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Dynasil Corp of America – ‘10-K’ for 9/30/19

On:  Thursday, 12/26/19, at 8:03am ET   ·   For:  9/30/19   ·   Accession #:  1104659-19-75906   ·   File #:  1-35011

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  As Of               Filer                 Filing    For·On·As Docs:Size             Issuer                      Filing Agent

12/26/19  Dynasil Corp of America           10-K        9/30/19   89:10M                                    Toppan Merrill/FA

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U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 0R 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended September 30, 2019.

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from ______________ to ______________

Commission file number: 001-35011

DYNASIL CORPORATION OF AMERICA

(Exact name of registrant as specified in its charter)

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

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨  No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes x  No ¨

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.)

Yes ¨ No x

As of March 31, 2019, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $9,805,000.

As of December 10, 2019 there were 15,002,905 shares of common stock, par value $0.0005 per share, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

None

PART I

This annual report on Form 10-K contains not only historical information, but also forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by those sections. We refer you to the information under the heading “Forward-Looking Statements."

As used in this annual report on Form 10-K, references to "Dynasil," the "Company," "we," "our" or "us," unless the context otherwise requires, refer to Dynasil Corporation of America and our subsidiaries.

All trademarks or trade names referred to in this report are the property of their respective owners.

ITEM 1. BUSINESS

General

Dynasil Corporation of America was founded as a New Jersey corporation in 1960 and incorporated in the state of Delaware through a migratory merger in March 2008. Our corporate headquarters are located at 313 Washington Street, Suite 403, Newton, MA 02458, and our corporate website is www.dynasil.com. You can access, free of charge, our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K and any other amendments to those reports, through a link at our website, or at the Commission’s website at www.sec.gov.

We have the following three reporting segments based on our main operating activities:

The segment amounts included in MD&A are presented on a basis consistent with our internal management reporting and accounting principles generally accepted in the U.S. (“U.S. GAAP”). Segment information appearing in Note 16 – Segment, Customer and Geographical Reporting of the Notes to Financial Statements is also presented on this basis.

Our business strategy is based on continued development of products in our Optics segment, as well as organic growth of existing Optics products, development and expansion of our funded research portfolio, investment in the commercialization of the technologies originating from our Innovation and Development segment, continuing development of the Xcede medical technologies, and acquisitions that align with our core competencies.

As previously disclosed, following a special meeting of Dynasil’s stockholders on August 7, 2019, the Company filed certificates of amendment to our certificate of incorporation and subsequently effected a 1-for-8,000 reverse stock split of our common stock, par value $0.0005 per share (the “Reverse Stock Split”), followed immediately by a 8,000-for-1 forward stock split of its common stock (the “Forward Stock Split,” and together with the Reverse Stock Split, the “Transaction”). In regards to the Transaction, stockholders with fewer than 8,000 shares of Dynasil common stock held of record immediately before the Transaction became entitled to receive cash payments in lieu of fractional shares equal to $1.15 per pre-Reverse Stock Split share. As a result of the Transaction, 2,825,268 shares of common stock were due to be exchanged for cash, totaling approximately $3,249,000.

Following the Transaction, the Company filed a Form 25 and Forms 15 with the SEC indicating our intent to delist and deregister our stock. Following the filing of this Annual Report on Form 10-K for the year ended September 30, 2019, therefore, the Company will cease to file annual, quarterly, current, and other reports and documents with the SEC and stockholders will cease to receive annual reports and proxy statements.

Historical Growth by Acquisition

Through a series of acquisitions beginning in March 2005, Dynasil has evolved from a single product line optics company to one focused on multiple optical product lines and a significant contract research business focused on advanced materials used in radiation detection and other advanced instrumentation. Our revenue has increased from $2 million in FY 2004 to $44 million in FY 2019.

The acquisitions we completed during this period included:

Our Optical Technology

We specialize in the production of optical materials, components and coatings for various applications in the medical, industrial, and homeland security/defense sectors.

Our Optics segment supplies synthetic crystals, optical materials, components, and coatings that are used in devices such as baggage scanners, medical imaging systems, optical instruments, lasers, analytical instruments, automotive components, semiconductor/electronic devices, spacecraft/aircraft components and advertising displays. These products are offered through four business units (Dynasil Fused Silica, Optometrics, Hilger and EMF).

We compete for business with fabricators of industrial optical materials, other optical components manufacturers, other optical crystal manufacturers and other optical coaters as well as other analytical instruments manufacturers and synthetic crystal manufacturers. We believe our proprietary processes, reputation, specialty product offering, products in development and the price at which we offer our products enable us to successfully compete in these markets. However, many of our competitors have greater financial, sales and marketing resources than we do, which may enable them to develop and market products that would compete against those developed by us.

Our products are distributed through a direct sales and marketing staff of ten people and through other channels, including manufacturer’s representatives and distributors in various foreign countries for international sales and U.S. manufacturers’ representatives for certain product lines. Marketing efforts include direct customer contact through sales visits, advertising in trade publications, attendance at trade shows and our newly designed e-commerce website.

Innovation and Development – the Future of Our Technology

Our former Contract Research segment was recently renamed the Innovation and Development segment to emphasize the new technology that is being developed at this segment’s business unit, RMD, particularly in the fields material science, radiation detection, digital imaging technology, magnetic imaging, laser optics and photonics. Using their expertise in these fields, the team at RMD develops advanced technology in materials, sensors and prototype instruments that detect or measure radiation, light, magnetism or sound for use in security, medical and industrial applications.

RMD is among the largest small business participants in U.S. government-funded research, performing research and development activities for government agencies including Department of Energy, Department of Defense, Department of Homeland Security, Domestic Nuclear Detection Office, National Institutes of Health and NASA. For over thirty years, RMD has successfully conducted government research under the auspices of the Small Business Innovation Research (“SBIR”) program. In recent years, RMD has augmented its SBIR research with larger, competitively bid government research and development contracts. To grow our research portfolio within the federal government, we are broadening our relationships within key federal funding agencies and the U.S. military. RMD also provides research for non-governmental entities in areas where it has the appropriate expertise. Such research is currently not a significant portion of RMD’s revenue. Our research initiatives are aligned with our focus on the homeland security, medical and industrial markets. As of September 30, 2019, RMD had a contract backlog of approximately $36.6 million, of which approximately 46% is SBIR contracts.

As of September 30, 2019, our Innovation and Development segment had a total of 78 employees, including 24 Ph.D. level scientists. RMD serves as a vehicle to expand our patent portfolio enabling the opportunity to advance our technology from development to commercialization using government-funded research. As of September 30, 2019, RMD had a portfolio of 75 issued U.S. patents and 31 pending patent applications, compared with 72 issued patents and 40 pending patent applications at the same point in 2018.

RMD competes for contract research work against a variety of small and large entities, including universities that submit research proposals based on specific government solicitations. We generate revenue under various types of contracts, which include Cost Reimbursement, Time & Materials (T&M), Fixed Price-Level of Effort and Firm Fixed Price (FFP) contracts. We believe that RMD’s reputation for conducting state-of-the art research and development, as well as the quality of its proposals, are significant competitive advantages. In addition, RMD maintains strong working relationships with universities, government agencies, national laboratories, research hospitals and corporations. However, some of our competitors may have greater financial, technical and human resources than we have and may be better able to operate large, well-funded research and development programs.

We believe that research projects can provide an important source for new commercial products in areas such as medical imaging, industrial sensors, critical care and point of care diagnostics and homeland security. For example, Dynasil Products’ lead paint analyzer and gamma medical probes businesses, which were sold in fiscal year 2014, emanated from the RMD portfolio. Most recently, our government-funded research work supported the development of our CLYC dual-mode radiation detection technology which we are currently selling commercially.

Biomedical: Xcede and Our Development of a Tissue Sealant Technology

Xcede's first product under development is a hemostatic patch (“Xcede Patch”), designed to be biocompatible, to be used when conventional techniques are inadequate or impractical to stop bleeding (hemostasis). As described above, in 2011, Dynasil Biomedical (“DBM”) acquired rights to the underlying tissue sealant technology as part of a transaction with a former hematologist at the Mayo Clinic. Since that time, DBM has invested significant capital developing this tissue sealant technology, including costs to further the related intellectual property rights and to conduct animal studies.

Beginning at its inception and through November 2016, Xcede funded its pre-clinical research activities through the issuance of $5.2 million in the aggregate principal amount of convertible notes bearing interest at 5% (“the Notes”). In November of 2016, the Notes were converted into Series A convertible preferred stock of Xcede (“Series A Preferred”). Series A Preferred participants include both outside investors (accounted for as noncontrolling interest) and DBM. The outside investors converted $3.1 million of Notes and accrued interest into 3,055,551 shares of Series A Preferred. DBM converted the remaining $2.4 million of Notes and accrued interest into 2,338,569 shares of Series A Preferred.

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

Each share of Series A Preferred and Series B Preferred (together “the Preferred Stock”) is convertible, at the option of the holder, into such number of fully paid and non-assessable shares of Xcede common stock (“Common Stock”) as determined by dividing the original issue price, as defined, by the conversion price in effect on the date of conversion, which is 1:1. Each holder of the Preferred Stock is entitled to one vote for each share of Common Stock that the holder of the Preferred Stock would be entitled to receive upon the conversion of the holder’s Preferred Stock into Common Stock. Upon any liquidation event, which includes certain change of control events, following payment of pre-equity distributions, the remaining proceeds or net assets of Xcede shall be paid and distributed in the following amounts and order of priority: (1) to satisfy the liquidation preference payment due to each holder of Series B Preferred, (2) to satisfy the liquidation preference payment due to each holder of Series A Preferred, (3) payment in full of any acquisition transaction payment, and (4) the remaining assets available to be distributed ratably among the holders of the Common Stock. If a liquidation event were to occur, the Series A Preferred’s liquidation value would be $1.016 per share and Series B Preferred’s liquidation value would be $1.27 per share. As of September 30, 2019, the liquidation value of the Series B Preferred would be approximately $1.5 million and the Series A Preferred would be approximately $5.5 million, of which $2.4 million is DBM’s portion and $3.1 million would be attributed to noncontrolling shareholders.

As of September 30, 2019, DBM owned approximately 63% of Xcede’s outstanding Common Stock and Preferred Stock and, as a result, Xcede is included in the Company’s consolidated balance sheets, results of operations and cash flows. Due to the Series A Preferred having a liquidation preference and therefore not representing a residual interest, cumulative net losses of Xcede are attributed only to common stockholders in accordance with common stock ownership. Noncontrolling interest represents the value of the Series A Preferred and common stock not owned by DBM plus 17% of cumulative losses of Xcede based on the 17% common stock ownership held by noncontrolling interests.

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

On July 20, 2018, Xcede received a notice of termination from CBI claiming that the results of a recent animal study showed that it is not commercially reasonable, in CBI’s assessment, to continue to the next development phase of the Patch.

In light of the foregoing, Xcede has halted clinical trial preparations at this time and has curtailed its operations to a minimal level while the Board of Directors of Xcede evaluates alternatives, including the viability of modifying the Xcede Patch to address the shortcomings cited by CBI and/or the possible sale or license of Xcede IP assets, subject to amending CBI’s security interest. Additionally, Xcede and the Company’s RMD subsidiary have begun an investigation of possible continued development of the Xcede Patch, which includes seeking government funding of this development. In September 2019, Xcede and RMD resubmitted an application for a Phase I SBIR grant for $225,000. There can be no assurances with respect to any such alternatives or that any additional outside funding to continue development of the Xcede Patch will be available to Xcede.

Strategy to Commercialize our Technologies

Our business strategy focuses on combining our expertise in funded research, product development and technology innovation to commercialize detection and analysis equipment for the homeland security, industrial and medical markets. We are executing on this strategy by:

For example, our CLYC dual mode nuclear detection crystal technology was developed by RMD under a program for the Department of Homeland Security for use in locating nuclear bombs or nuclear materials at our nation’s major cities, ports and borders. This technology has the potential to be very important to our national security, as well as other radiation detection applications, such as nuclear power plant safety. Our dual mode detection crystals have been commercialized in a detector currently being offered by a large manufacturer of detection equipment. RMD continues to further enhance this technology.

Our CLYC dual mode detection crystals technology is designed to be a single detector that replaces two detector subsystems – the gamma radiation detector and also the helium-3 detectors for neutrons. Increasing our value proposition is the fact that the stockpile of the chemical element helium-3, a byproduct of nuclear weapons production, is in short supply. The stockpile of helium-3 has been drawn down during the past 10 years, as the federal government has increased its use in neutron detectors to help prevent nuclear and radiological material from being smuggled into the U.S.

Intellectual Property (IP)

From October 2018 through September 2019, we have been granted four new U.S. patents and have filed 7 new patent applications. Our current portfolio, company-wide, is 79 issued and 39 pending applications, the largest percentage of which are issued to RMD. We believe that intellectual property represents an important strategic advantage for us.

Customers

We have more than 500 customers, with approximately 50% of our business concentrated in our top 10 customers. Our three largest customers are agencies and agents of the Federal government and accounted for approximately 14%, 8%, and 6%, respectively, of our revenues during fiscal year 2019. Our fourth and fifth largest customers are customers of our Optics segment and also accounted for approximately 5% and 3%, respectively, of our overall revenue during fiscal year 2019. The loss of any of these top five customers would likely have a material adverse effect on our business, financial condition and results of operations. Generally, our customers provide purchase orders for a specific part and quantity or they provide a contract for research projects. Product orders are normally filled over a period ranging from one to six weeks. We also have blanket orders for product quantities that will potentially be required in upcoming periods. Contract research projects generally run for a one to two year period.

Employees

As of September 30, 2019, we had a total of 218 employees, 207 of which are full-time. Of the total, 29 of our employees are engaged in administration, 12 are engaged in sales, 71 are engaged in research and/or engineering and 106 are engaged in manufacturing. The Company has a total of 26 Ph.D. level employees. Our operations are non-union except for a two-person union in one location.

Suppliers

Our largest supplier for materials and components is a supplier of the fused silica material that is fabricated and sold by our New Jersey facility. We believe that we have excellent relationships with our suppliers. If any of our suppliers should become unavailable to us for any reason, we believe that there are a number of potential replacements, although we might incur some delay in identifying such replacements.

Government Regulation

The businesses that we operate are subject to various federal and state regulations.

Our Innovation and Development segment (formerly Contract Research segment) is subject to the rules and regulations applicable to government contracting, including: the Federal Acquisition Regulation (FAR) and supplements, which regulate the formation, administration and performance of U.S. Government contracts; the Truth in Negotiations Act, which requires certification and disclosure of cost and pricing data in connection with certain contract negotiations; the Procurement Integrity Act, which regulates access to competitor bids and proposal information and government source selection information, and our ability to provide compensation to certain former government officials; the Civil False Claims Act, which provides for substantial civil penalties for violations, including for submission of a false or fraudulent claim to the U.S. Government for payment or approval; and the U.S. Government Cost Accounting Standards, which impose accounting requirements that govern our right to reimbursement under certain cost-based U.S. Government contracts.

The tissue sealant being developed by Xcede, our joint venture with Mayo Clinic, is subject to FDA regulations and approval in the United States and requires CE marking and other regulatory agency approval in other countries around the world.

Our use of radioactive materials in research and certain of our products (our dual-mode detector) subject us to laws regulating hazardous wastes under United States federal and certain state, environmental and atomic energy regulatory laws and similar laws in each jurisdiction in which our research and manufacturing facilities are located. Environmental compliance costs, which totaled approximately $54,000 for fiscal year 2019, have not historically had a material effect on our operating results.

With respect to our intellectual property rights, we rely on, and are subject to, the laws in the U.S. and abroad governing intellectual property protection.

Item 1A. RISK FACTORS

In your evaluation of our company and our businesses, you should carefully consider the risks and uncertainties described below, together with the information included elsewhere in this Annual Report on Form 10-K and the other documents we file with the Securities and Exchange Commission (“SEC”). The following factors describe the risks and uncertainties that we consider significant to the operation of our business, but should not be considered a complete listing of all potential risks and uncertainties that could adversely affect our operating results, financial position or liquidity. Additionally, our business is subject to the same general risks and uncertainties that affect many other companies, such as the overall United States (“U.S.”) and global economic conditions, international conflicts, geopolitical events, changes in laws or accounting rules, fluctuations in interest and exchange rates or other disruptions of expected economic and business conditions.

Risks Related To Our Business

The Company relies on its Innovation and Development segment for approximately half of its revenue. A decline in or temporary suspension of U.S. Government spending, changes in federal budgetary priorities, the timing of contract awards or a restructuring of the SBIR/STTR programs may adversely affect our future revenue and limit our growth prospects.

Our Innovation and Development (formerly Contract Research) business unit, RMD, is among the largest small business participants in U.S. government-funded research, performing research and development activities for government agencies including Department of Energy, Department of Defense, Department of Homeland Security, Domestic Nuclear Detection Office, National Institutes of Health, and National Aeronautics and Space Administration. Historically RMD has conducted its government research contracts through the SBIR (Small Business Innovation Research Program) and the STTR (Small Business Technology Transfer Program). Though RMD has augmented its SBIR contracts with larger competitively bid government contracts in recent years, a reduction in or elimination of the SBIR or the STTR programs could result in our inability to win contracts, as we may not have the resources to compete effectively against much larger, better-funded companies. Further, a significant decline in overall U.S. Government spending, including in the areas of national security, intelligence and homeland security, a significant shift in its spending priorities, the substantial reduction or elimination of particular defense-related programs or significant delays in contract or task order awards for large programs could adversely affect our future revenue and limit our growth prospects. While the October 2013 and December 2018 government shutdowns did not have a significant impact on the Company, a future government shutdown could result in the suspension of work on contracts in progress or in payment delays which would adversely affect our future revenue and cash flow.

The Company relies on a small number of key customers for a substantial portion of its revenue.

Ten customers accounted for approximately 50% of the Company’s revenue in 2019. Six of those ten customers were agencies of the U.S. Government and accounted for 37% of revenue. Although we have had business relationships with these customers for many years, there can be no guarantee that we will be able to win contracts with these agencies in the future. Accordingly our performance could be adversely affected by the loss of one or more of these key customers.

The U.S. Government may terminate, cancel, modify or curtail our contracts at any time prior to their completion and, if we do not replace them, we may be unable to achieve our expected future revenue and may suffer a decline in revenue.

As of September 30, 2019, our total contract research backlog was approximately $36.6 million. Backlog consists of the portion of existing contracts yet to be performed and awards of projects by agencies in favor of RMD for which contracts have not yet been executed. Many of the U.S. Government programs in which we participate as a contractor or subcontractor may extend for several years and include one or more base years and one or more option years. These programs are normally funded on an annual basis. Under our contracts, the U.S. Government generally has the right not to exercise options to extend or expand our contracts and may otherwise terminate, cancel, modify or curtail our contracts at its convenience. Any decisions by the U.S. Government not to exercise contract options or to terminate, cancel, modify or curtail our major programs or contracts would adversely affect our revenue, revenue growth and profitability.

The U.S. Government also has the right to terminate a contract for default, in which case, we may be exposed to liability, including for excess costs incurred by the customer in procuring undelivered services and products from another source. Depending on the nature and value of the contract, a performance issue or termination for default could cause our actual results to differ from those anticipated and could harm our reputation.

Our earnings and profitability may be adversely affected by our failure to accurately estimate and manage costs, time and resources.

We generate revenue under various types of contracts, which include cost reimbursement, Time & Materials (T&M), Fixed Price-Level of Effort and Firm Fixed Price contracts (FFP). Our earnings and profitability may vary materially depending on changes in the proportionate amount of revenue derived from each type of contract, the nature of services or products provided, as well as the achievement of performance objectives and the stage of performance at which the right to receive fees, particularly under incentive and award fee contracts, is finally determined. Cost reimbursement and T&M contracts generally have lower profitability than FFP contracts. Our operating results in any period may also be affected, positively or negatively, by variable purchasing patterns by our customers of our more profitable proprietary products. Our failure to accurately estimate costs or the resources and technology needed to perform our contracts or to effectively manage and control our costs during the performance of our work could result, and in some instances has resulted, in reduced profits or in losses. More generally, any increased or unexpected costs or unanticipated delays in connection with the performance of our contracts, including costs and delays caused by contractual disputes or other factors outside of our control, such as performance failures of our subcontractors, natural disasters or other force majeure events, could make our contracts less profitable than expected or unprofitable.

Goodwill and other intangible assets represent approximately 21% of our total assets and any impairment of these assets could negatively impact our results of operations.

Non-amortizing intangible assets, including goodwill, are tested for impairment annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Examples of events or changes in circumstances indicating that the carrying value of such intangible assets may not be recoverable could include a significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator, unanticipated competition, loss of key personnel, or a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of. Any future impairment of goodwill or other intangible assets would have a negative impact on our profitability and financial results.

Our Innovation and Development business faces aggressive competition that can impact our ability to obtain contracts and therefore affect our future revenue and growth prospects.

RMD’s competitors include other small high technology companies performing SBIR R&D, large firms such as Raytheon which performs related R&D, universities and national laboratories.

The markets in which we operate are characterized by rapid technology development and the needs of our customers change and evolve regularly. Accordingly, our success depends on our ability to develop services and products that address these changing needs and to provide people and technology needed to deliver these services and products. To remain competitive, we must consistently provide superior service, technology and performance on a cost-effective basis to our customers. Our competitors may be able to provide our customers with different or greater capabilities or technologies or better contract terms than we can provide, including technical qualifications, past contract experience, geographic presence, price and the availability of qualified professional personnel. In addition, our competitors may consolidate or establish teaming or other relationships among themselves or with third parties to increase their ability to address customers’ needs. Accordingly, larger or new competitors or alliances among competitors may emerge which may adversely affect our ability to compete.

Our business is subject to reviews, audits and cost adjustments by the U.S. Government, which, if resolved unfavorably to us, could adversely affect our profitability, cash position or growth prospects.

U.S. Government agencies, including the DCAA (Defense Contract Audit Agency), DCMA (Defense Contract Management Agency) and others, routinely audit and review a contractor’s performance on government contracts, indirect rates and pricing practices, and compliance with applicable contracting and procurement laws, regulations and standards. They also review the adequacy of the contractor’s compliance with government standards for its accounting and management internal control systems, including: control environment and overall accounting system, estimating system, purchasing system, property system and earned value management system. Both contractors and the U.S. Government agencies conducting these audits and reviews have come under increased scrutiny.

A finding of significant control deficiencies in our system audits or other reviews could result in decremented billing rates to our U.S. Government customers until the control deficiencies are corrected and our corrections are accepted by the auditing agency. Government audits and reviews may conclude that our practices are not consistent with applicable laws and regulations and result in adjustments to contract costs and mandatory customer refunds. Such adjustments can be applied retroactively, which could result in significant customer refunds. Our receipt of adverse audit findings or the failure to obtain an “approved” determination of our various accounting and management internal control systems, including our changes to indirect cost and direct labor estimating systems, from the responsible U.S. Government agency could significantly and adversely affect our business, including our ability to bid on new contracts and our competitive position in the bidding process. A determination of non-compliance with applicable contracting and procurement laws, regulations and standards could also result in the U.S. Government imposing penalties and sanctions against us, including withholding of payments, suspension of payments and increased government scrutiny that could delay or adversely affect our ability to invoice and receive timely payment on contracts, perform contracts or compete for contracts with the U.S. Government. We may suffer harm to our reputation if allegations of impropriety are made against us, which would impair our ability to win new contract awards or receive contract renewals.

Our indirect cost audits by the DCAA have been completed for fiscal year 2018 while fiscal year 2019 remains open pending DCAA audit. Although we have recorded contract revenue subsequent to fiscal 2018 based upon our estimate of costs that we believe will be approved upon final audit or review, we do not know the outcome of any ongoing or future audits or reviews and adjustments and, if future adjustments exceed our estimates, our profitability would be adversely affected.

Our failure to comply with a variety of complex procurement rules and regulations could result in our being liable for penalties, including termination of our U.S. Government contracts, disqualification from bidding on future U.S. Government contracts and suspension or debarment from U.S. Government contracting.

We must comply with laws and regulations relating to the formation, administration and performance of U.S. Government contracts, which affect how we do business with our customers and may impose added costs on our business. Some significant statutes and regulations that affect us include:

Our failure to comply with any of these rules or regulations could result in loss of business or penalties that could have a material adverse effect on our financial condition or results of operations.

Our loan agreements impose restrictions on our ability to take certain corporate actions and raise additional capital, and include a material adverse change (“MAC”) clause.

Our loan agreements contain numerous customary restrictions that limit our ability to undertake certain activities without the express prior written approval of our lenders. These include, but are not limited to, restricting our ability to:

These restrictions could significantly hamper our ability to raise additional capital. Our ability to receive the necessary approvals is largely dependent upon our relationship with our lenders and our financial performance, and no assurances can be given that we will be able to obtain the necessary approvals in the future. Our inability to raise additional capital could lead to working capital deficits that could have a material adverse effect on our operations in future periods.

One of our loan agreements also includes a MAC clause which permits the bank to call the loan if any event, fact, circumstance, change in, or effect on the Company could reasonably be expected to be materially adverse to the business.

We may not be able to generate sufficient positive cash flow in the future to fund our operations.

In addition to our bank financing, we are dependent upon cash flow from our businesses to fund our operations. It is our expectation that we can continue to increase our cash flows; however, there can be no assurance that we will be able to continue to do so. If we are unable to fund our operations from future cash flows together with our available bank financing, we will need to seek additional debt and/or equity financing, which may not be available on attractive terms, if at all, in which case there could be a material adverse effect on our results of operations and financial condition.

Our internal controls over financial reporting were not effective as of September 30, 2018.

The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal control over financial reporting and disclosure controls and procedures. In particular, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting, as required by Section 404(a) of the Sarbanes-Oxley Act. Our management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures and of our internal control over financial reporting as of September 30, 2018 and concluded that, as of that date, our disclosure controls and procedures were not effective as a result of material weaknesses in our internal control over financial reporting. We believe that these issues are now corrected and the necessary changes have been made. We will continue to monitor their effectiveness to properly ensure our ability to report financial results or other information required to be disclosed on a timely and accurate basis. 

Our Xcede joint venture requires further funding to support the development of its technology.

In July, 2018, Xcede received a notice of termination from CBI, its collaboration partner with respect to the Xcede Patch, which claimed that the results of a recent animal study showed that, in CBI’s assessment, continuing to the next development phase of the Xcede Patch it is not commercially reasonable. 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.

As a result of this action by CBI, Xcede halted clinical trial preparations 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.

Xcede will require outside funding in order to continue development of the Xcede Patch, any additional pre-clinical development activities, and any human clinical trials they may initiate. In the event Xcede raises any additional equity financing from outside sources, our equity interest in Xcede will decrease. There can be no assurance, however, that Xcede will be able to obtain future financing as needed or on terms which are attractive, in which case it might be required to close its operations and liquidate its assets in which case our investment would likely not be recovered.

Our failure to attract, train and retain skilled employees, including our management team, would adversely affect our ability to execute our strategy.

Portions of our business involve the development of tailored solutions for our customers, a process that relies heavily upon the expertise and services of our employees. Our continued success depends on our ability to recruit and retain highly trained and skilled engineering, technical and professional personnel. Competition for skilled personnel is intense and competitors aggressively recruit key employees. Particularly in highly specialized areas, it may become more difficult to retain employees and meet all of our needs for employees in a timely manner, which may affect our growth in the current fiscal year and in future years. Although we intend to continue to devote significant resources to recruit, train and retain qualified employees, we may not be able to attract and retain these employees. Any failure to do so could impair our ability to perform our contractual obligations efficiently and timely meet our customers’ needs and win new business, which could adversely affect our future results.

In addition to attracting and retaining qualified engineering, technical and professional personnel, we believe that our success will also depend on the continued employment of a highly qualified and experienced senior management team and its ability to retain existing business and generate new business. Our senior management team is important to our business because personal reputations and individual business relationships are a critical element of retaining and obtaining customer contracts in our industry, particularly with agencies performing classified operations. Our inability to hire and retain appropriately qualified and experienced senior executives could cause us to lose customers or new business opportunities.

Misconduct of employees, subcontractors, agents and business partners could cause us to lose existing contracts or customers and adversely affect our ability to obtain new contracts and customers and could have a significant adverse impact on our business and reputation.

Misconduct, should it occur, could include fraud or other improper activities such as falsifying time or other records and violations of laws, including the Anti-Kickback Act. Other examples could include the failure to comply with our policies and procedures or with federal, state or local government procurement regulations, regulations regarding the use and safeguarding of classified or other protected information, legislation regarding the pricing of labor and other costs in government contracts, laws and regulations relating to environmental, health or safety matters, bribery of foreign government officials, import-export control, lobbying or similar activities, and any other applicable laws or regulations. Intentional or unintentional violation of the Export Control Act or International Traffic in Arms Regulations could result in severe fines which could adversely affect our profitability. Any data loss or information security lapses resulting in the compromise of personal information or the improper use or disclosure of sensitive or classified information could result in claims, remediation costs, regulatory sanctions against us, loss of current and future contracts and serious harm to our reputation. Although we have implemented policies, procedures and controls to prevent and detect these activities, these precautions may not prevent all misconduct, and as a result, we could face unknown risks or losses. Our failure to comply with applicable laws or regulations or misconduct by any of our employees, subcontractors, agents or business partners could damage our reputation and subject us to fines and penalties, restitution or other damages, loss of security clearance, loss of current and future customer contracts and suspension or debarment from contracting with federal, state or local government agencies, any of which would adversely affect our business and our future results.

Quality problems with our processes, goods, and services could harm our reputation for producing high-quality products and erode our competitive advantage, sales and market share.

Quality is extremely important to us and our customers due to the serious and costly consequences of product failure. Our quality certifications are critical to the marketing success of our goods and services. If we fail to meet these standards, our reputation could be damaged, we could lose customers, and our revenue and results of operations could decline. Aside from specific customer standards, our success depends generally on our ability to manufacture to exact tolerances precision-engineered components, subassemblies, and finished devices from multiple materials. If our components fail to meet these standards or fail to adapt to evolving standards, our reputation as a manufacturer of high-quality components will be harmed, our competitive advantage could be damaged, and we could lose customers and market share.

From time to time we may make acquisitions. The failure to successfully integrate future acquisitions could harm our business, financial condition and operating results.

One component of our growth strategy is to selectively pursue strategic acquisitions. These transactions require significant investment of time and resources and may disrupt our business and distract our management from other responsibilities. Even if successful, these transactions could reduce earnings for a number of reasons, including the amortization of intangible assets, impairment charges, acquired operations that are not yet profitable or the payment of additional consideration under earn-out arrangements if an acquisition performs better than expected. Acquisitions, investments and joint ventures pose many other risks that could adversely affect our reputation, operations or financial results, including:

If our acquisitions fail, perform poorly or their value is otherwise impaired for any reason, including contractions in credit markets and global economic conditions, our business and financial results could be adversely affected.

In addition, we periodically divest businesses, including businesses that are no longer a part of our ongoing strategic plan. These divestitures similarly require significant investment of time and resources, may disrupt our business, distract management from other responsibilities and may result in losses on disposal or continued financial involvement in the divested business, including through indemnification, guarantee or other financial arrangements, for a period of time following the transaction, which would adversely affect our financial results.

Our financial results may vary significantly from period-to-period.

Our financial results may fluctuate as a result of a number of factors, many of which are outside of our control. For these reasons, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our financial results may be negatively affected by any of the risk factors listed in this “Risk Factors” section and other matters described elsewhere in this Annual Report on Form 10-K and the other documents we file with the SEC.

Changes in tax laws or exposure to additional income tax liabilities could have a material impact on our financial condition and results of operations.

We are subject to income taxes as well as non-income based taxes, in both the U.S. and United Kingdom (U.K.). We are subject to tax audits in various jurisdictions. Tax authorities may disagree with certain positions we have taken and assess additional taxes. We regularly assess the likely outcomes of these audits in order to determine the appropriateness of our tax provision. However, there can be no assurance that we will accurately predict the outcomes of these audits, and the actual outcomes of these audits could have a material impact on our consolidated earnings and financial condition. Additionally, changes in tax laws or tax rulings could materially impact our effective tax rate.

We face risks associated with our international business.

In 2019 and 2018, we generated approximately 21% and 25% of our sales outside the U.S., respectively. Our international business operations may be subject to additional and different risks than our U.S. business. Our ability to achieve and maintain profitable growth in international markets is subject to risks related to the differing legal, political, social and regulatory requirements and economic conditions of many countries. As a result of our expansion outside the U.S., we are subject to certain inherent risks, including political and economic uncertainty, inflation rates, exchange rates, trade protection measures, local labor conditions and laws, restrictions on foreign investments and repatriation of earnings, and weak intellectual property protection. If we are unable to manage these risks it would have a material adverse effect on our results of operations and financial condition.

The United Kingdom's decision to exit the European Union may bring short-term and long-term adverse impacts on our financial results.

The outcome of the United Kingdom's decision to leave the European Union ("Brexit") could adversely affect our business and our results of operations as our Hilger Crystals Ltd. business unit is located in the U.K. In the short-term, volatility in the British Pound could continue, which would negatively impact our financial results. In the longer term, any impact from Brexit on our United Kingdom operations will depend on the outcome of yet-to-be negotiated tariff, trade, regulatory and other matters.

Uncertainty over global tariffs, or the financial impact of tariffs, may negatively affect our results.

Recent changes in U.S. domestic and global tariff frameworks have increased our costs of producing goods and resulted in additional risks to our supply chain. Additional tariff changes are possible. We are engaged in efforts to mitigate tariff increases, but there is no assurance we will be successful. Further, uncertainties about future tariff changes could result in mitigation actions that prove to be detrimental to our business.

Increases in prices and declines in the availability of raw materials could negatively impact our financial results.

Our financial results are significantly affected by the cost of raw materials and energy. Most of the raw materials and energy used in production are purchased from outside sources, and the Company has made, and plans to continue to make, supply arrangements to meet the planned operating requirements for the future. Supply of critical raw materials and energy is managed by establishing contracts, multiple sources, and identifying alternative materials or technology whenever possible. An inability to obtain critical raw materials would adversely impact our ability to produce products. Increases in the cost of raw materials and energy may have an adverse effect on our earnings or cash flow in the event we are unable to mitigate these higher costs in a timely manner.

Our business and operations expose us to numerous legal and regulatory requirements and any violation of these requirements could harm our business.

We are subject to numerous federal, state and foreign legal requirements on matters as diverse as data privacy and protection, employment and labor relations, immigration, taxation, anticorruption, import/export controls, trade restrictions, internal and disclosure control obligations, securities regulation, environmental and anti-competition. We are also focused on expanding our business in certain identified growth areas, such as homeland security and biomedical technologies, which are highly regulated and may expose us to increased compliance risk. Compliance with diverse and changing legal requirements is costly, time-consuming and requires significant resources. Violations of one or more of these requirements in the conduct of our business could result in significant fines and other damages, criminal sanctions against us or our officers, prohibitions on doing business and damage to our reputation. Violations of these regulations or contractual obligations related to regulatory compliance in connection with the performance of customer contracts could also result in liability for significant monetary damages, fines and/or criminal prosecution, unfavorable publicity and other reputational damage, restrictions on our ability to compete for certain work and allegations by our customers that we have not performed our contractual obligations.

Moreover, we use controlled hazardous and radioactive materials in our business and generate wastes that are regulated as hazardous wastes under United States federal and certain state, environmental and atomic energy regulatory laws and similar laws in each jurisdiction in which our facilities are located. Our use of these substances and materials is subject to stringent, and periodically changing, regulation that can impose costly compliance obligations on us and have the potential to adversely affect our manufacturing activities. The risk of accidental contamination or injury from these materials cannot be completely eliminated. If an accident with these substances occurs, we could be held liable for any damages that result, in addition to incurring clean-up costs and liabilities, which can be substantial. Additionally, an accident could damage our research and manufacturing facilities resulting in delays and increased costs.

Our insurance may be insufficient to protect us from product and other liability claims or losses.

We maintain insurance coverage with third-party insurers as part of our overall risk management strategy and because some of our contracts require us to maintain specific insurance coverage limits. However, not every risk or liability is or can be protected by insurance, and, for those risks we insure, the limits of coverage we purchase or that are reasonably obtainable in the market may not be sufficient to cover all actual losses or liabilities incurred. If any of our third-party insurers fail, cancel our coverage or otherwise are unable to provide us with adequate insurance coverage, then our overall risk exposure and our operational expenses would increase and the management of our business operations would be disrupted. Our insurance may be insufficient to protect us from significant product and other liability claims or losses. Moreover, there is a risk that commercially available liability insurance will not continue to be available to us at a reasonable cost, if at all. If liability claims or losses exceed our current or available insurance coverage, our business and prospects may be harmed. Regardless of the adequacy of our liability insurance coverage, any significant claim may have an adverse effect on our industry and market reputation, leading to a substantial decrease in demand for our products and services and reduced revenue.

Our business and financial results could be negatively affected by cyber or other security threats.

As a U.S. Government contractor operating in multiple regulated industries and geographies, we handle sensitive information. Therefore, we are continuously exposed to cyber and other security threats, including computer viruses, attacks by hackers or physical break-ins. Any electronic or physical break-in or other security breach or compromise may jeopardize security of information stored or transmitted through our information technology systems and networks. This could lead to disruptions in mission critical systems, unauthorized release of confidential or otherwise protected information and corruption of data. Although we have implemented policies, procedures and controls to protect against, detect and mitigate these threats, attempts by others to gain unauthorized access to our information technology systems are becoming more sophisticated. These attempts include covertly introducing malware to our computers and networks and impersonating authorized users, among others, and may be perpetrated by well-funded organized crime or state sponsored efforts. We seek to detect and investigate all security incidents and to prevent their occurrence or recurrence. We continue to improve our threat protection, detection and mitigation policies, procedures and controls. In addition, we work with other companies in the industry and government participants on increased awareness and enhanced protections against cyber security threats. However, because of the evolving nature of these security threats, there can be no assurance that our policies, procedures and controls have or will detect or prevent any of these threats and we cannot predict the full impact of any such incident. We may experience similar security threats to the information technology systems that we develop, install or maintain under customer contracts. Although we work cooperatively with our customers and other business partners to seek to minimize the impacts of cyber and other security threats, we must rely on the safeguards put in place by those entities. Any remedial costs or other liabilities related to cyber or other security threats may not be fully insured or indemnified by other means. Occurrence of any of these security threats could adversely affect our reputation, ability to work on sensitive U.S. Government contracts, business operations and financial results.

Risks Relating To Dynasil’s Stock

We are a non-reporting company.

In August 2019, we filed a Form 25 and Forms 15 with the SEC to deregister and delist our stock. As a result, our stock is no longer listed on the Nasdaq Capital Market and trading in our stock will only occur in privately negotiated sales and potentially on the OTC Pink Sheets, if one or more brokers continues to choose to make a market for our common stock there and complies with applicable regulatory requirements; however, there can be no assurances regarding any such trading. Because of the limited liquidity for our common stock, the termination of our obligation to publicly disclose financial and other information, and the deregistration of our common stock under the Exchange Act, our stockholders may potentially experience a significant decrease in the value of their common stock.

Following the filing of this Annual Report on Form 10-K, we will cease to file annual, quarterly, current, and other reports and documents with the SEC, and stockholders will cease to receive annual reports and proxy statements. We do intend to continue to prepare audited annual financial statements and periodic unaudited financial statements and plan to make audited annual financial statements available to our stockholders. Nonetheless, our stockholders will have significantly less information about the Company and our business, operations, and financial performance than they have previously. We do intend to continue to hold stockholder meetings as required under Delaware law, including annual meetings, or to take actions by written consent of our stockholders in lieu of meetings.

As a result of our deregistration and delisting, we are no longer subject to the provisions of the Sarbanes-Oxley Act, the liability provisions of the Exchange Act or the oversight of the Nasdaq Capital Market. Our executive officers, directors and 10% stockholders are no longer required to file reports relating to their transactions in our common stock with the SEC. In addition, our executive officers, directors and 10% stockholders are no longer subject to the recovery of profits provision of the Exchange Act, and persons acquiring 5% of our common stock are no longer required to report their beneficial ownership under the Exchange Act. Additionally, we do not have the ability to access the public capital markets or to use public securities in attracting and retaining executives and other employees, and we have a decreased ability to use stock to acquire other companies.

Additionally, our public reporting obligations could be reinstated if on the first day of any fiscal year we have more than 300 stockholders of record, in which instance we would be required to resume reporting pursuant to Section 15(d) of the Exchange Act.

While our common stock is traded on the OTC Pink Sheets, its price is characterized by significant price volatility.

While our common stock is traded on the OTC Pink Sheets, its trading price is characterized by significant volatility when compared to the shares of larger, more established companies that have large public floats, and we expect that our share price will continue to be more volatile than the shares of such larger, more established companies traded on the major markets for the indefinite future. The volatility in our share price is attributable to a number of factors. First, as noted above, our common stock is, compared to the shares of such larger, more established companies, sporadically and thinly traded. As a consequence of this limited liquidity, the trading of relatively small quantities of shares by our stockholders may disproportionately influence the price of those shares in either direction. The price for our shares could, for example, decline precipitously in the event that a large number of our common stock is sold on the market without commensurate demand. As a consequence of this enhanced risk, more risk-adverse investors may, under the fear of losing all or most of their investment in the event of negative news or lack of progress, be more inclined to sell their shares on the market more quickly and at greater discounts than would be the case with the stock of a larger, more established company that has a large public float. Many of these factors are beyond our control and may decrease the market price of our common stock, regardless of our operating performance. We cannot make any predictions or projections as to what the prevailing market price for our common stock will be at any time, including as to whether our common stock will sustain its current market price, or as to what effect that the sale of shares or the availability of common stock for sale at any time will have on the prevailing market price, or if our common stock will continue to be traded on the OTC Pink Sheets.

We do not anticipate paying any cash dividends to our common shareholders.

We presently do not anticipate that we will pay dividends on any of our common stock in the foreseeable future. If payment of dividends does occur at some point in the future, it would be contingent upon our revenues and earnings, if any, capital requirements, and general financial condition. The payment of any common stock dividends will be within the discretion of our Board of Directors. We presently intend to retain any earnings to implement our business plan; accordingly, we do not anticipate the declaration of any dividends for common stock in the foreseeable future.

Xcede, our joint venture, is a pre-clinical stage business with no approved products, which makes it difficult to assess the business’s future viability.

In October 2013, Dynasil Biomedical formed Xcede, a joint venture with Mayo Clinic, to focus on and separately fund the development of its tissue sealant technology. Xcede has not yet demonstrated an ability to successfully overcome many of the risks and uncertainties frequently encountered by companies in new and rapidly evolving fields, particularly in the biomedical area. For example, to execute its business plan, Xcede will need to successfully:

If Xcede is unsuccessful in accomplishing these objectives, it may not be able to develop its tissue sealant product, raise capital, expand its business or continue its operations, which may have a material adverse effect on our stock price.

If our internal control over financial reporting is found not to be effective or if we make disclosure of existing or potential significant deficiencies or material weaknesses in those controls, investors could lose confidence in our financial reports, and our stock price may be adversely affected.

Section 404 of the Sarbanes-Oxley Act of 2002 has required us to include an internal control report with our Annual Report on Form 10-K. That report has included management’s assessment of the effectiveness of our internal control over financial reporting as of the end of the fiscal year. We have evaluated our internal control over financial reporting based on the integrated framework issued in 2013 by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. During the course of our evaluation of the internal controls, we have identified areas requiring improvement, and would have had to design enhanced processes and controls to address issues identified through this review. Additionally, in the past, due to the implementation of new accounting standards, our existing controls have had to be adapted and new deficiencies have arisen. Remedying significant deficiencies or material weaknesses that we identified have required us to incur significant costs and expend significant time and management resources. The disclosure of existing significant deficiencies or material weaknesses in those internal controls over financial reporting have had the potential to cause investors to lose confidence in our financial reports, and our stock price could have been adversely affected. As a result of our deregistration and delisting transaction, we are no longer subject to the provisions of the Sarbanes-Oxley Act.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

We own a manufacturing and office facility consisting of a one-story, masonry and steel building containing approximately 15,760 square feet in West Berlin, NJ. We lease a 10,000 square foot manufacturing and office building in Ayer, MA with a lease that expires in May 2025. We lease 7,200 square feet of manufacturing office space in a building in Littleton, MA with a lease that expires in November 2020. We lease a 40,654 square foot manufacturing and office building in Rochester, NY with a lease that expires in March 2022. We own a two-story, 44,000 square foot manufacturing and office facility in Ithaca, NY. We own a two-story, 17,000 square foot manufacturing and office facility in Margate, Kent, in the U.K. All of the foregoing owned and leased properties are used by our Optics segment. We lease a 40,000 square foot manufacturing, research, and office building in Watertown, MA for our RMD business from a related party with a month-to-month lease that continues until terminated by the landlord with not less than three years’ prior written notice or by the Company with not less than six months’ prior written notice. We lease 2,368 square feet of office space in Newton, MA for our Dynasil Corporation of America office with a lease that expires in December 2020. We believe that the properties are in satisfactory condition and suitable for our purposes. The New Jersey, New York, and U.K. properties are collateral against notes payable to banks.

ITEM 3. LEGAL PROCEEDINGS

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

The Company’s Common Stock has been listed on the Pink Open Market since August 26, 2019 under the symbol DYSL. From September 30, 2013 until August 23, 2019, the Company’s Common Stock was listed on the Nasdaq Capital Market. From December 20, 2010 until September 30, 2013, the Company’s Common Stock was listed on the Nasdaq Global Market. Prior to December 20, 2010, the Company’s Common Stock was quoted on the NASD-OTC Bulletin Board under the symbol "DYSL.OB".

As of December 10, 2019, there were 15,002,905 shares of the Company’s common stock outstanding held by approximately 31 holders of record.

The Company has paid no cash dividends on its common stock since its inception. The Company intends to retain any future earnings for use in its business and does not intend to pay cash dividends on its common stock in the foreseeable future.

ITEM 6. SELECTED FINANCIAL DATA

Not applicable.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following management's discussion and analysis should be read in conjunction with our financial statements and the notes thereto appearing elsewhere in this Annual Report on Form 10-K.

Overview

Reportable Segments

We have three reporting segments based on our main operating activities. Below is a summary of these segments:

The segment amounts included in management's discussion and analysis are presented on a basis consistent with our internal management reporting and accounting principles generally accepted in the U.S. (“U.S. GAAP”). Segment information appearing in Note 16 – Segment, Customer and Geographical Reporting of the Notes to Financial Statements included in this Report are also presented on this basis. A description of our strategy is included in Item 1 of this Annual Report on Form 10-K.

Our markets are characterized by rapidly changing technology and the needs of our customers, which change and evolve regularly. Accordingly, our success depends on our ability to develop services and products that address these changing needs and to provide the people and technology needed to deliver these services and products. To remain competitive, we must consistently provide superior service, technology and performance on a cost-effective basis to our customers. Our business performance is also influenced by a variety of other factors including, but not limited to, economic conditions, U.S. Government spending on research and development programs, competition, regulatory requirements and insurance costs. Further information on certain risks to our Company is included in Item 1A of this Annual Report on Form 10-K.

Fiscal 2019 Financial Overview

Our revenue in 2019 was $43.7 million, as compared to $40.7 million in 2018. This 7% increase in revenue resulted largely from a $2.8 million, or 16%, increase in revenue in our Innovation and Development segment, as well as a $0.2 million, or 1%, increase in revenue in our Optics segment.

In fiscal year 2019, we had net loss of ($0.4) million, compared to net income of $1.6 million in 2018, due in part to a $1.6 million tax benefit in 2018 related to R&E tax credits for the years ended 2013 through 2016. Additionally, during 2019, Dynasil incurred $0.8 million in expenses in a transaction to delist from the Nasdaq Stock Market and terminate the registration of our common stock with the Securities and Exchange Commission (the “SEC”), including a 1-for-8,000 reverse stock split of our common stock, par value $0.0005 per share, followed immediately by a 8,000-for-1 forward stock split of its common stock. As a result of this transaction, stockholders with fewer than 8,000 shares of Dynasil common stock held of record immediately prior became entitled to receive cash payments in lieu of fractional shares equal to $1.15 per pre-reverse stock split share.

Following the filing of this Annual Report on Form 10-K, the Company will cease to file annual, quarterly, current, and other reports and documents with the SEC, and stockholders will cease to receive annual reports and proxy statements. The Company’s common stock is no longer listed on the Nasdaq Capital Market.

Results of Operations

Revenue

Revenue for the fiscal year ended September 30, 2019 was $43.7 million, an increase of $3.0 million or 7% from the $40.7 million of revenue recorded in 2018.

Revenue in our Optics segment for the 12 months ended September 30, 2019 increased 1% to $23.2 million from $23.1 million in 2018, largely as the result of growth in a new product line.

Innovation and Development segment revenue increased 16% to $20.5 million in the year ended September 30, 2019, from $17.6 million in the same period in 2018, largely resulting from increased funding of awarded contracts. The contract revenue backlog increased to $36.6 million at September 30, 2019, up from the September 30, 2018 level of $30.8 million. The current backlog is comprised of approximately 46% SBIR contracts, which is reduced from the 47% SBIR contracts in the backlog at September 30, 2018. The Innovation and Development segment continues to seek to limit reliance on the SBIR program and increase the number of government agencies that currently contract for its research, as well as to diversify its contracting sources including contracting with commercial businesses. During the twelve months ended September 30, 2019 and 2018, the Innovation and Development segment generated $0.7 million and $1.7 million, respectively, in commercial revenue.

The Biomedical segment currently has no revenue.

Gross Profit

Gross profit for the year ended September 30, 2019 increased $0.9 million, or 6%, to $16.1 million from the prior year amount of $15.2 million. Gross profit as a percentage of revenue was 37% in both fiscal years 2019 and 2018.

The Optics segment’s gross profit as a percentage of revenue in fiscal year 2019 increased slightly to 34% as compared to 33% in fiscal year 2018. The gross profit in fiscal year 2019 was $7.9 million, an increase of $0.2 million, as a result of the improved efficiencies in certain product lines and slightly higher revenue during the 12 months ended September 30, 2019.

The Innovation and Development segment’s gross profit as a percent of revenue decreased to 40% in fiscal year 2019, as compared to 43% in fiscal year 2018, largely as a result of the mix of active contracts during 2019 and the decrease in the higher margin commercial revenue. Gross profit dollars in this segment increased to $8.1 million during fiscal year 2019 from $7.6 million in the same period in 2018.

Operating Expenses

Operating expenses increased in fiscal year 2019 to $16.1 million, or 37% of revenue, an increase of $1.0 million from $15.1 million in fiscal year 2018 or 37% of revenues. The increase was largely due to the increase in expenses in 2019 related to the Company’s delisting and deregistration transaction.

Operating expenses within the Optics segment increased to $7.9 million in fiscal year 2019, compared to $7.0 million in fiscal year 2018, due to increases in marketing, engineering personnel, and facility related expenditures. The percentage of SG&A to revenue increased to 34% in the 12 months ended September 30, 2019, as compared to 30% in the prior year.

Operating expenses within the Innovation and Development segment increased to $8.1 million, or 40% of revenue, in fiscal year 2019 from $7.1 million, or 40% of revenue, in the prior year. The increase in SG&A expenses in fiscal year 2019 are largely the result of investments in personnel and technology, as well other expenses related to the increased revenue in 2019.

Operating expenses in the Biomedical segment in fiscal year 2019 were approximately $0.1 million, as compared to $1.0 million in fiscal year 2018. The $0.9 million decrease in expenses year over year was primarily the result of Xcede’s decision to halt clinical trial preparations and curtail operations to a minimal level while it evaluates alternative avenues for the Xcede Patch, following the July 2018 notice of termination from Cook Biotech Inc.

As of September 30, 2019, the Company 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 63% ownership includes preferred stock with a liquidation preference. For reporting purposes only, common stock ownership is used in the allocation of the noncontrolling interest. Dynasil’s common stock ownership is 83% and the remaining 17% of Xcede’s common stock is owned by others and accounted for under the rules applicable to non-controlling interest. The pre-tax loss related to the common stock owned by others was $0.02 million in the fiscal year ended September 30, 2019, as compared to $0.2 million in 2018, and was not included in the Company’s net income (loss) attributable to common stockholders of ($0.4) million and $1.8 million, respectively.

In 2019, Xcede was funded by $0.1 million in cash from Dynasil. In 2018, Xcede was funded by $0.6 million in cash from Dynasil and $0.2 million in R&D services from Cook Biotech as it worked on developing the first in human clinical trial for Xcede’s hemostatic tissue sealant product under a note agreement.

Net Interest Expense

Net interest expense was $0.2 million in both fiscal years 2019 and 2018.

Income Tax Expense/Benefit

Total income tax expense was an expense of $0.2 million in fiscal year 2019, as compared to a credit of $1.6 million in fiscal 2018. The 2019 tax expense resulted from The 2018 credit included R&E tax credits for the years ended 2013 through 2016, the release of a tax reserve for state deferred tax assets being carried on the balance sheet that are now expected to be used in the foreseeable future, and net of higher expenses from recording the initial effect of the 2017 Tax Act.

Net Income

As a result of the items mentioned previously, our net loss for the year ended September 30, 2019 was ($0.4) million, compared to net income of $1.6 million in the prior year.

Our net income includes losses of approximately $0.1 million and $1.0 million in the years ended September 30, 2019 and 2018, respectively, from our Biomedical segment.

Liquidity and Capital Resources

Liquidity Overview

Our net cash as of September 30, 2019 was $0.3 million, a decrease of $2.1 million, compared to $2.4 million at September 30, 2018. The cash reduction was primarily due to the Company’s delisting and deregistration transaction.

We believe our cash on hand and borrowing capacity under our revolving line of credit will be sufficient to fund our current debt obligations, estimated capital expenditures and working capital needs for the next twelve months.

Net Cash From Operating Activities

Net cash used in operating activities was $0.5 million for fiscal year 2019 versus net cash provided by operating activities of $2.0 million for fiscal year 2018.

In fiscal year 2019, the net cash used of $0.5 million was primarily from the net loss of $0.4 million, which includes $0.8 million of costs associated with the Company’s delisting and deregistration transaction.  Unbilled receivables increased approximately $1.4 million due to strong innovation and development revenue in the fourth quarter of 2019. In addition, inventory increased by approximately $0.7 million to ensure the proper supply of material is available to meet customer demand. These increases were offset by non-cash items of approximately $2.1 million.

Cash Flows from Investing Activities

Cash flows from investing activities resulted in a use of $0.9 million for fiscal 2019 compared with a use of $2.3 million for fiscal 2018. In both fiscal 2019 and 2018, these funds were primarily used to purchase property, plant and equipment. The 2018 amount increased as we invested in future operations, including our new highly efficient anti-reflective, diamond-like coating product lines. We currently plan on additional capital expenditures of approximately $2.0 million during fiscal year 2020 for expansion within our existing segments.

Cash Flows from Financing Activities

Cash flows from financing activities resulted in a use of cash of $0.6 million. We used $3.2 million of cash to repurchase common stock. This transaction was financed using $2.0 million of new borrowing from Massachusetts Capital Resources Company, $0.9 million from the Middlesex Savings Bank line of credit, and $0.3 million of cash.  The remaining cash used for financing activities was used to repay existing debts.  We have approximately $3.1 million available under our line of credit with Middlesex Savings Bank at September 30, 2019.

Terms of Outstanding Indebtedness

As of September 30, 2019, Dynasil is in compliance with the terms of all of its outstanding indebtedness. As of such date, we had total indebtedness consisting of:

The following is a summary of the terms of the existing loan agreement in place with our senior lender, Middlesex Savings Bank, the terms of subordinated debt owed to Massachusetts Capital Resources Company and the terms of subordinated debt owed by Xcede to Cook Biotech Inc.

Middlesex Savings Bank Loan Agreement

Dynasil currently has a loan and security agreement with Middlesex Savings Bank (“Middlesex”) for general corporate purposes, as well as a $4.0 million line of credit note and an annual $1.0 million equipment line of credit agreement with a one year draw period in which the outstanding balance will be converted into a five year term note on the one year anniversary.

On July 31, 2018, the Company converted the outstanding balance on the original equipment line of credit with Middlesex of approximately $750,000 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. 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 change the maximum debt leverage ratio covenant to 2.5x from 3.0x.

On April 30, 2019, the Company converted the outstanding balance on the equipment line of credit with Middlesex of approximately $484,000 into a five year term note with an interest rate of 5.17%, which will be repaid in equal monthly installments from May 2019 through April 2024. Additionally, on May 1, 2019, the Company’s equipment line of credit was renewed for $750,000 through April 30, 2020, at which time the outstanding balance will be converted into a five year term note. Additionally, a modification was made to the borrowing base under the revolving line of credit note to increase the percentage of eligible accounts receivable available for borrowing from 80% to 85% and to eliminate eligible unbilled receivables as a category in obtaining advances under the revolving line of credit.

On August 5, 2019, the Company entered into a Loan Modification Agreement with Middlesex to modify the loan and security agreement, by and between the Company and Middlesex, to allow for the exclusion of certain Transaction-related expenses from the calculation of EBITDA.

On December 23, 2019, the Company and Middlesex entered in an agreement to extend the terms of the existing term loan and line of credit from May 2020 to April 2022, at which time all outstanding principal and unpaid interest will be due and payable. The new agreement includes a modification of the terms of the line of credit’s interest rate to add, at the Company's election, the option of the LIBOR Benchmark Rate, plus two and one-half of one (2.50%) percent per annum, in addition to the existing rate of the Lender's Prime Rate, but in no event less than three and one-quarter of one (3.25%) percent. Additionally, the $750,000 availability under the existing equipment line of credit has been extended through December 2020.

As of September 30, 2019, approximately $0.9 million was due under the revolving line of credit with Middlesex and the total availability was $3.1 million. As of September 30, 2019, no amount was outstanding under the equipment line of credit with Middlesex.

Note Purchase Agreement – Massachusetts Capital Resource Company

The Company and with Massachusetts Capital Resource Company (“MCRC”) entered into a Note Purchase Agreement (the “Agreement”) in July of 2012 in which the Company issued and sold to MCRC a $3.0 million subordinated note (the “Original MCRC Note”) for a purchase price of $3.0 million. The Original MCRC Note provided for interest at the rate of ten percent (10%) per annum, with interest to be payable monthly on the last day of each calendar month and principal payments of $130,000 beginning on September 30, 2015, and on the last day of each calendar month thereafter through and including July 31, 2017.

This Original MCRC Note was amended in 2015 to adjust the interest rate to six percent (6%) in connection with a prepayment of $2.0 million.

On January 3, 2018, the Company amended the Agreement with MCRC 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 Original MCRC Note from six percent (6%) to seven percent (7%) per annum.

On November 27, 2018, the Company amended the Agreement with MCRC to reinstate the interest only payment requirements of the Original MCRC Note and defer principal repayment requirements to November 30, 2019. Such amendment also extended the maturity date from July 31, 2019 to November 30, 2021.

On May 7, 2019, the Company received a waiver from MCRC to terms of the Agreement to allow and permit the Company’s proposed transaction to delist its Common Stock from the Nasdaq Stock Market, including the 1-for-8,000 reverse stock split on its outstanding shares of Common Stock (the “Reverse Split”), the payment of cash to stockholders subsequent to the Reverse Split who hold only a fractional interest, and the subsequent forward stock split of 8,000-for-1 to restore the remaining shareholders to their original share ownership as of immediately prior to the Reverse Split (for additional information, see Note 10, “Stockholders Equity”).

In connection with the events described above, on August 6, 2019, the Company entered into an Note Purchase Agreement with MCRC in which the Company borrowed an additional $2,000,000 in cash and replaced the Original MCRC Note which has an outstanding principal amount of $865,216, for an aggregate principal amount of $2,865,216 which will be due July 31, 2026 and bears eight (8%) percent interest per annum (the “Consolidated Note”). Until August 31, 2022 the Consolidated Note will require interest only payments, followed by principal and interest payments for the remaining four years of the Consolidated Note. Until August 31, 2021, the Company is subject to early-payback penalties. As a result of this amendment to the Agreement, the debt balance as of September 30, 2019 with MCRC was classified as long-term.

Under the terms of the Agreement and a Subordination Agreement dated August 6, 2019, MCRC and any successor holder of the Subordinated Note have agreed that the payment of the principal of and interest on the Subordinated Note is subordinated in right of payment, to the prior payment in full of all indebtedness of the Company for money borrowed from banks or other institutional lenders at any time outstanding.

The Agreement contains customary representations, warranties and covenants, including covenants by the Company limiting additional indebtedness, liens, guaranties, mergers and consolidations, substantial asset sales, investments and loans, sale and leasebacks, transactions with affiliates and fundamental changes. In addition, the Agreement contains financial covenants by the Company (as further defined in the Agreement) that (i) impose a Consolidated Maximum Leverage Ratio (consolidated total funded debt to consolidated EBITDA) equal to or less than 4.0 to 1.0 for each rolling four quarter period ending on or after September 30, 2019, and (ii) require a Debt Service Coverage Ratio of at least 1.10 to 1.0 for the prior 12 month period (EBITDA excluding non-cash and/or non-recurring expenditures, effective for the subsequent three fiscal quarters to give effect to the trailing twelve month testing periods for this covenant, minus unfinanced capital expenditures, minus dividends and distributions, minus cash taxes paid for ongoing operations, divided by scheduled interest and principal payments made on all debt) of not less than 1.10 to 1.00 for each rolling four quarter period ending on or after September 30, 2019. Non-recurring expenditures include without limitation, up to $750,000 of certain expenditures incurred in the de-listing of certain of the Company’s stock from NASDAQ and the deregistration of the Company’s common stock for the fiscal quarters ending June 30, 2019, September 30, 2019 and December 31, 2019 only.

The Agreement also provides for events of default customary for agreements of this type, including, but not limited to, non-payment, breach of covenants, insolvency and defaults on other debt. Upon an event of default, MCRC may elect to declare all obligations (including principal, interest and all others amounts payable) immediately due and payable, which will occur automatically if the Company becomes insolvent.

Note Purchase Agreement – Cook Biotech, Inc. and Xcede

In November 2016, Xcede entered into an additional Services Agreement, a Secured Promissory Note, a Loan Agreement, a Security Agreement and an Intellectual Property Security Agreement (collectively the “Note Agreement”) with Cook Biotech, Inc. (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 trials 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, with three draws of principal available, 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 outstanding principal and unpaid interest are due and payable in full at the earlier of closing of an acquisition transaction or December 31, 2025.

On July 20, 2018, Xcede received a notice of termination from CBI, its collaboration partner with respect to the Xcede Patch, which claimed that the results of a recent animal study showed that, in CBI’s assessment, continuing to the next development phase of the Xcede Patch is not commercially reasonable. 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 Note Agreement between Xcede and CBI. In addition, CBI has asserted that the foregoing study results trigger an immediate repayment of the $500,000 promissory note owed by Xcede to CBI under the Note Agreement, which otherwise has a stated maturity of December 31, 2025. The Xcede promissory note is collateralized by a security interest which CBI has in all of Xcede’s intellectual property. While Xcede vigorously contests this assertion, at this time it is unclear how this matter will be resolved between Xcede and CBI. See Note 3 – Xcede Technologies, Inc. Joint Venture.

As of September 30, 2019, Xcede had $0.5 million of outstanding indebtedness owed to CBI, which the Company carries in short-term debt. 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.

“Off Balance Sheet” Arrangements

Dynasil has no “Off Balance Sheet” arrangements other than non-cancelable operating lease agreements, primarily for property, that expire through 2025. See Note 12, “Lease Agreements,” in the Notes to Consolidated Financial Statements for a full description.

NEW ACCOUNTING PRONOUNCEMENTS

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

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the SEC. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We have identified the following as the items that require the most significant judgment and often involve complex estimation: revenue recognition, valuation of long-lived assets, intangible assets and goodwill, estimating allowances for doubtful accounts receivable, stock-based compensation, valuation of inventory, and accounting for income taxes.

Revenue Recognition

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

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 $253,000 during the twelve months ended September 30, 2019 for amounts included in the contract liability balance at September 30, 2018.

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.

Under the new standard, most contracts in the Innovation and Development segment were not materially impacted upon the adoption of Topic 606 as revenue will continue to be recognized over time.

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 nine months to three years, and estimates of contract costs have historically been consistent with actual results. Revisions in these estimates between accounting periods to reflect changing facts and circumstances have not had a material impact on operating results, and the Company does not expect future changes in these estimates to be material. The cumulative impact of any revisions to estimates and the full impact of anticipated losses on any type of contract are recognized in the period in which they become known.

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

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

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

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

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.

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 resulted in the recognition of revenue over time when compared to existing standards with the cumulative adjustment relating to contracts that were 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 is recognized using the "point in time" model of Topic 606, and the timing of such revenue recognition is not expected to differ materially from the historical revenue recognition. Other immaterial adjustments related to the Optics segment that are sometimes offered to customers include customer rights of return and volume discounts. The Company has elected the practical expedient that the Company will not be required to adjust promised amounts of consideration for the effects of a significant financing component if the transfer of promised goods or services will occur in one year or less.

See Note 2, “Summary of Significant Accounting Policies,” for further information regarding the Company’s adoption of ASC 606, Revenue from Contracts with Customers.

Goodwill

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

We generally perform our annual impairment testing of goodwill at the end of the fourth quarter of the fiscal year, or more frequently if events or changes in circumstances indicate that the assets might be impaired. We test impairment at the reporting unit level using the two-step process. Our primary reporting units tested for impairment are RMD, which comprises our Innovation and Development segment, and Hilger, which is a component of the Optics segment.

Step one of the impairment testing compares the carrying value of a reporting unit to its fair value. The carrying value represents the net book value of the net assets of the reporting unit or simply the equity of the reporting unit if the reporting unit is the entire entity. If the fair value of the reporting unit is greater than its carrying value, no impairment has been incurred and no further testing or analysis is necessary. We estimate fair value using a discounted cash flow methodology which calculates fair value based on the present value of estimated future cash flows. Estimating future cash flows requires significant judgment and includes making assumptions about projected growth rates, industry-specific factors, working capital requirements, weighted average cost of capital, and current and anticipated operating conditions. Assumptions by management are necessary to evaluate the impact of operating and economic changes. Our evaluation includes assumptions on future growth rates and cost of capital that are consistent with internal projections and operating plans. The use of different assumptions or estimates for future cash flows could produce different results. We regularly assess the estimates based on the actual performance of each reporting unit.

If the carrying value of a reporting unit is greater than its fair value, step two of the impairment testing process is performed to determine the amount of impairment to be recognized. Step two requires us to estimate an implied fair value of the reporting unit's goodwill by allocating the fair value of the reporting unit to all of the assets and liabilities other than goodwill. An impairment then exists if the carrying value of the goodwill is greater than the goodwill's implied fair value. With respect to our annual goodwill impairment testing performed during the fourth quarter of fiscal year 2019, step one of the testing determined the estimated fair value of RMD and Hilger exceeded their carrying values. Accordingly, we concluded that no impairment had occurred and no further testing was necessary.

Impairment of Long-Lived Assets

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

There was no impairment charge in the year ended September 30, 2019 and there was an impairment charge of $0.2 million in the year ended September 30, 2018.

Intangible Assets

Our intangible assets consist of acquired customer relationships and trade names of Hilger Crystals, Ltd., acquired know-how of Radiation Monitoring Devices, Inc. and provisionally patented technologies within Dynasil Biomedical Corp.

We estimate the fair value of indefinite-lived intangible assets using an income approach, and recognize an impairment loss when the estimated fair value of the indefinite-lived intangible assets is less than the carrying value. During the fourth quarter of fiscal year 2019, we conducted our annual impairment review of indefinite-lived intangible assets and concluded the fair value exceeded the carrying value.

We review intangible assets with finite lives for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Recoverability of these intangible assets is assessed based on the undiscounted future cash flows expected to result from the use of the asset. If the undiscounted future cash flows are less than the carrying value, the intangible assets with finite lives are considered to be impaired. The amount of the impairment loss, if any, is measured as the difference between the carrying amount of these assets and the fair value based on a discounted cash flow approach or, when available and appropriate, to comparable market values.

We amortize our intangible assets with definitive lives over their useful lives, which range from 5 to 20 years, based on the time period we expect to receive the economic benefit from these assets.

Allowance for Doubtful Accounts Receivable

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

Stock-Based Compensation

We account for stock-based compensation using fair value. Compensation costs are recognized for stock options granted to employees and directors. Options granted to employees and non-employees are recorded as an expense over the requisite service period based on the grant date estimated fair value of the grant, determined using the Black-Scholes option pricing model.

Income Taxes

As part of the process of preparing our consolidated financial statements, we are required to estimate our income tax provision (benefit) in each of the jurisdictions in which we operate. This process involves estimating our current income tax provision (benefit) together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets. We regularly evaluate our ability to recover the reported amount of our deferred income tax asset considering several factors, including our estimate of the likelihood of our generating sufficient taxable income in future years during the period over which temporary differences reverse. As a result of the conversion of the Xcede convertible notes in November 2016, our ownership percentage in Xcede decreased to less than 80%. Based on this ownership percentage, beginning with the year ended September 30, 2017, Xcede is no longer included in the consolidated federal tax return and the Company can no longer offset taxable income or share net operating losses with Xcede. The tax accounting impact, including the assessment on the valuation allowance against the U.S. federal and state net deferred tax assets, will continue to be evaluated in subsequent periods. The valuation allowance will be addressed independently for the Company and Xcede, instead of on a consolidated basis.

Inventories

Inventories are stated at the lower of average cost or net realizable value. Cost is determined using the first-in, first-out (FIFO) method and includes material, labor and overhead. Inventories consist primarily of raw materials, work-in-process and finished goods.

A significant decrease in demand for the Company's products could result in a short-term increase in the cost of inventory and an increase of excess inventory quantities on hand. In addition, as technologies change or new products are developed, product obsolescence could result in an increase in the amount of obsolete inventory quantities on hand. The Company records, as a charge to cost of revenue, any amounts required to reduce the carrying value to net realizable value.

Forward-Looking Statements

The statements contained in this Annual Report on Form 10-K which are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements regarding future events and our future results are based on current expectations, estimates, forecasts, and projections and the beliefs and assumptions of our management, including, without limitation, our expectations regarding results of operations, our compliance with the financial covenants under our loan agreements with Middlesex Savings Bank and Massachusetts Capital Resource Company, our expectations regarding results of operations, the commercialization of our technology, including the Xcede patch and our dual mode detectors, the success of efforts to develop a successful Xcede Patch and to fund that development, our development of new technologies including at Dynasil Biomedical, the adequacy of our current financing sources to fund our current operations, our growth initiatives, our capital expenditures, the strength of our intellectual property portfolio and statements about the perceived benefits of the Company’s delisting and deregistration transaction. These forward-looking statements may be identified by the use of words such as “plans,” “intends,” “may,” “could,” “expect,” “estimate,” “anticipate,” “continue,” or similar terms, though not all forward-looking statements contain such words. The actual results of the future events described in such forward looking statements could differ materially from those stated in such forward looking statements due to a number of important factors. These factors that could cause actual results to differ from those anticipated or predicted include, without limitation, our ability to develop and commercialize our products, including obtaining regulatory approvals, the size and growth of the potential markets for our products and our ability to serve those markets, the rate and degree of market acceptance of any of our products, general economic conditions, costs and availability of raw materials and management information systems, our ability to obtain and maintain intellectual property protection for our products, Xcede’s ability to produce preclinical data sufficient to enable it to initiate clinical studies of hemostatic patch, clinical results of Xcede’s programs which may not support further development, the ability of our RMD business unit to identify and pursue possible continued development opportunities for the Xcede patch, which is not assured, competition, the loss of key management and technical personnel, our ability to obtain timely payment of our invoices to governmental customers, litigation, the effect of governmental regulatory developments, the availability of financing sources, our ability to deleverage our balance sheet, our ability to identify and execute on acquisition opportunities and integrate such acquisitions into our business, seasonality and the many variables that may impact the Company’s projected cost savings, variables and risks related to the Company’s delisting and deregistration transaction, set forth in this Annual Report on Form 10-K, including the risk factors contained in Item 1A, and from time to time in the Company's other filings with the Securities and Exchange Commission. The Company disclaims any intention or obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Financial Statements

Report of Independent Registered Public Accounting Firm

To the Stockholders and the Board of Directors of

Dynasil Corporation of America and Subsidiaries

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Dynasil Corporation of America and its subsidiaries (the Company) as of September 30, 2019 and 2018, the related consolidated statements of operations and comprehensive income (loss), changes in stockholders' equity and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2019 and 2018, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ RSM US LLP

We have served as the Company's auditor since 2012.

Boston, Massachusetts

December 26, 2019

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2019 and 2018

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

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2019 and 2018 (Continued)

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

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

FOR THE YEARS ENDED SEPTEMBER 30, 2019 and 2018

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

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

FOR THE YEARS ENDED SEPTEMBER 30, 2019 and 2018

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

DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED SEPTEMBER 30, 2019 and 2018

Supplemental Disclosure of Cash Flow Information – See Note 15

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

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 1 – Nature of Operations

Nature of Operations

Dynasil Corporation of America (“Dynasil” or the “Company”) is primarily engaged in the development, marketing and manufacturing of detection, sensing and analysis technology and optical components as well as contract research. The Company’s products and services are used in a broad range of application markets including the homeland security, industrial and medical markets sectors. The products and services are sold throughout the United States (“U.S.”) and internationally.

Note 2 – Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Dynasil Corporation of America and its wholly-owned subsidiaries: Optometrics Corporation (“Optometrics”), Evaporated Metal Films Corporation (“EMF”), Radiation Monitoring Devices, Inc. (“RMD”), Hilger Crystals, Ltd (“Hilger”) and Dynasil Biomedical Corp (“Dynasil Biomedical”). 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 September 30, 2019, Dynasil Biomedical owned 63% of Xcede’s stock and, as a result, Xcede is included in the Company’s consolidated balance sheets, results of operations and cash flows. The 63% ownership includes preferred stock with a liquidation preference, and as a result, for reporting purposes only, common stock ownership is used in the allocation of noncontrolling interest. Dynasil’s common stock ownership is 83% and the remaining 17% of Xcede’s common stock is owned by others and accounted for under the rules applicable to non-controlling interest. All significant intercompany transactions and balances have been eliminated.

Revenue Recognition

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

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

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, as well as in the accompanying September 30, 2019 balance sheet, to be consistent with accounts currently used under the new standard.

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 $253,000 during the twelve months ended September 30, 2019 for amounts included in the contract liability balance at September 30, 2018.

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

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

The impact of the adoption of ASC 606 on the Company’s consolidated financial statements for the twelve months ended September 30, 2019 was a cumulative adjustment to increase the retained earnings in the amount of $22,000.

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.

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

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 nine months to three years, and estimates of contract costs have historically been consistent with actual results. Revisions in these estimates between accounting periods to reflect changing facts and circumstances have not had a material impact on operating results, and the Company does not expect future changes in these estimates to be material. The cumulative impact of any revisions to estimates and the full impact of anticipated losses on any type of contract are recognized in the period in which they become known.

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

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

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.

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

Unfulfilled Performance Obligations

For standard products, the Company recognizes revenue at a point in time when control passes to the customer. Absent substantial product acceptance clauses, this is based on the shipping terms.

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

Unfulfilled performance obligations represent amounts expected to be earned on executed contracts. Indefinite delivery and quantity contracts and unexercised options are not reported in total unfulfilled performance obligations. Unfulfilled performance obligations include funded obligations, which is the amount for which money has been directly authorized by the U.S. government and  by a commercial customer for which a purchase order has been received, and unfunded obligations, representing firm orders for which funding has not yet been appropriated. The approximate value of our Innovation and Development segment unfulfilled performance obligations was $37.5 million at September 30, 2019. The Company expects to satisfy 39% of the performance obligations in fiscal year 2020, 35% in fiscal year 2021, and the remaining amount by fiscal year 2022. The approximate value of our Optics segment unfulfilled performance obligations was $7.2 million at September 30, 2019. The Company expects to satisfy 82% of the performance obligations in fiscal year 2020 and 18% in fiscal year 2021.

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 of revenue for fiscal year ended September 30, 2019 in the tables below.

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

Allowance for Doubtful Accounts Receivable

The Company performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customer's current credit worthiness, as determined by a review of their current credit information. The Company continuously monitors collections and payments from its customers and maintains a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified. While such credit losses have historically been minimal, within expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same credit loss rates as in the past. A significant change in the liquidity or financial position of any significant customers could have a material adverse effect on the collectability of accounts receivable and future operating results. When all collection efforts have failed and it is deemed probable that a customer account is uncollectible, that balance is written off against the existing allowance.

Shipping and Handling Costs

Shipping and handling costs are included in the cost of sales. The amounts billed for shipping and included in net revenue were approximately $31,000 and $40,000 for the years ended September 30, 2019 and 2018, respectively.

Research and Development

The Company expenses research and development costs as incurred. Research and development costs include salaries, employee benefit costs, direct project costs, supplies and other related costs. Substantially all the Innovation and Development segment’s cost of revenue relates to research contracts performed by RMD which are in turn billed to the contracting party. Amounts of research and development included within cost of revenue for the years ended September 30, 2019 and 2018 were $12.4 million and $9.9 million, respectively. Research and development for the Company’s other businesses totaled $0.6 million and $0.8 million in fiscal years 2019 and 2018, respectively.

Unbilled Receivables

Unbilled receivables relate to research and development contracts and consists of actual costs incurred plus fees in excess of billings at contractual rates.

Patent Costs

Costs incurred in filing, prosecuting and maintaining patents (principally legal fees) are expensed as incurred and recorded within general and administrative expenses on the consolidated statements of operations. Such costs aggregated approximately $0.3 and $0.4 million for the years ended September 30, 2019 and 2018, respectively. Xcede capitalizes its patents which totaled $0 and $0.1 million at September 30, 2019 and 2018, respectively. In fiscal year 2018, Xcede recorded an impairment of $0.2 million.

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

Inventories

Inventories are stated at the lower of average cost or net realizable value. Cost is determined using the first-in, first-out (FIFO) method and includes material, labor and overhead. Inventories consist primarily of raw materials, work-in-process and finished goods.

A significant decrease in demand for the Company's products could result in a short-term increase in the cost of inventory and an increase of excess inventory quantities on hand. In addition, as technologies change or new products are developed, product obsolescence could result in an increase in the amount of obsolete inventory quantities on hand. The Company records, as a charge to cost of revenue, any amounts required to reduce the carrying value to net realizable value.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost or at fair market value for assets acquired in a business combination. Depreciation is provided using the straight-line method over the estimated useful lives of the respective assets. The estimated useful lives of assets for financial reporting purposes are as follows: building and improvements, 8 to 25 years; machinery and equipment, 5 to 20 years; office furniture and fixtures, 5 to 10 years; transportation equipment, 5 years. Maintenance and repairs are charged to expense as incurred; major renewals and betterments are capitalized. When items of property, plant and equipment are sold or retired, the related costs and accumulated depreciation are removed from the accounts and any gain or loss is included in income.

Goodwill

The Company annually assesses goodwill impairment at the end of the fourth quarter of the fiscal year by applying a fair value test. In the first step of testing for goodwill impairment, the Company estimates the fair value of each reporting unit. The reporting units with goodwill have been determined to be RMD, which is the Innovation and Development reportable segment, and Hilger, which is a component of the Optics reportable segment. The Company compares the fair value with the carrying value of the net assets assigned to each reporting unit. If the fair value is less than its carrying value, then the Company performs a second step and determines the fair value of the goodwill. In this second step, the fair value of goodwill is determined by deducting the fair value of a reporting unit’s identifiable assets and liabilities from the fair value of the reporting unit as a whole, as if that reporting unit had just been acquired and the purchase price were being initially allocated. If the fair value of the goodwill is less than its carrying value for a reporting unit, an impairment charge is recorded to earnings.

To determine the fair value of each of the reporting units as a whole, the Company uses a discounted cash flow analysis, which requires significant assumptions and estimates about the future operations of each reporting unit. Significant judgments inherent in this analysis include the determination of appropriate discount rates, the amount and timing of expected future cash flows and growth rates. The cash flows employed in the discounted cash flow analyses are based on financial forecasts developed internally by management. The discount rate assumptions are based on an assessment of the Company’s risk adjusted discount rate applicable for each reporting unit. In assessing the reasonableness of the determined fair values of the reporting units, the Company evaluates its results against its current market capitalization.

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

Goodwill (continued)

In addition, the Company evaluates a reporting unit for impairment if events or circumstances change between annual tests indicating a possible impairment. Examples of such events or circumstances include the following:

Intangible Assets

The Company's intangible assets consist of acquired customer relationships, trade names, acquired backlog, know-how and provisionally patented technologies. The Company amortizes its intangible assets with definitive lives over their useful lives, which range from 5 to 20 years, based on the time period the Company expects to receive the economic benefit from these assets.

The Company has a trade name related to its subsidiary located in the United Kingdom (“U.K.”) that has been determined to have an indefinite life and is therefore not subject to amortization and is reviewed at least annually for potential impairment. The fair value of the Company’s trade name is estimated and compared to its carrying value to determine if impairment exists. The Company estimates the fair value of this intangible asset based on an income approach using the relief-from-royalty method. This methodology assumes that, in lieu of ownership, a third party would be willing to pay a royalty in order to exploit the related benefits of this asset. This approach is dependent on a number of factors, including estimates of future sales, royalty rates in the category of intellectual property, discount rates and other variables. Significant differences between these estimates and actual results could materially affect the Company’s future financial results.

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

Recovery of Long-Lived Assets

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 (other than goodwill and any indefinite lived assets) or whether the remaining balances of those assets should be evaluated for possible impairment. Long-lived assets include, for example, customer relationships, trade names, backlog, know-how and provisionally patented technologies. Events or changes in circumstances that may indicate that an asset may be impaired include the following:

If an impairment indicator occurs, the Company performs a test of recoverability by comparing the carrying value of the asset or asset group to its undiscounted expected future cash flows, including proceeds from the disposition of the asset. The Company groups its long-lived assets for this purpose at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets or asset groups. If the carrying values are in excess of undiscounted expected future cash flows, the Company measures any impairment by comparing the fair value of the asset or asset group to its carrying value.

To determine fair value the Company uses discounted cash flow analyses and estimates about the future cash flows of the asset or asset group. This analysis includes a determination of an appropriate discount rate, the amount and timing of expected future cash flows and growth rates. The cash flows employed in the discounted cash flow analyses are typically based on financial forecasts developed internally by management. The discount rate used is commensurate with the risks involved. The Company may also rely on third party valuations and or information available regarding the market value for similar assets.

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

Recovery of Long-Lived Assets (continued)

If the fair value of an asset or asset group is determined to be less than the carrying amount of the asset or asset group, impairment in the amount of the difference is recorded in the period that the impairment occurs. Estimating future cash flows requires significant judgment and projections may vary from the cash flows eventually realized.

Advertising

The Company expenses all advertising costs as incurred. Advertising expense for the years ended September 30, 2019 and 2018 was approximately $143,000 and $145,000, respectively.

Retirement Plans

The Company has retirement savings plans available to substantially all full time employees which are intended to qualify as deferred compensation plans under Section 401(k) of the Internal Revenue Code and similar laws in the United Kingdom. Pursuant to these plans, employees contribute amounts as required or allowed by the plans or by law. The Company also makes matching contributions in accordance with the terms of the plans.

Income Taxes

The Company uses the asset and liability approach to account for deferred 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. On November 18, 2016, Dynasil’s ownership in Xcede was reduced to less than 80%. 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.

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.

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

Income Taxes (continued)

Due to the Tax Cuts and Jobs Act (“2017 Tax Act”) that was signed into law on December 22, 2017, the Company estimated and accounted for the tax implications of the 2017 Tax Act 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 recorded an income tax expense of $0.7 million related to such re-measurement in 2018. The 2017 Tax Act provided for a one-time transition tax is based on the total unremitted earnings of a company’s foreign subsidiaries which has previously been deferred from U.S. income taxes. The Company recorded an estimated provision for its one-time transition liability of its foreign subsidiary resulting in additional income tax expense of $0.2 million in 2018 and an income tax benefit of $0.07 million in 2019. As of September 30, 2018, the Company has completed its accounting for the tax effects of the 2017 Tax Act. See Note 9 – Income Taxes.

Earnings 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 during each period. 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 years ended September 30, 2019 and 2018, no common stock options were included in the calculation of dilutive shares as all of the 95,602 and 160,537 common stock options outstanding, respectively, had exercise prices above the current quarterly average market price per share and their inclusion would be anti-dilutive.

The computations of the weighted shares outstanding for the years ended September 30 are as follows:

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

Stock Based Compensation

Stock-based compensation cost is measured using the fair value recognition provisions of the FASB authoritative guidance, which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors, including employee stock options, based on estimated fair values. Stock-based compensation cost is measured at the grant date based on the value of the award and is recognized over the requisite service period of the award.

Foreign Currency Translation

The operations of Hilger, the Company’s foreign subsidiary, use their local currency as its functional currency. Assets and liabilities of the Company’s foreign operations, denominated in their local currency, Great Britain Pounds (GBP), are translated at the rate of exchange at the balance sheet date. Revenue and expense accounts are translated at the average exchange rates during the period. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are included in the foreign currency translation adjustment, a component of accumulated other comprehensive income in stockholders’ equity. Gains and losses generated by transactions denominated in foreign currencies are recorded in the accompanying statement of operations in the period in which they occur.

Comprehensive Income (Loss)

Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Other comprehensive income (loss) represents cumulative translation adjustments related to Hilger, the Company’s foreign subsidiary. The Company presents comprehensive income and losses in the consolidated statements of operations and comprehensive income (loss).

Financial Instruments

The carrying amount reported in the balance sheets for cash and cash equivalents, accounts receivable and accounts payable approximates fair value because of the immediate or short-term maturity of these financial instruments. The carrying amounts for fixed rate long-term debt and variable rate long-term debt approximate fair value because the underlying instruments are primarily at current market rates available to the Company for similar borrowings.

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of accounts receivable. In the normal course of business, the Company extends credit to certain customers. Management performs initial and ongoing credit evaluations of its customers and generally does not require collateral.

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

Concentration of Credit Risk

The Company maintains allowances for potential credit losses and has not experienced any significant losses related to the collection of its accounts receivable. As of September 30, 2019 and 2018, approximately $1,145,000 and $1,724,000 or 26% and 40% of the Company’s accounts receivable are due from foreign sales.

The Company maintains cash and cash equivalents at various financial institutions in New Jersey, Massachusetts and New York. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $250,000. Hilger also maintains cash and cash equivalents at a financial institution in the U.K. Accounts at this institution are insured by the Financial Services Compensation Scheme, the U.K.’s deposit guarantee scheme, up to £75,000. At September 30, 2019 and 2018, the Company's uninsured bank balances totaled approximately $0.1 million and $2.0 million, respectively. The Company has not experienced any significant losses on its cash and cash equivalents.

Recent Accounting Pronouncements

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 was 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.

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

Recent Accounting Pronouncements (continued)

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 guidance 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.

Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting. In May 2017, the FASB issued ASU No. 2017-09 which was issued to clarify and reduce both (i) diversity in practice and (ii) cost and complexity when applying the guidance in Topic 718, “Compensation – Stock Compensation” to changes in the terms and conditions of a share-based payment award. This update is effective for the Company in the fiscal year beginning October 1, 2018. The adoption of this standard did not have a material impact on the Company’s consolidated financial position, results of operations, or cash flows.

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

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

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 2 – Summary of Significant Accounting Policies (continued)

Cash and Cash Equivalents

The Company generally considers all highly liquid investments with original maturities of three months or less to be cash equivalents.

Reclassifications

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.

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 3 – Xcede Technologies, Inc. Joint Venture

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

Beginning at its inception and through November 2016, Xcede funded its pre-clinical research activities through the issuance of $5.2 million in the aggregate principal amount of convertible notes bearing interest at 5% (“the Notes”). In November of 2016, the Notes were converted into Series A convertible preferred stock of Xcede (“Series A Preferred”). Series A Preferred participants include both outside investors (accounted for as noncontrolling interest) and DBM. The outside investors converted $3.1 million of Notes and accrued interest into 3,055,551 shares of Series A Preferred. DBM converted the remaining $2.4 million of Notes and accrued interest into 2,338,569 shares of Series A Preferred.

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

Each share of Series A Preferred and Series B Preferred (together “the Preferred Stock”) is convertible, at the option of the holder, into such number of fully paid and non-assessable shares of Xcede common stock (“Common Stock”) as determined by dividing the original issue price, as defined, by the conversion price in effect on the date of conversion, which is 1:1. Each holder of the Preferred Stock is entitled to one vote for each share of Common Stock that the holder of the Preferred Stock would be entitled to receive upon the conversion of the holder’s Preferred Stock into Common Stock. Upon any liquidation event, which includes certain change of control events, following payment of pre-equity distributions, the remaining proceeds or net assets of Xcede shall be paid and distributed in the following amounts and order of priority: (1) to satisfy the liquidation preference payment due to each holder of Series B Preferred, (2) to satisfy the liquidation preference payment due to each holder of Series A Preferred, (3) payment in full of any acquisition transaction payment, and (4) the remaining assets available to be distributed ratably among the holders of the Common Stock. If a liquidation event were to occur, the Series A Preferred’s liquidation value would be $1.016 per share and Series B Preferred’s liquidation value would be $1.27 per share. As of September 30, 2019, the liquidation value of the Series B Preferred would be approximately $1.5 million and the Series A Preferred would be approximately $5.5 million, of which $2.4 million is DBM’s portion and $3.1 million would be attributed to noncontrolling shareholders.

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 3 – Xcede Technologies, Inc. Joint Venture (continued)

As of September 30, 2019, DBM owned approximately 63% of Xcede’s outstanding Common Stock and Preferred Stock and, as a result, Xcede is included in the Company’s consolidated balance sheets, results of operations and cash flows. Due to the Series A Preferred having a liquidation preference and therefore not representing a residual interest, cumulative net losses of Xcede are attributed only to common stockholders in accordance with common stock ownership. Noncontrolling interest represents the value of the Series A Preferred and common stock not owned by DBM plus 17% of cumulative losses of Xcede based on the 17% common stock ownership held by noncontrolling interests.

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

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 it evaluates alternatives, including the viability of modifying the Xcede Patch to address the shortcomings cited by CBI and/or the possible sale or license of Xcede IP assets, subject to amending CBI’s security interest. Additionally, Xcede and the Company’s RMD subsidiary have begun an investigation of possible continued development of the Xcede Patch, which includes seeking government funding of this development. In September 2019, Xcede and RMD resubmitted an application for a Phase I SBIR grant for $225,000. There can be no assurances with respect to any such alternatives or that any additional outside funding to continue development of the Xcede Patch will be available to Xcede.

Note 4 – Inventories

Inventories, net of reserves, at September 30, 2019 and 2018, consisted of the following:

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 5 - Property, Plant and Equipment

Property, plant and equipment, at September 30, 2019 and 2018, consist of the following:

Depreciation expense for the years ended September 30, 2019 and 2018 was $1,312,000 and $1,145,000, respectively.

Note 6 – Intangible Assets

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

Amortization expense for the years ended September 30, 2019 and 2018 was $108,000 and $112,000, respectively. In fiscal year 2018, the Company recorded an impairment loss of $182,000.

DYNASIL CORPORATION OF AMERICA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 and 2018

Note 6 – Intangible Assets (continued)

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