Dynasil Corporation of America

OTC:DYSL

Earnings Call Transcript

[Operator]

Good day. And welcome to the Dynasil Corporation of America’s Fiscal 2017 Year-End Conference Call. Today’s call is being recorded. At this time, all participants are in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions [Operator Instructions].

I would now like to turn the call over to Patty Kehe of Dynasil. Ms. Kehe, please go ahead.

[Patty Kehe, Corporate Secretary]

Thank you, Phil, and good afternoon, everyone. With me today are Peter Sulick, Dynasil’s Chairman, CEO and President and Rob Bowdring, Dynasil’s Chief Financial Officer. Before we begin, please note that various remarks management makes on today’s conference call that are not historical facts, including but not limited to, statements about our expectations, beliefs, plans, designs, objectives, prospects, financial condition, assumptions and future events or performance are forward-looking statements under the Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve risks and uncertainties. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including those discussed in Dynasil’s annual report on Form 10-K for the fiscal year ended September 30, 2017, filed today with the Securities and Exchange Commission. Dynasil’s filings can be accessed on the Investor Relations section of the Company’s Web site, www.dynasil.com.

In addition, any forward-looking statements represent the Company’s views as of today, December 20, 2017. These statements should not be relied upon as representing the Company’s views as of any subsequent date. While Dynasil may elect to update forward-looking statements at some point in the future, the Company specifically disclaims any obligation to do so.

Now, let me turn the call over to Peter Sulick.

[Peter Sulick, Chairman, Chief Executive Officer and President]

Thanks, Patty. Good afternoon, everyone. Thank you for joining us today to highlights our financial results and other activities for our 2017 fiscal year. Earlier today, we released our Form 10-K and press release with summary results for our 2017 fiscal year. You may want to refer to these documents for specific information during this call. Rob will summarize our results in a few minutes. I would like to begin by announcing our earnings for the year attributable to common shareholders was $2.2 million or $0.13 per share. If you follow Dynasil this year, you will already be aware that our positive bottom-line results are largely attributable to our U.S. income tax benefit, resulting from a tax deconsolidation of Xcede Technologies, Inc., the Company’s tissue sealant technology development joint venture.

Our revenue for fiscal 2017 decreased 14% overall from 2016. $4.4 million of this decrease resulted from a decline in revenue in our Optic segment. This was largely due to a reduction in orders from production adjustments by two of our largest customers. In fact, one of those customers curtailed all orders for the final five months of the fiscal year. We do see signs that these customers are increasing their orders in fiscal 2018 in the case of the one customer with the curtailed order we have been advised the order flow will slowly increase throughout 2018, returning to historical levels by the third quarter.

Our contract research segment had a $1.8 million or 9% decrease in revenue, largely from the transition in Presidential administrations in the first quarter of 2017. Both contract awards and funding were significantly delayed during this transition time. The unusual delays with government funding were unanticipated and disruptive, however, they were largely resolved during our fourth quarter and we do not anticipate a recurrence of this situation in 2018.

We're also happy to report that RMD contract revenue backlog increased to $33.2 million at September 20, 2017, up from the September 30, 2016 level of $30 million. RMD's commercial revenue continues to be a bright spot. During the 12 months ended September 30, 2017, the contract research segment generated $1.8 million in commercial revenue as compared to $0.6 million in fiscal 2016. RMD's quick dual mode simulator is getting considerable market traction, particularly within personalized radiation detector market. We anticipate this business will continue to grow into 2018.

For those of you unaware of the work RMD engages in, RMD is widely considered one of the leading research organizations in the world for simulator materials development. This includes thin film both crystals, ceramic, and plastic stimulators using a variety of different elements. In addition, RMD has expertise in solid state photo multipliers, augmented reality, medical imaging, medical applications of radiation detection, detector development and instrument development using the core IT, which RMD has developed.

These type of technologies are fundamental signs behind important projects in medical imaging, specifically tech, spec, radiation detection and baggage scanning. RMD collaborates with some of the largest OEM companies, National Research Laboratories and universities in the development of simulators and associated rays and detectors up to and including the development of full instruments and systems. At the present time, RMD has over 110 granted and/or pending patents covering its core technologies. We are advancing and anticipate investing in RMD's product portfolio in the coming years as commercial revenue opportunities become available.

This includes stimulators arrays and detectors and potentially could include medical probes and instrument assemblies. In addition, certain of RMD's IT may be transferred to Hilger for production and marketing. In short, we believe after many years of development, RMD's product portfolio is reaching the stage where commercialization is becoming a reality, reflective of the substantive increase in 2017 revenue.

You will note from our financial results the negative effect of our continued consolidation of the Xcede biomedical venture has on our earnings. Although, as we mentioned earlier this year, we can no longer include Xcede in our consolidated federal tax return, Dynasil still owns 83% of Xcede’s outstanding common stock and approximately 49% of Xcede’s outstanding preferred stock for an aggregate fully diluted ownership of approximately 61%.

As a result, the Xcede’s results remain included in the Company's consolidated financial statements. As of today, Xcede and Cook are on a plan for the first in human clinical trials of the Xcede Patch for early in 2018. This plan calls for dosing 30 or so patients, undergoing various forms of liver surgery and will be conducted in the Netherlands by surgeons well familiar with this field. We are awaiting the results of one final laboratory report before filing our clinical trial application in the Netherlands.

We anticipate this arriving in the immediate future. As I have mentioned on these calls in the past, the strong desire on the part of the Dynasil management and Board to solve the problem of a continued consolidation of Xcede into Dynasil's consolidated results. We are actively engaged in discussions to do one of the following; seek to separately finance Xcede through a private equity transaction; spin off Xcede, including in such a way that Dynasil stockholders would have a continued interest in Xcede and its potential upside; if that can be effectuated in an efficient manner. If such transaction were completed, Xcede will then be a standalone public company; the sale or merger of Dynasil's interest in Xcede to a third-party with a compatible business line.

There are discussions going on in all of these areas. While there can be no assurances that any transaction will be achieved or its timing, we are focused on this initiative. Our efforts are guided by the overriding goal to maximize value for the Dynasil stockholders in addition to cleaning up our reported results with the removal of Xcede from our financial statements. We do not believe Xcede's value is reflected in the value of Dynasil stock, so moving it off on its own, particularly if our shareholders retain some interest, should result in an improvement in the aggregate value of both companies.

Optic segment. The decrease in our Optics segment revenue is largely result of orders from production adjustments from one product in the UK and one large OEM customer in the U.S. These decreases are proving to have been temporary and product demand is beginning to increase as our customers scale to production back to 2016 levels. Finally, the 2016 Brexit-related devaluation continued to affect our reported results as compared to prior year through our fiscal third quarter.

It appears our recent exchange rate changes, the pound to dollar rate is improving but remains could be seen as we return to the pre-Brexit levels. I would like to touch briefly on our e-commerce initiative and future commercial opportunities. As previously announced, we launched an e-commerce Web site in early April, featuring Optometrics products. In early October, EMF and Fused Silica Products became available for purchase. Additionally, Hilger products were added to the sight earlier this week.

If you haven't visited our new site yet, I recommend you take a look at www.dynasil.com. As a low cost manufacturer, we are optimistic about our ecommerce effort in general and a very competitive market price.

Previously, I mentioned that Optometrics submitted a bid on subassembly business for an existing grading customer. To-date, the customer has not made a decision on this proposal, but is still considering it. If successful in obtaining this business, Optometrics will move up the food chain through assemblies rather than just components. We are not restricting this effort to just one customer, however.

During fiscal 2018, Optometrics will be investing in a prototype assembly fabrication center. With this investment, Optometrics will demonstrate capabilities in high volume optical assembly. We are actively approaching other potential customers for this service and are hopeful of securing business in this area during 2018.

With respect to future growth within this sector, we have identified opportunities in coded optics, infrared, and anti-reflective coatings and RMD simulation portfolio, which we believe are well deserving future capital investment and possible future acquisition and merger targets.

Now, let me turn the call over to Rob Bowdring, Our CFO.

[Rob Bowdring, Chief Financial Officer]

Thank you, Peter. As Peter touched on most of the significant items for the year, I will summarize a few additional points. As Peter noted, Dynasil's revenue for the year ended September 30, 2017 was $37.3 million, a decrease of $6.1 million or 14% from the $43.4 million we recorded in 2016. This decrease was a result of both our Optics segment decreasing by 14% and the 9% decrease in our Contract Research segment.

As Peter explained, the Contract Research segment decreased largely as a result of government transitional issues at our contracting government agencies as the new department heads had to review what was being issued by their areas.

The Contract Research segment has a number of initiatives underway to help relieve the impact of governmental fluctuations with certain types of funding. As we’ve discussed before, we are working to reduce our reliance on SBIR contracts and increase our success at bidding for other types of contracts. Additionally, we are working to broaden our agency base by bidding on contracts with a larger number of agencies.

We are happy to report that our efforts to diversify our contracting sources to outside the government have been successful this year. During the 12 months ended September 30, 2017, the Contract Research segment generated $1.8 million in commercial revenue compared to the $600,000 in 2016. We expect to sustain this revenue level in 2018 and our goal is to continue to grow this component of our Contract Research segment as we move forward.

As I discussed during last quarter's call, we anticipate that certain items were going to be different in 2017 as compared to the prior year. So we prepared for this with cost reductions where possible and we continue to make cost adjustments throughout the organizations as circumstances warrant. Gross profit for the year was $13.9 million or 37% of revenues compared to 15.6% or 36% of revenues during 2016.

On the Optic segment side, gross profit as a percent of revenue in 2017 remained consistent with 2016 at 34%. Gross profit in 2017 was $6.6 million, a reduction of $1.4 million as a result of revenue being $4.4 million less during the 12 months ended September 30, 2017 for this segment. It was a concerted effort to reduce manufacturing costs during the year to help mitigate the bottom-line impact of the anticipated lower revenue.

Gross profit as a percent of revenue on the Contract Research segment improved to 41% in 2017 compared to 38% in 2016, as a result of the increase in sales of our commercial products during the year. These items carry a healthier profit margin. Profit dollars on the other hand in this segment decreased slightly to $7.3 million during 2017, down from $7.6 million in the same period in 2016 due to lower revenue in fiscal 2017.

Total operating expenses will reduce in fiscal year 2017 to $14.5 million or 39% of revenue, a decrease of $400,000 from the $14.9 million spent in 2016. Operating expenses within the Optic segment remained at $6.2 million in 2017, approximately the same level as in fiscal 2016 through a cautious effort by the business units to control expenses within the segment and response to the segment’s increased revenue in 2017.

Operating expenses as a percent of revenue increased to 34% in the 12 months ended September 30, 2017, up from 26% of revenue. This increase was due to lower revenue in 2017. Operating expenses within contract research segment increased to 6.9% or 38% of revenue in fiscal year 2017, up from $6.6 million or 34% of revenue in the prior year. The increase in operating expenses in 2017 can be attributable to increased corporate costs and facility costs within the year.

As we’ve explained in our other 2017 calls, net income improved year-over-year as a direct results of the $2.7 million federal income tax benefit recorded in the first quarter of 2017 as a result of Xcede’s deconsolidation for federal income tax reporting. The remaining tax valuation allowance on the books is $1.5 million plus state taxes and Xcede taxes. Net income attributable to common shareholders was $2.2 million or $0.13 per share for the year ended September 30, 2017 and income of $700,000 or $0.04 per share for the year ended September 30, 2016.

Now for a quick look and review of our cash position as we end 2017 and move into 2018 -- [declined] by $200,000 compared to year-end September 30, 2016’s balance of $2.6 million, down to 2.4 million this year. The decrease was a result of working capital requirements across the Company, as well as we continue to pay down our term note with Middlesex Bank. As I mentioned in May’s call, Middlesex Savings Bank extended out $4 million line of credit through May 2020. In addition, Middlesex extended the company a new $1 million equipment line of credit that will be consolidated into a five-year term note.

We have not used either of these lines during 2017 but we intend to use equipment line as we move forward to start to invest in some new product line opportunities as Peter outlined earlier in the call. We believe we have sufficient cash resources to carry out our plans for the remainder of the year.

With that, Peter and I are happy to take your questions. Bill?

[Operator]

Thank you. We will now begin the question-and-answer session [Operator Instructions]. Our first question comes from Tim Clarkson with Van Clemens. Please go ahead.

[Tim Clarkson, Van Clemens]

I just wanted to go over again the basic technology on your bandage. Are you still convinced that this technology has really works --? I'm guessing that the way an animal would bleed or a human would bleed would be pretty similar. So if the works in the animals it should work in humans.

[Peter Sulick, Chairman, Chief Executive Officer and President]

So good question thank you. We we're very, very happy with the way the product works. We've been happy with the way the product works for a couple of years. This gone through extensive period of development, literally hundreds of large animal studies have been conducted with the product; small animal studies on survivability and a variety of other tests. There are many, many, many tests that have been involved in testing the product prior to the submission of the clinical trial data for the Netherlands. And all of this data is going to be included in submission.

The product has been proven to be very effective in sealing both mild-to-moderate bleeds as well as severe bleeds. But the particular clinical trials that we're going to be entering into are for the mild-to-moderate market. And we generally seal in that stage or in less than 60 seconds. So the answer is we're very, very positive about the results. What -- I'll just go on to say I think we underestimated the extensive amount of data requirements for a clinical trial submission. We expected that we would have that submission before this call and we would have had the ability to say we're in review right now. I think it's a matter of a very short period of time, we probably get to that time, but we only have two people working in the company. We rely extensively on Cook’s with support and we’re close.

[Tim Clarkson, Van Clemens]

Now, assuming you get this research done and I guess initially you're going to do it in Europe, right?

[Peter Sulick, Chairman, Chief Executive Officer and President]

Correct.

[Tim Clarkson, Van Clemens]

I mean if you're successful there, I mean what revenues could you potentially get in Europe on this bandage?

[Peter Sulick, Chairman, Chief Executive Officer and President]

We'll be under $10 million range in revenue in Europe. The primary market is the size of the market is approximately $1.5 billion in total for this particular product category; 60% of that market is in United States and about 40% of the market is in Europe. So we expect that we will probably launch the product in Europe initially that's the game plan, and then to launch the product in the United States. We do expect that the revenue in United States will be significantly greater.

[Tim Clarkson, Van Clemens]

How much time would it take to get an FDA approval here?

[Peter Sulick, Chairman, Chief Executive Officer and President]

We will launch the FDA cycle in late 2018 or early 2019, following the results of the European study. And it will take us about a year to get that approval.

[Tim Clarkson, Van Clemens]

So what kind of growth -- go ahead.

[Peter Sulick, Chairman, Chief Executive Officer and President]

The anticipated launch date in the U.S. will be in early 2020 -- throughout sometime in the year 2020.

[Tim Clarkson, Van Clemens]

What kind of gross margins would the product --?

[Peter Sulick, Chairman, Chief Executive Officer and President]

So that’s not a number that we have disclosed to the public. I will tell you…

[Tim Clarkson, Van Clemens]

I assume it will be high though…

[Peter Sulick, Chairman, Chief Executive Officer and President]

It will be very significant. It will be well, well above the kinds of gross margins of Dynasil generally incur. So you can look at comparable products in the marketplace and you can see that they have gross margins 60%, 80% kind of thing. We expect that we are going to be in that range.

[Tim Clarkson, Van Clemens]

One last, one other question. I know that you bought out some fairly significant thin film capability. And I'm just wondering how much of that equipment is being utilized adequately? Or is there still a lot of capacity out there?

[Peter Sulick, Chairman, Chief Executive Officer and President]

Basically we have separated our thin film coating between two operations. We have two 50,000 square foot facilities in New York State one is in Ithaca one is in Rochester. The one that we acquired was in Rochester was a 1396 inch coaters. We’ve moved a great deal of our regular recurring production to our Rochester facility and we are doing a lot of our developmental work and kind of built to print work and one off coding production in our Ithaca facility. And so I would say that we still have substantial capacity, within both of those, now that we have separated the workflow between the two. So we do have a lot of upside there and we are actively going after hut business in the automotive. We make a considerable number of hard mirrors already and we’re making those in Rochester.

[Operator]

[Operator Instructions] The next question comes from Joe Furst with Furst Associates. Please go ahead.

[Joe Furst, Furst Associates]

Just wondering if you could expand a little bit on the optics area of these two customers who cut back their orders so much, about maybe why they did it? And why do you think they’re going to come back, can you expand a little bit on that?

[Peter Sulick, Chairman, Chief Executive Officer and President]

So both of these products are -- one is a very new baggage scanning product, that we were involved in the development phase for a number of years. It then moved into the production phase. And frankly, it will probably was moved into production phase a little bit prematurely. And the customer had some quality problems with their product that resulted in them having to swap out components within the product during the year. So they literally shut down their manufacturing line for a portion of this year, beginning in the early part of our fiscal year and running through about six months into our fiscal year.

They continue to order from us during that period of time but at smaller quantity levels. And then for the last, about six months of our fiscal year, they had such a significant level of inventory of our product that they stopped ordering so that they could begin their inventory management process. They are back in not at the same level of production that they were in previously, they scaled their actual amount of production back, and they are ordering from us again at the level of their new production amounts.

And I was there earlier this month and they've assured us that their production levels are going to step up over the course of this coming year. We already have purchase orders covering this current quarter, which we've delivered product for that for the next quarter. And they have told us what their delivery expectations are for our third quarter and our fourth quarter. So I am pretty confident that they are going to return back to a more normalized level and that they are going to scale their production up in accordance with their own demand.

So I think in the case of that one customer, I feel pretty good at the levels. In the case of the other customer, they are already substantially above what their order flow was for most of last year. It's a grading customer, makes an optical product. We deliver somewhere between 500 and a 1,000 of these gradings a day -- a week to these customers -- a day to these customers. And we've seen their order flow go from 500 at its low point up to currently 850 a day. So, some of it is seasonal in nature because they do have a retail component to their product. But I think that we will see a return of both of those customers to the previous levels of ordering based on the POs.

[Joe Furst, Furst Associates]

And how about potential for growth in other products and to just grow the business in general with other things?

[Peter Sulick, Chairman, Chief Executive Officer and President]

So, we believe that we can get significant growth and we talked about it briefly in the RMD commercial area. We have a product development roadmap for RMD's products and we are on schedule for that product roadmap. You all know that over the past few years, we have been talking about our CLYC opportunity. The CLYC opportunity is largely in the security space. We make a very specific detector for Thermo Fisher for their SPRD, what's called their SPRD-GN plus pager. Thermo Fisher is bidding on a very large Coastguard order, we’re helpful that they may get that, they’re bidding on a number of other orders.

And so our success in that area is largely dependent upon bids that our customers make, which are generally funded by the federal government or by local governments. To the extent that our customer wins those bids, happy days are here again to the extent that they don’t then our order flow will be lower.

We are not ready to announce quite yet, but we are going to be actively engaged and we are actively selling at the moment a new optics product for us in a very large optic space something that we have not previously addressed. We are purchasing capital equipment for that initiative. The capital equipment is going to be installed over the course of the end of our second quarter and into our third quarter; it has a five to six month lead time. That particular capital equipment is going to be installed at EMF who -- certainly there is a coating related opportunity, but it’s going to be sold by both EMF and Optometrics. It is a very, very sizeable market that we’re going to be addressing, which we believe there is a hole in the market at the moment that can open up a great opportunity for us.

We will have modest revenue in that space this year but we’re positioning the company to take advantage of much bigger growth in that in years two and three. We’ve hired some new people who have a significant expertise in this area, including some new business development people who notice base quite well. So we’re excited about that potential and we will be launching that product opportunity in the first quarter, we will make it publicly know and that we’re going to be entering that space. So there is one very large market segment and we’re going to going after.

[Joe Furst, Furst Associates]

And with Xcede, do you think you might be able to come to a conclusion on what to do with that in the next quarter?

[Peter Sulick, Chairman, Chief Executive Officer and President]

I don’t think so, Joe. To be honest, I think there is always -- we are actively involved in discussions on financing. As you all know, Dynasil still put another $1.2 million into that a year ago November. It was tranched -- the final tranche will be going in January that will provide Xcede with adequate cash resources to get through about the end of the first quarter or so. calendar quarter, not of our fiscal year. We know that we have to do something in Xcede during the course of the next quarter, including another financing.

There are active discussions going on with outside third-parties to do that. And so we will solve the Xcede, at least the liquidity problem in Xcede, sometime over the course in the first quarter and we will keep it going. We anticipate that we will be in discussions with some of these financing sources over the course for the next month and half or so. There are meetings coming up in January on that. And there are one or two other things going on in Xcede that could be very helpful.

But to be honest, we have had this resistance to a substantive financing and I'm talking about $10 million to $15 million number that we need, both to launch the product and to do the U.S. pivotal trial depending upon the results of a clinical study. And we know that we will have those results over the course of the next six months. So I can't promise in the next quarter, but I would say over the course of the next six months, we'll have the necessary ammunition we need to be able to the solve the Xcede problem.

[Operator]

I’m seeing no further questions, I would like to turn the conference back over to Mr. Peter Sulick for any closing remarks.

[Peter Sulick, Chairman, Chief Executive Officer and President]

Thank you all for participating in our 2017 fiscal year-end results. On behalf of the entire Dynasil Corporation, our shareholders, our Board and our staff, I'd like to wish all of you happy holidays. We're working hard here to have a wonderful 2018 cautiously optimistic and look forward to talking to you all next year. Thank you.

[Operator]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.