Kelvyn Cullimore - Chairman, President and CEO.

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This is Kelvyn Cullimore, President and CEO of Dynatronics Corporation. I’d like to welcome you all to our conference call reporting the results of our first fiscal quarter of fiscal year 2014 which ended on September 30, 2013.

Before we begin as a reminder, during the course of this conference call we may make forward-looking statements regarding future events or the future financial performance of the Company.

Those statements involve risks and uncertainties that could cause actual results to differ perhaps materially from the results projected in such forward-looking statements.

We caution you that any such statements should be considered in conjunction with the disclosures, including specific risk factors and financial data contained in the Company's most recent filings with SEC including its most recent Annual Report on Form 10-K.

So today I'm going to update you on our results for the quarter ended September 30th and give you a little bit of color on what’s coming in Q2 and beyond. And when we are done, we'll open the lines for questions.

The fact that you're on the call means you have received the press release for the quarter and are aware of some of the results, so let me give you a little bit of detail on the numbers for the first quarter. Sales were down about $150,000 from 7.206 million to 7.055 million. It’s about a 2% decline.

That 2% decline compares to about a 6.7% rate of decline last fiscal year, so while we're still headed in the wrong direction with the 2% decline, it does seem to be leveling off and moving in a better direction on base sales. The decline in sales actually came because of lower demand for distributed products.

Detailed analysis showed that sales of our manufactured capital products and our manufactured supplies remained even to slightly improving. Most of the decline came in some of the distributed items, things like exercised products, nutritional supplements and taking products were the main categories where we saw the declines.

With lower sales obviously comes lower gross profit, our gross profit was down $130,000 compared to last year. There are two factors that contributed to that, that’s first of all the lower sales of a $151,000 accounted for about 55,000 of the decline.

But there was also a drop in gross profit margin from 37.6% last year to 36.6 this year and that accounted for the other $75,000. And this is the first year we've seen any kind of material drop in that profit margin and there were a couple of reasons for that.

Some of you may remember that several years ago we offered a software product we named STREAM, that program was eventually terminated, but it did have residual commissions that continued through January of this year before they started to decline and to be eliminated.

The loss of that STREAM margin this year compared to the fact that we did have that last year during the first quarter accounted for about half of that margin percentage drop. The other has to do with gross profit margins on manufactured items much of which is attributable to the new medical device tax that has taken a toll on us.

That tax has been rolled in as part of our cost of goods sold and has had an impact on accounts for about the other half. SG&A expenses for the month of the quarter were down.

We were able to reduce those by about $80,000, that broke down to be 54,000 in general expense, mostly professional fees, legal, accounting et cetera and 19,000 in lower building rents and operating expenses as we did make some changes in our physical facilities, and $6,000 lower in selling expense.

And in addition to that there was about $4,000 less in interest related expenses. With that unfortunately we were offsetting some of that SG&A expense with higher research and development expense. R&D expense was up about $49,000 compared to the same quarter last year.

This is all attributable to the one new product that we're going to be introducing in the current quarter.

The ThermoStim Probe which I'll talk about in a little more detail in a minute, that ThermoStim Probe will be the catalyst for our future sales plan and future profitability, so while the investment in the R&D has had a negative effect in the quarter ending September and will have an ongoing detrimental impact on profits in Q2, it will set the stage for higher profitability in sales in Q3 and beyond.

So that R&D expense will start to wind down in the second quarter and return to much more normalized lower level starting in January.

With about 130,000 less in margin and around 35,000 less in SG&A and interest expenses net of R&D increases, our pre-tax loss for the quarter increased 99 or about $95,000 over last year increasing our loss from $74,000 pre-tax last year to $169,000 pre-tax this year.

Due to the higher anticipated R&D, our tax credits associated with that cost increased our tax benefit for the quarter slightly with the tax benefit being about 36% of the loss instead of 30% last year.

All those factors combined, results in the net loss had essentially doubled from last year rising from 51,000 to 108,000 for all the reasons I’ve just discussed. The lower margin associated with lower sales being offset by lower expenses and somewhat moderated by a better tax benefit for the quarter.

It should be noted that during the quarter we did pay $40,000 in medical device tax. For those that are not familiar with that tax, it is a tax that was instituted last January and is associated with funding of Obamacare, the Affordable Care Act.

It is a very egregious tax as is obvious here we were not profitable in the quarter, yet we paid $40,000 in taxes because the tax is priced on sales of products not on profitability.

If you followed at all the discussions about the continuing resolution and the debt ceiling discussions going on in Congress you’re probably aware that the medical device tax was named specifically as one of the items on the table to be repealed and in an effort to come to terms on a continuing resolution and the budget of the debt ceiling.

In the end it was excluded and they did pretty much a clean resolution and kicked the can down the road to February. But the good news is that that medical device tax is very much on the table for repeal. That would be important for us and for all medical device manufacturers.

The both the Senate and the House of Representatives have had votes in which the majority have voted in favor of repeal at different times. So we’re fairly confident that in the coming year there will be a vehicle by which that medical device tax will be repealed.

We don’t know exactly when that will happen, hard to forecast, but the discussion surrounding the continuing resolution in the last month and the debt ceiling and the fact that the medical device tax figure prominently in those discussions is very encouraging.

So while we are disappointed to report yet another quarter with losses, the sales decline on base sales seems to be leveling out but we are anxious to turnaround those declining sales and to return to profitability and believe we have strategy in place to accomplish that.

Our strategy is based upon two main factors; number one, is the new products that we have been working hard to introduce this last year and will yet introduce before the end of Q2. Those products the most recent one was our 25 Series products, which replaced the 50 Series products, which was four combination therapy units.

In the past Dynatronics has never allowed their -- our combination therapy units to be generally available to the market, in other words, you had to be a specialty dealer to have access to those and that was a limited distribution.

With the introduction of the 25 Series, we have lifted those limitations and the 25 Series was the first combination therapy products that we are now making generally available to all sales distribution channels. We believe that will help to open up new markets and in fact we’re already seeing some of that happen as I’ll explain in a minute.

We did introduce our Solaris Plus products a year ago and those are fairing very well and we are still protecting those for geographic territories and not making those generally available. So we are only making the 25 Series available.

Then coming out the next new product that we’ll be introducing is our new ThermoStim Probe, the ThermoStim Probe is a very unique product. It is an accessory device that plugs into our new Solaris Plus products. It does not work with the 25 Series it only works with the Solaris Plus series of products.

That probe that is an accessory device has the ability to provide tissue mobilization which is basically physical manipulation using the edges of the probe along with the ability to cool the probe down to 39 degrees or heat it up 212 degrees so you can provide thermal therapy in conjunction with that and in addition to that deliver electrotherapy through that probe as well.

So you have one probe that can do multiple therapies at one time and there is nothing like it on the market. We do have a patent filed to protect our intellectual property associated with that. And we believe that this is going to be one of the most exciting products we’ve introduced in over a decade.

Part of the basis for saying that is that over the last six months we’ve taken our prototypes and introduced them to select clinicians and people to get feedback in that period of time over 500 demos have been done and the response has been overwhelmingly positive.

Literally every person that saw it said that they would want to have it in their clinic. That is a very encouraging statistic for us and we believe we’ll be the catalyst for improving sales as we go forward. In order to do that the second part of our strategy is to broaden distribution.

As I had mentioned previously with the new products we are now making some available to all sales channels which we have not done in the past. We have already added over 30 sales reps in the last 90 days either directly or through dealers that we have signed, many of whom are excited about both the 25 Series and the potential of the ThermoStim Probe.

We're targeting adding 75 total new sales reps by the end of the fiscal year as part of our strategy to broaden distribution. We're also implementing programs to make the high-end proprietary products available on a wider basis, while still protecting our territories of our best sales persons and dealers.

In other words many of these new sales channels that we're bringing on may have access to the higher products like the ThermoStim Probe and Solaris Plus by working with the dealer or representative who has exclusive in that territory.

And all of those things are helping to expand the distribution channel and we'll have a positive impact we hope beginning in Q2, but are confident it will in the quarters beyond. In addition, we have begun to increase our efforts on international sales. This has always been a weak area for us. So any improvement there will be welcomed.

We have had some significant progress with dealers in China and Southeast Asia, China market it takes time to develop and so we don't anticipate seeing significant benefit from that in the next quarter or two, but beyond that we will.

Mexico we have been working with a new distributor there that has already placed some very large orders that we believe will help us cultivate additional sales there and we're implementing new efforts in Europe.

All of that, I have the international sales to me are gravy and we're hopeful that we'll be successful in doing that better than we have done in the past. So let me, I know the main question people will ask is, what does all the new strategy mean and when will it have an effect.

So let me address a little bit of forward-looking guidance that maybe would be helpful. The ThermoStim Probe due to some regulatory delays and vendor delays and things probably will not begin shifting until December, which means the second quarter ending in December will not benefit from this strategy as much as we have hoped.

While we anticipate being profitable in the quarter, we probably will not be as we were last year, probably 50% of the profit that we have last year. But when you look beyond that and ask what will the ThermoStim provide? Our expectation right now is that we will sell between 100 and 200 of the new ThermoStim Probes a month, starting in Q3 and Q4.

To put that in perspective, that will generate around $100,000 to $200,000 in additional margin per month.

When you realize that the ThermoStim Probe has to be powered by a Solaris Plus unit and the Solaris Plus has only been out for barely a year, many will be required to purchase one of those units in addition our sales team anticipates around 80% of the ThermoStim Probe sales will also require the purchase a Solaris Plus unit, which we think will add another $150,000 to $250,000 in margin per month.

So putting those together at the low-end, we're looking at an additional $250,000 in margin per month or 750,000 per quarter.

That margin will be offset by some increased expenses which we anticipate will be in the neighborhood of $50,000 to $60,000 per month, and hopefully that gives a range of what we're anticipating and what we're planning for as a Company in the coming quarters, and what we believe the new ThermoStim Probe will do as a catalyst for this new sales strategy.

So by introducing the new products especially the ThermoStim Probe, making products more broadly available expanding our distribution. We believe that we're poised to see a breakout that we have been working for, for the last two years.

Of course these are somewhat speculative numbers, they are based on a selling ratio of one to two sales of a ThermoStim Probe per week per rep, that should be achievable and so that gives you kind of the guideline of what we anticipate going forward.

So in summary, the quarter ending on September was a greater loss than what we had last year, primarily due to slightly lower sales, lower gross profit margins and increased R&D expense.

And Q2 we'll feel see some of the effects of the higher R&D expense and slightly lower sales, but we will start hopefully to see the benefit of the new ThermoStim Probe coming in December.

We don't want to understate either, the fact that we do still see impact from a generally weak economy and the impact of the Affordable Care Act and the uncertainty associated with Obamacare in general continuous to be a cloud over our industry as people are waiting to see what the real effect is going to be before they make decisions on buying new equipment or expanding and things of that nature.

So we're still in a somewhat stifled economy from that perspective. However even given those factors, we believe that especially beginning in Q3 we'll see the benefit from the new sales strategy by having all the new product released, having a broader distribution and generating the additional margin that we’re anticipating.

So that gives you the overview of the Q1 and a little bit of perspective on Q2 and going forward. So with that, I’ll be happy to open the lines, if we can Tina. And that way we can take questions..

Question:.

and:.

We’ll do. (Operator Instructions) And we have no questions via the phone..

Okay. Do we have anyone, we’ll give you one more chance if you’d like to ask any questions maybe I anticipated your questions enough. Last quarter we had some very good questions I tried to key off those so hopefully I was able to respond or anticipate some of those questions, so. .

We do have someone with a question. It comes from Sam Birdmen. Pease go ahead sir. .

Couple of questions, so in regard to the push out of the product that was mostly related to parts or vendors or the product is already to ship because of the technologies is 100%?.

Technology is 100%. No problem with the technology it has been tested and validated, and verified. The main hold up right now just has to do with getting all of the components in from vendors. So we can start to assemble the parts. That is the main hold up right now.

And we’re gearing those up, this is not an unusual situation with the new product, you anticipate, you think you got everything lined up, they send in their first articles, here is what we think you ask for, you look at it and compare it to the drawings, it isn’t exactly right, you sent it back and you go through several iterations like that and we just -- it’s just taking a little bit longer to go through those iterations than we had planned.

So that’s been the primarily cause of the delay. But it is not because of the technology still being bedded technology has been validated..

So, in terms of when you finally are ready to ship the product.

You don’t feel there is going to be any issues of getting product to manufacturer?.

I do not, if for some reason demand is significantly greater than we’re anticipating than there could be some issues. Just again….

But that sounds okay..

That’s the kind of problems you hope you have..

Right..

We’re gearing up for the level that I just disclosed and so if we exceed that then there could be some delays in shipments. But at the 100 and 200 probe level we believe we’re prepared to do that..

If you look at the decline of sales this quarter, it was a little, it was much improved from prior quarters which is good to see. But going forward you’re pretty much, if you didn’t put the new product in the mix and let’s say it didn’t ship at all for a couple of quarters out.

Let’s say it didn’t ship until June quarter, can you pick up an increase in sales from these new distributors that you’re picking up on the line or not?.

Yes we can and the new distributors will help because we’re making products available to them that have not been available in the past. We certainly would not generate the kind of margin numbers that I articulated earlier with the ThermoStim Probe and the associated, margins associated with that.

But yes, we would see an increase in sales because of the additional distribution..

And the increase when you were giving the somewhat go forward numbers, telling us if you sold ex amount of probes what it would be for the margin dollars, then it would be added cost. Were the added cost put in because of adding distributors or adding infrastructure internationally.

What’s the majority of the added cost?.

The majority of the added cost has to do with sales commissions that would be associated so it’s a variable cost that goes along with the sales. So, you’ll have some of those costs as well as some additional sales cost with tradeshows and things of that nature.

And also to be very frank, one of the things that has happened over the last year is as sales have declined we’ve made significant tests in our overhead. Some of those tests went a little deep for instance our information systems department is a little bit behind right now, we need another person. We need to hire a person for that.

So there is a few targeted hires that we would do in addition to the sales expense that would be related to supporting the new level of sales..

In terms of production there wouldn’t be any added, right?.

What do you mean personnel added?.

Personnel..

Yes, we’ll add probably four to five people that understand the way we do our accounting. The cost of those people are absorbed in the labor that goes into building the product. So that’s already anticipated in the cost of goods sold..

And in terms of new products other than the new product mentioned here are there -- do you have a platform of new products coming out in ’14 that work after that product or other platforms?.

We always have new product concepts in the wings, some of them are incremental improvements on existing products and we have several of those in the works. We do not have any breakthrough new products on the drawing board for 2014, but we do have incremental improvements on existing products and technologies.

The 2014 will be a real focus on capitalizing on what has been building for the last two years.

And so as a result you will see a diminishment in R&D expense because R&D expense tends to build up as you’re getting close to releasing products and we don’t have any significant new products beyond what we’re getting ready to release in this quarter for 2014.

2014 you’ll see incremental improvements that you won’t see significant new products that are going to require high investment in R&D..

What should we expect the R&D line to go down on a quarterly basis and when do you expect it’s not going down?.

We will see it diminish this quarter over last quarter, but third quarter we’ll see it diminish even more and I would say you would probably see it diminish in the range of $30,000 to $40,000 a quarter..

So, not substantially, so roughly $120,000 over a 12 month period?.

Yes between 100,000 and 200,000 is probably where we’ll end up. When specifically if you compare it to fiscal to the -- because we are already down a little bit from our peak, at our peak we were up around 1.4 million in annual R&D expenditures and that should come down into the 1.1 million to 1.2 million range..

And in terms of the medical tax, is that paid quarterly?.

No, it’s paid every two weeks..

Every two weeks?.

Yes they give you -- or it’s twice a month, excuse me, not every two weeks, it’s twice a month. They give you no opportunity to do anything but pay that tax and so you have to estimate it, you pay based on their estimate and then true it up every quarter for when you have the actual numbers, so..

But you wouldn’t have to pay that tax on international sales, correct?.

No, there are no -- because that tax does not get paid out on international and we’re fortunate in the sense that many of the products that we manufacture ended up being exempt from the tax.

If we had to pay the 2.3% on all of our sales, it’d be devastating, it’d be devastating but right now we anticipate only about 30% of the products that we sell are actually subject to the tax. But it’s our high margin products, it’s the things we manufacture anyhow the Solaris, Solaris Plus, ThermoStim things of that nature..

And last question I wanted to ask you is in terms of products that are out there over the couple of years out, any products being discontinued because of poor sales that you had high hopes for?.

None that we had high hopes for, there are -- over the last five to six years, we have introduced various new products that have kind of had niche markets. We call them singles instead of doubles, triples are homeruns. We look at our ThermoStim Probe as a homerun.

We introduced the Vforce which is a vibration therapy device several years ago, it seems to be fading, that probably will not be continued but it has not had any significant impact on sales for over a year. So there is nothing out there that is a contributor now in a material way that we would be discontinuing..

Well I had one more I promise last question.

In terms of the new distributors Kelvyn, looking at those distributors taking up the whole line, or are you try to focus more on your manufactured line?.

Well, the new distributors that we are bringing on many of them, some of them will have access to the whole line..

Okay..

Others will have limited access because things like the Solaris Plus and the new ThermoStim are what we call specialty products and they require a special -- I mean we protect the geographic territories in which those are sold.

And that helps to protect margins and to maintain sales, but what we have done many of our dealers and sales reps who have the rights to those territories have recognized that by including the sub-dealers and sub-reps and given an access to the line it doesn’t hurt them it can actually help.

And so we’re seeing that access being developed even greater..

We have no further questions via the phone..

Okay, well Sam did a great job of asking very good questions. So hopefully that gave everyone a little more color on the quarter and what to look forward to. We appreciate you being on the call today.

As always if you have further questions, feel free to call me or Bob Cardon our VP of Administration and Investor Relations Manger and we will be able to help you with that. Look forward to our next call at which time we should have some really good news about release of the ThermoStim and have a better feel for where we stand with that.

So happy holidays everyone. Look forward to speaking to you in a few months. Thank you..

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect all lines. Thank you and have a good day..