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EX-99.1 - EXHIBIT 99.1 - DYNASIL CORP OF AMERICAtv500266_ex99-1.htm
EX-32.1 - EXHIBIT 32.1 - DYNASIL CORP OF AMERICAtv500266_ex32-1.htm
EX-31.1B - EXHIBIT 31.1B - DYNASIL CORP OF AMERICAtv500266_ex31-1b.htm
EX-31.1A - EXHIBIT 31.1A - DYNASIL CORP OF AMERICAtv500266_ex31-1a.htm

 

 

U. S. SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

(Mark One)

 

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2018

 

¨TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO ______.

 

Commission file number: 001-35011

 

DYNASIL CORPORATION OF AMERICA

(Exact name of registrant as specified in its charter)

 

Delaware 22-1734088
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

 

313 Washington Street, Suite 403, Newton, MA 02458
(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code: (617) 668-6855

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer ¨
Non-accelerated filer ¨ Smaller reporting company  x
Emerging growth company ¨  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. Yes ¨ No ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ¨ No x

 

As of August 6, 2018 there were 17,317,611 shares of common stock, par value $.0005 per share, outstanding.

 

 

 

 

 

 

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

 

INDEX

 

    Page
PART 1.   FINANCIAL INFORMATION  
     
Item 1.   Financial Statements  
     
DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES    
     
CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2018 AND SEPTEMBER 30, 2017   3
     
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2018 AND 2017   5
     
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY FOR THE NINE MONTHS ENDED JUNE 30, 2018   6
     
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED JUNE 30, 2018 AND 2017   7
     
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   8
     
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   22
     
Item 4.  Controls and Procedures   31
     
PART II.  OTHER INFORMATION   31
     
Item 1A. Risk Factors   31
     
Item 5(a). Other Information   31
     
Item 6.   Exhibits   32
     
Signatures   32

 

 2 

 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS.

 

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

   June 30,   September 30, 
   2018   2017 
ASSETS          
           
Current Assets          
Cash and cash equivalents  $1,511,000   $2,415,000 
Accounts receivable, net of allowances of $183,000 and $200,000 at June 30, 2018 and September 30, 2017, respectively   3,766,000    3,407,000 
Costs in excess of billings and unbilled receivables   1,065,000    1,317,000 
Inventories, net of reserves   4,457,000    4,326,000 
Prepaid expenses and other current assets   792,000    973,000 
Total current assets   11,591,000    12,438,000 
           
Property, Plant and Equipment, net   7,960,000    7,032,000 
           
Other Assets          
Intangibles, net   959,000    987,000 
Deferred tax asset   3,167,000    2,642,000 
Goodwill   5,907,000    5,940,000 
Security deposits   58,000    58,000 
Total other assets   10,091,000    9,627,000 
           
Total Assets  $29,642,000   $29,097,000 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
Current Liabilities          
Equipment line of credit  $281,000   $- 
Current portion of long-term debt   1,652,000    2,007,000 
Capital lease obligations, current   52,000    91,000 
Accounts payable   1,924,000    2,380,000 
Deferred revenue   109,000    129,000 
Accrued expenses and other liabilities   2,652,000    2,667,000 
Total current liabilities   6,670,000    7,274,000 
           
Long-term Liabilities          
Long-term debt, net of current portion   1,090,000    1,045,000 
Capital lease obligations, net of current portion   62,000    81,000 
Deferred tax liability, net   230,000    234,000 
Other long-term liabilities   172,000    38,000 
Total long-term liabilities   1,554,000    1,398,000 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

 3 

 

 

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED) (Continued)

 

   June 30,   September 30, 
   2018   2017 
LIABILITIES AND STOCKHOLDERS' EQUITY (Continued)          
           
Stockholders' Equity          
Common Stock, $0.0005 par value, 40,000,000 shares authorized, 18,091,931 and 17,893,763 shares issued, 17,281,771 and and 17,083,603 shares outstanding at June 30, 2018 and September 30, 2017, respectively.   9,000    9,000 
Additional paid in capital   21,756,000    21,406,000 
Accumulated other comprehensive income (loss)   (666,000)   (539,000)
Accumulated deficit   (39,000)   (919,000)
Less 810,160 shares of treasury stock - at cost   (986,000)   (986,000)
Total Dynasil stockholders' equity   20,074,000    18,971,000 
Noncontrolling interest   1,344,000    1,454,000 
Total stockholders' equity   21,418,000    20,425,000 
           
Total Liabilities and Stockholders' Equity  $29,642,000   $29,097,000 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

 4 

 

 

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

 

   Three Months Ended   Nine Months Ended 
   June 30,   June 30, 
   2018   2017   2018   2017 
Net revenue  $10,542,000   $8,836,000   $29,985,000   $28,065,000 
Cost of revenue   6,367,000    5,472,000    18,326,000    17,386,000 
Gross profit   4,175,000    3,364,000    11,659,000    10,679,000 
Operating expenses:                    
Sales and marketing   288,000    255,000    955,000    848,000 
Research and development   177,000    176,000    701,000    707,000 
General and administrative   3,100,000    3,205,000    9,519,000    9,321,000 
                     
Total operating expenses   3,565,000    3,636,000    11,175,000    10,876,000 
Income (loss) from operations   610,000    (272,000)   484,000    (197,000)
Interest expense, net   44,000    53,000    132,000    164,000 
Income (loss) before taxes   566,000    (325,000)   352,000    (361,000)
Income tax expense (benefit)   190,000    (111,000)   (404,000)   (2,769,000)
Net income (loss)   376,000    (214,000)   756,000    2,408,000 
Less: Net loss attributable to noncontrolling interest   (15,000)   (64,000)   (124,000)   (197,000)
Net income (loss) attributable to common stockholders  $391,000   $(150,000)  $880,000   $2,605,000 
                     
                     
Net income (loss)  $376,000   $(214,000)  $756,000   $2,408,000 
Other comprehensive income (loss):                    
Foreign currency translation   (384,000)   212,000    (127,000)   (18,000)
Total comprehensive income (loss)   (8,000)   (2,000)   629,000    2,390,000 
Less: comprehensive income (loss) attributable to noncontrolling interest   (15,000)   (64,000)   (124,000)   (197,000)
Total comprehensive income (loss) attributable to common stockholders  $7,000   $62,000   $753,000   $2,587,000 
                     
Basic net income (loss) per common share  $0.02   $(0.01)  $0.05   $0.15 
Diluted net income (loss) per common share  $0.02   $(0.01)  $0.05   $0.15 
                     
Weighted average shares outstanding                    
Basic   17,203,965    16,945,744    17,127,834    16,879,864 
Diluted   17,221,199    16,945,744    17,147,228    16,879,864 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

 5 

 

 

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

 

For the nine months ended June 30, 2018

 

          Additional   Other                   Total 
   Common   Common   Paid-in   Comprehensive   Accumulated   Treasury Stock   Noncontrolling   Stockholders' 
   Shares   Amount   Capital   Income (Loss)   Deficit   Shares   Amount   Interest   Equity 
Balance, September 30, 2017   17,893,763   $9,000   $21,406,000   $(539,000)  $(919,000)   810,160   $(986,000)  $1,454,000   $20,425,000 
Issuance of shares of common stock under employee stock purchase plan   11,593    -    13,000    -    -    -    -    -    13,000 
                                              
Stock-based compensation costs   186,575    -    337,000    -    -    -    -    14,000    351,000 
                                              
Foreign currency translation adjustment   -    -    -    (127,000)   -    -    -    -    (127,000)
                                              
Net income (loss)   -    -    -    -    880,000    -    -    (124,000)   756,000 
Balance, June 30, 2018   18,091,931   $9,000   $21,756,000   $(666,000)  $(39,000)   810,160   $(986,000)  $1,344,000   $21,418,000 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

 6 

 

 

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

   Nine Months Ended 
   June 30, 
   2018   2017 
Cash flows from operating activities:          
Net income (loss)  $756,000   $2,408,000 
Adjustments to reconcile net income (loss) to net cash:          
Stock compensation expense   351,000    343,000 
Foreign exchange loss (gain)   13,000    11,000 
Depreciation and amortization   927,000    926,000 
Deferred income taxes   (524,000)   (2,775,000)
Non-cash R&D services   209,000    238,000 
Other   (6,000)   68,000 
Other changes in assets and liabilities:          
Accounts receivable, net   (362,000)   74,000 
Inventories   (153,000)   (408,000)
Costs in excess of billings and unbilled receivables   253,000    25,000 
Prepaid expenses and other assets   42,000    188,000 
Accounts payable   (447,000)   (197,000)
Accrued expenses and other liabilities   55,000    (480,000)
Deferred revenue   (20,000)   (129,000)
Net cash from operating activities   1,094,000    292,000 
           
Cash flows from investing activities:          
Purchases of property, plant and equipment   (1,788,000)   (455,000)
Purchase of intangibles   (65,000)   (78,000)
Net cash from investing activities   (1,853,000)   (533,000)
           
Cash flows from financing activities:          
Proceeds from issuance of common stock   13,000    13,000 
Principal payments on capital leases   (72,000)   (80,000)
Proceeds from (payments of) equipment line of credit, net   281,000    - 
Proceeds from (payments of) bank and subordinated debt, net   (329,000)   (490,000)
Net cash from financing activities   (107,000)   (557,000)
           
Effect of exchange rates on cash and cash equivalents   (38,000)   (19,000)
           
Net change in cash and cash equivalents   (904,000)   (817,000)
           
Cash and cash equivalents, beginning  $2,415,000   $2,607,000 
Cash and cash equivalents, ending  $1,511,000   $1,790,000 
           
Supplemental disclosures of cash flow information:          
Cash paid during the year for:          
Interest  $109,000   $136,000 
Tax payments (refunds)   7,000    3,000 
Non cash activities:          
Assets purchased under capital leases   12,000    - 
Recapitalization of Xcede - conversion of non controlling notes payable to preferred stock   -    (3,103,000)
Subsidiary stock options issued to settle liabilities   -    75,000 
Subsidiary debt issued to fund research activities   -    500,000 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

 7 

 

 

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 1 - Basis of Presentation

 

The accompanying consolidated balance sheet as of June 30, 2018, the consolidated statements of operations and comprehensive income (loss) for the three and nine months ended June 30, 2018 and 2017, changes in stockholders’ equity for the nine months ended June 30, 2018 and cash flows for the nine months ended June 30, 2018 and 2017 of Dynasil Corporation of America and subsidiaries (the “Company”), and the related information contained in these notes have been prepared by management and are unaudited. Xcede Technologies, Inc. (“Xcede”) is a joint venture between Dynasil Biomedical and Mayo Clinic to spin out and separately fund the development of a tissue sealant technology. As of June 30, 2018, Dynasil Biomedical owned 63% of Xcede’s stock and, as a result, Xcede is included in the Company’s consolidated balance sheets, results of operations and cash flows. The remaining 37% of Xcede’s stock is owned by others and is accounted for under the rules applicable to non-controlling interest. Certain prior year balances have been reclassified to conform to the current year presentation. These reclassifications did not affect previously reported net income or stockholders’ equity. In the opinion of management, all adjustments (which include normal recurring and nonrecurring items) necessary to present fairly the Company’s financial position, results of operations and cash flows in conformity with generally accepted accounting principles for the periods presented have been made. Interim operating results are not necessarily indicative of operating results for a full year.

 

The preparation of our unaudited consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the unaudited consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Certain information and note disclosures normally included in the Company's annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's September 30, 2017 Annual Report on Form 10-K previously filed by the Company with the Securities and Exchange Commission.

 

The Company considers events or transactions that have occurred after the unaudited consolidated balance sheet date of June 30, 2018, but prior to the filing of the unaudited consolidated financial statements with the SEC on this Quarterly Report on Form 10-Q, to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure, as applicable. Subsequent events have been evaluated through the date of the filing of this Quarterly Report on Form 10-Q with the SEC.

 

Note 2 – Recent Accounting Pronouncements

 

Effective October 1, 2017, the Company adopted the guidance issued in Accounting Standard Update 2016-09, Improvements to Employee Share-Based Payment Accounting, which intends to simplify various aspects of how share-based payments are accounted for and presented in financial statements. The new standard contains several amendments that will simplify the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, statutory tax withholding requirements, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The changes in the new standard eliminate the accounting for excess tax benefits to be recognized in additional paid-in capital and tax deficiencies recognized either in the income tax provision or in additional paid-in capital. In addition, the new standard eliminates the limitation on recognition of excess stock compensation benefits until such benefits are actually realized, and instead applies the general recognition standard to these deferred tax assets. This standard was applied using a modified retrospective approach and the Company will recognize forfeitures of awards as they occur. The adoption of the ASU had no impact on the retained earnings, other components of equity or net assets as of the beginning of the period of adoption. For the nine month period ended June 30, 2018, the Company recognized all excess tax benefits and tax deficiencies as income tax expense or benefit as a discrete event. The Company has elected to present the cash flow statement on a prospective transition method and no prior periods have been adjusted.

 

 8 

 

 

Effective October 1, 2017, the Company adopted the guidance issued in Accounting Standard Update 2016-17, Consolidation (Topic 810): Interests Held through Related Parties That Are under Common Control, which amends the consolidation guidance on how a reporting entity that is the single decision maker of a VIE should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE. The adoption of this ASU did not have an impact on the Company’s financial statements.

 

Revenue from Contracts with Customers (Topic 606) Section A—Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs—Contracts with Customers (Subtopic 340-40). In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, Revenue from Contracts with Customers, as a new Topic, Accounting Standards Codification (“ASC”) Topic 606.  The new revenue recognition standard relates to revenue from contracts with customers, which, along with subsequent amendments issued, will supersede nearly all current U.S. GAAP guidance on this topic and eliminate industry-specific guidance.

 

As of June 30, 2018, the Company has made significant progress towards completing its assessment of the potential effects of ASU 2014-09 and its amendments on its consolidated financial statements, and is actively assessing the potential effects on business processes, systems and controls to support revenue recognition and the related disclosures under this ASU. The Company is required to adopt the new standards on October 1, 2018, and expects to do so using the modified retrospective transition method with the cumulative effect of initially applying the guidance recognized at the date of initial application. With the assistance of a third party engaged for this purpose, the Company’s assessment includes a detailed review of representative contracts from each of the Company’s revenue streams and a comparison of its historical accounting policies and practices to the new standard. The Company's preliminary assessment of this adoption method supports the determination that there are no expected changes in the accounting for the Research segment’s contract research revenue. Across other revenue streams, the timing of revenue recognition could be affected for multiple types of contracts, primarily multiple element contracts in its Optics segment, but those differences are not expected to have a material impact on the consolidated financial statements. However, the Company's assessment is not yet finalized and is subject to change. Additionally, the Company is currently evaluating any tax implications the adoption of this new standard may have on the consolidated financial statements. As part of this analysis, the Company is evaluating its information technology capabilities and systems, and does not expect to incur significant information technology costs to modify systems currently in place.

 

The Company is in the process of assessing its current revenue controls, and identifying and implementing any changes that may be necessary to comply with its new revenue policies and the provisions of ASU 2014-09, which will be effective for the Company as of October 1, 2018.

 

Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting. In May 2017, the FASB issued ASU No. 2017-09 which was issued to clarify and reduce both (i) diversity in practice and (ii) cost and complexity when applying the guidance in Topic 718, “Compensation – Stock Compensation” to changes in the terms and conditions of a share-based payment award. This update is required beginning with the Company’s 2019 fiscal year and should be applied prospectively to award modifications after the effective date. The Company is currently in the process of assessing the impact of this ASU on its consolidated financial statements.

 

Business Combinations (Topic 805): Clarifying the Definition of a Business: In January 2017, the FASB issued ASU 2017-01 which clarifies the definition of a business for determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The guidance is effective for the Company beginning October 1, 2018. The Company is currently in the process of assessing the impact of this ASU on its consolidated financial statements.

 

Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. In October 2016, the FASB issued ASU 2016-16 which eliminates the exception, other than for inventory transfers, under current U.S. GAAP under which the tax effects of intra-entity asset transfers (intercompany sales) are deferred until the transferred asset is sold to a third party or otherwise recovered through use.  Upon adoption of ASU 2016-16, the Company will recognize the tax expense from the sale of that asset in the seller’s tax jurisdiction when the transfer occurs, even though the pre-tax effects of that transaction are eliminated in consolidation.  Any deferred tax asset that arises in the buyer’s jurisdiction would also be recognized at the time of the transfer.  This new guidance is effective for the Company beginning in fiscal 2019, with early adoption permitted. Modified retrospective adoption is required with any cumulative-effect adjustment recorded to retained earnings as of the beginning of the period of adoption.  The cumulative-effect adjustment, if any, would consist of the net impact from (1) the write-off of any unamortized tax expense previously deferred and (2) recognition of any previously unrecognized deferred tax assets, net of any necessary valuation allowances.  The adoption of this standard is not expected to have a material impact on the Company’s financial statements.

 

 9 

 

 

Service Concession Arrangements (Topic 853): Determining the Customer of the Operation Services. In May 2017, the FASB issued ASU 2017-10 which provides guidance for operating entities when they enter into a service concession arrangement with a public-sector grantor. The ASU becomes effective for the Company at the beginning of its 2019 fiscal year, at the time the Company adopts Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606). The Company is currently in the process of assessing the impact of this ASU on its consolidated financial statements.

 

Leases (Topic 842). In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires lessees to put most leases on their balance sheets by recognizing a lessee’s rights and obligations, while expenses will continue to be recognized in a similar manner to today’s legacy lease accounting guidance. This ASU could also significantly affect the financial ratios used for external reporting and other purposes, such as debt covenant compliance. This new guidance is effective for the Company beginning in fiscal 2020, with early adoption permitted. The Company is currently in the process of assessing the impact of this ASU on its consolidated financial statements with the intention to adopt this ASU in fiscal year 2020.

 

Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment: In January 2017, the FASB issued ASU 2017-04 which simplifies the test for goodwill impairment by eliminating Step 2 from the Goodwill impairment test. This new guidance is effective for the Company beginning in fiscal year 2021. The adoption of this standard is not expected to have a material impact on the Company’s financial statements.

 

On December 22, 2017, the date the Tax Cuts and Jobs Act (“2017 Tax Act”) was signed into law, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) which provides guidance regarding accounting for the income tax effects of the Tax Cuts Act, including the impact of the Tax Cuts Act on deferred tax assets and liabilities for financial statements issued in the reporting period that includes the enactment date of December 22, 2017. The Company estimated and accounted for the tax implications of the Tax Cuts Act in the quarter ended December 31, 2017 and the resultant changes are reflected in the current financial statements. The Company re-measured certain U.S. deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%, and provisionally recorded an income tax expense of $0.5 million related to such re-measurement in the first quarter of fiscal 2018. It is still analyzing certain aspects of the Tax Act and refining its calculations during the measurement period. See Note 11 – Income Taxes.

 

Note 3 – Xcede Technologies, Inc. Joint Venture

 

In October 2013, the Company, through its subsidiary Dynasil Biomedical (“DBM”), formed Xcede, a joint venture with Mayo Clinic, in order to spin out and separately fund the development of its hemostatic tissue sealant technology, which formerly comprised the majority of its expense within the Biomedical segment.

 

Beginning at its inception and through November 2016, Xcede funded its pre-clinical research activities through the issuance of convertible notes bearing interest at 5% (the “Notes”) pursuant to a note purchase agreement dated October 2013 and most recently amended in November 2016 that provided for the issuance of up to $5.2 million in the aggregate principal amount of the Notes from external investors and certain directors and officers of the Company. The Notes were convertible into equity of Xcede.

 

In November 2016, Dynasil committed to invest $1.2 million of cash into Xcede over the following 18 months, all of which was invested prior to January 31, 2018, in exchange for Series B convertible preferred stock of Xcede (“Series B Preferred”). The value of the Series B Preferred, as it is wholly owned by DBM, was eliminated in consolidation. In conjunction with Dynasil’s committed investment, all $5.5 million in existing Notes and accrued interest were converted into 5,394,120 shares of Series A convertible preferred stock of Xcede (“Series A Preferred”) at a 20% discount to the price per share of the Series B Preferred, in accordance with the amended provisions of the Notes. The original conversion terms of the Notes were amended to require conversion into Series A Preferred rather than the class of stock issued in conjunction with the financing (Series B Preferred). Because the original conversion terms of the Notes were amended and as a result of assessing the impact of the rights and features of the Note amendment and their effect on the value to the issuer and holders, the transaction is recorded at fair value with a resulting gain on extinguishment of debt in the quarter ended December 31, 2016. Fair value was determined by management based on an independent valuation using a market and income approach and an option pricing model to allocate value to the respective shares. The fair value of the Series A Preferred was approximately $3.6 million on the date of issuance, as compared to the carrying value of the convertible principal and accrued interest of $5.5 million, resulting in a gain of approximately $1.9 million. Due to the related party nature of the transaction, this gain was recorded within the equity of Xcede. Of that $1.9 million, approximately $1.6 million was attributed to DBM and eliminated in consolidation, and approximately $0.3 million was attributed to noncontrolling interest.

 

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Series A Preferred participants included both outside investors (accounted for as noncontrolling interest) and DBM. The outside investors converted $3.1 million of Notes and accrued interest into 3,055,551 shares of Series A Preferred. DBM converted the remaining $2.4 million of Notes and accrued interest into 2,338,569 shares of Series A Preferred, the value of which is eliminated in consolidation.

 

Each share of Series A Preferred and Series B Preferred (together the “Preferred Stock”) shall be convertible, at the option of the holder, into such number of fully paid and non-assessable shares of Xcede common stock (“Common Stock”) as determined by dividing the original issue price, as defined, by the conversion price in effect on the date of conversion, which is 1:1. Each holder of the Preferred Stock shall have one vote for each share of Common Stock that the holder of the Preferred Stock would be entitled to receive upon the conversion of the holder’s Preferred Stock into Common Stock. Upon any liquidation event, which includes certain change of control events, following payment of pre-equity distributions, the remaining proceeds or net assets of Xcede shall be paid and distributed in the following amounts and order of priority: (1) to satisfy the liquidation preference payment due to each holder of Series B Preferred, (2) to satisfy the liquidation preference payment due to each holder of Series A Preferred, (3) payment in full of any acquisition transaction payment, and (4) the remaining assets available to be distributed ratably among the holders of the Common Stock. If a liquidation event were to occur, the Series A Preferred’s liquidation value would be $1.016 per share and Series B Preferred’s liquidation value would be $1.27 per share. As of June 30, 2018, the liquidation value of the Series B Preferred would be approximately $1.5 million and the Series A Preferred would be approximately $5.5 million, of which $2.4 million is DBM’s portion and $3.1 million would be attributed to noncontrolling shareholders.

 

As of June 30, 2018, DBM owned approximately 63% of Xcede’s outstanding Common Stock and Preferred Stock and, as a result, Xcede is included in the Company’s consolidated balance sheets, results of operations and cash flows. Due to the Series A Preferred having a liquidation preference and therefore not representing a residual interest, cumulative net losses of Xcede are attributed only to common stockholders in accordance with common stock ownership. Noncontrolling interest represents the value of the Series A Preferred and common stock not owned by DBM plus 17% of cumulative losses of Xcede based on the 17% common stock ownership held by noncontrolling interests.

 

Due to the issuance of Preferred Stock, DBM’s ownership percentage in Xcede decreased to less than 80%. Based on this ownership percentage, beginning in fiscal year 2017, Xcede is no longer included in the Dynasil consolidated federal tax return and the Company is no longer able to offset taxable income or benefit from net operating losses and other tax attributes related to Xcede. (See Note 11 – Income Taxes.)

 

As previously disclosed, in January 2016, Xcede announced that it had signed three agreements with Cook Biotech Inc. of West Lafayette, Indiana (“CBI”), including a Development Agreement, a License Agreement and a Supply Agreement, in connection with the development, regulatory approval and production of Xcede’s hemostatic patch (“Xcede Patch”). In November 2016, Xcede entered into another Services Agreement, a Secured Promissory Note, a Loan Agreement, a Security Agreement and an Intellectual Property Security Agreement (collectively the “Note Agreement”) with CBI, in which CBI committed to fund the pre-clinical testing of, and subject to the receipt of applicable regulatory approvals to initiate first in human clinical trial for, the Xcede Patch. Under the terms of the Note Agreement, in exchange for the services performed by CBI, Xcede committed to a multiple draw credit facility in the aggregate amount not to exceed $1.5 million. The Note Agreement made available three draws of principal, each in the amount of $500,000, upon satisfaction of conditions identified in the Note Agreement. The principal amounts outstanding bear interest at a fixed rate of 2% and are secured by all the rights of Xcede under the Development Agreement, Supply Agreement, and License Agreement, all the rights to the data and work product arising from the clinical trial being performed under the Services Agreement, all regulatory approvals for the Xcede Patch, all patent and patent applications owned or controlled by Xcede, and all trademark and service mark registrations and applications. The note was recorded at fair value net of unamortized discount based on an imputed interest rate of 5.4%. The outstanding principal and unpaid interest are due and payable in full at the earlier of closing of an acquisition transaction or December 31, 2025. Xcede will recognize research and development expense as the related services are performed by CBI. There was approximately $8,000 and $33,000 of research and development expense recognized during the three months ended June 30, 2018 and 2017, respectively. There was approximately $209,000 and $238,000 recognized during the nine months ended June 30, 2018 and 2017, respectively.

 

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On July 20, 2018, Xcede received a notice of termination from CBI, its collaboration partner with respect to the Xcede Patch currently under development. CBI asserted its termination rights under the Services Agreement dated November 16, 2016 and Development Agreement dated January 6, 2016 between Xcede and CBI, claiming that the results of a recent animal study showed that it is not commercially reasonable, in CBI’s assessment, to continue to the next development phase of the Xcede Patch. Upon a valid termination, CBI has no obligation to conduct further developmental activities with respect to the Xcede Patch, including any further in-kind funding under the Loan Agreement dated November 16, 2016 between Xcede and CBI. In addition, CBI has asserted that these study results trigger an immediate repayment of the $500,000 promissory note owed by Xcede to CBI under the Loan Agreement, which otherwise has a stated maturity of December 31, 2025. The Xcede promissory note is collateralized by a security interest which CBI has in all of Xcede’s intellectual property. While Xcede vigorously contests this assertion, at this time it is unclear how this matter will be resolved between Xcede and CBI. The Company continues to carry the promissory note in long-term debt.

 

As a result of this action by CBI, Xcede has halted clinical trial preparations at this time and has curtailed its operations to a minimal level while the Board of Directors of Xcede evaluates alternatives, including the viability of modifying the Xcede Patch to address the shortcomings cited by CBI and/or the possible sale or license of Xcede IP assets, subject to amending the security interest described above. There can be no assurances with respect to any such alternatives.

 

Dynasil is the sole holder of Xcede Series B Preferred Stock, which ranks senior to the other classes of outstanding Xcede equity, but junior to all Xcede indebtedness. Dynasil also owns shares of Xcede Series A Preferred Stock and Common Stock. On an as-converted basis, Dynasil indirectly owns about 63% of the shares outstanding.

 

Dynasil has no contractual obligation with respect to Xcede indebtedness. The Xcede promissory note is a contractual obligation solely of Xcede and is secured by Xcede’s intellectual property.

 

Dynasil’s Biomedical segment consists of a single business unit, Dynasil Biomedical Corporation, which has no operations other than to its equity ownership in Xcede. Since inception, this segment has had no revenue and has operated at a substantial loss. Dynasil does not currently anticipate any material impairment of assets or write-offs affecting its consolidated financial statements with respect to this segment as a result of this development.

 

Note 4 - Inventories

 

Inventories, net of reserves, consists of the following:

 

   June 30,   September 30, 
   2018   2017 
Raw Materials  $2,362,000   $2,540,000 
Work-in-Process   1,066,000    798,000 
Finished Goods   1,029,000    988,000 
   $4,457,000   $4,326,000 

 

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Note 5 – Intangible Assets

 

Intangible assets at June 30, 2018 and September 30, 2017 consist of the following:

 

   Useful  Gross   Accumulated     
June 30, 2018  Life (years)  Amount   Amortization   Net 
Acquired Customer Base  5 to 15  $722,000   $588,000   $134,000 
Know How  15   512,000    341,000    171,000 
Trade Names  Indefinite   274,000    -    274,000 
Patents  20   397,000    17,000    380,000 
Biomedical Technologies  5   260,000    260,000    - 
      $2,165,000   $1,206,000   $959,000 
                   
   Useful   Gross    Accumulated       
September 30, 2017  Life (years)   Amount    Amortization    Net 
Acquired Customer Base  5 to 15  $737,000   $551,000   $186,000 
Know How  15   512,000    316,000    196,000 
Trade Names  Indefinite   281,000    -    281,000 
Patents  20   333,000    9,000    324,000 
Biomedical Technologies  5   260,000    260,000    - 
      $2,123,000   $1,136,000   $987,000 

  

Amortization expense for the three months ended June 30, 2018 and 2017 was $28,000 and $24,000, respectively. Amortization expense for the nine months ended June 30, 2018 and 2017 was $84,000 and $75,000, respectively.

 

Estimated amortization expense for each of the next five fiscal years and thereafter is as follows:

 

   2018 (3 months)   2019   2020   2021   2022   Thereafter   Total 
Acquired Customer Base  $20,000   $80,000   $34,000   $-   $-   $-   $134,000 
Know How   9,000    34,000    34,000    34,000    34,000    26,000    171,000 
Patents   3,000    11,000    11,000    11,000    11,000    162,000    209,000 
   $32,000   $125,000   $79,000   $45,000   $45,000   $188,000   $514,000 

 

As of June 30, 2018, Xcede had $171,000 in patents that have not yet been granted, therefore, the amortization related to these patents is not included in the five-year amortization table above.

 

The Company continually assesses whether events or changes in circumstances have occurred that may warrant revision of the estimated useful lives of its long-lived assets or whether the remaining balances of those assets should be evaluated for possible impairment. There were no changes, aside from foreign exchange rate fluctuations, in the carrying value of long-lived assets, during the nine months ended June 30, 2018 and 2017.

 

Note 6 – Goodwill

 

Goodwill is subject to an annual impairment test. The Company considers many factors which may indicate the requirement to perform additional, interim impairment tests. These include:

 

·A significant adverse long term outlook for any of its industries;
·An adverse finding or rejection from a regulatory body involved in new product regulatory approvals;
·Failure of an anticipated commercialization of a product or product line;
·Unanticipated competition or the introduction of a disruptive technology;
·The testing for recoverability under the Impairment or Disposal of Long-Lived Assets Subsections of Subtopic 360-10 of a significant asset group within a reporting unit;
·A loss of key personnel; and

·An expectation that a reporting unit carrying goodwill, or a significant portion of a reporting unit, will be sold or otherwise disposed of.

 

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There were no changes, aside from foreign exchange rate fluctuations, in the carrying value of goodwill, during the nine months ended June 30, 2018 and 2017.

 

Note 7 – Debt

 

Senior Debt

 

On July 31, 2018, the Company converted the outstanding balance on the equipment line of credit with Middlesex Savings Bank (“Middlesex”) of approximately $750,000, of which $281,000 was outstanding on June 30, 2018, into a five year term note with an interest rate of 5.66%. Additionally, on August 9, 2018, the Company’s equipment line of credit was renewed for $750,000 through April 30, 2019, at which time the outstanding balance will be converted into a five year term note. As part of the renewal process and due to the additional credit being extended to the Company, the Middlesex loan and security agreement was amended on August 9, 2018 to decrease the maximum debt leverage ratio covenant to 2.5x from 3.0x.

 

On both March 31, 2018 and June 30, 2018, the Company was in compliance with all but one of the financial covenants contained in the loan agreement with Middlesex that require us to maintain certain ratios of earnings before interest, taxes, depreciation and amortization to fixed charges and to total debt and senior debt. On August 9, 2018, Middlesex issued a waiver for these events, as this circumstance arose due to the timing of equipment purchases as the Company invests for the future. The current year forecast shows Dynasil quickly resolving this situation and coming back into compliance with this covenant for the end of the fiscal year.

 

Subordinated Debt

 

On January 3, 2018, the Company amended the Note Purchase Agreement with Massachusetts Capital Resource Company to reinstate the interest only payment requirements of the loan and defer principal repayment requirements to November 30, 2018. Such amendment also increased the interest rate of the note from six percent (6%) to seven percent (7%) per annum.

 

Note 8 – Earnings (Loss) Per Common Share

 

Basic earnings (loss) per common share is computed by dividing the net income or loss attributable to common shares by the weighted average number of common shares outstanding. Diluted earnings per common share adjusts basic earnings per share for the effects of common stock options, common stock warrants, convertible preferred stock and other potential dilutive common shares outstanding during the periods.

 

For purposes of computing diluted earnings per share for the three and nine months ended June 30, 2018 and 2017, no common stock options were included in the calculation of dilutive shares as all of the 160,537 and 196,769 common stock options outstanding, respectively, had exercise prices above the applicable period’s average market price per share and their inclusion would be anti-dilutive. For both the three and nine months ended June 30, 2017, 70,000 shares of unvested restricted common stock were excluded from the calculation of dilutive shares, as the effect of their inclusion would be anti-dilutive. Additionally, for the three months ended June 30, 2017, no common share equivalents related to stock options or unvested restricted stock were included in the calculation of dilutive shares, since there was a loss attributable to common shareholders and the inclusion of common share equivalents would be anti-dilutive.

 

The computation of the weighted shares outstanding for the three months ended June 30, 2018 and 2017 is as follows:

 

   June 30, 2018   June 30, 2017 
Weighted average shares outstanding          
Basic   17,203,965    16,945,744 
Effect of dilutive securities          
Stock Options   -    - 
Restricted Stock   17,234    - 
Dilutive Average Shares Outstanding   17,221,199    16,945,744 

 

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The computation of the weighted shares outstanding for the nine months ended June 30, 2018 and 2017 is as follows:

 

   June 30, 2018   June 30, 2017 
Weighted average shares outstanding          
Basic   17,127,834    16,879,864 
Effect of dilutive securities          
Stock Options   -    - 
Restricted Stock   19,394    - 
Dilutive Average Shares Outstanding   17,147,228    16,879,864 

 

Note 9 - Stock Based Compensation

 

The fair value of the stock options granted is estimated at the date of grant using the Black-Scholes option pricing model.

 

The expected volatility was determined with reference to the historical volatility of the Company's stock. The Company uses historical data to estimate option exercise within the valuation model. The expected term of options granted represents the period of time that the options granted are expected to be outstanding. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury rate in effect at the time of grant. The dividend yield is expected to be zero because historically the Company has not paid dividends on common stock.

 

The Company’s Xcede joint venture adopted an Equity Incentive Plan in 2013 which provides for, among other incentives, the granting of options to purchase shares in Xcede’s common stock to officers, directors, employees and consultants. The options granted generally vest over a three year period. The fair value of the stock options granted is estimated at the date of grant using the Black-Scholes option pricing model using assumptions generally consistent with those used for Company stock options. Because Xcede is not publicly traded, the expected volatility is estimated with reference to the average historical volatility of a group of publicly traded companies that are believed to have similar characteristics to Xcede.

 

Stock compensation expense for the three and nine months ended June 30, 2018 and 2017 is as follows:

 

   Three Months Ended   Three Months Ended 
   June 30, 2018   June 30, 2017 
Stock Grants  $78,000   $60,000 
Restricted Stock Grants   14,000    13,000 
Option Grants   -    12,000 
Employee Stock Purchase Plan   1,000    1,000 
Subsidiary Option Grants   27,000    30,000 
Total  $120,000   $116,000 

 

   Nine Months Ended   Nine Months Ended 
   June 30, 2018   June 30, 2017 
Stock Grants  $209,000   $183,000 
Restricted Stock Grants   40,000    39,000 
Option Grants   17,000    37,000 
Employee Stock Purchase Plan   2,000    2,000 
Subsidiary Option Grants   83,000    82,000 
Total  $351,000   $343,000 

 

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At June 30, 2018, there was approximately $71,000 in unrecognized stock compensation cost for Dynasil, which is expected to be recognized over a weighted average period of approximately twelve months.

 

Restricted Stock Grants

 

A summary of restricted stock activity for the nine months ended June 30, 2018 is presented below:

 

Restricted Stock Activity for the Nine Months ended
June 30, 2018
  Shares   Weighted-Average
Grant-Date Fair Value
 
Nonvested at September 30, 2017   70,000   $1.73 
           
Granted   20,000    1.37 
Vested   (30,000)   1.73 
Cancelled   -    - 
Nonvested and expected to vest at June 30, 2018   60,000   $1.61 

 

Stock Option Grants

 

During the nine months ended June 30, 2018, no Dynasil stock options were granted. A summary of stock option activity for the nine months ended June 30, 2018 is presented below:

 

   Options
Outstanding
   Weighted Average
Exercise Price per
Share
   Weighted Average
Remain Contractual
Term (in Years)
 
Balance at September 30, 2017   196,769   $1.98    1.64 
Outstanding and exercisable at September 30, 2017   196,769   $1.98    1.64 
Granted   -    -      
Exercised   -    -      
Cancelled   (36,232)   1.82      
Balance at June 30, 2018   160,537   $2.01    1.18 
Outstanding and exercisable at June 30, 2018   160,537   $2.01    1.18 
                

 

Subsidiary Stock Option Grants

 

During the three months ended June 30, 2018, no Xcede stock options were granted. A summary of Xcede stock option activity for the nine months ended June 30, 2018 is presented below:

 

   Options
Outstanding
   Weighted Average
Exercise Price per
Share
   Weighted Average
Remain Contractual
Term (in Years)
 
Balance at September 30, 2016   123,147   $2.30    1.69 
Outstanding and exercisable at September 30, 2016   123,147   $2.30    1.69 
Granted   95,602    1.80    2.59 
Exercised   -    -      
Cancelled   (21,980)   3.03      
Balance at June 30, 2017   196,769   $1.98    1.89 
Outstanding and exercisable at June 30, 2017   196,769   $1.98    1.89 

 

At June 30, 2018, the Company’s Xcede joint venture had approximately $70,000 of unrecognized stock compensation expense associated with stock options expected to be recognized over a weighted average period of seven months.

 

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Note 10 – Segment, Customer and Geographical Reporting

 

Segment Financial Information

 

Dynasil reports three reportable segments: contract research (“Contract Research”), optics (“Optics”) and biomedical (“Biomedical”). Within these segments, there is a segregation of operating segments based upon the organizational structure used to evaluate performance and make decisions on resource allocation, as well as availability and materiality of separate financial results consistent with that structure. The Optics segment aggregates four operating segments – Dynasil Fused Silica, Optometrics, Hilger Crystals (“Hilger”), and Evaporated Metal Films – that manufacture commercial products, including optical crystals for sensing in the security and medical imaging markets, as well as optical components, optical coatings and optical materials for scientific instrumentation and other applications. The Contract Research segment is one of the largest small business participants in U.S. government-funded research. The Biomedical segment consists of a single operating segment, Dynasil Biomedical Corporation (“Dynasil Biomedical”), a medical technology incubator which owns rights to certain early stage medical technologies. Dynasil Biomedical holds common and preferred stock in the Xcede joint venture which is developing a tissue sealant technology and currently has no other operations.

 

The Company’s segment information for the three months ended June 30, 2018 and 2017 is summarized below:

 

Results of Operations for the Three Months Ended June 30,
2018
   Optics   Contract
Research
   Biomedical   Total 
Revenue  $6,159,000   $4,383,000   $-   $10,542,000 
Gross profit   2,299,000    1,876,000    -    4,175,000 
GM %   37%   43%   -    40%
Operating expenses   1,721,000    1,760,000    84,000    3,565,000 
Operating income (loss)   578,000    116,000    (84,000)   610,000 
                     
Depreciation and amortization   261,000    53,000    3,000    317,000 
Capital expenditures   707,000    76,000    20,000    803,000 
                     
Intangibles, net   408,000    171,000    380,000    959,000 
Goodwill   968,000    4,939,000    -    5,907,000 
Total assets  $21,117,000   $8,018,000   $507,000   $29,642,000 

 

Results of Operations for the Three Months Ended June 30,
2017
    Optics    Contract
Research
    Biomedical    Total 
Revenue  $4,837,000   $3,999,000   $-   $8,836,000 
Gross profit   1,655,000    1,709,000    -    3,364,000 
GM %   34%   43%   -    38%
Operating expenses   1,619,000    1,640,000    377,000    3,636,000 
Operating income (loss)   36,000    69,000    (377,000)   (272,000)
                     
Depreciation and amortization   248,000    52,000    1,000    301,000 
Capital expenditures   179,000    54,000    26,000    259,000 
                     
Intangibles, net   468,000    205,000    394,000    1,067,000 
Goodwill   955,000    4,939,000    -    5,894,000 
Total assets  $19,488,000   $8,004,000   $690,000   $28,182,000 

 

The Company’s segment information for the nine months ended June 30, 2018 and 2017 is summarized below:

 

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Results of Operations for the Nine Months Ended June 30,
2018
   Optics   Contract
Research
   Biomedical   Total 
Revenue  $17,011,000   $12,974,000   $-   $29,985,000 
Gross profit   6,038,000    5,621,000    -    11,659,000 
GM %   35%   43%   -    39%
Operating expenses   5,154,000    5,297,000    724,000    11,175,000 
Operating income (loss)   884,000    324,000    (724,000)   484,000 
                     
Depreciation and amortization   738,000    179,000    10,000    927,000 
Capital expenditures   1,635,000    153,000    65,000    1,853,000 
                     
Intangibles, net   408,000    171,000    380,000    959,000 
Goodwill   968,000    4,939,000    -    5,907,000 
Total assets  $21,117,000   $8,018,000   $507,000   $29,642,000 

 

Results of Operations for the Nine Months Ended June 30,
2017
    Optics    Contract
Research
    Biomedical    Total 
Revenue  $14,524,000   $13,541,000   $-   $28,065,000 
Gross profit   5,144,000    5,535,000    -    10,679,000 
GM %   35%   41%   -    38%
Operating expenses   4,544,000    5,182,000    1,150,000    10,876,000 
Operating income (loss)   600,000    353,000    (1,150,000)   (197,000)
                     
Depreciation and amortization   719,000    200,000    7,000    926,000 
Capital expenditures   373,000    88,000    72,000    533,000 
                     
Intangibles, net   468,000    205,000    394,000    1,067,000 
Goodwill   955,000    4,939,000    -    5,894,000 
Total assets  $19,488,000   $8,004,000   $690,000   $28,182,000 

 

Customer Financial Information

 

For both the three and nine months ended June 30, 2018 and 2017, no customer in the Optics segment represented more than 10% of the total segment revenue.

 

For the three months ended June 30, 2018, four customers of the Contract Research segment, three various agencies of the U.S. Government and one commercial customer, each represented more than 10% of the total segment revenue. For the nine months ended June 30, 2018, three customers of the Contract Research segment, all various agencies of the U.S. Government, each represented more than 10% of the total segment revenue. For the three and nine months ended June 30, 2017, three customers of the Contract Research segment, all various agencies of the U.S. Government, each represented more than 10% of the total segment revenue. For the three months ended June 30, 2018 and 2017, these customers made up 72% and 52%, respectively, of Contract Research revenue. For the nine months ended June 30, 2018 and 2017, these customers made up 59% and 58%, respectively, of Contract Research revenue.

 

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Geographic Financial Information

 

Revenue by geographic location in total and as a percentage of total revenue, for the three months ended June 30, 2018 and 2017 are as follows:

 

   Three Months Ended   Three Months Ended 
   June 30, 2018   June 30, 2017 
Geographic Location  Revenue   % of Total   Revenue   % of Total 
United States  $7,512,000    71%  $6,928,000    78%
Europe   2,029,000    19%   962,000    11%
Other   1,001,000    10%   946,000    11%
   $10,542,000    100%  $8,836,000    100%

 

Revenue by geographic location in total and as a percentage of total revenue, for the nine months ended June 30, 2018 and 2017 are as follows:

 

   Nine Months Ended   Nine Months Ended 
   June 30, 2018   June 30, 2017 
Geographic Location  Revenue   % of Total   Revenue   % of Total 
United States  $22,993,000    77%  $22,051,000    78%
Europe   4,662,000    15%   3,262,000    12%
Other   2,330,000    8%   2,752,000    10%
   $29,985,000    100%  $28,065,000    100%

 

Note 11 - Income Taxes

 

The Company uses the asset and liability approach to account for income taxes. Under this approach, deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and net operating loss and tax credit carry forwards. The amount of deferred taxes on these temporary differences is determined using the tax rates that are expected to apply to the period when the asset is realized or the liability is settled, as applicable, based on tax rates, and tax laws, in the respective tax jurisdiction then in effect. 

 

Dynasil Corporation of America and its wholly-owned U.S. subsidiaries file a consolidated federal income tax return and various state returns. The Company’s U.K. subsidiary files tax returns in the U.K. Prior to November 18, 2016, the Company’s subsidiary, Xcede was included in the federal and state tax returns filed by Dynasil. As of November 18, 2016, Dynasil’s ownership in Xcede was reduced to approximately 59%. As a result, Xcede is no longer included in Dynasil’s federal consolidated tax return and files a separate federal return. Xcede continues to be included in the Dynasil consolidated state tax filings pursuant to the respective state tax requirements.

 

In assessing the ability to realize the net deferred tax assets, management considers various factors including taxable income in carryback years, future reversals of existing taxable temporary differences, tax planning strategies and projections of future taxable income, to determine whether it is more likely than not that some portion or all of the net deferred tax assets will not be realized.

 

As a result of Xcede’s de-consolidation from the Company’s federal tax returns, the Company will no longer be able to offset taxable income with Xcede’s current or cumulative net operating losses. Upon review of relevant criteria for the new Dynasil federal consolidated group, it was determined that it is more likely than not that the federal deferred tax assets of the new Dynasil federal consolidated group will be realized based upon positive earnings history and expected future profits of the group. As a result, the federal deferred tax asset valuation allowance associated with the Dynasil federal consolidated group was reversed resulting in an income tax benefit in the amount of $2.7 million during the quarter ending December 31, 2016. Going forward, as the Company records income, it will be able to utilize the NOLs (net operating losses) within its deferred tax assets. Based upon the Company’s recent losses and uncertainty of future profits, the Company has determined that the uncertainty regarding the realization of the Company’s state and separate Xcede deferred tax assets is sufficient to warrant the continued need for a valuation allowance against these deferred tax assets.

 

 19 

 

 

The Company applies the authoritative provisions related to accounting for uncertainty in income taxes. As required by these provisions, the Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more-likely-than-not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being reached upon ultimate settlement with the relevant tax authority. As of June 30, 2018 and September 30, 2017, the Company has no liabilities for uncertain tax positions. Interest and penalty charges, if any, related to uncertain tax positions would be classified as income tax expense in the accompanying consolidated statement of operations. As of June 30, 2018 and September 30, 2017, the Company had no accrued interest or penalties related to uncertain tax positions. The Company currently has no federal or state tax examinations in progress. 

 

On December 22, 2017, the 2017 Tax Act was signed into law. The 2017 Tax Act, which was effective on December 22, 2017, significantly revised the U.S. tax code by, among other changes, lowering the corporate income tax rate from 35% to 21%, requiring a one-time transition tax on accumulated foreign earnings of certain foreign subsidiaries that were previously tax deferred and creating new taxes on certain foreign sourced earnings.  At June 30, 2018, the Company has not completed its accounting for the tax effects of the 2017 Tax Act; however, the Company has made a reasonable estimate of the effects on its existing deferred tax balances and the one-time transition tax.  The Company is reviewing and will continue to review its accounting of the tax effects of the 2017 Tax Act through the end of the fiscal year.

 

The Company re-measured certain U.S. deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%, and provisionally recorded an income tax expense of $0.5 million related to such re-measurement in the first quarter of fiscal 2018. It is still analyzing certain aspects of the Tax Act and refining its calculations during the measurement period.

 

The one-time transition tax is based on the total unremitted earnings of the Company’s foreign subsidiary, Hilger, which has previously been deferred from U.S. income taxes. The Company recorded a provisional amount for its one-time transition liability of its foreign subsidiary resulting in additional income tax expense of $0.2 million in the first quarter of fiscal 2018. The Company has not yet completed its calculation of the total unremitted earnings of Hilger. The transition tax is based in part on the amount of those earnings held in cash and other specified assets. The amount may change when the Company finalizes the calculation of Hilger’s total unremitted earnings previously deferred from U.S. federal taxation and finalizes the amounts held in cash or other specified assets.

 

There are Research and Experimentation tax credits available at both the federal and state levels resulting from the PATH Act of 2015 (“PATH 2015 R&E Tax Credit”). These credits are designed to encourage and reward companies for efforts in areas of research and experimentation. In June 2018, the Company completed a study encompassing all business activities and contracts in these areas for the years 2012 through 2016. As a result, the Company will have net tax credits of approximately $1.3 million on its federal income tax returns for the years ended September 30, 2012, 2013, 2014, 2015 and 2016 and approximately $0.8 million in state tax credits for the same time periods. 

 

During the quarter ended June 30, 2018, the Company completed its state PATH 2015 R&E Tax Credit analysis which resulted in an additional $800,000 of tax credits, largely against future state tax expenses. Due to the Company’s state tax filing status requiring Dynasil to continue to consolidate the Xcede losses for state tax purposes, this credit had a full tax valuation reserve applied to it and, accordingly, is not reflected in the statement of operations for the quarter. The PATH 2015 R&E Tax Credit totals approximately $2.1 million, of which the Federal component of $1.3 million is reflected in the Statement of Operations for the nine months ended June 30, 2018. This $800,000 of additional state PATH 2015 R&E Tax Credit is available as an offset to future state tax expenses.

 

The effective tax rates were 34% and 34% for the three months ended June 30, 2018 and 2017, respectively.  The effective tax rates were (115%) and 767% for the nine months ended June 30, 2018 and 2017, respectively. The results for both nine month periods ended June 30, 2018 and 2017 had significant events which resulted in an extreme variation in tax rates. The effective tax rate for the nine months ended, June 30, 2018 was primarily driven by the recently signed 2017 Tax Act, as well as the R&E tax credit study completed in the second quarter of fiscal year 2018. The effective tax rate for the nine months ended June 30, 2017 was primarily the result of the tax benefit of $2.7 million recorded for the release of the valuation allowance as a result of the tax deconsolidation of its Xcede subsidiary. The effective tax rate excluding the impact of the 2017 Tax Act was (308%) for the nine months ended June 30, 2018. The effective tax rates excluding the impact of the 2017 Tax Act, the PATH 2015 R&E Tax Credit, and the valuation allowance were 69% and (46%) for the nine months ended June 30, 2018 and 2017, respectively.

 

 20 

 

 

The Company files its tax returns as prescribed by the tax laws of the jurisdictions in which it operates. The Company’s tax filings for federal and state jurisdictions for the tax years beginning with 2014 are still subject to examination.

 

Note 12 – Subsequent Events

 

On July 20, 2018, Xcede received a notice of termination from CBI, its collaboration partner with respect to the Xcede Patch currently under development. CBI asserted its termination rights under the Services Agreement dated November 16, 2016 and Development Agreement dated January 6, 2016 between Xcede and CBI, claiming that the results of a recent animal study showed that it is not commercially reasonable, in CBI’s assessment, to continue to the next development phase of the Xcede Patch. Upon a valid termination, CBI has no obligation to conduct further developmental activities with respect to the Xcede Patch, including any further in-kind funding under the Loan Agreement dated November 16, 2016 between Xcede and CBI. In addition, CBI has asserted that these study results trigger an immediate repayment of the $500,000 promissory note owed by Xcede to CBI under the Loan Agreement, which otherwise has a stated maturity of December 31, 2025. The Xcede promissory note is collateralized by a security interest which CBI has in all of Xcede’s intellectual property. While Xcede vigorously contests this assertion, at this time it is unclear how this matter will be resolved between Xcede and CBI. See Note 3 for additional information.

 

On July 31, 2018, the Company converted the outstanding balance on the equipment line of credit with Middlesex Savings Bank (“Middlesex”) of approximately $750,000, of which $281,000 was outstanding on June 30, 2018, into a five year term note with an interest rate of 5.66%. Additionally, on August 9, 2018, the Company’s equipment line of credit was renewed for $750,000 through April 30, 2019, at which time the outstanding balance will be converted into a five year term note. As part of the renewal process and due to the additional credit being extended to the Company, the Middlesex loan and security agreement was amended on August 9, 2018 to decrease the maximum debt leverage ratio covenant to 2.5x from 3.0x.

 

On both March 31, 2018 and June 30, 2018, the Company was in compliance with all but one of the financial covenants contained in the loan agreement with Middlesex that require us to maintain certain ratios of earnings before interest, taxes, depreciation and amortization to fixed charges and to total debt and senior debt. On August 9, 2018, Middlesex issued a waiver for these events, as this circumstance arose due to the timing of equipment purchases as the Company invests for the future. The current year forecast shows Dynasil quickly resolving this situation and coming back into compliance with this covenant for the end of the fiscal year.

 

The Company has evaluated subsequent events through the date the financial statements were released.

 

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following management's discussion and analysis should be read in conjunction with our financial statements and the notes thereto contained herein and in the Dynasil Corporation of America ("Dynasil", the "Company" or "we") Form 10-K for the fiscal year ended September 30, 2017.

 

General Business Overview

 

Operations

 

Consolidated revenue for the quarter ended June 30, 2018 was $10.5 million, compared to revenue of $8.8 million for the third quarter of fiscal year 2017. This 19% increase in revenue was attributable to a 27% increase in our Optics segment revenue and a 10% increase in our Research segment revenue this period.

 

Consolidated revenue for the nine months ended June 30, 2018 also showed an increase over the same period in 2017, rising 7% to $30.0 million from $28.1 million. Our Optics segment revenue increased 17% year to date over the prior period, offsetting the Research segment revenue decrease of 4%, due to both lower commercial revenue as anticipated orders were delayed, and lower research revenue, due to the timing of contracts in the first two quarters of 2018.

 

Cost of revenue for the third quarter of 2018 was $6.4 million or 60% of revenue, a decrease of 2% over the 62% or $5.5 million cost of revenue for the quarter ended June 30, 2017. The decrease in percentage of revenue from fiscal year 2018 to fiscal year 2017 is reflective of the slight increase in overall revenue during the quarter, along with steps taken in the Optics segment to reduce manufacturing costs.

 

Total operating expenses were $3.6 million for the three-month period ended June 30, 2018, essentially the same as in the same period in fiscal year 2017. Despite the significant increase in revenue, expenses were held in check primarily due to a $0.3 million decrease in the Biomedical segment expenses. The reduced spending in Biomedical offset the increased spending across multiple areas, such as customer-related travel, IT, facilities and marketing in both the Optics and Research segments

 

Our Biomedical segment primarily consists of the results of our majority owned joint venture, Xcede Technologies, Inc. (“Xcede”). Xcede incurred $0.1 million in operating expenses in the third quarter of fiscal year 2018 compared to $0.4 million for the same three month period in 2017.

 

On July 20, 2018, Xcede received a notice of termination from Cook Biotech, Inc. (“CBI”), its collaboration partner with respect to Xcede’s hemostatic patch (“Patch”) currently under development. CBI asserted its termination rights under the Services Agreement dated November 16, 2016 and Development Agreement dated January 6, 2016 between Xcede and CBI, claiming that the results of a recent animal study showed that it is not commercially reasonable, in CBI’s assessment, to continue to the next development phase of the Patch. Upon a valid termination, CBI has no obligation to conduct further developmental activities with respect to the Patch, including any further in-kind funding under the Loan Agreement dated November 16, 2016 between Xcede and CBI. In addition, CBI has asserted that the study results trigger an immediate repayment of the $0.5 million promissory note owed by Xcede to CBI under the Loan Agreement, which otherwise has a stated maturity of December 31, 2025. The Xcede promissory note is collateralized by a security interest which CBI has in all of Xcede’s intellectual property. While Xcede vigorously contests this assertion, at this time it is unclear how this matter will be resolved between Xcede and CBI.

 

Xcede has halted clinical trial preparations at this time and has curtailed its operations to a minimal level while the Board of Directors of Xcede evaluates alternatives. Dynasil does not currently anticipate any material impairment of assets or write-offs affecting its consolidated financial statements with respect to this segment as a result of this development.

 

Income from operations for the quarter ended June 30, 2018 was $0.6 million compared to a loss from operations of ($0.3) million for the same period in 2017. Income from operations for the nine month period ended June 30, 2018 was $0.5 million compared to a loss from operations of ($0.2) million for the same nine month period in 2017.

 

 22 

 

 

During the quarter ended June 30, 2018, the Company completed its state PATH 2015 R&E Tax Credit analysis which resulted in an additional $800,000 of tax credits, largely against future state tax expenses. Due to the Company’s state tax filing status requiring Dynasil to continue to consolidate the Xcede losses for state tax purposes, this credit had a full tax valuation reserve applied to it and, accordingly, is not reflected in the statement of operations for the quarter. The PATH 2015 R&E Tax Credit totals approximately $2.1 million, of which the Federal component of $1.3 million is reflected in the Statement of Operations for the nine months ended June 30, 2018. This $800,000 of additional state PATH 2015 R&E Tax Credit is available as an offset to future state tax expenses.

 

Net income (loss) attributable to common stockholders was approximately $0.4 million or $0.02 per share for the quarter ended June 30, 2018 and approximately ($0.2) million or ($0.01) per share for the quarter ended June 30, 2017. Net income attributable to common stockholders was approximately $0.9 million or $0.05 per share for the nine months ended June 30, 2018 and approximately $2.6 million or $0.15 per share for the nine month period ended June 30, 2017, largely as a result of the release of the tax valuation allowance due to the federal tax deconsolidation of Xcede from the Company in the first quarter of fiscal year 2017.

 

Results of Operations

 

Results of Operations for the Three Months Ended June 30,
2018
   Optics   Contract
Research
   Biomedical   Total 
Revenue  $6,159,000   $4,383,000   $-   $10,542,000 
Gross profit   2,299,000    1,876,000    -    4,175,000 
GM %   37%   43%   -    40%
Operating expenses   1,721,000    1,760,000    84,000    3,565,000 
Operating income (loss)   578,000    116,000    (84,000)   610,000 
                     
Depreciation and amortization   261,000    53,000    3,000    317,000 
Capital expenditures   707,000    76,000    20,000    803,000 
                     
Intangibles, net   408,000    171,000    380,000    959,000 
Goodwill   968,000    4,939,000    -    5,907,000 
Total assets  $21,117,000   $8,018,000   $507,000   $29,642,000 

 

Results of Operations for the Three Months Ended June 30,
2017
   Optics   Contract
Research
   Biomedical   Total 
Revenue  $4,837,000   $3,999,000   $-   $8,836,000 
Gross profit   1,655,000    1,709,000    -    3,364,000 
GM %   34%   43%   -    38%
Operating expenses   1,619,000    1,640,000    377,000    3,636,000 
Operating income (loss)   36,000    69,000    (377,000)   (272,000)
                     
Depreciation and amortization   248,000    52,000    1,000    301,000 
Capital expenditures   179,000    54,000    26,000    259,000 
                     
Intangibles, net   468,000    205,000    394,000    1,067,000 
Goodwill   955,000    4,939,000    -    5,894,000 
Total assets  $19,488,000   $8,004,000   $690,000   $28,182,000 

 

Consolidated revenue for the quarter ended June 30, 2018 was $10.5 million, compared to revenue of $8.8 million for the third quarter of fiscal year 2017.

 

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The Optics segment revenue increased $1.3 million, or 27%, for the three months ended June 30, 2018 compared with the same period in the prior year, largely resulting from increased demand from our customers in the semiconductor/microlithography market.

 

Contract Research segment revenue increased $0.4 million, or 10%, for the three months ended June 30, 2018, as compared to the same three month period in 2017. Commercial revenue in the segment increased in the current quarter due to an increase in orders. The research backlog for the Contracts Research segment has increased in the current quarter to approximately $34.2 million at June 30, 2018.

 

The Biomedical segment had no revenues.

 

Gross profit for the three months ended June 30, 2018 was $4.2 million, or 40% of revenues, compared to $3.4 million, or 38% of revenues, for the three months ended June 30, 2017. Gross profit for the Optics segment increased to $2.3 million, or 37% of revenues, compared to $1.7 million, or 34% of revenues, as a direct result of the increase in revenue and specific steps taken to improve gross margin. Gross profit in the Contract Research segment remained steady at 43% in the quarter ended June 30, 2018, compared to the same quarter in 2017, largely as a result of the mix of active contracts during the third quarter of 2018.

 

The Biomedical segment, through Xcede, has been developing a hemostatic tissue sealant technology which has not been approved for commercial use and consequently has no gross profit.

 

Total operating expenses were $3.6 million for both the three months ended June 30, 2018 and 2017. Operating expenses for the Optics segment increased $0.1 million largely due to increases in headcount and related costs. Contract Research segment expenses increased to $1.8 million in the third quarter of fiscal year 2018, as compared to the $1.6 million in the same period last year due to increased spending in IT and customer-related travel. Biomedical segment expenses decreased $0.3 million in the quarter ended June 30, 2018 from $0.4 million in the quarter ended June 30, 2017 due to a reduction in spending resulting from to the delay of Xcede’s planned clinical trial, as disclosed elsewhere.

 

As a result of the factors discussed above, income from operations for the quarter ended June 30, 2018 was $0.6 million, compared to a loss from operations of ($0.3) million for the same period in 2017.

 

Net interest expense was essentially the same in both the three months ended June 30, 2018 and 2017.

 

The provision for income taxes for the third quarter of 2018 was $0.2 million as compared to a benefit of $0.1 million for the same period in fiscal year 2017. The 2018 provision in the third quarter of fiscal year 2018 was the result of the $0.6 million operating profit earned during the current quarter compared to the $0.3 million loss in 2017. During the quarter ended June 30, 2018, the Company completed its state PATH 2015 R&E Tax Credit analysis which resulted in an additional $800,000 of tax credits, largely against future state tax expenses. Due to the Company’s state tax filing status requiring Dynasil to continue to consolidate the Xcede losses for state tax purposes, this credit had a full tax valuation reserve applied to it and, accordingly, is not reflected in the statement of operations for the quarter. The PATH 2015 R&E Tax Credit totals approximately $2.1 million, of which the Federal component of $1.3 million is reflected in the Statement of Operations for the nine months ended June 30, 2018. This $800,000 of additional state PATH 2015 R&E Tax Credit is available as an offset to future state tax expenses.

 

During the third quarter of 2018 the Company completed its analysis of its federal and state PATH 2015 R&E Tax Credits for the years 2012 thru 2016. The Company will receive a future benefit of an additional $0.8 million in tax credits due to the Massachusetts state tax credits earned. These credits are not reflected in the Consolidated Statements of Operations and Comprehensive Income (loss) as the Company recorded a full valuation reserve due to the Company’s state tax filing status requiring Dynasil to continue to consolidate the Xcede losses for state tax purposes.

 

Net income (loss) attributable to common stockholders was approximately $0.4 million or $0.02 per share for the quarter ended June 30, 2018 and ($0.2) million or ($0.01) per share for the quarter ended June 30, 2017.

 

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Results of Operations – Year to Date

 

Results of Operations for the Nine Months Ended June 30,
2018
   Optics   Contract Research   Biomedical   Total 
Revenue  $17,011,000   $12,974,000   $-   $29,985,000 
Gross profit   6,038,000    5,621,000    -    11,659,000 
GM %   35%   43%   -    39%
Operating expenses   5,154,000    5,297,000    724,000    11,175,000 
Operating income (loss)   884,000    324,000    (724,000)   484,000 
                     
Depreciation and amortization   738,000    179,000    10,000    927,000 
Capital expenditures   1,635,000    153,000    65,000    1,853,000 
                     
Intangibles, net   408,000    171,000    380,000    959,000 
Goodwill   968,000    4,939,000    -    5,907,000 
Total assets  $21,117,000   $8,018,000   $507,000   $29,642,000 

 

Results of Operations for the Nine Months Ended June 30,
2017
   Optics   Contract Research   Biomedical   Total 
Revenue  $14,524,000   $13,541,000   $-   $28,065,000 
Gross profit   5,144,000    5,535,000    -    10,679,000 
GM %   35%   41%   -    38%
Operating expenses   4,544,000    5,182,000    1,150,000    10,876,000 
Operating income (loss)   600,000    353,000    (1,150,000)   (197,000)
                     
Depreciation and amortization   719,000    200,000    7,000    926,000 
Capital expenditures   373,000    88,000    72,000    533,000 
                     
Intangibles, net   468,000    205,000    394,000    1,067,000 
Goodwill   955,000    4,939,000    -    5,894,000 
Total assets  $19,488,000   $8,004,000   $690,000   $28,182,000 

  

Revenue for the nine months ended June 30, 2018 was $30.0 million, a $1.9 million increase over the nine months ended June 30, 2017.

 

Optics segment revenue increased $2.5 million, or 17%, for the nine months ended June 30, 2018, compared with the same period in the prior year. This increase was largely the result of a general increase in sales in all of our Optics businesses with a significant amount coming from our customers in the semiconductor/microlithography industries over the same period last year.

 

Revenue from our Contract Research segment decreased $0.6 million, or 4%, for the nine months ended June 30, 2018 as compared to the same period in 2017, primarily due to a delay in our commercial revenue orders. This business has begun to show an increase in orders in the third quarter of fiscal year 2018.

 

The Biomedical segment had no revenue in either the nine months ended June 30, 2018 or 2017.

 

Gross profit for the nine months ended June 30, 2018 was $11.7 million, or 39% of sales, compared to $10.7 million, or 38% of sales for the nine months ended June 30, 2017.

 

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Gross profit for the Optics segment increased approximately $0.9 million to $6.0 million for the nine months ended June 30, 2018, compared to the gross profit for the same period in fiscal year 2017, primarily as a result of the increase in revenues in the first nine months of fiscal 2018 as compared to the same period in 2017. The Optics segment’s gross margin as a percent of revenue remained steady year over year at 35% due to a conscious effort to control costs.

 

Gross profit for the Contract Research segment increased $0.1 million to $5.6 million for the nine months ended June 30, 2018, compared to the nine months ended June 30, 2017, primarily as a result of improved efficiencies in 2018 as compared to 2017. The Contract Research segment gross profit as a percent of revenue was 43% for the nine months ended June 30, 2018 as compared to 41% for the same period in the prior year due to research contracts utilizing internal resources versus sub-contractors.

 

The Biomedical segment, through Xcede, has been developing a tissue sealant technology which has not been approved for commercial use and consequently has no gross profit.

 

Total operating expenses increased $0.3 million to $11.2 million for the nine months ended June 30, 2018, as compared to the nine months ended June 30, 2017. This increase was spread fairly consistently across the organization, as we have upgraded resources, added people and improved systems in 2018, in preparation for new initiatives in 2019.

 

Income (loss) from operations was $0.5 million for the nine months ended June 30, 2018 and a loss of ($0.2) million for the same nine month period in 2017.

 

Net interest expense for the nine month period ended June 30, 2018 was $0.1 million as compared to $0.2 million in the same period in 2017. The primary reason for this reduction was the conversion of the Xcede notes into stock in the first quarter of 2017.

 

The provision for income taxes for the first nine months of 2018 was a benefit of $0.4 million as compared to a benefit of $2.8 million for the same period in fiscal year 2017. The 2018 provision was the result of the PATH 2015 R&E Tax Credit for the years 2012 through 2016, offset by the result of the 2017 Tax Act, in which we estimated the rate reduction impact to be $0.5 million, and the earnings and profit transition tax of our Hilger Crystals subsidiary to be $0.2 million. The 2017 benefit resulted from the deconsolidation of Xcede, which resulted in the Company no longer being able to offset taxable income with Xcede’s net operating loss results or carryforwards.

 

Net income attributable to common stockholders for the nine months ended June 30, 2018 was $0.9 million or $0.05 basic earnings per share, compared to net income of $2.6 million or $0.15 basic earnings per share for the nine months ended June 30, 2017.

 

Liquidity and Capital Resources

 

Liquidity Overview and Outlook

 

Net cash as of June 30, 2018 was $1.5 million, or approximately $0.9 million less than the net cash of $2.4 million at September 30, 2017.

 

Cash From Operating Activities

 

The Company generated approximately $1.1 million in cash from operating results, in which net income contributed $0.8 million, and the noncash items had an impact of $1.0 million, which was mainly offset by both the increase in accounts receivable of approximately $0.4 million and the decrease in accounts payable of $0.5 million. The accounts receivable increase was due to increased revenue in the Optics segment for the quarter ended June 30, 2018 compared to the quarter ended September 30, 2017. Other increases and reductions in assets and liabilities, including prepaids, costs in excess of billings, and accrued expenses, offset each other. 

 

Cash From Investing and Financing Activities

 

The Company used cash of approximately $1.9 million for the purchase of property, plant, equipment and patents for the nine months ended June 30, 2018 as we invest in new equipment for future product offerings and upgrade existing machinery.

 

 26 

 

 

Total outstanding bank debt as of June 30, 2018 was $3.0 million, essentially the same as at September 30, 2017. The net cash from financing activities during the nine months ended June 30, 2018 consisted of $0.3 million in principal payments, offset by $0.3 million in financing from the new Middlesex Savings Bank equipment line of credit.

 

As of June 30, 2018, the Company’s outstanding indebtedness to Middlesex Savings Bank (“Middlesex”) consisted of $1.3 million of senior debt borrowed under the $2.0 million fixed rate, five-year term note that was established in February 2016 and $0.3 million owed to Middlesex under the equipment line of credit.

 

On July 31, 2018, the Company converted the outstanding balance on the equipment line of credit with Middlesex Savings Bank (“Middlesex”) of approximately $750,000, of which $281,000 was outstanding on June 30, 2018, into a five year term note with an interest rate of 5.66%. Additionally, on August 9, 2018, the Company’s equipment line of credit was renewed for $750,000 through April 30, 2019, at which time the outstanding balance will be converted into a five year term note. As part of the renewal process and due to the additional credit being extended to the Company, the Middlesex loan and security agreement was amended on August 9, 2018 to decrease the maximum debt leverage ratio covenant to 2.5x from 3.0x.

 

On both March 31, 2018 and June 30, 2018, the Company was in compliance with all but one of the financial covenants contained in the loan agreement with Middlesex that require us to maintain certain ratios of earnings before interest, taxes, depreciation and amortization to fixed charges and to total debt and senior debt. On August 9, 2018, Middlesex issued a waiver for these events, as this circumstance arose due to the timing of equipment purchases as the Company invests for the future. The current year forecast shows Dynasil quickly resolving this situation and coming back into compliance with this covenant for the end of the fiscal year.

 

On January 3, 2018, the Company amended the Note Purchase Agreement (the “Note”) with Massachusetts Capital Resource Company to reinstate the interest only payment requirements of the loan, defer principal repayment requirements to November 30, 2018, and institute a 1% rate increase, raising the Note’s interest rate to 7% per annum. As of June 30, 2018 $0.8 million of subordinated debt is owed to the Massachusetts Capital Resources Company.

 

Management believes that the cash and availability under the lines of credit discussed above are adequate to meet the Company’s current liquidity requirements for the next twelve months.

 

As of June 30, 2018, Xcede had $0.5 million of outstanding indebtedness, which consisted of a promissory note issued to Cook Biotech Inc. (“CBI”) in November 2016 and due on December 31, 2025. As disclosed elsewhere, CBI has asserted that it is entitled to immediate repayment of this note due to results of a recent animal study conducted pursuant to the collaboration between Xcede and CBI. While Xcede vigorously contests this assertion, at this time it is unclear how this matter will be resolved between Xcede and CBI.

 

Critical Accounting Policies and Estimates

 

There have been no material changes in our critical accounting policies or critical accounting estimates since September 30, 2017. For further discussion of our accounting policies see the “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017 as well as the notes to the financial statements contained in this Quarterly Report on Form 10-Q.

 

The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

 

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Revenue Recognition

 

Revenues from the sale of the Company’s products and services are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectability is reasonably assured. The Company generally ships products F.O.B. shipping point. Revenue from research and development activities is derived generally from the following types of contracts: reimbursement of costs plus fees, fixed price or time and material type contracts. Revenue is recognized when the products are shipped per customers’ instructions, the contract has been executed, the contract or sales price is fixed or determinable, delivery of services or products has occurred and the Company’s ability to collect the contract price is considered reasonably assured.

 

Government funded services revenues from cost plus contracts are recognized as costs are incurred on the basis of direct costs plus allowable indirect costs and an allocable portion of the contracts’ fixed fees. Revenue from fixed-type contracts is recognized under the percentage of completion method with estimated costs and profits included in contract revenue as work is performed. Revenues from time and materials contracts are recognized as costs are incurred at amounts generally commensurate with billing amounts. Recognition of losses on projects is taken as soon as the loss is reasonably determinable.

 

The majority of the Company’s contract research revenue is derived from the United States government and government related contracts. Such contracts have certain risks which include dependence on future appropriations and administrative allotment of funds and changes in government policies. Costs incurred under United States government contracts are subject to audit. The Company believes that the results of such audits will not have a material adverse effect on its financial position or its results of operations.

 

In May 2014, the FASB issued ASU 2014-09 which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. Using these guidelines, a comprehensive framework was established for determining how much revenue to recognize and when it should be recognized. The standard is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. Entities have the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard. In 2016 and 2017, the FASB issued several ASU’s related to ASU 2014-09, which simplify and provide additional guidance to companies for implementation of the standard. To be consistent with this core principle, an entity is required to apply the following five-step approach:

 

·Identify the contract(s) with a customer;
·Identify each performance obligation in the contract;
·Determine the transaction price;
·Allocate the transaction price to each performance obligation; and
·Recognize revenue when or as each performance obligation is satisfied.

 

As of June 30, 2018, the Company has made significant progress towards completing its assessment of the potential effects of ASU 2014-09 and its amendments on its consolidated financial statements, and is actively assessing the potential effects on business processes, systems and controls to support revenue recognition and the related disclosures under this ASU. The Company is required to adopt the new standards on October 1, 2018, and expects to do so using the modified retrospective transition method with the cumulative effect of initially applying the guidance recognized at the date of initial application. With the assistance of a third party engaged for this purpose, the Company’s assessment includes a detailed review of representative contracts from each of the Company’s revenue streams and a comparison of its historical accounting policies and practices to the new standard. The Company's preliminary assessment of this adoption method supports the determination that there are no expected changes in the accounting for the Research segment’s contract research revenue. Across other revenue streams, the timing of revenue recognition could be affected for multiple types of contracts, primarily multiple element contracts in its Optics segment, but those differences are not expected to have a material impact on the consolidated financial statements. However, the Company's assessment is not yet finalized and is subject to change. Additionally, the Company is currently evaluating any tax implications the adoption of this new standard may have on the consolidated financial statements. As part of this analysis, the Company is evaluating its information technology capabilities and systems, and does not expect to incur significant information technology costs to modify systems currently in place.

 

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The Company is in the process of assessing its current revenue controls, and identifying and implementing any changes that may be necessary to comply with its new revenue policies and the provisions of ASU 2014-09, which will be effective for the Company as of October 1, 2018.

 

Goodwill

 

Goodwill is subject to an annual impairment test. We consider many factors which may indicate the requirement to perform additional, interim impairment tests. These include:

 

·A significant adverse long term outlook for any of our industries;
·An adverse finding or rejection from a regulatory body involved in new product regulatory approvals;
·Failure of an anticipated commercialization product line;
·Unanticipated competition or a disruptive technology introduction;
·The testing for recoverability under the Impairment or Disposal of Long-Lived Assets Subsections of Subtopic 360-10 of a significant asset group within a reporting unit;
·A loss of key personnel; and
·An expectation that a reporting unit carrying goodwill, or a significant portion of a reporting unit, will be sold or otherwise disposed of.

 

Goodwill is tested by reviewing the carrying value compared to the fair value at the reporting unit level. Fair value for the reporting unit is derived using the income approach. Under the income approach, fair value is calculated based on the present value of estimated future cash flows. Assumptions by management are necessary to evaluate the impact of operating and economic changes and to estimate future cash flows. Management’s evaluation includes assumptions on future growth rates and cost of capital that are consistent with internal projections and operating plans.

 

The Company generally performs its annual impairment testing of goodwill during the fourth quarter of its fiscal year, or more frequently if events or changes in circumstances indicate that the assets might be impaired. The Company tests impairment at the reporting unit level using the two-step process. The Company’s primary reporting units tested for impairment are Radiation Monitoring Devices, which comprises our Contract Research segment, and Hilger Crystals, a component of our Optics segment.

 

Intangible Assets

 

The Company’s intangible assets consist of acquired customer relationships and trade names of Hilger Crystals, Ltd., acquired know-how of Radiation Monitoring Devices, Inc. and purchased and patented biomedical technologies within the Biomedical segment. The Company amortizes its intangible assets with definitive lives over their useful lives, which range from 5 to 20 years, based on the time period the Company expects to receive the economic benefit from these assets. No impairment charge was recorded during the six month periods ended June 30, 2018 or 2017.

 

The Company continually assesses whether events or changes in circumstances have occurred that may warrant revision of the estimated useful lives of its intangible and indefinite-lived assets or whether the remaining balances of those assets should be evaluated for possible impairment. The only changes in in the carrying value of intangible and indefinite-lived assets during the nine months ended June 30, 2018 were the addition of patents and fluctuations in foreign exchange rate.

 

Impairment of Long-Lived Assets

 

The Company’s long-lived assets include property, plant and equipment. The Company evaluates long-lived assets for recoverability whenever events or changes in circumstances indicate that an asset may have been impaired. In evaluating an asset for recoverability, the Company estimates the future cash flow expected to result from the use of the asset and eventual disposition. If the expected future undiscounted cash flow is less than the carrying amount of the asset, an impairment loss, equal to the excess of the carrying amount over the fair value of the asset, is recognized.

 

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The Company continually assesses whether events or changes in circumstances have occurred that may warrant revision of the estimated useful lives of its long-lived assets or whether the remaining balances of those assets should be evaluated for possible impairment. There were no changes, aside from foreign exchange rate fluctuations, in the carrying value of long-lived assets, during the nine months ended June 30, 2018.

 

Allowance for Doubtful Accounts Receivable

 

The Company performs ongoing credit evaluations of our customers and adjusts credit limits based upon payment history and the customer's current credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been minimal, within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. A significant change in the liquidity or financial position of any of our significant customers could have a material adverse effect on the collectability of our accounts receivable and our future operating results.

 

Stock-Based Compensation

 

The Company accounts for stock-based compensation using fair value. Compensation costs are recognized for stock-based compensation granted to employees and directors. Options and restricted stock awards are recorded as an expense over the requisite service period based on the grant date estimated fair value of the grant, which in the case of options is determined using the Black-Scholes option pricing model.

 

Income Taxes

 

As part of the process of preparing our consolidated financial statements, we are required to estimate our income tax provision (benefit) in each of the jurisdictions in which we operate. This process involves estimating our current income tax provision (benefit) together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets. We regularly evaluate our ability to recover the reported amount of our deferred income tax assets considering several factors, including our estimate of the likelihood of the Company generating sufficient taxable income in future years during the period over which temporary differences reverse.

 

Recent Accounting Pronouncements

 

See Note 2, "Recent Accounting Pronouncements" in the Notes to Consolidated Financial Statements for a full description of recent accounting pronouncements, including the respective dates of adoption or expected adoption and effects on our consolidated financial position, results of operations and cash flows.

 

Forward-Looking Statements

 

The statements contained in this Quarterly Report on Form 10-Q which are not historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements regarding future events and our future results are based on current expectations, estimates, forecasts, and projections and the beliefs and assumptions of our management, including, without limitation, our expectations regarding results of operations, our compliance with the financial covenants under our loan agreements with Middlesex Savings Bank and Massachusetts Capital Resource Company the commercialization of our technology, our development of new technologies, the future prospects of Xcede’s patch technology, the adequacy of our current financing sources to fund our current operations, our growth initiatives, governmental budgetary and funding matters, our capital expenditures and the strength of our intellectual property portfolio. These forward-looking statements may be identified by the use of words such as “plans”, “intends,” “may,” “could,” “expect,” “estimate,” “anticipate,” “continue” or similar terms, though not all forward-looking statements contain such words. The actual results of the future events described in such forward looking statements could differ materially from those stated in such forward looking statements due to a number of important factors. These factors that could cause actual results to differ from those anticipated or predicted include, without limitation, our ability to develop and commercialize our products, including obtaining regulatory approvals, the size and growth of the potential markets for our products and our ability to serve those markets, the rate and degree of market acceptance of any of our products, the ability of Xcede’s Board of Directors to successfully contest the assertions by CBI under the collaboration arrangement and otherwise preserve value for its stockholders, including the viability of modifying the Xcede patch to address the shortcomings cited by CBI or selling or licensing Xcede’s IP assets, general economic conditions, costs and availability of raw materials and management information systems, our ability to obtain and maintain intellectual property protection for our products, results of Xcede’s programs which may not support further development, competition, the loss of key management and technical personnel, our ability to obtain timely payment of our invoices to governmental customers, changing priorities or reductions in government spending, litigation, the effect of governmental regulatory developments, the availability of financing sources, our ability to comply with our debt obligations, our ability to deleverage our balance sheet, our ability to identify and execute on acquisition opportunities and integrate such acquisitions into our business, and seasonality, as well as the uncertainties set forth in the Company’s Annual Report on Form 10-K, filed on December 20, 2017, including the risk factors contained in Item 1A, and from time to time in the Company's other filings with the Securities and Exchange Commission. The Company disclaims any intention or obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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ITEM 4 CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures.

 

Our management, with the participation and supervision of our Chief Executive Officer and Chief Financial Officer, is responsible for our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified under the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to our principal executive officer and our principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

 

Our management, including the Chief Executive Officer and the Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures as of June 30, 2018. Based on this evaluation, our management concluded that as of June 30, 2018, these disclosure controls and procedures were effective at the reasonable assurance level.

 

Changes in Internal Control Over Financial Reporting

 

There were no changes in our internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II – OTHER INFORMATION

 

ITEM 1A.  RISK FACTORS

 

In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended September 30, 2017, and from time to time in the Company’s other filings with the Securities and Exchange Commission, which could materially affect our business, financial condition or future results. The risks described in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or future results.

 

ITEM 5(a). OTHER INFORMATION

 

On July 31, 2018, the Company exercised its right under its existing equipment line of credit with Middlesex Savings Bank (“Middlesex”) to convert the outstanding balance on the line of credit of approximately $750,000, of which $281,000 was outstanding on June 30, 2018, into a five year term note with an interest rate of 5.66%.

 

Additionally, on August 9, 2018, Middlesex renewed the Company’s equipment line of credit for $750,000, to remain in effect until April 30, 2019, at which time the outstanding balance thereunder will be converted into a five year term note. Such renewal was made pursuant to the Company’s existing loan and security agreement with Middlesex, dated May 4, 2014, as amended, and the line of credit is subject to the terms and conditions of that agreement. In connection with the renewal process and due to Middlesex extending the additional credit to the Company, the loan and security agreement with Middlesex was amended on August 9, 2018 to decrease the maximum debt leverage ratio covenant to 2.5x from 3.0x.

 

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The loan and security agreement with Middlesex contains, among other customary provisions, a financial covenant that requires us to maintain a minimum debt service ratio (the “Financial Covenant”). On both March 31, 2018 and June 30, 2018, the Company was not in compliance the Financial Covenant, as a result of the timing of equipment purchases as the Company invests for the future. On August 9, 2018, Middlesex issued a waiver of our requirement to meet the Financial Covenant as of such dates. Based on our current year forecast, we anticipate being in compliance with the Financial Covenant as of the end of the fiscal year.

 

ITEM 6 EXHIBITS

 

31.1(a)Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.1(b)Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1Section 1350 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished but not filed for purposes of the Securities Exchange Act of 1934).

 

99.1Press release, dated August 14, 2018 issued by Dynasil Corporation of America announcing its financial results for the quarter ended June 30, 2018.

 

101The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of June 30, 2018 and September 30, 2017, (ii) Consolidated Statements of Operations for the three and nine months ended June 30, 2018 and 2017, (iii) Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended June 30, 2018; (iv) Consolidated Statements of Cash Flows for the nine months ended June 30, 2018 and 2017, and (v) Notes to Consolidated Financial Statements.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

DYNASIL CORPORATION OF AMERICA    
       
BY: /s/ Peter Sulick DATED: August 14, 2018  
  Peter Sulick,    
  Chief Executive Officer and President    
       
  /s/ Robert J. Bowdring DATED: August 14, 2018  
  Robert J. Bowdring,    
  Chief Financial Officer    

 

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