Dynatronics
Annual Report 2016

Plain-text annual report

2016 Annual Report This annual report contains forward-looking statements related to anticipated financial performance, product development and similar matters. Securities laws provide a safe harbor for such statements. The company notes that risks inherent in its business and a variety of factors could cause or contribute to a difference between actual results and anticipated results. Letter to Shareholders Sales and Marketing: Outside the Box Board of Directors and Management Management’s Discussion and Analysis Report of Independent Registered Public Accounting Firm Financial Statements Notes to Financial Statements Corporate Information 2 5 7 8 16 18 22 35 In last year’s letter to our shareholders, I detailed the change in direction we initiated when we partnered with private equity investors affiliated with Prettybrook Partners. These investors injected over $4 million in capital into Dynatronics in June, 2015. We are now a full year into that partnership and our progress has been notable. Change has been the hallmark of the past year – and it has been calculated to build the right platform and infrastructure to facilitate achieving our strategic objectives. Those objectives can be generally summarized in three stated goals. Achieve organic growth in our existing business through more aggressive sales management and marketing, expanding geographic coverage domestically and internationally, introducing new products, and pursuing post-acute care markets Actively seek acquisitions within the areas of physical therapy and athletic training that will enhance our product offering, leverage our sales force and potentially expand our distribution capabilities Improve shareholder value as we achieve the first two objectives by implementing an investor relations plan to keep the market abreast of Dynatronics’ progress While our objectives are simple, laying the foundation to achieve them has required strategic planning and measured change to better position us for success. One of the most significant changes of this last year has been the turnover on our board of directors. I would take this opportunity to express appreciation to former board members who served the company well for many years: Howard Edwards, the late Joseph Barton, Richard Linder, Val Christensen and Larry Beardall were all instrumental in Letter to Shareholders 2 2016LETTER TOSHAREHOLDERSbuilding the foundation on which our new strategic plans of Dynatronics for almost three decades, retired in July are being constructed. 2016, and Jim has assumed investor relations duties in Our board as currently constituted represents a his stead. cross-section of men and women with significant relevant In September 2016, we announced the appointment of business experience. The new board members appointed David A. Wirthlin as Chief Financial Officer (CFO), effective this past year include: Erin Enright – Managing Partner of Prettybrook Partners LLC; former medical technology executive and Managing Director of Equity Capital Markets with Citigroup David Holtz – Principal of Provco Group Ltd.; former CEO of Nucryst Pharmaceuticals Corp. and former SVP of Finance for Integra Lifesciences October 11, 2016. Mr. Wirthlin will succeed Terry Atkinson who will continue to serve an important role at Dynatronics as Director of Accounting. David’s deep expertise and experience as both a private and public company CFO brings significant depth to the Dynatronics’ management team. We believe these changes have positioned us to achieve our stated objectives. They have entailed significant investment in the core business, which we expect will Scott Klosterman – Executive Vice President at HNI positively impact our financial performance in fiscal 2017 Healthcare; former Division President, COO and CFO and thereafter. of Chattanooga Group (a division of DJO, Inc.) Of course, none of this change would be possible without Brian Larkin – Senior Vice President and General Manager at Acelity LP; former Corporate Vice President of Integra Lifesciences Add to this Dr. Scott Ward, a legacy board member and director of the physical therapy program at the University of Utah and five-time past president of the American Physical Therapy Association, and we believe we have a board with expertise in the industry, finance, sales and corporate transactions, which will help us in our efforts to increase shareholder value. We have also experienced significant management changes this past year. Longtime sales and marketing executive, Larry Beardall, whose vision and skill helped build the company over three decades, left the company in June 2016. Mr. Jeff Gephart was hired in March 2016 as the senior vice president of sales and has assumed many of Mr. Beardall’s duties. Jeff has extensive experience in the industry, including many years as vice president of sales with Chattanooga Group — one of our primary competitors. Jeff has strengthened our sales management team and instituted a strategy to build Dynatronics’ business organically. Recent hires include a new sales manager to manage the eastern region sales territory, and a new director to head up international sales, both of whom had long experience with Chattanooga Group. In August 2015 we hired Jim Ogilvie as our director of business development. Jim’s duties are primarily focused on our second strategic objective of growth through acquisitions. However, his excellent analytical skills and experience have been broadly valuable to the management team. Most recently, Bob Cardon, who served as an officer the support and vision of our partners at Prettybrook Partners. We could not ask for a better partnership than what we have developed with Prettybrook. For the second consecutive fiscal year, we realized revenue increases. Growth in fiscal year 2016 was over 4 percent, compared to approximately 6 percent for fiscal year 2015 and in contrast to the approximately 7 percent sales declines we experienced during the two previous fiscal years. We believe we can achieve continued revenue growth in fiscal year 2017. The financial results for fiscal year 2016 reflect the strategic investments I have outlined. The company reported a net loss applicable to shareholders of $2,275,000. Of that amount, we recorded one time severance expenses of $768,000, and we booked an inventory write-down of approximately $270,000 due primarily to non-performing inventory purchased for a GPO contract two years ago. An additional $372,000 in expense was associated with non-cash dividends to preferred shareholders, which were paid in common stock. These three factors account for $1,410,000 of the $2,275,000 reported loss applicable to stockholders. The remaining approximately $900,000 in losses were in large part attributable to expenses related to new employees and other strategic decisions designed to build a solid platform for achieving our objectives in fiscal year 2017. Our cash position decreased during the year from almost $4 million to approximately $1 million. Of this $3 million decline, $2.2 million was the repayment of debt, including retiring our working capital line of credit. The balance of the cash use was related to capital expenditures as well as financing operating losses during the year. 3 Letter to Shareholders Despite the decrease in cash during the year, we believe that our cash position is adequate to fund operations for the coming year. In addition to the cash on the balance sheet, we put a $1.0 million working capital line of credit in place in September of 2016. We believe that our existing revenue stream, current capital resources, together with the working capital line of credit will be more than sufficient to fund operations. Dynatronics today looks very different than the company of the past. Fiscal year 2016 was a year of change, restructuring and repositioning to better execute on our strategic plans. The changes have been significant and somewhat costly as we reorganized and augmented the company’s management and supporting personnel. We enter fiscal 2017 confident that Dynatronics is well on its way to achieving our strategic objectives. KELVYN H. CULLIMORE, JR. Chairman, President and CEO Letter to Shareholders 4 g a r k e tin S ale s & M x o e B u tsid e t h O 5 Letter to ShareholdersSALES AND MARKETING: OUTSIDE THE BOX SALES We are implementing an inbound marketing strategy to deliver The reorganization of our sales force has been designed qualified leads to our sales force beginning in November and to create a scalable platform for future growth. We have December of 2016. This new strategy is focused on a redesign implemented a sales management system to provide not only of our website, strategic trade shows and targeted marketing the area sales representatives but also the management team campaigns within our core markets. These programs are being with better insight into short- and long-term sales forecasting. implemented according to the market research we have just The objective is to increase sales force efficiency by focusing completed. Moving forward, all marketing programs will be efforts on revenue drivers. designed around a clearly defined strategy and measured to In fiscal year 2017 we are launching several new products, achieve the greatest ROI. In addition to generating leads for our which will help drive new growth domestically and interna- sales force, this inbound marketing strategy will increase our tionally. The September 2016 launch of our new Dynatron® brand awareness in core markets. 125B Stand-Alone Ultrasound and the July launches of the redesigned iBox™ Iontophoresis unit and the Dynatron Our inbound marketing plan is built around these strategies: Solaris® Plus line nicely complement our modality portfolio. Creating new customer acquisitions by increasing traffic Additionally, products in the R&D pipeline are scheduled for to our website, utilizing search engine optimization (SEO) release in the last half of fiscal year 2017. tools, social media monitoring and blogging platforms Converting the traffic on our website and at tradeshows to sales by offering problem-solving solutions We continue to enhance distribution in all U.S. and international markets. Domestically, we will add sales repre- sentatives to increase penetration into key markets. Also, we are increasing efforts to partner with key distributors for Personalizing the remarketing process by using website our core manufactured products such as tables, hot/cold behavior and individual user data to personalize email products and the 25 Series™ of therapeutic modalities. Inter- campaigns Implementing a new customer tracking system to more accurately capture customer data, providing an increased level of customer service x o e B u tsid e t h O 125B nationally, we are assessing key markets where we can add distributors most efficiently, based on market opportunities. Our sales force is refocusing on our core markets of physical therapy, chiropractic and athletic training. Within the physical therapy space we are developing a strategy that targets the post-acute care market. The post-acute care market (more commonly known as long-term care) continues to expand, and the demand for rehabilitation services within these facilities is also growing. Dynatronics’ extensive portfolio of products gives us a unique opportunity to compete for contracts large and small. With our reorganized sales force, expanding domestic and international coverage, the introduction of new products and the refocus on our core competencies in physical therapy, Dynatronics is poised for meaningful growth. Sales and Marketing: Outside the Box 6  MANAGEMENT DISCUSSION AND ANALYSIS BOARD OF DIRECTORS Pictured below, in order from left to right Kelvyn H. Cullimore, Jr. Chairman, President and CEO Erin S. Enright Managing Partner of Prettybrook Partners, LLC David B. Holtz Principal of Provco Group Ltd. Scott A. Klosterman Executive Vice President at HNI Healthcare Brian M. Larkin Senior Vice President of Acelity LP R. Scott Ward, Ph.D. Chairman of the Department of Physical Therapy at the University of Utah MANAGEMENT TEAM Kelvyn H. Cullimore, Jr. Chairman, President and CEO David A. Wirthlin Chief Financial Officer T. Jeff Gephart Senior Vice President of Sales Douglas G. Sampson Vice President of Production and R&D Bryan D. Alsop Vice President of Information Technology 7 Board of Directors and Management  MANAGEMENT DISCUSSION AND ANALYSIS The following discussion should be read in conjunction with our consolidated financial statements and notes to those consolidated financial statements, included elsewhere in our Annual Report on Form 10-K filed with the Securities and Exchange Commision on Sept. 28, 2016. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from our expectations. Factors that could cause or contribute to those differences include, but are not limited to, those identified below and those discussed in the section of the Annual Report entitled “Item 1A. Risk Factors.” OVERVIEW Our principal business is the manufacturing, distribution and marketing of physical medicine products. We offer a broad line of medical equipment including therapy devices, medical supplies and soft goods, treatment tables and rehabilitation equipment. Our products are sold to and used primarily by physical therapists, chiropractors, sports medicine practitioners, and podiatrists. Our fiscal year ends on June 30. Reference to fiscal year 2016 refers to the year ended June 30, 2016. RESULTS OF OPERATIONS Fiscal Year 2016 Compared to Fiscal Year 2015 Net Sales Net sales in fiscal year 2016, increased $1.3 million or 4.4% to $30.4 million, compared to $29.1 million in fiscal year 2015. Net sales in the fourth quarter of fiscal year 2016 increased approximately $260,000 or 2.8% to $8.1 million, compared to $7.9 million in the fourth quarter of 2015. The rate of sales growth throughout fiscal 2016 was driven by new Management’s Discussion and Analysis of Financial Condition 8 clinic openings, clinic expansions, and addition of new sales therapeutic devices. Increasing sales of capital equipment management and personnel, as well as strengthening demand products will be one of the keys to improving gross profit in our core domestic market. Sales of capital equipment (both margins going forward. proprietary and distributed), especially the Dynatron Solaris® line of products, were the leading growth categories in 2016. Selling, General and Administrative Expenses We believe that the upward trend in sales indicates increased Selling, general and administrative, or SG&A expenses, were customer confidence in our markets. about $11.0 million or 36.1% of net sales in fiscal year 2016, Sales of proprietary manufactured physical medicine compared to $9.2 million or 31.7% of net sales in fiscal year products represented approximately 44% of total physical 2015. During the fourth quarter of fiscal year 2016, we medicine product sales in fiscal years 2016 and 2015. recorded approximately $770,000 in expense related to the Distribution of products manufactured by other suppliers severance of two executives. These payments will be made accounted for the balance of our physical medicine product through a combination of cash and common stock over a two sales in those years. year period. We do not anticipate severance charges at these In fiscal years 2016 and 2015, sales of physical medicine levels to continue in the future. products accounted for 91.7% and 91.4%, respectively. The increase in SG&A expenses exclusive of severance Chargeable repairs, billable freight and a small amount costs include: (1) approximately $400,000 in increased of revenue from products outside of physical medicine selling expense related primarily to several new hires in accounted for the balance of revenues in both years. sales management and higher commission expense; (2) During the fiscal year ended June 30, 2016, we approximately $300,000 of increased administrative expense phased out the sales of our aesthetic product line known related primarily to higher insurance costs, new hires, and as Synergie®. In fiscal years 2016 and 2015, sales of increased regulatory costs; and (3) approximately $300,000 of Synergie® were approximately $110,000 and $160,000, expense resulting from new initiatives related to our corporate respectively. These sales were included in the non-physical strategy, including Board of Directors fees, director and officer medicine product revenue. Gross Profit liability insurance, investor relations services, and business development activities. We anticipate the costs associated with the new initiatives under (3) to continue at about the same Gross profit totaled $10.4 million, or 34.0% of net sales, in levels into fiscal 2017. fiscal year 2016, compared to $9.1 million, or 31.1% of net sales, in fiscal year 2015. In fiscal year 2016, we recorded Research and Development a $270,000 non-cash charge to write off obsolete inventory Research and development (R&D) expenses for 2016, were primarily related to non-performing products purchased $1.1 million compared to $925,000 in 2015. As a percentage in 2014 for the Amerinet GPO contract, defective products of net sales, R&D expense increased to 3.5% of net sales in rejected for quality purposes, and our standard inventory 2016, compared to 3.2% of net sales in fiscal year 2015. We allowance of $120,000 annually. We do not anticipate continue to emphasize the importance of being a technological significant inventory adjustment charges in the future beyond leader in our field. The increased R&D expenses related our standard allowance. primarily to the introduction of new products in fiscal year During fiscal year 2015, we also recorded approximately 2016. In the first quarter of fiscal year 2017, we introduced $840,000 in inventory obsolescence charges above the an upgraded version of the Dynatron Solaris® Plus and 25 standard annual inventory allowance of $120,000. This SeriesTM of combination therapy devices. In addition, we additional charge was due primarily to strategic decisions introduced the new Dynatron® 125B stand-alone ultrasound made during the fourth quarter of 2015 to discontinue, device. In the latter part of fiscal year 2016, we released an re-evaluate or de-emphasize some product lines. updated version of our iontophoresis device. We also have Exclusive of the reduction in obsolete inventory write offs, other new products in process for introduction during fiscal increased sales of manufactured capital and the Dynatron year 2017. All these factors combined to increase the cost Solaris® line of products, which carry higher-than-average of R&D for fiscal year 2016. We believe that developing new margins, were the primary contributors to increased gross products is a key element in our strategy and critical to moving profit as a percentage of net sales in 2016, compared to 2015. purchasing momentum in a positive direction. R&D costs are Management has developed plans for increasing gross expensed as incurred and are expected to remain at current profits by focusing sales on the Company’s proprietary levels in the coming year. 9 Management’s Discussion and Analysis of Financial Condition Interest Expense valuation allowance of $1.4 million and $840,000 in non-cash Interest expense decreased by approximately $40,000 in inventory write off in excess of our allowance. fiscal year 2016, to approximately $290,000, compared to approximately $330,000 in fiscal year 2015. The reduction Net Loss Applicable to Common Shareholders in interest expense is directly related to the payoff and Net loss applicable to common shareholders was $2.3 million termination of our line of credit in the third quarter of fiscal year or $0.84 per share, compared to $4.4 million, or $1.73 per 2016. Exclusive of interest on the line of credit, components of share for the year ended June 30, 2015. Fiscal year 2015 our interest expense include imputed interest from the sale/ included a deemed dividend of $2.1 million associated with a leaseback of our corporate headquarters facility, mortgage beneficial conversion feature triggered by the sale of our Series interest on our Tennessee property and a small amount A Preferred to affiliates of Prettybrook as detailed in our report of interest for equipment loans for office furnishings and filed on form 10-K for the fiscal year ended June 30, 2015. Also vehicles. Most of the $290,000 interest expense in fiscal year included in the net loss applicable to common shareholders in 2016 ($220,000) was imputed interest related to the lease. fiscal year 2015 was a valuation allowance against deferred tax assets of $1.4 million. Loss Before Income Tax Benefit In fiscal year 2016, the net loss applicable to common Pre-tax loss in fiscal year 2016 was $2.0 million, compared to shareholders included a valuation allowance against deferred $1.4 million in fiscal year 2015. The increase in pre-tax loss tax assets of approximately $745,000. Fiscal year 2016 is due primarily to (1) $770,000 in severance expense payable also included recognition of dividends paid on our Series A to two former executives; (2) $1.0 million increase in expenses Preferred of $372,000 compared to $1,000 in fiscal year associated with increased SG&A; and (3) $145,000 increase in 2015. The dividends paid in fiscal year 2016, equate to R&D, all of which was partially offset by increased gross profit approximately $0.13 per share. associated with increased sales as discussed above. Pre-tax losses in fiscal year 2015 also included incremental inventory write offs of approximately $840,000 in excess of LIQUIDITY AND CAPITAL RESOURCES our $120,000 allowance, and approximately $255,000 in We have financed operations through cash from operations aborted acquisition expense. Income Taxes and available cash reserves. Working capital decreased by $1.9 million to $5.8 million as of June 30, 2016, inclusive of the current portion of long-term obligations and credit facilities, Income tax benefit was approximately $65,000 in fiscal year compared to working capital of $7.7 million as of June 30, 2016, compared to income tax provision of $850,000 in fiscal 2015. As of June 30, 2016 the Company did not have in place year 2015. In fiscal year 2015, the Company determined the a working capital line of credit. However, a $1.0 million working valuation allowance was required and as a result implemented capital line of credit facility was put in place in September of a valuation allowance of $1.4 million all in the fourth quarter 2016 and is fully available to the Company. Current assets of fiscal year 2015. The recording of this valuation allowance were 63.9% of total assets as of June 30, 2016 and 69.5% of resulted in recording a tax expense of $850,000 on the 2015 total assets as of June 30, 2015. fiscal year financial statements. See Note 9 to the consolidated financial statements as well as “Critical Accounting Policies Cash and Cash Equivalents and Estimates – Deferred Income Tax Assets” for more Our cash and cash equivalents position as of June 30, 2016, information regarding the valuation allowance and its impact was approximately $1.0 million, compared to cash and cash on the effective tax rate for 2016. Net Loss equivalents of $3.9 million as of June 30, 2015. During the course of the year, we retired our line of credit in the amount of $1.9 million, which payoff constituted a significant use of Net loss for fiscal year 2016 was $1.9 million, compared to cash during the year ended June 30, 2016. The balance of $2.3 million for the year ended June 30, 2015. Our 2016 the cash used related to operations and implementation of results include a $745,000 non-cash deferred tax asset strategic objectives. During September 2016, we entered valuation allowance offsetting all but $65,000 in tax benefit into a new $1.0 million line of credit, which expires September for the year, $770,000 severance expense, and $270,000 2017 (See Note 6 to the consolidated financial statements for non-cash inventory write off, as discussed above. In fiscal more information regarding the line of credit). year 2015, the net loss included a non-cash deferred tax asset During the current and prior year we incurred significant Management’s Discussion and Analysis of Financial Condition 10 operating losses and negative cash flows from operations. of credit is on stand-by status. We pay $2,000 per month as We believe that our existing revenue stream, current capital a minimum access fee to the line of credit. If we determine to resources, together with the working capital line of credit activate the line we are required to provide the lender with 45 initiated in September 2016 will be sufficient to fund operations days’ notice of our intent to begin borrowing. The line of credit through September 30, 2017. has a maturity date of September 2017. The line of credit has To fully execute on our business strategy of acquiring no negative loan covenants. However, once the line of credit other entities, we will need to raise additional capital. Absent is activated there are affirmative covenants to provide regular additional financing, we will not have the resources to execute accounts receivable reports and financial statements within our acquisition strategies. 90 days of month end. Accounts Receivable Debt Trade accounts receivable, net of allowance for doubtful Long-term debt, excluding current installments decreased accounts, increased approximately $175,000, or 5.3%, to $3.5 approximately $100,000 to approximately $550,000 as of million as of June 30, 2016, compared to $3.3 million as of June 30, 2016, compared to approximately $650,000 as of June 30, 2015. Trade accounts receivable represent amounts June 30, 2015. Our long-term debt is primarily comprised of due from our customers including medical practitioners, the mortgage loan on our office and manufacturing facility in clinics, hospitals, colleges and universities and sports Tennessee. The principal balance on the mortgage loan is teams as well as dealers and distributors that purchase our approximately $600,000, of which $500,000 is classified as products for redistribution. We believe that our estimate of long-term debt, with monthly principal and interest payments the allowance for doubtful accounts is adequate based on our of $13,278. Our mortgage loan matures in 2021. historical knowledge and relationship with these customers. As discussed above, in conjunction with the sale and Accounts receivable are generally collected within 30 days of leaseback of our corporate headquarters in August 2014, we the agreed terms. Inventories entered into a $3.8 million lease for a 15-year term with an investor group. That sale generated a profit of $2.3 million which is being recorded monthly over the life of the lease at Inventories, net of reserves, decreased $425,000, or 7.8%, to $12,500 per month, or approximately $150,000 per year. The $5.0 million as of June 30, 2016, compared to $5.4 million building lease is recorded as a capital lease with the related as of June 30, 2015. During fiscal year 2016, we recorded a amortization being recorded on a straight line basis over 15 $270,000 non-cash write off of inventory, of which $150,000 years at approximately $250,000 per year. Lease payments was based on non-performing inventory related to our of approximately $27,000 are payable monthly increasing at Amerinet GPO contract and defective products rejected for a rate of approximately 2% per year over the life of the lease. quality purposes. Inventory levels may fluctuate based on the Total accumulated amortization related to the leased building timing of large inventory purchases from overseas suppliers. is approximately $480,000 at June 30, 2016. Imputed interest Accounts Payable for the fiscal year ended June 30, 2016, was approximately $200,000. Future minimum gross lease payments required Accounts payable decreased approximately $600,000, or under the capital lease as of June 30, 2016 are as follows: 24.0%, to $1.9 million as of June 30, 2016, from $2.5 million as 2017, $334,950; 2018, $341,648; 2019, $348,478; 2020, of June 30, 2015. We continue to take advantage of available $355,450; 2021, $362,566 and $3,245,126 thereafter. early payment discounts when offered by our vendors. Included in the above lease payments is $1.4 million of Line of Credit In March 2016, we retired our working capital line of credit. Inflation imputed interest. That line of credit has been reinstated effective September Our revenues and net income have not been unusually 2016, in the amount of $1.0 million. Interest on the line of credit affected by inflation or price increases for raw materials and is based on the prime rate plus 5%. It is collateralized by our parts from vendors. inventory and accounts receivable. Borrowing limitations are based on 85% of eligible accounts receivable and $700,000 Stock Repurchase Plans of eligible inventory. Our current borrowing base on the line of In 2011, our Board of Directors adopted a stock repurchase credit would be approximately $3.4 million. Presently the line plan authorizing repurchases of shares in the open market, 11 Management’s Discussion and Analysis of Financial Condition through block trades or otherwise. Decisions to repurchase • Customer demand; shares under this plan are based upon market conditions, the • Historical sales; level of our cash balances, general business opportunities, • Forecast sales; and other factors. The Board periodically approves the dollar • Product obsolescence; amounts for share repurchases under the plan. As of June • Strategic marketing and production plans 30, 2016, approximately $450,000 remained available under • Technological innovations; and the Board’s authorization for purchases under the plan. There • Character of the inventory as a distributed item, finished is no expiration date for the plan. No purchases were made manufactured item or raw material. under this plan during the year ended June 30, 2016, or during Any modifications to estimates of inventory valuation reserves the past four fiscal years. are reflected in cost of goods sold within the statements of operations during the period in which such modifications are determined necessary by management. As of June 30, 2016, CRITICAL ACCOUNTING POLICIES and 2015, our inventory valuation reserve balance, which This Management’s Discussion and Analysis of Financial established a new cost basis, was approximately $415,000 Condition and Results of Operations is based upon our and $360,000, respectively, and our inventory balance was consolidated financial statements, which have been prepared $5.0 million and $5.4 million, net of reserves, respectively. in accordance with GAAP. The preparation of these financial During fiscal year 2016, we recorded a $270,000 non-cash statements requires estimates and judgments that affect write off of inventory based on two factors: 1) non-performing the reported amounts of our assets, liabilities, net sales inventory related to our Amerinet GPO contract and 2) and expenses. Management bases estimates on historical defective products. We do not anticipate these inventory write experience and other assumptions it believes to be reasonable offs in the future beyond our current allowance of $120,000 given the circumstances and evaluates these estimates on an annually. ongoing basis. Actual results may differ from these estimates under different assumptions or conditions. See Note 15 to Revenue Recognition our consolidated financial statements for the impact of recent Our sales force and distributors sell our products to end users, accounting pronouncements. including physical therapists, professional trainers, athletic We believe that the following critical accounting policies trainers, chiropractors, and medical doctors. Sales revenues involve a high degree of judgment and complexity. See Note 1 are recorded when products are shipped FOB shipping point to our consolidated financial statements for fiscal year 2016, under an agreement with a customer, risk of loss and title for a complete discussion of our significant accounting policies. have passed to the customer, and collection of any resulting The following summary sets forth information regarding receivable is reasonably assured. Amounts billed for shipping significant estimates and judgments used in the preparation of and handling of products are recorded as sales revenue. our consolidated financial statements. Costs for shipping and handling of products to customers are recorded as cost of sales. Inventory Reserves The nature of our business requires that we maintain sufficient Allowance for Doubtful Accounts inventory on hand at all times to meet the requirements of our We must make estimates of the collectability of accounts customers. We record finished goods inventory at the lower receivable. In doing so, we analyze historical bad debt trends, of standard cost, which approximates actual cost (first-in, customer credit worthiness, current economic trends and first-out) or market. Raw materials are recorded at the lower of changes in customer payment patterns when evaluating the cost (first-in, first-out) or market. Inventory valuation reserves adequacy of the allowance for doubtful accounts. Our accounts are maintained for the estimated impairment of the inventory. receivable balance was $3.5 million and $3.3 million, net of Impairment may be a result of slow-moving or excess allowance for doubtful accounts of $390,000 and $415,000, inventory, product obsolescence or changes in the valuation as of June 30, 2016, and 2015, respectively. of the inventory. In determining the adequacy of reserves, we analyze the following, among other things: Deferred Income Tax Assets • Current inventory quantities on hand; uncertainty as to the realizability of deferred tax assets. The • Product acceptance in the marketplace; realization of deferred tax assets is dependent upon our ability A valuation allowance is required when there is significant Management’s Discussion and Analysis of Financial Condition 12 to generate sufficient taxable income within the carryforward BUSINESS PLAN AND OUTLOOK periods provided for in the tax law for each tax jurisdiction. We Over the past 12-months we have been working closely with have considered the following possible sources of taxable income Prettybrook to execute on our current business plan. We when assessing the realization of our deferred tax assets: have strengthened the core operations through executive • Future reversals of existing taxable temporary differences; of key sales and administrative personnel and pursued • Future taxable income or loss, exclusive of reversing several merger and acquisition candidates. We believe the temporary differences and carryforwards; realization of these initiatives will be manifest during fiscal • Tax-planning strategies; and 2017. Our key objectives in the coming year are as follows: management changes, new product innovations, addition • Taxable income in prior carryback years. We considered both positive and negative evidence in management, new product introductions, geographic determining the continued need for a valuation allowance, expansion both domestic and international and including the following: expansion into post-acute care markets; • Achieve organic sales growth through improved sales Positive evidence: • Identify and act on acquisition opportunities that will further enhance our product offering, distribution • Current forecasts indicate that we will generate pre-tax coverage and leverage our current sales network to income and taxable income in the future. However, there improve gross profit margins; and can be no assurance that the new strategic plans will • Improve our investor relations efforts in order to better result in profitability. alert the market to our strategic growth objectives. • A majority of our tax attributes have indefinite carryover periods. Negative evidence: A key element of our business plan was to bring greater emphasis to our sales efforts. In March 2016, we hired Thomas J. (Jeff) Gephart as Senior Vice President of Sales. • We have several years of cumulative losses as of Mr. Gephart spent almost a decade as Vice President June 30, 2016. of Sales for Chattanooga Group, our largest competitor, managing their extensive sales network. Subsequently, he We place more weight on objectively verifiable evidence worked as Director of Sales and Marketing in the US market than on other types of evidence and management currently for Zimmer MedizinSystems, a German manufacturer of believes that available negative evidence outweighs the rehabilitation products and, most recently, as Director of available positive evidence. We have therefore determined Sales and Marketing for Gebauer Corporation, where he that we do not meet the “more likely than not” threshold that supervised sales, marketing and customer service for their deferred tax assets will be realized. Accordingly, a valuation worldwide operations. He brings to the Company both allowance is required. Any reversal of the valuation allowance market expertise and significant experience in building will favorably impact the Company’s results of operations in sales organizations. Enhancing our sales network is critical the period of reversal. for our success as we acquire companies and build the At June 30, 2015, and June 30, 2016, we recorded platform. We are confident that he is the right leader to valuation allowances against our deferred tax assets. In strengthen both the sales and marketing organization. fiscal year 2015, we recorded a full valuation allowance In addition to Jeff’s management expertise, other key against deferred tax assets. In fiscal year 2016, we recorded hires have been made to push sales growth. A new Eastern a valuation allowance against all but approximately $65,000 Sales Region was created and we hired a new sales manager of deferred tax assets. The residual tax benefit left in fiscal to manage that territory. This hire was previously a regional year 2016 is attributed to reconciliation of all tax accounts at sales manager for one of our largest competitors, DJO the fiscal year end allowing us to true up the full allowance Global. He brings significant experience, product knowledge deemed necessary for the period. Future valuation allowances and customer relationships to the job. We also hired a new or recapture of existing allowances will depend on analysis of director to head up international sales for the Company in positive and negative evidence at the time of reporting. light of the pending retirement of the Company’s founder The Company’s federal and state income tax returns for who had previously been managing International Sales on June 30, 2013, 2014, and 2015, are open tax years. a part-time basis. Our new director of international sales 13 Management’s Discussion and Analysis of Financial Condition established a global training program for sales representa- combination therapy device; tives at DJO Global and Chattanooga Group. Over the past • Improving gross profit margins by, among other 10 years he led the technical sales support effort globally initiatives, increasing market share of manufactured and is certified as a Lean and Kaizen facilitator. capital products by promoting sales of our state-of-the- We will release several new product innovations during art Dynatron® ThermoStim probe, Dynatron Solaris® fiscal 2017 to strengthen our current product offering and to Plus and 25 SeriesTM products; expand our product portfolio. In August 2016, we completed • Maintaining our position as a technological leader and the release of our upgraded Dynatron Solaris® Plus and 25 innovator in our markets through the introduction of new SeriesTM product lines as well as the release in September products during the new fiscal year; 2016, of the Dynatron® 125B stand-alone ultrasound. We • Increasing international sales by (1) leveraging the believe these innovations will have a meaningful contribution CE Mark approval in Europe and other countries by to our performance in the next 12-months. identifying appropriate distributors for the approved In the last several months we have announced products, (2) Finalizing regulatory approvals in countries restructuring changes to the core Dynatronics management such as China, Mexico, Peru and other countries in team. In June 2016, Larry K. Beardall, Executive Vice Southeast Asia, and (3) further developing relationships President of Marketing and Strategic Planning and member with existing distributors in countries such as Japan in of the Board of Directors left Dynatronics. His duties have order to increase sales in those countries where products been assumed by Mr. Gephart who has extensive experience are approved; in marketing and strategic planning. In July 2016, Bob • Exploring strategic business acquisitions. This will Cardon, Vice President of Administration announced his leverage and complement our competitive strengths, retirement. In August 2015, we hired a new director to increase market reach and allow us to potentially expand manage the Company’s business development strategy. into broader medical markets; and These changes in executive management are designed to • Attending strategic conferences to make investors aware more effectively pursue the corporate strategies articulated of our strategic plans, attract new capital to support in this business plan – particularly the business development the business development strategy and identify other strategies. acquisition targets We are actively pursuing an acquisition strategy to consolidate other small manufacturers and distributors in Market Information our core markets (i.e. physical therapy, athletic training, As of September 22, 2016, we had approximately 2,846,678 and chiropractic). We are primarily seeking candidates that shares of common stock issued and outstanding. Our fall into the following categories: common stock is included on the NASDAQ Capital Market • Manufacturers that extend our product portfolio and low sales prices for our common stock as quoted on the • Distributors that extend geographic reach or provide NASDAQ system for the quarterly periods indicated. (symbol: DYNT). The following table shows the range of high different channel access • Tuck-in manufacturers / distributors in adjacent markets (i.e. Orthopedics, Sports Medicine, Podiatry, etc.) Fiscal Year Ended June 30: 2016 2015 In summary, based on our defined strategic initiatives we are focusing our resources in the following areas: High Low High Low 1st Quarter Jul-Sep $4.44 $2.65 $5.00 $3.69 • Updating and improving our selling and marketing efforts including new sales management, new reporting 2nd Quarter Oct-Dec $3.36 $2.76 $5.76 $3.34 tools, and focusing our sales and marketing efforts into our core markets; 3rd Quarter Jan-Mar $3.09 $2.56 $3.89 $2.78 • Seeking to improve distribution of our products through recruitment of additional qualified sales representatives 4th Quarter Apr-Jun $3.21 $2.55 $3.51 $2.70 and dealers attracted by the many new products being offered and expanding the availability of proprietary Management’s Discussion and Analysis of Financial Condition 14 Stockholders As of September 22, 2016, we had approximately 520 shareholders of record. This number does not include beneficial owners of shares held in “nominee” or “street” name by a bank, broker or other holder of record. In addition to the shareholders of record, we estimate that there are a total of 1,500 beneficial owners of our common stock. Dividends We currently have approximately 1.6 million shares of Series A Preferred outstanding. Dividends payable on these shares accrue at the rate of 8% per year and are payable quarterly in stock or cash. The formula for paying this dividend in common stock can change the effective yield on the dividend to more or less than 8% depending on the price of the stock at the time of issuance. We have never paid cash dividends on our common stock. Our anticipated capital requirements are such that we intend to follow a policy of retaining earnings, if any, in order to finance the development of the business. Purchases of Equity Securities In February 2011, the Board of Directors approved $1,000,000 for open market share repurchases of the Company’s common stock. Approximately $500,000 remained on this authorization as of June 30, 2016. We did not purchase any shares of common stock during the year ended June 30, 2016 or in the prior four fiscal years. Preferred Stock In June 2015, we raised approximately $4.0 million in equity financing. The purchasers of these securities included affiliates of Prettybrook Partners, LLC (“Prettybrook”) and certain other purchasers (collectively with Prettybrook, the “Preferred Investors”). The Preferred Investors purchased 1,610,000 shares of our Series A Preferred and received (i) A-Warrants, exercisable by cash exercise only, to purchase 1,207,500 shares of our common stock, and (ii) B-Warrants, exercisable by “cashless exercise”, to purchase 1,207,500 shares of our common stock. Proceeds from this financing are to be used to promote organic growth of the Company through expansion of our sales distribution channels both domestically and internationally, improve infrastructure and operating systems, and support strategic acquisition opportunities. 15 Management’s Discussion and Analysis of Financial Condition BOARD OF DIRECTORS AND STOCKHOLDERS DYNATRONICS CORPORATION COTTONWOOD HEIGHTS, UTAH We have audited the accompanying consolidated balance a basis for designing audit procedures that are appropriate sheet of Dynatronics Corporation (“Company”) as of June 30, in the circumstances, but not for the purpose of expressing 2016 and the related consolidated statements of operations, an opinion on the effectiveness of the Company’s internal stockholders’ equity, and cash flows for the year then ended. control over financial reporting. Accordingly, we express no These financial statements are the responsibility of the such opinion. An audit also includes examining, on a test Company’s management. Our responsibility is to express an basis, evidence supporting the amounts and disclosures in opinion on these financial statements based on our audit. the financial statements, assessing the accounting principles We conducted our audit in accordance with the standards used and significant estimates made by management, as well of the Public Company Accounting Oversight Board (United as evaluating the overall financial statement presentation. States) and in accordance with auditing standards generally We believe that our audit provides a reasonable basis for our accepted in the United States of America. Those standards opinion. require that we plan and perform the audit to obtain In our opinion, the consolidated financial statements reasonable assurance about whether the financial statements referred to above present fairly, in all material respects, the are free of material misstatement. The Company is not financial position of Dynatronics Corporation at June 30, required to have, nor were we engaged to perform, an audit of 2016, and the results of its operations and its cash flows for its internal control over financial reporting. Our audit included the year then ended, in conformity with accounting principles consideration of internal control over financial reporting as generally accepted in the United States of America. /s/ BDO USA, LLP Salt Lake City, Utah September 28, 2016 Report of Independent Registered Public Accounting Firm 16 BOARD OF DIRECTORS AND STOCKHOLDERS DYNATRONICS CORPORATION COTTONWOOD HEIGHTS, UTAH We have audited the accompanying consolidated balance procedures that are appropriate in the circumstances, but not sheet of Dynatronics Corporation and subsidiary as of June 30, for the purpose of expressing an opinion on the effectiveness 2015 and the related consolidated statements of operations, of the Company’s internal control over financial reporting. stockholders’ equity, and cash flows for the year then ended. Accordingly, we express no such opinion. An audit includes These financial statements are the responsibility of the examining, on a test basis, evidence supporting the amounts Company’s management. Our responsibility is to express an and disclosures in the financial statements, assessing the opinion on these financial statements based on our audit. accounting principles used and significant estimates made We conducted our audit in accordance with the standards by management, as well as evaluating the overall financial of the Public Company Accounting Oversight Board (United statement presentation. We believe that our audit provides a States). Those standards require that we plan and perform reasonable basis for our opinion. the audit to obtain reasonable assurance about whether In our opinion, the consolidated financial statements the financial statements are free of material misstatement. referred to above present fairly, in all material respects, the The Company is not required to have, nor were we engaged financial position of Dynatronics Corporation as of June 30, to perform, an audit of its internal control over financial 2015, and the results of its operations and cash flows for the reporting. Our audit included consideration of internal year then ended, in conformity with accounting principles control over financial reporting as a basis for designing audit generally accepted in the United States of America. /s/ Mantyla McReynolds, LLC Salt Lake City, Utah September 28, 2015 Report of Independent Registered Public Accounting Firm 17 Balance Sheets Years ended June 30: Assets Current assets: 2016 2015 Cash and cash equivalents Trade accounts receivable, less allowance for doubtful accounts of $389,050 as of June 30, 2016 and $471,444 as of June 30, 2015 $ 966,183 3,523,731 3,925,967 3,346,770 Other receivables Inventories, net Prepaid expenses Prepaid income taxes Total current assets Property and equipment, net Intangible asset, net Other assets 10,946 4,997,254 256,735 — 6,748 5,421,787 273,629 338,108 9,754,849 13,313,009 4,777,565 5,025,076 160,123 580,161 190,803 623,342 Total assets $ 15,272,698 19,152,230 Liabilities and Stockholders’ Equity Current liabilities: Current portion of long-term debt Current portion of capital lease Current portion of deferred gain Line of credit Warranty reserve Accounts payable Accrued expenses Accrued payroll and benefits expenses Income tax payable $ 137,283 183,302 150,448 121,884 173,357 150,448 — 1,909,919 152,605 153,185 1,914,342 2,520,327 358,787 1,034,688 2,895 279,547 263,092 — Total current liabilities 3,934,350 5,571,759 Long-term debt, net of current portion Capital lease, net of current portion Deferred gain, net of current portion Deferred rent Deferred income tax liabilities Total liabilities Commitments and contingencies Stockholders’ equity: 553,191 3,281,547 1,830,449 85,151 — 651,118 3,464,850 1,980,897 41,150 136,128 9,684,688 11,845,902 — — Preferred stock, no par value: Authorized 5,000,000 shares; 1,610,000 shares 3,708,152 3,728,098 issued and outstanding at June 30, 2016 and June 30, 2015, respectively Common stock, no par value: Authorized 50,000,000 shares; 7,545,880 6,969,700 2,805,280 shares and 2,642,389 shares issued and outstanding at June 30, 2016 and June 30, 2015, respectively Accumulated deficit (5,666,022) (3,391,470) Total stockholders’ equity 5,588,010 7,306,328 Total liabilities and stockholders’ equity $ 15,272,698 19,152,230 S e e a c c o m p a n y i n g n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s . 18 Dynatronics Corporation Consolidated Balance Sheets June 30, 2016 and 2015 Statements of Operations Years ended June 30: Net sales Cost of sales Gross profit Selling, general, and administrative expenses Research and development expenses 2016 2015 $ 30,411,757 29,117,528 20,057,614 20,048,069 10,354,143 9,069,459 10,978,606 9,229,405 1,070,383 926,954 Operating loss (1,694,846) (1,086,900) Other Income (expense): Interest income Interest expense Other income, net 2,885 4,920 (289,149) (330,842) 14,298 13,577 Total other income (expense) (271,966) (312,345) Loss before income tax benefit (1,966,812) (1,399,245) Income tax (provision) benefit 64,551 (851,092) Net loss $ (1,902,261) (2,250,337) Deemed dividend on 8% convertible preferred stock 8% Convertible preferred stock dividend, in common stock 8% Convertible preferred stock dividend, in cash Net loss applicable to common stockholders Basic and diluted net loss per common share — (2,109,971) (372,291) — — (882) $ $ (2,274,552) (4,361,190) ( 0.84) ( 1.73) Weighted-average basic and diluted common shares outstanding: 2,706,424 2,520,723 S e e a c c o m p a n y i n g n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s . Dynatronics Corporation Consolidated Statements of Operations Years Ended June 30, 2016 and 2015 19 Statements of Stockholders’ Equity Years ended June 30, 2016 and 2015 Common Common Preferred Preferred Total Stock Shares Stock Amount Stock Shares Stock Accumulated Stockholders’ Amount Deficit Equity Balances as of July 1, 2014 2,520,389 $ 7,149,812 — $ Stock-based compensation — 66,372 Issuance of common 122,000 394,060 — — stock in association with capital raise — — — (1,141,133) $ 6,008,679 — — 66,372 394,060 Issuance of preferred — (640,544) 1,610,000 3,728,980 — 3,088,436 stock and warrants, net of issuance costs Preferred stock dividend, in cash Preferred stock beneficial conversion feature Dividend of beneficial conversion feature Net loss — — — — — — — — — (882) — (882) — 2,109,971 — 2,109,971 — (2,109,971) — (2,109,971) — — (2,250,337) (2,250,337) Balances as of June 30, 2015 2,642,389 $ 6,969,700 1,610,000 $ 3,728,098 (3,391,470) $ 7,306,328 Stock-based compensation 71,596 203,889 Issuance of preferred stock and warrants, net of issuance costs — — Preferred stock dividend, 91,295 273,375 in common stock Preferred stock dividend, in common stock, to be issued Net loss Balances as of June 30, 2016 — 98,916 — — — — — — — — (19,946) — — 203,889 (19,946) — (273,375) (98,916) — — — — (1,902,261) (1,902,261) 2,805,280 7,545,880 1,610,000 3,708,152 (5,666,022) 5,588,010 S e e a c c o m p a n y i n g n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s . 20 Dynatronics Corporation Consolidated Statements of Stockholders’ Equity Year’s Ended June 30, 2016 and 2015 Statements of Cash Flows Years ended June 30: Cash flows from operating activities: Net loss Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization of property and equipment Amortization of intangible assets Amortization of other assets Amortization of building lease Gain on sale of assets Stock-based compensation expense Change in deferred income taxes Change in provision for doubtful accounts receivable Change in provision for inventory obsolescence Deferred gain on sale/leaseback Change in operating assets and liabilities: Receivables, net Inventories, net Prepaid expenses Other assets Income tax payable Prepaid income taxes Accounts payable and accrued expenses 2016 2015 $ (1,902,261) (2,250,337) 229,930 30,680 51,372 251,934 4,703 203,889 (136,128) (28,394) 57,213 350,959 44,637 51,372 230,939 — 66,372 848,691 92,089 23,190 (150,448) (137,910) (152,765) 367,320 16,894 (8,191) 2,895 341,003 285,377 (264,617) 712,871 (265,968) (278,258) (368,560) — 79,022 Net cash used in operating activities (534,977) (1,065,508) Cash flows from investing activities: Purchase of property and equipment Proceeds from sale of property and equipment (195,946) (66,333) — 3,800,000 Net cash provided by (used in) investing activities (195,946) 3,733,667 Cash flows from financing activities: Principal payments on long-term debt Principal payments on long-term capital lease Net change in line of credit Proceeds from issuance of preferred stock, net (125,638) (173,358) (784,405) (161,793) (1,909,919) (1,611,290) (19,946) 3,482,496 Net cash provided by (used in) financing activities (2,228,861) 925,008 Net change in cash and cash equivalents (2,959,784) 3,593,167 Cash and cash equivalents at beginning of the period 3,925,967 332,800 Cash and cash equivalents at end of the period 966,183 3,925,967 Supplemental disclosures of cash flow information: Cash paid for interest Cash paid for income taxes Supplemental disclosures of non-cash flow investing and financing activities: Capital lease - building Capital lease and note payable obligations incurred to acquire property and equipment 8% preferred stock dividend, in common stock Deemed dividend on 8% convertible preferred stock Preferred stock issuance costs paid in common stock 307,644 — — 43,110 372,291 — — 324,314 356,151 3,800,000 — — 2,109,971 394,060 S e e a c c o m p a n y i n g n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s . Dynatronics Corporation Consolidated Statements of Cash Flows Years Ended June 30, 2016 and 2015 21  NOTES TO FINANCIAL STATEMENTS (1) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Description of Business Dynatronics Corporation (the Company), a Utah corporation, distributes and markets a broad line of medical products, many of which are designed and manufactured by the Company. Among the products offered by the Company are therapeutic, diagnostic, and rehabilitation equipment, medical supplies and soft goods and treatment tables to an expanding market of physical therapists, podiatrists, orthopedists, chiropractors, and other medical professionals. (b) Principles of Consolidation The consolidated financial statements include the accounts and operations of Dynatronics Corporation and its wholly owned subsidiary, Dynatronics Distribution Company, LLC. The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP). All significant 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 (first-in, first-out method), which approximates actual cost, or market. Raw materials are stated at the lower of Dynatronics Corporation Notes to Consolidated Statements June 30, 2016 and 2015 22 cost (first in, first out method) or market. The Company (h) Intangible Assets periodically reviews the value of items in inventory and Costs associated with the acquisition of trademarks, trade provides write-downs or write-offs of inventory based on its names, license rights and non-compete agreements are assessment of slow moving or obsolete inventory. Write-downs capitalized and amortized using the straight-line method over and write-offs are charged against the reserve. periods ranging from 3 months to 20 years. (e) Trade Accounts Receivable (i) Revenue Recognition Trade accounts receivable are recorded at the invoiced amount The Company recognizes revenue when products are shipped and do not bear interest, although a finance charge may be FOB shipping point under an agreement with a customer, risk applied to such receivables that are past the due date. The of loss and title have passed to the customer, and collection allowance for doubtful accounts is the Company’s best estimate of any resulting receivable is reasonably assured. Amounts of the amount of probable credit losses in the Company’s billed for shipping and handling of products are recorded as existing accounts receivable. The Company determines the sales revenue. Costs for shipping and handling of products to allowance based on a combination of statistical analysis, customers are recorded as cost of sales. historical collections, customers’ current credit worthiness, the age of the receivable balance both individually and in the (j) Research and Development Costs aggregate and general economic conditions that may affect the Direct research and development costs are expensed as customer’s ability to pay. All account balances are reviewed on incurred. an individual basis. Account balances are charged off against the allowance when the potential for recovery is considered (k) Product Warranty Costs remote. Recoveries of receivables previously charged off are Costs estimated to be incurred in connection with the recognized when payment is received. Company’s product warranty programs are charged to expense as products are sold based on historical warranty (f) Property and Equipment rates. Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight (l) Net Loss per Common Share line method over the estimated useful lives of the assets. Net loss per common share is computed based on the Buildings and their component parts are being depreciated weighted-average number of common shares outstanding over their estimated useful lives that range from 5 to 31.5 and, when appropriate, dilutive common stock equivalents years. Machinery, office equipment, computer equipment outstanding during the year. Convertible preferred stock and and software and vehicles are being depreciated over their stock options and warrants are considered to be common estimated useful lives that range from 3 to 7 years. stock equivalents. The computation of diluted net loss per common share does not assume exercise or conversion of (g) Long-Lived Assets securities that would have an anti-dilutive effect. Long–lived assets, such as property and equipment, are Basic net loss per common share is the amount of net reviewed for impairment whenever events or changes in loss for the year available to each weighted-average share of circumstances indicate that the carrying amount of an asset common stock outstanding during the year. Diluted net loss may not be recoverable. Recoverability of assets to be held and per common share is the amount of net loss for the year used is measured by a comparison of the carrying amount of available to each weighted-average share of common stock an asset to estimated undiscounted future cash flows expected outstanding during the year and to each common stock to be generated by the asset. If the carrying amount of an equivalent outstanding during the year, unless inclusion of asset exceeds its estimated future cash flows, an impairment common stock equivalents would have an anti-dilutive effect. charge is recognized for the difference between the carrying The reconciliation between the basic and diluted weighted- amount of the asset and the fair value of the asset. Assets to average number of common shares for the years ended June be disposed of are separately presented in the balance sheet 30, 2016 and 2015, is summarized as follows: and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. 23 Dynatronics Corporation Notes to Consolidated Statements June 30, 2016 and 2015 Basic weighted-average number of common shares outstanding during the year 2,706,424 2,520,723 Weighted-average number of dilutive common stock equivalents outstanding during the year — — Diluted weighted-average number of common and common equivalent shares 2,706,424 2,520,723 outstanding during the year 2016 2015 Outstanding common stock equivalents not included (n) Stock-Based Compensation in the computation of diluted net loss per common share The Company accounts for stock-based compensation totaled 4,127,814 as of June 30, 2016 and 4,105,290 as of in accordance with FASB ASC 718, Stock Compensation. June 30, 2015. These common stock equivalents were not Stock-based compensation cost is measured at the grant included in the computation because to do so would have date based on the fair value of the award and is recognized as been antidilutive. (m) Income Taxes expense over the applicable vesting period of the stock award (generally five years) using the straight-line method. The Company recognizes an asset or liability for the deferred (o) Concentration of Risk income tax consequences of all temporary differences between In the normal course of business, the Company provides the tax bases of assets and liabilities and their reported amounts unsecured credit to its customers. Most of the Company’s in the consolidated financial statements that will result in customers are involved in the medical industry. The Company taxable or deductible amounts in future years when the reported performs ongoing credit evaluations of its customers and amounts of the assets and liabilities are recovered or settled. maintains allowances for probable losses which, when realized, Accounting standards require the consideration of a valuation have been within the range of management’s expectations. allowance for deferred tax assets if it is “more likely than not” The Company maintains its cash in bank deposit accounts that some component or all of the benefits of deferred tax assets which at times may exceed federally insured limits. will not be realized. Accruals for uncertain tax positions are As of June 30, 2016, the Company has approximately provided for in accordance with the requirements of Financial $716,000 in cash and cash equivalents in excess of the FDIC Accounting Standards Board (FASB) Accounting Standards limits. The Company has not experienced any losses in such Codification (ASC) 740-10, Income Taxes. Under ASC 740-10, the accounts. Company may recognize the tax benefits from an uncertain tax position only if it is more likely than not that the tax position will (p) Operating Segments be sustained on examination by the taxing authorities, based on The Company operates in one line of business: the the technical merits of the position. The tax benefits recognized development, marketing, and distribution of a broad line of in the financial statements from such a position are measured medical products for the physical therapy markets. As such, based on the largest benefit that has a greater than 50% the Company has only one reportable operating segment. likelihood of being realized upon ultimate settlement. ASC 740-10 Physical medicine products made up 92% of net sales also provides guidance on derecognition of income tax assets for the year ended June 30, 2016 and 91% for the year ended and liabilities, classification of current and deferred income June 30, 2015. Chargeable repairs, billable freight and other tax assets and liabilities, accounting for interest and penalties miscellaneous revenues account for the remaining 8% and associated with tax positions, and income tax disclosures. 9% of net sales for the years ended June 30, 2016 and 2015, Judgment is required in assessing the future tax consequences respectively. of events that have been recognized in the financial statements or tax returns. Variations in the actual outcome of these future (q) Use of Estimates tax consequences could materially impact the Company’s Management of the Company has made a number of estimates financial position, results of operations and cash flows. and assumptions relating to the reporting of assets, liabilities, Dynatronics Corporation Notes to Consolidated Statements June 30, 2016 and 2015 24 revenues and expenses, and the disclosure of contingent assets and liabilities in accordance with US GAAP. Significant 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 differ from those estimates. (r) Advertising Costs Advertising costs are expensed as incurred. Advertising expense for the years ended June 30, 2016 and 2015 was approximately $100,900 and $93,700, respectively. (2) INVENTORIES (3) PROPERTY AND EQUIPMENT Inventories consist of the following as of June 30: Property and equipment consist of the following as of June 30: 2016 2015 2016 2015 Raw materials Finished goods $ 2,059,048 2,086,411 Land $ 30,287 3,353,964 3,693,921 Buildings Inventory reserve (415,758) (358,545) Machinery and equipment Office equipment 5,603,859 1,686,386 275,977 30,287 5,586,777 1,635,386 273,420 $ 4,997,254 5,421,787 Computer equipment 2,102,005 1,984,046 Vehicles 253,513 247,571 Included in cost of goods sold for the years ended June 30, 2016 Less accumulated depreciation (5,174,462) (4,732,411) 9,952,027 9,757,487 and 2015, is a write off of slow moving and obsolete inventory and amortization totaling $270,000 and $952,212, respectively. The $270,000 non-cash charge during fiscal year 2016 is based on non- $ 4,777,565 5,025,076 performing inventory related to our Amerinet GPO contract and defective product rejected for quality purposes. The $952,212 non-cash charge reflects a write off of inventory related to strategic decisions made during the fourth quarter of fiscal 2015 resulting in some product lines being discontinued, re-evaluated or Depreciation expense for the years ended June 30, 2016 de-emphasized. These decisions created additional obsolescence and 2015 was $229,930 and $350,959, respectively. that upon analysis warranted the inventory write off. Included in the above caption, ”Buildings” at June 30, 2016 and 2015 are assets held under a capital lease obligation totaling $3,800,000 (gross). The net balance of the capital lease as of June 30, 2016 and 2015 was $3,317,127 and $3,569,061, respectively. Building amortization under the capital lease for the years ended June 30, 2016 and 2015 was $251,934 and $230,939, respectively. 25 Dynatronics Corporation Notes to Consolidated Statements June 30, 2016 and 2015 (4) INTANGIBLE ASSETS (5) WARRANTY RESERVE Identifiable intangible assets and their useful lives consist of A reconciliation of the change in the warranty reserve consists the following as of June 30: of the following for the fiscal years ended June 30: 2016 2015 2016 2015 Trade name—15 years $ 339,400 339,400 Beginning warranty $ 153,185 157,753 Domain name—15 years Non-compete covenant 5,400 149,400 5,400 reserve balance 149,400 Warranty repairs —4 years Warranties issued Customer relationships 120,000 120,000 Changes in estimated —7 years warranty costs Trademark licensing 45,000 45,000 (143,934) 141,009 2,345 (145,698) 145,267 (4,137) agreement—20 years Backlog of orders —3 months 2,700 2,700 Customer database 38,100 38,100 Ending warranty reserve $ 152,605 153,185 —7 years Total identifiable intangibles Less accumulated amortization 700,000 700,000 (6) LINE OF CREDIT (539,877) (509,197) line of credit. That line of credit has been re-instated effective In March 2016, the Company retired its working capital September 2016 in the amount of $1.0 million. Interest on the line of credit is based on the prime rate plus 5%. It is collat- Net carrying amount $ 160,123 190,803 eralized by inventory and accounts receivable. Borrowing limitations are based on 85% of eligible accounts receivable and $700,000 of eligible inventory. The current borrowing base on the line of credit would be approximately $3.4 million. Presently the line of credit is on stand-by status. The Amortization expense associated with the intangible Company will pay $2,000 per month as a minimum access assets was $30,680 and $44,637 for the fiscal years ended fee to the line of credit. If the Company determines to activate June 30, 2016 and 2015, respectively. Estimated amortization the line it is required to provide the lender with 45 days’ notice expense for the identifiable intangibles is expected to be of intent to begin borrowing. The line of credit has a maturity as follows: 2017, $30,680; 2018, $26,430; 2019, $26,430; date of September 2017. The line of credit has no negative 2020, $26,430; 2021, $20,420 and thereafter $29,733. loan covenants. However, once the line of credit is activated there are affirmative covenants to provide regular accounts receivable reports and financial statements within 90 days of month end. Dynatronics Corporation Notes to Consolidated Statements June 30, 2016 and 2015 26 (7) LONG TERM DEBT 2017, $8,001; 2018, $8,001 and 2019, $6,001. Long term debt consists of the following as of June 30: The Company rents office, warehouse and storage space and office equipment under agreements which run one year or more in duration. The rent expense for the years ended June 2016 2015 30, 2016 and 2015 was $186,882 and $188,498, respectively. Future minimum rental payments required under operating 6.44% promissory $ 630,901 745,562 leases that have a duration of one year or more as of June 30, note secured by trust deed on real property, maturing January 2021, payable in monthly installments of $13,278 2016 are as follows: 2017, $54,852; 2018, $5,088 and 2019, $2,544. During fiscal year 2015, the office and warehouse spaces in Detroit, Michigan and Hopkins, Minnesota were leased on an annual/monthly basis from employees/stockholders; or entities 5.99% promissory note 39,355 — controlled by stockholders, who were previously principals of secured by a vehicle, payable in monthly installments of $833 through December 2020 Promissory note secured 20,218 27,168 by a vehicle, payable in monthly installments of $639 through February 2019 the dealers acquired in July 2007. The leases are related-party transactions with two employee/stockholders. The expense associated with these related-party transactions totaled $70,800 expense for both fiscal years ended June 30, 2016 and 2015. Capital Leases On August 8, 2014, the Company sold the property that houses its operations in Utah and leased back the premises for a term of 15 years. The sale price was $3.8 million. Proceeds from 13.001% promissory note — 272 the sale were primarily used to reduce debt obligations of the secured by equipment, payable in monthly installments of $70 through October 2015 Company. The sale of the building resulted in a $2,269,255 gain, which is recorded in the consolidated balance sheet as deferred gain and will be recognized in selling, general and administrative expense over the 15 year life of the lease. The building lease is recorded as a capital lease with Less current portion 690,474 (137,283) 773,002 (121,884) the related amortization being recorded on a straight line basis over 15 years. Total accumulated amortization related $ 553,191 651,118 reflecting amortization charges of $251,934 in fiscal 2016 to the leased building at June 30, 2016 was $482,873 and $230,939 in fiscal 2015. The difference in amortization reflects the fact that fiscal 2015 was only 11 months, being the first year of the lease. Future minimum gross lease payments required under the capital lease as of June 30, 2016 are as The aggregate maturities of long term debt for each of follows: 2017, $334,950; 2018, $341,648; 2019, $348,478; the years subsequent to June 30, 2016 are as follows: 2017, 2020, $355,450; 2021, $362,566 and $3,245,126 thereafter. $137,283; 2018, $146,094; 2019, $153,559; 2020, $157,646 Included in the above lease payments is $1,438,211 of and 2021, $95,892. imputed interest. (8) LEASES Operating Leases (9) ACCRUED PAYROLL AND BENEFITS EXPENSE As of June 30, 2016 accrued payroll and benefits expense was $1,034,688 as compared to $263,092 for the year The Company leases vehicles under noncancelable ended June 30, 2015. Included in fiscal 2016 was $767,786 operating lease agreements. Lease expense for the years of accrued severance for two executive management officers. ended June 30, 2016 and 2015, was $14,430 and $16,106, respectively. Future minimum lease payments required under noncancelable operating leases that have initial or remaining lease terms in excess of one year as of 2016 is as follows: 27 Dynatronics Corporation Notes to Consolidated Statements June 30, 2016 and 2015 (10) INCOME TAXES Income tax benefit (provision) for the years ended June 30 consists of: 2016: U.S. federal State and Local 2015: U.S. federal State and Local Current — — — Deferred 40,245 24,306 Total 40,245 24,306 64,551 64,551 (16,981) 14,580 (678,953) (169,738) (695,934) (155,158) (2,401) (848,691) (851,092) $ $ $ $ The actual income tax benefit (provision) differs from the “expected” tax benefit (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: Net deferred income tax assets (liabilities) – non-current: 2016 2015 2016 2015 Expected tax benefit $ State taxes, net of federal tax benefit R&D tax credit 668,716 63,844 475,743 58,661 86,659 28,916 Valuation allowance (744,724) (1,447,247) Incentive stock options Other, net (6,105) (3,839) (3,322) 36,157 $ 64,551 (851,092) Deferred income tax assets and liabilities related to the tax effects of temporary differences are as follow as of June 30: Inventory $ 57,079 67,324 capitalization for income tax purposes Inventory reserve Warranty reserve Accrued product liability Allowance for doubtful accounts 162,146 59,516 5,875 139,832 59,742 9,918 151,730 162,803 Property and $ (71,038) (67,158) equipment, principally due to differences in depreciation Research and development credit carryover Other intangibles Deferred gain on sale lease back Operating loss carry forwards 304,669 133,393 (62,448) 863,370 (68,970) 874,235 721,074 — Valuation allowance (2,191,973) (1,447,247) Total deferred income $ — (136,128) tax assets (liabilities) – non-current Dynatronics Corporation Notes to Consolidated Statements June 30, 2016 and 2015 28 A valuation allowance is required when there is significant for June 30, 2013, 2014 and 2015 are open tax years. The uncertainty as to the realizability of deferred tax assets. The anticipated NOL carry ward from fiscal 2016 is $1,780,000. The ability to realize deferred tax assets is dependent upon the Company has not uncertain tax positions as of June 30, 2016. Company’s ability to generate sufficient taxable income within the carryforward periods provided for in the tax law for each tax jurisdiction. The Company has considered the following (11) MAJOR CUSTOMERS AND possible sources of taxable income when assessing the SALES BY GEOGRAPHIC LOCATION realization of its deferred tax assets: During the fiscal years ended June 30, 2016 and 2015, sales • future reversals of existing taxable The Company exports products to approximately 30 temporary differences; countries. Sales outside North America totaled $850,200 or • future taxable income or loss, exclusive of reversing 2.8% of net sales, for the fiscal year ended June 30, 2016 temporary differences and carryforwards; compared to $880,500, or 3% of net sales, for the fiscal year to any single customer did not exceed 10% of total net sales. • tax-planning strategies; and ended June 30, 2015. • taxable income in prior carryback years. The Company considered both positive and negative (12) COMMON STOCK AND COMMON STOCK EQUIVALENTS evidence in determining the need for a valuation allowance, For the year ended June 30, 2016, the Company granted including the following: Positive evidence: 36,174 shares of restricted common stock to directors in connection with compensation arrangements and 35,422 shares to employees. For the year ended June 30, 2015, the Company • Current forecasts indicate that the Company will granted no restricted common stock to directors or officers in generate pre-tax income and taxable income in the connection with compensation arrangements. future. However, there can be no assurance that On June 30, 2015, the Company issued 122,000 shares of the new strategic plans will result in profitability. restricted common stock to the exclusive placement agent and • A majority of the Company’s tax attributes the financial advisor in conjunction with the $4 million capital have indefinite carryover periods. raise. Negative evidence: The Company maintained a 2005 equity incentive plan for the benefit of employees, on June 29, 2015 the shareholders • The Company has several years of approved a new 2015 equity incentive plan setting aside 500,000 cumulative losses as of June 30, 2016. shares. The 2015 plan was filed with the SEC on September 3, 2015. Incentive and nonqualified stock options, restricted The Company places more weight on objectively verifiable common stock, stock appreciation rights, and other share-based evidence than on other types of evidence and management awards may be granted under the plan. Awards granted under currently believes that available negative evidence outweighs the plan may be performance-based. As of June 30, 2015, the available positive evidence. Management has therefore 405,404 shares of common stock were authorized and reserved determined that the Company does not meet the “more for issuance, but were not granted under the terms of the 2015 likely than not” threshold that deferred tax assets will be equity incentive plan. realized. In accordance with accounting rules, management The Company granted 95,000 options under its 2015 equity has implemented a full valuation allowance against all but incentive plan during fiscal year 2016. There were no options approximately $65,000 of the tax benefit for fiscal year 2016. granted during fiscal year 2015. The options are granted at not The benefit left remaining is the result of certain adjustments less than 100% of the market price of the stock at the date of to the deferred tax assets in the fourth quarter to true up all grant. Option terms are determined by the board, and exercise tax asset accounts. Any reversal of the valuation allowance dates may range from 6 months to 10 years from the date of grant. will favorably impact the Company’s results of operations in The fair value of each option grant was estimated on the date the period of reversal. of grant using the Black Scholes option pricing model with the The Company’s federal and state income tax returns following assumptions: 29 Dynatronics Corporation Notes to Consolidated Statements June 30, 2016 and 2015 Expected dividend yield Expected stock price volatility Risk-free interest rate Expected life of options 2016 0% 63%–65% 1.83%–2.04% 10 years The weighted average fair value of options granted during fiscal year 2016 was $2.10. The following table summarizes the Company’s stock option activity during the reported fiscal years: 2016 Number of shares 2016 Weighted average exercise price Weighted average remaining contractual term 2015 Number of shares 2015 Weighted average exercise price 91,152 $ 5.07 3.56 years 155,604 $ 6.45 95,000 — (64,595) 3.27 — 4.74 — — (64,452) — — 8.41 5.07 Options outstanding at beginning of the year Options granted Options exercised Options canceled or expired Options outstanding at 121,557 3.84 2.80 years 91,152 end of the year Options exercisable at 63,940 4.75 90,520 5.48 end of the year Range of exercise prices at end of the year $ 1.75 – 5.55 $ 1.75 – 7.10 The Company recognized $203,889 and $66,372 $203,889 stock-based compensation was $79,333 which in stock-based compensation for the years ended June was related to severance payments due to changes in 30, 2016 and 2015, respectively, which is included in executive management. selling, general, and administrative expenses in the As of June 30, 2015 there was $293,564 of unrecognized consolidated statements of operations. The stock-based stock-based compensation cost that is expected to be compensation includes amounts for both restricted expensed over periods of four to eight years. stock and stock options under ASC 718. Included in the No options were exercised during the fiscal years 2016 Dynatronics Corporation Notes to Consolidated Statements June 30, 2016 and 2015 30 and 2015. The aggregate intrinsic value of the outstanding The Preferred Investors purchased a total of 1,610,000 options as of June 30, 2016 and 2015 was $3,816 and shares of Series A Preferred Stock, and received in connection $3,289, respectively. with such purchase, (i) A-Warrants, exercisable by cash exercise only, to purchase 1,207,500 shares of common stock, (13) SERIES A 8% CONVERTIBLE PREFERRED STOCK AND and (ii) B-Warrants, exercisable by “cashless exercise”, to COMMON STOCK WARRANTS purchase 1,207,500 shares of common stock. The warrants On June 30, 2015, the Company completed a private placement are exercisable for 72 months from the date of issuance and with affiliates of Prettybrook Partners, LLC (“Prettybrook”) carry a Black-Scholes put feature in the event of a change in and certain other purchasers (collectively with Prettybrook, control. The put right is not subject to derivative accounting the “Preferred Investors”) for the offer and sale of shares of as all equity holders are treated the same in the event of a the Company’s Series A 8% Convertible Preferred Stock (the change in control. “Series A Preferred”) in the aggregate amount of approximately The Company’s Board of Directors has the authority to $4 million. Offering costs incurred in conjunction with the cause us to issue, without any further vote or action by the private placement were recorded net of proceeds. The Series shareholders, up to 3,390,000 additional shares of preferred A Preferred is convertible to common stock on a 1:1 basis. A stock, no par value per share, in one or more series, to Forced Conversion can be initiated based on a formula related to designate the number of shares constituting any series, and to share price and trading volumes as outlined in the terms of the fix the rights, preferences, privileges and restrictions thereof, private placement. The dividend is fixed at 8% and is payable including dividend rights, voting rights, rights and terms in either cash or common stock. This dividend is payable of redemption, redemption price or prices and liquidation quarterly and equates to an annual payment of $372,291 in cash preferences of such series. or a value in common stock based on the trading price of the The Series A Preferred includes a conversion right at a stock on the date the dividend is declared. Certain redemption price that creates an embedded beneficial conversion feature. rights are attached to the Series A Preferred, but none of the A beneficial conversion feature arises when the conversion redemption rights for cash are deemed outside the control of the price of a convertible instrument is below the per share fair Company. The redemption rights deemed outside the control of value of the underlying stock into which it is convertible. The the Company require common stock payments or an increase in conversion price is ‘in the money’ and the holder realizes the dividend rate. The Series A Preferred includes a liquidation a benefit to the extent of the price difference. The issuer preference under which Preferred Investors would receive cash of the convertible instrument realizes a cost based on the equal to the stated value of their stock plus unpaid dividends. In theory that the intrinsic value of the price difference (i.e., the accordance with the terms of the sale of the Series A Preferred, price difference times the number of shares received upon the Company was required to register the underlying common conversion) represents an additional financing cost. The shares associated with the Series A Preferred and the warrants. conversion rights associated with the Series A Preferred issued That registration statement filed on form S-3 went effective on by the Company do not have a stated life and, therefore, all of August 13, 2015. the beneficial conversion feature amount of $2,109,971 was The Series A Preferred votes on an as-converted basis, amortized to dividends on the same date the preferred shares one vote for each share of Common Stock issuable upon were issued. The $2,109,971 dividend is added to the net loss conversion of the Series A Preferred, provided, however, that to arrive at the net loss applicable to common stockholders no holder of Series A Preferred shall be entitled to cast votes for purposes of calculating loss per share for the year ended for the number of shares of Common Stock issuable upon June 30, 2015. conversion of such Series A Preferred held by such holder that The Company paid dividends in common stock of exceeds the quotient of (x) the aggregate purchase price paid $273,375 during fiscal 2016 and $882 in cash for fiscal 2015. by such holder of Series A Preferred for its Series A Preferred, At June 30, 2016, there was $98,916 in accrued dividends divided by (y) the greater of (i) $2.50 and (ii) the market price payable for the quarter ended June 30, 2016. of the Common Stock on the trading day immediately prior to the date of issuance of such holder’s Preferred Stock. The market price of the Common Stock on the trading day (14) BENEFICIAL CONVERSION FEATURE ADJUSTED AND immediately prior to the date of issuance was $3.19 per share. RECLASSIFICATION Based on a $4,025,000 investment and a $3.19 per share ASC 470-20-30-8 provides that if the intrinsic value of the price the number of Common Stock equivalents eligible for beneficial conversion feature is greater than the proceeds voting by Preferred shareholders is 1,261,755. allocated to the convertible instrument, the amount of the 31 Dynatronics Corporation Notes to Consolidated Statements June 30, 2016 and 2015 discount assigned to the beneficial conversion feature shall (17) SUBSEQUENT EVENTS be limited to the amount of the proceeds allocated to the On July 7, 2016, the Company issued 33,305 shares of convertible instrument. In the prior year, the Company did not common stock as payment for the accrued “Preferred Stock limit the amount of the beneficial conversion feature to the Dividend.” amount of proceeds which resulted in an overstatement of the On September 23, 2016, the Company initiated a $1.0 dividend of the beneficial conversion feature of $748, 916. The million working capital line of credit. For information on the Company has corrected this error in the prior year financial line of credit see note #6. statements which resulted in a reduction in net loss applicable to common stockholders from $5,110,106 to $4,361,190 and a decrease in basic and diluted net loss per common share (18) RECENT ACCOUNTING PRONOUNCEMENTS from $2.03 to $1.73. Additionally, certain reclassifications The Financial Accounting Standards Board (“FASB”) issued to common stock and preferred stock were done to correct Accounting Standard Update (“ASU”) 2014-09, 2015-14 and the consolidated balance sheet and consolidated statement 2016-8 – Revenue from Contracts with Customers, which of stockholders’ equity. These corrections and reclassifica- provides a single, comprehensive revenue recognition model tions had no impact to net loss, total stockholders’ equity or for all contracts with customers. The core principal of the ASUs the statement of cash flows. The Company has evaluated the is that an entity should recognize revenue when it transfers effect of this error and reclassifications, both qualitatively and promised goods or services to customers in an amount that quantitatively, and concluded that it did not have a material reflects the consideration to which the entity expects to be impact on, nor require amendment of, any previously filed entitled in exchange for those goods or services. The ASUs annual or quarterly statements. also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments (15) EMPLOYEE BENEFIT PLAN and changes in judgments and assets recognized from costs The Company has a deferred savings plan which qualifies incurred to obtain or fulfill a contract. In July 2015, the FASB under Internal Revenue Code Section 401(k). The plan covers deferred the effective date of this standard. As a result, the all employees of the Company who have at least six months standard and related amendments will be effective for the of service and who are age 20 or older. For fiscal years 2016 Company for its fiscal year beginning July 1, 2018, including and 2015, the Company made matching contributions of interim periods within that fiscal year. Early application is 25% of the first $2,000 of each employee’s contribution. permitted, but not before the original effective date of June 1, The Company’s contributions to the plan for 2016 and 2015 2017. Entities are allowed to transition to the new standard by were $36,103 and $34,099, respectively. Company matching either retrospective application or recognizing the cumulative contributions for future years are at the discretion of the board effect. The Company is currently evaluating the guidance, of directors. including which transition approach will be applied and the estimated impact it will have on our consolidated financial statements. (16) LIQUIDITY AND CAPITAL RESOURCES In March 2016, the FASB issued ASU No. 2016-09, As of June 30, 2016, the Company had $966,183 of cash, Compensation - Stock Compensation (Topic 718): compared to $3,925,967 as of June 30, 2015. During the Improvements to Employee Share-Based Payment Accounting current and prior year the Company incurred significant (“ASU 2016-09”). This ASU amends certain aspects of operating losses and negative cash flows from operations. accounting for share-based payments to employees, including The Company believes that its existing revenue stream, (i) requiring all income tax effects of share-based awards to be current capital resources, together with the working capital recognized in the income statement when the award vests or line of credit initiated in September 2016 will be sufficient settles and eliminating APIC pools, (ii) permitting employers to fund operations through September 30, 2017. For more to withhold the share equivalent of an employee’s maximum information on the line of credit see note #6. tax liability without triggering liability accounting and (iii) To fully execute on its business strategy of acquiring other allowing companies to make a policy election to account for entities, the Company will need to raise additional capital. forfeitures as they occur. ASU 2016-09 is effective for annual Absent additional financing, the Company will not have the reporting periods beginning after December 15, 2016 and resources to execute its current business plan and may have early adoption is permitted. The Company is evaluating the to curtail its current acquisition strategy. impact of adopting ASU 2016-09 on its financial statements, Dynatronics Corporation Notes to Consolidated Statements June 30, 2016 and 2015 32 but does not believe the new guidance will have a significant 6. An entity is required to present separately in other impact on how it accounts for share-based payments. comprehensive income the portion of the total change in In February 2016, the FASB issued ASU No. 2016-02, the fair value of a liability resulting from a change in the Leases (Topic 842) (“ASU 2016-02”). This ASU primarily instrument-specific credit risk when the entity has elected provides new guidance for lessees on the accounting to measure the liability at fair value in accordance with treatment of operating leases. Under the new guidance, the fair value option for financial instruments. lessees are required to recognize assets and liabilities arising from operating leases on the balance sheet. ASU 2016-02 also aligns lessor accounting with the revenue recognition guidance in Topic 606 of the Accounting Standards Codification. ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018 with early adoption permitted and is required to be adopted on a modified retrospective basis, meaning the new leasing model will be applied to the earliest year presented in the financial statements and thereafter. The 7. Separate presentation of financial assets and liabilities by measurement category and form of financial asset is required on the balance sheet or accompanying notes. 8. An entity should evaluate the need for a valuation allowance on a deferred tax asset related to available- for-sale securities in combination with the entity’s other deferred tax assets Company is currently evaluating the impact of adopting this For public business entities, the amendments in this new accounting standard on its financial statements. update are effective for fiscal years beginning after December In January 2016, the FASB issued ASU 2016-01, Financial 15, 2017. An entity should apply the amendments by means Instruments – Overall (Topic 825-10): Recognition and of a cumulative-effect adjustment to the balance sheet as of Measurement of Financial Assets and Financial Liabilities. The the beginning of the fiscal year of adoption. The amendments objective of this update is to enhance the reporting model for related to equity securities without readily determinable fair financial instruments to provide users of financial statements values should be applied prospectively to equity investments with more decision-useful information. The amendments that exist as of the date of adoption. The Company notes this in this update make the following eight improvements to new guidance will apply to its reporting requirements and generally accepted accounting principles: will implement the new guidance accordingly and is currently evaluating the impact this new guidance will have on its 1. Equity investments (except those accounted for under financials. the equity method or that result in consolidation of the investee) are to be measured at fair value with changes in fair value included in net income. However, an entity may choose to measure equity investments without readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. 2. A qualitative assessment is required for investments without readily determinable fair values in order to identify impairment. If impairment is identified, the investment is to be measured at fair value. In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. This update, which is part of the FASB’s larger Simplification Initiative project aimed at reducing the cost and complexity of certain areas of the accounting codification, requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position, which eliminates the requirement that an entity separate deferred tax liabilities and assets into current and non-current amounts. This update does not affect the current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount on the balance sheet. This amendment 3. The requirement to disclose the fair value of financial applies to all entities with a classified statement of financial instruments measured at amortized cost is eliminated position. For public business entities, this update is effective for non-public business entities. for fiscal years beginning after December 15, 2016, and 4. The requirement to disclose the method(s) and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost is eliminated for public business entities. 5. Public entities are required to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. interim periods within those annual periods. The Company notes this guidance will apply to its reporting requirements and has implemented the new guidance effective with the current 2016 fiscal year reports. In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory. This objective of this update is to simplify Topic 330, which currently requires an entity to measure inventory at the lower of cost or market. Market could be replacement cost, net realizable 33 Dynatronics Corporation Notes to Consolidated Statements June 30, 2016 and 2015 value, or net realizable value less an approximately normal profit margin. The amendments in this update do not apply to inventory that is measured using last-in, first-out (LIFO) or the retail inventory method. The amendments apply to all other inventory, which includes inventory that is measured using first-in, first-out (FIFO) or average cost. An entity should measure inventory within the scope of this update at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The update will be effective for fiscal years beginning after December 15, 2016. The Company currently applies a lower of cost or market and is currently assessing the magnitude of the difference between using market value versus net realizable value; however, it is not anticipated to have a material effect on the Company’s financial. In August 2014, the FASB issued ASU 2014-15 Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The new standard provides guidance around management’s responsi- bility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The new standard is effective for fiscal years ending after December 15, 2016. Early adoption is permitted. After adoption the Company will assess going concern based on the guidance in this standard . Dynatronics Corporation Notes to Consolidated Statements June 30, 2016 and 2015 34 AVAILABILITY OF FORM 10-K GENERAL INFORMATION Dynatronics Corporation files an annual report on Form 10-K Dynatronics Corporation, a Utah corporation organized each year with the Securities and Exchange Commission. A on April 29, 1983, manufactures, markets and distributes copy of the Form 10-K for the fiscal year ended June 30, 2016, a broad line of therapeutic, diagnostic and rehabilitation may be obtained at no charge by sending a written request to: equipment, medical supplies and soft goods, and treatment tables to an expanding market of physical therapists, sports Mr. Jim Ogilvie, Director of Business Development and IR medicine practitioners and athletic trainers, chiropractors, Dynatronics Corporation 7030 Park Centre Drive, Cottonwood Heights, Utah 84121 podiatrists, orthopedists, and other medical professionals. OFFICERS AND DIRECTORS Kelvyn H. Cullimore, Jr. ANNUAL MEETING The company’s annual shareholder meeting will be held at Chairman of the Board, President and CEO Dynatronics’ corporate headquarters on December 16, 2016 David A. Wirthlin Chief Financial Officer T. Jeff Gephart Senior Vice President of Sales at 3:00 pm MT. 7030 Park Centre Drive, Cottonwood Heights, Utah 84121 Douglas G. Sampson ACCOUNTANTS, LEGAL COUNSEL AND TRANSFER AGENT Vice President of Production and R&D BDO USA, LLP, Salt Lake City, Utah Bryan D. Alsop Independent Registered Public Accounting Firm Durham Jones & Pinegar, Salt Lake City, Utah Vice President of Information Technology Corporate Legal Counsel Kirton & McConkie, Salt Lake City, Utah Intellectual Property Legal Counsel Interwest Transfer Company P.O. Box 17136, Salt Lake City, Utah 84117 Transfer Agent DYNATRONICS CORPORATION HEADQUARTERS 7030 Park Centre Drive, Cottonwood Heights, Utah 84121 1.800.874.6251, http://www.dynatronics.com Erin S. Enright Director David B. Holtz Director Scott A. Klosterman Director Brian M. Larkin Director R. Scott Ward, PT PhD Director Corporate Information 35 Dynatronics Corporation 7030 Park Centre Dr., Cottonwood Heights, Utah 84121 1.800.874.6271 — www.dynatronics.com 2016 Annual Report 

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