Dynasil Corporation of America's (DYSL) CEO Peter Sulick on Q4 2014 Results - Earnings Call Transcript

| About: Dynasil Corporation (DYSL)
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Dynasil Corporation of America (NASDAQ:DYSL) Q4 2014 Earnings Conference Call December 16, 2014 4:15 PM ET

Executives

Peter Sulick - President & CEO

Tom Leonard – CFO

Patty Kehe – IR

Analysts

Keith Markey - Griffin securities

Joe First - First Associates

Tim Clarkson - Van Clemens Capital

Operator

Good day and welcome to the Dynasil Corporation of America Fiscal 2014 Fourth 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 you to ask questions at the end of today’s call. (Operator Instructions).

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

Patty Kehe

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

Before we begin, please note that various remarks management makes today 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 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, 2014 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 December 16, 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 today to talk about our annual financial results for our 2014 fiscal year. As we discussed in our public filings and on our third quarter call in August, Dynasil recently emerged from a several year period marked by operating losses and the default of the financial covenants of our credit agreements. As a result, 2014 was a transition year for us where we concluded certain transactions intended to deleverage our company and remove the default condition under our credit agreements.

It was a year where we positioned the company for future growth, and invested in areas where this growth could be realized. We also weathered a government shutdown in October 2013 with little lost revenue. I will discuss some of our financial metrics in a minute, but wanted to give you a snapshot of our challenges and how our corporate and operational management stepped up to meet them over the past couple of years.

Beginning in September 2012, Dynasil went into default of our credit agreements. We have disclosed this extensively in the past, so I will not go into the reasons for it on the call. That said, between September 1, 2012 and September 30, 2014, we reduced our bank and subordinated debt from approximately $12 million to approximately $5 million. This was done through continued monthly amortization of our bank debt, in addition to two supplemental payments totaling $4 million in our first quarter 2014.

In May 2014, we completed a new bank financing which paid off our former senior lender, and removed the default condition under both our senior and subordinated lenders. We also sold off two of the products in our Dynasil products portfolio, which were creating substantial operating losses for us, the Navigator Probe and the Lead Paint Analyzer. These sales provided us with the cash used for the supplemental bank payments in the first quarter.

One of the success stories of 2014 is that the lost revenue associated with these products was ultimately replaced by revenue from organic growth across our other commercial companies. For 2014, three of our companies, Optimetrics, EMF and Dynasil Fused Silica had record revenue results and Hilger had the largest revenue year under our ownership. This is a significant accomplishment given our liquidity situation.

Tom will go into details on our results in a few minutes, but with respect to certain high-level financial metrics for fiscal year 2014, we had income from operations of $2.7 million compared to a loss of $8.2 million in 2013. Our net income included approximately $8.8 million of losses from our biomedical segment in both of 2014 and 2013. Our revenue declined to $42.3 million in 2014 compared to $42.8 million in 2013. Excluding the revenues of the instruments segment, whose lead paint and Gamma Medical probe businesses were sold in the first quarter of 2014, earnings increased 10.3% to $41.5 million in 2014 from $37.6 million in 2013 due to revenue growth across all four business units in the optics segment. This revenue growth enabled us to generate the operational performance described above.

In October 2013, the net assets of the tissue sealant technology previously owned by Dynasil Biomedical, were contributed to Xcede Technologies Inc., a joint venture with Mayo Medical Ventures, an investment arm of the Mayo Clinic. During fiscal year 2014, Xcede has raised $1.4 million of convertible notes from outside investors to fund its development costs. However, because Dynasil Biomedical owns 90% of the common stock at Xcede, it is required to be included in our consolidated net income for financial reporting purposes, resulting in a net income loss of approximately $0.8 million as mentioned earlier.

The tissue sealant technology Xcede is developing addresses a very large market, one of the largest markets available today sell through R&D development. We are actively looking into creative financing options for this entity, which could include finding a way to spin it off to our shareholders. As previously disclosed, we are also in discussions with large biomedical companies about the technology, have expanded the management team, are actively recruiting additional expertise for the Xcede board, and are developing the protocols and the plan for first in human trials.

Also, during this year, we completed the acquisition of the assets of DichroTec LLC located in Rochester, New York. DichroTec has become an operating division of our EMF subsidiary located about 90 minutes away in Ithaca, New York. This acquisition was done to expand the coding production capacity of EMF. We have acquired 1496 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. I’ve gone into greater detail about this acquisition in the third quarter call, so I do not need to review it again now. DichroTec was losing money, and will take us part of 2015 to turn it around. Hence we will incur an additional operating income loss during part of 2015 necessary to fix this operation. But again, we are very excited about the growth prospects this acquisition represents for our optical coating business. We believe with this capacity, we can grow this business to 2 to 3 times current EMF revenue over the next few years.

There are certain other actions we’ve engaged in which I would also like to highlight. We disclosed over the past year a substantial contract for optical grading, which our Optimetrics subsidiary entered into with L-3. In 2014, Dynasil invested about $1 million in capital equipment and leaseholds to support this development. We have filed a patent on this new grading technology which Optimetrics developed for this particular application. Optimetrics is now able to meet the current customer demand for this product, and has the capacity to double production if demand increases.

With respect to Click, a material we use to detect both gamma and neutron radiation, and developed through funding received from the U.S Department of Homeland Security, the market for this product has been very limited, well below what we were projecting three to four years ago. However, there are signs that the market may start to expand. The end user market is largely dependent on government funding to acquire next generation instruments used for the detection of radiation coming across borders. There are certain initiatives which could result in the upgrade and replacement of existing instrumentation technology, which we’re watching closely along with our OEM partners, and could result in increased demand for Click. We stand ready to supply this material should the market demand materialize. We’re hopeful that 2015 will be a breakout year for our Click detectives.

In our effort to continually grow our commercial businesses, we have other initiatives which I will discuss in the future should they materialize. We also have some exciting projects within RMD which can result in commercial joint venture or licensing opportunities for us in the near term. With respect to RMD, we have weathered the government shutdown and sequestration related budget cuts. RMD is smaller than in the past four years but, is more focused, has much improved the accounting and project management systems in place and I’m very pleased with the performance of 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 has developed a different approach to this business, including reaching out to some commercial customers for contract revenues and it is looking very encouraging. We entered the year with about a $30 million backlog and have a goal of keeping this at the 18 month level. Since we purchased RMD, we have also substantially changed the mix of our research revenue from high on SPIR funding to majority of our projects in non-SPIR.

Let me now turn the call over to Tom Leonard, our CFO.

Tom Leonard

Thank you, Peter and good afternoon everyone. As Peter stated, revenues for the fiscal year ended September 30 2014 were $42.3 million, or slightly below the $42.8 million from revenues recorded in 2013. The $0.4 million decline in revenue was primarily a result of the $4.3 million decrease in the instrument segment revenues, which decreased as a result of the sale of our lead paint and medical instruments businesses in the first quarter of 2014. This decrease was substantially offset by increased revenues from our optic segment, which I’ll discuss in a moment.

Revenues from contract research, our largest segment, were essentially unchanged in 2014 compared to 2013, reflecting continuing restrain in federal agency contract awards. While Contract Research revenues were $21.9 million in both 2014 and 2013, we have experienced more difficulty in forecasting the timing of revenues due to delays in government agency award and funding decisions. The contract revenue backlog for contract research has declined from $40 million in 2013 to $30 million as Peter mentioned in 2014, which is approximately 47% of SPIR grants. Reducing reliance on the SPIR program is a continuing goal for our RMD business.

Peter and I referred earlier to the revenue increases generated by the Optics businesses. The Optic segment revenue increased 25.9% to $19.6 million from $15.6 million in 2013. In addition to each of the four business units in the optic segment achieving revenue growth in 2014, the DichroTec acquisition that Peter described contributed approximately $0.5 million to the revenues of the Optics segment in the fourth quarter of 2014.

Gross profit for the fiscal year 2014 decreased $1.4 million or 7.5% to $16.7 million from $18.1 million last year. Gross profit as a percentage of revenue decreased to 39.5% from 42.3% at September 30, 2013, primarily as a result of higher gross profit margins in the instrument segment that were substantially all sold in the first quarter of 2014. If you remove the instrument segment from both years, gross profit increased $0.7 million to $16.4 million in 2014 from $15.7 million in 2013.

Gross profits for the Contract Research segment declined $0.5 million to $9.3 million in 2014 from $9.8 million in 2013 as a result of changes in the mix of direct and indirect hours. Direct labor hours have a higher gross profit margin than indirect hours and expenses. I believe that gross profit is not a particularly good metric in a Contract Research business as SG&A costs are included in overhead rates and therefore impact revenue, but they do not impact the cost of goods sold.

So for example, lower SG&A cost would typically increase operating income in a Contract Research business, but they would reduce revenue and gross profit. I believe a better metric for a Contract Research business is simply to look at operating income, which increased almost $0.3 million in 2014 compared to 2013. The Optic segment’s gross profit increased by $1.5 million or 25.7% to $7.1 million in 2014 from $5.6 million in 2013, while gross profit as a percentage of revenue remained essentially flat, approximately 36.2% in both years.

SG&A expenses decreased $4.1 million to $15.3 million in fiscal year 2014, from $19.4 million in fiscal year 2013. Excluding the SG&A expenses associated with the instrument segment, which we sold in the first quarter of 2014, SG&A expenses were down to $14.9 million in 2014 from $15.9 million in 2013, primarily due to SG&A cost savings in the contract research segment. That decrease was due to actions taken in the third quarter of 2014 in response to the decline in government spending in contract awards.

Contract research SG&A decreased to $ 8.5 million in fiscal 2014 from $ 9.3 million in the prior year. SG&A within the optic segment remained nearly the same at $5.6 million in 2014 and 2013 while SG&A costs in the biomedical segment in fiscal 2014 were approximately $800,000 compared to $1 million in 2013.

As a result, the company had net income of $2.0 million for the year ended in September 30, 2014, compared to a net loss of $8.7 million for the year ended 2013. Net income of 2014 includes the $1.2 million gain from the sale of the two businesses, while the loss in 2013 included an intangible asset impairment charge of $6.8 million. So excluding the gain on the sale in 2014, and the asset impairment charge in 2013, our net income increased $0.8 million in 2014 from a $1.9 million net loss in 2013. It's also important to note that in both years, our net income was reduced by approximate $ 0.8 million of losses incurred by our biomedical segment.

Turning into our balance sheet, our cash at September 30, 2014 was approximately $3.8 million versus $2.4 million at September 30, 2013. I'm very pleased to report that the company had $106 million of unused availability under the line of credit from our bank as our available line was $3.7 million and we had borrowed $2.1 million as of September 30. With the completion of this refinancing and the improvements in the operating results we discussed, I believe we’ve addressed the major issues that we had identified in prior communication and I know I'm sleeping a little better. However, we will continue to be diligent in our efforts to continue to improve the performance of the company.

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

Question-and-Answer Session

Operator

[Operator instructions] Our first question comes from Keith Markey at Griffin Securities

Keith Markey - Griffin securities

Hi. Thanks for taking my call and what a terrific year you had. Just wondering if you could address a little -- talk a little bit about aligning the RMD segment with your commercial optics segments, how that -- what kind of progress you’re making there and what you are looking forward to doing in the coming year.

Peter Sulick

Sure. As we mentioned briefly, Keith, as you know Click is one of the products that we transferred from RMD over to Hilger. We have currently an initiative underway to transfer our thin film scintillator product line over to EMF. So part of the rationale behind the purchase of the evaporators at EMF was to be able to commercialize our thin film scintillator technology. We don’t have – we’ve not had the capacity to be able to do that within RMD. So we now have these evaporators that can handle that type of technology. We are actively moving that, the technology from RMD over to EMF. EMF is going to being producing prototypes of thin film scintillators for different commercial customers and we expect to have that technology fully transferred over, over the course of the next six months. So we will then get into the RFQ process for the thin film scintillator business. We also have a series of other scintillator products that RMD is working on that could potentially be transferred both to EMF and to Hilger, all funded by a variety of different funding sources from the government including Homeland Security, DOD, Department of Energy, et cetera.

Operator

You next question comes from Joe First at First Associates

Joe First - First Associates

Good afternoon gentlemen. Congratulation on so much progress over the course of the year. I think now we’re focusing on growing the company rather than saving it, which is a nice change as you know. One quick question about RMD. You mentioned about them now trying to get some business that is non-government business now. With non-government position you can, I would assume that you can get more to the bottom line than with government business. I assume that’s correct and you’re working on that aspect?

Peter Sulick

That is correct. When we get -- we don’t have a lot of this, Joe. This past year we got about $0.75 million of non-government research business and they’ve had a higher profit margin. But getting it is important and the customers that we are working for, one of which is in the oil field services area, which utilizes a great deal of simulating crystals. If that business expands, it could be quite attractive to us. We are really in the embryonic stages of going after it but it is looking promising. Will it replace our government research our business? No, but it is nice supplemental research business for us to get.

Joe First - First Associates

Right and then I'm glad to see that with the tissue sealant business that you are thinking about doing something to get that so that the loss doesn’t go under to Dynasil. And also if you do financing and take it public, the market value of that thing will show incremental value to Dynasil obviously. And I think the market likes companies like that, especially this days. And the result you’ve gotten before going into human trials has been obviously good enough. You expect the human trials to work or you wouldn’t be doing it. So congratulations on doing that. I think that would be a win-win situation if you can do that.

Peter Sulick

Thank you.

Operator

[Operator instruction] Our next question comes from Tim Clarkson at Van Clemens.

Tim Clarkson - Van Clemens Capital

Tim Clarkson. Anyhow, the question I have is I know a little bit about some coating. I guess you are going thin film simulation. I don’t get -- what’s been…?

Peter Sulick

No. We are doing thin film scintillators.

Tim Clarkson - Van Clemens Capital

Scintillators. Are you actually -- so you are -- is that what you are coating or what's the …?

Peter Sulick

No. I mean we are coating substrates. The substrates will end up being utilized in thin films scintillators which as you probably know will become the product utilized in medical imaging, specifically x-ray medical imaging. A good example of it is if you go to the dentist and they take a digital picture of your teeth using a very small thin film scintillators to record that image and then translate it over to a digital image on a computer screen. We invented that technology here at RMD and we are hoping to get into the commercialization of it.

Tim Clarkson - Van Clemens Capital

Okay, is there -- do you have any concept what size market it is or?

Peter Sulick

The market is very large. The primary -- a number of the companies that are utilize these kinds of products have their own captive manufacturing plants for thin film scintillators. So companies like Phillips and GE and those companies already make their own. But there is a pretty sizeable market, which is generally serviced by Hamamatsu for companies like Carestream and Siemens and others that we are hoping to be able to address and be competitive in. That market is in the hundreds of millions of dollars.

Tim Clarkson - Van Clemens Capital

Is this a relatively high margin type of business or low margin or medium business?

Peter Sulick

No, it’s relatively high margin. It’s a pretty good business, 40% 50%. You are in an RFQ process so you’re bidding against others, but you take your best shot and hope you win.

Tim Clarkson - Van Clemens Capital

With the new equipment you have, how much volume could you potentially do?

Peter Sulick

We have, with our 14 coating chambers we could do probably $20 million worth of that business if we could get it. Now we don’t really expect that we could get anything like that, but we do have substantial capacity.

Tim Clarkson - Van Clemens Capital

What kind of equipment is there? I'm just curious.

Peter Sulick

It’s vacuum deposition chambers. You reduce the inside of the chamber to essentially a vacuum state and you deposit different kinds of materials onto substrates.

Tim Clarkson - Van Clemens Capital

Oh, yeah. I know all about it since the first stock I ever bought was Back Tech Systems. So I become a minor expert in this kind of technology. Who made the equipment for you?

Peter Sulick

It was made by Dichrolam. So these chambers were originally used to coat Dichrolam sunglasses.

Tim Clarkson - Van Clemens Capital

Oh, okay, great. One last question. On the wound care stuff, how many years are you guys from potentially having a commercialized product if you get the money?

Peter Sulick

Let me clarify. We are not necessarily getting into the “wound care market.” We are getting into the sealant and hemostat market which is slightly different.

Tim Clarkson - Van Clemens Capital

Right. Now I get that.

Peter Sulick

How far are we away? The answer really is going to depend upon the human clinical trials and the protocols used for the clinical trials and how the clinical trials go now. We have done studies on over 70 large animals already. We know that the product works quite well. But we’ve not done any human studies yet. We are very -- we’ve done survivability studies, and we’ve done a variety of things. We are very hopeful that the studies will go well. We expect that they will because everything in the product has already been through a variety in different human clinical trials. But depending upon the protocols used, the trials can take anywhere from six months to 18 months to complete because you have to do six months to 18 months.

It's really going to depend upon where the trials are being conducted and how many patients you have that are going through the particular procedures that you’re addressing, whether or not those patients will agree to be utilized in a clinical trial, how sick they are. You want to ensure that the patients that you are trying these on are -- don’t have other complications that might be a problem for the trials. There is -- the protocols used in these trials are very, very specific and finding the people that we can use is an important part of the consideration when you get into the trial. So the answer is it's too early to tell what the exact answer to that question is. We are hoping that it's going to be less than 18 months, that it could be six months. We’d like it to be less than six months if possible, but we are in the stage right now of determining what's that going to be.

Tim Clarkson - Van Clemens Capital

How much money would it cost to complete a trial like that?

Peter Sulick

It's going to be in the $2.5 million to $ 3 million kind of range. That’s the number that we’ve projected.

Tim Clarkson - Van Clemens Capital

Is that money that would have to be raised then? Is that it?

Peter Sulick

Yes, it will. We do not have that kind of money in Xcede today.

Tim Clarkson - Van Clemens Capital

Joint venture with somebody on that or?

Peter Sulick

I mentioned in my prepared remarks that we are considering the possibility of spinning this out. And I think Mr. First I think addressed it a little bit in his comments. We are actively looking at ways to finance this such that we provide adequate liquidity into Xcede and we figure out a way to have it not necessarily affect Dynasil’s performance going forward and we figure out a way to get the ownership of it into the hands of our shareholders. It's not an easy solution to come up with, but we are working on some ways -- actively working on ways to try to do it.

Tim Clarkson - Van Clemens Capital

Right. Well, good. I appreciate your patience with my questions. Thank you.

Peter Sulick

No. No problem. Thanks a lot.

Operator

[Operator instruction] Seeing no further questions, I would like to turn the conference back over to Mr. Sulick for any closing remarks.

End of Q&A Session

Peter Sulick

Thank you, Annie. We’re all working hard here on your behalf. We look forward to a good year this year. We have some good things going on and I think we’re going to have some interesting developments as the year progresses. Happy holidays everyone and good night.

Tom Leonard

Thank you very much.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

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