Blueprint
UNITED
STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark
One)
☑
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the
fiscal year ended June 30, 2018.
or
☐
TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the
transition period from __________ to ____________.
Commission
file number 0-12697
Dynatronics Corporation
(Exact
name of registrant as specified in its charter)
Utah
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87-0398434
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(State
or other jurisdiction of incorporation or
organization)
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(I.R.S.
Employer Identification No.)
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7030 Park Centre Drive, Cottonwood Heights, Utah 84121
(Address
of principal executive offices, Zip Code)
Registrant’s
telephone number, including area code: (801) 568-7000
Securities
registered under Section 12(b) of the Exchange Act:
None
Securities
registered under Section 12(g) of the Exchange Act:
Common Stock, no par value
(Title
of class)
Indicate
by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes ☐
No ☑
Indicate
by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes
☐ No ☑
Indicate
by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes ☑ No ☐
Indicate
by check mark whether the registrant has submitted electronically
and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405
of Regulation S-T (§ 232.405 of this chapter) during the
preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files). Yes
☑ No ☐
Indicate
by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ☐
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated filer, a
smaller reporting company, or an emerging growth company. See the
definitions of “large accelerated filer,”
“accelerated filer” “smaller reporting
company,” and “emerging growth company” in Rule
12b-2 of the Exchange Act.
Large
accelerated filer ☐
|
Accelerated
filer ☐
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Non-accelerated
filer ☐ (Do not check if a smaller
reporting company)
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Smaller
reporting company ☑
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Emerging
growth company ☐
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|
If an
emerging growth company, indicate by check mark if the registrant
has elected not to use the extended transition period for complying
with any new or revised financial accounting standards provided
pursuant to Section 13(a) of the Exchange Act.
☐
Indicate by check
mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes ☐ No ☑
The
aggregate market value of the common stock held by non-affiliates
of the registrant as of December 31, 2017 (the last day of the
registrant’s most recently completed second fiscal quarter),
was approximately $12.4 million, based upon the closing sale price
of the common stock as reported by the NASDAQ Capital Market on
December 29, 2017, the last business day prior to such
date.
As of
September 14, 2018, there were 8,161,029 shares of the
registrant’s common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The
registrant incorporates information required by Part III (Items 10,
11, 12, 13, and 14) of this report by reference to portions of the
registrant’s definitive proxy statement with respect to its
2018 Annual Meeting of Shareholders to be filed with the Securities
and Exchange Commission within 120 days after the close of
thefiscal year ended June 30, 2018,
pursuant to Regulation 14A.
TABLE OF
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Cautionary Note Regarding Forward-Looking Statements
This
Annual Report on Form 10-K, including documents incorporated
herein by reference, contains “forward-looking
statements” within the meaning of the U.S. Private Securities
Litigation Reform Act of 1995 and Section 21E of the
Securities Exchange Act of 1934, as amended (the “Exchange
Act”). These forward-looking statements include, but are not
limited to: any projections of net sales, earnings, or other
financial items; any statements of the strategies, plans and
objectives of management for future operations; any statements
concerning proposed new products or developments; any statements
regarding future economic conditions or performance; any statements
of belief; and any statements of assumptions underlying any of the
foregoing. Forward-looking statements can be identified by their
use of such words as “may,” “will,”
“estimate,” “intend,”
“continue,” “believe,”
“expect,” or “anticipate” and similar
references to future periods.
Forward-looking
statements are neither historical facts nor assurances of future
performance. Instead, they are based only on our current beliefs,
expectations and assumptions regarding the future of our business,
future plans and strategies, projections, anticipated events and
trends, the economy and other future conditions. Because
forward-looking statements relate to the future, they are subject
to inherent uncertainties, risks and changes in circumstances that
are difficult to predict and many of which are outside of our
control. Our actual results and financial condition may differ
materially from those indicated in the forward-looking statements.
Therefore, you should not rely on any of these forward-looking
statements. Important factors that could cause our actual results
and financial condition to differ materially from those indicated
in the forward-looking statements include, among others, those that
are discussed in "Part I, Item 1A. Risk Factors" and
throughout "Part II, Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations." Readers
are cautioned that actual results could differ materially from the
anticipated results or other expectations that are expressed in
forward-looking statements within this report. The forward-looking
statements included in this report speak only as of the date
hereof, and we undertake no obligation to publicly update or revise
any forward-looking statement, whether as a result of new
information, future events or otherwise, except as required by
law.
Company Background and Recent Developments
Dynatronics
Corporation designs, manufactures, markets, and distributes
orthopedic soft goods, medical supplies, and physical therapy and
rehabilitation equipment. Through our various distribution
channels, we market and sell to orthopedists, physical therapists,
chiropractors, athletic trainers, sports medicine practitioners,
clinics, and
hospitals.
We
conduct our operations at our headquarters in Cottonwood Heights,
Utah, a suburb of Salt Lake City, and in other facilities located
in Chattanooga, Tennessee; Northvale, New Jersey; and Eagan,
Minnesota. Organized in 1983, Dynatronics has grown by adding
product offerings, developing best-in-class distribution to meet
the needs of our target customers, and acquiring complementary
medical businesses in related fields.
On
October 2, 2017, we acquired substantially all of the assets of
Bird & Cronin, Inc. (“Bird & Cronin”), a
manufacturer and distributor of orthopedic soft goods and specialty
patient care products. The Bird & Cronin acquisition has
further expanded our sales reach into the orthopedic and patient
care markets by leveraging their products and distribution network
with our existing product and distribution strengths.
Unless
the context otherwise requires, all references in this report to
“registrant,” “we,” “us,”
“our,” “Dynatronics,” or the
“Company” refer to Dynatronics Corporation, a Utah
corporation and our wholly owned subsidiaries. In this report,
unless otherwise expressly indicated, references to
“dollars” and “$” are to United States
dollars.
Business Strategy
We
aspire to be a global leader in providing physical therapy,
rehabilitation, and athletic training equipment and supplies that
enable clinicians to improve patients’ health more
effectively and non-invasively, while creating value for our
shareholders. Our strategy is to achieve these aims by delivering
quality products, providing excellent customer service, expanding
distribution channels, strengthening our brand, and pursuing
accretive business combinations. We expect successful execution of
these strategies will lead to (1) organic growth, (2) growth by
acquisition into new markets and channels, and (3) enhanced
shareholder value as we grow revenues and profits, expand our
shareholder base, and increase our market
capitalization.
Corporate Information
Dynatronics is a
Utah corporation founded in 1983 as “Dynatronics Laser
Corporation” to acquire our predecessor company, Dynatronics
Research Company, which was also a Utah corporation, formed in
1979. Our principal offices are located at 7030 Park Centre Drive,
Cottonwood Heights, Utah 84121, and our telephone number is (801)
568-7000. Our website address is www.dynatronics.com.
Information on our website is not part of this report. Our Annual
Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current
Reports on Form 8-K and other reports and documents we file with
the Securities and Exchange Commission (or “SEC”) are
available via a link to the SEC’s website www.sec.gov on
our website under the “Investors” tab. We operate on a
fiscal year ending June 30. For example, reference to fiscal year
2018 refers to the fiscal year ended June 30, 2018. All references
to financial statements in this report refer to the consolidated
financial statements of Dynatronics Corporation and its
wholly-owned subsidiaries, Bird & Cronin, LLC, Hausmann
Enterprises, LLC, and Dynatronics Distribution Company,
LLC.
Additional Recent Developments
On June
26, 2018 (the “Transition Date”), our board of
directors (“Board of Directors” or “Board”)
appointed Christopher Richard von Jako, Ph.D. as our Chief
Executive Officer and increased the size of the Board of Directors
from six to seven members. Dr. von Jako was appointed to serve as a
director to fill the newly created vacancy on the Board with a term
expiring at the 2018 Annual Meeting of Shareholders. As an employee
director, Dr. von Jako will not be compensated for service on the
Board of Directors apart from his compensation as an
employee.
Also as
of the Transition Date, at the request of the Board, Kelvyn H.
Cullimore, Jr. stepped down as the Company’s Chief Executive
Officer, a position he had held for 25 years. Mr. Cullimore will
continue to serve as a non-employee director and member of the
Board of Directors and will stand for re-election as a director at
the 2018 Annual Meeting of Shareholders.
Dr. von
Jako served as President and CEO of NinePoint Medical, Inc. from
November 2014 to June 2018. NinePoint Medical is a privately-held
medical device company that designs, manufactures, and sells an
Optical Coherence Tomography (OCT) imaging platform for clinical
use in gastroenterology for the evaluation of human tissue
microstructure. He successfully secured a significant strategic
investment and long-term partnership with Merit Medical Systems,
Inc. (NASDAQ: MMSI) in April 2018. From May 2013 to November 2014,
he was the President and CEO of NeuroTherm, Inc., a medical device
company that develops, manufactures, and markets state-of-the-art
image-guided solutions for pain management until its acquisition by
St. Jude Medical Corporation (now Abbott). Prior to joining
NeuroTherm, from 2010 to 2013, he served as President of ActiViews,
Inc., a privately-held medical device company which developed and
marketed minimally invasive tools for Interventional Radiology. In
his nearly 25 years in the medical device industry, he also has
worked in senior management positions at Radionics, a division of
Covidien plc (now Medtronic plc), which he later sold to Integra
LifeSciences Holdings Corporation, and Medtronic plc. Dr. von Jako
holds a Ph.D. in Biomedical Sciences from the University of
Pécs Medical School (Pécs, Hungary), a M.S. degree in
Radiological Sciences and Technology from the department of Nuclear
Engineering at the Massachusetts Institute of Technology
(Cambridge, MA), and a double B.S. degree in Physics and
Mathematics from Bates College (Lewiston, ME).
There
are no arrangements or understandings between Dr. von Jako and any
other persons pursuant to which he was selected as an officer or
director. He has no direct or indirect material interest in any
transaction required to be disclosed pursuant to Item 404(a) of
Regulation S-K.
We
entered into an employment agreement with Dr. von Jako (the
“Employment Agreement”) dated May 24, 2018, which
became effective on the Transition Date, which provides for the
following: (i) an annual base salary of $275,000; (ii) a target
annual cash bonus up to a maximum of 30% of base salary (provided
that quantitative and qualitative objectives established by the
Compensation Committee of the Board have been met); (iii) a new
hire grant of stock options to purchase 50,000 shares of common
stock and a restricted stock award of 50,000 shares, each vesting
in four annual installments of 25% commencing on the first
anniversary date of the Transition Date; and (iv) annual grants of
stock options and restricted stock awards having an aggregate fair
market value on date of grant of between $150,000 and $200,000 at
the discretion of the Compensation Committee, with such fair market
values determined with reference to a Black-Scholes model as to the
options and the trading prices of the Company’s common stock
as of the grant date as to the restricted stock award. Fifty
percent of the new hire stock option grant and restricted stock
awards will vest in the event of a termination of Dr. von
Jako’s employment by us without cause during the first 12
months of his employment. In the event of a termination of his
employment upon a change in control, all previously issued equity
grants held by Dr. von Jako at the time of termination will vest in
full, notwithstanding the terms of any equity incentive plan or
applicable award agreements. Acceleration of vesting in any event
will be subject to the execution of a general release of known and
unknown claims in a form satisfactory to us.
Dr. von
Jako also has entered into our standard form of indemnification
agreement for executives and directors and an Agreement Regarding
Confidential Information, Ownership of Inventions, Non-Competition,
Customer Non-Solicitation and Employee Non-Solicitation Covenants,
and Acknowledgment of At-Will Employment, which are part of his
Employment Agreement. Among other things, these agreements impose
certain restrictions on Dr. von Jako, including compliance with
post-employment covenants to (i) protect our confidential
information; (ii) not accept employment with or provide services to
a competitor for one year after termination; (iii) not solicit our
employees or customers for two years after termination; and (iv)
not disparage or otherwise impair the our reputation or
goodwill.
In
February 2018, we created a new Therapy Products Division
(“TPD”) consisting of our legacy Utah and Tennessee
operations, and hired Brian D. Baker as the President of TPD. With
this new alignment, we are now organized in three divisions,
Hausmann, Bird & Cronin, and TPD, with the Presidents of each
division reporting directly to the CEO, who reports to the Chairman
of the Board.
Our Products
We sell
products that are manufactured both by us and by third parties.
Approximately 70% of our net sales (excluding freight, repairs, and
miscellaneous items) in fiscal year 2018 were of products that we
manufactured.
We
offer a broad line of products for physical therapy, orthopedic
rehabilitation, and athletic training applications including
orthopedic soft goods; therapeutic, athletic training, and
orthopedic rehabilitation equipment and supplies;
advanced-technology therapeutic medical devices; and therapeutic,
medical, and custom athletic treatment tables. Our Bird &
Cronin division also features the Physician's Choice® retail
brand, and specializes in custom manufacturing of orthopedic soft
goods for select partners.
Our
products are used primarily by orthopedists, physical therapists,
chiropractors, athletic trainers, sports medicine practitioners,
and the retail consumer. The following table illustrates our
various product categories.
Orthopedic
Soft Goods and Medical Supplies
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● Upper and Lower
Extremity Braces and Slings
● Belts, Wraps,
Straps
● Physician’s
Choice®
● Pillows and
Cushions
● Wedges, Bolsters,
Mats
● Hot and Cold
Packs
● Clinical
Accessories
● Aids to Daily
Living
● Exercise Balls and
Bands
● Sports Med and
Taping Products
● Lotions and
Gels
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Physical
Therapy and Rehabilitation
Equipment
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● Therapeutic
Modality Devices (Electrotherapy, Ultrasound, Phototherapy, and
Thermal Therapy Modalities)
● Motorized and
Stationary Treatment Tables and Mat Platforms
● Custom Athletic
Training Equipment
● Strength and Cardio
Training Equipment
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Orthopedic Soft Goods and Medical Supplies
We
design, manufacture and distribute a significant range of soft
goods and medical supply products including ankle braces, wrist
braces, hot packs, cold packs, lumbar rolls, cervical collars,
slings, cervical pillows, bolsters, positioning wedges, back
cushions, lotions and gels, paper products, athletic tape, splints,
elastic wraps, exercise weights, exercise bands and tubing,
electrodes, rehabilitation products and back, ankle and wrist
braces. We are consistently recognized as Best in Class by our
various distribution, OEM, and branded partners. We continually
seek to update our line of manufactured and distributed soft goods
and medical supplies.
Physical Therapy and Rehabilitation Equipment
We sell
power and manually operated treatment tables, mat platforms,
parallel bars and work tables. We also sell training stairs, weight
racks, and other rehabilitation and athletic training room
products. Most of these products are manufactured at our Tennessee
and New Jersey facilities.
The New
Jersey facility specializes in manufacturing high quality laminated
med-surg and rehabilitation products. Laminate construction allows
for better contamination control and ease of maintenance over other
materials. Over 75% of Hausmann products are part of an unrivaled
“Quick Ship” program promising shipment within one to
10 business days from date of order. Last year Hausmann shipped 98%
of orders on time. One of the fastest growing segments of our
business is the PROTEAM™ line of products for athletic
training. The athletic training tables and taping stations are
manufactured for and sold to professional and college teams in over
5,000 locations. At our Tennessee facility the focus is on solid
wood products. Between the two facilities we cover the spectrum of
products for a wide array of customers.
At our
Utah facility we design, manufacture and distribute a broad line of
devices that include electrotherapy, ultrasound, phototherapy,
thermal therapy or a combination of these modalities in a single
device. These modalities can be effective in treating pain,
increasing local blood circulation, promoting relaxation of muscle
spasms, preventing retardation of disuse atrophy, and accelerating
muscle re-education.
In addition to our
own products, we also distribute a significant range of products
from other manufacturers including exercise equipment, treatment
tables, treadmills, walkers, compression therapy devices, stair
climbers, parallel bars, laser light
therapy equipment, shortwave diathermy, and radial pulse
equipment.
Sales Mix among Key Products
No
single product accounted for more than 10% of total revenues in
fiscal years 2018 and 2017. Sales of products manufactured by us
represented approximately 70% and 49% of total product sales,
excluding freight and other revenue, in fiscal years 2018 and 2017,
respectively. The increase in percentage of products manufactured
in fiscal year 2018 can be attributed to the acquisitions of
Hausmann in the fourth quarter of fiscal year 2017 and Bird &
Cronin in the second quarter of fiscal year 2018.
Patents and Trademarks
Patents. We own a United States
patent on our thermoelectric technology that will remain in effect
until February 2033. We also hold a United States patent on our
combination traction/phototherapy technology that will remain in
effect until December 2026, and a United States patent on our
phototherapy technology that will remain in effect until August
2025.
Trademarks and Copyrights. We
own trademarks used in our business, particularly marks relating to
our corporate and product names. United States trademark
registrations that are significant to our business, include
Dynatron®, Dynatron Solaris®, Dynaheat®, Body
Ice®, Powermatic®, Bird & Cronin®,
Physician’s Choice®, and the Hausmann Logo.
Federal
registration of a trademark enables the registered owner of the
mark to bar the unauthorized use of the registered mark in
connection with a similar product in the same channels of trade by
any third party anywhere in the United States, regardless of
whether the registered owner has ever used the trademark in the
area where the unauthorized use occurs. We may register additional
trademarks in countries where our products are or may be sold in
the future. Protection of registered trademarks in some
jurisdictions may not be as extensive as the protection provided by
registration under U.S. law. Trademark protection continues in
some countries so long as the trademark is used, and in other
countries, so long as the trademark is registered. Trademark
registration is for fixed terms and can be renewed indefinitely.
Our print materials are also protected under copyright laws, both
in the United States and internationally.
We also
claim ownership and protection of certain product names,
unregistered trademarks, and service marks under common law. Common
law trademark rights do not provide the same level of protection
that is afforded by the registration of a trademark. In addition,
common law trademark rights are limited to the geographic area in
which the trademark is actually used. We believe these trademarks,
whether registered or claimed under common law, constitute valuable
assets, adding to recognition of the Company and the effective
marketing of our products.
Trade Secrets. We own certain
intellectual property, including trade secrets that we seek to
protect, in part, through confidentiality agreements with key
employees and other parties involved in research and development.
Even where these agreements exist, there can be no assurance that
these agreements will not be breached, that we would have adequate
remedies for any breach, or that our trade secrets will not
otherwise become known to or independently developed by
competitors.
We
intend to protect our legal rights in our intellectual property by
all appropriate legal action. Consequently, we may become involved
from time to time in litigation to determine the enforceability,
scope, and validity of any of the foregoing proprietary rights. Any
patent litigation could result in substantial cost and divert the
efforts of management and technical personnel.
Warranty Service
We
provide a warranty on all products we manufacture for time periods
generally ranging in length from 90 days to five years from the date of sale. We
service warranty claims on these products primarily at the Utah,
Tennessee, New Jersey and Minnesota facilities depending on the
product and service required. We also have field service available
in other parts of the United States and Canada. Our warranty
policies are comparable to warranties generally available in the
industry. Warranty claims were approximately $123,000 in fiscal
year 2018, and $144,000 in 2017.
Distributed
products carry warranties provided by the manufacturers of those
products. We do not generally supplement these warranties or
provide unreimbursed warranty services for distributed products. We
also sell accessory items for our manufactured products that are
supplied by other manufacturers. These accessory products carry
warranties from their original manufacturers without supplement
from us.
Customers and Markets
We sell
our products to licensed practitioners such as orthopedists,
physical therapists, chiropractors, and athletic trainers. Our
customers also include professional sports teams and universities,
sports medicine specialists, post-acute care facilities, hospitals,
clinics, retail distributors and equipment manufacturer (OEM)
partners. We utilize direct sales representatives and independent
sales representatives to sell our products, together with a network
of over 300 independent dealers throughout the United States and
internationally. Most dealers purchase and take title to the
products, which they then sell to end users.
We have
entered into agreements with independent hospitals and clinics,
regional and national chains of physical therapy clinics and
hospitals, integrated delivery networks, group purchasing
organizations (“GPOs”), and government agencies. We
sell our products directly to these large groups, clinics, and
hospitals pursuant to preferred pricing arrangements. No single
customer or group of related accounts was responsible for 10% or
more of net sales in fiscal years 2018 and 2017.
We
export products to approximately 30 different countries. Sales
outside North America totaled approximately $3,606,000 in fiscal
year 2018 (or approximately 5.6% of net sales) and $814,000 in
fiscal year 2017 (or approximately 2.3% of net sales). Our Utah
facility is certified to the ISO 13485 quality standard for medical
device manufacturing. We have no foreign manufacturing operations,
but we purchase certain products and components from foreign
manufacturers.
Competition
We
believe our key products are distinguished competitively by our use
of the latest technology. Many of our competitors merely distribute
competing products, whereas we are expected to manufacture the
majority of the products that we sell. Also, our distribution
channels provide important competitive advantages due to many
established relationships with clinics which directly affect the
sale and distribution of our products.
We do
not compete with any single competitor across all of our product
lines and have numerous competitors of varying sizes, including
personal care companies, branded consumer healthcare companies and
private label manufacturers. Information necessary to determine or
reasonably estimate our market share or that of any competitor in
any of these markets of our highly fragmented industry is not
readily available to us.
Orthopedic Soft Goods and Medical Supplies
We
compete against various manufacturers and distributors of medical
supplies and soft goods, some of which are larger, more established
and have greater resources than Dynatronics. Excellent customer
service, on-hand inventory of high quality products, along with
providing online ordering capability and value to customers is of
key importance for us to remain competitive in this market. Our
competitors are primarily distributors such as Performance Health
Holdings Corp. (“Performance Health”), Scrip, Inc.,
North Coast Medical, Inc. (“North Coast Medical”), and
MeyerDC, and manufacturers such as Össur hf., DJO Global, Inc.
(“DJO”), and Breg, Inc. All competitors of distributed
products rely primarily on catalog, inside sales, or internet
sales.
Physical Therapy and Rehabilitation Equipment
Our
primary competition in the physical therapy and rehabilitation
equipment market is from domestic manufacturers including Hill
Laboratories Company, Performance Health, Bailey Manufacturing
Company, Tri W-G, Inc., DJO,
Armedica Manufacturing Corporation, and Clinton Industries, Inc. We
believe we compete in this market based on our industry experience
and product quality. In addition, certain components of our
equipment are manufactured overseas, which we believe allows for
pricing advantages over our competitors.
We compete in
the clinical market for therapeutic modality devices with both
domestic and foreign companies. Several of our products are
protected by patents or where patents have expired, the proprietary
technology on which those patents were based. We believe that the
integration of advanced technology in the design of our products
has distinguished Dynatronics-branded products in this very
competitive market. For example, we were the first company to
integrate infrared phototherapy as part of a combination therapy
device. The introduction of the ThermoStim probe was the first of
its product type on the market. We believe these factors give us a
competitive edge. Approximately 10-15 companies produce devices
directly competitive with our products. Some of these competitors
are larger and are well established, and have greater financial
resources than Dynatronics. We believe that our primary domestic
competitors in the therapeutic device manufacturing market include
DJO, Compass Health Brands and its affiliate Richmar, ThermoTek,
Inc., Travanti Pharma, Inc., North Coast Medical, and Mettler
Electronics Corp.
Manufacturing and Quality Assurance
We
manufacture our electrotherapy, ultrasound, phototherapy and
traction therapy devices at our facility in Cottonwood Heights,
Utah. We manufacture treatment tables, rehabilitation equipment,
soft goods, and other medical products at our facilities in
Chattanooga, Tennessee, Northvale, New Jersey and Eagan, Minnesota.
Our manufactured products are made from custom components both
fashioned internally from sourced raw materials, as well as
purchased from third-party suppliers. All parts and components
purchased from these suppliers meet established specifications.
Trained staff performs all sub-assembly, final assembly and quality
assurance testing by following established procedures. Our design
and development process ensures that products meet the requirements
of the medical device industry. The supply chain process manages
quality suppliers of components and materials to ensure their
availability for our manufacturing teams.
The
development and manufacture of a portion of our products
manufactured at our Utah facility is subject to rigorous and
extensive regulation by the U.S. Food and Drug Administration, or
FDA, and international regulatory agencies. In compliance with the
FDA’s Current Good Manufacturing Practices, or CGMP, and
standards established by the International Organization for
Standardization, or ISO, we have developed a comprehensive Quality
System that processes customer feedback and analyzes product
performance trends. Conducting prompt reviews of timely
information, allows us to respond to customer needs and ensure
quality performance of the devices we produce.
Our
Utah facility is certified to ISO 13485:2003 standards for medical
products. ISO 13485 is an internationally recognized quality
management system standard adopted by over 90
countries.
Products
manufactured at our facility in Tennessee are subject to our
internal quality system which is modeled on the quality system at
our facility in Utah.
Products
manufactured at our facilities in New Jersey and Minnesota follow a
similar pattern of compliance to an internal quality system that
meets the requirements of CGMP. This quality system controls the
production of products meeting the expectations of our customers
for quality products and services.
Research and Development
Total
research and development (“R&D”) expenses in fiscal
year 2018 were $1,194,000, compared to approximately $1,081,000 in
fiscal year 2017. The increase in R&D expenses was driven by
$325,000 in costs incurred on a project which was abandoned,
partially offset by a reduction in other R&D expense of
approximately $212,000. As a percentage of net sales, R&D
expenses represented approximately 1.9% and 3.0% in fiscal years
2018 and 2017, respectively.
Regulatory Matters
The
manufacture, packaging, labeling, advertising, promotion,
distribution and sale of our products are subject to regulation by
numerous national and local governmental agencies in the United
States and other countries. In the United States, the FDA regulates
some of our products pursuant to the Medical Device Amendment of
the Food, Drug, and Cosmetic Act, or FDC Act, and regulations
promulgated thereunder. Advertising and other forms of promotion
(including claims) and methods of marketing of the products are
subject to regulation by the FDA and by the Federal Trade
Commission, or FTC, under the Federal Trade Commission
Act.
As a
medical device manufacturer, we are required to register with the
FDA and once registered we are subject to inspection for compliance
with the FDA’s Quality Systems regulations. These regulations
require us to manufacture our products and maintain related
documents in a prescribed manner with respect to manufacturing,
testing, and control activities. Further, we are required to comply
with various FDA requirements for reporting customer complaints
involving our devices. The FDC Act and its medical device reporting
regulations require us to provide information to the FDA if
allegations are made that one of our products has caused or
contributed to a death or serious injury, or if a malfunction of a
product would likely cause or contribute to death or serious
injury. The FDA also prohibits an approved device from being
marketed for unapproved uses. All of our therapeutic treatment
devices as currently designed are cleared for marketing under
section 510(k) of the Medical Device Amendment to the FDC Act or
are considered 510(k) exempt. If a device is subject to section
510(k) approval requirements, the FDA must receive pre-market
notification from the manufacturer of its intent to market the
device. The FDA must find that the device is substantially
equivalent to a legally marketed predicate device before the agency
will clear the new device for marketing.
We
intend to continuously improve our products after they have been
introduced to the market. Certain modifications to our marketed
devices may require a premarket notification and clearance under
section 510(k) before the changed device may be marketed, if the
change or modification could significantly affect safety or
effectiveness. As appropriate, we may therefore submit future
510(k) notifications to the FDA. No assurance can be given that
clearance or approval of such new applications will be granted by
the FDA on a timely basis, or at all. Furthermore, we may be
required to submit extensive preclinical and clinical data
depending on the nature of the product changes. All of our devices,
unless specifically exempted by regulation, are subject to the FDC
Act’s general controls, which include, among other things,
registration and listing, adherence to the Quality System
Regulation requirements for manufacturing, medical device reporting
and the potential for voluntary and mandatory recalls described
above.
In
March 2010, the Patient Protection and Affordable Care Act, known
as the Affordable Care Act, and the Health Care and Education
Reconciliation Act of 2010 were signed into law. The Affordable
Care Act provides for a 2.3% excise tax on U.S. sales of medical
devices, including our products, effective as of 2013. The excise
tax was suspended for a two-year period beginning January 1, 2016
and was further suspended through December 31, 2019. The passage of
the Affordable Care Act imposed new reporting and disclosure
requirements for device manufacturers with regard to payments or
other transfers of value made to certain healthcare providers.
Specifically, any transfer of value exceeding $10 in a single
transfer or cumulative transfers over a one-year period exceeding
$100 to any statutorily defined practitioner (primarily physicians,
podiatrists, dentists and chiropractors, or a teaching hospital)
must be reported to the federal government by March 31st of each year for
the prior calendar year. The data is assembled and posted to a
publicly accessible website by September 30th following the March
31st
reporting date. If we fail to provide these reports, or if the
reports we provide are not accurate, we could be subject to
significant penalties. Several states have adopted similar
reporting requirements. We believe we are in compliance with the
Affordable Care Act and have systems in place to assure continued
compliance.
The
medical device excise tax included in the Affordable Care Act is an
excise tax on the first sale of medical devices by a manufacturer,
producer, or importer equal to 2.3% of the sales price. Taxable
medical devices include any device as defined in Section 201(h) of
the FDC Act intended for humans, with the exception of eyeglasses,
contact lenses, hearing aids and any other device determined by the
Secretary of Health and Human Services to be a type which is
generally purchased by the general public at retail for individual
use (“exempt devices”). On December 18, 2015, President
Obama signed into law H.R. 2029, the “Consolidated
Appropriations Act, 2016,” which included a two-year
moratorium on themedical
device excise tax, effective January 1, 2016. In January 2018, the
tax was suspended for an additional two year period. The U.S. House
of Representatives recently voted to repeal the tax on July 24,
2018. However, the U.S. Senate must also approve the repeal. Absent
further legislative action, the tax will be automatically
reinstated for medical device sales starting on January 1,
2020.
In
March 2017, the FDA published guidance relating to Class II devices
that would no longer be required to submit a pre-market
notification (510(k)). This list was finalized in the Federal
Register on July 11, 2017. Among the Class II devices exempted by
this determination are some phototherapy devices such as those
manufactured by us. That guidance indicates that such devices are
considered safe and effective without adding the burden of a
pre-market approval by the FDA. While this change diminishes the
regulatory burden for such products, it also lowers the barriers to
entry for competitive products. We view this change as generally
positive for us and our ability to leverage existing technology
competencies in this segment.
Failure
to comply with applicable FDA regulatory requirements may result
in, among other things, injunctions, product withdrawals, recalls,
product seizures, fines, and criminal prosecutions. Any such action
by the FDA could materially adversely affect our ability to
successfully market our products. Our Utah, Tennessee and New
Jersey facilities are inspected periodically by the FDA for
compliance with the FDA’s CGMP and other requirements,
including appropriate reporting regulations and various
requirements for labeling and promotion. The FDA Current Quality
Systems Regulations are similar to the ISO 13485 Quality Standard.
The CGMP regulation requires, among other things, that (i) the
manufacturing process be regulated and controlled by the use of
written procedures, and (ii) the ability to produce devices that
meet the manufacturer’s specifications be validated by
extensive and detailed testing of every aspect of the
process.
Advertising of our
products is subject to regulation by the FTC under the FTC Act.
Section 5 of the FTC Act prohibits unfair methods of competition
and unfair or deceptive acts or practices in or affecting commerce.
Section 12 of the FTC Act provides that the dissemination or the
causing to be disseminated of any false advertisement pertaining
to, among other things, drugs, cosmetics, devices or foods, is an
unfair or deceptive act or practice. Pursuant to this FTC
requirement, we are required to have adequate substantiation for
all advertising claims made about our products. The type of
substantiation required depends upon the product claims
made.
If the
FTC has reason to believe the law is being violated (e.g., the
manufacturer or distributor does not possess adequate
substantiation for product claims), it can initiate an enforcement
action. The FTC has a variety of administrative and judicial
processes and remedies available to it for enforcement, including
compulsory process authority, cease and desist orders, and
injunctions. FTC enforcement could result in orders requiring,
among other things, limits on advertising, consumer redress, and
divestiture of assets, rescission of contracts, or such other
relief as may be deemed necessary. Violation of such orders could
result in substantial financial or other penalties. Any such action
against us by the FTC could materially and adversely affect our
ability to successfully market our products.
From
time to time, legislation is introduced in the Congress of the
United States or in state legislatures that could significantly
change the statutory provisions governing the approval,
manufacturing, and marketing of medical devices and products like
those we manufacture. In addition, FDA regulations and guidance are
often revised or reinterpreted by the agency in ways that may
significantly affect our business and our products. It is
impossible to predict whether legislative changes will be enacted,
or FDA regulations, guidance, or interpretations will be changed,
and what the impact of such changes, if any, may be on our business
and our results of operations. We cannot predict the nature of any
future laws, regulations, interpretations, or applications, nor can
we determine what effect additional governmental regulations or
administrative orders, when and if promulgated, domestically or
internationally, would have on our business in the future. They
could include, however, the recall or discontinuance of certain
products, additional record keeping, expanded documentation of the
properties of certain products, expanded or different labeling, and
additional scientific substantiation. The necessity of complying
with any or all such requirements could have a material adverse
effect on our business, results of operations or financial
condition.
In
addition to compliance with FDA rules and regulations, we are also
required to comply with international regulatory laws including
Health Canada, CE Mark, or other regulatory schemes used by other
countries in which we choose to do business. Foreign governmental
regulations have become increasingly stringent and more common, and
we may become subject to more rigorous regulation by foreign
governmental authorities in the future. Penalties for
non-compliance with foreign governmental regulation could be
severe, including revocation or suspension of a company’s
business license and criminal sanctions. Any domestic or foreign
governmental law or regulation imposed in the future may have a
material adverse effect on us. We believe all of our present
products are in compliance in all material respects with all
applicable performance standards in countries where the products
are sold. We also believe that our products comply with CGMP,
record keeping and reporting requirements in the production and
distribution of the products in the United States.
Foreign Government Regulation
Although it is not
a current focus, we may expand our activities to market our
products in European and other select international markets in the
future. The regulatory requirements for our products vary from
country to country. Some countries impose product standards,
packaging requirements, labeling requirements and import
restrictions on some of the products we manufacture and distribute.
Each country has its own tariff regulations, duties and tax
requirements. Failure to comply with applicable foreign regulatory
requirements may subject us to fines, suspension or withdrawal of
regulatory approvals, product recalls, seizure of products,
operating restrictions and criminal prosecution.
Environment
Environmental
regulations and the cost of compliance with them are not material
to our business. Numerous federal, state and local laws regulate
the sale of products containing certain identified ingredients that
may impact human health and the environment. For instance,
California has enacted Proposition 65, which requires the
disclosure of specified listed ingredient chemicals on the labels
of products sold in that state and the use of warning labels when
such ingredients may be found. Although we do not believe that any
of the ingredients in our current manufactured products is
reportable under Proposition 65, this and other similar legislation
may become more comprehensive in the future and/or new products we
may develop or distribute could become subject to these
regulations.
Seasonality
Our
business is affected by some seasonality, which could result in
fluctuation in our operating results. Sales are typically higher in
our first and fourth fiscal quarters (the spring and summer months
of the calendar year), while sales in our second and third fiscal
quarters are generally slower (in the fall and winter months).
Therefore, our quarterly operating results are not necessarily
indicative of operating results for the entire year, and historical
operating results in a quarterly or annual period are not
necessarily indicative of future operating results.
Employees
On June
30, 2018, we had 336 employees, of which 323 were full-time
employees and 13 were part-time employees. Included in these
figures are 56 union employees covered by a
collective bargaining agreement scheduled to expire in February
2019. We believe our labor relations with both union and
non-union employees are satisfactory. By comparison, we had 233
employees (219 full-time and 14 part-time) on June 30,
2017.
In
addition to the risks described elsewhere in this report and in
certain of our other filings with the SEC, the following risks and
uncertainties, among others, could cause our actual results to
differ materially from those contemplated by us or by any
forward-looking statement contained in this report. You should
consider the following risk factors, in addition to the information
presented elsewhere in this report, particularly under the heading
"Cautionary Note Regarding Forward-Looking Statements," on page 1
of this report, and in the sections “Part I, Item 1.
Business,” “Part II, Item 7. Management's Discussion
and Analysis of Financial Condition and Results of
Operations,” as well as in the filings we make from time to
time with the SEC, in evaluating us, our business and an investment
in our securities. The fact that some of these risk factors may be
the same or similar to those that we have included in other reports
that we have filed with the SEC in past periods means only that the
risks are present in multiple periods. We believe that many of the
risks that are described here are part of doing business in the
industry in which we operate and will likely be present in all
periods. The fact that certain risks are endemic to the industry
does not lessen their significance.
Risks Related to Our Business and Industry
We have a recent history of losses, and we may
not return to or sustain profitability in the future. We
have incurred net losses for seven consecutive fiscal years. In
recent years, we have made substantial investments in research and
development, infrastructure, distribution channel expansion and
acquisitions to support anticipated future revenue growth. We
expect to continue to make significant investments in the
development and expansion of our business, which may make it
difficult for us to return to profitability. Our present business
strategy is to improve cash flow by acquiring businesses that are
cash flow positive and by adding to our existing product line and
expanding our sales and marketing efforts, including the addition
of in-house sales personnel and acquisitions. We cannot predict
when we will again achieve profitable operations or that we will
not require additional financing to fulfill our business
objectives. We may not be able to increase revenue in future
periods, and our revenue could decline or grow more slowly than we
expect. We may incur significant losses in the future for many
reasons, including due to the risks described in this
report.
We may need additional funding and may be
unable to raise additional capital when needed, which could
adversely affect our results of operations and financial
condition. In the future, we may require additional capital
to pursue business opportunities or acquisitions or respond to
challenges and unforeseen circumstances. We may also decide to
engage in equity or debt financings or enter into credit facilities
for other reasons. We may not be able to secure additional debt or
equity financing in a timely manner, on favorable terms, or at all.
Any debt financing obtained by us in the future could involve
restrictive covenants relating to our capital raising activities
and other financial and operational matters, which may make it more
difficult for us to obtain additional capital and to pursue
business opportunities, including potential acquisitions. Failure
to obtain additional financing when needed or on acceptable terms
would have a material adverse effect on our business
operations.
Our level of indebtedness may harm our
financial condition and results of operations. Our level of
indebtedness will impact our future operations in many important
ways, including, without limitation, by:
●
Requiring that a
portion of our cash flows from operations be dedicated to the
payment of any interest or amortization required with respect to
outstanding indebtedness;
●
Increasing our
vulnerability to adverse changes in general economic and industry
conditions, as well as to competitive pressure; and
●
Limiting our
ability to obtain additional financing for working capital,
acquisitions, capital expenditures, general corporate and other
purposes.
At the
scheduled maturity of our credit facilities or in the event of an
acceleration of a debt facility following an event of default, the
entire outstanding principal amount of the indebtedness under such
facility, together with all other amounts payable thereunder from
time to time, will become due and payable. It is possible that we
may not have sufficient funds to pay such obligations in full at
maturity or upon such acceleration. If we default and are not able
to pay any such obligations due, our lenders have liens on
substantially all of our assets and could foreclose on our assets
in order to satisfy our obligations. If we are unable to meet our
debt service obligations and other financial obligations, we could
be forced to restructure or refinance our indebtedness and other
financial transactions, seek additional equity capital or sell our
assets. We might then be unable to obtain such financing or capital
or sell our assets on satisfactory terms, if at all. Our line of
credit with a lender matures in September 2019, which will require
that we renew the facility at that time. There is no assurance we
will be successful in renewing the credit facility with our current
lender or refinancing the facility with another lender. In
addition, any refinancing of our indebtedness could be at
significantly higher interest rates, and/or result in significant
transaction fees.
If we fail to generate sufficient cash flow in
the future, we may require additional financing. If we are
unable to generate sufficient cash flow from operations in the
future to service our debt, we may be required to refinance some or
all our existing debt, sell assets, borrow more money or raise
capital through the sale of our equity securities. If these or
other kinds of additional financing become necessary, we may be
unable to arrange such financing on terms that would be acceptable
to us or at all.
Our inability to successfully manage growth
through acquisitions, and the integration of recently acquired
businesses, products or technologies may present significant
challenges and could harm our operating results. Over the
past 18 months, we have made two significant acquisitions. Our
business plan includes the acquisition of other businesses,
products, and technologies. In the future we expect to acquire or
invest in other businesses, products or technologies that we
believe could complement or expand our existing product lines,
expand our customer base and operations, enhance our technical
capabilities or otherwise offer growth or cost-saving
opportunities. As we grow through acquisitions, we face additional
challenges of integrating the operations, culture, information
management systems and other characteristics of the acquired entity
with our own. Efforts to integrate future acquisitions may be
hampered by delays, the loss of certain employees, changes in
management, suppliers or customers, proceedings resulting from
employment terminations, culture clashes, unbudgeted costs, and
other issues, which may occur at levels that are more severe or
prolonged than anticipated. If we identify an appropriate
acquisition candidate, we may not be successful in negotiating
favorable terms of the acquisition, financing the acquisition or
effectively integrating the acquired business, product or
technology into our existing business and operations. Our due
diligence may fail to identify all of the problems, liabilities or
other shortcomings or challenges of an acquired business, product
or technology, including issues related to intellectual property,
product quality or product architecture, regulatory compliance
practices, revenue recognition or other accounting practices, or
employee or customer issues.
We have
incurred, and will likely continue to incur, significant expenses
in connection with negotiating and consummating acquisitions, we
may not achieve the synergies or other benefits we expected to
achieve, and we may incur write-downs, impairment charges or
unforeseen liabilities that could negatively affect our operating
results or financial position or could otherwise harm our business.
If we finance acquisitions by issuing convertible debt or equity
securities, the ownership interest of our existing shareholders may
be significantly diluted, which could adversely affect the market
price of our stock. Further, contemplating, investigating,
negotiating or completing an acquisition and integrating an
acquired business, product or technology could divert management
and employee time and resources from other matters that are
important to our existing business.
If we fail to establish new sales and
distribution relationships or maintain our existing relationships,
or if our third party distributors and dealers fail to commit
sufficient time and effort or are otherwise ineffective in selling
our products, our results of operations and future growth could be
adversely impacted. The sale and distribution of
certain of our products depend, in part, on our relationships with
a network of third-party distributors and dealers. These
third-party distributors and dealers maintain the customer
relationships with the hospitals, clinics, orthopedists, physical
therapists and other healthcare professionals that purchase, use
and recommend the use of our products. Although our internal sales
staff trains and manages these third-party distributors and
dealers, we do not control or directly monitor the efforts that
they make to sell our products. In addition, some of the dealers
that we use to sell our products also sell products that directly
compete with our core product offerings. These dealers may not
dedicate the necessary effort to market and sell our products or
they may source products we distribute directly from the
manufacturer. If we fail to attract and maintain relationships with
third-party distributors and dealers or fail to adequately train
and monitor the efforts of the third-party distributors and dealers
that market and sell our products, or if our existing third-party
distributors and dealers choose not to carry our products, our
results of operations and future growth could be adversely
affected.
If we do not successfully develop and market
new products or continue to enhance or find new applications for
our existing products, we may not achieve our planned
growth. Our future success and our ability to increase net
sales and earnings depend, in part, on our ability to acquire or
develop, manufacture, and distribute new products, enhance our
existing products, and find new applications for our existing
products. However, we may not be able to:
●
successfully
develop or acquire new products or enhance existing
products;
●
find new
applications for existing products;
●
manufacture, market
and distribute new products or enhance existing products in a
cost-effective manner;
●
establish
relationships with marketing or distribution partners for these
products; or
●
obtain required
regulatory clearances and approvals for these
products.
In
addition, if any of our new or enhanced products contain undetected
errors or design defects, especially when first introduced, or if
new applications that we develop for existing products do not work
as planned, our ability to market these products could be
substantially delayed or otherwise materially adversely affected,
resulting in lost net sales, potential damage to our reputation or
refusal by hands-on healthcare practitioners to accept these
products.
We rely on our management team and other key
employees, and the loss of one or more key employees could harm our
business. Our success and future growth depend upon the
continued services of our management team and other key employees,
including in the areas of research and development, marketing,
sales, services and general and administrative functions. From time
to time, there may be changes in our management team resulting from
the hiring or departure of executives, which could disrupt our
business. If new key employees and other members of our senior
management team cannot work together effectively, or if other
members of our senior management team resign, our ability to
effectively manage our business may be impacted. We may terminate
any executive officer’s employment at any time, with or
without cause, and any executive officer may resign at any time,
with or without cause. We do not maintain key person life insurance
on any of our employees. The loss of any of our key employees could
harm our business.
Healthcare reform in the United States has had
and is expected to continue to have a significant effect on our
business and on our ability to expand and grow our business.
The Affordable Care Act, as amended by the Health Care and
Education Reconciliation Act, significantly expanded health
insurance coverage to uninsured Americans and changed the way
health care is financed by both governmental and private payers.
These provisions may be modified, repealed, or otherwise
invalidated, in whole or in part. Future rulemaking could affect
rebates, prices or the rate of price increases for health care
products and services, or required reporting and disclosure. We
cannot predict the timing or impact of any future rulemaking or
changes in the law. For example, in December 2015, Congress passed
legislation known as the PATH Act. This legislation suspended the
medical device tax imposed by The Affordable Care Act for calendar
years 2016 and 2017. In January 2018, the tax was suspended for an
additional two year period. Although the excise tax has been
suspended by Congress until the end of calendar 2019, its status is
unclear for 2020 and subsequent years. During each of the fiscal
years ended June 30, 2015 and 2016, prior to suspension of the
excise tax, we incurred approximately $200,000 in additional taxes,
related to this tax, which reduced our gross profit. Without
specific action by Congress to extend the suspension, the medical
device tax is scheduled to be reinstated in January 2020. We cannot
predict whether the suspension will be continued beyond January 1,
2020. If the excise tax is not repealed or further suspended, it
will likely adversely impact our future results of
operations.
Our products are regulated by numerous
government agencies, both inside and outside the United
States. The impact of this on us is direct, to the extent we
are subject to these laws and regulations, and indirect in that in
a number of situations, even though we may not be directly
regulated by specific healthcare laws and regulations, our products
must be capable of being used by our customers in a manner that
complies with those laws and regulations. The manufacture,
distribution, marketing, and use of some of our products are
subject to extensive regulation and increased scrutiny by the FDA
and other regulatory authorities globally. Any new Class II product
must undergo lengthy and rigorous testing and other extensive,
costly and time-consuming procedures mandated by FDA and foreign
regulatory authorities. Changes to current Class II products may be
subject to vigorous review, including additional 510(k) and other
regulatory submissions, and approvals are not certain. Our
facilities must be approved and licensed prior to production and
remain subject to inspection from time to time thereafter. Failure
to comply with the requirements of FDA or other regulatory
authorities, including a failed inspection or a failure in our
adverse event reporting system, could result in adverse inspection
reports, warning letters, product recalls or seizures, monetary
sanctions, injunctions to halt the manufacture and distribution of
products, civil or criminal sanctions, refusal of a government to
grant approvals or licenses, restrictions on operations or
withdrawal of existing approvals and licenses. Any of these actions
could cause a loss of customer confidence in us and our products,
which could adversely affect our sales. The requirements of
regulatory authorities, including interpretative guidance, are
subject to change and compliance with additional or changing
requirements or interpretative guidance may subject the Company or
our products to further review, result in product launch delays or
otherwise increase our costs.
Changing market patterns may affect demand for
our products. Increasingly, medical markets are moving
toward evidence-based practices. Such a move could shrink demand
for products we offer if it is deemed there is inadequate evidence
to support the efficacy of the products. Likewise, to achieve
market acceptance in such environments may require expenditure of
funds to do clinical research that may or may not prove adequate
efficacy to satisfy all customers.
The cost of healthcare has risen significantly
over the past decade and numerous initiatives and reforms initiated
by legislators, regulators and third-party payers to curb these
costs have resulted in a consolidation trend in the medical device
industry as well as among our customers, including healthcare
providers. These conditions could result in greater pricing
pressures and limitations on our ability to sell to important
market segments, such as group purchasing organizations, integrated
delivery networks and large single accounts. We expect that market
demand, government regulation, third-party reimbursement policies
and societal pressures will continue to change the worldwide
healthcare industry, resulting in further business consolidations
and alliances which may exert further downward pressure on the
prices of our products and adversely impact our business, financial
condition and results of operations.
The sale, marketing, and pricing of our
products, and relationships with healthcare providers are under
increased scrutiny by federal, state, and foreign government
agencies. Compliance with anti-kickback statutes, false
claims laws, the FDC Act (including as these laws relate to
off-label promotion of products), and other healthcare related
laws, as well as competition, data and patient privacy, and export
and import laws, is under increased focus by the agencies charged
with overseeing such activities, including FDA, the Office of
Inspector General (OIG), Department of Justice (DOJ) and the FTC.
The DOJ and the SEC have increased their focus on the enforcement
of the U.S. Foreign Corrupt Practices Act (“FCPA”)
described below under “Our
commercial activities internationally are subject to special risks
associated with doing business in environments that present a
heightened corruption and trade sanctions risk.” The
laws and standards governing the promotion, sale, and reimbursement
related to our products and laws and regulations governing our
relationships with healthcare providers and governments can be
complicated, are subject to frequent change and may be violated
unknowingly. Violations or allegations of violations of these laws
may result in large civil and criminal penalties, debarment from
participating in government programs, diversion of management time,
attention and resources and may otherwise have an adverse effect on
our business, financial condition and results of operations. In the
event of a violation, or the allegation of a violation of these
laws, we may incur substantial costs associated with compliance or
to alter one or more of our sales and marketing practices and we
may be subject to enforcement actions which could adversely affect
our business, financial condition and results of
operations.
Our commercial activities internationally are
subject to special risks associated with doing business in
environments and jurisdictions that present a heightened corruption
and trade sanctions risk. We operate our business and market
and sell products internationally, including in countries in Asia,
Latin America, and the Middle East, which may be considered
business environments that pose a relatively higher risk of
corruption than the United States, and therefore present greater
political, economic and operational risk to us, including an
increased risk of trade sanction violations. In addition, there are
numerous risks inherent in conducting our business internationally,
including, but not limited to, potential instability in
international markets, changes in regulatory requirements
applicable to international operations, currency fluctuations in
foreign countries, political, economic and social conditions in
foreign countries and complex U.S. and foreign laws and treaties,
including tax laws, the FCPA, and the Bribery Act of 2010
(“U.K. Anti-Bribery Act”). The FCPA prohibits
U.S.-based companies and their intermediaries from making improper
payments to government officials for the purpose of obtaining or
retaining business. The FCPA also imposes recordkeeping and
internal controls requirements on public companies in the U.S. The
U.K. Anti-Bribery Act prohibits both domestic and international
bribery as well as bribery across both public and private sectors.
In recent years, the number of investigations and other enforcement
activities under these laws has increased. As we expand our
business to include pursuit of opportunities in certain parts of
the world that experience government corruption, in certain
circumstances compliance with anti-bribery laws may conflict with
local customs and practices. Our policies mandate compliance with
all applicable anti-bribery laws. Further, we require our partners,
subcontractors, agents and others who work for us or on our behalf
to comply with these and other anti-bribery laws. If we fail to
enforce our policies and procedures properly or maintain adequate
record-keeping and internal accounting practices to accurately
record our transactions, we may be subject to regulatory sanctions.
In the event that we believe or have reason to believe that our
employees have or may have violated applicable anti-corruption
laws, including the FCPA, trade sanctions or other laws or
regulations, we are required to investigate or have outside counsel
investigate the relevant facts and circumstances, and if violations
are found or suspected, could face civil and criminal penalties,
and significant costs for investigations, litigation, settlements
and judgments, which in turn could have a material adverse effect
on our business.
If significant tariffs or other restrictions
are placed on imports or any related counter-measures are taken by
foreign countries, our revenue and results of operations may be
materially harmed. Potential changes in international trade
relations between the United States and other countries, could have
a material adverse effect on our business. There is
currently significant uncertainty about the future relationship
between the United States and various other countries, with respect
to trade policies, treaties, government regulations and tariffs.
The Trump Administration has signaled that it may alter trade
agreements and terms between the United States and other countries,
including limiting trade and/or imposing a tariff on imports.
Recently, the United States has increased tariffs on certain goods
imported into the United States from China, Mexico, Canada and
other countries, following which the governments of these countries
have increased tariffs on certain goods imported into them from the
United States, in response to which the United States announced
plans to impose additional tariffs. In addition, the Administration
has called for substantial changes to the North American Free Trade
Agreement (“NAFTA”), which might adversely affect our
markets in Mexico and Canada. While it is currently unclear how the
U.S. Administration or foreign governments will act with respect to
tariffs, international trade agreements and policies, a trade war
or further governmental action related to tariffs or international
trade policies has the potential to adversely impact our business,
financial condition and results of operations. The materials
subject to tariffs announced to date do not impact our raw material
costs. Based on the current structure of our international
business, we do not expect these changes in foreign trade policy to
have a material impact on our business or financial statements.
However, if further tariffs are imposed on a broader range of
imports, or if retaliatory trade measures are taken by other
countries in response to additional tariffs, we may be required to
raise our prices, which may result in the loss of customers and
harm our operating performance.
The United Kingdom’s vote to exit from
the European Union could adversely impact us. On June 23,
2016, in a referendum vote commonly referred to as
“Brexit,” a majority of British voters voted to exit
the European Union. In March 2017, the British government delivered
formal notice of the U.K.’s intention to leave the European
Union. The British government is currently in negotiations with the
European Union to determine the terms of the U.K.’s exit. A
withdrawal could potentially disrupt the free movement of goods,
services and people between the U.K. and the European Union,
undermine bilateral cooperation in key geographic areas and
significantly disrupt trade between the U.K. and the European Union
or other nations as the U.K. pursues independent trade relations.
In addition, Brexit could lead to legal uncertainty and potentially
divergent national laws and regulations as the U.K. determines
which European Union laws to replace or replicate. The effects of
Brexit will depend on any agreements the U.K. makes to retain
access to European Union or other markets either during a
transitional period or more permanently. It is unclear what
long-term economic, financial, trade and legal implications the
withdrawal of the U.K. from the European Union would have and how
such withdrawal would affect our business globally and in the
region. In addition, Brexit may lead other European Union member
countries to consider referendums regarding their European Union
membership. Any of these events, along with any political, economic
and regulatory changes that may occur, could cause political and
economic uncertainty in Europe and internationally and harm our
business in Europe.
If we fail to obtain regulatory approval in
foreign jurisdictions, then we cannot market our products in those
jurisdictions. We sell or plan to market some of our
products in foreign jurisdictions, as well as in China and the
European Union. Many foreign countries in which we market or may
market our products have regulatory bodies and restrictions similar
to those of the FDA. International sales are subject to foreign
government regulation, the requirements of which vary substantially
from country to country. The time required to obtain approval by a
foreign country may be longer or shorter than that required for FDA
approval and the requirements may differ. Companies are now
required to obtain a CE Mark, which shows conformance with the
requirements of applicable European Conformity directives, prior to
the sale of some medical devices within the European Union. Some of
our current products that require CE Markings have them and it is
anticipated that additional and future products may require them as
well. We may be required to conduct additional testing or to
provide additional information, resulting in additional expenses,
to obtain necessary approvals. If we fail to obtain approval in
such foreign jurisdictions, we would not be able to sell our
products in such jurisdictions, thereby reducing the potential
revenue from the sale of our products.
We store, process, and use data, some of which
contain personal information and are subject to complex and
evolving laws and regulations regarding privacy, data protection
and other matters, which are subject to change. Some of the
data we store, process, and use, contains personal information,
subjecting us to a variety of laws and regulations in the United
States and other countries with respect to privacy, rights of
publicity, data protection, content, protection of minors, and
consumer protection. These laws can be particularly restrictive.
Both in the United States and abroad, these laws and regulations
are evolving and remain subject to change. Several proposals are
pending before federal, state and foreign legislative and
regulatory bodies that could significantly affect our business. A
number of states have enacted laws or are considering the enactment
of laws governing the release of credit card or other personal
information received from consumers:
●
California recently
enacted legislation, the California Consumer Privacy Act
(“CCPA”) that, among other things, will require covered
companies to provide new disclosures to California consumers, and
afford such consumers new abilities to opt-out of certain sales of
personal information, when it goes into effect on January 1,
2020.
●
The EU General Data
Protection Regulation (“GDPR”), which came into effect
on May 25, 2018, establishes new requirements applicable to the
processing of personal data (i.e., data which identifies an
individual or from which an individual is identifiable), affords
new data protection rights to individuals, and imposes penalties
for serious data breaches. Individuals also have a right to
compensation under GDPR for financial or non-financial losses. GDPR
has imposed additional responsibility and liability in relation to
our processing of personal data in the EU. GDPR has also required
us to change our various policies and procedures in the EU and, if
we are not compliant, could materially adversely affect our
business, results of operations and financial
condition.
●
Canada’s
Personal Information and Protection of Electronic Documents Act
provides Canadian residents with privacy protections in regard to
transactions with businesses and organizations in the private
sector and sets out ground rules for how private sector
organizations may collect, use, and disclose personal information
in the course of commercial activities.
●
In November 2016,
the Standing Committee of China’s National People’s
Congress passed its Cybersecurity Law (“CSL”), which
took effect in June 2017. The CSL is the first Chinese law that
systematically lays out regulatory requirements on cybersecurity
and data protection, subjecting many previously under-regulated or
unregulated activities in cyberspace to government
scrutiny.
The
costs of compliance with, and other burdens imposed by, the GDPR,
CSL and these other laws may limit the use and adoption of our
products and services and could have an adverse impact on our
business, operating results and financial condition. Foreign
governments also may attempt to apply such laws extraterritorially
or through treaties or other arrangements with U.S. governmental
entities. In addition, the application and interpretation of these
laws and regulations are often uncertain and could result in
investigations, claims, changes to our business practices,
increased cost of operations and declines in sales, any of which
could materially adversely affect our business, results of
operations and financial condition. We cannot assure you that the
privacy policies and other statements regarding our practices will
be found sufficient to protect us from liability or adverse
publicity relating to the privacy and security of personal
information. Whether and how existing local and international
privacy and consumer protection laws in various jurisdictions apply
to the internet and other online technologies is still uncertain
and may take years to resolve. Privacy laws and regulations, if
drafted or interpreted broadly, could be deemed to apply to the
technology we use and could restrict our information collection
methods or decrease the amount and utility of the information that
we would be permitted to collect. A determination by a court or
government agency of a failure, or perceived failure, by us, the
third parties with whom we work or our products and services to
protect employee, applicant, vendor, website visitor or customer
personal data (including as a result of a breach by or of a
third-party provider) or to comply with any privacy-related laws,
government regulations or directives or industry self-regulatory
principles or our posted privacy policies could result in damage to
our reputation, legal proceedings or actions against us by
governmental entities or otherwise, which could have an adverse
effect on our business. In addition, concerns about our practices
with regard to the collection, use, disclosure, or security of
personally identifiable information or other privacy-related
matters, even if unfounded and even if we are in compliance with
applicable laws, could damage our reputation and harm our business.
We have and post on our website our own privacy policy and cookie
statement concerning the collection, use and disclosure of user
personal data.
Failures in, material damage to, or
interruptions in our information technology systems, software or
websites, including as a result of cyber-attacks, and difficulties
in updating our existing software or developing or implementing new
software could have a material adverse effect on our business or
results of operations. We depend increasingly on our
information technology systems in the conduct of our business. For
example, we own, license or otherwise contract for sophisticated
technology and systems to do business online with customers,
including for order entry and fulfillment, processing and payment,
product shipping and product returns. We also maintain internal and
external communications, product inventory, supply, production and
enterprise management, and personnel information on information
systems. Our information systems are subject to damage or
interruption from power outages, computer and telecommunications
failures, computer viruses, security breaches and natural and
manmade disasters. In particular, from time to time we and third
parties who provide services for us experience cyber-attacks,
attempted breaches of our or their information technology systems
and networks or similar events, which could result in a loss of
sensitive business or customer information, systems interruption or
the disruption of our operations. The techniques used to obtain
unauthorized access, disable or degrade service or sabotage systems
change frequently and may be difficult to detect for long periods
of time, and accordingly we may be unable to anticipate and prevent
all data security incidents. Like many businesses, our systems come
under frequent attack from third parties. We are required to expend
capital and other resources to protect against such cyber-attacks
and potential security breaches or to alleviate problems caused by
such potential breaches or attacks. Despite the constant monitoring
of our technology systems and hiring of specialized third parties
to identify and address any vulnerabilities through implementation
of multi-tiered network security measures, it is possible that
computer programmers and hackers, or even internal users, may be
able to penetrate, create systems disruptions or cause shutdowns of
our network security or that of third-party companies with which we
have contracted. As a result, we could experience significant
disruptions of our operations and incur significant expenses
addressing problems created by these breaches. Such unauthorized
access could disrupt our business and could result in a loss of
revenue or assets and any compromise of customer information could
subject us to customer or government litigation and harm our
reputation, which could adversely affect our business and growth.
Although we
maintain cyber liability insurance that provides liability and
insurance coverages, subject to limitations and conditions of the
policies, our insurance may not be sufficient to protect against
all losses or costs related to any future breaches of our
systems.
Market access could be a limiting factor in
our growth. The emergence of Group Purchasing Organizations
(GPO’s) that control a significant amount of product flow to
hospitals and other acute care customers may limit our ability to
grow in the acute care space. GPO’s issue contracts to
manufacturers approximately every three years through a bidding
process. Despite repeated efforts, we have been relatively
unsuccessful in landing any significant GPO contracts. The process
for being placed on contract with a GPO is rigorous and
non-transparent. Performance Health, a large competitor, controls
the majority of GPO contracts in our market space holding in many
instances a sole source contract.
A percentage of our workforce is subject to a
collective bargaining agreement. Approximately 17% of our
workforce is subject to a collective bargaining agreement, which is
subject to negotiation and renewal every three years. The current
agreement is scheduled to expire in February 2019. Our inability to
negotiate the renewal of this collective bargaining agreement, or
any prolonged work stoppages could have a material adverse effect
on our business, results of operations, financial condition and
cash flows. We cannot ensure that we will be successful in
negotiating new collective bargaining agreements, that such
negotiations will not result in significant increases in the cost
of labor, or that a breakdown in such negotiations will not result
in the disruption of our operations. In addition, employees who are
not currently represented by labor unions may seek representation
in the future. Although we have generally enjoyed good relations
with both our union and non-union employees, if we are subject to
labor actions, we may experience an adverse impact on our operating
results.
We rely on a combination of patents, trade
secrets, and nondisclosure and non-competition agreements to
protect our proprietary intellectual property, and we will continue
to do so. While we intend to defend against any threats to
our intellectual property, these patents, trade secrets, or other
agreements may not adequately protect our intellectual property.
Third parties could obtain patents that may require us to negotiate
licenses to conduct our business, and the required licenses may not
be available on reasonable terms or at all. We also rely on
nondisclosure and non-competition agreements with certain
employees, consultants, and other parties to protect, in part,
trade secrets and other proprietary rights. We cannot be certain
that these agreements will not be breached, that we will have
adequate remedies for any breach, that others will not
independently develop substantially equivalent proprietary
information, or that third parties will not otherwise gain access
to our trade secrets or proprietary knowledge.
Certain of the products we sell are subject to
market and technological obsolescence. We offer
approximately 20,000 to 25,000 variations of products. If our
customers discontinue purchasing a given product, we might have to
record expense related to the diminution in value of inventories we
have in stock, and depending on the magnitude, that expense could
adversely impact our operating results. In addition to the products
of others that we distribute, we design and manufacture our own
medical devices and products. We may be unable to effectively
develop and market products against the products of our competitors
in a highly competitive industry. Our present or future products
could be rendered obsolete or uneconomical by technological
advances by our competitors. Competitive factors include price,
customer service, technology, innovation, quality, reputation and
reliability. Our competition may respond more quickly to new or
emerging technologies, undertake more extensive marketing
campaigns, have greater financial, marketing and other resources
than us or be more successful in attracting potential customers,
employees and strategic partners. Given these factors, we cannot
guarantee that we will be able to continue our level of success in
the industry.
We are dependent on a limited number of
third-party suppliers for components and raw materials and the loss
of any of these suppliers, or their inability to provide us with an
adequate supply of materials that meet our quality and other
requirements, could harm our business. We rely on
third-party suppliers to provide components for our products,
manufacture products that we do not manufacture ourselves and
perform services that we do not provide ourselves, including
package-delivery services. Because these suppliers are independent
third parties with their own financial objectives, actions taken by
them could have a materially negative effect on our results of
operations. The risks of relying on suppliers include our inability
to enter into contracts with such suppliers on reasonable terms,
breach, or termination by suppliers of their contractual
obligations, inconsistent or inadequate quality control, relocation
of supplier facilities, and disruption to suppliers’
business, including work stoppages, suppliers’ failure to
comply with complex and changing regulations, and third party
financial failure. Any problems with our suppliers and associated
disruptions to our supply chain could materially negatively impact
our ability to supply the market, substantially decrease sales,
lead to higher costs, or damage our reputation with our customers,
and any longer-term disruptions could potentially result in the
permanent loss of our customers, which could reduce our recurring
revenues and long-term profitability. Disruption to our supply
chain could occur as a result of any number of events, including,
but not limited to, increases in wages that drive up prices; the
imposition of regulations, trade protection measures, tariffs,
duties, import/export restrictions, quotas or embargoes on key
components; labor stoppages; transportation failures affecting the
supply and shipment of materials and finished goods; the
unavailability of raw materials; severe weather conditions; natural
disasters; civil unrest, geopolitical developments, war or
terrorism; computer viruses, physical or electronic breaches, or
other information system disruptions or security breaches; and
disruptions in utility and other services.
We may be adversely affected by product
liability claims, unfavorable court decisions or legal
settlements. Our business exposes us to potential product
liability risks that are inherent in the design, manufacture and
marketing of medical devices. We maintain product liability
insurance coverage which we deem to be adequate based on historical
experience; however, there can be no assurance that coverage will
be available for such risks in the future or that, if available, it
would prove sufficient to cover potential claims or that the
present amount of insurance can be maintained in force at an
acceptable cost. In addition, we may incur significant legal
expenses regardless of whether we are found to be liable.
Furthermore, the assertion of such claims, regardless of their
merit or eventual outcome, also may have a material adverse effect
on our business reputation and results of operations.
Tax reform legislation in the U.S. could
adversely affect our business and financial condition. On
December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“Tax
Act”) was signed into law, making significant changes to the
Internal Revenue Code. Changes under the Tax Act include, but are
not limited to, a corporate tax rate decrease from 35% to 21%
effective for tax years beginning after December 31, 2017, a
one-time transition tax on the mandatory deemed repatriation of
cumulative foreign earnings, limitation of the tax deduction for
interest expense to 30% of adjusted earnings (except for certain
small businesses), limitation of the deduction for net operating
losses to 80% of current year taxable income and elimination of net
operating loss carrybacks, one time taxation of offshore earnings
at reduced rates regardless of whether they are repatriated,
elimination of U.S. tax on foreign earnings (subject to certain
important exceptions), immediate deductions for certain new
investments instead of deductions for depreciation expense over
time, and modifying or repealing many business deductions and
credits (including reducing the business tax credit for certain
research and development expenses). The overall impact of the new
federal tax law is uncertain, and our business and financial
condition could be adversely affected. For example, because of the
tax rate decrease, our deferred tax assets and our corresponding
valuation allowance against these deferred tax
assets have been reduced and may continue to be adversely
impacted. In addition, it is uncertain if and to what extent
various states will conform to Tax Act and what effect that legal
challenges will have on the Tax Act, including litigation in the
U.S. and international challenges brought at organizations such as
the World Trade Organization. The impact of the Tax Act on holders
of our equity and derivative securities is also uncertain and could
be adverse.
Intellectual property litigation and
infringement claims could cause us to incur significant expenses or
prevent us from selling certain of our products. The medical
device industry is characterized by extensive intellectual property
litigation and, from time to time, we are the subject of claims by
third parties of potential infringement or misappropriation.
Regardless of outcome, such claims are expensive to defend and
divert the time and effort of management and operating personnel
from other business issues. A successful claim or claims of patent
or other intellectual property infringement against us could result
in our payment of significant monetary damages and/or royalty
payments or negatively impact our ability to sell current or future
products in the affected category.
Changes in financial accounting standards or
practices may cause adverse, unexpected financial reporting
fluctuations and affect our reported results of operations.
Financial accounting standards may change or their interpretation
may change. A change in accounting standards or practices can have
a significant effect on our reported results and may even affect
our reporting of transactions completed before the change becomes
effective. Changes to existing rules or the re-examining of current
practices may adversely affect our reported financial results or
the way we conduct our business.
If we fail to establish new sales and
distribution relationships or maintain our existing relationships,
or if our third party distributors and dealers fail to commit
sufficient time and effort or are otherwise ineffective in selling
our products, our results of operations and future growth could be
adversely impacted. The sale and distribution of certain of
our products depend, in part, on our relationships with a network
of third party distributors and dealers. These third party
distributors and dealers maintain the customer relationships with
the hospitals, clinics, orthopedists, physical therapists and other
healthcare professionals that purchase, use and recommend the use
of our products. Although our internal sales staff trains and
manages these third party distributors and dealers, we do not
directly monitor the efforts that they make to sell our products.
In addition, some of the dealers that we use to sell our products
also sell products that directly compete with our core product
offerings. These dealers may not dedicate the necessary effort to
market and sell our products or they may source products we
distribute directly from the manufacturer. If we fail to attract
and maintain relationships with third party distributors and
dealers or fail to adequately train and monitor the efforts of the
third party distributors and dealers that market and sell our
products, or if our existing third party distributors and dealers
choose not to carry our products, our results of operations and
future growth could be adversely
affected.
Risks Related to Our Common Stock
A decline in the price of our common stock
could affect our ability to raise working capital and adversely
impact our operations. Our operating results, including
components of operating results such as gross margin and cost of
product sales, may fluctuate from time to time, and such
fluctuations could adversely affect our stock price. Our operating
results have fluctuated in the past and can be expected to
fluctuate from time to time in the future. The market price for our
common stock may also be affected by our ability to meet or exceed
expectations of analysts or investors. Any failure to meet these
expectations, even if minor, could materially adversely affect the
market price of our common stock. A prolonged decline in the price
of our common stock for any reason could result in a reduction in
our ability to raise capital.
Our stock price has been volatile and we
expect that it will continue to be volatile. For example
during the year ended June 30, 2018, the selling price of our
common stock ranged from a high of $3.55 to a low of $2.10. The
volatility of our stock price can be due to many factors,
including:
●
quarterly
variations in our operating results;
●
changes in the
market’s expectations about our operating
results;
●
failure of our
operating results to meet the expectation of securities analysts or
investors in a particular period;
●
changes in
financial estimates and recommendations by securities analysts
concerning us or the healthcare industry in general;
●
strategic decisions
by us or our competitors, such as acquisitions, divestments,
spin-offs, joint ventures, strategic investments or changes in
business strategy;
●
operating and stock
price performance of other companies that investors deem comparable
to us;
●
news reports
relating to trends in our markets;
●
changes in laws and
regulations affecting our business;
●
material
announcements by us or our competitors;
●
material
announcements by the manufacturers and suppliers we
use;
●
sales of
substantial amounts of our common stock by our directors, executive
officers or significant shareholders or the perception that such
sales could occur; and
●
general economic
and political conditions such as trade wars and tariffs, recession,
and acts of war or terrorism.
Investors in our securities may experience
substantial dilution upon the conversion of preferred stock to
common, exercise of stock options and warrants, future issuances of
stock, grants of restricted stock and the issuance of stock in
connection with acquisitions of other companies.
Our
articles of incorporation authorize the issuance of up to
100,000,000 shares of common stock and 50,000,000 shares of
preferred stock. Our Board of Directors has the authority to issue
additional shares of common and preferred stock up to the
authorized capital stated in the articles of incorporation. The
Board may choose to issue some or all of such shares of common or
preferred stock to acquire one or more businesses or to provide
additional financing in the future. As of September 6, 2018, we had
outstanding a total of 2,000,000 shares of Series A 8% Convertible
Preferred Stock (the “Series A Preferred”), 1,459,000
shares of Series B Convertible Preferred Stock (the “Series B
Preferred”), and 1,440,000 shares of Series C Non-Voting
Convertible Preferred Stock (the “Series C Preferred”),
as well as warrants for the purchase of approximately 6,738,500
shares of common stock. The Series A Preferred, Series B Preferred
and Series C Preferred shares are convertible into a total of
4,899,000 shares of common stock. The conversion of these
outstanding shares of preferred stock and the exercise of the
warrants will result in substantial dilution to our common
shareholders. In addition, from time to time, we have issued and we
expect we will continue to issue stock options or restricted stock
grants or similar awards to employees, officers, and directors
pursuant to our equity incentive award plans. Investors in our
equity securities may expect to experience dilution as these awards
vest and are exercised by their holders and as the restrictions
lapse on the restricted stock grants. We also may issue stock or
stock purchase warrants for the purpose of raising capital to fund
our growth initiatives, in connection with acquisitions of other
companies, or in connection with the settlement of obligations or
indebtedness, which would result in further dilution of existing
shareholders. The issuance of any such shares of common or
preferred stock may result in a reduction of the book value or
market price of the outstanding shares of our common stock. If we
do issue any such additional shares of common stock or securities
convertible into or exercisable for the purchase of common stock,
such issuance also will cause a reduction in the proportionate
ownership and voting power of all other shareholders and may result
in a change in control of the Company.
The stock markets (including the NASDAQ
Capital Market, on which we list our common stock) have experienced
significant price and volume fluctuations. As a result, the
market price of our common stock could be similarly volatile, and
investors in our common stock may experience a decrease in the
value of their shares, including decreases unrelated to our
financial condition, operating performance or prospects. The price
of our common stock could be subject to wide fluctuations in
response to a number of factors, including strategic decisions by
us or our competitors, such as acquisitions, divestments,
spin-offs, joint ventures, strategic investments or changes in
business strategy.
We are able to issue shares of preferred stock
with greater rights and preferences than our common stock.
Our Board of Directors is authorized to issue one or more series of
preferred stock from time to time without any action on the part of
our shareholders. The Board also has the power, without shareholder
approval, to set the terms of any such series of preferred stock
that may be issued, including voting rights, dividend rights and
preferences over our common stock with respect to dividends and
other terms. If we issue additional preferred stock in the future
that has a preference over our common stock with respect to the
payment of dividends or other terms, or if we issue additional
preferred stock with voting rights that dilute the voting power of
our common stock, the rights of holders of our common stock or the
market price of our common stock would be adversely
affected.
The holders of the Series A Preferred and
Series B Preferred are entitled to receive dividends on the Series
A Preferred and Series B Preferred they hold and depending on
whether these dividends are paid in cash or stock, the payment of
such dividends will either decrease cash that is available to us to
invest in our business or dilute the holdings of other
shareholders. Our agreements
with the holders of the Series A Preferred Stock and Series B
Preferred provide that they will receive quarterly dividends at 8%,
subject to adjustment as provided in the applicable declarations of
the rights and preferences of these series of preferred stock. We
may under certain circumstances elect to pay these dividends in
stock. Payment of the dividends in cash decreases cash available to
us for use in our business and the use of shares of common stock to
pay these dividends results in dilution of our existing
shareholders.
The concentration or potential concentration
of equity ownership by Prettybrook Partners, LLC and its affiliates
may limit your ability to influence corporate
matters. As of June 30,
2018, Prettybrook Partners, LLC and its managing directors and
affiliates (collectively “Pretty Brook”), owned
approximately 966,000
shares of common stock, 1,061,000 shares of Series A Preferred, and
300,000 shares of Series B Preferred. These securities represent
approximately 19% of the voting power of our issued and outstanding
equity securities. Under the terms of the Series A Preferred, by
agreement with us and the remaining holders of the Series A
Preferred, Prettybrook has the right to appoint up to three members
of our seven-member Board of Directors (the Preferred Directors)
and has appointed a non-voting observer to the Board. Moreover, the
exercise of warrants issued to Prettybrook in the Series A
Preferred financing and the Series B Preferred financing
transactions in which Prettybrook was an investor could further
enable Prettybrook to exert significant control over the operations
of the Company and influence over all corporate activities,
including the election or removal of directors and the outcome of
tender offers, mergers, proxy contests or other purchases of common
stock that could give our shareholders the opportunity to realize a
premium over the then-prevailing market price for their shares of
common stock. This concentrated control will limit your ability to
influence corporate matters and, as a result, we may take actions
that our shareholders do not view as beneficial. In addition, such
concentrated control could discourage others from initiating
changes of control. In such cases, the perception of our prospects
in the market and the market price of our common stock may be
adversely affected.
Sales of a large number of our securities, or
the perception that such sales might occur, could depress the
market price of our common stock. A substantial number of
shares of our equity securities are eligible for immediate resale
in the public market. Any sales of substantial amounts of our
securities in the public market, or the perception that such sales
might occur, could depress the market price of our common
stock.
Our ability to issue preferred stock could
delay or prevent takeover attempts. As of September 6, 2018,
we had 4,899,000 shares of convertible preferred stock outstanding
and our Board of Directors has the authority to cause us to issue,
without any further vote or action by the shareholders, up to
approximately 45,101,000 additional shares of preferred stock, no
par value per share, in one or more series, and to designate the
number of shares constituting any series, and to fix the rights,
preferences, privileges and restrictions thereof, including
dividend rights, voting rights, rights and terms of redemption,
redemption price or prices and liquidation preferences of such
series of preferred stock. In the event of issuance, the preferred
stock could be used as a method of discouraging, delaying,
deferring or preventing a change in control without further action
by the shareholders, even where shareholders might be offered a
premium for their shares. Although we have no present intention to
issue any shares of our preferred stock, we may do so in the future
under appropriate circumstances.
Our
corporate headquarters and principal executive offices are located
at 7030 Park Centre Drive, Cottonwood Heights, Utah. Cottonwood
Heights is a suburb of Salt Lake City, Utah. The headquarters
consist of a single facility housing administrative offices,
manufacturing and warehousing space, totaling approximately 36,000
square feet. We sold the building in August 2014, and now lease it
back from the purchaser. The monthly lease payment is approximately
$27,000 and the lease terminates in 2029. We account for the
agreement as a capital lease which results in depreciation and
implied interest expense each period offset by an amortized gain on
the sale of the property. Overall the net monthly occupancy cost of
this lease is $29,000.
We own
a 53,200 square-foot manufacturing facility and undeveloped acreage
available for future expansion in Chattanooga, Tennessee, subject
to a mortgage requiring monthly payments to a bank of approximately
$13,000 and maturing in 2021. The interest rate on this obligation
is 6.4% per annum.
We
lease a 60,000 square-foot manufacturing and office facility in
Northvale, New Jersey to house our Hausmann operations. The initial
two-year term of this lease commenced in April 2017, with annual
lease payments of $360,000 for the first year and 2% increases in
each subsequent year. The lease provides for two options to extend
the term of the lease for two years per extension term, subject to
annual 2% per year increases in base rent, and a third extension
option at the end of the second option term for an additional five
years at fair market value. We lease this facility from Hausmann
Industries Inc., from which we acquired the Hausmann assets and
operations in 2017. Hausmann Industries, Inc. is controlled by
David Hausmann, who is now the President of our Hausmann
Division.
We lease a 85,000
square-foot manufacturing and office facility in Eagan, Minnesota
to house our Bird & Cronin operations. This lease has an
initial three-year term that commenced in October 2017, with annual
lease payments of $600,000 per year. We may extend the lease under
two, two-year optional extensions. The landlord is Bird &
Cronin, Inc., from which we acquired the Bird & Cronin assets
and operations in 2017. Stockholders of Bird & Cronin, Inc.
include employees of the Company, including the co-Presidents of
our Bird & Cronin Division, Mike Cronin and Jason
Anderson.
We
believe the facilities described above are adequate for our current
needs and that they will accommodate our presently expected growth
and operating needs. As our business continues to grow, additional
facilities or the expansion of existing facilities may be required.
The leases in New Jersey and Minnesota that are now with entities
owned by related parties were negotiated at arms’ length as
part of the applicable acquisition transactions. We believe that
the terms of those agreements are commercially reasonable for the
markets in which those facilities are located.
We also own
equipment used in the manufacture and assembly of our products. The
nature of this equipment is not specialized and replacements may be
readily obtained from any of a number of suppliers. In addition, we
own computer equipment and engineering and design equipment used in
research and development programs.
Item 3. Legal Proceedings
There
are no pending legal proceedings of a material nature to which we
are a party or to which any of our property is the
subject.
Item 4. Mine Safety Disclosures
Not
applicable.
PART II
Item 5. Market for
Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
Market Information
As of
September 14, 2018, we had approximately 8,161,029 shares of common
stock issued and outstanding. Our common stock is included on the
NASDAQ Capital Market (symbol: DYNT). The following table shows the
range of high and low sales prices for our common stock as quoted
on the NASDAQ system for the quarterly periods
indicated.
Fiscal
Year Ended June 30,
|
|
|
|
|
|
|
|
1st Quarter
(July-September)
|
$3.15
|
$2.10
|
$2.99
|
$2.33
|
2nd Quarter
(October-December)
|
$3.05
|
$2.15
|
$2.90
|
$2.29
|
3rd Quarter
(January-March)
|
$3.55
|
$2.40
|
$3.35
|
$2.30
|
4th Quarter
(April-June)
|
$3.25
|
$2.80
|
$3.75
|
$2.70
|
Shareholders
As of
September 18, 2018, we had approximately 400 shareholders of
record, not including shareholders whose shares are held in
“nominee” or “street” name by a bank,
broker or other holder of record.
Dividends
We have
never paid cash dividends on our common stock. Our anticipated
capital requirements are such that we intend to follow a policy of
retaining earnings, if any, in order to finance the development of
the business.
As of
June 30, 2018, we had outstanding 2,000,000 shares of Series A
Preferred, 1,459,000 shares of Series B Preferred, and 1,440,000
shares of Series C Non-Voting Convertible Preferred Stock
(“Series C Preferred”). These series of preferred stock
have rights and preferences that rank senior to or in certain
circumstances, on par with, our common stock. The declarations of
the rights and preferences of these series of preferred stock
contain covenants that prohibit us from declaring and distributing
dividends on our common stock without first making all
distributions that are due to any senior securities. Dividends
payable on the Series A Preferred and the Series B Preferred accrue
at the rate of 8% per year and are payable quarterly. We may, at
our option under certain circumstances, make distributions of these
dividends in cash or in shares of common stock. When possible, we
pay dividends on the Series A Preferred and Series B Preferred in
shares of common stock. The formula for paying these dividends in
common stock can change the effective yield on the dividend to more
or less than 8% depending on the market price of the common stock
at the time of issuance.
Purchases of Equity Securities
We did
not purchase any shares of common stock during the year ended June
30, 2018 or in the prior six fiscal years.
Item 6. Selected Financial
Data
Not
applicable.
Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
The following discussion contains assumptions,
estimates and other forward-looking statements that involve a
number of risks and uncertainties, including those discussed under
“Risk Factors,” “Cautionary Note Regarding
Forward-Looking Statements,” and elsewhere in this Annual
Report on Form 10-K. These risks could cause our actual results to
differ materially from those anticipated in these forward-looking
statements.
The following discussion contains assumptions, estimates and other
forward-looking statements that involve a number of risks and
uncertainties, including those discussed under the heading
“Cautionary Note Regarding Forward-Looking Statements,”
in “Part I, Item 1A. Risk Factors,” and elsewhere in
this Annual Report on Form 10-K. These risks could cause our actual
results to differ materially from those anticipated in these
forward-looking statements.
The following discussion and analysis of our financial condition
and results of operations should be read in conjunction with the
Consolidated Financial Statements and related Notes thereto, which
are included in Part II, Item 8. of this report.
Overview
We
design,
manufacture, market, and distribute orthopedic soft goods, medical
supplies, and physical therapy and rehabilitation equipment.
Through our various distribution channels, we market and sell to
orthopedists, physical therapists, chiropractors, athletic
trainers, sports medicine practitioners, clinics, and
hospitals.
Results of Operations
Fiscal Year 2018 Compared to Fiscal Year 2017
Net Sales
Net
sales in fiscal year 2018 increased 80.1%, or $28,657,000, to
$64,415,000, compared to net sales of $35,758,000 in fiscal year
2017. The year-over-year increase was due primarily to our
acquisitions of Hausmann in April 2017 and Bird & Cronin in
October 2017 that contributed a combined $30,540,000 of the
increase in net sales in the fiscal year ended June 30, 2018. This
increase was partially offset by a decline in net sales of
approximately $1,883,000, or 5.3%, primarily due to a lower volume
of TPD physical therapy and rehabilitation equipment and medical
supplies.
Gross Profit
Gross
profit for the year ended June 30, 2018 increased $8,913,000, or
about 77.5%, to $20,421,000, or 31.7% of net sales. By comparison,
gross profit for the year ended June 30, 2017 was $11,508,000, or
32.2% of net sales. The increase in gross profit was driven by the
acquisitions of Hausmann and Bird & Cronin. These acquisitions
contributed a combined increase in gross profit of approximately
$9,967,000 in the fiscal year ended June 30, 2018. Gross profit in
fiscal year 2018 was adversely affected by approximately $1,054,000
primarily due to: (1) lower sales which accounted for approximately
$520,000 in lower gross profit, and (2) reduced gross margin
percentage resulting in $534,000 lower gross profit. The
year-over-year decrease in gross margin percentage to 31.7% from
32.2% in the prior year was due primarily to the inclusion of
Hausmann sales, which had a lower gross margin percentage as well
as reduced gross margin attributable to higher freight costs and a
write-down of inventory due to product rationalization in the year
ended June 30, 2018.
Selling, General and Administrative Expenses
Selling, general
and administrative (“SG&A”) expenses increased
69.2%, or $8,376,000, to $20,478,000 for the year ended June 30,
2018, compared to $12,102,000 for the year ended June 30, 2017.
Selling expenses represented $1,965,000 of the increase in SG&A
expenses in fiscal year 2018. Increases in selling expenses
included an increase of $2,638,000 associated with the Hausmann and
Bird & Cronin operations. This increase in selling expenses was
partially offset by $673,000 lower selling costs due primarily to
lower commission expense on lower sales during the fiscal year
ended June 30, 2018. General and administrative
(“G&A”) expenses represented $6,411,000 of the
increase in SG&A expenses in fiscal year 2018.
The
primary components of the increase in G&A expenses included:
(1) $5,046,000 added by the operations at Hausmann and Bird &
Cronin; (2) $978,000 in severance expense; (3) $483,000 in other
G&A expenses; and (4) $268,000 in higher salaries and benefits.
Increased G&A expense in 2018 was partially offset by a
$364,000 decrease in acquisition expenses compared to the prior
year period. Severance related expenses recorded in fiscal year
2018 were associated primarily with the separation of our former
chief executive and the reduction of our workforce by 10 employees
to better align our resources with the needs of our business and to
focus on improving profitability.
Research and Development
R&D
expenses for the year ended June 30, 2018 increased 10.4%, or
$113,000, to $1,194,000 compared to $1,081,000 for the year ended
June 30, 2017. The increase resulted from $325,000 in costs
incurred on a project which was abandoned during the year ended
June 30, 2018, offset by a reduction in other R&D expenses of
approximately $212,000.
Interest Expense
Interest expense
increased approximately $150,000 in fiscal year 2018, to
approximately $428,000, compared to approximately $278,000 in
fiscal year 2017. The increase in interest expense is primarily
related to an increase in our line of credit balance resulting in
interest charges of $185,000 and $43,000 for the years ended June
30, 2018 and 2017, respectively. Another large component of
interest expense is imputed interest related to the sale/leaseback
of our corporate headquarters facility which totaled $179,000 and
$189,000, respectively, for the years ended June 30, 2018 and 2017.
Interest expense also included interest on the mortgage on our
Tennessee property, and interest paid on equipment loans for office
furnishings and vehicles.
Net Loss Before Income Tax
Pre-tax
loss for the year ended June 30, 2018 was $1,673,000 compared to
$1,866,000 for the year ended June 30, 2017. The $193,000
improvement in pre-tax loss was primarily attributable to the
$8,913,000 improvement in gross profit, offset by $8,376,000 in
increased SG&A expenses, $113,000 in higher R&D expenses
and $150,000 in increased interest expense discussed
above.
Income Taxes
Income
tax benefit was $70,000 in fiscal year 2018, compared to income tax
benefit of $0 in fiscal year 2017. On December 22, 2017, the U.S.
government enacted comprehensive tax reform legislation commonly
referred to as the Tax Cuts and Jobs Act (“Tax Act”).
The Tax Act makes significant changes to the U.S. Internal Revenue
Code of 1986, as amended. Among other items, the Tax Act
permanently reduces the federal corporate tax rate to 21% effective
January 1, 2018. As our fiscal year end falls on June 30, the
statutory federal corporate tax rate for fiscal year 2018 will be
prorated to 27.5%, with the statutory rate for fiscal 2019 and
beyond at 21%. As a consequence of the Tax Act, we decreased the
valuation allowance on our net deferred income tax assets equal to
the one-time revaluation of our net deferred tax assets at the
lower tax rate. We decreased the valuation allowance on our net
deferred income tax assets by $332,000 for the year ended June
30, 2018, and increased the valuation allowance by $772,000 for the
year ended June 30, 2017.
Net Loss
Net
loss for the year ended June 30, 2018 was $1,602,000, compared to
$1,866,000 for the year ended June 30, 2017. Fiscal year 2018
included a $70,000 income tax benefit, otherwise, the changes in
net loss are the same as explained above under the heading Net Loss
Before Income Tax.
Net Loss Attributable to Common Stockholders
Net
loss attributable to common stockholders decreased $794,000 to
$3,499,000 ($0.53 per share) for the year ended June 30, 2018,
compared to $4,293,000 ($1.36 per share) for the year ended June
30, 2017. The decrease in net loss attributable to common
stockholders is due primarily to a $264,000
reduction in net loss for the year and a
decrease of approximately
$920,000 in deemed dividend and accretion of discount associated
with the issuance of Series C Preferred shares and associated
common stock purchase warrants in connection with our acquisition
of Bird & Cronin, which was less in comparison to the deemed
dividends in the prior year associated with the issuance of Series
A Preferred in December 2016 and Series B Preferred in April 2017.
The deemed dividend reflects the difference between the value of
common stock underlying the issued preferred shares as if
converted, based on the closing price of our common stock on the
date of issuance of the preferred stock, less the amount of the
purchase price assigned to the preferred shares in an allocation of
the purchase price between the preferred shares and the common
stock warrants that were issued with the preferred shares.
The decrease in net loss attributable to common stockholders was
partially offset by $390,000 in additional preferred stock
dividends associated with 390,000 shares of Series A Preferred
issued in December 2016 and 1,559,000 shares of Series B Preferred
issued in April 2017. We paid
accrued dividends by issuing shares of our common stock and paying
$105,000 in cash.
Liquidity and Capital Resources
We have
historically financed operations through cash from operations,
available cash reserves, borrowings under a line of credit facility
(see Line of Credit,
below), and the proceeds from the sale of our equity securities. As
of June 30, 2018, we had $1,696,000 in cash, compared to $255,000
as of June 30, 2017. During fiscal year 2018, we had positive cash
flows from operating activities. We believe that our existing
revenue stream, cash flows from consolidated operations, current
capital resources, and borrowing availability under the line of
credit provide sufficient liquidity to fund operations through at
least September 30, 2019.
On
March 31, 2017, we entered into an agreement with a bank to
establish an asset-based lending facility (the “Line of
Credit”, see Line of
Credit, below). As of June 30, 2018, there was approximately
$1,370,000 of additional borrowing capacity related to this Line of
Credit. To fully execute on our business strategy of acquiring
other entities and to adequately fund our ongoing operations, we
will need to raise additional capital. Absent additional financing,
we may have to curtail our current acquisition
strategy.
Working
capital was $6,837,000 as of June 30, 2018, compared to working
capital of $5,834,000 as of June 30, 2017. The current ratio was
1.5 to 1 as of June 30, 2018, compared to 1.8 to 1 as of June 30,
2017. Current assets were 50.9% of total assets as of June 30,
2018, and 51.7% of total assets as of June 30, 2017.
Cash and Cash Equivalents
Our
cash and cash equivalents position increased $1,441,000 to
$1,696,000 as of June 30, 2018, compared to $255,000 as of June 30,
2017. The primary sources of cash in the year ended June 30, 2018,
were (i) net proceeds of approximately $6,600,000 from the sale of
our Series C Preferred and warrants in connection with the
acquisition of Bird & Cronin, (ii) net borrowings of $4,114,000
under our line of credit, and (iii) approximately $762,000 of net
cash provided by operating activities. Primary uses of cash
included the acquisition of Bird & Cronin, which used
$9,063,000, net of the acquisition holdback.
Accounts Receivable
Trade
accounts receivable, net of allowance for doubtful accounts,
increased approximately $2,530,000, or 47.9%, to $7,811,000 as of
June 30, 2018, from $5,281,000 as of June 30, 2017. The increase
was primarily due to the acquisition of Bird & Cronin that
added $2,251,000 in accounts receivable as of June 30, 2018. We
believe that our estimate of the allowance for doubtful accounts is
adequate based on our historical experience and relationships with
our customers. Accounts receivable are generally collected within
approximately 30 days of invoicing.
Inventories
Inventories, net of
reserves, increased $3,590,000, or 48.5%, to $10,988,000 as of June
30, 2018, compared to $7,398,000 as of June 30, 2017. The increase
resulted primarily from our acquisition of Bird & Cronin, which
added approximately $4,482,000 of net inventory as of June 30,
2018. Inventory levels fluctuate based on timing of large inventory
purchases from domestic and overseas suppliers as well as
variations in sales and production activities. During fiscal year
2018, we recorded in cost of goods sold of approximately $692,000
in non-cash write-offs of inventory related to discontinued product
lines, excess repair parts, product rejected for quality standards,
and other non-performing inventory compared to inventory write-offs
of $435,000 in fiscal year 2017. We believe that our estimate of
the allowance for inventory reserves is adequate based on our
historical knowledge and product sales trends.
Accounts Payable
Accounts payable
increased approximately $1,078,000, or 46.2%, to $3,413,000 as of
June 30, 2018, from $2,335,000 as of June 30, 2017. The increase
was due in large part to our recent acquisition of Bird &
Cronin, which added accounts payable of approximately $983,000 at
June 30, 2018.
Line of Credit
On
March 31, 2017, we entered into an $8,000,000 loan and security
agreement with Bank of the West to provide asset-based financing to
fund acquisitions and for working capital (“Line of
Credit”), replacing an earlier $1,000,000 line of credit
dating to September 2016. On September 28, 2017, we entered into an
amended credit facility that modified the Line of Credit in order
to provide sufficient asset-based financing for the Bird &
Cronin acquisition and for operating capital. As amended, the Line
of Credit provides for revolving credit borrowings in an amount up
to the lesser of $11,000,000 or the calculated borrowing base. The
borrowing base is computed monthly and is equal to the sum of
stated percentages of eligible accounts receivable and inventory,
less a reserve. Amounts outstanding on the Line of Credit bear
interest at LIBOR, plus 2.25% (4.32% as of June 30, 2018). The Line
of Credit matures on September 30, 2019 and is subject to an unused
line fee of .25%.
On July
13, 2018, we further modified and amended the Line of Credit to
adjust the maximum monthly consolidated leverage and a minimum
monthly consolidated fixed charge coverage ratio. We paid a
commitment fee of 0.25% in connection with the establishment of the
Line of Credit and upon each modification of the Line of
Credit.
Our
obligations under the Line of Credit are secured by a
first-priority security interest in substantially all of our
assets. The Line of Credit requires a lockbox arrangement and
contains affirmative and negative covenants, including covenants
that restrict our ability to, among other things, incur or
guarantee indebtedness, incur liens, dispose of assets, engage in
mergers and consolidations, make acquisitions or other investments,
make changes in the nature of its business, and engage in
transactions with affiliates. The agreement also contains financial
covenants including a maximum monthly consolidated leverage and a
minimum monthly consolidated fixed charge coverage
ratio.
As of
June 30, 2018, we had borrowed $6,286,000 under the Line of Credit
compared to total borrowings of $2,172,000 as of June 30, 2017.
There was approximately $1,370,000 and $3,709,000 available to us
under the Line of Credit to borrow as of June 30, 2018 and 2017,
respectively.
Debt
Long-term debt,
excluding current installments decreased approximately $159,000 to
approximately $303,000 as of June 30, 2018, compared to
approximately $462,000 as of June 30, 2017. Our long-term debt is
primarily comprised of the mortgage loan on our office and
manufacturing facility in Tennessee maturing in 2021, and also
includes loans related to equipment and a vehicle. The principal
balance on the mortgage loan is approximately $378,000, of which
$239,000 is classified as long-term debt, with monthly principal
and interest payments of $13,000.
In conjunction
with the sale and leaseback of our corporate headquarters in August
2014, we entered into a $3,800,000 lease for a 15-year term with an
investor group. That sale generated a profit of $2,300,000 which is
being recorded monthly over the life of the lease at $13,000 per
month, or approximately $150,000 per year. The building lease is
recorded as a capital lease with the related amortization being
recorded on a straight line basis over 15 years at approximately
$252,000 per year. Lease payments, currently approximately $27,000,
are payable monthly and increase annually by approximately 2% per
year over the life of the lease. Total accumulated amortization
related to the leased building is approximately $987,000 at June
30, 2018. Imputed interest for the fiscal year ended June 30, 2018,
was approximately $179,000. In addition to the Utah building, we
lease certain equipment which have been determined to be capital
leases. As of June 30, 2018, future minimum gross lease payments
required under the capital leases were as follows:
2019
|
$373,702
|
2020
|
380,674
|
2021
|
387,790
|
2022
|
395,040
|
2023
|
399,794
|
Thereafter
|
2,502,438
|
Total
|
$4,439,438
|
Inflation
Our
revenues and net income have not been unusually affected by
inflation or price increases for raw materials and parts from
vendors.
Stock Repurchase Plan
In
2011, our Board of Directors adopted a stock repurchase plan
authorizing repurchases of shares in the open market, through block
trades or otherwise. Decisions to repurchase shares under this plan
are based upon market conditions, the level of our cash balances,
general business opportunities, and other factors. The Board may
periodically approve amounts for share repurchases under the plan.
As of June 30, 2018, approximately $449,000 remained available
under this authorization for purchases under the plan. We have not
repurchased any shares under the plan during the past five fiscal
years.
Critical Accounting Policies
This
"Management’s Discussion and Analysis of Financial Condition
and Results of Operations" is based upon our Consolidated Financial
Statements (see Part II, Item 8. below), which have been prepared
in accordance with accounting principles generally accepted in the
U.S. (“GAAP”). The preparation of these financial
statements requires us to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenue and
expenses as well as the disclosure of contingent assets and
liabilities. We regularly review our estimates and assumptions. The
SEC has requested that all registrants address their most critical
accounting policies. The SEC has indicated that a “critical
accounting policy” is one which is both important to the
representation of the registrant’s financial condition and
results and requires management’s most difficult, subjective
or complex judgments, often as a result of the need to make
estimates about the effect of matters that are inherently
uncertain. We base our estimates on past experience and on various
other assumptions our management believes to be reasonable under
the circumstances, the results of which form the basis for making
judgments about carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results will
differ, and may differ materially from these estimates under
different assumptions or conditions. Additionally, changes in
accounting estimates could occur in the future from period to
period. Our management has discussed the development and selection
of our most critical financial estimates with the audit committee
of our Board of Directors. The following paragraphs identify our
most critical accounting policies:
Inventories
The
nature of our business requires that we maintain sufficient
inventory on hand at all times to meet the requirements of our
customers. We record finished goods inventory at the lower of
standard cost, which approximates actual cost (first-in, first-out)
or market. Raw materials are recorded at the lower of cost
(first-in, first-out) or market. Inventory valuation reserves are
maintained for the estimated impairment of the inventory.
Impairment may be a result of slow-moving or excess inventory,
product obsolescence or changes in the valuation of the inventory.
In determining the adequacy of reserves, we analyze the following,
among other things:
●
Current inventory
quantities on hand;
●
Product acceptance
in the marketplace;
●
Strategic marketing
and production plans
●
Technological
innovations; and
●
Character of the
inventory as a distributed item, finished manufactured item or raw
material.
Any
modifications to estimates of inventory valuation reserves are
reflected in cost of goods sold within the statements of operations
during the period in which such modifications are determined
necessary by management. As of June 30, 2018, and 2017, our
inventory valuation reserve balance, was approximately $458,000 and
$403,000, respectively, and our inventory balance was $10,988,000
and $7,398,000, net of reserves, respectively.
Revenue Recognition
Our
sales force and distributors sell our products to end users,
including physical therapists, athletic trainers, chiropractors,
and medical doctors. Sales revenues are recorded when products are
shipped FOB shipping point under an agreement with a customer, risk
of loss and title have passed to the customer, and collection of
any resulting receivable is reasonably assured. Amounts billed for
shipping and handling of products are recorded as sales revenue.
Costs for shipping and handling of products to customers are
recorded as cost of sales.
Allowance for Doubtful Accounts
We must
make estimates of the collectability of accounts receivable. In
doing so, we analyze historical bad debt trends, customer credit
worthiness, current economic trends and changes in customer payment
patterns when evaluating the adequacy of the allowance for doubtful
accounts. Our accounts receivable balance was $7,811,000 and
$5,281,000, net of allowance for doubtful accounts of $370,000 and
$382,000 as of June 30, 2018, and 2017, respectively.
Deferred Income Tax Assets
A
valuation allowance is required when there is significant
uncertainty as to the realizability of deferred tax assets. The
realization of deferred tax assets is dependent upon our ability to
generate sufficient taxable income within the carryforward periods
provided for in the tax law for each tax jurisdiction. We have considered
the following possible sources of taxable income when assessing the
realization of our deferred tax assets:
●
future reversals of
existing taxable temporary differences;
●
future taxable
income or loss, exclusive of reversing temporary differences and
carryforwards;
●
tax-planning
strategies; and
●
taxable income in
prior carryback years.
We
considered both positive and negative evidence in determining the
continued need for a valuation allowance, including the
following:
Positive evidence:
●
Current forecasts
indicate that we will generate pre-tax income and taxable income in
the future. However, there can be no assurance that the new
strategic plans will result in profitability.
●
A majority of our
tax attributes have indefinite carryover periods.
Negative evidence:
● We have seven years
of cumulative losses as of June 30, 2018.
We
place more weight on objectively verifiable evidence than on other
types of evidence and management currently believes that available
negative evidence outweighs the available positive evidence. We
have therefore determined that we do not meet the “more
likely than not” threshold that deferred tax assets will be
realized. Accordingly, a valuation allowance is required. Any
reversal of the valuation allowance will favorably impact our
results of operations in the period of reversal.
Recent Accounting Pronouncements
On December 22, 2017, the U.S. government enacted comprehensive tax
reform legislation commonly referred to as the Tax Cuts and Jobs
Act (“Tax Act”). The Tax Act provides for significant
changes to the U.S. Internal Revenue Code of 1986, as amended.
Among other items, the Tax Act permanently reduces the federal
corporate tax rate to 21% effective January 1, 2018.
The SEC issued Staff Accounting Bulletin No. 118 (“SAB
118”), which provides guidance on accounting for the tax
effects of the Tax Act. SAB 118 provides a measurement period that
should not extend beyond one year from the Tax Act enactment date
for companies to complete the accounting under Accounting Standards
Codification (ASC) 740 - Income Taxes (“ASC 740”). In
accordance with SAB 118, a company must reflect the income tax
effects of those aspects of the Tax Act for which the accounting
under ASC 740 is complete. To the extent that a company’s
accounting for certain income tax effects of the Tax Act is
incomplete but it can determine a reasonable estimate, it must
record a provisional estimate in the consolidated financial
statements. If a company cannot determine a provisional estimate to
be included in the consolidated financial statements, it should
continue to apply ASC 740 on the basis of the provisions of the tax
laws that were in effect immediately before the enactment of the
Tax Act. Under the staff guidance in SAB 118, in the financial
reporting period in which the Tax Act is enacted, the income tax
effects of the Tax Act (i.e., only for those tax effects in which
the accounting under ASC 740 is incomplete) would be reported as a
provisional amount based on a reasonable estimate (to the extent a
reasonable estimate can be determined), which would be subject to
adjustment during a “measurement period” until the
accounting under ASC 740 is complete. The measurement period is
limited to no more than one year beyond the enactment date under
the staff's guidance. SAB 118 also describes supplemental
disclosures that should accompany the provisional amounts,
including the reasons for the incomplete accounting, the additional
information or analysis that is needed, and other information
relevant to why the registrant was not able to complete the
accounting required under ASC 740 in a timely manner. The impact of
the Tax Act is reflected in Note 11.
In January 2017, the Financial Accounting Standards Board
(“FASB”) issued ASU 2017-04, Intangibles—Goodwill
and Other (Topic 350), Simplifying the Test for Goodwill
Impairment. The amendment in this update simplifies how an entity
is required to test goodwill for impairment by eliminating Step 2
from the goodwill impairment test. An entity should apply the
amendments in this update on a prospective basis. The amendment
will be effective for reporting periods beginning after December
15, 2019, and early adoption is permitted. We early adopted this
standard as of July 1, 2017. This adoption did not have a material
impact on our consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic
842,) a new guidance on leases. This guidance replaces the prior
lease accounting guidance in its entirety. The underlying principle
of the new standard is the recognition of lease assets and lease
liabilities by lessees for substantially all leases, with an
exception for leases with terms of less than twelve months. The
standard also requires additional quantitative and qualitative
disclosures. The guidance is effective for interim and annual
reporting periods beginning after December 15, 2018, and early
adoption is permitted. The standard requires a modified
retrospective approach, which includes several optional practical
expedients. Accordingly, the standard is effective for us on July
1, 2019. We are currently evaluating the impact that this guidance
will have on our consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts
with Customer (Topic 606). This authoritative accounting guidance
related to revenue from contracts with customers. This guidance is
a comprehensive new revenue recognition model that requires a
company to recognize revenue to depict the transfer of goods or
services to a customer at an amount that reflects the consideration
it expects to receive in exchange for those goods or services. This
guidance is effective for annual reporting periods beginning after
December 15, 2017. Companies may use either a full retrospective or
a modified retrospective approach to adopt this guidance. We
adopted this updated accounting guidance beginning July 1, 2018
using the modified retrospective method. This adoption has not had
a material impact on our consolidated financial statements other
than additional disclosures.
Business Plan and Outlook
This
past year we have continued to strengthen our executive management
team, strengthened our sales organization and pursued acquisition
candidates. In that regard, we successfully acquired and integrated
assets and operations of Bird & Cronin which has significantly
increased our market presence and improved our operating results.
We will continue to pursue our growth strategies in fiscal 2019 as
follows:
●
Achieve organic
sales growth through improved sales management, geographic
expansion, improved market penetration, and continued expansion
into post-acute care markets;
●
Identify and act on
additional acquisition opportunities that will further enhance our
product offering, distribution coverage and leverage our current
sales network to improve gross profit margins and cash flows;
and
●
Bolster our
investor relations activities and strengthen our financial markets
position.
To better
execute on our growth strategies, during fiscal year 2018 we made
important additions to our executive management team. In January
2018, Skyler Black joined us as Corporate Controller. In February
2018, Brian Baker and Daryl Connell joined us as President of TPD
and Chief Information Officer, respectively. In June 2018, we
appointed Christopher von Jako, Ph.D. as Chief Executive Officer.
In addition, as a result of the Bird & Cronin acquisition, Mike
Cronin and Jason Anderson, now function as the co-Presidents of our
Bird & Cronin subsidiary. These changes are all calculated to
better position us to execute on our strategic growth
plans.
We are
actively pursuing our acquisition strategy to consolidate other
small manufacturers and distributors in our core markets (i.e.
orthopedic soft goods, physical therapy, athletic training, and
chiropractic). We are primarily seeking candidates that fall into
the following categories:
●
Manufacturers that
extend our product portfolio
●
Distributors that
extend geographic reach or provide different channel
access
●
Tuck-in
manufacturers / distributors in adjacent markets
In
summary, based on our defined strategic initiatives we are focusing
our resources in the following areas:
●
Updating and
improving our selling and marketing efforts including focusing our
sales and marketing efforts into our core markets;
●
Seeking to improve
distribution of our products through recruitment of additional
qualified sales representatives and dealers attracted by the many
new products being offered and expanding the availability of
proprietary combination therapy device;
●
Improving gross
profit margins by, among other initiatives, increasing market share
of manufactured orthopedic soft goods, physical therapy and
rehabilitation equipment products;
●
Maintaining our
position as a technological leader and innovator in our markets
through the introduction of new products during the new fiscal
year;
●
Exploring strategic
business acquisitions to leverage and complement our competitive
strengths, increase market reach and allow us to potentially expand
into broader medical markets; and
●
Attending strategic
conferences to make investors aware of our strategic plans, attract
new capital to support the business development strategy and
identify other acquisition targets.
Item 7A. Quantitative and
Qualitative Disclosures about Market Risk
Not
Applicable.
Item 8. Financial Statements and
Supplementary Data
Audited
consolidated financial statements and related documents required by
this item are included in this report on the pages indicated in the
following table:
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders
Dynatronics
Corporation
Opinion on the Financial Statements
We have
audited the accompanying consolidated balance sheets of Dynatronics
Corporation and subsidiaries (the “Company”) as of June
30, 2018 and 2017, the related consolidated statements of
operations, stockholders’ equity, and cash flows for the
years then ended, and the related notes (collectively referred to
as the “financial statements”). In our opinion,
the financial statements present fairly, in all material respects,
the financial position of the Company as of June 30, 2018 and 2017,
and the results of its operations and its cash flows for each of
the two years in the period ended June 30, 2018, in conformity with
U.S. generally accepted accounting principles.
Basis for Opinion
These
financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on the
Company’s financial statements based on our audits. We are a
public accounting firm registered with the Public Company
Accounting Oversight Board (United States) (“PCAOB”)
and are required to be independent with respect to the Company in
accordance with the U.S. federal securities laws and the applicable
rules and regulations of the Securities and Exchange Commission and
the PCAOB.
We
conducted our audits in accordance with the standards of the
PCAOB. Those standards require that we plan and perform
the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement, whether due
to error or fraud. The Company is not required to have,
nor were we engaged to perform, an audit of its internal control
over financial reporting. As part of our audits we are
required to obtain an understanding of internal control over
financial reporting but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal
control over financial reporting. Accordingly, we
express no such opinion.
Our
audits included performing procedures to assess the risk of
material misstatement of the financial statements, whether due to
error or fraud, and performing procedures that respond to those
risks. Such procedures included examining, on a test basis,
evidence regarding the amounts and disclosures in the financial
statements. Our audits also included evaluating the accounting
principles used and significant estimates made by management, as
well as evaluating the overall presentation of the financial
statements. We believe that our audits provide a
reasonable basis for our opinion.
/s/
Tanner LLC
We have
served as the Company’s auditor since 2017.
Salt
Lake City, Utah
September
27, 2018
|
Consolidated Balance Sheets
|
As
of June 30, 2018 and 2017
|
|
|
|
|
|
|
Assets
|
|
|
Current
assets:
|
|
|
Cash and cash
equivalents
|
$1,696,116
|
$254,705
|
Trade accounts
receivable, less allowance for doubtful accounts of $370,300 as of
June 30, 2018 and $382,333 as of June 30, 2017
|
7,810,846
|
5,281,348
|
Other
receivables
|
52,819
|
33,388
|
Inventories,
net
|
10,987,855
|
7,397,682
|
Prepaid
expenses
|
778,654
|
503,800
|
Income tax
receivable
|
95,501
|
-
|
|
|
|
Total
current assets
|
21,421,791
|
13,470,923
|
|
|
|
Property and
equipment, net
|
5,850,899
|
4,973,477
|
Intangible assets,
net
|
7,131,758
|
2,754,118
|
Goodwill
|
7,116,614
|
4,302,486
|
Other
assets
|
532,872
|
562,873
|
|
|
|
Total
assets
|
$42,053,934
|
$26,063,877
|
|
|
|
Liabilities
and Stockholders' Equity
|
|
|
Current
liabilities:
|
|
|
Accounts
payable
|
$3,412,960
|
$2,334,563
|
Accrued payroll and
benefits expense
|
1,929,465
|
1,472,773
|
Accrued
expenses
|
830,243
|
656,839
|
Income tax
payable
|
-
|
8,438
|
Warranty
reserve
|
205,850
|
202,000
|
Line of
credit
|
6,286,037
|
2,171,935
|
Current portion of
long-term debt
|
164,003
|
151,808
|
Current portion of
capital lease obligations
|
226,727
|
193,818
|
Current portion of
deferred gain
|
150,448
|
150,448
|
Current portion of
acquisition holdback
|
1,379,512
|
294,744
|
|
|
|
Total
current liabilities
|
14,585,245
|
7,637,366
|
|
|
|
Long-term debt, net
of current portion
|
303,348
|
461,806
|
Capital lease
obligations, net of current portion
|
2,972,540
|
3,087,729
|
Deferred gain, net
of current portion
|
1,529,553
|
1,680,001
|
Acquisition
holdback and earn out liability, net of current
portion
|
875,000
|
750,000
|
Other
liabilities
|
411,466
|
122,585
|
|
|
|
Total
liabilities
|
20,677,152
|
13,739,487
|
Commitments and
contingencies
|
|
|
|
|
|
Stockholders'
equity:
|
|
|
Preferred stock, no
par value: Authorized 50,000,000 shares; 4,899,000 shares and
3,559,000 shares issued and outstanding as of June 30, 2018 and
June 30, 2017, respectively
|
11,641,816
|
8,501,295
|
Common stock, no
par value: Authorized 100,000,000 shares; 8,089,398 shares and
4,653,165 shares issued and outstanding as of June 30, 2018 and
June 30, 2017, respectively
|
20,225,107
|
11,838,022
|
Accumulated
deficit
|
(10,490,141)
|
(8,014,927)
|
|
|
|
Total
stockholders' equity
|
21,376,782
|
12,324,390
|
|
|
|
Total
liabilities and stockholders' equity
|
$42,053,934
|
$26,063,877
|
|
|
|
See accompanying
notes to consolidated financial statements.
|
|
|
|
Consolidated Statements of Operations
|
For
the Years Ended June 30, 2018 and 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
$64,414,910
|
$35,758,330
|
Cost of
sales
|
43,994,235
|
24,249,832
|
Gross
profit
|
20,420,675
|
11,508,498
|
|
|
|
Selling, general,
and administrative expenses
|
20,477,556
|
12,101,539
|
Research and
development expenses
|
1,194,013
|
1,081,373
|
Operating
loss
|
(1,250,894)
|
(1,674,414)
|
|
|
|
Other income
(expense):
|
|
|
Interest
expense, net
|
(428,462)
|
(277,630)
|
Other
income, net
|
6,786
|
85,649
|
Net other
expense
|
(421,676)
|
(191,981)
|
|
|
|
Loss before income
taxes
|
(1,672,570)
|
(1,866,395)
|
|
|
|
|
70,314
|
-
|
|
|
|
Net
loss
|
(1,602,256)
|
(1,866,395)
|
|
|
|
Deemed dividend on
convertible preferred stock and accretion of discount
|
(1,023,786)
|
(1,944,223)
|
Preferred stock
dividend, cash
|
(104,884)
|
(16,241)
|
Convertible
preferred stock dividend, in common stock
|
(768,074)
|
(466,269)
|
|
|
|
Net loss
attributable to common stockholders
|
$(3,499,000)
|
$(4,293,128)
|
|
|
|
Basic and diluted
net loss per common share
|
$(0.53)
|
$(1.36)
|
|
|
|
Weighted-average
common shares outstanding:
|
|
|
|
|
|
Basic and
diluted
|
6,622,429
|
3,152,425
|
|
|
|
See accompanying
notes to consolidated financial statements.
|
|
|
|
Consolidated Statements of Stockholders'
Equity
|
For
the Years Ended June 30, 2018 and 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances as of June
30, 2016
|
2,805,280
|
$7,545,880
|
1,610,000
|
$3,708,152
|
$(5,666,022)
|
$5,588,010
|
|
|
|
|
|
|
|
Stock-based
compensation
|
143,054
|
419,925
|
-
|
-
|
-
|
419,925
|
|
|
|
|
|
|
|
Issuance of common
stock, net of issuance costs of $268,328
|
1,565,173
|
3,405,948
|
-
|
-
|
-
|
3,405,948
|
|
|
|
|
|
|
|
Issuance of
preferred stock and warrants, net of issuance costs of
$302,581
|
-
|
-
|
1,949,000
|
4,793,143
|
-
|
4,793,143
|
|
|
|
|
|
|
|
Preferred stock
dividend, in cash
|
-
|
-
|
-
|
-
|
(16,241)
|
(16,241)
|
|
|
|
|
|
|
|
Preferred stock
dividend, in common stock, issued or to be issued
|
139,658
|
466,269
|
-
|
-
|
(466,269)
|
-
|
|
|
|
|
|
|
|
Preferred stock
beneficial conversion feature
|
-
|
-
|
-
|
1,944,223
|
-
|
1,944,223
|
|
|
|
|
|
|
|
Dividend of
beneficial conversion feature
|
-
|
-
|
-
|
(1,944,223)
|
-
|
(1,944,223)
|
|
|
|
|
|
|
|
Net
loss
|
-
|
-
|
-
|
-
|
(1,866,395)
|
(1,866,395)
|
|
|
|
|
|
|
|
Balances as of June
30, 2017
|
4,653,165
|
11,838,022
|
3,559,000
|
8,501,295
|
(8,014,927)
|
12,324,390
|
|
|
|
|
|
|
|
Stock-based
compensation
|
103,853
|
254,758
|
-
|
-
|
-
|
254,758
|
|
|
|
|
|
|
|
Issuance of
preferred stock and warrants, net of issuance costs of
$399,879
|
-
|
-
|
4,381,935
|
10,600,121
|
-
|
10,600,121
|
|
|
|
|
|
|
|
Preferred stock
dividend, in cash
|
-
|
-
|
-
|
-
|
(104,884)
|
(104,884)
|
|
|
|
|
|
|
|
Preferred stock
dividend, in common stock, issued or to be issued
|
290,445
|
768,074
|
-
|
-
|
(768,074)
|
-
|
|
|
|
|
|
|
|
Preferred stock
converted to common stock
|
3,041,935
|
7,459,600
|
(3,041,935)
|
(7,459,600)
|
-
|
-
|
|
|
|
|
|
|
|
Reduction in equity
retained for aquisition holdback
|
-
|
(95,347)
|
-
|
-
|
-
|
(95,347)
|
|
|
|
|
|
|
|
Preferred stock
beneficial conversion and accretion of discount
|
-
|
-
|
-
|
1,023,786
|
-
|
1,023,786
|
|
|
|
|
|
|
|
Dividend of
beneficial conversion and accretion of discount
|
-
|
-
|
-
|
(1,023,786)
|
-
|
(1,023,786)
|
|
|
|
|
|
|
|
Net
loss
|
-
|
-
|
-
|
-
|
(1,602,256)
|
(1,602,256)
|
|
|
|
|
|
|
|
Balances as of June
30, 2018
|
8,089,398
|
$20,225,107
|
4,899,000
|
$11,641,816
|
$(10,490,141)
|
$21,376,782
|
|
|
|
|
|
|
|
See
accompanying notes to consolidated financial
statements.
|
|
|
|
|
|
|
Consolidated Statements of Cash Flows
|
For
the Years Ended June 30, 2018 and 2017
|
|
|
|
|
|
|
|
Cash flows from
operating activities:
|
|
|
Net
loss
|
$(1,602,256)
|
$(1,866,395)
|
Adjustments
to reconcile net loss to net cash provided by (used in) operating
activities:
|
|
|
Depreciation
and amortization of property and equipment
|
419,148
|
242,542
|
Amortization
of intangible assets
|
638,360
|
95,005
|
Amortization
of other assets
|
74,568
|
124,774
|
Amortization
of capital lease assets
|
254,418
|
251,934
|
Loss
(gain) on sale of property and equipment
|
20,438
|
(15,754)
|
Stock-based
compensation expense
|
254,758
|
419,925
|
Change
in allowance for doubtful accounts receivable
|
(20,033)
|
(6,717)
|
Change
in allowance for inventory obsolescence
|
55,652
|
(13,021)
|
Amortization
deferred gain on sale/leaseback
|
(150,448)
|
(150,448)
|
Change
in operating assets and liabilities:
|
|
|
Trade
accounts receivable
|
(292,090)
|
(81,321)
|
Inventories
|
491,356
|
(269,977)
|
Prepaid
expenses
|
(181,865)
|
(110,224)
|
Other
assets
|
(44,567)
|
(107,486)
|
Income
tax payable/receivable
|
(106,391)
|
5,543
|
Accounts
payable and accrued expenses
|
950,754
|
(46,708)
|
|
|
|
Net
cash provided by (used in) operating activities
|
761,802
|
(1,528,328)
|
|
|
|
Cash flows from
investing activities:
|
|
|
Purchase
of property and equipment
|
(242,911)
|
(117,876)
|
Net
cash paid in acquisitions - see Note 2
|
(9,063,017)
|
(9,116,089)
|
Proceeds
from sale of property and equipment
|
12,160
|
32,000
|
|
|
|
Net
cash used in investing activities
|
(9,293,768)
|
(9,201,965)
|
|
|
|
Cash flows from
financing activities:
|
|
|
Principal
payments on long-term debt
|
(146,263)
|
(152,668)
|
Principal
payments on long-term capital lease
|
(194,955)
|
(183,302)
|
Payment
of acquisition holdbacks
|
(294,744)
|
-
|
Net
change in line of credit
|
4,114,102
|
2,171,935
|
Proceeds
from issuance of preferred stock, net
|
6,600,121
|
8,199,091
|
Preferred
stock dividends paid in cash
|
(104,884)
|
(16,241)
|
|
|
|
Net
cash provided by financing activities
|
9,973,377
|
10,018,815
|
|
|
|
Net
change in cash and cash equivalents
|
1,441,411
|
(711,478)
|
|
|
|
Cash and cash
equivalents at beginning of the period
|
254,705
|
966,183
|
|
|
|
Cash and cash
equivalents at end of the period
|
$1,696,116
|
$254,705
|
|
|
|
Supplemental
disclosure of cash flow information:
|
|
|
Cash
paid for interest
|
$412,455
|
$271,254
|
Supplemental
disclosure of non-cash investing and financing
activity:
|
|
|
Deemed
dividend on convertible preferred stock and accretion of
discount
|
1,023,786
|
1,944,223
|
Preferred
stock dividends paid or to be paid in common stock
|
768,074
|
466,269
|
Preferred
stock issued to acquire "Bird & Cronin"
|
3,904,653
|
-
|
Acquisition
holdback
|
1,504,512
|
-
|
Conversion
of preferred stock to common stock
|
7,459,600
|
-
|
Capital
lease and note payable obligations incurred to acquire property and
equipment
|
112,675
|
75,808
|
Preferred
stock issuance costs paid in common stock
|
-
|
17,000
|
|
|
|
See accompanying
notes to consolidated financial statements.
|
|
|
DYNATRONICS
CORPORATION
Notes to Consolidated Financial Statements
June
30, 2018 and 2017
Note
1. Basis
of Presentation and Summary of Significant Accounting
Policies
Description of Business
Dynatronics Corporation (“the
Company,” “Dynatronics”) designs,
manufactures, markets, and distributes orthopedic soft goods,
medical supplies, and physical therapy and rehabilitation
equipment. Through our various distribution channels, we market and
sell to orthopedists, physical therapists, chiropractors, athletic
trainers, sports medicine practitioners, clinics, and
hospitals.
Principles of Consolidation
The
consolidated financial statements include the accounts and
operations of Dynatronics Corporation and its wholly owned
subsidiaries, Hausmann Enterprises, LLC, Bird & Cronin, LLC
(see Note 2) and Dynatronics Distribution Company, LLC. The
consolidated financial statements are prepared in conformity with
U.S. generally accepted accounting principles (U.S. GAAP). All
significant intercompany account balances and transactions have
been eliminated in consolidation.
Cash and Cash Equivalents
Cash
and cash equivalents include all highly liquid investments with
maturities of three months or less at the date of purchase. Also
included within cash and cash equivalents are deposits in-transit
from banks for payments related to third-party credit card and
debit card transactions. Cash and cash equivalents totaled
approximately $1,696,000 and $255,000 as of June 30, 2018 and 2017,
respectively.
Inventories
Finished
goods inventories are stated at the lower of standard cost, which
approximates actual cost using the first-in, first-out method, or
net realizable value. Raw materials are stated at the lower of cost
(first-in, first-out method) or net realizable value. The Company
periodically reviews the value of items in inventory and records
write-downs or write-offs based on its assessment of slow moving or
obsolete inventory. The Company maintains a reserve for obsolete
inventory and generally makes inventory value adjustments against
the reserve.
Trade Accounts Receivable
Trade
accounts receivable are recorded at the invoiced amount and do not
bear interest, although finance charges may be applied to past due
accounts. The Company maintains an allowance for doubtful accounts
that is the Company’s estimate of credit risk in the
Company’s existing accounts receivable. The Company
determines the allowance based on a combination of statistical
analysis, historical collection patterns, customers’ current
credit worthiness, the age of account balances, and general
economic conditions. All account balances are reviewed on an
individual basis. Account balances are charged against the
allowance when the potential for recovery is considered remote.
Recoveries of accounts previously written off are recognized when
payment is received.
Property and Equipment
Property
and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the
estimated useful lives of the assets. Buildings and improvements
are depreciated over estimated useful lives that range from 5 to
31.5 years. Leasehold improvements are amortized over the
remaining term of the respective building lease. Machinery, office
equipment, computer equipment and software and vehicles are
depreciated over estimated useful lives that range from 3 to 7
years.
Goodwill
Goodwill
resulted from the Hausmann and Bird & Cronin acquisitions (see
Note 2). Goodwill in a business combination represents the purchase
price in excess of identifiable tangible and intangible assets.
Goodwill and intangible assets that have an indefinite useful life
are not amortized. Instead they are reviewed periodically for
impairment.
The
Company evaluates goodwill on an annual basis in the fourth quarter
or more frequently if management believes indicators of impairment
exist. Such indicators could include, but are not limited to (1) a
significant adverse change in legal factors or in business climate,
(2) unanticipated competition, or (3) an adverse action or
assessment by a regulator. The Company first assesses 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,
including goodwill. If management concludes that it is more likely
than not that the fair value of a reporting unit is less than its
carrying amount, management conducts a quantitative goodwill
impairment test. The impairment test involves comparing the fair
value of the applicable reporting unit with its carrying value. The
Company estimates the fair values of its reporting units using a
combination of the income, or discounted cash flows, approach and
the market approach, which utilizes comparable companies’
data. If the carrying amount of a reporting unit exceeds the
reporting unit’s fair value, an impairment loss is recognized
in an amount equal to that excess, limited to the total amount of
goodwill allocated to that reporting unit. The Company’s
evaluation of goodwill completed during the year resulted in no
impairment losses.
Long-Lived Assets
Long–lived
assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets is measured by a
comparison of the carrying amount of an asset to estimated
undiscounted future cash flows expected to be generated by the
asset. If the carrying amount of an asset exceeds its estimated
future cash flows, an impairment charge is recognized for the
difference between the carrying amount of the asset and the fair
value of the asset. Assets to be disposed are separately presented
in the balance sheet at the lower of net book value or fair value
less estimated disposition costs, and are no longer
depreciated.
Intangible Assets
Costs
associated with the acquisition of trademarks, certain trade names,
license rights and non-compete agreements are capitalized and
amortized using the straight-line method over periods ranging from
3 months to 20 years. Trade names determined to have an indefinite
life are not amortized, but are required to be tested for
impairment and written down, if necessary. The Company assesses
indefinite lived intangible assets for impairment each fiscal year
or more frequently if events and circumstances indicate impairment
may have occurred.
Revenue Recognition
The
Company recognizes revenue when products are shipped FOB shipping
point under an agreement with a customer, risk of loss and title
have passed to the customer, and collection of any resulting
receivable is reasonably assured. Amounts billed for shipping and
handling of products are recorded as sales. Costs for shipping and
handling of products to customers are recorded as cost of
sales.
Research and Development Costs
Research
and development costs are expensed as incurred.
Product Warranty Costs
The
Company provides a warranty on all products it manufactures for
time periods ranging in length from 90 days to five years from the date of sale. Costs
estimated to be incurred in connection with the Company’s
product warranty programs are charged to expense as products are
sold based on historical warranty rates. The Company maintains a
reserve for estimated product warranty costs to be incurred related
to products previously sold.
Net Loss per Common Share
Net
loss per common share is computed based on the weighted-average
number of common shares outstanding and, when appropriate, dilutive
potential common shares outstanding during the year. Convertible
preferred stock, stock options and warrants are considered to be
potential common shares. The computation of diluted net loss per
common share does not assume exercise or conversion of securities
that would have an anti-dilutive effect.
Basic
net loss per common share is the amount of net loss for the year
available to each weighted-average share of common stock
outstanding during the year. Diluted net loss per common share is
the amount of net loss for the year available to each
weighted-average share of common stock outstanding during the year
and to each potential common share outstanding during the year,
unless inclusion of potential common shares would have an
anti-dilutive effect.
Outstanding
options, warrants and convertible preferred stock for common shares
not included in the computation of diluted net loss per common
share because they were anti-dilutive, totaled 11,222,589 as of
June 30, 2018 and 9,029,080 as of June 30, 2017. These
potential common shares are not included in the computation because
they would be anti-dilutive.
Income Taxes
The
Company recognizes an asset or liability for the deferred income
tax consequences of all temporary differences between the tax bases
of assets and liabilities and their reported amounts in the
consolidated financial statements that will result in taxable or
deductible amounts in future years when the reported amounts of the
assets and liabilities are recovered or settled. Accounting
standards require the consideration of a valuation allowance for
deferred tax assets if it is “more likely than not”
that some component or all of the benefits of deferred tax assets
will not be realized. Accruals for uncertain tax positions are
provided for in accordance with applicable accounting standards.
The Company may recognize the tax benefits from an uncertain tax
position only if it is more likely than not that the tax position
will be sustained on examination by the taxing authorities, based
on the technical merits of the position. The tax benefits
recognized in the financial statements from such a position are
measured based on the largest benefit that has a greater than 50%
likelihood of being realized upon ultimate settlement. Judgment is
required in assessing the future tax consequences of events that
have been recognized in the financial statements or tax returns.
Variations in the actual outcome of these future tax consequences
could materially impact the Company’s financial position,
results of operations and cash flows.
Income Tax Reform
On
December 22, 2017, the U.S. government enacted comprehensive tax
reform legislation commonly referred to as the Tax Cuts and Jobs
Act (“Tax Act”). The Tax Act provides for significant
changes to the U.S. Internal Revenue Code of 1986, as amended.
Among other items, the Tax Act permanently reduces the federal
corporate tax rate to 21% effective January 1, 2018. As the
Company’s fiscal year end falls on June 30, the statutory
federal corporate tax rate for fiscal 2018 will be prorated to
27.5%, with the statutory rate for fiscal 2019 and beyond at 21%.
As a result of the reduction in the corporate income tax rate from
35% to 21% under the Act, the Company revalued its net deferred tax
assets at December 31, 2017 and included these estimates in our
consolidated financial statements for the year ended June 30, 2018.
The final transition impacts of the Tax Act may vary from the
current estimate, possibly materially, due to, among other things,
further clarification and changes in interpretations of the Tax
Act, any legislative action to address questions that arise because
of the Tax Act, and any changes in accounting standards for income
taxes or related interpretations in response to the Tax Act. In
accordance with Staff
Accounting Bulletin No. 118 (“SAB 118”), any
necessary measurement adjustments will be recorded and disclosed
within one year from the enactment date within the period the
adjustments are determined.
Stock-Based Compensation
Stock-based
compensation cost is measured at the grant date based on the fair
value of the award determined by using the Black-Scholes
option-pricing model and is recognized as expense over the
applicable vesting period of the stock award (zero to five years)
using the straight-line method.
Concentration of Risk
In the
normal course of business, the Company provides unsecured credit to
its customers. Most of the Company’s customers are involved
in the medical industry. The Company performs ongoing credit
evaluations of its customers and maintains allowances for probable
losses which, when realized, have been within the range of
management’s expectations. The Company maintains its cash in
bank deposit accounts which at times may exceed federally insured
limits.
As of
June 30, 2018 and 2017, the Company had approximately $1,575,000
and $242,000, respectively, in cash and cash equivalents in excess
of federally insured limits. The Company has not experienced any
losses in such accounts.
Certain
of the Company's employees are covered by a collective bargaining
agreement. As of June 30, 2018, approximately 17% of the Company's
employees were covered by a collective bargaining agreement
scheduled to expire in 2019.
Operating Segments
The
Company operates in one line of business: the development,
manufacturing, marketing, and distribution of a broad line of
medical products for the orthopedic, physical therapy and similar
markets. As such, the Company has only one reportable operating
segment.
Use of Estimates
Management
of the Company has made a number of estimates and assumptions
relating to the reporting of assets, liabilities, revenues and
expenses, and the disclosure of contingent assets and liabilities
in accordance with U.S. GAAP. Significant items subject to such
estimates and assumptions include the impairment and useful lives
of long-lived assets; valuation allowances for doubtful accounts
receivables, deferred income taxes, and obsolete inventories;
accrued product warranty costs; and fair values of assets acquired
and liabilities assumed in an acquisition. Actual results could
differ from those estimates.
Reclassification
Certain
amounts in the prior year's consolidated statement of operations
have been reclassified for comparative purposes to conform to the
presentation in the current year's consolidated statement of
operations.
Recent Accounting Pronouncements
On December 22, 2017, the U.S. government enacted comprehensive tax
reform legislation commonly referred to as the Tax Cuts and Jobs
Act. The Tax Act provides for significant changes to the U.S.
Internal Revenue Code of 1986, as amended. Among other items, the
Tax Act permanently reduces the federal corporate tax rate to 21%
effective January 1, 2018. The SEC issued SAB 118, which provides
guidance on accounting for the tax effects of the Tax Act. SAB 118
provides a measurement period that should not extend beyond one
year from the Tax Act enactment date for companies to complete the
accounting under Accounting Standards Codification (ASC) 740 -
Income Taxes (“ASC 740”). In accordance with SAB 118, a
company must reflect the income tax effects of those aspects of the
Tax Act for which the accounting under ASC 740 is complete. To the
extent that a company’s accounting for certain income tax
effects of the Tax Act is incomplete but it can determine a
reasonable estimate, it must record a provisional estimate in the
consolidated financial statements. If a company cannot determine a
provisional estimate to be included in the consolidated financial
statements, it should continue to apply ASC 740 on the basis of the
provisions of the tax laws that were in effect immediately before
the enactment of the Tax Act. Under the staff guidance in SAB 118,
in the financial reporting period in which the Tax Act is enacted,
the income tax effects of the Tax Act (i.e., only for those tax
effects in which the accounting under ASC 740 is incomplete) would
be reported as a provisional amount based on a reasonable estimate
(to the extent a reasonable estimate can be determined), which
would be subject to adjustment during a “measurement
period” until the accounting under ASC 740 is complete. The
measurement period is limited to no more than one year beyond the
enactment date under the staff's guidance. SAB 118 also describes
supplemental disclosures that should accompany the provisional
amounts, including the reasons for the incomplete accounting, the
additional information or analysis that is needed, and other
information relevant to why the registrant was not able to complete
the accounting required under ASC 740 in a timely manner. The
impact of the Tax Act is reflected in Note 11.
In January 2017, the Financial Accounting Standards Board
(“FASB”) issued ASU 2017-04, Intangibles—Goodwill
and Other (Topic 350), Simplifying the Test for Goodwill
Impairment. The amendment in this update simplifies how an entity
is required to test goodwill for impairment by eliminating Step 2
from the goodwill impairment test. An entity should apply the
amendments in this update on a prospective basis. The amendment
will be effective for reporting periods beginning after December
15, 2019, and early adoption is permitted. The Company early
adopted this standard as of July 1, 2017. This adoption did not
have a material impact on the consolidated financial
statements.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic
842,) a new guidance on leases. This guidance replaces the prior
lease accounting guidance in its entirety. The underlying principle
of the new standard is the recognition of lease assets and lease
liabilities by lessees for substantially all leases, with an
exception for leases with terms of less than twelve months. The
standard also requires additional quantitative and qualitative
disclosures. The guidance is effective for interim and annual
reporting periods beginning after December 15, 2018, and early
adoption is permitted. The standard requires a modified
retrospective approach, which includes several optional practical
expedients. Accordingly, the standard is effective for the Company
on July 1, 2019. The Company is currently evaluating the impact
that this guidance will have on the consolidated financial
statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts
with Customer (Topic 606). This authoritative accounting guidance
related to revenue from contracts with customers. This guidance is
a comprehensive new revenue recognition model that requires a
company to recognize revenue to depict the transfer of goods or
services to a customer at an amount that reflects the consideration
it expects to receive in exchange for those goods or services. This
guidance is effective for annual reporting periods beginning after
December 15, 2017. Companies may use either a full retrospective or
a modified retrospective approach to adopt this guidance. The
Company adopted this updated accounting guidance beginning July 1,
2018 using the modified retrospective method. This adoption has not
had a material impact on the Company’s consolidated financial
statements other than additional disclosures.
Note
2. Acquisitions
Bird & Cronin
On
October 2, 2017, the Company, through its wholly-owned subsidiary
Bird & Cronin, LLC, a newly formed Utah limited liability
company, completed the purchase of substantially all the assets of
Bird & Cronin, Inc. (“Bird & Cronin”), a
manufacturer and distributor of orthopedic soft goods and specialty
patient care products. This acquisition has expanded the
Company’s sales in the orthopedic and patient care markets by
leveraging the products and distribution network offered by Bird
& Cronin.
At the
closing of the acquisition, the Company paid Bird & Cronin cash
of $9,063,017 and delivered 1,397,375 shares of its Series D
Non-Voting Convertible Preferred Stock (“Series D
Preferred”) to Bird & Cronin valued at approximately
$3,533,333. The purchase price is subject to customary
representations, warranties, indemnities, working capital
adjustment and an earn-out payment ranging from $500,000 to
$1,500,000, based on future sales.
A
holdback of cash totaling $933,334 and 184,560 shares of common
stock (converted from Series D Preferred) valued at approximately
$466,667 was retained for purposes of satisfying adjustments to the
purchase price as may be required. Pursuant to a working capital
adjustment and indemnification claim provisions, the purchase price
was subsequently decreased $399,169. The cash portion of the
holdback was also increased by $95,347 in exchange for a reduction
in retained shares of common stock for the same value. In addition,
the amount recognized for the earn-out liability was subsequently
decreased by $625,000 to $875,000 as of June 30, 2018. The $875,000
is combined with the acquisition holdback in the accompanying
consolidated balance sheets. As part of the acquisition, the
Company assumed certain liabilities and obligations of Bird &
Cronin related to its ongoing business (primarily trade accounts
and similar obligations in the ordinary course).
In
connection with the acquisition, the Company completed a private
placement of Series C Non-Voting Convertible Preferred Stock
(“Series C Preferred”) and common stock warrants to
raise cash proceeds of $7,000,000 pursuant to the terms and
conditions of a Securities Purchase Agreement entered into on
September 26, 2017 (see Note 14). Certain principals of Bird &
Cronin are holders of the Company’s issued and outstanding
common stock and two of the principals, Michael Cronin and Jason
Anderson, are employees of the Company.
Also in
connection with the acquisition, the Company entered into a lease
with Trapp Road Limited Liability Company, a Minnesota limited
liability company controlled by the former owners of Bird &
Cronin operation, to lease the facility in Eagan, Minnesota (the
“Minnesota Facility”) effective as of the closing date
with an initial three-year term. Annual rental payments of $600,000
are payable in monthly installments of $50,000. The lease term will
automatically be extended for two additional periods of two years
each, without any increase in the lease payment, subject to the
Company’s right to terminate the lease or to provide notice
not to extend the lease prior to the end of the term. The Company
also offered employees of Bird & Cronin employment with
Dynatronics at closing including the Co-Presidents of Bird &
Cronin, Mike Cronin and Jason Anderson, who entered into employment
agreements with the Company to serve as Co-Presidents of the
acquired business.
The
Acquisition has been accounted for under the purchase method as
prescribed by applicable accounting standards. Under this method,
the Company has allocated the purchase price to the assets acquired
and liabilities assumed at estimated fair values. The total
consideration transferred or to be transferred, totaled $14,472,182
(which
is comprised of cash of $9,063,017, holdbacks of $1,504,512, and
preferred stock of $3,904,653 net of offering costs). The
following table summarizes the estimated fair value of the assets
acquired and liabilities assumed as of the date of
acquisition:
Cash and cash
equivalent
|
$454
|
Trade accounts
receivable
|
2,232,703
|
Inventories
|
4,137,181
|
Prepaid
expenses
|
92,990
|
Property and
equipment
|
1,228,000
|
Intangible
assets
|
5,016,000
|
Goodwill
|
2,814,128
|
Warranty
reserve
|
(5,000)
|
Accounts
payable
|
(607,084)
|
Accrued
expenses
|
(247,611)
|
Accrued payroll and
benefits
|
(189,579)
|
Purchase
price
|
$14,472,182
|
Intangible
assets subject to amortization include $4,313,000 that relate to
customer relationships with a useful life of ten years and other
intangible assets of $83,000 with a useful life of five years.
Intangible assets not subject to amortization of $620,000 relate to
trade names. The goodwill recognized from the acquisition is
estimated to be attributable, but not limited to, the acquired
workforce and expected synergies that do not qualify for separate
recognition. The full amount of goodwill and intangible assets are
expected to be deductible for tax purposes.
As of
June 30, 2018, the earn-out liability and holdbacks of $1,504,512
come due, contingent upon the terms set forth in the purchase
agreement, as follows:
October 2,
2018
|
$162,845
|
April 1,
2019
|
466,667
|
August 15,
2019
|
875,000
|
Acquisition
holdback
|
$1,504,512
|
Hausmann
On
April 3, 2017, the Company, through its wholly-owned subsidiary
Hausmann Enterprises, LLC, a newly formed Utah limited liability
company, completed the purchase of substantially all the assets of
Hausmann Industries, Inc., a New Jersey corporation
(“Hausmann”) for $10,000,000 in cash. This acquisition
has expanded Dynatronics’ sales in the physical therapy,
athletic training and other markets by leveraging the products and
distribution network offered by the Hausmann.
Financing
was provided by proceeds from the sale of equity securities in a
private offering to accredited investors and borrowings under a
loan and security agreement (see Note 14). Closing of the private
placement occurred concurrently with the closing of the
acquisition. At closing, the Company paid Hausmann $9,000,000 of
the $10,000,000 purchase price holding back $1,000,000 for purposes
of satisfying adjustments to the purchase price as may be required
and indemnification claims, if any. Pursuant to a working capital
adjustment provision, the purchase price was subsequently increased
$160,833 to $10,160,833. The Company paid an additional $116,089 to
Hausmann and held back an additional $44,744. The $44,744 is
combined with the acquisition holdback in the accompanying
consolidated balance sheets. As part of the acquisition, the
Company assumed certain liabilities and obligations of Hausmann
related to its ongoing business (primarily trade accounts and
similar obligations in the ordinary course).
In
connection with the acquisition, the Company sold equity securities
for gross proceeds of $7,795,000 in the private placement entered
into with certain accredited investors, including institutional
investors (see Note 14). Certain
principals of Hausmann are holders of the Company’s Series B
Preferred and one of the principals, David Hausmann, is an employee
of the Company.
Also in
connection with the acquisition, the Company entered into an
agreement with Hausmann to lease the 60,000 square-foot
manufacturing and office facility in Northvale, New Jersey (the
"New Jersey Facility") effective as of the closing date with an
initial two-year term, annual lease payments of $360,000 for the
first year, and 2% increases in each subsequent year. The lease
grants the Company two options to extend the term of the lease for
two years per extension term, subject to annual 2% per year
increases in base rent, and a third option at the end of the second
option term for an additional five-years at fair market value. The
Company also offered employment to Hausmann’s employees at
closing including David Hausmann, the primary stockholder of
Hausmann and its former principal executive officer. Mr. Hausmann
entered into an employment agreement with the Company effective at
the closing to serve as the President of the acquired
business.
The acquisition has been accounted for under the purchase method as
prescribed by applicable accounting standards. Under this method,
the Company has allocated the purchase price to the assets acquired
and liabilities assumed at estimated fair values. The total
purchase price was $10,160,833. The following table summarizes the fair values of
the assets acquired and liabilities assumed as of the date of
acquisition:
Cash and cash
equivalents
|
$600
|
Trade accounts
receivable
|
1,691,420
|
Inventories
|
2,117,430
|
Prepaid
expenses
|
136,841
|
Property and
equipment
|
512,950
|
Intangible
assets
|
2,689,000
|
Goodwill
|
4,302,486
|
Warranty
reserve
|
(50,000)
|
Accounts
payable
|
(544,625)
|
Accrued
expenses
|
(33,981)
|
Accrued payroll and
benefits
|
(661,288)
|
Purchase
price
|
$10,160,833
|
The
estimated purchase price included a holdback of cash totaling
$1,044,744 for purposes of satisfying adjustments to the purchase
price and indemnification claims, if any. In the second and third
fiscal quarters of 2018, the Company released $44,744 and $250,000,
respectively, of the holdback to the sellers. As of June 30, 2018,
the Company retained a holdback of $750,000 due to be paid to the
seller on October 3, 2018.
Financial Impact of Acquired Businesses
The
acquired businesses purchased in fiscal year 2018 and 2017 noted
above contributed revenues of $34,352,000 and $3,812,000, and
a net income of $2,491,000 and $223,000, inclusive
of $594,000 and $64,000 of acquired intangible
amortization, to the Company for the years ended June 30, 2018 and
2017, respectively.
The
unaudited pro forma financial results for the twelve months ended
June 30, 2018 and 2017 combines the consolidated results of the
Company, Bird & Cronin and Hausmann assuming the Bird &
Cronin acquisition had been completed on July 1, 2016 and the
Hausmann acquisition on July 1, 2015. The reported revenue and net
loss of $64,414,910 and $1,602,256 would have been $70,870,000 and
$1,556,000 for the twelve months ended June 30, 2018, respectively,
on an unaudited pro forma basis. For 2017, the reported revenue and
net loss of $35,758,330 and $1,866,395 would have been revenue and
net income of $71,128,000 and $663,000 for the year ended June 30,
2017, respectively, on an unaudited pro forma basis.
The
unaudited pro forma consolidated results are not to be considered
indicative of the results if the acquisitions occurred in the
periods mentioned above, or indicative of future operations or
results. The unaudited supplemental pro forma earnings were
adjusted to exclude $160,000 of acquisition-related costs incurred
in fiscal year 2017.
Note
3. Inventories
Inventories consist
of the following as of June 30:
|
|
|
Raw
materials
|
$6,216,150
|
$3,766,940
|
Work in
process
|
625,830
|
470,721
|
Finished
goods
|
4,604,264
|
3,562,758
|
Inventory
reserve
|
(458,389)
|
(402,737)
|
|
$10,987,855
|
$7,397,682
|
Included in cost of
goods sold for the years ended June 30, 2018 and 2017, are
inventory write-offs of $692,000 and $435,000, respectively. The
write-off reflects inventories related to discontinued product
lines, excess repair parts, product rejected for quality standards,
and other non-performing inventories.
Note
4. Property
and Equipment
Property
and equipment consist of the following as of June 30:
|
|
|
Land
|
$30,287
|
$30,287
|
Buildings
|
5,664,096
|
5,640,527
|
Machinery and
equipment
|
2,229,202
|
2,246,910
|
Office
equipment
|
318,613
|
283,805
|
Computer
equipment
|
2,136,078
|
2,194,119
|
Vehicles
|
115,233
|
195,001
|
|
10,493,509
|
10,590,649
|
Less accumulated
depreciation and amortization
|
(4,642,610)
|
(5,617,172)
|
|
$5,850,899
|
$4,973,477
|
Depreciation
and amortization expense for the years ended June 30, 2018 and
2017 was $419,148 and $242,542, respectively.
Included
in the above caption, “Buildings” as of June 30, 2018
and 2017 is a building lease that is accounted for as a capital
lease asset (see Notes 9 and 10) with a gross value of $3,800,000.
The net book value of capital lease assets as of June 30, 2018 and
2017 was $2,923,449 and $3,065,193, respectively. Amortization of
capital lease assets was $254,418 and $251,934 for the years ended
June 30, 2018 and 2017.
Note 5. Intangible
Assets
Identifiable
intangible assets, other than goodwill, consisted of the following
as of and for the years ended June 30, 2018 and 2017:
|
Trade name - indefinite life
|
|
|
|
|
Gross carrying amount
|
|
|
|
|
|
June
30, 2017
|
$464,000
|
$389,800
|
$504,400
|
$2,030,800
|
$3,389,000
|
Additions
|
620,000
|
-
|
83,000
|
4,313,000
|
5,016,000
|
Disposals
|
-
|
(119,200)
|
(114,000)
|
(100,400)
|
(333,600)
|
June
30, 2018
|
1,084,000
|
270,600
|
473,400
|
6,243,400
|
8,071,400
|
|
|
|
|
|
|
Accumulated Amortization
|
|
|
|
|
|
June
30, 2017
|
$-
|
$266,149
|
$167,150
|
$201,583
|
$634,882
|
Additions
|
-
|
43,241
|
83,450
|
511,669
|
638,360
|
Disposals
|
-
|
(119,200)
|
(114,000)
|
(100,400)
|
(333,600)
|
June
30, 2018
|
-
|
190,190
|
136,600
|
612,852
|
939,642
|
Net
book value
|
$1,084,000
|
$80,410
|
$336,800
|
$5,630,548
|
$7,131,758
|
|
Trade name - indefinite life
|
|
|
|
|
Gross carrying amount
|
|
|
|
|
|
June
30, 2016
|
$-
|
$389,800
|
$149,400
|
$160,800
|
$700,000
|
Additions
|
464,000
|
-
|
355,000
|
1,870,000
|
2,689,000
|
Disposals
|
-
|
-
|
-
|
-
|
-
|
June
30, 2017
|
464,000
|
389,800
|
504,400
|
2,030,800
|
$3,389,000
|
|
|
|
|
|
|
Accumulated Amortization
|
|
|
|
|
|
June
30, 2016
|
$-
|
$241,087
|
$149,400
|
$149,390
|
$539,877
|
Additions
|
-
|
25,062
|
17,750
|
52,193
|
95,005
|
Disposals
|
-
|
-
|
-
|
-
|
-
|
June
30, 2017
|
-
|
266,149
|
167,150
|
201,583
|
634,882
|
Net
book value
|
$464,000
|
$123,651
|
$337,250
|
$1,829,217
|
$2,754,118
|
As of
June 30, 2018, as a result of discontinuing the use of one of our
previously acquired dealers, the Company wrote-off the related
trade name, non-compete covenants, and customer relationships of
the dealer.
Amortization
expense associated with the intangible assets was $638,360 and
$95,005 for the fiscal years ended June 30, 2018 and 2017,
respectively. Estimated future amortization expense for the
identifiable intangible assets is expected to be as follows as of
June 30:
2019
|
$707,093
|
2020
|
707,093
|
2021
|
707,093
|
2022
|
676,893
|
2023
|
618,300
|
Thereafter
|
2,631,286
|
Total
|
$6,047,758
|
Note 6. Warranty
Reserve
A
reconciliation of the change in the warranty reserve consists of
the following for the fiscal years ended June 30:
|
|
|
Beginning warranty
reserve balance
|
$202,000
|
$152,605
|
Warranty costs
incurred
|
(122,708)
|
(143,444)
|
Warranty expense
accrued
|
120,524
|
148,820
|
Warranty reserve
assumed in the Acquisition
|
5,000
|
50,000
|
Changes in
estimated warranty costs
|
1,034
|
(5,981)
|
Ending warranty
reserve
|
$205,850
|
$202,000
|
Note
7. Line
of Credit
On
March 31, 2017, the Company entered into an $8,000,000, loan and
security agreement with Bank of the West to provide asset-based
financing to the Company for funding acquisitions and for working
capital (“Line of Credit”). The Line of Credit replaced
the $1,000,000 line of credit previously put in place with an asset
based lender in September 2016, and closed prior to the Hausmann
acquisition (see Note 2).
The
Line of Credit provided for revolving credit borrowings by the
Company in an amount up to the lesser of $8,000,000 or the
calculated borrowing base. The borrowing base is computed monthly
and is equal to the sum of stated percentages of eligible accounts
receivable and inventory, less a reserve. Amounts outstanding bear
interest at LIBOR plus 2.25% (4.32% as of June 30, 2018). The
Company paid a commitment fee of .25% and the line is subject to an
unused line fee of .25%.
On
September 28, 2017, the Company modified the Line of Credit and
entered into an amended credit facility to provide asset-based
financing to be used for funding the Bird & Cronin acquisition
and for operating capital. The amended credit facility provides for
revolving credit borrowings by the Company in an amount up to the
lesser of $11,000,000 or the calculated borrowing base. The Company
paid a commitment fee of .25% for the modification. The Line of
Credit, as amended, matures September 30, 2019.
On July
13, 2018, the Company further modified the Line of Credit and
amended credit facility. The amended credit facility modifies the
maximum monthly consolidated leverage and a minimum monthly
consolidated fixed charge coverage ratio. The Company paid a
commitment fee of .25% for the modification.
The
Company’s obligations under the Line of Credit are secured by
a first-priority security interest in substantially all of the
Company’s assets. The Line of Credit requires a lockbox
arrangement and contains affirmative and negative covenants,
including covenants that restrict the ability of the Company to,
among other things, incur or guarantee indebtedness, incur liens,
dispose of assets, engage in mergers and consolidations, make
acquisitions or other investments, make changes in the nature of
its business, and engage in transactions with affiliates. The
agreement also contains financial covenants applicable to the
Company, including a maximum monthly consolidated leverage and a
minimum monthly consolidated fixed charge coverage
ratio.
As of
June 30, 2018, the Company had borrowed $6,286,037 under the Line
of Credit compared to $2,171,935 as of June 30, 2017. There was
approximately $1,370,000 and $3,709,000 available to borrow as of
June 30, 2018 and 2017.
Note
8. Long-Term
Debt
Long-term debt
consists of the following as of June 30:
|
|
|
6.44% promissory
note secured by trust deed on real property, maturing January 2021,
payable in monthly installments of $13,278
|
$378,255
|
$508,633
|
5.99% promissory
note secured by a vehicle, payable in monthly installments of $833
through December 2020
|
23,162
|
31,500
|
6.04% promissory
note secured by copier equipment, payable monthly installments of
$924 through October 2022
|
43,099
|
43,989
|
3.99% promissory
note secured by equipment, payable in monthly installments of $247
through February 2023
|
12,403
|
14,822
|
3.97% promissory
note secured by equipment, payable in monthly installments of $242
through February 2021
|
7,325
|
9,878
|
7.56% promissory
note secured by copier equipment, payable in monthly installments
of $166 through February 2020
|
3,107
|
4,792
|
|
467,351
|
613,614
|
Less current
portion
|
(164,003)
|
(151,808)
|
|
$303,348 |