce polymeric structures that have the ability to enhance detection of biologic molecules.
Lumera recently acquired exclusive rights within our markets to Helix Biopharmas Heterodimer Protein Technology (HPT). The combination of Helixs HPT technology and Lumeras proprietary nanosurface modification chemistry will, for the first time, allow researchers to consistently utilize existing DNA arrays to produce protein arrays that accurately mimic the native living cell environment of the body.
Lumera is collaborating with the Institute for Systems Biology to develop a high-throughput, label-free detection platform. The technology platform consists of Lumeras ProteomicProcessor and NanoCapture Array technology. The ProteomicProcessor tool reads Lumeras high density NanoCapture Microarrays in real-time, without the use of molecular labels. By combining these technologies, researchers will be able to more quickly isolate, compile and process large amounts of data at high-speeds to accelerate proteomic research.
Electro-optic devices such as modulators translate electric signals into optical signals. Such devices are used in communication systems to transfer data over fiber-optic networks. Optical data transfer is significantly faster and more efficient than transfer technologies using only electric signals, permitting more cost-effective use of bandwidth for broadband Internet and voice services.
Current technologies that translate electric signals into optical signals generally rely on inorganic electro-optic materials. Polymer-based electro-optic modulators provide advantages over traditional switching technologies based on inorganic materials in terms of switching speed, optical transmission properties and lower operating voltages. We believe that the advantages in switching speed and other characteristics of polymer-based electro-optic modulators may drive increased sales of these modulators over the next several years.
We anticipate that an additional market for electro-optic devices may develop in connection with computer components. Some integrated circuit manufacturers are seeking to solve problems that exist with metal interconnects, which are used to move data directly from microprocessors to other computer components. Metal interconnects may become more problematic as processor speeds continue to increase. Unlike many metal interconnects, polymer-based interconnects can operate at higher circuit speeds by optically transmitting data between computer components and systems.
Lumera Product Opportunity
We are developing a new generation of electro-optic modulators and other devices for optical networks based on our proprietary polymer materials. Our polymer-based modulators can operate at speeds up to five times faster than existing inorganic crystal-based electro-optic modulators. In addition, using our polymers we can build modulators with three-dimensional flexible geometries that are not possible using inorganic materials. We believe we can design polymer-based electro-optic modulators that are smaller, lighter and more energy efficient than electro-optic modulators using inorganic crystals.
We delivered modulators to a U.S. government agency for testing in the second half of 2004. As the commercial market develops, we will introduce a 10 gigahertz modulator designed to have significant price, power and size advantages over competing modulators. In addition, we have developed electro-optic materials that are being tested by several potential customers to be used in optical interconnects for high-speed computing applications.
Wireless Antennas and Systems
We believe an opportunity exists in the emerging market for wireless smart antennas. Smart antennas, which currently are used primarily in the defense sector, have historically used mechanical parts to steer radio frequency beams. This functionality allows the antenna to dynamically track users of the antenna signal, thereby improving the users quality of service through associated software that can provide better allocation of bandwidth among a number of users. Potential applications for smart antennas include global positioning satellite devices and systems and cellular, automotive, aerospace and defense applications.
Lumera Product Opportunity
Our AccuPath Smart Antenna, which is in the development phase, features polymer-based technology that provides electronic rather than mechanical beam steering. Accordingly, our smart antenna has no moving parts, which we expect will improve its accuracy and durability compared to antennas that use mechanical beam steering. In addition, we anticipate that our proprietary design will result in a smart antenna that is small, lightweight and low cost. We are developing a smart antenna for customer specific applications for potential use in WiMAX wireless broadband services. We have not yet begun commercial production of smart antennas.
The table below outlines the position of our key products within our product pipeline.
Government Research Applications
In addition to our various products in development for commercial markets, Lumera continues to work with various U.S. government agencies such as the Defense Advanced Research Projects Agency (DARPA) and the Air Force Research Labs to develop polymers and polymer-enabled devices to improve the performance and reduce the cost of airborne and space-based wireless applications, including sensors and navigation, tracking and communications systems.
In addition, we expect increased government-sector demand for biotechnology disposables. The National Institutes of Health, the National Science Foundation and agencies associated with the Department of Homeland Security provide substantial funding for the private sector. These agencies represent a significant resource for additional product research funds to develop testing and diagnostic methods using biochips.
We develop customized products on a contract basis for U.S. government agencies and government subcontractors, including high performance electro-optic modulators currently unavailable in the commercial market. These development contracts provide us with revenues, help fund our research and development efforts and provide access to certain technological resources of the government and government subcontractors.
Our objective is to be a leading provider of products based on our proprietary technology and know-how in nanotechnology-based polymer materials. We are initially targeting the markets for biotechnology disposables, electro-optic devices and wireless antennas and systems. We are also developing customized polymer-based applications for government agencies. Our business strategy has the following components:
Research and Development Process
We have integrated our operations with the goal of minimizing the time to market for our potential products and streamlining the product development process. We have four internal technical service groups supporting our research and development efforts:
Materials and chemistry. Our materials and chemistry group develops materials to meet the performance specifications requested by customers. This group is responsible for using existing synthesis methods as well as developing new methods to create novel polymer materials that meet customer specifications. Once a polymer material has passed all of the testing parameters and has been shown to have promise for commercial applications, this group develops new methods to synthesize larger quantities of such material.
Materials characterization and testing. Our materials characterization and testing group oversees early stage evaluations and conducts a full battery of tests at the completion of the synthesis of each new polymer material. This group evaluates test data using our central database. The group also helps create development strategies to optimize materials to meet customer specifications.
Process development and device fabrication. Our process development and device fabrication group integrates data from the material characterization and testing group to fabricate devices. This group analyzes device testing results to refine and improve fabrication processes and methods. In addition, the group works closely with the other departments, providing technical proposals on how materials or design variations can help enable more efficient fabrication processes.
Device design, testing and packaging. Our device design, testing and packaging group takes customer specifications and creates an initial device design using simulation software. Following device fabrication, this group runs a series of optical and electronic tests and creates a report that provides our other groups with directions on enhancing performance in future generations of materials and processes. The group also has the capability to package devices in pilot production quantities.
External collaborations are an important aspect of our strategic plan. We have relationships with the following partners:
University of Washington. We collaborate actively with the University of Washington, a leading research institution, to conduct research and development in the field of optical materials technology. In October 2000, we entered into a sponsored research agreement with the University of Washington to further the development of electro-optic materials and devices. Pursuant to this agreement, we approved a research plan submitted by the University of Washington and sponsor several post-doctoral researchers and graduate research assistants. Their research covers improvements to polymer materials in several areas, including electro-optic activity, optical loss, long-term thermal stability and nanotechnology processibility. This research has resulted in 6 U.S. patent applications that are subject to our licensing agreement with the university. Pursuant to the sponsored research agreement, we agreed to pay the University of Washington an aggregate of $5.8 million. As of December 31, 2004, we had paid $5.1 million of this amount.
In connection with the sponsored research agreement, we also entered into an exclusive licensing agreement with the University of Washington in October 2000, pursuant to which we acquired rights to intellectual property relating to electro-optic polymers and related organic materials and processes in the following fields of use:
The sponsored research agreement allows us to add new patents and technology under the licensing agreement. The licensing agreement terminates upon the expiration of the last of the University of Washingtons patents that relate to this technology and that are licensed to us under the agreement, unless earlier terminated by the university or by us. Pursuant to the agreement, we issued shares of our common stock to the university valued at an aggregate of approximately $3.0 million. We also paid a $200,000 license fee to the university in March 2001. We have also agreed to pay certain costs related to filing and processing patents related to the agreement and to make ongoing royalty payments of at least $75,000 per year.
We have also paid an additional $900,000 to the University of Washington under the terms of a separate letter agreement for additional research related to the optical materials.
Arizona Microsystems, L.L.C. We have a consulting agreement with Arizona Microsystems, a company that specializes in the research and development of electro-optic polymeric materials and fabrication processes. Pursuant to this agreement, Arizona Microsystems provides us with consulting services in the field of electro-optic polymers. Pursuant to this consulting agreement, we have agreed to pay them $5,000 per month during the
term of the agreement. In addition, pursuant to a separate licensing agreement with Arizona Microsystems, we have an exclusive sublicense in the field of electro-optic polymers to the rights to seven patents from Arizona Microsystems.
Helix Biopharma/Sensium. We recently entered into a worldwide exclusive license agreement with Sensium Technologies, Inc., a subsidiary of Helix BioPharma. Sensium licensed to us a number of patents and the related technology for use in our NanoCapture Arrays. If we incorporate the Sensium technology into a product, we will pay Sensium a negotiated royalty on all sales of such products.
Institute for Systems Biology. We recently entered into a collaborative agreement with the Institute for Systems Biology (ISB) for the purpose of developing high-throughput diagnostic tools and accelerate the path to market for our ProteomicProcessor and related consumables.
We also have arrangements with various individual consultants who are experts in the field of polymers, including a professor at the University of Colorado at Boulder who has published numerous scholarly articles relating to novel polymer devices and applications of interest in high-speed digital-to-analog conversion and optically controlled phased-array radar. We also have arrangements with a professor at the University of Southern California who specializes in material characterization, device processing, optical device design and device applications, and a professor at the University of California, Los Angeles who consults with us in the areas of device processing, optical device design, high-speed radio frequency design and system-level device applications.
Patents and Other Intellectual Property
We were founded to develop and exploit technologies relating to polymers and related materials. Specifically, our technologies relate to:
As a small company seeking to market and sell novel products in new markets, we believe that a robust technology portfolio is an essential element of our business strategy. Accordingly, we believe that our success will depend in large part on our ability to:
Our intellectual property consists principally of patentable inventions and trade secrets. We have developed some of this intellectual property internally and have also acquired intellectual property from our strategic partners and others. We and our strategic partners protect our intellectual property by filing domestic and foreign patent applications where appropriate and by maintaining an active program designed to preserve the confidentiality of our trade secrets. With respect to inventions and other intellectual property created under our development contracts with the U.S. government and government contractors, we typically have the right to
retain title to any patents that issue to us in connection with the performance of these contracts, with the government retaining a non-exclusive license to use the patented technology for government purposes. The government typically also retains rights in any technical data that we develop using federal funding and deliver under a development contract. If we do not comply with government notice requirements with respect to inventions developed under these development contracts, the government could demand ownership of the inventions, in which case we would retain a license to use the inventions.
We have 5 issued United States patents and approximately 29 currently pending United States patent applications, 2 of which have received notices of allowance. Our patents and patent applications are directed to polymer and small molecule materials, methods of making materials, processing of materials, processing of devices, device designs and microarray analysis methods. We also have an exclusive sublicense in the field of electro-optic polymers to the rights to seven patents from Arizona Microsystems and have licensed four patent applications covering technology from the University of Washington. In addition, we have 7 international patent applications pending under the Patent Cooperation Treaty. In connection with our transaction with Sensium, we licensed 3 U.S. patents and rights under patents granted under 2 additional U.S. patent applications, each of which has various corresponding international patents.
The discoveries or technologies covered by the patents and patent applications we own or license may not have commercial value. Also, issued patents may not provide commercially meaningful protection against competitors. Other parties may be able to design around our issued patents or independently develop technology having effects similar or identical to our patented technology. In addition, the scope of our patents and patent applications is subject to uncertainty and competitors or other parties may obtain similar patents of uncertain scope. For example, other parties may discover uses for polymers or technology different from the uses covered in our patents or patent applications, and these other uses may be separately patentable. Also, other parties may have patents covering the composition of polymers for which we have patents or patent applications covering only methods of use of these polymers.
Third parties may infringe the patents that we own or license, or claim that our potential products or related technologies infringe their patents. Any patent infringement claims that might be brought by or against us may cause us to incur significant expenses, divert the attention of our management and key personnel from other business concerns and, if successfully asserted against us, require us to pay substantial damages. In addition, a patent infringement suit against us could force us to stop or delay developing, manufacturing or selling potential products that are claimed to infringe a patent covering a third partys intellectual property.
In addition to our patented intellectual property, we also rely on unpatented technology, trade secrets and confidential information. We require each of our employees and consultants to execute a confidentiality agreement before beginning their employment or consulting relationship with us. These agreements generally provide that the individual must keep confidential and not disclose to other parties any confidential information developed or learned by the individual during the course of his or her relationship with us. Our agreements with employees provide that any intellectual property developed by the employee during the course of his or her employment is automatically assigned to us. Our agreements with consultants generally provide that we have the option to exclusively license all inventions conceived by the consultant in the course of rendering services to us. These agreements with employees and consultants may not provide effective protection of our technology or confidential information or, in the event of unauthorized use or disclosure, may not provide adequate remedies.
As part of our business strategy we collaborate with third parties in our research and development activities. Accordingly, disputes may arise about inventorship and corresponding rights to know-how and inventions resulting from the joint creation or joint use of intellectual property. In addition, these third parties may circumvent any proprietary protection we do have. They may independently develop equivalent technologies or independently gain access to and disclose substantially equivalent information, and confidentiality agreements and material transfer agreements we have entered into with them may not provide us with effective protection.
We currently manufacture prototype NanoCapture Arrays in our research facilities. Our in-house facilities are capable of producing sufficient quantities of bio-chips to meet initial commercial development quantities. We will require additional capacity to meet anticipated further demand. We are investigating leasing additional production laboratory space that would accommodate larger bio-chip volumes as well as enable polymer modulator production. We may also expand our facilities to accommodate larger production volumes and research capability.
Sales and Marketing
Lumera is transitioning from a product-focused company to becoming a customer-focused organization. We are aggressively pursuing sales and marketing of our products targeting opinion / market leaders and initial customers. We have identified a number of high profile beta test sites in each of our current target markets, which will serve to validate the instrument and chips, as well as create awareness about Lumeras technology. We will leverage these expected initial sales with opinion and market leaders to obtain future contracts and sales references. We are partnering with leading U.S. research institutions and opinion leaders such as the Institute of Systems Biology.
We are targeting life science research centers and universities for protein pathway basic discovery and are in discussions with biotech companies and large pharmaceutical companies interested in the mechanisms of molecular biology, protein-protein interactions and networking, cell signaling, aging, death and disease. We plan to reach these potential customers through targeted direct selling, followed by non-exclusive co-marketing partnerships. In addition, we plan to advertise in trade journals, participate in targeted industry trade shows and organizations, engage in focused public relations campaigns, and make scientific presentations at technical conferences.
In addition to our bioscience expertise, we have employees with experience in the marketing of polymer materials and related products. Our marketing professionals are focused on selling our bioscience biochips/instruments, electro-optic devices and smart antenna product offerings. As our potential products advance in development, we expect to increase our marketing and sales resources.
In addition to using our own sales and marketing organization, we may promote our potential products with marketing partners. We may also rely on relationships with companies with established distribution systems and direct sales forces to distribute and sell our potential products.
The markets that we are targeting for our polymer materials technology are intensely competitive. In the biotechnology disposables market, we expect to compete with Tactical Fabs, Inc., Erie Scientific Company and Corning Incorporated. In the bioscience instrumentation and tools area we expect to compete with BiaCore, Affymetrix, Applera, Agilent and others. In the electro-optic modulators market, we expect to compete with Fujitsu Limited, Sumitomo Osaka Cement Company, Ltd., Avanex, Inc. and JDS Uniphase Corporation. In the wireless antenna and systems market, we expect to compete with Skycross, Inc., Cushcraft Corporation, HyperLink Technologies, Inc. and MAXRAD, Inc.
We believe the principal competitive factors affecting our markets are the:
Although we believe that we are well positioned to compete adequately with respect to these factors in the future, our future success is currently difficult to predict because we are an early stage company and all of our potential products are still in early stages of development.
Many of our existing and potential competitors have substantially greater research and product development capabilities and financial, scientific, marketing and human resources than we do. As a result, these competitors may:
We are subject to federal, state and local laws and regulations relating to the generation, handling, treatment, storage and disposal of certain toxic or hazardous materials and waste products that we use or generate in our operations. We regularly assess our compliance with environmental laws and management of environmental matters.
We are also subject to federal procurement regulations associated with our U.S. government contracts. Violations of these regulations can result in civil, criminal or administrative proceedings involving fines, compensatory and punitive damages, restitution and forfeitures as well as suspensions or prohibitions from entering into government contracts. In addition, the reporting and appropriateness of costs and expenses under our government contracts are subject to extensive regulation and audit by the Defense Contract Audit Agency, an agency of the U.S. Department of Defense. The contracts and subcontracts to which we are a party are also subject to potential profit and cost limitations and standard provisions that allow the U.S. government to terminate such contracts at its convenience. We will be entitled to reimbursement of our allowable costs and to an allowance for earned profit if the contracts are terminated by the U.S. government for convenience.
Sales of our potential products and services internationally may be subject to the policies and approval of the U.S. Department of State and Department of Defense. Any international sales may also be subject to United States and foreign government regulations and procurement policies, including regulations relating to import-export control, investments, exchange controls and repatriation of earnings.
As of December 31, 2004, we employed 38 full-time and part-time employees. Our team of chemists, materials scientists, electrical engineers, and optical physicists includes 11 Ph.D.s. From time to time, we also use independent contractors. None of our employees is represented by collective bargaining arrangements. To date, we have experienced no work stoppages, and we believe that our relationship with our employees is good.
Our facilities occupy approximately 16,000 square feet of combined use office and laboratory space at our headquarters facility in Bothell, Washington. We lease these facilities from Microvision pursuant to a sublease that expires in April 2006.
Our facilities contain the following:
In addition, our facilities contain general office space for up to 40 employees. We anticipate that we will sublease additional space until April 2006, at which time we anticipate leasing enough space to accommodate all of our foreseeable office and research lab space we need to meet the requirements of our growth.
The Company is subject to various claims and pending or threatened lawsuits in the normal course of business. The Company is not currently party to any legal proceedings that management believes the adverse outcome of which would have a material adverse effect on the Companys financial position, results of operations or cash flows.
There were no matters submitted to a vote of shareholders during the fourth quarter of the year ending December 31, 2004.
Executive officers are appointed by our Board of Directors and hold office until their successors are elected and duly qualified. Mr. Mino also serves as director of Lumera. The following persons serve as executive officers of Lumera:
Thomas D. Mino, age 58, has served as Chief Executive Officer, President and a director since September 2001. From November 1999 to September 2001, he served as Vice President and General Manager of the high-speed long-haul business unit of Agere Systems Inc., an optical components supplier. From 1991 to October 1998, Mr. Mino served as President and Chief Executive Officer of Synergy Semiconductor Corp., a specialty high-speed semiconductor manufacturer. Mr. Mino has a B.S.E.E. degree in Electrical Engineering from the University of Pittsburgh.
Robert J. Petcavich, Ph.D., age 50, has served as Senior Vice President Chief Technology Officer since July 2004 and as Chief Technology Officer since October 2003. From July 1992 to December 2002, Dr. Petcavich served as Chairman, Chief Executive Officer and Chief Technology Officer of Planet Polymer Technologies, Inc., an advanced materials company that he founded in 1991. From 1996 to December 2001, Dr. Petcavich served as the Chairman and Chief Executive Officer of Alife Medical Inc., a natural language processing software services provider that he founded in 1996. Dr. Petcavich has a Ph.D. degree in Polymer Science, an M.S. degree in Solid State Science, and a B.S. degree in Chemistry from Pennsylvania State University. Dr. Petcavich currently serves as a director of Planet Polymer Technologies.
Daniel C. Lykken, age 51, has served as Vice President of Sales and Marketing since April 2004. From February 2003 to February 2004, Mr. Lykken served as Vice President Worldwide Sales of TeleSym Inc., a voice-over-Internet Protocol software company. From February 2002 to February 2003, Mr. Lykken served as a Strategic Account Team Manager of WatchMark Corporation, a service assurance and operational support system software provider. From October 2000 to August 2001, Mr. Lykken served as Director of Sales of Talk2 Technologies, Inc., an enhanced services provider to telecommunication carriers. From November 1999 to October 2000, Mr. Lykken served as Partner and Director of Sales of Meridian Venture Catalyst, LLC, a venture catalyst firm. From June 1999 to November 1999, Mr. Lykken served as Senior Sales Executive of Hitachi Data Systems, a data storage company. Mr. Lykken has a B.S. degree in Economics from Concordia College.
Peter J. Biere, age 48, has served as Chief Financial Officer and Treasurer of Lumera Corporation since August 2004. From September 2003 to August 2004, Mr. Biere acted as Interim CEO and CFO of Entrées, Inc. From February 2002 to August 2003, Mr. Biere provided financial consulting services. From July 1999 to January 2002, Mr. Biere served as Chief Financial Officer of Locate Networks, a location-based wireless service provider. From May 1993 to July 1999, Mr. Biere served as Senior Vice President and Chief Financial Officer of Zones, Inc., where he helped lead that companys initial public offering. Mr. Biere has a B.A. in Accounting and an M.A. in Accounting from the University of Iowa.
The Companys Common Stock trades on the NASDAQ National Market under the symbol LMRA. As of March 1, 2005, there were 2,850 holders of record of 16,571,930 shares of Common Stock outstanding. The Company has never declared or paid cash dividends on the Common Stock. As of March 1, 2005, the closing price of our Common Stock on the NASDAQ National Market was $4.89. The Company currently anticipates that it will retain any future earnings to fund the operation of its business and does not anticipate paying dividends on the Common Stock in the foreseeable future.
The Companys Common Stock began trading publicly on July 26, 2004. The quarterly high and low sales prices of the Companys common stock as reported by the NASDAQ National Market are as follows:
The information under the heading Equity Compensation Plan Information in the Companys definitive Proxy Statement for the Annual Meeting of Shareholders to be held June 2, 2005, to be filed with the SEC, is incorporated into Item 12 of this report by reference.
Selected financial data presented below has been derived from and should be read in conjunction with our audited consolidated financial statements and the notes thereto, and Managements Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this report. A summary of selected annual financial data from Inception (January 7, 2000) through December 31 of each year-end is presented below:
Lumera Corporation was established in early 2000 to develop proprietary polymer materials and products based on these materials for a broad range of applications. We design and synthesize polymer materials at the molecular level by using our expertise in nanotechnology, which is the development of products and production processes at a scale smaller than 100 nanometers (a nanometer is one-billionth of a meter). Our goal is to optimize the electrical, optical and surface properties of these materials. We use these materials to improve the design, performance and functionality of products for use in biochemical analysis; in optical communications networks and in wireless antennas and systems. We believe we have developed a proprietary intellectual property position based on a combination of patents, licenses and trade secrets relating to the design and characterization of polymer materials, methods of polymer synthesis and production of polymers in commercial quantities, as well as device design, characterization, fabrication, testing and packaging technology.
From inception through 2004, we concentrated primarily on the development of our technology and potential products. To date, substantially all of our revenues have come from contracts to develop custom-made electro-optic materials and devices for government agencies. As we transition to a product-based company we expect to record both revenue and expense from product sales, to incur increased costs for sales and marketing and to increase general and administrative expense. Accordingly, the financial condition and results of operations reflected in our historical financial statements are not expected to be indicative of our future financial condition and results of operations. Until December 31, 2003, the Company was considered to be in the development stage. In early 2004, the Company commercialized the devices for potential wireless networking and optical networking applications and had largely completed financial planning, establishing sources of supply, acquiring plant and equipment and recruiting personnel. Therefore, the Company was considered to have exited the development stage in 2004.
We were previously a subsidiary of Microvision, Inc. and we relied on Microvision for the provision of certain administrative services. As of December 31, 2004 we have fully transitioned away from our former inter-company arrangement with Microvision and currently provide all executive, investor relations, accounting and finance, human resources, information systems and facilities services with Company personnel. The following table reflects payments made for services under the former Microvision Agreement:
Results of Operations
Revenue. Substantially all of our revenue since inception has been generated from cost plus fixed fee development contracts with several United States government agencies or with government contractors. Our projects have primarily been to develop specialized electro-optic polymer materials and devices. We entered into a $1.6 million contract in August 2001 with a government agency that was renewed in October 2002 for $1.0 million, again in November 2003 for $950,000 and recently in January 2005 for $1.1 million. We entered into a feasibility study with a government contractor in December 2002 for $149,000 that was extended in 2003 for an additional $400,000 until shifting governmental funding priorities terminated the project. We entered into a contract with a governmental agency in August 2003 for $497,000 that was renewed in December 2004 for $210,000. Our revenue from government contracting has fluctuated year to year and we expect that future periods could also fluctuate significantly.
Prospectively, we intend to also generate revenue through sales of our products to original equipment manufacturers, or OEMs, and industry partners and through development contracts. We expect that future revenue from U.S. government contracts will decrease as a percentage of revenue and that product revenue from the sale of commercial products will increase both on a dollar basis and as a percentage of revenue in future years.
Cost of Revenue. Historically, cost of revenue has consisted primarily of the direct and allocated indirect costs of performing on development contracts. Direct costs include labor, materials and other costs incurred directly in performing specific projects. Indirect costs include labor and other costs associated with our research and product development efforts and building our technical capabilities and capacity. The cost of revenue can fluctuate substantially from period to period depending on the level of both the direct costs incurred in the performance of projects and the level of indirect costs incurred. The cost of revenue as a percentage of revenue can fluctuate significantly from period to period depending on the contract mix, the cost of future planned products and the level of direct and indirect cost incurred.
We expect that cost of revenue on a dollar basis will increase in the future as a result of anticipated sales of products, additional development contract work that we expect to perform, and commensurate growth in our personnel and technical capacity required to perform on these contracts.
Research and Development Expense. Research and development expense consists primarily of:
A significant portion of our research and development expense to date relate to cash payments and a grant of common stock pursuant to various agreements we have with the University of Washington (UW). We issued 802,414 shares of common stock in January 2001 under our UW Sponsored Research Agreement, recognizing $3.0 million of research expense through February 2004. Cash payments under the Sponsored Research Agreement, following several amendments, totaled $5.0 million through December 31, 2004, and will total $5.75 million when the final payment is made in June 2005. After each amendment, we prospectively adjusted the amortization of the research payments over the revised service period. We have also paid the UW a total of $0.9 million through December 31, 2004 for additional research related to polymer materials. In addition, we have ongoing minimum royalty obligations to the UW of $75,000 annually.
We expect to continue to incur substantial research and development expense to develop commercial products using polymer materials technology. These expenses could increase as a result of continued development and commercialization of our polymer materials technology, including subcontracting work to potential development partners, expanding and equipping in-house laboratories, acquiring rights to additional technologies, hiring additional technical and support personnel and pursuing other potential business opportunities.
Marketing, General and Administrative Expense. Marketing, general and administrative expense consists primarily of compensation and support costs for management and administrative staff, and for other general and administrative costs, including accounting, consulting and other operating expenses. It also consists of costs
associated with corporate awareness campaigns such as web site development and participation at trade shows, corporate communications initiatives and efforts with potential customers and joint venture partners to identify and evaluate product applications in which our technology could be integrated or otherwise used.
We have fully transitioned away from our former inter-company arrangement with Microvision and currently provide all executive, investor relations, accounting and finance, human resources, information systems and facilities services with Company personnel.
We expect marketing, general and administrative expense to increase in future periods as we:
Interest Income and Expense. Interest income consists of earnings from investment securities. Dividend and interest income are recognized when earned. Realized gains and losses are included in other income. Interest expense consists of interest accrued on our 6.5% Convertible Promissory Notes issued in April 2004, which were repaid upon completion of our initial public offering.
Income Taxes. From inception through December 31, 2004, we have generated federal net operating loss carry forwards of approximately $34.3 million and research and development credits of approximately $868,000. Our net operating loss carry forwards begin expiring in 2018 through 2024. In some circumstances, as specified in the Internal Revenue Code, a 50% or more ownership change by certain combinations of our shareholders during any three-year period would result in a limitation on our ability to use a portion of our net operating loss carry forwards. We have recorded a valuation allowance for the full amount of its potential future tax benefits.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, contract losses, bad debts, investments and contingencies and litigation. We base our estimates on historical experience, terms of existing contracts, information provided by our current and prospective customers and strategic partners, information available from other outside sources, and on various other assumptions management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following accounting policies require our more significant judgments and estimates used in the preparation of our financial statements.
We recognize revenue as work progresses on long-term, cost plus fixed fee and fixed price contracts using the percentage-of-completion method, which relies on estimates of total expected contract revenue and costs. We use this revenue recognition methodology because we can make reasonably dependable estimates of the revenue and costs. Recognized revenues are subject to revisions as the contracts progress to completion and actual revenue and cost become certain. Revisions in revenue estimates are reflected in the period in which the facts that give rise to the revisions become known.
We estimate contract costs based on the experience of our professional researchers, the experience we have obtained in our internal research efforts, and our performance on previous contracts. We believe this allows us to reasonably estimate the tasks required and the contract costs; however, there are uncertainties in estimating these costs, such as the ability to identify precisely the underlying technical issues hindering development of the technology; the ability to predict all the technical factors that may affect successful completion of the proposed tasks; and the ability to retain researchers having enough experience to complete the proposed tasks in a timely manner. To date, we have mitigated the risk of failing to perform under these contracts by negotiating best efforts provisions, which do not obligate us to complete contract deliverables.
University of Washington Sponsored Research Agreement
We record research expense under the sponsored research agreement with the University of Washington on a straight-line basis because we do not have sufficient information to more readily determine the pattern of performance of research by the University of Washington under this agreement. Total research expenses to be recognized are based on the total expected payments to be made under the agreement. We have entered into several amendments to the original agreement, most recently in April 2004, and have extended the period of time over which payments will be made and have also changed the amount of these payments. We entered into these amendments to conserve our cash resources and to better align payments with expected performance by the University of Washington under the agreement. We prospectively adjust our expense recognition after each of these amendments. These amendments have had a significant impact on the amount of expense recognized in any one fiscal period. The Agreement ends in June 2005; scheduled payments under the Agreement will have totaled $5,750,000 instead of the $9,000,000 under the terms of the original agreement.
Results of Operations
Comparison of Years ended December 31, 2004 and 2003
Revenue. Revenue decreased by $736,000 to $989,000 for the year ended December 31, 2004 from $1,725,000 for the year ended December 31, 2003, due primarily to a government sub-contract awarded during 2003 that was not renewed for 2004. We recognized $488,000 of revenue on this contract during 2003. Also contributing to the decline in 2004 revenues were two government contracts that we ceased working on during the fourth quarter while both contracts entered the renewal phase, causing a delay in billable revenue. Both of these contracts, together valued at $1.3 million, have been renewed for work we expect to perform and bill in 2005.
Cost of Revenue. Cost of revenue decreased by $363,000 to $651,000 for the year ended December 31, 2004 from $1,014,000 for the year ended December 31, 2003, due primarily to lower labor costs, which declined by $146,000 and overhead allocations which declined by $241,000, due to lower levels of government contract activities during 2004.
Research and Development Expense. Research and development expense decreased $3,041,000 to $4,561,000 for the year ended December 31, 2004, from $7,602,000 for the year ended December 31, 2003. Net expenses associated with our various agreements with the University of Washington declined by approximately $4.2 million in 2004 from 2003. In April 2004, the Sponsored Research Agreement (SRA) with the University of Washington was amended, reducing the total payment amount required under the agreement from $9 million to $5.75 million, and eliminating a contingent payment of $2.0 million which was originally due in May 2005. We recorded a $2.4 million benefit in 2004 to bring previously expensed costs in line with the amended payment schedule. Apart from the one-time benefit, expenses recognized under the UW Agreement, including SRA and stock amortization costs, totaled $1.6 million in 2004 compared with $2.9 million in 2003. Cash payments under the UW Agreement totaled $800,000 in 2004 compared with $1.3 million in 2003.
The following table summarizes the payments made and expenses recognized under the various UW Agreements for the comparative periods:
Non-cash stock-based compensation expense associated with stock options granted to research personnel during 2004 at prices below fair value totaled $573,000, up from $34,000 during 2003. We also incurred $162,000 more expense related to technology transfer and patent expense reimbursement with Arizona Micro Systems in 2004. In addition, we applied more resources to product development efforts in 2004 resulting in labor and research costs which were approximately $438,000 higher in 2004 compared to 2003.
Marketing, General and Administrative Expense. Marketing, general and administrative expense increased $3,318,000 to $4,588,000 for the year ended December 31, 2004 from $1,270,000 for the year ended December 31, 2003. The increased expense during 2004 was primarily attributable to non-cash amortization for stock options granted in April 2004 at below market prices of $1,320,000, expenses for additional marketing and finance personnel totaling $731,000, higher cash incentive compensation costs of $356,000, higher audit and legal fees which increased by $440,000 and other cost increases primarily related to being a public company which were approximately $300,000.
Interest Income. Interest income increased $198,000 to $237,000 for the year ended December 31, 2004 from $39,000 in 2003 due to higher levels of investments following the companys public offering in July 2004.
Interest Expense. Interest expense was $349,000 for the year ended December 31, 2004. In April 2004, we issued $2,300,000 of 6.5% Convertible Notes together with warrants to purchase common stock. The Notes were repaid in August 2004 following our public offering. We incurred $345,000 of interest expense associated with the Notes in 2004, $44,000 of which was paid in cash for the stated interest on the Notes and $301,000 of non-cash debt issuance costs associated with the value of the warrants. There was no interest expense in 2003.
Deemed Dividend upon Issuance of Preferred Stock. In March 2004, we raised cash proceeds of $500,000 from the sale of 250,000 shares of Series B convertible preferred stock to private investors. The conversion price of the Series B convertible preferred stock issued was less than the fair value of the Class A common stock on the issuance date. As a result, we recorded a $500,000 beneficial conversion feature upon issuance of the preferred stock. This amount was immediately recorded as a deemed dividend to preferred shareholders because the Series B preferred stock had no stated term and was immediately convertible into Class A common stock.
Comparison of Years ended December 31, 2003 and 2002
Revenue. Revenue increased by $779,000 to $1,725,000 for the year ended December 31, 2003 from $946,000 for the year ended December 31, 2002. The increase in 2003 resulted from a higher level of development contract business in 2003. In 2003 and 2002, our revenue was primarily derived from development contracts with the United States government. We also derived revenue in 2003 from services provided to a semiconductor company.
Cost of Revenue. Cost of revenue increased by $684,000 to $1,014,000 for the year ended December 31, 2003 from $330,000 for the year ended December 31, 2002 due primarily to higher labor and related costs, which increased $266,000 and overhead allocations which increased by $395,000, related to increased levels of government contract activities during 2003.
Research and Development Expense. Research and development expense decreased by $698,000 to $7,602,000 for the year ended December 31, 2003 from $8,300,000 for the year ended December 31, 2002. Expenses relating to our sponsored research agreement with the University of Washington declined by $476,000 to $1,924,000 in compared to $2,400,000 recorded in 2002. As a result of the amendments made to the original research agreement during 2003 and 2002, our payments were less than the expense recorded. As of December 31, 2003 and 2002, we had paid $1,948,000 and $1,025,000 less than expense recorded, respectively. Total payments made under the agreement were $4,375,000 through December 31, 2003.
The following table summarizes the payments made and expenses recognized under the various UW Agreements for the comparative periods:
Marketing, General and Administrative Expense. Marketing, general and administrative expense increased $49,000 to $1,270,000 for the year ended December 31, 2003 from $1,221,000 for the year ended December 31, 2002. During both 2002 and 2003 we relied on our former parent for substantially all accounting, legal and certain other administrative expenses, which were consistent during the two comparative periods. These expenses were reimbursed under an inter-company agreement.
Interest Income and Expense. Interest income decreased $160,000 to $39,000 for the year ended December 31, 2003 from $199,000 for the year ended December 31, 2002. The decrease in interest income resulted from decreasing average cash and investment securities balances from 2002 through 2003 as we incurred operating losses. We incurred no interest expense in 2003 or 2002.
Liquidity and Capital Resources
We have funded our operations to date primarily through the sale of common stock and convertible preferred stock and, to a lesser extent, through revenues from development contracts and sales of services. We had an accumulated deficit of $38.2 million as of December 31, 2004. Our initial public offering in July 2004 provided $38.7 million in cash proceeds before offering expenses.
At December 31, 2004 we had $30.2 million in cash and cash equivalents and investment securities held for sale, some of which are classified as long term with maturities more than 12 months beyond the balance sheet date.
Net cash used in operating activities totaled $7.4 million, $4.7 million and $5.2 million for the years ended December 31, 2004, 2003 and 2002, respectively. Net cash used in operations during 2004 increased by $2.7 million over 2003. Increased cash expenditures during 2004 were due to approximately $1.1 million in higher
labor and benefit costs for corporate headcount that was added during the year, additional legal, audit and consulting fees related to public company activities totaling approximately $670,000 and higher insurance and other prepaid costs of $568,000.
Net cash used in investing activities during 2004 totaled $27.2 million and was primarily comprised of short and long term cash investments made following our public offering. During 2003 net cash provided by the sale of short term investments totaled $2.4 million. We used $378,000 to purchase capital equipment in 2004 compared with $455,000 and $562,000 in 2003 and 2002, respectively. Historically, capital expenditures have been used to make leasehold improvements to leased office space and to purchase production equipment, computer hardware and software, laboratory equipment and furniture and fixtures to support our growth. Capital expenditures are expected to increase in the future as we expand our operations.
Cash provided by financing activities was $37.5 million in 2004 and $2.6 million in 2003. The increase in cash provided by financing activities resulted primarily from increases in the net proceeds from the issuance of stock and notes as follows:
No cash was provided by financing activities in 2002.
Our future expenditures and capital requirements will depend on numerous factors, including: the progress of our research and development efforts; the rate at which we can, directly or through arrangements with original equipment manufacturers, introduce and sell products incorporating our polymer materials technology; the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; market acceptance of our products and competing technological developments; and our ability to establish cooperative development, joint venture and licensing arrangements.
We expect that our cash used in operations will increase during 2005 and beyond as a result of:
Our business does not presently generate the cash needed to finance our current and anticipated operations. We expect that cash and investments held for sale, along with revenues from our existing contractual relationships, will be sufficient to fund our operations at least through the end of 2006 (See Risk Factors). We
may seek additional funding through public or private financings, including equity financings, and through other arrangements, including collaborative arrangements. If we raise additional funds by issuing equity or convertible debt securities, the percentage ownership of our existing stockholders may be reduced, and these securities may have rights superior to those of our common stock.
The following table lists our contractual obligations as of December 31, 2004:
New Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R), Share-Based Payment, which is a revision of SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be valued at fair value on the date of grant, and to be expensed over the applicable vesting period. Pro forma disclosure of the income statement effects of share-based payments is no longer an alternative. SFAS No. 123(R) is effective for all share-based awards granted on or after July 1, 2005. In addition, companies must also recognize compensation expense related to any awards that are not fully vested as of the effective date. Compensation expense for the unvested awards will be measured based on the fair value of the awards previously calculated in developing the pro forma disclosures in accordance with the provisions of SFAS No. 123. We are evaluating the alternative methods for implementing SFAS No. 123(R). If we elect to implement SFAS No. 123(R) on July 1, 2005 using the modified prospective method, we expect that the impact on 2005 earnings will be in the range of $1.5 to $2.6 million.
RISK FACTORS THAT MAY AFFECT OUR RESULTS
We have incurred substantial operating losses since our inception and will continue to incur substantial operating losses for the foreseeable future.
Since our inception, we have been engaged primarily in the research and development of our polymer materials technologies and potential products. As a result of these activities, we incurred net losses of $29.3 million from inception through December 31, 2003, and $8.9 million for the twelve months ended December 31, 2004. We anticipate that we will continue to incur operating losses through at least 2005. As of December 31, 2004, we had an accumulated deficit of $38.2 million.
We may not be able to generate significant additional revenue either through development contracts from the U.S. government or government subcontractors or through customer contracts for our potential products or technologies. We expect to continue to make significant operating and capital expenditures for research and development and to improve and expand production, sales, marketing and administrative systems and processes. As a result, we will need to generate significant additional revenue to achieve profitability.
We are subject to the risks frequently experienced by early stage companies.
The likelihood of our success must be considered in light of the risks frequently encountered by early stage companies, especially those formed to develop and market new technologies. These risks include our potential inability to:
We are entering new markets, and if we fail to accurately predict growth in these new markets, we may suffer substantial losses.
We are devoting significant resources to the development of products and the support of marketing and sales efforts in new markets, such as the WiFi market and the disposable biochip and broader proteomics markets. We expect to continue to seek to identify and develop products for new markets. New markets change rapidly and we cannot assure you that they will grow or that we will be able to accurately forecast market demand, or lack thereof, in time to respond appropriately. Our investment of resources to develop products for these markets may either be insufficient to meet actual demand or result in expenses that are excessive in light of actual sales volumes. Failure to predict growth and demand accurately in new markets may cause us to suffer substantial losses. In addition, as we enter new markets, there is a significant risk that:
The establishment and maintenance of original equipment manufacturer and other collaborative relationships is critical to the success of our business.
We expect to sell many of our products directly to research laboratories and commercial customers or through potential industry partners. For example, we expect to offer disposable bio-chips to research labs and customers who will use them in DNA analysis and protein discovery. Our ability to generate revenues depends significantly on the extent to which potential customers and other potential industry partners develop, promote and sell systems that incorporate our products. Any failure by potential customers and other potential industry partners to successfully develop and market systems that incorporate our products could adversely affect our sales. The extent to which potential customers and other industry partners develop, promote and sell systems incorporating our products is based on a number of factors that are largely beyond our ability to control.
Our future growth will suffer if we do not achieve sufficient market acceptance of our products.
We are developing nanotechnology-enabled polymer-based products. We do not know when a market for these products will develop, if at all. Our success depends, in part, upon our ability to gain market acceptance of our products. To be accepted, our products must meet the technical and performance requirements of our potential customers. The WiFi antenna and biochip markets are evolving rapidly and involve many competitors and competing technologies, and the optical communications industry is currently fragmented with many competitors developing different technologies. We expect that only a few of these technologies will ultimately gain market acceptance. Products based on polymer materials may not be accepted by OEMs and systems integrators of optical communications networks. In addition, even if we achieve some degree of market acceptance for our potential products in one industry, we may not achieve market acceptance in other industries for which we are developing products. If the markets we are targeting fail to accept polymer-based products or determine that other products are superior, we may not be able to achieve market acceptance of our products.
All of our current products are still in the development stage or are being tested by potential customers. We cannot assure you that these customer tests will be successful or that they will result in actual sales of our products.
Achieving market acceptance for our products will require marketing efforts and the expenditure of financial and other resources to create product awareness and demand by customers. We may be unable to offer products that compete effectively due to our limited resources and operating history. Also, certain large corporations may be predisposed against doing business with a company of our limited size and operating history. Failure to achieve broad acceptance of our products by customers and to compete effectively would harm our operating results.
Successful commercialization of our current and future products will require us to maintain a high level of technical expertise.
Technology in our target markets is undergoing rapid change. To succeed in our target markets, we will have to establish and maintain a leadership position in the technology supporting those markets. Accordingly, our success will depend on our ability to:
We cannot assure you that we will be able to achieve any of these objectives.
Many of our products will have long sales cycles, which may cause us to expend resources without an acceptable financial return and which makes it difficult to plan our expenses and forecast our revenues.
Many of our products will have long sales cycles that involve numerous steps, including initial customer contacts, specification writing, engineering design, prototype fabrication, pilot testing, regulatory approvals (if needed), sales and marketing and commercial manufacture. During this time, we may expend substantial financial resources and management time and effort without any assurance that product sales will result. The anticipated long sales cycle for some of our products makes it difficult to predict the quarter in which sales may occur. Delays in sales may cause us to expend resources without an acceptable financial return and make it difficult to plan expenses and forecast revenues.
We will require additional capital to continue to fund our operations. If we do not obtain additional capital, we may be required to substantially limit our operations.
Our business does not presently generate the cash needed to finance our current and anticipated operations. Based on our current operating plan and budgeted cash requirements, we believe that we will be able to fund our operations at least through 2006. We will require additional capital to continue to fund our operations in future periods. We expect that we will need to seek additional funding through public or private financings, including equity financings, and through other arrangements, including collaborative arrangements. Poor financial results, unanticipated expenses or unanticipated opportunities could require additional financing sooner than we expect. Such financing may be unavailable when we need it or may not be available on acceptable terms. If we raise additional funds by issuing equity or convertible debt securities, the percentage ownership of our existing stockholders may be reduced, and these securities may have rights superior to those of our common stock. If adequate funds are not available to satisfy either short-term or long-term capital requirements, or if planned revenues are not generated, we may be required to limit our operations substantially. These limitations of operations may include reductions in capital expenditures and reductions in staff and discretionary costs.
We currently rely heavily on a small number of development contracts with the U.S. Department of Defense and government contractors. The termination or non-renewal of one or more of these contracts could significantly reduce our revenue.
In 2004, 2003 and 2002, 99%, 99% and 100%, respectively, of our revenue was derived from performance on a limited number of development contracts with various agencies within the U.S. Department of Defense and with General Dynamics, a government subcontractor. Any significant disruption or deterioration of our relationships with either the Department of Defense or General Dynamics could significantly reduce our revenues. Our government programs must compete with programs managed by other contractors for limited amounts and uncertain levels of funding. The total amount and levels of funding are susceptible to significant fluctuations on a year-to-year basis. Our competitors frequently engage in efforts to expand their business relationships with the government and are likely to continue these efforts in the future. In addition, our development contracts with government agencies are subject to potential profit and cost limitations and standard provisions that allow the U.S. government to terminate such contracts at any time at its convenience. Termination of our development contracts, a shift in government spending to other programs in which we are not involved, or a reduction in government spending generally or defense spending specifically could severely harm our business. We intend to continue to compete for government contracts and we expect such contracts will be a significant percentage of our revenue for the foreseeable future.
Our development contracts with various agencies within the U.S. Department of Defense and with General Dynamics, a government subcontractor, require ongoing compliance with applicable federal procurement regulations. Violations of these regulations can result in civil, criminal or administrative proceedings involving fines, compensatory and punitive damages, restitution and forfeitures, as well as suspensions or prohibitions from entering into such development contracts. Also, the reporting and appropriateness of costs and expenses under these development contracts are subject to extensive regulation and audit by the Defense Contract Audit Agency, an agency of the U.S. Department of Defense. Any failure to comply with applicable government regulations could jeopardize our development contracts and otherwise harm our business.
Some of our products in development are directed at the telecommunications and networking markets, which continue to be subject to overcapacity and slow growth or decline.
We intend over the next several years to derive a substantial portion of our sales from product sales in the telecommunications and networking markets, including sales of our electro-optic devices and smart antennas. We have not yet made any commercial sales of these products, and developments that adversely affect the telecommunications or networking markets, including delays in traffic growth and changes in U.S. government regulation, could halt our efforts to generate revenue or cause revenue growth to be slower than anticipated from sales of electro-optic modulators and antenna products. Reduced spending and technology investment by
telecommunications companies may make it more difficult for our products to gain market acceptance. Such companies may be less willing to purchase new technology such as ours or invest in new technology development when they have reduced capital expenditure budgets.
Our quarter-to-quarter performance may vary substantially, and this variance, as well as general market conditions, may cause our stock price to fluctuate greatly and potentially expose us to litigation.
Substantially all of our revenues to date have been generated from a limited number of development contracts with the U.S. government and government contractors. Our revenues have varied significantly based on when government contracts commence or end and whether they receive funding appropriations. Because we intend to expand into commercial sales of our potential products, we are unable to accurately estimate future quarterly revenue and operating expenses based on historical performance. Our quarterly operating results may vary significantly based on many factors, including:
Our current and future expense estimates are based, in large part, on estimates of future revenue, which is difficult to predict. We expect to continue to make significant operating and capital expenditures in the area of research and development and to invest in and expand production, sales, marketing and administrative systems and processes. We may be unable to, or may elect not to, adjust spending quickly enough to offset any unexpected revenue shortfall. If our increased expenses are not accompanied by increased revenue in the same quarter, our quarterly operating results would be harmed.
In one or more future quarters, our results of operations may fall below the expectations of investors and the trading price of our common stock may decline as a consequence. We believe that quarter-to-quarter comparisons of our operating results will not be a good indication of our future performance and should not be relied upon to predict the future performance of our stock price. In the past, companies that have experienced volatility in the market price of their stock have often been subject to securities class action litigation. We may be the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our managements attention from other business concerns, which could seriously harm our business.
We cannot predict the pace of marketable products we may generate, and any inability to generate a sufficient number of marketable products would reduce our revenues and harm our business.
Our future revenues and profitability are dependent upon our ability to create marketable products, whether through our own research and development efforts or through collaborations with customers or industry partners. Because of the inherently uncertain nature of research and development activities, we cannot predict the pace of new product introductions. We must undertake additional research and development before we are able to develop additional products for commercial sale. Product development delays by us or potential product development partners, or the inability to enter into relationships with these potential partners, may delay or prevent us from introducing products for commercial sale. In addition, our product candidates may not result in products having the commercial potential we anticipate. Any of these factors could reduce our potential commercial sales and lead to inability to generate revenue and attain profitability.
The failure to compete successfully could harm our business.
We expect to face competitive pressures from a variety of companies in each of our target markets. Some of our present and potential competitors have or may have substantially greater research and product development capabilities, financial, scientific, marketing, manufacturing and human resources, name recognition and experience than we have. As a result, these competitors may:
The failure to compete successfully against these existing or future competitors could harm our business.
We may be unable to establish sales and marketing capabilities necessary to successfully commercialize our potential products.
We currently have limited sales and marketing capabilities. To date, we have relied on sales and marketing leadership from our Chief Executive Officer, Mr. Mino, our Chief Technology Officer, Dr. Petcavich, and our Vice President of Sales and Marketing, Mr. Lykken. We will need to either hire more sales personnel with expertise in the markets we intend to address or contract with others to provide for sales support. Although our potential products are all based on our polymer materials technology, the potential products themselves address different markets and can be offered through multiple sales channels. Addressing each market effectively will require sales and marketing resources tailored to the particular market and to the sales channels that we choose to employ. In addition, the markets in which we operate are highly complex and technical; we may not have adequate expertise at Lumera to adequately market our products. We may be unable to establish marketing and sales capabilities necessary to commercialize and gain market acceptance for our potential products. Co-promotion or other marketing arrangements with others to commercialize products could significantly limit the revenues we derive from these products, and these parties may fail to commercialize such products successfully.
We may be unable to obtain effective intellectual property protection for our potential products and technology.
Our intellectual property, or any intellectual property that we have or may acquire, license or develop in the future, may not provide meaningful competitive advantages. Our patents and patent applications, including those we license, may be challenged by competitors, and the rights granted under such patents or patent applications may not provide meaningful proprietary protection. For example, we are aware of numerous patents held by third parties that relate to polymer materials, WiFi antennas, biochips and electro-optic devices. These patents could be used as a basis to challenge the validity or limit the scope of our patents or patent applications. A successful challenge to the validity or limitation of the scope of our patents or patent applications could limit our ability to commercialize our polymer materials technology and, consequently, reduce our revenues.
Moreover, competitors may infringe our patents or those that we license, or successfully avoid these patents through design innovation. To combat infringement or unauthorized use, we may need to resort to litigation, which can be expensive and time-consuming and may not succeed in protecting our proprietary rights. In addition, in an infringement proceeding a court may decide that our patents or other intellectual property rights are not valid or are unenforceable, or may refuse to stop the other party from using the intellectual property at issue on the ground that it is non-infringing. Policing unauthorized use of our intellectual property is difficult and expensive, and we may not be able to, or have the resources to, prevent misappropriation of our proprietary rights, particularly in countries where the laws may not protect these rights as fully as the laws of the United States.
We also rely on the law of trade secrets to protect unpatented technology and know-how. We try to protect this technology and know-how by limiting access to those employees, contractors and strategic partners with a need to know this information and by entering into confidentiality agreements with these parties. Any of these parties could breach the agreements and disclose our trade secrets or confidential information to our competitors, or these competitors might learn of the information in other ways. Disclosure of any trade secret not protected by a patent could materially harm our business.
We may be subject to patent infringement claims, which could result in substantial costs and liability and prevent us from commercializing our potential products.
Third parties may claim that our potential products or related technologies infringe their patents. Any patent infringement claims brought against us may cause us to incur significant expenses, divert the attention of our management and key personnel from other business concerns and, if successfully asserted against us, require us to pay substantial damages. In addition, as a result of a patent infringement suit, we may be forced to stop or delay developing, manufacturing or selling potential products that are claimed to infringe a patent covering a third partys intellectual property unless that party grants us rights to use its intellectual property. We may be unable to obtain these rights on terms acceptable to us, if at all. Even if we are able to obtain rights to a third partys patented intellectual property, these rights may be non-exclusive, and therefore our competitors may obtain access to the same intellectual property. Ultimately, we may be unable to commercialize our potential products or may have to cease some of our business operations as a result of patent infringement claims, which could severely harm our business.
If our potential products infringe the intellectual property rights of others, we may be required to indemnify customers for any damages they suffer. Third parties may assert infringement claims against our current or potential customers. These claims may require us to initiate or defend protracted and costly litigation on behalf of customers, regardless of the merits of these claims. If any of these claims succeed, we may be forced to pay damages on behalf of these customers or may be required to obtain licenses for the products they use. If we cannot obtain all necessary licenses on commercially reasonable terms, we may be unable to continue selling such products.
The technology we license from various third parties may be subject to government rights and retained rights of the originating research institution.
We license technology from the University of Washington and various other research institutions or companies. Many of our partners and licensors have obligations to government agencies or universities. Under their agreements, a government agency or university may obtain certain rights over the technology that we have developed and licensed, including the right to require that a compulsory license be granted to one or more third parties selected by the government agency.
In addition, our partners often retain certain rights under their licensing agreement with us, including the right to use the technology for noncommercial academic and research use, to publish general scientific findings
from research related to the technology, and to make customary scientific and scholarly disclosures of information relating to the technology. It is difficult to monitor whether our partners limit their use of the technology to these uses, and we could incur substantial expenses to enforce our rights to our licensed technology in the event of misuse.
The loss of our chief executive officer, or any inability to attract and retain additional personnel, could impair our ability to maintain or expand our business.
Our future success depends to a significant extent on the continued service of our key management personnel, particularly Thomas D. Mino, our chief executive officer. We do not maintain key person life insurance on any of our executive officers other than Mr. Mino and do not intend to purchase any in the future.
Our future success will also depend on our ability to attract, retain and motivate highly skilled personnel. In particular, we will need to hire a significant number of technical personnel. Competition for highly educated qualified personnel in the polymer as well as bio-tech industries is intense. If we fail to hire and retain a sufficient number of qualified engineering, sales and technical personnel, we will not be able to maintain or expand our business.
If we fail to develop and maintain the quality of our manufacturing processes, our operating results would be harmed.
The manufacture of our potential products is a multi-stage process that requires the use of high-quality materials and advanced manufacturing technologies. Also, polymer-related device development and manufacturing must occur in a highly controlled, clean environment to minimize particles and other yield- and quality-limiting contaminants. In spite of stringent quality controls, weaknesses in process control or minute impurities in materials may cause a substantial percentage of a product in a lot to be defective. If we are not able to develop and continue to improve on our manufacturing processes or to maintain stringent quality controls, or if contamination problems arise, our operating results would be harmed.
We are dependent on third parties to manufacture our current products and our revenues could decline if these third parties do not timely complete our orders and our reputation will suffer if we do not maintain high quality standards.
We have entered into manufacturing arrangements with a number of third party manufacturers and intend to enter into agreements with additional corporate partners, OEMs and other third parties. Currently, our antenna products are assembled by third-party manufacturers. We contract with manufacturing companies to perform various portions of our product manufacturing, testing, assembly and shipping and purchase components to be used in our potential products from third-party vendors. If these third parties do not timely complete our orders, or do not properly manufacture our products, our reputation could be harmed, and our revenues could decline. We cannot assure you that we will be able to negotiate arrangements with these third parties on acceptable terms, if at all, or that these arrangements will be successful in yielding commercially viable products. If we cannot maintain our current relationships or establish new arrangements, we will require additional capital to undertake those activities on our own and will require manufacturing expertise that we do not currently possess and that may be difficult to obtain.
If we decide to make commercial quantities of products at our facilities, we will be required to make significant capital expenditures to increase capacity.
We lack the internal ability to manufacture products at a level beyond the stage of early commercial introduction. To the extent we do not have an outside vendor to manufacture our products, we will have to increase our internal production capacity and we will be required to expand our existing facilities or to lease or construct new facilities or to acquire entities with additional production capacities. These activities would require
us to make significant capital investments and may require us to seek additional equity or debt financing. We cannot assure you that such financing would be available to us when needed on acceptable terms, or at all. If we are unable to expand internal production capacity on a timely basis to meet increases in demand, we could lose market opportunities for sales. Further, we cannot assure you that any increased demand for our potential products would continue for a sufficient period of time to recoup our capital investments associated with increasing our internal production capacity.
In addition, we do not have experience manufacturing our potential products in large quantities. In the event of significant demand for our potential products, large-scale production might prove more difficult or costly than we anticipate and lead to quality control issues and production delays.
We may not be able to manufacture products at competitive prices.
To date, we have produced limited quantities of products for research, development and demonstration purposes. The cost per unit for these products currently exceeds the price at which we could expect to profitably sell them. If we cannot substantially lower our cost of production as we move into sales of products in commercial quantities, our financial results will be harmed.
We conduct all of our operations at a single facility, and circumstances beyond our control may result in significant interruptions.
We conduct all of our research and development, internal manufacturing and management activities at a single facility in Bothell, Washington. A disaster such as a fire, flood, earthquake, volcanic eruption or severe storm at or near this facility could prevent us from further developing our technologies or manufacturing our potential products, which would harm our business.
We could be exposed to significant product liability claims that could be time-consuming and costly and impair our ability to obtain and maintain insurance coverage.
We may be subject to product liability claims if any of our potential products are alleged to be defective or harmful. Product liability claims or other claims related to our potential products, regardless of their outcome, could require us to spend significant time and money in litigation, divert our managements time and attention from other business concerns, require us to pay significant damages, harm our reputation or hinder acceptance of our potential products. Any successful product liability claim may prevent us from obtaining adequate product liability insurance in the future on commercially reasonable terms. Any inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could impair our ability to commercialize our potential products.
If we fail to effectively manage our growth, our business could suffer.
Failure to manage our growth could harm our business. To date, substantially all of our activities and resources have been directed at the research and development of our technology and development of potential products. The transition from research and development to a vendor of products will require effective planning and management. In addition, future expansion will be expensive and will likely strain our management and other resources.
In order to effectively manage growth, we must:
We cannot assure you that we will be able to accomplish these tasks effectively or otherwise effectively manage our growth.
We may be unable to effectively implement new transaction accounting, operational and financial systems.
We recently transitioned away from our dependence on Microvision, Inc. to provide various accounting, administrative and personnel services. We are in the process of implementing complex transaction accounting, operational and financial systems, procedures and controls necessary to properly control and report on business activities. Deficiencies in the design and operation of our systems, procedures and controls, including internal controls over financial reporting, or our ability to attract and retain qualified personnel to operate these systems could adversely affect our ability to record, process, summarize and report material financial information.
We are subject to regulatory compliance related to our operations.
We are subject to various U.S. governmental regulations related to occupational safety and health, labor and business practices. Failure to comply with current or future regulations could result in the imposition of substantial fines, suspension of production, alterations of our production processes, cessation of operations, or other actions, which could harm our business.
We may be unable to export our potential products or technology to other countries, convey information about our technology to citizens of other countries or sell certain products commercially, if the products or technology are subject to United States export or other regulations.
We are developing certain polymer-based products that we believe the United States government and other governments may be interested in using for military and information gathering or anti-terrorism activities. United States government export regulations may restrict us from selling or exporting these potential products into other countries, exporting our technology to those countries, conveying information about our technology to citizens of other countries or selling these potential products to commercial customers. We may be unable to obtain export licenses for products or technology if necessary. We currently cannot assess whether national security concerns would affect our potential products and, if so, what procedures and policies we would have to adopt to comply with applicable existing or future regulations.
Our use of the name Lumera may result in infringement claims and other legal challenges, which could cause us to incur significant expenses, pay substantial damages and be prevented from using this name.
Our use of the name Lumera may result in infringement claims and other legal challenges, which could cause us to incur significant expenses, pay substantial damages and be prevented from using this name. In April 2004 we filed a trademark application with the U.S. Patent and Trademark Office to register the trademark Lumera. We are aware of a company that has also applied for a trademark for the name Lumera in connection with PC-based electromechanical controls for use in the control and operation of automation equipment. We may not receive approval of our trademark application for the name Lumera, and, even if the application is approved, the trademark may be challenged by third parties or invalidated. As a result of such infringement claims or challenges, we may incur significant expenses, pay substantial damages and be prevented from using the name Lumera unless we enter into royalty or license agreements. We may not be able to obtain royalty or license agreements on terms acceptable to us, if at all. Use of the name Lumera or similar names by third parties may also cause confusion to our clients and confusion in the market, which could decrease the value of our brand and harm our reputation.
We may incur liability arising from the use of hazardous materials.
Our business and our facilities are subject to a number of federal, state and local laws and regulations relating to the generation, handling, treatment, storage and disposal of certain toxic or hazardous materials and
waste products that we use or generate in our operations. Many of these environmental laws and regulations subject current or previous owners or occupiers of land to liability for the costs of investigation, removal or remediation of hazardous materials. In addition, these laws and regulations typically impose liability regardless of whether the owner or occupier knew of, or was responsible for, the presence of any hazardous materials and regardless of whether the actions that led to the presence were taken in compliance with the law. In our business, we use hazardous materials that are stored on site. We use various chemicals in our manufacturing process which may be toxic and covered by various environmental controls. The waste created by use of these materials is transported off-site by an unaffiliated waste hauler. Many environmental laws and regulations require generators of waste to take remedial actions at an off-site disposal location even if the disposal was conducted lawfully. The requirements of these laws and regulations are complex, change frequently and could become more stringent in the future. Failure to comply with current or future environmental laws and regulations could result in the imposition of substantial fines, suspension of production, alteration of our production processes, cessation of operations or other actions, which could severely harm our business.
Acquisitions or investments may be unsuccessful and may divert our managements attention and consume significant resources.
We may in the future acquire or make investments in other businesses as well as products and technologies to complement our current business. Any future acquisition or investment may require us to use significant amounts of cash, make potentially dilutive issuances of equity securities or incur debt. In addition, acquisitions involve numerous risks, any of which could harm our business, including:
Our plan to develop relationships with strategic partners may not be successful.
As part of our business strategy, we have developed relationships and entered into agreements with strategic partners, such as with Helix BioPharma, the University of Washington and Arizona Microsystems, to conduct research and development of technologies and products. We expect to continue to evaluate similar opportunities. For these efforts to be successful, we must identify partners whose competencies complement ours. We must also successfully enter into agreements with them on terms attractive to us, and integrate and coordinate their resources and capabilities with our own. We may be unsuccessful in entering into agreements with acceptable partners or negotiating favorable terms in these agreements. Also, we may be unsuccessful in integrating the resources or capabilities of these partners. In addition, our strategic partners may prove difficult to work with or less skilled than we originally expected. If we are unsuccessful in our collaborative efforts, our ability to develop and market products could be severely limited.
As our business grows, if we need to establish global operations, we will be subject to various risks.
Many of the markets that we propose to address are global and may require us to conduct foreign operations, including the establishment of sales, manufacturing and possible research and development facilities in other countries. While the specific risks that will apply to these activities would depend on the circumstances, we could
become subject to risks relating to foreign currency fluctuations, political and social unrest, local regulatory systems and varying standards for the protection of intellectual property. The existence of any of these risks will complicate our business and may lead to unexpected and adverse effects on our business. If we are required to conduct significant foreign operations, we will also need expertise in such operations, which we do not presently have.
Insiders have substantial control over us.
Our principal stockholders, directors and executive officers and entities affiliated with them beneficially own approximately 46% of the outstanding shares of our common stock. As a result, these stockholders, if they were to act together, would be able to control or significantly influence matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other extraordinary transactions.
Microvision currently owns securities representing more than 33% of our voting securities. Two of our six current directors, including the Chairman of our board of directors, are also directors of Microvision. Our interests may not always be aligned with Microvisions. We do not have formal guidelines for dealing with potential conflicts of interest, but will address any such conflicts on a case by case basis. Microvision will continue to have the ability to exert considerable influence over our direction for the foreseeable future. Microvision recently announced that it had pledged 1,750,000 shares of our stock held by it to secure a financing. Some or all of that stock and the other 3,683,777 shares held by Microvision may be publicly distributed over the next two years, which could cause a substantial decrease in our stock price.
Our limited operating history makes financial forecasting difficult for us and for others that may publish estimates of our future financial results.
As a result of our limited operating history, it is difficult to accurately forecast our revenue and results, including product sales and government contract revenue, cost of revenue, research and development expenses, marketing, general and administrative expenses and other financial and operating data. We have a limited amount of meaningful historical financial data upon which to base projected revenue or expenses. We base our current expense levels and estimates of future expense levels on our operating plans and estimates of future revenue, and our future expenses will be dependent in large part upon our future levels of product sales. Sales and results are difficult to forecast because we do not currently have any commercial customers, we are uncertain of the extent of orders for our products and the mix, volume and timing of any such orders, and we are uncertain of the receipt of and extent of performance under government contracts. As a result, we may be unable to make accurate financial forecasts of revenue or expenses. Financial analysts and others that may seek to project our future performance face similar difficulties. This inability to accurately forecast our revenue and expenses could cause our financial results to differ materially from any projected financial results and could cause a decline in the trading price of our common stock.
Our investment policy restricts the types of investments we make to ensure principal preservation and liquidity. Our cash investments, which are all classified as available for sale according to their various maturity dates, are recorded on our balance sheet at their fair value. Any unrealized gains or losses are reported as a component of comprehensive income (loss). We do not leverage any of our investments, nor do we hold them for the purpose of trading.
We invest so that approximately 60 days of operating expenses are either held in cash or are within 30 days of maturity. Substantially all of the Companys cash equivalents and investment securities are at fixed interest rates and, as such, the fair value of these instruments is affected by changes in market interest rates. Due to the generally short-term maturities of these investment securities, the Company believes that the market risk arising from its holdings of these financial instruments is not significant. A one-percent change in market interest rates would have approximately a $200,000 impact on the fair value of the investment securities.
INDEX TO FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
and Shareholders of
In our opinion, the financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Lumera Corporation at December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements. These financial statements and financial statement schedule are the responsibility of the companys management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Prior to July 28, 2004, the Company was a subsidiary of Microvision, Inc.. As discussed in Note 3, the Company had extensive transactions and relationships with that entity for each of the three years ended December 31, 2004.
/s/ PRICEWATERHOUSECOOPERS LLP
March 29, 2004
The accompanying notes are an integral part of these financial statements.
STATEMENT OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
STATEMENTS OF CHANGES IN MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
SHAREHOLDERS EQUITY (DEFICIT)
FOR THE PERIOD FROM DECEMBER 31, 2001 TO DECEMBER 31, 2004
The accompanying notes are an integral part of these financial statements.
STATEMENTS OF COMPREHENSIVE LOSS
The accompanying notes are an integral part of these financial statements.
STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these financial statements.
NOTES TO FINANCIAL STATEMENTS
Lumera Corporation (the Company or Lumera) was incorporated in Washington State in 1999 and reincorporated in Delaware in 2004, and was established to develop, manufacture and market devices using proprietary polymer materials. Until December 31, 2003, the Company was considered to be in the development stage. In early 2004, the Company commercialized the devices for potential wireless networking and optical networking applications and had largely completed financial planning, establishing sources of supply, acquiring plant and equipment and recruiting personnel. Therefore, the Company was considered to have exited the development stage in 2004. On July 26, 2004, Lumera completed its initial public offering (IPO) of 6.0 million shares of common stock at an offering price of $6.95 per share, raising proceeds of $38.7 million before expenses. The Company was a majority owned subsidiary of Microvision, Inc. (Microvision) until its IPO (see Note 3).
The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America.
Use of EstimatesThe preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Companys management has identified revenue recognition and accounting for research payments under the University of Washington agreements as areas where significant estimates and assumptions have been made in preparing the financial statements. The Company also evaluates the requirement for allowances for uncollectible receivables, and valuation allowances for deferred income tax assets.
Cash and Cash EquivalentsThe Company considers all highly liquid investment securities with remaining maturities, at the date of purchase, of three months or less to be cash equivalents. Management determines the appropriate classification of investment securities at the time of purchase and evaluates such designation as of each balance sheet date. The Company has classified its entire investment portfolio as available-for-sale. Available-for-sale securities are stated at fair value with unrealized gains and losses included in shareholders equity (deficit) as a component of other comprehensive income (loss), unless the loss is deemed to be other-than-temporary, in which case it is recognized immediately as an expense. Dividend and interest income are recognized when earned. Realized gains and losses are included in interest income or expense. The cost of securities is based on the specific identification method.
Concentration of Credit RiskFinancial instruments that potentially subject the Company to concentrations of credit risk are primarily cash and cash equivalents and investments. The Company has a cash investment policy that generally restricts investments to ensure preservation of principal and maintenance of liquidity. The Company typically does not require collateral from its customers. The Company makes provision for doubtful accounts when required. To date, the Company has not experienced any bad debts.
Revenue RecognitionRevenue has primarily been generated from research and development cost reimbursement contracts for the United States government. Revenue on such contracts is recorded using the percentage-of-completion method measured on a cost-incurred basis. Changes in contract performance, contract conditions, and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result in revisions to costs and revenues and are recognized in the period in which the revisions are determined. Profit incentives are included in revenue when realization is assured.
NOTES TO FINANCIAL STATEMENTS(Continued)
Losses, if any, are recognized in full as soon as identified. Losses occur when the estimated direct and indirect costs to complete the contract exceed the unrecognized revenue on the contract. The Company evaluates the reserve for contract losses on a contract-by-contract basis. No losses have been incurred on any contracts to date.
In August 2001, the Company entered into a $1,623,000 contract with a government agency to develop new electro-optic polymer materials appropriate for the fabrication of a wideband optical modulator demonstration system.
In October 2002, the Company entered a $1,030,000 contract modification with a government agency to continue to develop new electro-optic polymer materials appropriate for the fabrication of a wideband optical modulator demonstration system.
In December 2002, the Company entered into a feasibility study to assess prospects of developing an electro-optic organic polymer with a government subcontractor for $149,000 that was extended into a Phase II in 2003 for an additional $400,000.
In August 2003, the Company entered into a $497,000 contract with a government agency to develop ultra-linear optical waveguide modulator technology.
In November 2003, the Company entered into a $950,000 contract extension with a government agency to continue development of electro-optical polymer materials and devices for wideband optical modulators.
In December 2004, the Company entered into a $210,000 contract extension with a government agency to develop ultra-linear optical waveguide modulator technology.
In December 2004, the company entered into a $1,120,000 contract extension with a government agency to continue development of electro-optical polymer materials and devices for wideband optical modulators.
All of the Companys current and prior contracts with the government have been or are cost plus fixed fee type contracts. Under the terms of a cost plus fixed fee contract, the United States government reimburses the Company for actual direct and indirect costs incurred in performing the contracted services. The Company is under no obligation to spend more than the contract value to complete the contracted services. In addition, completion of the contracted services is generally on a best efforts basis. If the services are not completed, the government has the option to negotiate a follow-on contract to complete the services or to not pursue the services further with the Company. Contract deliveries consist of monthly financial reports, periodic technical reports and any devices if they have been successfully fabricated. There are no contractual provisions for repayments of any amounts disbursed to date under these contracts. The United States government accounted for 99% of revenues in 2004 and 2003 all of the Companys revenues in 2002.
Cost and estimated earnings in excess of billings on uncompleted contracts comprises amounts of revenue recognized on contracts that the Company has not yet billed to a customer because the amounts were not contractually billable at the balance sheet date. The Company was contractually able to bill 100% and 95% of the balance at December 31, 2004 and 2003, respectively, within 30 days of the respective year end.
Property and EquipmentProperty and equipment is stated at cost. Depreciation is computed over the estimated useful lives of the assets (two to five years) using the straight-line method. Leasehold improvements are depreciated over the shorter of estimated useful lives or the term of the lease.
NOTES TO FINANCIAL STATEMENTS(Continued)
A summary of property and equipment at December 31 follows:
Depreciation expense was $1,198,000, $1,185,000 and $1,049,000 for December 31, 2004, 2003 and 2002, respectively.
Valuation of Long-Lived AssetsThe Company reviews the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Measurement of the impairment loss is based on the fair value of the asset, or group of assets. Generally, fair value will be determined using valuation techniques such as present value of expected future cash flows.
Research and DevelopmentResearch and development costs are expensed as incurred. As described in Note 10, the Company issued shares of common stock in connection with a research agreement. The value of these shares is amortized over the period of the research agreement.
Fair Value of Financial InstrumentsThe Companys financial instruments include cash and cash equivalents, investment securities, accounts receivable, accounts payable, and accrued liabilities. The carrying amounts of financial instruments approximate fair value due to their short maturities.
Income TaxesThe Company has filed a separate tax return since inception. The Company follows the liability method of accounting for income taxes. This liability method requires recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.
Stock Based CompensationThe Company has a stock-based employee compensation plan, which is described further in Note 7. The Company accounts for stock-based employee compensation arrangements on the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees and related amendments and interpretations. The Company complies with the disclosure provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, which requires fair value recognition for employee stock-based compensation. The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force (EITF) Issue No. 96-18.
NOTES TO FINANCIAL STATEMENTS(Continued)
Total non-cash stock option expense related to employee and director awards was $1,285,000, $6,000, and $7,000 for the years ended December 31, 2004, 2003 and 2002, respectively. Had compensation cost for employee options been determined using the fair values at the grant dates, consistent with the methodology prescribed under SFAS No. 123, the Companys net loss available to common shareholders and associated net loss per share would have increased to the pro forma amounts indicated below:
See Note 7 for the assumptions used in calculating the fair values of employee options.
Net Loss per ShareBasic net loss per share is calculated on the basis of the weighted-average number of common shares outstanding during the periods. Net loss per share assuming dilution is calculated on the basis of the weighted-average number of common shares outstanding and the dilutive effect of all potentially dilutive securities, including common stock equivalents and convertible securities.
Basic and diluted net loss per share is the same because all potentially dilutive securities outstanding are anti-dilutive. Potentially dilutive securities not included in the calculation of diluted earnings per share include options and warrants to purchase common stock for all periods presented, and Series A and Series B convertible preferred stock for 2003 and 2002 and periods prior to the IPO in 2004. Total common stock options and common stock warrants not included in the calculation of diluted earnings per share were 1,893,630, 1,069,180 and 797,430 for December 31, 2004, 2003 and 2002, respectively.
Recent Accounting PronouncementsOn December 16, 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R), Share-Based Payment, which is a revision of SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be valued at fair value on the date of grant, and to be expensed over the applicable vesting period. Pro forma disclosure of the income statement effects of share-based payments is no longer an alternative. SFAS No. 123(R) is effective for all share-based awards granted on or after July 1, 2005. In addition, companies must also recognize compensation expense related to any awards that are not fully vested as of the effective date. Compensation expense for the unvested awards will be measured based on the fair value of the awards previously calculated in developing the pro forma disclosures in accordance with the provisions of SFAS No. 123. We are evaluating the alternative methods for implementing SFAS No. 123(R). If we elect to implement SFAS No. 123(R) on July 1, 2005 using the modified prospective method, we expect that the impact on 2005 earnings will be in the range of $1.5 to $2.6 million.
NOTES TO FINANCIAL STATEMENTS(Continued)
The Company had available-for-sale investment securities at December 31, 2004, the estimated fair value of which totaled $15,460,000 for securities with maturities of one year or less and $11,216,000 for securities with maturities greater than one year. The Company had no available-for-sale investment securities at December 31, 2003. All investment securities have been classified as available-for-sale and are carried at estimated fair value with unrealized gains and losses included as a component of accumulated other comprehensive income in stockholders equity. The Company had unrealized losses on investment securities of $145,000 and $20,000 for the years ending December 31, 2004 and 2003, respectively. At December 31, 2004, management has concluded that these unrealized losses are temporary due to the Companys ability to hold these investments to maturity.
The Company had no net realized gains (losses) on investment securities for the year ending December 31, 2004. Realized losses were $39,000 and $8,000 for the years ended December 31, 2003 and 2002, respectively.
Since inception until July 2004 the Company was a majority owned subsidiary of Microvision, Inc. At December 31, 2003, Microvision had the following ownership interests in the Company:
In July 2004, all outstanding shares of the Companys Series A convertible preferred stock, Series B convertible preferred stock and Class B common stock were automatically converted to common stock upon completion of the Companys IPO in July 2004. Prior to the IPO, Microvision owned approximately 52% of the Companys outstanding common stock on an as if converted basis. Following completion of the IPO, Microvisions ownership percentage is approximately 33%. Additionally, the Chief Executive Officer of Microvision, Richard F. Rutkowski, is a member of the board of directors of both Microvision and the Company. Microvision and the Company also share one other common director.
In February 2004, the Company agreed to pay Mr. Rutkowski a $5,000 monthly retainer to supplement our management team during our public offering. During this retainer period, which ended in July 2004, Mr. Rutkowski also performed his role as chief executive officer of Microvision. We also paid Mr. Rutkowski a one-time fee of $100,000 upon the successful completion of our convertible note financing in April 2004. The company recognized $130,000 of administrative expense during this period. In addition, we paid Mr. Rutkowski a one-time fee of $100,000 upon the participation in and successful completion of our initial public offering, which was treated as a cost of raising capital. The boards of both Microvision and Lumera approved paying Mr. Rutkowski these fees.
During 2002, 2003 and 2004, the Company was allocated lease and utilities costs from Microvision under a month-to-month lease. In addition, the Company was charged a $5,000 per month fee to reimburse Microvision for certain other charges not directly incurred by the Company.
In 2004, the Company entered into a sublease agreement with Microvision for its corporate facilities at a base rate of approximately $21,000 per month, plus common area charges, which is effective through April 6, 2006.
NOTES TO FINANCIAL STATEMENTS(Continued)
The following are a summary of charges from Microvision to the Company for each year ended December 31:
Accrued liabilities consist of the following at December 31:
No provision for income taxes has been recorded for any periods presented since the Company has incurred net losses from the date of inception.
At December 31, 2004, the Company had $34.3 million of federal net operating loss carry forwards, which may be used to offset future taxable income. These carry forwards expire beginning in 2018 through 2024. The Internal Revenue Code places certain limitations on the annual amount of net operating loss carry forwards that can be utilized if certain changes in the Companys ownership occur.
At December 31, 2004 the Company had $868,000 of research and experimentation credits carry forwards which will expire beginning in 2019 through 2024.
Deferred taxes consist of the following at December 31:
The Company has recorded a valuation allowance for the full amount of its deferred tax assets at December 31, 2004 and 2003, as the Company believes it is more likely than not that the deferred tax assets will not be realized.
The valuation allowance and the research and experimentation credits account for substantially all of the difference between the Companys effective income tax rate and the Federal statutory rate of 34%.
NOTES TO FINANCIAL STATEMENTS(Continued)
At December 31, 2004, the authorized capital of the Company consisted of 120 million shares of Common Stock, of which 1,521,080 shares are reserved for options granted under the Companys 2000 Stock Option Plan and 2,500,000 shares are reserved for outstanding and future option grants under the Companys 2004 Equity Incentive Plan. The Company also has 30,000,000 shares of authorized undesignated preferred stock, none of which have been issued.
In July 2004 the Company completed its initial public offering (IPO), issuing 6 million shares of common stock at $6.95 per share. Upon completion of the IPO all outstanding shares of the companys Common A and B and Preferred A and B shares were automatically converted to common shares. At December 31, 2004 there were 16,546,430 shares of common stock outstanding.
Common StockIn March 2000, the Company issued 4,700,000 shares of its Class B common stock to Microvision, Inc. and 670,000 shares of its Class B common stock to certain Microvision directors, executives, and other individuals (individuals). The shares issued to Microvision were valued at $94,000 and the proceeds were offset against the outstanding loan balance due. The shares issued to the individuals were valued at $12,000 and were issued subject to subscription loans, for which cash was received in November 2000.
In January 2001, the Company issued 802,414 shares of Class A common stock valued at $3,009,000 in connection with the research agreement described in Note 10.
Upon the Companys initial public offering in July 2004 all shares of common A and B were automatically converted to Common Stock on a one-for-one basis.
Convertible Preferred StockIn August through October 2003, the Company raised $2,670,000 (before issuance costs of $67,000) from the sale of 1,335,025 shares of Series B convertible preferred stock to private investors. In March 2004, the Company raised $500,000 from the sale of 250,000 shares of Series B convertible preferred stock to private investors issued in March 2004. The $2 per share conversion price of the Series B convertible preferred stock issued was less than the fair value of the Class A common stock on the issuance date. As a result, the Company recorded a $500,000 beneficial conversion feature upon issuance of the preferred stock. This amount was immediately recorded as a deemed dividend to preferred shareholders because the Series B convertible preferred stock had no stated term and was immediately convertible into Class A common stock.
Upon the Companys initial public offering in July 2004 all shares of convertible preferred stock were automatically converted to Common Stock. Each Series A Preferred share was converted into 1.14 shares of common stock in accordance with anti-dilution provisions enacted upon the sale of the Preferred B shares resulting in 2,727,291 shares of common stock issued in exchange for 2,400,000 Series A Preferred shares. Each share of Series B Preferred was exchanged for common shares on a one-for-one basis, resulting in the issuance of 1,585,025 shares of common stock issued in exchange for the Series B Preferred shares.
DividendsNo dividends on convertible preferred stock or common stock have been declared from inception through December 31, 2004.
Arizona Microsystems, L.L.C. warrants exercisedIn October 2002, the Company issued a warrant to purchase 164,000 shares of Class A common stock at an exercise price of $3.65 per share to Arizona Microsystems, L.L.C. for use of certain technology. These warrants were exercised in a cashless transaction for 38,935 shares of common stock in July 2004.
NOTES TO FINANCIAL STATEMENTS(Continued)
Stock Option PlansIn 2000, the Company adopted the 2000 Stock Option Plan (the 2000 Plan). The 2000 Plan provided for the granting of stock options to employees, consultants and non-employee directors of the Company. The Company reserved 3,000,000 shares of Class A Common Stock for issuance pursuant to the 2000 Plan. Following the adoption of the 2004 Equity Incentive Plan in July 2004, no more options will be issued under the 2000 Stock Option Plan. Grants, net of shares exercised and forfeited, under the Companys 2000 Stock Option Plan totaled 1,521,080 shares at December 31, 2004.
In July 2004, the Company adopted the 2004 Equity Incentive Plan (the 2004 Plan). Awards under the Plan, can be a combination of stock options, stock appreciation rights, restricted stock, unrestricted stock, stock units (including restricted stock units), performance awards, cash awards and other awards not described that are convertible into or otherwise based on the Companys stock.
The 2004 Plan established an initial option pool of 2,000,000 shares plus an annual increase beginning in 2005, equal to the least of (i) 2,000,000 shares, (ii) 13.4% of the number of shares of Stock outstanding as of the Companys immediately preceding fiscal year, or (iii) such lesser amount, if any, as the Board may determine. For the 2005 Plan year, Lumeras Board has elected to increase the option share pool by 500,000 shares.
Options under both the 2000 plan and the 2004 Plan may be granted for periods up to 10 years. Options granted under either plan may be either Incentive Stock Options (ISOs) or non-qualified stock options. The exercise price of an ISO cannot be less than 100% of the estimated fair value of the common stock at the date of grant. To date, options granted generally vest over four years.
A summary of stock compensation expense for each period is as follows:
NOTES TO FINANCIAL STATEMENTS(Continued)
The following table presents activity under the Plans:
The following table presents the Companys outstanding and exercisable stock options at December 31, 2004:
NOTES TO FINANCIAL STATEMENTS(Continued)
Non-Employee OptionsIncluded in the option disclosures above are options granted to certain non-employees under the Companys plan, as follows:
In August 2003, the Company issued options to purchase an aggregate of 164,000 shares of its Class A common stock to two consultants in connection with entering into certain consulting agreements. In April 2004, 61,500 of these shares were forfeited upon termination of one of the consulting agreements. The options have an exercise price of $3.65 per share and a 10-year life. In aggregate, 41,000 of the options were vested on the grant date. The remaining 61,500 shares vest one-third on each subsequent annual anniversary of the grant date and are subject to re-measurement at each balance sheet date during the vesting period. The aggregate value of both options was estimated at $136,000 at the grant date and December 31, 2003 and $415,000 at December 31, 2004. The fair value of these options, net of forfeited options, is being recognized as compensation expense over the two-year period of service under the agreements. Total non-cash compensation expense related to these options was $287,000 and $32,000 for the year ended December 31, 2004 and 2003. The fair values of the options were estimated at the grant date and December 31, 2003 and 2004, using the Black-Scholes option pricing model with the following weighted-average assumptions: dividend yield of 0%; expected volatility of 83% for all measurement dates, respectively; risk-free interest rates of 4.4%, 4.3% and 4.1% for each of the measurement dates, respectively; and expected lives of 10 years, 9.7 years and 8.6 years for each of the measurement dates, respectively.
In March 2004, the Company granted options under the 2000 Plan to purchase 65,000 shares of Class A common stock to a Microvision employee. These options have been accounted for as a dividend to Microvision and recorded at their fair value of $272,000, in accordance with the guidance in EITF Issue No. 00-23 Issue 21, Options Granted to Employees of Entities under Common Control.
In April 2004, a member of the Companys Board of Directors resigned, and accepted a position on the Companys Business Advisory Board. Upon the directors resignation, 30,000 unvested options, which vest 5,000 at the end of each subsequent quarter, were re-measured as non-employee options, the aggregate value of which was estimated to be $137,000 at the grant date and $215,000 at December 31, 2004. The fair value of these options is being recognized as compensation expense over the vesting period. Total non-cash compensation expense related to these options was $149,000 for the year ended December 31, 2004. The fair values of the options were estimated at the grant date and December 31, 2004 using the Black-Scholes option pricing model with the following weighted-average assumptions: dividend yield of 0%; expected volatility of 83%; risk-free interest rates of 4.62% and 4.24%; and expected lives of 10 years and 9.5 years.
Options issued at below market priceIn March 2004 the Company granted options under the 2000 Plan to its CEO and non-employee directors to purchase an aggregate of 415,000 shares of common stock with a weighted average exercise price of $2.00 per share which was below the then current market value. The aggregate value of these options was estimated at $1,230,000 and is being recognized as compensation expense over the vesting period. In April 2004, a member of the Companys Board of Directors resigned, and accepted a position on the Companys Business Advisory Board. Upon the directors resignation, 30,000 unvested options were re-measured as non-employee options, reducing the aggregate value to be amortized to compensation expense by $82,000. During 2004, the Company recognized compensation expense associated with these option grants of $922,000. As of December 31, 2004, $218,000 of deferred compensation remained to be amortized.
In April 2004 the Company granted options under the 2000 Plan to its employees to purchase an aggregate of 156,650 shares of common stock at a price below the then current market value. The options have an exercise price of $2.00 per share and a 10-year life. One quarter of the options vested on July 1, 2004 with the remaining options vesting annually over the subsequent three years fully vested. In July 2004, the Company issued options under the 2000 Plan to its employees to purchase an aggregate of 78,250 shares of common stock at a price below the then current market value. The options have a weighted average exercise price of $3.76 per share and a 10-year life. The aggregate value of these option grants was estimated at $802,000 and is being recognized as compensation expense over the vesting period. During 2004, the Company recognized compensation expense associated with these option grants of $360,000. As of December 31, 2004, $413,000 of deferred compensation remained to be amortized.
NOTES TO FINANCIAL STATEMENTS(Continued)
Fair Value DisclosureThe fair values of the options granted by Lumera to employees were estimated on the date of each grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2004, 2003 and 2002, respectively:
In October 2002, the Company issued a warrant to purchase 164,000 shares of Class A common stock at an exercise price of $3.65 per share to Arizona Microsystems, L.L.C. for use of certain technology. These warrants were exercised in a cashless transaction for 38,935 common shares in July 2004.
In April 2004 the company issued warrants to purchasers of its convertible promissory notes for an aggregate of 115,000 shares of Common Stock at and exercise price of $7.20 per share. The value of the warrants granted, which are exercisable through April 21, 2009, was estimated to be approximately $344,000 using the Black Scholes option pricing model. The relative fair value of the warrants of $301,000 was be treated as a debt issuance cost and was amortized to interest expense over the one-year term of the debt.
In July 2004 the Company issued warrants to its Underwriters in connection with the Companys initial public offering to purchase a total of 600,000 shares of Lumera common stock at a purchase price of $8.34, or 120% of the price of the Companys shares upon completion of its IPO. The warrants are exercisable through July 28, 2009. These warrants were treated as a cost of raising capital.
Microvision holds a warrant to purchase a total of 170,546 shares of Common Stock at an exercise price of $8.80 per share. The warrant is exercisable through March 2011. The Microvision warrant, originally issued for 150,000 Series A Preferred shares at $10.00 per share, carried anti-dilution rights which, upon completion of the Companys IPO, triggered an automatic adjustment to the number of shares and exercise price.
In April 2004, the Company received cash proceeds from the issuance of convertible promissory notes in the aggregate principal amount of $2.3 million. The notes accrued interest at a rate of 6.5% per annum and were payable on demand at the earlier of March 31, 2005 or upon the closing of an underwritten public offering of the Companys common stock. The principal amount and any accrued but unpaid interest in respect of each note was convertible, at the option of the holder, into shares of the Companys Class A common stock. The conversion price of the Notes was stated as the lesser of $6.00 per share of common stock or the price per share offered to the public in any underwritten IPO of the Companys common stock.
In connection with the sale of these convertible notes, the Company also issued warrants to purchase an aggregate of 115,000 shares of common stock at a price of $7.20 per share. The warrants expire in April 2009. The value of the warrants granted was estimated to be approximately $344,000 at the date of grant using the Black Scholes option pricing model. The Company allocated the proceeds to the convertible note and warrant based on their relative fair value. The relative fair value of the warrants of $301,000 was treated as a debt issuance cost and was amortized to interest expense over the one-year term of the debt.
NOTES TO FINANCIAL STATEMENTS(Continued)
Upon completion of the Companys IPO in July 2004 the notes became due and payable. All of the note holders elected to receive cash payments, which resulted in principal and interest payments totaling $2,344,000 in August 2004. The unamortized debt issuance costs were recognized immediately as interest expense at that time. During 2004, the Company recognized a total of $345,000 of interest expense associated with the Notes.
Agreements with the University of WashingtonIn October 2000, the Company entered into a license agreement (License Agreement) and a research agreement (Sponsored Research Agreement) with the University of Washington (UW). The License Agreement grants the Company rights to certain intellectual property including technology being developed under the sponsored Research Agreement whereby the Company has a royalty-bearing license to make, sell or sublicense the licensed technology. Under the terms of the License Agreement, the Company issued 802,414 shares of the Companys Class A common stock to the UW. The shares, although initially subject to a vesting schedule tied to performance under the Sponsored Research Agreement, were vested in full by mutual agreement between the UW and the Company on January 8, 2001. The shares issued were valued by management at $3,009,000, based on a value of $3.75 per share on the date of issuance. Management considered a number of factors, including an independent valuation, projected cash flows from the Companys technology and expected future products, general market conditions and the risks inherent in achieving the Companys business plan in determining the fair value of the common shares issued. The value of the shares issued was recorded as prepaid stock-based research expense and was fully amortized to expense as of March 31, 2004.
Under the terms of the License Agreement, the Company is also required to pay certain costs related to filing and processing of patents and copyrights related to the agreements. Additionally, the Company is required to pay certain ongoing royalty payments at a minimum of $75,000 per annum. The Company has not made any royalty payments to date in excess of these minimums. These payments have been expensed as incurred.
As part of the Sponsored Research Agreement, the Company agreed to pay an aggregate of $9,000,000 in quarterly payments over three years for research services. The first payment was made on February 26, 2001. The Company expensed the total expected payments on a straight-line basis because there was no more readily determinable pattern of the performance of the research services under the agreement.
In February 2002, the Company and the UW amended the Sponsored Research Agreement to extend quarterly payments and performance through 2005. In March 2003, the Company and the UW entered into a second amendment to the Sponsored Research Agreement, which deferred certain 2003 payments until 2004. In November 2003, the Company and the UW entered into a third amendment to the Sponsored Research Agreement. Under the terms of the third amendment, the Companys payment obligation to the UW was reduced to $125,000 per quarter from October 1, 2003 to September 30, 2004, and $300,000 for the quarter ending December 31, 2004. The amendment required the Company to make its unpaid payments of $2,000,000 by May 2005. In April 2004, the Company and the University of Washington entered into a fourth amendment to the Sponsored Research Agreement that required payments of $125,000 for the quarters ending March 31, 2004 and September 30, 2004 and eliminated a contingent payment of $2,000,000 that had been due in April 2004. For each of the quarters ending September 30, 2004 and December 31, 2004, the Company was required to pay $250,000. The agreement will terminate in 2005 after payments of $375,000 are made at the beginning of each of the first two quarters. Total payments under the Amended Sponsored Research Agreement will be $5,750,000 instead of the $9,000,000 under the terms of the original agreement.
Subsequent to each amendment noted above, the Company prospectively adjusted the amortization of the research payments to account for the extended period over which the payments would be made and services
NOTES TO FINANCIAL STATEMENTS(Continued)
provided. As a result of these adjustments, the Company had cumulatively recognized expenses in excess of payments made of $1,948,000 at December 31, 2003. As a result of the fourth amendment and the elimination of the contingent $2 million payment in 2005, the company recognized a credit to research and development expense of $2.4 million in 2004.
In April 2004, the Company and the University of Washington entered into a fourth amendment to the Sponsored Research Agreement that required payments of $125,000 for the quarters ending March 31, 2004 and September 30, 2004 and eliminated a contingent payment of $2,000,000 that had been due in April 2004. For each of the quarters ending September 30, 2004 and December 31, 2004, the Company was required to pay $250,000. The agreement will terminate in 2005 after payments of $375,000 are made at the beginning of each of the first two quarters. Total payments under the Amended Sponsored Research Agreement will be $5,750,000 instead of the $9,000,000 under the terms of the original agreement.
The following table summarizes payments made and expense recorded during the years ending December 31:
The following table outlines future required payments and royalties related to the Sponsored Research Agreement and optical materials arrangement for the years ending December 31:
Lease CommitmentsThe Company has a sublease agreement with Microvision for its corporate facilities at a base rate of approximately $21,000 per month, plus common area charges, which is effective through April 6, 2006. The Company had no other significant operating or capital leases at December 31, 2004.
Claims and LitigationIn the opinion of management, litigation, contingent liabilities and claims against the Company in the normal course of business are not expected to involve any judgments or settlements that would be material to the Companys financial condition, results of operations or cash flows.
On August 31, 2004, the Company established its retirement savings plan (the Plan), which qualifies under the Internal Revenue Code Section 401(k) and covers all qualified employees. The Plan allows the
NOTES TO FINANCIAL STATEMENTS(Continued)
Company to match 50% of an employees contribution to the Plan up to a maximum 6% of the employees base salary. During the period from September through December 31, 2004, the Company contributed $19,000 to the Plan under the matching program. Prior to August 31, 2004 the Companys employees participated in the Microvision retirement savings plan. The Company contributed $33,000, $43,000 and $40,000 in matching payments under the Microvision Plan in the first eight months of 2004, and 2003 and 2002, respectively.
The following table represents certain unaudited quarterly financial information for the eight quarters ended December 31, 2004. In managements opinion, this information has been prepared on the same basis as the audited financial statements and includes all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the unaudited quarterly results of operations set forth herein.
Quarterly and annual earnings per share are calculated independently, based on the weighted average number of shares outstanding during the periods.
Schedule IIVALUATION AND QUALIFYING ACCOUNTS AND RESERVES
There have been no changes in or disagreements with accountants in accounting or financial disclosure matters during the Companys fiscal years ended December 31, 2004 and 2003.
As of December 31, 2004, we carried out an evaluation, under the supervision and with the participation of the Companys management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e) and 15d-15(e). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Security and Exchange Commissions rules and forms, and to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Companys management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
There have been no changes in the Companys internal controls or in other factors that could significantly affect internal controls over financial reporting during the period being reported on which could materially affect, or are reasonably likely to materially affect, the Companys internal control over financial reporting.
We are required to review and evaluate the design and effectiveness of our disclosure controls and procedures on an ongoing basis and to improve our controls and procedures over time and to correct any deficiencies that we may discover in the future. Our goal is to ensure that our senior management has timely access to all material financial and non-financial information concerning our business. While we believe the present design of our disclosure controls and procedures is effective to achieve our goal, future events affecting our business may cause us to modify our disclosure controls and procedures.
We are in the process of implementing the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 which requires our management to assess the effectiveness of our internal control over financial reporting and include an assertion in our 2005 annual report as to the effectiveness of our internal controls over financial reporting. Subsequently, our independent registered public accounting firm, PricewaterhouseCoopers LLP, will be required to attest to whether our assessment of the effectiveness of our internal controls over financial
reporting is fairly stated in all material respects and separately report on whether it believes we maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005. We are in the process of performing the system and process documentation, evaluation and testing required for management to make this assessment and for the registered public accounting firm to provide its attestation report. We have not completed this process or its assessment, and this process will require significant amounts of management time and resources. In the course of evaluation and testing, management may identify deficiencies that would need to be addressed and remediated.
The information under the headings Election of Directors, Section 16(a) Beneficial Ownership Reporting Compliance, and Audit Committee Report in the Lumera Corporation definitive Proxy Statement to be filed with the Securities and Exchange Commission in connection with the next Annual Meeting of Shareholders to be held on June 2, 2005 (the Proxy Statement) is incorporated herein by reference. See Item 4A in Part 1 of this report for information regarding executive officers of the Company. We adopted a Code of Conduct applicable to our principal executive officer, principal financial officer, and principal accounting officer, in addition to all of our other employees, which is attached hereto as Exhibit 14.
The information required by this item is incorporated by reference to the Proxy Statement under the heading Executive Compensation.
The following table shows the number of shares of common stock that could be issued upon exercise of outstanding options and warrants, the weighted average exercise price of the outstanding options and warrants and the remaining shares available for future issuance as of December 31, 2004.
The other information required by this item is incorporated by reference in the Proxy Statement under the heading Information about Microvision Common Stock Ownership.
The information required by this item is incorporated by reference to the Proxy Statement under the heading Certain Relationships and Related Transactions.
The information required by this Item is incorporated by reference to the Proxy Statement under the heading Independent Accountants.
(1) Financial Statements
Balance Sheets as of December 31, 2004 and 2003
Statements of Operations for the years ended December 31, 2004, 2003 and 2002
Statements of Shareholders Equity for the years ended December 31, 2004, 2003 and 2002
Statements of Comprehensive Loss for the years ended December 31, 2004, 2003 and 2002
Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002
Valuation and Qualifying Accounts and Reserves for the years ended December 31, 2004, 2003 and 2002
See the Exhibit Index on page 62 of this Annual Report on Form 10-K.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the following capacities on March 25, 2005.
INDEX TO EXHIBITS
The following documents are filed herewith or have been included as exhibits to previous filings with the Securities and Exchange Commission and are incorporated by reference as indicated below.