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Edited Transcript of DYSL earnings conference call or presentation 13-Feb-19 10:00pm GMT

Q1 2019 Dynasil Corporation of America Earnings Call

WATERTOWN Mar 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Dynasil Corporation of America earnings conference call or presentation Wednesday, February 13, 2019 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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* Timothy Clarkson

Van Clemens & Co., Inc. - Analyst

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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 First Quarter of Fiscal Year 2019 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, Haley, 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 conditions, 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 Form 10-K for the fiscal year ended September 30, 2018, filed in December with the Securities and Exchange Commission.

Dynasil's filing 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, February 13, 2019. 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 the first quarter of our 2019 fiscal year.

Earlier today, we released our Form 10-Q and press release with summary results for the 3 months ended December 31, 2018. 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 documents for specific information during the call.

Rob will provide further details on our results in a few minutes. I would like to begin by announcing another quarter of year-over-year double-digit revenue increases in our Optics segment. Note that it is our fifth consecutive quarter of double-digit growth. Our Optics segment revenue increased 16% as compared to the same period last year while our Innovation and Development revenue also showed a modest 1% increase over the prior year, and our overall revenue increased 9% for the first quarter of our 2019 fiscal year.

We continue to invest in growth initiatives in our Optics segment to support further revenue growth, increasing spending both in personnel and marketing initiatives. As a result, the operating expenses in our Optics segment increased 20% over the same period last year. Our Optics management and marketing teams recently returned from our major trade show of the year, Photonics West, where we made new contacts for our growing infrared, or IR, business. We're excited about the developing interest in our IR, HEAR and hard carbon capabilities.

Our investments in this area consist of new personnel, capital equipment, formula development and a considerable marketing effort to establish our presence in the IR area. While we have not yet seen meaningful revenue, we have been included on a large number of bids, and this is very encouraging. With the exception of approximately $160,000 of accounting expenses associated with the implementation of the new revenue recognition rules, all G&A and certain costs of goods expense increases are directly associated with strategic revenue growth initiatives, specifically, continued website development, now optimized for e-commerce, the addition of staff for both our IR and assembly business, and marketing for all of our Optics businesses, most particularly for the growth initiatives.

We're actively engaged in content generation for LinkedIn and Facebook, and we have started a quarterly newsletter. We had multiple presentations at IEEE and Photonics West and plan additional presentations at upcoming shows. We also distributed a very unique video direct mail piece to decision makers in the IR area.

In summary, we're very active in the marketing front and are hopeful this will result in revenue gains in the near term. A hard reality is that if we are going to grow, we need to invest in that growth, which is what we are doing and what our board endorsed.

As I mentioned on our call in December, for financial reporting purposes, we renamed our former Contract Research segment to Innovation and Development to better reflect 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. At the present time, RMD is working on approximately 50 projects across a broad section of science areas.

We're happy to report that the recent U.S. government shutdown did not have a significant impact on our Innovation and Development business. We're not certain the possible effects of any future shutdown as 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. But as our government contracts are with a number of different agencies, we're hopeful to be able to continue to minimize effects of any future slowdown.

For this particular shutdown, we continue to work on projects, with only our payments being delayed. Seven of our projects across 2 government areas were affected. Our project backlog remains strong at $33.3 million or in excess of 24 months of project revenue.

Our total gross profit for the 3 months ending December 31, 2018, was $3.7 million or 37% of revenue compared to $3.6 million or 39% of revenue for the 3 months ended December 31, 2017. Both of our Optics -- both of our operating segments' gross profit as a percentage of revenue decreased this year as compared to last. The Optics decrease was the result, in part, of the product mix and material cost in some of our product lines. Innovation and Development's gross profit decrease was a result of fewer commercial product sales this quarter over the same period last year. As I have mentioned, the timing of our product sales is very difficult to predict.

Operating expenses in our Optics segment were up 20% over last year. Additionally, Innovation and Development segment's operating expenses also increased 9% due, in part, to personnel expenses. Both operating segments' increased expenses were the direct result of the shared approximately $160,000 in accounting expenses incurred due to the implementation of new revenue recognition policies. This cost of implementation in both expense and time has been significant. However, despite the increases in the 2 operating segments, our overall operating expenses only increased 2% year-over-year due to the cessation of work on Xcede's preparations for first-in-human clinical trials, which resulted in a $400,000 decrease in operating expenses.

An update on Xcede. 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 this 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 continue to maintain the IP through this time of investigation. 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 good evening, everyone. In typical fashion, Peter touched on most of the key items for the quarter. I will summarize a few additional points.

As Peter noted, Dynasil's revenue for the first quarter of fiscal year 2019, which ended December 31, 2018, was $10 million, a 9% increase as compared with revenue of $9.2 million for the quarter ended December 31, 2017. Both of our operating segments showed increases in revenue year-over-year.

Our Optics segment revenue increased $800,000 or 16% for the first quarter compared to the same period in the prior year, where we grew by 12%. The increase was primarily the result of revenue growth in 3 of our 4 operating units in this segment, with increased demand coming from our established customer base.

The Innovation and Development segment revenue increased by $100,000 to $4.3 million for the quarter -- for the first quarter of fiscal 2019 as compared to last year's first quarter as a result of more funded contracts. The research backlog for Innovation and Development remains strong at 33.3% at the end of December. Overall, our gross profit for the 3 months ended December 31, 2018, was $3.7 million or 37% of revenues compared to $3.6 million or 39% of revenues for 2017's first quarter.

Gross profit for the Optics segment decreased by 2% to 33% of revenue or $1.9 million for the quarter ended December 31 compared to 35% of revenues or $1.7 million for the quarter ended December 31, 2017. Innovation and Development's gross profit decreased to $1.8 million or 42% of revenue as compared to $1.9 million or 44% of revenue in the same period in fiscal year 2018.

As Peter mentioned, total operating expenses increased to $3.8 million for the 3 months ended December 31, 2018, from $3.7 million for the same quarter in fiscal 2018. Operating expenses for the Optics segment increased $300,000 in the first quarter of fiscal year 2019 as compared to the prior year due to personnel additions and related charges, increased marketing expenses with the creation of our marketing department, along with the increased accounting and auditing costs associated with the implementation of the new 606 revenue recognition guidelines.

Innovation and Development expenses increased to $1.9 million in the first quarter of fiscal 2019 as compared to the $1.7 million in the first quarter of fiscal year 2018 as a result of increases in personnel and hiring costs, similar to the Optics segment. In addition, as I and Peter both mentioned, in the Optics segment, we had increased accounting and auditing expenses here as well. Some of these expenses will continue as we go forward due to the nature of our business and the increased auditing requirements of these rule changes. The Biomedical segment expenses decreased by $400,000 in the 3 months ended December 31, 2018, compared to the 3 months ended December 31, 2017, primarily due to our stopping work on the preparations for the first-in-human clinical trials.

Now as a result of the items discussed above -- previously, I should say, income from operations for the 3 months ended December 31 was a loss of $100,000 compared to a loss of $200,000 for the same period in fiscal 2018. The provision for income taxes for the first quarter of fiscal 2019 was an approximate benefit of $100,000 as compared to a charge of $700,000 for the same period in fiscal 2018.

To refresh your memory, the 2018 Q1 charge was primarily the result of the 2017 Tax Act, in which we estimated the rate reduction impact to be $500,000, the earnings and profit transition tax of our Hilger Crystals subsidiary in the U.K. to be $100,000 and a current quarter earnings provision of $100,000.

The net loss for the 3 months ended December 31, 2018, was $100,000 or minus $0.01 in basic earnings per share compared to a loss of $800,000 or minus $0.05 in basic earnings per share for the quarter ended December 31, 2017. Again, as Peter and I noted, approximately $160,000 was spent on accounting expenses for the adoption of the new 606 accounting revenue recognition policy that was required to be in place as of October 1, 2018. Unfortunately, this implementation continues to take a considerable amount of extra effort.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Tim Clarkson of Van Clemens.

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Timothy Clarkson, Van Clemens & Co., Inc. - Analyst [2]

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Just wanted you to talk a little bit more specifically about the Optics, why you're excited about it and what exactly do you guys have that makes your technology proprietary and where you think you can grow it and make some more money there?

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

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Sure. Quite excited about what's going on in Optics. And as you can tell, we've been growing that business quite a bit over the last couple of years. So, Tim, we -- I alluded to it in my prepared remarks, we are aggressively pursuing a growth strategy within our Optics companies going after the infrared market and the highly efficient AR market and another segment of that market called the hard carbon coatings.

We have not participated in that market in the past. It's an in excess of $1 billion market. The addressable market for us is in the range of about $200 million. And there are some compelling reasons why we decided to get into it. Because there've been some local factories that were here in New England that have closed and that opened up some opportunities for us both in terms of our ability to get people who were very knowledgeable in the IR space both in terms of the business development side and the technology side that hadn't been available to us previously. So we've hired a number of people in that area, and that's what's reflected in the increase in our expenses.

The -- it's a very profitable part of the Optics business. We typically anticipate getting 45%-plus margins in that, which is -- which, as you know from just looking at our numbers over the years, is much better than some of the kinds of margins that we've typically been able to get across our other optical components businesses. So that's part of the reason why we are aggressively going after it.

And the differentiator for us is that we have some coating technology within Dynasil which we're excited about, which results in what we call virtually 0 pinholes in our IR Optics. And that's a very big deal for the IR space and particularly in the diamond-like coating space. We designed and had built for us a particular kind of coating technology called an up-coater that provides DLC coatings up as opposed to down so that it really minimizes some of the kinds of pinhole issues that you get in hard carbon coatings.

And examples of these are weapon systems that are used on Navy ships where they have a lot of salt intrusion and things like that. And to the extent that you have holes in your diamond-like carbon coating, it tends to break down the coating surface relatively quickly. So we have that technology that we're very excited about and our recent direct marketing piece, which we went out with, focuses on that aspect of our coating technology that we think is unique for us. So that's one thing.

We've also been aggressively pursuing the optical assembly business. We haven't gotten any of that business yet, but we did build a clean room assembly space at one of our facilities. And we are, I think, very close to getting our first meaningful piece of business in the assembly area. So those are the things that we're doing within the Optics space to expand it. Any other questions, Tim?

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Timothy Clarkson, Van Clemens & Co., Inc. - Analyst [4]

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Well, I noticed that you purchased and made another big investment in the stock in the last, what, 3 months or so. But how many -- you bought 1 million shares is public information, right?

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

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I bought 2 million shares.

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Timothy Clarkson, Van Clemens & Co., Inc. - Analyst [6]

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2 million shares. And you paid, what, over around $1 a share, something like that?

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

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I did, yes.

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Timothy Clarkson, Van Clemens & Co., Inc. - Analyst [8]

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Well, obviously, you see some upside there and you're putting your money where your mouth is. I mean, I would assume that you're at least looking at some kind of a reasonable return on that investment, right?

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

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I'm hoping for an unreasonable return...

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Timothy Clarkson, Van Clemens & Co., Inc. - Analyst [10]

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All right. All right. All right, well, good. Based on the way the stock is trading, there's not a lot of other believers, but that's all right. I think...

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

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I know. Well, fortunately, I'm the ultimate insider, I suppose. So I will just say a few things. I did get some online questions that I can sort of address. And, Tim, maybe you can listen in and stay on the line.

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Timothy Clarkson, Van Clemens & Co., Inc. - Analyst [12]

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Yes. Yes. I'll just listen in. Sure.

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

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Yes, so I've done this in the past, where I've asked and answered my own questions. These came via an e-mail a little bit probably a couple hours ago. So the first one is, "Considering how undervalued the stock is currently, is management considering a buyback, meaning a stock buyback?" The answer is, is that management, and more specifically, the board, is always looking at alternatives to improve the returns to our investors. And we have over the years looked at stock buybacks. They're complicated in many ways. You're restricted to a very limited time period when you can actually do buyback transactions, similar to 144-type transactions. There's a very small period of time during the year when the company can actually do those.

You have to hire a broker who's quite knowledgeable in that sort of execution of trades. There's a lot of limitations on the trades. We understand all of that. That's not to say that we would not consider doing a stock buyback or potentially doing a stock tender offer to purchase back some of our stock. At the moment, we don't have the liquid resources necessary to do it. We have been spending our, let's call it, free cash flow on investing back in the company and hoping to grow the company through that. However, I can assure you that we and the board are always looking at various options. So that is always under consideration.

Second question was, "How much money is invested annually on RMD -- R&D?" That is a public disclosure that I think we actually make in our public documents.

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

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10-K, yes.

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [15]

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In 2018, we invested $10.7 million in R&D, $800,000 of which was in the Optics area. So obviously, a considerable amount of the R&D that we invest is in RMD. That's government funded for the most part, but we self-fund the $800,000 in the Optics area. We wouldn't work in R&D there.

"Is the company considering selling some of its numerous patents to unlock shareholder value and possibly do a buyback with the proceeds?" The answer is, the company is always looking at monetizing our IP. We have 78 issued and 53 pending patents. I don't think that includes the Xcede patents, does it?

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Patricia M. Kehe, Dynasil Corporation of America - Corporate Secretary [16]

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Yes.

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

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Yes, it does. That was all-inclusive.

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [18]

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All right. We have 8 patents, I believe, in Xcede. So what we typically do on the IP side and looking at our IP portfolio is license it out as opposed to sale of IP. We have licenses outstanding with a couple of very large companies right now that we receive royalty payments on. It's not meaningful enough at the moment to justify a stock buyback for what we're getting for the IP royalty, but it is a consideration. So it's certainly something that we would think about.

Also, I want to touch briefly on, before anyone asks the question, touch briefly on the cost in the Xcede and the Biomedical area, which is a separate line item on our categorized P&L. You can see there that we expend about $50,000 on Biomedical cost in the first quarter. Virtually all of that cost is to support the Xcede and the Dynasil Biomedical IP, so the 8 patents that I just talked about.

To keep those patents current, we have international patent filings on all of those various patents. They're expensive to maintain. And until we make the final determination as to whether or not we're actually going to try to get some additional government funding around the Xcede Patch, which we will be making over the course of the next quarter, so by the end of June, we will make a determination. We're either going to have a filing for some government funding on that or we're not, in which case, we will make a final decision on what we're going to do with Xcede. But in the interim, we've been keeping the Xcede patents alive. That's what that money has been for.

Any other questions, Tim? You still there?

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Timothy Clarkson, Van Clemens & Co., Inc. - Analyst [19]

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Well, just to ask another question. Is there a way of bringing in an outside consultant to look at this Xcede thing to see if there's -- if it's a legitimate place to put more money or is it time to cut it off?

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [20]

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Well, look, I don't want to sort of unrealistically get anybody's hopes up. The Xcede Patch, we did not take it into clinical trials. It failed prior to the clinical trials because of a certain characteristic that it had when it was heavily, let's call it, intubated at the site, which meant a lot of saline was put on it. Not something that we do here in the United States, but for the European clinical trial, something happened to it that -- and so in its current format, the Xcede Patch for the usage that we were anticipating is not going to move forward. There is no, I think, interest on either our part or on the part of anyone that we've surfaced to date to move that product forward in its current state.

What we were potentially talking about with the Xcede Patch is a different use, meaning a wound care product as opposed to a product that's used during surgery. So internal use. It may very well be that, that is a viable use for the product, but it is a very difficult area to do clinical trials in and to develop a product around because, obviously, clinical trials have to be done during some kind of trauma. And so it's a tough one.

We could bring consultants in, but I think the issue is, Tim, that we've incurred an awful lot of cost around this product already and there's a lot of, I guess -- I don't know. I would say we're all kind of tired.

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Timothy Clarkson, Van Clemens & Co., Inc. - Analyst [21]

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No, I get that. I get that. But sometimes, I mean, you have to admit it was a weird kind of a failure because it was -- here, it succeeds in the United States and because the Europeans have a, from our point of view, a nonnormative way of doing it, it doesn't succeed. I mean, it's a weird kind of failure and...

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [22]

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Yes, the other issue is that CBI, Cook Biotech, pulled out, and they were funding all the product development. So the only thing we were really funding was the G&A-related cost for Linda and [Sarah], that kind of stuff. So Cook had millions of dollars in product development in this thing, and they were going to become the manufacturing partner. Once we lost Cook, which they pulled away, we didn't have anyone that was willing to continue to want to fund the development. So -- and we can't afford it on our own. It's -- everybody's pretty tired of it at this point.

So the answer is we haven't completely thrown in the towel. Maybe we will spend a little bit more time on it and see if there is some potential application. We can't fund any product development in that area. We'd have to find some way to do that, and right now I have a limited team here. So we have to focus on some of our knitting outside of Xcede at the moment, and that's kind of what we're doing, so. And that's what we're excited about today.

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Timothy Clarkson, Van Clemens & Co., Inc. - Analyst [23]

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Yes, and I think that one point you need to make is, on this Xcede deal, is that, I mean, you personally lost as much or more money on it as anyone. I mean, you were funding it, too. So it's not like -- you have a great vested interest in wanting to succeed. So you're not casually walking away on this deal either. So...

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [24]

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It was very disappointing when we got the results back from the European training session with the doctors because we literally we thought we were going into clinical trials within a week, and it was -- and this is after massive amounts of work, toxicology studies. I mean, huge amounts of work necessary to get us to this point and -- so anyway...

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Timothy Clarkson, Van Clemens & Co., Inc. - Analyst [25]

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Yes, it is water under -- gone, but, I mean, it was a tough deal not only for the company, but for you personally. So...

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [26]

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Yes. Yes. Tim, I more than expect to make it up on my Dynasil investment.

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Timothy Clarkson, Van Clemens & Co., Inc. - Analyst [27]

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Well, there you go. There you go. Well, I do appreciate that and I do appreciate that you're putting your money where your mouth is. And I was inspired today on the stock and it's a weird business and -- but Dynasil's been around a long time and I know you're doing everything you can to revitalize it. So...

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [28]

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Yes. All right. Thank you very much.

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Operator [29]

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(Operator Instructions) And at this time, I am seeing no further questions. I would now like to turn the conference back over to Mr. Sulick for any closing remarks.

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [30]

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Thank you all for participating in our first quarter 2019 fiscal year results analyst call. We'll be back again after our second quarter...

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Patricia M. Kehe, Dynasil Corporation of America - Corporate Secretary [31]

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In May.

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Robert Joseph Bowdring, Dynasil Corporation of America - Principal Accounting Officer & CFO [32]

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In May.

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Peter Sulick, Dynasil Corporation of America - Chairman, President & CEO [33]

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So good evening.

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Operator [34]

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