U. S. SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

(Mark One)

 

x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2019

 

¨  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 every Interactive Data File required to be submitted 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 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  x 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

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Trading symbol   Name of each exchange of which registered
Common stock   DYSL   Nasdaq Capital Market

 

As of August 7, 2019 there were 17,618,173 shares of common stock, par value $.0005 per share, outstanding.

 

 

 

 

 

 

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

 

INDEX

 

  Page
PART 1. FINANCIAL INFORMATION 3
Item 1. Financial Statements 3
   
DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES  
   
CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2019 AND SEPTEMBER 30, 2018 3
   
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2019 and 2018 5
   
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2019 AND 2018 6
   
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED JUNE 30, 2019 and 2018 7
   
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 27
   
Item 4.  Controls and Procedures 37
   
PART II.  OTHER INFORMATION 38
   
Item 1A. Risk Factors 38
   
Item 6. Exhibits 39
   
Signatures 40

 

  2  

 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS.

 

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

    June 30,     September 30,  
    2019     2018  
    (Unaudited)        
                 

ASSETS 

               
Current Assets                
Cash and cash equivalents   $ 519,000     $ 2,327,000  
Accounts receivable, net of allowances of $274,000 and $262,000 at June 30, 2019 and September 30, 2018, respectively     5,347,000       4,069,000  
Unbilled receivables     2,422,000       1,214,000  
Contract assets     62,000       1,000  
Inventories, net of reserves     4,544,000       4,106,000  
Prepaid expenses and other current assets     717,000       664,000  
Total current assets     13,611,000       12,381,000  
                 
Property, Plant and Equipment, net     7,762,000       8,098,000  
                 
Other Assets                
Intangibles, net     665,000       755,000  
Deferred tax asset     4,128,000       4,333,000  
Goodwill     5,864,000       5,900,000  
Long term contract assets     7,000       7,000  
Security deposits     53,000       58,000  
Total other assets     10,717,000       11,053,000  
                 
Total Assets   $ 32,090,000     $ 31,532,000  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY                
                 
Current Liabilities                
Line of credit   $ 961,000     $ -  
Current portion of long-term debt     1,431,000       1,246,000  
Capital lease obligations, current portion     33,000       40,000  
Accounts payable     2,544,000       2,355,000  
Contract liabilities     33,000       253,000  
Accrued expenses and other liabilities     2,667,000       2,803,000  
Total current liabilities     7,669,000       6,697,000  
                 
Long-term Liabilities                
Long-term debt, net of current portion     1,797,000       2,075,000  
Capital lease obligations, net of current portion     30,000       52,000  
Deferred tax liability, net     200,000       205,000  
Other long-term liabilities     181,000       175,000  
Total long-term liabilities     2,208,000       2,507,000  

 

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

 

  3  

 

 

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Continued)

 

LIABILITIES AND STOCKHOLDERS' EQUITY (Continued)

 

    June 30,     September 30,  
    2019     2018  
    (Unaudited)        
Stockholders' Equity                
Common Stock, $0.0005 par value, 40,000,000 shares authorized, 18,377,083 and 18,152,074 shares issued, 17,566,923 and and 17,341,914 shares outstanding at June 30, 2019 and September 30, 2018, respectively.     9,000       9,000  
Additional paid in capital     22,153,000       21,865,000  
Accumulated other comprehensive income (loss)     (832,000 )     (700,000 )
Retained earnings     599,000       841,000  
Less 810,160 shares of treasury stock - at cost     (986,000 )     (986,000 )
Total Dynasil stockholders' equity     20,943,000       21,029,000  
Noncontrolling interest     1,270,000       1,299,000  
Total stockholders' equity     22,213,000       22,328,000  
                 
Total Liabilities and Stockholders' Equity   $ 32,090,000     $ 31,532,000  

 

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,  
    2019     2018     2019     2018  
Net revenue   $ 11,090,000     $ 10,542,000     $ 32,650,000     $ 29,985,000  
Cost of revenue     6,984,000       6,367,000       20,494,000       18,326,000  
Gross profit     4,106,000       4,175,000       12,156,000       11,659,000  
Operating expenses:                                
Sales and marketing     425,000       288,000       1,300,000       955,000  
Research and development     162,000       177,000       486,000       701,000  
General and administrative     3,665,000       3,100,000       10,317,000       9,519,000  
                                 
Total operating expenses     4,252,000       3,565,000       12,103,000       11,175,000  
Income (loss) from operations     (146,000 )     610,000       53,000       484,000  
Interest expense, net     56,000       44,000       144,000       132,000  
Income (loss) before taxes     (202,000 )     566,000       (91,000 )     352,000  
Income tax (benefit)     66,000       190,000       207,000       (404,000 )
Net income (loss)     (268,000 )     376,000       (298,000 )     756,000  
Less: Net loss attributable to noncontrolling interest     (5,000 )     (15,000 )     (18,000 )     (124,000 )
Net income (loss) attributable to common stockholders   $ (263,000 )   $ 391,000     $ (280,000 )   $ 880,000  
                                 
Net income (loss)   $ (268,000 )   $ 376,000     $ (298,000 )   $ 756,000  
Other comprehensive income (loss):                                
Foreign currency translation     (136,000 )     (384,000 )     (132,000 )     (127,000 )
Total comprehensive income (loss)     (404,000 )     (8,000 )     (430,000 )     629,000  
Less: comprehensive income (loss) attributable to noncontrolling interest     (5,000 )     (15,000 )     (18,000 )     (124,000 )
Total comprehensive income (loss) attributable to common stockholders   $ (399,000 )   $ 7,000     $ (412,000 )   $ 753,000  
                                 
Basic net income (loss) per common share   $ (0.02 )   $ 0.02     $ (0.02 )   $ 0.05  
Diluted net income (loss) per common share   $ (0.02 )   $ 0.02     $ (0.02 )   $ 0.05  
                                 
Weighted average shares outstanding                                
Basic     17,522,644       17,203,965       17,426,316       17,127,834  
Diluted     17,522,644       17,221,199       17,426,316       17,147,228  

 

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)

 

    Three Months Ended     Nine Months Ended  
    June 30,     June 30,  
    2019     2018     2019     2018  
Common Amount                                
Balance, beginning of period   $ 9,000     $ 9,000     $ 9,000     $ 9,000  
Balance, end of period     9,000       9,000       9,000       9,000  
Additional Paid-in Capital                                
Balance, beginning of period     22,060,000       21,635,000       21,865,000       21,406,000  
Issuance of shares of common stock under employee stock purchase plan     4,000       5,000       14,000       13,000  
Stock-based compensation costs     89,000       116,000       274,000       337,000  
Balance, end of period     22,153,000       21,756,000       22,153,000       21,756,000  
Other Comprehensive Income (Loss)                                
Balance, beginning of period     (696,000 )     (282,000 )     (700,000 )     (539,000 )
Foreign currency translation adjustment     (136,000 )     (384,000 )     (132,000 )     (127,000 )
Balance, end of period     (832,000 )     (666,000 )     (832,000 )     (666,000 )
Retained Earnings (Accumulated Deficit)                                
Balance, beginning of period     862,000       (430,000 )     841,000       (919,000 )
Impact of change in accounting policy     -       -       22,000       -  
Xcede stock surrender of Series A Preferred     -       -       16,000       -  
Net income (loss)     (263,000 )     391,000       (280,000 )     880,000  
Balance, end of period     599,000       (39,000 )     599,000       (39,000 )
Treasury Stock                                
Balance, beginning of period     (986,000 )     (986,000 )     (986,000 )     (986,000 )
Balance, end of period     (986,000 )     (986,000 )     (986,000 )     (986,000 )
Noncontrolling Interest                                
Balance, beginning of period     1,274,000       1,355,000       1,299,000       1,454,000  
Stock-based compensation costs     1,000       4,000       5,000       14,000  
Xcede stock surrender of Series A Preferred     -       -       (16,000 )     -  
Net income (loss)     (5,000 )     (15,000 )     (18,000 )     (124,000 )
Balance, end of period     1,270,000       1,344,000       1,270,000       1,344,000  
Total Stockholders' Equity   $ 22,213,000     $ 21,418,000     $ 22,213,000     $ 21,418,000  
                                 
Common Shares                                
Number of shares, beginning of period     18,301,216       18,008,871       18,152,074       17,893,763  
Issuance of shares of common stock under employee stock purchase plan     5,623       3,637       17,453       11,593  
Stock-based compensation costs - shares issued     70,244       79,423       207,556       186,575  
Number of shares, end of period     18,377,083       18,091,931       18,377,083       18,091,931  
Treasury Shares                                
Number of shares, beginning of period     810,160       810,160       810,160       810,160  
Number of shares, end of period     810,160       810,160       810,160       810,160  

 

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,  
    2019     2018  
Cash flows from operating activities:                
Net income (loss)   $ (298,000 )   $ 756,000  
Adjustments to reconcile net income (loss) to net cash:                
Stock compensation expense     279,000       351,000  
Foreign exchange loss (gain)     26,000       13,000  
Depreciation and amortization     1,056,000       927,000  
Deferred income taxes     205,000       (524,000 )
Non-cash R&D services     -       209,000  
Other     34,000       (6,000 )
Other changes in assets and liabilities:                
Accounts receivable, net     (1,321,000 )     (362,000 )
Unbilled receivables     (1,168,000 )     253,000  
Contract assets     (61,000 )     -  
Inventories     (503,000 )     (153,000 )
Prepaid expenses and other assets     (55,000 )     42,000  
Accounts payable     203,000       (447,000 )
Accrued expenses and other liabilities     (129,000 )     55,000  
Contract liabilities     (219,000 )     (20,000 )
Net cash from operating activities     (1,951,000 )     1,094,000  
                 
Cash flows from investing activities:                
Purchases of property, plant and equipment     (679,000 )     (1,788,000 )
Purchase of intangibles     -       (65,000 )
Net cash from investing activities     (679,000 )     (1,853,000 )
                 
Cash flows from financing activities:                
Proceeds from issuance of common stock     14,000       13,000  
Principal payments on capital leases     (29,000 )     (72,000 )
Proceeds from (payments of) line of credit, net     961,000       -  
Proceeds from (payments of) equipment line of credit, net     484,000       281,000  
Proceeds from (payments of) bank and subordinated debt, net     (584,000 )     (329,000 )
Net cash from financing activities     846,000       (107,000 )
                 
Effect of exchange rates on cash and cash equivalents     (24,000 )     (38,000 )
                 
Net change in cash and cash equivalents     (1,808,000 )     (904,000 )
                 
Cash and cash equivalents, beginning   $ 2,327,000     $ 2,415,000  
Cash and cash equivalents, ending   $ 519,000     $ 1,511,000  
                 
Supplemental disclosures of cash flow information:                
Cash paid during the year for:                
Interest   $ 132,000     $ 109,000  
Tax payments (refunds)     (5,000 )     7,000  
Non cash activities:                
Equipment line of credit to term note conversion     484,000       -  
Xcede stock surrender of Series A Preferred     18,000       -  
Assets purchased under capital leases     -       12,000  

 

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

 

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DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 1 - Basis of Presentation

 

The accompanying consolidated balance sheet as of June 30, 2019, the consolidated statements of operations and comprehensive income (loss) for the three and nine months ended June 30, 2019 and 2018, changes in stockholders’ equity for the three and nine months ended June 30, 2019 and 2018, and cash flows for the nine months ended June 30, 2019 and 2018 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, 2019, 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, 2018 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, 2019, 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

 

Revenue from Contracts with Customers . Effective October 1, 2018, the Company adopted Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers , and all the related amendments using the modified retrospective transition method. Under the modified retrospective approach, the Company applied the standards to new contracts and those that were not completed as of October 1, 2018 which resulted in a cumulative adjustment to increase the retained earnings in the amount of $22,000. Prior periods will not be retrospectively adjusted, but the Company will maintain dual reporting for the year of initial application in order to maintain comparability of the periods presented. The cumulative effect of the changes made to the October 1, 2018 unaudited consolidated balance sheet for the adoption of Topic 606 was as follows:

 

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    Balance at     Adjustment for     Adjusted balance at  
    September 30, 2018     Topic 606     October 1, 2018  
Assets:                        
Unbilled receivables     1,214,000       40,000       1,254,000  
Inventories, net of reserves     4,106,000       (18,000 )     4,088,000  
                         
Liabilities:                        
                         
Contract liabilities     253,000       -       253,000  
                         
Stockholders' equity:                        
Retained earnings     841,000       22,000       863,000  

  

Contract assets were formerly reported within costs in excess of billings and unbilled receivables. Contract liabilities were formerly reported as deferred revenue. The titles have been changed in the table below to be consistent with accounts currently used under the new standard.

 

    September 30, 2018  
    As Reported     As Adopted  
Unbilled receivables     1,215,000       1,214,000  
Contract assets     -       1,000  
Security and other deposits     65,000       58,000  
Long term contract assets     -       7,000  
Deferred revenue     253,000       -  
Contract liabilities     -       253,000  

 

The Company receives payments from customers based on a billing schedule as established in our contracts. Contract asset relates to our conditional right to consideration for our completed performance under the contract. Accounts receivable are recorded when the right to consideration becomes unconditional. Contract liability relates to payments received in advance of performance under the contract. Contract liabilities are recognized as revenue as (or when) we perform under the contract. The Company recognized revenue in the amount of $0 during the three months ended June 30, 2019 and $253,000 during the nine months ended June 30, 2019 for amounts included in the contract liability balance at September 30, 2018.

 

Under the new standard, most contracts in the Innovation and Development (formerly Contract Research) segment, which primarily provide contract research services, were not materially impacted upon the adoption of Topic 606 as revenue will continue to be recognized over time. Contracts in the Optics segment generally provide for the following revenue sources: standard product sales, custom product development and sales, and non-recurring engineering contracts. Revenues for this segment are recognized using either the “point in time” or “over time” methods of Topic 606, depending upon the revenue source. The change in revenue recognition for the Optics segment related to certain custom optics products and the related non-recurring engineering costs which changed from “point in time” to “over time” upon the adoption of Topic 606. This change will result in the recognition of revenue over time when compared to existing standards with the cumulative adjustment relating to contracts that are not complete as of September 30, 2018 recognized as an adjustment of $22,000 to opening retained earnings on October 1, 2018. The revenue for the standard products will be recognized using the "point in time" model of Topic 606, and the timing of such revenue recognition is not expected to differ materially from the historical revenue recognition. Other immaterial adjustments related to the Optics segment that are sometimes offered to customers include customer rights of return and volume discounts. The Company has elected the practical expedient that the Company will not be required to adjust promised amounts of consideration for the effects of a significant financing component if the transfer of promised goods or services will occur in one year or less.

 

  9  

 

 

The impact of the adoption of ASC 606 on the Company’s consolidated financial statements for the three and nine months ended June 30, 2019 was immaterial as compared to what would have been reported under the previous guidance.

 

Innovation and Development Segment Revenues

 

The Company performs research and development for U.S. Federal government agencies, educational institutions and commercial organizations. The Company accounts for a research contract when a contract has been executed, the rights of the parties are identified, payment terms are identified, the contract has commercial substance, and collectability of the contract price is considered probable. Revenue is earned under reimbursement of costs plus fees, fixed price, or time and material type contracts.

 

The Company’s contracts with agencies of the U.S. government are subject to periodic funding by the respective contracting agency. Funding for a contract may be provided in full at inception of the contract or ratably throughout the contract as the services are provided. In evaluating the probability of funding for purposes of assessing collectability of the contract price, the Company considers previous experience with the customers, communication with the customers regarding funding status, and knowledge of available funding for the contract or program. If funding is not assessed as probable, revenue recognition is deferred until realization is reasonably assured.

 

Under the typical payment terms of the Company’s U.S. government contracts, the customer pays either performance-based payments or progress payments. Performance-based payments, which are typically used in the firm fixed price contracts, are interim payments based on quantifiable measures of performance or on the achievement of specified events or milestones. Progress payments, which are typically used in the Company’s cost-plus type contracts, are interim payments based on costs incurred as the work progresses. For the Company’s U.S. government cost-plus contracts, the customer generally pays during the performance period for 80%-90% of the actual costs incurred. Because the customer retains a small portion of the contract price until completion of the contract and audit of allowable costs, cost-plus type contracts generally result in revenue recognized in excess of billings which the Company presents as contract assets on the balance sheet. Amounts billed and due from customers are classified as receivables on the balance sheet, whereas amounts earned, but not yet billed to the Company’s customers due to timing, are classified as unbilled receivables on the balance sheet. The Company recognizes a liability for performance-based payments paid in advance which are in excess of the revenue recognized and presents these amounts as contract liabilities on the balance sheet.

 

To determine the proper revenue recognition method for research and development contracts, the Company evaluates whether two or more contracts should be combined and accounted for as one single modified contract and whether the combined or single contract should be accounted for as more than one performance obligation. For instances where a contract has options that were bid with the initial contract and awarded at a later date, the Company combines the options with the original contract when options are awarded. For most contracts, the customer contracts for research with multiple milestones that are interdependent, thus, the entire contract is accounted for as one performance obligation. The effect of the combined or modified contract on the transaction price and measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.

 

Contract revenue recognition is measured over time as the Company performs the work because of continuous transfer of knowledge and control to the customer. For U.S. government contracts which are typically subject to the Federal Acquisition Regulation ("FAR"), this continuous transfer of knowledge and control to the customer is supported by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay for cost incurred plus a reasonable profit, and take control of any work in process. From time to time, as part of normal management processes, facts may change, causing revisions to estimated total costs or revenues expected. The cumulative impact of any revisions to estimates and the full impact of anticipated losses on any type of contract are recognized in the period in which they become known.

 

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Because of knowledge and control transferring over time, revenue is recognized based on the extent of progress towards completion of the performance obligation. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the services to be provided. The Company generally uses the input method, more specifically the cost-to-cost measure of progress for the contracts because it best depicts the transfer of knowledge and control to the customer which occurs as the Company incur costs on these contracts. Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. The underlying bases for estimating contract research revenues are measurable expenses, such as labor, subcontractor costs and materials, and data that are updated on a regular basis for purposes of preparing cost estimates. The Company’s research contracts generally have a period of performance of nine months to three years, and estimates of contract costs have historically been consistent with actual results. Revisions in these estimates between accounting periods to reflect changing facts and circumstances have not had a material impact on operating results, and the Company does not expect future changes in these estimates to be material. The cumulative impact of any revisions to estimates and the full impact of anticipated losses on any type of contract are recognized in the period in which they become known.

 

Under cost-plus contracts, the Company is reimbursed for costs that are determined to be reasonable, allowable and allocable to the contract and paid a fixed fee representing the profit negotiated between the Company and the contracting agency. Revenue from cost-plus contracts is recognized as costs are incurred plus an estimate of applicable fees earned. The Company considers fixed fees under cost-plus contracts to be earned in proportion to the allowable costs incurred in performance of the contract.

 

Revenue from time and materials contracts is recognized based on direct labor hours expended at contract billing rates plus other billable direct costs. The Company has elected the practical expedient to recognize revenue in the amount for which it has the right to invoice the customer, provided that invoiced amount corresponds directly with the value to the customer of the Company’s performance to date.

 

Fixed price contracts may include either a product delivery or specific service performance throughout a period. For fixed price contracts that are based on the proportional performance method and involve a specified number of deliverables, the Company recognizes revenue based on the proportion of the cost of the deliverables compared to the cost of all deliverables included in the contract as this method more accurately measures performance under these arrangements. For fixed price contracts that provide for the development and delivery of a specific prototype or product, revenue is recognized based upon the performance completed to date, using an output method of revenue recognition based on milestones reached.

 

Whether certain costs under government contracts are allowable is subject to audit by the government. Certain indirect costs are charged to contracts using provisional or estimated indirect rates, which are subject to later revision based on government audits of those costs. Management is of the opinion that costs subsequently disallowed, if any, would not likely have a significant impact on revenues recognized for those contracts.

 

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Optics Segment Revenues

 

The Company produces standard and customized products for commercial organizations, educational institutions, and U.S. Federal government agencies. In addition, the Company also offers services which include non-recurring engineering services. To determine the proper revenue recognition method for Optics contracts, the Company evaluates whether two or more contracts should be combined and accounted for as one single contract and whether the combined or single contract should be accounted for as more than one performance obligation. The Company recognizes revenue when the performance obligation has been satisfied by transferring the control of the product or service to the customer. For contracts with multiple performance obligations, the Company allocates the contract’s transaction price to each performance obligation based on their relative stand-alone selling prices. In such circumstances, the Company uses the observable price of goods or services which are sold separately in similar circumstances to similar customers. If these prices are not observable, then the Company will estimate the stand-alone selling price using information that is reasonably available. For the majority of the Company’s standard products and services, price list, and discount structures related to customer type are available. For products and services that do not have price list and discount structures, the Company may use one or more of the following: (i) adjusted market assessment approach or (ii) expected cost plus a margin approach. The adjusted market approach requires evaluation of the market in which the Company sells goods or services and estimates the price that a customer in that market would be willing to pay for those goods or services. The expected cost plus margin approach requires the Company to forecast expected costs of satisfying the performance obligation and then add a reasonable margin for that good or service. Shipping and handling activities primarily occur after a customer obtains control and are considered fulfillment cost rather than separate performance obligations. Similarly, sales and similar taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected by the entity from a customer are excluded from the measurement of the transaction price.

 

Unfulfilled Performance Obligations

 

For standard products, the Company recognizes revenue at a point in time when control passes to the customer. Absent substantial product acceptance clauses, this is based on the shipping terms. For custom products that require engineering and development based on customer requirements and provide for cost plus reasonable margin throughout the contract, the Company recognizes revenue over time using the output method for any items shipped and any finished goods or work in process that is produced for balances of open sales orders. For any finished goods or work in process that has been produced for the balance of open sales orders the Company recognizes revenue by applying the average selling price for such open order to the lesser of the on hand balance in finished goods or open sales order quantity which the Company presents as a contract asset on the balance sheet. Cost of sales is recognized based on the standard cost of the finished goods and work in process associated with this revenue and inventory balances are reduced accordingly.

 

Unfulfilled performance obligations represent amounts expected to be earned on executed contracts. Indefinite delivery and quantity contracts and unexercised options are not reported in total unfulfilled performance obligations. Unfulfilled performance obligations include funded obligations, which is the amount for which money has been directly authorized by the U.S. government and  by a commercial customer for which a purchase order has been received, and unfunded obligations, representing firm orders for which funding has not yet been appropriated. The approximate value of our Innovation and Development segment unfulfilled performance obligations was $38.3 million at June 30, 2019. The Company expects to satisfy 34% of the performance obligations in fiscal year 2019, 55% in fiscal year 2020, and the remaining amount by fiscal year 2021. The approximate value of our Optics segment unfulfilled performance obligations was $7.0 million at June 30, 2019. The Company expects to satisfy 53% of the performance obligations in fiscal year 2019 and 47% in fiscal year 2020.

 

The Company disaggregates revenue from contracts with customers by geographic locations, customer-type, contract type, timing of recognition, and major categories for each segments, as the Company believes it best depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors. See details in the tables below .

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    Three Months Ended June 30, 2019     Nine Months Ended June 30, 2019  
    Optics     Innovation &
Development 		    Total     Optics     Innovation &
Development 		    Total  
Total Revenue by Geographic Location                                                
United States   $ 3,688,000     $ 4,981,000     $ 8,669,000     $ 10,567,000     $ 14,334,000     $ 24,901,000  
Asia     667,000       -       667,000       2,440,000       22,000       2,462,000  
Europe     1,422,000       46,000       1,468,000       4,608,000       97,000       4,705,000  
Other     122,000       164,000       286,000       231,000       351,000       582,000  
Total   $ 5,899,000     $ 5,191,000     $ 11,090,000     $ 17,846,000     $ 14,804,000     $ 32,650,000  
                                                 
Total Revenue by Contract Type                                                
Firm-fixed price   $ 5,899,000     $ 500,000     $ 6,399,000     $ 17,846,000     $ 1,663,000     $ 19,509,000  
Non-Firm Fixed price     -       4,691,000       4,691,000       -       13,141,000       13,141,000  
Total   $ 5,899,000     $ 5,191,000     $ 11,090,000     $ 17,846,000     $ 14,804,000     $ 32,650,000  
                                                 
Total Revenue by Major Customer Type                                                
U.S. government revenue   $ 53,000     $ 4,856,000     $ 4,909,000     $ 56,000     $ 14,072,000     $ 14,128,000  
U.S. commercial revenue     3,634,000       125,000       3,759,000       10,511,000       262,000       10,773,000  
Foreign commercial and other revenue     2,212,000       210,000       2,422,000       7,279,000       470,000       7,749,000  
Total   $ 5,899,000     $ 5,191,000     $ 11,090,000     $ 17,846,000     $ 14,804,000     $ 32,650,000  
                                                 
Total Revenue by Major Products/Services                                                
Optical components   $ 5,850,000     $ -     $ 5,850,000     $ 17,682,000     $ -     $ 17,682,000  
Contract research     -       5,009,000       5,009,000       -       14,430,000       14,430,000  
Other products and services     49,000       182,000       231,000       164,000       374,000       538,000  
Total   $ 5,899,000     $ 5,191,000     $ 11,090,000     $ 17,846,000     $ 14,804,000     $ 32,650,000  
                                                 
Total Revenue by Timing of Recognition                                                
Goods/services transferred over time   $ 712,000     $ 5,017,000     $ 5,729,000     $ 1,780,000     $ 14,456,000     $ 16,236,000  
Goods transferred at a point in time     5,187,000       174,000       5,361,000       16,066,000       348,000       16,414,000  
Total   $ 5,899,000     $ 5,191,000     $ 11,090,000     $ 17,846,000     $ 14,804,000     $ 32,650,000  

 

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. This update is effective for the Company in the fiscal year beginning October 1, 2018, at the time the Company adopted Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606). The Company implemented this ASU on October 1, 2018 and it did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

 

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. 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 impact of the adoption of this standard on future periods will be dependent on future asset transfers, which generally occur in connection with acquisitions and other business structuring activities. The Company implemented this ASU on October 1, 2018 and it did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

 

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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 Company implemented this ASU on October 1, 2018 and it did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

 

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 effective for the Company in the fiscal year beginning October 1, 2018. The adoption of this standard did not have a material impact on the Company’s consolidated financial position, results of operations, or cash flows.

 

Leases (Topic 842). In February 2016, the FASB issued ASU 2016-02 (as subsequently amended by ASU 2018-01, ASU 2018-10, ASU 2018-11 and ASU 2018-20) which requires that a lessee recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. As with previous guidance, there continues to be a differentiation between finance leases and operating leases, however this distinction now primarily relates to differences in the manner of expense recognition over time and in the classification of lease payments in the statement of cash flows. Lease assets and liabilities arising from both finance and operating leases will be recognized in the statement of financial position. ASU 2016-02 leaves the accounting for leases by lessors largely unchanged from previous GAAP. The transitional guidance for adopting the requirements of ASU 2016-02 calls for a modified retrospective approach that includes a number of optional practical expedients that entities may elect to apply. In addition, ASU 2018-11 provides for an additional (and optional) transition method by which entities may elect to initially apply the transition requirements in Topic 842 at that Topic’s effective date with the effects of initially applying Topic 842 recognized as a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption and without retrospective application to any comparative prior periods presented. Also, ASU 2018-20 provides certain narrow-scope improvements to Topic 842 as it relates to lessors. The guidance in ASU 2016-02 will become effective for the Company as of the beginning of the 2020 fiscal year. The Company is reviewing vendor relationships and 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.

 

 

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Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, including Accounting Standards Update (ASU) 2016-13. In June 2016, the FASB issued ASU 2016-13 which significantly changes how entities account for credit losses for financial assets and certain other instruments, including trade receivables and contract assets that are not measured at fair value through net income. The ASU requires a number of changes to the assessment of credit losses, including the utilization of an expected credit loss model, which requires consideration of a broader range of information to estimate expected credit losses over the entire lifetime of the asset, including losses where probability is considered remote. Additionally, the standard requires the estimation of lifetime expected losses for trade receivables and contract assets that are classified as current. The Company is reviewing the effect of the ASU on its results of operations, financial condition, and cash flows.

 

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 $5.2 million in the aggregate principal amount of convertible notes bearing interest at 5% (“the Notes”). In November of 2016, the Notes were converted into Series A convertible preferred stock of Xcede (“Series A Preferred”). Series A Preferred participants include 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.

 

Additionally, DBM invested $1.2 million of cash into Xcede in exchange for Series B convertible preferred stock of Xcede (“Series B Preferred”). Series A Preferred was issued at a 20% discount to the price per share of the Series B Preferred, in accordance with the amended provisions of the Notes. The value of DBM’s Series A Preferred and Series B Preferred, as they are wholly owned by DBM, is eliminated in consolidation.

 

Each share of Series A Preferred and Series B Preferred (together “the Preferred Stock”) is 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 is entitled to 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, 2019, 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, 2019, 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.

 

In 2016, Xcede signed agreements with Cook Biotech Inc. (“CBI”) in connection with the development, regulatory approval and production of Xcede’s hemostatic patch (the “Xcede Patch”) in which CBI committed to fund up to $1.5 million for the pre-clinical testing for the Xcede Patch. Xcede utilized $0.5 million in CBI services in exchange for a note that is currently outstanding.

 

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On July 20, 2018, Xcede received a notice of termination from 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.

 

In light of the foregoing, 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 CBI’s security interest. Additionally, Xcede and the Company’s RMD subsidiary have begun an investigation of possible continued development of the Xcede Patch, which includes seeking government funding of this development. In September 2019, Xcede and RMD plan to resubmit an application for a Phase I SBIR grant for $225,000. There can be no assurances with respect to any such alternatives or that any additional outside funding to continue development of the Xcede Patch will be available to Xcede.

  

 

Note 4 - Inventories

 

Inventories, net of reserves, consists of the following:

 

    June 30,     September 30,  
    2019     2018  
Raw Materials   $ 2,482,000     $ 2,362,000  
Work-in-Process     1,073,000       890,000  
Finished Goods     989,000       854,000  
    $ 4,544,000     $ 4,106,000  

 

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Note 5 – Intangible Assets

 

Intangible assets at June 30, 2019 and September 30, 2018 consist of the following:

 

    Useful   Gross     Accumulated        
June 30, 2019   Life (years)   Amount     Amortization     Net  
Acquired Customer Base   5 to 15   $ 703,000     $ 635,000     $ 68,000  
Know How   15     512,000       376,000       136,000  
Trade Names   Indefinite     266,000       -       266,000  
Patents   20     223,000       28,000       195,000  
Biomedical Technologies   5     260,000       260,000       -  
        $ 1,964,000     $ 1,299,000     $ 665,000  
                             
    Useful   Gross     Accumulated        
September 30, 2018   Life (years)   Amount     Amortization     Net  
Acquired Customer Base   5 to 15   $ 719,000     $ 601,000     $ 118,000  
Know How   15     512,000       350,000       162,000  
Trade Names   Indefinite     272,000       -       272,000  
Patents   20     223,000       20,000       203,000  
Biomedical Technologies   5     260,000       260,000       -  
        $ 1,986,000     $ 1,231,000     $ 755,000  

 

Amortization expense for the three months ended June 30, 2019 and 2018 was $27,000 and $28,000, respectively. Amortization expense for the nine months ended June 30, 2019 and 2018 was $82,000 and $84,000, respectively.

 

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

 

    2019 (3 months)     2020     2021     2022     2023     Thereafter     Total  
Acquired Customer Base   $ 20,000     $ 48,000     $ -     $ -     $ -     $ -     $ 68,000  
Know How     9,000       34,000       34,000       34,000       25,000       -       136,000  
Patents     3,000       11,000       11,000       11,000       11,000       148,000       195,000  
    $ 32,000     $ 93,000     $ 45,000     $ 45,000     $ 36,000     $ 148,000     $ 399,000  

 

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, 2019 and 2018.

 

 

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

 

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

 

There were no changes, aside from foreign exchange rate fluctuations, in the carrying value of goodwill, during the nine months ended June 30, 2019 and 2018.

 

 

Note 7 – Debt

 

Senior Debt

 

On April 30, 2019, the Company converted the outstanding balance on the equipment line of credit with Middlesex Savings Bank (“Middlesex”) of approximately $484,000 into a five year term note with an interest rate of 5.17%, which will be repaid in equal monthly installments from May 2019 through April 2024. Additionally, on May 1, 2019, the Company’s equipment line of credit was renewed for $750,000 through April 30, 2020, at which time the outstanding balance will be converted into a five year term note.

 

Subordinated Debt

 

On November 27, 2018, the Company amended the Note Purchase Agreement (the “Note”) with Massachusetts Capital Resource Company (“MCRC”) to reinstate the interest only payment requirements of the loan and defer principal repayment requirements to November 30, 2019. Such amendment also extended the maturity date from July 31, 2019 to November 30, 2021.

 

On May 7, 2019, the Company received a waiver from MCRC to terms of the Note to allow and permit the Company’s proposed transaction to delist its Common Stock from the Nasdaq Stock Market, including the 1-for-8,000 reverse stock split on its outstanding shares of Common Stock (the “Reverse Split”), the payment of cash to stockholders subsequent to the Reverse Split who hold only a fractional interest, and the subsequent forward stock split of 8,000-for-1 to restore the remaining shareholders to their original share ownership as of immediately prior to the Reverse Split.

 

In connection with the events described above, on August 6, 2019, the Company entered into an Note Purchase Agreement with MCRC, the Company’s subordinated lender, in which the Company borrowed an additional $2,000,000 in cash and replaced the existing Note which has an outstanding principal amount of $865,216, for an aggregate principal amount of $2,865,216 which will be due July 31, 2026 and bears eight percent interest per annum. Until August 31, 2022 this loan will require interest only payments, followed by principal and interest payments for the remaining four years of the loan. Until August 31, 2021, the Company is subject to early-payback penalties. As a result of this amendment to the Note, the debt balance as of June 30, 2019 with MCRC was classified as long-term.

 

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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 the three and nine months ended June 30, 2019 and 2018, no common share equivalents related to stock options were included in the calculation of dilutive shares, as all of the 95,602 and 160,537 common stock options outstanding, respectively, had exercise prices above the applicable period’s average market price per share and the inclusion of common share equivalents would be anti-dilutive. Additionally, for the three and nine months ended June 30, 2019 and 2018, 25,000 and 60,000 shares of restricted common stock were excluded from the calculation of dilutive shares, respectively, as the effect of their inclusion would be anti-dilutive.

 

The computation of the weighted shares outstanding for the three months ended June 30, 2019 and 2018 is as follows:

 

    June 30, 2019     June 30, 2018  
Weighted average shares outstanding                
Basic     17,522,644       17,203,965  
Effect of dilutive securities                
Stock Options     -       -  
Restricted Stock     -       17,234  
Dilutive Average Shares Outstanding     17,522,644       17,221,199  

  

The computation of the weighted shares outstanding for the nine months ended June 30, 2019 and 2018 is as follows:

 

    June 30, 2019     June 30, 2018  
Weighted average shares outstanding                
Basic     17,426,316       17,127,834  
Effect of dilutive securities                
Stock Options     -       -  
Restricted Stock     -       19,394  
Dilutive Average Shares Outstanding     17,426,316       17,147,228  

 

 

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 and employee termination 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.

 

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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.

 

As of June 30, 2019, DBM owned approximately 63% of Xcede’s outstanding Common Stock and Preferred Stock. No significant change in the Company’s position with respect to the ownership of Xcede’s stock occurred during the three months ended June 30, 2019.

 

Stock compensation expense for the three and nine months ended June 30, 2019 and 2018 is as follows:

 

    Three Months Ended     Three Months Ended  
    June 30, 2019     June 30, 2018  
Stock Grants   $ 73,000     $ 78,000  
Restricted Stock Grants     6,000       14,000  
Option Grants     -       -  
Employee Stock Purchase Plan     1,000       1,000  
Subsidiary Option Grants     10,000       27,000  
Total   $ 90,000     $ 120,000  
                 
    Nine Months Ended     Nine Months Ended  
    June 30, 2019     June 30, 2018  
Stock Grants   $ 215,000     $ 209,000  
Restricted Stock Grants     29,000       40,000  
Option Grants     -       17,000  
Employee Stock Purchase Plan     3,000       2,000  
Subsidiary Option Grants     32,000       83,000  
Total   $ 279,000     $ 351,000  

 

At June 30, 2019, there was approximately $32,000 in unrecognized stock compensation cost for Dynasil, which is expected to be recognized over a weighted average period of approximately thirteen months.

 

Restricted Stock Grants

 

A summary of restricted stock activity for the nine months ended June 30, 2019 is presented below:

 

Restricted Stock Activity for the Nine Months
ended June 30, 2019 		  Shares     Weighted-Average
Grant-Date Fair Value 		 
Nonvested at September 30, 2018     60,000     $ 1.61  
                 
Granted     -       -  
Vested     (35,000 )     1.68  
Cancelled     -       -  
Nonvested and expected to vest at June 30, 2019     25,000     $ 1.50  

 

  20  

 

 

Stock Option Grants

 

During the nine months ended June 30, 2019, no Dynasil stock options were granted. A summary of stock option activity for the nine months ended June 30, 2019 is presented below:

 

    Options
Outstanding 		    Weighted Average
Exercise Price per
Share 		    Weighted Average
Remain
Contractual Term
(in Years) 		 
Balance at September 30, 2018     160,537     $ 2.01       0.93  
Outstanding and exercisable at September 30, 2018     160,537     $ 2.01       0.93  
Granted     -       -          
Exercised     -       -          
Cancelled     (64,935 )     2.33          
Balance at June 30, 2019     95,602     $ 1.80       0.59  
Outstanding and exercisable at June 30, 2019     95,602     $ 1.80       0.59  

 

Subsidiary Stock Option Grants

 

During the nine months ended June 30, 2019, no Xcede stock options were granted. A summary of Xcede stock option activity for the nine months ended June 30, 2019 is presented below:

 

    Options
Outstanding 		    Weighted Average
Exercise Price per
Share 		    Weighted Average
Remain
Contractual Term
(in Years) 		 
Balance at September 30, 2018     1,300,956     $ 1.00       7.10  
Outstanding and exercisable at September 30, 2018     1,229,685       1.00       7.11  
Granted     -       -          
Exercised     -       -          
Cancelled     -       -          
Balance at June 30, 2019     1,300,956       1.00       6.35  
Outstanding and exercisable at June 30, 2019     1,283,768     $ 1.00       6.35  

 

At June 30, 2019, the Company’s Xcede joint venture had approximately $10,000 of unrecognized stock compensation expense associated with stock options expected to be recognized over a period of three months.

 

 

Note 10 – Segment, Customer and Geographical Reporting

 

Segment Financial Information

 

Dynasil reports three reportable segments: innovation and development (“Innovation and Development”), (formerly known as the Contract Research segment), 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 Innovation and Development 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.

 

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The Company’s segment information for the three months ended June 30, 2019 and 2018 is summarized below:

 

Results of Operations for the Three Months Ended June 30,
2019
    Optics     Innovation and
Development* 		    Biomedical     Total  
Revenue   $ 5,899,000     $ 5,191,000     $ -     $ 11,090,000  
Gross profit     2,112,000       1,994,000       -       4,106,000  
GM %     36 %     38 %     -       37 %
Operating expenses     2,237,000       1,992,000       23,000       4,252,000  
Operating income (loss)     (125,000 )     2,000       (23,000 )     (146,000 )
                                 
Depreciation and amortization     297,000       63,000       3,000       363,000  
Capital expenditures     90,000       29,000       -       119,000  
                                 
Intangibles, net     334,000       136,000       195,000       665,000  
Goodwill     925,000       4,939,000       -       5,864,000  
Total assets   $ 21,084,000     $ 10,805,000     $ 201,000     $ 32,090,000  

 

Results of Operations for the Three Months Ended June 30,
2018
    Optics     Innovation and
Development* 		    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  

 

*Formerly Contract Research

 

  22  

 

 

The Company’s segment information for the nine months ended June 30, 2019 and 2018 is summarized below:

 

Results of Operations for the Nine Months Ended June 30,
2019
    Optics     Innovation and
Development* 		    Biomedical     Total  
Revenue   $ 17,846,000     $ 14,804,000     $ -     $ 32,650,000  
Gross profit     6,121,000       6,035,000       -       12,156,000  
GM %     34 %     41 %     -       37 %
Operating expenses     5,993,000       6,012,000       98,000       12,103,000  
Operating income (loss)     128,000       23,000       (98,000 )     53,000  
                                 
Depreciation and amortization     863,000       183,000       10,000       1,056,000  
Capital expenditures     586,000       93,000       -       679,000  
                                 
Intangibles, net     334,000       136,000       195,000       665,000  
Goodwill     925,000       4,939,000       -       5,864,000  
Total assets   $ 21,084,000     $ 10,805,000     $ 201,000     $ 32,090,000  

 

Results of Operations for the Nine Months Ended June 30,
2018
    Optics     Innovation and
Development* 		    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  

 

*Formerly Contract Research

 

Customer Financial Information

 

For three and nine months ended June 30, 2019, one customer in the Optics segment represented more than 10% of the total segment revenue. For the three and nine months ended June 30, 2018, no customer in the Optics segment represented more than 10% of the total segment revenue.

 

For the three and nine months ended June 30, 2019, three customers of the Innovation and Development 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, four customers of the Innovation and Development 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 Innovation and Development segment, all various agencies of the U.S. Government, each represented more than 10% of the total segment 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, 2019 and 2018 are as follows:

 

    Three Months Ended     Three Months Ended  
    June 30, 2019     June 30, 2018  
Geographic Location   Revenue     % of Total     Revenue     % of Total  
United States   $ 8,669,000       78 %   $ 7,512,000       71 %
Asia     667,000       6 %     877,000       9 %
Europe     1,468,000       13 %     2,029,000       19 %
Other     286,000       3 %     124,000       1 %
    $ 11,090,000       100 %   $ 10,542,000       100 %

 

Revenue by geographic location in total and as a percentage of total revenue, for the nine months ended June 30, 2019 and 2018 are as follows:

 

    Nine Months Ended     Nine Months Ended  
    June 30, 2019     June 30, 2018  
Geographic Location   Revenue     % of Total     Revenue     % of Total  
United States   $ 24,901,000       76 %   $ 22,993,000       76 %
Asia     2,462,000       8 %     877,000       3 %
Europe     4,705,000       14 %     4,662,000       16 %
Other     582,000       2 %     1,453,000       5 %
    $ 32,650,000       100 %   $ 29,985,000       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.

 

  24  

 

 

As a result of Xcede’s de-consolidation from the Company’s federal tax returns, the Company is no longer 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.

 

As a result of Xcede’s decision to halt clinical trial preparations and curtail operations to a minimal level while the Board of Directors of Xcede evaluates alternative avenues to develop the Xcede Patch, following the July 2018 notice of termination from Cook Biotech Inc. (“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, the Company has concluded that it is more likely than not that the deferred tax assets associated with the Company’s unitary state filings will be realized based on future profit for the group and thus has reversed the related valuation allowance on the Company’s NOLs of approximately $0.6 million. In addition, the Company conducted a research and experimentation study which released the tax valuation allowance and increased deferred tax assets by $0.6 million. The reversal resulted in an income tax benefit of approximately $1.2 million recorded during the year ended September 30, 2018. 

 

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, 2019 and September 30, 2018, 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, 2019 and September 30, 2018, 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.  The Company has completed its accounting for the tax effects of the 2017 Tax Act. 

 

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 recorded an income tax expense of $0.7 million related to such re-measurement in the quarter ended December 31, 2018. The one-time transition tax was based on the total unremitted earnings of the Company’s foreign subsidiary, Hilger, which had previously been deferred from U.S. income taxes. The Company recorded a provision for its one-time transition liability of its foreign subsidiary resulting in additional income tax expense of $0.2 million in fiscal year 2018.

 

During the fiscal year ended, September 30, 2018, the Company has federal research credits of $2.9 million, primarily resulted from a benefit in the third quarter of fiscal year 2018 related to R&E tax credits for the years ended 2013 through 2016. The federal credits begin expiring in fiscal year 2030. During the fiscal year ended September 30, 2018, the Company had state research credits of $852,000 which begin expiring in fiscal year 2027. 

 

The effective tax rates were (33%) and 34% for the three months ended June 30, 2019 and 2018, respectively. The effective tax rates were (227%) and (115%) for the nine months ended June 30, 2019 and 2018, respectively. The results for both nine month periods ended June 30, 2019 and 2018 had significant events which resulted in an extreme variation in tax rates. The effective tax rate for the three and nine months ended June 30, 2019 were a result of the anticipated non-deductible transaction costs resulting from the Board of Directors’ plan to cease the registration of the Company’s common stock under federal securities laws (see Note 12 – Subsequent Events). 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 third quarter of fiscal year 2018. The effective tax rate excluding the impact of the 2017 Tax Act and the PATH 2015 R&E Tax Credit was 69% for the nine months ended June 30, 2018.

 

  25  

 

 

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 2013 are still subject to examination.

 

 

Note 12 – Subsequent Events

 

On August 7, 2019, the Company held a special meeting of stockholders (the “Special Meeting”). At the Special Meeting, the holders of a majority of the Company’s issued and outstanding shares of common stock entitled to vote approved amendments to the Company’s certificate of incorporation, as amended (the “Certificate of Incorporation”), to effect a 1-for-8,000 reverse stock split of the Company’s common stock (the “Reverse Stock Split”), followed immediately by a 8,000-for-1 forward stock split of the Company’s common stock (the “Forward Stock Split,” and together with the Reverse Stock Split, the “Transaction”).

 

Following the Special Meeting, the Company filed certificates of amendment to the Certificate of Incorporation with the State of Delaware to effect the Reverse Stock Split, followed immediately by the Forward Stock Split, both effective on August 7, 2019 at 5:01 and 5:02 p.m., respectively. As a result of the Transaction, each stockholder owning fewer than 8,000 shares of the Company’s common stock immediately prior to the effective time of the Reverse Stock Split became entitled to receive $1.15 per share, without interest, in cash for each share of the Company’s common stock held by such stockholder at the effective time of the Reverse Stock Split. As a result of the Transaction, based on information provided to the Company by its transfer agent, Continental Stock Transfer & Trust Company, and the Depository Trust Company (DTC), 2,825,268 pre-split shares of common stock are due to be exchanged for cash, and the aggregate amount payable by the Company to the former holders of such shares is approximately $3,249,000.

  

Stockholders who owned 8,000 or more shares of the Company’s common stock immediately prior to the effective time of the Reverse Stock Split were not entitled to receive any cash for their fractional share interests resulting from the Reverse Stock Split, if any. The Forward Stock Split that immediately followed the Reverse Stock Split reconverted whole shares and fractional share interests held by such stockholders back into the same number of shares of the Company’s common stock held by such stockholders immediately before the effective time of the Reverse Stock Split. As a result, the total number of shares of the Company’s common stock held by such stockholders did not change.

 

The Company has given notice to The Nasdaq Stock Market (“Nasdaq”) of its intent to voluntarily delist its common stock and to withdraw the registration of its common stock with the Securities and Exchange Commission (SEC). The Company intends to file a Form 25 Notification of Removal From Listing with the SEC on or about August 19, 2019. As a result, the Company expects that listing of its shares on Nasdaq will be terminated on or about August 29, 2019, at which time the Company intends to file a Form 15 with the SEC to suspend the Company’s reporting obligations under Section 15(d) of the Exchange Act.

 

In connection with the events described above, on August 5, 2019, the Company entered into a Loan Modification Agreement with Middlesex, the Company’s senior lender, to modify the Loan and Security Agreement dated May 1, 2014, by and between the Company and Middlesex, to allow for the exclusion of certain transaction-related expenses from the calculation of EBITDA.

 

In connection with the events described above, on August 6, 2019, the Company entered into an Note Purchase Agreement with MCRC, the Company’s subordinated lender, in which the Company borrowed an additional $2,000,000 in cash and replaced the existing Note, which has an outstanding principal amount of $865,216, for an aggregate principal amount of $2,865,216, which will be due July 31, 2026 and bears eight percent interest per annum. Until August 31, 2022 this loan will require interest only payments, followed by principal and interest payments for the remaining four years of the loan. Until August 31, 2021, the Company is subject to early-payback penalties.

 

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, 2018.

 

General Business Overview

 

Operations

 

Consolidated revenue for the quarter ended June 30, 2019 was $11.1 million, compared to revenue of $10.5 million for the third quarter of fiscal year 2018. This $0.6 million or 5% increase resulted from an 18% increase in Innovations and Development segment revenue, which was partially offset by a 4% decrease in Optics segment revenue.

 

Gross profit for the quarter ended June 30, 2019 was $4.1 million, or 37% of revenue, as compared to the gross profit of $4.2 million, or 40% of revenue for the quarter ended June 30, 2018.

 

Total operating expenses were $4.3 million for the three-month period ended June 30, 2019, a 19% increase over the $3.6 million in operating expenses for the three months ended June 30, 2018. The increase was attributable to $0.5 million expended in the Company’s efforts to delist from The Nasdaq Stock Market, as well as increased recruitment and personnel expenses as the Company continues to fill key positions. The operating expenses in our Biomedical segment continued to decrease in the third quarter as compared to the same period last year. Biomedical segment expenses to date in fiscal 2019 were $0.1 million, as compared to $0.7 million in the first three quarters of fiscal year 2018. Last year, our majority owned joint venture, Xcede Technologies, Inc. (“Xcede”), was preparing for clinical trials. As described below, these activities have since been suspended due to a notice of termination Xcede received from Cook Biotech, Inc. (“CBI”) in July 2018, in which CBI asserted its termination rights under the Note Agreement and Development Agreement between Xcede and CBI, claiming that in CBI’s assessment it is not commercially reasonable to continue to the next development phase of Xcede’s hemostatic patch.

 

In light of the foregoing, 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 CBI’s security interest. Additionally, the Company’s RMD subsidiary and Xcede have begun an investigation of the possible continued development of the Xcede Patch, which includes seeking government funding of this development. In April 2019, Xcede filed an application for a government grant seeking $225,000, which is currently being revised, with a plan to resubmit this application in September 2019. There can be no assurances with respect to any such alternatives or that any additional outside funding to continue development of the Xcede Patch will be available to Xcede. Without such funding, the Board of Directors of Xcede may be required to cease all operations of Xcede. In the event that such a determination were to be made by the Xcede Board of Directors in the future, the Company expects that it would be required to account for Xcede at such time as discontinued operations in accordance with ASC 205-20 and would recognize a non-cash gain based on the losses absorbed by the Company in excess of their actual ownership percentage. This potential gain will have no impact on the Company’s cash position when and if it is recognized or in the future.

 

Income (loss) from operations for the quarter ended June 30, 2019 was a loss of ($0.1) million, compared with income from operations of $0.6 million for the quarter ended June 30, 2018.

 

The provision for income taxes for the third quarter of 2019 was approximately $0.1 million, as compared to a provision of $0.2 million for the third quarter of fiscal year 2018.

 

Net income attributable to common stockholders was a loss of ($0.3) million, or ($0.02) per share, as compared to income of $0.4 million, or $0.02 per share for the quarters ended June 30, 2019 and 2018, respectively, largely as a result of the increased expenses in the fiscal year 2019.

 

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Corporate Structure Changes

 

As previously disclosed, following a special meeting of Dynasil’s stockholders on August 7, 2019, the Company filed certificates of amendment to our certificate of incorporation and subsequently effected a 1-for-8,000 reverse stock split of our common stock, par value $0.0005 per share (the “Reverse Stock Split”), followed immediately by a 8,000-for-1 forward stock split of its common stock (the “Forward Stock Split,” and together with the Reverse Stock Split, the “Transaction”). In regards to the Transaction, stockholders with fewer than 8,000 shares of Dynasil common stock held of record immediately before the Transaction became entitled to receive cash payments in lieu of fractional shares equal to $1.15 per pre-Reverse Stock Split share. As a result of the Transaction, based on information provided to the Company by its transfer agent, Continental Stock Transfer & Trust Company, and the Depository Trust Company (DTC), 2,825,268 pre-split shares of common stock are due to be exchanged for cash, and the aggregate amount payable by the Company to the former holders of such shares is approximately $3,249,000. We anticipate that stockholders who are to be cashed out in conjunction with the Transaction will receive payment as soon as practicable thereafter.

 

On or about Monday, August 19, we expect to file a Form 25 with the Securities and Exchange Commission (the “SEC”) to indicate our intention to terminate the registration of our common stock with the SEC. Following that filing, and on or about August 29, we intend to file a Form 15 with the SEC to de-list our common stock from the Nasdaq Capital Market. As a result of these filings, (i) the Company would cease to file annual, quarterly, current, and other reports and documents with the SEC, and stockholders would cease to receive annual reports and proxy statements, and (ii) the Company’s common stock would no longer be listed on the Nasdaq Capital Market.

 

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Results of Operations

 

Results of Operations for the Three Months Ended June 30,
2019
    Optics     Innovation and
Development* 		    Biomedical     Total  
Revenue   $ 5,899,000     $ 5,191,000     $ -     $ 11,090,000  
Gross profit     2,112,000       1,994,000       -       4,106,000  
GM %     36 %     38 %     -       37 %
Operating expenses     2,237,000       1,992,000       23,000       4,252,000  
Operating income (loss)     (125,000 )     2,000       (23,000 )     (146,000 )
                                 
Depreciation and amortization     297,000       63,000       3,000       363,000  
Capital expenditures     90,000       29,000       -       119,000  
                                 
Intangibles, net     334,000       136,000       195,000       665,000  
Goodwill     925,000       4,939,000       -       5,864,000  
Total assets   $ 21,084,000     $ 10,805,000     $ 201,000     $ 32,090,000  

 

Results of Operations for the Three Months Ended June 30,
2018
    Optics     Innovation and
Development* 		    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  

 

*Formerly Contract Research

 

Consolidated revenue for the quarter ended June 30, 2019, was $11.1 million, a 5% increase as compared with revenue of $10.5 million for the quarter ended June 30, 2018.

 

Optics segment revenue decreased $0.3 million, or 4%, for the three months ended June 30, 2019 compared with the same period in the prior year, primarily as a result of a slowdown in the optics market during the quarter. The decrease in this quarter is largely the result of delayed and decreased orders from a few of our large key customers.

 

Innovation and Development segment revenue increased by $0.8 million or 18% to $5.2 million for the third quarter of fiscal year 2019, as compared with the same period in the prior year due to an increase in funded research contract awards. The research backlog for the Innovation and Development segment is very strong at $38.3 million at June 30, 2019.

 

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The Biomedical segment has no revenue as it is currently exploring development options for Xcede’s tissue sealant technology.

 

Cost of revenue for the quarter ended June 30, 2019 was 63%, or $7.0 million, as compared to 60% or $6.4 million for the quarter ended June 30, 2018.

 

Gross profit for the three months ended June 30, 2019 was $4.1 million, compared to $4.2 million, for the three months ended June 30, 2018. The gross profit as a percent of revenue for the third quarter of 2019 was 37%, as compared to 40% in the same period in 2018. The gross profit for the Optics segment was $2.1 million for the quarter ended June 30, 2019, compared to $2.3 million for the quarter ended June 30, 2018. The gross profit as a percent of revenue for the Optics segment was 36% in the third quarter of 2019 and 37% in the third quarter of 2018. This reduction was the result of lower revenue and higher material costs within one of the business units in the segment. The Innovation and Development segment gross profit increased to $2.0 million, as compared to $1.9 million in the same period in fiscal year 2018, as a result of actively working on an increased number of contract research projects in 2019. Gross profit as a percent of revenue decreased in the third quarter of 2019 by 4% as compared to 2018 due to fewer commercial product sales in 2019 which have higher margins than contract research sales.

 

The Biomedical segment, through Xcede, is engaged in exploring development options for a tissue sealant technology which has not been approved for commercial use, and consequently it has no gross profit.

 

Total operating expenses increased to $4.3 million for the three months ended June 30, 2019 from $3.6 million for the same quarter in fiscal year 2018. Operating expenses for the Optics segment in the third quarter of 2019 were $2.2 million, a $0.5 million increase over the operating expenses of $1.7 million in the same period in 2018. Innovation and Development segment expenses increased to $2.0 million in the third quarter of fiscal year 2019, as compared to $1.8 million in the third quarter of fiscal year 2018. The primary reason for the increase in both of these segments was the $0.5 million of expenses in the Company’s efforts to delist from the Nasdaq Stock Market incurred during the quarter, as well as increases in salaries and hiring costs. Biomedical segment expenses decreased by $0.1 million in the three months ended June 30, 2019, compared to the three months ended June 30, 2018, primarily due to the cessation of work on its preparations for first-in-human clinical trials.

 

As a result of the items discussed above, income from operations for the three months ended June 30, 2019 was a loss of ($0.1) million compared to income of $0.6 million for the same period in fiscal year 2018.

 

Net interest expense was essentially the same in both the three month periods ended June 30, 2019 and 2018.

 

The provision for income taxes for the third quarter of 2019 was approximately $0.1 million, as compared to $0.2 million for the third quarter of fiscal year 2018.

 

Net income for the three months ended June 30, 2019 was a loss of ($0.3) million, or ($0.02) in basic earnings per share, as compared to income of $0.4 million, or $0.02 in basic earnings per share, for the quarter ended June 30, 2018.

 

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Results of Operations – Year to Date

 

Results of Operations for the Nine Months Ended June 30,
2019
    Optics     Innovation and
Development* 		    Biomedical     Total  
Revenue   $ 17,846,000     $ 14,804,000     $ -     $ 32,650,000  
Gross profit     6,121,000       6,035,000       -       12,156,000  
GM %     34 %     41 %     -       37 %
Operating expenses     5,993,000       6,012,000       98,000       12,103,000  
Operating income (loss)     128,000       23,000       (98,000 )     53,000  
                                 
Depreciation and amortization     863,000       183,000       10,000       1,056,000  
Capital expenditures     586,000       93,000       -       679,000  
                                 
Intangibles, net     334,000       136,000       195,000       665,000  
Goodwill     925,000       4,939,000       -       5,864,000  
Total assets   $ 21,084,000     $ 10,805,000     $ 201,000     $ 32,090,000  

 

Results of Operations for the Nine Months Ended June 30,
2018
    Optics     Innovation and
Development* 		    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  

 

*Formerly Contract Research

 

Revenue for the nine months ended June 30, 2019 increased 9% to $32.7 million, a $2.7 million increase over the nine months ended June 30, 2018.

 

Optics segment revenue increased $0.8 million, or 5%, for the nine months ended June 30, 2019, compared with the same period in the prior year, primarily as a result of revenue growth in three of the four operating units in this segment. Our Optics segment revenue showed increased orders from a number of our larger established customers during the first part of the year.

 

Revenue from our Innovation and Development segment increased $1.8 million, or 14%, for the nine months ended June 30, 2019 as compared to the same period in 2018, primarily due to increased orders from some of our key government customers, partially offset by a delay in our commercial product orders.

 

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The Biomedical segment had no revenue in either the nine months ended June 30, 2019 or 2018.

 

Gross profit for the nine months ended June 30, 2019 was $12.2 million, or 37% of sales, compared to $11.7 million, or 39% of sales for the nine months ended June 30, 2018. The $0.5 gross profit increase was attributed to the higher revenue generated in the first nine months.

 

Gross profit for the Optics segment increased approximately $0.1 million to $6.1 million for the nine months ended June 30, 2019, compared to the gross profit for the same period in fiscal year 2018. Gross profit for the Innovation and Development segment increased $0.4 million in the nine months ended June 30, 2019 to $6.0 million compared to $5.6 million in the nine months ended June 30, 2018. Both increases were the result of the increases in revenue in the first nine months of fiscal 2019, as compared to the same period in 2018.

 

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

 

Total operating expenses increased $0.9 million to $12.1 million for the nine months ended June 30, 2019, as compared to the total operating expenses of $11.2 million for the nine months ended June 30, 2018. This increase was spread across the Optics and Innovation and Development segments due to the $0.5 million of expenses incurred in the Company’s efforts to delist from the Nasdaq Stock Market, as well as increases in personnel-related expenses, offset by $0.6 million of lower expenses in the Biomedical segment due to curtailed operations.

 

Income (loss) from operations was essentially breakeven for the nine months ended June 30, 2019 and $0.5 million for the same nine month period in 2018 due the items indicated above.

 

Net interest expense for both the nine month periods ended June 30, 2019 and 2018 was $0.1 million.

 

The provision for income taxes for the first nine months of 2019 was a $0.2 million as compared to a benefit of $0.4 million for the same period in fiscal year 2018. The 2018 provision was the result of the $1.3 million PATH 2015 R&E Tax Credit estimate for the years 2012 thru 2016 that was recognized in the third quarter of 2018, offset by the result of the 2017 Tax Act, in which we estimated the rate reduction impact to be $0.5 million, the earnings and profit transition tax of our Hilger Crystals subsidiary to be $0.1 million and the first quarter earnings provision of $0.1 million.

 

Net income attributable to common stockholders for the nine months ended June 30, 2019 was a loss of ($0.3) million or ($0.02) basic earnings per share, compared to net income of $0.9 million or $0.05 basic earnings per share for the nine months ended June 30, 2018.

 

Liquidity and Capital Resources

 

Net cash as of June 30, 2019 was $0.5 million, or approximately $1.8 million less than net cash of $2.3 million at September 30, 2018.

 

As of June 30, 2019, the Company was in full compliance with all of its bank covenants. The Company had $4.0 million of available cash under its Middlesex Savings Bank line of credit based on its collateral calculations as of June 30, 2019, of which the outstanding balance was $961,000. Management believes that its cash on hand, together with availability under its credit agreements, are adequate to meet the Company’s current liquidity requirements for the next twelve months.

 

On November 27, 2018, the Company amended the Note Purchase Agreement with Massachusetts Capital Resource Company (“MCRC”) to reinstate the interest-only payment requirements of the loan and defer principal repayment requirements to November 30, 2019. Such amendment also extended the maturity date from July 31, 2019 to November 30, 2021. On June 30, 2019, approximately $865,000 in principal was outstanding on the MCRC loan.

 

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In connection with the Company’s efforts to delist from the Nasdaq Stock Market, on August 6, 2019, the Company entered into an Note Purchase Agreement with MCRC, the Company’s subordinated lender, in which the Company borrowed an additional $2,000,000 in cash and replaced the existing Note, which has an outstanding principal amount of $865,216, for an aggregate principal amount of $2,865,216, which will be due July 31, 2026 and bears eight percent interest per annum. Until August 31, 2022 this loan will require payback of interest payments only, followed by principal and interest payments for the remaining four years of the loan. Until August 31, 2021, the Company is subject to early-payback penalties. As a result of this amendment to the Note, the debt balance as of June 30, 2019 with MCRC was classified as long-term.

 

On April 30, 2019, the Company converted the outstanding balance on the equipment line of credit with Middlesex Savings Bank (“Middlesex”) of approximately $484,000, which was outstanding on June 30, 2019, into a five year term note with an interest rate of 5.17%. Additionally, on May 1, 2019, the Company’s equipment line of credit was renewed for $750,000 through April 30, 2020, at which time the outstanding balance will be converted into a five year term note. It also modified the borrowing base under its revolving line of credit note to increase the percentage of eligible accounts receivable available for borrowing from 80% to 85% and to eliminate eligible unbilled receivables as a category in obtaining advances under the revolving line of credit. On August 5, 2019, the Company entered into a Loan Modification Agreement with Middlesex to modify the Loan and Security Agreement, by and between the Company and Middlesex, to allow for the exclusion of certain transaction-related expenses from the calculation of EBITDA.

 

Following the consummation of the Transaction and taking into account the expenses thereof (including payments to cashed-out stockholders and professional fees), the Company has outstanding bank indebtedness of $6.4 million and $2.8 million available in the Company’s line of credit.

 

On June 30, 2019, Xcede had $0.5 million of outstanding indebtedness owed to CBI. The note was recorded at fair value at issuance net of unamortized discount based on an imputed interest rate of 5.4%. On July 20, 2018, Xcede received a notice of termination from CBI, which included CBI’s assertion that the foregoing study results trigger an immediate repayment of the $500,000 promissory note owed by Xcede to CBI under the Note Agreement and cancelled the remaining availability under the Note Agreement. While Xcede vigorously contests this assertion, at this time it is unclear how this matter will be resolved between Xcede and CBI. The Company carries the promissory note in short-term debt.

 

Cash From Operating Activities

 

In total, operating activities used cash of $2.0 million for the nine months ended June 30, 2019. Approximately $0.5 million of cash was used for inventory increases to ensure the proper supply of material is available to meet customer demand and $0.1 million was used to pay down year end accrued expenses. In addition, unbilled receivables, accounts receivables and contract liabilities increased, which used approximately $2.7 million of cash due to increased revenues in the third quarter of 2019 compared to revenue in the fourth quarter of 2018. The decreases in cash were offset by net loss, net of non-cash items of approximately $1.3 million.

 

Cash From Investing and Financing Activities

 

The Company used cash of approximately $0.7 million for the purchase of property, plant, and equipment for the nine months ended June 30, 2019.

 

Total outstanding bank debt as of June 30, 2019 increased approximately $0.9 million to $4.2 million from $3.3 million at September 30, 2018. The net cash increase from financing activities during the nine months ended June 30, 2019 was approximately $0.9 million as a result of $1.0 million in short term borrowing against the Middlesex revolving line of credit, $0.5 million borrowing against the Middlesex equipment line of credit, offset by $0.6 million in principal payments on all debt.

 

Critical Accounting Policies and Estimates

 

During the nine months ended June 30, 2019, we adopted ASU 2014-09, which provides for new requirements in regards to revenue recognition. See Note 2 – Recent Accounting Pronouncements for further details. Aside from the adoption of ASU 2014-09, there been no material changes in our critical accounting policies or critical accounting estimates since September 30, 2018. 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, 2018 as well as the notes to the financial statements contained in this Quarterly Report on Form 10-Q.

 

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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:

 

Revenue Recognition

 

We generate revenues from contract research, product sales, and non-recurring engineering contracts.

 

Our Optics segment produces standard and customized products for commercial organizations, educational institutions, and U.S. Federal government agencies. In addition, we also offer services which include non-recurring engineering services. We recognize revenue when the performance obligation has been satisfied by transferring the control of the product or service to the customer. For contracts with multiple performance obligations, we allocate the contract’s transaction price to each performance obligation based on their relative stand-alone selling prices. In such circumstances, the Company uses the observable price of goods or services which are sold separately in similar circumstances to similar customers. If these prices are not observable, then we will estimate the stand-alone selling price using information that is reasonably available. For the majority of our standard products and services, price list, and discount structures related to customer type are available. For products and services that do not have price list and discount structures, we may use one or both of the following: (i) adjusted market assessment approach or (ii) expected cost plus a margin approach. The adjusted market approach requires evaluation of the market in which we sell goods or services and estimation of the price that a customer in that market would be willing to pay for those goods or services. The expected cost plus margin approach requires the Company to forecast expected costs of satisfying the performance obligation and then add a reasonable margin for that good or service. Shipping and handling activities primarily occur after a customer obtains control and are considered fulfillment cost rather than separate performance obligations.

 

Our Innovation and Development segment performs research and development for U.S. Federal government agencies, educational institutions and commercial organizations. We account for a research contract when a contract has been executed, the rights of the parties are identified, payment terms are identified, the contract has commercial substance, and collectability of the contract price is considered probable. Revenue is earned under reimbursement of costs plus fees, fixed price, or time and material type contracts. Revenue is recognized when the contract has been approved by both parties, each entity can identify each’s party’s rights regarding goods and services to be transferred, the payment terms have been identified, the contract has commercial substance, and it is probable that we will collect substantially all of the consideration to which it is entitled in exchange for the goods or services transferred.

 

Under the typical payment terms of our U.S. government contracts, the customer pays either performance-based payments or progress payments. Performance-based payments, which are typically used in the firm fixed price contracts, are interim payments based on quantifiable measures of performance or on the achievement of specified events or milestones. Progress payments, which are typically used in our cost-plus type contracts, are interim payments based on costs incurred as the work progresses. For our U.S. government cost-plus contracts, the customer generally pays during the performance period for 80%-90% of the actual costs incurred. Because the customer retains a small portion of the contract price until completion of the contract and audit of allowable costs, cost-plus type contracts generally result in revenue recognized in excess of billings which we present as contract assets on the balance sheet. Amounts billed and due from customers are classified as receivables on the balance sheet, whereas amounts earned, but not yet billed to the Company’s customers due to timing, are classified as unbilled receivables on the balance sheet. We recognize a liability for performance-based payments paid in advance which are in excess of the revenue recognized and presents these amounts as contract liabilities on the balance sheet.

 

Effective October 1, 2018, we adopted Topic 606, Revenue from Contracts with Customers, using the modified retrospective transition method, and implemented changes to its business processes, systems and controls to support revenue recognition and the related disclosures under this ASU. Under the modified retrospective approach, we applied the standards to new contracts and those that were not completed as of October 1, 2018. For those contracts not completed as of October 1, 2018, this method resulted in a cumulative adjustment to increase the Company’s retained earnings in the amount of $22,000.

 

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This guidance has resulted in very few changes in revenue recognition for the standard contracts in both the Optics and the Innovation and Development segments. This new guidance may lead to recognition of certain revenue transactions sooner than in the past on contracts that require us to maintain stated inventory levels, as we have an enforceable right to payment for the required inventory, and on contracts such as engineering services and design and tooling transactions, as we have an enforceable right to payment for these performance obligations satisfied over time.

 

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 Innovation and Development 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 nine-month periods ended June 30, 2019 or 2018.

 

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. There were no changes, aside from foreign exchange rate fluctuations, in the carrying value of intangible and indefinite-lived assets, during the nine months ended June 30, 2019.

 

Impairment of Long-Lived Assets

 

The Company’s long-lived assets include property, plant and equipment and intangible assets subject to amortization. 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, 2019.

 

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 adoption of ASC 2014-09, which provides for new requirements in regards to revenue recognition, as well as respective dates of adoption or expected adoption and effects on our consolidated financial position, results of operations and cash flows.

 

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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, our expectations regarding results of operations, the commercialization of our technology, including the Xcede patch and our dual mode detectors, the success of efforts to develop a successful Xcede Patch and to fund that development, our development of new technologies including at Dynasil Biomedical, the adequacy of our current financing sources to fund our current operations, our growth initiatives, our capital expenditures, the strength of our intellectual property portfolio, statements about the timing and effectiveness of the reverse and forward stock splits, the deregistration and delisting of the Company’s common stock and the perceived benefits and costs of the proposed transaction. 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, 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, Xcede’s ability to produce preclinical data sufficient to enable it to initiate clinical studies of hemostatic patch, clinical results of Xcede’s programs which may not support further development, the ability of our RMD business unit to identify and pursue possible continued development opportunities for the Xcede patch, which is not assured, competition, the loss of key management and technical personnel, our ability to obtain timely payment of our invoices to governmental customers, litigation, the effect of governmental regulatory developments, the availability of financing sources, our ability to deleverage our balance sheet, our ability to identify and execute on acquisition opportunities and integrate such acquisitions into our business, seasonality, the many variables that may impact the Company’s projected cost savings, variables and risks related to the stock split transaction, SEC regulatory review of the Company’s filings related to the such transaction, and the continuing determination of the Board of Directors and Special Committee that such transaction is in the best interests of all stockholders, as well as the uncertainties set forth in the Company’s Annual Report on Form 10-K, filed on December 21, 2018, 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. 

 

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, 2019. Based on the evaluation of our disclosure controls and procedures as of June 30, 2019, our Chief Executive Officer and our Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were not effective.

 

As disclosed in our Annual Report on Form 10-K for the year ended September 30, 2018, we identified a material weakness in our internal control over financial reporting as of September 30, 2018. Internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) are an integral part of disclosure controls and procedures. This material weakness, which is described in detail in our 2018 Annual Report on Form 10-K, can be summarized as relating to our controls over the revenue recognition process. Specifically, we lacked personnel with an appropriate level of knowledge, experience and training in contract review and management to provide reasonable assurance that revenue was being properly recorded in accordance with GAAP. Additionally, as our cost recognition system for contract revenue is a manual entry system, additional training and in-depth review for accuracy and completeness are required.

 

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The measures that we have identified and implemented to address the material weakness are also discussed in detail in our 2018 Form 10-K. The Company believes that it has taken steps that it believes will remediate the previously identified material weakness. However, certain controls designed and implemented during the third quarter of the 2019 fiscal year to address the material weakness in the initial contract review and period-end financial reporting processes have not been operational for a sufficient period of time to allow management to conclude that they are operating effectively. As a result, management has determined as of June 30, 2019 the control deficiency that existed in the prior year still exists, and, that our internal controls do not effectively mitigate the risk that a material misstatement in our financial statements could occur and not be prevented or detected. We expect the evaluation and testing of the steps previously taken to remediate the previously identified material weaknesses will continue throughout fiscal year 2019 in order to allow management sufficient basis to conclude that the controls are operating effectively.

 

Changes in Internal Control Over Financial Reporting

 

As a result of our adoption of the new revenue standard (Topic 606), we implemented controls to ensure adequate evaluation of contracts and assessment of the impact of the new accounting standard related to revenue recognition on our financial statements to facilitate its adoption on October 1, 2018. There were not any significant changes to our internal control over financial reporting due to the adoption of the new standard, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f) during the period covered by this Quarterly Report or in other factors that have materially affected, or are reasonably likely to materially affect, our internal controls 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 herein and in Part I, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended September 30, 2018, which could materially affect our business, financial condition or future results. The risks described in this report 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.

 

Risks Related To Dynasil’s Stock

 

The Company intends to delist the Common Stock from the Nasdaq Stock Market and deregister the Common Stock under the Exchange Act.

 

As previously disclosed, the Company has given notice to The Nasdaq Stock Market of its intent to voluntarily delist the Common Stock and to withdraw the registration of the Common Stock with the SEC. The Company intends to file a Form 25 Notification of Removal From Listing with the SEC on or about August 19, 2019. As a result, the Company expects that listing of its shares on Nasdaq will be terminated on or about August 29, 2019, at which time the Company intends to file a Form 15 with the SEC to suspend the Company’s reporting obligations under Section 15(d) of the Exchange Act. Following deregistration, the Company will no longer file annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K. Accordingly, there will be significantly less information regarding the Company available to stockholders and potential investors. In addition, the Company will no longer be subject to the provisions of the Sarbanes-Oxley Act and certain of the liability provisions of the Exchange Act, although the Company will still be subject to the antifraud provisions of the Exchange Act and any applicable state securities laws. Following deregistration, the Company’s executive officers, directors and 10% stockholders will no longer be required to file reports relating to their transactions in the Common Stock with the SEC. In addition, the Company’s executive officers, directors and 10% stockholders will no longer be subject to the recovery of short-swing profits provision of the Exchange Act, and persons acquiring 5% of the Common Stock will no longer be required to report their beneficial ownership under the Exchange Act. Following the delisting of the Common Stock, any trading in the Common Stock would only occur in privately negotiated sales or potentially on the OTC Pink Market, if one or more brokers chooses to make a market for the Common Stock there and complies with applicable regulatory requirements; however, there can be no assurances regarding any such trading. The lack of public information and increased illiquidity will make trading in our shares of Common Stock more difficult, which may cause the value of the Common Stock to decrease.

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ITEM 6 EXHIBITS

 

10.01   Amendment to the loan agreement between the Company and Middlesex Savings Bank, dated August 5, 2019.
     
10.02   Note Purchase Agreement between the Company and Massachusetts Capital Resource Company, dated August 6, 2019.
     
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.
     
32.1   Section 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).
     
99.1   Press release, dated August 13, 2019 issued by Dynasil Corporation of America announcing its financial results for the quarter ended June 30, 2019.
     
101   The following materials from Dynasil Corporation of America’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2019, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of June 30, 2019 and September 30, 2018, (ii) Consolidated Statements of Operations for the three months ended June 30, 2019 and 2018, (iii) Consolidated Statements of Changes in Stockholders’ Equity for the three and nine months ended June 30, 2019 and 2018; (iv) Consolidated Statements of Cash Flows for the three months ended June 30, 2019 and 2018, and (v) Notes to Consolidated Financial Statements, tagged as blocks of text.

 

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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 13, 2019  
  Peter Sulick,        
  Chief Executive Officer and President        
           
           
  /s/ Robert J. Bowdring   DATED: August 13, 2019  
  Robert J. Bowdring,        
  Chief Financial Officer        

 

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