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Edited Transcript of DYSL earnings conference call or presentation 26-Dec-18 10:00pm GMT

Full Year 2018 Dynasil Corporation of America Earnings Call

WATERTOWN Jan 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Dynasil Corporation of America earnings conference call or presentation Wednesday, December 26, 2018 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Patricia M. Kehe

Dynasil Corporation of America - Corporate Secretary

* Peter Sulick

Dynasil Corporation of America - Chairman, President & CEO

* Robert Joseph Bowdring

Dynasil Corporation of America - Principal Accounting Officer & CFO

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Conference Call Participants

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* Joe Furst

Furst Associates - Owner

* Robert Cooper

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Presentation

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Operator [1]

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Good day, and welcome to Dynasil Corporation of America's Fiscal 2018 Conference Call. Today's call is being recorded. (Operator Instructions) I would now like to turn the call over to Patty Kehe of Dynasil. Ms. Kehe, please go ahead.

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Patricia M. Kehe, Dynasil Corporation of America - Corporate Secretary [2]

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Thank you, Mark, and good afternoon, everyone. With me today are Peter Sulick, Dynasil's Chairman, CEO and President; and Rob Bowdring, Dynasil's Chief Financial Officer.

Before we begin, please note that various remarks management makes on today's conference call that are not historical facts, including, but not limited to, statements about our expectations, beliefs, plans, designs, objectives, prospects, financial condition, assumptions and future events or performance are forward-looking statements under the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including those discussed in Dynasil's annual report on 10-K for the fiscal year ended September 30, 2018, filed on Friday with the Securities and Exchange Commission.

Dynasil's filings can be accessed on the Investor Relations section of the company's website, www.dynasil.com. Any forward-looking statements represent the company's views as of today, December 26, 2018. 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.

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [3]

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Thanks, Patty. Good afternoon, everyone. Thank you for joining us today to highlight our financial results and other activities for our 2018 fiscal year. I regret the unfortunate timing of this call as we were very tight with our SEC filing schedule this year. In preparation of our October 1 adoption of the so-called 606 revenue recognition rules, full implementation resulted in considerable additional work by the finance team and the auditors for year-end 2018. We apologize for any inconvenience having this call on December 26 has caused.

On Friday, we released our Form 10-K and press release with summary results for our 2018 fiscal year. The press release includes a table showing our results for each of our segments, Optics, Innovation and Development and Biomedical, for both this year and last. You may want to refer to these statements for specific information during this call.

Rob will provide further details on our results in a few minutes. I would like to begin by announcing our earnings for the year attributable to common stockholders was $1.8 million or $0.10 per share. These results were driven in part by a 9% increase over prior year. The $3.4 million increase in revenue resulted from a $3.8 million or approximately 20% increase in revenue in our Optics segment, offset by a $0.4 million or 2% decrease in revenue in our Innovation and Development segment.

For financial reporting purposes, we have renamed our former Contract Research segment to Innovation and Development. This is reflective of the exciting new technology being developed at this segment's business unit, RMD, particularly in the fields of material science, radiation detection, digital and magnetic imaging, laser optics and photonics. Using decades of expertise in these fields, the team at RMD develops advanced technology and materials, sensors, detectors and prototype instruments that detect or measure radiation, light, magnetism or sound for use in security, medical and industrial applications. Dynasil has 78 patents granted and another 53 patents filed for and pending. A vast majority of these granted and pending patents are at RMD.

Our Optics segment experienced solid year-over-year revenue growth with revenue increasing 20% over 2017. Efforts across all of our Optics businesses as well as our new marketing team have resulted in this outstanding performance.

We have not discussed it in depth in the past, but during 2018, we invested over $1.6 million in a combination of capital, personnel and coating formula development for our infrared or IR initiative. Of this amount, approximately $1.2 million was capital in the form of new coating, polishing or lapping equipment, much of which we designed in-house. We also dedicated and converted existing coating chambers to this effort, and we perfected coating formulas for numerous IR applications across multiple substrates. We now offer a very competitive product suite for the IR marketplace, including diamond-like coating capabilities.

We also moved -- we also worked on our in-house metrology, quality standards, processes, documentation, staff training and other operational needs necessary to service the multi-billion dollar IR marketplace. While we had limited revenue during 2018, I'm happy to report that we have numerous prospects developing for the remainder of 2019 and beyond. We are very optimistic about our IR opportunities, which we specifically identified as a strategic growth initiative in 2017 and actively pursued during fiscal 2018.

The Innovation and Development segment's 2% decrease in revenue largely resulted from a reduction in NIH funding and a delay in our commercial revenue orders. As you know, we generate $16 million to $18 million in Innovation and Development segment revenue in a typical year. This year, uncertainty and disruptions in project funding resulted in our yearly projected revenue being closer to $16 million despite a substantial backlog. We are very dependent upon stability and predictability from our government customers, and this is not uniform across the government agencies we service. Managing a project business dependent on direct billings to specific projects becomes challenging in this environment and requires active oversight. Currently, parts of the government, including one large agency we do significant work for, are shut down as a result of the border wall impasse. This is a real-time case in point on the need for active management.

The innovation segment is also supplemented by product sales, which are also typically government dependent. Very often, it is difficult to predict with any accuracy when this revenue is going to be realized. I'm happy to report the project backlog in the innovation segment continues to remain strong into 2019, and we are hopeful that certain of the appropriation programs we are dependent upon for commercial revenue will be awarded during 2019. There's a possibility that commercial revenue in this area could grow dramatically, but it is difficult to predict, dependent upon a competitive bidding process with our commercial partners, and is always dependent on a very long product development cycle. That said, we have some wonderful technology with exciting possibilities.

Our income from operations increased $0.9 million from a loss of operations of $0.6 million in fiscal year 2017 to income from operations of $0.3 million in fiscal year 2018. We previously mentioned about $400,000 in P&L costs we incurred during 2018 in advance of revenue for the IR initiative. In addition, we have invested in a marketing team and marketing programs to expand our visibility, particularly in the digital marketing area. We are now active on Facebook, LinkedIn and other sites. Recently, we have relaunched our e-commerce site and have largely converted the Dynasil website to focus on e-commerce as opposed to an investor portal.

As announced last July, Xcede Technologies Inc., our majority owned subsidiary, has halted clinical trial preparations and curtailed its operations in response to a termination notice received from Cook Biotech Inc. This was a major disappointment on the eve of beginning clinical trials. Xcede had adequate capital to get through the clinical trial but had never been successful despite multiple attempts at raising substantive direct funding. Following the CBI termination, there was no appetite on the part of Dynasil or the angel investors to continue funding a new round of product development and essentially beginning the process over again. As a result, the decision was made to suspend operations.

Our innovation team at RMD is investigating funding for continued development of the Xcede Patch, specifically for wound care. We have also reengaged with our partners at CBI to assist in the process. There can be no assurances with respect to any such alternatives or that any additional outside funding to continue development of the Xcede Patch will be available to RMD. We will make an attempt. There is IP and science available to RMD, which could be promising, but it is a long shot. For 2018, Dynasil recognized approximately $1 million in Xcede cost on the P&L, which will not continue in the future due to the suspension of operations. I'm happy to discuss Xcede in more detail should anyone be interested during the Q&A session.

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

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Robert Joseph Bowdring, Dynasil Corporation of America - Principal Accounting Officer & CFO [4]

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Thank you, Peter, and happy holidays to all of you who have joined us today. As Peter touched on most of the key items for the quarter, I will summarize a few additional points.

As Peter noted, Dynasil's revenue in 2018 was $40.7 million as compared to $37.3 million in 2017. This 9% increase in revenue resulted from $3.8 million or 20% increase in the revenue of our Optics segment, somewhat offset by a $400,000 or 2% decrease in revenue in our Innovation and Development segment. Most of our Optics division has improved over last year, particularly our New Jersey-based Fused Silica team as they responded to increased demand from customers in the semiconductor microlithography market, resulting in a very strong year for them.

As Peter outlined, Innovation and Development's revenue decreased by 2% to $17.4 million in the year ended September 30, 2018, from $18 million in the same period in 2017, largely resulting from a reduction of NIH funding and a delay in our commercial revenue orders. NIH continues to be one of our top 5 RMD customers. It was just down versus years past.

As Peter mentioned, our Innovation and Development backlog remained strong at year-end at over $31 million and it has become even stronger since September 30. Overall, gross profit for the fiscal year increased to $1.3 million to $15.2 million or 37% of revenue compared to $13.9 million or the same 37% of revenue for last year.

The Optics segment's gross profit as a percent of revenue in fiscal year 2018 decreased slightly to 33% as compared with 2017's gross profit of 34%. The gross profit in 2018 was $7.7 million, an increase of $1.1 million or 17% as a result of higher revenue during the 12 months that ended September 30.

Both gross profit dollars and gross profit as a percent of revenue for the Innovation and Development segment improved in fiscal year 2018 compared to 2017, largely as a result of the mix of active contracts during 2018, which carried stronger margins because more internal resources were utilized rather than subcontractors. Gross profit dollars in this segment increased to $7.6 million during 2018, up from $7.3 million in 2017. Gross profit as a percent of revenue improved to 43% in 2000 (sic) [2018] compared to 41% in 2017. All of the above resulted in a very substantial turnaround in the company's income from operations, which for the year ended 2018 was $300,000 compared to a loss from operations of $600,000 in the same period of 2017, a $900,000 improvement in this key metric.

Now a word about taxes. Total income tax expense was actually a benefit of $1.6 million in fiscal year 2018 as compared to a benefit of $2.7 million in fiscal 2017. The 2018 benefit resulted from a pickup in the second quarter related to the Research and Experimentation or R&E tax credits that the company earned in the years 2013 through 2016 and a benefit in the fourth quarter for the lease of the company's tax reserve for state deferred tax assets that were being carried on the balance sheet that now are expected to be used in the foreseeable future. These positive items were offset by the first quarter expense from the effect of the 2017 Tax Act.

Last year's benefit was related to the deconsolidation of Xcede for federal income tax purposes and the release of the federal tax valuation allowance, again as we now expect to have taxable income and we plan to use these tax assets in the foreseeable future. As a result of the items mentioned previously, our net income for the year ended September 30, 2018, was $1.6 million compared to net income of $1.9 million in the prior year.

I would like to spend a minute picking up on Peter's opening statement and restate our apology for splitting the timing of our annual report filed on Form 10-K in this call during this last week of the year. The company had been working on the adoption of the new 606 accounting revenue recognition policy throughout this year knowing that it was required to be in place as of October 1. Unfortunately, it took considerable amount of extra effort, much more than we expected, especially at year-end.

As we went through the process, additional steps were taken by both ourselves and the audit team to review revenue under both the old method for 2018 and the new methods starting with this new fiscal year. As a result of these reviews, we realized there was very little difference in the way we were recording and presenting total revenue during fiscal 2018 and going forward under this new guidance.

As we indicated in the 10-K, the difference to our financial statements was insignificant. What did come from the additional audit review was that there was revenue of a few contracts that were being accounted for in the same way as the majority of our other contracts when they should have been treated differently, resulting in revenue recognition adjustments and manual system error corrections. Even though the net impact to operating income was only $32,000, these errors were viewed as a breakdown in internal controls, causing us to determine that we had a material weakness. We have already begun the improvements necessary to implement changes to eliminate these errors and will quickly correct this deficiency in the near term.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of [Robert Cooper].

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Robert Cooper, [2]

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You keep mentioning the infrared business. What kind of opportunities do you foresee over the next couple of years?

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [3]

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I'll take that one, Rob. So Robert, the infrared business is a multibillion-dollar business overall, which Dynasil has not participated in that at all, and we recognize that we weren't involved in this market. It was a growing market. There were certain participants in our regional area, the Northeast, that were dropping the business, and there was a consolidation going on among those people in California and elsewhere. So it opened up a really wonderful opportunity for us. We were able to hire some people last year that have deep experience in infrared optics, and that opened up for us the ability to go after some of the key customers that had previously been customers of some of these other operations that closed down.

But in order to take advantage of that, we needed to have a couple of systems in place that we didn't previously have, and so we had to design and build some of those systems or have built some of those systems. And the lead time for acquiring some of these kinds of capital assets is very long. In fact, one of the coating chambers that we needed to acquire took us almost 9 months between the time the order was placed and we actually had the machine in operation. So there is a long lead time in this business, but there's also a very long tail. Once you get into it, you tend to be in defense department-related optical systems, and they tend to have very long life cycles.

So during 2018, we perfected our various processes. We put in place the necessary hardware that we needed, and then we began to actively sell to a number of different, very large OEM customers starting the beginning of this year. These kinds of systems go into helicopters, gun sites, tanks, et cetera, et cetera, large optical systems that tend to be solid, stable operation -- solid and stable business for a relatively long period of time. So that's why we are excited about it.

The addressable market for us is somewhere in the $100 million to $200 million range meaning that while this is a multi-billion dollar marketplace, what we can realistically go after is in the $100 billion to $200 billion range. We are projecting that we can get a small fraction of that over the next couple of years, and we're hopeful that we will and it will be meaningful to us if we are able to do that.

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Robert Cooper, [4]

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Okay. In regards to you had hired a few months, maybe 6 months ago, a Vice President of Marketing. You guys keep incurring further expenses on that. I mean, what do you expect to get out of that?

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [5]

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Well, we didn't have any marketing department at all in the entire company. So whatever minor amount of marketing activities we were engaged with was really just picked up by certain of us as we could fill in. And the sales cycle these days is completely different than what it had been 20 years ago or 30 years ago or maybe even 10 years ago, and so digital marketing becomes extremely important, not just for image purposes but for the sales cycle itself. Most people who have done a lot of research through the Internet before they actually contact us for pricing or long order runs and things like that.

So because we were not active in this whole digital marketing area, when anyone would do a Google search, for example, even though we are manufacturers of some of these very important products, like gratings as an example, we wouldn't appear on the first 3 or 4 pages because we just simply didn't have enough content on the Internet to move some of our units, whether it is Optometrics or Dynasil or Evaporated Metal Films or whoever up to the first page. And it's very rare that people get past the first or second page in a search. So we recognize that if we were going to be, let's say, more active in some -- in the direct sales area, we had to advance our search results to the first page or the second page. And these digital marketing guys are very actively involved in the development of content, specifically to do that.

In addition, we launched a website for e-commerce and across 4 of our divisions. We serially launched it, starting with Optometrics and then we launched 3 other divisions after that. And it became very apparent that the website itself was not optimized for e-commerce. It was not contemporary. We did the best we could with it, but we needed some professional guidance on how to optimize the website. And these guys got directly involved in that, and we launched our new website literally just 2 or 3 weeks ago. So we now have a different look and a much easier process to actually go in and find what you're looking for and then ultimately check out. So we are very hopeful that over a longer period of time, not immediately, but maybe over 2 or 3 years, that all of this effort will result in increased revenue. So -- and we're pretty optimistic so far with what we've seen come out of the marketing department.

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Robert Cooper, [6]

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I have 2 more for you. With the little news that we do get, I see you're publicly disclosing all of your ISO certifications.

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [7]

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Right.

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Robert Cooper, [8]

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What is that really about? And why, as an investor, why should we care or...

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [9]

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Well, it's very important, extremely important actually because it's very difficult to get certain kinds of orders from customers that are interested in quality control and things like that, if you do not have ISO certification. And so we have been very active in getting ISO certified or recertified as the ISO rules change, and we've done that now for every -- virtually every one of our units. We still have one that isn't, which we are going to work on theirs, but it's a box that gets checked off by, let's say, a purchasing manager, Robert. And if you do not have it, it becomes a very negative impact on a potential sale. So ISO is important in the purchasing world and in the manufacturing world for quality and other purposes.

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Robert Cooper, [10]

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All right. My last question for you is the valuation of the company seems quite ridiculous compared to the revenues, et cetera. What's the approximate book value?

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [11]

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Rob's probably a better one to answer this one, but I'll take a shot at it. I think our book value is in the range of $20 million -- $22 million. Rob, do you have that number?

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Robert Joseph Bowdring, Dynasil Corporation of America - Principal Accounting Officer & CFO [12]

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Yes, that sounds about right. Let me go grab.

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [13]

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I think, Robert, in terms of a per share price, it's around $1.20 to $1.25 a share, and I think that translates to about $22 million or so.

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Robert Joseph Bowdring, Dynasil Corporation of America - Principal Accounting Officer & CFO [14]

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Yes, well, $21 million -- $20.7 million.

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Operator [15]

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(Operator Instructions) Our next question comes from the line of Joe Furst of Furst Associates.

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Joe Furst, Furst Associates - Owner [16]

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Peter, I just wanted to make sure I have something straight here. Last year, it seems you were able to make $0.10 a share even though you lost about $1 million from Xcede, is that correct?

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Robert Joseph Bowdring, Dynasil Corporation of America - Principal Accounting Officer & CFO [17]

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That's correct, Joe.

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Joe Furst, Furst Associates - Owner [18]

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Good. So if everything else were equal, you'd make a lot more money next year. And also, I guess some people saw it, but I don't know if everybody did but you have enough confidence in this company to spend $1 a share from buying a 1.5 million shares from the estate of the founder. So I want to commend you for doing that. It certainly demonstrates to shareholders that you have confidence in the company. And also, can you make a couple of comments about the future of the Optometrics area of the approach you take to get there and where it might come from?

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [19]

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Well, so we did -- I did spend a fair amount of time talking about IR. And our IR business is a combination of the sales team is actually located at Optometrics, but the manufacturing is done in Ithaca, New York, at our EMF operation. So it's a combination of the 2. The actual revenue is going to be recorded at EMF. So we have the expenses being incurred partly at Optometrics and then the sales will be recorded at EMF. Although from the point of view of the public, it's all 1 Dynasil entity, obviously.

Where we are seeing significant growth, Joe, is in our Optometrics subsidiary, in our core business at Optometrics and also in our core business, and Rob mentioned it briefly, of Fused Silica. There is tremendous demand right now for optics component products, and we are a very high quality manufacturer of those. We provide product to a wide range of customers in that space, including catalog companies that buy from us for catalog sales, and the demand has just been escalating significantly, and we don't see that actually abating. So we're quite encouraged by this growth in demand, which, by the way, our 20% growth in Optics doesn't include any growth at all for IR historically. So we got no IR growth last year, but we anticipate getting some growth in that space this year. So it's just a generally broad increase in demand across the optics space, and it's pretty encouraging at the moment.

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Operator [20]

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And I'm showing no further questions at this time. I would now like to turn the call back to Peter Sulick for closing remarks.

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [21]

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Thank you. Happy holidays to everyone, and I look forward to speaking with you in 1.5 months or so when we talk about our first quarter. Good night.

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Operator [22]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.