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, 2012.

General Business Overview

On December 31, 2012, the Company announced it is in default of certain financial covenants set forth in the terms of its outstanding indebtedness with respect to its fiscal year ended September 30, 2012. Under the default condition, our lenders have the ability to require immediate payment of all indebtedness under our loan agreements. While the lenders have not exercised this right, their ability to require immediate payment has caused all of our outstanding indebtedness to be accelerated to current classification on our consolidated financial statements.

The Company continues to be current with all principal and interest payments due on all its outstanding indebtedness and management expects to continue discussions with its lenders to address the financial covenant situation. However, the Company cannot predict when or whether a resolution of this situation will be achieved.

Given the uncertainty created by the defaults under the Company's outstanding indebtedness, the Company's independent registered public accounting firm has included a "going concern" qualification in its audit opinion for the year ended September 30, 2012.

Revenue for the first quarter of fiscal year 2013, which ended December 31, 2012, was $10.6 million, a decrease of 13.0% compared with revenue of $12.1 million for the quarter ended December 31, 2011. The decrease in revenue was primarily in the Contract Research and Instruments segments. Contract Research revenues declined $1.3 million or 21.1% primarily as a result of lower billable material and subcontractor costs. Contract revenue backlog continues to be strong at approximately $33.3 million. The Instruments segment revenues declined $699,000 or 35.3% primarily due to delays by customers of purchases of the existing products in anticipation of the availability of newly refreshed products which have not yet been approved by the necessary regulatory agencies.

Cost of Revenue for the first quarter of 2013 was $5.9 million, a decrease of 15.4% compared with $7.0 million for the quarter ended December 31, 2011. Total operating expenses decreased $122,000 or 2.5% to $4.8 million from the three month period ended December 31, 2011.

Loss from Operations for the quarter ended December 31, 2012 was ($191,000) compared with Income from Operations of $186,000 for the quarter ended December 31, 2011. Loss before Taxes for the quarter was ($378,000) compared with Income before Taxes of $62,000 for the quarter ended December 31, 2011. Net Loss was ($379,000) or ($0.03) per share for the quarter ended December 31, 2012, compared with Net Income of $370,000, or $0.02 per share, for the quarter ended December 31, 2011.

We continue to invest in efforts to support growth initiatives for organic product development of specific product lines within Instruments, our dual mode detector commercialization effort within Contract Research and development of Biomedical technologies. These investments include technology development activities, capital equipment depreciation, development of intellectual property, and staff additions. The dual mode detector technology is producing revenue while still under development. We are currently delivering limited quantities of commercial grade crystals now and are working to further improve the size and quality of this product. Also, at the current time, the Company is actively exploring commercialization opportunities in thin film digital x-rays, sensors for nondestructive testing and radiation dosimeters based on technologies developed in the Contracts Research segment. Additionally, Dynasil has prepared a separate business and financing plan for one of the biomedical technologies. Our intention is to spin out the tissue sealant technology into an independent entity in which Dynasil will retain a substantial interest. This will accomplish both the elimination of some of the G&A support for these technologies as well as enable us to recruit additional expertise to help us advance the technology. While we expect to complete this financing plan in the next three months, we do not have definitive agreements, lender approval or commitments from investors and there can be no assurance that we can consummate this transaction in that timeframe or at any future time.

Commercialization of technology from our extensive research and development portfolio and strategic acquisitions are expected to be the key 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.

Results of Operations



                         Results of Operations for the Three Months Ended December 31,
                                                     2012
                                  Contract
                                  Research          Optics        Instruments      Biomedical         Total
Revenue                            4,910,840        4,251,940        1,284,038         106,457       10,553,275
Gross Profit                       2,214,053        1,700,555          605,801         106,457        4,626,866
Operating Income (Loss)                 (606 )        385,676         (455,694 )      (120,663 )       (191,287 )

Depreciation and Amortization         62,782          185,628          163,048          15,000          426,458
Capital expenditures                 186,330          122,146            7,092               -          315,568

Intangibles, Net                     339,886          946,525        5,016,201         224,996        6,527,608
Goodwill                           4,938,625        1,310,802        4,015,072               -       10,264,499
Total Assets                      13,290,669       10,607,828       12,092,507         388,671       36,379,675




                         Results of Operations for the Three Months Ended December 31,
                                                     2011
                                  Contract
                                  Research          Optics        Instruments      Biomedical         Total
Revenue                            6,225,283        3,912,551        1,983,536          10,925       12,132,295
Gross Profit                       2,440,288        1,462,418        1,251,423         (27,181 )      5,126,948
Operating Income (Loss)              145,217          164,123           79,544        (202,556 )        186,328

Depreciation and Amortization         37,160          193,503          134,457          15,000          380,120
Capital expenditures                 262,020          140,876            2,445               -          405,341

Intangibles, Net                     429,400        1,075,619        5,493,933         285,000        7,283,952
Goodwill                           4,938,625        1,283,775        6,299,571               -       12,521,971
Total Assets                      11,284,826       13,692,936       15,351,880         384,688       40,714,330

Revenue for the three months ended December 31, 2012 was $10,553,275, a 13.0% decrease from $12,132,295 for the three months ended December 31, 2011. Revenue from our Contract Research segment decreased $1,314,443 or 21.1% while revenue from our Instruments segment decreased $699,498 or 35.3%. The Contract Research segment revenue decline primarily reflects lower billable material and subcontractor costs during the three months ended December 31, 2012 compared to the three months ended December 31, 2011. The research backlog for the Contracts research segment has remained consistent at nearly 18 months. The Company expects the Contract Research revenue to continue to be below the prior year in the quarter ending March 31, 2012. We believe the Instruments segment revenue decline is a result of customers delaying purchases of our existing products in anticipation of the availability of newly refreshed products which have not yet been approved by the necessary regulatory agencies. We have taken steps to reduce costs while awaiting regulatory approvals which are expected imminently but the timing is as yet unknown. Further, there can be no assurance when or if regulatory approvals will be obtained. We believe that without and until we obtain regulatory approvals, product revenues in the Instruments segment will continue to deteriorate. The Optics segment revenue increased $339,389 or 8.7% for the three months ended December 31, 2012, primarily as a result of the timing and mix of product sales. The Biomedical segment revenues primarily relate to a technology development contract with the Mayo Clinic.

Gross Profit for the three months ended December 31, 2012 was $4,626,866, or 43.8% of sales, compared to $5,126,948 or 42.3% of sales for the three months ended December 31, 2011. Gross profit as a percent of sales increased for the Contract Research segment to 45.1% at December 31, 2012 from 39.2% at December 31, 2011 primarily as a result of timing of certain non-billable costs and the level of profitability of the contracts in process during the respective periods. Gross profit for the Instruments segment decreased to 47.2% of sales at December 31, 2012 from 63.1% of sales for the quarter ended December 31, 2011 as a result of lower product volumes and unfavorable manufacturing efficiencies. Gross profit for the Optics segment increased to 40.0% of sales at December 31, 2012 from 37.4% of sales for the quarter ended December 31, 2011 primarily as a result of better margins on the mix of products sold. The Biomedical segment gross profit equals its revenue because the cost of the funded research is included in research and development expense beginning in fiscal 2013.

Total operating expenses for the three months ended December 31, 2012 decreased slightly to $4,818,153, or 45.7% of sales compared to $4,940,620 or 40.7% of sales for the three months ended December 31, 2011. The decrease in total operating expenses includes an approximate $600,000 decrease in general and administrative expenses associated with the product refresh within the Instruments segment, partially offset by increased personnel costs in the other segments.

Loss from Operations for the three months ended December 31, 2012 was ($191,287) compared to Income from Operations of $186,328, a decrease of $377,615 from the prior year comparable period. The decrease was primarily associated with the lower sales in the Contracts Research and Instruments segments discussed above as well as higher costs measured as a percentage of sales in the Instruments segment. The increase in operating income in the Optics and Biomedical segments primarily reflect the increase in revenue and improved gross profit discussed above.

Net interest expense for the three months ended December 31, 2012 was $186,757, compared with $124,157 for the three months ended December 31, 2011. The increase in interest expense was primarily associated with the issuance of a $3 million subordinated note payable in July, 2012 at an interest rate of 10%. Interest-bearing debt outstanding at December 31, 2012 was $11,511,905, compared to $11,984,492 at September 30, 2012.

Income tax expense for the three months ended December 31, 2012 consisted primarily of state tax expense offset by the estimated NOL carryback to 2011 and certain U.K. tax research credits. The Company recorded a tax benefit of $308,000 for the three months ended December 31, 2011 primarily from the recognition of Research and Experimentation credits and certain state tax losses.

Net Loss for the three months ended December 31, 2012 was ($379,342), or ($0.03) in basic earnings per share, compared with Net Income of $370,338, or $0.02 in basic earnings per share, for the quarter ended December 31, 2011.

Liquidity and Capital Resources

Liquidity Overview

On December 31, 2012, the Company announced it is in default of the financial covenants set forth in the terms of its outstanding indebtedness at September 30, 2012. These covenants require the Company to maintain specified ratios of earnings before interest, taxes, depreciation and amortization (EBITDA) to fixed charges and to total/senior debt. The Company continues to be current with all principal and interest payments due on all its outstanding indebtedness and management expects to continue discussions with its lenders to address the financial covenant situation.

These financial covenant defaults give the lenders the right to accelerate the maturity of the indebtedness outstanding and foreclose on any security interest. Furthermore, Sovereign Bank, N.A, the Company's senior lender, may, at its option, impose a default interest rate with respect to the senior debt outstanding, which is 5% higher than the rate otherwise in effect. To date, the lenders have not taken any such actions.

As of December 31, 2012, the Company had total indebtedness outstanding of approximately $12 million, consisting of approximately $9.0 million of senior debt owed to Sovereign Bank and approximately $3.0 million of subordinated debt owed to Massachusetts Capital Resources Company. The Company's indebtedness is secured by substantially all the accounts and assets of the Company and is guaranteed by its subsidiaries.

The causes for the covenant violations are lower revenue and higher than expected expenses in the Company's Instruments and Contract Research segments during the fiscal quarter ended September 30, 2012 and continuing into the first quarter of fiscal 2013, combined with the continued investment in its Biomedical technologies and its Dual Mode nuclear detection initiative. In addition, the Company incurred a significant, non-recurring charge in the fourth quarter of 2012 of approximately $466,000 to its selling, general and administrative expenses related to costs incurred as a result of a review, under the direction of the Audit Committee of the Board, of certain cash application processes and billing practices of the RMD division. This investigation has been completed and has resulted in modifications in the division's practices and internal controls. The Company does not anticipate additional expenses for this matter.

Management expects to continue discussions with its lenders to address the financial covenant defaults as of September 30, 2012 as described above. These financial covenant defaults continued through the first quarter of fiscal 2013. The Company cannot predict when or whether a resolution of this situation will be achieved.

The Company has recently taken and will continue to take actions to improve its liquidity, including the implementation of a number of initiatives designed to conserve cash, optimize profitability and right-size the cost structure of its various businesses. The Company has retained Argus Management Corporation and Mirus Capital as financial advisors to assist it in evaluating strategic and restructuring alternatives, including the potential sale of product lines and/or a Company division. While the Company is actively considering such strategic alternatives, there can be no assurances that any such transaction will occur, or, if a transaction is completed, it will be on terms favorable to the Company.

Liquidity Outlook

Net cash as of December 31, 2012 was $2,472,900 or approximately $943,000 less than the net cash of $3,414,880 at September 30, 2012. The Company does not currently have cash available to satisfy its obligations under its indebtedness if it were to be accelerated or payment demanded. If the Company is not able to resolve its current defaults under its outstanding indebtedness and improve its liquidity through the actions described above, it may not have sufficient liquidity to meet its anticipated cash needs for the next twelve months.

Cash Provided by (Used in) Operating Activities

In total, including the changes accounts receivable and accounts payable and accrued expenses, operating activities used cash of $223,000 for the three months ended December 31, 2012.

Cash Used in Investing and Financing Activities

Cash used for the purchase of property, plant and equipment for the three months ended December 31, 2012 was approximately $316,000. Payments of long term debt for the three months ended December 31, 2012 were $473,000 primarily as part of regularly scheduled payments to Sovereign Bank, N.A., the Company's senior lender, under the five year Term Debt and Acquisition Line of Credit. Net cash used in financing activities was approximately $466,000 for the three months ended December 31, 2012.

Critical Accounting Policies and Estimates

There have been no material changes in our critical accounting policies or critical accounting estimates since September 30, 2012. We have not adopted any accounting policies since September 30, 2012 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, 2012 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.

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, Dynasil Products (previously known as RMD Instruments), which is a component of our Instruments segment, and Hilger Crystals, also 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 $2,284,499 in the quarter ended September 30, 2012.

Intangible Assets

The Company's intangible assets consist of an acquired customer base of Optometrics, LLC, acquired customer relationships and trade names of RMD Instruments, LLC, and acquired backlog and 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. No impairment charge was recorded during the periods ended December 31, 2012 and 2011.

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.

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.

RECENTLY ISSUED ACCOUNTING STANDARDS

In June 2011, the FASB issued Accounting Standards Update 2011-05 ("ASU 2011-05"), Comprehensive Income (Topic 220), Presentation of Comprehensive Income. ASU 2011-05 eliminates the current option to report other comprehensive income and its components in the statement of changes in stockholder's equity. In addition, the new guidance requires consecutive presentation of the statement of net income and other comprehensive income with the presentation of reclassification adjustments from other comprehensive income to net income on the face of the financial statements. In December 2011, the FASB issued Accounting Standards Update 2011-12 ("ASU 2011-12"), Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, which is an update to ASU 2011-05. This amendment indefinitely defers the guidance relating to the presentation of reclassification adjustments. ASUs 2011-05 and 2011-12 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. The Company adopted ASU 2011-05 and ASU 2011-12 effective March 31, 2012 with the effect being a change in financial statement presentation.

In September 2011, the FASB issued Accounting Standards Update 2011-08 ("ASU 211-08"), Intangibles-Goodwill and Other (Topic 350), Testing Goodwill for Impairment, to simplify how entities test goodwill for impairment. ASU 2011-08 allows entities to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If a greater than 50 percent likelihood exists that the fair value is less than the carrying amount, then a two-step goodwill impairment test as described in Topic 350 must be performed. The qualitative assessment is optional, allowing companies to go directly to the quantitative assessment. The guidance provided by this update becomes effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. This new standard is effective for the Company beginning in fiscal 2013. The Company does not expect it to have a material impact on its consolidated financial statements.

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The amendments result in a consistent definition of fair value and common requirements for measurement of and disclosure regarding fair value between U.S. GAAP and International Financial Reporting Standards. Specifically, the amendments clarify the application of existing fair value measurement and disclosure requirements, including: a) application of the highest and best use and valuation premise concepts, b) measurement of the fair value of an instrument classified in a reporting entity's shareholders equity, and c) quantitative disclosure about the unobservable inputs used in a fair value measurement that is categorized within Level 3 of the fair value hierarchy. The amendments also change a particular principle or requirement for fair value measurement and disclosure, including:
a) measurement of the fair value of financial instruments that are managed . . .