DYSL Dynasil Corp of America

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1 - Basis of Presentation

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

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

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

Note 2 – Recent Accounting Pronouncements

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

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

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

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

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

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

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

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

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

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

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

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

Note 3 – Xcede Technologies, Inc. Joint Venture

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Note 6 – Goodwill

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

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

Note 7 – Debt

Senior Debt

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

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

Subordinated Debt

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

Note 8 – Earnings (Loss) Per Common Share

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

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

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

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

Note 9 - Stock Based Compensation

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

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

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

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

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

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

Note 10 – Segment, Customer and Geographical Reporting

Segment Financial Information

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

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

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

Customer Financial Information

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

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

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

Note 11 - Income Taxes

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

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

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

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

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

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

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

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

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

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

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

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