News Column

DYNASIL CORP OF AMERICA - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

May 12, 2014

The following management's discussion and analysis should be read in conjunction with our financial statements and the notes thereto in the Dynasil Corporation of America ("Dynasil", the "Company" or "we") Form 10-K for the fiscal year

ended September 30, 2013. General Business Overview Bank Financing

The Company incurred substantial losses from operations for the years ended September 30, 2013 and 2012 and failed to comply with the financial covenants set forth in the terms of its outstanding loan agreements for the year ended September 30, 2012 and each of the quarters during the year ended September 30, 2013. These covenants required the Company to maintain specified ratios of earnings before interest, taxes, depreciation and amortization (EBITDA) to fixed charges and to total/senior debt. The Company returned to profitability for the three month period ended December 31, 2013 and regained compliance with the financial covenants referred to above. However our senior lender, continued to request that we not pay interest due monthly to our subordinated lender. The senior lender originally requested we not pay interest beginning in February 2013, and the total amount accrued but unpaid was approximately $500,000 at March 31, 2014. Nonpayment of interest when due is a separate event of default. In addition, the senior lender advised us that it was unwilling to negotiate with the Company regarding waivers for our past quarterly covenant violations after we reported that we had regained compliance for the three months ended December 31, 2013. On May 1, 2014, the Company entered into a three year revolving line of credit arrangement with a new bank. The line of credit is secured by substantially all the Company's assets and the amount available for advances is determined monthly based on eligible billed and unbilled accounts receivable and inventory. Upon the closing of the loan, the Company repaid approximately the $1.8 million owed the senior lender and the $600,000 of accrued interest at April 30, 2014 due the subordinated lender. The subordinated lender issued a waiver for our prior

covenant violations. 17 As a result, the Company is no longer in default of any of its loan obligations and has reclassified the subordinated debt to a long term liability based on its terms. Operations Revenue for the second quarter of fiscal year 2014, which ended March 31, 2014, was $10.4 million, a decrease of $100,000 or 1.0% compared with revenue of $10.5 million for the quarter ended March 31, 2013. The decrease was primarily a result of a $1.0 million decrease in revenues related to the Instruments segment offset by a $900,000 increase in revenues in the Optics segment. The lead paint and medical instruments businesses which comprised substantially all of the Instruments segment were sold in first quarter ended December 31, 2013. The Optics segment increase of $900,000 or 21.8% reflects increases in sales in each of the four business units comprising the Optics segment, including a $350,000 nonrefundable payment received by one of the businesses in connection with previous engineering and design efforts associated with a new customer contract. Cost of Revenue for the second quarter of 2014 was $6.0 million, an increase of 3.5% compared with $5.8 million for the quarter ended March 31, 2013 primarily as a result of the increased cost of revenue associated with the Contract Research segment as a result of a change in the mix of subcontractor costs to direct labor costs, the latter of which have higher profit margins. Total operating expenses decreased $8.0 million or 67.3% to $3.9 million compared to the three month period ended March 31, 2013 primarily because the Company recorded a $6.8 million impairment charge in the second quarter ended March 31, 2013 to write-down the goodwill and long-lived assets of the Company's Instruments asset group. Additionally, the lead paint and medical products businesses in the Instruments segment, which were sold in the first quarter of fiscal year 2014, were incurring substantial development costs associated with product refreshes during the second quarter of 2013. Income from Operations for the quarter ended March 31, 2014 was approximately $500,000 compared with Loss from Operations of ($7.2 million) for the quarter ended March 31, 2013. Net Income was $300,000 or $0.02 per share for the quarter ended March 31, 2014, compared with Net Loss of ($7.2 million), or ($0.49) per share, for the quarter ended March 31, 2013.



We continue to invest in efforts to support growth initiatives for the commercialization of our dual mode detector within the Contract Research segment. The dual mode detector technology began generating revenue in 2012 while still under development. We are currently delivering limited quantities of commercial grade crystals and are working to further improve the size and quality of this product.

Commercialization of technology from our research and development activities and strategic acquisitions are drivers of our future growth and we plan to continue to invest in these growth opportunities, depending upon the availability of capital to fund these endeavors. 18 Results of Operations Results of Operations for the Three Months Ended March 31, 2014 Contract Research Optics Instruments Biomedical Total Revenue $ 5,614,060$ 4,788,669 $ - $ 3,729$ 10,406,458 Gross Profit 2,441,719 1,919,261 (5,822 ) 3,729 4,358,887 Impairment of goodwill - - - - - Operating Income (Loss) 241,938 522,112 (75,585 ) (221,238 ) 467,227

Depreciation and Amortization 69,949 183,499

- 15,000 268,448 Capital expenditures 12,028 396,530 - - 408,558 Intangibles, Net 315,651 857,579 - 148,331 1,321,561 Goodwill 4,938,625 1,333,603 - - 6,272,228 Total Assets $ 10,230,207$ 13,815,832$ 455,096$ 332,338$ 24,833,473 Results of Operations for the Three Months Ended March 31, 2013 Contract Research Optics Instruments Biomedical Total Revenue $ 5,487,850$ 3,931,766$ 1,014,320$ 50,594$ 10,484,530 Gross Profit 2,647,870 1,481,948 461,101 50,594 4,641,513 Impairment of goodwill - - 6,763,072 - 6,763,072 Operating Income (Loss) 232,015 2,336



(7,270,801 ) (211,564 ) (7,248,014 )

Depreciation and Amortization 79,637 184,696 164,384 15,000 443,717 Capital expenditures (187,425 ) 87,536 - - (99,889 ) Intangibles, Net 349,786 866,488 2,349,767 209,997 3,776,038 Goodwill 4,938,625 1,197,017 - - 6,135,642 Total Assets $ 13,332,151$ 9,748,703$ 4,862,956$ 334,658$ 28,278,468

Total revenue for the three months ended March 31, 2014 decreased slightly to $10.4 million for the three months ended March 31, 2014 from $10.5 million for the three months ended March 31, 2013 as increases in our Optics segment revenues substantially offset the decline in Instruments segment revenue as a result of the sales of the lead paint and medical products businesses that comprised substantially all of the Instruments segment. Revenue from our Contract Research segment increased approximately $100,000 or 2.3%. Contract Research revenues have remained relatively steady over the most recent four quarters. The research backlog for the Contracts Research segment has declined approximately $5.0 million from September 30, 2013 to $33.0 million at March 31, 2014. In addition to normal business activity, the decrease in backlog in the second quarter ended March 31, 2014 includes removal of a $750,000 contract in which the Company's RMD subsidiary was a subcontractor. While the Company has not been significantly affected by cuts in government spending to date, the Company continues to closely monitor Federal government R&D spending levels. The Optics segment revenue increased approximately $900,000 or 21.8% for the three months ended March 31, 2014, as a result of increased volume of sales in each of the four businesses included in the Optics segment. The Instruments segment revenue decline is primarily a result of the sale of the lead paint and medical product businesses in the first quarter ending December 31, 2013. 19

Gross profit for the three months ended March 31, 2014 was $4.4 million, or 41.9% of sales, compared to $4.6 million or 44.3% of sales for the three months ended March 31, 2013. Gross profit as a percent of sales decreased for the Contract Research segment to 43.5% at March 31, 2014 from 48.2% at March 31, 2013 primarily as a result of higher billable material and subcontractor costs for the three months ended March 31, 2014 compared to three months ended March 31, 2013. Billable material and subcontractor costs have lower profit margins than direct labor costs.

Gross profit for the Optics segment increased $400,000 for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The gross profit margin increased to 40.1% of sales at March 31, 2014 compared to 37.7% of sales for the quarter ended March 31, 2013, primarily as a result of a $350,000 nonrefundable payment received in connection with previous engineering and design efforts associated with a customer contract. The Biomedical segment, through Xcede, is developing a tissue sealant technology which has not been approved for commercial use and consequently has no gross profit. Total operating expenses for the three months ended March 31, 2014 decreased to $3.9 million, or 37.4% of sales, compared to $11.9 million for the three months ended March 31, 2013, which period included an impairment charge of $6.8 million associated with an interim impairment evaluation performed on the Company's Products business unit in the Instruments segment. The remaining decrease in total operating expenses is primarily a result of the sale of the lead paint and medical products businesses in the Instruments segment which were incurring substantial product development costs during the first quarter ended March 31, 2013 and a higher level of legal and consulting costs incurred in 2013 as a result of the financial difficulties the Company was experiencing. Income from Operations for the three months ended March 31, 2014 was $500,000 compared to loss from operations of ($7.2 million) for the three months ended March 31, 2013. This change is largely a result of the $6.8 million impairment charge recorded in the three months ended March 31, 2013. The Company expects to maintain its operating expenses at the current levels. Net interest expense was increased slightly for the three months ended March 31, 2014 compared with the three months ended March 31, 2013 primarily reflecting the accrual of default interest on the MCRC loan.



Income tax expense for the three months ended March 31, 2014 consisted primarily of state tax expense offset by certain U.K. tax research credits.

Net Income for the three months ended March 31, 2014 was $300,000, or $0.02 in basic earnings per share, compared with Net Loss of ($7.2 million), or ($0.49) in basic earnings per share, for the quarter ended March 31, 2013. 20



Results of Operations - Year to Date

Results of Operations for the Six Months Ended March 31, 2014 Contract Research Optics Instruments Biomedical Total Revenue $ 11,454,502$ 8,887,177$ 772,578$ 3,729$ 21,117,986 Gross Profit 4,971,257 3,516,521 317,908 3,729 8,809,415 Impairment of goodwill - - - - - Operating Income (Loss) 590,332 920,544 966,178 (395,610 ) 2,081,444 Depreciation and Amortization 139,496 361,607 2,003 31,667 534,773 Capital expenditures 12,028 527,448 - - 539,476 Intangibles, Net 315,651 857,579 - 148,331 1,321,561 Goodwill 4,938,625 1,333,603 - - 6,272,228 Total Assets $ 10,230,207$ 13,815,832$ 455,096$ 332,338$ 24,833,473 Results of Operations for the Six Months Ended March 31, 2013 Contract Research Optics Instruments Biomedical Total Revenue $ 10,398,690$ 8,183,706$ 2,298,358$ 157,051$ 21,037,805 Gross Profit 4,861,923 3,061,891 1,066,902 157,051 9,147,767 Impairment of goodwill - - 6,763,072 - 6,763,072 Operating Income (Loss) 231,409 388,012



(7,726,495 ) (332,227 ) (7,439,301 )

Depreciation and Amortization 142,419 370,324 327,432 30,000 870,175 Capital expenditures (1,095 ) 209,682 7,092 - 215,679 Intangibles, Net 349,786 866,488 2,349,767 209,997 3,776,038 Goodwill 4,938,625 1,197,017 - - 6,135,642 Total Assets $ 13,332,151$ 9,748,703$ 4,862,956$ 334,658$ 28,278,468



Revenue for the six months ended March 31, 2014 was flat at $21.1 million compared to $21.0 million for the six months ended March 31, 2013.

Revenue from our Contract Research segment increased $1.1 million or 10.2% for the six months ended March 31, 2014 compared to the same period in 2013. The Contract Research segment revenue reflects a return to more normal levels after a decline resulting from lower billable material and subcontractor costs primarily in the three months ended December 31, 2012. The Optics segment revenue increased $700,000 or 8.6% for the six months ended March 31, 2014, primarily as a result of the $350,000 nonrefundable payment discussed previously and volume increases at the four businesses included in the Optics segment. Revenue from our Instruments segment decreased $1.5 million or 66.4% for the six months ended March 31, 2014 compared to the same period in 2013. The Instruments segment revenue decline is primarily a result of the sale of the lead paint and medical product businesses in the first quarter ending December 31, 2013. Gross profit for the six months ended March 31, 2014 was $8.8 million, or 41.7% of sales, compared to $9.1 million or 43.5% of sales for the six months ended March 31, 2013. 21 Gross profit as a percent of sales decreased for the Contract Research segment to 43.4% at March 31, 2014 from 46.8% at March 31, 2013 primarily as a result of a change in the mix of costs to material, subcontractor and indirect from direct labor which results in lower gross profit margins (although the total contract profitability is unchanged). Gross profit for the Optics segment increased approximately $500,000 to $3.5 million for the six months ended March 31, 2014 compared to the six months ended March 31, 2013 primarily as a result of higher product revenues and the $350,000 nonrefundable payment described above. Gross profit for the Instruments segment decreased $800,000 to $300,000 for the six months ended March 31, 2014 from $1.1 million for the six months ended March 31, 2013 primarily a result of the sale of the lead paint and medical product businesses in the first quarter ending December 31, 2013.



The Biomedical segment gross profit equals its revenue because the cost of the funded research is included in research and development expense.

Total operating expenses for the six months ended March 31, 2014 were $7.9 million compared to $16.6 million for the six months ended March 31, 2013. Operating expenses for the six months ended March 31, 2013 included a non-cash impairment charge of $6.8 million. Excluding that charge, operating expenses decreased $2.2 million primarily as a result of the elimination of operating expenses associated with the Instruments segment which was sold in the first quarter ending December 31, 2013 as well as a lower level of legal and consulting costs incurred in 2014. Income from operations for the six months ended March 31, 2014 was $2.1 million compared to a loss from operations of ($7.4 million) for the prior year comparable period. Excluding the impact of the impairment charge, the loss from operations for the six months ended March 31, 2013 would have been ($700,000). The increase in income of $2.7 million is primarily associated with the $1.2 million gain on the sale of the businesses in the Instruments segment and a $700,000 reduction in losses from operations of the Instruments segment which was sold in the first quarter ended December 31, 2013. The Contract Research and Optics segments had improvements in income from operations for the six months ended March 31, 2014 compared to the six months ended March 31, 2013 of $400,000 and $500,000, respectively.



Net interest expense for the six months ended March 31, 2014 and 2013 was essentially unchanged at $400,000 reflecting a lower interest expense associated with a $6 million reduction in outstanding senior bank debt offset by the accrual of default rate interest on the debt due to our subordinated lender.

Income tax expense for the three months ended March 31, 2014 consisted primarily of state tax expense offset by certain U.K. tax research credits.

Net income for the six months ended March 31, 2014 was $1.7 million or $0.11 per share, compared with a net loss of ($7.6 million), or ($0.52) per share for the six months ended March 31, 2013.



Use of Non-GAAP Financial Measures

In addition to financial measures prepared in accordance with generally accepted accounting principles (GAAP), this MD&A also contains non-GAAP financial measures. Specifically, Dynasil has discussed Operating Expenses and Income (Loss) from Operations, in each case excluding the effect of the $6.8 million impairment charge recorded in the second quarter of 2013 to write down the goodwill and long-lived intangible assets of the Company's Instruments segment. The Company believes that the inclusion of these non-GAAP financial measures helps investors to gain a meaningful understanding of the Company's core operating results and enhance comparing such performance with prior periods. The non-GAAP financial measures included in this MD&A are not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP.



Liquidity and Capital Resources

New Senior Loan Agreement On May 1, 2014, Dynasil entered into a loan and security agreement (the "Bank Loan Agreement") and line of credit note (the "Note") with Middlesex Savings Bank ("Middlesex") pursuant to which Middlesex agreed to provide up to $4 million, subject to the availability restrictions described below, under a revolving line of credit loan to Dynasil for general corporate purposes. The Bank Loan Agreement provides that the loan expires on May 1, 2017, at which time all outstanding principal and unpaid interest shall become due and payable. The Bank Loan Agreement and the Note are secured by (i) a security interest in substantially all of the Company's personal property and (ii) a sixty-five percent (65%) of the Dynasil's equity interests in its UK subsidiary, Hilger Crystals, Ltd. Under the note, the borrowing base is determined monthly based on eligible billed and unbilled accounts receivable and eligible inventory. The interest rate under the Note is equal the Prime Rate, but in no event less

than 3.25%. 22

Upon the closing of the Bank Loan Agreement on May 1, 2014, Dynasil repaid in full the approximately $1.8 million of principal and accrued interest and fees owed to Santander Bank under the Company's existing Loan and Security Agreement dated as of July 7, 2010, as amended (the "Santander Loan Agreement"), by and between the Company and Santander Bank, N.A. (formerly known as Sovereign Bank, N.A.). In addition, Dynasil used the proceeds from the Bank Loan Agreement to repay $600,000 of accrued interest due to Massachusetts Capital Resource Company. As a result, as of May 1, 2014, the Company has total indebtedness outstanding consisting of $2.4 million newly drawn senior debt owed to Middlesex Savings Bank and approximately $3.0 million of existing subordinated debt owed to Massachusetts Capital Resource Company due July 2017. The Bank Loan Agreement contains customary representations, warranties and covenants. The Bank Loan Agreement limits Dynasil and its subsidiaries' ability to, among other things: be a party to a merger, incur additional indebtedness, incur liens and make investments, without the prior written consent of the Bank. So long as Dynasil will, after payment, be in compliance with the financial covenant referenced below, the Bank Loan Agreement permits Dynasil to pay dividends and make other distributions. In other circumstances, Dynasil may pay dividends and make other distributions with the prior written consent of the Bank. The Bank Loan Agreement also contains other terms, conditions and provisions that are customary for commercial lending transactions of this sort. The Bank Loan Agreement requires, at the close of each fiscal quarter, Dynasil to maintain a Debt Service Coverage ratio, as defined, of at least 1.20 to 1.00 on a trailing four quarter basis. The Bank Loan Agreement provides for events of default customary for credit facilities of this type, including but not limited to non-payment, defaults on other debt, misrepresentation, breach of covenants, representations and warranties, insolvency and bankruptcy, change of management, as defined and the occurrence of a material adverse change, as defined. Upon an event of default, the amounts outstanding under the Bank Loan Agreement may be declared by the Bank to be immediately due and payable and the Bank's agreement to make advances under the Note may be terminated. Liquidity Outlook Net cash as of March 31, 2014 was $3.5 million or approximately $1.1 million more than the net cash of $2.4 million at September 30, 2013. In connection with the refinancing completed on May 1, 2014, the Company used approximately $1.8 million to repay its senior lender in full and to pay $600,000 of interest due its subordinated lender as of April 30, 2014. Based on the collateral calculation as of March 31, 2014, the Company had $2.8 million of availability under the line of credit.



Cash From Operating Activities

In total, including the changes in accounts receivable and accounts payable and accrued expenses, operating activities generated cash of $1.6 million for the six months ended March 31, 2014.



Cash From Investing and Financing Activities

The Company generated $4.4 million in net proceeds from the sale of its lead paint and medical products businesses and used cash of approximately $500,000 for the purchase of property, plant and equipment for the six months ended

March 31, 2014. Payments of long term debt for the six months ended March 31, 2014 were $4.9 million consisting of $3.9 million in special payments associated with the sale of the two businesses identified above as well as regularly scheduled principal payments to Santander Bank, N.A., the Company's senior lender. The Company's Xcede subsidiary raised $400,000 through the issuance of convertible notes through March 31, 2014. Net cash used in financing activities was approximately $4.4 million for the six months ended March 31, 2014. 23



Critical Accounting Policies and Estimates

There have been no material changes in our critical accounting policies or critical accounting estimates since September 30, 2013. We have not adopted any accounting policies since September 30, 2013 that have or will have a material impact on our consolidated financial statements. For further discussion of our accounting policies see the "Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013 as well as the notes in this Form 10-Q.



The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

Revenue Recognition Revenue from sales of products is recognized at the time title and the risks and rewards of ownership pass. 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. 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. 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 government and 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 government contracts 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

Goodwill is subject to an annual impairment test. We consider many factors which may indicate the requirement to perform additional, interim impairment tests. These include:



A significant adverse long term outlook for any of our industries;

An adverse finding or rejection from a regulatory body involved in new product

regulatory approvals;

Failure of an anticipated commercialization product line;

Unanticipated competition or a disruptive technology introduction;

The testing for recoverability under the Impairment or Disposal of Long-Lived

Assets Subsections of Subtopic 360-10 of a significant asset group within a

reporting unit;

A loss of key personnel; and

An expectation that a reporting unit carrying goodwill, or a significant

portion of a reporting unit, will be sold or otherwise disposed of. 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. 24 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 Radiation Monitoring Devices, which comprises our Contract Research segment, and Hilger Crystals, a component of our Optics segment.

The carrying value of goodwill in our Instruments segment exceeded the new residual fair value of goodwill in the fourth quarter of 2012, and, as a result, the Company recorded a pre-tax impairment loss of $2.3 million in the quarter ended September 30, 2012. During the second quarter of 2013, the Company performed an interim impairment test of the long lived assets and goodwill associated with its Dynasil Products reporting unit and wrote off goodwill of $4.0 million and $2.8 million of long lived assets other than goodwill for a total write-off of $6.8 million Intangible Assets The Company's intangible assets consist of an acquired customer relationships and trade names of Optometrics Corp. and Hilger Crystals, Ltd., acquired know-how of Radiation Monitoring Devices, Inc. and purchased biomedical technologies within the Biomedical Segment. 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.



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. No impairment charge was recorded during the three or six month periods ended March 31, 2014. During the three months ended March 31, 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 $2.8 million plus a $4.0 million write-off of goodwill as discussed above.



Allowance for Doubtful Accounts Receivable

The Company performs 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. Stock-Based Compensation The Company accounts 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. Income Taxes

As part of the process of preparing our consolidated financial statements, we are required to estimate our income tax provision (benefit) in each of the jurisdictions in which we operate. This process involves estimating our current income tax provision (benefit) together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets. We regularly evaluate our ability to recover the reported amount of our deferred income 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. 25



RECENT ACCOUNTING PRONOUNCEMENTS

In July 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. Currently, GAAP does not include explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This ASU clarifies that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows: to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. This ASU applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013, although early adoption is permitted. This ASU will be applied prospectively to all unrecognized tax benefits that exist at the effective date. We have not yet adopted this ASU, and we are currently evaluating the effect it will have on our consolidated financial statements. In July 2013, the FASB issued ASU No. 2013-10, Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes. This ASU permits the Fed Funds Effective Swap Rate (OIS) to be used as a U.S. benchmark interest rate for hedge accounting purposes, in addition to the U.S. government treasury obligation rate and the London Interbank Offered Rate (LIBOR). This ASU also removes the restriction on using different benchmark rates for similar hedges. This ASU is effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The Company does not currently have any hedging arrangements and therefore will not be materially impacted by the new guidance. In March 2013, the FASB issued ASU No. 2013-05, Foreign Currency Matters (Topic 830): Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity. When a reporting entity (parent) ceases to have a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity, the parent is required to apply the guidance in subtopic 830-30 to release any related cumulative translation adjustment into net income. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. This ASU is effective prospectively for fiscal years and interim periods beginning after December 15, 2013. This ASU will be applied prospectively to derecognition events occurring after the effective date. Early adoption is permitted. We do not expect the adoption of this ASU to have a material effect on our consolidated financial statements. 26



Forward-Looking Statements

The statements contained in this Quarterly Report on Form 10-Q which are not historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements regarding future events and our future results are based on current expectations, estimates, forecasts, and projections and the beliefs and assumptions of our management, including, without limitation, our expectations regarding results of operations, our compliance with the financial covenants under our loan agreements with Middlesex Savings Bank and Massachusetts Capital Resource Company, 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, our ability to remediate the material weaknesses in our internal control over financial reporting, 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 comply with the financial covenants 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 identify and execute on acquisition opportunities and integrate such acquisitions into our business, and seasonality, as well as the uncertainties set forth in the Company's Annual Report on Form 10-K, filed on December 20, 2013, 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.


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