ASTROTECH Corp: Form 10-Q for the period ended Dec 31, 2014

The following information should be read in conjunction with the unaudited condensed consolidated financial statements and the accompanying notes included in Part I, Item 1 of this Report.

Business Overview

Astrotech Corporation (Nasdaq: ASTC) (“Astrotech,” “the Company,” “we,” “us” or “our”), a Washington corporation, is a company that was formed in 1984 to leverage the environment of space for commercial purposes. For 30 years, the Company remained a crucial player in space commerce activities, which supported the launch of 23 shuttle missions and more than 300 spacecraft. We currently prepare and process scientific research in microgravity and develop and manufacture sophisticated, next generation chemical sensor equipment. We are also evaluating potential investment opportunities where we can leverage our significant operating experience to add considerable value.

On August 22, 2014, the Company completed the previously announced sale (“Asset Sale”) of substantially all of its assets used in the Company's former Astrotech Space Operations (“ASO”) business unit (“the ASO business”) to Lockheed Martin Corporation for an agreed upon purchase price of $61.0 million, less a working capital adjustment. As of December 31, 2014, the estimated purchase price is $59.3 million, which includes a working capital adjustment of $1.7 million. As of December 31, 2014, the Company has received cash of $52.6 million and has recorded receivables of $0.6 million for the working capital holdback, which is classified in other current assets, and $6.1 million for the indemnity holdback. The working capital holdback will be settled during the Company’s third quarter, once both sides agree on the final net working capital amount as of the date of the transaction. The indemnity holdback is being held in escrow under the terms of an escrow agreement until February 2016 (the 18-month anniversary of the consummation of the transaction). The Company believes it will fully realize the indemnity holdback in February 2016. Our former ASO business consists of (i) ownership, operation and maintenance of spacecraft processing facilities in Titusville, Florida and Vandenberg Air Force Base, California (“VAFB”); (ii) supporting government and commercial customers processing complex communication, earth observation and deep space satellite launches; (iii) designing and building spacecraft processing equipment and facilities; and (iv) providing propellant services including designing, building and testing propellant service equipment for fueling spacecraft.

With the sale of the Company’s former ASO business, the Company now operates a single reportable business unit, Spacetech, and its efforts are focused on the following:

• Working with development partners to build industry specific applications using our chemical detection mass spectrometry technology;
• Enhancing and extending the capabilities and fields of use of our mass spectrometry technology;
• Commercializing unique space and defense related technologies; and
• Developing next generation vaccines using the unique environment of microgravity.

Spacetech

Spacetech is a technology incubator designed to commercialize space-industry technologies. Spacetech is currently pursuing two distinct opportunities:

1st Detect

1st Detect develops, manufactures and sells ultra-small mass spectrometers and related equipment. Mass spectrometers, in general, measure the mass and relative abundance of ions in a sample to create a “mass spectrum”. This resulting mass spectrum is a unique fingerprint that can be compared to a reference library of mass spectra to verify the identity of a sample. Mass spectrometers can identify chemicals with more accuracy and precision than competing instruments given their extreme sensitivity and specificity and they are a staple of almost all analytical laboratories. By leveraging technology initiated by an engagement with the National Aeronautics and Space Administration (“NASA”) to develop a mass spectrometer for the International Space Station (“ISS”), the Company has developed a series of instruments that are significantly smaller, lighter, faster and less expensive than competing mass spectrometers, and significantly more sensitive and accurate than other competing chemical detectors at a lower price point. Our efforts have resulted in a technology that has been or will be deployed in the following areas:

• Explosive device detection in airports – our device has at least 100 times the specificity of the current generation of screening devices, meaning fewer false alarms and a higher probability of threat detection. Our solution also has better resolution, translating into detection of a broader range of compounds, which allows us to see not only traditional explosives, but also homemade and improvised explosives, an area where the current technology lags.
• Military – our technology is extremely sensitive, so we can detect chemical warfare agents in much lower concentrations than incumbent technologies. The high level of specificity of our instrumentation not only improves detection of traditional threats, but also detects next generation chemical agents not easily detectable by current instrumentation. We expect that our products will be used to verify decontamination of previously contaminated sites and to positively identify a suspect compound following an alarm on a less sophisticated instrument.
• Industrial process control – we are enabling cost effective real-time in situ mass spectrometer analysis for the first time. While competing technologies can alarm when there is an anomaly in a process, our technology can provide insights about those deviations where other instrumentation is limited.
• Food & beverage – we are also enabling cost effective real-time in situ mass spectrometer analysis for the first time in the food and beverage industry. Not only does our instrumentation provide a full set of information to more thoroughly analyze results when there is a deviation in quality, but we provide objectivity that human taste testers cannot.
• Semiconductor – our products are able to detect excursion events. Most incumbent technologies are tuned to look for a particular contaminant, but our instrument can warn of virtually any potential contaminant, making ours a much more robust solution.
• Oil & gas – given the sensitivity and speed of our technology, we can detect smaller leaks sooner than the competition as well as more completely characterize production and potential production.
• Laboratory research – our products are significantly less expensive than the competition and have a minimal footprint, making our products a great solution for entities with limited funding and counter space.
• Petrochemical & refining – our products are able to provide real time information upon which automatic and/or humans may make consequential decisions regarding product quality, efficiency of production, and feedstock performance.

Our product portfolio currently consists of the following products:

• MMS-1000™ - the MMS-1000™ is a small, low power desktop mass spectrometer designed for the laboratory market. The unique design of this unit enables fast, mass spectrometric quality chemical analysis but requires minimal benchtop space (about the size of a shoebox), requires less power than a typical light bulb, and unlike traditional instruments, requires no consumables or special infrastructure. It has been particularly well-received by the laboratory research marketplace.
• OEM-1000 - the OEM-1000 is a mass spectrometer component that is designed to be integrated into customers specific packaging and enclosures, and is well-suited to be integrated with application specific sampling or separation technology. A variant, the OEM-1000PI has recently been integrated into a Thermogravimetric Analyzer (“TGA”) manufactured by RIGAKU Corp. of Tokyo, Japan, one of the leading instrumentation companies in Asia. The integrated instrument named Thermo iMS2 is the world’s first integrated TGA with MS/MS capabilities and is expected to be well-received by the international research and development markets. A further variant of the OEM-1000 has been selected by Battelle, a leading supplier of military chemical detection equipment, for integration into the Next Generation Chemical Detector, a program under development by the DOD’s Joint Program Executive for Chemical and Biological Defense.
• iONTRAC – the iONTRAC is a process analyzer utilizing the same mass spectrometer technology as the MMS-1000™. The iONTRAC provides near real-time monitoring of industrial processes such as petrochemical processing, food & beverage manufacturing, and semiconductor cleanroom environmental monitoring. The instrument is designed to autonomously monitor processes and report conditions over industry standard factory management system (“FMS”) infrastructure.

Astrogenetix

Astrogenetix is a biotechnology company formed to commercialize products processed in the unique environment of microgravity. Astrogenetix pursued an aggressive space access strategy to take advantage of the NASA space shuttle program prior to its retirement in 2011. This strategy gave Astrogenetix unprecedented access to research in microgravity, as we flew experiments twelve times over a three year period. In collaboration with NASA, NASA has engaged leading vaccine development experts through a premier educational institution to independently evaluate Astrogenetix’s platform with specific direction to aid in the filing of an Investigational New Drug (“IND”) application for Salmonella. Given that NASA is providing much of the necessary funding for this research, additional investment in Astrogenetix has been scaled back considerably as efforts are concentrated on filing this IND. The team is also evaluating a vaccine target for Methicillin-Resistant Staphylococcus Aureus (“MRSA”) based on early discoveries made in microgravity. We have negotiated a Space

Act Agreement with NASA for a minimum of twenty-eight additional space flights following the successful filing of the IND for Salmonella.

Business Developments

Sale of Astrotech Space Operations business (“Asset Sale”)

On August 22, 2014, the Company completed the Asset Sale. As of December 31, 2014, the estimated purchase price is $59.3 million, which includes a working capital adjustment of $1.7 million. As of December 31, 2014, the Company has received cash of $52.6 million and has recorded receivables of $0.6 million for the working capital holdback, which is classified in other current assets, and $6.1 million for the indemnity holdback. The working capital holdback will most likely be settled in the next quarter, once both sides agree on the final net working capital amount as of the date of the transaction. The indemnity holdback is being held in escrow under the terms of an escrow agreement until February 2016 (the 18-month anniversary of the consummation of the transaction). The Company expects to fully realize the indemnity holdback in February 2016. Our former ASO business consists of (i) ownership, operation and maintenance of spacecraft processing facilities in Titusville, Florida and Vandenberg Air Force Base, California (“VAFB”); (ii) supporting government and commercial customers processing complex communication, earth observation and deep space satellite launches; (iii) designing and building spacecraft processing equipment and facilities; and (iv) providing propellant services including designing, building and testing propellant service equipment for fueling spacecraft.

During the first quarter of fiscal 2015, we recorded a pre-tax gain of $25.6 million ($23.7 million, after tax) on the Asset Sale. All of the operations of our former ASO business, which were previously reported within our former ASO business unit segment, have been reclassified as discontinued operations in our unaudited condensed consolidated financial statements for the quarter ended September 30, 2014, and as of June 30, 2014. See Note 3 to our unaudited condensed consolidated financial statements for more information regarding the Asset Sale and the use of related proceeds.

Payoff of Term Loan

On August 22, 2014, the Company used a portion of the proceeds from the Asset Sale to pay off the outstanding balance of its term loan of $5.7 million. The Company has no outstanding debt as of December 31, 2014.

Payoff of Texas Emerging Technology Fund Award

On August 28, 2014, the Company used a portion of the proceeds from the Asset Sale to settle its funding from the State of Texas Emerging Technology Fund for $2.3 million.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with Generally Accepted Accounting Principles (“GAAP”) for interim financial statements. 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 assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed 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. Estimates and assumptions are reviewed periodically. Actual results may differ from these estimates under different assumptions or conditions.

With the sale of our former ASO business unit, several of our critical accounting policies will no longer be applicable in subsequent fiscal years. Management will update its disclosure of our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2015 Annual Report on Form 10-K.

Results of Operations

Quarter ended December 31, 2014 compared to Quarter ended December 31, 2013:

Selected consolidated financial data for the quarter ended December 31, 2014 and 2013 is as follows (dollars in thousands):

Revenue – Total revenue decreased $78 thousand during the second quarter of fiscal 2015 compared to the second quarter of fiscal 2014. During the second quarter of fiscal 2014 we had revenue associated with a legacy handrail project of $82 thousand. During the second quarter of fiscal 2015 we finished the first phase of the new subcontract agreement with a third party on the Next Generation Chemical Detector (“NGCD”) program.

Gross Profit – Gross profit decreased $82 thousand during the second quarter of fiscal 2015 compared to the second quarter of fiscal 2014 due to our decrease in revenue as described above. Also, we had no cost of revenues during the second quarter of fiscal 2014 compared to $4 thousand of cost of revenues in the second quarter of fiscal 2015.

Operating Expenses – Our operating expenses increased $623 thousand, or 26% during the second quarter of fiscal 2015 compared to the same period in the prior fiscal year. Significant changes to operating expenses included the following:

• Selling, general and administrative expense decreased by $11 thousand primarily driven by a decrease in compensation of $350 thousand offset by an increase in legal expenses of $354 thousand and consulting and audit fees aggregating $28 thousand.
• Research and development expense increased by $634 thousand primarily driven by R&D expense reductions in the quarter ending December 31, 2014 compared to the quarter ending December 31, 2013 along with an increase in materials ordered and additional positions hired during the December 31, 2014 quarter.

Income Taxes on Continuing Operations – Our income tax benefit increased $0.2 million due to higher losses on continuing operations during the second quarter of fiscal 2015, compared to the same period in the prior fiscal year.

Discontinued Operations – Discontinued operations includes the reclassification of operations of the Company’s former ASO business unit for the three months ended December 31, 2013. The loss from discontinued operations decreased $855 thousand during the second quarter of fiscal 2015, compared to the same period in the prior year. Significant changes included the following:

• Operating income from discontinued operations decreased by $2.5 million as our former ASO business unit’s operating results were only included through August 21, 2014; therefore, there was no income recognition for the three months ending December 31, 2014.
• Cost of revenues from discontinued operations decreased by $2.7 million due to our decreases in operating income as described above.

Six months ended December 31, 2014 compared to six months ended December 31, 2013:

Selected consolidated financial data for the six months ended December 31, 2014 and 2013 is as follows (dollars in thousands):

Revenue – Total revenue increased $242 thousand for the six months ended December 31, 2014, compared to the six months ended December 31, 2013 due to the first phase of a new subcontract agreement with a third-party on the NGCD program.

Gross Profit – Gross profit decreased $39 thousand during the six months ended December 31, 2014 compared to the six months ended December 31, 2013 due to no cost of revenues being recorded during the six months ended December 31, 2013.

Operating Expenses – Our operating expenses increased $917 thousand, or 19%, during the six months ended December 31, 2014, compared to the same period in the prior fiscal year. Significant changes to operating expenses included the following:

• Selling, general and administrative expense increased by $397 thousand primarily driven by transaction-related costs within Corporate operations, most notably a significant increase in legal expense, as well as higher employee-related costs due to additional headcount within our 1st Detect business unit.
• Research and development expense increased by $520 thousand primarily driven by R&D expense reductions in the quarter ending December 31, 2014 compared to the quarter ending December 31, 2013 along with an increase in materials ordered and additional positions hired during the December 31, 2014 quarter.

Income Taxes on Continuing Operations – Our income tax benefit increased $0.3 million due to higher losses on continuing operations during the six months ended December 31, 2014, compared to the same period in the prior fiscal year.

Discontinued Operations – Discontinued operations includes the reclassification of operations of the Company’s former ASO business unit for the six months ended December 31, 2013. Income from discontinued operations increased $23.2 million during the six months ended December 31, 2014 compared to the same period in the prior year. Significant changes included the following:

• Gain on the Asset Sale of $25.6 million ($23.7 million after-tax) which reflects the excess of the sum of the cash proceeds received over the net book value of the net assets of the Company’s former ASO business unit.
• Operating income from discontinued operations decreased by $6.3 million as our former ASO business unit’s operating results were only included through August 21, 2014 in the six months ended December 31, 2014, compared to a full six months in the six months ended December 31, 2013.
• Income tax expense increased $0.8 million due to the gain on the ASO transaction, offset by net operating loss carryforwards allocated to discontinued operations.

Liquidity and Capital Resources

The following is a summary of the change in our cash and cash equivalents (in thousands):

Cash and Cash Equivalents and Short-Term Investments

As of December 31, 2014, we had cash and cash equivalents and short-term investments of $42.4 million, and our working capital was approximately $41.5 million. As of December 31, 2013, we had cash and cash equivalents and short-term investments of $6.7 million and our working capital was approximately $3.8 million. Cash and cash equivalents and short-term investments increased by approximately $35.7 million as of December 31, 2014, as compared to December 31, 2013 due to proceeds received from the sale of our former ASO business unit.

Operating Activities

Net cash used in operating activities from continuing operations increased to $4.2 million for the six months ended December 31, 2014, compared to $2.4 million for the six months ended December 31, 2013, which was primarily the result of a net income tax liability of $0.6 million associated with both the losses on our current operations and the gain on the sale of our former ASO business unit offset by larger decreases in accrued expenses compared to the same period in the prior fiscal year.

Net cash provided by operating activities from discontinued operations was ($1.6) million for the six months ended December 31, 2014, compared to net cash provided by operating activities from discontinued operations of $3.4 million for the six months ended December 31, 2013. The change was related to the sale of our former ASO business unit prior to the end of the six months ended December 31, 2014.

Investing Activities

Cash used in investing activities from continuing operations for the six months ended December 31, 2014 increased $35.6 million compared to the six months ended December 31, 2013. The proceeds from the sale of the ASO business were used to purchase short-term investments.

Cash provided by investing activities from discontinued operations increased to $52.6 million for the six months ended December 31, 2014, compared to $0.9 million for the six months ended December 31, 2013, which was due to the sale of our former ASO business.

Financing Activities

Cash used in financing activities from continuing operations increased $2.6 million for the six months ended December 31, 2014, compared to the six months ended December 31, 2013. The increase was due to the payoff of funding from the State of Texas Emerging Technology Fund for $2.3 million. There was also $0.4 million used for shares bought back during this period.

Cash used in financing activities from discontinued operations increased to $5.7 million for the six months ended December 31, 2014, compared to $0.2 million for the six months ended December 31, 2013. This increase was related to the payoff of our term loan that was secured by the assets of our former ASO business unit.

Debt

Credit Facilities

In October 2010, our former ASO business entered into a financing facility with a commercial bank providing a $7.0 million term loan note and a $3.0 million revolving credit facility. The $7.0 million term loan was to terminate in October 2015, and the $3.0 million revolving credit facility expired in October 2012. On August 22, 2014, the Company used a portion of the proceeds from the sale of its former ASO business to pay off the outstanding balance of its term loan of $5.7 million.

Liquidity

As of December 31, 2014, we had cash and cash equivalents and short-term investments of $42.4 million and our working capital was approximately $41.5 million, which excludes an indemnity cash holdback receivable of $6.1 million being held in escrow as part of the sale of our ASO business. The indemnity cash holdback may be received no later than February 2016 subject to certain conditions in the asset purchase agreement entered into in connection with the Asset Sale.

Our future capital requirements will depend on a number of factors, including our success in developing and expanding markets for our products, payments under possible future strategic arrangements, continued progress of our research and development of potential products, the need to acquire licenses to new technology, costs associated with increasing our manufacturing and development facilities, costs associated with strategic acquisitions including integration costs and assumed liabilities, litigation expense and the status of competitive products and potential cost associated with both protecting and defending our intellectual property. In addition, actions taken as a result of the ongoing internal evaluation of our business could result in expenditures not currently contemplated in our estimates for 2015. We believe, however, that our existing cash and cash equivalents are sufficient to fund our operating expenses, capital equipment requirements and other expected liquidity requirements for the coming year. Factors that could affect our capital requirements, in addition to those listed above, include continued collections of accounts receivable consistent with our historical experience and our ability to manage product development efforts.

On August 22, 2014, we completed the Asset Sale. As of December 31, 2014, the estimated purchase price is $59.3 million, which includes a working capital adjustment of $1.7 million. As of December 31, 2014, the Company has received cash of $52.6 million and has recorded receivables of $0.6 million for the working capital holdback and $6.1 million for the indemnity holdback. The working capital holdback will be settled in the third quarter, once both sides agree on the final net working capital amount as of the date of the transaction. The indemnity holdback is being held in escrow under the terms of an escrow agreement until February 2016 (the 18-month anniversary of the consummation of the transaction). A portion of the proceeds from the sale were used to pay off the term loan of $5.7 million and to settle our funding from the State of Texas Emerging Technology Fund for $2.3 million. The remaining funds will fund current operations and support strategies for our remaining business unit, Spacetech.

We believe we have sufficient liquidity to continue to fund our operating expenses, capital requirements and other expected liquidity requirements over the next fiscal year.

Income Taxes

We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts. Valuation allowances are established, when necessary, to reduce deferred tax assets to amounts that are more likely than not to be realized. As of December 31, 2014, the Company has established a full valuation allowance against all of its net deferred tax assets to the extent they will not be utilized to offset the gain and income from discontinued operations.

To the extent that a loss from continuing operations can be utilized to offset the income otherwise resulting from discontinued operations, it has been recognized as a tax benefit from continuing operations. To the extent that a loss or credit carryover can be utilized to offset the income from discontinued operations, it has been recognized as a tax benefit from discontinued operations.

During the second quarter, the Company identified a reclassification in its intraperiod tax allocations between continuing and discontinued operations reported in the first quarter. During the first quarter, a portion of the valuation allowance benefit was included in continuing operations rather than in discontinued operations. As a result of the reclassification, the continuing operations tax benefit generated in the second quarter has been reduced by $352 thousand, the amount of additional benefit included in continuing operations in the first quarter. The total effective tax rate for continuing operations is approximately 37.0% fiscal year to date. This reclassification had no impact on total tax expense in either first or second quarter.

The disposition of the ASO business resulted in the recognition of a taxable gain of approximately $27.0 million. The Company will utilize losses generated during its current fiscal year ending June 30, 2015, as well as loss carryovers and credits that are unrestricted by IRC Section 382 (which limits the utilization of loss carryovers). As of December 31, 2014, the Company expects that it will be able to offset all but $2.2 million of the gain. Any additional losses incurred during the current fiscal year ending June 30, 2015, will reduce the taxable gain and the taxes associated with that gain. The Company is currently unable to reasonably estimate the impact of any additional losses that may occur during the remainder of its fiscal year ending June 30, 2015. As of December 31, 2014, the net federal and state tax impact of the disposition gain (net of the losses incurred during the six months ended December 31, 2014, and the tax attribute carryovers from prior years) is $0.5 million.

FASB ASC 740, Income Taxes (“FASB ASC 740”) addresses the accounting for uncertainty in income taxes recognized in an entity’s financial statements and prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. The Company has an unrecognized tax benefit of $0.1 million for the six months ended December 31, 2014 and 2013.

Off-Balance Sheet Arrangements

We did not have any off-balance sheet arrangements as of December 31, 2014.

(a) Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (“Exchange Act”), which are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as of the end of the period covered by this Quarterly Report. Based on the evaluation and criteria of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.

(b) Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Exchange Act Rule 13a-15(d) during the quarter ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.