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LUNA INNOVATIONS INC FILES (8-K) Disclosing Entry into a Material Definitive Agreement, Change in Directors or Principal Officers, Regulation FD Disclosure, Other Events, Financial Statements and Exhibits

January 22, 2014

Item 1.01. Entry into a Definitive Material Agreement. On January 17, 2014 , Luna Innovations Incorporated ("we" or the "Company") entered into an Asset Purchase Agreement with Intuitive Surgical Operations, Inc. and Intuitive Surgical International, Ltd. (collectively, "Buyer"), which are wholly owned subsidiaries of Intuitive Surgical, Inc. ("ISI") (the "Asset Purchase Agreement"). Under the Asset Purchase Agreement, effective as of 12:01 a.m. on January 21, 2014 , the Company closed on its sale to Buyer of substantially all of its assets related to its medical shape sensing business, including all of patents and patent applications used or useful for its fiber optical shape sensing and localization technology, for $6 million in cash at closing and a second $6 million in cash to be paid no later than 90 days after closing, plus up to $8 million upon the accomplishment by Buyer of certain technical specifications (the "Technical Specifications Payment") and up to $10 million in potential future royalties (altogether, the "Transaction"). The Company had been engaged since 2007 in a development project for ISI developing a fiber optic-based shape sensing and position tracking system to be integrated into ISI's products. Also as a part of the Transaction, Buyer has hired certain employees of the Company, many of whom were historically engaged in this development project. The second $6 million to be paid within 90 days has been placed in escrow. The Technical Specifications Payment is tied to the achievement of certain technical specifications that were previously established for the development project between the Company and ISI. If these technical specifications are not achieved but the Company's fiber optical shape sensing and localization technology is nevertheless included in an ISI medical system that receives Food and Drug Administration approval as the system's only localization solution, then Buyer shall pay the Company $6 million upon such approval. The royalties will be paid at a rate of $10,000 per commercially-sold medical robotic system that includes the Company's fiber optical shape sensing and localization technology. The foregoing deferred and/or potential payments are subject to set off against any liabilities the Company may have to Buyer for any breach of the Company's representations or obligations under the Asset Purchase Agreement. The Asset Purchase Agreement contains representations and warranties, covenants and indemnification provisions common to transactions of this nature, except that the Company's indemnification obligations are only limited in time until no further payments are due from Buyer. Any disputes between the parties will be handled by mediation and arbitration in Chicago, Illinois . All of the transfers of technology contemplated in the Transaction have been made subject to the Company's existing licenses and related obligations to Hansen Medical, Inc. ("Hansen") and Philips Medical Systems Nederland BV . Also, in connection with the Transaction, the Company and Buyer entered into a License Agreement of the same date (the "2014 License Agreement") under which the Company received a license back to all of its transferred technology outside the field of medicine and in respect of its existing non-shape sensing products in certain non-robotic medical fields. The license back to the Company outside the medical field is exclusive to the Company except that Buyer retained certain non-sublicensable rights for itself. This license back to the Company is revocable if the Company were, after notice and certain time periods, (i) to challenge the validity or enforceability of the transferred -------------------------------------------------------------------------------- patents and patent applications, (ii) to commercialize its fiber optical shape sensing and localization technology in the field of medicine (except to perform on a development and supply project for Hansen), (iii) to violate its obligations related to its ability to sublicense in the field of medicine or (iv) to violate its confidentiality obligations in a manner that advantages a competitor in the field of medicine and not cure such violation. As a part of the Transaction, the Company has retained assets and rights necessary to perform on its development and supply project for Hansen if that project is re-started. Also, as a part of the Transaction, for a period of 15 years after closing, the Company has agreed to exit and not develop or commercialize its fiber optical shape sensing and localization technology in the field of medicine (except for Hansen as described above). For a period of 10 years after closing, Buyer has agreed not to use any of the assets being acquired in the Transaction, including the key employees being hired, to compete with the Company outside the field of . . . Item 5.02. Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers. (e) In connection with, and effective upon closing of, the Transaction, Dr. Mark Froggatt resigned from his position as Chief Technology Officer of the Company and was hired by Buyer. In addition, in connection with the completion of the Transaction, the Company has agreed to pay Dr. Froggatt a bonus of $334,200 . Additionally, Dr. Frogatt's unvested stock options became immediately vested upon closing of the Transaction. The cash bonus represents the amount of his annual salary plus his target bonus, which would be payable under a "Change of Control" as defined in his Employment Agreement with the Company dated March 28, 2012 . Dr. Froggatt will remain available to the Company on a consulting basis for certain purposes. Item 7.01. Regulation FD Disclosure. On January 22, 2014 , the Company issued a press release announcing the execution of the Asset Purchase Agreement with Buyer and the completion of the Transaction. A copy of this press release is furnished herewith as Exhibits 99.1 to this report. In accordance with general instruction B.2 to Form 8-K, the information in this Item 7.01, including the press release furnished as an -------------------------------------------------------------------------------- exhibit hereto, shall not be deemed to be "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or Securities Exchange Act of 1934. Item 8.01. Other Events. Risk Factors An investment in our common stock is subject to numerous risks, many of which are described in our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and registration statements we file from time to time with the SEC . The Transaction results in additional risks, in addition to those that are described in our most recent SEC filings, and the following risk factors should be considered in addition to such risk factors when making a decision to purchase or sell our common stock. Our license back from Buyer is revocable and, without this license, we cannot continue to market, manufacture or sell our fiber-optic products. As described above, as a part of the Transaction, we received a license back from Buyer to all of our transferred technology outside the field of medicine and in respect of our existing non-shape sensing products in certain non-robotic medical fields. Also as described above, this license is revocable upon certain continuing events or breaches. Maintaining this license is necessary for us to conduct our fiber-optic products business, both for our telecom products and our ODiSI sensing products. If this license were to be revoked, we would no longer be able to market, manufacture or sell these products and it would result in a material adverse effect to our business, results of operations and financial condition. Our narrowed scope and focus may make it more difficult for us to achieve or maintain operating profitability. In connection with the Transaction, the Company has reduced its overall size and narrowed its focus to one key growth objective: to become the leading provider of fiber optic sensing systems and standard test methods for composite materials. There can be no guarantee that we will be successful in pursuing this objective. Although we anticipate realizing cost savings as a result of the Transaction, we will continue to incur significant operating expenses associated with our public company infrastructure. Accordingly, we will need to significantly increase the revenue we generate from our remaining operations in order to achieve or maintain operating profitability, and there can be no guarantee that we will be able to do so. Item 9.01. Financial Statements and Exhibits. (b) Pro Forma Financial Information -------------------------------------------------------------------------------- UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The following unaudited pro forma condensed consolidated financial statements are presented to illustrate the effects of the Transaction on our historical financial position and results of operations. Historical amounts for the years ended December 31, 2012 and December 31, 2011 are derived from our audited 2012 and 2011 condensed consolidated financial statements. Historical amounts as of and for the nine months ended September 30, 2013 and for the nine months ended September 30, 2012 are derived from our unaudited condensed consolidated financial statements. The pro forma adjustments are based upon available information and certain assumptions that we believe are reasonable in the circumstances. These adjustments are more fully described in the notes to the pro forma condensed consolidated financial statements below. The unaudited pro forma condensed consolidated balance sheet at September 30, 2013 assumes that the transaction took place on that date. The unaudited pro forma condensed consolidated statements of operations for the nine months ended September 30, 2013 and 2012, and for the years ended December 31, 2012 and 2011, assume the transaction took place on January 1, 2011 , the beginning of our 2011 fiscal year. Such information in not necessarily indicative of our financial position or results of operations that would have occurred if the transaction had been consummated as of the dates indicated, nor should it be construed as being a representation of our future financial performance or results of operations. The unaudited pro forma condensed consolidated financial statements should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements, the related notes and other financial information included in our previously filed Forms 10-K and 10-Q for the respective periods. -------------------------------------------------------------------------------- Luna Innovations Incorporated Unaudited Pro Forma Condensed Consolidated Statement of Operations For the Nine Months Ended September 30, 2012 Pro Forma Actual Adjustments Pro Forma Revenues Technology development revenues $ 11,528,700 $ - $ 11,528,700 Product and license revenues 8,715,630 (2,206,013 )(a) 6,509,617 Total revenues 20,244,330 (2,206,013 ) 18,038,317 Cost of revenues Technology development costs 8,074,595 - 8,074,595 Product and license costs 3,821,980 (1,324,973 )(b)(c) 2,497,007 Total cost of revenues 11,896,575 (1,324,973 ) 10,571,602 Gross profit 8,347,755 (881,040 ) 7,466,715 Operating expense Selling, general & administrative 7,777,206 (188,597 )(e) 7,588,609 Research, development and engineering 1,923,300 109,879 (c)(d)(f)(g) 2,033,179 Total operating expense 9,700,506 (78,718 ) 9,621,788 Operating loss from continuing operations (1,352,751 ) (802,322 ) (2,155,073 ) Other income (expense) Other income, net 85,083 - 85,083 Interest expense, net (222,473 ) - (222,473 ) Total other expense (137,390 ) - (137,390 ) Loss from continuing operations before income tax expense (1,490,141 ) (802,322 ) (2,292,463 ) Income tax expense 21,417 - 21,417 Loss from continuing operations $ (1,511,558 ) $ (802,322 ) $ (2,313,880 ) See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. -------------------------------------------------------------------------------- Luna Innovations Incorporated Unaudited Pro Forma Condensed Consolidated Statement of Operations For the Nine Months Ended September 30, 2013 Pro Forma Actual Adjustments Pro Forma Revenues Technology development revenues $ 8,564,744 - $ 8,564,744 Product and license revenues 7,623,203 (2,552,762 )(a) 5,070,441 Total revenues 16,187,947 (2,552,762 ) 13,635,185 Cost of revenues Technology development costs 6,663,194 - 6,663,194 Product and license costs 3,516,196 (1,180,645 )(b)(c) 2,335,551 Total cost of revenues 10,179,390 (1,180,645 ) 8,998,745 Gross profit 6,008,557 (1,372,117 ) 4,636,440 Operating expense Selling, general & administrative 7,388,835 (192,524 )(e) 7,196,311 Research, development and engineering 2,065,337 (261,554 )(c)(d)(f)(g)(h) 1,803,783 Total operating expense 9,454,172 (454,078 ) 9,000,094 Operating loss from continuing operations (3,445,615 ) (918,039 ) (4,363,654 ) Other income (expense) Other income, net 85,289 - 85,289 Interest expense, net (150,732 ) - (150,732 ) Total other expense (65,443 ) - (65,443 ) Loss from continuing operations before income tax benefit (3,511,058 ) (918,039 ) (4,429,097 ) Income tax benefit (1,087,839 ) (354,651 )(i) (1,442,490 ) Loss from continuing operations $ (2,423,219 ) $ (563,388 ) $ (2,986,607 ) See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. -------------------------------------------------------------------------------- Luna Innovations Incorporated Unaudited Pro Forma Condensed Consolidated Statement of Operations For the Year Ended December 31, 2011 Pro Forma Actual Adjustments Pro Forma Revenues Technology development revenues $ 15,586,123 $ - $ 15,586,123 Product and license revenues 13,195,822 (3,126,722 )(a) 10,069,100 Total revenues 28,781,945 (3,126,722 ) 25,655,223 Cost of revenues Technology development costs 11,482,856 - 11,482,856 Product and license costs 6,589,943 (2,930,834 )(b)(c) 3,659,109 Total cost of revenues 18,072,799 (2,930,834 ) 15,141,965 Gross profit 10,709,146 (195,888 ) 10,513,258 Operating expense Selling, general & administrative 11,294,202 (326,894 )(e) 10,967,308 Research, development and engineering 2,273,886 1,044,602 (c)(d)(f)(g) 3,318,488 Total operating expense 13,568,088 717,708 14,285,796 Operating loss from continuing operations (2,858,942 ) (913,596 ) (3,772,538 ) Other income (expense) Other income, net 227,565 - 227,565 Interest expense, net (376,524 ) - (376,524 ) Total other expense (148,959 ) - (148,959 ) Loss from continuing operations before income tax expense (3,007,901 ) (913,596 ) (3,921,497 ) Income tax expense 10,307 - 10,307 Loss from continuing operations $ (3,018,208 ) $ (913,596 ) $ (3,931,804 ) See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. -------------------------------------------------------------------------------- Luna Innovations Incorporated Unaudited Pro Forma Condensed Consolidated Statement of Operations For the Year Ended December 31, 2012 Pro Forma Actual Adjustments Pro Forma Revenues Technology development revenues $ 15,126,834 $ - $ 15,126,834 Product and license revenues 11,250,717 (2,538,731 )(a) 8,711,986 Total revenues 26,377,551 (2,538,731 ) 23,838,820 Cost of revenues Technology development costs 10,749,335 - 10,749,335 Product and license costs 5,242,043 (1,585,227 )(b)(c) 3,656,816 Total cost of revenues 15,991,378 (1,585,227 ) 14,406,151 Gross profit 10,386,173 (953,504 ) 9,432,669 Operating expense Selling, general & administrative 10,334,603 (252,135 )(e) 10,082,468 Research, development and engineering 2,512,840 5,179 (c)(d)(f)(g) 2,518,019 Total operating expense 12,847,443 (246,957 ) 12,600,486 Operating loss from continuing operations (2,461,270 ) (706,547 ) (3,167,817 ) Other income (expense) Other income, net 108,061 - 108,061 Interest expense, net (286,529 ) - (286,529 ) Total other expense (178,468 ) - (178,468 ) Loss from continuing operations before income tax expense (2,639,738 ) (706,547 ) (3,346,285 ) Income tax expense 21,417 - 21,417 Loss from continuing operations $ (2,661,155 ) $ (706,547 ) $ (3,367,702 ) See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. -------------------------------------------------------------------------------- Luna Innovations Incorporated Unaudited Pro Forma Condensed Consolidated Balance Sheet As of September 30, 2013 Pro Forma Actual Adjustments Pro Forma Current assets Cash and cash equivalents $ 8,184,665 $ 6,000,000 (j) $ 14,184,665 Accounts receivable, net 5,656,564 5,580,600 (j) 11,237,164 Inventory, net 3,775,508 (54,660 )(j) 3,720,848 Prepaid expenses 492,696 - 492,696 Other current assets 70,208 - 70,208 Total current assets 18,179,641 11,525,940 29,705,581 Property and equipment, net 2,155,032 (56,144 )(j) 2,098,888 Intangible assets, net 327,293 (93,453 )(j) 233,840 Other assets 61,501 61,501 Total assets $ 20,723,467 $ 11,376,343 $ 32,099,810 Current liabilities Current portion of long-term debt $ 1,500,000 - $ 1,500,000 Current portion of capital lease obligation 65,627 - 65,627 Accounts payable 1,270,190 - 1,270,190 Accrued liabilities 2,717,560 1,900,463 (j) 4,618,023 Deferred credits 558,076 - 558,076 Total current liabilities 6,111,453 1,900,463 8,011,916 Long-term debt obligation 1,000,000 - 1,000,000 Long-term capital lease obligation 127,337 - 127,337 Total liabilities 7,238,790 1,900,463 9,139,253 Commitments and contingencies Stockholders' equity Preferred stock, par value $0.001 , 1321,514 shares authorized, issued and outstanding 1,322 - 1,322 Common stock, par value $0.001 , 100,000,000 shares authorized, 14,483,900 shares issued and outstanding 14,779 - 14,779 Additional paid-in capital 62,430,014 - 62,430,014 Accumulated deficit (48,961,438 ) 9,475,880 (j) (39,485,558 ) Total stockholders' equity 13,484,677 9,475,880 22,960,557 Total liabilities and stockholders' equity $ 20,723,467 $ 11,376,343 $ 32,099,810


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