Kelvyn Cullimore - Chairman, President and CEO.

Analysts:.

[starts abruptly] third fiscal quarter financial results conference call. The purpose of today's conference call is to discuss the financial results for the quarter and nine months ending March 31, 2015.

Before we begin, as a reminder, during the course of the conference call, management may make forward-looking statements regarding future events or the financial future 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 the SEC, including the most recent Annual Report on Form 10-K.

Today I plan to update you on Dynatronics’ results for the period ending March 31 and following my presentation, we will open the call up for questions and answers. We have a lot to cover today and so let me just dive in, so that we can get started and get to your questions.

The sales for the third quarter increased by 8.2% or $505,000 to $6.691 million compared to $6.186 last year during the same period. For the nine month period, we have seen an increase of 4% or about $822,000.

As you can see, the third quarter was a significant acceleration of increased sales for the fiscal year and has accounted for a significant part of the growth in top line sales for the fiscal year through the nine month period.

This has been a welcome change given that up to about a year ago we were seeing average 7% declines in revenue year-over-year and so it's been since about a year ago right now that we started to see things turn around.

In this particular quarter, the increased sales were attributable primarily to distributed capital products, that means high ticket items that are made by other manufacturers that we distribute, as well as our own manufactured metal and wood treatment tables that accounted for a significant amount of the increase for the quarter and for the nine month period ending March 31.

However, despite the strong increase in sales during the quarter, our gross profit actually declined by $64,000, about 2.8%, dropping from 36.5% of sales last year to 32.8% this year. And here are the reasons for that. While sales did increase during the quarter, the increase was primarily, as I mentioned, in the lower margin distributed capital.

That particular category actually increased 44% over the same period last year and our manufactured wood and metal tables, which carry the lowest margin of the manufactured items that we sell increased by 29%. So some of these sales occurred because there were large orders that come out at a little bit of discounted pricing.

The good news is that this is an indicator that the market is turning around that there is demand for new products, there is some growth starting to occur and we just need to make sure that our higher margin manufactured capital items catch up to the sales of the distributed items.

In addition to this shift in product mix, we did see a slight decline in sales of our higher margin manufactured products, which only accounted for 23.6% of sales this quarter compared to 28% during the same period last year.

So the margin shift has been primarily due to that shift in product mix selling lot more of the lower margin distributed items and less of the higher margin manufactured items. In addition, we have seen a slight shift in sales to dealers as opposed to our direct rep network.

We've seen the dealers begin to account for a higher percentage of sales during this quarter and since we sell to them at wholesale prices that does have an effect on lowering the average selling price and thus the margins. Going to the nine month period, our gross profit decreased $92,000.

So as you can see, with our gross profit decreasing $64,000 in this quarter and $92,000 year-to-date, the majority of that decrease did occur in the third quarter. The gross profit margins for the nine month period dropped from 36.9% last year to 34.1% this year.

We really believe that we have seen that product mix account for the large part of that, but again, it is a good indicator from the market in general that there is demand for these higher ticket items and we believe it will just be a matter of time to get the manufactured capital to follow suit.

Improving gross profit margins in the coming quarters will be dependent on focusing our efforts on those higher margin manufacturing modalities and also reviewing some of our pricing schemes. So that is going to be an area of significant focus.

We need to ride the wave of higher sales in the distributed products and supplement that with increasing sales of our manufactured capital as well. The increase in sales we have been able to generate as we indicated was mostly neutralized, but lower gross profit margins.

And so as we improve our gross profit margins on the manufactured items in the future, we expect to return margins to more historical norms. The margins experienced in the third quarter were quite an anomaly and we don’t anticipate that that kind of product mix will continue.

As far as expenses go, we have been working to reduce expenses and during the third quarter, overall SG&A expenses were down by about $28,000. However, during the quarter, we also incurred about $36,000 of non-recurring legal and other acquisition related expenses associated with the terminated acquisition we discussed in the call last quarter.

Excluding those costs, we would have had $64,000 less in SG&A expenses in the quarter. There was also $17,000 lower selling expenses in the quarter primarily associated with lower commission. But we did see some higher expenses that were associated with the sale and leaseback of the building here in Cottonwood Heights.

Just the amortization expense for that alone was a $25,000 increase. So there were some general components there that had an impact. We did see $80,000 of lower labor and overhead expenses, however.

So with the $80,000 of lower labor expense, $17,000 lower selling expenses, they were offset by the increase in the acquisition related expenses and the building expense, and about $7,000 in general expenses. During the nine month period, expenses decreased by $92,000 compared to last year.

But during the nine month period we had significantly higher non-recurring legal and acquisition related expenses of about $256,000. If you exclude those one-time costs, our SG&A expenses for the nine months were down approximately $350,000 year-over-year during the nine month period.

Specifically, we had general expenses were up about $17,000, we did have the higher amortization expenses during the period of about $68,000 associated with the leaseback of the building. But we did lower selling expenses by $104,000 and we did lower labor and overhead expenses by $329,000.

So those were the components primarily contributing to the net decrease of $92,000 in expenses. R&D has increased during the quarter by about $23,000 and that’s particularly related to work we are doing on a couple of new products that will be introduced by the end of the calendar year.

We don’t expect to see significantly increased R&D, but there will be mild increases in R&D as we work through these products, that we think will help boost sales in the future. As everyone maybe aware, we spent significant amounts on R&D over the last two or three years.

That diminished last year as we introduced the ThermoStim Probe and we saw our R&D expenses return to more normalized levels beginning with this same quarter last year.

That with the work of these two new products that we are building on the platform that was developed in the last couple of years, we have seen just a slight upward tick this quarter in R&D expenses. Although for the nine month period, our R&D expenses are actually down $78,000.

Looking at the pre-tax loss for the quarter, we reported a pre-tax loss of about $345,000. Exclusive of the one-time transaction related costs, we were at approximately $310,000 in operating losses, which was still a $55,000 greater loss than Q3 of last year.

Included in that $55,000 was incremental costs of about $37,000 related to the sale and leaseback, the amortization expenses and the imputed interest costs associated with that. So that accounted for the majority of that incremental increase from operations. But of course, the primary contributor to the losses was the drop in gross profit margin.

Had we been able to maintain the same gross profit margins this year that we did last year, we would have contributed another $250,000 of gross profit, but of course we didn't and so it is still even with the increased sales showing a little bit higher loss.

For the nine months, the pre-tax loss was $514,000 but that does include $256,000 in transaction costs, one-time transaction costs. Absent that, our operating losses were about $258,000 through nine months, that is about $90,000 improvement from operations during the same nine month period last year.

Additional costs during the period associated with the sale and leaseback of the Cottonwood Heights facility totaled about $76,500. So if you add that back in to the $90,000 that shows that there was a significant underlying operating improvement during the nine month period.

We also wanted to alert you that we did pay $37,000 in medical device taxes in Q3 and $122,000 for the nine month period. We are hopeful that with the new Congress, the medical device tax will be repelled, it is certainly a bipartisan issue that seems to have some traction and we're looking towards that hopefully in this calendar year.

For income tax, the current quarter [indiscernible] 39.6% effective rate compared to 36.5% effective rate last year, those are just timing differences. It should be noted that the sale of our building during this fiscal year generated a taxable gain of well over $2 million.

That gain does not get reported on the financials as a one-time gain, we are required to amortize that over the 15 year life of the leaseback.

However, the tax, it's a taxable gain for the year and that gain will be mostly offset by the accumulated deferred tax assets or NOLs we've accumulated so that we will not have a big tax bill associated with that sale.

Our net loss bottom line given all of these factors, we ended up reporting a net loss of about $208,000 compared to $162,000 last year and for the nine month period the net loss of $301,000 compared to $225,000 last year, that's inclusive of all of the one-time expenses associated with the failed [ph] acquisition.

And it should be noted that even with the one-time transaction costs, we still ran cash flow positive for the nine-month period. We'll talk a little bit about our strategic plans.

We are certainly encouraged by the acceleration of sales growth of 8.2% during this quarter compared to 4% year-to-date and especially when compared to the 7% annual declines of the year or two prior to that and we have been working on keeping expenses in check as well over the last two years, if fact, we calculate that we’ve reduced expenses by combined $1.5 million during that period of time.

In August of 2014, as we've mentioned, we did sell our building in Cottonwood Heights, Utah for $2.8 million and leased it back for 15 years, this allowed us to reduce our debt by about $2.7 million. And as I mentioned earlier, tax on the gain is mostly offset using our cumulative tax attributes.

Our R&D pipeline includes new therapeutic devices that we intend to introduce towards the end of this calendar year and we believe the introduction of these new products will help to continue to sustain sales growth.

We are continuing to work on expanding our sales coverage geographically and by market, and trying to achieve better market penetration. Some of you may know of our competitor Patterson Medical has been put up for sale by their parent company and that has helped us somewhat.

We've had a few folks come to us and they're interested in joining our team, because of uncertainty associated with that situation. Probably one of the most promising areas has been the growth in international sales. We are ostensibly a couple of months away from approvals in China.

We've been working on that for the last year and are in the final phase of that approval. We've just got approval this quarter for Japan and did a large shipment to Japan in April. And Southeast Asia is also -- we're working on some approvals in Southeast Asia. We have a specific distributor in China and Southeast Asia who are working with that.

Upon approval we'll be carrying our products. In fact, we're at a trade show in China this week. Mexico has also taken some interest.

We've just met with and working on getting approval of our products in Mexico, which we anticipate will be achieved in the next four months and the distributors we've aligned up there are most anxious to begin distribution of the products and we've got sales in such unique places of Dominican Republic and Egypt as well as other areas of Europe that are starting to get a foothold, which is something that we've always struggled with.

So, international sales are showing some real promise and expect to be a contributor. In March of this year, we moved our line of credit from our bank relationship with Zions Bank who had been with for 20 years to a new lender. That was motivated as mutual agreement with us and Zions because of the performance of the past two years.

They thought like it would be important for us to move that and we did and we have a good relationship with the new lender.

Unfortunately, because the new lender is not a commercial bank, the effective borrowing rate is about 10% on our line of credit compared to the previous 4% but our borrowings are significantly lower to the debt reduction we achieved to the sale of the building and some of the restructuring that we did there.

Probably, the most important news to report is associated with the May 1 press release that we sent out, in which, we announced we entered into a securities purchase agreement with affiliates of Prettybrook Partners, LLC for the sale of shares of our Series A 8% convertible preferred stock and the aggregate of up to $5 million.

So far, the investors have committed to $4 million of the offering. Series A preferred stock and warrants will be granted to investors out of the offering.

Proceeds from this private placement will be used to promote organic growth through expansion of the Company's sales distribution channels both domestically and internationally, improve our infrastructure and operating systems and support strategic acquisition opportunities.

On May 4, we filed a current report on Form 8-K to disclose this transaction and provide additional details regarding the transaction. The transaction is expected to close on June 30, following receipt of shareholder approval of certain terms of the transaction obtained at our Annual Meeting of Shareholders scheduled for June 29.

A proxy statement was filed in association with that June 29 meeting and will be being made public as soon as it is cleared by the SEC, but it was also part of the filing references with the 8-K. So, those documents are publicly available. This transaction is a direct evolution of the failed acquisition that we disclosed on our last call.

All the money that we're -- that is being invested in the Company will help us progress and grow. We're probably even more excited about the individuals doing the investing and the credibility that they bring to our strategic efforts.

Prettybrook Partners is headed by the husband and wife team of Stuart Essig and Erin Enright, both have been very successful in their own right in business and professional ventures. Some of you may know, Stuart Essig has been the architect that built Integra LifeSciences. He remains still as a Chairman of the Board of that company.

Management and the Board basically felt that it was time to take steps to transform Dynatronics from the pedestrian performance over the past few years to a growth Company. To do so, not only require a capital but it required the right partners. And we're confident we have found both.

The Dynatronics of the future will be much different from the Dynatronics of the past. Thanks to the resources being brought to the table by our new investors and the access to deal flow that's available to them. We're confident that this path will lead to improved valuation of the Company and a better long-term outcome for all shareholders.

That is why management recommended this transaction and the Board approved it. So as we move forward, we hope to see continued improvement with sustained sales increases and with our focus on gross profits to bring those back more in line.

Factors affecting our performance in the coming months will be the acceleration of sales growth, the international sales growth, gross profits being returned to more historic norms or certainly improved over what we saw in the third quarter, capitalize on the new products being introduced over the past two years and the new ones being introduced in the coming six months to eight months, expanding our distribution capabilities, vigilance and maintaining operating efficiencies and then strategic acquisitions and growth initiatives related to the Prettybrook Partner's capital infusion.

We probably have never been at a point in our history where there was greater expectations for the future as it relates to this transformation that we are making with this investment and we are very excited about what potential that brings. So with that, San, let's go ahead and open the line for questions.

We'll be happy to take those questions at this time..

Q – A –.

Well, I'm sure there are -- there's got to be lots of questions in people's minds at this time.

I will just say that the past few years of struggling through the ObamaCare impacts, Medical Device taxes, reimbursement issues, things of that nature have really forced management to look strongly at opportunities for changing the trajectory of the company.

And while we are confident about the underlying market that we're in, meaning physical medicine and rehab, and there are indications that that market is bouncing back and certainly indications with ObamaCare that there is going to be a strong demand for these kinds of services in the future.

We also believe that by partnering with the Prettybrook affiliates that we'll be able to identify additional companies to further strengthen us. I know some may be concerned about dilution associated with that investment, but we really believe that not doing something transformative would have resulted in perhaps a worst outcome.

We need to do this kind of future planning in order to build value into the company and we really believe that we have found the right path to accomplish that. So with that, we'll give you one more chance for questions. San, tell them one more time how to place the question..

[Operator Instructions] And there are no audio questions at this time..

Gosh, I must have done such a good job of explaining everything that I anticipated the questions. Obviously if there are questions that you have, we're certainly happy to respond to them. If you'd like to call us directly, we'll be happy to do our best to answer your questions for the best of our ability.

We look forward to the future calls, should be some exciting times ahead, we really appreciate your interest and your willingness to take the time to be on this call today and hope to have you on future calls to discuss even more exciting things. Thanks for being with us today. That will end the call..