NOTE 6. INVENTORIES
NOTE 7. RELATED-PARTY TRANSACTIONS
The Company leases office, manufacturing and warehouse facilities in Detroit, Michigan, Hopkins, Minnesota, and Northvale, New Jersey and Eagan, Minnesota from employees/employees, shareholders orand entities controlled by shareholders, who were previously principals of businesses acquired by the Company. The combined expenses associated with these related-party transactions totaled approximately $108,000$257,400 and $18,000$17,700 for the three months ended September 30,December 31, 2017 and 2016, respectively, and $365,400 and $35,400 for the six months ended December 31, 2017 and 2016, respectively.
Certain significant shareholders, officers and directors of the Company participated as investors in the private placementplacements of the Company'sCompany’s Series A Preferred, Series B Preferred and Series BC Preferred. The terms of thethese offerings were reviewed and approved by the disinterested members of the Company'sCompany’s Board of Directors who did not invest in the private placementplacements and who do not own any shares of Series A Preferred, Series B Preferred or Series BC Preferred. The affiliated investors participated in these offerings on terms that were no more favorable than the terms granted to unaffiliated investors.
Pursuant to the Company'sCompany’s acquisition of Hausmann Industries, Inc. ("Hausmann"(“Hausmann”) in April 2017, the Company held back approximately $1,044,744approximately$1,045,000 of the purchase price. This obligation to Hausmann is a liability on the Company's balance sheets asAs of September 30,December 31, 2017, and June 30, 2017.2017, the holdback liability to Hausmann under the purchase agreement was $1,000,000 and $1,045,000, respectively. Certain principals of Hausmann are holders of the Company'sCompany’s Series B Preferred and one of the principals, David Hausmann, is an employee of the Company.
6In connection with the Acquisition of B&C in October 2017, the Company held back approximately $647,000 in cash plus an earn-out payment of a minimum of $500,000 up to $1,500,000. These obligations to B&C, totaling approximately $2,147,000, are liabilities on the Company’s balance sheet as of December 31, 2017. In addition, the Company withheld approximately 467,000 shares of common stock to be released to B&C pursuant to the holdback provisions in the Asset Purchase Agreement. These shares are included in common stock on the Company’s balance sheet at December 31, 2017. Certain principals of B&C are holders of the Company’s common stock and two of the principals, Michael Cronin and Jason Anderson, are employees of the Company.
NOTE 8. LINE OF CREDIT
On September 28, 2017, the Company modified its credit agreement with Bank of the West and entered into an Amended Credit Facility (the "“Amended Credit Facility"”) to provide asset-based financing to the Company to be used for funding the acquisition of substantially all of the assets of Bird & Cronin, Inc., a Minnesota corporation ("B&C") (See note 10)Acquisition (see Note 2) and for operating capital. The Amended Credit Facility provides for revolving credit borrowings by the Company 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%. The Company paid a commitment fee of .25% and the line is subject to an unused line fee of .25%. The maturity date is September 30, 2019. The Company'sCompany’s obligations under the Amended Credit Facility are secured by a first-priority security interest in substantially all of its assets, including those of its subsidiaries. The Amended Credit Facility includes financial covenants, such as ratios for consolidated leverage and fixed charge coverage, and customary affirmative and negative covenants for a credit facility of this type, including, among others, the provision of annual, quarterly and monthly financial statements and compliance certificates, maintenance of property, insurance, compliance with laws and environmental matters, restrictions on incurrence of indebtedness, granting of liens, making investments and acquisitions, paying dividends, entering into affiliate transactions and asset sales. The Amended Credit Facility also contains penalties in connection with customary events of default, including, among others, payment, bankruptcy, representation and warranty, covenant, change in control, judgment and events or conditions that have a Material Adverse Effect (as defined in the Amended Credit Facility). As of September 30,December 31, 2017, the Company had borrowed approximately $7,103,000$6,742,979 under the Amended Credit Facility compared to $2,172,000$2,171,935 as of June 30, 2017, which included $5,000,000 drawn on September 29, 2017, in anticipation of closing the B&C acquisition on October 2, 2017. There was approximately $2,030,000$1,874,268 available to borrow under the original loan and security agreement as of September 30,December 31, 2017.
NOTE 9. INCOME TAXES
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (“Tax Act”). The Tax Act provides for significant changes to the U.S. Internal Revenue Code of 1986, as amended. Among other items, the Act permanently reduces the federal corporate tax rate to 21% effective January 1, 2018. As the Company’s fiscal year end falls on June 30, the statutory federal corporate tax rate for fiscal 2018 will be prorated to 27.5%, with the statutory rate for fiscal 2019 and beyond at 21%.
As a result of the reduction in the corporate income tax rate from 35% to 21% under the Act, the Company revalued its net deferred tax assets at December 31, 2017. As of December 31, 2017 and June 30, 2017, a full valuation allowance has been established against net deferred tax assets. This resulted in no reported income tax expense associated with the operating profit reported during the three and six months ended December 31, 2017.
The final transition impacts of the Tax Act may vary from the current estimate, possibly materially, due to, among other things, further clarification and changes in interpretations of the Tax Act, any legislative action to address questions that arise because of the Tax Act, any changes in accounting standards for income taxes or related interpretations in response to the Tax Act, and the completion of the Company’s consolidated financial statements as of and for the year ending June 30, 2018. In accordance with SAB 118, any necessary measurement adjustments will be recorded and disclosed within one year from the enactment date within the period the adjustments are determined.
NOTE 10. RECENT ACCOUNTING PRONOUNCEMENTS
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (“Tax Act”). The Tax Act provides for significant changes to the U.S. Internal Revenue Code of 1986, as amended. Among other items, the Act permanently reduces the federal corporate tax rate to 21% effective January 1, 2018.
Additionally, the SEC released Staff Accounting Bulletin No. 118 (“SAB 118”) which provides guidance on accounting for the Act’s impact under ASC Topic 740, Income Taxes (“ASC 740”). The guidance in SAB 118 addresses certain fact patterns where the accounting for changes in tax laws or tax rates under ASC 740 is incomplete upon issuance of an entity's financial statements for the reporting period in which the Act is enacted. Under the staff guidance in SAB 118, in the financial reporting period in which the Act is enacted, the income tax effects of the Act (i.e., only for those tax effects in which the accounting under ASC 740 is incomplete) would be reported as a provisional amount based on a reasonable estimate (to the extent a reasonable estimate can be determined), which would be subject to adjustment during a “measurement period” until the accounting under ASC 740 is complete. The measurement period is limited to no more than one year beyond the enactment date under the staff's guidance. SAB 118 also describes supplemental disclosures that should accompany the provisional amounts, including the reasons for the incomplete accounting, the additional information or analysis that is needed, and other information relevant to why the registrant was not able to complete the accounting required under ASC 740 in a timely manner. For discussion of the impacts of the Tax Act, refer to Note 9.
In November 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-14,Income Statement – Reporting Comprehensive Income (Topic 220), Revenue Recognition (Topic 605), and Revenue from Contracts with Customers (Topic 606): Amendments to SEC Paragraphs Pursuant to the Staff Accounting Bulletin (“SAB”) No. 116 and SEC Release No. 33-10403. This ASU amended, superseded and added certain SEC paragraphs in Topic 220, Topic 605 and Topic 606 to reflect the August 2017 issuance of SAB 116 and SEC Release No. 33-10403. The SEC staff issued SAB 116 to align its revenue guidance with Accounting Standards Codification (“ASC”) 606. For public business entities, this update is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early application is permitted. The Company is currently evaluating the impact of the adoption of this update on its consolidated financial statements.
In July 2017, the FASB issued ASU 2017-11 – Earnings per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Non-controlling Interests with a Scope Exception.Part I of this update addresses the complexity of accounting for certain financial instruments with down round features. Current accounting guidance creates cost and complexity for entities that issue financial instruments (such as warrants and convertible instruments) with down round features that require fair value measurement of the entire instrument or conversion option. Stakeholders asserted that accounting for freestanding and embedded instruments with down round features as liabilities subject to fair value measurement on an ongoing basis creates a significant reporting burden and unnecessary income statement volatility associated with changes in value of an entity'sentity’s own share price. That is, current accounting guidance requires changes in fair value of an instrument with a down round feature to be recognized in earnings for both increases and decreases in share price, even though an increase in share price will not cause a down round feature to be triggered and a decrease will cause an adjustment to the strike price only if and when an entity engages in a subsequent equity offering.
Part II of this update addresses the difficulty of navigating Topic 480, Distinguishing Liabilities from Equity, because of the existence of the extensive pending content in the FASB Accounting Standards Codification. This pending content is the result of the indefinite deferral of accounting requirements about mandatorily redeemable financial instruments of certain nonpublic entities and certain mandatorily redeemable non-controlling interests.
The amendments in Part I of this update change the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round features no longer precludes equity classification when assessing whether the instrument is indexed to an entity'sentity’s own stock. The amendments in Part II of this update recharacterize the indefinite deferral of certain provisions of Topic 48 that now are presented as pending content in the Codification, to a scope exception. Those amendments do not have an accounting effect. The Company is currently evaluating the impact the adoption of this update will have on its consolidated financial statements and disclosures. This amendment is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.
In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment. The amendment in this update simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. An entity should apply the amendments in this update on a prospective basis. This amendment will be effective for the Company in its fiscal year beginning July 1, 2020. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact the adoptionhas early adopted this standard as of ASU 2017-04 will have on its consolidated financial statements and disclosures.
In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805), Clarifying the Definition of a Business. The Board issued this update to clarify the definition of a business with the objective of assisting entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Under Topic 805, there are three elements of a business—inputs, processes, and outputs (collectively referred to as a "set"“set”) although outputs are not required as an element of a business set. The amendments in this update provide a screen to determine when a set is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business, reducing the number of transactions that need to be further evaluated. If the screen is not met, the amendments in this update:
1. | require that a business set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output, and |
| |
2. | remove the evaluation of whether a market participant could replace missing elements. |
1.
require that a business set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output, and
2.
remove the evaluation of whether a market participant could replace missing elements.
The amendments provide a framework for evaluating whether both an input and a substantive process are present. Lastly, the amendments in this update narrow the definition of the term output so that the term is consistent with how outputs are described in Topic 606. This amendment will be effective for the Company in its fiscal year (including interim periods) beginning July 1, 2018. The Company is currently evaluating the impact the adoption of ASU 2017-01 will have on its consolidated financial statements and disclosures.
In February 2016, the FASB issuedASU No. 2016-02, Leases (Topic 842,)a new guidance on leases. This guidance replaces the prior lease accounting guidance in its entirety. The underlying principle of the new standard is the recognition of lease assets and lease liabilities by lessees for substantially all leases, with an exception for leases with terms of less than twelve months. The standard also requires additional quantitative and qualitative disclosures. The guidance is effective for interim and annual reporting periods beginning after December 15, 2018, and early adoption is permitted. The standard requires a modified retrospective approach, which includes several optional practical expedients. Accordingly, the standard is effective for the Company on July 1, 2019. It The Company is currently evaluating the impact that this guidance will have on the consolidated financial statements of the Company.statements.
In January 2016, the FASB issuedASU 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 financial instruments, which includes amendments 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 The Company is currently evaluating the impact that the standard will have on the consolidated financial statements.
In May 2014, the FASB issuedASU 2014-09, Revenue from Contracts with Customer (Topic 606). This authoritative accounting guidance related to revenue from contracts with customers. This guidance is a comprehensive 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 retrospective approach to adopt this guidance. The Company is evaluating which transition approach to use and its impact, if any, on its consolidated financial statements.
NOTE 10.11. SUBSEQUENT EVENTS
On October 2, 2017, the Company closed the acquisition of substantially all of the assets of B&C, pursuant to an Asset Purchase Agreement dated as of September 26, 2017 (the "Asset Purchase Agreement") for $10,000,000 in cash (subject to adjustment), $4,000,000 in shares of Dynatronics preferred stock designated as Series D Non-Voting Convertible Preferred Stock (the "Series D Preferred"), and an earn out provision ranging from $500,000 to $1,500,000 based on future sales (collectively, the "Acquisition"). The Company assigned the assets acquired in the Acquisition to its wholly-owned subsidiary, Bird & Cronin, LLC, a newly formed Utah limited liability company. The Company financed the Acquisition with $7,000,000 in gross proceeds from the sale of newly designated Series C Non-Voting Convertible Preferred Stock (the "Series C Preferred") and amounts borrowed pursuant to the Amended Credit Facility (see Note 8). The Company drew $5,000,000 on the Amended Credit Facility on September 29, 2017. The funding of the Private Placement and payment of the consideration under the Asset Purchase Agreement occurred simultaneously on October 2, 2017 (the "Closing").
B&C is a closely-held corporation founded in 1968 that designs, manufactures, and distributes orthopedic soft goods and specialty patient care products to customers in the United States and internationally. Over 95% of B&C's products are made in an 85,000 square-foot manufacturing facility located at 1200 Trapp Road, Eagan, Minnesota (the "Facility") owned by an affiliate of B&C. The Acquisition does not include a purchase of the facility. At the Closing, the Company entered into a lease with Trapp Road Limited Liability Company, a Minnesota limited liability company controlled by the former owners of B&C, to occupy the facility for a term of three years at annual rental payments of $600,000, payable in monthly installments of $50,000. The lease provides that the lease term will automatically be extended for two additional periods of two years each, without any increase in the lease payment, subject to the Company's right to terminate the lease or to provide notice not to extend the term of the lease prior to the end of the term.
At the Closing of the Acquisition, the Company paid B&C cash of $9,063,017 and delivered 1,397,375 shares of its Series D Preferred Stock valued at approximately $3,533,333. A holdback of cash totaling $933,334 and 184,559 shares of Series D Preferred valued at approximately $466,666 will be retained for purposes of satisfying adjustments to the purchase price as may be required by the Asset Purchase Agreement and indemnification claims, if any. Subject to adjustments or claims as provided by the Asset Purchase Agreement, 50% of the holdback amount will be released to B&C one year from the Closing, and the balance of the holdback amount will be released to B&C 18 months after Closing. As part of the Acquisition, the Company will pay and discharge certain liabilities and obligations of B&C related to its ongoing business (primarily trade accounts and similar obligations in the ordinary course).
The Company offered employees of B&C employment with Dynatronics at Closing. In addition, the Co-Presidents of B&C, Mike Cronin and Jason Anderson, entered into employment agreements with the Company (the "Employment Agreements") to serve as Co-Presidents of Bird & Cronin, LLC, reporting to the Company's CEO, Kelvyn H. Cullimore, Jr. The Company will pay them each an annual salary of $175,000 and an annual bonus of up to $10,000, as determined by Mr. Cullimore. The Company will also provide them with other employee benefits provided to its employees generally at their level of management (including, e.g., paid time off and paid holidays, health insurance, Section 125 Flexible Spending Account, and 401(k)). In addition to the restrictive covenants applicable to them under the Asset Purchase Agreement, the Employment Agreements include restrictive covenants which limit the ability of Messrs. Anderson and Cronin to be employed by a competitor of, or otherwise to compete with, Dynatronics for, in Mr. Anderson's case, a two-year period, and, in Mr. Cronin's case, a one-year period following the later of (i) termination of employment and (ii) the latest date upon which Dynatronics makes any severance payment to the employee.
The Asset Purchase Agreement contains customary representations, warranties and covenants by B&C and the Company, as well as customary indemnification provisions among the parties. Post-closing covenants include a covenant that for a period of five years, B&C and its shareholders (including Mr. Cronin) will refrain from, among other things, solicitation of employees, customers and business of B&C or the Company and from other competitive activity as defined in the Asset Purchase Agreement, and requires them and their representatives (as defined in the Asset Purchase Agreement) to maintain (other than in connection with performing obligations pursuant to the Lease or the Employment Agreements, as applicable), the confidentiality of, and not use, confidential information relating to the acquired business or purchased assets, except as permitted by the Asset Purchase Agreement.In connection with the Acquisition, the Company completed a private placement (the "Private Placement") of the Series C Preferred and common stock warrants ("Series C Warrants") to raise $7.0 million pursuant to the terms and conditions of a Securities Purchase Agreement entered into September 26, 2017. The Series C Warrants have an exercise price of $2.75 per share of common stock and a term of six years. They may not be exercised unless and until shareholder approval has been obtained. At the election of the holder of a Series C Warrant, the holder may be restricted from the exercise of the Series C Warrant or any portion of the Series C Warrant held by such holder, to the extent that, after giving effect to the exercise, such holder (together with such holder's affiliates, and any persons acting as a group together with such holder or any of such holder's affiliates) would beneficially own in excess of 4.99% (or 9.99%, as such holder may elect) of the number of shares of the common stock outstanding immediately after giving effect to the exercise.
Each share of Series C Preferred and Series D Preferred is convertible into one share of common stock of the Company automatically upon, but not before receipt of shareholder approval required under applicable Nasdaq Marketplace Rules. A holder of Series C Preferred may elect to retain the Series C Preferred and not convert, subject to future beneficial ownership limitations and loss of preferential rights.
Until it has obtained shareholder approval, the Company will not issue any shares of common stock in an amount that exceeds 19.9% of the issued and outstanding shares of common stock of the Company in connection with the Series C Preferred or the Series D Preferred. At the Company's 2017 Annual Meeting of Shareholders, to be held on November 29, 2017, the Company will seek shareholder approval as described above. Certain key shareholders of the Company (officers, directors and certain shareholders) have entered into agreements with the Series C Investors and with B&C to vote all voting securities of the Company over which such persons have voting control as of the record date for the meeting of shareholders, amounting to, in the aggregate, at least 35% of all current voting power of the Company, in favor of the shareholder approval described above.
The Company filed a registration statement on Form S-3 with the SEC on October 13, 2017, amended on October 24, 2017, to register the shares of common stock issuable upon conversion of the Series C Preferred and Series D Preferred and the exercise of the Series C Warrants. That registration statement became effective on October 26, 2017.
On October 23, 2017, the Company announced that it had signed an exclusive distribution agreement for the United States with Zimmer MedizinSysteme GmbH ("Zimmer") for select therapy equipment. Under the terms of the agreement, the Company will be the exclusive U.S. distributor for Zimmer's ThermoPro™ (Shortwave Diathermy), enPuls™ (Radial Pulse Therapy), and OptonPro™ (Class IV Laser) products. Principally operating outside the U.S., Zimmer is a leading manufacturer of physical rehabilitation modalities in Germany, and one of the top three manufacturers of therapeutic modalities in Europe.
In October 2017,January 2018, the Company paid approximately $187,000$201,000 of preferred stock dividends with respect to the Series A Preferred and Series B Preferred that were accrued during the three months ended September 30,December 31, 2017. The Company paid the dividends by issuing 83,14769,574 shares of common stock. Also during October 2017, the Company issued 25,000 shares of common stock upon conversion of 25,000 shares of Series B Preferred.
10
ItemItem 2.
Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Statement Concerning Forward-Looking Statements
Information contained in this Form 10-Q, particularly in the following Discussion and Analysis of Financial Condition and Results of Operations, includes statements considered to be "forward-looking statements"“forward-looking statements” within the safe harbors provided by Section 27A of the Securities Act of 1933, as amended (the "“Securities Act"”) and Section 21E of the Securities Exchange Act of 1934, as amended ("(“Exchange Act"”). These statements refer to our expectations, hopes, beliefs, anticipations, commitments, intentions and strategies regarding the future. They may be identified by the use of words or phrases such as "believes," "expects," "anticipates," "should," "plans," "estimates," "intends,"“believes,” “expects,” “anticipates,” “should,” “plans,” “estimates,” “intends,” and "potential,"“potential,” among others. Forward-looking statements include, but are not limited to, statements regarding product development, market acceptance, financial performance, revenue and expense levels in the future and the sufficiency of existing assets to fund future operations and capital spending needs. Actual results could differ materially from the anticipated results or other expectations expressed in such forward-looking statements. The forward-looking statements contained in this report are made as of the date of this report and we assume no obligation to update them or to update the reasons why actual results could differ from those projected in such forward-looking statements, except as required by law.
Overview
Dynatronics Corporation ("(“Company," "” “Dynatronics," "” “we"”) designs, manufactures and distributes advanced-technology therapeutic medical devices, therapeutic and medical treatment tables, rehabilitation equipment, custom athletic training treatment tables and equipment, institutional cabinetry, orthopedic soft goods, as well as other rehabilitation and therapy products and supplies. Through our various distribution channels, we market and sell our products to physical therapists, chiropractors, athletic trainers, sports medicine practitioners, orthopedists, and other medical professionals, hospitals, and institutions. We operate on a fiscal year ending June 30. For example, reference to fiscal year 2018 refers to the year ending June 30, 2018.
Recent Events
On October 2,November 29, 2017, we purchased substantially allheld our annual meeting of shareholders who approved the automatic conversion of the assets of Bird & Cronin, Inc., a privately-held Minnesota corporation ("B&C") pursuant toSeries C Preferred and the terms and conditions contained in an Asset Purchase Agreement dated as of September 26, 2017 (the "Asset Purchase Agreement") for $10,000,000 in cash (subject to adjustment), $4,000,000 in shares of our preferred stock designated as Series D Non-Voting Convertible Preferred Stock (the "Series D Preferred Stock"), and an earn out provision ranging from $500,000 to $1,500,000 based on future sales (the "Acquisition"). We assigned the assets acquiredcommon stock, subject, in the Acquisition to our wholly-owned subsidiary, Bird & Cronin, LLC, a newly formed Utah limited liability company. We financedcase of the Acquisition with proceeds from the sale of our Series C Non-Voting Convertible Preferred, Stock ("to the right of the holder to elect to continue to hold the Series C Preferred and defer conversion subject to beneficial ownership limitation provisions. These unconverted shares of Series C Preferred are non-voting and are no longer entitled to certain preferences of the Series C Preferred Stock") to accredited investors in a private offering (the "Private Placement") such as the accrual or receipt of dividends, liquidation preferences and funds borrowed under our asset-based credit facility with Bank of the West, amendedredemption rights, and are treated as of September 28, 2017 (the "Amended Credit Facility"). Gross proceeds from the Private Placement were $7,000,000. See Part II, Item 2. Unregistered Sales of Equity Securities and Use of Proceeds, below,common shares for more information about the Private Placement. We borrowed $5,000,000 on the Amended Credit Facility on September 29, 2017 to use for the Acquisition. The funding of the Private Placement and payment of the consideration under the Asset Purchase Agreement occurred simultaneously on October 2, 2017 (the "Closing").such purposes.
B&C was founded in 1968 and prior to the Acquisition designed, manufactured, and distributed orthopedic soft goods and specialty patient care products to customers in the United States and internationally. Over 95% of B&C's products were made in an 85,000 square-foot manufacturing facility located at 1200 Trapp Road, Eagan, Minnesota (the "Facility") owned by an affiliate of B&C. The Acquisition did not include a purchase of the Facility. At the Closing, we entered into a lease ("Lease") with Trapp Road Limited Liability Company, a Minnesota limited liability company owned by principals of B&C, to occupy the Facility for a term of three years at annual rental payments of $600,000, payable in monthly installments of $50,000. The Lease provides that the term will automatically be extended for two additional two-year terms, without any increase in the lease payment, subject to our right to terminate the Lease or to provide notice not to extend the term of the Lease prior to the end of the term. The business previously conducted by B&C at the Facility is now conducted by our subsidiary, Bird & Cronin, LLC.
At the Closing of the Acquisition, we paid B&C cash of $9,063,017 and delivered 1,397,375 shares of our Series D Preferred Stock valued at approximately $3,533,333. A holdback of cash totaling $933,334 and 184,559 shares of Series D Preferred Stock valued at approximately $466,666 will be retained for purposes of satisfying adjustments to the purchase price as may be required by the Asset Purchase Agreement and indemnification claims, if any. Subject to such adjustments or claims, 50% of the holdback amount will be released to B&C one year from the Closing, and the balance of the holdback amount will be released to B&C 18 months after Closing. Under the Acquisition Agreement, we agreed to pay and discharge certain liabilities and obligations of B&C related to its ongoing business (primarily trade accounts and similar obligations in the ordinary course).We offered employees of B&C employment with Dynatronics at Closing. In addition, the Co-Presidents of B&C, Mike Cronin and Jason Anderson, entered into employment agreements with the Company (the "Employment Agreements") to serve as Co-Presidents of Bird & Cronin, LLC, reporting to our CEO, Kelvyn H. Cullimore, Jr. Under the Employment Agreements, each of them is paid an annual salary of $175,000 and an annual bonus of up to $10,000, as determined by Mr. Cullimore, and they receive other employee benefits provided to our employees generally at their level of management (including, e.g., paid time off and paid holidays, medical/dental/vision insurance, Section 125 Flexible Spending Account and 401(k)). In addition to certain restrictive covenants applicable to them under the Asset Purchase Agreement described in the following paragraph, the Employment Agreements include restrictive covenants limiting the ability of Messrs. Anderson and Cronin to be employed by a competitor of, or otherwise to compete with, Dynatronics for, in Mr. Anderson's case, a two-year period, and, in Mr. Cronin's case, a one-year period, following the later of (i) termination of employment and (ii) the latest date upon which Dynatronics makes any severance payment to the terminated executive.
The Asset Purchase Agreement contains customary representations, warranties and covenants, as well as indemnification provisions. Post-closing covenants include a covenant that for a period of five years, B&C and its shareholders (including Mr. Cronin) will refrain from, among other things, solicitation of employees, customers and business of B&C or the Company and from other competitive activity as defined in the Asset Purchase Agreement, and requires them and their representatives (as defined in the Asset Purchase Agreement) to maintain (other than in connection with performing obligations pursuant to the Lease or the Employment Agreements, as applicable), the confidentiality of, and not use, confidential information relating to the acquired business or purchased assets, except as permitted by the Asset Purchase Agreement.
On October 23, 2017, we announced that we have entered into an exclusive distribution agreement for the United States with Zimmer MedizinSysteme GmbH ("Zimmer") for select therapy equipment. Under the terms of the agreement, we are now the exclusive U.S. distributor for Zimmer's ThermoPro™ (Shortwave Diathermy), enPuls™ (Radial Pulse Therapy), and OptonPro™ (Class IV Laser) products. Combining our existing modalities with these Zimmer products will provide our customers in the U.S. with a complete range of modality products. Principally operating outside the U.S., Zimmer is a leading manufacturer of physical rehabilitation modalities in Germany, and one of the top three manufacturers of therapeutic modalities in Europe. Prior to the execution of this agreement, we operated for the last nine months as a distributor for Zimmer on a nonexclusive basis, building our base of experience and confidence in the products. The Zimmer product line will be sold through both our direct sales force and dealer channel.
Business Outlook
Our strategic objective is to accelerate growth both organically and by acquisition. In support of this strategy, we completed the acquisition ofWe acquired the assets of Hausmann Industries, Inc. ("(“Hausmann"”) in April 2017 and we acquired the Acquisitionassets of Bird & Cronin, Inc. (“Bird & Cronin”) in October 2017. These acquisitions have strengthenedenhanced our market position and will improveimproved our operating results, and positionpositioning us for positive cash flow.
The debt and equity financings completed in connection with these acquisitions have strengthened our financial position and provided operating capital in addition to acquisition funding.capital. We believe our relationshiprelationships with Prettybrook Partners LLC initiated in June 2015, providesand Bank of the West provide us with strategic and financial resources that will facilitate the execution of our strategic objectives.
In the past three years we have invested in executive talent and infrastructure to organize and prepare for additional significant growth. We have added executive talent across the organization including sales, operations, finance, and information technology. The management additions have bolstered our capacity to successfully acquire and integrate additional acquisition targets and to drive improvement in operating results in our current operations.
Our merger and acquisition strategy is focused on acquiring complementary businesses that simultaneously meet our investment criteria and enhancebroaden our product offerings. We continue to evaluate severala variety of acquisition opportunities and aimopportunities. Our target is to execute on at least one acquisition in calendar 2018. We believe this strategy leverages our unique distribution channel with high quality products that will increase sales and profitability and/or expand our distribution reach and product offering, further strengthening our position in the market.
Organic growth is anotheralso an essential element of our growth plan. Each operational division has established strategic plan. We previously began implementing a planplans to add new dealers and sales representatives to expand our coverage across North America and into international territories. We continue to invest in our sales organization to improve our market penetration and market expansion.
Dynatronics is a leader instimulate growth through expansion of distribution channels, product innovation and product quality. The strategy for introducing technologically updated or new products continues to be an emphasis, including both proprietary and OEM products. Our recent appointment as the exclusive dealer for certain therapeutic modalities manufactured by Zimmer will add complementary therapeutic modalities to those we manufacture. We expect that our continued introduction of new products will reinforce our reputation as an innovator of quality products and further strengthen our position as a leader in the design and manufacture of therapeutic modalities.specific initiatives with existing customer base.
As delivery of healthcare in the U.S. progresses under legislative reform, we believe there will be increasing demand for rehabilitation and physical therapy products and services. There is increasing pressure to find alternatives to the surgical suite. We believe this will lead to more demand for physical therapy services as a method for avoiding, preventing or delaying the need for surgical interventions. There are orthopedic clinics now embedding physical therapy and rehabilitation within their offering of services in order to better address patient needs in a pre-surgical as well as post-surgical environment. Third-party payers are also demanding better outcomes and structuring reimbursement conventions to reward practitioners who show identifiably improved outcomes. Physical therapy and rehabilitation has always figured prominently in the post-surgical environment to achieve the best outcomes following orthopedic surgical procedures. With the new reimbursement paradigms, the importance of physical therapy will only increase. The concept of "pre-habilitation"“pre-habilitation” to avoid, prevent or delay surgical interventions, combined with traditional rehabilitation to achieve the best post-surgical outcomes provides a positive environment for growth of physical therapy and rehabilitation services and products in the future.
We also service the athletic training market. The growth of college athletics – particularly in the "Power Five"“Power Five” conferences – is creating a demand for the best and most impressive training facilities. We are working to tap into that demand by offering our custom designed furniture and proprietary products. The acquisition of Hausmann will particularly boost this effort as it has historically had success with its ProTeam™ line of products that address this same market.
In summary, based on our defined strategic initiatives we are focusing our resources in the following areas:
· | Joining resources of the acquired entities to maximize cross-selling opportunities without disrupting each entity's current channels of distribution; |
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· | Exploring operating synergies with acquired companies while respecting established operating paradigms at each operation; |
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· | Seeking to improve distribution of our products through recruitment of additional qualified sales representatives and dealers attracted by the many new products being offered and expanding the availability of proprietary combination therapy devices; |
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· | Improving gross profit margins by, among other initiatives, increasing market share of manufactured products with emphasis on our high margin therapeutic modalities including state-of-the-art Dynatron® ThermoStim probe, Dynatron Solaris® Plus and 25 Series™ products as well as new products from other manufacturers such as Zimmer. |
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· | Maintaining our position as a technological leader and innovator in our markets through the promotion of new products introduced during the current fiscal year and seeking opportunities to introduce other new products during the current fiscal year; |
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· | Exploring strategic business acquisitions. This will leverage and complement our competitive strengths, increase market reach and allow us to ultimately broaden our footprint in the physical medicine markets; |
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· | Attending strategic conferences to make investors aware of our strategic plans, attract new capital to support the business development strategy and identify other acquisition targets. |
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Joining resources of the acquired entities to maximize cross-selling opportunities without disrupting each entity’s current channels of distribution;
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Exploring operating synergies with acquired companies while respecting established operating paradigms at each operation;
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Seeking to improve distribution of our products through expansion of sales channels;
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13Improving gross profit margins by, among other initiatives, increasing market share of manufactured products with emphasis on our high margin therapeutic modalities including state-of-the-art Dynatron® ThermoStim probe, Dynatron Solaris® Plus and 25 Series™ products as well as new products from other manufacturers such as Zimmer;
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Maintaining our position as a technological leader and innovator in our markets through the promotion of new products introduced over the last year and seeking opportunities to introduce other new products during the current fiscal year;
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Exploring strategic business acquisitions. This will leverage and complement our competitive strengths, increase market reach and allow us to ultimately broaden our footprint in the physical medicine markets; and
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Attending appropriate investor conferences to better publicize our strategic plans, attract new capital to support the business development strategy and identify other acquisition targets.
Results of Operations
The following discussion and analysis of our financial condition and results of operations for the three and six months ended September 30,December 31, 2017, and 2016, should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto appearing in Part I, Item 1 of this report, and our Annual Report on Form 10-K for the fiscal year ended June 30, 2017, which includes audited financial statements for the year then ended. We have rounded many numbers to the nearest thousand dollars in this analysis. These numbers should be read as approximate. Results of operations for the firstsecond fiscal quarter and six months ended September 30,December 31, 2017, are not necessarily indicative of the results that may be achieved for the full fiscal year ending June 30, 2018. This quarterly report includes the financial results of the newly acquired Bird and Cronin division. In connection with that acquisition, we filed a Current Report on Form 8-K on October 6, 2017.
Net Sales
Net sales increased 56.8%$9,368,000, or $4,635,000,107.5%, to $12,798,000$18,081,000 for the quarter ended September 30,December 31, 2017, compared to net sales of $8,163,000$8,713,000 for the quarter ended September 30,December 31, 2016. The year-over-year increase in net sales for the quarter ended September 30,December 31, 2017 was driven primarily by our acquisitionacquisitions of Hausmann in April 2017 and Bird & Cronin in October 2017, that contributed $4,671,000$4,368,000 and $5,698,000, respectively, in net sales in the quarter whichended December 31, 2017. These increases were partially offset by a decrease of approximately $699,000, or 8.0%, in net sales from Dynatronics’ legacy operations. Included in the quarter ended December 31, 2016 was also an 11.9% increase over Hausmann's pre-acaquisition salesa $517,000 non-recurring order that accounts for the same quartermajority of the prior year.$699,000 sales differential between the two comparative quarters.
For the six months ended December 31, 2017, net sales increased $14,003,000, or 83.0%, to $30,879,000, compared to net sales of $16,876,000 for the corresponding period ended December 31, 2016. The year-over-year increase in our net sales also included a 10%, or $316,000, increase, inwas attributable primarily to the acquisitions of Hausmann and Bird & Cronin. Hausmann contributed net sales of Dynatronics legacy manufactured products,$9,040,000 in the six months ended December 31, 2017 and Bird & Cronin contributed net sales of $5,698,000 in the three months ended December 31, 2017. These increases were partially offset by a 7%decrease of approximately $731,000, or 4.3%, or $352,000, decrease, in distributed products and other sales.net sales from Dynatronics’ legacy operations, primarily due to the $517,000 order in the second quarter of fiscal 2017 that did not repeat in the second quarter of fiscal 2018.
Gross Profit
Gross profit for the quarter ended September 30,December 31, 2017 increased $1,545,000 $2,697,000, or about 55.3%87.7%, to $4,339,000,$5,770,000, or 33.9%31.9% of net sales.sales. By comparison, gross profit for the quarter ended September 30,December 31, 2016 was $2,795,000, $3,073,000, or 34.2%35.3% of net sales.sales. The year-over-year increase in gross profit was attributable to the acquisitions of Hausmann and Bird & Cronin that contributed $1,066,000 and $2,082,000, respectively, in gross profit in the quarter ended December 31, 2017. These increases were partially offset by a decrease of approximately $451,000 in Dynatronics’ legacy operations gross profit. That decrease was primarily attributable to lower sales which accounted for approximately $236,000 lower gross profit and reduced gross margin percentage resulting in $215,000 lower gross profit. The year-over-year decrease in gross margin percentage to 31.9% from 35.3% was due primarily to inclusion of Hausmann sales, which had a lower gross margin percentage in the quarter, as well as reduced gross margin in Dynatronics’ legacy operations, primarily attributable to reduced margins on freight charged to customers.
Gross profit for the six months ended December 31, 2017 increased $4,241,000, or about 72.3% to $10,109,000, or 32.7%, of net sales, compared to gross profit for the six months ended December 31, 2016 of $5,868,000, or 34.8% of net sales. The year-over-year increase in gross profit was driven by the additionacquisitions of Hausmann'sHausmann and Bird & Cronin that contributed $2,685,000 and $2,082,000, respectively, in gross profit of approximately $1,619,000 in the current year period and increased gross profit of $115,000 on sales of Dynatronics' manufactured products,six months ended December 31, 2017. These increases were partially offset by a decrease of $189,000 inapproximately $525,000 gross profit onin Dynatronics’ legacy operations, primarily attributable to lower sales of Dynatronics' distributed productswhich accounted for approximately $171,000 lower gross profit and other revenue.reduced gross margin percentage resulting in $354,000 lower gross profit. The year-over-year decrease in gross margin percentage to 33.9%32.7% from 34.2%34.8% was due primarily to the inclusion of Hausmann lower gross margin percentage as well as reduced gross margin in Dynatronics’ legacy operations, primarily attributable to the addition of Hausmann products in the current quarter, a change in product mix, and higherreduced margins on freight costs.charged to customers.
Selling, General and Administrative Expenses
Selling, general and administrative ("(“SG&A"”) expenses increased 38.3%$2,259,000, or $1,058,000,79.2%, to $3,823,000$5,110,000 for the quarter ended September 30,December 31, 2017, compared to $2,764,000$2,851,000 for the quarter ended September 30,December 31, 2016. Selling expenses in the current quarter represented $276,000$691,000 of the $1,058,000$2,259,000 increase in SG&A expenses. Increases in selling expenses were driven primarily by $311,000included the addition of $858,000 of expenses associated with Hausmann and Bird & Cronin operations, partially offset by $35,000$167,000 lower selling costs in the Dynatronics'Dynatronics’ legacy operations.
operations comprised primarily of reduced commissions on lower sales. General and administrative ("(“G&A"”) expenses represented $782,000$1,567,000 of the $1,058,000$2,259,000 increase in SG&A expenses for the quarter ended December 31, 2017. Increases in G&A expenses included the addition of $1,623,000 in G&A expenses from Hausmann’s and Bird & Cronin’s operations, partially offset by $56,000 in decreased G&A expenses in Dynatronics’ legacy operations. G&A expenses included approximately $100,000 in acquisition related expenses during the current quarter.
SG&A expenses for the six months ended December 31, 2017 increased $3,317,000, or 59.1%, to $8,933,000, compared to $5,616,000 for the six months ended December 31, 2016. Selling expenses represented $968,000 of the $3,317,000 increase in SG&A expenses. IncreasesIncluded in selling expenses were $1,169,000 of selling expenses associated with Hausmann and Bird & Cronin operations, partially offset by $202,000 lower selling costs in Dynatronics’ legacy operations comprised primarily of lower commissions on lower sales. G&A expenses represented $2,349,000 of the $3,317,000 increase in SG&A expenses for the six months ended December 31, 2017. Included in G&A expenses were driven primarily by $640,000 in$2,263,000 from Hausmann’s operations and Bird & Cronin’s operations, and $86,000 from Dynatronics’ legacy operations. G&A expenses of Hausmann's operations and $212,000included $314,000 in acquisition-related costs associated withacquisition expenses in the Acquisition, offset in part by $83,000 in lower G&A labor and benefits in Dynatronics' legacy operations.six months ended December 31, 2017.
Research and Development Expenses
Research and development expenses for the quarter ended September 30,December 31, 2017 decreased 9.7%increased $244,000, or approximately $27,000,78.8%, to $252,000$553,000 from approximately $279,000$309,000 in the quarter ended September 30,December 31, 2016. Research and development expenses for the six months ended December 31, 2017 increased $217,000, or 36.9%, to $805,000 from approximately $588,000 in the six months ended December 31, 2016. The decreaseincreases in both the quarter and six months ended December 31, 2017 were driven by $325,000 in costs incurred on a project which was drivenabandoned during the quarter ended December 31, 2017, offset by a reduction of expenses associated with new product development.in other R&D costs are expensed as incurredexpenses of approximately $81,000 and are expected to remain approximately at present levels in$108,000 for the balance of the current fiscal year.quarter and six months, respectively, ended December 31, 2017.
Net Income (Loss) Before Income Tax
Pre-tax income for the quarter ended
September 30,December 31, 2017 was approximately
$199,000,$14,000, compared to a pre-tax loss of
$286,000$95,000 for the quarter ended
September 30,December 31, 2016.
The
$484,000$109,000 improvement in pre-tax income
for the quarter was primarily attributable to
a $1,545,000 increase in$2,697,000 higher gross profit, offset by
an increase$2,259,000 increased SG&A expenses and $244,000 higher research and development expenses. Pre-tax income for the six months ended December 31, 2017 was approximately $213,000, compared to a pre-tax loss of
$1,058,000 of$381,000 for the six months ended December 31, 2016. The $594,000 improvement in pre-tax income for the six months was primarily attributable to $4,241,000 higher gross profit, offset by $3,317,000 in increased SG&A
expenses and $217,000 higher research and development expenses. These changes
in both the quarter and six months ended December 31, 2017 were primarily
relatedattributable to components of
Hausmann'sHausmann’s and Bird & Cronin’s results of operations
as well asoffset by the $325,000 in costs related to the abandoned project in the second fiscal quarter and transaction
related costs
associated withof $100,000 and $314,000 in the
Acquisition.quarter and six months ended December 31, 2017, respectively.Income Tax Provision (Benefit)
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (“Tax Act”). The Tax Act provides for significant changes to the U.S. Internal Revenue Code of 1986, as amended. Among other items, the Act permanently reduces the federal corporate tax rate to 21% effective January 1, 2018. As the Company’s fiscal year end falls on June 30, the statutory federal corporate tax rate for fiscal 2018 will be prorated to 27.5%, with the statutory rate for fiscal 2019 and beyond at 21%.
Income tax provision was $0 for both quartersthe quarter and six months ended September 30,December 31, 2017, respectively. This compares to income tax provision of $0 for the quarter and 2016.six months ended December 31, 2016, respectively. We decreased the valuation allowance on our net deferred income tax assets by approximately $74,000equal to the one-time revaluation of our net deferred tax assets at the lower tax rate.
Net Income (Loss)
Net income was $14,000 for the quarter ended September 30, 2017 and increased the valuation allowance by $102,000 for the quarter ended September 30, 2016, eliminating any income tax expense or benefit that would have otherwise been recognized. See Liquidity and Capital Resources – Deferred Income Tax Assets below for more information regarding the valuation allowance and its anticipated impact on the effective tax rate for fiscal 2018. Net Income (Loss)
Net income was approximately $199,000 for the quarter ended September 30,December 31, 2017, compared to a net loss of
$286,000$95,000 for the quarter ended
September 30,December 31, 2016. Net income was $213,000 for the six months ended December 31, 2017, compared to a net loss of $381,000 for the six months ended December 31, 2016. The
improvementchanges in net income
for the quarter was driven by(loss) are the same
factors discussedas explained above
underfor Net Income (Loss) Before Income Tax.Tax.Net Income (Loss) ApplicableLoss Attributable to Common Stockholders
Net income applicableloss attributable to common stockholders was approximately $12,000$1,314,916 ($0.000.23 per share) for the quarter ended September 30,December 31, 2017, compared to a loss of $375,000$560,000 ($0.130.19 per share) for the quarter ended September 30,December 31, 2016. Net income (loss) applicableThe $755,000 year-over-year increase in net loss attributable to common stockholders includes the effectis due to approximately $217,000 of accruedadditional preferred stock dividends to holders of our Series A 8% Convertible Preferred Stock ("Series A Preferred Stock") and Series B Convertible Preferred Stock ("Series B Preferred Stock") which totaled $187,000 for the quarter ended September 30, 2017 compared to $89,000 for the quarter ended September 30, 2016. The increase in dividends in the quarter ended September 30, 2017 compared to the quarter ended September 30, 2016, reflects the issuance of additionalassociated with 390,000 shares of Series A Preferred Stock issued in December 2016, 1,559,000 shares of Series B Preferred issued in April 2017, and 2,800,000 of Series C Preferred shares and 1,581,935 shares of Series D Preferred Shares issued in October 2017. The increase was also attributable to approximately $454,000 in additional deemed dividends and approximately $194,000 in accretion of discounts associated with the Series C Preferred shares and warrants issued in connection with the Bird & Cronin Acquisition in comparison to deemed dividends associated with Series A Preferred in December 2016. These increases were partially offset by $109,000 in higher net income in the quarter ended December 31, 2017, compared to the same quarter of the prior year.
Net loss attributable to common stockholders increased $368,000 to $1,303,330 ($0.25 per share) for the six months ended December 31, 2017, compared to $935,000 ($0.33 per share) for the six months ended December 31, 2016. The decrease in net loss is due to approximately $594,000 in higher net income in the six months ended December 31, 2017, compared to the same period of the prior year, partially offset by $315,000 of additional preferred stock dividends associated with issuance of the same preferred shares described in the previous paragraph as well as an increase of approximately $454,000 in additional deemed dividends and approximately $194,000 in accretion of discounts associated with the Series BC Preferred Stockshares and warrants issued in April 2017. We paid all accruedconnection with the Bird & Cronin Acquisitionin comparison to deemed dividends indicated above by issuing shares of our common stock.associated with Series A Preferred in December 2016.
The deemed dividends reflect the difference between the underlying common share value of the issued preferred shares as if converted, based on the closing price of the Company’s common stock on the date of the issuance, less an amount of the purchase price assigned to the preferred shares in an allocation of the purchase price between the preferred shares and the common stock warrants that were issued with the preferred shares.
Liquidity and Capital Resources
We have historically financed operations through cash from operating activities, available cash reserves, borrowings under a line of credit facility and sales of equity securities. On September 28, 2017, we entered into an Amended Credit Facility for a two-year asset-based lending facility for up to the lesser of $11,000,000 or an amount available based upon a borrowing base calculation (see, Line of Credit, below). and sales of equity securities. We expect to obtain capital for future acquisitions using borrowings and proceeds from debt and equity offerings. Working capital was $6,102,000$9,091,000 as of September 30,December 31, 2017, compared to working capital of $5,834,000 as of June 30, 2017. The current ratio was 1.51.6 to 1 as of September 30,December 31, 2017 and 1.8 to 1 as of June 30, 2017. Current assets were 60.7% of total assets as of September 30, 2017 and 51.7% of total assets as of June 30, 2017. Cash and Cash Equivalents
Our cash and cash equivalents position increased $3,397,000 to $3,652,000 as of September 30,December 31, 2017, was $5,548,000 compared to cash and cash equivalents of $255,000 as of June 30, 2017. The primary source of cash in the threesix months ended September 30,December 31, 2017, was approximately $1,677,000 net cash provided by operating activities, net borrowings of $4,571,000 under the Amended Credit Facilityour line of $5,000,000credit and net proceeds of approximately $6,600,000 from sale of our Series C Preferred and warrants in September 2017, in anticipation of the Closing ofconnection with the Acquisition on October 2, 2017.of Bird & Cronin.
Accounts Receivable
Trade accounts receivable, net of allowance for doubtful accounts, increased approximately $561,000,$2,104,000, or 10.6%39.8%, to $5,842,000$7,385,000 as of September 30,December 31, 2017, from $5,281,000 as of June 30, 2017. The increase iswas primarily due to increased salesthe addition of the Bird & Cronin that added $1,819,000 in the quarter ended September 30,accounts receivable as of December 31, 2017. 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 30 days of invoicing.
Inventories
Inventories, net of reserves, decreased $243,000increased $4,207,000 or 3.3%56.9%, to $7,154,000$11,605,000 as of September 30,December 31, 2017, compared to $7,398,000 as of June 30, 2017. The increase was driven by the addition of the Bird & Cronin subsidiary that had $4,707,000 of net inventory as of December 31, 2017. Inventory levels fluctuate based on timing of large inventory purchases from domestic and overseas suppliers as well as variations in sales and production activities. We believe that our allowance for inventory obsolescence is adequate based on our analysis of inventory, sales trends, and historical experience.
Accounts Payable
Accounts payable increased approximately $838,000$2,116,000 or 35.9%90.6%, to $3,173,000$4,451,000 as of September 30,December 31, 2017 from $2,335,000 as of June 30, 2017. The increase iswas driven primarily dueby the addition of the Bird & Cronin subsidiary that had $1,346,000 of accounts payable at December 31, 2017. The increase was also attributable to increased purchasing and production activitiesan increase in support of increased sales in the quarter ended September 30, 2017, compareddays payable from approximately 27 to sales in the quarter ended June 30, 2017.34.
Line of Credit
Our line of credit balance increased $4,571,000 to $6,743,000 as of December 31, 2017, we modified our credit agreement and entered into the Amended Credit Facility to provide asset-based financing to be used for funding the Acquisition and for operating capital. The Amended Credit Facility provides for revolving credit borrowings 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%. We paid a commitment fee of .25% and the line is subject to an unused line fee of .25%. The maturity date is September 30, 2019. Our obligations under the Amended Credit Facility are secured by a first-priority security interest in substantially all of our assets, including those of our subsidiaries. The Amended Credit Facility includes financial covenants, such as ratios for consolidated leverage and fixed charge coverage, and customary affirmative and negative covenants for a credit facility of this type, including, among others, the provision of annual, quarterly and monthly financial statements and compliance certificates, maintenance of property, insurance, compliance with laws and environmental matters, restrictions on incurrence of indebtedness, granting of liens, making investments and acquisitions, paying dividends, entering into affiliate transactions and asset sales. The Amended Credit Facility also contains penalties in connection with customary events of default, including, among others, payment, bankruptcy, representation and warranty, covenant, change in control, judgment and events or conditions that have a material adverse effect (as defined in the Amended Credit Facility).
As of September 30, 2017, we had borrowed approximately $7,103,000 under the Amended Credit Facility compared to $2,172,000 as of June 30, 2017. We drew $5,000,000 on September 29, 2017 in anticipation of Closingclosing the Acquisition of Bird & Cronin on October 2, 2017.
Debt
Long-term debt, excluding current installments, decreased $39,000$75,000 to $423,000$387,000 as of September 30,December 31, 2017, compared to $462,000 as of June 30, 2017. Our long-term debt is primarily comprised of the mortgage loan on our office and manufacturing facility in Tennessee and also includes loans related to equipment and a vehicle. The principal balance on the mortgage loan iswas approximately $477,000$445,000 of which $344,000$310,000 is classified as long-term debt, with monthly principal and interest payments of $13,278 through January 2021.
In conjunction with the sale and leaseback of our corporate headquarters in August 2014, we entered into a $3,800,00015-year building lease forthat we treated as a 15-year term with an investor group. Thatcapital lease valued at $3,800,000. We are amortizing the capital lease asset on a straight line basis over 15 years at approximately $21,000 per month, or $63,000 per quarter. Accumulated amortization of the capital lease asset was approximately $861,000 at December 31, 2017. The building sale generatedresulted in a profit of $2,300,000 whichthat is being recorded monthlytreated as a deferred gain that is amortized as an offset to amortization expense over the life of the lease at $12,500 per month, or approximately $37,500 per quarter. The building lease is recorded as a capital lease withbalance of the related amortization being recorded on a straight line basis over 15 yearsdeferred gain at December 31, 2017 was approximately $21,000 per month, or $63,000 per quarter.$1,755,000. Lease payments, currently approximately $29,000, are payable monthly and increase approximately 2% per year over the life of the lease. Total accumulated amortization related toThe balance of the leased building iscapital lease liability was approximately $798,000$3,186,000 at September 30,December 31, 2017. Imputed interest for the quarter ended September 30,December 31, 2017, was approximately $46,000.$45,000.
Deferred Income Tax Assets
A valuation allowance is required when there is significant uncertainty as to the realizability of deferred income tax assets. The ability to realize deferred income 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 determined that we do not meet the "more“more likely than not"not” threshold that deferred income tax assets will be realized. Accordingly, a valuation allowance is required. Any reversal of the valuation allowance in future periods will favorably impact our results of operations in the period of reversal. As of September 30,December 31, 2017 and June 30, 2017, we recorded a full valuation allowance against our net deferred income tax assets. Deferred income tax assets and the related valuation allowance were decreased by an estimated $74,000 for the quarter ended September 30, 2017. This resulted in no reported income tax benefitexpense associated with the operating incomeprofit reported during the quarterthree and six months ended September 30,December 31, 2017.
Inflation
Our revenues and net income have not been unusually affected by inflation or price increases for raw materials and parts from vendors.
Stock Repurchase Plans
We have a stock repurchase plan available to us at the discretion of the Board of Directors. Approximately $449,000 remained of this authorization as of September 30,December 31, 2017. No purchases have been made under this plan since September 28, 2011.
Off-Balance Sheet Arrangements
As of September 30,December 31, 2017, we had no off-balance sheet arrangements.
Critical Accounting Policies
The preparation of our financial statements requires that we make estimates and judgments. We base these on historical experience and on other assumptions that we believe to be reasonable. Our critical accounting policies are discussed in Item 7, "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations"Operations” section of our Annual Report on Form 10-K for the year ended June 30, 2017. There have been no material changes to the critical accounting policies previously disclosed in that report.
IItemtem 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes to information from that presented in our Annual Report on Form 10-K for the year ended June 30, 2017.
IItemtem 4. Controls and Procedures Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information that is required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized, and reported within the time periods that are specified in the Securities and Exchange Commission's ("Commission’s (“SEC"”) rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding any required disclosure. In designing and evaluating these disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act) as of September 30,December 31, 2017. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30,December 31, 2017.
Changes in Internal Control Overover Financial Reporting
On October 2, 2017 we acquired the assets of Bird & Cronin. We have established oversight, procedures, and controls over financial reporting to accurately consolidate the financial statements of Bird & Cronin and to properly reflect acquisition-related accounting and disclosures. We are continuing to evaluate the design of internal controls over financial reporting for the Bird & Cronin subsidiary.
Except as described above, there were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended September 30,December 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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