Note 2 – Recent Accounting Pronouncements

Revenue from Contracts with Customers. Effective October 1, 2018, the Company adopted Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers, and all the related amendments using the modified retrospective transition method. Under the modified retrospective approach, the Company applied the standards to new contracts and those that were not completed as of October 1, 2018 which resulted in a cumulative adjustment to increase the retained earnings in the amount of $22,000. Prior periods will not be retrospectively adjusted, but the Company will maintain dual reporting for the year of initial application in order to maintain comparability of the periods presented. The cumulative effect of the changes made to the October 1, 2018 unaudited consolidated balance sheet for the adoption of Topic 606 was as follows:


	Balance at	Adjustment for	Adjusted balance at
	September 30, 2018	Topic 606	October 1, 2018
Assets:
Unbilled receivables	1,214,000	40,000	1,254,000
Inventories, net of reserves	4,106,000	(18,000)	4,088,000

Liabilities:

Contract liabilities	253,000	—	253,000

Stockholders’ equity:
Retained earnings	841,000	22,000	863,000

Contract assets were formerly reported within costs in excess of billings and unbilled receivables. Contract liabilities were formerly reported as deferred revenue. The titles have been changed in the table below to be consistent with accounts currently used under the new standard.


	September 30, 2018
	As Reported	As Adopted
Unbilled receivables	1,215,000	1,214,000
Contract assets	—	1,000
Security and other deposits	65,000	58,000
Long term contract assets	—	7,000
Deferred revenue	253,000	—
Contract liabilities	—	253,000

The Company receives payments from customers based on a billing schedule as established in our contracts. Contract asset relates to our conditional right to consideration for our completed performance under the contract. Accounts receivable are recorded when the right to consideration becomes unconditional. Contract liability relates to payments received in advance of performance under the contract. Contract liabilities are recognized as revenue as (or when) we perform under the contract. The Company recognized revenue in the amount of $0 during the three months ended June 30, 2019 and $253,000 during the nine months ended June 30, 2019 for amounts included in the contract liability balance at September 30, 2018.

Under the new standard, most contracts in the Innovation and Development (formerly Contract Research) segment, which primarily provide contract research services, were not materially impacted upon the adoption of Topic 606 as revenue will continue to be recognized over time. Contracts in the Optics segment generally provide for the following revenue sources: standard product sales, custom product development and sales, and non-recurring engineering contracts. Revenues for this segment are recognized using either the “point in time” or “over time” methods of Topic 606, depending upon the revenue source. The change in revenue recognition for the Optics segment related to certain custom optics products and the related non-recurring engineering costs which changed from “point in time” to “over time” upon the adoption of Topic 606. This change will result in the recognition of revenue over time when compared to existing standards with the cumulative adjustment relating to contracts that are not complete as of September 30, 2018 recognized as an adjustment of $22,000 to opening retained earnings on October 1, 2018. The revenue for the standard products will be recognized using the "point in time" model of Topic 606, and the timing of such revenue recognition is not expected to differ materially from the historical revenue recognition. Other immaterial adjustments related to the Optics segment that are sometimes offered to customers include customer rights of return and volume discounts. The Company has elected the practical expedient that the Company will not be required to adjust promised amounts of consideration for the effects of a significant financing component if the transfer of promised goods or services will occur in one year or less.

The impact of the adoption of ASC 606 on the Company’s consolidated financial statements for the three and nine months ended June 30, 2019 was immaterial as compared to what would have been reported under the previous guidance.

Innovation and Development Segment Revenues

The Company performs research and development for U.S. Federal government agencies, educational institutions and commercial organizations. The Company accounts for a research contract when a contract has been executed, the rights of the parties are identified, payment terms are identified, the contract has commercial substance, and collectability of the contract price is considered probable. Revenue is earned under reimbursement of costs plus fees, fixed price, or time and material type contracts.

The Company’s contracts with agencies of the U.S. government are subject to periodic funding by the respective contracting agency. Funding for a contract may be provided in full at inception of the contract or ratably throughout the contract as the services are provided. In evaluating the probability of funding for purposes of assessing collectability of the contract price, the Company considers previous experience with the customers, communication with the customers regarding funding status, and knowledge of available funding for the contract or program. If funding is not assessed as probable, revenue recognition is deferred until realization is reasonably assured.

Under the typical payment terms of the Company’s U.S. government contracts, the customer pays either performance-based payments or progress payments. Performance-based payments, which are typically used in the firm fixed price contracts, are interim payments based on quantifiable measures of performance or on the achievement of specified events or milestones. Progress payments, which are typically used in the Company’s cost-plus type contracts, are interim payments based on costs incurred as the work progresses. For the Company’s U.S. government cost-plus contracts, the customer generally pays during the performance period for 80%‑90% of the actual costs incurred. Because the customer retains a small portion of the contract price until completion of the contract and audit of allowable costs, cost-plus type contracts generally result in revenue recognized in excess of billings which the Company presents as contract assets on the balance sheet. Amounts billed and due from customers are classified as receivables on the balance sheet, whereas amounts earned, but not yet billed to the Company’s customers due to timing, are classified as unbilled receivables on the balance sheet. The Company recognizes a liability for performance-based payments paid in advance which are in excess of the revenue recognized and presents these amounts as contract liabilities on the balance sheet.

To determine the proper revenue recognition method for research and development contracts, the Company evaluates whether two or more contracts should be combined and accounted for as one single modified contract and whether the combined or single contract should be accounted for as more than one performance obligation. For instances where a contract has options that were bid with the initial contract and awarded at a later date, the Company combines the options with the original contract when options are awarded. For most contracts, the customer contracts for research with multiple milestones that are interdependent, thus, the entire contract is accounted for as one performance obligation. The effect of the combined or modified contract on the transaction price and measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.

Contract revenue recognition is measured over time as the Company performs the work because of continuous transfer of knowledge and control to the customer. For U.S. government contracts which are typically subject to the Federal Acquisition Regulation ("FAR"), this continuous transfer of knowledge and control to the customer is supported by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay for cost incurred plus a reasonable profit, and take control of any work in process. From time to time, as part of normal management processes, facts may change, causing revisions to estimated total costs or revenues expected. The cumulative impact of any revisions to estimates and the full impact of anticipated losses on any type of contract are recognized in the period in which they become known.

Because of knowledge and control transferring over time, revenue is recognized based on the extent of progress towards completion of the performance obligation. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the services to be provided. The Company generally uses the input method, more specifically the cost-to-cost measure of progress for the contracts because it best depicts the transfer of knowledge and control to the customer which occurs as the Company incur costs on these contracts. Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. The underlying bases for estimating contract research revenues are measurable expenses, such as labor, subcontractor costs and materials, and data that are updated on a regular basis for purposes of preparing cost estimates. The Company’s research contracts generally have a period of performance of nine months to three years, and estimates of contract costs have historically been consistent with actual results. Revisions in these estimates between accounting periods to reflect changing facts and circumstances have not had a material impact on operating results, and the Company does not expect future changes in these estimates to be material. The cumulative impact of any revisions to estimates and the full impact of anticipated losses on any type of contract are recognized in the period in which they become known.

Under cost-plus contracts, the Company is reimbursed for costs that are determined to be reasonable, allowable and allocable to the contract and paid a fixed fee representing the profit negotiated between the Company and the contracting agency. Revenue from cost-plus contracts is recognized as costs are incurred plus an estimate of applicable fees earned. The Company considers fixed fees under cost-plus contracts to be earned in proportion to the allowable costs incurred in performance of the contract.

Revenue from time and materials contracts is recognized based on direct labor hours expended at contract billing rates plus other billable direct costs. The Company has elected the practical expedient to recognize revenue in the amount for which it has the right to invoice the customer, provided that invoiced amount corresponds directly with the value to the customer of the Company’s performance to date.

Fixed price contracts may include either a product delivery or specific service performance throughout a period. For fixed price contracts that are based on the proportional performance method and involve a specified number of deliverables, the Company recognizes revenue based on the proportion of the cost of the deliverables compared to the cost of all deliverables included in the contract as this method more accurately measures performance under these arrangements. For fixed price contracts that provide for the development and delivery of a specific prototype or product, revenue is recognized based upon the performance completed to date, using an output method of revenue recognition based on milestones reached.

Whether certain costs under government contracts are allowable is subject to audit by the government. Certain indirect costs are charged to contracts using provisional or estimated indirect rates, which are subject to later revision based on government audits of those costs. Management is of the opinion that costs subsequently disallowed, if any, would not likely have a significant impact on revenues recognized for those contracts.

Optics Segment Revenues

The Company produces standard and customized products for commercial organizations, educational institutions, and U.S. Federal government agencies. In addition, the Company also offers services which include non-recurring engineering services. To determine the proper revenue recognition method for Optics contracts, the Company evaluates whether two or more contracts should be combined and accounted for as one single contract and whether the combined or single contract should be accounted for as more than one performance obligation. The Company recognizes revenue when the performance obligation has been satisfied by transferring the control of the product or service to the customer. For contracts with multiple performance obligations, the Company allocates the contract’s transaction price to each performance obligation based on their relative stand-alone selling prices. In such circumstances, the Company uses the observable price of goods or services which are sold separately in similar circumstances to similar customers. If these prices are not observable, then the Company will estimate the stand-alone selling price using information that is reasonably available. For the majority of the Company’s standard products and services, price list, and discount structures related to customer type are available. For products and services that do not have price list and discount structures, the Company may use one or more of the following: (i) adjusted market assessment approach or (ii) expected cost plus a margin approach. The adjusted market approach requires evaluation of the market in which the Company sells goods or services and estimates the price that a customer in that market would be willing to pay for those goods or services. The expected cost plus margin approach requires the Company to forecast expected costs of satisfying the performance obligation and then add a reasonable margin for that good or service. Shipping and handling activities primarily occur after a customer obtains control and are considered fulfillment cost rather than separate performance obligations. Similarly, sales and similar taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected by the entity from a customer are excluded from the measurement of the transaction price.

Unfulfilled Performance Obligations

For standard products, the Company recognizes revenue at a point in time when control passes to the customer. Absent substantial product acceptance clauses, this is based on the shipping terms. For custom products that require engineering and development based on customer requirements and provide for cost plus reasonable margin throughout the contract, the Company recognizes revenue over time using the output method for any items shipped and any finished goods or work in process that is produced for balances of open sales orders. For any finished goods or work in process that has been produced for the balance of open sales orders the Company recognizes revenue by applying the average selling price for such open order to the lesser of the on hand balance in finished goods or open sales order quantity which the Company presents as a contract asset on the balance sheet. Cost of sales is recognized based on the standard cost of the finished goods and work in process associated with this revenue and inventory balances are reduced accordingly.

Unfulfilled performance obligations represent amounts expected to be earned on executed contracts. Indefinite delivery and quantity contracts and unexercised options are not reported in total unfulfilled performance obligations. Unfulfilled performance obligations include funded obligations, which is the amount for which money has been directly authorized by the U.S. government and by a commercial customer for which a purchase order has been received, and unfunded obligations, representing firm orders for which funding has not yet been appropriated. The approximate value of our Innovation and Development segment unfulfilled performance obligations was $38.3 million at June 30, 2019. The Company expects to satisfy 34% of the performance obligations in fiscal year 2019, 55% in fiscal year 2020, and the remaining amount by fiscal year 2021. The approximate value of our Optics segment unfulfilled performance obligations was $7.0 million at June 30, 2019. The Company expects to satisfy 53% of the performance obligations in fiscal year 2019 and 47% in fiscal year 2020.

The Company disaggregates revenue from contracts with customers by geographic locations, customer-type, contract type, timing of recognition, and major categories for each segments, as the Company believes it best depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors. See details in the tables below.


	Three Months Ended June 30, 2019						Nine Months Ended June 30, 2019
			Innovation &						Innovation &
	Optics		Development		Total		Optics		Development		Total
Total Revenue by Geographic Location
United States	$	3,688,000	$	4,981,000	$	8,669,000	$	10,567,000	$	14,334,000	$	24,901,000
Asia		667,000		—		667,000		2,440,000		22,000		2,462,000
Europe		1,422,000		46,000		1,468,000		4,608,000		97,000		4,705,000
Other		122,000		164,000		286,000		231,000		351,000		582,000
Total	$	5,899,000	$	5,191,000	$	11,090,000	$	17,846,000	$	14,804,000	$	32,650,000

Total Revenue by Contract Type
Firm-fixed price	$	5,899,000	$	500,000	$	6,399,000	$	17,846,000	$	1,663,000	$	19,509,000
Non-Firm Fixed price		—		4,691,000		4,691,000		—		13,141,000		13,141,000
Total	$	5,899,000	$	5,191,000	$	11,090,000	$	17,846,000	$	14,804,000	$	32,650,000

Total Revenue by Major Customer Type
U.S. government revenue	$	53,000	$	4,856,000	$	4,909,000	$	56,000	$	14,072,000	$	14,128,000
U.S. commercial revenue		3,634,000		125,000		3,759,000		10,511,000		262,000		10,773,000
Foreign commercial and other revenue		2,212,000		210,000		2,422,000		7,279,000		470,000		7,749,000
Total	$	5,899,000	$	5,191,000	$	11,090,000	$	17,846,000	$	14,804,000	$	32,650,000

Total Revenue by Major Products/Services
Optical components	$	5,850,000	$	—	$	5,850,000	$	17,682,000	$	—	$	17,682,000
Contract research		—		5,009,000		5,009,000		—		14,430,000		14,430,000
Other products and services		49,000		182,000		231,000		164,000		374,000		538,000
Total	$	5,899,000	$	5,191,000	$	11,090,000	$	17,846,000	$	14,804,000	$	32,650,000

Total Revenue by Timing of Recognition
Goods/services transferred over time	$	712,000	$	5,017,000	$	5,729,000	$	1,780,000	$	14,456,000	$	16,236,000
Goods transferred at a point in time		5,187,000		174,000		5,361,000		16,066,000		348,000		16,414,000
Total	$	5,899,000	$	5,191,000	$	11,090,000	$	17,846,000	$	14,804,000	$	32,650,000

Service Concession Arrangements (Topic 853): Determining the Customer of the Operation Services. In May 2017, the FASB issued ASU 2017‑10 which provides guidance for operating entities when they enter into a service concession arrangement with a public-sector grantor. This update is effective for the Company in the fiscal year beginning October 1, 2018, at the time the Company adopted Accounting Standards Update No. 2014‑09, Revenue from Contracts with Customers (Topic 606). The Company implemented this ASU on October 1, 2018 and it did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. In October 2016, the FASB issued ASU 2016‑16 which eliminates the exception, other than for inventory transfers, under current U.S. GAAP under which the tax effects of intra-entity asset transfers (intercompany sales) are deferred until the transferred asset is sold to a third party or otherwise recovered through use. Upon adoption of ASU 2016‑16, the Company will recognize the tax expense from the sale of that asset in the seller’s tax jurisdiction when the transfer occurs, even though the pre-tax effects of that transaction are eliminated in consolidation. Any deferred tax asset that arises in the buyer’s jurisdiction would also be recognized at the time of the transfer. Modified retrospective adoption is required with any cumulative-effect adjustment recorded to retained earnings as of the beginning of the period of adoption. The cumulative-effect adjustment, if any, would consist of the net impact from (1) the write-off of any unamortized tax expense previously deferred and (2) recognition of any previously unrecognized deferred tax assets, net of any necessary valuation allowances. The impact of the adoption of this standard on future periods will be dependent on future asset transfers, which generally occur in connection with acquisitions and other business structuring activities. The Company implemented this ASU on October 1, 2018 and it did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

Business Combinations (Topic 805): Clarifying the Definition of a Business. In January 2017, the FASB issued ASU 2017‑01 which clarifies the definition of a business for determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The Company implemented this ASU on October 1, 2018 and it did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting. In May 2017, the FASB issued ASU No. 2017‑09 which was issued to clarify and reduce both (i) diversity in practice and (ii) cost and complexity when applying the guidance in Topic 718, “Compensation – Stock Compensation” to changes in the terms and conditions of a share-based payment award. This update is effective for the Company in the fiscal year beginning October 1, 2018. The adoption of this standard did not have a material impact on the Company’s consolidated financial position, results of operations, or cash flows.

Leases (Topic 842). In February 2016, the FASB issued ASU 2016‑02 (as subsequently amended by ASU 2018‑01, ASU 2018‑10, ASU 2018‑11 and ASU 2018‑20) which requires that a lessee recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. As with previous guidance, there continues to be a differentiation between finance leases and operating leases, however this distinction now primarily relates to differences in the manner of expense recognition over time and in the classification of lease payments in the statement of cash flows. Lease assets and liabilities arising from both finance and operating leases will be recognized in the statement of financial position. ASU 2016‑02 leaves the accounting for leases by lessors largely unchanged from previous GAAP. The transitional guidance for adopting the requirements of ASU 2016‑02 calls for a modified retrospective approach that includes a number of optional practical expedients that entities may elect to apply. In addition, ASU 2018‑11 provides for an additional (and optional) transition method by which entities may elect to initially apply the transition requirements in Topic 842 at that Topic’s effective date with the effects of initially applying Topic 842 recognized as a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption and without retrospective application to any comparative prior periods presented. Also, ASU 2018‑20 provides certain narrow-scope improvements to Topic 842 as it relates to lessors. The guidance in ASU 2016‑02 will become effective for the Company as of the beginning of the 2020 fiscal year. The Company is reviewing vendor relationships and assessing the impact of this ASU on its consolidated financial statements with the intention to adopt this ASU in fiscal year 2020.

Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. In January 2017, the FASB issued ASU 2017‑04 which simplifies the test for goodwill impairment by eliminating Step 2 from the Goodwill impairment test. This new guidance is effective for the Company beginning in fiscal year 2021. The adoption of this standard is not expected to have a material impact on the Company’s financial statements.

Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, including Accounting Standards Update (ASU) 2016-13. In June 2016, the FASB issued ASU 2016-13 which significantly changes how entities account for credit losses for financial assets and certain other instruments, including trade receivables and contract assets that are not measured at fair value through net income. The ASU requires a number of changes to the assessment of credit losses, including the utilization of an expected credit loss model, which requires consideration of a broader range of information to estimate expected credit losses over the entire lifetime of the asset, including losses where probability is considered remote. Additionally, the standard requires the estimation of lifetime expected losses for trade receivables and contract assets that are classified as current. The Company is reviewing the effect of the ASU on its results of operations, financial condition, and cash flows.