The following discussion contains assumptions, estimates and other
forward-looking statements that involve a number of risks and uncertainties,
including those discussed under the heading "Cautionary Note Regarding
Forward-Looking Statements," on page 1 of this Form 10-K, "Risk Factors"(Part I,
Item 1A of this Form 10-K) and elsewhere in this Form 10-K. These risks could
cause our actual results to differ materially from those anticipated in these
forward-looking statements.
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements and related Notes thereto, which are included in Part II, Item 8 of
this report.
Overview
Wedesign, manufacture, and sell a broad range of restorative products for
clinical use in physical therapy, rehabilitation, orthopedics, pain management,
and athletic training. Through our distribution channels, we market and sell to
orthopedists, physical therapists, chiropractors, athletic trainers, sports
medicine practitioners, clinics, hospitals, and consumers.
Results of Operations
Fiscal Year 2020 Compared to Fiscal Year 2019
Net Sales
Net sales in fiscal year 2020 decreased $9,156,000, or 14.6%, to $53,409,000,
compared to net sales of $62,565,000in fiscal year 2019. The year-over-year
decrease is primarily due to the expected decline in sales due to stay-at-home
policies and government restrictions in response to the COVID-19 pandemic, as
well as the continued decline in physical therapy and rehabilitation product
sales.
22
Gross Profit
Gross profit for the year ended June 30, 2020 decreased $4,076,000, or 21.3%, to
$15,098,000, or 28.3% of net sales. By comparison, gross profit for the year
ended June 30, 2019 was $19,174,000, or 30.6% of net sales. The year-over-year
decrease in gross profit was attributable to: (1) lower sales which reduced
gross profit by approximately $2,806,000 and (2) reduced gross margin percent
which reduced gross profit by approximately $1,270,000. The year-over-year
decrease in gross margin percentage to 28.3% from 30.6% was due primarily to
lower efficiency of the production process as a result of lower sales.
Selling, General, and Administrative Expenses
Selling, general, and administrative ("SG&A") expenses decreased $1,879,000, or
9.4%, to $18,091,000 for the year ended June 30, 2020, compared to
$19,970,000for the year ended June 30, 2019. Selling expenses decreased
$1,605,000 compared to the prior year period, due primarily to lower commission
expense on lower sales and decreased sales management salaries during the year.
General and administrative ("G&A") expenses decreased $274,000 compared to the
prior-year period, driven by a $234,000 increase in severance expenses offset
by a $508,000 decrease in other G&A expenses primarily related to lower payroll
and benefits as a result of headcount reductions.
Interest Expense
Interest expense decreased approximately $76,000 in fiscal year 2020, to
approximately $436,000, compared to approximately $512,000 in fiscal year 2019.
The decrease in interest expense is primarily related to lower interest rates
and lower average borrowings on our line of credit resulting in interest charges
of $196,000 and $269,000 for the years ended June 30, 2020 and 2019,
respectively. Another large component of interest expense is imputed interest
related to the sale/leaseback of our corporate headquarters facility which
totaled $156,000 and $167,000, respectively, for the years ended June 30, 2020
and 2019. Interest expense also included interest on the mortgage on our
Tennessee property, imputed interest related to other capital leases, and
interest paid on equipment loans for office furnishings and vehicles.
Net Loss Before Income Tax
Pre-tax loss for the year ended June 30, 2020 was $3,436,000 compared to
$916,000 for the year ended June 30, 2019. The $2,519,000 increase in pre-tax
loss was primarily attributable to a decrease of $4,076,000 in gross profit and
an increase of $322,000 in net other expense, partially offset by a decrease of
$1,879,000 in SG&A. The increase in net other expense was primarily attributable
to a $375,000 gain on revaluation of the Bird & Cronin acquisition earn-out
liability in the year ended June 30, 2019 partially offset by a decrease in
interest expense.
Income Tax
Income tax benefit was $10,000 in fiscal year 2020, compared to an income tax
provision of $5,000 in fiscal year 2019.
Net Loss
Net loss for the year ended June 30, 2020 was $3,425,000, compared to $922,000
for the year ended June 30, 2019. The reasons for the change in net loss are the
same as those given under the headings Net Loss Before Income Taxand Income Tax
in this Management's Discussion and Analysis of Financial Condition and Results
of Operations ("MD&A").
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Net Loss Attributable to Common Stockholders
Net loss attributable to common stockholders increased $2,601,000 to $4,317,000
($0.42 per share) for the year ended June 30, 2020, compared to $1,716,000
($0.21 per share) for the year ended June 30, 2019. The increase in net loss
attributable to common stockholders for the year is due primarily to: (1) a
$2,503,000 increase in net loss; (2) a $174,000 increase in deemed dividends on
convertible preferred stock and accretion of discounts; and (3) a $77,000
decrease in preferred stock dividends.
Liquidity and Capital Resources
We have historically financed operations through cash from operating activities,
available cash reserves, borrowings under a line of credit facility (see, Line
of Credit, below) and proceeds from the sale of our equity securities. As of
June 30, 2020, we had $2,216,000 in cash and cash equivalents, compared to
$156,000 as of June 30, 2019. During fiscal year 2020, we had positive cash
flows from operating activities.
Working capital was $8,396,000 as of June 30, 2020, compared to working capital
of $5,638,000 as of June 30, 2019. The current ratio was 2.1 to 1 as of June 30,
2020 and 1.4 to 1 as of June 30, 2019. Current assets were 42.8% of total assets
as of June 30, 2020, and 50.2% of total assets as of June 30, 2019.
We believe that our cash generated from operations, current capital resources
including recent loan and equity proceeds, and available credit provide
sufficient liquidity to fund operations for the next 12 months. However, the
continuing effects of the COVID-19 pandemic could have an adverse effect on our
liquidity and cash and we continue to evaluate and take action, as necessary, to
preserve adequate liquidity and ensure that our business can continue to operate
during these uncertain times.
In March 2020, we entered into an equity distribution agreement with Canaccord
Genuity LLC and Roth Capital Partners LLC, pursuant to which we arranged to
offer and sell shares of our common stock in an at-the-market offering ("ATM")
under a registration statement previously filed by us on Form S-3 with the
Securities and Exchange Commission. On March 13, 2020, we filed a Prospectus
Supplement amending the registration statement and commenced the ATM. Under the
terms of the equity distribution agreement, we may sell shares of our common
stock in an aggregate amount of up to $10,000,000, with Canaccord Genuity LLC
and Roth Capital Partners LLC acting as our sales agents at the market prices
prevailing on The Nasdaq Capital Market at the time of the sale of such shares.
We will pay Canaccord Genuity LLC and Roth Capital Partners, LLC a fixed
commission rate equal to 3.0% of the gross sale price per share of common stock
sold.
In April 2020, we sold an aggregate of 3,200,585 shares of common stock under
the equity distribution agreement in the ATM. We incurred offering costs
totaling $238,000, inclusive of commissions paid to the sales agents at a fixed
rate of 3.0%, together with legal, accounting and filing fees. Net proceeds from
the sale of the shares totaled $2,287,000. Proceeds were used to strengthen our
liquidity and working capital position.
On April 29, 2020, we entered into a promissory note (the "Note") with Bank of
the West to evidence a loan to the Company in the amount of $3,477,412 under the
Paycheck Protection Program (the "PPP") established under the Coronavirus Aid,
Relief, and Economic Security Act (the "CARES Act"), administered by the U.S.
Small Business Administration ("SBA").
In accordance with the requirements of the CARES Act, we expect to use the
proceeds from the loan exclusively for qualified expenses under the PPP,
including payroll costs, mortgage interest, rent and utility costs, as further
detailed in the CARES Act and applicable guidance issued by the SBA. Interest
will accrue on the outstanding balance of the Note at a rate of 1.00% per annum.
We intend to apply for forgiveness of all amounts due under the Note, in an
amount equal to the sum of qualified expenses under the PPP incurred during the
24 weeks following initial disbursement. Notwithstanding our expected
eligibility to apply for forgiveness, no assurance can be given that we will
obtain forgiveness of all or any portion of amounts due under the Note.
Subject to any forgiveness granted under the PPP, the Note is scheduled to
mature two years from the date of initial disbursement under the Note and is
payable in monthly installments beginning 10 months after the completion of the
24 week covered period. The Note may be prepaid at any time prior to maturity
without penalty. The Note contains customary provisions related to events of
default, including, among others, failure to make payments, bankruptcy, breaches
of representations, significant changes in ownership, and material adverse
effects. The occurrence of an event of default may result in the collection of
all amounts owing under the Note, and/or filing suit and obtaining judgment
against us. Our obligations under the Note are not secured by any collateral or
personal guarantees.
24
Cash and Cash Equivalents and Restricted Cash
Our cash and cash equivalents and restricted cash position increased $2,060,000
to $2,316,000 as of June 30, 2020, compared to $256,000 as of June 30, 2019. The
primary sources of cash in the year ended June 30, 2020, was $3,090,000 of net
cash provided by operating activities, $2,287,000 net proceeds from issuance of
common stock, and $3,477,000 proceeds from the PPP Note. Primary uses of cash
included net payments of $5,528,000 under our line of credit and acquisition
holdbacks of $500,000.
Accounts Receivable
Trade accounts receivable, net of allowance for doubtful accounts, decreased
approximately $2,601,000, or 34.7%, to $4,894,000 as of June 30, 2020, from
$7,495,000 as of June 30, 2019. The decrease was primarily due to a decline in
sales in the year ended June 30, 2020. Trade accounts receivable represents
amounts due from our customers including dealers and distributors, medical
practitioners, clinics, hospitals, colleges, universities and sports teams. We
believe that our estimate of the allowance for doubtful accounts is adequate
based on our historical experience and relationships with our customers.
Accounts receivable are generally collected within approximately 40 days of
invoicing.
Inventories
Inventories, net of reserves, decreased $3,156,000, or 27.4%, to $8,372,000 as
of June 30, 2020, compared to $11,528,000 as of June 30, 2019. The decrease was
primarily due to steps taken to right-size incoming material purchases and
adjust inventory management as part of our working capital plans in response to
the impacts of COVID-19. During fiscal year 2020, we recorded in cost of goods
sold, $460,000 in non-cash write-offs of inventory related to discontinued
product lines, excess repair parts, product rejected for quality standards, and
other non-performing inventory, compared to inventory write-offs of $0 in fiscal
year 2019. We believe that our estimate of the allowance for inventory reserves
is adequate based on our historical knowledge and product sales trends.
Accounts Payable
Accounts payable decreased approximately $976,000, or 24.5%, to $3,014,000 as of
June 30, 2020, from $3,990,000 as of June 30, 2019. The decrease in accounts
payable was driven primarily by a reduction in inventory purchases and timing of
payments.
Line of Credit
We have a line of credit with Bank of the West ("Line of Credit") available
pursuant to a loan and security agreement, as amended (the "Loan and Security
Agreement"), that matures on January 15, 2022. Our obligations under the Line of
Credit are secured by a first-priority security interest in substantially all of
our assets. The Line of Credit requires a lockbox arrangement and contains
affirmative and negative covenants, including covenants that restrict our
ability to, among other things, incur or guarantee indebtedness, incur liens,
dispose of assets, engage in mergers and consolidations, make acquisitions or
other investments, make changes in the nature of our business, and engage in
transactions with affiliates. The agreement also contains financial covenants
including a minimum monthly consolidated fixed charge coverage ratio which only
applies when the excess availability amount under the Line of Credit is less
than the greater of $1,000,000 or 10% of the borrowing base. As amended, the
Loan and Security Agreement provides for revolving credit borrowings in an
amount up to the lesser of $11,000,000 or the calculated borrowing base. The
borrowing base is computed monthly and is equal to the sum of stated percentages
of eligible accounts receivable and inventory, less a reserve. Amounts
outstanding bear interest at LIBOR plus 2.25% (approximately 2.4% as of June 30,
2020). The Line of Credit is subject to a quarterly unused line fee of .25%.
As of June 30, 2020, we had borrowed $1,013,000 under the Line of Credit
compared to total borrowings of $6,541,000 as of June 30, 2019. There was
approximately $5,040,000and $1,480,000available to borrow as of June 30, 2020
and 2019, respectively.
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Debt
Long-term debt increased approximately $3,302,000 to approximately
$3,605,000 as of June 30, 2020, compared to approximately $303,000 as of June
30, 2019. Our long-term debt is primarily comprised of the PPP Note, mortgage
loan on our office and manufacturing facility in Tennessee maturing in 2021, and
also includes loans related to equipment and a vehicle. The principal balance on
the PPP Note is $3,477,412, all of which is classified as long-term debt at June
30, 2020. The principal balance on the mortgage loan is approximately $91,000,
all of which is classified as current portion of long-term debt at June 30,
2020, with monthly principal and interest payments of $13,000.
Finance Lease Liability
Finance lease liability as of June 30, 2020 and 2019 totaled approximately
$2,914,000 and $3,199,000, respectively. Our capital lease obligations consist
primarily of a capitalized building lease. In conjunction with the sale and
leaseback of our Utah building in August 2014, we entered into a 15-year lease,
classified as a finance lease, originally valued at $3,800,000. The building
lease asset is amortized on a straight line basis over 15 years at approximately
$252,000 per year. Total accumulated amortization related to the leased building
is approximately $1,491,000 at June 30, 2020. The sale generated a profit of
$2,300,000, which is being recognized straight-line over the life of the lease
at approximately $150,000 per year as an offset to amortization expense. The
balance of the deferred gain as of June 30, 2020 is $1,379,000. Lease payments,
currently approximately $30,000, are payable monthly and increase annually by
approximately 2% per year over the life of the lease. Imputed interest for the
fiscal year ended June 30, 2020 was approximately $156,000. In addition to the
Utah building, we lease certain equipment which have been determined to be
finance leases. As of June 30, 2020, future minimum gross lease payments
required under the capital leases were as follows:
2021 $465,624
2022 472,874
2023 445,280
2024 384,754
2025 392,446
Thereafter 1,720,902
Total $3,881,880
Operating Lease Liability
Operating lease liability as of June 30, 2020 and June 30, 2019 totaled
approximately $3,358,000 and $0, respectively. The operating lease liability was
recorded upon the adoption of ASU No. 2016-02, Leases. Our operating lease
liability consists primarily of building leases for office, manufacturing,
warehouse and storage space.
Acquisition Holdback and Earn-Out Liability
Acquisition earn-out liability decreased $500,000 or 100.0%, to $0 as of June
30, 2020, from $500,000 as of June 30, 2019. The decrease is due to payments
during the year ended June 30, 2020.
Inflation
Our revenues and net income have not been unusually affected by inflation or
price increases for raw materials and parts from vendors.
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Stock Repurchase Plan
In 2011, our Board of Directors adopted a stock repurchase plan authorizing
repurchases of shares in the open market, through block trades or otherwise.
Decisions to repurchase shares under this plan are based upon market conditions,
the level of our cash balances, general business opportunities, and other
factors. The Board may periodically approve amounts for share repurchases under
the plan. As of June 30, 2020, approximately $449,000 remained available under
this authorization for purchases under the plan. No purchases have been made
under this plan since September 28, 2011.
Critical Accounting Policies
This MD&A is based upon our Consolidated Financial Statements (see
Part II, Item 8 below), which have been prepared in accordance with accounting
principles generally accepted in the U.S. ("GAAP"). The preparation of these
financial statements requires us to make estimates and assumptions that affect
the reported amounts of assets, liabilities, revenue and expenses as well as the
disclosure of contingent assets and liabilities. We regularly review our
estimates and assumptions. The SEC has requested that all registrants address
their most critical accounting policies. The SEC has indicated that a "critical
accounting policy" is one which is both important to the representation of the
registrant's financial condition and results and requires management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain. We
base our estimates on past experience and on various other assumptions our
management believes to be reasonable under the circumstances, the results of
which form the basis for making judgments about carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
will differ, and may differ materially from these estimates under different
assumptions or conditions. Additionally, changes in accounting estimates could
occur in the future from period to period. Our management has discussed the
development and selection of our most critical financial estimates with the
audit committee of our Board of Directors. The following paragraphs identify our
most critical accounting policies:
Inventories
The nature of our business requires that we maintain sufficient inventory on
hand at all times to meet the requirements of our customers. We record finished
goods inventory at the lower of standard cost, which approximates actual cost
(first-in, first-out) or market. Raw materials are recorded at the lower of cost
(first-in, first-out) or market. Inventory valuation reserves are maintained for
the estimated impairment of the inventory. Impairment may be a result of
slow-moving or excess inventory, product obsolescence or changes in the
valuation of the inventory. In determining the adequacy of reserves, we analyze
the following, among other things:
?
Current inventory quantities on hand;
?
Product acceptance in the marketplace;
?
Customer demand;
?
Historical sales;
?
Forecast sales;
?
Product obsolescence;
?
Strategic marketing and production plans
?
Technological innovations; and
?
Character of the inventory as a distributed item, finished manufactured item or
raw material.
Any modifications to estimates of inventory valuation reserves are reflected in
cost of goods sold within the statements of operations during the period in
which such modifications are determined necessary by management. As of June 30,
2020, and 2019, our inventory valuation reserve balance, was approximately
$568,000 and $139,000, respectively, and our inventory balance was $8,372,000
and $11,528,000, net of reserves, respectively.
27
Revenue Recognition
Our sales force and distributors sell Manufactured and Distributed Products to
end users, including orthopedists, physical therapists, chiropractors, athletic
trainers, sports medicine practitioners, clinics, hospitals, and consumers.
Revenue is recognized when performance obligations under the terms of a contract
with a customer are satisfied which occurs upon the transfer of control of a
product. This occurs either upon shipment or delivery of goods, depending on
whether the contract is FOB origin or FOB destination. Revenue is measured as
the amount of consideration expected to be received in exchange for transferring
products to a customer.Contracts sometimes allow for forms of variable
consideration including rebates and incentives. In these cases, the Company
estimates the amount of consideration to which it will be entitled in exchange
for transferring products to customers utilizing the most likely amount method.
Rebates and incentives are estimated based on contractual terms or historical
experience and a liability is maintained for rebates and incentives that have
been earned but are unpaid.Revenue is reduced by estimates of potential future
contractual discounts including prompt payment discounts. Provisions for
contractual discounts are recorded as a reduction to revenue in the period sales
are recognized. Estimates are made of the contractual discounts that will
eventually be incurred. Contractual discounts are estimated based on negotiated
contracts and historical experience.Shipping and handling activities are
accounted for as fulfillment activities. As such, shipping and handling are not
considered promised services to our customers. Costs for shipping and handling
of products to customers are recorded as cost of sales.
Allowance for Doubtful Accounts
We must make estimates of the collectability of accounts receivable. In doing
so, we analyze historical bad debt trends, customer credit worthiness, current
economic trends and changes in customer payment patterns when evaluating the
adequacy of the allowance for doubtful accounts. Our accounts receivable balance
was $4,894,000 and $7,495,000, net of allowance for doubtful accounts of
$185,000 and $90,000 as of June 30, 2020, and 2019, respectively.
Deferred Income Taxes
A valuation allowance is required when there is significant uncertainty as to
the realizability of deferred tax assets. The realization of deferred tax assets
is dependent upon our ability to generate sufficient taxable income within the
carryforward periods provided for in the tax law for each tax jurisdiction. We
have considered the following possible sources of taxable income when assessing
the realization of our deferred tax assets:
?
future reversals of existing taxable temporary differences;
?
future taxable income or loss, exclusive of reversing temporary differences and
carryforwards;
?
tax-planning strategies; and
?
taxable income in prior carryback years.
We considered both positive and negative evidence in determining the continued
need for a valuation allowance, including the following:
Positive evidence:
?
Current forecasts indicate that we will generate pre-tax income and taxable
income in the future. However, there can be no assurance that our strategic
plans will result in profitability.
?
A majority of our tax attributes have indefinite carryover periods.
Negative evidence:
? We have nine years of cumulative losses as of June 30, 2020.
28
We place more weight on objectively verifiable evidence than on other types of
evidence and management currently believes that available negative evidence
outweighs the available positive evidence. We have therefore determined that we
do not meet the "more likely than not" threshold that deferred tax assets will
be realized. Accordingly, a valuation allowance is required. Any reversal of the
valuation allowance will favorably impact our results of operations in the
period of reversal.As of June 30, 2019 and June 30, 2018, we recorded a full
valuation allowance against our net deferred income tax assets. The anticipated
accumulated net operating loss carryforward as of June 30, 2020, is
approximately $9,237,000, which will begin to expire in 2037.
Recent Accounting Pronouncements
See Note 1 to the Consolidated Financial Statements included in Item 8 of the
Form 10-K for a description of recent accounting pronouncements.
Off-Balance Sheet Financing
We have no off-balance sheet debt or similar obligations. We have no
transactions or obligations with related parties that are not disclosed,
consolidated into or reflected in our reported results of operations or
financial position. We do not guarantee any third-party debt.
Business Plan and Outlook
This past year our focus has been on driving profitability in our legacy
business through multiple cost-reduction initiatives, while continuing to build
our restorative products platform for long-term success. We are confident that
the steps we have taken will position the company for success moving forward. In
fiscal 2021 we are focused on executing our strategies as follows:
?
Drive sales through enhancing our partnerships with key strategic accounts,
optimizing our sales channels, demand generation, and continuing to deliver
superior customer care;
?
Increase our operating profitability through disciplined management of our
financial ratios, cost reduction initiatives, and product portfolio management;
?
Pursue merger and acquisition opportunities in our core markets through pipeline
management, disciplined valuation, and superior execution; and
?
Bolster our communication with the investor community through investor
conferences, non-deal road shows, and calls with equity research analysts and
investors.
We are actively pursuing an acquisition strategy to consolidate other
manufacturers and distributors in our core markets (i.e. physical therapy,
rehabilitation, orthopedics, pain management, and athletic training). We are
primarily seeking candidates that fall into the following categories:
?
Manufacturers in markets where we have a competitive advantage;
?
Distributors that extend geographic reach or provide different channel access;
?
Tuck-in manufacturers / distributors in adjacent markets; and
?
Value-oriented businesses with growth potential, stable margins, and cash flow.
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