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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2010
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 87-0398434
---- ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
7030 Park Centre Drive, Cottonwood Heights, UT 84121
----------------------------------------------------
(Address of principal executive offices, Zip Code)
(801) 568-7000
--------------
(Registrant's telephone number, including area code)
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. [X] 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 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 whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
The number of shares outstanding of the registrant's common stock, no par value,
as of November 8, 2010 is 13,439,637.
DYNATRONICS CORPORATION
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2010
TABLE OF CONTENTS
Page Number
-----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements...............................................1
Condensed Consolidated Balance Sheets (Unaudited)
September 30, 2010 and June 30, 2010....................................1
Condensed Consolidated Statements of Income (Unaudited)
Three Months Ended September 30, 2010 and 2009..........................2
Condensed Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended September 30, 2010 and 2009..........................3
Notes to Condensed Consolidated Financial Statements....................4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................7
Item 3. Quantitative and Qualitative Disclosures About Market Risk........13
Item 4. Controls and Procedures...........................................13
PART II. OTHER INFORMATION
Item 5. Other Information.................................................13
Item 6. Exhibits..........................................................14
ii
DYNATRONICS CORPORATION
Condensed Consolidated Balance Sheets
(Unaudited)
Assets September 30, June 30,
2010 2010
------------- -------------
Current assets:
Cash and cash equivalents $ 188,998 383,756
Trade accounts receivable, less allowance
for doubtful accounts of $276,045 as
of September 30, 2010 and $254,664 as
of June 30, 2010 3,922,264 3,735,251
Other receivables 63,806 70,919
Inventories, net 5,718,664 5,766,800
Prepaid expenses and other current assets 279,283 262,577
Current portion of deferred income tax assets 446,661 390,510
------------- -------------
Total current assets 10,619,676 10,609,813
Property and equipment, net 3,565,944 3,561,271
Intangible assets, net 431,757 452,558
Other assets 303,341 314,790
Deferred income tax assets, net of
current portion 23,338 151,897
------------- -------------
Total assets $ 14,944,056 15,090,329
============= =============
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of long-term debt $ 378,224 381,841
Line of credit 2,688,791 2,768,492
Warranty reserve 186,022 186,022
Accounts payable 1,764,637 1,404,022
Accrued expenses 374,205 462,641
Accrued payroll and benefits expense 311,228 427,326
Income tax payable - 55,936
------------- -------------
Total current liabilities 5,703,107 5,686,280
Long-term debt, net of current portion 2,513,116 2,604,772
------------- -------------
Total liabilities 8,216,223 8,291,052
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Commitments and contingencies
Stockholders' equity:
Common stock, no par value: Authorized
50,000,000 shares; issued 13,439,637
shares as of September 30, 2010 and
13,591,152 shares as of June 30, 2010 7,783,794 7,872,250
Accumulated deficit (1,055,961) (1,072,973)
------------- -------------
Total stockholders' equity 6,727,833 6,799,277
------------- -------------
Total liabilities and stockholders'
equity $ 14,944,056 15,090,329
============= =============
See accompanying notes to condensed consolidated financial statements.
1
DYNATRONICS CORPORATION
Condensed Consolidated Statements of Income
(Unaudited)
Three Months Ended
September 30
2010 2009
------------- -------------
Net sales $ 7,919,288 8,282,463
Cost of sales 4,967,455 5,103,121
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Gross profit 2,951,833 3,179,342
Selling, general and administrative expenses 2,500,517 2,712,368
Research and development expenses 349,796 215,968
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Operating income 101,520 251,006
------------- -------------
Other income (expense):
Interest income 972 2,800
Interest expense (77,669) (118,994)
Other income, net 4,914 6,963
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Net other income (expense) (71,783) (109,231)
------------- -------------
Income before income tax provision 29,737 141,775
Income tax provision (12,725) (73,150)
------------- -------------
Net income $ 17,012 68,625
============= =============
Basic and diluted net income per common share $ 0.00 0.01
============= =============
Weighted-average basic and diluted common shares
outstanding:
Basic 13,452,812 13,675,257
Diluted 13,462,110 13,690,303
See accompanying notes to condensed consolidated financial statements.
2
DYNATRONICS CORPORATION
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended
September 30
2010 2009
------------- -------------
Cash flows from operating activities:
Net income $ 17,012 68,625
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization of
property and equipment 83,841 69,333
Amortization of intangible assets 20,801 22,328
Stock-based compensation expense 11,544 12,638
Change in deferred income tax assets 72,408 89,923
Provision for doubtful accounts
receivable 27,000 27,000
Provision for inventory obsolescence 30,000 30,000
Change in operating assets and
liabilities:
Receivables (206,900) (114,259)
Inventories 18,136 (143,655)
Prepaid expenses and other assets (5,257) 51,939
Accounts payable and accrued expenses 156,081 (95,498)
Income tax payable (55,936) -
------------- -------------
Net cash provided by operating
activities 168,730 18,374
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Cash flows from investing activities:
Capital expenditures (88,514) (114,676)
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Net cash used in investing
activities (88,514) (114,676)
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Cash flows from financing activities:
Principal payments on long-term debt (95,273) (78,948)
Net change in line of credit (79,701) 425,292
Redemption of common stock (100,000) (6,603)
------------- -------------
Net cash (used in) provided by
financing activities (274,974) 339,741
------------ -------------
Net change in cash and cash
equivalents (194,758) 243,439
Cash and cash equivalents at beginning of period 383,756 141,714
------------- -------------
Cash and cash equivalents at end of period $ 188,998 385,153
============= =============
Supplemental disclosures of cash flow information:
Cash paid for interest $ 79,531 121,110
Cash paid for income taxes 10,100 4,400
3
See accompanying notes to condensed consolidated financial statements.
DYNATRONICS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. PRESENTATION
The condensed consolidated balance sheets as of September 30, 2010 and June 30,
2010, the condensed consolidated statements of income for the three months ended
September 30, 2010 and 2009, and the condensed consolidated statements of cash
flows for the three months ended September 30, 2010 and 2009 were prepared by
Dynatronics Corporation (the "Company") without audit pursuant to the rules and
regulations of the Securities and Exchange Commission ("SEC"). Certain
information and disclosures normally included in financial statements prepared
in accordance with U.S. generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. In the opinion of
management, all necessary adjustments, which consist only of normal recurring
adjustments, to the financial statements have been made to present fairly the
Company's financial position, results of operations and cash flows. The results
of operations for the three months ended September 30, 2010 are not necessarily
indicative of the results for the fiscal year ending June 30, 2011. The Company
has previously filed with the SEC an annual report on Form 10-K which included
audited financial statements for each of the two years ended June 30, 2010 and
2009. It is suggested that the financial statements contained in this Form 10-Q
be read in conjunction with the statements and notes thereto contained in the
Company's most recent Form 10-K.
NOTE 2. NET INCOME PER COMMON SHARE
Net income per common share is computed based on the weighted-average number of
common shares outstanding and, when appropriate, dilutive common stock
equivalents outstanding during the period. Stock options are considered to be
common stock equivalents. The computation of diluted net income per common share
does not assume exercise or conversion of securities that would have an
anti-dilutive effect.
Basic net income per common share is the amount of net income for the period
available to each weighted-average share of common stock outstanding during the
reporting period. Diluted net income per common share is the amount of net
income for the period available to each weighted-average share of common stock
outstanding during the reporting period and to each common stock equivalent
outstanding during the period, unless inclusion of common stock equivalents
would have an anti-dilutive effect.
The net income per common share was the same for both the basic and diluted
calculations for the three months ended September 30, 2010 and 2009. The
reconciliations between the basic and diluted weighted-average number of common
shares outstanding for the three months ended September 30, 2010 and 2009 are as
follows:
Three Months Ended
September 30
2010 2009
------------- -------------
Basic weighted-average number of common shares
outstanding during the period 13,452,812 13,675,257
Weighted-average number of dilutive common
stock options outstanding during the period 9,298 15,046
------------- -------------
Diluted weighted-average number of common and
common equivalent shares outstanding during the
period 13,462,110 13,690,303
============= =============
Outstanding options not included in the computation of diluted net income per
common share, because they were anti-dilutive, for the three-month periods ended
September 30, 2010 and 2009 totaled 897,610 and 923,302, respectively.
4
NOTE 3. STOCK-BASED COMPENSATION
Stock-based compensation cost is measured at the grant date, based on the
estimated fair value of the award, and is recognized over the employee's
requisite service period. The Company recognized $11,544 and $12,638 in
stock-based compensation expense during the three months ended September 30,
2010 and 2009, respectively, as selling, general and administrative expenses in
the condensed consolidated statements of income.
Stock Options. The Company maintains a 2005 equity incentive plan for the
benefit of employees. Incentive and nonqualified stock options, restricted
common stock, stock appreciation rights, and other share-based awards may be
granted under the plan. Awards granted under the plan may be performance-based.
As of September 30, 2010, there were 942,241 shares of common stock authorized
and reserved for issuance, but not granted under the terms of the 2005 equity
incentive plan, as amended.
The following table summarizes the Company's stock option activity during the
three-month period ended September 30, 2010.
Weighted-
Average
Number of Exercise
Options Price
------------- -------------
Outstanding at beginning of period 932,805 $ 1.35
Granted 17,196 .69
Exercised - -
Cancelled (7,760) 1.47
-------------
Outstanding at end of period 942,241 1.34
=============
Exercisable at end of period 541,316 1.65
=============
The Black-Scholes option-pricing model is used to estimate the fair value of
options granted under the Company's stock option plan. The weighted-average fair
values of stock options granted under the plan for the three months ended
September 30, 2010 and 2009 were based on the following assumptions at the date
of grant as follows:
Three Months Ended
September 30,
2010 2009
------------- -------------
Expected dividend yield 0% 0%
Expected stock price volatility 60% 58 - 59%
Risk-free interest rate 2.54% 3.31 - 3.72%
Expected life of options 10 years 10 years
Weighted-average grant date fair value $ 0.48 $0.59
Expected option lives and volatilities are based on historical data of the
Company. The risk-free interest rate is based on the U.S. Treasury Bill rate on
the grant date for constant maturities that correspond with the option life.
Historically, the Company has not declared dividends and there are no future
plans to do so.
As of September 30, 2010, there was $92,685 of total unrecognized stock-based
compensation cost related to grants under the stock option plan that will be
expensed over a weighted-average period of 2.6 years. There was $5,962 of
intrinsic value for options outstanding as of September 30, 2010.
NOTE 4. COMPREHENSIVE INCOME
For the three months ended September 30, 2010 and 2009, comprehensive income was
equal to the net income as presented in the accompanying condensed consolidated
statements of income.
NOTE 5. INVENTORIES
Inventories consisted of the following:
September 30, June 30,
2010 2010
------------- -------------
Raw materials $ 2,297,931 2,256,197
Finished goods 3,787,266 3,841,674
Inventory obsolescence reserve (366,533) (331,071)
------------- -------------
$ 5,718,664 5,766,800
============= =============
5
NOTE 6. RELATED-PARTY TRANSACTIONS
The Company leases office and warehouse space in Girard, Ohio; Detroit,
Michigan; Hopkins, Minnesota; and Pleasanton, California from four significant
stockholders and former independent distributors on an annual basis under
operating lease arrangements. Management believes the lease agreements are on an
arms-length basis and the terms are equal to or more favorable than would be
available to third parties. The expense associated with these related-party
transactions totaled $57,300 and $49,500 for the three months ended September
30, 2010 and 2009, respectively.
NOTE 7. RECENT ACCOUNTING PRONOUNCEMENTS
Recent Accounting Pronouncements
In October 2009, the FASB issued Accounting Standards Update No. 2009-13 (FASB
ASU 09-13), Revenue Recognition (Topic 605): Multiple-Deliverable Revenue
Arrangements (a consensus of the FASB Emerging Issues Task Force). FASB ASU
09-13 updates the existing multiple-element arrangement guidance currently in
FASB Topic 605-25. This new guidance eliminates the requirement that all
undelivered elements have objective evidence of fair value before a company can
recognize the portion of the overall arrangement fee that is attributable to the
items that have already been delivered. Further, companies will be required to
allocate revenue in arrangements involving multiple deliverables based on the
estimated selling price of each deliverable, even though such deliverables are
not sold separately by either the Company itself or other vendors. This new
guidance also significantly expands the disclosures required for
multiple-element revenue arrangements. The revised guidance was effective
beginning on July 1, 2010. The adoption of this pronouncement had no significant
effect on the Company's financial statements.
In October 2009, the FASB issued Accounting Standards Update No. 2009-14 (FASB
ASU 09-14), Certain Revenue Arrangements That Include Software Elements--a
consensus of the FASB Emerging Issues Task Force, that reduces the types of
transactions that fall within the current scope of software revenue recognition
guidance. Existing software revenue recognition guidance requires that its
provisions be applied to an entire arrangement when the sale of any products or
services containing or utilizing software when the software is considered more
than incidental to the product or service. As a result of the amendments
included in FASB ASU 09-14, many tangible products and services that rely on
software will be accounted for under the multiple-element arrangements revenue
recognition guidance rather than under the software revenue recognition
guidance. Under this new guidance, the following components would be excluded
from the scope of software revenue recognition guidance: the tangible element of
the product, software products bundled with tangible products where the software
components and non-software components function together to deliver the
product's essential functionality, and undelivered components that relate to
software that is essential to the tangible product's functionality. FASB ASU
09-14 also provides guidance on how to allocate transaction consideration when
an arrangement contains both deliverables within the scope of software revenue
guidance (software deliverables) and deliverables not within the scope of that
guidance (non-software deliverables). This guidance was effective for revenue
arrangements entered into or materially modified in fiscal years beginning on
July 1, 2010. The adoption of this pronouncement had no significant effect on
the Company's financial statements.
6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
Our principal business is the design, manufacture, marketing, distribution
and sale of physical medicine and aesthetic products. We manufacture and
distribute a broad line of medical equipment including therapy devices, medical
supplies and soft goods, treatment tables and rehabilitation equipment. Our line
of aesthetic products includes aesthetic massage and microdermabrasion devices,
as well as skin care products. Our products are sold to and used primarily by
physical therapists, chiropractors, sports medicine practitioners, podiatrists,
plastic surgeons, dermatologists, aestheticians and other aesthetic services
providers. We operate on a fiscal year ending June 30. For example, reference to
fiscal year 2011 refers to the year ending June 30, 2011.
Results of Operations
The following discussion and analysis of our financial condition and
results of operations for the three months ended September 30, 2010, should be
read in conjunction with the condensed consolidated financial statements and
notes thereto appearing in Part I, Item 1 of this report, and our Annual Report
on Form 10-K for the year ended June 30, 2010, which includes audited financial
statements for the year then ended. Results of operations for the three months
ended September 30, 2010 are not necessarily indicative of the results that will
be achieved for the full fiscal year ending June 30, 2011.
Net Sales
Net sales decreased 4.4% to $7,919,288 in the quarter ended September 30,
2010, compared to $8,282,463 in the quarter ended September 30, 2009. As
difficult economic conditions continue in the United States, declining sales in
certain areas of the country were mostly offset by improved performance in other
parts of the country. During the quarter, we realized lower sales of higher
priced exercise equipment and vibration therapy devices, while sales of our
combination electrotherapy/ultrasound devices increased.
Gross Profit
Gross profit decreased 7.2% to $2,951,833, or 37.3% of net sales, in the
quarter ended September 30, 2010, compared to $3,179,342, or 38.4% of net sales,
in the quarter ended September 30, 2009. The decrease in gross profit reflects a
mix of sales favoring the lower margin supplies and distributed products instead
of the higher margin capital equipment products. The diminishment in sales of
higher margin capital equipment is a reflection of the continuing weak economic
conditions in the United States where the majority of our sales are made. As
economic conditions begin to improve and credit facilities become more readily
available, we believe sales of capital equipment will increase.
Selling, General and Administrative Expenses
Selling, general and administrative ("SG&A") expenses decreased $211,851
to $2,500,517, or 31.6% of net sales, in the quarter ended September 30, 2010,
from $2,712,368, or 32.7% of net sales, in the quarter ended September 30, 2009.
The following factors impacted SG&A expenses for the quarter ended September 30,
2010, as compared to the same period in 2009:
o $122,646 in lower selling expenses
o $119,222 in lower general expenses including lower legal and
professional fees
o $30,017 of higher costs related to labor, depreciation and other
operating costs.
The reduction in SG&A expenses was accomplished through our ongoing cost
reduction campaign to improve efficiencies. Over the past two years, we have
focused on lowering transaction costs, streamlining customer service and
production processes, and improving our sales support functions.
Research and Development Expenses
Research and development ("R&D") expenses increased $133,828 to $349,796,
or 4.4% of sales, in the quarter ended September 30, 2010, compared to $215,968,
or 2.6% of sales in the quarter ended September 30, 2009. We are developing a
number of important new therapy devices that are expected to be introduced in
calendar year 2011. These development efforts are directly responsible for the
increase in R&D expenses. It is anticipated that R&D expenses for fiscal year
2011 will be approximately $1,400,000. We believe that developing new products
is a key element in the Company's growth strategy. R&D costs are expensed as
incurred.
7
Interest Expense
Interest expense decreased by $41,325 to $77,669 in the quarter ended
September 30, 2010 compared to $118,994 in the quarter ended September 30, 2009
due to lower interest rates, decreased borrowings and lower carrying balances on
our bank line of credit compared to the prior year period. During fiscal year
2010, we renegotiated the interest rate on one of our mortgage loans, reducing
it from 9.1% to 5.6%.
Income Tax Expense
Income tax expense was $12,725, or 42.8% of pre-tax income, in the quarter
ended September 30, 2010, compared to $73,150, or 51.6% of pre-tax income, in
the prior year comparable quarter. The differences between the federal statutory
rate of 34% and the effective rates are mainly related to state income taxes and
other permanent book to tax differences such as stock-based compensation and
meals and entertainment expenses.
Net Income
Net income decreased to $17,012 ($.00 per share) in the quarter ended
September 30, 2010, compared to $68,625 ($.01 per share) in the quarter ended
September 30, 2009. The main factor contributing to the reduction in earnings
was $133,828 in higher R&D expenses. Lower gross profit from decreased sales and
gross profit margin also contributed to the lower earnings, but were mostly
offset by lower SG&A and interest expenses.
Liquidity and Capital Resources
We have financed operations through available cash reserves and borrowings
under a line of credit with a bank. Working capital was $4,638,850 as of
September 30, 2010, inclusive of the current portion of long-term obligations
and credit facilities, compared to working capital of $4,923,533 as of June 30,
2010.
Accounts Receivable
Trade accounts receivable, net of allowance for doubtful accounts,
increased $187,013, or 5.0%, to $3,922,264 as of September 30, 2010, compared to
$3,735,251 as of June 30, 2010. Trade accounts receivable represent amounts due
from our dealer network as well as from medical practitioners and clinics. We
believe that our estimate of the allowance for doubtful accounts is adequate
based on our historical knowledge and relationship with these customers.
Accounts receivable are generally collected within 30 days of the agreed terms.
Inventories
Inventories, net of reserves, decreased $48,136, or 0.8%, to $5,718,664 as
of June 30, 2010, compared to $5,766,800 as of June 30, 2010. The amount of
inventories we carry fluctuates each period. A main contributor to those
fluctuations is inventory purchases from overseas suppliers.
Accounts Payable
Accounts payable increased $360,615, or 25.7%, to $1,764,637 as of
September 30, 2010, from $1,404,022 as of June 30, 2010. The increase in
accounts payable is a result of the timing of our weekly payments to suppliers
and the timing of purchases of product components. Accounts payable are
generally not aged beyond the terms of our suppliers. We take advantage of
available early payment discounts when offered by our vendors.
Cash and Cash Equivalents
Our cash position as of September 30, 2010 was $188,998, a decrease of
50.8%, from cash of $383,756 as of June 30, 2010. Our cash position varies from
quarter to quarter, but typically stays within a normal range of $150,000 to
$400,000. We expect that cash flows from operating activities, together with
amounts available through an existing line of credit facility, will be
sufficient to cover operating needs in the ordinary course of business for the
next twelve months. If we experience an adverse operating environment, including
a further worsening of the general economy in the United States, or unusual
capital expenditure requirements, additional financing may be required. No
assurance can be given that additional financing, if required, would be
available on terms favorable to us, or at all.
8
Line of Credit
The outstanding balance on our line of credit was $2,688,791 as of
September 30, 2010, compared to $2,768,492 as of June 30, 2010. The current
balance on the line of credit is the lowest it has been since the acquisition of
six dealers in June and July 2007 and approximately $3,511,000 below its highest
point in fiscal year 2009.
Interest on the line of credit is based on the 90-day LIBOR rate (0.29% as
of September 30, 2010) plus 4%, with a minimum interest rate of 4.5%. The line
of credit is collateralized by accounts receivable and inventories, as well as a
security interest in our headquarters facility in Salt Lake City, Utah.
Borrowing limitations are based on approximately 45% of eligible inventory and
up to 80% of eligible accounts receivable, up to a maximum credit facility of
$7,000,000. Interest payments on the line are due monthly. As of September 30,
2010, the borrowing base was approximately $5,529,000, resulting in
approximately $2,840,000 available on the line. The line of credit includes
covenants requiring us to maintain certain financial ratios. As of September 30,
2010, we were in compliance with the loan covenants. The line of credit expires
on December 15, 2010 and we expect it will be renewed; however, there is no
assurance that it will be renewed or that, if renewed, it will be extended on
the same terms.
The current ratio was 1.8 to 1 as of September 30, 2010 compared to 1.9 to
1 as of June 30, 2010. Current assets represented 70% of total assets as of
September 30, 2010 and June 30, 2010.
Debt
Long-term debt excluding current installments totaled $2,513,116 as of
September 30, 2010, compared to $2,604,772 as of June 30, 2010. Long-term debt
is comprised primarily of the mortgage loans on our office and manufacturing
facilities in Utah and Tennessee. The principal balance on the mortgage loans is
approximately $2,645,676 with monthly principal and interest payments of
$46,304.
Inflation and Seasonality
Our revenues and net income from continuing operations have not been
unusually affected by inflation or price increases for raw materials and parts
from vendors.
Our business operations are not materially affected by seasonality
factors.
Critical Accounting Policies
This management's discussion and analysis of financial condition and
results of operations is based upon our condensed consolidated financial
statements. The preparation of these financial statements requires estimates and
judgments that affect the reported amounts of our assets, liabilities, net sales
and expenses. Management bases estimates on historical experience and other
assumptions it believes to be reasonable given the circumstances and evaluates
these estimates on an ongoing basis. Actual results may differ from these
estimates.
The following critical accounting policies involve a higher degree of
judgment and complexity and require significant estimates and judgments used in
the preparation of our consolidated financial statements.
Inventory Reserves
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 costs (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:
9
o Current inventory quantities on hand;
o Product acceptance in the marketplace;
o Customer demand;
o Historical sales;
o Forecast sales;
o Product obsolescence;
o Technological innovations; and
o 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 the cost of goods sold within the statement of income during the
period in which such modifications are determined necessary by management. As of
September 30 and June 30, 2010, our inventory valuation reserve balance, which
established a new cost basis, was $365,533 and $331,071, respectively, and our
inventory balance was $5,718,664 and $5,766,800, net of reserves, respectively.
Revenue Recognition
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 $3,922,264 and $3,735,251, net of allowance for doubtful accounts of
$276,045 and $254,664, as of September 30, and June 30, 2010, respectively.
Deferred Income Tax Assets
At each reporting date, our management performs an analysis of the
deferred income tax assets and their recoverability. Based on several factors,
including our strong earnings history of pre-tax profit averaging over $500,000
per year in 18 of the last 21 fiscal years and the fact that the principal
causes of the loss in fiscal 2008 (goodwill impairment and expenses resulting
from six acquisitions) are considered to be unusual and are not expected to
recur in the near future, we believe that it is more likely than not that all of
the net deferred income tax assets will be realized. During fiscal year 2010,
$501,465 of the deferred income tax assets were utilized to carry back against
profits from 2004 and 2005, reducing the deferred income tax asset by 39%.
Business Plan and Outlook
During fiscal year 2010, we achieved significant improvement in our
operating results compared to the prior fiscal year. In fiscal year 2011, we
will continue to pursue a focused strategy to improve sales and overall
operations that includes the following elements:
o strengthening distribution channels by adding direct sales
representatives and dealers in key locations
o pursuing sales with large chains of clinics and national accounts,
including Group Purchasing Organizations
o using tools such as e-commerce solutions and other IT related
methodologies to reduce cost of operations and enhance the reach of
our sales efforts
o enhancing product profit margins through improved manufacturing
processes and negotiating better pricing with our vendors
o developing and introducing new state-of-the-art products for future
growth
o Seeking ways to leverage our distribution network to bring new
products to market.
The landscape of our primary market, the physical medicine marketplace,
continues to change. Past years saw consolidation among manufacturers and
distributors including our own acquisitions completed in fiscal years 2007 and
2008. More recently, two additional significant changes have taken place.
According to its filings under the Securities Exchange Act of 1934, DJO, Inc.,
one of our primary competitors, closed its Chattanooga Group operations in the
quarter ended July 3, 2010 and redistributed those manufacturing, R&D and
support functions to other DJO facilities, in and out of the United States. The
effect of this announcement is that the full operations of the former
Chattanooga Group have been reduced to a product brand sold by DJO through
non-proprietary distribution channels. In addition, DJO, Inc. has disclosed that
on June 12, 2009 it sold its Empi Therapy Solutions catalog division to
Patterson Medical (Sammons Preston), another competitor of the Company. This
essentially eliminated Empi as a significant catalog competitor and further
reduced competition in our market.
10
These consolidations combined with prior year consolidations and
continuing declines in the number of independent distributors have significantly
narrowed distribution channels in our market. At the present time, we believe
that there remain only two companies with a national direct sales force selling
proprietary and distributed products: Dynatronics and Patterson Medical (through
its Sammons Preston subsidiary). All other distribution in our market is
directed through catalog companies with no direct sales force, or through
independent local dealers. However, the network of local independent dealers is
rapidly diminishing due to consolidation efforts and increased competition from
Dynatronics, Sammons Preston and catalog companies. In the past year, we have
reinforced our direct sales team to include over 50 direct sales employees and
independent sales representatives. In addition to these direct sales
representatives, we continue to enjoy a strong relationship with scores of local
dealers. We believe we have the best trained and most knowledgeable sales force
in the industry. The recent changes within our market provide a unique
opportunity for us to grow market share in the coming years through recruitment
of high-quality sales representatives and dealers.
With the broad line of products we now offer and with a strong sales force
that we expect will grow stronger in the coming year, we believe that we are
well positioned to develop relationships with large chains of clinics and
hospitals, national accounts and Group Purchasing Organizations ("GPO's") that
purchase primarily on contract. This is a segment of business which was
previously closed to us because we were not an approved vendor with the various
GPO's and national or regional chains of care facilities. With the broader
offering of products now available through our catalog, we are better able to
compete for this high volume business and have seen success this past year in
becoming the preferred vendor to many national and regional accounts.
To further our efforts to recruit high-quality direct sales
representatives and dealers as well as to better appeal to the large GPO's and
national customers, we will continue to improve efficiencies of our operations
and the sales support for the industry. Chief among those changes was the
introduction of our first true e-commerce solution on July 6, 2010. With the
introduction of this e-commerce solution, customers are able to more easily
place orders and obtain information about their accounts. Sales representatives
are increasing their effectiveness with the abundance of information available
to them electronically through our e-quote system which is a companion to the
e-commerce solution introduced. Not only is our e-commerce solution improving
sales, but it should also permit us to reduce our transactional costs thus
enabling us to accommodate higher sales without significantly increasing
overhead.
The recent passage of the Patient Protection and Affordable Care Act along
with the Health Care and Educational Reconciliation Act will affect our future
operations. The addition of millions to the rolls of the insured will
undoubtedly increase demand for services. That increased demand is expected to
translate into increased sales of our products. The magnitude of those increases
is difficult to assess at this time. At the same time, this legislation will
impose an excise tax on all manufacturers of medical devices which we estimate
will exceed $500,000 annually for Dynatronics based on the current statutory
language. Because the effects of this legislation will not be felt until 2013 at
the earliest, it is difficult to project the full impact this legislation will
have, especially since there is a likelihood of amendments to the legislation
prior to it becoming fully effective. In the meantime, we are working to take
full advantage of every opportunity presented by this legislation to increase
sales and to offset any negative effects that may accompany those opportunities.
We continue to focus research and development efforts on new product
innovation and re-designing existing products. Several products are currently
under development and are scheduled for introduction in the latter half of
calendar 2011. The commitment to innovation of high-quality products has been a
hallmark of Dynatronics and will continue throughout the coming year. The
renewed emphasis on R&D will have the effect of diminishing reportable profits
during the current fiscal year as R&D costs are expensed as incurred. Management
is confident the short-term cost of the investment in these new products will
yield long-term dividends.
Economic pressures from the recent recession not only have affected
available credit that would facilitate large capital purchases, but have also
reduced demand for discretionary services such as those provided by our
aesthetic products. As a result, we trimmed back our expenses in the Synergie
division to be more reflective of the current environment. Fortunately, the
Synergie Elite aesthetic product line introduced in April 2008 continues to have
appeal due to its design and price point. We believe that our aesthetic devices
remain the best value on the market and are seeking innovative ways to market
our products including strategic partnerships, both domestic and international,
to help regain sales momentum. As the economy begins to improve, we expect to
see increased sales of these higher margin products.
11
We have long believed that international markets present an untapped
potential for growth and expansion. Adding new distributors in several countries
will be the key to this expansion effort. Our past efforts to improve
international marketing have yielded only marginal improvements. We remain
committed, however, to finding the most cost effective ways to expand our
markets internationally. Over the coming year, our efforts will be focused on
partnering with key manufacturers and distributors interested in our product
line or technology. Our Utah operation, where all electrotherapy, ultrasound,
traction, light therapy and Synergie products are manufactured, is certified to
ISO 13485:2003, an internationally recognized standard of excellence in medical
device manufacturing. This designation is an important requirement in obtaining
the CE Mark certification, which allows us to market our products in the
European Union and other international locations.
Refining our business model for supporting sales representatives and
distributors also will be a focal point of operations. We will continue to
evaluate the most efficient ways to maintain our satellite sales offices and
warehouses. In addition, more emphasis is being placed on pricing management to
protect margins for both manufactured and distributed products. The ongoing
refinement of this model is expected to yield further efficiencies that will
better achieve sales goals while at the same time reduce expenses.
With the sale of our manufactured capital equipment being the largest
contributor to margin generation, we have placed renewed emphasis on improving
manufacturing operations, including considering more offshore manufacturing of
components as well as streamlining manufacturing operations in Utah and
Tennessee. Past experience has shown that when recessionary pressures start to
subside, the pent up demand for capital equipment can be significant. Our recent
efforts to prudently reduce costs during the difficult times have made us a
leaner operation and well positioned for a continued ramp up in demand.
Based on our defined strategic initiatives, we are focusing our resources
in the following areas:
o Reinforcing distribution through a strategy of recruiting direct
sales representatives and working closely with the most successful
distributors of capital equipment.
o Improving sales by focusing sales strategies on pursuing business
opportunities with large chains of clinics, national and regional
accounts, and Group Purchasing Organizations.
o Using our first e-commerce solution in order to facilitate business
opportunities and reduce transactional costs.
o Significantly improving operational efficiencies by lowering
manufacturing and transactional costs, automating processes,
redefining policies and procedures and working to make every
customer a profitable customer.
o Strengthening pricing management and procurement methodologies.
o Minimizing expense associated with the Synergie product line until
the economy improves and demand for capital equipment re-emerges,
and, in the meantime, seeking additional independent distributors
and strategic partnerships.
o Focusing international sales efforts on identifying key distributors
and strategic partners who could represent the Company's product
line, particularly in Europe.
o Continuing development of new state-of-the-art products, both
high-tech and commodity, in fiscal year 2011, for both the
rehabilitation and aesthetic markets.
o Exploring strategic business alliances that will leverage and
complement the Company's competitive strengths, increase market
reach and supplement capital resources.
12
Cautionary Statement Concerning Forward-Looking Statements
----------------------------------------------------------
The statements contained in this Form 10-Q, particularly the foregoing
discussion in Part I, Item 2, Management's Discussion and Analysis of Financial
Condition and Results of Operations, that are not purely historical, are
"forward-looking statements" within the meaning of Section 21E of the Securities
Exchange Act of 1934. These statements refer to our expectations, hopes,
beliefs, anticipations, commitments, intentions and strategies regarding the
future. They may be identified by the use of words or phrases such as
"believes," "expects," "anticipates," "should," "plans," "estimates," "intends,"
and "potential," among others. Forward-looking statements include, but are not
limited to, statements regarding product development, market acceptance,
financial performance, revenue and expense levels in the future and the
sufficiency of existing assets to fund future operations and capital spending
needs. Actual results could differ materially from the anticipated results or
other expectations expressed in such forward-looking statements for the reasons
detailed under the headings "Risk Factors" in our Annual Report on Form 10-K for
the year ended June 30, 2010. The forward-looking statements contained in this
report are made as of the date of this report and we assume no obligation to
update them or to update the reasons why actual results could differ from those
projected in such forward-looking statements, except as required by law.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to various market risks. Market risk is the potential risk
of loss arising from adverse changes in market prices and rates. We do not enter
into derivative or other financial instruments for trading or speculative
purposes. There have been no material changes in our market risk during the
quarter ended September 30, 2010, although the general weakness in the U.S.
economy is expected to lead to greater discounting market-wide to stimulate
sales in a declining economic environment. In addition, further weakening of the
economy could result in greater risks of collections of accounts receivable.
Our primary market risk exposure is interest rate risk. As of September
30, 2010, approximately $3,897,000 of our debt bore interest at variable rates.
Accordingly, our net income is affected by changes in interest rates. For every
one hundred basis point change in the average interest rate under our existing
debt, our annual interest expense would change by approximately $38,970.
In the event of an adverse change in interest rates, we could take actions
to mitigate our exposure. However, due to the uncertainty of the actions that
would be taken and their possible effects, this analysis assumes no such
actions. Recent efforts to reduce the balances on our operating line of credit
have mitigated this risk.
Item 4. Controls and Procedures
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we conducted
an evaluation of the effectiveness, as of September 30, 2010, of our disclosure
controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended, or the Exchange Act. The purpose of
this evaluation was to determine whether as of the evaluation date our
disclosure controls and procedures were effective to provide reasonable
assurance that the information we are required to disclose in our filings with
the Securities and Exchange Commission, or SEC, under the Exchange Act (i) is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms and (ii) is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required disclosure. Based on
their evaluation, our management has concluded, that our disclosure controls and
procedures were effective as of September 30, 2010.
There has been no change in our internal control over financial reporting
during the quarter ended September 30, 2010 that has materially affected, or
that is reasonably likely to materially affect, our internal control over
financial reporting.
13
PART II. OTHER INFORMATION
Item 5. Other Information
NASDAQ Minimum Bid Requirement
On June 16, 2010, we received a deficiency letter from the NASDAQ Stock
Market, indicating that we had failed to comply with the minimum bid requirement
for continued inclusion under Marketplace Rule 4310(c)(4). Under the deficiency
notice, our common stock is subject to potential delisting because, for a period
of 30 consecutive business days, the bid price of the common stock closed below
the minimum $1.00 per share requirement for continued inclusion. The deadline
for compliance with the rule is December 13, 2010. If prior to that date the bid
price of our common stock closes at $1.00 per share or more for a minimum of 10
consecutive business days, NASDAQ staff may provide written notification that we
have achieved compliance with the rule.
We are using our best efforts to regain compliance with the minimum bid
price rule. However, there can be no assurance that compliance will be achieved
given the overall current condition of financial and stock markets in the United
States. If compliance is not achieved and our stock is delisted, we expect that
the common stock will begin trading on the OTC bulletin board where there is no
minimum bid requirement.
Related-Party Transactions
We lease office and distribution facilities in California owned by John
Rajala, a stockholder and Territorial Sales Manager. Mr. Rajala also
beneficially owns 8.6% of our outstanding common stock. The rental paid to Mr.
Rajala for the leased facilities is $120,000 per year under a written lease
agreement. The lease agreement is on an arms-length basis and the terms are
equal to or more favorable than would be available to a third party. This
transaction with a related party has been approved by our Board of Directors.
In addition, we lease office and warehouse space in Girard, Ohio; Detroit,
Michigan; and Hopkins, Minnesota; from three stockholders and former independent
distributors on an annual basis under operating lease arrangements. Management
believes the lease agreements are on an arms-length basis and the terms are
equal to or more favorable than would be available to third parties. The expense
associated with these related-party transactions totaled $57,300 for the three
months ended September 30, 2010.
Item 6. Exhibits
(a) Exhibits
3.1 Articles of Incorporation and Bylaws of Dynatronics Laser Corporation.
Incorporated by reference to a Registration Statement on Form S-1 (No.
2-85045) filed with the SEC and effective November 2, 1984
3.2 Articles of Amendment dated November 21, 1988 (previously filed)
3.3 Articles of Amendment dated November 18, 1993 (previously filed)
10.1 Employment contract with Kelvyn H. Cullimore, Jr. (previously filed)
10.2 Employment contract with Larry K. Beardall (previously filed)
10.3 Loan Agreement with Zions Bank (previously filed)
10.5 Amended Loan Agreement with Zions Bank (previously filed)
10.6 1992 Amended and Restated Stock Option Plan (previously filed)
10.7 Dynatronics Corporation 2006 Equity Incentive Award Plan (previously filed
as Annex A to the Company's Definitive Proxy Statement on Schedule 14A
filed on October 27, 2006)
10.8 Form of Option Agreement for the 2006 Equity Incentive Plan for incentive
stock options (previously filed as Exhibit 10.8 to the Company's Annual
Report on Form 10-KSB for the fiscal year ended June 30, 2006)
14
10.9 Form of Option Agreement for the 2006 Equity Incentive Plan for
non-qualified options (previously filed as Exhibit 10.9 to the Company's
Annual Report on Form 10-KSB for the fiscal year ended June 30, 2006)
10.10 Building Lease Agreement with The Rajala Family Trust dated June 30, 2009
11 Computation of Net Income per Share (included in Notes to Consolidated
Financial Statements)
31.1 Certification under Rule 13a-14(a)/15d-14(a) of principal executive
officer (filed herewith)
31.2 Certification under Rule 13a-14(a)/15d-14(a) of principal financial
officer (filed herewith)
32 Certifications under Section 906 of the Sarbanes-Oxley Act of 2002 (18
U.S.C. Section 1350) (filed herewith)
15
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DYNATRONICS CORPORATION
-----------------------
Registrant
Date November 11, 2010 /s/ Kelvyn H. Cullimore, Jr.
------------------------ -------------------------------------
Kelvyn H. Cullimore, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Date November 11, 2010 /s/ Terry M. Atkinson, CPA
------------------------ -------------------------------------
Terry M. Atkinson, CPA
Chief Financial Officer
(Principal Financial and Accounting
Officer)
16
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