The following management's discussion and analysis should be read in conjunction with our financial statements and the notes thereto appearing elsewhere in
this Form 10-K. Overview
The Company is divided into four reporting segments based on our main operating activities. Below is a summary of these segments:
· Optics: The Optics segment encompasses four business units (our original
optics business ("Dynasil Fused Silica"),
EMF) that manufacture commercial products, including optical crystals for
sensing in the security and medical imaging markets, as well as optical
components, optical coatings and optical materials for scientific instrumentation and other applications. · Instruments: The Instruments segment consists of Dynasil Products (formerly known as RMD Instruments), which manufactures precision instrumentation for medical and commercial applications.
· Biomedical: The Biomedical segment consists of a single business unit,
technology incubator, developing disruptive technologies for a wide
spectrum of applications, including hematology, hypothermic core cooling
and tissue sealants. For information about our financial segments and geographical information about our operating revenues and assets, see Note 17 to the Consolidated Financial Statements included in this Report. A description of our strategy is included in Item 1 of this Form 10-K. Our markets are characterized by rapidly changing technology 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 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 also is influenced by a variety of other factors including, but not limited to, economic conditions,
U.S. Governmentspending on research and development programs, the availability of Research & Experimentation tax credits, competition, regulatory requirements and insurance costs. Further information on certain risks to our Company is located in Item 1a of this Form 10-K.
Fiscal 2013 Financial Overview
December 31, 2012, the Company announced it was in default of certain financial covenants set forth in the terms of its outstanding indebtedness with respect to its fiscal year ended September 30, 2012. We continued to be in default throughout our fiscal year ended September 30, 2013and through the date of this filing. As a result, our lenders have the ability to require immediate payment of all indebtedness under our loan agreements. While our lenders have not exercised this right, their ability to require immediate payment has caused all of our outstanding indebtedness to be accelerated to current classification in our consolidated financial statements. 21 The Company has accrued but not remitted monthly interest payments to its subordinated lender since February 2013and does not expect to resume interest payments to its subordinated lender until it resolves its default with the senior lender. The Company has made all principal and interest payments due to its senior lender through the date of this filing. In addition to making the required principal payments of approximately $1.9 millionduring fiscal year 2013, the Company also repaid an additional $0.3 millionof principal in connection with the contribution of its tissue sealant intellectual property to Xcede, a joint venture, formed on or about October 1, 2013. Subsequent to yearend, in addition to our regular monthly interest and principal payments, we repaid an additional $1.25 millionto Santander from cash received in connection with the sale of our lead paint analyzer business. Management is continuing to pursue potential other sales transactions which, if consummated, would result in additional principal payments to the bank and also expects to continue discussions with its lenders to address the financial covenant situation. Because of the continuing default of the financial covenants and the possibility of an acceleration of the indebtedness by the lenders, the Company has classified all its outstanding indebtedness as a current liability in the accompanying consolidated balance sheets. Given the uncertainty created by the defaults under the Company's outstanding indebtedness and sustained substantial losses from operations for the years ended September 30, 2013and 2012, the Company's independent registered public accounting firm has included a "going concern" explanatory paragraph in its audit opinion for the year ended September 30, 2013. In addition to the formation of the Xcede joint venture and the sale of the lead paint business, the Company has taken and will continue to take actions to improve its liquidity, including the implementation of a number of initiatives designed to conserve cash, improve profitability and right-size the cost structure of its various businesses.
2013 Overview of Results
In fiscal year 2013, we incurred a net loss of
$8.7 millioncompared to a net loss of $4.3 millionin 2012. The net losses included goodwill and intangible asset impairment charges totaling $6.8 millionand $2.3 millionin 2013 and 2012, respectively. Our net losses, exclusive of the impairment loss amounts indicated above, decreased in 2013 to $1.9 millionfrom $2.0 millionin 2012. Revenue declined 10.7% to $42.8 millionin 2013 from $47.9 millionin 2012. Contract Researchsegment revenues declined $3.4 millionprimarily as a result of lower billable material and subcontractor costs partially offset by higher billable direct labor hours. In addition, our Instruments segment revenues declined $1.3 millionprimarily as a result of the lack of availability of our updated lead paint analyzer which has not been approved for sale and our updated medical probe product which was not approved for sale until May 2013. The disclosure above of our net loss exclusive of the impairment charges is a non-GAAP measure. See page 33 for more information. As a result of the higher-than-expected costs related to the product upgrades and delays in product launches in our Instruments segment, the Company determined that there was a decline in the fair value of its Instruments segment, and we recorded a non-cash goodwill and intangibles impairment charge of $6.8 millionfor the year ended September 30, 2013. Additionally, the Company incurred approximately $1.0 millionin consulting and legal fees associated with evaluating strategic and restructuring alternatives, including the potential sale of product lines and/or a division. As a result of the foregoing, our loss from operations for fiscal 2013 was $8.2 million, compared with a loss from operations of $3.7 millionin fiscal 2012. The net loss for fiscal 2013 was $8.7 million, or $0.59per share, compared with a loss of $4.3 million, or $0.29per share, in 2012.
On or about
October 1, 2013, Dynasil Biomedical formed Xcede, a joint venture with the Mayo Clinic, to spin out and separately fund the development of its tissue sealant technology. Xcede has initiated financing efforts and has received funding from internal sources and outside investors. To date, Xcede is 90% owned by Dynasil Biomedical and Dynasil Biomedical holds a majority of the seats on Xcede's board of directors. Although it is anticipated that the Company will continue for the foreseeable future to hold a significant equity interest in Xcede, the Company expects that its equity interest will decrease over time if and to the extent that Xcede is successful in raising equity financing from outside sources. 22 On November 7, 2013, the Company sold its Lead Paint detector business to Protec Instrument Corporation, a Delawarecorporation ("Protec"), which is a wholly owned subsidiary of Laboratoires Protec S.A., a French corporation and former European distributor of the lead paint detector products. The sales price totaled approximately $1.4 million, less certain adjustments and including the assumption of certain liabilities by Protec. The transaction also resulted in payment of approximately $0.4 millionin satisfaction of outstanding accounts receivable. Concurrently with the sale, the Company and Protec entered into a transition services agreement pursuant to which the Company will provide certain transitional services to Protec for up to five months after closing. The Company used $1.25 millionof the proceeds to repay amounts owed to Santander, as described above under "Bank Default". Results of Operations Results of Operations for the Fiscal Year Ended September 30, 2013 Contract Research Optics Instruments Biomedical Total Revenue $ 21,888,746 $ 15,564,766 $ 5,104,812 $ 194,508 $ 42,752,832Gross Profit 9,821,711 5,647,680 2,421,846 194,508 18,085,745 SG&A 9,345,214 5,624,291 3,486,729 969,532 19,425,766 Impairment of goodwill & long-lived assets - - 6,829,072 - 6,829,072 Operating Income (Loss) 476,497 23,389 (7,893,955) (775,024) (8,169,093) GM % 44.9 % 36.3 % 47.4 % 100.0 % 42.3 % Depreciation and Amortization 316,864 765,018 454,569 60,000 1,596,451 Capital expenditures 31,439 506,371 7,092 - 544,902 Intangibles, Net 332,717 882,296 2,089,573 179,997 3,484,583 Goodwill 4,938,625 1,302,358 - - 6,240,983 Total Assets $ 9,831,209 $ 12,380,248 $ 4,253,926 $ 211,843 $ 26,677,226Results of Operations for the Fiscal Year Ended September 30, 2012 Contract Research Optics Instruments Biomedical Total Revenue $ 25,273,308 $ 16,055,952 $ 6,452,603 $ 105,287 $ 47,887,150Gross Profit 9,862,413 5,875,551 3,684,320 83,459 19,505,743 SG&A 9,523,642 5,398,350 5,065,794 939,149 20,926,935 Impairment of goodwill - - 2,284,499 - 2,284,499 Operating Income (Loss) 338,771 477,201 (3,665,973) (855,690) (3,705,691) GM % 39.0 % 36.6 % 57.1 % 79.3 % 40.7 % Depreciation and Amortization 237,623 796,847 575,246 60,003 1,669,719 Capital expenditures 348,314 462,445 207,454 - 1,018,213 Intangibles, Net 366,853 960,821 5,135,634 239,997 6,703,305 Goodwill 4,938,625 1,300,463 4,015,072 - 10,254,160 Total Assets $ 12,870,151 $ 11,588,145 $ 12,537,403 $ 469,729 $ 37,465,428Revenue Revenues for the fiscal year ended September 30, 2013were $42.8 million. This represents a decrease of $5.1 millionor 10.7% over revenues for the fiscal year ended September 30, 2012of $47.9 million. Contract Researchrevenues declined by $3.4 millionor 13.4% as a result of downturns in research grants awarded by the Domestic Nuclear Detection Office ("DNDO") of $2.0 millionand the National Institutes of Health("NIH") of $1.2 million. Governmental Agencycontract awards are constrained by the Federal Budget and our contract revenues will reflect increases and decreases in contract awards that parallel Federal budgetary shifts. More recently, DNDO awards have rebounded from FY 2013 levels, while NIH awards are continuing at 2013 levels, reflecting Government funding priorities. The contract revenue backlog for contract research continues to be strong and is approximately $40 million, of which 48% is SBIR grants as of September 30, 2013. The Company continues to seek to diversify its contracting sources and to limit its reliance on both the SBIR program and the limited number of government agencies that currently contract for research. This diversification also includes contract research for commercial businesses rather than governmental agencies. 23
Revenues in the Optics segment decreased by
Revenues in the Instruments segment decreased
$1.3 millionor 20.9% to $5.1 millionin fiscal year 2013. We believe the decrease was a result of customers delaying purchases of our existing products in anticipation of the availability of the newly refreshed products. Our refreshed medical probe product began shipping in May 2013; however, we suspended work required to obtain HUD approval for our lead paint analyzer product in the second quarter of 2013. Subsequent to our fiscal yearend, we completed the sale of the Lead Paint business in our Instrument segment as discussed in Note 18 in the Notes to the Consolidated Financial Statements.
The Biomedical segment revenues of
Gross profit for fiscal year 2013 decreased
Gross profit remained essentially flat for the
Contract Researchsegment despite the 13.4% decline in revenues. Gross profit as a percentage of revenue increased to 44.9% from 39.0%, due to improvements in contract management in 2013 which reduced costs associated with losses incurred to complete contracts and costs incurred in excess of provisional contract rates. The Optics segment's gross profit decreased by $0.2 millionor 3.9% while gross profit as a percentage of revenue remained essentially flat at 36.3% in 2013 compared to 36.6% in 2012. The Instrument segment's gross profit decreased $1.3 millionor 34.3% to $2.4 millionin 2013 from $3.7 millionin 2012. Instrument segment's gross profit as a percentage of revenue declined to 47.4% in 2013 from 57.1% in 2012 as a result of continuing fixed costs spread over a lower revenue volume; discounting of existing products during the periods when the refreshed product was not yet available; and lower revenue in 2013 of the RadCam product which has higher gross margins.
Selling, General & Administrative ("SG&A") Expenses
SG&A expenses decreased
$1.5 millionto $19.4 millionor 45.4% of revenue in fiscal year 2013, from $20.9 millionor 43.7% of revenue for fiscal year 2012. SG&A expenses decreased primarily as a result of the substantial completion of the engineering costs associated with the product refreshes in our Instruments segment and the elimination in 2013 of approximately $0.5 millionof expenses incurred in 2012 related to an internal review of billing and accounting practices and internal controls at the RMD division. This investigation has been satisfactorily completed and, as a result, the Company has adopted certain improved practices and internal controls. No material additional expenses related to this matter were incurred in the fiscal year ended September 30, 2013. These decreases were partially offset by increased sales and marketing expense in the Optics segment.
Contract Research SG&A decreased slightly to
SG&A within the Optics segment increased
The Instruments segment had the greatest decrease in SG&A costs, decreasing
$1.6 millionto $3.5 millionor 68.3% of revenue in 2013 compared to $5.1 millionor 78.5% of revenue in 2012. This segment had two main product lines: a hand-held lead paint analyzer and a medical gamma probe used primarily in breast cancer treatment. The Company began a product refresh on both product lines in 2012 to enhance them with new features and functionality to maintain their market positions. The Company spent $1.3 millionin fiscal year 2012 on research and development on the products and significant additional amounts on sales and marketing efforts in advance of the new product launches. In fiscal year 2013, these costs and other SG&A costs were substantially reduced while awaiting regulatory approval. Regulatory approval for the medical gamma probe was received in May 2013while efforts to obtain the approval of the lead paint analyzer were suspended in the second quarter of fiscal 2013 while the Company reviewed various strategic alternatives. As a result of the delays associated with both product lines and the review of strategic alternatives for the lead paint analyzer product, the Company performed an interim impairment test and recorded an impairment of goodwill and intangibles totaling $6.8 millionin the quarter ending March 31, 2013. Finally, SG&A costs in the Biomedical segment in fiscal year 2013 were approximately $1.0 millionas compared to $0.9 millionin fiscal year 2012. These costs were incurred to advance the development of the three main technologies: hematology, hypothermic core cooling and tissue sealants. On or about October 1, 2013, Dynasil Biomedical formed Xcede, a joint venture with Mayo Clinic, to spin out and separately fund the development of the tissue sealant technology. While we believe these technologies are progressing favorably, they remain in the early stages of development and there can be no assurance that we will be able to successfully bring any of them to market.
are continuing to explore the availability of outside financing, including through a sale, licensing or joint venture involving one or more of the remaining technologies, though we may not be able to secure any such financing arrangement on favorable terms or at all.
Net Interest Expense
Net interest expense increased to
$0.9 millionin fiscal 2013 from $0.6 millionin fiscal 2012 primarily as a result of the $3.0 millionborrowing from Massachusetts Capital Resources Companybeing outstanding for the full year in fiscal 2013 compared to 2 months in fiscal 2012. The Company has been accruing interest on this debt at the default rate of 14% rather than the normal rate of 10% since it suspended interest payments in February 2013
Income Tax Credit
Total income tax expense (credit) increased from a tax credit of (
$41,000) in fiscal 2012 to a tax credit of ( $303,000) in fiscal 2013. The increase in the credit is due to lower state tax liability in 2013 compared to 2012 and higher foreign research credits claimed in 2013.
As a result, the Company had a net loss of
$8.7 millionfor the year ended September 30, 2013compared to a net loss of $4.3 millionfor the fiscal year ended September 30, 2012. Our net losses, exclusive of the impairment loss amounts indicated above, were $1.9 millionin 2013 compared to $2.0 millionin 2012.
Liquidity and Capital Resources
December 31, 2012, the Company announced it is in default of the financial covenants set forth in the terms of its outstanding indebtedness at September 30, 2012and we remain in default as of September 30, 2013. These covenants require the Company to maintain specified ratios of earnings before interest, taxes, depreciation and amortization (EBITDA) to fixed charges and to total/senior debt. These financial covenant defaults give the lenders the right to accelerate the maturity of the indebtedness outstanding and foreclose on any security interest. Furthermore, the Company's lenders, may, at their option, impose default interest rates with respect to their indebtedness. While we continue to be current with all principal and interest payments with Santander, we have not paid approximately $0.3 millionin interest owed to MCRC. As of the date hereof, neither of our lenders has accelerated our payment obligations. 25 The causes for the covenant violations were lower revenue and higher than expected expenses in the Company's Instruments and Contract Researchsegments during the fiscal quarter ended September 30, 2012and continuing through fiscal 2013, combined with the continued investment in Dynasil Biomedical Corp.and the Company's Dual Mode nuclear detection initiative. In addition, in the fiscal quarter ended September 30, 2012, the Company incurred a significant, non-recurring charge of approximately $0.5 millionto its selling, general and administrative expenses related to costs incurred as a result of a review of certain cash application processes and billing practices and internal controls of the RMD division. As of September 30, 2013, the Company had total indebtedness outstanding of approximately $9.8 million, consisting of approximately $6.8 millionof senior debt owed to Santander and approximately $3.0 millionof subordinated debt owed to MCRC. Subsequent to September 30, 2013, in addition to our regular monthly interest and principal payments, we repaid an additional $1.25 millionto Santander from cash received in connection with the sale of our lead paint analyzer business. We are continuing to evaluate potential alternatives that would resolve our current default status including additional sales transactions, negotiation of a forbearance agreement or a new borrowing arrangement with another lender. However, we cannot provide any assurance that the alternatives will be successful or that our obligations under our debt agreements will not be accelerated in the future or that our lenders will not exercise other remedies for default. Because of the uncertainty of any resolution of the covenant violations and the possibility of an acceleration of the indebtedness by the lenders, the Company has reclassified all of its outstanding indebtedness to current classification in the financial statements for the year ended September 30, 2013and 2012 filed herewith. As a result of the above and the Company's sustained substantial losses from operations for the years ended September 30, 2013and 2012, the Company's independent registered public accounting firm, McGladrey LLP, has included a "going concern" explanatory paragraph in its audit opinion with respect to such financial statements. Net cash as of September 30, 2013was $2.4 millionwhich was a decrease of $1.0 millionas compared to $3.4 millionat September 30, 2012. The Company does not currently have cash available to satisfy its obligations under its indebtedness if it were to be accelerated or payment demanded. If the Company is not able to resolve its current defaults under its outstanding indebtedness and improve its liquidity through the actions described above, it may not have sufficient liquidity to meet its anticipated cash needs for the next twelve months.
Net cash provided by operating activities
Net cash provided by operating activities was
$1.7 millionfor fiscal year 2013 versus $0.7 millionfor fiscal year 2012. The fiscal year 2013 net loss was $8.7 million. There were non-cash expenses contained in the net loss including stock compensation expense of $0.4 million, depreciation and amortization expense of $1.6 millionand the impairment of goodwill and long lived assets of $6.8 million. These major non-cash items totaled $8.8 million. The net change in assets and liabilities totaled $1.8 million. This included a $2.0 milliondecrease in billed and unbilled accounts receivable primarily as a result of improved billing and collection practices in the Contracts Researchsegment. The decrease in assets was partially offset by an increase in liabilities of $0.5 millionfor accounts payable, accrued expenses and deferred revenue.
Cash flows from investing activities
Cash flows used in investing activities were
Cash flows from financing activities
Cash flows from financing activities used
$2.2 millionof cash in fiscal 2013 and used $0.7 millionof cash in fiscal 2012 primarily for regularly scheduled payments to Santander Bankunder the five year term debt agreement. 26
Summary of Terms of Outstanding Indebtedness
Management expects to continue discussions with its lenders to address the financial covenant defaults as of
September 30, 2013as described above. The following is summary of the terms of the existing loan agreement in place with the Company's senior lender, Santander Bank, and the terms of subordinated debt owed to Massachusetts Capital Resources Company.
Santander Bank Loan Agreement
June 29, 2012, the Company entered into a letter agreement (the "Waiver Letter") with Santander as well as Amendment No. 3 (the "Amendment") to the Loan and Security Agreement, dated July 7, 2010, as amended on April 1, 2012and April 12, 2012(the "Original Loan Agreement"). Under the Waiver Letter, the Lender agreed to waive non-compliance by the Company with certain financial covenants under the Original Loan Agreement as of June 30, 2012, subject to the Company's compliance with the terms of the Amendment, including the requirement that the Company would raise, on or before September 30, 2012, at least $2.0 millionin gross proceeds from the sale of its capital stock and/or the incurrence of new indebtedness which is subordinated to the indebtedness in favor of the Lender, on terms and conditions acceptable to the Lender in its sole discretion (the "Required Capital Raise") and applying the proceeds as described below, all of which the Company has successfully completed. The Amendment also made certain other changes to the Original Loan Agreement, including certain financial covenants, limitations on capital expenditures and the termination of the Company's acquisition line of credit, in each case as described in more detail below. The Amendment did not change the interest rates on outstanding indebtedness under the Original Loan Agreement.
The terms of the Amendment are described below:
· The Required Capital Raise on or before
Under the Amendment, the Company agreed with the Lender that the Company would raise, on or before
September 30, 2012, at least $2.0 millionin gross proceeds from the sale of its capital stock and/or the incurrence of new indebtedness which is subordinated to the indebtedness in favor of the Lender, on terms and conditions acceptable to the Lender in its sole discretion. As disclosed in the Company's Form 8-K filed on June 8, 2012, the Company has incurred indebtedness in favor of certain entities affiliated with Dr. Gerald Entine(together, "Entine") in the aggregate principal amount of $1,857,546(the "Entine Indebtedness"). The Company incurred the Entine Indebtedness in satisfaction of its obligation to repurchase certain shares of Dynasil common stock from Entine pursuant to a put right exercised by Entine on February 12, 2012. The proceeds of the Required Capital Raise must first be used to repay all amounts outstanding under the Entine Indebtedness by September 30, 2012, and thereafter for general working capital needs. The Required Capital Raise has been completed as of July 31, 2012pursuant to the Note Purchase Agreement ("the Agreement") with Massachusetts Capital Resource Companydescribed below. Pursuant to the terms of the Agreement, the Company issued and sold to MCRC a $3.0 millionsubordinated note (the "Subordinated Note") for proceeds of $3.0 million.
· Amendment to Leverage Ratio Covenants
For the Consolidated Maximum Leverage Ratio (Consolidated Total Funded Debt to Consolidated EBITDA, as defined in the Amendment), the Amendment (i) revised the required ratio for
September 30, 2012from 3.25x to 4.5x; (ii) revised the required ratio for December 31, 2012from 3.0x to 4.5x; and (iii) revised the required ratio for March 31, 2013and for each rolling four quarters thereafter from 3.0x to 4.0x. The Amendment also included a new Consolidated Maximum Adjusted Leverage Ratio covenant, which is Consolidated Total Funded Debt (excluding subordinated debt) to Consolidated EBITDA, as defined in the Amendment. The Amendment requires the Company to maintain a Consolidated Maximum Adjusted Leverage Ratio equal to or less than (i) 3.25x to 1.00x for each of the rolling four quarter periods ending on September 30, 2012and December 31, 2012, and (ii) 3.0x to 1.0x for each rolling four quarter period ending on or after March 31, 2013. 27 For the purposes of calculating both the Consolidated Maximum Leverage Ratio and the Consolidated Maximum Adjusted Leverage Ratio, Consolidated EBITDA (as defined in the Amendment) will be (i) at September 30, 2012, the actual Consolidated EBITDA for the 3 months then ended times 4; (ii) at December 31, 2012, the actual Consolidated EBITDA for the 6 months then ended times 2; and (iii) at March 31, 2013, the actual Consolidated EBITDA for the 9 months then ended times 4/3 (provided that the add-backs for costs are not annualized).
· Amendment to Fixed Charge Coverage Ratio Covenants
For the Consolidated Fixed Charge Coverage Ratio, the Amendment (i) revised the required ratio for
September 30, 2012from 1.10x to 1.00x; (ii) revised the required ratio for December 31, 2012from 1.20x to 1.00x; (iii) revised the required ratio for March 31, 2013from 1.20x to 1.05x; (iv) revised the required ratio at June 30, 2013from 1.20x to 1.10x; and (v) did not change the required ratio at September 30, 2013(remained at 1.20x). The Consolidated Fixed Charge Coverage Ratio is defined as Consolidated EBITDA (as defined in the Amendment) for the applicable period divided by the sum of (a) the Company's consolidated interest expense for such period, plus (b) the aggregate principal amount of scheduled payments on the Company's indebtedness made during such period (excluding any repayment of the Entine Indebtedness), plus (c) the sum of all cash dividends and other cash distributions to the Company's shareholders during such period, plus (d) the sum of all taxes paid in cash by the Company during such period, less (e) up to $75,000paid to the IRS, to the extent characterized as interest expense, in connection with certain historical tax filings (the " IRS Payments"). For the purposes of calculating the Consolidated Fixed Charge Coverage Ratio, Consolidated EBITDA will be (i) at September 30, 2012, the actual Consolidated EBITDA for the 3 months then ended times 4; (ii) at December 31, 2012, the actual Consolidated EBITDA for the 6 months then ended times 2; and (iii) at March 31, 2013, the actual Consolidated EBITDA for the 9 months then ended times 4/3 (provided that the add-backs for Entine Indebtedness repayment and the IRS Paymentsare not annualized).
· Restriction on Capital Expenditures
For the fiscal year ending
September 30, 2012, the Amendment reduced the limitation on the Company's capital expenditures from $3.25 millionto $2.25 millionand for fiscal years ending September 30, 2013and for each fiscal year thereafter, the Amendment raised the limitation on the Company's capital expenditures from $2.00 millionto $2.25 million.
· Termination of Acquisition Line of Credit
The Amendment also accelerated the termination date of the Company's
$5 millionacquisition line of credit to June 29, 2012, which prevented the Company from being able to draw on the approximately $1 millionof previously available undrawn funds.
Note Purchase Agreement -
As described above, the Company is currently in financial default under its note purchase agreement with MCRC.
July 31, 2012, the Company entered into the Agreement with MCRC. Pursuant to the terms of the Agreement, the Company issued and sold to MCRC the $3.0 millionSubordinated Note for proceeds of $3.0 million. The Company has used a portion of the proceeds from the sale of the Subordinated Note to repay the Entine Indebtedness in the aggregate principal amount of $1.9 millionand has agreed to use the balance of the proceeds for working capital purposes. The Subordinated Note matures on July 31, 2017, unless accelerated pursuant to an event of default, as described below. The Subordinated Note bears interest at the rate of ten percent (10.0%) per annum, with interest to be payable monthly on the last day of each calendar month in each year, the first such payment to be due and payable on August 31, 2012. Under the terms of the Agreement, beginning on and with September 30, 2015, and on the last day of each calendar month thereafter through and including July 31, 2017, the Company will redeem, without premium, $130,434in principal amount of the Subordinated Note together with all accrued and unpaid interest then due on the amount redeemed. 28 Under the terms of the Agreement and a Subordination Agreement dated July 31, 2012, among the Company, the Guarantor Subsidiaries, the Lender and MCRC, MCRC and any successor holder of the Subordinated Note have agreed that the payment of the principal of and interest on the Subordinated Note shall be 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, including money borrowed from the Lender under the Original Loan Agreement. 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 (a) 5.0 to 1.0 for each of the rolling four quarter periods ending on September 30, 2012and December 31, 2012, and (b) 4.5 to 1.0 for each rolling four quarter period ending on or after March 31, 2013, and (ii) require a Consolidated Fixed Charge Coverage Ratio (consolidated EBITDA to consolidated fixed charges) of not less than (a) .75 to 1.00 for each of the rolling four quarter periods ending on September 30, 2012and December 31, 2012, (b) .8 to 1.0 for each of the rolling four quarter period ending on March 31, 2013and June 30, 2013, and (c) .95 to 1.00 for each rolling four quarter period ending on or after September 30, 2013. 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 shall occur automatically if the Company becomes insolvent. On September 26, 2013, Santander and MCRC agreed to certain amendments to the Loan and Security Agreement, dated July 7, 2010, as amended on April 1, 2012, April 12, 2012and June 29, 2012and the Note Purchase Agreement dated July 31, 2012, respectively, in order to permit the Company to form Xcede, a joint venture with the Mayo Clinic, to spin out and separately fund the development of the tissue sealant technology.
"Off Balance Sheet" Arrangements
The Company has no "Off Balance Sheet" arrangements.
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. 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 Americaand 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 revenues 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 and accounting for income taxes.
Revenue from sales of products is recognized at the time title and the risks and rewards of ownership pass. Revenue is recognized when the products are shipped per customers' instructions, the contract has been executed, the contract or sales price is fixed or determinable, delivery of services or products has occurred and the Company's ability to collect the contract price is considered reasonably assured. 29
Revenue from research and development activities is derived generally from the following types of contracts: reimbursement of costs plus fees, fixed price or time and material type contracts. Government funded services revenues from cost plus contracts are recognized as costs are incurred on the basis of direct costs plus allowable indirect costs and an allocable portion of the contracts' fixed fees. Revenue from fixed-type contracts is recognized under the percentage of completion method with estimated costs and profits included in contract revenue as work is performed. Revenues from time and materials contracts are recognized as costs are incurred at amounts generally commensurate with billing amounts. Recognition of losses on projects is taken as soon as the loss is reasonably determinable. The majority of the Company's contract research revenue is derived from the
United States governmentand government related contracts. Such contracts have certain risks which include dependence on future appropriations and administrative allotment of funds and changes in government policies. Costs incurred under United States governmentcontracts are subject to audit. The Company believes that the results of such audits will not have a material adverse effect on its financial position or its results of operations.
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. The Company generally performs its annual impairment testing of goodwill during the fourth quarter of its fiscal year, or more frequently if events or changes in circumstances indicate that the assets might be impaired. The Company tests impairment at the reporting unit level using the two-step process. The Company's primary reporting units tested for impairment are RMD, which comprises our
Contract Researchsegment, Dynasil Products (also known as RMD Instruments), which comprises our Instruments segment, and Hilger Crystals, 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. The Company estimates 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. The Company's 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. The Company regularly assesses 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 the Company 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 the Company's annual goodwill impairment testing performed during the fourth quarter of fiscal year 2013, step one of the testing determined the estimated fair value of RMD substantially exceeded its carrying value. The estimated fair value of the Hilger Crystals reporting unit exceeded its carrying value by approximately 20%. Accordingly, the Company concluded that no impairment had occurred and no further testing was necessary. 30 During the second quarter of 2013, the Company performed an interim impairment test of long lived assets and goodwill associated with its Dynasil Products reporting unit and asset group. Under step two of the impairment testing, the income method was used to allocate the fair values of all of the assets and liabilities of this reporting unit, with the remaining residual fair value allocated to goodwill. The result of this impairment test was to write off Product's goodwill totaling $4.0 millionand approximately $2.8 millionof its long lived assets other than goodwill for a total write-off of $6.8 million.
During the fourth quarter of 2012, the Company completed its annual goodwill impairment reviews and wrote off
Impairment of Long-Lived Assets
The Company's long-lived assets include property, plant and equipment and intangible assets subject to amortization. The Company evaluates 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, the Company estimates 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. During the second quarter of 2013, in connection with an interim impairment test of long lived assets and goodwill associated with its Dynasil Products reporting unit, the Company determined that the fair value of the long-lived assets (other than goodwill) of Products was less than the carrying amount of those assets and, as a result, recorded a pre-tax impairment charge of approximately
$2.8 millionplus a $4.0 millionwrite-off of goodwill as discussed above.
There was no impairment charge during the year ended
The Company's intangible assets consist of an acquired customer base of
Optometrics, LLC, acquired customer relationships and trade names of Hilger Crystals, customer relationships and trade names of Dynasil Products, acquired backlog and know-how of Radiation Monitoring Devices, Inc., and provisionally patented technologies within Dynasil Biomedical Corp.Dynasil estimates the fair value of indefinite-lived intangible assets using an income approach, and recognizes 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 2013, the Company conducted its annual impairment review of indefinite-lived intangible assets with no impairments to the carrying values identified. The Company reviews 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. The Company amortizes its intangible assets with definitive lives over their useful lives, which range from 4 to 15 years, based on the time period the Company expects 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 our 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 our historical experience and any specific customer collection issues that we have 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 that we have 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 our future operating results. 31 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 and warrants 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.
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 taxes considering several factors, including our estimate of the likelihood of the Company generating sufficient taxable income in future years during the period over which temporary differences reverse. The Company believes it is more likely than not that these carry-forwards will not be realized and, therefore, a valuation allowance has been applied.
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 default under the financial covenants under our loan agreement with
Santander Bankand Massachusetts Capital Resource Company, Xcede obtaining financing from outside investors, the commercialization of our products including our dual mode detectors, 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 and the strength of our intellectual property portfolio. 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 resolve our current default under our outstanding indebtedness, 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, our ability to address our material weaknesses in our internal controls, 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, 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, and seasonality, as well as the uncertainties 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. 32
Use of Non-GAAP Financial Measures
In addition to financial measures prepared in accordance with generally accepted accounting principles (GAAP), this report also contains a measure of our net loss excluding goodwill and intangible asset impairment charges. The Company believes that the inclusion of this non-GAAP financial measure helps investors to gain a meaningful understanding of the Company's core operating results and enhance comparing such performance with prior periods. Our management uses this non-GAAP measure, in addition to GAAP financial measures, as the basis for measuring our core operating performance and comparing such performance to that of prior periods. The non-GAAP financial measure included in this report is not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP.