Dynatronics
Annual Report 2017

Plain-text annual report

2017 ANNUAL REPORT Growth Through Acquisitions: A Letter to Shareholders Acquistions 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 3 - 4 5 - 6 7 8 - 13 14 - 15 16 - 20 21 - 34 35 2 2 GROWTH THROUGH ACQUISITIONS A Letter to Shareholders With the investment in Dynatronics by Pret- Organic sales during the fiscal year modalities, positions us particularly well in tybrook Partners and their affiliates in June continued to be strong, marking the third the athletic training market. 2015 we set out on a corporate plan founded consecutive year of revenue growth. Hausmann was founded in 1955 and has on strategic acquisitions blended with Excluding the effect of the acquisition of enjoyed an excellent reputation in our market organic growth. Fiscal 2017 saw accelerated Hausmann Industries in the last quarter of for quality products and on-time delivery. realization of this plan, including our first the fiscal year, our organic growth was 5%, David Hausmann has functioned as President significant acquisition and continued organic improving slightly on the 4% growth rate of the company for over 20 years and will revenue growth. reported last year. continue to serve in that capacity under an We further bolstered our management This growth was mostly attributable to employment agreement negotiated as part team during the fiscal year as we added greater focus in the long-term care market. of the terms of the transaction. Cyndi McHenry as our Vice President of Demand by skilled nursing facilities, nursing Hausmann manufactures their products Operations. Cyndi’s prior history of approx- homes and intermediate care facilities is at their 65,000 square foot facility in North- imately 20 years with St. Jude Medical has being driven largely by the aging population vale, NJ. We have leased the facility from the enabled her to bring industry knowledge of the baby boomer generation. We expect previous owners of Hausmann. We are iden- and broad functional skills to her role. Cyndi to see continued strength in demand from tifying sales and marketing synergies and we worked as their Senior Director of Global this segment of the market. intend to explore operational synergies over Operations Integration and Site Optimiza- In addition to the steady organic growth time. tion from 2013 to 2015, where she defined we have experienced over the last three To fund the acquisition, we raised $7.8 strategy and led business integrations and years, fiscal year 2017 brought the first million through a private placement of site consolidations in the US and interna- significant acquisition since the Prettybrook 1,559,000 shares of our Series B Preferred tionally. Before this position, she served as investment. In April 2017 we acquired stock and common shares. Prettybrook the Director of Product Development (2008- substantially all of the assets of Hausmann Partners and their affiliates participated in the 2013) and Director of Engineering Opera- Industries, Inc. for approximately $10 million. equity investment, which also included the tions and Services (2002-2008). With sales of approximately $15 million per Hausmann sellers and new institutional inves- Her contribution has been instrumental in year, Hausmann manufactures products tors. We also established an asset based line streamlining operations at our Utah, California that are complementary to our current line of credit with Bank of the West that provides and Tennessee facilities. We have hired new of products. Hausmann is a manufacturer of up to $8 million in financing at a rate of 2.25% leaders at our Utah and Tennessee plants, and powered and non-powered laminate treat- over LIBOR. Our available borrowings under in September 2017 we consolidated the ware- ment tables and rehabilitation and athletic the line, based on the borrowing base calcu- housing function performed at our former training products, while Dynatronics has lation at the time of acquisition, were approx- Livermore, CA, facility into our operations in traditionally offered solid wood products. imately $6 million. Utah. This change reduces costs and makes Hausmann’s PROTEAM line serves the needs Almost six months to the day after we operations more efficient without negatively of professional and college sports programs. closed the Hausmann transaction, we impacting shipping times to our customers in The combination of the two product lines, completed the acquisition of substantially all the western United States. along with our high quality therapeutic of the assets of Bird & Cronin, Inc., a Minne- 3 Letter to Shareholders apolis based manufacturer of orthopedic soft goods and specialty care products. Bird & Cronin has been in business since 1969 and, like Hausmann, is recognized as a quality manu- facturer with excellent brand recognition. We believe that the addition of Bird & Cronin to Dynatronics diversifies our product lines and significantly expands our sales channels in the important hospital market. Bird & Cronin is managed by Mike Cronin and Jason Anderson. They have been Co-Pres- idents of the organization for the past several years and will continue in their capacities as Co-Presidents of the Bird & Cronin division of Dynatronics. Over the next year we will explore synergies in sales and marketing, as well as operations. We financed this acquisition by expanding our asset based line of credit to $11 million, raising $7 million through an offering of a Series C Preferred, and issuing $4 million in a Series D Preferred to the sellers. Both the Series C and Series D Preferred will convert to common stock upon approval of our shareholders, which is expected to occur at the November 29, 2017 shareholder meeting. The total purchase price for Bird & Cronin was $14 million, with $.5 million to $1.5 million in additional consideration to be paid through an earn-out provision over the next two years. Bird & Cronin and Hausmann reported sales of $24.0 million and $14.8 million respectively in their audited financial statements for fiscal year 2016. When added to the $31.9 million in sales reported by Dynatronics in our last fiscal year, net of Hausmann sales, the combined sales total an annual run rate of approximately $70 million. In those same audited financial statements Bird & Cronin and Hausmann reported respectively $2.1 million and $0.9 million in net profits. We believe the developments of this last year are strong indicators of our ability to execute on our stated strategic plans and a positive harbinger of what the future holds for Dynatronics. We intend to work diligently to continue our organic growth, complete value-enhancing acqui- sitions and increase the Company’s cash flow. Our goal and our commitment is to bring ever greater value to you, our shareholders. Kelvyn H. Cullimore, Jr. Chairman, President and CEO 4 Letter to Shareholders Business Description Hausmann Industries is an industry leading manufacturer of physical therapy and athletic training equipment; primarily laminate treatment tables. It produces premium priced products with a reputation for on-time delivery, high quality and excellent customer service. The business is headquartered in Northvale, New Jersey and employs approximately 86 employees. Over ninety percent of products are manufactured in its 65,000 square foot facility. More information can be found on its website www.hausmann.com. Product Portfolio Tables and Equipment Customer Mix Hausmann sells nearly all of its products Strategic Rationale Dynatronics manufactures complementary • Wide range of treatment tables, through third party dealers. Many of these stools, benches and cabinets to the relationships have been cultivated through products that can be sold into Hausmann’s physical therapy markets decades of delivering consistent quality existing base of customers, which provide access to large national accounts and ProTeam product and service. The core dealer network sells to customers buying groups. • Customized, modular taping stations in private practice physical therapy, athletic The combined company will be solidly for athletic trainers training, and hospital rehabilitation. cash flow positive. • All-laminate products as well as treatment The transaction increases revenue tables, stools, benches and cabinets without additional selling costs in the combined entity. Transaction Summary We successfully closed the acquisition on April 3, 2017 at a purchase price of approx- imately $10.0 million in cash. Dynatronics financed the transaction through an asset- based lending facility with Bank of the West and the issuance of $7.8 million of equity securities. More information can be found in the press release and related 8-K filed with the SEC in connection with this transaction. 5 5 Mergers and Acquistions Business Description Bird and Cronin is an industry leading Product Portfolio Bird & Cronin is a market leader in orthopedic Transaction Summary The acquisition was successfully closed designer, manufacturer and distributor of soft goods. They offer a full-line of ortho- on October 2, 2017 at a purchase price of orthopedic soft goods and specialty patient pedic soft goods with over thirty different approximately $14.0 million in cash and Dyna- care products. It is known as a premium product categories. brand with a deep portfolio of branded and private label products. The business is headquartered in Eagan, Customer Mix Bird & Cronin has strong relationships with tronics stock, with an additional $0.5 million to $1.5 million in additional consideration to be paid through an earn-out provision over the next two years. Minnesota and employs approximately 110 over 2,000 customers across the globe. Its Dynatronics financed the transaction employees. Over 90 percent of products diverse customer base consists of distribu- through an asset-based lending facility with are manufactured in its 85,000 square foot tors, OEMs and clinics / hospitals. Much like Bank of the West, the issuance of $7.0 million facility. More information can be found Hausmann, many of these of Series C Preferred Stock, and the issuance relationships have of $4.0 million of Series D Preferred Stock to been cultivated the sellers. Both the Series C and Series D through decades of Preferred will convert to common stock upon delivering consis- shareholder approval. More information can tent quality product be found in the press release and related 8-K and service. filed with the SEC related to this transaction. on its website www.birdcronin.com. Strategic Rationale The transaction provides an opportunity to expand Bird & Cronin products into private practice physical therapy, athletic training and chiropractic markets. The combined company will be solidly cash flow positive. In addition, Bird & Cronin is both Gross Margin and Adjusted EBITDA Margin accretive. Revenue and possible operating synergies will be evaluated over the next twelve months. Combined Company Pro Forma Revenue ($’s in millions) $100 $80 $60 $40 $20 $0 $70 + $46.8 $31.9 Dynatronics Hausmann®* Bird & Cronin®** *Hausmann Revenue from December 31, 2016 audited financial statements. **Bird & Cronin Revenue from September 30, 2016 audited financial statements. 6 6 Mergers and Acquistions Boa rd of D i rec tor s 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 Chief Financial Officer of HNI Healthcare Brian M. Larkin Vice President and General Manager of Diabetes Care at Becton Dickinson R. Scott Ward, Ph.D. Chairman of the Department of Physical Therapy at the University of Utah M a na g ement Te a m Kelvyn H. Cullimore, Jr. Chairman, President and CEO Michael Cronin Co-President, Bird & Cronin® Division David A. Wirthlin Chief Financial Officer Jason Anderson Co-President, Bird & Cronin® Division T. Jeff Gephart Senior Vice President of Sales David H. Hausmann President, Hausmann® Division Cynthia L. McHenry Vice President of Operations Jim. N. Ogilvie Vice President of Business Development Douglas G. Sampson Vice President of R&D, Quality and Regulatory Bryan D. Alsop Vice President of Information Technology 7 Board of Directors and Management MANAGEMENT’S DISCUSSION AND ANALYSIS of Financial Condition and Results of Operations You should read this discussion together their medical equipment and supply needs, increasing demand for and sales of our higher with the audited financial statements, including electrotherapy, therapeutic ultra- margin manufactured and OEM products. related notes and other financial information sound, phototherapy, rehabilitation products included elsewhere in this Annual Report on and supplies, treatment tables, custom- Gross Profit Form 10-K. The following discussion contains ized training room products and exercise Gross profit for the year ended June, 2017 assumptions, estimates and other forward- products. looking statements that involve a number increased $1,154,000, or about 11.1%, to $11,508,000, or 32.2% of net sales. By of risks and uncertainties, including those discussed under “Risk Factors,” “Special Results of Operations Fiscal Year 2017 Compared to Fiscal Year 2016 comparison, gross profit for the year ended June 30, 2016 was $10,354,000, or 34.0% Note on Forward-Looking Statements” and elsewhere in this Annual Report on Form Net Sales of net sales. The increase in gross profit dollars was driven by Hausmann gross profit 10-K. These risks could cause our actual Net sales in fiscal year 2017 increased 17.6%, of approximately $1,082,000 and increased results to differ materially from those antici- or $5,346,000, to $35,758,000, compared to gross profit of $492,000 on sales of Dyna- pated in these forward-looking statements. net sales of $30,412,000 in fiscal year 2016. tronics’ distributed capital equipment which The year-over-year increase was driven increased 21.0% over the prior fiscal year. References to “we,” “us,” and “our” refer primarily by our acquisition of Hausmann These increases were partially offset by lower to Dynatronics Corporation and its consol- that contributed $3,812,000 in net sales in gross profit of approximately $420,000 on idated subsidiaries. References to “Notes” the fourth fiscal quarter ended June 30, other product categories. The year-over-year refer to the Notes to Consolidated Financial 2017, which represented a 4.5% increase decrease in gross margin percentage from Statements included herein (refer to Item 8). over Hausmann’s sales for the same quarter 34.0% to 32.2% was primarily attributable to Overview We design, manufacture and distribute of the prior year, prior to the acquisition of the Hausmann acquisition, which generated Hausmann. The year-over year increase was gross margin of approximately 28.1% in the also driven by a 5% increase ($1,534,000) quarter ended June 30, 2017. Our Hausmann advanced-technology medical devices, in sales of Dynatronics legacy products, subsidiary sells primarily to dealers at whole- therapeutic and medical treatment tables, including a $1,645,000 increase in net sales sale and generates slightly lower gross rehabilitation equipment, custom athletic of distributed capital equipment, which margin percentage, but also incurs lower training treatment tables and equipment, are other manufacturers’ products that we selling costs than much of the Dynatronics institutional cabinetry as well as thousands distribute. These increases were partially legacy business. The overall gross margin of rehabilitation and therapy products and offset by a net decrease of $110,000 in sales also decreased due to increased sales of supplies. Through our various distribution of other product categories. Much of the distributed capital products that carry a lower channels, we market and sell our products growth in sales of distributed capital equip- gross margin than our manufactured thera- to physical therapists, chiropractors, athletic ment was in long-term care markets where peutic modalities, and due to higher inven- trainers, sports medicine practitioners, and we devoted increased sales and marketing tory write-offs in fiscal year 2017. Those write- other medical professionals and institutions. resources this year. We are executing on stra- offs increased by $165,000 from $270,000 in We offer customers a one-stop shop for tegic and marketing initiatives with the aim of fiscal year 2016 to $435,000 in 2017, due to 8 Managements Discussion and Analysis discontinued product lines, excess repair interest expense is related primarily to the Net Loss Applicable to parts, product rejected for quality standards, payoff and termination of our previous line of Common Shareholders and other non-performing inventory. credit in the third quarter of fiscal year 2016, Net loss applicable to common stockholders Selling, General and Administrative Expenses offset by our new line of credit established was $4,293,000 ($1.36 per share) for the at the end of third quarter of fiscal year 2017. year ended June 30, 2017, compared to The largest component of interest expense $2,275,000 ($0.84 per share) for the year Selling, general and administrative (“SG&A”) in fiscal year 2017 was $189,000 of imputed ended June 30, 2016. The higher net loss expenses increased 10.2%, or $1,123,000, to interest related to the sale/leaseback of our applicable to common stockholders for the $12,102,000 for the year ended June 30, 2017, corporate headquarters facility. Interest year ended June 30, 2017 is due to increased compared to $10,979,000 for the year ended expense also included interest on our line of dividends on Preferred Stock as explained June 30, 2016. Selling expenses represented credit, mortgage interest on our Tennessee below and $1,944,000 in deemed dividends $774,000 of the $1,123,000 increase in SG&A property, and a small amount of interest for associated with the issuance of 390,000 expenses. Increases in selling expenses were equipment loans for office furnishings and shares of Series A Preferred in December driven primarily by $310,000 associated with vehicles. Hausmann operations, all incurred in the 2016 and 1,559,000 shares of Series B Preferred in April 2017. The deemed divi- fourth quarter of our fiscal year, $303,000 in Loss Before Income Tax Benefit dends reflect the difference between the higher personnel costs associated with hiring Pre-tax loss for the year ended June 30, 2017 underlying common share value of the Series additional sales management and marketing was $1,866,000 compared to pre-tax loss of A Preferred and Series B Preferred shares as personnel to implement our plans for organic $1,967,000 for the year ended June 30, 2016. if converted, based on the closing price of growth, and $112,000 associated with our The $101,000 decrease in pre-tax loss was the Company’s common stock on the date digital marketing program. primarily attributable to a $1,154,000 increase of the applicable transaction (December 28, General and administrative (“G&A”) in gross profit and a $768,000 reduction of 2016 for Series A Preferred and April 3, 2017 expenses represented $349,000 of the severance expense, offset by $774,000 of for the Series B Preferred), less an amount of $1,123,000 increase in SG&A expenses. higher selling expenses, $628,000 of higher the purchase price assigned to the Series A Increases in G&A expenses were driven acquisition costs, and $489,000 of increases Preferred or Series B Preferred, as applicable, primarily by $628,000 in increased acqui- in other G&A expenses. The Hausmann oper- in an allocation of purchase price between sition related costs and $540,000 associ- ations contributed approximately $223,000 the preferred shares and common stock ated with the Hausmann operations. These in pre-tax income. increases in G&A were offset by $768,000 in lower severance related expenses. Severance Income Taxes purchase warrants that were issued with the Series A Preferred and Series B Preferred. Net loss applicable to common stock- related expenses were recorded in fiscal year Income tax benefit was $0 in fiscal year 2017, holders includes the effect of accrued divi- 2016 primarily associated with the separation compared to income tax benefit of $65,000 dends to holders of the Series A Preferred and of two executives. in fiscal year 2016. We increased the valua- Series B Preferred which totaled $466,000 tion allowance on our net deferred income for the year ended June 30, 2017 compared Research and Development tax assets by $772,288 and $744,724 for the to $372,000 for the year ended June 30, R&D expenses for the year ended June years ended June 30, 2017 and 2016, respec- 2016. The increase in dividends reflects the 30, 2017 increased 1.0%, or $11,000, to tively, eliminating any income tax benefit that issuance of additional Series A Preferred $1,081,000 compared to $1,070,000 for would have otherwise been recognized. See shares in December 2016 and the issuance the year ended June 30, 2016. Hausmann Note 11 to the consolidated financial state- of Series B Preferred in April 2017. We paid operations resulted in $12,000 of R&D. ments as well as “Critical Accounting Policies accrued dividends by issuing shares of our Product development and improvement are and Estimates – Deferred Income Tax Assets” common stock and paying $16,240 in cash. important elements of our strategy to obtain for more information regarding the valuation The cash payments related to a portion of the repeat business and to capture market share. allowance and its impact on the effective tax dividends accrued on the shares of Series A R&D costs are expensed as incurred and are rate for 2017. Preferred issued December 28, 2016. expected to remain approximately at present levels in the next fiscal year. Net Loss Net loss for fiscal year 2017 was $1,866,000, Liquidity and Capital Resources We have historically financed operations Interest Expense compared to $1,903,000 for the year ended through cash from operations, available cash Interest expense decreased by approxi- June 30, 2016. Fiscal year 2016 included a reserves, borrowings under a line of credit mately $11,000 in fiscal year 2017, to approxi- $65,000 income tax benefit, otherwise, the facility, and sales of equity securities. On mately $278,000, compared to approximately changes in net loss are the same as explained March 31, 2017, we entered into a new two $289,000 in fiscal year 2016. The reduction in above for Loss Before Income Tax. year loan and security agreement with Bank 9 Managements Discussion and Analysis of the West (the “Loan and Security Agree- $2,104,000 in accounts receivable as of June to the Company to be used for funding the ment”) for an asset based lending facility for 30, 2017. This increase was partially offset by Hausmann acquisition and for operating up to the lesser of $8,000,000 or an amount a decrease in accounts receivable in our other capital. This Loan and Security Agree- available based upon a borrowing base operations due to collection activities. Trade ment replaces the previous $1,000,000 calculation established in the agreement. accounts receivable represent amounts due line of credit, which we closed prior to the We expect to obtain capital for future acqui- from our customers including medical practi- Hausmann acquisition. sitions using proceeds from debt and equity tioners, clinics, hospitals, colleges and univer- The Loan and Security Agreement offerings. Working capital was $5,834,000 as sities and sports teams as well as dealers and provides for revolving credit borrowings by of June 30, 2017 compared to working capital distributors that purchase our products for the Company in an amount up to the lesser of $5,820,000 as of June 30, 2016. The current redistribution. We believe that our estimate of $8,000,000 or the calculated borrowing ratio was 1.8 to 1 as of June 30, 2017 and 2.5 of the allowance for doubtful accounts is base. The borrowing base is computed to 1 as of June 30, 2016. Current assets were adequate based on our historical knowledge monthly and is equal to the sum of stated 51.7% of total assets as of June 30, 2017 and and relationship with our customers. Accounts percentages of eligible accounts receiv- 63.9% of total assets as of June 30, 2016. receivable are generally collected within able and inventory, less a reserve. Amounts approximately 30 days of invoicing. outstanding bear interest at LIBOR plus Cash and Cash Equivalents Our cash and cash equivalents position as Inventories 2.25%. We paid a commitment fee of .25% and the line is subject to an unused line fee of June 30, 2017, was $255,000 compared Inventories, net of reserves, increased of .25%. The maturity date is two years from to cash and cash equivalents of $966,000 $2,401,000, or 48.0%, to $7,398,000 as of the date of the agreement. Our obligations as of June 30, 2016. The primary sources of June 30, 2017, compared to $4,997,000 as under the Loan and Security Agreement are cash in the year ended June 30, 2017 were of June 30, 2016. The increase was driven secured by a first-priority security interest in two equity offerings in which we raised net primarily by the addition of the Hausmann substantially all of our assets. The Loan and proceeds of approximately $8,199,000 and subsidiary that had $1,993,000 of net inven- Security Agreement contains affirmative net borrowing under a new line of credit of tory as of June 30, 2017. Inventory levels and negative covenants, including cove- $2,172,000. Primary uses of cash included fluctuate based on the timing of large inven- nants that restrict the ability of the Company the acquisition of Hausmann, which used tory purchases from domestic and overseas and its subsidiaries to, among other things, $9,116,000 net of the acquisition holdback, suppliers as well as increased parts related to incur or guarantee indebtedness, incur liens, and net cash used in operating activities of new products being planned for introduction. dispose of assets, engage in mergers and approximately $1,528,000 of which $425,000 During fiscal year 2017, we recorded approx- consolidations, make acquisitions or other was due to changes in working capital and imately $435,000 in non-cash write-offs of investments, make changes in the nature $678,000 in transaction costs associated with inventory related to discontinued product of its business, and engage in transac- the Hausmann acquisition. lines, excess repair parts, product rejected for tions with affiliates. The Loan and Security During the current and prior year we quality standards, and other non-performing Agreement also contains financial covenants incurred significant operating losses and inventory compared to inventory write-offs of applicable to the Company and its subsid- negative cash flows from operating activities. $270,000 in fiscal year 2016. We believe that iaries, including a maximum monthly consol- We believe that our existing and acquired our estimate of the allowance for inventory idated leverage and a minimum monthly revenue streams, current capital resources, reserves is adequate based on our historical consolidated fixed charge coverage ratio. together with cash flows from our Hausmann knowledge and product sales trends. As of June 30, 2017, we had borrowed subsidiary will be sufficient to fund opera- tions through at least one year from the filing Accounts Payable approximately $2,172,000 under the Loan and Security Agreement compared to no date of this Annual Report on Form 10-K. Accounts payable increased approximately borrowings as of June 30, 2016. To fully execute on our business strategy of $420,000, or 22.0%, to $2,335,000 as of acquiring other entities, we will need to raise June 30, 2017, from $1,914,000 as of June Debt additional capital. 30, 2016. The increase was driven primarily Long-term debt, excluding current install- by the addition of the Hausmann subsidiary ments decreased approximately $91,000 Accounts Receivable that had $614,000 of accounts payable at to approximately $462,000 as of June 30, Trade accounts receivable, net of allowance for June 30, 2017. doubtful accounts, increased approximately $1,758,000, or 49.9%, to $5,281,000 as of June Line of Credit 2017, compared to approximately $553,000 as of June 30, 2016. Our long-term debt is primarily comprised of the mortgage loan 30, 2017, from $3,524,000 as of June 30, 2016. On March 31, 2017, we entered into the on our office and manufacturing facility in The increase is primarily due to the addition Loan and Security Agreement with Bank of Tennessee and also includes loans related of the Hausmann subsidiary that added the West to provide asset-based financing to equipment and a vehicle. The principal 10 Managements Discussion and Analysis balance on the mortgage loan is approxi- plan during the year ended June 30, 2017, or • Historical sales; mately $508,000 of which $378,000 is clas- during the past five fiscal years. • Forecast sales; sified as long-term debt, with monthly prin- cipal and interest payments of $13,278. Our mortgage loan matures in 2021. Critical Accounting Policies This Management’s Discussion and Analysis • Strategic marketing and production plans • Technological innovations; and • Product obsolescence; In conjunction with the sale and leaseback of Financial Condition and Results of Oper- • Character of the inventory as a distrib- of our corporate headquarters in August ations is based upon our consolidated finan- uted item, finished manufactured item 2014, we entered into a $3.8 million lease for cial statements, which have been prepared in or raw material. a 15-year term with an investor group. That accordance with GAAP. The preparation of sale generated a profit of $2.3 million which these financial statements requires estimates Any modifications to estimates of inven- is being recorded monthly over the life of and judgments that affect the reported tory valuation reserves are reflected in cost the lease at $12,500 per month, or approxi- amounts of our assets, liabilities, net sales and of goods sold within the statements of mately $150,000 per year. The building lease expenses. Management bases estimates on operations during the period in which such is recorded as a capital lease with the related historical experience and other assumptions modifications are determined necessary by amortization being recorded on a straight it believes to be reasonable given the circum- management. As of June 30, 2017, and 2016, line basis over 15 years at approximately stances and evaluates these estimates on an our inventory valuation reserve balance, which $250,000 per year. Lease payments, currently ongoing basis. Actual results may differ from established a new cost basis, was approxi- approximately $28,000, are payable monthly these estimates under different assumptions mately $403,000 and $415,000, respectively, and increase annually by approximately or conditions. See Note 18 to our consoli- and our inventory balance was $7,398,000 and 2% per year over the life of the lease. Total dated financial statements for the impact of $4,997,000, net of reserves, respectively. accumulated amortization related to the recent accounting pronouncements. leased building is approximately $735,000 We believe that the following critical Revenue Recognition at June 30, 2017. Imputed interest for the accounting policies involve a high degree Our sales force and distributors sell our fiscal year ended June 30, 2017, was approx- of judgment and complexity. See Note 1 products to end users, including physical imately $189,000. Future minimum gross to our consolidated financial statements for therapists, athletic trainers, chiropractors, lease payments required under the capital fiscal year 2017, for a complete discussion and medical doctors. Sales revenues are lease as of June 30, 2017 are as follows: of our significant accounting policies. The recorded when products are shipped FOB 2018, $342,000; 2019, $348,000; 2020, following summary sets forth information shipping point under an agreement with a $355,000; 2021, $363,000; 2022, $370,000 regarding significant estimates and judg- customer, risk of loss and title have passed and $2,875,000 thereafter. ments used in the preparation of our consol- to the customer, and collection of any idated financial statements. resulting receivable is reasonably assured. Inflation Our revenues and net income have not Inventory Reserves Amounts billed for shipping and handling of products are recorded as sales revenue. been unusually affected by inflation or The nature of our business requires that Costs for shipping and handling of products price increases for raw materials and parts we maintain sufficient inventory on hand to customers are recorded as cost of sales. from vendors. at all times to meet the requirements of our customers. We record finished goods inven- Allowance for Doubtful Accounts Stock Repurchase Plans tory at the lower of standard cost, which We must make estimates of the collectability In 2011, our Board of Directors adopted a approximates actual cost (first-in, first-out) of accounts receivable. In doing so, we stock repurchase plan authorizing repur- or market. Raw materials are recorded at analyze historical bad debt trends, customer chases of shares in the open market, through the lower of cost (first-in, first-out) or market. credit worthiness, current economic trends block trades or otherwise. Decisions to Inventory valuation reserves are maintained and changes in customer payment patterns repurchase shares under this plan are based for the estimated impairment of the inventory. when evaluating the adequacy of the allow- upon market conditions, the level of our cash Impairment may be a result of slow-moving ance for doubtful accounts. Our accounts balances, general business opportunities, or excess inventory, product obsolescence receivable balance was $5,281,000 and and other factors. The Board periodically or changes in the valuation of the inventory. $3,524,000, net of allowance for doubtful approves the dollar amounts for share repur- In determining the adequacy of reserves, we accounts of $382,000 and $389,000 as of chases under the plan. As of June 30, 2017, analyze the following, among other things: June 30, 2017, and 2016, respectively. approximately $448,000 remained available under the Board’s authorization for purchases • Current inventory quantities on hand; Deferred Income Tax Assets under the plan. There is no expiration date for • Product acceptance in the marketplace; A valuation allowance is required when there the plan. No purchases were made under this • Customer demand; is significant uncertainty as to the realizability 11 Managements Discussion and Analysis of deferred tax assets. The realization of (Topic 350), Simplifying the Test for Goodwill nition of the term output so that the term is deferred tax assets is dependent upon our Impairment. The amendment in this update consistent with how outputs are described ability to generate sufficient taxable income simplifies how an entity is required to test in Topic 606. This amendment will be effec- within the carryforward periods provided goodwill for impairment by eliminating Step tive for us in our fiscal year (including interim for in the tax law for each tax jurisdiction. 2 from the goodwill impairment test. An periods) beginning July 1, 2018. We are We have considered the following possible entity should apply the amendments in this currently evaluating the impact the adoption sources of taxable income when assessing update on a prospective basis. This amend- of ASU 2017-01 will have on its consolidated the realization of our deferred tax assets: ment will be effective for us in our fiscal financial statements and disclosures. year beginning July 1, 2020. Early adoption In February 2016, the FASB issued ASU • future reversals of existing taxable is permitted for interim or annual goodwill No. 2016-02, Leases (Topic 842,) a new temporary differences; impairment tests performed on testing guidance on leases. This guidance replaces • future taxable income or loss, exclusive dates after January 1, 2017. We are currently the prior lease accounting guidance in its of reversing temporary differences and evaluating the impact the adoption of ASU entirety. The underlying principle of the new carryforwards; 2017-04 will have on its consolidated finan- standard is the recognition of lease assets • tax-planning strategies; and cial statements and disclosures. and lease liabilities by lessees for substan- • taxable income in prior carryback years. In January 2017, the FASB issued ASU tially all leases, with an exception for leases 2017-01, Business Combinations (Topic with terms of less than twelve months. The We considered both positive and negative 805), Clarifying the Definition of a Business. standard also requires additional quantitative evidence in determining the continued need for The Board issued this update to clarify the and qualitative disclosures. The guidance is a valuation allowance, including the following: definition of a business with the objective effective for interim and annual reporting Positive evidence: transactions should be accounted for as 2018, and early adoption is permitted. The of assisting entities with evaluating whether periods beginning after December 15, acquisitions (or disposals) of assets or busi- standard requires a modified retrospective • Current forecasts indicate that we will nesses. Under Topic 805, there are three approach, which includes several optional generate pre-tax income and taxable elements of a business—inputs, processes, practical expedients. Accordingly, the income in the future. However, there and outputs (collectively referred to as a standard is effective for us on July 1, 2019. can be no assurance that the new stra- “set”) although outputs are not required as We are currently evaluating the impact that tegic plans will result in profitability. an element of a business set. The amend- this guidance will have on our consolidated • A majority of our tax attributes have ments in this update provide a screen to financial statements. indefinite carryover periods. determine when a set is not a business. The In January 2016, the FASB issued ASU Negative evidence: the fair value of the gross assets acquired (or related to financial instruments - overall • We have six years of cumulative losses disposed of) is concentrated in a single iden- recognition and measurement of financial as of June 30, 2017. tifiable asset or a group of similar identifiable assets and financial liabilities. The guidance screen requires that when substantially all of 2016-01, Financial Instruments, a guidance assets, the set is not a business, reducing enhances the reporting model for financial We place more weight on objectively the number of transactions that need to be instruments, which includes amendments verifiable evidence than on other types of further evaluated. If the screen is not met, the to address aspects of recognition, measure- evidence and management currently believes amendments in this update: ment, presentation and disclosure. The that available negative evidence outweighs update to the standard is effective for public the available positive evidence. We have 1. require that a business set must include, companies for interim and annual periods therefore determined that we do not meet at a minimum, an input and a substan- beginning after December 15, 2017. Accord- the “more likely than not” threshold that tive process that together significantly ingly, the standard is effective for us on July 1, deferred tax assets will be realized. Accord- contribute to the ability to create 2018. We are currently evaluating the impact ingly, a valuation allowance is required. Any output, and that the standard will have on the consoli- reversal of the valuation allowance will favor- 2. remove the evaluation of whether dated financial statements. ably impact the Company’s results of opera- a market participant could replace In May 2014, the FASB issued ASU 2014-09, tions in the period of reversal. missing elements. Revenue from Contracts with Customer (Topic 606). This authoritative accounting Recent Accounting Pronouncements In January 2017, the Financial Accounting The amendments provide a framework guidance related to revenue from contracts for evaluating whether both an input and a with customers. This guidance is a compre- Standards Board (“FASB”) issued ASU substantive process are present. Lastly, the hensive new revenue recognition model that 2017-04, Intangibles—Goodwill and Other amendments in this update narrow the defi- requires a company to recognize revenue 12 Managements Discussion and Analysis to depict the transfer of goods or services margins and cash flows. To that end, we • Tuck-in manufacturers / distributors to a customer at an amount that reflects announced the agreement to acquire in adjacent markets (i.e. Orthopedics, the consideration it expects to receive in substantially all the assets of B&C as Sports Medicine, etc.) exchange for those goods or services. This described in the “Recent Develop- guidance is effective for annual reporting ments” section of this report; and In summary, based on our defined stra- periods beginning after December 15, 2017. • Bolster our investor relations activities and tegic initiatives we are focusing our resources Accordingly, we will adopt this guidance on strengthen our financial markets position. in the following areas: July 1, 2018. Companies may use either a full retrospective or a modified retrospec- To better execute on our growth strat- • Updating and improving our selling and tive approach to adopt this guidance. We egies, during fiscal year 2017 we made marketing efforts including new sales are evaluating which transition approach to important additions to our executive management, new reporting tools, and use and its impact, if any, on its consolidated management team. In October 2016, David focusing our sales and marketing efforts financial statements. Wirthlin joined the Company as Chief Finan- into our core markets; In August 2014, the FASB issued ASU cial Officer. In March 2017, we hired Cyndi • Seeking to improve distribution of our 2014-15 Presentation of Financial State- McHenry as our Vice President of Operations. products through recruitment of addi- ments—Going Concern, an authoritative As a result the Hausmann acquisition, David tional qualified sales representatives accounting guidance related to the disclo- Hausmann, a seasoned industry executive, and dealers attracted by the many new sure of uncertainties about an entity’s ability functions as the President of our Hausmann products being offered and expanding to continue as a going concern. This guidance subsidiary. We have also made changes to the availability of proprietary combina- requires management to evaluate, at each our production management at both our tion therapy device; interim and annual reporting period, whether Utah and Tennessee operations. These • Improving gross profit margins by, there are conditions or events that raise changes are all calculated to better position among other initiatives, increasing substantial doubt about the entity’s ability us to execute on our strategic growth plans. market share of manufactured capital to continue as a going concern within one We will release new product innovations products by promoting sales of our year after the date the consolidated financial during fiscal 2018 to strengthen our current state-of-the-art Dynatron® Ther- statements are issued, and provide related product offering and to expand our product moStim probe, Dynatron Solaris® Plus disclosures. We adopted this guidance for portfolio. In the fall of 2017 we anticipate and 25 Series™ products; the fiscal year ended June 30, 2017. the release of our new Knee Rom product, • Maintaining our position as a tech- Business Plan and Outlook This past year we have continued to a device designed to enable practitioners to nological leader and innovator in our better assist patients with knee mobilization markets through the introduction of new following surgery. The promotion of this new products during the new fiscal year; strengthen our executive management product, as well as other new products antic- • Exploring strategic business acquisi- team, strengthened our sales organization ipated for this year, are expected to increase tions. This will leverage and comple- and pursued acquisition candidates. In that sales during fiscal year 2018. ment our competitive strengths, regard we successfully acquired and inte- On April 3, 2017, we completed the acqui- increase market reach and allow us grated assets and operations of Hausmann sition of Hausmann and on September 26, to potentially expand into broader Industries which has significantly increased 2017 we entered into an Asset Purchase medical markets; and our market presence and improved our oper- Agreement to acquire the assets of B&C. • Attending strategic conferences to ating results. We will continue to pursue our These two transactions provide momentum make investors aware of our strategic growth strategies in fiscal 2018 as follows: toward the execution of our strategic plan to plans, attract new capital to support grow by acquisition. the business development strategy and • Achieve organic sales growth through We are actively pursuing our acquisition identify other acquisition targets improved sales management, new strategy to consolidate other small manufac- product introductions, geographic turers and distributors in our core markets expansion, improved market pene- (i.e. physical therapy, athletic training, and tration, and continued expansion into chiropractic). We are primarily seeking candi- post-acute care markets; dates that fall into the following categories: • Identify and act on additional acqui- sition opportunities that will further • Manufacturers that extend our enhance our product offering, distribu- product portfolio tion coverage and leverage our current • Distributors that extend geographic sales network to improve gross profit reach or provide different channel access 13 Managements Discussion and Analysis To the Board of Directors and Stockholders Dynatronics Corporation We have audited the consolidated balance a basis for designing audit procedures that sheet of Dynatronics Corporation and are appropriate in the circumstances, but not subsidiaries (collectively, the Company) as for the purpose of expressing an opinion on of June 30, 2017, and the related consol- the effectiveness of the Company’s internal idated statements of operations, stock- control over financial reporting. Accord- holders’ equity, and cash flows for the year ingly, we express no such opinion. An audit then ended. These financial statements are includes examining, on a test basis, evidence the responsibility of the Company’s manage- supporting the amounts and disclosures ment. Our responsibility is to express an in the financial statements. An audit also opinion on these financial statements based includes assessing the accounting princi- on our audit. ples used and significant estimates made We conducted our audit in accordance by management, as well as evaluating the with the standards of the Public Company overall financial statement presentation. We Accounting Oversight Board (United States). believe that our audit provides a reasonable Those standards require that we plan and basis for our opinion. perform the audit to obtain reasonable In our opinion, the financial statements assurance about whether the financial state- referred to above present fairly, in all material ments are free of material misstatement. respects, the financial position of Dynatronics The Company is not required to have, nor Corporation and subsidiaries as of June 30, were we engaged to perform, an audit of 2017, and the results of their operations and the Company’s internal control over financial their cash flows for the year then ended in reporting. Our audit included consideration conformity with U.S. generally accepted of internal control over financial reporting as accounting principles. /s/ Tanner LLC Salt Lake City, Utah September 27, 2017 14 Report of Independent Registered Public Accounting Firm Report of Independent Registered Accounting Firm Board of Directors and Stockholders Dynatronics Corporation, Cottonwood Heights, Utah We have audited the accompanying consol- for designing audit procedures that are idated balance sheet of Dynatronics Corpo- appropriate in the circumstances, but not ration (“Company”) as of June 30, 2016 for the purpose of expressing an opinion on and the related consolidated statements of the effectiveness of the Company’s internal operations, stockholders’ equity, and cash control over financial reporting. Accordingly, flows for the year then ended. These finan- we express no such opinion. An audit also cial statements are the responsibility of the includes examining, on a test basis, evidence Company’s management. Our responsibility supporting the amounts and disclosures is to express an opinion on these financial in the financial statements, assessing the statements based on our audit. accounting principles used and significant We conducted our audit in accordance estimates made by management, as well as with the standards of the Public Company evaluating the overall financial statement Accounting Oversight Board (United States). presentation. We believe that our audit Those standards require that we plan and provides a reasonable basis for our opinion. perform the audit to obtain reasonable In our opinion, the consolidated financial assurance about whether the financial state- statements referred to above present fairly, ments are free of material misstatement. in all material respects, the financial position The Company is not required to have, nor of Dynatronics Corporation at June 30, 2016, were we engaged to perform, an audit of and the results of its operations and its cash its internal control over financial reporting. flows for the year then ended, in confor- Our audit included consideration of internal mity with accounting principles generally control over financial reporting as a basis accepted in the United States of America. /s/ BDO USA, LLP Salt Lake City, Utah September 28, 2016 15 Report of Independent Registered Public Accounting Firm C onsol id ated Ba l a nce She et s Years ended June 30: Assets Current assets Cash and cash equivalents Trade accounts receivable, less allowance for doubtful accounts of $382,333 as of June 30, 2017 and $389,050 as of June 30, 2016 Other receivables Inventories, net Prepaid expenses Total current assets Property and equipment, net Intangible assets, net Goodwill Other assets Total assets Liabilities and Stockholders’ Equity Current liabilities: Accounts payable Accrued payroll and benefits expense Accrued expenses Income tax payable Warranty reserve Line of credit Current portion of acquisition holdback Current portion of long-term debt Current portion of capital lease Current portion of deferred gain Total current liabilities Long-term debt, net of current portion Capital lease, net of current portion Deferred gain, net of current portion Acquisition holdback, net of current portion Deferred rent Total liabilities Commitments and contingencies Stockholders' equity: 2 017 2 016 $ 254,705 $ 966,183 5,281,348 3,523,731 33,388 10,946 7,397,682 4,997,254 503,800 256,735 13,470,923 9,754,849 4,973,477 2,754,118 4,302,486 562,873 4,777,565 160,123 — 580,161 $ 26,063,877 $ 15,272,698 $ 2,334,563 $ 1,914,342 1,472,773 1,034,688 656,839 8,438 202,000 2,171,935 294,744 151,808 193,818 150,448 358,787 2,895 152,605 — — 137,283 183,302 150,448 7,637,366 3,934,350 461,806 3,087,729 1,680,001 750,000 122,585 553,191 3,281,547 1,830,449 — 85,151 13,739,487 9,684,688 Preferred stock, no par value: Authorized 50,000,000 shares; 3,559,000 shares and 1,610,000 8,501,295 3,708,152 shares issued and outstanding as June 30, 2017 and June 30, 2016, respectively Common stock, no par value: Authorized 100,000,000 shares; 4,653,165 shares and 2,805,280 11,838,022 7,545,880 shares issued and outstanding as of June 30, 2017 and June 30, 2016, respectively Accumulated deficit Total stockholders’ equity (8,014,927) (5,666,022) 12,324,390 5,588,010 Total liabilities and stockholders’ equity $ 26,063,877 $ 15,272,698 See accompanying notes to consolidated financial statements. 16 Dynatronics Corporation Consolidated Balance Sheets as of June 30, 2017 and 2016 C onsol id ated St atement s of O p er at ions Years ended June 30: Net sales Cost of sales Gross profit Selling, general, and administrative expenses Research and development expenses Operating loss Other income (expense): Interest income Interest expense Other income, net Total other expense Loss before income tax benefit Income tax (provision) benefit Net loss 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 2 017 2 016 $ 35,758,330 $ 30,411,757 24,249,832 20,057,614 11,508,498 10,354,143 12,101,539 10,978,606 1,081,373 1,070,383 (1,674,414) (1,694,846) 508 (277,630) 85,141 2,885 (289,149) 14,298 (191,981) (271,966) (1,866,395) (1,966,812) — 64,551 (1,866,395) (1,902,261) (1,944,223) (466,269) (16,241) (4,293,128) (1.36) $ $ — (372,291) — $ $ (2,274,552) (0.84) Weighted-average basic and diluted common shares outstanding 3,152,425 2,706,424 See accompanying notes to consolidated financial statements. 17 Dynatronics Corporation Consolidated Statements of Operations for the Years Ended June 30, 2017 and 2016 C onsol id ated St atement s of Stoc k holder s’ E qu it y Years ended June 30, 2017 and 2016 Common Stock Shares Common Stock Amount Preferred Stock Shares Preferred Stock Amount Total Accumulated Stockholders’ Deficit Equity 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, in common 91,295 372,291 stock, issued or to be issued Net loss — — — — — — — (19,946) — — 203,889 (19,946) — (372,291) — — (1,902,261) (1,902,261) Balances as of June 30, 2016 $ 2,805,280 $ 7,545,880 1,610,000 $ 3,708,152 $ (5,666,022) $ 5,588,010 Stock-based compensation 143,054 419,925 Issuance of common stock in association with 1,565,173 3,405,948 capital raise, net of issuance costs of $268,328 — — — — — 419,925 — 3,405,948 — 1,949,000 4,793,143 — 4,793,143 Issuance of preferred stock and warrants, net of issuance costs of $302,581 Preferred stock dividend, in cash — — — Preferred stock dividend, in common 139,658 466,269 stock, issued or to be issued Preferred stock beneficial conversion feature Dividend of beneficial conversion feature Net loss — — — — — — — — — — — — — (16,241) (16,241) (466,269) — 1,944,223 (1,944,223) — — 1,944,223 (1,944,223) — (1,866,395) (1,866,395) Balances as of June 30, 2017 $ 4,653,165 $ 11,838,022 $ 3,559,000 $ 8,501,295 $ (8,014,927) $ 12,324,390 See accompanying notes to consolidated financial statements. 18 Dynatronics Corporation Consolidated Statements of Stockholders’ Equity for the Years Ended June 30, 2017 and 2016 C onsol id ated St atement s of Ca sh F low s 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 capital lease Gain on sale of property and equipment 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 Accounts payable and accrued expenses Net cash used in operating activities Cash flows from investing activities: Purchase of property and equipment Net cash paid in acquisition - see Note 2 Proceeds from sale of property and equipment Net cash used in investing activities 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 stock, net Preferred stock dividends paid in cash Net cash provided by (used in) financing activities Net change in cash and cash equivalents Cash and cash equivalents at beginning of the period 2 017 2 016 $ (1,866,395) $ (1,902,261) 242,542 95,005 124,774 251,934 (15,754) 419,925 — (6,717) (13,021) 229,930 30,680 51,372 251,934 4,703 203,889 (136,128) (28,394) 57,213 (150,448) (150,448) (81,321) (269,977) (110,224) (107,486) 5,543 (46,708) (152,765) 367,320 16,894 (8,191) 343,898 285,377 (1,528,328) (534,977) (117,876) (195,946) (9,116,089) 32,000 — — (9,201,965) (195,946) (152,668) (183,302) (125,638) (173,358) 2,171,935 (1,909,919) 8,199,091 (16,241) (19,946) — 10,018,815 (2,228,861) (711,478) (2,959,784) 966,183 3,925,967 Cash and cash equivalents at end of the period $ 254,705 $ 966,183 Continued on next page. 19 Dynatronics Corporation Consolidated Statements of Cash Flow for the Years Ended June 30, 2017 and 2016 C onsol id ated St atement s of Ca sh F low s (cont i nued) Years ended June 30: 2 017 2 016 Supplemental disclosure of cash flow information: Cash paid for interest Supplemental disclosure of non-cash investing and financing activity: Capital lease and note payable obligations incurred to acquire property and equipment Deemed dividends on 8% convertible preferred stock 8% Preferred stock dividends paid or to be paid in common stock Preferred stock issuance costs paid in common stock Fair value of assets acquired and liabilities assumed in the Hausmann acquisition on April 3, 2017 - see Note 2: Cash and cash equivalents Trade accounts receivable Inventories Prepaid expenses Property and equipment Intangible assets Goodwill Warranty reserve Accounts payable Accrued expenses Accrued payroll and benefits Purchase price Acquisition holdback Net cash paid in acquisition See accompanying notes to consolidated financial statements. $ $ 271,254 $ 307,644 75,808 $ 43,110 1,944,223 466,269 17,000 600 1,691,420 2,117,430 136,841 512,950 2,689,000 4,302,486 (50,000) (544,625) (33,981) (661,288) 10,160,833 (1,044,744) 9,116,089 — 372,291 — — — — — — — — — — — — — — — 20 Dynatronics Corporation Consolidated Statements of Cash Flow for the Years Ended June 30, 2017 and 2016 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Basis of Presentation and Summary of Significant Accounting Policies company account balances and transactions accounts that is the Company’s estimate of have been eliminated in consolidation. credit risk in the Company’s existing accounts Description of Business Dynatronics Corporation (“the Cash Equivalents Cash equivalents include all highly Company,” “Dynatronics”) designs, manufac- liquid investments with maturities of three (c) receivable. The Company determines the allowance based on a combination of statis- tical analysis, historical collection patterns, customers’ current credit worthiness, the age (1) (a) tures and distributes advanced-technology months or less at the date of purchase. Also of account balances, and general economic medical devices, therapeutic and medical included within cash equivalents are deposits conditions. All account balances are reviewed treatment tables, rehabilitation equipment, in-transit from banks for payments related to on an individual basis. Account balances are custom athletic training treatment tables and third-party credit card and debit card trans- charged against the allowance when the equipment, institutional cabinetry as well as actions. Cash equivalents totaled approxi- potential for recovery is considered remote. other rehabilitation and therapy products mately $255,000 and $966,000 as of June 30, Recoveries of accounts previously written off and supplies. Through the Company’s various 2017 and 2016, respectively. are recognized when payment is received. distribution channels, it markets and sells its products to physical therapists, chiroprac- tors, athletic trainers, sports medicine practi- tioners, and other medical professionals and (d) Inventories Finished goods inventories are Property and Equipment Property and equipment are stated stated at the lower of standard cost, which less accumulated depreciation. (f) at cost institutions. The Company offers customers approximates actual cost using the first-in, Depreciation is computed using the straight a one-stop shop for their medical equipment first-out method, or net realizable value. Raw line method over the estimated useful and supply needs, including electrotherapy, materials are stated at the lower of cost (first lives of the assets. Buildings and improve- therapeutic ultrasound, phototherapy, reha- in, first out method) or net realizable value. ments are depreciated over estimated bilitation products and supplies, treatment The Company periodically reviews the value useful lives that range from 5 to 31.5 years. tables, customized training room products of items in inventory and records write-downs Leasehold improvements are amortized and exercise products. or write-offs based on its assessment of slow over the remaining term of the respective (b) Principles of Consolidation The consolidated financial state- maintains a reserve for obsolete inventory ment, computer equipment and software and generally makes inventory value adjust- and vehicles are depreciated over estimated moving or obsolete inventory. The Company building lease. Machinery, office equip- ments include the accounts and operations ments against the reserve. useful lives that range from 3 to 7 years. of Dynatronics Corporation and its wholly owned subsidiaries, Hausmann Enterprises, LLC (see Note 2) and Dynatronics Distribu- tion Company, LLC. The consolidated finan- (e) Trade Accounts Receivable Trade accounts receivable are Goodwill Goodwill resulted from the (g) recorded at the invoiced amount and do Hausmann acquisition (see Note 2). Goodwill cial statements are prepared in conformity not bear interest, although finance charges in a business combination represents the with U.S. generally accepted accounting may be applied to past due accounts. The purchase price in excess of identifiable principles (U.S. GAAP). All significant inter- Company maintains an allowance for doubtful tangible and intangible assets. Goodwill 21 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 and intangible assets that have an indefinite rately presented in the balance sheet at the warranty costs to be incurred related to useful life are not amortized. Instead they are lower of net book value or fair value less products previously sold. reviewed periodically for impairment. estimated disposition costs, and are no The Company evaluates goodwill on an longer depreciated. annual basis in the fourth quarter or more frequently if management believes indica- tors of impairment exist. Such indicators could include, but are not limited to (1) a (i) Intangible Assets Costs associated with the acquisi- tion of trademarks, certain trade names, (m) Net Loss per Common Share Net loss per common share is computed based on the weighted-average number of common shares outstanding and, when appropriate, dilutive potential significant adverse change in legal factors license rights and non-compete agree- common shares outstanding during the year. or in business climate, (2) unanticipated ments are capitalized and amortized using Convertible preferred stock, stock options competition, or (3) an adverse action or the straight-line method over periods and warrants are considered to be potential assessment by a regulator. The Company ranging from 3 months to 20 years. Trade common shares. The computation of diluted first assesses qualitative factors to deter- names determined to have an indefinite life net loss per common share does not assume mine whether it is more likely than not that are not amortized, but are required to be exercise or conversion of securities that the fair value of a reporting unit is less than tested for impairment and written down, if would have an anti-dilutive effect. its carrying amount, including goodwill. If necessary. The Company assesses indefi- Basic net loss per common share is the management concludes that it is more likely nite lived intangible assets for impairment amount of net loss for the year available to than not that the fair value of a reporting each fiscal year or more frequently if events each weighted-average share of common unit is less than its carrying amount, and circumstances indicate impairment stock outstanding during the year. Diluted management conducts a quantitative may have occurred. net loss per common share is the amount of net loss for the year available to each goodwill impairment test. The impairment test involves comparing the fair value of the applicable reporting unit with its carrying value. The Company estimates the fair (j) Revenue Recognition The Company recognizes revenue weighted-average share of common stock outstanding during the year and to each when products are shipped FOB shipping point potential common share outstanding values of its reporting units using a combi- under an agreement with a customer, risk of during the year, unless inclusion of poten- nation of the income, or discounted cash loss and title have passed to the customer, and tial common shares would have an anti-di- flows, approach and the market approach, collection of any resulting receivable is reason- lutive effect. which utilizes comparable companies’ data. ably assured. Amounts billed for shipping and The reconciliation between the basic If the carrying amount of a reporting unit handling of products are recorded as sales. and diluted weighted-average number of exceeds the reporting unit’s fair value, Costs for shipping and handling of products to common shares for the years ended June 30, an impairment loss is recognized in an customers are recorded as cost of sales. 2017 and 2016, is summarized as follows: amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. The Company’s evaluation of goodwill completed during the year Research and Development Costs Research and (k) development costs are resulted in no impairment losses. expensed as incurred. Long-Lived Assets Long–lived assets are reviewed for impairment whenever events or changes (h) Product (l) Warranty Costs The Company provides in circumstances indicate that the carrying a warranty on all amount of an asset may not be recover- products it manufac- 2 017 2 016 Basic weighted-average 3,152,425 2,706,424 number of common shares outstanding during the year Weighted-average number of — — potential common shares outstanding during the year able. Recoverability of assets is measured tures for time periods Diluted weighted-average number of 3,152,425 2,706,424 by a comparison of the carrying amount of ranging in length from common and potential common an asset to estimated undiscounted future 90 days to five years shares outstanding during the year cash flows expected to be generated by from the date of sale. the asset. If the carrying amount of an Costs estimated to be asset exceeds its estimated future cash incurred in connection with the Company’s flows, an impairment charge is recognized product warranty programs are charged Outstanding potential common shares for the difference between the carrying to expense as products are sold based on not included in the computation of diluted amount of the asset and the fair value of historical warranty rates. The Company net loss per common share totaled 9,029,080 the asset. Assets to be disposed are sepa- maintains a reserve for estimated product as of June 30, 2017 and 4,127,814 as of June 22 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 30, 2016. These potential common shares are involved in the medical industry. The are not included in the computation because Company performs ongoing credit evalua- they would be antidilutive. tions of its customers and maintains allowances (2) Acquisition On April 3, 2017, Dynatronics, through its wholly-owned subsidiary Hausmann (n) Income Taxes The Company for probable losses which, when realized, Enterprises, LLC, (Subsidiary) a newly formed have been within the range of management’s Utah limited liability company, completed recognizes an expectations. The Company maintains its cash the purchase of substantially all the assets asset or liability for the deferred income tax in bank deposit accounts which at times may of Hausmann Industries, Inc., a New Jersey consequences of all temporary differences exceed federally insured limits. corporation (“Hausmann”) for $10 million in between the tax bases of assets and liabilities As of June 30, 2017 and 2016, the cash, pursuant to an asset purchase agree- and their reported amounts in the consol- Company had approximately $242,000 and ment dated March 21, 2017, by and between idated financial statements that will result $716,000, respectively, in cash and cash the Company and Hausmann (“Asset Purchase in taxable or deductible amounts in future equivalents in excess of federally insured Agreement”). The transaction is referred to as years when the reported amounts of the limits. The Company has not experienced any the “Acquisition.” This acquisition will expand assets and liabilities are recovered or settled. losses in such accounts. Dynatronics’ sales in the physical therapy, Accounting standards require the consider- ation of a valuation allowance for deferred tax assets if it is “more likely than not” that some component or all of the benefits of deferred (q) Operating Segments The Company operates in one line of business: the development, manufacturing, athletic training and other markets by lever- aging the products and distribution network offered by the acquired company. Financing for the Acquisition was provided tax assets will not be realized. Accruals for marketing, and distribution of a broad line by proceeds from the sale of equity securities uncertain tax positions are provided for in of medical products for the physical therapy in a private offering to accredited investors accordance with applicable accounting stan- and similar markets. As such, the Company (the “Private Placement”) and borrowings dards. The Company may recognize the has only one reportable operating segment. under a loan and security agreement (see Note tax benefits from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical (r) Use of Estimates Management of the Company has made a number of estimates and assumptions 7). Closing of the Private Placement occurred concurrently with the closing of the Acqui- sition. At the closing of the Acquisition, the Company paid Hausmann $9.0 million of the merits of the position. The tax benefits recog- relating to the reporting of assets, liabilities, $10.0 million purchase price holding back $1.0 nized in the financial statements from such a revenues and expenses, and the disclosure of million for purposes of satisfying adjustments position are measured based on the largest contingent assets and liabilities in accordance to the purchase price as may be required by the benefit that has a greater than 50% likelihood with U.S. GAAP. Significant items subject to such Asset Purchase Agreement and indemnifica- of being realized upon ultimate settlement. estimates and assumptions include the impair- tion claims, if any. Pursuant to a working capital Judgment is required in assessing the future ment and useful lives of long-lived assets; valu- adjustment provision in the Asset Purchase tax consequences of events that have been ation allowances for doubtful accounts receiv- Agreement, the purchase price was subse- recognized in the financial statements or tax ables, deferred income taxes, and obsolete quently increased $160,833 to $10,160,833. returns. Variations in the actual outcome of inventories; accrued product warranty costs; The Company paid an additional $116,089 these future tax consequences could materi- and fair values of assets acquired and liabilities to Hausmann and held back $44,744 until no ally impact the Company’s financial position, assumed in an acquisition. Actual results could later than November 15, 2017. The $44,744 results of operations and cash flows. differ from those estimates. is combined with the acquisition holdback Stock-Based Compensation Stock-based compensation cost Advertising Costs Advertising costs are expensed as is measured at the grant date based on the incurred. Advertising expense for the years (o) in the accompanying consolidated balance sheets. Subject to additional adjustments or claims as provided by the Asset Purchase Agreement, 25% of the holdback amount will fair value of the award determined by using ended June 30, 2017 and 2016 was approx- be released to Hausmann on January 1, 2018, the Black-Scholes option-pricing model and imately $73,000 and $100,000, respectively. and the balance will be released to Hausmann is recognized as expense over the applicable vesting period of the stock award (zero to five years) using the straight-line method. Reclassification Certain amounts in the prior year’s sition, the Company assumed certain liabilities and obligations of Hausmann related to its 18 months after closing. As part of the Acqui- consolidated statement of stockholders’ ongoing business (primarily trade accounts Concentration of Risk In the normal course of business, the (p) Company provides unsecured credit to its equity have been reclassified for comparative and similar obligations in the ordinary course). purposes to conform to the presentation in In connection with the Acquisition, the the current year’s consolidated statement of Company sold equity securities for gross customers. Most of the Company’s customers stockholders’ equity. proceeds of $7,795,000 in the Private Place- 23 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 (s) (t) ment pursuant to the terms of a Securities Purchase Agreement dated March 21, 2017 (the “Secu- related to the fair value adjustment to acqui- rities Purchase Agreement”) entered into with certain accredited investors, including institutional sition-date inventory. 2016 supplemental investors (the “Investors”). See Note 14 for details. pro forma earnings were adjusted to include Also in connection with the Acquisition, Subsidiary entered into an agreement with Hausmann to these charges. lease the 60,000 square-foot manufacturing and office facility in Northvale, New Jersey (the “New Jersey Facility”) effective as of the closing date (the “Lease”) with an initial two-year term, annual lease payments of $360,000 for the first year, and 2% increases in each subsequent year. The Lease grants Subsidiary two options to extend the term of the Lease for two years per extension term, subject to annual 2% per year increases in base rent, and a third option at the end of the Inventories Inventories consist of the following (3) as of June 30: second option term for an additional five-years at fair market value. The Company also offered employment to Hausmann’s employees at closing including David Hausmann, the primary stockholder of Hausmann and its former principal executive officer. Mr. Hausmann entered into an employment agreement with the Company effective at the closing to assist in the transition of the acquired business. The Acquisition has been accounted for under the purchase method as prescribed by applicable accounting standards. Under this method, the Company has allocated the 2 017 2 016 Raw materials $ 3,766,940 $ 1,999,936 Work in process 470,721 59,112 Finished goods 3,562,758 3, 353,964 Inventory reserve (402,737) (415,758) purchase price to the assets acquired and liabilities assumed at estimated fair values. $ 7,397,682 $ 4,997,254 The total purchase price was $10,160,833. The following table summarizes the esti- mated fair value of the assets acquired and liabilities assumed as of the date of acquisition. Included in cost of goods sold for the years ended June 30, 2017 and 2016, are inventory write-offs of $435,000 and $270,000, respec- tively. During the fiscal year 2017 the write-off As of June 30, 2017, the Company had paid reflects inventories related to discontinued $9,116,089 of the purchase price and retained product lines, excess repair parts, product holdbacks of $1,044,744 due as follows: rejected for quality standards, and other Cash and cash equivalents $ 600 Trade accounts receivable Inventories Prepaid expenses Property and equipment Intangible assets Goodwill Warranty reserve Accounts payable Accrued expenses 1,691,420 2,117,430 136,841 512,950 2,689,000 4,302,486 (50,000) Nov. 15, 2017 $ (544,625) Jan. 1, 2018 (33,981) Oct. 3, 2018 44,744 250,000 750,000 Accrued payroll and benefits (661,288) Acquisition $ 1,044,744 Purchase price $ 10,160,833 holdback non-performing inventories. The $270,000 during fiscal year 2016 was based on write- offs of non-performing inventories related to the Company’s Amerinet GPO contract and product rejected for quality standards. Property and Equipment Property and equipment consist of (4) the following as of June 30: 2 017 2 016 $ 30,287 $ 30,287 5,640,527 2,246,910 283,805 2,194,119 195,001 5,603,859 1,686,386 275,977 2,102,005 253,513 10,590,649 9,952,027 Less accumulated deprecia- (5,617,172) (5,174,462) tion and amortization $ 4,973,477 $ 4,777,565 The amounts of Hausmann’s net sales and net income included in the Company’s consolidated statement of operations for the year ended June 30, 2017 were $3,812,000 and $223,000, respectively. Pro forma net sales and net loss of the combined operations had the acquisition date been July 1, 2016 are: Land Buildings Machinery and equip. Office equip. Net Sales Net Income Computer equip. (loss) Vehicles Supplemental pro forma for year ended June 30, 2017 46,859,000 Supplemental pro forma for year ended June 30, 2016 45,378,000 $ $ (917,000) (1,129,000) 2017 supplemental pro forma earnings were adjusted to exclude $90,000 of acquisition-related costs incurred in 2017 and $-0- of nonrecurring expense 24 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 Depreciation and amortization expense for the years ended June 30, 2017 and 2016 was $242,542 and $229,930, respectively. Included in the above caption, “Buildings” as of June 30, 2017 and 2016 is a building (7) Line of Credit On March 31, 2017, the Company entered into an $8,000,000, two year, lease that is accounted for as a capital lease asset (See Notes 9 and 10) with a gross value of loan and security agreement to provide $3,800,000. The net book value of the capital lease asset as of June 30, 2017 and 2016 was asset-based financing to the Company $3,065,193 and $3,317,127, respectively. Amortization of the capital lease asset was $251,934 for funding acquisitions and for working for each of the years ended June 30, 2017 and 2016. capital (“Loan and Security Agreement”). This Loan and Security Agreement replaces (5) June 30: Intangible Assets Identifiable intangible assets and their useful lives consist of the following as of the $1,000,000 line of credit previously put in place with an asset based lender in September 2016 and closed prior to the April 2017 Acquisition. The Loan and Security Agreement provides for revolving credit borrowings by the Company in an amount up to the lesser of 2 017 2 016 Trade name – indefinite Trade name – 15 years Domain name – 15 years Non-compete covenant – 4-5 years Customer relationships – 7-10 years Trademark licensing agreement – 20 years Backlog of orders – 3 months Customer database – 7 years Total identifiable intangibles Less accumulated amortization $ 464,000 $ 339,400 5,400 504,400 1,990,000 45,000 2,700 38,100 149,400 120,000 45,000 2,700 38,100 3,389,000 (634,882) 700,000 (539,877) — 339,400 $8,000,000 or the calculated borrowing base. The borrowing base is computed monthly 5,400 and is equal to the sum of stated percentages of eligible accounts receivable and inventory, less a reserve. Amounts outstanding bear interest at LIBOR plus 2.25% (3.47% as of June 30, 2017). The Company paid a commit- ment fee of .25% and the line is subject to an unused line fee of .25%. The loan matures March 31, 2019. The Company’s obligations under the Net carrying amount $ 2,754,118 $ 160,123 Loan and Security Agreement are secured by a first-priority security interest in substan- tially all of the Company’s assets. The Loan and Security Agreement requires a Amortization expense associated with the intangible assets was $95,005 and $30,680 for the lockbox arrangement and contains affir- fiscal years ended June 30, 2017 and 2016, respectively. Estimated amortization expense for mative and negative covenants, including the identifiable intangible assets is expected to be as follows: 2018, $283,730; 2019, $283,730; covenants that restrict the ability of the 2020, $283,730; 2021, $277,720; 2022, $258,033 and thereafter $903,175. Company to, among other things, incur Warranty Reserve A reconciliation of the change in the warranty reserve consists of the following for the (6) fiscal years ended June 30: 2 017 2 016 or guarantee indebtedness, incur liens, dispose of assets, engage in mergers and consolidations, make acquisitions or other investments, make changes in the nature of its business, and engage in transac- tions with affiliates. The Loan and Security Agreement also contains financial covenants applicable to the Company, including a Beginning warranty reserve balance Warranty costs incurred Warranty expense accrued Warranty reserve assumed in the Acquisition Changes in estimated warranty costs $ 152,605 $ 153,185 maximum monthly consolidated leverage (143,444) 148,820 50,000 (5,981) (143,934) and a minimum monthly consolidated fixed 141,009 charge coverage ratio. As of June 30, 2017, — 2,345 the Company had borrowed approximately $2,172,000 under the Loan and Security Ending warranty reserve $ 202,000 $ 152,605 Agreement and had no borrowings on the previous line of credit as of June 30, 2016. There was approximately $3,709,000 avail- able to borrow under the loan and security agreement as of June 30, 2017. 25 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 Long Term Debt Long term debt consists of the following as of June 30: (8) the sale were primarily used to reduce debt obligations of the Company. The building lease is recorded as a capital lease obligation in the accompanying consol- idated balance sheets. The capital lease asset is included in Property and Equipment 2 017 2 016 6.44% promissory note secured by trust deed on real property, maturing $ 508,633 $ 630,901 (See Note 4). The balance of the capital lease January 2021, payable in monthly installments of $13,278 obligation was as follows as of June 30: 5.99% promissory note secured by a vehicle, payable in 31,500 39,355 monthly installments of $833 through December 2020 Promissory note secured by a vehicle, payable in — 20,218 monthly installments of $639, paid in full 6.04% promissory note secured by copier equipment, payable monthly installments of $851 through February 2022 3.99% promissory note secured by equipment, payable in monthly installments of $247 through February 2023 3.97% promissory note secured by equipment, payable in monthly installments of $242 through February 2021 7.56% promissory note secured by copier equipment, payable in monthly installments of $166 through February 2020 43,989 14,822 9,878 4,792 — — — — 2 017 2 016 Balance of $ 3,281,547 $ 3,464,849 capital lease obligation Less current (193,818) (183,302) portion $ 3,087,729 $ 3,281,547 Less current portion $ 461,806 $ 553,191 613,614 (151,808) 690,474 (137,283) Future minimum gross lease payments required under the capital lease are as follows for the fiscal years ending June 30: 2018, $341,648; 2019, $348,478; 2020, $355,450; The aggregate maturities of long term debt for each of the years subsequent to June 30, 2021, $362,566; 2022, $369,816 and 2017 are as follows: 2018, $151,808; 2019, $163,031; 2020, $172,988; 2021, $109,731; 2022, $2,875,310 thereafter. Included in the future $12,617 and 2023, $3,439. lease payments are $1,249,136 of imputed interest and $122,585 of deferred rent. Leases Operating Leases (9) The Company leases vehicles under non-cancelable operating lease agreements. Lease Deferred Gain The sale of the building (See (10) expense for the years ended June 30, 2017 and 2016, was $8,001 and $14,430, respectively. Note 9) resulted in a $2,269,255 gain, which is Future minimum lease payments required under non-cancelable operating leases that have recorded in the consolidated balance sheets initial or remaining lease terms in excess of one year as of June 30, 2017 is as follows: 2018, as deferred gain that is being recognized in $8,001 and 2019, $6,001. selling, general and administrative expenses The Company rents office, manufacturing, warehouse and storage space and office equip- over the 15 year life of the lease on a straight ment under agreements which run one year or more in duration. Rent expense for the years line basis. The balance of the deferred gain ended June 30, 2017 and 2016 was $289,323 and $186,882, respectively. Future minimum was as follows as of June 30: rental payments required under operating leases that have a duration of one year or more as of June 30, 2017 are as follows: 2018, $402,888; 2019,$407,744; 2020, $39,000 and 2021, $32,500. During fiscal year 2017, the office, manufacturing and warehouse facilities in Detroit, Michigan, Hopkins, Minnesota and Northvale, New Jersey were leased on an annual/monthly 2 017 2 016 basis from employees/stockholders; or entities controlled by stockholders, who were previ- Balance of $ 1,830,449 $ 1,980,897 ously principals of businesses acquired by the Company. The leases are related-party trans- deferred actions. The expense associated with these related-party transactions totaled $160,800 and gain $70,800 for the fiscal years ended June 30, 2017 and 2016, respectively. Less current (150,448) (150,448) Capital Lease 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 portion $ 1,680,001 $ 1,830,449 26 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 Income Taxes Income tax benefit (provision) for the years ended June 30 consists of: (11) dependent upon the Company’s ability to generate sufficient taxable income within the carryforward periods as provided in the tax law for each tax jurisdiction. The Current Deferred Total Company has considered the following 2017 U.S. federal State and local 2016 U.S. federal State and local $ $ $ $ — $ — — $ — — $ — $ — $ 40,245 $ 24,306 — — — — — 40,245 24,306 possible sources of taxable income when assessing the realization of its deferred income tax assets: • future reversals of existing taxable temporary differences; • future taxable income or loss, exclusive of reversing temporary differences and 64,551 $ 64,551 carryforwards; The actual income tax benefit (provi- sion) differs from the “expected” tax benefit 2 017 2 016 (provision) computed Expected tax benefit 634,574 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: State taxes, net of federal tax benefit $ 57,176 $ R&D tax credit Valuation allowance 40,000 (772,288) Incentive stock options $ (11,284) $ Other, net 51,822 668,716 63,844 86,659 (744,724) (6,105) (3,839) — — $ 64,551 • tax-planning strategies; and • taxable income in prior carryback years. The Company considered both positive and negative evidence in determining the need for a valuation allowance, including the following: Positive evidence: • Current forecasts indicate that the Company will generate pre-tax income and taxable income in the future. However, there can be no assurance that the new strategic plans will result Deferred income tax assets and liabilities related to the tax effects of temporary differences in profitability. are as follow as of June 30: • A majority of the Company’s tax attri- butes have indefinite carryover periods. 2 017 2 016 Negative evidence: Net deferred income tax assets (liabilities): Inventory capitalization for income tax purposes $ 92,681 $ Inventory reserve Warranty reserve Accrued product liability Allowance for doubtful accounts 157,068 78,780 9,103 149,110 Property and equipment, principally due to differences in depreciation (103,308) Research and development credit carryover Other intangibles Deferred gain on sale lease-back Operating loss carry forwards Valuation allowance 351,903 (45,256) 846,061 1,428,119 57,079 162,146 59,516 5,875 151,730 (71,038) 304,669 (62,448) 863,370 721,074 • The Company has several years of cumulative losses as of June 30, 2017. The Company places more weight on objectively verifiable evidence than on other types of evidence and management currently believes that available negative evidence outweighs the available positive evidence. Management has therefore determined that the Company does not meet the “more likely (2,964,261) (2,191,973) than not” threshold that deferred income tax Total deferred income tax assets (liabilities) $ — $ — assets will be realized and has implemented a full valuation allowance against the tax benefit for fiscal years 2017 and 2016. Any reversal of the valuation allowance will favor- A valuation allowance is required when there is significant uncertainty as to the realiz- ably impact the Company’s results of opera- ability of deferred income tax assets. The ability to realize deferred income tax assets is tions in the period of reversal. 27 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 The anticipated accumulated NOL carry The Company issued 139,658 shares of common stock during the fiscal year ended June 30, forward from fiscal year 2017 is approxi- 2017 and 91,295 shares of common stock during the fiscal year ended June 30, 2016 as payment mately $3,577,000 that will begin to expire of preferred stock dividends. in 2038. The Company has no uncertain tax The Company maintained a 2005 equity incentive plan for the benefit of employees. positions as of June 30, 2017. On June 29, 2015 the shareholders approved a new 2015 equity incentive plan setting Major Customers and Sales by Geographic Location (12) During the fiscal years ended June 30, 2017 aside 500,000 shares (“2015 Equity Plan”). The 2015 Equity Plan was filed with the SEC on September 3, 2015. Incentive and nonqualified stock options, restricted common stock, stock appreciation rights, and other share-based awards may be granted under the plan. Awards granted under the plan may be performance-based. As of June 30, 2017, 299,549 and 2016, sales to any single customer did shares of common stock were authorized and reserved for issuance, but were not granted not exceed 10% of total net sales. under the terms of the 2015 Equity Plan. The Company exports products to The Company granted 49,500 options under its 2015 Equity Plan during fiscal year 2017 approximately 30 countries. Sales outside and 95,000 options during fiscal year 2016. The options were granted at not less than 100% of North America totaled approximately the market price of the stock at the date of grant. Option terms are determined by the board $814,000 or 2.3% of net sales, for the fiscal of directors, and exercise dates may range from 6 months to 10 years from the date of grant. year ended June 30, 2017 compared to The fair value of each option grant $850,000 or 2.8% of net sales, for the fiscal was estimated on the year ended June 30, 2016. Common Stock and Common (13) Stock Equivalents On December 16, 2016, the shareholders date of grant using the Black Scholes option pricing model with the following approved an increase to the aggregate assumptions: number of shares of common stock that the Company is authorized to issue from 50,000,000 shares to 100,000,000 shares. 2 017 2 016 Expected dividend yield 0% 0% Expected stock price volatility 47% - 54% 63% - 65% Risk-free interest rate 1.84% - 2.02% Expected life of options 6 - 8 years 1.83% - 2.04% 8 years For the year ended June 30, 2017, the The weighted average fair value of options granted during fiscal year 2017 was $1.33. Company granted 36,122 shares of restricted The following table summarizes the Company’s stock option activity during the reported common stock to directors in connection fiscal years: with compensation arrangements and 106,932 shares to employees. For the year ended June 30, 2016, the Company granted 36,174 shares of restricted common stock to directors in connec- tion with compensation arrangements and 35,422 shares to employees. For the year ended June 30, 2017, the Company issued 1,559,000 shares of common stock pursuant to the Private Placement with gross proceeds of $7,795,000 used for the Acquisition and 6,173 shares for professional fees in conjunction with the Acquisition. 2 017 2 017 2 017 2 016 2 016 Weighted Average Exercise Price Weighted Average Remaining Contractual Term Weighted Average Exercise Price Number of Shares Number of Shares Options outstanding at 121,557 $ 3.33 3.56 years 91,152 $ 5.07 beginning of the year Options granted Options canceled or expired 49,500 (4,067) Options outstanding at 166,990 end of the year 2.83 4.86 3.14 6.51 years 95,000 (64,595) 4.76 years 121,557 3.27 4.74 3.84 Options exercisable at 74,473 4.46 63,940 4.75 end of the year Range of exercise prices at end of the year $ 1.75 - 5.55 $ 1.75 – 5.55 28 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 The Company recognized $419,925 and of $400,000 in cash or a value in common 390,000 shares available for future issuance. $203,889 in stock-based compensation for stock based on the trading price of the stock Those remaining 390,000 shares were sold the years ended June 30, 2017 and 2016, on the date the dividend is declared. Certain and issued in December 2016 as described respectively, which is included in selling, redemption rights are attached to the Series A above. The only difference between the shares general, and administrative expenses in the Preferred, but none of the redemption rights of Series A Preferred issued in June 2015 and consolidated statements of operations. The for cash are deemed outside the control of those issued in December 2016 is that the stock-based compensation includes amounts the Company. The redemption rights deemed formula determining voting rights for the for both restricted stock and stock options. outside the control of the Company require shares issued in June 2015 indicated a cutback Included in the stock-based compensation common stock payments or an increase in the in the voting power of those shares as required for fiscal year 2017 and 2016 was $123,877 dividend rate. The Series A Preferred includes by the Series A Designation. The shares of and $79,333, respectively, related to sever- a liquidation preference under which Series A Series A Preferred issued in December 2016 ance expenses that were settled with the Preferred Investors would receive cash equal were not subject to any cutback. For infor- issuance of common stock. to the stated value of their stock plus unpaid mation regarding the original issuance of As of June 30, 2017 there was $259,241 dividends. In accordance with the terms of the the Series A Preferred in June 2015, see the of unrecognized stock-based compensation sale of the Series A Preferred, the Company Company’s Annual Report on Form 10-K for cost that is expected to be expensed over was required to register the underlying the fiscal year ended June 30, 2016. the next four years. common shares associated with the Series A In April 2017, the Company closed the No options were exercised during Preferred and the Series A Warrants issued to Private Placement in which it raised gross fiscal years 2017 and 2016. The aggregate the Preferred Investors in the private place- proceeds of $7,795,000 pursuant to the terms intrinsic value of the outstanding options as ment, as described below. That registration of a Securities Purchase Agreement dated of June 30, 2017 and 2016 was $1,646 and statement was filed on Form S-3 on January March 21, 2017 (the “Securities Purchase $3,816, respectively. 28, 2017 and amended on February 1, 2017. Agreement”). Certain accredited investors, Preferred Stock On December 16, 2016 the shareholders approved an increase to the (14) The registration statement became effective including institutional investors (the “Series on February 10, 2017. B Preferred Investors”) participated in the The Series A Preferred votes on an as-con- Private Placement pursuant to which the verted basis, one vote for each share of Company issued a total of 1,559,000 units at aggregate number of shares of preferred common stock issuable upon conversion of $5.00 per unit, with each unit made up of one stock that the Company is authorized to issue the Series A Preferred, provided the number of share of common stock, no par value per share from 5,000,000 shares to 50,000,000 shares. shares of potential common stock eligible for (“Common Stock”) at $2.50 per share, one On December 28, 2016, the Company voting by the Preferred Investors is 390,000. share of Series B Convertible Preferred stock, completed a private placement with affiliates The Preferred Investors purchased a total no par value per share (“Series B Preferred”) at of Prettybrook Partners, LLC (“Prettybrook”) of 390,000 shares of Series A Preferred, and $2.50 per share, and a warrant to purchase 1.5 and certain other purchasers (collectively with received in connection with such purchase shares of Common Stock, exercisable at $2.75 Prettybrook, the “Series A Preferred Inves- common stock purchase warrants (collec- per share for six years. Ladenburg Thalmann tors”) for the offer and sale of the remaining tively, the “Series A Warrants”); (i) A-War- & Co. Inc. (“Ladenburg”) acted as placement designated 390,000 shares of the Compa- rants, exercisable by cash exercise only, to agent in connection with the Private Place- ny’s Series A 8% Convertible Preferred Stock purchase 292,500 shares of common stock, ment and the Company paid Ladenburg fees (the “Series A Preferred”) for gross proceeds and (ii) B-Warrants, exercisable by “cashless and expenses related to placing certain inves- of approximately $975,000. Proceeds from exercise”, to purchase 292,500 shares of tors in the Private Placement. The Series B the private placement were recorded net of common stock, but only after exercise of Preferred is convertible to common stock on offering costs incurred. The Series A Preferred holder’s A-Warrants. The Series A Warrants a 1:1 basis. A forced conversion can be initi- is convertible to common stock on a 1:1 are exercisable for 72 months from the date ated based on a formula related to share price basis. A forced conversion can be initiated of issuance and carry a put feature in the and trading volumes as outlined in the Certif- based on a formula related to share price and event of a change in control. The put right icate Designating the Preferences, Rights and trading volumes as outlined in the Certifi- is not subject to derivative accounting as all Limitations of the Series B Preferred (“Series cate Designating the Preferences, Rights and equity holders are treated the same in the B Designation”). The dividend is fixed at 8% Limitations of the Series A Preferred (“Series event of a change in control. and is payable in either cash or common stock A Designation”). The dividend is fixed at 8% The Company’s shareholders originally subject to conditions contained in the Series and is payable in either cash or common stock authorized the issuance of 2,000,000 shares B Designation. This dividend is payable quar- subject to conditions contained in the Series of the Series A Preferred in June, 2015. The terly and equates to an annual payment of A Designation. This dividend is payable Company sold and issued 1,610,000 shares $311,800 in cash or a value in common stock quarterly and equates to an annual payment of Series A Preferred in June 2015, leaving based on the trading price of the stock on 29 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 the date the dividend is declared. Certain Series B Preferred shares as if converted, redemption rights are attached to the Series B based on the closing price of the Company’s Preferred, but none of the redemption rights common stock on the date of the applicable (15) Employee Benefit Plan The Company has two deferred savings plans which qualify under Internal for cash are deemed outside the control of transaction (December 28, 2016 for Series A Revenue Code Section 401(k). the Company. The redemption rights deemed Preferred and April 3, 2017 for the Series B The first plan covers all employees of the outside the control of the Company require Preferred), less an amount of the purchase Dynatronics Corporation entity, (the “Parent common stock payments or an increase in the price assigned to the Series A Preferred or Company”), who have at least six months of dividend rate. The Series B Preferred includes Series B Preferred, as applicable, in an alloca- service and who are age 20 or older. For fiscal a liquidation preference, subject to the liqui- tion of purchase price between the preferred years 2017 and 2016, the Parent Company dation preference of the Series A Preferred, shares and common stock purchase warrants made matching contributions of 25% of the under which Series B Preferred Investors would that were issued with the Series A Preferred first $2,000 of each employee’s contribution, receive cash equal to the stated value of their and Series B Preferred. For the year ended with a six-year vesting schedule. The Parent stock plus unpaid dividends. In connection June 30, 2017, the Company recorded Company’s contributions to the plan for with the Private Placement, the Company also deemed dividends of $1,944,223 consisting fiscal years 2017 and 2016 were $45,294 and entered into a Registration Rights Agreement, of $375,858 associated with the Series A $36,103, respectively. The Parent Company obligating the Company to file a registration Preferred and $1,568,365 associated with the matching contributions for future years are at statement with the Securities and Exchange Series B Preferred. The deemed dividends the discretion of the board of directors. Commission within 45 days of closing to are combined with net loss and payment of The second plan covers all employees of register all shares of Common Stock issuable dividends on preferred stock to compute net Hausmann Enterprises LLC, the Subsidiary, as part of the units, as well as all shares of loss applicable to common stockholders for who have at least twelve months of service Common Stock underlying conversion of the purposes of calculating loss per share. and who are age 21 or older. For the fiscal year Series B Preferred stock or payment of Series The Company chose to pay preferred stock 2017, the Subsidiary made matching contribu- B dividends or issuable upon exercise of the dividends by issuing common shares valued tions of 50% of the first 6% of each employ- warrants. On April 14, 2017, the Company at $370,672 in fiscal year 2017 and $273,375 ee’s deferred contribution up to a maximum filed a registration statement on Form S-3 in fiscal year 2016. At June 30, 2017, there was of 3% of compensation, with a six-year vesting with the Securities and Exchange Commission $194,513 in accrued dividends payable for schedule applies. The Subsidiary’s contribu- to meet these registration obligations. The the quarter ended June 30, 2017, which were tions to the plan for the three-months in which registration statement became effective on issued in July 2017. The Company also paid it was owned by the Parent Company were April 24, 2017. preferred stock dividends of $16,241 in cash approximately $93,000. As of June 30, 2017, the Company currently in fiscal year 2017. No cash dividends were had 3,559,000 shares of Series A Preferred paid in fiscal year 2016. and Series B Preferred outstanding. Divi- In case of liquidation, dissolution or dends payable on these shares accrue at the winding up of the Company, Preferred Liquidity and Capital Resources (16) As of June 30, 2017, the Company had rate of 8% per year and are payable quarterly stock has preferential treatment beginning $255,000 in cash, compared to $966,000 in stock or cash. The Company generally with the Series A Preferred, then Series as of June 30, 2016. During fiscal year 2017, pays the dividends in stock. The formula for B Preferred. After preferential amounts, the Company incurred operating losses and paying this dividend in common stock can if any, to which the holders of Preferred negative cash flows from operating activi- change the effective yield on the dividend to Stock may be entitled, the holders of all ties. The Company believes that its existing more or less than 8% depending on the price outstanding shares of common stock shall revenue stream, cash flows from consoli- of the stock at the time of issuance. be entitled to share ratably in the remaining dated operations, current capital resources, In connection with each of the issuances of assets of the Company. Liquidation prefer- and borrowing availability pursuant to the Series A Preferred and the Series B Preferred, ence is as follows: the Company recorded a deemed dividend related to a beneficial conversion feature, which reflects the difference between the underlying common share value of the Series A Preferred and Shares Shares Value/ Designated Outstanding Preference Liquidation Series A Preferred 2,000,000 Series B Preferred 1,800,000 2,000,000 1,559,000 5,000,000 3,897,500 Loan and Security Agreement provide suffi- cient liquidity to fund operations through at least September 30, 2018. On March 31, 2017, the Company entered into a new two year Loan and Security Agree- ment (See Note 7) as of June 30, 2017 there was approximately $3,709,000 of additional borrowing capacity related to this Loan and Security Agreement. To fully execute on its business strategy of acquiring other entities, the Company will need to raise additional 30 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 capital. Absent additional financing, the Company will hold back $1.4 million of the and Mr. Anderson as beneficial owners Company may have to curtail its current purchase price for purposes of satisfying of stockholders of B&C) will refrain from acquisition strategy. adjustments to the purchase price as may be solicitation of employees, customers and Subsequent Events On September 26, 2017, the Company entered into a definitive agreement (17) required by the Asset Purchase Agreement business of B&C or the Company and from and indemnification claims, if any. Subject other competitive activity as defined in the to adjustments or claims as provided by Asset Purchase Agreement, and requires the Asset Purchase Agreement, 50% of the them and their representatives (as defined in (the “Asset Purchase Agreement”) to acquire holdback amount will be released to B&C the Asset Purchase Agreement) to maintain substantially all of the assets of Bird & Cronin, on the first anniversary date of the closing of (other than in connection with performing Inc., a Minnesota corporation (“B&C”), for the Acquisition; the balance of this holdback obligations pursuant to the Lease or the $14.5 million to $15.5 million in cash and amount will be released to B&C 18 months Employment Agreements, as applicable) the securities, subject to adjustment, as provided after Closing. As part of the Acquisition trans- confidentiality of, and not use, confidential in the Asset Purchase Agreement (the action, the Company will pay and discharge information relating to the acquired business “Acquisition”). The Company will fund the certain liabilities and obligations of B&C or purchased assets, except as permitted by Acquisition with proceeds from the private related to its ongoing business (primarily the Asset Purchase Agreement. placement of the Company’s Series C 6% trade accounts and similar obligations in The Company will file a Current Report Non-Voting Convertible Preferred Stock (the the ordinary course). Each share of Series on Form 8-K with the Asset Purchase “Private Placement”) and borrowings under D Preferred is convertible into one share of Agreement, Financial Statements and other an amended asset-based lending facility that common stock of the Company automatically documents as exhibits, containing a more the Company has in place with Bank of the upon, but not before receipt of shareholder complete description of the Acquisition West (the “Amended Credit Facility”). B&C approval, as described below under the and the related transactions. The foregoing designs and manufactures orthopedic soft heading “Conversion of Series C and Series description of the Asset Purchase Agree- goods and medical supplies which it sells D Preferred Stock.” ment does not purport to be complete and is and distributes in the United States and inter- The Company will make offers of employ- subject to, and qualified in its entirety by, the nationally under its own brands and under ment to employees of B&C to become Dyna- full text of the Asset Purchase Agreement. private-label manufacturing agreements. tronics employees at Closing. The Company On September 25, 2017, the Company Closing of the Acquisition is expected to has also entered into employment agree- obtained a commitment letter for an occur on or about October 2, 2017, concur- ments with the co-presidents of B&C, Michael amended loan and security agreement and rent with the closing of the Private Place- Cronin and Jason Anderson, who will act in related documentation to amend the Compa- ment and funding of the Amended Credit the same positions with the wholly-owned ny’s credit facility with Bank of the West Facility. At the Closing, the Company will operating subsidiary of the Company that (“Bank”) to provide asset-based financing acquire substantially all of the assets of B&C will act as assignee of Dynatronics at closing to the Company to be used for funding the and following the Closing, Dynatronics will and become the operating entity thereafter. Acquisition and for operating capital (the operate the business formerly conducted by Under these agreements, the Company will “Amended Credit Facility”). Amounts avail- B&C at its Minneapolis, Minnesota facility, pay each of Messrs. Cronin and Anderson able to the Company under the Amended which is owned by an affiliate of the prin- an annual salary of $175,000, a bonus up to Credit Facility will be subject to a borrowing cipal shareholder of B&C. The Company $10,000 as determined by the Company’s base calculation of up to a maximum avail- will lease the facility on terms contained in a CEO, and other employee benefits provided ability of $11,000,000 and will bear interest at lease agreement (the “Lease”) with an initial to the Company’s employees generally at LIBOR plus 2.25%. The Company will pay a three-year term, with annual lease payments their level of management at the Minnesota line increase fee of $7,500 and an unused line of $600,000. location (including, e.g., paid time off and fee of .25%. The maturity date is two years The purchase price for B&C is an amount paid holidays, medical/dental/vision insur- from the date of the note. The borrowing not to exceed $15.5 million and no less than ance, Section 125 Flexible Spending Account base is computed as an amount equal to $14.5 million, payable in cash of $10.5 million (FSA), and 401(k)). 80% of eligible accounts receivable, 48% of and shares of the Company’s Series D 6% The Asset Purchase Agreement contains finished goods inventory, and 15% of raw Non-Voting Convertible Preferred Stock (the customary representations, warranties and materials inventory. “Series D Preferred”) valued at $4.0 million covenants by B&C and the Company, as The Amended Credit Facility is subject to (as provided in the Asset Purchase Agree- well as customary indemnification provi- documentation (including a loan and security ment), with a potential for an additional sions among the parties. Post-closing cove- agreement, financing statements, notes and $1.0 million earn-out based on revenues nants include a covenant that for a period other agreements) and the obligations of of the business during the two year period of five years (the “Restrictive Period”), B&C the Company will be secured by first priority following the closing of the Acquisition. The and its stockholders (including Mr. Cronin liens on substantially all of the Company’s 31 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 and its subsidiaries’ assets (as defined in the under Section 4(a)(2) of the Securities Act Purchase Agreement, the Company has cove- Amended Credit Facility). The Amended and Regulation D promulgated thereunder, nanted to obtain approval of the Company’s Credit Facility includes financial covenants, relating to offers and sales by an issuer not shareholders (“Shareholder Approval”) as such as ratios for consolidated leverage and involving any public offering, and in reliance may be required by the Nasdaq Rules for fixed charge coverage, and customary affir- on similar exemptions under applicable state the Company to issue the shares of common mative and negative covenants for a transac- laws. Each purchaser represented that it is an stock underlying the conversion or exercise tion of this type, including, among others, the accredited investor and that it is acquiring the of any rights under the Series C or the Series provision of annual, quarterly and monthly securities for investment purposes only and D Preferred Stock or the execution of the financial statements and compliance certif- not with a view to any resale, distribution or warrants, including the following: icates, maintenance of property, insurance, other disposition of such securities in violation Nasdaq Listing Rule 5635(a), which compliance with laws and environmental of the United States federal securities laws. requires shareholder approval prior to the matters, restrictions on incurrence of indebt- Securities issued in the Private Placement are issuance of securities in connection with an edness, granting of liens, making investments “restricted securities” under the Securities Act acquisition of the stock or assets of another and acquisitions, paying dividends, entering and may not be transferred, sold or otherwise company where the total number of shares of into affiliate transactions and asset sales. The disposed of unless they are subsequently common stock to be issued is or will be equal Amended Credit Facility also contains penal- registered or an exemption is available under to or in excess of 20% of the total number of ties in connection with customary events of the Securities Act. Neither this Form 10-K, nor shares of common stock outstanding before default, including, among others, payment, the exhibits attached hereto, is an offer to sell the issuance of the stock or securities; bankruptcy, representation and warranty, or the solicitation of an offer to buy the securi- Nasdaq Listing Rule 5635(b), which covenant, change in control, judgment and ties described herein. requires prior shareholder approval for events or conditions that have a Material Each share of Series C Preferred is convert- issuances of securities that could result in a Adverse Effect (as defined in the Amended ible into one share of common stock of the “change of control” of the issuer - Nasdaq Credit Facility). Company automatically upon, but not before may deem a change of control to occur The foregoing description of the receipt of shareholder approval. A holder may when, as a result of an issuance, an investor Amended Credit Facility does not purport to elect to retain the Series C Preferred and not or a group would own, or have the right to be complete and is subject to, and qualified convert subject to future beneficial owner- acquire, 20% or more of the outstanding in its entirety by, the full text of the loan and ship limitations and loss of preferential rights. shares of common stock or voting power, and security agreement and related documents, Purchasers of the securities include a select such ownership or voting power of an issuer which will be filed as exhibits to the Compa- group of accredited investors, including insti- would be the largest ownership position of ny’s Current Report on Form 8-K, to be filed tutional investors (the “Investors”). Certain the issuer; in connection with the Acquisition. of Dynatronics’ officers and directors and Nasdaq Rule 5635(c), requiring share- In connection with the Acquisition, the significant shareholders, are Investors in the holder approval when common stock may Company initiated a private offering of the Private Placement. be issued to “insiders” (directors, officers, Company’s equity securities to raise up to Conversion of the Series C and Series employees or consultants) of the issuer in $7.0 million (the “Private Placement”). Closing D Preferred Stock. Until Dynatronics has transactions at prices less than market value, of the Private Placement under the Securities obtained shareholder approval, the Company which includes sales deemed to be “equity Purchase Agreement will occur simultane- will not issue any shares of common stock in compensation” paid to insiders, as well as ously with the Closing of the Acquisition. In an amount that exceeds 19.9% of the issued the issuance of common stock at less than the Private Placement, the Company offered and outstanding shares of common stock of market prices in payment of dividends or for and sold shares of the Company’s Series C the Company, in connection with the Series C redemption of other securities or payment of 6% Convertible Non-Voting Preferred Stock Preferred or the Series D Preferred. debt; and (the “Series C Preferred”) and common stock The Company’s Common Stock is Nasdaq Rule 5635(d), which requires purchase warrants (“Warrants”) to a limited currently listed on The NASDAQ Capital shareholder approval prior to the issuance number of accredited investors (the “Inves- Market and therefore the Company is subject of common stock in connection with certain tors”) pursuant to the terms and conditions of to the Nasdaq Listing Rules (“Nasdaq Rules”) non-public offerings involving the sale, a Securities Purchase Agreement. governing listing requirements (Section 5500 issuance or potential issuance of common The Series C Preferred and the Warrants of the Nasdaq Rules for securities listed on stock (and/or securities convertible into or and their underlying securities are offered the Capital Market) and corporate gover- exercisable for common stock) equal to and will be issued in reliance upon exemp- nance (Section 5600 of the Nasdaq Rules) of 20% or more of common stock outstanding tions from the registration requirements companies with securities listed on Nasdaq. before the issuance. of the Securities Act of 1933, as amended Pursuant to the terms of both the Asset At the Company’s 2017 Annual Meeting (the “Securities Act”), including exemptions Purchase Agreement and the Securities of Shareholders, to be held in November 32 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 or December 2017, the Company will seek Ladenburg pursuant to its agreement with the fair value of the gross assets acquired (or shareholder approval of these matters as the Company, in accordance with applicable disposed of) is concentrated in a single iden- described above. Certain key shareholders FINRA rules and regulations. No compensa- tifiable asset or a group of similar identifiable of the Company (officers, directors and tion, fees, or discounts will be paid or given to assets, the set is not a business, reducing certain shareholders) are have entered into any other person in connection with the offer the number of transactions that need to be agreements with the Investors and with B&C and sale of the securities. further evaluated. If the screen is not met, the to vote all voting securities of the Company The foregoing descriptions of the Series amendments in this update: over which such persons have voting control C Preferred, Series D Preferred, Securities as of the record date for the meeting of Purchase Agreement, Voting Agreements, 1. require that a business set must include, shareholders, amounting to, in the aggre- and warrants do not purport to be complete at a minimum, an input and a substan- gate, at least 35% of all current voting power and are subject to, and qualified in their tive process that together significantly of the Company in favor of the shareholder entirety by, the full text of these documents, contribute to the ability to create approvals described above. which will be filed as exhibits to the Compa- output, and In connection with the Private Placement ny’s Current Report on Form 8-K regarding 2. remove the evaluation of whether and the Acquisition, the Company agreed to the Acquisition. a market participant could replace file registration statements under the Secu- rities Act registering the issuance and resale of all shares of common stock underlying the conversion of the Series C Preferred and Series Recent Accounting Pronouncements (18) In January 2017, the Financial Accounting missing elements. The amendments provide a framework D Preferred and the exercise of the Warrants. Standards Board (“FASB”) issued ASU for evaluating whether both an input and The rights and preferences of the Series 2017-04, Intangibles—Goodwill and Other a substantive process are present. Lastly, C Preferred and the Series D Preferred will (Topic 350), Simplifying the Test for Goodwill the amendments in this update narrow the be designated by the Company’s Board of Impairment. The amendment in this update definition of the term output so that the Directors in amendments to the Company’s simplifies how an entity is required to test term is consistent with how outputs are Amended and Restated Articles of Incor- goodwill for impairment by eliminating Step 2 described in Topic 606. This amendment poration (the “Designations”) which will be from the goodwill impairment test. An entity will be effective for the Company in its fiscal filed prior to the closing of the Acquisition should apply the amendments in this update year (including interim periods) beginning with the Utah Division of Corporations and on a prospective basis. This amendment July 1, 2018. The Company is currently Commercial Code. will be effective for the Company in its fiscal evaluating the impact the adoption of ASU The Warrants have an exercise price of year beginning July 1, 2020. Early adoption 2017-01 will have on its consolidated finan- $2.75 per share of Common Stock and a term is permitted for interim or annual goodwill cial statements and disclosures. of six years. The Warrants may not be exer- impairment tests performed on testing In February 2016, the FASB issued ASU cised unless and until Shareholder Approval dates after January 1, 2017. The Company is No. 2016-02, Leases (Topic 842,) a new has been obtained. At the election of the currently evaluating the impact the adoption guidance on leases. This guidance replaces holder of the Warrant, the holder may be of ASU 2017-04 will have on its consolidated the prior lease accounting guidance in its restricted from the exercise of the Warrant financial statements and disclosures. entirety. The underlying principle of the new or any portion of the Warrant held by such In January 2017, the FASB issued ASU standard is the recognition of lease assets holder, to the extent that, after giving effect 2017-01, Business Combinations (Topic and lease liabilities by lessees for substan- to the conversion, such holder (together with 805), Clarifying the Definition of a Business. tially all leases, with an exception for leases such holder’s affiliates, and any persons acting The Board issued this update to clarify the with terms of less than twelve months. The as a group together with such holder or any definition of a business with the objective standard also requires additional quantitative of such holder’s affiliates) would beneficially of assisting entities with evaluating whether and qualitative disclosures. The guidance is own in excess of 4.99% (or 9.99%, as such transactions should be accounted for as effective for interim and annual reporting holder may elect) of the number of shares of acquisitions (or disposals) of assets or busi- periods beginning after December 15, the Common Stock outstanding immediately nesses. Under Topic 805, there are three 2018, and early adoption is permitted. The after giving effect to the exercise. elements of a business—inputs, processes, standard requires a modified retrospective Ladenburg Thalmann & Co. Inc. (“Laden- and outputs (collectively referred to as a approach, which includes several optional burg”) acted as placement agent and “set”) although outputs are not required as practical expedients. Accordingly, the the Company will pay Ladenburg fees for an element of a business set. The amend- standard is effective for the Company on July its services in connection with proceeds ments in this update provide a screen to 1, 2019. It is currently evaluating the impact received in the Private Placement from determine when a set is not a business. The that this guidance will have on the consoli- Investors introduced to the Company by screen requires that when substantially all of dated financial statements of the Company. 33 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 In January 2016, the FASB issued ASU 2016-01, Financial Instruments, a guidance related to financial instruments - overall recognition and measurement of financial assets and financial liabilities. The guidance enhances the reporting model for finan- cial instruments, which includes amend- ments to address aspects of recognition, measurement, presentation and disclosure. The update to the standard is effective for public companies for interim and annual periods beginning after December 15, 2017. Accordingly, the standard is effective for the Company on July 1, 2018. It is currently eval- uating the impact that the standard will have on the consolidated financial statements. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customer (Topic 606). This authoritative accounting guidance related to revenue from contracts with customers. This guidance is a compre- hensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. This guidance is effective for annual reporting periods beginning after December 15, 2017. Accordingly, the Company will adopt this guidance on July 1, 2018. Companies may use either a full retrospective or a modified retro- spective approach to adopt this guidance. The Company is evaluating which transition approach to use and its impact, if any, on its consolidated financial statements. In August 2014, the FASB issued ASU 2014-15 Presentation of Financial State- ments—Going Concern, an authoritative accounting guidance related to the disclo- sure of uncertainties about an entity’s ability to continue as a going concern. This guidance requires management to evaluate, at each interim and annual reporting period, whether there are condi- tions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the consolidated financial statements are issued, and provide related disclosures. The Company adopted this guidance for the fiscal year ended June 30, 2017. 34 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 General Information Dynatronics Corporation, a Utah corporation organized on April 29, 1983, manufactures, markets and distributes a broad line of ther- apeutic, diagnostic and rehabilitation equip- ment, medical supplies and soft goods, and treatment tables to an expanding market of physical therapists, sports medicine practi- tioners and athletic trainers, chiropractors, podiatrists, orthopedists, and other medical professionals. Annual Meeting The company’s annual shareholder meeting will be held at Dynatronics’ corporate head- quarters on November 29, 2017 at 3:00 pm MT. 7030 Park Centre Drive Cottonwood Heights, Utah 84121 Accountants, Legal Counsel and Transfer Agent Tanner, LLC, Salt Lake City, Utah Independent Registered Public Accounting Firm Durham Jones & Pinegar, Salt Lake City, Utah 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 www.dynatronics.com Availability of Form 10-K Dynatronics Corporation files an annual report on Form 10-K each year with the Secu- rities and Exchange Commission. A copy of the Form 10-K for the fiscal year ended June 30, 2017, may be obtained at no charge by sending a written request to: Mr. Jim Ogilvie Vice President of Business Development Dynatronics Corporation 7030 Park Centre Drive Cottonwood Heights, Utah 84121 Officers and Directors Kelvyn H. Cullimore, Jr. Chairman, President and CEO David A. Wirthlin Chief Financial Officer T. Jeff Gephart Senior Vice President of Sales Cynthia L. McHenry Vice President of Operations Jim. N. Ogilvie Vice President of Business Development Douglas G. Sampson Vice President of R&D, Quality and Regulatory Bryan D. Alsop Vice President of Information Technology Erin S. Enright Director David B. Holtz Director Scott A. Klosterman Director Brian M. Larkin Director R. Scott Ward, PT PhD Director 35 Dynatronics Corporation Notes to Consolidated Statements June 30, 2017 and 2016 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 antic- ipated results. 36 

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