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Appendix E Case Studies TABLE App-E-1  SBIR Case Study Firms: Principal Technology and Business Firm Principal Technology Principal Business AeroSoft, GASP—an engineering analysis Engineering research and development. Inc. tool (computer software) to predict aerodynamics/gas dynamics with respect to any aircraft or spacecraft. ARACOR X-ray computed tomography Develops and manufactures x-ray test and technology for several CT applications. inspection systems. Creare, Inc. Variety of technologies in An engineering R&D services company. Biomedical applications, cryogenics, fluid dynamics and heat transfer, manufacturing technology, sensors and controls, and software and data systems. Deformation Developed simulation software to Computer simulation of forging Control solve thermo-mechanical problems for processes. Providing engineering Technology, the heat treatment industry. Developed services to the metalworking community Inc. (DCT) DANTE™, as simulation software— specializing in process simulation and Distortion Analysis for Thermal computer-based analysis of thermal Engineering. and mechanical processes such as heat treatment, forging, rolling, extrusion, and powder consolidation. Essential Developed a semiconductor—Light PIN diodes which are photodetectors, Research, emitting technology (LED)—Quantum laser diodes Inc. (ERI) Dots 218

APPENDIX E 219 TABLE App-E-1  Continued Firm Principal Technology Principal Business Luna Core technologies are in fiber optics, Manufacturing process control, next- Innovations, wireless, and ultrasonic sensing, generation cancer drug development, Inc. biotechnology, advanced materials, analytical instrumentation, novel nondestructive evaluation, and nanomaterials, advanced petroleum integrated systems. monitoring system, and wireless remote asset management. Mainstream Thermal control, energy conversion, HVAC products, A/C certifications, Engineering turbomachinery-based technologies recreational boating, environmental Corporation and nanotechnology. control units, generators/engines, M9ACE crew cooling, oil-less compressors, heat transfer fluids. Space Core Technologies: Micro Electronics Innovative avionics and space optical Photonics, Photonics Packaging; Ultra-High- communications components, networks, Inc. (SPI) Speed Fiber Optic Transceivers; services and support. Products Optical Network Components; and include: SPI’s LaserFire® (Free- Free Space Optical Transceivers. Space Communications Transceivers); MEMSpot® (beam steering devices currently under development); Micro- Electo-Mechanical Systems (MEMS); SPI’s FireFibre® (4-Channel transmitters and receivers); and SPI’s FireRing® (High Speed Real-Time Fiber Optic Networks). Technology Solid Oxide Fuel Cell System (SOFC). Fuel cell systems integrator. A compact, Management, multifuel, modular, kilowatt class system, Inc. (TMI) which can be delivered overnight. TiNi Alloy MEMS (Microelectronic-Mechanical Heat engines that run on hot and cold Company Systems) and nanotechnology. Thin water, with application to aerospace film microfabrication and materials devices; microdevices and nanodevices science. The result is micro-miniature made of TiNi thin film. valves and micro-switches with potential applications to consumer products and manufacturing. Their technologies have applications in four areas: Biotech, Aerospace, Energy, and Medicine.

220 APPENDIX E TABLE App-E-2  Strengths of the NASA SBIR Program as Identified by Firms Interviewed for the Case Studies 1.  SBIR program is a cost-effective model for small business to obtain government funded projects—eliminates the intimidation factor for small business. 2.  Generally there are good topics to apply to over time. 3.  Requires the development of a new technology. 4.  The program is a great resource for companies to develop technologies, in particular technologies that would not be developed by larger companies. 5.  Allows for government to do some key research. 6.  Nice complement between NASA and DoD programs (broad and narrow scope, respectively). 7.  The range of ideas that get to see the light of day—ideas grow out of it. 8.  Policy on Intellectual Property is an important plus. 9.  Innovativeness is encouraged. 10. Provides opportunities to work with government research labs and equipment which some small firms could not do without SBIR. 11. Not a lot of strings attached like with VCs. 12. Freedom to pursue technology they want within confines of solicitation. 13. Data rights. 14. SBIR allows high risk/high payoff ideas to get funding at the seed level which is difficult to do through private industry. 15. SBIR promotes working with other companies and universities combining ideas with others to emphasize a team approach. This helps to ensure that the applicant has the right team to get a reliable, solid solution to a problem. 1 SBIR is a merit-based competition. Size of company does not matter so it levels the playing 6.  field relative to large companies.

APPENDIX E 221 TABLE App-E-3  Weaknesses of the NASA SBIR Program, as Identified by Firms Interviewed for the Case Studies 1.  Agencies opt for lower risk projects too often. 2.  Inconsistency of topics. 3.  Inadequate feedback on losing Phase Is. 4.  There is often only a market for one unit purchased by the agency, thus a limited market for the product. This makes the SBIR program technology driven rather than market driven. 5.  Need to increase funding levels of Phase I and Phase II awards. 6.  Need more structured process for transitioning to Phase III. 7.  Requires small companies to develop an accounting capability and this might discourage some companies from applying for the program. 8.  Need to be more flexible with no-cost extensions. 9.  Time lags in program is primary weakness. 1 Insider’s knowledge is needed to compete. 0.  1 Not all awardees that are good at Phase I and Phase II projects are necessarily good at 1.  commercializing. 1 For 2.  SBIRs, there is 3 ½ years from writing a proposal to finalizing a Phase II. Over that time, technology changes. That is the real time lag problem. It would be helpful if firms can change direction of the contract as information changes. 1 There should be a yearly technical conference (instead of having to contact topic authors 3.  during the solicitation process). Currently, conferences are geared more to application/ contractual issues rather than technological issues. Agencies would then get fewer proposals because they would be able to more clearly define their technical needs. 1 Need more opportunities to talk to primes (such as opportunity that Dawnbreaker provides). 4.  1 Concern with growing emphasis on short-term technology objectives. This trend moves against 5.  S  BIR’s original purpose and is causing less innovation.

222 APPENDIX E AeroSoft, Inc. David H. Finifter The College of William and Mary April 10, 2006 SUMMARY AeroSoft, Inc., is located in Blacksburg, Virginia. The company was founded and incorporated in 1988 by Dr. Robert Walters. It was set up to develop, license, market and support software for computational fluid dynamics (CFD) appli- cations, utilizing novel algorithms which expand the capabilities of its users. AeroSoft also provides customized solutions for aerospace and military clients which wish to hire the expertise needed to solve individual problems, but with no interest in purchasing CFD software. The company should be categorized as a “lifestyle company” not a “growth company.” In 1993, the company had five employees and it currently has eight. The company has three related technologies (GASP, GUST, and SENSE)— engineering software packages—that have been developed and in each case, SBIR funding played an important role. Currently, about 50 percent of the company’s revenue comes from SBIR/STTR and other government contracts (with the Air Force currently) and 50 percent of the revenue comes from licenses sales that have been a commercial success. The firm was initially woman-owned but is not currently. In 1990, AeroSoft developed GASP v1 (structured code). GASP v2 was re- leased in 1992 and in 1995, the company released GASP v3 (parallel CFD solver with GUI). In 1996, AeroSoft’s focus shifted from CFD analysis to CFD analysis and design. Dr. Walters sold the company to Dr. William McGrory in 1998. In 1998, the company released GUST v1 (unstructured flow solver and grid genera- tor). Also, in 1998, the company released SENSE v1 as a sensitivity analysis tool. In 2001, the company released both GASP v4 and GUST v2. GASP is AeroSoft’s most important innovation. It is an engineering analysis tool (computer software) to predict aerodynamics/gas dynamics with regard to any aircraft or spacecraft. It involves computational fluid dynamics and is a struc- tured solver. A second technology, GUST, is similar to GASP in that it is set up to predict aerodynamics. It is an unstructured solver. AeroSoft’s third technology is SENSE. This is a designer tool as opposed to an analysis tool. It is for the same applications as GUST and GASP. It provides design sensitivities and determines how performance will change as a property of the vehicle or the flow varies. SENSE is used in the design phase. The impact that AeroSoft’s technologies have on its customers includes: reduced cost, additional capability, higher quality, and increased ability to achieve agency mission.

APPENDIX E 223 The SBIR program was critical to the formation of the firm. AeroSoft would not have existed without SBIR. For the first four years, AeroSoft, Inc. was a pa- per company to bid on SBIRs and it had no employees. Its first Phase I, through NSF, did not turn into a Phase II. Then the company won two NASA Phase Is that became Phase II awards. The growth of the company is completely attributable to SBIR (it was 90 percent of the revenue). It took seven years for the technology to get commercialized and then gradually the firm got up to the fifty/fifty ratio that it now has with SBIRs and other revenue. It currently has an Air Force SBIR Phase II. Of its Air Force contracts, now two-thirds are SBIRs with the Air Force and the other one-third are non-SBIR Air Force contracts. AeroSoft still sells li- censes to NASA but does not currently have a NASA SBIR award. It has licenses for its software with NASA Glenn, Langley, Johnson, Ames, and Marshall. The SBIR awards may or may not have had an effect on securing other financing. It may have been mildly beneficial with banks. The company is not in search of VC funding or other private investors. SBIR did help the company get Air Force non-SBIR contracts. The SBIR funding gave core engineering technologies to the company. There are fundamental algorithms and physical modeling directly attributable to SBIR. SBIR not only helped the company survive, but more recently it helped to maintain some of its critical employees. It has also helped with growth, too. The company became aware of SBIR from the solicitation from NSF. Aero- Soft’s CEO was in the academic community with university connections. There was no geographical connection to SBIR agencies. To determine which agency it would apply to, the basis was the research topics and agencies where the com- pany had applicable strengths. Basically it was looking for key words of “high speed aerodynamics.” AeroSoft’s strategy is limited by the topics available. In the past it has had a good success rate. It has gotten more difficult as the number of companies com- peting increases. AeroSoft’s strategy is basically to pick the number of proposals on which it has time to do a good job. In other experience, it finds that Air Force contracts are more relaxed and allow for establishment of longer term relationships. It has proven itself as an Air Force contractor. While Phase I is a short rushed time frame, Phase II is more like a regular Air Force contract. It is able to establish a relationship and get good closure on a research topic. How Would It Change the SBIR Process?—It is hard to get good two-way communication. This is not uniform across Technical Point of Contact (TPOCs) and depends on who you talk with to get different quality of information. The company wants to be sure it is worthwhile to propose the topics. In terms of debriefings, most of the debriefs simply state that “you did a great job technically but we didn’t pick you,” with no indication of whether you should come back. The company must use its own judgment about whether to

224 APPENDIX E go back. It should be noted that SENSE did a couple of Phase Is before it went into Phase II. AeroSoft has had very little success in getting third-party private investment via Phase IIB. It basically plows back the licensing revenue into the firm. This is more a function of the software aspect of the product. There are not many third parties who want to commit money. It can get letters of support from third parties but not funding. The company would like to see more flexibility in government funding Phase III or IIB. In its case, the firm is technically top heavy and its sales and marketing are weak. Selection Process: The company sees that fairness of the program selection process varies. Politics play a role. How strongly a champion fights for you mat- ters. But it has won its share and lost its share, so it is not complaining. The feedback the company gets is not always helpful. There needs to be more candor. The company never knows anything about winners or other losers. It would be good to know from the debriefing that with certain changes it would want to resubmit the proposal. Funding Lags: With regard to funding delays and time lags between Phases I and II, the owner has had to take out loans to keep staff on board. So the program should try to improve the continuity of topics. Size and Number of Awards: In regard to the size and number of awards, it prefers more opportunities for the company. It would add more contracts at current levels of funding per award. Note that computer equipment costs have actually gone down, so for its case, it is still able to fund the same number of man-hours with the relatively fixed level of awards. Strengths of SBIR Program: The company cited two program strengths. First, the SBIR program is a cost-effective model for small business to obtain government funded projects. Small companies are intimidated by the require- ments for large contracts and the SBIR program eliminates the intimidation fac- tor. Second, there are generally good topics to apply to over time. Weaknesses of SBIR Program: There were a few weakness cited by Aero- Soft. First, the people writing the tasks and research topics are potential high risk takers but opt for lower risk projects. Second, there is an inconsistency of topics. It is either feast or famine on some topics. Finally, there is inadequate feedback on losing Phase Is. BACKGROUND ON THE COMPANY Introduction: This case is based heavily on an interview with AeroSoft, Inc. President William D. McGrory, Ph.D., on December 21, 2004 and on the company’s Web site. AeroSoft, Inc. is located at 1872 Pratt Drive, Suite 1275, Blacksburg, VA 24060-6363 (phone 540-557-1900; fax 540-557-1919). The Web site is <http://www.aerosft.com>. The company was founded and incorporated in 1988 by Dr. Robert Walters.

APPENDIX E 225 It was set up to develop, license, market and support software for computational fluid dynamics (CFD) applications, utilizing novel algorithms which expand the capabilities of its users. AeroSoft also provides customized solutions for aerospace and military clients which wish to hire the expertise needed to solve individual problems, but with no interest in purchasing CFD software. Company History: As described on AeroSoft’s Web site, the company his- tory is as follows. AeroSoft was founded in 1988 by Dr. Robert Walters. In 1990, AeroSoft developed GASP v1 (structured code). GASP v2 was released in 1992 and in 1995, the company released GASP v3 (parallel CFD solver with GUI). In 1996, AeroSoft’s focus shifted from CFD analysis to CFD analysis and design. Dr. Walters sold the company to Dr. William McGrory in 1998. In 1998, the company released GUST v1 (unstructured flow solver and grid generator). Also, in 1998, the company released SENSE v1 as a sensitivity analysis tool. In 2001, the company released both GASP v4 and GUST v2. Principal Business: The principal business is engineering research and de- velopment. It is a government contractor and engineering service provider in the aerospace and defense industries. AeroSoft had total revenue of $1.1 Million in 2005. For AeroSoft, SBIR/ STTR funding as a percentage of revenue was 36 percent last year. The company has had no patents or IPOs as a result of SBIRs. It has had 15 Phase I and eight Phase II awards, with five Phase Is and two Phase II awards from NASA The initial Phase II came through NASA Langley, in 1993 with a second one in 1996 from MSFC. More recently, SBIR Phase II awards have come through the Air Force and Navy. The company had no funding at the time of the first SBIR award except for a few small consulting contracts. The faculty member who owned the company at the time funneled the contracts through the company. In 1993, the company had five employees and it currently has eight. The company should be categorized as a “lifestyle company” not a “growth company.” Dr. William McGrory became president of the company in 1998. AeroSoft is committed to accelerating the rate at which it brings new CFD capabilities to the aerospace and military markets. Since its inception, the com- pany has strategically utilized the SBIR program to fund innovative research and development and then teamed with strategic allies and/or utilized internal fund- ing to complete the latter stages of product development. The first commercially available product, GASP v2.2 was released in the spring of 1994. In 1994, Aero- Soft completed two Phase II SBIR awards sponsored by NASA which provided support for the development of GASPv3 and its unstructured CFD software, GUST. GASPv3 became commercially available in June 1995. AeroSoft has completed the development work on both GUSTv1 (released in December, 1998) and SENSE (released in December, 1998). GASPv4 was released in mid-1999. All of AeroSoft’s contracts have been completed in a timely fashion and on budget. In addition, various commercial licenses to use AeroSoft software are held by 47 organizations including 9 universities, 14 government facilities, 20

226 APPENDIX E commercial entities, and 4 overseas organizations. AeroSoft has been engaged in general consulting and contracting work for some of the major aircraft compa- nies including The Boeing Company, McDonnell Douglas Corporation, General Dynamics, Pratt & Whitney, and General Electric. It has also been team members of the Aero-Thermal Technology Development Program sponsored by the U.S. Army Strategic Defense Command. The company has three related technologies—engineering software ­packages— that have been developed and in each case, SBIR funding played an important role. Currently, about 50 percent of the revenue comes from SBIR/STTR and other government contracts (with the Air Force currently) and 50 percent of the revenue comes from licenses sales that have been a commercial success. The firm was initially woman-owned but is not currently. Linkage to University—AeroSoft has a strong linkage to Virginia Tech. Several members of the firm’s technical staff were Ph.D.s from Virginia Tech including its CEO. TECHNOLOGY OF THE COMPANY GASP is AeroSoft’s most important innovation. It is an engineering analy- sis tool (computer software) to predict aerodynamics/gas dynamics with regard to any aircraft or spacecraft. It involves computational fluid dynamics and is a structured solver. The Web site description of GASP is as follows: GASP is a structured, multiblock CFD flow solver which solves the Reynolds Averaged Navier-Stokes (RANS) equations. It is applicable to compressible flow fields approximately Mach 0.1 and greater. This would include flows with finite-rate or equilibrium chemistry, such as combustion problems or reentry type flows. GASP can per- form both steady and time accurate simulations. The code has a six degree of freedom (6-dof) motion modeling capability and uses a Chimera overlapping grid system for moving body simulations. Overlapping grids may also be used for complex steady state simulations. GASP is the firm’s most stable, and validated product. A second technology, GUST, is similar to GASP in that it is set up to predict aerodynamics. It is an unstructured solver. The Web site description of GUST is as follows: GUST, in a nutshell is an unstructured version of GASP. It too is a compressible CFD flow solver for anything from perfect gas calculations up to finite-rate chemistry, with non-equilibrium thermodynamics (like GASP). However, GUST operates on unstructured or arbitrary control volumes. Currently the grid generators that in- terface with GUST generate tetrahedral, pyramids, prisms, and hexahedra (brick element). So, one can run on a GASP type structured grid, but also more grid types. AeroSoft’s third technology is SENSE. This is a designer tool as opposed to

APPENDIX E 227 an analysis tool. It is for the same applications as GUST and GASP. It provides design sensitivities and determines how performance will change as you vary the property of the vehicle or the flow. SENSE is used in the design phase. The Web site description of SENSE is as follows: SENSE takes a user sup- plied structured multiblock cfd solution, and will predict the variation about that solution with respect to one or more design variables. For example, it will tell one how the entire solution at a point will vary as one changes the angle of attack. SENSE in not meant to replace a CFD solver, but to augment it. The government determines “Grand Challenge Problems”—that is, the gov- ernment decides what uses there are for supercomputers in predicting turbulence. GASP is used for some of these applications. NASA and the Air Force uses GASP on the supercomputer and it is licensed from AeroSoft. An important aspect of the product’s success is that anyone using the supercomputer can use GASP. There are licenses with government as well as with Northrup Grumman, some large aerospace firms, and some small aerospace firms. AeroSoft also ex- ports to Japan (to the space industry, i.e., the NASA equivalent and also Japanese contractors), Israel (military applications), and France (military applications). Also, several U.S. universities use GASP. Occasionally AeroSoft will use the software to do engineering analysis but mostly it licenses it. It has not done much to market the product. It is sometimes paid to add features to GASP. This is all a very small part of its activities. COMMERCIALIZATION The impact that AeroSoft’s technologies have on its customers includes re- duced cost, additional capability, higher quality, and increased ability to achieve agency mission. Potential software applications (as listed on the company’s Web site) include the following: • Configuration analysis. • General aeronautical education. • Expendable launch vehicles. • Aero-thermodynamic analysis. • Experimental validation. • Basic algorithm research. • Re-entry heating problems. • Waverider design. • Propulsion. • Space shuttle analysis. • Chemical deposition lasers. • Civil transport analysis and design.

228 APPENDIX E • Shock-boundary layer interactions. • X-33 analysis. • Rocket analysis. • Internal flow analysis. • Missile defense. IMPORTANCE OF SBIR The SBIR program was critical to the formation of the firm. AeroSoft would not have existed without SBIR. For the first four years, AeroSoft, Inc. was a pa- per company to bid on SBIRs and it had no employees. Its first Phase I, through NSF, did not turn into a Phase II. Then the company won two NASA Phase I awards that became Phase II awards. The growth of the company is completely attributable to SBIR (it was 90 percent of the revenue). It took seven years for the technology to get commercialized and then gradually the firm got up to the 50/50 ratio that it now has with SBIRs and other revenue. The firm does STTRs as well as SBIRs. It does not really distinguish between the two since it often teams with universities on SBIR awards. It finds the research goals are about the same for SBIR and STTR. AeroSoft currently has an Air Force SBIR Phase II. Of its Air Force con- tracts, now two-thirds are SBIRs with the Air Force and the other one third are other non-SBIR Air Force contracts. AeroSoft still sells licenses to NASA but does not currently have a NASA SBIR award. It has licenses for its software with NASA Glenn, Langley, and Johnson. NASA Ames uses a copy of the software but it does not currently support the firm. The company has received SBIR awards from NASA Langley, Ames, and Marshall. NASA and the Air Force use GASP on HPC MSRC facilities.(High Performance Computing Major Shared Resource Center) Anyone who uses these supercomputer facilities can use GASP due to the licensing arrangement. This is a clear positive spillover effect of the firm’s research output. The SBIR awards may or may not have had an effect on securing other fi- nancing. It may have been mildly beneficial with banks. The company is not in search of VC funding or other private investors. SBIR did help the company get Air Force non-SBIR contracts. The SBIR gave core engineering technologies to the company. There are fundamental algorithms and physical modeling directly attributable to SBIR. SBIR not only helped the company survive, but more recently, it helped to maintain some of its critical employees. It has also helped with growth, too. In the future, AeroSoft is planning to go with the model it currently has. If it were to expand at all, it would do some applications. AeroSoft has no patents from SBIR project. There are many research publi- cations that came out of the company’s SBIRs. Most are customers. There were approximately 30 publications authored by researchers from AeroSoft.

APPENDIX E 229 NASA Phase II Projects: The following summarizes the two NASA Phase II projects that AeroSoft has had: 1. Year of Award: 1993.  Project Title: Computational Fluid Dynamics Enhancements to Reduce End-User Work Load.  Sales to: (a) DoD/Primes: $110,000; (b) Private Sector: $16,126. Ad- ditional Investment: 0. 2. Year of Award: 1993.  Project Title: A Generalized Computational Fluid Dynamics Package for All Mach Numbers.  Sales to: (a) DoD/Primes: $1,922,462; (b) Export: $34,525; (c) Private Sector: $1,819,854.  Additional Investment: 0. AeroSoft has also been awarded SBIR Phase II awards from two other agen- cies. These are Navy and the Air Force. ISSUES WITH CURRENT SBIR PROGRAM The company became aware of SBIR from the solicitation from NSF. Aero- Soft’s CEO was in the academic community with university connections. There was no geographical connection to SBIR agencies. To determine which agency it would apply to, the basis was the research topics and agencies where the com- pany had applicable strengths. Basically, it was looking for key words of “high speed aerodynamics.” While the firm does not see any particular differences across NASA centers, there were big differences between the SBIR programs at DoD and NASA. However, while the introductory sections of the proposals differ, the meat of the proposals is about the same. AeroSoft’s strategy is limited by the topics available. In the past, it has had a good success rate. It has gotten more difficult as the number of companies com- peting increases. AeroSoft’s strategy is basically to pick the number of proposals on which it has time to do a good job. It does a manageable number of proposals given the staffing constraints. That strategy does pay off. It once had the entire firm working on proposals for a couple of months. Now it spends relatively little time and picks the ones it is expert in. It has proven itself as an Air Force contractor. While Phase I is a short rushed time frame, Phase II is more like a regular Air Force contract. It is able to estab- lish a relationship and get good closure on a research topic. How Would It Change the SBIR Process?—It is hard to get good two-way communication. This is not uniform across Technical Points of Contact (TPOCs)

230 APPENDIX E and depends on who you talk with to get different quality of information. The company wants to be sure it is worthwhile to propose the topics. In terms of debriefings, most of the debriefs simply state that “you did a great job technically but we didn’t pick you,” with no indication of whether you should come back. The company must use its own judgment about whether to go back. It should be noted that SENSE did a couple of Phase Is before it went into Phase II. There is a pretty good range of topic specifications. Commercialization po- tential depends on the project. In regard to frequency of solicitation, the Air Force has two rounds, but these are not always topics to which AeroSoft could submit. AeroSoft would opt for a more uniform distribution of topics as opposed to a higher frequency of an- nouncements. It is feast or famine with regard to topics. AeroSoft has had very little success in getting third-party private investment via Phase IIB. It basically plows back the licensing revenue into the firm. This is more a function of the software aspect of the product. There are not many third parties who want to commit money. It can get letters of support from third parties but not funding. The company would like to see more flexibility in government funding Phase III or IIB. In its case, the firm is technically top heavy and its sales and marketing are weak. Selection Process The company sees that fairness of the program selection process varies. Politics play a role. How strongly a champion fights for you matters. But it has won its share and lost its share, so it is not complaining. The feedback the company gets is not too helpful. There needs to be more candor. The company never knows anything about winners or other losers. It would be good to know from the debriefing that with certain changes it would want to resubmit the proposal. Funding Lags With regard to funding delays and time lags between Phases I and II, the owner has had to take out loans to keep staff on board. So the program should try to improve the continuity of topics. The company liked the idea of Phase I follow on and is sorry to see it go. Size and Number of Awards In regard to the size and number of awards, the company would not opt for fewer larger ones. It prefers enough opportunities for the company. The dollar amounts are minimally adequate. It would add more contracts at current levels

APPENDIX E 231 of funding per award. Note that computer equipment costs have actually gone down, so for its case, it is still able to fund the same number of man-hours with the relatively fixed level of awards. An interesting note—The Air Force has split SBIRs. For Phase II awards, it will give one half of Phase II and then have to resubmit for new statement of work. In terms of software development, the company does this. In terms of soft- ware research, the agency wants it this way. It produces less high risk projects. This is not necessarily a good thing. The company will do either high or low risk projects. However, it is a problem that the SBIR program has it written in the “rules” that the project be high risk work. If a response is low risk, but that is what the customer really wants, then it is hard to make it through the selection process. Strengths of SBIR Program The company cited two program strengths. First, the SBIR program is a cost- effective model for small business to obtain government funded projects. Small companies are intimidated by the requirements for large contracts and the SBIR program eliminates the intimidation factor. Second, there are generally good top- ics to apply to over time. Weaknesses of SBIR Program There were a few weaknesses cited by AeroSoft. First, the people writing the tasks and research topics are potential high risk takers but opt for lower risk projects. Second, there is an inconsistency of topics. It is either feast or famine on some topics. Finally, there is inadequate feedback on losing Phase Is. Suggested Changes AeroSoft advocates for increased funding for this good program. Its percep- tion is that the sponsors are not funding all the projects it would like.

232 APPENDIX E ARACOR Michael S. Fogarty Portland State University and Case Western Reserve University April 28, 2005 OVERVIEW ARACOR (Advanced Research and Applications Corporation) was started in 1977 by Dr. Robert A. Armistead in Sunnyvale, California, a part of Silicon Val- ley. An ARACOR office is also located near Wright-Patterson Air Force Base’s Air Force Research Laboratory in Dayton, Ohio. Armistead is the company’s president. ARACOR was purchased in January 2004 by OSI Systems, Inc., a NASDAQ company, and is now known as Rapiscan Systems High Energy In- spection Corporation ARACOR’s story revolves around the early development of industrial X-ray computed tomography (CT). Over time, their development of CT technology and involvement in high energy X-ray imaging led to the development of a mobile X-ray inspection system (Eagle) which is now being used by of the Department of Homeland Security at U.S. Seaports and Borders to inspect containers and trucks. Armistead began development of the technology at SRI International; he left SRI to start ARACOR in 1977. Almost three decades later, the firm was purchased by OSI Systems. ARACOR became a public company in January 2005. Armistead continues as the company’s president. From startup until purchased by OSI, the company had received 78 Phase I and 42 Phase II awards. Armistead sees their location in the Bay Area as providing significant advan- tages, including the availability of complementary technology and resources and a large workforce of scientists and engineers. Also in the area are major universi- ties and two national laboratories. This case illustrates several important issues for the SBIR program: 1) the importance of sustained, strategic use of a large number of SBIR awards by one company over a long period of time; 2) the significance of SBIR during periods when other potential sources of early-stage funding, such as VC companies, show no interest because the technology is viewed as too risky and doesn’t offer a large commercial market; 3) the founder’s skill in competing for SBIR awards from several agencies while utilizing the funding to build the company sufficiently to gain contract funding from several federal agencies (i.e., the founder was able to meet the company’s short-term needs while continuing to develop the technology   Based on an interview with Dr. R. A. Armistead, ARACOR’s president, Sunnyvale, California; Web site information; patent data from USPTO; and the DoD’s SBIR database.

APPENDIX E 233 over a long period of time); and 4) Although the Eagle was developed to support the “war on drugs,” it has become even more vital after 9-11. Most important, with increasing emphasis on using SBIR to support shorter-term mission objec- tives, we should ask: How will proposals from today’s budding ARACORs be evaluated and what are the implications for U.S. technology innovation? COMPANY AND FOUNDER BACKGROUND Dr. Armistead attended the Virginia Military Institute. With his ROTC ser- vice deferred, he received an Oak Ridge National Laboratory graduate fellowship to Carnegie Mellon University in Pittsburgh, PA. He completed his doctorate research on site at the Oak Ridge National Laboratory, Tenn. After graduate work, he fulfilled his military service stationed at the Pentagon. He was assigned to DASA (Defense Atomic Support Agency), which was responsible for stockpil- ing and underground tests of nuclear weapons. Armistead acted as liaison with several West Coast companies, including Stanford Research Institute (SRI) and Lockheed. After completing his military commitment, he took a position with SRI, where he became manager of the radiation and solid-state physics depart- ment. During this time he obtained a master’s degree in business administration from the University of Santa Clara. The Nobel Prize in medicine was awarded to two scientists who developed the CAT scan (computed axial tomography) in the mid-1970s. While several companies focused on medical applications, Armistead saw the need and possi- bility of using the science for applications to inanimate objects. Importantly, in- dustrial applications could ignore obstacles that existed in medical applications, such as the human-safe level of radiation tolerance (120kV; current ARACOR systems employ up to 15MV) and image blurring due to involuntary patient motion. This produces CT systems with significantly higher performance and enables the inspection of a wide variety of objects ranging from automobile parts to nuclear weapons. At the same time, the industrial applications of CT scanner technology create new problems, such as issues involving variation in materials and the large size of objects. It was necessary to use a higher level of energy and X-rays that are more penetrating. Industrial applications also required the development of more complex computer algorithms. Effective March 2005 ARACOR’s name was changed to Rapiscan Systems High Energy Inspection Corporation. ARACOR Was Just Purchased by OSI Systems Bob Armistead founded ARACOR in 1977 after leaving SRI and developing a contract relationship with Aerojet Strategic Propulsion Company, which needed an application of Armistead’s technology. The technology was first used to find defects in solid rocket motors. This application drew on one DSAT project, an

234 APPENDIX E SBIR from the Air Force and an SBIR program from the National Science Foun- dation. As of January 7, 2005, ARACOR became a wholly owned subsidiary of OSI Systems, Inc. OSI Systems is a diversified global developer, manufacturer and seller of several products: medical monitoring, optoelectronic-based compo- nents and systems, and security and inspection systems. With more than 30 years of optoelectronics experience, OSI competes in three areas: Medical Devices, OEM Manufacturing, and Security and Inspection Systems. Develops and Manufactures CT Systems for Industrial Purposes ARACOR develops and manufactures X-ray test and inspection systems for industrial purposes. These include nondestructive evaluation and process control applications, and manufactures cargo inspection systems. ARACOR is a lead- ing manufacturer of digital radiographic (DR) and computed tomography (CT) systems. They also provide research services in related areas. ARACOR’s SBIR-Supported Technology Supports Homeland Security One Homeland Security example is the Eagle, which is a mobile and relocat- able high-energy X-ray system for inspecting vehicles and cargo containers. In less than 30 seconds, the Eagle can scan a densely-loaded 20-foot container using full penetration and resolution. The resulting high quality X-ray images are im- mediately available to an inspector on the Eagle or can be wirelessly transmitted to a remote facility. Major competitors are large firms in the security business, such as SAIC and AS&E. ARACOR’s Eagle received a 2004 R&D 100 award for their technology. The Eagle also got the “Best of the Best” award from R&D Magazine in 2004. ARACOR TECHNOLOGY ARACOR utilizes X-ray computed tomography technology for several CT applications. CT is a digital X-ray inspection technology used to produce im- ages of an object’s internal features, including information characterizing the object’s materials and geometry. The CT data can be processed and used for various purposes: reverse engineering, metrology, and two and three-dimensional visualization. ARACOR has developed a proprietary X-ray detector system, which is a foundation for their high-energy X-ray imaging products. This system uses advanced, solid-state linear-array detector technology. As a result, they achieve important performance advantages relative to systems based on film and fluo- rescent-screen technologies. Advantages include superior rejection of scattered radiation, greater dynamic range, and higher detection efficiency.

APPENDIX E 235 COMMERCIALIZATION ARACOR received an early important California contract in a bid against several other large firms. Their first contract was $3 million for CT for finding defects in rocket engines. Much later, they received a U.S. Customs $20 million contract for several Eagle systems to search for drugs. ARACOR has had $25 million sales of the Eagle, which is used for inspec- tion of sea containers, and trucks to detect contraband. According to Armistead, the primary indication of the company’s commer- cial value occurred with its acquisition by OSI Systems, Inc. After U.S. Customs gave them $20 million for the Eagle, which was about two years ago, they got inquiries from VC and private equity capital firms. There were eight suitors. They finally went with one that was already involved in security and had worldwide marketing resources. This was OSI Systems. IMPORTANCE OF SBIR ARACOR Founded Prior to SBIR Creation Despite the early connection to SBIR, the firm’s startup was not associated with SBIR. ARACOR was founded several years prior to SBIR’s creation. By the time ARACOR received its first SBIR award it employed about 20 people. When it became a public company in January 2005, the company which outsources much of its manufacturing, employed 33 people as of February 15, 2005. Other Early-state Funding The company’s earliest funding came from Armistead and his family. There were no other investors; ARACOR did not receive either Angel or VC fund- ing. Initially, VC funding was not an option because the VC had to see both the product and a market of major dimensions. At the time, they only had the technology. Armistead views a Phase III activity as carrying a product developed dur- ing Phase I and II to the next level, Phase III could entail delivering additional units to the government agency that funded the program; extending the technol- ogy to other types of systems and/or applications; or developing a commercial product. ARACOR Has Received 120 SBIR Awards Over Two Decades Prior to its purchase, ARACOR received a large number of SBIR awards: 78 Phase I and 42 Phase I coming from NSF, DoD and NASA. Their original award was with Wright-Patterson Air Force Base in Dayton, Ohio. Armistead believes

236 APPENDIX E that SBIR’s strength is also its weakness: The SBIR award requires the develop- ment of a new innovative technology, but only guarantees that there is a market for one unit. Thus, while the government agency may satisfy its requirement, there may not be a follow-on market for the new product. The weakness is that only one sale is guaranteed. There is no #2 guaranteed. In other words, the SBIR is primarily technology driven rather than product driven. ARACOR had 23 employees at the time it received its first SBIR award. Although ARACOR was not founded because of an SBIR award, the Eagle is a derivative of the technology developed with the SBIR awards. As the founder pointed out, “the SBIR is a brick, not a building.” A combination of SBIR awards were used to build the CT industrial inspection technology. Some of the later awards were used to demonstrate how CT technology could be used for different applications, such as the inspection of materials, nondestructive inspection of rocket motors, the quality assurance of nuclear weapons, etc. SBIR Awards Helped to Strategically to Build and Control the Company’s Growth Although the company wasn’t founded because of SBIR awards, the SBIR programs were very important in developing the company’s technology and prod- ucts. Therefore, SBIR both directly and indirectly contributed to the company’s growth and to the current employment level. One key to their success is that ARACOR never bid on SBIR just to get an SBIR; the view is that the project must fit strategically. Armistead pointed out that some companies seek VC funding in order to develop their technology and products. However, to receive VC funding, the company must be able to demonstrate a potentially large com- mercial market. SBIR funding on the other hand is awarded on the basis of the value and uniqueness of the technology and enables government organizations to satisfy arising problems even when there is not a demonstrable market for the new technology system. Their Technology Has Triggered Further Developments by Other Companies SBIR awards were very important in supporting the development of the firm’s technology capabilities. Some of ARACOR’s patents and key products were based on technology that evolved from R&D supported by SBIR. ARACOR was first to offer computed tomography (CT) scanners for industrial applications. Their technology appears to have helped trigger further technology development by other companies, including GE and InVision Technologies, which later intro- duced their own industrial CT systems. Several additional issues emerged. First, although the company lists three patents as resulting from SBIR projects, patenting has not been the primary tool

APPENDIX E 237 for developing and commercializing ARACOR’s technology. Second, SBIR’s primary role in marketing ARACOR’s capabilities was the development of the technology itself and the applications that came from the SBIR programs rather than information about the company’s winning of SBIR awards. Third, the com- pany did not participate in business/commercialization support activities provided by either SBIR agencies or states. ISSUES WITH THE CURRENT SBIR PROGRAM Too Much Phase I to Phase II Delay One difficulty with SBIR is that you can have a great idea but there is too much delay. This begins with waiting for topics/subtopics. Once the proposal is written, it’s necessary to wait six months to get a Phase I award to do “proof of principle” for $100,000. Then, after a successful Phase I, there is often another 6-12 month delay for the Phase II award. By this time the technical concept is two years old before getting to the Phase II program. ARACOR prefers DoD’s “Fast Track.” At the completion of a Phase I proposal a Phase II proposal can be submitted. DoD provides funds to keep the project team together and focused on the technology. In other cases the company found it difficult to hold a team together with delays between Phase I and II awards. However, they pursued other projects so that the company wasn’t de- pendent on SBIR awards. A Preference for Larger Awards Over More SBIRs The sense was that within limits the program could make trade-offs between the award size and the number of awards. Nevertheless, certain important prod- ucts couldn’t be developed with the current amounts. For example, their first CT system order with the Air Force was $3 million, which clearly can’t be developed under a $50,000 SBIR award. Armistead had no complaints concerning the fairness of the award selection process, although he wasn’t familiar with the selection details. In summary, Armistead thinks SBIR is a valuable and successful program. He believes that the awards should be used to enable the government to benefit from the innovative ideas of small businesses and strong encouragement should be provided to commercialize important new technology. He believes that some checks and balances should be established to prevent firms from just existing only to receive SBIR awards.

238 APPENDIX E Creare, Inc. Philip E. Auerswald Center for Science and Technology Policy George Mason University August 2005 OVERVIEW Creare, Inc., is a privately held engineering services company located in Hanover, NH. The company was founded in 1961 by Robert Dean, formerly a research director at Ingersoll Rand. It currently has a staff of 105 of whom 40 are engineers (27 PhDs) and 21 are technicians and machinists. A substantial percent- age of the company’s revenue is derived from the SBIR program. As of Fall 2004, Creare had received a total of 325 Phase I awards, 151 Phase II awards—more in the history of the program than all but two other firms. While its focus is on en- gineering problem solving rather than the development of commercial products, since its founding it has been New Hampshire’s version of Shockley Semiconduc- tor, spawning a dozen spin-off firms employing over 1500 people in the immedi- ate region, with annual revenues reportedly in excess of $250 million.  Creare’s initial emphasis was on fluid mechanics, thermodynamics, and heat transfer research. For its first two decades its client base concentrated in the turbo-machinery and nuclear industries. In the 1980s the company expanded to energy, aerospace, cryogenics, and materials processing. Creare expertise spans many areas of engineering. Research at Creare now bridges diverse fields such as biomedical engineering and computational fluid and thermodynamics. At any given point in time Creare’s staff is involved in approximately 50 projects. Of the 40 engineers, 10-15 are active in publishing, external relations with clients, and participation in academic conferences. The company currently employs one MBA to manage administrative matters (though the company has operated for long periods of time with no MBAs on staff). As Vice President and Principal Engineer Robert Kline Schoder states, “Those of us who are leading business development also lead the projects, and also publish. We wear a lot of hats.” The company’s facilities comprise a small research campus, encompassing over 43,000 square feet of office, laboratory, shop, and library space. In addition to multipurpose labs, Creare’s facilities include a chemistry lab, a materials lab with a scanning electron microscope, a clean-room, an electronics lab, cryogenic   The other two firms are Foster-Miller (recently sold, and no longer eligible for the SBIR program) and Physical Science, Inc.   list is given in the annex to this case study. A

APPENDIX E 239 test facilities, and outdoor test pads. On-site machine shops and computer facili- ties offer support services. FIRM DEVELOPMENT FOUNDING AND GROWTH Creare’s founder, Robert (Bob) Dean, earned his Ph.D. in engineering (fluid/ thermal dynamics) from MIT. He joined Ingersoll Rand as a director of research. Not finding the research work in a large corporation to his liking, he took an academic position at Dartmouth’s Thayer School. Soon thereafter, he and two partners founded Creare. One of the two left soon after the company’s founding; the other continued with the company. But for its first decade, Robert Dean was the motive force at Creare. Engineer Nabil Elkouh relates that the company was originally established to “invent things, license the inventions, and make a lot of money that way.” Technologies that would yield lucrative licensing deals proved to be difficult to find. The need to cover payroll led to a search for contract R&D work to cover expenses until the proverbial “golden eggs” started to hatch. The culture of the company was strongly influenced by the personality of the founder, who was highly engaged in solving research and engineering problems, but not interesting in building a commercial company—indeed, it was precisely to avoid a “bottom line” preoccupation that he had left Ingersoll Rand. Thus, even the “golden eggs” that Bob Dean was focused on discovering were innovations to be licensed to other firms, not innovations for development at Creare. As Elkouh observes “the philosophy was—even back then—that what a product business needs isn’t what an R&D business needs. You’re not going to be as creative as you can be if you’re doing this to support the mother ship. . . . Products go through ebbs and flows and sometimes they need a lot of resources.” Furthermore, Dean was a “small organization person,” much more comfortable only in companies with a few dozen people than in a large corporation. A case in point: In 1968, Hypertherm was established as a subsidiary within Creare to develop and manufacture plasma-arc metal-cutting equipment. A year later Creare spun off Hypertherm. Today, with 500 employees, it is the world leader in this field. By 1975, an internal division had developed within Creare. Where Dean, the founder, continued to be focused on the search for ideas with significant commercial potential, others at Creare preferred to maintain the scale and focus consistent with a contract research firm. The firm split, with Dean and some engineers leaving to start Creare Innovations. Creare Innovations endured for a decade, during which time it served as an incubator to three successful compa- nies: Spectra, Verax, Creonics. The partners who remained at Creare, Inc., instituted “policies of stability” that would deemphasize the search for “golden eggs”—ultimately including

240 APPENDIX E policies, described below, to make it easy for staff members to leave and start companies based upon Creare technologies. The nuclear power industry became the major source of support for Creare. That changed quickly following the accident at Three Mile Island. At about the same time, the procurement situation with the federal government changed. Procurement reform made contracting with the federal government a far more elaborate and onerous process than it had been previously. As research funds from the nuclear industry disappeared and federal procurement contracts became less accessible to a firm of Creare’s size, the company was suddenly pressured to seek new customers for its services. In the wake of these changes came the SBIR program. The company’s presi- dent at the time, Jim Block, had worked with the New Hampshire Senator Warren Rudman, a key congressional supporter of the original SBIR legislation. As a consequence, the company knew that SBIR was on its way. Creare was among the first firms to apply for, and to receive, an SBIR award. Elkouh notes that “early in the program, small companies hadn’t figured out how to use it. Departments hadn’t figured out how to run the program.” The man- agement of the project was ad hoc. The award process was far less competitive than it is today.” Emphasis on commercialization was minimal. Program manag- ers defined topics according to whether or not they would represent an interesting technical challenge. There was little intention on the part of the agency to use the information “other than just as a report on the shelf.” IMPACTS From the earliest stages of its involvement in the SBIR program, Creare has specialized in solving agency initiated problems. Many of these problems required multiple SBIR projects, and many years, to reach resolution. In most in- stances, the output of the project was simply knowledge gained—both by Creare employees directly, and as conveyed to the funding agency in a report. Impacts of the work were direct and indirect. As Elkouh states: “You’re a piece in the government’s bigger program. The Technical Program Officer learns about what you’re doing. Other people in the community learn about what you’re doing— both successes and failures. That can influence development of new programs.” Notwithstanding the general emphasis within the company on engineering problem solving without an eye to the market, the company has over thirty years generated a range of innovative outputs. The firm has 21 patents resulting from SBIR-funded work. Staff members have published dozens of papers. The firm has licensed technologies including high-torque threaded fasteners, an aid in breast cancer surgery, corrosion preventative coverings, an electronic regulator for firefighters, and mass vaccination devices (pending). Products and services de-   Numbers as of fall 2004.

APPENDIX E 241 veloped at Creare include thermal-fluid modeling and testing, miniature vacuum pumps, fluid dynamics simulation software, network software for data exchange, and the NCS Cryocooler used on the Hubble Space Telescope to restore the op- eration of the telescope’s near-infrared imaging device. In some cases, the company has developed technical capabilities that have remained latent for years until a problem arose for which those capabilities were required. The cryogenic cooler for the Hubble telescope is an example. The technologies that were required to build that cryogenic refrigerator started being developed in the early 80s as one of Creare’s first SBIR projects. Over 20 years, Creare received over a dozen SBIR projects to develop the technologies that ultimately were used in the cryogenic cooler. Additionally, Creare has been awarded “Phase III” development funds from programmatic areas that were ten times the magnitude of all of the cumulative total of SBIR funds received for fundamental cryogenic refrigerator technology development. However, until the infrared imaging device on the Hubble telescope failed due to the unexpectedly rapid depletion of the solid nitrogen used to cool it, there had been no near-term application of the technologies that Creare had developed. The company has built five cryogenic cooler prototypes, and has been contacted by DoD primes and other large corporations seeking to have Creare custom build cryogenic coolers for their needs. Cooling systems for computers provide another example. The company worked intensively for a number of years in two-phase flow for the nuclear in- dustry. This work branched into studies of two-phase flow in space—that is, a liquid-gas flow transferring heat under microgravity conditions. In the course of this work, the company developed a design manual for cooling systems based on this technology. The manual sold fifteen copies. As Elkouh observes, “there aren’t that many people interested in two-phase flow in space.” A Creare-developed computer modeling program for two-phase flows under variable gravity had a similar limited market. Ten years later, Creare received a call from a large semiconductor manufacturing company seeking new approaches to cooling its equipment because fans and air simply were not working any more. This led to a sequence of large industrial projects doing feasibility studies and design work to assist the client in evaluating different possible cooling systems, including two-phase approaches. The work covered the spectrum from putting together complete design methods—based on work performed under SBIR awards—to building experimental hardware. Most recently, NASA has contacted Creare with a renewed interest in the technology. From the agency standpoint, there is a benefit to Creare’s relative stability as a small firm: They don’t have to go back  See National Aeronautics and Space Administration, “Small Business/SBIR: NICMOS C ­ ryocooler—Reactivating a Hubble Instrument,” Aerospace Technology Innovation 10(4):19-21, 2002. Access at <http://ipp.nasa.gov/innovation/innovation104/6-smallbiz1.html>. See also <http:// www.nasatech.com/spinoff/spinoff2002/goddard.html>.

242 APPENDIX E to square one to develop the technologies if a need disappears and then arises again years later. As academic research in the 1990s demonstrated the power of small firms as machines of job creation, the perception of the program changed. In the process, the relationship of perennial SBIR recipient firms such as Creare changed as well. These new modes of relationship, and some recommendations for the future, are described below. SPIN-OFF COMPANIES The success of the numerous companies that have spun off from Creare natu- rally leads to the question: Is fostering spin-offs an explicit part of the company’s business model? The answer is no to the extent that the company does not normally seek an equity stake in companies that it spins off. The primary reason has to do with the culture of Creare. Elkouh states that, as a rule, Creare has sought to inhibit firms as little as possible. “If you encumber them very much, they’re going to fail. They are going to have a hard enough row to hoe to get themselves going. So, generally, we’ve tried to institute fairly minimal encumbrances on them. We’ve even licensed technology to companies who’ve spun off on relatively generous terms for them.” Does the intermittent drain of talent and technology from Creare due to the creation of spin-off firms create a challenge to the firm’s partners? According to Kline-Schoder, no: “It has not happened all that often and when it has, op- portunities for people who stay just expand. It’s not cheap [to build a company] starting from scratch. So there’s a barrier to people leaving and doing that. The other thing—in some sense, is that Creare is a lifestyle firm. Engineers are given a lot of freedom—a lot of autonomy in terms of things to work on. We think that Creare is a rather attractive place to work. So there’s that barrier too.” ROLE OF THE SBIR PROGRAM The founding of Creare pre-dated the start of the SBIR program by 20 years. However, SBIR came into being at an extremely opportune moment for the firm. It is very difficult to say whether or not the firm would have continued to exist without the program, but it is plain that the streamlined government procurement process for small business contracting ushered in by the SBIR program facilitated its sustainability and growth. In the intervening years, the SBIR program and technologies developed under the program have become the primary sources of revenue for the firm. What accounts for the company’s consistent success in winning SBIR awards? Kline-Schoder relates that “I’ve come across companies that have spun- out of a university or a larger organization. I routinely receive calls—five years or

APPENDIX E 243 more after I met these startups—calling us and asking ‘We were wondering, how you guys have been so successful? Can you tell us how do you do it?’” As reported by the firm’s staff members, Creare’s rate of success in competi- tions where it has no prior experience with the technology or no prior relationship with the sponsor—“cold” proposals—is about the same as the overall average for the program. However, in domains where it has done prior work, the company’s success rate is higher than that of the program overall. In some of these cases the author of the technical topic familiar with Creare’s work may contact the firm to make them aware of the topic (this phenomenon is not unique to Creare). Where the company has success with “cold proposals,” it is often because the company successfully bridges disciplinary boundaries. In these instances, as Elkouh states, “we may have done something in one field. Someone in a differ- ent field needs something that’s related to our previous work and we carry that experience over.” IMPROVING THE ADMINISTRATION OF THE SBIR PROGRAM According to Creare’s current staff members, the single most significant determinant of the Phase III potential of a project is the engagement of the author of the technical topic. Kline-Schoder states: “If your goal is to, at the end, have something that transitions (either commercially or to the government) having well written topics with authors who are energetic enough and know how to make that process happen. Oftentimes we see that you develop something, it works—it’s great—and then the person on the other side doesn’t know what to do. Even if you sat it on a table, the government wouldn’t know how to buy it. There’s no mechanism for them to actually buy it.” It is something of an irony that today, forty years after its founding, Creare is increasingly fulfilling the original ambitions of its founder: earning an increasing share of its revenue from the licensing of its technologies. Here, also, the active engagement of the topic author is critical. In one instance Elkouh worked with a Navy technical topic manager who saw the potential in a covering that had been developed at Creare with SBIR funds. This individual introduced him to over 300 people, and helped set up 100 presentations. That process led to Creare making a connection with a champion within a program area in the Navy who had the funds and was willing to seek a mechanism to buy the technology from Creare for the Navy’s use. However, even in this instance, concluding the license was not a simple matter. The appropriation made it into the budget—but that funding was still two years away. Elkouh: “The government funded the development of the technology because there was a need. Corrosion is the most pervasive thing that the Navy actually fights—a ship is a piece of metal sitting in salt water. There were reports from the fleet of people saying ‘We want to cover our whole ship in this.’ So now

244 APPENDIX E you have the people who use it say they want it, but who buys it? There is this vacuum right there—who buys it?” With regard to contracting challenges, the SBIR program has largely solved the problem of a small business receiving R&D funds. From the standpoint of the staff interviewed at Creare, the contracting process directly related to the award is straightforward. What the SBIR program has not solved is the challenge of taking a technology developed under the SBIR program and finding the place within the agency, or the government, that could potentially purchase the technology. Large corporations are no more willing to fund technology development than are government agencies. Kline-Schoder reports being approached by a large multinational interested in a technology that had been developed at Creare. The company offered to assist Creare with marketing and distribution once the technology had been fully developed into a product. However, the company was unwilling to offer any of the development funds required to get from a prototype to production. Further obstacles to the commercial development of SBIR-funded technol- ogy are clauses within the enabling legislation pertaining to technology transfer. Kline-Schoder: “FAR clauses were in existence before the SBIR program. They were inherited by the SBIR program, but they don’t fit. For instance, they state that the government is entitled to a royalty-free license to any technology devel- oped under SBIR. But there has never been a clear definition of what that means.” In one instance Creare developed a coating of interest to a private company for use in a specific product. The federal government was perceived ultimately to be the major potential market for the product in question. The issue arose: Could the company pay a royalty to Creare for its technology, given that it would be prohibited from passing on the cost to the federal buyer? Contracting challenges related to the FAR clauses created a significant obstacle to the commercialization of the technology, even when two private entities were in agreement on its poten- tial value. “We could potentially be sitting here now looking at fairly substantial licensing revenues from that product as would [the corporate partner] and it’s not happening because of that IP issue.” A second issue pertaining to the intellectual property pertains to timing. As the clause is written, a company that invents something under an SBIR is obliged to disclose the invention to the government. Two years from the day that the company discloses, it must state whether or not it will seek a patent for the in- vention. However, the gap between the start of Phase I and the end of Phase II is most often longer than two years. So the SBIR-funded company is placed in the awkward position of being compelled to state whether or not it intends to seek a patent on a technology essentially before it is clear if the technology works. Pres- sure to disclose inventions have increased over time, as the commercial focus of the program has intensified. The time pressure is even more severe when Creare seeks to find the specific corporate partner who wants to use the technology in a product. The requirement also, importantly, precludes the SBIR-funded company

APPENDIX E 245 from employing trade secrets as an approach to protecting its intellectual prop- erty—in certain contexts, a significant constraint. Kline-Schoder: “Patenting is not the only way to protect intellectual property. The way things are structured now, you don’t have that choice. No matter what invention you disclose, you have to decide within two years whether or not to patent. If you don’t patent, then the rights revert to the government.” In this context, Creare has a much longer time horizon that most small companies. The view expressed by the Creare staff members interviewed was that the size of awards is adequate for the scope of tasks expected. The variation in program administration among agencies is a strength of the program—although creating uniform reporting requirements for SBIR Phase III and commercializa- tion data would significantly reduce the burdens on the company. Finally, from an institutional standpoint, no substitutes exist for the SBIR program. Private firms often will not pay for the kind of development work funded by SBIR. Once the scale of a proposed project grows over $100,000, a private company will question the value of outsourcing the project. Lack of control is also a concern. CONCLUSION Creare appears to occupy a singular niche among SBIR-funded companies. The company’s forty-year history as a small research firm is one characteristic that sets it apart from other SBIR-funded firms. The many spin-offs it has pro- duced are a second. However, from the standpoint of its ongoing success in the SBIR program and in providing corporate consulting services, Creare’s most significant differentiating characteristic may be its range of expertise. The scope of the SBIR-funded work at Creare is very broad. The reports of staff members suggest that the firm’s competitive advantage relative to other small research firms is based to a significant extent on that breadth. “A lot of companies com- partmentalize people,” as Elkouh observes. “Everybody here is free to work on a variety of projects. At the end of the day, the companies I work with think that is where we bring the value.” The same factor may account for the longevity of the firm. “We diversified internally by hiring people in different areas. That is when the cross-pollination happened.” Areas come and go. Small product companies or small startup companies focused in one area will struggle when the money disappears for whatever reason. Having evolved into a diversified research firm, Creare has endured. CREARE—ANNEX: SAMPLE OF INDEPENDENT COMPANIES WITH ORIGINS LINKED TO CREARE • Hypertherm, now the world’s largest manufacturer of plasma cutting tools, was founded in 1968 to advance and market technology first developed at

246 APPENDIX E Creare. Hypertherm is consistently recognized as one of the most innovative and employee-friendly companies in New Hampshire. • Creonics, founded in 1982, is now part of the Allen-Bradley division of Rockwell International. It develops and manufactures motion control systems for a wide variety of industrial processes. • Spectra, a manufacturer of high-speed ink jet print heads and ink depo- sition systems (now a subsidiary of Markem Corporation) was formed in 1984 using sophisticated deposition technology originally developed at Creare. • Creare’s longstanding expertise in computational fluid dynamics (CFD) gave birth to a uniquely comprehensive suite of CFD software that is now mar- keted by Fluent (a subsidiary of Aavid Thermal Technologies, Inc.), a Creare spin-off company that was started in 1988. • Mikros, founded in 1991, is a provider of precision micromachining ser- vices using advanced electric discharge machining technology initially developed at Creare.

APPENDIX E 247 Deformation Control Technology, Inc. (DCT) Michael S. Fogarty Portland State University and Case Western Reserve University May 5, 2005 OVERVIEW The Deformation Control Technology, Inc., (DCT) case illustrates SBIR’s support of a small existing software company whose Midwest market was dra- matically changing with an increasingly important role of technology in the region’s anchor industries. The SBIR program provided an important source of funding for the company’s R&D, permitting them to respond to new market needs. SBIR has played a particularly important role for DCT by contributing 95 percent of the company’s R&D funding. The company was awarded four Phase I and three Phase II awards from 1993 to 2005. SBIR awards also helped give bet- ter access to the larger defense contractors. DCT continues to operate at a small size, with three employees and annual sales about $600,000. The industrial changes involved a major technology shift that combined a switch to casting and thermal process of materials and performance of engineer- ing components at high temperature, with the decline of forging in Northeast Ohio as more high-tech companies were gaining ground. The technological change involved a shift to thermal type analyses. The Midwest location is clearly a major factor shaping DCT’s experience in commercializing their software. SBIR awards supported the company’s R&D that, for example, created a capability for simulating the causes for material failure and the interrelationship among the various coatings, materials, and how they interact to affect failure rates. DCT views NASA as increasingly focusing the SBIR program over the last five years specific space-related needs with very little commercial significance for Northeast Ohio, and on interactions with minority companies. Their view is that narrowly focused topics with specific mission objectives significantly limits opportunities for commercialization, which they see as conflicting with SBIR’s original purpose. One result is much less incentive to write SBIR proposals. Given the significance of earlier awards in funding nearly 100 percent of its R&D, the implication is that DCT will be increasingly unable to continue mak- ing software advances. In particular, they see themselves less able to compete   Based on an interview with Andrew Freborg, April 12, 2005, Cleveland, Ohio, and follow-up communications.

248 APPENDIX E with European companies where governments support research and technical implementation. COMPANY AND FOUNDER BACKGROUND The company’s founder and president is B. Lynn Ferguson. Ferguson has a doctorate in Materials Engineering from Drexel University. The company was founded by two partners in 1982, but not as a result of SBIR. DCT’s president is originally from Philadelphia. Prior to DCT, he worked for TRW in Beechwood, a Cleveland suburb, where he did research on forging and powder metals. DCT began as a scientific company linked to forging and powder metals. During the 1980s one of the two partners left but the company continued. At the time it was focused on industrial process consulting, which then shifted to forg- ing design process and analysis. Today’s company results from the background of the remaining individuals in computer simulation of forging processes. This was DCT’s strength in the late 1980s and early 1990s. DCT Developed in Response to Changes in the Midwest’s Forging Industry DCT describes their capabilities as providing engineering services to the metalworking community, specializing in process simulation and computer-based analysis of thermal and mechanical processes such as heat treatment, forging, rolling, extrusion and powder consolidation. The marketplace evolved toward more and more emphasis on thermal stress, casting and thermal process of materials and performance of engineering com- ponents at high temperature. The shift occurred because the forging industry in Northeast Ohio was declining and more high-tech companies were gaining ground. There shift was toward thermal type analyses. SBIR became key asset for doing the R&D necessary to adjust to the changing market. ESSENTIAL RESEARCH TECHNOLOGY DCT Collaborated with the National Center for Manufacturing Sciences in Developing Simulation Software to Solve Thermo- Mechanical Problems for the Heat Treatment Industry Deformation Control Technology (DTC) has developed simulation software to solve thermo-mechanical problems for the heat treatment industry. The prob- lems include distortion and stress due to casting, mold performance, and phase distribution and distortion in heat treated components. The firm specializes in applying simulation methods to thermo-mechanical problems by combing several disciplines: mechanics, metallurgy, process simulation and optimization. DCT’s involvement in the National Center for Manufacturing Science’s

APPENDIX E 249 (NCMS) project resulted in DANTE(TM), a simulation software that is commer- cially available exclusively through the company. (DANTE stands for Distortion Analysis for Thermal Engineering.) The project was a university-government- industry collaboration. Sandia National Laboratories in California developed the materials model, and owns the model. The Colorado School of Mines developed the phase transformation kinetics models under contract to NCMS (NCMS is the owner). The software is licensed through DCT. The software’s importance is that it permits manufacturers to simulate conditions rather than rely exclusively on trial and error. Dimensional changes occur during heat treatment due to several factors: thermal expansion and contraction, phase transformation, and internal stress. While these changes cannot be prevented during heat treatment, they can be accounted for during design. Distortion (unanticipated dimensional change) is a significant problem, costing industry millions annually. The phases and distribu- tion of phases, internal stress state, and the steel part’s final hardness is predicted by DANTE. NASA issued a second call in a related technology on characterization of more complex shapes and complex operating conditions—still in their aerospace work. Along with this there was a DoE collaborative project. DoD issued an SBIR call, which resulted in DCT getting a Phase I to demonstrate that it was possible to adapt heat treat simulation to aerospace applications: military aircraft, primarily attach helicopters (U.S. Army). While the basic principle was similar, the modeling of materials is very different, involving a melding of metallurgy and computational physics. The Technology Continues to Change The simulation technology is continuing to change significantly. They have two main competitors: Scientific Forming Technologies Corporation in Colum- bus, Ohio and CRC Research Institute in Japan. In addition, they see themselves as competing with government-sponsored research in Germany, France and Ko- rea, where governments support research and technical implementation. COMMERCIALIZATION Commercial Sales Have Grown Slowly The percent of DCT’s revenue that is public versus private varies year by year. During the period 1995-1998, the split was probably 60 percent federal/40 percent commercial; then 1999-2002 it became about 70 percent federal/30 per- cent commercial; and 2003-2004 private sources increased significantly, resulting   See Gear Technology, November/December 2002, p. 24.

250 APPENDIX E in 80 percent commercial/20 percent federal; and in 2005 the split is equal at 50 percent/50 percent. DCT experienced steady growth over most of its life until the economic downturn in 2001, which hit them very hard. At the time they added an additional person to help move the technology to the next level. They have begun to see a very positive return from this decision. The Region’s Struggling Industries Are Slow to Adopt DCT’s Software Reflecting adverse conditions in Midwest manufacturing, DCT believes that either manufacturing will become more innovative or they will die. A lot of manufacturing capacity was lost. But, the market has picked up again because “the price of steel went up fast [with the] growth in purchases by the Chinese, causing steel to become profitable again.” Despite this, the market for their software shows slow growth, according to Freborg. He believes it to be the reluctance of U.S. industrial companies to invest in technology, largely stemming from a weak regional economy and a cultural attitude embedded in the region’s manufacturing industries. Freborg refers to this as a “sink or swim” attitude. Most of DCT’s sales are to automotive companies in Michigan and to re- search institutions. It currently employs three people and have annual sales of $600,000. They estimate that SBIR has contributed approximately $200,000 in sales. Their Dante software is trademarked as a result of SBIR. DCT has no patents and has no current plans to patent. The software is held by a firm that provides a general commercial software. So DCT’s proprietary software makes the general software useful for their applications. Most Customers Are Located in the Midwest Commercial customers are mostly located in Northeast Ohio and in Detroit’s auto industry. They also have some Pittsburgh customers in specialized manu- facturing. Also, some aerospace customers are located Connecticut. They have virtually nothing on the West Coast. Publishing Technical Papers Helps Market Their Software Freborg views DCT’s technical papers as being highly important as their principal way of marketing. DCT is here because it’s a good interstate location, commute to Pittsburgh, airport, and large concentration of metals industries.

APPENDIX E 251 IMPORTANCE OF SBIR DCT’s SBIR Awards 1993 NASA Phase I 1995 NASA Phase II 1998 Follow-up NASA Phase I 1999 DoD Phase I 2001 DoD Phase II 2004 DoD Phase I 2005 DoD Phase II SBIR Provided the R&D Support Needed for Developing Simulation Software While DCT was founded because of SBIR, the funds made it possible to do the R&D that supported development of the simulation software. DCT has no other sources of external funding and no government contracts. SBIR has sup- ported R&D that wouldn’t otherwise been possible and has provided credibility which has helped get better access to the larger defense contractors. If SBIR were eliminated, DCT believes that would do very little R&D, perhaps only some specialized R&D for specific companies. DCT received its first Phase I in 1993 with NASA Glenn. The project fo- cused on a thermal barrier coating-related NASA aerospace turbine. At the same time, they became involved with a DoE collaborative project examining the use of simulation of steel heat treatment. (Freborg’s background was chemical metal- lurgy & industrial process development at LTV.) From, DCT completed a Phase II went on to a number of good software ap- plications. Using a Phase II SBIR sponsored by NASA, DCT developed a finite element modeling technique. The technology helps design ceramic coatings for high temperature components. By allowing increasing temperatures, it also im- proves the efficiency of turbine and diesel engines. Part of the work supported by a NASA Glenn Phase II led NASA to identify DCT as a “success story.” The simulation models were used to quantify the relative significance of complex materials property interactions. The technology is currently available for use. For example, it has been successfully applied in the design of thermal barrier coatings for turbine applications. Its application reduces experimentation costs and helps in developing new design concepts. A 1995 Phase II award helped to advance their simulation capabilities. They can simulate, for example, why the material would fail and the interrelationship among the various coatings, materi- als, including how they interacted to be more or less likely to fail. DCT learned about SBIR through word of mouth and through their president, who knew the mechanisms from his previous employment at TRW. NASA had told DCT about the simulation problem at a ASM (American Society for Met-

252 APPENDIX E als) meeting where the company’s president was participating. Freborg’s view is that the networking is beneficial but a lot depends on the tenacity of the NASA program manager. DCT had the capabilities to do the work but there was no application. A Phase I was used to show that it could be simulated. A Phase II followed and was used to develop the prototype and demonstrate in a more com- prehensive application. SBIR support has also helped in publishing a lot of papers. Publishing gives them needed commercial exposure. DCT publishes 4-6 papers per year with DoD’s SBIR support. ISSUES WITH THE CURRENT SBIR PROGRAM DCT Plans to Be Selective in Applying for Future SBIR Projects DCT’s plans to seek additional SBIR support but only selectively. They have to avoid topics that are too specific. They view responding to highly specific top- ics as especially difficult for a small business. NASA’s Increasingly Narrow Focus on Specific Mission Needs Limits Commercialization and Usefulness by DCT DCT is particularly concerned that NASA increasingly turns to outsourc- ing for NASA technology. As a result, SBIRs are very narrowly targeted on technologies that have relatively little commercial value. Freborg believes that this trend conflicts with the purpose of SBIR. In addition, DCT believes that top- ics/subtopics are “wired,” and NASA uses the emphasis on meeting immediate needs as an excuse. The belief is that, while the switch to “infusion” is an excellent idea; one implications is less opportunity for private-sector commercialization and a need for greater assistance in commercializing for government. According to Fre- borg, DCT sees SBIR’s purpose as private sector commercialization. But they see NASA funding very specific research for very strong niche needs in NASA with no needs outside NASA. The change has created an impediment writing applications. In addition, working with other companies, they’ve concluded that many projects are wired. Some of this appears as “repeated emphasis in certain areas, specificity of the topics/subtopics, and multiple awards (for example, six at a time).” Government, the RTTC and Nonprofit Intermediaries Are Seen as Unresponsive to the Needs of Basic Industries They view the Midwest’s RTTC (GLITeC) as making very little contribution to the region’s basic industries, paying more attention to “sexy” topics and “show-

APPENDIX E 253 casing.” As a result, DCT considers solicitations as a waste of time and effort. In general, they have not found government or nonprofit institutions to be helpful. “It’s very hard to get their attention and assistance.” Freborg says that DCT has had only a minor relationship with the Cleveland Advanced Manufacturing Pro- gram (CAMP). He believes that their assistance goes primarily to Cleveland State University, that manages to hoard projects and funding. CAMP is the region’s Manufacturing Extension Program (MEP). Regarding the RTTC, GLITeC provided some very basic, helpful informa- tion on a business plan, but otherwise has not very helpful. “They seem to focus on a few select companies and have a high turnover of people.” DCT concludes that there’s a disconnect between NASA needs and innova- tion. In one example, they see GliTeC’s use of people running their commercial- ization workshops as wanting projects that show big markets. The question is: How does someone who is developing a little sensor for mouse urine in space identify a large market? In their view, they can get a criticism of a proposal that says they’re not showing a broad enough commercial application. From a broader perspective, Freborg thinks that the older industries, such as steel and forging, are being left to die. “The economic problems with these industries only get attention when the steel mill is shut down.” DCT’s view is that state and local assistance would be helpful if it focused on local basic manufacturing industries and if government agencies were more responsive. Phase I to II Funding Delays Are a Significant Problem Phase I to Phase II funding delays present a significant problem to DCT. They respond by curtailing development or absorbing costs internally. They consider the DoD “Fast Tract” as an excellent option, which NASA doesn’t cur- rently have. NASA Glenn Budgets Expected Cuts Would Have Minimal Effect on DCT Their view is that NASA Glenn’s expected 30 percent budget cut in 2005- 2006 would have only minimal effect on their company. The reason is that over the last five years NASA’s has “increasingly used SBIR to focus on space-related needs, with very little commercial significance for Northeast Ohio, and on in- teractions with minority companies.” DCT has not been awarded any Phase III awards. They see these as also “political and wired.” In their view, they think that NASA often knows less about Phase III awards than proposal writers.

254 APPENDIX E Phase I Awards Should Be Indexed to Inflation They view Phase I award amounts are becoming increasingly limiting. The recommend indexing the awards, such as adjusting for trends in the cost of R&D. Phase II awards are seen as adequate. The Selection Process Should Be Clearer DCT thinks that the selection process could be made much clearer. For ex- ample, it would be helpful to get a clearer understanding of rankings, picking of categories (specificity), etc. Experience Indicates that NASA’s SBIR Program Is Less Efficient than DoD DoD is much more efficient in their contracting, award process and manage- ment of the program than NASA. On the other hand, NASA’s payment process is more efficient. Payment is more efficient with NASA.

APPENDIX E 255 Essential Research, Inc. Michael S. Fogarty Portland State University and Case Western Reserve University April 28, 2005 OVERVIEW Essential Research, Inc., (ERI) was founded in 1996 by three NASA subcon- tractors who had received a number of SBIR awards. Two years later, with growth in the company they hired C. William King to run the business. King bought the company in 2000 and has continued to develop the technology and the company using personal funds, contract sales and SBIR. This case reflects a common theme: the original researchers’ talent and en- thusiasm for research, not commercialization. Most likely, the technology would not have developed to a level with significant commercialization opportunities without bringing in a new person—an entrepreneur with the technology back- ground and substantially more business experience. Five years later, according to King, ERI is on the verge of a breakthrough and significant growth. The Essential Research case illustrates several important SBIR issues: 1) the potential significance of SBIR for creating spin-offs from technology developed by NASA research; 2) the extent to which successful commercialization by cre- ating a spin-off company hinges on the availability of an entrepreneur who both understands the technology and brings a high level of business experience; 3) the importance of proximity to a NASA facility with specialized testing equipment and researchers involved in the technology; and 4) the hurdle faced by such a firm in a regional environment characterized by a weaker entrepreneurial culture and banks tied to the region’s older industries. The case highlights the special importance of SBIR funding to high-tech businesses in the nation’s older indus- trial regions and SBIR’s need to clarify its role in supporting high-tech business in these disadvantaged regions.   Thisreport is based on an interview with C. William King, Essential Research, Inc., April 12, 2005, Cleveland, Ohio, and information from ERI’s Web site, patent data from the USPTO, and DoD’s SBIR database.

256 APPENDIX E COMPANY AND FOUNDER BACKGROUND Essential Research Is a NASA Glenn Spin-off Essential Research was founded in 1996 by three NASA researchers who were subcontractors to NASA. The group had many SBIRs. Because they had many contracts, it was necessary to hire people. They then realized that they needed someone to run the business. In 1998 C. William King, who had just left a position as VP of Engineering for Danahur Corporation and was looking for a position. The three founders hired King as the company’s general manager. Two years later he bought the company. Now he is now ERI’s owner and president. Bill King received an MBA in 1977 at the University of Pittsburgh. He had considerable business experience, including a position as technical director of R&D and director of new product development. In the R&D position, he had 33 people working in R&D for him. He brought experience with business, selling, marketing, product development, and scientific technology experience. He also brought experience in selling many products, with a market worth of about $250 million. Bill King Bought ERI and Became the Entrepreneur to Build the Company When King joined the company he created a business plan, and told the three researchers that they needed to borrow a couple million dollars to make this happen, and, in fact, he had already identified funders. The NASA researchers were too risk averse to borrow the money and eventually turned the business plan down. Essential Research then spent the next two years making money. However, instead of investing these funds in the company, the firm’s founders withdrew the money. At the same time they had just leased the company’s current 5,000 square foot space, which was bare. Moreover, they were fighting among themselves. It was at this point on July 1, 2000, that King bought company. His first step was to update the business plan. At the time he purchased Essential Research, there were eleven employees. The four original owners quit. Since then the com- pany has had a steady employment of seven. He firmly believes that one key to success is governance—i.e., the board of directors, which he appoints. He has known all of them a long time before put- ting them on the board. His board includes, a banker, a lawyer, an accountant, a marketing person, and a technologist. Each brings a different and deeper expertise to the business. His son, William P. King, is a key member of their board. The son has a doctorate from Stanford in Nanotechnology and is currently a professor at Georgia Institute of Technology. 2003-2002 and 2004-2003 were very bad years economically, however, according to King, ERI is now poised to grow. Within 4-5 years he expects to employ 50-100 people.

APPENDIX E 257 ESSENTIAL RESEARCH TECHNOLOGY One Key Is ERI’s Laboratory for Making Opto-Electrical Devices Mr. King developed three related laboratories at the new site. All three labo- ratories are essential for making a completed opto-electrical device. The first laboratory holds the MOCVD machine (Metal-Organic Chemical Vapor Deposi- tion). The machine is housed in a class 1,000 clear clean room and is used to grow layers of InAs, GaAs, InGaAs, and so forth on a substrate. The chemicals are referred to as optical semiconductors and grow in the machine at a rate of two atomic layers per second, which is called an epiwafer. A second laboratory holds a photolithography machine, a scanning electron microscope and other equipment, housed in a class 10,000 clean room. These equipment are used in a manufacturing process. Their purpose is to etch and perform quality control on very tiny complex patterns on the epiwafer to make opto-electronic devices. ERI’s third laboratory is a class 10,000 clean room containing three vacuum deposition machines. The machines are used to coat the “photo-etched” epiwafer with gold to make bond pads (electrical contacts) and optically antireflective and reflective layers. Their chief scientist is from nearby Pittsburgh. He was a Fellow scientist with the Westinghouse Research Center, located in the Pittsburgh area, which moved when Northrop-Grumman shut down. He didn’t move with them. ERI Has Made a Breakthrough Using Quantum Dot Technology Essential Research made a breakthrough in light emitting diode (LED) tech- nology that allows wider use of quantum dot technology to replace incandescent light. They are using this LED to satisfy a commercial need. The quantum dot LED journey started in with a sales call to a local company. They visited a pos- sible customer and stated that they could create 900 percent more light instead of 10-15 percent more light at conventional wavelengths, but the company didn’t want it. However, they said that they could really use LED’s emitting light in a certain infrared wavelength. And they were willing to buy one million per year if ERI could do this. ERI solved the problem. They worked on the problem that led to quantum dots, even though given existing knowledge indicated that it was impossible. Now it was possible. The reason they got a recent Phase I SBIR was that they could make the quantum dots. They had demonstrated growing dots and put this in the proposal to DARPA, which, according to King, is willing to take more risk and gives more dollars. Other agencies want less risk and higher probability of success. One recent trade journal article indicated that the market is $3 billion and growing 58 percent per year. Essential Research has been quietly working on the technology for 25 months. According to King, ERI’s competitors are firms with

258 APPENDIX E the current technology. There are approximately two dozen organizations that can make quantum dots in the world and they know who they are. The following is a quote from Bill King describing the quantum dot technology: We are engaged in the development of a novel semiconductor—light-emitting diode—that emits light in the 1.7 to 2.4 micron (Near Infrared—NIR) wave- length range based on the use of quantum dots in a III-V compound semicon- ductor structure. These wavelengths are commercially needed but have yet to be economically produced. Substantial cost savings are expected over current technology. Conventional wisdom holds that these wavelengths cannot be pro- duced by III-V compound semiconductor light-emitting diodes. These quantum dots are approximately 0.2 to 2 nanometers high and 2 to 10 nanometers in diameter. The name quantum dot is derived from the fact that as the size of a particle of bulk semiconductor decreases to the nanometer length scale, the electronic properties of the semiconductor change. Once the diameter becomes smaller than the bulk exciton radius, the energy levels in the particle become quantized and the transitions are locked into specific energy states, as opposed to the ordi- nary band structure present in bulk semiconductors. Each quantum dot behaves essentially as a potential well for electrons trapped within it (i.e. the quantum mechanical “particle in a box”). The energy levels are thus quantized, and their energies are inversely related to the size of the box. Therefore, the size of the particle will dictate the threshold energy that it may absorb or emit. The presence of an ordered array of semiconducting quantum dots within the p/n junction of a diode results in the existence of an energy band(s) within, what in an ordinary semiconductor is its band gap. These dots will allow for the creation of lower energy (longer wavelength) photons that the device could not normally produce. It is theoretically possible to develop a quantum dot junction that could be in- corporated with current LED cell technology to provide energy conversion in the longer wavelength region of the spectrum. The precise emission spectra of a particular dot will vary with both dot size and spacing. Much like the energy dependence with multiple quantum wells, the energy states of the quantum dot are inversely proportional to their size. Thus, as the radius of a dot is increased, its absorption edge will shift to lower energies and longer wavelengths. COMMERCIALIZATION King Projects Year Five Revenue of $20 Million Mr. King’s assessment is that ERI is “close to hitting pay dirt.” They project revenue of $20 million in year five. He expects that they could be bought in four years. Someone offered to buy the company a couple of months ago, but he didn’t   Presentation by C. William King, University of Dayton, December 3, 2004.

APPENDIX E 259 sell because he wants to grow the company. “I have been through the hard times, now it’s fun, so why sell.” ERI Has Worked Hard to Build Links and Resources Within the Midwest Region ERI has developed important links to resources in Northeast Ohio. For exam- ple, King made a presentation to JumpStart on April 14. Jumpstart is a Cleveland economic development organization designed to help grow new businesses in Northeast Ohio. In 2004 JumpStart indicated that it plans to provide a total of $3 million a year of seed financing to ten to fifteen companies a year, with an average investment per company of $250,000. King was informed on the April 26th that JumpStart will loan ERI $125,000. Illustrating the region’s heavy involvement in helping to cultivate small, high-tech businesses, JumpStart’s funding will be combined with support is derived from regional foundations, corporations and the state of Ohio. VCs Have Shown Recent Interest in ERI King has also talked with VC firms. In fact, he had an offer from about five local VCs to invest in the company. But he turned them down because they require too much equity and/or control. “Bill King has been ERI’s own angel funder.” He applied for a patent in November 2004. Support for the technology came from internal R&D funds but also a Phase I SBIR award. Although the idea had been conceived prior to the SBIR, the company needed the SBIR to help fund the technology’s development. King’s view is that without the SBIR the technol- ogy would have taken another two years to get to market. The reason is that the LED development project is a large one and ERI can’t generate sufficient money internally to do all of the development. NASA Glenn Continues to Be a Key Asset King’s expectation is that in the next two years ERI will need more equip- ment and space. Most likely he will go to a bank for funding to build ER’s own building. He plans to stay in Northeast Ohio, mainly because of ERI’s link to NASA Glenn, which is just a few miles west of the company. According to Mr. King, NASA is a great asset—its people and testing equipment. Specifically, it is the GRC’s photovoltaic research that makes them so valuable. Although the original three NASA researchers left, King still has NASA badges for his people, from a space act agreement: this access gives ERI important moral support, con- versations about technology, and use of testing equipment. As a consequence, the expected 30 percent NASA Glenn budget cuts are

260 APPENDIX E very troubling. One possibility is that ERI would buy its equipment and hire some of NASA’s people. However, thinking ahead, King has been working to make the NASA equipment less important. ERI Has Early Alpha Customers The company already has four or five alpha customers, which are some of the very first customers for a new product—usually before the product is offered for sale in the general market. These customers realize that the product may still have bugs; however, because early use gives them an advantage, they agree to be guinea pig. In most cases, the customers are quiet about any mistakes the product may have in order to prevent it from getting a bad reputation prior to its availability in the general marketplace. ERI Has Sold a Number of Products Stemming from SBIR Awards ERI has sold a number of products stemming from SBIR, representing 100 81 percent of 2005/2004 sales revenue. These include PIN diodes in seven dif- ferent sizes (AlGaAs and InGaAs), which are photodetectors, laser diodes, 1.55 micro GaAs waveguides; thermophotovoltaic cells; solar cells; and light emitting diodes at various wavelengths. In 2005 sales are expected to be $1.4 million. Sales in 2004 were $1.05 million; 2003 was $800,000; 2002 was $600,000. There were no commercial sales in 2000. Federal agencies are buying services now, not products. For example, ERI is helping fabricate parts for NASA and SANDIA labs. They’ve also sold parts to Lockheed-Martin as government contractor. THE IMPORTANCE OF LOCATION ERI Is Located in Northeast Ohio Because It’s a Spinoff from NASA Glenn Location is a major issue for Essential Research. Their location is primarily due to the firm’s being a spinoff from NASA Glenn in Cleveland. Initially, the firm was on NASA premises. Most important, if NASA Glenn were to disap- pear with the re-allocations underway, ER will be forced to change its business practices. At present they are not totally independent from Glenn; however, part of their strategy is to become independent. The Region’s Old Industrial Culture Is a Significant Location Disadvantage At the same time, King worries about their Northeast Ohio location. There are only 250 MOCVD machines in the world, mostly elsewhere. None are in

APPENDIX E 261 Ohio. NASA has two but they are not commercial. Even Case Western Universi- ty’s MEMS program doesn’t have the machine. Ohio lending institutions are unfamiliar with high-tech business and are very risk averse. Mr. King had to go to banks three times to explain the MOCVD technology. According to King, even though the bank was given everything, the environment is hostile. The loan officer said “we can’t take you.” He said they could lend to a low-risk, low-tech company. King’s observation is: “If banks persist in funding only the pasts tried and true, they will contribute to Northeast Ohio’s downfall.” The company that manufactures the MOVCD is located in the UK. However, they’ve only had to come to Cleveland once for repair purposes. Their machine was refurbished, which they got for half the cost of a new machine ($750,000). ERI’s experience illustrates the scope of problems with their Northeast Ohio location. One is that they can’t get liability insurance locally. Second, local banks simply don’t understand the technology. Their only source of external funding, other than SBIR, is a bank. The bank only wanted cash-flow projects. According to King, the SBIR awards were not important in obtaining a bank loan. State Science and Technology Only Partially Offsets the Region’s Culture One other source of funding was a state Ohio Department of Development guaranteed loan of about $200,000-300,000, which King knew about. The loan was for capital equipment. King also views other state and local science & technology infrastructure as a mixed bag. For example, “when money flows down from state it flows through the old corporate mindset. Money supports the institutions and not the small guy. State funds support the intermediaries but not to the creative people.” Importantly, Essential Research can rely on Ohio State University as a source of some needed talent. Regional Partnerships Have Been an Important Asset King has developed important partnerships with a variety of universities and the Cleveland Clinic. Has made joint proposals to government and the private sector with the University of Toledo, University of Dayton, Ohio State University, Ohio University, Notre Dame, University of Rochester, and MIT. So far he hasn’t done anything with Wright-Patterson Air Force Base, but he is networking with them. They are considering Essential Research as a provider of custom wafers. He has made presentations and talked with people at all of these institutions and they are happy to partner with him. He also has submitted an STTR to the University of Michigan. Although he hasn’t had one yet, he views the STTR and SBIR as the same, except one has a university collaborator.

262 APPENDIX E In addition, ERI is doing BioMems with the Cleveland Clinic. ERI does work for them using two of the three labs. Many direct competitor companies don’t have all three labs. One New Hampshire company has all three. ERI has a number of customers in the northeast Ohio region, some of which are large ones. There appears to be a large potential local customer base. IMPORTANCE OF SBIR Essential Research Probably Wouldn’t Exist Without SBIR Mr. King says that Essential Research would probably not exist without SBIR. SBIR was key to the company’s early success. However, he believes that it’s possible that VC funding would be an option. SBIRs allow the owners to keep the equity and the intellectual property. VCs require equity and the owners would likely lose control of the company. “VCs want in and out with a pile of money.” In contrast, King plans to be involved for the long run. While SBIR can only provide small dollars, it has played a key role for all ERI’s personnel. But building the company requires a million dollars. In the beginning, in order to purchase and fund the company, King borrowed money on his house with the equipment as collateral. Absent VC funding, ERI raises larger sums of money by contract sales of products as the company continues to improve its technology. Through 2000 their funding was 100 percent SBIR. Now the company relies on SBIR to fund roughly one person. Despite its importance, SBIR was never used as validation for the company. A Growing Fraction of ER’s Revenue Comes from Commercial Sales King became very effective in writing successful SBIR proposals. His suc- cess rate is about one in three, or perhaps one in four. He knows how to write a winning proposal. They continued getting SBIRs since he bought company. However, SBIRs contribute a declining percentage of revenue. They are still im- portant because the SBIR is being used to further build advance the technology. All of the company’s income prior to 2000 was SBIR. By 2004, however, 81 percent of the company’s revenue was commercial (sales revenue to non- governmental sources); 19 percent was government. The transition to commer- cial sales was important because the government is an unreliable source. ERI has a $600,000 Phase II that starts now and continues for 2 years. ERI’s 2005 projected revenues are expected to be $1.39 million, with profits before taxes of $283,000. ERI has three patents, all from SBIR support. Even though they have tried, none are licensed. But knowledge gained from the patented technology was 100

APPENDIX E 263 percent useful for their current work. The patents protect what the company’s doing now. ERI has also published dozens of papers as a vehicle for marketing and sales. The papers show what the company is doing and, according to King, legitimizes the work supported by SBIR. Although they haven’t received any calls in direct response to the papers, they are important. ERI works in a small community that knows who they are. ERI has a Phase I and a Phase II on quantum dots. So SBIR continues to play a key role allowing the technology to be further developed to meet the timeline. They couldn’t have gotten to this point without the previous SBIR. And they plan to apply for more SBIRs. Currently, they are working with a University of Toledo researcher on one technology. They also have a company partner. They are wait- ing to hear about a joint SBIR submitted to the U.S Army. ISSUES WITH THE CURRENT SBIR PROGRAM ERI Expects That NASA’s Budget Changes Will Make SBIR More Important Mr. King believes that SBIR will become more important in the new NASA funding environment, especially with the emphasis on internal competition for funds in NASA’s budgeting process. The reason is that, if a company receives an SBIR in a specific area of technology, the internal NASA technical repre- sentative will get funds to oversee the project. For example, Essential Research just received a Phase II SBIR from NASA Glenn in NASA’s photovoltaic area. One of Glenn’s scientists in this field will have part of his/her salary covered for managing the project. Variation in Evaluators’ Assessment of Risk Creates Uncertainty One problem with proposals is the variability of evaluators—some say too risky, some say not innovative enough. What this means is that evaluators express different views concerning the riskiness of the proposed project. The first evalu- ator may say that it’s too risky, which can cause you to rewrite the proposal as less risky; then the next set of evaluators may decide that the proposed project isn’t risky enough. “The feeling is that if you left the proposal the same—and didn’t listen to the first set of evaluators—that it would have won the second time around. Instead, I lose twice trying to please the first set of evaluators.” King feels that risk doesn’t have to be the variable. Instead, it could be factor involving a technical, business or timing issue.

264 APPENDIX E Phase I to Phase II Delays Create Big Issues King says there are big, big, big issues in delay between Phase I and II. He handles it with the 81 percent commercial—makes commercial part of strat- egy important. He would recommend to SBIR that they say yes/no in a timely manner. The Midwest’s RTTC Hasn’t Provided Relevant Help Regarding support services, his view is that GLITec (the region’s RTTC) doesn’t provide any useful support services to his business. “I’ve got nanotechnol- ogy, I need nano customers.” King stresses an important issue: GLITeC’s business model is one involving their help transferring NASA technology to an outside firm. In the case of Essential Research, the reverse exists: The company has more technology than NASA in its field. The point is that companies will view the role differently depending on whether the RTTC emphasizes private-sector commercialization or use of tech- nology by NASA. Marketing strategy is entirely network—talks, etc. According to King, some SBIR firms may benefit from the RTTC’s help in getting mentors, but this hasn’t been an issue for ERI because they already have great mentors. Award Size Should at Least Keep Up with Inflation Mr. King thinks that because the cost of research is going up that awards need to be made bigger. But this shouldn’t be at the expense of fewer. He would like to see SBIR’s budget increase by 10-20 percent. “At a minimum, SBIR’s budget should keep up with inflation.” He noted a few other issues: The SBIR paperwork doesn’t present a prob- lem because ERI has become good at doing it. Regarding, proposal selection, he thinks it is very important to get quicker yes/no turnover. The feedback hasn’t been applicable because of variability among proposal readers—for some the proposed work is too theoretical; for others it’s too practical. Overall, he’s ex- perienced only minor differences between agencies and none of the differences have affected ERI’s performance.

APPENDIX E 265 Luna Innovations, Inc. David H. Finifter College of William and Mary April 18, 2006 SUMMARY This case is based heavily on an interview with Luna Innovations, Inc.’s Scott Meller, P.E.—President, Contracts Research Division, the company’s 2005 Web site, and a presentation made by company CEO and Chairman Dr. Kent Murphy at a conference on SBIR Phase III issues organized by the National Academy of Sciences. Luna is headquartered in Blacksburg, Virginia. Luna was founded in 1990. Its motto is “Ideas taking flight.” Dr. Murphy and Mike Gunther (now Vice President of Operations) founded Fiber and Sensor Technologies based on an accelerometer/high performance strain gauge technol- ogy for monitoring the health of aircraft designs. The firm’s initial contract was private (Dr. Kent Murphy had a patent). However, the firm would not be where it currently is without SBIR. All its successes and spin-offs are attributable to SBIR. The firm was originally Fiber and Sensor Technologies, then F&S, and now Luna. In 1993 it had five employees. It became Luna Innovations, Inc. and currently has 185 employees. Luna Innovations has created five new companies since 2000 while open- ing additional branches in Charlottesville, Danville, Roanoke, Hampton Roads, and Mclean, Virginia, and Baltimore, Maryland. As described on its Web site, the company focus areas include manufacturing process control, next-genera- tion cancer drug development, analytical instrumentation, novel nanomaterials, advanced petroleum monitoring systems and wireless remote asset management. Luna’s core technologies are in fiber optic, wireless, and ultrasonic sensing, bio- technology, advanced materials and integrated systems. It has had over a decade of consecutive growth. Luna actively transitions basic research and development into cost-effective products for industry, defense, communities and the environ- ment. Luna’s mission is to identify market opportunities, develop new technolo- gies, and fully develop commercial potential. Luna Innovations is an employee-owned company that applies innovative science and technology to develop unique solutions for significant real world problems and then assembles the resources to develop commercial potential. The SBIR program plays a strong supporting role in allowing Luna Innovations the opportunity to investigate ideas and then move ideas with quantifiable results on to commercial viability. According to Dr. Murphy, the keys to driving innovation to equity are the following:

266 APPENDIX E • Success in building business. • Continuous pipeline of opportunities. • Utilization of university and federal research. • Utilization of funding resources. • Drive to create products. • Accelerating the innovation process. Luna has had several business successes that include spin-offs, for example: Luna Technologies—Optical test instrumentation; Luna Energy—Downhole oil and gas sensors (acquired by Baker Hughes); Luna iMonitoring—Wireless sensing (acquired by HIS Energy); Luna Analytics—Proteomics and clinical diagnostics. Luna’s revenues are derived from products, licenses, contracts, and spin- offs. It is a growing and profitable diversified company. It is an award-winning leader in commercializing intellectual property. It has over one hundred patents, licensed patents, and patent applications. As described on the company’s Web site, Luna has developed core technolo- gies in the following areas: fiber optic, wireless, and ultrasonic sensing, biotech- nology, advanced materials, and integrated systems. SBIR is not so critical for survival as for growth and an ability for the firm to strengthen and get technologies further along. When Luna got its first SBIRs, they allowed expansion into other areas. There were only founder’s funds, no other investors. SBIR awards helped in changing the project from an idea on paper to a feasible idea and prototype. Then they would get more specific for the agency involved. SBIR makes Luna more competitive for Broad Agency Announcements (BAAs). These are open to everyone, but SBIR makes the firm more competitive since the technology-based idea has been proven via the SBIR. SBIR helps develop the firm’s technical capability. It allows high-risk/high- payoff ideas to get funding at the seed level which is difficult to do through pri- vate industry. In fact, if there were no SBIR, Luna probably would have survived or died based on the initial product/private contract it had. SBIR has allowed Luna to have multiple ideas or projects in the pipeline so one or more will be a “home run.” Luna is very focused. It reviews all solicitations and then chooses promis- ing topics based on market or idea. Then it refines the topic and matches it with longer term goals of the company. It melds the technology push with the govern- ment/industry market pull. The company prefers to do fewer proposals that are market focused. It needs to be efficient with proposal expenditures. Luna has won Phase II awards from several other agencies. These include: Air Force, Army, Navy, NSF, EPA, DoC/NIST, USDA/DoA, DNA/DSWA/ DTRA, DoT, and OSD. In regard to the application process, Luna would prefer fewer awards be

APPENDIX E 267 given for a larger dollar amount. The government should analyze proposals more carefully and do fewer. There should be more money for Phase II awards. They should have a yearly technical conference (instead of having to contact topic authors during the solicitation process). Currently, conferences are geared more to application/contractual issues rather than technological issues. Agencies would then get fewer proposals because they would be able to more clearly define their technical needs. In terms of the process of selection, Luna believes that there is not enough time put into reviewing Phase Is. Debriefs often do not provide detailed feedback. The process for Phase II and Phase IIB is fair and adequate. Strengths of SBIR According to Luna, there are several strengths of the SBIR Program. In gen- eral, the program allows business to test high-risk/high-payoff ideas. It fosters building technology areas in small business. It allows for licensing out innova- tions. The program solves problems of government agencies. There is some flex- ibility that SBIR offers that VC and other funding alternatives do not provide. SBIR promotes working with other companies and universities combining ideas with others to emphasize a team approach. This helps to ensure that the applicant has the right team to get a reliable, solid solution to a problem. The SBIR program is reliable. The funding does not get pulled unlike some government programs. The firm knows the funding will be there. The intellectual property arrangements are good, owned by small business. When working with private partners, this is not always the case. According to Luna, small business is the backbone of the nation and SBIR gives small business more of a chance vis-à-vis large firms. The SBIR program also promotes teamwork with large or- ganizations. Also, the SBIR program indirectly supports the intellectual base of the country by supporting student interns, keeping the nation trained and bringing in new engineers and scientists flowing into the pool. Weaknesses of SBIR According to Luna, SBIR has some weaknesses as well. The funding level has been fixed over time. Phase II awards should be more closely linked to the task being proposed like NIH does. It also believes that the number of Phase I awards is too large. And finally, access to agency technologists is not always easy. Recommended Changes in the Program Luna recommends a larger funding level for the program. It suggests that there should be more information from agencies on their needs by offering

268 APPENDIX E technology conferences. It wonders if there is not some way to give preferential treatment to firms that are really solving commercial problems. The program should not promote doing research for research sake. Therefore, taking company performance into account in the award process would be useful. However, that said, the program should not penalize real startups. Therefore, if the applicant had a number of previous awards, then its track record of commercialization should come into play. Also, Phase III needs to be communicated and promoted more. That is where the process is really completed. There must be better communication within the agency about Phase III possibilities. Opportunities to sole source to next level (i.e., Phase III) is important. There is a disconnect between SBIR and other shops within the agency. This is really a weakness of SBIR. The Navy TAP program is a good start at connecting small businesses with potential Phase III customers. All agencies would benefit from implementing a program like this. BACKGROUND ON THE COMPANY Introduction This case is based heavily on an interview with Luna Innovations, Inc.’s Scott Meller, P.E.—President, Contracts Research Division—done on December 22, 2004, the company’s Web site, and a presentation made by company CEO and Chairman Dr. Kent Murphy on June 14, 2005, at a conference on SBIR Phase III issues organized by the National Academy of Sciences. Luna is headquartered at 2851 Commerce Street Blacksburg, VA 24060-6657. Its phone number is (540) 552-5128; fax number is (540) 951-0760. The company’s Web site is <http:// www.lunainnovations.com>. Luna was founded in 1990. Its motto is “ideas taking flight.” Dr. Murphy and Mike Gunther (now Vice President of Operations) founded Fiber and Sensor Technologies based on an accelerometer/high performance strain gauge technol- ogy for monitoring the health of aircraft designs. The firm’s initial contract was private (Dr. Murphy had a patent). However, the firm would not be where it cur- rently is without SBIR. All its successes and spin-offs are attributable to SBIR. The firm was originally Fiber and Sensor Technologies, then F&S and now Luna. In 1993 it had five employees. It became Luna Innovations, Inc. and currently has 185 employees. The total revenue for fiscal year 2005 was $16,454,000. Its SBIR/STTR funding as a percent of total revenue is 60 percent. Luna went public on June 2, 1006. Luna has had over 100 Phase I SBIR/STTR awards and over 90 Phase II SBIRs since inception in 1990. The SBIRs have come through the Air Force, NASA, NSF, the Navy, EPA, the Army, DOC/NIST, and DOT. Luna has established five spin-off companies. The company is not woman- or minority-owned. Luna Innovations has created five new companies since 2000 while opening

APPENDIX E 269 additional branches in Charlottesville, Danville, Roanoke, Hampton Roads, and Mclean Virginia and Baltimore Maryland. As described on its Web site, the com- pany focus areas include manufacturing process control, next-generation cancer drug development, analytical instrumentation, novel nanomaterials, advanced petroleum monitoring systems and wireless remote asset management. Luna’s core technologies are in fiber optic, wireless, and ultrasonic sensing, biotechnol- ogy, advanced materials and integrated systems. It has had over a decade of con- secutive growth. Luna actively transitions basic research and development into cost-effective products for industry, defense, communities and the environment. Luna’s mission is to identify market opportunities, develop new technologies, and to fully develop commercial potential. Luna Innovations is an employee-owned company that applies innovative science and technology to develop unique solutions for significant real world problems and then assembles the resources to develop commercial potential. The SBIR Program plays a strong supporting role in allowing Luna Innovations the opportunity to investigate ideas and then move ideas with quantifiable results on to commercial viability. Luna’s research projects include work for the Depart- ment of Defense, Department of Energy, National Science Foundation, National Institutes of Health, and NASA. Luna is a two time recipient of the Tibbets Award from the Small Business Administration. In 1998, Inc. 500 named Luna one of the 500 fastest growing companies in the U.S. In 2001, the High Tech Entrepreneur of the Year award went to CEO Dr. Kent Murphy from the New Century Technology Council. In 2003, Luna Technologies received the Optical Test Product of the Year from Frost & Sullivan. In 2004, Luna Technologies was awarded Emerging Company of the Year from Frost & Sullivan. In 2004, Luna won the High Technology Company of the Year award from the New Century Technology Council. Luna’s revenues are derived from products, licenses, contracts, and spin- offs. It is a growing and profitable diversified company. It is an award-winning leader in commercializing intellectual property. It has over one hundred patents, licensed patents, and patent applications. Luna is very dedicated to skill development and having the right skill mix. Among its 185 employees are the following: electrical engineers, optical engi- neers, mechanical engineers, materials scientists, physicists, biochemists, soft- ware engineers, computer engineers, organizational chemists, polymer chemists, aerospace engineers, and microbiologists. According to Dr. Murphy, the keys to driving innovation to equity are the following: • Success in building business. • Continuous pipeline of opportunities. • Utilization of university and federal research. • Utilization of funding resources.

270 APPENDIX E • Drive to create products. • Accelerating the innovation process. The Luna Business Model Luna Innovations’ mission is to identify significant problems, apply innova- tive science and technology to generate unique solutions, and provide the launch pad to fully develop its commercial potential. Luna is a next-generation, employee-owned company that has built a com- plete network for driving innovative technologies through the development cycle all the way to fully functioning separate companies. These spin-off companies produce and distribute products that address billion dollar markets. Luna’s corporate structure provides the framework to nurture ideas with tremendous commercial potential. The business model provides the appropriate support throughout the commercialization cycle as the typical engineer and sci- entist moves through the Luna network, including technology transfer from Luna Innovations, and then rebuilding a technical staff focused on the next identified commercial market. COMPANY TECHNOLOGIES As described on the company’s Web site, Luna has developed core technolo- gies in the following areas: fiber optic, wireless, and ultrasonic sensing, biotech- nology, advanced materials, and integrated systems. The R&D includes: • Fiber Optic Sensing (harsh environment and distributed sensing). • Optical Devices (fiber optic sensors, photonic crystal waveguides and engineered instrumentation solutions). • Nanotechnologies (carbonaceous nano materials). • Nondestructive Evaluation (NDE also called nondestructive testing or NDT). • Biotechnology. • Advanced Materials (multifunctional thin films and composites). • Corrosion (monitoring and prevention). • Wireless (remote sensing and assessment management with internet accessibility). Fiber optic sensors do the following: improve measurements; reduce costs; oper- ate in harsh environments; produce faster measurements; allow for remote opera- tion; and have intrinsic safety.

APPENDIX E 271 COMMERCIALIZATION In terms of Luna commercialization profile and commercialization versus serving as an agency supplier, there is a mix but slanted toward commercializa- tion. Most of this comes in the form of spin-offs from technology developed by SBIRs and some to government agencies. The principal business is that Luna is an R&D firm that does high-risk research and filters out best ideas and brings them to market. It takes new tech- nology to market effectively. It does that for “hot” technologies. This occurs in three areas: optical devices, advanced materials, and life sciences. Much of the sensor based work in different markets have also moved into more materials based areas. There are numerous commercial products internal to Luna Innovations and at spin-off companies. Optical telecom occurs through Luna Technologies, which was acquired by Luna Innovations in September 2005. Petroleum downhole mea- surement runs through Luna Energy. Wireless measurement in oil runs through Luna iMonitoring—(companies sold now). Sensor systems have been sold ever since the start of the company. This has been sold to infrastructure like civil engineering type customers. There are industrial applications in monitoring temperature. There are a large amount of R&D type sales from auto industry to university-based work. Also, there are sales to government programs via government R&D labs for measurement needs they have. In addition, we should expect industrial markets for wireless sensor and fiber optics sensor to move forward. Plus, spin-off companies continue to grow. Luna has pursued various commercialization strategies. The strategy depends on the market or customer. It has pursued pure VC approaches, formed strategic partnerships, and licensed and sold technologies to other companies. In terms of spillovers, Luna products have provided measurements that are not possible (with sensors). Other approaches are more costly. It improves a process or tests out a new scientific application. Luna has had several business successes that include spin-offs: • Luna Technologies—Optical test instrumentation. • Luna Energy—Downhole oil and gas sensors (acquired by Baker Hughes). • Luna iMonitoring—Wireless sensing (acquired by HIS Energy). • Luna Analytics—Proteomics and clinical diagnostics. • Luna Quest—Cancer inhibitors. Here are more specifics about some of Luna’s spin-offs. 1. Luna Technologies was established in December 2000. It is based on a technology licensed from NASA. It had $12 million raised in A&B rounds. Its market is defined as telecom at $125 million. Its product is fiber optic components

272 APPENDIX E and subassemblies test equipment. Its top competitor is Agilent. The status of the spin-off is that it is VC funded. The spin-off is exceeding its revenue projections. Luna Technologies was acquired by Luna Innovations in September of 2005 and continues to operate as our Luna Technologies Division. 2. Luna Energy, LLC was established in February 2002. It is based on a sensor technology licensed from Luna Innovations. Its market is oil and gas physical sensing at $100 million. Its product is physical sensors for downhole monitoring. Its top competitor is Schlumberger. The status of the spin-off is that it has been acquired by a Fortune 100 company, Baker Hughes. 3. Luna iMonitoring was established in May 2002. It is based on a technol- ogy licensed from Luna Innovations. It is in the petroleum market, $250 million for second tier on shore wells. The product is remote asset management sensors. Its top competitor is Weatherford. The status of the spin-off is that it has been acquired by IHS Energy. 4. Luna Analytics was established in June 2001. It is based on a technol- ogy licensed from Luna Innovations and Lucent. The market is in the area of life sciences research (i.e., proteomics) at $100 million. The product is a direct detection instrument to quantify protein and small molecule interactions. Its top competitor is Biacore. The status of the spin-off is that is a joint venture product development and technology license agreement signed with the industry leader. Luna’s model for driving technologies to commercialization—Luna’s tech- nology launch pad: • Identifies market opportunities; • Develops technologies internally and when necessary integrates intel- lectual property from universities, government labs, and other industries; • Secures initial development funds from government and industrial or- ganizations, including internal Luna funds to demonstrate technical feasibility; and • Builds expert entrepreneurial management teams, writes well-developed business plans, and raises private investments including angel, venture capital and large corporation strategic investors. The Luna Group History of Success Luna Innovations is proud of its record in commercializing the technologies evolving out of SBIR contracts and has introduced a number of products to the marketplace while establishing five spin-off companies. These companies are focused on sales of revenue generating products that include fiber optic telecom- munications that power the Internet; proteomics instrumentation that provides leads for new drug discoveries and rapid in-office clinical diagnostics; high- volume production of nanomaterials and technologies that lead to enhanced con-

APPENDIX E 273 trast agents for medical diagnostics, advanced systems for down-hole petroleum monitoring, wireless sensing networks for real-time, remote asset management and next-generation cancer drug discovery. These new companies are businesses built by Luna Innovations, by identifying market potential, developing new technology, proving technical feasibility, building management teams and raising private investments. The Luna family of companies currently employs more than 185 profession- als in basic research, development, administration, and production. Drawing upon a strong team of scientists, business professionals and engineers from diverse technical backgrounds, Luna has built a unique set of core capabilities in fiber optic and ultrasonic sensing, advanced materials, biochemistry, and integrated systems. The Luna spin-offs have enjoyed much success over the past two years. • Luna Technologies’ Optical Vector Analyzer, based on technologies from NASA, was Frost & Sullivan’s 2002 Optical Test Product of the Year. • Luna Energy has Baker Hughes, a Fortune 100 company and a leader in oilfield services, as its investment partner. The NIST ATP funded research on this technology. • Luna iMonitoring began with an NSF adaptive vibration sensor and many wireless contracts with the Navy and Air Force. In October 2003, the com- pany was acquired by IHS Energy and is now producing remote sensing products for the oil and gas industry. • Luna nanoMaterials was aided by an NSF program that focused on pro- duction and separation technology. The company is making molecules that can- not be produced anywhere else on earth and has also scaled up its manufacturing of nanomaterials for bulk purchase. The Luna team is passionate about turning ideas into useful products to improve the quality of life globally, while creating sustainable, high-value jobs in the U.S. While Luna remains a small business and a HubZone company, the company has experienced extensive revenue growth since 2000 accompanied by an exponential increase in nongovernment investment in the company and its divisions. In the past five years, Luna received $39.1 million in revenue from Phase I and Phase II SBIR contracts which have been augmented by $91.2 million in non-SBIR funding. For every $1 of SBIR funding awarded, Luna has generated $2 in non-SBIR funding. Luna’s research continues to produce new products, technologies, and jobs—all proof that the Luna is exceeding the commercializa- tion returns envisioned by our federal R&D partners.

274 APPENDIX E IMPORTANCE OF SBIR In addition to Phase I and Phase II awards, Luna has won three Phase IIB or Phase II enhancements projects. Luna has received over 30 NASA Phase I/II awards since inception in 1990. SBIR is not so critical for survival as for growth and an ability for the firm to strengthen and get technologies further along. When Luna got its first SBIRs, they allowed expansion into other areas. There were only founder’s funds, no other investors. SBIR awards help in changing the project from an idea on pa- per to a feasible idea and prototype. Then they would get more specific for the agency involved. SBIR makes Luna more competitive for Broad Agency Announcements (BAAs). These are open to everyone, but SBIR makes the firm more competitive since the technology-based idea has been proven via the SBIR. SBIR helps develop the firm’s technical capability. It allows high-risk/high- payoff ideas to get funding at the seed level which is difficult to do through pri- vate industry. In fact, if there were no SBIR, Luna probably would have survived or died based on the initial product/private contract it had. SBIR has allowed Luna to have multiple ideas or projects in the pipeline so one or more will be a “home run.” The most important innovation for Luna was in fiber optic sensor develop- ment. It has an exclusive license from Virginia Tech. It was critical. Other impor- tant links were EFPI, Advanced Materials, Flame Retardants, and Development of Nanomaterials. It also has licenses from VA Tech, some patents, and produces the product. Working with government and industry partners takes some of the risk out of it. There is a technology push and a market (government and industry) pull. There have been over 100 scientific papers attributable to SBIR. There have been over 90 patents and patent applications awarded or in pro- cess. Of these, 75 percent are related to SBIR. It also licenses technology teaming with universities. Luna does some work with STTR, when it fits with the business goals of the company and valuable IP exists at a university to team with. It is not clear how Luna became aware of the SBIR program. Probably customers it was selling to suggested it. There is no geographic linkage or limit to opportunities. There is no particular agency linkage. It is the “problem” it is looking for and the agency is secondary. It looks at the technology the agency is requesting to guide the process. Some agencies are more academic such as NSF, DoE, and NIH, which are peer reviewed and do not have a particular application in mind. This contrasts to DoD and NASA which are more specific and the solicitation is tied to specific application programs. Luna accommodates both and applies to technologies that have most promise. With DoD, an applicant can get to the customer and discuss problems and are more specific about applications, compared to NIH, where the

APPENDIX E 275 applicant cannot know the details. However, there is less flexibility with DoD and NASA compared to the peer-review agencies. Luna is very focused. It reviews all solicitations and then chooses promis- ing topics based on market or idea. Then it refines the topic and matches it with longer term goals of the company. It melds the technology push with the govern- ment/industry market pull. The company prefers to do fewer proposals that are market focused. It needs to be efficient with proposal expenditures. In regard to non-SBIR contracts, Luna participates in NASA and the Air Force and through prime contractors as subs. Some of the awards are more ex- ploratory and similar to SBIR awards whereas others are tied to deliverables of the agency (but some SBIRs are like that too). These are more competitive since it is competing against a larger number of competitors. If the contracts are out- side of the SBIR realm, they are more flexible from the agencies’ point of view so they can get what is needed to do the job. Also, for larger non-SBIR awards, there are more regulatory requirements, in some ways less flexibility and more reporting requirements. The following is a list of NASA Phase II Awards received by Luna: 1. Year of Award: 1996. Project Title: Metal-Coated Optical Fiber Tem- perature and Pressure Sensors. Sales to Private Sector: $1,278,045. Additional Investment from: (a) Other Federal Agencies: $17,280; (b) Private Sector: $1,599,319. 2. Year of Award: 1996. Project Title: Optical Fiber Strain Gage Using Polyimides. Sales to Private Sector: $1,312,816. Additional Investment from Private Sector: $1,642,831. 3. Year of Award: 1996. Project Title: Smart Material Products for Com- munications, Actuation and Sensing. Sales to Private Sector: $119,451. Addi- tional Investment from Private Sector: $354,166. 4. Year of Award: 1998. Project Title: Micromachined Fiber Optic Ac- celerometers. Sales to Private Sector: $1,332,097. Additional Investment from Private Sector: $166,959. 5. Year of Award: 1999. Project Title: Fiber Optic Based NDE Systems for Space and Aircraft. Sales to Private Sector: $1,110,618. Additional Investment from Private Sector: $1,389,804. 6. Year of Award: 1999. Project Title: Multimeasure and Optical Fiber Sensors for Flight Test Applications. Sales to Private Sector: $1,717,910. Ad- ditional Investment from Private Sector: $1,667,726. 7. Year of Award: 2002. Project Title: Carbon Nanotube-Fiber Optic Skin Friction & Temperature Sensor. Sales: 0. Additional Investment from Private Sector: $1,441,275. 8. Year of Award: 2002. Project Title: SiC Fiber Optic Sensors for Turbine Engine Monitoring. Sales to Private Sector: $1,212,827. Additional Investment from Private Sector: $1,312,265.

276 APPENDIX E 9. Year of Award: 2002. Project Title: Rotational Molding of Thermoplas- tic Cryogenic Propellant Tanks. Sales: 0. Additional Investment: 0. 10. Year of Award: 2002. Project Title: Distributed Optical Fiber Sensor Demodulation System. Sales: 0. Additional Investment: 0. 11. Year of Award: 2002. Project Title: Distributed Fiber Optic Sensors for Space-Based Nuclear Reactors. Sales: 0. Additional Investment: 0. 12. Year of Award: 2003. Project Title: Advanced Monitoring System for Space Flight Applications. Sales: 0. Additional Investment: 0. Phase II awards from other agencies include: Air Force, Army, Navy, NSF, EPA, DOC/NIST, USDA/DOA, DNA/DSWA/DTRA, DOT, and OSD. ISSUES WITH CURRENT SBIR PROGRAM In regard to the application process, Luna would prefer fewer awards be given for a larger amount of awards. The government should analyze proposals more carefully and do fewer. There should be more money for Phase II awards. It is hard to get a hold of the technology resources. It would be helpful to have the agency do a conference. They should have a yearly technical conference (instead of having to contact topic authors during the solicitation process). Currently, con- ferences are geared more to application/contractual issues rather than technologi- cal issues. Agencies would then get fewer proposals because they would be able to more clearly define their technical needs. There is of course always freedom in the technology a firm proposes, but then they need to specify parameters. Firms prefer more flexibility, but agencies have needs. Frequency of Solicitations In regard to frequency of solicitations, DoD has increased from two to four and that is no problem. Luna prefers fewer solicitations but with more focus. In- stead of four solicitations, it prefers fewer topics and more money for awards. Process of Selection In terms of the process of selection, Luna believes that there is not enough time put into reviewing Phase Is. Debriefs often do not provide detailed feedback. The process for Phase II and Phase IIB is fair and adequate. Timing In terms of timing NASA in particular is done well. There are specific dates given and the agency meets them. In general, the award process for SBIR has reasonable time lags compared to other government programs. NIH definitely

APPENDIX E 277 has a longer lag between application and award, but it allows the applicant to resubmit based on feedback from reviews. Strengths of SBIR According to Luna, there are several strengths of the SBIR Program. In general, the program allows business to test high-risk/high payoff ideas. It fos- ters building technology areas in small business. It allows for licensing out in- novations. The program solves problems of government agencies. There is some flexibility that SBIR offers that VC and other funding alternatives do not provide. SBIR promotes working with other companies and universities combining ideas with others to emphasize a team approach. This helps to ensure that the applicant has the right team to get a reliable, solid solution to a problem. The SBIR program is reliable. The funding does not get pulled unlike some government programs. The firm knows the funding will be there. The intellectual property arrangements are good, owned by small business. When working with private partners, this is not always the case. According to Luna, small business is the backbone of the nation and SBIR gives small business more of a chance vis-à-vis large firms. The SBIR program also promotes teamwork with large or- ganizations. Also, the SBIR program indirectly supports the intellectual base of the country by supporting student interns, keeping the nation trained and bring- ing in new engineers and scientists flowing into the pool. There tends to be more flexibility and the award winner can communicate with the agency to satisfy both government and market needs. Weaknesses of SBIR According to Luna, SBIR has some weaknesses as well. The funding level has been fixed over time. Phase II awards should be more closely linked to the task being proposed like NIH does. It also believes that the number of Phase I awards is too large. And finally, access to agency technologists is not always easy. Recommended Changes in the Program Luna recommends a larger funding level for the program. It suggests that there should be more information from agencies on their needs by offering technology conferences. It wonders if there is not some way to give preferential treatment to firms that are really solving commercial problems. The program should not promote doing research for research sake. Therefore, taking company performance into account in the award process would be useful. However, that said, the program should not penalize real startups. Therefore, if the applicant had

278 APPENDIX E a number of previous awards, then its track record of commercialization should come into play. Also, Phase III has not been communicated or promoted very much in gen- eral. That is where the process is really completed. There must be better com- munication within the agency about Phase III possibilities. Opportunities to sole source to next level (i.e., Phase III) is important. There is a disconnect between SBIR and other shops within the agency. This is really a weakness of SBIR. The Navy TAP program is a good start at connecting small businesses with potential Phase III customers. All agencies would benefit from implementing a program like this.

APPENDIX E 279 Mainstream Engineering Corporation Julie Ann Elston December 13, 2006 The SBIR program has helped Mainstream Engineering Corporation—an in- novator in heating, ventilating, air conditioning and refrigeration products—build competencies, identify new technology needs, conduct research and development, and commercialize products through federal procurement and in the market. Mainstream believes that governmental needs, as outlined in the SBIR’s topic list, aid in the identification of new technology needs; in that, their general view is the United States government’s needs are a microcosm to the needs of the world at large, both public and private sector. This model allows identification of topics within their area of specialization. They then conduct an analysis of the commercial potential of the end product and new technology. If the technology and product holds potential, then research and development is undertaken. The firm’s owner/director, Dr. Robert P. Scaringe, received a Ph.D. in me- chanical engineering at RPI and worked in R&D at General Electric for several years. He then accepted a professorship in Mechanical Engineering at Florida Institute of Technology, and founded Mainstream Engineering Corporation in Rockledge Florida in 1986. The firm began to work with the SBIR program after the Air Force WPAFB contacted Dr. Scaringe with a thermal control problem and suggested the SBIR program as a means of funding the development of a solution to the problem. SBIR EFFECTS ON THE FIRM Mainstream views SBIR awards as the government as an underwriter of re- search and development to small business and as source of funds to help offset the cost of a project. Dr. Scaringe notes that “the awards have allowed [Mainstream] to compete with bigger corporations by offsetting the heavy costs of research and development.” He added that “[we] would not have been as successful today without the assistance of the program.” Dr. Scaringe measures his company’s success by products and technologies that come to market and states that “100 percent of projects that were funded with Phase II monies went to market (23 Phase II awards since 1986), while most that received Phase I monies went commercial.” SBIR’s has also had an impact on improving the firm’s competitive capabili- ties. The SBIR program allows for all patents, royalties, and trademarks to be held by the company that created them. This is attractive because it allows the company to prosper from its research and development. Mainstream has received multiple awards and multiple commercial products

280 APPENDIX E resulting from SBIR funding—too many to list really—the key products however are Mainstream’s (HVAC/R). COMMERCIAL OUTPUTS Mainstream sells products and services derived from SBIR funding in the market place. Mainstream only takes on projects that have commercialization as an end. All Mainstream projects that received Phase II awards went on to com- mercialization. Dr. Scaringe estimated that 80 percent of products developed are for Department of Defense with the remaining 20 percent going to the Depart- ments of Energy and Transportation and NASA. Mainstream’s heating, ventilating, air conditioning and refrigeration products (HVAC/R) are sold in more than 7,000 trade wholesalers throughout the United States. Overseas, Mainstream has distributors in Europe, Israel, South America and the Middle East. Mainstream’s automotive air conditioning products are licensed and sold through Interdynamics Corporation in all major Auto parts stores as well as “Big Box” outlets such as Wal-Mart and Target. Mainstream’s retail air filtration and related indoor air quality (IAQ) products are private labeled and sold through various industry leaders via “Big Box,” supermarket and drug chains stores. Mainstream licenses some of its patents but always keeps core technologies that apply to the HVAC/R and IAQ markets. These core technology products are manufactured in the United States and distributed through Mainstream’s network of more than 7,000 trade distributors. PRIVATE RETURNS AND SPILLOVER EFFECTS Dr. Scaringe provided the following examples of technologies developed with SBIR that yielded both private return and spillover effects: • Mainstream 2-kilowatt diesel generator.  Whereas the standard Depart- ment of Defense 2-kilowatt generator weighs 138 lbs and requires 4-man trans- port, Mainstream’s backpack generator weighs only 65 lbs and requires a 1-man transport. Mainstream’s generator has the same power output, lighter weight, more compact, easier to transport, and quieter. • QwikBoost.  This air conditioning additive increases the performance of refrigerators, air conditioners, and heat pumps by 8 to 10 percent. This tech- nology is incorporated into Mainstream’s HVAC/R product line and licensed to another company for the automotive industry. • Mainstream Modular Lightweight Environmental Control Unit (MECU). This field-deployable tent air conditioner heats or cools military tents in extreme temperatures. It states a 28 percent boost in performance over existing units and incorporates a weight and volume reduction by 56 percent. The second genera-

APPENDIX E 281 tion prototype can operate in nuclear, biological, or chemical (NBC) or non-NBC mode. KNOWLEDGE EFFECTS Mainstream has generated numerous papers, patents, and trademarks, which appear to indicate the presence of significant knowledge generation. As of No- vember 2000, Mainstream had 115 papers published or presented. In addition, as of September 2003 the company claimed 51 patents, 35 trademarks, and 15 more patents pending. Dr. Scaringe also provided examples of know-how from SBIR-funded proj- ects that were carried over to other (civilian) endeavors of the firm. Some ex- amples include: • Ion-propulsion for NASA to water purification. • Portable generator for army to same for campers and smaller marine craft. • Thermal control for avionics, aircraft and spacecraft to HVAC/R prod- ucts for the general public. • Spacecraft air quality to Indoor Air Quality improvements for the gen- eral public. • Non-toxic working fluids. • Fire suppressants and coolants for the DoD and NASA are also now available as safe working fluids for the public. FIRM PERSPECTIVES ON THE SBIR PROGRAM According to the Dr. Scaringe, the SBIR program has been helpful to the firm, adding “I wouldn’t be here today without the SBIR program.” Below are the main positive features of the program, as identified by Mainstream, followed by some criticisms of the way the program is managed. Fair Selection Processes Dr. Scaringe finds the selection process to be extremely fair and refreshingly unpolitical in nature compared to Florida state “Plus-up” practices where certain firms may be given noncompetitive subsidies. Patent Rights Retention and Commercialization Importantly, SBIR allows whole retention of patents, trademarks, and intel- lectual property rights. “I have applied for and received the BAA awards, which are far easier to do than the SBIR if all I want is to do basic research. The SBIR

282 APPENDIX E awards are harder and less cost effective until you consider the payoffs from the ensuing patent rights and commercialization.” New Product Development Using SBIR “In our view the SBIR program is funding our R&D effort to develop a new product. So if it cost $300,000 in R&D and the Phase I program gives us $100,000 than that is a $100,000 savings and not a $200,000 loss. We love to get a Phase II, but if we don’t a Phase II, the government still paid for $100,000 of our R&D costs. Remember, we only take on projects that our marketing studies show would make a great product that can be protected by our patents. We do not pursue R&D just for the sake of pure research—I believe that is the role of university research, rather we pursue R&D to solve a specific problem and sell a product.” “I lose money on the Phase I proposals in that it costs what I receive from winning a Phase I and then some to complete the Phase I. I do it only because of the potential for commercialization of a product which comes out of the project, i.e., the Phase II and Phase IIB are when the real returns kick in.” Helping to Identify New Technology Needs Mainstream believes that governmental needs, as outlined in the SBIR’s topic list, aid the company identify new technology needs. They use this list to screen for potential technologies that can be commercialized within their area of specialization in HVAC/R. They then conduct an analysis of the commercial potential of the end product and new technology. If the technology and product holds potential then research and development is undertaken and SBIRs are applied for. Dr. Scaringe said that “If the topic listed has commercialization po- tential and was also in one of the core competencies of the firm: thermal control and energy, chemical engineering and chemistry, or mechanical design and rapid prototyping, then the company applied.” In summing up the positive contributions of SBIR, he noted that SBIR al- lows a small company like Mainstream to compete against larger companies in research and development. Dr. Scaringe balanced these positive views of SBIR with specific criticisms of some of the program’s administrative processes. These are reviewed below. “Vague” Solicitations Dr. Scaringe noted that “In general, NASA’s solicitations are a bit too vague for my interests, and they have also changed very little in the past two decades.” “Obviously, the government does not need to know the solution to the problem, but they should be able to define the problem in very specific terms. If they can’t

APPENDIX E 283 maybe is it not a problem but just a passing fancy. Too many times, we have solved one of their problems only to find out they have no need for the solution. They have no specific application that would benefit. That is why we do a market study first. To determine if there is a commercial need; if not, we avoid the topic, because there is probably no government need either.” Solicitations Are Too Frequent “Too many solicitations! For example, the DoD used to have one solicitation in January, the first week or so. With the Christmas holiday, it would have been much better in February but once a year was nice. Then they added a summer topic list and last year there were four DoD SBIR topic solicitations. This is very disruptive and makes us feel like we are always writing SBIRs. My staff would love it if we could get back to once a year for each agency.” Need for Greater Expertise in Proposal Reviews According to Dr. Scaringe, NASA reviewers do not appear to be well versed in the technology they are evaluating, probably because NASA subcontracts this work to independent firms to evaluate proposals. These subcontracted firms have no real expertise in the various topic areas and they have no passion for the suc- cess of the technology.” “Both NASA and the Department of Defense recently started using third parties to review proposals instead of using the scientific personnel that wrote the topic solicitation to address a technological need. This creates a problem, in that, no third party can have the resources and experts to handle all the different types of technologies addressed in the proposals; and therefore, the reviews are getting really bad. That is to say somewhat vague and poorer in quality, indicating that the review of the proposals should go to the person that wrote the topic solicita- tion. In addition, the most recent practice of deciding Phase II awards before the Phase I is even half over is terrible and should be discontinued.” To improve the review process, Dr. Scaringe recommends using as review- ers the people in the government that wrote the topic description because “they understand the problem.” He urges that outside subcontractors, who care little and know even less about the subject area, not be used as reviewers. Late Payments “Payment is a major problem. We typically wait 60 to 90 days for payment. This new electronic payment system is a mess. We are having a tremendous prob- lem getting paid. Either the system is not working properly or the government folks don’t know how to use it. After more than 18 years in business, we have recently been forced to ask our local congressman to step in and help us get the

284 APPENDIX E government to pay its past due bills. The government does not consider these bills past due, because the invoices have not been “approved” by the government proj- ect engineer. In many cases the engineer is in the Middle East and not available for payment. It would be nice if payments could be more streamlined. However, I understand that in many cases these problems were impossible to anticipate.” Multiple Awards According to Dr. Scaringe, SBIR mills (firms that are successful in getting SBIRs but not successful in commercialization of products resulting from the SBIR) should be restricted. “That money could be used to help needy firms that would have produced products, even if their proposal writing skills are not as strong.” PAPERS PUBLISHED OR PRESENTED Mainstream provided a list of 115 scientific papers that have been published or presented, 51 patents, as well as numerous trademarks.

APPENDIX E 285 Space Photonics, Inc. (SPI) Julie Ann Elston May 2, 2005 OVERVIEW SPI is a twelve-employee firm that specializes in optical communications systems and components for the aerospace industry. Located in the Genesis In- cubator on the University of Arkansas Fayetteville campus, SPI seeks to provide innovative avionics and space optical communications components, networks, services and support. SPI was founded in 1999 by CEO Chuck Chalfant and CTO Fred Orlando, as a spin-off from Optical Networks Inc. (ONI) Systems in San Jose, California. To date they have received a total of $5.534 million in R&D funding for a number of specific photonic product development efforts. $4.86 million of this funding was received through the Small Business Innovation Research (SBIR) program. In 2004 Space Photonics became the first company to receive Arkansas’ new tax incentive that provides up to 33 percent in match- ing tax credits for Federal R&D programs, and is a recipient of the SBA Tibbets Award for outstanding SBIR leadership. HISTORY AND DEVELOPMENT OF THE FIRM, TECHNOLOGIES AND PRODUCTS The founders, Chuck Chalfant and Fred Orlando, first met in 1985 when they worked at Lockheed Martin in Sunnyvale, California. The current location in Arkansas is due to Chalfant’s love of the area he grew up in rather than strategic considerations, but they are now working on several SBIR-funded projects with various members of the University of Arkansas engineering faculty. Chalfant became familiar with the SBIR program around 1988 just after he went to work for a new technology startup firm called Optivision. Both Orlando and Chalfant worked together on a series of fiber optical network projects in the Silicon Valley region. They estimate a total of six successful Phase I and four Phase II grants in the 1990-1995 period. At Optivision they worked on space applications of optical networks for DoD and NASA grants through primarily Goddard Space Center, and JPL. In 1995 they estimate gross revenues of $18-20 million, with 50 percent coming from government sources, mostly fiber optical switches, and 50 percent from commercial application in the form of video com- pression. By 1997 Optivision had 100 employees and a new president, but with diverging markets, Chalfant decided to join ten engineers to spin off their own firm—Optical Networks Incorporated (ONI). At this point roughly all intellectual property and optical work from the SBIR grants went to ONI. The ‘novation”

286 APPENDIX E process of dividing up the grant contracts however was problematic and did not end until 1999. While VC firm Kleiner Perkins invested a total of $100 million over time in ONI to bring it public during the 2001 technology stock bubble, they specifically did not want to carry the government contracts with them, including the SBIRs, because of the high overhead and their wish to IPO clean of govern- ment ownership. This fortuitous coincidence of events allowed the new spin-off firm, Space Photonics, incorporated in 1998, to obtain all of the government contracts and SBIR’s of mostly NASA projects for Goddard and JPL, as well as $400,000 worth of government equipment. Without SBIR grants, both Chalfant and Orlando do not believe their firm would exist, let alone grow. Today, they have added several SBIR Phase Is and Phase IIs to their total from earlier firms bring the total includ- ing novated contracts to eight Phase Is and five Phase IIs, and have just received a $2.5 million contract from the Airforce (90 percent from SBIR), as well as two recently awarded Phase II SBIR contracts worth $1.5 million. Currently they are grossing about 80 percent from DoD and 20 percent from NASA contracts. Regarding growth, the SBIR program has been critical: in 2004 gross revenues were $650,000, and in 2005 revenues are expected to be $2.5 million. After successfully completing several prototype development programs re- cently, they are now beginning a major aerospace product qualification program, with a current contract backlog of about $4 million, and anticipate adding five new employees by the end of the year. Throughout their career, the SBIR program has been the common thread of funding and direction for innovation, although it is impossible to estimate via revenues or otherwise which SBIR grants are responsible for which outputs. ROLE OF SBIR PROGRAM ON FIRM DEVELOPMENT AND TECHNOLOGY One important point the founders made is that SBIR allowed them to grow without diluting their ownership of the firm (55 percent Chalfant, 40 percent Orlando, 5 percent other employees). They also stated that they doubt they would exist without it, and that it is undoubtedly the “the best damn government program ever devised.” Through specific program solicitations it has been directly responsible for the type of technologies developed as they allowed the solicitation process to lead them to develop the kind of technologies that were asked for “because we basically fol- lowed the money.” The SBIR program also assisted them in getting outside funding through the Air Force “Enhancement Program”, in which the Air Force promised to fund a Phase II at $250,000 if SPI got an outside investor, which SPI did with $250,000 DoD matching funds.

APPENDIX E 287 SBIR AWARDS, PROGRAM FAIRNESS AND PROBLEMS The founders also felt that the program was very fair, but did have one problem with a recent NSF proposal, which was rejected because “we could not demonstrate a nongovernmental commercial customer.” They felt that this is (1) difficult to do with these types of technologies and that (2) DoD as a customer should be sufficient. COMMERCIALIZATION ISSUES, FUNDING GAPS, AND PARTNERSHIPS The biggest problem experienced in the SBIR program was moving from Phase II to Phase III. Specifically after the Phase II, funds are needed to carry though to the next step which is a protoflight. And since no one wants to buy an untested flight technology, this is a huge problem for SPI and similar firms. They also noted that the primes also would not fund the test flights. SPI stressed that aeronautics is a tough field for any small firm to break into with the primes like McDonnell Douglass, Boeing, and Lockheed Martin—that are used to ruling the roost. Also these firms sometimes act like they are inter- ested in the work or technology of smaller more innovative firms like SPI because the government wants them to do so. SPI has actually experienced a situation like this where these same firms then tell the government a technology is too risky, but later end up proposing the same type of project/technology to the government and charge the government 100 times as much money for a project than SPI would. On the other hand, they also noted that Honeywell heard about one of their technologies through the SBIR Awards list and that it helped them to foster a joint project with them which has been very successful. CURRENT AND PLANNED PRODUCTS AND PATENTS DERIVED FROM SBIR-FUNDED RESEARCH • SPI’s LaserFire® Free-Space Laser Communications Transceivers. • MEMSpot® (two patents pending) beam steering devices are currently under development. • Micro-Electro-Mechanical Systems (MEMS). • SPI’s FireFiber® 4-Channel transmitters and receivers operate at a data rate of 3.2 Gbps per channel, and can provide up to 12.8 Gbps of aggregate op- erational bandwidth. • By 2007 they plan to provide upgrades for these transceivers providing up to 10 Gbps per channel operation and 40 Gbps of aggregate bandwidth. • SPI’s FireRing® High Speed Real-Time Fiber Optic Networks provide compatibility with network interface protocols including but not limited to ATM/ SONET, Fibre Channel, Gigabit Ethernet, Firewire (IEEE 1394b), IEEE 1393, and HIC (IEEE 1355) network implementations.

288 APPENDIX E SCIENTIFIC PAPERS RESULTING FROM SBIR-FUNDED RESEARCH 1. Chalfant, C.H., Orlando, F.J., and Parkerson, P.J., “Photonic Packaging for Space Applications,” presented at the IMAPS OE Workshop, Oct. 12, 2001. 2. Andrucyk, D.J., Chalfant, C.H., Orlando, F.J., “IEEE 1393 Spaceborne Fiber Optic Data Bus: A Standard Approach to On-Board Payload Data Handling Networks,” Published in the American Institute of Aeronautics and Astronautics Paper # 99-4507. 3. Chalfant, C.H., Orlando, F.J., and Parkerson, P.J., “Parallel Spaceborne Fiber Optic Data Bus Physical Layer” Invited Paper: SPIE Conference on Pho- tonic Processing Technology and Applications II in Orlando, FL: April 1998. 4. Andrucyk, D.J., LaBel, K.A., Luers, P.J., Marshall, C.J., Marshall, P.W., Ott M.N., Reed, R.A., Seidleck, C.M., “On the Suitability of Fiber Optic Data Links in the Space Radiation Environment: A Historical and Scaling Technology Perspective”. 5. Bretthauer, J.W., Chalfant, C.H., Orlando, F.J., Rezek, E., Sawyer, M., “Spaceborne Fiber Optic Data Bus (SFODB)”. 6. Ott, M.N., “Twelve Channel Optical Fiber Connector Assembly: From Commercial Off the Shelf to Space Flight Use”. 7. “Spaceborne Fiber Optic Data Bus (SFODB) Operational & Interface Description,” SFODB Operational & Interface Description; Orlando & Associ- ates, Inc., 1998.

APPENDIX E 289 TABLE App-E-4  Space Photonics SBIR Awards—As of May 1, 2005, Eight Phase I SBIRs and Five Phase II SBIRs Have Been Awarded Contract Award Amount Project Description Customer Date Status ($) Phase I SBIR—Enhanced IEEE 1393 Air Force— 1999 Completed in 2000 100,000 Spaceborne Fiber Optic Transmitters Kirtland AFB and Receivers Phase I SBIR—IEEE 1394 Fiber Optic NASA/JPL 1999 Completed in 2000 70,000 Transceiver Phase II SBIR—Enhanced IEEE 1393 Air Force— 2000 Completed in 2003 750,000 Spaceborne Fiber Optic Transmitters Kirtland AFB and Receivers Phase II SBIR—Ultra-high Bandwidth NASA/GSFC 2000 Completed in 2003 594,000 Spaceborne Fiber Optic Data Networks Phase I SBIR—Miniature Free Space Air Force— 2001 Completed in 2002 100,000 Optical Transceiver for Space Kirtland AFB Phase I STTR—Dual Wavelength Army 2001 Completed in 2002 100,000 Optical Thyristor Phase I SBIR NSF 2003 Completed in 2004 100,000 Phase I SBIR—Intelligent Free Space Air Force— 2003 Completed in 2004 100,000 Optical Communications Node Kirtland AFB Phase II SBIR plus the AF Air Force— 2003 Completion 1,250,000 Enhancement & Extension—Miniature Kirtland AFB Target: May 1, Free Space Optical Transceiver for 2006 Space Phase I SBIR—Free Space Laser Air Force— 2004 Completed in 2004 100,000 Communications Turret for Aircraft Wright Patterson AFB Phase II SBIR—Intelligent Free Space Air Force— 2004 Start August 750,000 Optical Communications Node Kirtland Node 2 2004—End August 2006 Phase II SBIR—Free Space Laser Air Force— 2005 Start February 750,000 Communications Turret for Aircraft Wright 2005—End Patterson AFB February 2007 Phase I SBIR—Performance Enhanced Air Force— 2005 Start May 2005— 100,000 Managed FPGA Eglin AFB End February 2006 Total SBIR Awards 4,864,000 SOURCE: Space Photonics Inc.

290 APPENDIX E Technology Management, Inc. Michael S. Fogarty Portland State University and Case Western Reserve University March 31, 2006 SUMMARY Technology Management, Inc. (TMI), located in Cleveland, Ohio, was estab- lished in 1990 by Benson P. Lee to commercialize a patented SOFC (solid oxide fuel cell) technology developed by Standard Oil of Ohio (SOHIO) at their R&D Center in Warrensville Heights, Ohio, and later acquired by BP. 10 TMI received its first SBIR award from DoE in 1991. Between 1991 and 2005, TMI received an additional nine Phase I and four Phase II awards to- taling approximately $2.7 million. (See Table App-E-5.) Their SBIR funding has come from multiple agencies, including NASA, DoD (DARPA/TRP, Navy, MDA), DoE, and USDA. TMI has also received significant funding from other important non-SBIR sources: the National Institute of Standards & Technology (NIST) through the Advanced Technology Program ($2.8M); the NASA Glenn Garrett Morgan Commercialization Initiative ($60K); the U.S. Air Force Dual Use Science & Technology Program ($1.6M); EPRI (the Electric Power Research Institute ($400K); and the Ohio Department of Development’s Technology Action and Third Frontier Fund ($2.8M), and the USDA/DoE Biomass R&D Initiative ($1.6M). TMI, which began with zero employees at the time of its first SBIR award, now employs over 20. Although they continue to apply for funding, the SBIR program is no longer a primary source of funding. TMI illustrates several important SBIR issues. First is the significance of the SBIR as a source of early funding—to seed a larger funding strategy. In this case, TMI leveraged SBIR funds to obtain multiple awards from multiple agencies in developing complex technology capabilities. SBIR’s early-stage funding was es- sential for TMI to pursue the basic and applied research necessary to prove the features of their SOFC technology. However, SBIR has been only one component of a portfolio of early-stage funding, including NIST’s Advanced Technology Program and the State of Ohio. Second, TMI’s case also highlights the importance of patents as a vehicle for controlling the destiny of the technology, in this case for eventual commer- cialization and manufacture. (From the beginning TMI’s goal has been to control the selection of manufacture, marketing and distribution partners to maximize 10  The TMI case is mainly based on a telephone interview on May 16, 2005, and several email communications with Benson P. Lee, CEO of Technology Management, Inc.

APPENDIX E 291 TABLE App-E-5  TMI’s SBIR Awards 1991-2004 Amount Agency/ (thousands Type of Award Year of dollars) Primary Technical Achievement DoD SBIR MDA 2004 100 Characterizes a regenerate fuel cell energy storage system DoE SBIR 2000 60 Test an improved, lower cost, interconnect material Phase I NASA SBIR 1998 70 Reversible Fuel Cell/Electrolyzer Developed Phase I USDA SBIR 1997-99 200 Sulfur-Tolerant Reformer Stack Testing on Biogas Phase II Navy SBIR 1996-99 743 Materials/Stack Development Systems Design for Phase II Shipboard SOFC TRP SBIR 1994 100 Sulfur-bearing Logistic Fuel Operation, Stack Phase I Development USDA SBIR 1996 50 Social and Economic Impact of Fuel Cells Phase I USDA SBIR 1996 50 Alternative Fuels Testing Phase I NASA SBIR 1993 and 670 Materials/Stack Development for Reversible Fuel Phase I and 1996 Cells/Electrolyzer Phase II DoE SBIR 1995 75 Seal Materials Development Phase I DoE SBIR 1992 50 SOFC Component & Stack Development Phase I DoE SBIR 1991 and 549 SOFC Components & Stack Development Phase I and 1992-94 Phase II SOURCE: Technology Management, Inc. shareholder value.) TMI has seven patents granted and two current applications.11 Their desire to control the technology is fundamental to the execution of their business model, which is based on multiple exclusive licenses with strategic part- ners. In order to accomplish commercialization through this business model, TMI has been constrained from using either spin-off or spin-in uses of the technology unless they are consistent with TMI’s commercialization objectives. An example would be NASA’s interest in using the reversible features demonstrated in their Phase II SBIR to advance the NASA mission. In this case, while the technology is clearly “dual-purpose,” new incentives and new mechanisms may be neces- sary for achieving NASA’s spin-in objectives. Just because the technology has 11  Source: USPTO Web site search.

292 APPENDIX E applications in both the private sector and in NASA doesn’t guarantee that it will be used by NASA. A third important issue represented by TMI’s case is the significance of NASA’s SBIR TRL (Technology Readiness Level) focus. TRL ranges from 1 through 9, where 1 is basic research and nine includes flight projects. In the past NASA has emphasized use of SBIR to fund TRL 3-6 projects. Current discus- sions suggest that NASA’s increased emphasis on spin-in outcomes will lead to higher TRL uses of SBIR. If so, companies like TMI would be excluded from participation since they use SBIR funding to support early-stage R&D primarily oriented to private-sector commercialization of the technology. Some of the most significant technologies in U.S. history started with markets which did not exist or were not yet large enough to be measurable (e.g., electricity, the automobile, the airplane). These technologies, known as “disruptive,” include the fuel cell. From the CEO’s perspective, any distraction from a focus on commercialization is unwelcome. He views the current SBIR program as one of the few which weighs technical merit over market size.12 Finally, TMI’s case illustrates the significance of location, which is Cleve- land, one of the nation’s older industrial regions. (Ohio receives a very small share of SBIR awards relative to the size of its economy.) Nevertheless, TMI views Ohio as providing several clear advantages for fuel-cell technology firms: (1) there is a balance of activity in fuel cells at all levels from materials to components to systems and applications. The Ohio Fuel Cell Coalition (OFCC) consists of business, academic and government leaders. The OFCC provides an important forum for knowledge sharing involving fuel cell technology; (2) Ohio provides an excellent supplier base for fuel cell companies. As a fuel cell systems integrator, TMI enjoys the proximity and interest of manufacturing companies making components for fuel cell systems; (3) The Ohio Department of Develop- ment contributed early-stage funding. For example, Ohio’s Technology Action Fund, now known as the Third Frontier Fuel Cell Initiative, provided over $2 million to TMI, helping to provide cost share for several federal awards and fill cash gaps between the firm’s awards. In addition, ODOD promotes fuel cells at national forums. ORIGIN OF TMI TMI was organized in 1990 to commercialize a single technology purchased from BP/SOHIO in 1990. The SOFC technology (solid oxide fuel cell) was originally developed by BP/SOHIO in Ohio. BP held multiple U.S. and foreign patents. 12 Second, TMI’s experience with its fuel-cell technology illustrates what is referred to as the “innovators dilemma.” Because the fuel cell is a disruptive technology like the airplane, electricity, etc., commercialization presents a special challenge in that such technologies start with zero market demand.

APPENDIX E 293 Benson P. Lee, TMI’s CEO, moved to Cleveland 35 years ago. He had been CEO of several startup companies prior to starting TMI. Beginning with zero employees at the time it received its first SBIR award (a 1991 DoE SBIR Phase I), TMI now employs over 20. TMI had no income until 1991. The company used SBIR funding as a critical source of early-stage (seed) funding. SBIR was especially good because it required no matching funding. Now, following a decade’s development of the technology, their record of achievements allow them to compete in open competition with much larger, multinational fuel-cell companies. An example is the $2.8 million ATP award to advance the technology. According to their CEO they “graduated” from being dependent on SBIRs as a primary source of funding, which is one measure of success. Their goal from day one has been to become competitive in the market- place, not just as a developer of technology. SBIR WAS KEY TO THE STARTUP AND DEVELOPMENT OF TMI’S CAPABILITIES TMI’s first income came from a $50,000 DoE SBIR Phase I award in 1991 (the company was founded one year earlier). This was followed by a second Phase I and then a Phase II. (See Table App-E-5 for a list of TMI’s SBIR awards.) When TMI was formed, they were not familiar with any large sources of seed funds other than SBIR. The company has received a total of $2.7 million SBIR funding since 1991. In the CEO’s view (Benson Lee), they could not have developed the company without the early SBIR seed funds and a $400,000 award from EPRI (the Electric Power Research Institute). These were followed by a $4 million DARPA award. According to Mr. Lee, it is clear this funding would not have occurred without the work performed under their SBIR funding. Although they no longer look to SBIR as their primary funding source, TMI still writes two or three proposals a year, winning one about every 18 months. (They are now waiting on a Phase II from DoD.) They also plan to submit future proposals. Mr. Lee cites two additional advantages of the SBIR program: First, merit competition levels the playing field for small businesses. This aspect of the SBIR program is very important because in open competition corporate scale is a factor as new technology ideas from small businesses must compete against the largest fuel-cell companies, where factors such as matching funds and Washington-based lobbyists as well as in-place manufacturing capability appear to have less risk. TMI considers the SBIR review process to be very good and typically fair and timely. Second, they view SBIR as conferring prestige on the company because the agencies provide a high quality review process. People know that the firm didn’t lobby to get the award. Moreover, many of the program managers submit- ting SBIR abstracts are the same individuals who manage the largest programs in the agency.

294 APPENDIX E PROPRIETARY TECHNOLOGY LIMITS SPIN-IN USES BY NASA TMI describes its market entry product as follows: a compact, multifuel, modular, kilowatt class system, which can be delivered overnight by common carrier. The TMI system operates on common fuels and can be maintained by a single person without specialized tools, equipment or training. TMI’s byline is: “a fuel cell system which can be used anywhere, anytime, by anyone.” According to TMI, no other known company has a fuel cell system with these features. TMI has used multiple laboratory systems to demonstrate these features and is cur- rently raising funds to begin field testing and set up pre-commercial manufactur- ing for broader field trials. From the CEO’s perspective, TMI is a classic example of planning the work and then working the plan. Whereas many small companies succumbed to being an R&D company surviving on R&D contracts, TMI never lost sight of the fact they were in the business of developing a commercially viable fuel cell system. PATENTS ARE VERY IMPORTANT According to Lee, all of their patents and their know-how, drawn from years of TMI’s generic knowledge base are considered part of a core technology portfolio. Although none of the patents are specifically linked to any specific SBIR research because their patents are viewed as reflecting TMI’s general knowledge, one key issue in evaluating SBIR is: How have SBIR awards shaped the company’s knowledge base? And how has their knowledge base shaped the development of more specific technologies? In addition, for competitive reasons TMI does not publish papers, so there are no papers based on SBIR-supported research. From day one TMI’s goal has been to commercialize the technology and become a manufacturer—not simply a source of spin-in technology. Such firms present a challenge for spin-in uses of the SBIR Program. For example, highly innovative firms focused on commercialization of proprietary technology may choose to constrain spin-in uses of a technology, even when the technology has important mission purpose potential. According to Lee, “These are our crown jewels.” The potential conflict is shown by the fact that TMI did not pursue an offer by NASA to undertake a Phase III project to advance the use of the technol- ogy for a space program because it did not present a pathway to a commercial market. Their case raises an important issue, namely that TMI would probably be less likely to receive NASA funding with the agency’s new emphasis on spin-in uses of SBIR/STTR. The CEO stated that TMI would not be attracted by the shift to NASA’s spin-in uses of SBIR if this change would require them to become an R&D consultant and divert them from their goal to pursue commercial products. Their view is that, unless the mission of the firm is to be an R&D consultant or to com-

APPENDIX E 295 mercialize their technology for space applications, work for NASA could create an opportunity cost and be a distraction from the goal of commercialization into terrestrial markets. According to TMI’s CEO, increased spin-in uses of SBIR will require new mechanisms that foster synergy and collaborations. The challenge is to construct a relationship that benefits the agency while allowing the firm to pursue its main goal—whatever that may be. One question is: How can the topic be written to better align the project with what NASA would like to do? The idea is that NASA would utilize the knowledge developed by the firm using the SBIR award to think in new ways and cultivate innovation by NASA. OHIO LOCATION OFFERS ADVANTAGES TMI’s view is that Ohio is a “superb” location for the development of fuel cell technology. According to the CEO, market success with the fuel cell technol- ogy will depend on the manufacturers, which is well suited to the Midwest. In fact, because Ohio is a location for three or four fuel cell, component and systems companies, TMI’s location does not present a problem in recruiting bright young researchers. Ohio scores high in fuel-cell development. Silicon Valley may have a little better venture capital situation, but Ohio provides access to companies in the supply chain: pumps, pump makers, etc. One asset is the membership of the Ohio Fuel Cell Coalition (OFCC), which mostly consists of supplier firms. 13 AWARD SIZE IS GOOD BUT PHASE I-PHASE II DELAYS PRESENT A BIG PROBLEM TMI has no suggestions for altering the size of Phase I and Phase II awards. The $100,000 Phase I is ample to prove a concept. But the time gap between Phase I-Phase II often causes cash flow problems for a small business. The CEO didn’t take a salary for the first 2-3 years. Recognizing the problem and with the belief that biotechnology and fuel cell technologies can be competitive in Northeast Ohio, the State of Ohio had a program that bridged Phase I to Phase II. Ohio’s award was part of the state’s fuel cell initiative. 13  The coalition includes business, academic and government leaders. Also as of March 15, 2005, the following organizations are coalition members: NexTech Materials, BIOMEX, Cinergy Ventures, Molded Fiber Glass Companies, ThermalTech Engineering, Inc., Kent State, Sierra Lobo, HydroGen LLC, Graftech, AvMat LLC, Nordson, Primrose, Inc., CSA-International, Catacel, Lorain County Community College, University of Dayton Research Institute (UDRI), FirstEnergy, TMI, Meacham Company, Ohio Cat, PIA Group, Air Force Research Lab at WPAFB, Stark Development Board, Parker Hannifin, Sinclair Community College, City of Lorain, SGL Carbon, Hocking College, Tech- nical Staffing Professionals, Metamateria, Behn Quartz, Refractory Specialties, Inc., Vanner, Inc., and LCP Holding, LLC.

296 APPENDIX E TECHNOLOGY MANAGEMENT, INC.—ANNEX CEVEC (CUYAHOGA EAST VOCATIONAL EDUCATIONAL CONSORTIUM) DEMONSTRATION—OCTOBER, 2005 The first public demonstration (October 2005) was a 3kW system at CEVEC using three 1-kW modules connected in parallel and operating on propane. The photo to the right shows the 3kW system (on a transport cart) recharging a fork- lift and providing security lighting. TMI personnel are operating and monitoring the system with interaction with CEVEC staff during the demonstration. TMI believes this demonstration may be one of the very first known to use a multiple module SOFC configuration. The advantages of redundancy are higher reliability, power availability, and built-in back up. Particularly for mission critical applica- tions such as telecommunications, which require continuous power and back up, this system design has the potential for also being extremely cost competitive over the full product life cycle.

APPENDIX E 297 TiNi Alloy14 Michael S. Fogarty Portland State University and Case Western Reserve University May 5, 2005 OVERVIEW TiNi Alloy was started in 1987 in the Bay Area. SBIR funding has been essential to supporting the R&D that has created successful technology applica- tions of the company’s MEMS technology by other companies. One implication of this case is that an assessment of SBIR’s contribution to TiNi Alloy requires examining both the innovative technologies created with SBIR support and the bulk of commercialization activity accomplished by other firms using the tech- nologies. In other words, the economic assessment needs to allow for different firms playing separate roles: one being R&D and a second being the primary commercialization. TiNi has continued to employ 8-9 people throughout the 19 years since it was a startup. Their founder currently seeks a path that would involve the company’s manufacture of a new product. The TiNi Alloy case illustrates how SBIR was used to fund a startup whose main activity is R&D with most commercialization occurring through licensing of patents to companies successfully using the technology for new products. Specifically, the case illustrates several important features and issues with the SBIR program: (1) SBIR’s current emphasis on shorter-term, less risky projects that meet a mission need would not support TiNi-type technology developments; (2) Evaluation of the economic effects of SBIR must allow for commercialization occurring in at least two steps: (a) the initial R&D and development of early-state technology, which has been TiNi’s primary function; and (b) commercialization by different companies that license intellectual property produced by the SBIR- supported firm; (3) commercialization occurs with uncertainty and over long pe- riod of time, indicating the importance of evaluation taking a similarly long-time horizon; (4) location matters a lot, in some cases favoring an SBIR-supported firm (as in TiNi’s case) and in others creating a disadvantage for the firm (a TiNi Alloy would be very unlikely to startup and become successful in a Cleveland, Buffalo, or Detroit). TiNi may also illustrate the importance of multiple SBIR awards from several agencies as essential for developing a technology that at least initially, because of there being no obvious large commercial product market, is not attractive to VC. 14  This case was based on an interview with David Johnson, TiNi’s founder and CEO, San Leandro, California; Web site information; patent data from USPTO; and the DoD’s SBIR database.

298 APPENDIX E TiNi represents one potential model for a successful SBIR outcome: use SBIR funds to support highly innovative R&D labs with a potentially important, commercializable technology that can be taken the next step by other firms with manufacturing and marketing capabilities. COMPANY AND FOUNDER BACKGROUND TiNi Alloy was founded in 1987 by A. David Johnson, who owns ninety percent of the company and is the CEO and CTO. TiNi is primarily an R&D lab specializing in MEMS and nanotechnology. They have employed eight or nine people almost from the beginning and produce revenues of $650,000 to $1,500,000 annually. TiNi Has Received 31 SBIR Awards TiNi had three employees at the time the first SBIR award was received. Over the lifetime of the company TiNi has received 21 Phase I awards, ten of which progressed to Phase II. Their Phase II awards have come from several sources, including NASA, DARPA, HHS/NIH, NSF, DoE, the Air Force, and BMDO/SDIO. Four Phase II awards are associated with NASA. The company started by building heat engines that run on hot and cold water. A set of aerospace devices followed. Their recent focus has been microdevices and nanodevices made of TiNi thin film. The company believes that the next stage of their technology will involve nanodevices with implantable medical device applications. The Silicon Valley Location Has Given Them a Key Advantage The main advantages of their Bay Area location is, first, access to others doing MEMS work and, second, the ability to obtain and maintain important equipment that would be difficult elsewhere. In Johnson’s view, “Silicon Valley offers a reservoir of talent, equipment, finances, expertise, and intellectual stimu- lation.” He thinks that he’s in Silicon Valley because of the factors that cause the region to feed on itself. TiNi summarizes its history as follows: incorporated in 1987; launched TiNi Aerospace in 1995; obtained Lee Co. License in 1999 and a Smart Therapeutics license in 2000. Their current situation is also summarized: They have a technol- ogy, which is thin film TiNi microfabrication; they have patented the intellectual property; there exists an opportunity with a major medical device company; and they hope to develop a corneal implant manufacturing facility, with funding either through TiNi Alloy or as a spin-off company.

APPENDIX E 299 TiNi TECHNOLOGY TiNi’s Core Competency Includes Microfabrication and Materials Science TiNi is derived from Titanium Nickel; AKA Nitinol. The company’s strength is Microelectro-mechanical Systems (MEMS). Their core competency includes microfabrication (sputter deposition, photolithography, chemical milling, scan- ning electron microscopy) and materials science (Shape Memory Alloys, finite el- ement analysis). Their MEMS technology combines silicon microfabrication with shape-memory metals. The result is micro-miniature valves and micro-switches with potential applications to consumer products and manufacturing. Their technologies have applications in four areas: Biotech, Aerospace, En- ergy, and Medicine. Biotech Applications in biotech stem from increasingly small sample sizes coupled with more sophisticated instruments, which creates a need for miniature valves and pumps. Costly samples and chemicals require conservation of liquids and, therefore, the system’s entire internal volume must be minimized. As a result, valves and pumps must be small and have the capability of controlling pressure up to several atmospheres. Aerospace The trend is toward smaller and more sophisticated space vehicles. TiNi Al- loy develops micromachined liquid control and pneumatic valves. Through TiNi Aerospace they also provide separation devices for space vehicles. Energy Battery technology lags behind requirements for compact sources of elec- trical energy while portable computers and various other instruments require considerable power. One solution involves using fuel cells, which can potentially provide substantially more power density. However, they also require more so- phisticated control systems and, consequently, miniature valves. TiNi’s technol- ogy includes a liquid control valve to provide this application. Medicine One standard component used to treat cardiovascular disease is the stent. TiNi’s thin film technology (in particular their 3-D devices) give access to the body’s smaller blood vessels and other lumens. TiNi is also targeting their R&D

300 APPENDIX E to clot retrievers and aneurysm closures for treating intracranial disease. They are also focusing R&D on implantable drug delivery systems. COMMERCIALIZATION Commercialization of Technology Has Occurred Through Licensing Its Patents to Commercially Successful Companies To summarize David Johnson’s view, TiNi has used SBIR awards to develop valuable technology but they have had limited success with commercialization through manufacturing and sales. Licensing of patents has brought them their largest financial returns. TiNi has received more than 20 patents on its technology and has ten ap- plications on file. TiNi’s business model strategy is focused on technology de- velopment and licensing. Their inventions cover thin film technology, devices, and processes. The company has three current licenses: (1) Lee: Pneumatic Valves (an agreement interpreted to include latching valves for NASA; (2) SMART/Boston Scientific (for intravascular stent devices; this acquisition provided TiNi with significant revenue); and (3) TiNi Aerospace (for separation devices used in satellites and spacecraft; the agreement involves inclusion of a “thermal fuse” valve for airliners). The company has two agreements that are being negotiated, one involving a consumer product and a second for a medical product. TiNi Aerospace is located about one mile away. Close cooperation between the two companies continues. As of June 2003, commercialization associated with their Phase II awards produced total revenue of $5,918,000. Their Frangibolt(TM) has become a standard component on satellites (a shape memory alloy powered separation device). The device has been used by TRW, the European Space Agency, and Lockheed-Martin. In addition, TiNi’s pin-puller was used on the Mars Global Explorer, and is scheduled for use in NASA’s STEREO program. Evidence of Technology Benefits to Other Firms Indirectly, TiNi’s technology developments have influenced technology de- velopments by other firms. They pioneered making shape memory alloy in the form of thin film and combining it with silicon to make MEMS devices. Several universities have established graduate research programs in this subject and two medical device companies are currently exploring its use in implantable devices. Part of TiNi’s funding has come from contracting R&D services to several commercial firms: GM’s Delphi division (fuel injectors), JNJ (implantable medi-

APPENDIX E 301 cal systems), Ford Motor Company (electrical connectors), and SMART Thera- peutics (intravascular devices). IMPORTANCE OF SBIR SBIR Was a “Godsend” to TiNi Johnson considers “SBIR as a godsend to him.” When the Superconductor- Super Collider program was eliminated in the early 1980s, his position with the Lawrence-Berkeley lab, where he had been for twenty years, was eliminated. He discovered the SBIR program when talking with a colleague about a Braille computer display. At the time he had no funding, so in 1987 he approached NIH for an SBIR. TiNi Alloy was founded before a proposal was submitted; however, the two first SBIR grants paid salaries for the first year of business. But SBIR Is a Mixed Bag Johnson views SBIR as a mixed bag (both positive and negative long-term consequences): It has been good for conducting experiments in interesting areas and encourages fiscal discipline, but it’s insufficient to grow a company and, even if the concept is proven, a gap still exists. “What’s needed is something that people will buy.” SBIR has permitted TiNi to explore a wide range of technolo- gies that would not have been possible otherwise. This had put them in a strong intellectual property position. However, jumping from one contract to another has prevented them from focusing on one application with sufficient effort to achieve manufacturing and sales of products. Johnson has also co-founded a company that got angel and individual invest- ment funding for a medical product. This company was acquired by a large medi- cal firm, providing operating support for TiNi Alloy for several years. Johnson believes that the technology was the most important factor in getting funding. The SBIR awards did not have a major influence on the decision to fund the work. Although they have done contract work for several companies in the automotive and medical industries, this has not been their major revenue source. ISSUES WITH THE CURRENT SBIR Johnson believes that success comes in several forms: the SBIR firm can license, produce and sell, or be acquired and/or go public. Phase I-Phase II Delays Handled Through Multiple Proposals The delay in funding between Phase I and Phase II funding is a problem which they have handled by trying to have several proposals in the pipeline at the

302 APPENDIX E same time. As a result, however, they lose momentum, causing Phase II projects to be less successful. SBIR Phase I Awards Should Be Smaller But with Reduced Goals Johnson’s view is that there should not be a fixed amount for Phase I. In fact, he thinks that it would sometimes be more effective if the grants were smaller and the goals were reduced accordingly. Other times the amount is too little, meaning that it is too small to expect significant results. He believes that the amount should be negotiated, taking into account the proposer’s estimate of the project’s challenge, with the implication that this approach encourages more in- novation. He strongly believes that SBIR’s current focus encourages significantly less innovation. Parts of the Selection Process Are Fair But Other Aspects Are Unfair He pointed out that his SBIR experience varies quite a bit by agency: Because each agency has its own objectives, the selection process varies by agency and, therefore, is at least fair from this perspective. He has experienced closer coopera- tion with NASA than with either NIH or DARPA. However, Johnson views the process as sometimes being unfair, “in particular when a solicitation is written to favor one proposer.” For example, in his view, NIH seems to favor proposers with access to medical expertise—an MD or a university with a name and probably something that has already proven successful. He felt that even a Phase I requires these, and it will make money. This criterion needn’t bear any relationship to the project’s contribution to innovation. Nevertheless, he believes that this approach may not be unreasonable as long as everyone knows the rules. Views SBIR’s Increasing Focus on Less Risky, Less Innovative Projects as a Major Mistake Johnson hasn’t submitted an SBIR proposal for several years and will not submit further proposals unless the subject fits with the direction he wants TiNi to go. He is particularly concerned with the growing emphasis on short-term technology objectives. He views this trend as moving against SBIR’s original purpose and causing less innovation. In his view, Johnson sees the recent SBIR shift to shorter-term mission objectives as a major mistake. (“The focus on mission technology is a subver- sion of the program’s intent.”) He believes that SBIR should take risks that VC companies won’t.

APPENDIX E 303 Two Interesting Examples He gave an example of an innovation that stemmed from his idea. One day he got a telephone call asking about thin film. He then wrote a NASA SBIR, which got funded and allowed for demonstration of an application to computer memory. Although it didn’t work, he made thin film. After this step, he created his first Web page. The Web page created contacts. This was followed by SBIRs from both NSF and DARPA. One contact from a person from New York Uni- versity was about a medical application. After meeting, the NYU person licensed Johnson’s technology and set up a new business, giving Johnson stock in the company. The company was formed as Smart Therapeutics. It developed a prod- uct that was sold to Boston Scientific, which provided TiNi Alloy with money. The point is that SBIR funded highly innovative thin film technology that re- quired a second firm to complete the commercialization, indirectly further fund- ing TiNi Alloy through the second company’s sales. None of this was planned. “No one knows where the next good thing will come from.” In fact, Johnson thinks that the best projects didn’t have a business plan. He gave a second interesting example. Shortly after he started TiNi, someone asked: Can the technology be used to make explosive bolts? After putting down the telephone, while walking down the stairs he got an idea: a device that breaks the bolt but not explosively. He made a prototype in a couple of weeks that proved the concept. Then he sought funding from SBIR but failed to get support. A Navy person saw the technology as a means to separate in space and funded it. The technology (the FRANGIBOLT) was used for the Clementine Space Mission. TiNi Aerospace was launched to commercialize the product and has paid royalties back to TiNi Alloy Company. SBIR/States’ Commercialization Support Has Not Been Important to TiNi Alloy Johnson attended only one conference by MDA that was intended to pro- vide commercialization advice and assistance. The effect on TiNi was minimal because there was no follow-up. He believes that people like himself need men- toring: help from people with experience taking things to market. One example involves working with larger companies. Sherwin-Williams, GM, and Gillette were all interested in Johnson’s technology. He wrote proposals but nothing hap- pened. How does a small firm make these connections? He has also talked with VC. But the VC consider his technology too diverse. So he hasn’t gotten VC funds. Does he need a partner to take the next step? TiNi Alloy Company and TiNi Aerospace are planning a spin-off to make a consumer product, and will invite VC investment.

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The Small Business Innovation Research (SBIR) program is one of the largest examples of U.S. public-private partnerships. Founded in 1982, SBIR was designed to encourage small business to develop new processes and products and to provide quality research in support of the many missions of the U.S. government, including health, energy, the environment, and national defense. In response to a request from the U.S. Congress, the National Research Council assessed SBIR as administered by the five federal agencies that together make up 96 percent of program expenditures.

This book, one of six in the series, reports on the SBIR program at the National Aeronautics and Space Administration, and finds that the program is making significant progress in achieving the Congressional goals for the program. Keeping in mind NASA's unique mission and the recent significant changes to the program, the committee found the SBIR program to be sound in concept and effective in practice at NASA.. The book recommends programmatic changes that should make the SBIR program even more effective in achieving its legislative goals.

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