The following discussion contains assumptions, estimates and other
forward-looking statements that involve a number of risks and uncertainties,
including those discussed under the heading "Cautionary Note Regarding
Forward-Looking Statements," on page 1 of this Form 10-K, "Risk Factors"(Part I,
Item 1A of this Form 10-K) and elsewhere in this Form 10-K. These risks could
cause our actual results to differ materially from those anticipated in these
forward-looking statements.
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements and related Notes thereto, which are included in Part II, Item 8 of
this report.
Overview
Wedesign, manufacture, and sell a broad range of restorative products for
clinical use in physical therapy, rehabilitation, orthopedics, pain management,
and athletic training. Through our distribution channels, we market and sell to
orthopedists, physical therapists, chiropractors, athletic trainers, sports
medicine practitioners, clinics, and hospitals.
Results of Operations
Fiscal Year 2021 Compared to Fiscal Year 2020
Net Sales
Net sales in fiscal year 2021 decreased $5,610,000, or 10.5%, to $47,799,000,
compared to net sales of $53,409,000 in fiscal year 2020. The year-over-year
decrease is primarily due to the continued impact of COVID-19, including reduced
demand for our products, reduced capacity and operating hours, supply chain
disruptions, and extended handling times.
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Gross Profit
Gross profit for the year ended June 30, 2021 decreased $2,212,000, or 14.7%, to
$12,886,000, or 27.0% of net sales. By comparison, gross profit for the year
ended June 30, 2020 was $15,098,000, or 28.3% of net sales. The year-over-year
decrease in gross profit was attributable to: (1) lower sales, which reduced
gross profit by approximately $1,586,000 and (2) reduced gross margin percent,
which reduced gross profit by approximately $626,000. The year-over-year
decrease in gross margin percentage to 27.0% from 28.3% was due primarily to
$488,000 in costs associated with exit activities as a result of optimizing the
business, higher freight and material costs, and lower efficiency of the
production process as a result of lower sales. These items were partially offset
by the benefit of the employee retention credit under the CARES Act, as amended,
of $175,000 in the year ended June 30, 2021.
Selling, General, and Administrative Expenses
Selling, general, and administrative ("SG&A") expenses decreased $1,445,000, or
8.0%, to $16,646,000 for the year ended June 30, 2021, compared to
$18,091,000for the year ended June 30, 2020. Selling expenses decreased
$1,383,000 compared to the prior year period, due primarily to lower commission
expense on lower sales and decreased sales management salaries during the year.
General and administrative ("G&A") expenses decreased $62,000 compared to the
prior-year period, driven primarily by a decrease in payroll and benefit costs
as a result of headcount reductions. This decrease included the benefit of the
employee retention credit of $216,000. These reductions were partially offset by
$513,000 in costs associated with exit activities as a result of optimizing the
business.
Interest Expense
Interest expense decreased approximately $220,000, or 50.5%, to $216,000 for the
year ended June 30, 2021, compared to $436,000 for the year ended June 30, 2020.
The decrease in interest expense is primarily related to lower interest rates
and lower average borrowings on our line of credit resulting in interest charges
of $30,000 for the year ended June 30, 2021, compared to $196,000 for the year
ended June 30, 2020. A large component of interest expense is imputed interest
related to the sale/leaseback of our Utah facility, which totaled $143,000 and
$156,000, respectively, for the years ended June 30, 2021 and 2020. Interest
expense also included interest on the mortgage on our Tennessee property,
interest on our paycheck protection program loan, imputed interest related to
other capital leases, and interest paid on equipment loans for office
furnishings and vehicles.
Gain on Extinguishment of Debt
Gain on extinguishment of debt increased to $3,518,000 for the year ended June
30, 2021 compared to $0 for year ended June 30, 2020 due to a gain on
extinguishment of our paycheck protection program loan.
Other Income (Expense)
Other income increased approximately $2,456,000 to $2,449,000 for the year ended
June 30, 2021, compared to other expense of $7,000 for the year ended June 30,
2020. The increase in other income is primarily due to: (1) a $717,000 gain on
the sale of property and equipment, principally, our Tennessee property, and (2)
a $1,726,000 employee retention credit for funds received or receivable from the
U.S. federal government under the CARES Act.
Net Income (Loss) Before Income Tax
Pre-tax income for the year ended June 30, 2021 was $1,991,000 compared to a
loss of $3,436,000 for the year ended June 30, 2020. The $5,427,000 increase in
pre-tax income was primarily attributable to a decrease of $2,212,000 in gross
profit, offset by a decrease of $1,445,000 in SG&A, $220,000 in interest
expense, and an increase of $5,974,000 in other income.
Income Tax
Income tax benefit was $10,000 in fiscal year 2021 and 2020.
Net Income (Loss)
Net income for the year ended June 30, 2021 was $2,001,000 compared to net loss
of $3,425,000 for the year ended June 30, 2020. The reasons for the change in
net loss are the same as those given under the headings Net Income (Loss) Before
Income Tax and Income Taxin this Management's Discussion and Analysis of
Financial Condition and Results of Operations ("MD&A").
23
Net Income (Loss) Attributable to Common Stockholders
Net income attributable to common stockholders increased $5,526,000 to
$1,209,000 ($0.08 per share) for the year ended June 30, 2021, compared to a
loss of $4,317,000 ($0.42 per share) for the year ended June 30, 2020. The
increase in net income attributable to common stockholders for the year is due
primarily to: (1) a $5,427,000 increase in net income; (2) a $122,000 decrease
in deemed dividends on convertible preferred stock and accretion of discounts;
and (3) a $23,000 increase in preferred stock dividends.
Liquidity and Capital Resources
We have historically financed operations through cash from operating activities,
available cash reserves, borrowings under a line of credit facility (see Line of
Credit, below) and proceeds from the sale of our equity securities. As of June
30, 2021, we had $6,102,000 in cash and cash equivalents, compared to $2,216,000
as of June 30, 2020. During fiscal year 2021 and 2020, we generated positive
cash flows from operating activities.
Working capital was $12,433,000 as of June 30, 2021, compared to working capital
of $8,396,000 as of June 30, 2020. The current ratio was 2.5 to 1 as of June 30,
2021 and 2.1 to 1 as of June 30, 2020. Current assets were 53.4% of total assets
as of June 30, 2021, and 42.8% of total assets as of June 30, 2020.
We believe that our cash generated from operations, current capital resources
including recent equity proceeds, and available credit provide sufficient
liquidity to fund operations for the next 12 months. However, the continuing
effects of the COVID-19 pandemic could have an adverse effect on our liquidity
and cash and we continue to evaluate and take action, as necessary, to preserve
adequate liquidity and ensure that our business can continue to operate during
these uncertain times.
In March 2020, we entered into an equity distribution agreement with Canaccord
Genuity LLC and Roth Capital Partners LLC, pursuant to which we arranged to
offer and sell shares of our common stock in an at-the-market offering ("ATM")
under a registration statement previously filed by us on Form S-3 with the
Securities and Exchange Commission. On March 13, 2020, we filed a Prospectus
Supplement amending the registration statement (as amended, the "Original
Registration Statement") and commenced the ATM. Under the terms of the equity
distribution agreement, we may sell shares of our common stock in an aggregate
amount of up to $10,000,000, with Canaccord Genuity LLC and Roth Capital
Partners LLC acting as our sales agents at the market prices prevailing on The
Nasdaq Capital Market at the time of the sale of such shares. We will pay
Canaccord Genuity LLC and Roth Capital Partners, LLC a fixed commission rate
equal to 3.0% of the gross sale price per share of common stock sold.
In April 2020, we sold an aggregate of 3,200,585 shares of common stock under
the equity distribution agreement in the ATM. We incurred offering costs
totaling $238,000, inclusive of commissions paid to the sales agents at a fixed
rate of 3.0%, together with legal, accounting and filing fees. Net proceeds from
the sale of the shares totaled $2,287,000. Proceeds were used to strengthen our
liquidity and working capital position. In February 2021, we sold an aggregate
of 2,230,600 shares of common stock under the equity distribution agreement in
the ATM. Offering costs were incurred totaling $138,000, inclusive of
commissions paid to the sales agents at a fixed rate of 3.0%, together with
legal, accounting and filing fees. Net proceeds from the sale of the shares
totaled $3,462,000. Proceeds were used to strengthen the our liquidity and
working capital position. In May 2021, we filed a registration statement on Form
S-3 together with a Prospectus Supplement, for the purpose of replacing the
Original Registration Statement, which expired after three years, pursuant to
applicable SEC rules. The replacement registration statement provides for
potential futures sales in conjunction with a prospectus supplement for up to
$2,677,997 in common stock in the ATM.
24
Cash and Cash Equivalents and Restricted Cash
Our cash and cash equivalents and restricted cash position increased $3,938,000
to $6,254,000 as of June 30, 2021, compared to $2,316,000 as of June 30, 2020.
The primary sources of cash in the year ended June 30, 2021, was $383,000 net
cash provided by operating activities, $1,678,000 net proceeds from the sale of
property and equipment, and $3,462,000 net proceeds from issuance of common
stock. Primary uses of cash included net payments of $1,013,000 under our line
of credit.
Accounts Receivable
Trade accounts receivable, net of allowance for doubtful accounts, increased
approximately $749,000, or 15.3%, to $5,643,000 as of June 30, 2021, from
$4,894,000 as of June 30, 2020. The increase was primarily due to an increase in
sales in the quarter ended June 30, 2021 compared to the quarter ended June 30,
2020. Trade accounts receivable represents amounts due from our customers
including dealers and distributors, medical practitioners, clinics, hospitals,
colleges, universities and sports teams. We believe that our estimate of the
allowance for doubtful accounts is adequate based on our historical experience
and relationships with our customers. Accounts receivable are generally
collected within approximately 40 days of invoicing.
Inventories
Inventories, net of reserves, decreased $1,846,000, or 22.0%, to $6,526,000 as
of June 30, 2021, compared to $8,372,000 as of June 30, 2020. The decrease was
primarily due to the elimination of low-margin third-party distributed products
and outsourcing of therapeutic modality production to a third party
manufacturer. During fiscal year 2021, we recorded in cost of goods sold
$452,000 in non-cash write-offs of inventory related to discontinued product
lines, excess repair parts, product rejected for quality standards, and other
non-performing inventory, compared to inventory write-offs of $460,000 in fiscal
year 2020. We believe that our estimate of the allowance for inventory reserves
is adequate based on our historical knowledge and product sales trends.
Accounts Payable
Accounts payable increased approximately $724,000, or 24.0%, to $3,738,000 as of
June 30, 2021, from $3,014,000 as of June 30, 2020. The increase in accounts
payable was driven primarily by an increase in inventory purchases and timing of
payments.
Line of Credit
We have a line of credit with Bank of the West ("Line of Credit") available
pursuant to a loan and security agreement, as amended (the "Loan and Security
Agreement"), that matures on January 15, 2022. Our obligations under the Line of
Credit are secured by a first-priority security interest in substantially all of
our assets. The Line of Credit requires a lockbox arrangement and contains
affirmative and negative covenants, including covenants that restrict our
ability to, among other things, incur or guarantee indebtedness, incur liens,
dispose of assets, engage in mergers and consolidations, make acquisitions or
other investments, make changes in the nature of our business, and engage in
transactions with affiliates. The agreement also contains financial covenants
including a minimum monthly consolidated fixed charge coverage ratio which only
applies when the excess availability amount under the Line of Credit is less
than the greater of $1,000,000 or 10% of the borrowing base. As amended, the
Loan and Security Agreement provides for revolving credit borrowings in an
amount up to the lesser of $11,000,000 or the calculated borrowing base. The
borrowing base is computed monthly and is equal to the sum of stated percentages
of eligible accounts receivable and inventory, less a reserve. Amounts
outstanding bear interest at LIBOR plus 2.25% (approximately 2.4% as of June 30,
2021). The Line of Credit is subject to a quarterly unused line fee of .25%.
Borrowings on the Line of Credit were $0and $1,013,000 as of June 30, 2021 and
2020, respectively. As of June 30, 2021, there was approximately $4,960,000
available to borrow.
25
Debt
Long-term debt decreased approximately $3,586,000 to approximately$19,000 as of June 30, 2021, compared to approximately $3,605,000 as of June 30,
2020. Our long-term debt is primarily comprised of loans related to equipment.
On April 29, 2020, we entered into a promissory note (the "Note") with Bank of
the West to evidence a loan in the amount of $3,477,000 under the paycheck
protection program ("PPP") established under the CARES Act, administered by the
U.S. Small Business Administration ("SBA"). In accordance with the requirements
of the CARES Act, we used the proceeds from the loan exclusively for qualified
expenses under the PPP, including payroll costs, mortgage interest, rent and
utility costs, as further detailed in the CARES Act and applicable guidance
issued by the SBA. Interest accrued on the outstanding balance of the Note at a
rate of 1.00% per annum. On June 29, 2021, we received notification from Bank of
the West that the SBA approved our forgiveness application for the entire
balance of the Note for $3,518,000, including all accrued interest thereon,
leaving the Company with a remaining Note balance of zero as of June 30, 2021.
The gain on extinguishment of $3,518,000 is included in other income on the
Consolidated Statement of Operations for the year ended June 30, 2021.
Finance Lease Liability
Finance lease liability as of June 30, 2021 and 2020 totaled approximately
$2,596,000 and $2,914,000, respectively. Our finance lease obligations consist
primarily of a building lease. In conjunction with the sale and leaseback of our
Utah building in August 2014, we entered into a 15-year lease, classified as a
finance lease, originally valued at $3,800,000. The building lease asset is
amortized on a straight line basis over 15 years at approximately $252,000 per
year. Total accumulated amortization related to the leased building is
approximately $1,743,000 at June 30, 2021. The sale generated a profit of
$2,300,000, which is being recognized straight-line over the life of the lease
at approximately $150,000 per year as an offset to amortization expense. The
balance of the deferred gain as of June 30, 2021 is $1,229,000. Lease payments,
currently approximately $30,000, are payable monthly and increase annually by
approximately 2% per year over the life of the lease. Imputed interest for the
fiscal year ended June 30, 2021 was approximately $143,000. In addition to the
Utah building, we lease certain equipment pursuant to arrangements which have
been determined to be finance leases. As of June 30, 2021, future minimum gross
lease payments required under the finance leases were as follows:
2022 $472,874
2023 445,280
2024 384,754
2025 392,446
2026 400,292
Thereafter 1,320,610
Total $3,416,256
Operating Lease Liability
Operating lease liability as of June 30, 2021 and June 30, 2020 totaled
approximately $2,470,000 and $3,358,000, respectively. Our operating lease
liability consists primarily of building leases for office, manufacturing,
warehouse and storage space.
Inflation
Cost inflation including increases in ocean container rates, raw material
prices, labor rates, and domestic transportation costs have impacted
profitability. Continued imbalances between supply and demand for these
resources may continue to exert upward pressure on costs. Our ability to recover
these costs increased through price increases may continue to lag the cost
increases, resulting in downward pressure on margins.
26
Stock Repurchase Plan
In 2011, our Board of Directors adopted a stock repurchase plan authorizing
repurchases of shares in the open market, through block trades or otherwise.
Decisions to repurchase shares under this plan are based upon market conditions,
the level of our cash balances, general business opportunities, and other
factors. The Board may periodically approve amounts for share repurchases under
the plan. As of June 30, 2021, approximately $449,000 remained available under
this authorization for purchases under the plan. No purchases have been made
under this plan since September 28, 2011.
Critical Accounting Policies
This MD&A is based upon our Consolidated Financial Statements (see
Part II, Item 8 below), which have been prepared in accordance with accounting
principles generally accepted in the U.S. ("GAAP"). The preparation of these
financial statements requires us to make estimates and assumptions that affect
the reported amounts of assets, liabilities, revenue and expenses as well as the
disclosure of contingent assets and liabilities. We regularly review our
estimates and assumptions. The SEC has requested that all registrants address
their most critical accounting policies. The SEC has indicated that a "critical
accounting policy" is one which is both important to the representation of the
registrant's financial condition and results and requires management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain. We
base our estimates on past experience and on various other assumptions our
management believes to be reasonable under the circumstances, the results of
which form the basis for making judgments about carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
will differ, and may differ materially from these estimates under different
assumptions or conditions. Additionally, changes in accounting estimates could
occur in the future from period to period. Our management has discussed the
development and selection of our most critical financial estimates with the
audit committee of our Board of Directors. The following paragraphs identify our
most critical accounting policies:
Inventories
The nature of our business requires that we maintain sufficient inventory on
hand at all times to meet the requirements of our customers. We record finished
goods inventory at the lower of standard cost, which approximates actual cost
(first-in, first-out) or market. Raw materials are recorded at the lower of cost
(first-in, first-out) or market. Inventory valuation reserves are maintained for
the estimated impairment of the inventory. Impairment may be a result of
slow-moving or excess inventory, product obsolescence or changes in the
valuation of the inventory. In determining the adequacy of reserves, we analyze
the following, among other things:
?
Current inventory quantities on hand;
?
Product acceptance in the marketplace;
?
Customer demand;
?
Historical sales;
?
Forecast sales;
?
Product obsolescence;
?
Strategic marketing and production plans;
?
Technological innovations; and
?
Character of the inventory as a distributed item, finished manufactured item or
raw material.
Any modifications to estimates of inventory valuation reserves are reflected in
cost of goods sold within the statements of operations during the period in
which such modifications are determined necessary by management. As of June 30,
2021, and 2020, our inventory valuation reserve balance, was approximately
$627,000 and $568,000, respectively, and our inventory balance was $6,526,000
and $8,372,000, net of reserves, respectively.
27
Revenue Recognition
Our sales force and distributors sell Manufactured and Distributed Products to
end users, including orthopedists, physical therapists, chiropractors, athletic
trainers, sports medicine practitioners, clinics, and hospitals. Revenue is
recognized when performance obligations under the terms of a contract with a
customer are satisfied which occurs upon the transfer of control of a product.
This occurs either upon shipment or delivery of goods, depending on whether the
contract is FOB origin or FOB destination. Revenue is measured as the amount of
consideration expected to be received in exchange for transferring products to a
customer.Contracts sometimes allow for forms of variable consideration including
rebates and incentives. In these cases, the Company estimates the amount of
consideration to which it will be entitled in exchange for transferring products
to customers utilizing the most likely amount method. Rebates and incentives are
estimated based on contractual terms or historical experience and a liability is
maintained for rebates and incentives that have been earned but are
unpaid.Revenue is reduced by estimates of potential future contractual discounts
including prompt payment discounts. Provisions for contractual discounts are
recorded as a reduction to revenue in the period sales are recognized. Estimates
are made of the contractual discounts that will eventually be incurred.
Contractual discounts are estimated based on negotiated contracts and historical
experience.Shipping and handling activities are accounted for as fulfillment
activities. As such, shipping and handling are not considered promised services
to our customers. Costs for shipping and handling of products to customers are
recorded as cost of sales.
Allowance for Doubtful Accounts
We must make estimates of the collectability of accounts receivable. In doing
so, we analyze historical bad debt trends, customer credit worthiness, current
economic trends and changes in customer payment patterns when evaluating the
adequacy of the allowance for doubtful accounts. Our accounts receivable balance
was $5,643,000 and $4,894,000, net of allowance for doubtful accounts of
$399,000 and $185,000 as of June 30, 2021, and 2020, respectively.
Deferred Income Taxes
A valuation allowance is required when there is significant uncertainty as to
the realizability of deferred tax assets. The realization of deferred tax assets
is dependent upon our ability to generate sufficient taxable income within the
carryforward periods provided for in the tax law for each tax jurisdiction. We
have considered the following possible sources of taxable income when assessing
the realization of our deferred tax assets:
?
future reversals of existing taxable temporary differences;
?
future taxable income or loss, exclusive of reversing temporary differences and
carryforwards;
?
tax-planning strategies; and
?
taxable income in prior carryback years.
We considered both positive and negative evidence in determining the continued
need for a valuation allowance, including the following:
Positive evidence:
?
Current forecasts indicate that we will generate pre-tax income and taxable
income in the future. However, there can be no assurance that our strategic
plans will result in profitability.
?
A majority of our tax attributes have indefinite carryover periods.
Negative evidence:
? We have nine years of losses out of the last ten fiscal years as of June 30,
2021.
28
We place more weight on objectively verifiable evidence than on other types of
evidence and management currently believes that available negative evidence
outweighs the available positive evidence. We have therefore determined that we
do not meet the "more likely than not" threshold that deferred tax assets will
be realized. Accordingly, a valuation allowance is required. Any reversal of the
valuation allowance will favorably impact our results of operations in the
period of reversal.As of June 30, 2021 and June 30, 2020, we recorded a full
valuation allowance against our net deferred income tax assets. The anticipated
accumulated net operating loss carryforward as of June 30, 2021, is
approximately $10,383,000, which will begin to expire in 2037.
Recent Accounting Pronouncements
See Note 1 to the Consolidated Financial Statements included in Item 8 of the
Form 10-K for a description of recent accounting pronouncements.
Off-Balance Sheet Financing
We have no off-balance sheet debt or similar obligations. We have no
transactions or obligations with related parties that are not disclosed,
consolidated into or reflected in our reported results of operations or
financial position. We do not guarantee any third-party debt.
Business Plan and Outlook
This past year our focus has been on driving profitability in our business
through business optimization initiatives, while continuing to build our
restorative products platform for long-term success.
On April 22, 2021, the Company announced its plans to eliminate low-margin
distributed products, streamline sales exclusively to dealers, and focus sales
and marketing efforts on products manufactured by Dynatronics. These
optimization initiatives are expected to result in a reduction to revenue but
also an increase to gross margin and operating income relative to fiscal year
2021.
Summary of Optimization Changes Announced
Drive Sales Growth and Better Partner with Customers
?
Eliminate approximately 1,600 SKUs of low-margin, third-party distributed
products, which are unprofitable, low growth, and add complexity
?
Focus sales and marketing resources on products manufactured by Dynatronics
?
Streamline sales exclusively to dealers, thereby eliminating perceived
competition with customers from historic direct sales efforts
Expand Margins and Profitability
?
Focus on higher margin, differentiated products manufactured by the Company
?
Consolidate support functions to reflect this focus
?
Target significant accretion to EBITDA and profitability through this
optimization
?
Strengthen balance sheet via sustainable cash flow from operations, which can
support additional investment and/or M&A in target markets
On August 9, 2021, the Company announced that the optimization initiatives
announced on April 22, 2021 had been substantially completed as planned. The
customer and dealer reaction to Dynatronics' optimization has been strong and
early results have exceeded our base case expectation.
We are confident that the steps we have taken will position the Company for
success moving forward. In fiscal 2022 we are focused on executing our
strategies as follows:
?
Drive sales through enhancing our partnerships with key strategic accounts,
demand generation, and continuing to deliver superior customer care;
?
Increase our operating profitability through disciplined product portfolio
management;
?
Pursue merger and acquisition opportunities in our core markets through pipeline
management, disciplined valuation, and superior execution; and
?
Bolster our communication with the investor community through investor
conferences and calls with equity research analysts and investors.
We are actively pursuing an acquisition strategy to consolidate other
manufacturers in our core markets (i.e. physical therapy, rehabilitation,
orthopedics, pain management, and athletic training). We are primarily seeking
candidates that fall into the following categories:
?
Manufacturers in markets where we have a competitive advantage;
?
Tuck-in manufacturers in adjacent markets; and
?
Value-oriented businesses with growth potential, stable margins, and cash flow.
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