Kelvyn Cullimore – Chairman, Chief Executive Officer and President David Wirthlin – Chief Financial Officer.

Jeffrey Cohen – Ladenburg Thalmann & Co. Inc..

Operator:.

Well, we welcome everybody to the Dynatronics Third Quarter Earnings Investor Conference Call. My name is Kelvyn Cullimore Jr., I'm the Chief Executive Officer; and I have David Wirthlin, our Chief Financial Officer here with me as well. As you're probably aware, we just filed our 10-Q for our third quarter and issued an earnings press release.

Before we begin today, as a reminder, during the course of this call, management 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 the SEC, including its most recent annual report on Form 10-K.

Today, we're going to talk specifically about the results from the quarter and nine months ended March 31, 2017. When we've concluded our presentation, we'll have the operator open up the call for any questions that you might have. There is been a number of significant events since our last call.

On March 21, 2017, we entered into an asset purchase agreement to acquire substantially all of the assets of Hausmann Industries, Inc. In business since 1955, Hausmann designs and manufactures medical, physical therapy and athletic training equipment to customers in the United States and internationally.

The business is located in Northvale, New Jersey where they manufacture products in a 60,000 square foot manufacturing and office facility. The purchase price was $10 million in cash, subject to adjustment.

We finance the acquisition with proceeds from the sale of our equity securities and a private offering to accredited investors and borrowings under an asset-based credit facility with a financial institution. On April 3, 2017, we've closed the acquisition and took control of the assets and concurrently closed the private placement.

We obtained funding under the bank credit facility on March 31, 2017. At the closing of the acquisition, we paid Hausmann $9 million of the $10 million purchase price and withheld $1 million for purposes of satisfying adjustments to the purchase price as may be required under the asset purchase agreement.

25% of the holdback amount will be released to Hausmann on January 1, 2018, and the balance will be released in October 2018. In addition to acquiring assets, we assumed certain operating liabilities, such as accounts payable and other obligations incurred in ordinary course of business. We also offered employments to Hausmann's employees at closing.

David Hausmann, the principal stockholder and principal executive officer of Hausmann, entered into an employment agreement with the company and will continue to manage operations and assist in the transition of the acquired business. As I mentioned, we funded the Hausmann acquisition in part through a bank loan secured with Bank of the West.

It's an asset-based loan that replaced the previous asset-based line of credit we established in September 2016. We retired that previous loan by paying an early termination fee of $14,000.

The new bank loan provides a revolving credit facility in an amount up to the lesser of $8 million or a borrowing base computed as a percentage of accounts receivable and inventory. The interest rate is LIBOR plus 2 1/4%. The credit facility matures in 2 years and is secured by substantially all of our assets.

Presently, the borrowing base calculations supports our outstanding borrowings of over $5.5 million. We drew $2.5 million on this loan on March 31 to help fund the closing of the transaction on April 3, 2017.

We're very pleased to have initiated this relationship with a major financial institution that can grow with Dynatronics as we pursue our growth strategy. The balance of the funding for this transaction was provided by a private placement through which we raised gross proceeds of approximately $7.8 million from certain accredited investors.

We issued 1,559,000 units at $5 per unit. Each unit was made up of one share of our common stock at $2.50 per share, one share of our Series B convertible preferred stock at $2.50 per share and a warrant to purchase 1.5 commons – shares of common stock exercisable at $2.75 per share for 6 years.

Ladenburg Thalmann acted as placement agent for the private placement.

In connection with the private placement, we also entered into a registration rights agreement, obligating us to file within 45 days of the closing, a registration statement with the Securities and Exchange Commission to register all the shares of common stock issuable as part of the private placement, including all shares of common stock underlying conversion of the Series B preferred, shares issuable as payment of Series B dividends and shares issuable upon exercise of the warrant.

We have filed that registration statement and it actually went effective on April 24, 2017. With this acquisition, we believe we have taken a significant step forward in executing on our strategy to grow not only organically but by acquisition.

This is consistent with the plan we laid out for our team and our investors 2 years ago, concurrent with the investment by Prettybrook Partners in our company. We believe Hausmann is an excellent fit with Dynatronics.

We are impressed with their management team, quality products, customer service, reputation of a timely delivery and with their consistent positive operating results. I have a few more comments regarding Hausmann that I will make in my closing remarks.

But for now, I'd like to turn the time to David Wirthlin, our Chief Financial Officer, to provide a financial report on our third quarter ended March 31, 2017..

Thanks, Kelvyn. I will provide some additional detail and color to the press release that we've issued this afternoon. There are a couple of significant factors that had a material impact on our operating results this quarter. The first, we incurred significant legal and accounting fees in conjunction with the acquisition of Hausmann.

Those costs, which have approximated $486,000, are detailed in our 10-Q, and I will comment on them further when discussing SG&A cost for the quarter. Also, as we discussed previously, we have made a number of investments in the past 1.5 years to strengthen our sales and marketing activity.

We have hired several highly qualified individuals to manage sales and marketing efforts. We expanded our reach in the long-term care market. We have initiated a sales training program for all of our sales representatives. As we have updated our – and we have updated our web presence and have begun a digital marketing program.

These investments in sales and marketing continue to drive year-over-year sales growth. We are reporting increased sales for both the quarter and 9 months ended March 31, 2017. Net sales for the quarter ended March 31, 2017, increased 4.1% to $7.7 million compared to $7.4 million in the same quarter of the prior year.

The year-over-year sales growth for the quarter came primarily from growth in sales of therapeutic modalities and distributed capital equipment. We achieved a 10.4% increase in sales of therapeutic modalities, our highest-margin category. We also had a 13% increase in sales of distributed capital equipment.

These products are primarily exercise and therapy products manufactured by others that we distribute. These gains were partially offset by decreases in sales of other product categories, including distributed supply as well as manufactured capital equipment, such as wood and metal treatment tables.

Net sales for the 9 months ended March 31, 2017, increased 10.4% to $24.6 million compared to $22.3 million the prior year. The 10.4% increase in sales was achieved primarily by increases in sales of distributed capital equipment. Our increased focus this year on long-term care markets has driven much of this growth.

Over time, we expect to convert more of these customers to purchase our therapeutic modalities and self-manufactured capital equipment which carry higher margins. Our overall marketing and sales strategy is to increase sales of our higher-margin capital products that we both manufacture or are manufactured for us.

Due to increased year-over-year sales, gross profit for the quarter increased $215,000 or 8.7% to $2.7 million compared to $2.5 million the same period last year. Gross margin percentage for the quarter increased to 35% compared to 33.6% last year.

The increase was driven primarily by a sales mix that included a higher portion of our sales from therapeutic modalities that carry higher gross margin than our other product categories. Gross profit for the 9 months ended March 31, 2017, increased $896,000 or 11.7% to $8.6 million compared to $7.7 million last year.

The increase in gross profit was driven by higher sales of distributed capital equipment and therapeutic modalities. Gross margin for the 9 months increased modestly from 34.4% to 34.8%, driven by higher margins on therapeutic modalities, offset by lower margins on distributed capital equipment.

For the third quarter, selling, general and administrative expenses increased 20.3% or $533,000 to $3.2 million for the quarter compared to $2.6 million for the same quarter last year. For the nine months, SG&A expenses increased 17.8% or $1.3 million to $8.8 million compared to $7.4 million in the first 9 months of last year.

Selling and marketing expenses represented $118,000 of the $533,000 SG&A increase for the quarter. The increase included $115,000 in higher sales management and marketing personnel cost, $38,000 in higher trade show and travel expenses and $29,000 associated with our digital marketing program.

These amounts were partially offset by a $64,000 increase, excuse me, decrease in sales, commissions and other selling expenses. The decreasing commissions is reflective of modifications to our commission program, introduced in the first – in the fiscal year and increased sales to dealers who don't receive commissions.

For the 9 months ended December 31, 2016, increases in selling and marketing expenses were $554,000 of the $1.3 million increase in SG&A. The increase included $368,000 in higher sales management personnel cost, $83,000 in digital marketing expenses and $78,000 in trade show and travel expenses.

SG&A expenses include costs associated with our acquisition of Hausmann Industries, which resulted in significant unusual SG&A expenses for the quarter and 9 months ended March 31, 2017. Increases in general and administrative expenses for the quarter represented $415,000 of the $533,000 increase in SG&A expenses.

This was driven by $486,000 of acquisition-related expenses incurred in the quarter, representing a $450,000 increase compared to the same quarter of the prior year. In other words, increased Hausmann-related expenses accounted for the entire increase in G&A expenses during the quarter.

For the 9 months ended March 31, general and administrative expenses increased $770,000. We incurred acquisition expenses of $533,000, representing a $489,000 increase over the first 9 months of the prior fiscal year.

We also experienced a $296,000 increase in labor and benefits, mostly related to our Tennessee facility in the first 6 months of the fiscal year. New management in Tennessee has made changes to return labor expenses there to more historical norms.

Research and development expenses decreased 7.8% from $250,000 to $231,000 for the quarter compared to the same quarter last year as various projects reached fruition. For the 9 month period, R&D increased 6.5% from $769,000 to $819,000 year-over-year.

The increases for the nine-month period relate to new products already introduced during the year and products yet to be introduced in the next quarter. Introduction of new products continues to figure into revenue growth in the future. Our net loss for the quarter was $755,000 compared to a net loss of $451,000 in the third quarter last year.

The $304,000 increase in net loss was primarily due to the $450,000 increase in acquisition expenses and the $118,000 in increased sales expense, partially offset by $215,000 of higher gross profit. Net loss for the 9 months was $1.1 million compared to $757,000 last year.

The $379,000 increase in net loss was due primarily to $554,000 in higher selling and marketing expenses, $489,000 in higher acquisition cost and $296,000 in increased labor and benefits, partially offset by $896,000 in higher gross profit.

Net loss applicable to common stockholders was $849,000 or $0.28 per share for the quarter ended March 31, 2017 compared to $531,000, $0.19 per share for the quarter ended March 31, 2016. For the 9 months, net loss applicable to common stockholders was $1.8 million, $0.61 per share, compared to $1 million or $0.37 per share for the prior year.

There are 2 adjustments to get from net loss to net loss applicable common stockholders. First, net loss applicable to common stockholders includes the impact of accrued dividends to holders of the Series A preferred, which were $94,000 for the first quarter ended March 31, 2017, compared to $81,000 for the same quarter of 2016.

For the 9 months ended March 31, 2017, the accrued dividends were $272,000 compared to $242,000 for the same period of the prior year. The increase in dividends reflects the issuance of additional Series A preferred shares in December of 2016. We paid nearly all of these accrued dividends by issuing shares of common stock.

Second, the net loss applicable to common stockholders for the 9 months ended March 31, 2017, includes a $376,000 noncash deemed dividend associated with the issuance of 390,000 shares of Series A preferred in December 2016.

The deemed dividend reflects the difference between the underlying common share value of the preferred shares as if converted and an amount of the purchase price assigned to the Series A preferred in an allocation of purchase price between the preferred and the common stock purchase warrants that were issued with the preferred.

There will be another deemed dividend accounted for in our fourth quarter associated with the 1,559,000 shares of Series B preferred stock that we issued in connection with the acquisition of Hausmann. That summarizes the operating results. Kelvyn will make a few final remarks before we open for questions..

Thanks, David. I appreciate that report. We posted our seventh consecutive quarter of year-over-year sales growth. And exclusive of increased acquisition cost, our net loss was reduced by one third over last year.

The acquisition-related cost during the quarter associated with the Hausmann transaction masks some of that underlying improvement in operations. The sales growth and resulted increase in gross profit is not only a result of strategic growth initiative, but it's also helping fund those initiatives.

We believe we have the right team in place to continue to execute on our strategic plans. We're very pleased that we have successfully closed the first acquisition of our stated growth plan. The Hausmann transaction has gone very smoothly and customers have responded favourably.

We're excited about this transaction and believe it has sent a strong message to the market. And it’s not only our strategy, but our commitment to physical therapy and athletic training space. The transaction closed in early April. Hausmann's quarter ended March 31, 2017, will not be reflected in our filings.

However, we can tell you that Hausmann unaudited net sales for the quarter ended March 31, 2017, and 2016 rounded to approximately $3.5 million in each year. We will begin to report consolidated operating results beginning with our fourth quarter of fiscal 2017. Hausmann annual sales have been relatively stable over the last several years.

Averaging annual sales over the past 3 years is about $14.9 million. We expect Hausmann to continue to produce consistent gross margins of approximately 28% to 30%.

While this gross margin is lower than Dynatronics' historical gross margin, it should be noted that Hausmann sells only through dealers at wholesale as opposed to legacy Dynatronics sales which are a mix of both wholesale and retail. Thus, Hausmann's selling and marketing costs are consistently much lower than Dynatronics.

We recognize that any acquisition creates both disruption and opportunity. That said, we will manage this important acquisition very conservatively. What I mean by that is that we will be operating the Hausmann business with the objective of minimizing disruption even if this postpones, to some extent, the achievement of cost synergies.

Our primary objective will be to continue serving Hausmann's customers, driving consolidated revenue growth and enhancing the value of our combined franchise. We will also be focused on achieving consolidated positive cash flow for all of Dynatronics. We believe this business combination creates many opportunities to improve the combined operations.

However, we have no plans to do any significant integration in the immediate future. We will operate Hausmann as a mostly standalone subsidiary for the foreseeable future to ensure preservation of the successful business model under which it has been operating.

Looking forward with the inclusion of Hausmann and taking into account a conservative view of the first combined operating year, we expect consolidated revenues for the fiscal year 2018 to be in the range of $46 million to $50 million.

And continue to be optimistic that the combined it Dynatronics-Hausmann business will grow top line revenue in the mid-single-digits thereafter. In terms of seasonality, Dynatronics' strongest quarter has traditionally been our second fiscal quarter ended December 31. Hausmann's strongest quarter has historically been the quarter ended September 30.

The weakest quarter for both of us has typically been the quarter ended March 31. So we expect seasonality and the overall business to be somewhat exacerbated by the acquisition.

In closing, through improved sales management, new product introductions, geographic expansion, both domestic and international, and expansion into post-acute care markets, we were able to grow the business organically through the first 9 months of this fiscal year.

Additionally, we have done much in the way of restructuring to position the company to be more scalable for growth. The changes have been significant and have required investment in the business as we recognize, as we reorganize and augment the company's management and employee base.

We believe we have made good progress in this effort, but expect to make further investments as our revenues continue to grow. In this regard, at the end of the quarter, we hired Cyndi McHenry to augment our management team. Cindy brings to us a great depth of operating experience, most recently at St. Jude Medical.

The addition of Cindy to our management team will better enable us to achieve greater efficiencies and operations and to be better positioned to grow through acquisitions. We believe we are well positioned to advance this strategic initiative, our strategic objectives with revenue growth and improved cash flow.

Our acquisition of Hausmann Industries is an important milestone in the implementation of our strategic growth plan. That said, it's just the first of what we hope to be a continued program of M&A for Dynatronics.

We will continue to identify and act on additional acquisition opportunities that will further enhance our product offering and distribution coverage and leverage our current sales network to improve those gross profit.

It's important to note that approximately half of the equity financing for the Hausmann acquisition was provided by legacy investors associated with Prettybrook Partners. We believe this is an indication of those investors' continued confidence in our long-term growth plans.

It's noteworthy that members of the Hausmann family also precipitated in the capital raise that was used to fund the acquisition of their own business. That said, through the placement, we were also able to attract sophisticated, new institutional investors to the company. Our credit facility with Bank of the West is another important development.

It will position the company with a banking relationship to execute on additional acquisitions and have access to working capital as we grow the business. Finally, we've made substantial investment to improve our Investor Relations efforts in order to better alert the market of our strategic growth objectives and performance.

Fiscal 2017 has been an exciting and productive year thus far. I want to conclude by thanking all our shareholders, both new and old, for their support and input.

The management team at Dynatronics is committed to serving our customers with safe and effective products, building our business through organic growth and acquisitions and enhancing shareholder value. Without the support of our shareholders, of course, none of this will be possible.

So with that, Stephanie, we'd like to now invite listeners to ask questions if they would like to. If you would explain to them the process for doing so..

Absolutely [Operator Instructions] And we'll take our first question from Jeffrey Cohen [Ladenburg Thalmann & Co. Inc.] Please go ahead..

Hi, Kelvyn and David.

How are you?.

Very well.

Jeff, how are you?.

I am doing fine. So I'll try to stay in order with some questions I have here. So you spoke a little bit about specific modalities that were driving revenues for the quarter and you were talking about the 10.4% for the distributed products in 13%.

Could you just review that for me briefly as far as strength in the quarter?.

Sure.

You're talking about what caused the growth in the modalities and the distributed capital?.

Yes..

Yes. A lot of that had to do with our growth in the long-term care market. We have seen significant inroads into that and that's been sustaining some of that growth. And we're appreciative of that. So that's the primary reason.

Of course, there's some – even though the third quarter is typically our worst quarter because typically, what happens is people have budgets to spend and they spend everything. By the end of December, they start with the New Year’s budget. There is also some evidence to show that people with new budgets also like to buy some capital equipment.

Not totally reflected in it being a strong quarter for us, but that does contribute to the capital equipment of therapeutic modalities and distributed capital..

Okay. Got it. Can you talk a little bit about margins? It looks like your Q3 margins were fairly spot on with what we expected. Can you talk about Q4 and what to expect there? I think we're modelling a little bit lower just for the quarter and then kind of normalizing during fiscal 2018.

Could you help providing any guidance, can you kind of walk through how you're thinking about margins over the next few quarters?.

Yes. Well, the margin for the quarter was 35%. We – for the base Dynatronics business, we would expect it to stay right in that range. The Hausmann, of course, we'll have a quarter of Hausmann in the fourth quarter. Their margins have typically been in the 28% to the 30% range.

So I think if you blend those on a weighted average, we would expect them to be in the neighbourhood of 33%, 32% to 33% in combined..

Okay. Got it.

So that 32%, 33% range, you expect to kind of carry through, through fiscal 2018?.

Yes, we – that will be hard to say for the full fiscal year. I mean, we're trying to get our arms around the Hausmann acquisition right now and understand better at how to deal with margins and how we move forward.

As we indicated, our sales growth is going to be focused on higher-margin products and we think that will have an impact on our margins going forward.

But for right now, based on the outcomes of this particular quarter and when you take Hausmann, who represents about a 50% increase in our sales, you've got a third in the 28% to 30% range and a third in the 34, I mean, two thirds in the 34% to 35% range. That's kind of the base that we're at right now..

Okay. Got it. And could you review for me? So your acquisition-related expenses during the third quarter were $415,000 and for the 9-month period, $533,000.

Is that correct?.

Yes, $486,000 in the current period. It was $450,000 increase over last year because we did have some acquisition expense since last year..

Okay.

So $486,000 for the third quarter?.

Correct..

Correct..

Okay. And then so – okay. So $486,000 for the third quarter, $533,000 for the 9-month period.

And was that guidance you put out, Kelvyn? $46 million to $50 million for fiscal 2018? Is that correct?.

Yes, that's about correct because we as you know, since we brought on the investment from Prettybrook Partners, one of our stated objectives has been to grow through an M&A strategy. And while this is the first successful foray we've had, it's not the only foray we've had in looking at potential acquisitions.

And so those costs in the prior years were related to other endeavours that we were pursuing..

Okay. Got it. And then on the SG&A line, so the quarter was $3.15 million. So how might that look for the balance of this year and for 2018? I guess what I'm looking at is I'm thinking about, say, 17% or 18% on an annual increase.

Does that seem reasonable to you?.

So the question is whether our SG&A expense increases at 17% to 18%, we're going to sustain it at those same increasing levels..

No, they shouldn't increase – continue to increase at those levels. We had a lot of acquisition expenses, in the neighbourhood of $0.5 million of acquisition expenses, that really drove a lot of that growth. If you take that out, our SG&A expenses year-over-year were pretty much in line without too much growth.

So we don't think it will grow at that rate..

I would say, correct. Right now, our SG&A expenses, of course, the selling expenses could have a little bit of a variable component because of commissions and things of that nature, but you'll see some increase as sales increase.

But our overall sales and general and administrative expenses are starting to stabilize, and I think that's evident by what we reported in the quarter, and we've added some new personnel. But a lot of the growth to scale up has now been put in place.

And I'm sure there will still be additional expenses exclusive of acquisition-related cost, but not at that and not at that same growth rate..

Okay. I got it. So taking out the acquisition-related expenses, 2017 SG&A is going to look like $11.5 million, approximately $11.75 million. So you're saying you're looking more like 4% to 10% higher for 2018 from that level. I think I've got numbers that are a little bit too high at the moment..

Well, yes, and keep in mind that we also will be adding the Hausmann overhead in the consolidated model going forward as well..

So if you look, historically, Hausmann has run their SG&A expenses the last couple of years around 23% of their sales, while ours have been up in the neighbourhood of 35%, plus acquisition costs on top of that..

Yes..

Okay. Okay, perfect. And then one more, David, if I may.

When you talk about Q4 8% dividend, the deemed dividend on your 8% preferred stock, so will that be another $376,000 during the fourth quarter? Is that correct, same size as during the March quarter?.

Well, it'll be more than that because it was a lot – a much bigger raise. Was – in December of 2016, we had 390,000 shares that we issued for the acquisition. It was 1,559,000 shares, so it will be much bigger from that perspective. There are also some other factors in our – we made an initial estimate in our 8-K that it would be about $1.6 million.

That is not audited. That could change materially from that number, but that was our estimate as we did the acquisition..

Okay, $1.6 million during the March quarter or $1.6 million in totality for the year? Which one? $1.6 million for the March quarter?.

For the fourth quarter. For the new Series B equity raise, $1.6 million in the fourth quarter..

Perfect. Okay, that does it for me. Thanks, guys. Great progressions..

You bet, Jeff. Thank you. Good questions..

[Operator Instructions] And it appears there are no further telephone questions..

Okay. Stephanie, thank you. I imagine Jeff's questions were thorough enough. He probably made it possible to have all the other questions answered. So well done, Jeff. Thank you. If there are no other questions, then Stephanie, we'll terminate the call at this point..

And this concludes today's call. Thank you for your participation. You may now disconnect..