The accompanying notes are an integral part of these unaudited
consolidated financial statements.
The accompanying notes are an integral part of these unaudited
consolidated financial statements.
The accompanying notes are an integral part of these unaudited
consolidated financial statements.
The accompanying notes are an integral part of these unaudited
consolidated financial statements.
The accompanying notes are an integral part of these unaudited
consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1 - Basis of Presentation
The accompanying consolidated balance sheet
as of December 31, 2018, the consolidated statements of operations and comprehensive income (loss) for the three months ended December
31, 2018 and 2017, changes in stockholders’ equity for the three months ended December 31, 2018 and 2017, and cash flows
for the three months ended December 31, 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 December 31, 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, 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 December 31, 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, 2018, the Company
adopted Topic 606,
Revenue from Contracts with Customers,
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. For those contracts not completed as of October 1, 2018, this method 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 disclose the effect on revenue of adopting the new guidance. 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:
|
|
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 $115,000 during the three
months ended December 31, 2018 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" criteria 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.
The impact of the adoption of ASC 606 on
the Company’s consolidated financial statements for the three months ended December 31, 2018 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.
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
six 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.
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 for which a purchase order has been received
by a commercial customer, 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 $33.3 million at December 31,
2018. The Company expects to satisfy 61% of the performance obligations in fiscal year 2019, 25% in fiscal year 2020, and the remaining
amount by fiscal year 2024. The approximate value of our Optics segment unfulfilled performance obligations was $4.0 million at
December 31, 2018. The Company expects to satisfy 96% of the performance obligations in fiscal year 2019 and 4% 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
.
|
|
Three Months Ended December 31, 2018
|
|
|
|
Optics
|
|
|
Innovation &
Development
|
|
|
Total
|
|
Total Revenue by Geographic Location
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
3,275,000
|
|
|
$
|
4,185,000
|
|
|
$
|
7,460,000
|
|
Asia
|
|
|
915,000
|
|
|
|
15,000
|
|
|
|
930,000
|
|
Europe
|
|
|
1,485,000
|
|
|
|
39,000
|
|
|
|
1,524,000
|
|
Other
|
|
|
46,000
|
|
|
|
68,000
|
|
|
|
114,000
|
|
Total
|
|
$
|
5,721,000
|
|
|
$
|
4,307,000
|
|
|
$
|
10,028,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenue by Contract Type
|
|
|
|
|
|
|
|
|
|
|
|
|
Firm-fixed price
|
|
$
|
5,721,000
|
|
|
$
|
558,000
|
|
|
$
|
6,279,000
|
|
Non-Firm Fixed price
|
|
|
-
|
|
|
|
3,749,000
|
|
|
|
3,749,000
|
|
Total
|
|
$
|
5,721,000
|
|
|
$
|
4,307,000
|
|
|
$
|
10,028,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenue by Major Customer Type
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government revenue
|
|
$
|
3,000
|
|
|
$
|
4,181,000
|
|
|
$
|
4,184,000
|
|
U.S. commercial revenue
|
|
|
3,272,000
|
|
|
|
4,000
|
|
|
|
3,276,000
|
|
Foreign commercial and other revenue
|
|
|
2,446,000
|
|
|
|
122,000
|
|
|
|
2,568,000
|
|
Total
|
|
$
|
5,721,000
|
|
|
$
|
4,307,000
|
|
|
$
|
10,028,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenue by Major Products/Services
|
|
|
|
|
|
|
|
|
|
|
|
|
Optical components
|
|
$
|
5,639,000
|
|
|
$
|
-
|
|
|
$
|
5,639,000
|
|
Contract research
|
|
|
-
|
|
|
|
4,199,000
|
|
|
|
4,199,000
|
|
Other products and services
|
|
|
82,000
|
|
|
|
108,000
|
|
|
|
190,000
|
|
Total
|
|
$
|
5,721,000
|
|
|
$
|
4,307,000
|
|
|
$
|
10,028,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenue by Timing of Recognition
|
|
|
|
|
|
|
|
|
|
|
|
|
Goods/services transferred over time
|
|
$
|
560,000
|
|
|
$
|
4,199,000
|
|
|
$
|
4,759,000
|
|
Goods transferred at a point in time
|
|
|
5,161,000
|
|
|
|
108,000
|
|
|
|
5,269,000
|
|
Total
|
|
$
|
5,721,000
|
|
|
$
|
4,307,000
|
|
|
$
|
10,028,000
|
|
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.
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 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.
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”) of Xcede. 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 December 31, 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 December 31, 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.
In 2016, Xcede signed agreements with Cook
Biotech Inc. of West Lafayette, Indiana (“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.
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, the Company’s
RMD subsidiary has begun an investigation of possible continued development of the Xcede Patch, which could include seeking government
funding of this development. 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 RMD.
Note 4 - Inventories
Inventories, net of reserves, consists of the following:
|
|
December 31,
|
|
|
September 30,
|
|
|
|
2018
|
|
|
2018
|
|
Raw Materials
|
|
$
|
2,458,000
|
|
|
$
|
2,362,000
|
|
Work-in-Process
|
|
|
1,090,000
|
|
|
|
890,000
|
|
Finished Goods
|
|
|
944,000
|
|
|
|
854,000
|
|
|
|
$
|
4,492,000
|
|
|
$
|
4,106,000
|
|
Note 5 – Intangible Assets
Intangible assets at December 31, 2018 and September 30, 2018
consist of the following:
|
|
Useful
|
|
Gross
|
|
|
Accumulated
|
|
|
|
|
December 31, 2018
|
|
Life (years)
|
|
Amount
|
|
|
Amortization
|
|
|
Net
|
|
Acquired Customer Base
|
|
5 to 15
|
|
$
|
702,000
|
|
|
$
|
604,000
|
|
|
$
|
98,000
|
|
Know How
|
|
15
|
|
|
512,000
|
|
|
|
358,000
|
|
|
|
154,000
|
|
Trade Names
|
|
Indefinite
|
|
|
266,000
|
|
|
|
-
|
|
|
|
266,000
|
|
Patents
|
|
20
|
|
|
223,000
|
|
|
|
23,000
|
|
|
|
200,000
|
|
Biomedical Technologies
|
|
5
|
|
|
260,000
|
|
|
|
260,000
|
|
|
|
-
|
|
|
|
|
|
$
|
1,963,000
|
|
|
$
|
1,245,000
|
|
|
$
|
718,000
|
|
|
|
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 December 31,
2018 and 2017 was $27,000 and $28,000, respectively.
Estimated amortization expense for each of the next five fiscal
years and thereafter is as follows:
|
|
2019 (9 months)
|
|
|
2020
|
|
|
2021
|
|
|
2022
|
|
|
2023
|
|
|
Thereafter
|
|
|
Total
|
|
Acquired Customer Base
|
|
$
|
60,000
|
|
|
$
|
38,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
98,000
|
|
Know How
|
|
|
26,000
|
|
|
|
34,000
|
|
|
|
34,000
|
|
|
|
34,000
|
|
|
|
26,000
|
|
|
|
-
|
|
|
|
154,000
|
|
Patents
|
|
|
8,000
|
|
|
|
11,000
|
|
|
|
11,000
|
|
|
|
11,000
|
|
|
|
11,000
|
|
|
|
148,000
|
|
|
|
200,000
|
|
|
|
$
|
94,000
|
|
|
$
|
83,000
|
|
|
$
|
45,000
|
|
|
$
|
45,000
|
|
|
$
|
37,000
|
|
|
$
|
148,000
|
|
|
$
|
452,000
|
|
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 three months ended December 31, 2018
and 2017.
Note 6 – Goodwill
Goodwill is subject to an annual impairment
test. The Company considers many factors which may indicate the requirement to perform additional, interim impairment tests. These
include:
|
·
|
A significant adverse long term outlook
for any of its industries;
|
|
·
|
An adverse finding or rejection from a
regulatory body involved in new product regulatory approvals;
|
|
·
|
Failure of an anticipated commercialization
of a product or product line;
|
|
·
|
Unanticipated competition or the introduction
of a disruptive technology;
|
|
·
|
The testing for recoverability under the Impairment or Disposal of
Long-Lived Assets Subsections of Subtopic 360-10 of a significant asset group within a reporting unit;
|
|
·
|
A loss of key personnel; and
|
|
·
|
An expectation that a reporting unit carrying goodwill, or a significant
portion of a reporting unit, will be sold or otherwise disposed of.
|
There were no changes, aside from foreign
exchange rate fluctuations, in the carrying value of goodwill, during the three months ended December 31, 2018 and 2017.
Note 7 – Debt
Subordinated Debt
On November 27, 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, 2019. Such amendment also extended the maturity date from July
31, 2019 to November 30, 2021.
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 months ended December 31,
2018 and 2017, no common share equivalents related to stock options 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. Additionally,
for the three months ended December 31, 2018 and 2017, 50,000 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 December 31, 2018 and 2017 is as follows:
|
|
December 31, 2018
|
|
|
December 31, 2017
|
|
Weighted average shares outstanding
|
|
|
|
|
|
|
|
|
Basic
|
|
|
17,324,976
|
|
|
|
17,047,690
|
|
Effect of dilutive securities
|
|
|
|
|
|
|
|
|
Stock options
|
|
|
-
|
|
|
|
-
|
|
Restricted stock
|
|
|
-
|
|
|
|
-
|
|
Dilutive average shares outstanding
|
|
|
17,324,976
|
|
|
|
17,047,690
|
|
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.
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 December 31, 2018, DBM owned approximately
63% of Xcede’s outstanding Common Stock and Preferred Stock. No change in the Company’s position with respect to the
ownership of Xcede’s stock occurred during the three months ended December 31, 2018.
Stock compensation expense for the three months ended December
31, 2018 and 2017 is as follows:
|
|
Three Months Ended
|
|
|
Three Months Ended
|
|
Stock Compensation Expense
|
|
December 31, 2018
|
|
|
December 31, 2017
|
|
Stock grants
|
|
$
|
51,000
|
|
|
$
|
39,000
|
|
Restricted stock grants
|
|
|
15,000
|
|
|
|
13,000
|
|
Option grants
|
|
|
-
|
|
|
|
12,000
|
|
Employee stock purchase plan
|
|
|
1,000
|
|
|
|
1,000
|
|
Subsidiary option grants
|
|
|
11,000
|
|
|
|
28,000
|
|
Total
|
|
$
|
78,000
|
|
|
$
|
93,000
|
|
At December 31, 2018, there was approximately
$41,000 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 three months ended December 31, 2018 is presented below:
Restricted Stock Activity for the Three Months
ended December 31, 2018
|
|
Shares
|
|
|
Weighted-Average
Grant-Date Fair Value
|
|
Nonvested at September 30, 2018
|
|
|
60,000
|
|
|
$
|
1.61
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
-
|
|
|
|
|
|
Vested
|
|
|
(10,000
|
)
|
|
$
|
1.70
|
|
Cancelled
|
|
|
-
|
|
|
|
-
|
|
Nonvested and expected to vest at December 31, 2018
|
|
|
50,000
|
|
|
$
|
1.59
|
|
Stock Option Grants
During the three months ended December
31, 2018, no Dynasil stock options were granted. A summary of stock option activity for the three months ended December 31, 2018
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
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Balance at December 31, 2018
|
|
|
160,537
|
|
|
$
|
2.01
|
|
|
|
0.68
|
|
Outstanding and exercisable at December 31, 2018
|
|
|
160,537
|
|
|
$
|
2.01
|
|
|
|
0.68
|
|
Subsidiary Stock Option Grants
During the three months ended December
31, 2018, no Xcede stock options were granted. A summary of Xcede stock option activity for the three months ended December 31,
2018 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
|
|
|
|
7.31
|
|
Outstanding and exercisable at September 30, 2018
|
|
|
1,229,685
|
|
|
|
1.00
|
|
|
|
7.11
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Cancelled
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Balance at December 31, 2018
|
|
|
1,300,956
|
|
|
|
1.00
|
|
|
|
6.85
|
|
Outstanding and exercisable at December 31, 2018
|
|
|
1,248,384
|
|
|
$
|
1.00
|
|
|
|
6.85
|
|
At December 31, 2018, the Company’s
Xcede joint venture had approximately $32,000 of unrecognized stock compensation expense associated with stock options expected
to be recognized over a period of nine 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.
The Company’s segment information
for the three months ended December 31, 2018 and 2017 is summarized below:
Results of Operations for the Three Months
Ended December 31,
2018
|
|
Optics
|
|
|
Innovation and
Development*
|
|
|
Biomedical
|
|
|
Total
|
|
Revenue
|
|
$
|
5,721,000
|
|
|
$
|
4,307,000
|
|
|
$
|
-
|
|
|
$
|
10,028,000
|
|
Gross profit
|
|
|
1,879,000
|
|
|
|
1,813,000
|
|
|
|
-
|
|
|
|
3,692,000
|
|
GM %
|
|
|
33
|
%
|
|
|
42
|
%
|
|
|
-
|
|
|
|
37
|
%
|
Operating expenses
|
|
|
1,885,000
|
|
|
|
1,879,000
|
|
|
|
53,000
|
|
|
|
3,817,000
|
|
Operating income (loss)
|
|
|
(6,000
|
)
|
|
|
(66,000
|
)
|
|
|
(53,000
|
)
|
|
|
(125,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
276,000
|
|
|
|
59,000
|
|
|
|
3,000
|
|
|
|
338,000
|
|
Capital expenditures
|
|
|
187,000
|
|
|
|
17,000
|
|
|
|
-
|
|
|
|
204,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intangibles, net
|
|
|
363,000
|
|
|
|
154,000
|
|
|
|
201,000
|
|
|
|
718,000
|
|
Goodwill
|
|
|
925,000
|
|
|
|
4,939,000
|
|
|
|
-
|
|
|
|
5,864,000
|
|
Total assets
|
|
$
|
21,870,000
|
|
|
$
|
8,109,000
|
|
|
$
|
205,000
|
|
|
$
|
30,184,000
|
|
Results of Operations for the Three Months
Ended December 31,
2017
|
|
Optics
|
|
|
Innovation and
Development*
|
|
|
Biomedical
|
|
|
Total
|
|
Revenue
|
|
$
|
4,942,000
|
|
|
$
|
4,247,000
|
|
|
$
|
-
|
|
|
$
|
9,189,000
|
|
Gross profit
|
|
|
1,724,000
|
|
|
|
1,851,000
|
|
|
|
-
|
|
|
|
3,575,000
|
|
GM %
|
|
|
35
|
%
|
|
|
44
|
%
|
|
|
-
|
|
|
|
39
|
%
|
Operating expenses
|
|
|
1,576,000
|
|
|
|
1,723,000
|
|
|
|
445,000
|
|
|
|
3,744,000
|
|
Operating income (loss)
|
|
|
148,000
|
|
|
|
128,000
|
|
|
|
(445,000
|
)
|
|
|
(169,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
231,000
|
|
|
|
65,000
|
|
|
|
3,000
|
|
|
|
299,000
|
|
Capital expenditures
|
|
|
590,000
|
|
|
|
19,000
|
|
|
|
16,000
|
|
|
|
625,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intangibles, net
|
|
|
453,000
|
|
|
|
188,000
|
|
|
|
337,000
|
|
|
|
978,000
|
|
Goodwill
|
|
|
1,012,000
|
|
|
|
4,939,000
|
|
|
|
-
|
|
|
|
5,951,000
|
|
Total assets
|
|
$
|
18,969,000
|
|
|
$
|
8,114,000
|
|
|
$
|
614,000
|
|
|
$
|
27,697,000
|
|
*Formerly Contract Research
Customer Financial Information
For the three months ended December 31,
2018 one customer in the Optics segment represented greater than 10% of the total segment revenue. For the three months ended December
31, 2017, no customer in the Optics segment represented more than 10% of the total segment revenue.
For the three months ended December 31,
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. For the three months ended December 31, 2017, four 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.
Geographic Financial Information
Revenue by geographic location in total
and as a percentage of total revenue, for the three months ended December 31, 2018 and 2017 are as follows:
|
|
Three Months Ended
|
|
|
Three Months Ended
|
|
|
|
December 31, 2018
|
|
|
December 31, 2017
|
|
Geographic Location
|
|
Revenue
|
|
|
% of Total
|
|
|
Revenue
|
|
|
% of Total
|
|
United States
|
|
$
|
7,460,000
|
|
|
|
74
|
%
|
|
$
|
7,353,000
|
|
|
|
80
|
%
|
Asia
|
|
|
930,000
|
|
|
|
9
|
%
|
|
|
522,000
|
|
|
|
5
|
%
|
Europe
|
|
|
1,524,000
|
|
|
|
16
|
%
|
|
|
1,268,000
|
|
|
|
14
|
%
|
Other
|
|
|
114,000
|
|
|
|
1
|
%
|
|
|
46,000
|
|
|
|
1
|
%
|
|
|
$
|
10,028,000
|
|
|
|
100
|
%
|
|
$
|
9,189,000
|
|
|
|
100
|
%
|
Note 11 - Income Taxes
The Company uses the asset and liability
approach to account for income taxes. Under this approach, deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes
and net operating loss and tax credit carry forwards. The amount of deferred taxes on these temporary differences is determined
using the tax rates that are expected to apply to the period when the asset is realized or the liability is settled, as applicable,
based on tax rates, and tax laws, in the respective tax jurisdiction then in effect.
Dynasil Corporation of America and its
wholly-owned U.S. subsidiaries file a consolidated federal income tax return and various state returns. The Company’s U.K.
subsidiary files tax returns in the U.K. Prior to November 18, 2016, the Company’s subsidiary, Xcede was included in the
federal and state tax returns filed by Dynasil. As of November 18, 2016, Dynasil’s ownership in Xcede was reduced to approximately
59%. As a result, Xcede is no longer included in Dynasil’s federal consolidated tax return and files a separate federal return.
Xcede continues to be included in the Dynasil consolidated state tax filings pursuant to the respective state tax requirements.
In assessing the ability to realize the
net deferred tax assets, management considers various factors including taxable income in carryback years, future reversals of
existing taxable temporary differences, tax planning strategies and projections of future taxable income, to determine whether
it is more likely than not that some portion or all of the net deferred tax assets will not be realized.
As a result of Xcede’s de-consolidation
from the Company’s federal tax returns, the Company 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 results 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 December 31, 2018 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 December 31, 2018 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 second 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 39% and (309%)
for the three months ended December 31, 2018 and 2017, respectively. The effective tax rate for the three months ended, December
31, 2017 was a result of the 2017 Tax Act. The effective tax rate excluding the impact of the 2017 Tax Act was (16%) for the three
months ended December 31, 2017.
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
The Company has evaluated subsequent events
through the date the financial statements were released.