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Dynasil Corporation of America (NASDAQ:DYSL)

Q3 2014 Earnings Conference Call

August 20, 2014 05:00 PM ET

Executives

Patty Kehe - IR

Peter Sulick - Chairman, Interim CEO and President

Tom Leonard - CFO

Analysts

Tim Clarkson - Van Clemens Capital

Ben Mackovak - Cavalier Capital

Operator

Good day and welcome to the Dynasil Corporation of America Fiscal 2014 Third Quarter Conference Call. Today’s call is being recorded. At this time all participants are in a listen only mode. There will be an opportunity for questions at the end of the call. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the conference over to Ms. Patty Kehe of Dynasil. Ms. Kehe the floor is yours ma’am.

Patty Kehe

Thank you Mike and good afternoon everyone. With me are Dynasil’s Chairman, Interim CEO and President Peter Sulick; and Tom Leonard, Dynasil’s Chief Financial Officer.

Before we begin please note that various remarks management makes on today’s conference call are not historical facts including but not limited to statements about our expectations, beliefs, plans, designs, objectives, prospects, financial conditions, assumptions and future events or performance are forward looking statements under the Private Securities Litigation Reform Act of 1995.

Forward looking statements involve risk 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, 2013 filed with the Securities Exchange Commission. Dynasil's filings can be accessed on the Investor Relations Section of the Company's website at www.dynasil.com. In addition, any forward-looking statements represent the Company's view as of today August 20, 2014. 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

Thanks Patty. Good afternoon everyone. We’re happy to be joining you again for a quarterly conference call. As you all know from our public announcements and filings, Dynasil went through a period of default of the financial covenants of our credit agreements as of September 30, 2012. With much effort by our entire team we’re now in compliance and just reported our third consecutive fiscal quarter positive earnings.

And this is our first conference call in 18 months. I would like to take a few minutes to review the steps that we took to return the Company to profitability, to leverage our core strengths for future opportunities and to discuss what some of those opportunities are.

The end of our 2012 fiscal year was marked by a number of events that led to our announcement in December 2012 that we were in default of our financial covenants with our lenders. The Company made significant investments during fiscal 2012 to refresh the LPA lead paint detector and the navigator medical product lines as well as in our quick new mode detector program and our biomedical business. Additionally we incurred one-time expenses for a review of certain cash application processes and billing practices at our R&D division.

Beginning in early 2013 the Company immediately took steps to right size our cost structure, conserve cash, improve our balance sheet and optimize profitability. We hired Argus Management to assist us in the process and successfully manage our cash through (remain in current) [ph] with our principal and interest payments to our primary vendor. We placed certain subsidiaries and products on the market to generate cash and we prepared a plan to spin out one of our technologies in our biomedical business. I’m happy to report that all these efforts have had a very positive result as follows.

In October 2013 we announced the formation of Xcede Technologies and separately funded subsidiary of Dynasil Biomedical. This entity continues the tissue sealant technology developed within Dynasil which I will discuss later. In October of 2013 we devastated the LTA product line from our Dynasil products business, this transaction allowed us to make an additional 1.2 million principal payment to our primary vendor. In December of 2013 we devastated Dynasil products gamma medical probe and made a $2.7 million reduction in our senior debt. Also as result of regular principal payments and the above one-time special payments we reduced our senior debt due Santander Bank from approximately 9 million at December 30, 2012 to 2.4 million at December 31, 2013.

On May 1, 2014 we closed the new revolving line of credit and pay also remaining 1.8 million on to Santander Bank. We’re now maintaining cash balances appropriate for our business in compliance with all credit agreements have additional borrowing capacity if necessary and remove from consideration the sales of any of our businesses. Our stock price was below $1 during early 2013 resulting in notification by NASDAQ that we did not meet the minimum debt requirement. Our stock prices since rebounded and we regained compliance with the NASDAQ listing requirements in January of 2014.

During the downturn the stock hit a lot of below $0.50 and has recently rebounded to the range of $1.70, $1.80. This increase from the low of the summer of 2013 to today is approximately 3.5 to 4 times. On the operational side of our businesses we conserve cash as best as possible and look for revenue opportunities leveraging our optics, photonics expertise as well as technology development coming out of research side of the company. I’m pleased to say that many of these initiatives are beginning to bear fruit and I believe over the next several years we will experience revenue expansion on the commercial side of our business, margin improvements and we’ll continue to monitor G&A expense to properly match it with the rest of the business.

Now, for a brief summary of our results, for the quarter followed by more in-depth discussion by Tom Leonard, our Chief Financial Officer. For the quarter ended June 30, 2014 Dynasil reported revenue of 10.6 million a decline of 6% from the same period in 2013. The decrease was the result of a $1.5 million decrease in revenues related to the lead paint and medical instruments businesses which were sold in the first quarter ended December 31, 2013 and a $400,000 decrease in revenues of the Contract Research segment offset by $1.3 million increase in revenues in the Optic segment or 33% over the same period in the prior year. Largely due to the changes that I mentioned above despite a slight decrease in revenue this quarter operating income for the quarter ended June 30, 2014 increased to approximately $200,000 from a loss of $200,000 in quarter ended June 30, 2013.

Improvement in operating income extends across each of Dynasil’s four business segments as compared to the same period in 2013. Also during this quarter we completed the acquisition of the assets of DichroTec LLC located in Rochester New York about 90 minutes away from EMF operation in Ithaca, New York. This acquisition is recorded on the books for approximately $1.7 million and consists of (1496) [ph] inch vacuum deposition coating chambers, a line coder furnaces, cleaning machines, cutting machines and a host of other equipment necessary for large volume coating operations. While much of this equipment is not new I repurchased these and one of these chambers new it would have cost us more than the total of this acquisition. In addition we hired 18 former employees with considerable skills in the coating industry and DichroTec had an existing book of business of approximately $2 million in revenue annually.

DichroTec also have a certain proprietary coating processes which are unique to the company and which we’re hoping to leverage. We believe we made a very opportunistic buy but it is not without issues. Under previous owners this business was using money and will take us sometime to turn around. In addition we need to spend money upgrading equipment, improving operating processes consolidating the sales and marketing functions and generally bringing our new EMF Rochester operation into our EMF Ithaca management processes.

However, we now have extensive coating capabilities among the most extensive in the United States, this opens up markets to us which we have simply not been able to address. These markets are in the automobile, medical imaging, large coated optics, lighting, coated flexible substrates and fuel cell substrates industries among others. Our combined EMF operation has a capacity to double, if we can capture the revenue opportunities available to us.

There are certain other actions we have engaged and which I would also like to highlight. The Xcede Technologies spin off is very exciting and continually evolving. Dynasil has not provided funding for this operation but we’re still required to consolidate it into our books. It results in pretty substantial hit to our P&L quarterly but does not affect our EBITDA. Xcede has recently filed another patent for a reformulation of the tissue sealant patch which we believe is even better than the previous formulations. Xcede now has six patents for this material.

We’re in discussions with large medical device pharma companies with existing products in this area. The discussion center on either funding continued development are investing directly in Xcede. It is too early to tell which direction this will ultimately take or what the impact will be on Dynasil, so this opportunity is exciting and evolving. It also provides us with a road map for possible similar technologies spin offs into the future.

We disclosed over the past year a substantial contract for optical grading which are Optimetrics subsidiary entered into with L-3. We have invested about $1 million in capital to support this development which we have filed a patent on new technology Optimetrics developed for this particular application. During our third quarter and continuing into this current quarter Optimetrics has been increasing production to meet the demand under this contract. While I cannot disclose the amount of revenue Optimetrics will derive from this opportunity it is significant to that company’s annual volume.

In the past we’ve talked extensively about a new scintillation crystal developed RMD referred to as Click. This material is used to detect both gamma and neutron radiation and was developed through funding received from U.S. Department of Homeland Security. As of today the market for this product has been very limited, well below what we were projecting. But there are signs that it may start to expand.

The end user market is very largely dependent on government funding to acquire next generation instruments used in detection of radiation coming across borders. There are certain initiatives which could result in the upgrade and replacement of existing instrumentation technology; we’re watching this closely as are our OEM partners. We stand ready to supply this material. I am very pleased with the performance of the material should the market demand materialize.

In our effort to continually grow our commercial businesses, we have other initiatives which I will discuss in the future should materialize. We also have some exciting projects within RMD which can also result in commercial joint venture licensing opportunities for us in the long run. With respect to RMD whether the government shut down and sequestration related to budget cuts. RMD is explored the past four years but its focus has more improved the counting and project management systems in place.

I am very pleased with the performance in Dr. Kanai Shah the President of RMD.

One encouraging sign is that certain of our important government agency customers are beginning to show signs of returning to the market. Kanai and his team's developed a different approach to this business including reaching out to some commercial customers for contract revenues and is very encouraging.

We’re entering the year with about $33 million backlog and have a goal of keeping this at the 18 month level.

Now let me turn the call over to Tom Leonard our CFO.

Tom Leonard

Thank you Peter and good afternoon everyone. As Peter mentioned total revenue for the quarter ended June 30, 2014 decreased to 10.6 million for the three months ended June 2014 from 11.3 million for the three months ended June 30, 2013. The $700,000 revenue decline was primarily a result of 1.5 million decrease in revenues that resulted from the sale of our lead paint and medical instruments businesses in the first quarter of 2014. In addition revenue from the contract research segment decreased approximately $400,000 while the optics segment revenue increased by 1.3 million.

The contract research segment revenue decreased to $400,000 or 7%. Resulted as we completed various research projects during the quarter while we experienced a modest slowdown in new contract research awards from certain government agencies. As Peter mentioned the contract research backlog has declined to approximately 33 million, due to the slowdown in the timing of award grants and award funding. As a result the company expects quarterly revenue to decline further in the fourth quarter.

We have taken steps to reduce expenses to align with our expected lower revenue and continue to monitor federal government R&D spending levels. On the positive side the optics segment revenue increased approximately 1.3 million or 33% for the three months ended June 30, 2014 as a result of increased volume of sales in each of our four businesses included in the optics segment.

The Optimetrics contract that Peter referred to earlier was a significant contributor to the revenue increase but our Fused Silica, Hilger Crystal and EMF coatings businesses also showed good revenue growth. Gross profit for the three months ended June 30, 2014 was 3.9 million or 37% of revenues compared to 4.7 million or 42% of revenues for the three months ended June 30, 2013.

Gross profit as a percent of sales decreased for the Contract Research segment to 38% at June 30, 2014 from 42% at June 30, 2013, primarily as a result of lower revenues without a corresponding decrease in overhead costs. Gross profit on government contracts is also impacted by the mix of direct labor and sub-contractor cost and can vary from period-to-period.

Gross profit for our Optic segment increased $400,000 for the three months ended June 30, 2014 compared to the three months ended June 30, 2013. The gross profit margin decreased to 34% of sales at June 30, 2014 compared to 36% of sales for the quarter ended June 30, 2013 as a result of start-up training and inefficiencies associated with Optometrics' new contract and its related factory modifications in capital equipment additions.

We also had lower margins on certain large fused silica orders shift shipped during the quarter. Total operating expenses from the three months ended June 30, 2014 decrease to 3.8 million or 36% of sales compared to 4.9 million or 43% of sales for the three months ended June 30, 2013.

The decrease in total operating expenses is primarily a result of the sale lead paint and medical product businesses in the instrument segment which had operating expenses relative to our other business units. In addition the Contract Research segment reduce its operating expense levels during the quarter to better align with its expected lower revenue that I discussed earlier. We expect operating expense levels in total to continue approximately at the current level.

As a result income from operations for the three months ended June 30, 2014 was $200,000 compared to a loss from operations of $200,000 for the three months ended June 30, 2013. Net interest expense decrease slightly for the three months ended June 30, 2014 compared to three months ended June 30, 2013 as the company is no longer accruing the fall interest on the MCRC loan.

Turning to the balance sheet cash at the end of the third quarter was approximately 3.1 million versus 2.4 million as of September 30, 2013. Very pleased to report that the company had 1.2 million of unused availability under its new line of credit from Middlesex Savings Bank as our available line was 3.6 million and we had borrowed 2.4 million as of June 30th. With the completion of the refinancing and the improvements in the operating results I discussed I believe we’ve addressed the major issues that Peter identified early in his remarks. However, we will continue to be diligent in our efforts to improve the performance of the company.

With that Peter and I will be happy to take your questions. Operator?

Question-and-Answer Session

Operator

Thank you sir. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from Tim Clarkson of Van Clemens Capital. Please go ahead.

Tim Clarkson - Van Clemens Capital

Yes, just a couple of points and then a question. I just like to really commend the management for number one, for getting a profitable and restoring financial order and then secondly also for having significant amount of your money invested in the company, that’s refreshing. So I really appreciate your turning this company around and putting your money where you where your mouth is. And then my question is on that (one) [ph] treatment technology that you spun off, if you could just tell me a little about what that technology is and what the upside is?

Peter Sulick

Sure. Basically I'll try to describe it visually so you can now get a sense of what it sort of looks like. it comes in ab aluminum foil package that looks an awful lot like a very, very large band aid and you open it and inside is a kind of (gelatin) [ph] substance that also looks like a band aid you separate that and you hold it on to a wound and this is not a wound that would be on the skin, it’s a wound that’s typically inside the body and it is used for sealing very heavy bleeding wounds. And it was developed by Dan Erikson who is a hematologist by background. He is the fellow that we brought a number of technologies from him several years ago. He has been working for us in Dynasil Biomedical continuing to develop this technology and two to three others.

And basically it competes in a market or it will compete in a market that is similar in the range of $5 billion to $10 billion in revenues. So from the point of Dynasil it is a product that we’re developing for a market that is significantly larger than any of the other markets that we have.

Now as you know Tim we’re in the early stage technology development sort of business, that’s what we do at R&D and that’s very much what this technology relates to. So will we ever earnings in the business of distributing tissue sealants highly unlikely that we would be in that business but when we be in the business of continuing to develop technologies like this to the point where they accrete great value and Dynasilcan benefit from that value accreting absolutely. And this is one of the first attempts of that.

So when I talked about the possibility of our partnering with strategic partners on this investment that is exactly the kind of model that we want to use. So we’re talking to companies that have expertise in this area that could potentially come in and assist not only with financing but with technical assistance on the continued development of the products through human clinical trials potentially CE mark development and potentially then FDA approval. And ultimately whoever it is we likely partner with would be the company that would take that product to the market.

Tim Clarkson - Van Clemens Capital

And is this product then -- has it been actually used on either animal or human wounds?

Peter Sulick

Absolutely. I mean we have done probably -- I don’t have the exact number, it’s probably something 70 or 80 animal clinical studies with this product, sealing everything from high pressure arteries to heart, to lungs, to kidney to liver to those kinds of applications. So both high pressure type situations and just general sealing.

And it has been proven to be a very, very effective product in sealing those kinds of things. Where there is a pretty significant market for it. So it has not been tested yet on any humans, we haven’t started that yet. And we probably won’t start that for somewhere between six months to a year. And in order to do it we need to get additional funding in Xcede.

Xcede doesn’t have an adequate amount of capital balance to fund that kind of thing which, if you’re involved in that market it’s extremely expensive. So we have to have partners, we have to have additional financial resources et cetera to fund that kind of thing. But we’re getting it to the point where it’s going to be set up to be able to go into human clinical trials, which means we would have gone through survivability studies which has already done one around off, we need to another one.

So we know that it won’t, hopefully won’t. Whoever we just tested survived, so obviously you can’t through human clinical through human clinical trial until you prove that. So we’re in the process of doing all that and fortunately Dynasil has got a meaningful continued interest in it, likely will be diluted over time as we bring additional money in to fund all this kind of development. But I think it’s a wonderful opportunity for Dynasil. What it ultimately will result in isn’t clear at this point but we all feel pretty good about it.

Operator

The next question we have comes from Ben Mackovak of Cavalier Capital.

Ben Mackovak - Cavalier Capital

Can you give us a little more insight into the contract research revenue? For Q4 what’s the magnitude that we should expect? I know you said it will be lower than Q3. But any other info you can give us around that? And also can we expect the gross margin for that business to bounce back?

Peter Sulick

Sure. If I were to put it on a range, I would say that the revenue for R&D the fourth quarter will be approximately 10% to 15% lower than say the average for the prior three quarters, it’s about that range. We have taken a number of steps within R&D to cut back expenses. We actually had a --I guess layoff isn’t the right politically correct term, but we had a reduction in staff at R&D. But we actually that the margin let’s say the net income margin on the business will be approximately the same. I don’t think it’s going to change very much at all, because we’ve taken some steps to reduce the cost there in anticipation of the decline in the revenue.

So we’re trying to manage that then and not trying, we are managing it and where we believe and where we see that some of these particular projects are ending we’re not going to be able to continue to get project funding on those. We take the steps early enough in the process to reduce the cost associated with those projects. And that is the process and the cycle that we’re going through within R&D.

To the extent that we get let`s say our backlog were to increase from currently the 33 million backup into the 38 million to 40 million range, we can scale back up at that point to begin to service those projects as they come in. So we’re trying to match the revenue with the resource requirements that we have based on our forecasting of the projects.

Ben Mackovak - Cavalier Capital

Okay. And one last question, we’ve heard some companies talk recently about the government trying to retain ownership to the IP, it sounds like if people run the SG&A through the government is trying to push back a little bit on that, are you facing that or is that something that you -- ?

Peter Sulick

Nothing has changed there, but I think it’s important that you understand exactly the condition of where we are and this is with respect to SPIR type research funding in general. The government funds this type of research but they do retain the right to be able to utilize the invention, if for whatever reason the patent holder which in this case will be us decides not to develop the patent in the government fields that is absolutely essential that whatever the particular patent covers needs to be produced. They retain that right, they very rarely exercise it, but they do have it. So in fact if the government suddenly believes that whatever the technology is, needs to be produced, most likely the person that are the holding patents will produce it because government doesn’t really want to get into that game but they do retain that right.

So nothing has changed for us with respect to that. They are not owning the patents, they’re just maintaining a right to utilize it if we decide not to.

Operator

(Operator Instructions) At this time we have no further questions. We’re going to conclude our question-and-answer session. At this time I’d like to turn the conference back over to management for any closing remarks.

Peter Sulick

I just wanted to thank you all for listening-in. We expect to continue to have this as we go forward and hopefully we’ll continue to have some good news. So thanks all and talk to you next time.

Tom Leonard

Thank you very much.

Operator

And we thank you gentlemen for your time today. The conference call has now concluded. Again we thank you all for attending today’s presentation. At this time you may disconnect your lines. Thank you and have a great day everyone.

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