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PAVmedDynatronics Corporation 2012 Annual Report Letter to Shareholders Marketing Section Management’s Discussion and Analysis Report of Independent Registered Public Accounting Firm Financial Statements Notes to Financial Statements Corporate Information 3 6 9 18 19 23 30 Letter To Shareholders For the past two years we have been engaged in the most intensive research and development projects in the history of the company. Investing in research and development has been a key to our success over the years. It has earned Dynatronics a reputation for being innovative, creative and progressive in the design and development of new products for the markets we serve. Th is level of innovation has been critical in maintaining a competitive edge. In addition to the SolarisPlus, we have introduced the Quad7 thermal therapy device. Th is exciting new product provides multiple combinations of thermal and compression therapy and introduces hand-held thermal probes capable of coupling with the SolarisPlus devices to deliver thermal therapy and electrotherapy in combination – another groundbreaking product and design only available from Dynatronics. However, engaging in intensive research and development comes at a cost. For the last two fi scal years we have averaged approximately $1,400,000 in annual research and development costs. Th is compares to approximately $1,085,000 average for the three prior fi scal years – an increase of approximately 30 percent. Th is added investment has diminished profi ts by over $300,000 for each of fi scal years 2012 and 2011. Although the investment reduced profi tability for the last two years, it has placed us in a position to introduce more new products in fi scal year 2013 than in any other year in our history. In fact, we anticipate introducing a dozen new products during fi scal year 2013. Th ese new products will eff ectively renovate and update our core product line and introduce new technologies in combinations never before seen in our marketplace. In August 2012, we introduced the new SolarisPlus line of combination devices. Th is is our proprietary, top-of-the-line family of therapy devices. It includes seven wave forms of electrotherapy, three frequencies of ultrasound therapy, three wavelengths of light therapy in a probe or pad confi guration at powers signifi cantly higher than predecessor products, plus the ability to do combination treatments of electrotherapy and ultrasound or electrotherapy and thermal therapy. No devices on the market are as powerful or capable of so many diverse functions. What’s more, all modalities can run simultaneously. Th at level of power and versatility is unequalled in our competitors’ units. Other new products are contemplated for introduction in the latter half of fi scal year 2013. We expect that these will further establish Dynatronics as a leader in the design and development of inventive new products. We believe that the addition of these products will drive sales in the coming years and prove the investment in research and development of the last two years to have been very worthwhile, despite the impact on profi tability. Fiscal year 2012 was only the fourth year that we have not shown a profi t since we began commercializing products in 1987. Although our net loss was only $23,535, it was nevertheless a loss. Th e investment in research and development was only part of the reason for the net loss for the fi scal year. Diminished sales also contributed. Th rough December 2011, sales were running slightly ahead of the prior fi scal year. However, from January through June 2012, the trend reversed and sales were down approximately 10 percent over the prior year. Th ere are many reasons for the drop in sales. We had one large customer that became insolvent and closed its doors. We also had a product line similar to the Quad7 product we previously distributed that was no longer available to us. In fact, it was the loss of that line that motivated the development and introduction of our Quad7 product. Th ere has also been a perceptible fatigue in our market caused by ongoing economic strain. Th e impending eff ects of health care reform have caused many to proceed with caution. Normal cycles for replacing capital equipment have been lengthened as practitioners have made do with existing devices and equipment. Th e opening of new clinics and expansion of existing clinics has slowed to a proverbial crawl. All of these factors have combined to produce an adverse impact on our sales and profi tability. 3 Our response to these conditions has been two-pronged. Th e fi rst prong has been to reduce expenses. Following an unexpectedly large loss in the quarter ended March 31, 2012, we took steps to reduce expenses, including staffi ng and R&D costs. Th e result is that we have cut expenses by over $750,000 annually. Th is reduction in expenses off sets the loss of margin associated with lower sales. Th e second prong of our response has been to stimulate sales through the introduction of new products. Th e best way to encourage purchase of new products is to off er innovative and unique products that exceed practitioners’ expectations. We believe SolarisPlus, Quad7 and the other new products scheduled for introduction in this next year will do just that. Th e introduction of these new products is also timely as it places us in an excellent position to take advantage of recovering economic markets and any increased demand that may be associated with healthcare reform. Th e continuing impact of the Aff ordable Care Act looms large for small companies like Dynatronics. While there is a possibility of increased demand resulting from the addition of millions of patients to the rolls of the insured, such potential is blunted by the reality of the medical device tax imposed on manufacturers such as Dynatronics to help pay for adding those insured. We estimate that had the device tax been eff ective this last year we would have been required to pay approximately $400,000 in excise taxes despite reporting a net loss. An excise tax is based on sales, not profi tability. Th e medical device tax is scheduled to become eff ective in January 2013. We plan to raise prices to cover this added fi nancial burden, but there is no guarantee we will be able to cover the entire tax, as there is little tolerance for price increases in the market. As a board member of the Medical Device Manufacturers Association, I have been actively lobbying Congress for the repeal of this onerous tax. I am pleased that a bill introduced by our own Senator from Utah, Orrin Hatch, proposes a repeal of this tax. Th e repeal has already been passed in the House of Representatives. Th e November elections will have a signifi cant bearing on whether Senator Hatch will be successful in pushing the repeal through the Senate. With the challenges to profi tability of the past year, we have been notifi ed by NASDAQ that our failure to maintain the $1 minimum bid price on our stock must be cured by November 5, 2012 or our stock will be de-listed. It is the stated intent of the board of directors that appropriate steps be taken to maintain the visibility of our common stock on NASDAQ with the goal of preserving shareholder liquidity and confi dence. Th e specifi cs of that plan will be disclosed in our proxy statement fi led in connection with our upcoming annual meeting of shareholders. Th ese are challenging economic times. It has required constant restructuring and re-evaluation of strategies to be responsive to the challenges. Our eff orts to grow through securing contracts with group purchasing organizations have not been eff ective. Despite off ering proposals confi rmed by the GPOs as being competitive, most have chosen to award sole source contracts to a competitor. Th ere seems to be little motivation to engage a new supplier. While these results are discouraging, we are not prepared to surrender the eff ort. We will continue to vie for portions of that business we believe are accessible. In the meantime we are positioning ourselves as the vendor of choice for the private practice segment of the market. We continue to recruit new sales persons and dealers to broaden our reach. We will introduce a new, comprehensive 2013-14 catalog that will off er products from other manufacturers not off ered in the past. As one of only two companies in our market with a direct sales force coast to coast, we fi ll an important niche that is enhanced by the fact we are a manufacturer of many of the products we sell. Being a manufacturer not only allows us to be more price competitive than those that are just distributors, but also permits us to control the innovative nature and quality of the products. No other company in our industry has the breadth of manufacturing that we off er, married with a signifi cant national sales force. Th ese are the elements that should help keep us competitive in the face of economic challenge and government regulation. 4 Management’s Discussion and Analysis of Financial Condition and Results of Operations Th e following discussion should be read in conjunction with our consolidated fi nancial statements and notes to those consolidated fi nancial statements, included elsewhere in this Annual Report on Form 10-K. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to diff er materially from our expectations. s Overview Our principal business is the manufacture, distribution and marketing of physical medicine products and aesthetic products, many of which we design and manufacture. We off er a broad line of medical equipment including therapy devices, medical supplies and soft goods, treatment tables and rehabilitation equipment. Our line of aesthetic equipment 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. Our fi scal year ends on June 30. Reference to fi scal year 2012 refers to the year ended June 30, 2012. Results of Operations Fiscal Year 2012 Compared to Fiscal Year 2011 Net Sales Net sales in fi scal year 2012 were $31,664,181 compared to $32,692,859 in fi scal year 2011. Th e $1,028,678 decrease in sales is primarily attributable to the following factors: 1) the apparent insolvency of and interruption of purchases by a large, independent distributor that historically purchased between $150,000 to $250,000 per quarter from the Company; and 2) lower sales of capital equipment likely due to continuing weakness of the U.S. economy leading to a postponement of purchases of durable medical equipment. We also believe the uncertainty surrounding healthcare reform in the United States has had the eff ect of limiting expansion and improvements in our market sector. We expect the introduction of our new SolarisPlus products and Quad 7 devices to stimulate sales in fi scal year 2013. Sales of manufactured physical medicine products represented approximately 42% and 43% of total physical medicine product sales in fi scal years 2012 and 2011, respectively. Distribution of products manufactured by other suppliers accounted for the balance of our physical medicine product sales in those years. Sales of manufactured aesthetic products in fi scal years 2012 and 2011, represented approximately 73% and 77% of total aesthetic product sales, respectively, with distributed products making up the balance. Th e majority of our sales revenues come from the sale of physical medicine products, both manufactured and distributed. In fi scal years 2012 and 2011, sales of physical medicine products accounted for 91% and 92% of total sales, respectively. Chargeable repairs, billable freight revenue, aesthetic product sales and other miscellaneous revenue accounted for approximately 9% and 8% of total revenues in 2012 and 2011. Gross Profi t Gross profi t totaled $11,943,233, or 37.7% of net sales, in fi scal year 2012, compared to $12,484,824, or 38.2% of net sales, in fi scal year 2011. Th e decrease in gross profi t in absolute dollars and as a percentage of net sales during the year mostly refl ects the decrease in total sales attributed to the factors discussed above. Th e most signifi cant reduction in sales was our higher margin capital equipment which had the eff ect of lowering the gross margin percentage as lower margin supplies and distributed items became a larger percentage of overall sales in fi scal year 2012. Looking ahead, we expect to generate improved sales of higher margin capital equipment with the introduction of our new SolarisPlus products (released in August 2012) and the Quad 7. In addition, as the eff ects of healthcare reform become clearer following the presidential and general elections in the United States in November 2012, we expect confi dence to increase and demand for our products to begin to strengthen. 9 Selling, General and Administrative Expenses Interest Expense SG&A expenses were $10,506,460, or 33.2% of net sales, in fi scal year 2012, compared to $10,431,463, or 31.9% of net sales, in fi scal year 2011. Th e $74,997 increase in SG&A expenses in fi scal year 2012 as compared to 2011 is a result of the following: • $24,231 of higher selling expenses; • $31,735 of higher production labor and depreciation expenses; • $19,031 of higher general expenses including higher regulatory compliance costs and legal fees During the fourth quarter of fi scal year 2012 and the fi rst quarter of fi scal year 2013, the Company identifi ed over $750,000 of annual cost reductions which are being implemented to 1) reduce labor costs through a reduction in force; 2) reduce overhead costs; and 3) improve operating effi ciencies. Research and Development Over the last two years, we have undertaken the most extensive research and development eff orts in our history. More new products will be introduced in fi scal 2013 than any year since the Company began. As a result, research and development (“R&D”) expense increased 2%, or $26,694, to $1,410,406 in fi scal year 2012, from $1,383,712 in 2011. R&D expense increased as a percentage of net sales in fi scal year 2012 to 4.5% from 4.2% of net sales in fi scal year 2011. In March 2012, we introduced the Dynatron Quad7, the fi rst of several new planned product introductions. Th e Company has been heavily involved with developing fi ve new SolarisPlus units, four of which were introduced to the market in August 2012. Th ese development eff orts are directly responsible for the signifi cant R&D expenses for the past two years. By contrast, the average annual R&D expenditures in the three years ended June 30, 2010 were $1,087,671. R&D expenses are expected to normalize closer to historic levels in fi scal year 2013, as a result of the completion of development of the new SolarisPlus products. R&D costs are expensed as incurred. Interest expense decreased by $32,411, to $261,993 in fi scal year 2012 compared to $294,404 in fi scal year 2011 due to lower negotiated borrowing rates on our bank line of credit compared to fi scal year 2011, and the fi rst mortgage on our Salt Lake City facility entering the fi nal two years of its term. Income/Loss Before Income Tax Provision Pre-tax loss in fi scal year 2012 was $190,241, compared to pre-tax income of $418,864 in fi scal year 2011. Th e reduction in income before income tax provision for 2012 resulted from lower sales and gross profi ts generated during the year as explained above, along with higher selling, labor, depreciation and R&D expenses. Th e reduction of gross margin accounted for $542,000 of the $609,000 diff erence in pre-tax results, or about 90%. Th e balance of the diff erence is accounted for by higher SG&A expenses as well as higher R&D expenses. Th e increase in selling expense was associated with our pursuit of GPO and national account business, while increased depreciation expense was related to increased investments in information systems. We off set some of these higher expenses with lower interest expense for the year ended June 30, 2012. As noted above, steps have been taken to reduce expenses at an annualized amount of approximately $750,000, the eff ect of which only began to be realized in the last two months of the fi scal year. Income Tax Provision/Benefi t Income tax benefi t was $166,706 in fi scal year 2012, compared to income tax provision of $147,976 in fi scal year 2011. Due to tax benefi ts associated with R&D tax credits and other credits, the income tax benefi t reduced the pre-tax loss in fi scal year 2012 by 87.6% compared to an eff ective tax rate of 35.3% in 2011. Th e diff erence in the eff ective tax rates is attributable to higher R&D tax credits in fi scal year 2012, as well as certain permanent book to tax diff erences. 10 Net Income/Loss Inventories Net loss was $23,535 ($.00 per share) in fi scal year 2012, compared to net income of $270,888 ($.02 per share) in fi scal year 2011. Th e reduction in net income in 2012 was caused primarily by decreased sales and margins generated during the year compared to fi scal year 2011. However, the net loss was mitigated by the recognition of signifi cant tax benefi ts associated with R&D tax credit as explained above. We expect that R&D expense will decrease in fi scal year 2013 as a result of the completion of development of the new SolarisPlus products in August 2012. We expect improved profi tability in fi scal year 2013, due to a reduction in R&D expense and with other reductions implemented or anticipated to be made as well as sales of new products that we recently introduced. Liquidity and Capital Resources We have fi nanced operations through available cash reserves and borrowings under a line of credit with a bank. Working capital was $3,565,858 as of June 30, 2012, inclusive of the current portion of long-term obligations and credit facilities, compared to working capital of $4,552,731 as of June 30, 2011. During fi scal year 2012, we generated $35,812 in cash from operating activities, used $401,408 to repurchase and retire common stock, paid $328,707 for capital expenditures primarily related to improving our e-commerce and IT infrastructure, and paid $371,339 in principal on long- term debt. In addition, we purchased $450,782 of inventory primarily for the introduction of the new Dynatron Quad7 product. During fi scal year 2012, the outstanding balance on our line of credit increased by $913,660. Accounts Receivable Trade accounts receivable, net of allowance for doubtful accounts, decreased $5,042, or 0.1%, to $3,667,086 as of June 30, 2012, compared to $3,672,128 as of June 30, 2011. 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, net of reserves, increased $450,782, or 8.0%, to $6,098,597 as of June 30, 2012, compared to $5,647,815 as of June 30, 2011. Th e amount of inventory we carry fl uctuates each period based on the timing of large inventory purchases from overseas suppliers. Inventory levels increased in fi scal year 2012 in conjunction with the introduction of the Dynatron Quad7 unit. Accounts Payable Accounts payable increased $286,038, to $2,413,201 as of June 30, 2012, from $2,127,163 as of June 30, 2011. Th e 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 off ered by our vendors. Cash and Cash Equivalents Our cash position as of June 30, 2012 was $278,263, compared to cash of $384,904 as of June 30, 2011. We expect that cash fl ows from operating activities, together with amounts available through an existing line-of-credit facility, will be suffi cient 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 fi nancing may be required. However, no assurance can be given that additional fi nancing, if required, would be available on terms favorable to us, or at all. 11 Line of Credit Critical Accounting Policies During fi scal year 2012, the outstanding balance on our line of credit increased by $913,660, leaving a balance outstanding of $3,497,597 as of June 30, 2012, compared to $2,583,937 as of June 30, 2011. Th e increase in the line of credit was primarily the result of $401,408 used to repurchase and retire common stock, $328,707 for capital expenditures primarily related to improving our e-commerce and IT infrastructure and $371,339 in principal payments on long-term debt. We also purchased an additional $450,782 of inventory primarily related to the introduction of the new Dynatron Quad7 product. Management’s discussion and analysis of fi nancial condition and results of operations is based upon our consolidated fi nancial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. Th e preparation of these fi nancial statements requires estimates and judgments that aff ect 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 diff er from these estimates under diff erent assumptions or conditions. Interest on the line of credit is based on the 90-day LIBOR rate (0.46% as of June 30, 2012) plus 3%. Th e line of credit is collateralized by accounts receivable and inventories. 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 June 30, 2012, the borrowing base was approximately $5,115,000, resulting in approximately $1,617,000 available on the line. Th e line of credit is renewable on December 15, 2012 and includes covenants requiring us to maintain certain fi nancial ratios. As of June 30, 2012, we were in compliance with the loan covenants. Th e current ratio was 1.5 to 1 as of June 30, 2012 compared to 1.8 to 1 as of June 30, 2011. Current assets represented 70% of total assets as of June 30, 2012 and June 30, 2011. Th e lower current ratio refl ects the use of short term borrowings to fi nance stock repurchases, capital equipment investments and repayment of long-term debt. Debt Long-term debt (excluding current installments) totaled $1,916,315 as of June 30, 2012, compared to $2,238,417 as of June 30, 2011. Long- term debt is comprised primarily of the mortgage loans on our offi ce and manufacturing facilities in Utah and Tennessee. Th e principal balance on the mortgage loans is approximately $2,118,000 with monthly principal and interest payments of $37,503. For a more complete explanation of the long-term debt, see Note 7 to the fi nancial statements. We believe that the following critical accounting policies involve a high degree of judgment and complexity. See Note 1 to our consolidated fi nancial statements for fi scal year 2012, for a complete discussion of our signifi cant accounting policies. Th e following summary sets forth information regarding signifi cant estimates and judgments used in the preparation of our consolidated fi nancial statements. Inventory Reserves Th e nature of our business requires that we maintain suffi cient inventory on hand at all times to meet the requirements of our customers. We record fi nished goods inventory at the lower of standard cost, which approximates actual costs (fi rst-in, fi rst-out) or market. Raw materials are recorded at the lower of cost (fi rst-in, fi rst-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; • Customer demand; • Historical sales; • Forecast sales; • Product obsolescence; 12 • Technological innovations; and Deferred Income Tax Assets • Character of the inventory as a distributed item, fi nished manufactured item or raw material. Any modifi cations to estimates of inventory valuation reserves are refl ected in cost of goods sold within the statements of operations during the period in which such modifi cations are determined necessary by management. As of June 30, 2012 and 2011, our inventory valuation reserve balance, which established a new cost basis, was $292,999 and $337,748, respectively, and our inventory balance was $6,098,597 and $5,647,815, net of reserves, respectively. Revenue Recognition Our sales force and distributors sell our products to end users, including physical therapists, professional trainers, athletic trainers, chiropractors, medical doctors and aestheticians. 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 $3,667,086 and $3,672,128, net of allowance for doubtful accounts of $201,349 and $293,436, as of June 30, 2012 and 2011, respectively. In August 2012 and August 2011, our management performed an analysis of the deferred income tax assets and their recoverability. Based on several factors, including our strong earnings history of pre-tax profi t averaging over $500,000 per year in 18 of the last 22 fi scal years and the fact that the principal causes of the loss in fi scal 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. Business Plan and Outlook During the past two years, we have focused much of our resources and energy on developing new and innovative products. Th e scope of that R&D eff ort has been more signifi cant than at any time in our history. As a result, more new products will be introduced during fi scal year 2013 than we have introduced in any other year. In March 2012, we introduced the new Dynatron Quad7 therapy device to the market. Th e innovative Quad7 utilizes thermoelectric technology to deliver thermal therapy (either cold or hot therapy) combined with compression treatments through a variety of wraps and innovative Th ermoStim Probes. Th e Th ermoStim Probes are unique in their design as they allow for delivery of electrotherapy treatments concurrent with thermal therapy. Th e Quad7 has the fl exibility to off er seven diff erent treatments including intermittent compression, cold with compression, heat with compression, cold with stim, heat with stim, cold therapy alone, and heat therapy alone. Th is capability dramatically expands both the variety and location of conditions that can be treated. Th e Quad7 employs state-of-the-art technology providing precise temperature control moving beyond the current technology by eliminating the need for ice. Th ermal therapy in our Quad7 is achieved by using a thermoelectric computer chip technology. 13 In August 2012, we introduced to the market our new Dynatron SolarisPlus line of electrotherapy/ultrasound/ light therapy units. Th is new product line consists of four new units: the Dynatron SolarisPlus 709, 708, 706, and 705. Th ese attractive new units provide our most advanced technology in combination therapy devices by adding tri-wave light therapy capabilities to enhanced electrotherapy and ultrasound combination devices. Tri-wave light therapy features infrared, red and blue wavelength light. Th e new Dynatron Solaris light pad is capable of treating large areas of the body via unattended infrared, red and blue wavelength light therapy. As part of the SolarisPlus product line introduction, we also introduced a new display cart specifi cally designed for these units. Th is new cart is expected to begin shipping in October 2012. Th e SolarisPlus line is expected to quickly become popular for its power and versatility. Th e new units are capable of simultaneously powering fi ve electrotherapy channels, ultrasound therapy, a light probe and light pad. Th e commitment to innovation of high-quality products has been a hallmark of Dynatronics and will continue to be part of our future strategic objectives. Th is emphasis on R&D contributed in large part to the lower profi tability we experienced over the past two years. R&D costs for us have been cyclical in nature. Th e higher costs in fi scal year 2012 refl ect the fact that we have been in a more intense part of the development cycle. With the new products introduced to the market in August 2012, we expect that R&D costs will cycle back to a lower level more in line with historical amounts. However, we have several additional products that are targeted for introduction in the coming fi scal year that will build on the technology developed over the past two years. Management is confi dent the higher costs associated with the more intense part of the development cycle in the short term will yield long-term benefi ts and are important to assuring that we maintain our reputation in the industry for being an innovator and leader in product development. In calendar 2011, we announced the signing of contracts with four Group Purchasing Organizations (GPOs): Premier, Inc., Amerinet, Inc., FirstChoice Cooperative and Champs Group Purchasing. Th ese GPOs represent tens of thousands of clinics and hospitals around the nation. With the broader off ering of products now available through our catalog and e-commerce website, we are better able to compete for this high volume business. Over the past two years, we have also been successful in becoming a preferred vendor to many national and regional accounts. Th e contracts with the GPOs represent a license to solicit business directly from the members of the respective GPOs. Th e GPOs do not order any product directly. Th ey serve the function of negotiating favorable pricing terms on behalf of their members. We believe it will require years of eff ort to develop relationships with the individual GPO and national account clinics and hospitals and convert this business to our brand. Th is has been manifest by the lack of signifi cant progress under the limited contracts with Premier and Amerinet and the decision by other GPO’s like MedAssets and Novation to not put Dynatronics on contract. While we will continue to seek eff ective ways of accessing business with GPO members outside of a GPO contract, the pattern of the GPO’s has not been conducive to putting new vendors, like Dynatronics, on contract. Th erefore, while we will continue to petition for fairer treatment by the GPO’s we also realize that the resources that may be required to secure contracts with the GPO’s could be more productively deployed in other ways to improve sales of our products. While we are not abandoning the GPO eff ort, we recognize that the GPO bar is set very high and we would be better served initiating other strategies to increase sales. In late 2012 or early 2013 we plan to introduce a new, updated version of our product catalog. Th is new catalog will expand our product off ering in order to better service the broader needs of our customers. It will also provide an excellent new sales tool for all of our sales representatives in the fi eld as well as provide a foundation for expanding our e-commerce platform. 14 Over the past few years, consolidations in our market have changed the landscape of our industry’s distribution channels. 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. All other distribution in our market is directed through catalog companies with no direct sales force, or through independent local dealers that have limited geographical reach. In the past year, we have reinforced our direct sales team to include 53 direct sales employees and independent sales representatives. In addition to these direct sales representatives, we continue to enjoy a strong relationship with scores of independent dealers. We believe we have the best trained and most knowledgeable sales force in the industry. Th e changes taking place 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. To further our eff orts to recruit high-quality direct sales representatives and dealers, we intend to continue to improve effi ciencies of our operations and the sales support for the industry. Chief among the steps we are taking to make these improvements was the introduction of our fi rst true e-commerce solution on July 6, 2010 and the enhancements to that portal in the two years since its introduction. With the availability of this e-commerce solution, customers are able to more easily place orders and obtain information about their accounts. Sales representatives are increasing their eff ectiveness 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 easy and effi cient to use, it should also facilitate reducing transactional costs thus enabling us to accommodate higher sales without signifi cantly increasing overhead. Th e passage in 2010 of the Patient Protection and Aff ordable Care Act and with the Health Care and Educational Reconciliation Act will aff ect our future operations. Th e addition of millions to the rolls of the insured is expected to increase demand for services. Th at increased demand could lead to increased sales of our products. Th e magnitude of those increases is diffi cult to assess at this time. A negative impact of this legislation as enacted is its imposition of an excise tax on all manufacturers and importers of medical devices. An excise tax is assessed against sales, not profi ts. Th erefore, even in a year when we may have no profi ts, we will still owe the excise tax to the federal government. Barring a change in the statute, we estimate that this tax would be approximately $300,000 to $400,000 annually based on current sales levels. Because of the phase-in of various provisions in the legislation, the impact of the 2012 elections, and possible legislative actions, we cannot predict what the full eff ects of this legislation on our business and industry will be. Th e fi rst impact is expected in the early part of calendar year 2013. In addition, rule-making under the law is not yet complete which could mean a temporary postponement in implementing the tax. In the meantime, we are taking full advantage of every opportunity presented by this legislation to increase sales and to off set any negative eff ects that may accompany those opportunities. Should the tax become eff ective January 1, 2013 as anticipated, we will likely be compelled to raise prices as a refl ection of that new tax. Economic pressures from the recent recession in the United States have aff ected available credit that would facilitate large capital purchases, and have also reduced demand for discretionary services such as those provided by the purchasers of our aesthetic products. As a result, we reduced our expenses in the Synergie department. We believe that our aesthetic devices remain the best value on the market and we are seeking innovative ways to market these products, including strategic partnerships, both domestic and international, to help enhance sales momentum. 15 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 eff ort. We remain committed to fi nding the most eff ective ways to expand our markets internationally. Over the coming year, our eff orts will be focused on partnering with key manufacturers and distributors interested in our product line or technology. Our Utah facility, where all electrotherapy, ultrasound, traction, light therapy and Synergie products are manufactured, is certifi ed to ISO 13485:2003, an internationally recognized standard of excellence in medical device manufacturing. Th is designation is an important requirement in obtaining the CE Mark certifi cation, which allows us to market our products in the European Union and in other international locations. Refi ning our business model for supporting sales representatives and distributors also will be a focal point of operations. We will continue to evaluate the most effi cient ways to maintain our satellite sales offi ces and warehouses. Th e ongoing refi nement of this model is expected to yield further effi ciencies that will better achieve sales goals while, at the same time, reduce expenses. Our eff orts to prudently reduce costs in the face of some economic uncertainty have made us a leaner operation. During calendar 2012, we identifi ed a number of cost saving measures totaling more than $750,000 annually that have been or will be implemented to reduce expenses. We will continue to be vigilant in maintaining appropriate overhead costs and operating costs while still providing support for anticipated increases in sales from our new products. Based on our defi ned strategic initiatives, we are focusing our resources in the following areas: • Increasing market share of manufactured capital products by promoting sales of our new state-of-the-art Dynatron Quad7 and Dynatron SolarisPlus products introduced in calendar 2012. • Introducing additional new products to better capitalize on opportunities in our core market including the market for the Quad 7 technology. Th e introduction of additional new products in the coming year is made possible by the technology platform built over the past two years of intense R&D eff ort. Th erefore, the new products can be introduced with minimal additional R&D expenditures. • Continue to seek ways of petitioning for more business with GPO’s, but redirect focus to more viable and immediate opportunities in the private practice market including customers that may be members of GPO’s, but not required to purchase under a GPO contract. Increased focus will be given to developing business with large chains of clinics, including national and regional accounts. • Introducing a new 2013-14 product catalog featuring a broader product off ering. • Using our e-commerce solution in order to facilitate business opportunities and reduce transactional costs. • Reinforcing distribution through a strategy of recruiting direct sales representatives and working closely with the most successful distributors of capital equipment. • Improving operational effi ciencies by reducing costs to be more refl ective of current levels of sales. Strengthening pricing management and procurement methodologies. • Minimizing expense associated in the Synergie department until demand for capital equipment re-emerges, and, in the meantime, seeking additional independent distributors and strategic partnerships. • Focusing international sales eff orts on identifying key distributors and strategic partners who could represent the Company’s product line, particularly in Europe. • Improving effi ciencies as a distributor of other manufacturers’ products and considering ways to enhance our role as a distributor and not just a manufacturer. • Exploring strategic business alliances that will leverage and complement our competitive strengths, increase market reach and supplement capital resources. 16 NASDAQ Minimum Bid Requirement Shareholders As of September 22, 2012, the approximate number of stockholders of record was 430. Th is number does not include benefi cial owners of shares held in “nominee” or “street” name. Including such benefi cial owners, we estimate that the total number of benefi cial owners of our common stock is approximately 2,600. 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 in order to fi nance the development of the business. On May 9, 2012, we received a defi ciency 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 defi ciency notice, our common stock is subject to potential delisting because, for a period of 180 consecutive days, the bid price of the common stock closed below the minimum $1.00 per share requirement for continued inclusion. NASDAQ allows six months to comply with the rule and an additional six months if certain criteria are met. Th e deadline for our compliance with the rule is November 5, 2012. 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 notifi cation that we have achieved compliance with the rule. If compliance is not achieved, we may seek shareholder approval for a reverse stock split in order to cure the NASDAQ listing defi ciency. Alternatively, the Company’s stock may be delisted and begin trading on the OTC bulletin board or OTC Markets where there is no minimum bid requirement. Th ere can be no assurance that a market will develop for the Company’s stock under any of these alternatives. Market Information As of September 22, 2012, we had approximately 12,688,650 shares of common stock issued and outstanding. Our common stock is included on the NASDAQ Capital Market (symbol: DYNT). Th e following table shows the range of high and low sale prices for our common stock as quoted on the NASDAQ system for the quarterly periods indicated: 1st Quarter (July-September) 2nd Quarter (October-December) 3rd Quarter (January-March) 4th Quarter (April-June) Fiscal Year Ended June 30, 2012 2011 High Low High Low $1.77 $.83 $.93 $.80 $.80 $.62 $.67 $.47 $.75 $.72 $1.18 $2.14 $0.62 $0.60 $0.62 $1.12 17 Dynatronics Corporation Consolidated Balance Sheets - June 30, 2012 and 2011 Assets Current assets: Cash and cash equivalents Trade accounts receivable, less allowance for doubtful accounts of $201,349 as of June 30, 2012 and $293,436 as of June 30, 2011 Other receivables Inventories, net Prepaid expenses and other Prepaid income taxes Current portion of deferred income tax assets Total current assets Property and equipment, net Intangible assets, net Other assets Deferred income tax assets, net of current portion Total assets Liabilities and Stockholders’ Equity Current liabilities: Current portion of long-term debt Line of credit Warranty reserve Accounts payable Accrued expenses Accrued payroll and benefi ts expense Total current liabilities Long-term debt, net of current portion Deferred income tax liabilities, net of current portion Total liabilities Commitments and contingencies Stockholders' equity: Common stock, no par value: Authorized 50,000,000 shares; issued 12,688,650 shares as of June 30, 2012 and 13,060,392 shares as of June 30, 2011 Accumulated defi cit Total stockholders' equity Total liabilities and stockholders’ equity See accompanying notes to consolidated fi nancial statements. 2012 2011 $ 278,263 384,904 3,667,086 11,718 6,098,597 226,596 3,550 368,348 3,672,128 14,164 5,647,815 266,439 28,754 418,607 10,654,158 10,432,811 3,677,898 324,715 482,719 131,440 3,722,749 369,352 294,269 - $ 15,270,930 14,819,181 $ 395,055 3,497,597 181,000 2,413,201 386,229 215,218 368,135 2,583,937 185,245 2,127,163 379,336 236,264 7,088,300 5,880,080 1,916,315 - 2,238,417 85,525 9,004,615 8,204,022 7,091,935 7,417,244 (825,620) (802,085) 6,266,315 6,615,159 $ 15,270,930 14,819,181 19 Dynatronics Corporation Consolidated Statements of Operations - Years Ended June 30, 2012 and 2011 Net sales Cost of sales Gross profi t Selling, general, and administrative expenses Research and development expenses Operating income Other income (expense): Interest income Interest expense Other income, net Total other income (expense) 2012 2011 $ 31,664,181 19,720,948 11,943,233 32,692,859 20,208,035 12,484,824 10,506,460 1,410,406 10,431,463 1,383,712 26,367 669,649 16,183 (261,993) 29,202 16,395 (294,404) 27,224 (216,608) (250,785) Income (loss) before income tax benefi t (provision) (190,241) 418,864 Income tax benefi t (provision) Net income (loss) 166,706 (147,976) $ (23,535) 270,888 Basic and diluted net income (loss) per common share $ (0.00) 0.02 Weighted-average basic and diluted common shares outstanding: Basic Diluted 12,811,017 12,811,017 13,332,583 13,367,049 20 See accompanying notes to consolidated fi nancial statements. Dynatronics Corporation Consolidated Statements of Stockholders’ Equity - Years Ended June 30, 2012 and 2011 Balances as of July 1, 2010 13,591,152 $ 7,872,250 (1,072,973) 6,799,277 Number of shares Common stock Accumulated defi cit Total stockholders’ equity Issuance of common stock upon exer- cise of employee stock options 4,884 7,949 Repurchase of common stock (543,240) (519,053) Stock-based compensation Net income 7,596 - 56,098 - - - - 270,888 Balances as of June 30, 2011 13,060,392 $ 7,417,244 (802,085) Repurchase of common stock (399,287) (401,408) Stock-based compensation Net loss 27,545 - 76,099 - Balances as of June 30, 2012 12,688,650 $ 7,091,935 - - (23,535) . (825,620) 7,949 (519,053) 56,098 270,888 6,615,159 (401,408) 76,099 (23,535) 6,266,315 See accompanying notes to consolidated fi nancial statements. 21 Dynatronics Corporation Consolidated Statements of Cash Flows - Years Ended June 30, 2012 and 2011 Cash fl ows from operating activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization of property and equipment Amortization of intangible assets Gain on disposal of assets Stock-based compensation expense Change in deferred income tax assets Provision for doubtful accounts receivable Provision for inventory obsolescence Change in operating assets and liabilities: Receivables Inventories Prepaid expenses and other assets Prepaid income taxes Accounts payable and accrued expenses 2012 2011 $ (23,535) 270,888 404,374 44,637 - 76,099 (166,706) 108,000 120,000 (100,512) (570,782) (148,607) 27,771 265,073 370,726 83,206 (703) 56,098 209,325 108,000 90,000 11,878 28,985 16,659 (84,690) 447,997 Net cash provided by operating activities 35,812 1,608,369 Cash fl ows from investing activities: Purchase of property and equipment Proceeds from sale of property and equipment Net cash used in investing activities Cash fl ows from fi nancing activities: Proceeds from issuance of long-term debt Principal payments on long-term debt Net change in line of credit Proceeds from issuance of common stock Purchase and retirement of common stock Net cash provided by (used in) fi nancing activities Net change in cash and cash equivalents Cash and cash equivalents at beginning of the year (328,707) - (534,001) 2,500 (328,707) (531,501) 45,341 (371,339) 913,660 - (401,408) - (380,061) (184,555) 7,949 (519,053) 186,254 (1,075,720) (106,641) 1,148 384,904 383,756 Cash and cash equivalents at end of the year $ 278,263 384,904 Supplemental disclosure of cash fl ow information: Cash paid for interest Cash paid for income taxes Supplemental disclosure of non-cash investing and fi nancing activities: Long-term debt incurred for purchase of property and equipment See accompanying notes to consolidated fi nancial statements. 22 $ 263,491 2,100 298,941 12,100 44,334 - Dynatronics Corporation Notes to Consolidated Financial Statements - June 30, 2012 and 2011 (1) Basis of Presentation and Summary of Signifi cant Accounting Policies (a) Description of Business Dynatronics Corporation (the Company), a Utah corporation, distributes and markets a broad line of medical and aesthetic products, many of which are designed and manufactured by the Company. Among the products off ered by the Company are therapeutic, diagnostic, and rehabilitation equipment, medical supplies and soft goods, treatment tables and aesthetic medical devices to an expanding market of physical therapists, podiatrists, orthopedists, chiropractors, plastic surgeons, dermatologists, and other medical professionals. the customer’s ability to pay. All account balances are reviewed on an individual basis. Account balances are charged off against the allowance when the potential for recovery is considered remote. Recoveries of receivables previously charged off are recognized when payment is received. (f ) Property and Equipment Property and equipment are stated at cost and are depreciated using the straight line method over the estimated useful lives of the assets. Th e building and its component parts are being depreciated over their estimated useful lives that range from 5 to 31.5 years. Estimated lives for all other depreciable assets range from 3 to 7 years. (b) Principles of Consolidation Th e consolidated fi nancial statements include the accounts and operations of Dynatronics Corporation and its wholly owned subsidiary, Dynatronics Distribution Company, LLC. All signifi cant intercompany account balances and transactions have been eliminated in consolidation. (c) Cash Equivalents Cash equivalents include all highly liquid investments with maturities of three months or less at the date of purchase. Also included within cash equivalents are deposits in-transit from banks for payments related to third-party credit card and debit card transactions. (d) Inventories Finished goods inventories are stated at the lower of standard cost (fi rst-in, fi rst-out method), which approximates actual cost, or market. Raw materials are stated at the lower of cost (fi rst in, fi rst out method) or market. (e) Trade Accounts Receivable Trade accounts receivable are recorded at the invoiced amount and do not bear interest, although a fi nance charge may be applied to such receivables that are past the due date. Th e allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. Th e Company determines the allowance based on a combination of statistical analysis, historical collections, customers’ current credit worthiness, the age of the receivable balance both individually and in the aggregate and general economic conditions that may aff ect (g) Long-Lived Assets Long–lived assets, such as property and equipment, 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 to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash fl ows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash fl ows, an impairment charge is recognized for the diff erence between the carrying amount of the asset and the fair value of the asset. Assets to be disposed of are separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. (h) Intangible Assets Costs associated with the acquisition of trademarks, trade names, license rights and non-compete agreements are capitalized and amortized using the straight-line method over periods ranging from 3 months to 15 years. (i) Revenue Recognition Th e 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 revenue. Costs for shipping and handling of products to customers are recorded as cost of sales. (j) Research and Development Costs Direct research and development costs are expensed as incurred. 23 in accordance with the requirements of Financial Accounting Standards Board (FASB) Accounting Standards Codifi cation (ASC) 740-10, Income Taxes. Under ASC 740- 10, the Company may recognize the tax benefi ts 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. Th e tax benefi ts recognized in the fi nancial statements from such a position are measured based on the largest benefi t that has a greater than 50% likelihood of being realized upon ultimate settlement. ASC 740-10 also provides guidance on derecognition of income tax assets and liabilities, classifi cation of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized in the fi nancial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact the Company’s fi nancial position, results of operations and cash fl ows. (n) Stock-Based Compensation Th e Company accounts for stock-based compensation in accordance with FASB ASC 718, Stock Compensation. Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the applicable vesting period of the stock award (generally fi ve years) using the straight-line method. (o) 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. Th e 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. Th e Company maintains its cash in bank deposit accounts which at times may exceed federally insured limits. Th e Company has not experienced any losses in such accounts. Th e Company believes it is not exposed to any signifi cant credit risks with respect to cash or cash equivalents. (k) Product Warranty Costs 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. (l) Net Income (Loss) per Common Share Net income (loss) 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 year. Stock options are considered to be common stock equivalents. Th e computation of diluted net income (loss) per common share does not assume exercise or conversion of securities that would have an anti-dilutive eff ect. Basic net income (loss) per common share is the amount of net income (loss) for the year available to each weighted-average share of common stock outstanding during the year. Diluted net income (loss) per common share is the amount of net income (loss) for the year available to each weighted-average share of common stock outstanding during the year and to each common stock equivalent outstanding during the year, unless inclusion of common stock equivalents would have an anti-dilutive eff ect. Th e reconciliation between the basic and diluted weighted-average number of common shares for the years ended June 30, 2012 and 2011 is summarized as follows: Basic weighted-average number of common shares outstanding during the year Weighted-average number of dilutive common stock options outstanding during the year Diluted weighted-average number of common and common equivalent shares outstanding during the year 2012 2011 12,811,017 13,332,583 - 34,466 12,811,017 13,367,049 Outstanding options not included in the computation of diluted net loss per common share totaled 865,463 as of June 30, 2012. Th ese common stock equivalents were not included in the computation because to do so would have been antidilutive. (m) Income Taxes Th e Company recognizes an asset or liability for the deferred income tax consequences of all temporary diff erences between the tax bases of assets and liabilities and their reported amounts in the consolidated fi nancial 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. Accruals for uncertain tax positions are provided for 24 (p) Operating Segments Th e Company operates in one line of business: the development, marketing, and distribution of a broad line of medical products for the physical therapy and aesthetics markets. As such, the Company has only one reportable operating segment. Th e Company groups its sales into physical medicine products and aesthetic products. Physical medicine products made up 91% and 92% of net sales for the years ended June 30, 2012 and 2011, respectively. Aesthetics products made up 1% of net sales for both the years ended June 30, 2012 and 2011. Chargeable repairs, billable freight and other miscellaneous revenues account for the remaining 8% and 7% of net sales for the years ended June 30, 2012 and 2011, respectively. (q) 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 US Generally Accepted Accounting Principles (US GAAP). Signifi cant items subject to such estimates and assumptions include the carrying amount of property and equipment; valuation allowances for receivables, income taxes, and inventories; accrued product warranty costs; and estimated recoverability of intangible assets. Actual results could diff er from those estimates. (r) Advertising Costs Advertising costs are expensed as incurred. Advertising expense for the years ended June 30, 2012 and 2011 was approximately $87,400 and $115,300, respectively. (2) Inventories Inventories consist of the following as of June 30: Raw materials Finished goods Inventory reserve 2012 $ 2,401,676 3,989,920 (292,999) $ 6,098,597 2011 2,329,536 3,656,027 (337,748) 5,647,815 (3) Property and Equipment Property and equipment consist of the following as of June 30: Land Buildings Machinery and equipment Offi ce equipment Offi ce equipment Vehicles Less accumulated depreciation and amortization 2012 2011 $ 354,743 3,745,404 1,521,896 263,861 354,743 3,726,224 1,530,389 260,626 1,905,332 1,732,700 289,678 247,369 8,080,914 7,852,051 (4,403,016) (4,129,302) $ 3,677,898 3,722,749 (4) Intangible Assets Identifi able intangible assets and their useful lives consist of the following as of June 30: Trade name – 15 years Domain name – 15 years Non-compete covenant – 4 years Customer relationships – 7 years Trademark licensing agreement – 20 years Backlog of orders – 3 months Customer database – 7 years License agreement – 10 years Total identifi able intangibles Less accumulated amortization Net carrying amount 2012 2011 $ 339,400 5,400 149,400 120,000 45,000 2,700 38,100 73,240 773,240 (448,525) $ 324,715 339,400 5,400 149,400 120,000 45,000 2,700 38,100 73,240 773,240 (403,888) 369,352 Amortization expense associated with the intangible assets was $44,637 and $83,206 for fi scal years 2012 and 2011, respectively. Estimated amortization expense for the identifi able intangibles is expected to be as follows: 2013, $44,637; 2014, $44,637; 2015, $30,680; 2016, $30,680; 2017, $30,680 and thereafter $143,400. 25 (5) Warranty Reserve A reconciliation of the change in the warranty reserve consists of the following for the fi scal years ended June 30: 2012 2011 Beginning warranty reserve balance $ 185,245 Warranty repairs Warranties issued Changes in estimated warranty costs (124,844) 127,059 (6,460) Ending product warranty reserve $ 181,000 186,022 (135,542) 149,362 (14,597) 185,245 (6) Line of Credit Th e Company has a revolving line-of-credit facility with a commercial bank in the amount of $7,000,000. Borrowing limitations are based on 45% of eligible inventory and up to 80% of eligible accounts receivable resulting in a borrowing limit of $5,115,000 as of June 30, 2012. As of June 30, 2012 and 2011, the outstanding balance was approximately $3,498,000 and $2,584,000, respectively. Available borrowings as of June 30, 2012 were $1,617,000. Th e line of credit is collateralized by inventory and accounts receivable and bears interest at a rate based on the lender’s 90- day LIBOR rate plus 3%. Th e interest rate was 3.5% and 3.2% as of June 30, 2012 and 2011, respectively. Th is line is subject to biennial renewal and matures on December 15, 2012. Accrued interest is payable monthly. Th e Company’s revolving line of credit agreement includes covenants requiring the Company to maintain certain fi nancial ratios. As of June 30, 2012, management believes the Company was in compliance with its loan covenants. (7) 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 2012 2011 $ 1,048,496 1,137,179 5.649% promissory note secured by building, maturing December 2017, payable in monthly installments of $16,985 961,196 1,105,292 6.21% promissory note secured by a trust deed on real property, maturing November 2013, payable in monthly installments of $7,240 8.49% promissory note secured by equipment, payable in monthly installments of $2,097 through December 2014 14.305% promissory note secured by equipment, payable in monthly installments of $2,338 through May 2014 4.75% promissory note secured by a vehicle, payable in monthly installments of $721 through May 2017 5.531% promissory note secured by a vehicle, payable in monthly installments of $482 through August 2016 5.887% promissory note secured by a vehicle, payable in monthly installments of $390 through March 2017 5.75% promissory note secured by a vehicle, payable in monthly installments of $435 through October 2013 10.15% promissory note secured by a vehicle, payable in monthly installments of $448 through December 2012 13.001% promissory note secured by equipment, payable in monthly installments of $70 through October 2015 7.95% promissory note secured by a vehicle, payable in monthly installments of $724 through July 2013 16.35% promissory note secured by equipment, payable in monthly installments of $409 through October 2011 9.69% promissory note secured by equipment, payable in monthly installments of $318 through October 2011 108,243 183,687 56,515 75,980 46,781 66,572 37,859 21,460 19,284 6,661 2,612 2,263 - - - - - - 11,351 7,456 - 16,627 1,580 828 Total long-term debt Less current portion 2,311,370 2,606,552 (395,055) (368,135) Long-term debt, net of current portion $ 1,916,315 2,238,417 Th e aggregate maturities of long term debt for each of the years subsequent to 2012 are as follows: 2013, $395,055; 2014, $355,217; 2015, $308,500; 2016, $314,467; 2017, $327,162 and thereafter $610,969. 26 (8) Leases Th e Company leases vehicles under noncancelable operating lease agreements. Lease expense for the years ended June 30, 2012 and 2011, was $7,812 and $15,898, respectively. Future minimum lease payments required under noncancelable operating leases that have initial or remaining lease terms in excess of one year as of 2012 are as follows: 2013, $6,507. Expected tax benefi t (provision) State taxes, net of federal tax benefi t R&D tax credit Other, net 2012 2011 64,682 4,478 75,000 22,546 (142,414) (12,650) - 7,088 166,706 (147,976) $ $ Deferred income tax assets and liabilities related to the tax eff ects of temporary diff erences are as follow as of June 30: Net deferred income tax assets – current: Inventory capitalization for income tax purposes $ Inventory reserve Warranty reserve Accrued product liability Allowance for doubtful accounts Total deferred income tax asset - current Net deferred income tax assets (liabilities) – non- current: Property and equipment, principally due to diff erences in depreciation Research and development credit carryover Other intangibles Operating loss carry forwards 2012 2011 75,127 114,270 70,590 29,835 78,526 368,348 73,812 131,721 72,245 26,389 114,440 418,607 (268,839) 328,927 (126,640) 197,992 (266,858) 212,161 (144,047) 113,219 Total deferred income tax assets (liabilities) – non-current $ 131,440 (85,525) Th e Company rents offi ce, warehouse and storage space and offi ce equipment under agreements which run one year or more in duration. Th e rent expense for the years ended June 30, 2012 and 2011 was $231,142 and $285,347, respectively. Future minimum rental payments required under operating leases that have a duration of one year or more as of June 30, 2012 are as follows: 2013, $109,775; 2014, $56,400; 2015, $39,775 and 2016, $29,925. During fi scal year 2011, the offi ce and warehouse spaces in Girard, Ohio; Detroit, Michigan; Pleasanton, California; and Hopkins, Minnesota were leased on an annual/ monthly basis from employees/stockholders; or entities controlled by stockholders, who were previously principals of the dealers acquired in June and July, 2007. Th e leases are related-party transactions with four employee/stockholders, however, management believes the lease agreements have been conducted on an arms-length basis and the terms are similar to those that would be available to other third parties. Eff ective July 1, 2011, the offi ce in Girard, Ohio was moved to Boardman, Ohio and is leased through from a third party. (9) Income Taxes Income tax benefi t (provision) for the years ended June 30 consists of: 2012: U.S. federal State and local 2011: U.S. federal State and local Current Deferred Total - - - 159,921 6,785 166,706 159,921 6,785 166,706 61,449 (100) 61,349 (209,689) (148,240) 364 264 (209,325) (147,976) $ $ $ $ Th e actual income tax benefi t (provision) diff ers from the “expected” tax benefi t (provision) computed by applying the U.S. federal corporate income tax rate of 34% to income (loss) before income taxes for the years ended June 30, are as follows: 27 In assessing the realizability of deferred income tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Th e ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the years in which those temporary diff erences become deductible. Management considers the scheduled reversal of deferred income tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred income tax assets are deductible, management believes it is more likely than not that the Company will realize the benefi ts of these deductible diff erences. (10) Major Customers and Sales by Geographic Location During the fi scal years ended June 30, 2012 and 2011, sales to any single customer did not exceed 10% of total net sales. Th e Company exports products to approximately 30 countries. Sales outside North America totaled $896,887, or 2.8% of net sales, for the fi scal year ended June 30, 2012 compared to $678,576, or 2.1% of net sales, for the fi scal year ended June 30, 2011. (11) Common Stock and Common Stock Equivalents On July 15, 2003, the board of directors (board) approved an open-market share repurchase program for up to $500,000 of the Company’s common stock. On November 27, 2007, the board approved an additional $250,000 for the open-market share repurchase program after the original $500,000 was used. In February 2011, the board approved an additional $1,000,000 for repurchases under the program. During fi scal year 2010, the board authorized the repurchase of up to $100,000 of stock annually for three years from each of two former distributors that were acquired by the Company in 2007. During the year ended June 30, 2012, the Company acquired and retired 399,287 shares of common stock for $401,408. During the year ended June 30, 2011, the Company acquired and retired 543,240 shares of common stock for $519,053. During the years ended June 30, 2012 and 2011, the Company granted 27,545 and 7,596 shares, respectively, of restricted common stock to directors and offi cers in connection with compensation arrangements. Th e Company maintains a 2005 equity incentive plan for the benefi t of employees. Incentive and nonqualifi ed 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. Eff ective November 27, 2007, the plan was amended, as approved by the stockholders, to increase the number of shares available by 1,000,000 shares. As of June 30, 2012, 500,869 shares of common stock were authorized and reserved for issuance, but were not granted under the terms of the 2005 equity incentive plan as amended. 28 Th e Company granted options to acquire common stock under its 2005 equity incentive plan during fi scal years 2012 and 2011. Th e options are granted at not less than 100% of the market price of the stock at the date of grant. Option terms are determined by the board, and exercise dates may range from 6 months to 10 years from the date of grant. Th e fair value of each option grant was estimated on the date of grant using the Black Scholes option pricing model with the following assumptions: Expected dividend yield Expected stock price volatility Risk-free interest rate Expected life of options 2012 0% 69% 2.09% 10 years 2011 0% 60-64% 2.5 - 3.43% 10 years Th e weighted average fair value of options granted during fi scal years 2012 and 2011 was $.62 and $.53, respectively. Th e following table summarizes the Company’s stock option activity during the fi scal years 2012 and 2011: 2012 2011 Weighted average exercise price Weighted average remaining contractual term Number of shares Weighted average exercise price Number of shares Options outstanding at beginning of the year 933,462 $ 1.33 4.84 years 932,805 $ Options granted Options exercised Options canceled or expired 52,277 - (120,276) .82 - 1.31 66,248 (4,884) (60,707) Options outstanding at end of the year Options exercisable at end of the year Range of exercise prices at end of the year 865,463 1.30 4.12 years 933,462 561,664 1.55 534,412 $ 0.35 - 1.89 $ 0.35 - 1.99 1.35 .74 1.63 1.10 1.33 1.64 In June 2011, the FASB issued authoritative guidance on the presentation of comprehensive income. Th is guidance specifi es that an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. Th is guidance does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassifi ed to net income. It also does not change the presentation of related tax eff ects, before related tax eff ects, or the portrayal or calculation of earnings per share. Th is guidance is to be applied retrospectively and is eff ective for fi scal years, and interim periods within those years, eff ective for Dynatronics July 1, 2012. Th e adoption of this guidance will not have a material eff ect on our consolidated fi nancial statements as it amended only the presentation of comprehensive income. Comprehensive income (loss) was equal to the net income (loss) as presented in the consolidated fi nancial statements for the fi scal years ended June 30, 2012 and 2011. Th e Company recognized $76,099 and $56,098 in stock-based compensation for the years ended June 30, 2012 and 2011, respectively, which is included in selling, general, and administrative expenses in the consolidated statements of operations. Th e stock- based compensation includes amounts for both restricted stock and stock options under ASC 718. As of June 30, 2012 there was $503,528 of unrecognized stock-based compensation cost that is expected to be expensed over periods of four to 10 years. No options were exercised during the fi scal year 2012, and the aggregate intrinsic value on the date of exercise of options exercised during fi scal year 2011 was $1,552. Th e aggregate intrinsic value of the outstanding options as of June 30, 2012 and 2011 was $1,281 and $206,721, respectively. (12) Employee Benefi t Plan Th e Company has a deferred savings plan which qualifi es under Internal Revenue Code Section 401(k). Th e plan covers all employees of the Company who have at least six months of service and who are age 20 or older. For fi scal years 2012 and 2011, the Company made matching contributions of 25% of the fi rst $2,000 of each employee’s contribution. Th e Company’s contributions to the plan for 2012 and 2011 were $37,745 and $38,728, respectively. Company matching contributions for future years are at the discretion of the board of directors. (13) Subsequent Events In accordance with ASC 855-10, management determined that through the date of this report, there are no material subsequent events to report. (14) Recent Accounting Pronouncements In September 2011, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance related to testing goodwill for impairment. Th is guidance provides that entities may fi rst assess qualitative factors to determine whether it is necessary to perform the two-step goodwill impairment test. If the qualitative assessment results in a more than 50% likely result that the fair value of a reporting unit is less than the carrying amount, then the entity must continue to apply the two- step impairment test. If the entity concludes the fair value exceeds the carrying amount, then neither of the two steps in the goodwill impairment test is required. Th is guidance is eff ective for annual and interim goodwill impairment tests performed for fi scal years beginning after December 15, 2011 with early adoption permitted. Th e adoption of this pronouncement had no signifi cant eff ect on the Company’s fi nancial statements. 29 Corporate Information Availability of Form 10-K Dynatronics Corporation fi les an annual report on Form 10-K each year with the Securities and Exchange Commission. A copy of the Form 10-K for the fi scal year ended June 30, 2012, may be obtained at no charge by sending a written request to: Mr. Bob Cardon, Vice President of Administration, Dynatronics Corporation, 7030 Park Centre Drive, Cottonwood Heights, Utah 84121. Annual Meeting Th e company’s annual shareholders meeting will be Monday, December 17, 2012 at 3:00 p.m. MST (or at such other time as is properly noticed) at Dynatronics’ corporate headquarters, 7030 Park Centre Drive, Cottonwood Heights, Utah 84121. General Information Dynatronics Corporation, a Utah corporation organized on April 29, 1983, manufactures, markets and distributes a broad line of therapeutic, diagnostic and rehabilitation equipment, medical supplies and soft goods, treatment tables, and aesthetic massage and microdermabrasion devices to an expanding market of physical therapists, sports medicine practitioners and athletic trainers, chiropractors, podiatrists, orthopedists, plastic surgeons, dermatologists, aestheticians and other medical professionals. Offi cers and Directors Kelvyn H. Cullimore Jr. Chairman of the Board, President, and CEO Larry K. Beardall Executive Vice President of Sales and Marketing and Director Terry M. Atkinson, CPA Chief Financial Offi cer Robert J. (Bob) Cardon Vice President of Administration, Secretary and Treasurer Douglas G. Sampson Vice President of Production and R&D Bryan D. Alsop Vice President of Information Technology Howard L. Edwards Director Retired Corporate Secretary, ARCO Company Val J. Christensen Director Former President, Energy Solutions Inc. Joseph H. Barton Director Retired Sr. Vice President, GranCare Inc. Accountants, Legal Counsel and Transfer Agent Independent Registered Public Accounting Firm Tanner LLC Salt Lake City, Utah Corporate Legal Counsel Durham Jones & Pinegar Salt Lake City, Utah Intellectual Property Legal Counsel Kirton & McConkie Salt Lake City, Utah Transfer Agent Interwest Transfer Company P.O. Box 17136 Salt Lake City, Utah 84117 Dynatronics Corporation Headquarters 7030 Park Centre Drive Cottonwood Heights, Utah 84121 1.800.874.6251 http://www.dynatronics.com 30 Th is annual report contains forward-looking statements related to anticipated fi nancial performance, product development and similar matters. Securities laws provide a safe harbor for such statements. Th e company notes that risks inherent in its business and a variety of factors could cause or contribute to a diff erence between actual results and anticipated results. Dynatronics Corporation Headquarters 7030 Park Centre Dr., Cottonwood Heights, Utah 84121 1.800.874.6251 - www.dynatronics.com
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