Dynatronics Corporation

Q1 2023 Earnings Conference Call

11/10/2022

spk02: Good morning, ladies and gentlemen, and welcome to Dynatronics' first quarter fiscal year 2023 earnings call. As a reminder, this conference call is being recorded today, November 10, 2022. Following today's presentation, there will be a question and answer session. At this time, all participants are in listen-only mode. It is now my pleasure to turn the floor over to your host, John Krier, the company's president, chief executive officer, and chief financial officer. John, the floor is yours.
spk06: Thank you, operator. Good morning, everyone, and welcome to the Diamond Electronics first quarter earnings call.
spk03: Before we begin, I will call your attention to our safe harbor statement.
spk07: I remind you that the discussions during this conference call will include forward-looking statements.
spk06: Factors that could cause the actual results to differ materially are discussed in the company's most recent filings with the SEC. We caution you not to place undue reliance on forward-looking statements we make this morning. We undertake no obligation to update or revise forward-looking statements. During our prepared remarks, we will be referring to slides that are available for viewing in the webcast and posted on our Investor Center page at Dynatronics.com. On today's call, we will cover the highlights and achievements of the first quarter of fiscal year 2023, as well as provide commentary on the financials, and then we will have the operator open the phone lines for questions. Slide three highlights just a few of our recent accomplishments, which enabled the company to exceed our baseline continued product net sales expectation set in April 2021, and advance many of our strategic priorities. Three key takeaways for our first quarter. One, we continue to execute against our differentiated strategy, which has led to an increase of 6.8 percentage points in the gross margin from Q4 of fiscal year 22, which has now grown to 30.2% in the current quarter. Each strategic and implementation step we have taken is accretive to our long-term goals of organic revenue growth and consistent profitability. Q1 was a big step forward in expanding gross margin. Second, our first quarter net sales represent the sixth consecutive quarter of exceeding our baseline sales expectation and represents a 1.7% increase from prior year after the exclusion of 0.5 million of discontinued product net sales disclosed in the prior quarter. We maintain our fiscal year 23 revenue guidance of $45.0 million to $48.0 million in net sales. And finally, we are executing against our growth strategy with a clean balance sheet, while also handling the increased demand for our products and maintaining the higher inventory levels required due to the current supply chain environment. Q1 was our ninth consecutive quarter without debt. As a reminder, the full income statement and management discussion and analysis can be found in the 10Q. I will summarize some of the key financials here. Net sales were $12.1 million for the first quarter of fiscal year 23. That compares to net sales of $12.1 in fiscal year 22. The year over year decrease is primarily due to a reduction in sales of discontinued third party distributed products. This was partially offset by revenue from new products and an increase in customer demand compared to the prior year period. Gross profit for the quarter was 3.64 million or 30.2% of net sales compared to 3.66 million or 29.8% of net sales in the same period prior year. The increase in gross profit as a percentage of net sales was driven by net price realization and overall product mix. Gross margin improvement nearly offset the gross profit decline attributable to the reduction in third-party distributed products. While we have seen a slowing of cost increases during Q1 of fiscal year 23 in both freight and raw materials, we expect cost pressures to continue for the remainder of fiscal year 2023. Selling general and administrative expenses increased 21,000 or 0.5% to 4.11 million for the quarter ended September 30, 2022 compared to 4.09 million for the quarter ended September 30, 2021. Selling expenses increased 209,000 compared to the prior year period due primarily to higher marketing program expenses and added personnel. The increase in selling expenses was offset by a decrease in corporate expenses of $188,000 compared to the prior year period, driven mostly by a reduction in professional services. Net loss for Q1 fiscal year 23 was $0.5 million. That compares to a net income of 0.4 million in the same period of fiscal year 22.
spk03: The change was primarily attributable to a decrease of $946,000 in other income, a decrease of $21,000 in gross profit, and an increase of $21,000 in SG&A. The reduction in net other income is primarily attributable to the $943,000 receivable from the U.S. federal government under the CARES Act in the prior year period.
spk06: Outstanding shares will increase approximately $300,000 per quarter depending on our share price. As of September 30, 2022, the number of common shares outstanding was approximately $18.5 million. The net cash balance was approximately $1 billion. million on September 30, 2022, an increase of 0.3 million from June 30, 2022. Supply chain volatility continues to cause longer lead times, and as a result, the organization made a strategic decision to place additional orders on on key raw materials and other supplies. We are working to reduce our inventory balance over the fiscal year 23 as the supply chain environment improves. Cash generated by operating activities was $0.4 million for the first quarter of fiscal year 23. the company continues to manage the reduction of additional safety stock to offset continued expected supply chain disruptions, requirements of new product introductions, and margin expansion to generate profitability and cash flow from operations. This concludes our summary of the financial and operating results. Turning to slide four, We will continue to provide guidance on metrics that we are confident with, and we are affirming our expectation of net sales in fiscal year 23 to be in the range of 45.0 million to 48.0 million. The midpoint of this sales guidance represents a 5% organic growth rate relative to the 44.3 million annual net sales in fiscal year 22. The company expects the distribution of net sales in fiscal year 23 across the quarters to align with historical trends. Highest in the first quarter, lower in the second and third quarters, with a bounce back in the fourth quarter. Moving to slide five. As we have stated in earlier calls, gross margin expansion remains a key focus. Gross margin improved to 30.2% in Q1, a 6.8% sequential increase over the Q4 gross margin of 23.4%, and 7.8% improvement over the Q3 gross margin of 22.4%. This improvement came from a combination of price increases and new product launches. We expect our gross margin in fiscal year 23 to continue to show expansion. Cash flow from operations in fiscal year 23 should begin to benefit from the sell-down of inventory strategically built over the past year and improved profitability resulting from higher gross margins. As a company, we focus on higher margin, differentiated products that we manufacture. Our target is to achieve 40% gross margins over the longer term, which is comparable to or better than what we believe our peers achieve. Dynatronics does not rely as heavily on long-term agreements as many other companies in our markets. We have been successful with our dealers and customers by providing them with an option to accept our standard price increases or to buy more products from all our brands and be rewarded with lower price increases. We anticipate that price increases will offset some of our inflationary cost pressures over time. we have taken and will continue to take multiple actions to offset costs, including selective price increases, exploring alternate sourcing relationships, and improving factory yields. Slide six reaffirms Dynatronics fiscal year 23 guidance details. As we have discussed, we intend to provide guidance on metrics that we are confident with. Net sales are expected to be in the range of $45.0 million to $48.0 million. The midpoint of this range, $46.5 million, represents 5% organic revenue growth. Given the persistent inflationary pressure, ongoing impacts of COVID-19, and supply chain challenges, we are deferring providing gross margin guidance. We do expect fiscal year 23 to continue the expansion towards our longer-term target of 40%. We anticipate selling general and administrative expenses of 30%, to 35% of net sales in fiscal year 2023. As we gain revenue scale, we expect to continually leverage our SG&A cost base. We understand what it takes to build a scalable platform to grow our customer and sales base, to be a much larger company in our markets, drive margin expansion, and consistently deliver strong cash flow from operations to create value for shareholders. We will continue to focus on further improving all our financial metrics. This guidance is based on our current operations and is subject to the risk factors and other forward-looking statements and uncertainties contained in this presentation and in our filings with the SEC. Turning to slide seven, the Diatronics Growth Platform targets initiatives in each of these strategic priorities. The team has made solid strides with our third consecutive quarter of sequential gross margin expansion. We have achieved our 30% gross margin in the face of strong supply chain headwinds. Our short-term focus will be to continue this trend with a view to achieving 40% gross margins over the longer term. operating discipline continues to improve throughout our organization. Over the past two-plus years, we have grown sales and managed our selling, general, and administrative cost base, and we are now demonstrating that we can expand gross margin. We expect that the changes we have made to deliver higher annual net sales, higher annual gross margin, operating income, and cash flow from operations as we move through fiscal year 23. Let's move to slide eight. We have delivered sales growth for six consecutive quarters, well above market growth and grown our 9.25 million continued product sales baseline set in April 2021. Dynatronics has multiple levers to drive sales growth at a macro level, capturing market share, product innovations and through acquisitions. The markets we serve exhibit stable organic growth profiles, approximately three to four percent annually. In addition to this market growth, we intend to continue to take market share and introduce new products that will enable us to grow faster than the market. Please turn to slide nine on winning market share. We win market share through one Superior commercial execution. Make the dealers' and customers' lives as easy as possible and make it simpler to do business with us. And two, favorable mix shift to product innovations. This winning formula has demonstrated organic revenue growth and is beginning to demonstrate margin expansion. We remain focused on driving improvements in our dealer and end customer experience, offering volume tiered pricing that rewards customer loyalty and delivering product innovations that give dealers reasons to continue moving their end customers to Dynatronics. Dynatronics management team is focused on methodical execution and continually seeking a strong differentiated understanding of the commercial landscape in the product categories we compete in. Let's move to slide 10.
spk03: Our M&A strategy is detailed here to give you an idea of what we look for. We have the leadership
spk06: to execute on any opportunities that meet our well-defined criteria. Each week, I, or a member of our team, consistently engage in partnership or acquisition discussions as a core part of our long-term strategy. Our focus criteria include greater than 40% gross margin and cash flow contribution within the first year. We remain focused on our current markets, and our near-term targets are at the lower end of the $5 to $30 million revenue range. We prefer to make a smaller acquisition using our balance sheet or bank debt. rather than equity because we believe our share price is undervalued, and we want to unlock some of that value. Slide 11 is the investment highlight for Dynatronics. The markets we serve, rehabilitation and bracing, have stable growth profiles. Our sales and share growth has been driven by customer and dealer reaction to the business transformation. Sales have exceeded the market or our baseline expectation in six consecutive quarters. We target improvement in gross margin in fiscal year 23 and generated 6.8% sequential improvement in Q1 of fiscal year 23. We have approximately $1.0 million of cash and $11.9 million of inventory on the balance sheet at the end of September with no debt. Dynatronics has not borrowed against its asset base of inventory or accounts receivable since July 2020, representing nine consecutive quarters of no debt. We are demonstrating progress against each of our strategic goals with more to come. The investment community is actively listening to our story, and we will continue to share our progress and updates as we move into the new fiscal year. We will be presenting and hosting one-on-one meetings at upcoming investor events, which will be detailed in upcoming press releases and on our investor relations website. I will be presenting on November 14th to 15th, 2022 at the Investor Summit, live and virtually from New York City. Next Monday and Tuesday's event is another opportunity to share details of our transformation journey and we hope to meet with you. I will now turn it over for questions.
spk02: Ladies and gentlemen, the floor is now open for questions. If you have any questions or comments, please press star one on your phone at this time. We ask that while posing your question, you please pick up your handset if listening on speakerphone to provide optimum sound quality. Please hold while we poll for questions. Your first question for today is coming from Jeffrey Cohen at Lattenberg Thelman.
spk04: Oh, hi, John. How are you?
spk07: Doing well, Jeff. Good morning.
spk04: So a couple questions. First, congrats on the margins, Boston, through 30%. And it looks like on your slide six, you're targeting 30 to 35 for the full year. Oh, I'm sorry, that's SG&A. So on the margin side, should we or could we expect that to increase? Is 30 the new baseline?
spk07: You know, Jeff, it's certainly a great quarter in terms of the gross margin improvement.
spk06: I'm really proud of the organization as a whole for executing our path to gross margin improvement. As it relates to the full year, we're still deferring guidance as we understand the timing of all of the inflationary costs rolling through inventory and what to expect going forward. But we do expect that we'll continue our progression towards our longer-term target of 40%. There may be some up and downs as we go through that, which is why we're not providing specific guidance on it, but we're certainly happy with the 30.2% for the quarter.
spk04: Okay, got it. And could you talk about the inventory a little bit? Still up there at around 11.9. Is that going to be a focus for the year? Would you anticipate over the coming quarters that that would be work down a little bit?
spk06: That's absolutely our target. That's a key lever for us in terms of driving cash flow from operations. We drove $0.4 million of cash flow from operations in the first quarter. That's a very important precursor, if you will, to profitability. Brian Baker and the team are focused on that throughout the year. We also have to modulate that with the strong demand that we can see with the double-digit growth that we've had in the past. We have new product introductions coming, and so we have to manage all of that.
spk03: You should expect that we will manage that down through the year to drive some cash flow from operations.
spk04: Got it. And as long as you brought that up, could you talk about some of the new product introductions that are anticipated organically?
spk06: Absolutely. You know, over the last year, we've had about seven releases, and really, it was only six months ago that we released our three new tables in the Mammoth Collection, and that's going to be a longer-term project and a collection. Those results are just starting to make its way into our financials from a revenue perspective, yet we had to build up inventory to support the launch. You can expect more releases throughout the fiscal year. No details that I have today to share about it, but I know that Sarah Mealman and our marketing team are very focused on listening to our customers who've given us some great ideas, and we look forward to releasing more throughout the year.
spk03: It will be a driver of our longer-term growth.
spk06: We have to take market share with good execution. We have to launch new products, and then eventually, when the time is right, ideally land an acquisition or two.
spk04: Okay. And our final question about the M&A environment out there, which you just mentioned. What's changed over the past few quarters as far as availability, pricing, and what you've been looking at?
spk06: It's still the same environment. I enjoy the conversations that we have. There's some great organizations out there that are trying to determine what they think the inflationary pressures are going to mean to their business long term. Where are they at with being able to now differentiate in our new normal of supply chain challenges? Is it better to partner with an organization like us? So I wouldn't say that the market has changed as much as ongoing dialogue. Prices are still dependent on a willing buyer and a willing seller. But we're looking for them, and hopefully at some point we'll be able to do that.
spk04: Got it. Okay, thanks for taking our questions, John.
spk07: Thanks, Jeff. Have a great day.
spk02: Your next question is coming from Brooks O'Neill at Lake Street Capital Markets.
spk05: Good morning, John. Congratulations on the margin expansion. That's really terrific. So I'm just going to ask a couple quick questions. First, obviously you expanded the inventory strategically to address the supply chain challenges. Do you see risk in the inventory position now related to the inflationary environment and or the demand environment you see out there in the market today?
spk06: It's certainly something we have to watch for, Brooks, in general, just like everybody that's out there today. The point that I would call attention to for Dynatronics is that we made a strategic shift to focus on our manufactured products. And that allows the fact that we're not reliant on somebody else's distributed products that may go in or out of vogue with our customers. These are our core products that our customers are ordering day to day. So we'll have the tail to be able to drive those through. So it's a much less risk than maybe other organizations have that do not sell their own manufactured products. It's a key strategic advantage we have.
spk05: Great. That makes sense to me. Let me ask you one more question that I think is on the mind of a lot of the investors that are out there in the world today. You mentioned that you see your share prices undervalued today. How do you and the board think about issuing shares for the preferred as opposed to borrowing money and or using cash?
spk06: We are very sensitive to share count and dilution of our overall value you know today when you look at the share count the enterprise market value and you look at our working capital you see that our working capital is is in excess of that it's one of the reasons we think that we're undervalued with our overall revenue when we look at cash or we look at capital allocation whether it be in the form of shares or
spk03: on the preferred or exercise in the business. We're looking at all of those factors and making sure that we make the right decision.
spk06: So wherever we can deploy cash for growth, drive EBITDA, drive profitability, we're going to do that. But I will tell you that we're very focused on our overall share count and it's something that we do consider.
spk05: Good. I appreciate that. Let me ask one last one. Any thoughts about hiring a CFO or how do you and the board think about that?
spk06: We certainly look at it from a managing of a risk perspective. When I first joined the organization, I came in as the CFO and coming from a financial background, starting my career at Deloitte, I have an advantage of being able to do both. And as we look at it today as a company with roughly 50 million of revenue and designing a path to profitability, we're making strategic investments on personnel. And so today, as long as I can continue to perform both roles, perform them adequately, we'll continue to make investments in marketing or engineering or supply chain, those things that propel growth as opposed to potentially a financial leader. But we will bring a financial leader in when we think it's the right time.
spk05: Great. Thank you very much for taking my questions.
spk03: Thanks, Brooks.
spk02: Your next question for today is coming from Scott Henry at Ross Capital.
spk01: Thank you and good morning. I guess first in observation, the font is getting really small in the press release. My eyes are starting to struggle. You might want to increase that font. But moving on to more relevant questions and comments. The SG&A in the quarter, It's a little higher than maybe I expected, but that seems to be happening on a seasonal basis. Would I expect, meaning higher in the first quarter and the fourth quarter, lower in the middle of the year? With regards to SG&A, would you expect that trend to continue?
spk06: Good morning, Scott. That is absolutely the trend that you should expect.
spk07: Our first quarter is positive.
spk06: usually our highest from an SG&A spend, primarily related to our fiscal year audit costs and other professional fees that are largely borne in the first quarter. So you should expect that. It is still under the 35%. I think we landed at 34% for the quarter. So it's within our range that we've provided, but you should expect that this will be the higher end of it.
spk01: Okay. And then I know you don't want to give gross margin guidance. And I think the first question was directed towards it. But I guess the question is, is the gross margin in first quarter, is there anything unusual in that number? Is there any reason to think that that was a stronger than typical quarter and there would be some reversion to the mean? Or is that a normal quarter and we'll hope it stays there or Or we'll see where the variance is.
spk06: The way that I interpret that, Scott, is it's a very strong quarter for us. Nothing abnormal in the quarter that I would point to in general. But we're starting to see signs of our overall gross margin improvement plan come to life. The challenge in being able to provide guidance going forward is there's still a number of shocks and disruptions out there that we're unable to fully get the timing right on in terms of communicating, which is why we're deferring it. but that doesn't mean we're not executing against our plan. The first thing we did was rationalized our products last year. That's an ongoing, we've rationalized our pricing and our customers. We just started the new product launches that are making their way into revenue for the first time. And now we're moving our way into manufacturing efficiencies and revenue scale. So we have a six point gross margin improvement plan. You're starting to see the benefit from it, you know, where this will ultimately land time will tell, but I'm certainly really proud of the team and the organization for Q1.
spk03: Okay, and is it still pretty heavily dependent on just the total revenues in the quarter, meaning is there a big component of it that will see better gross margins in the higher revenue quarter, or is it variable?
spk01: How should we think about those factors?
spk06: We should think about it like most organizations. You know, revenue scale is the fifth lever we pull on growth, smarts, and improvements. So the higher the revenue, we're going to generate more scale. It doesn't materially drop with lower revenue, but it does suffer. So it is dependent on revenue. I don't know whether it's more or less than other organizations, but we will benefit from higher revenue. It will not go down as much on lower revenue.
spk01: Okay, great. And I guess the final question and kind of line of discussion is, you know, John, I think you've done a great job stabilizing the company coming out of COVID. And we're seeing, you know, you're beating numbers. You're stabilizing the business. The cash flow situation is good. but the market cap's kind of in the no one cares category. I mean, for a 50 million revenue company or approximately 50, no one cares, no one's paying attention. Do you think it's time to really set a plan, whatever it be, a three-year plan, a three-point plan, with the idea of, hey, it's time to turn this into a profitable company and we're either going to acquire, we're going to have organic growth, or we're going to sell this company, just with the idea being that, you know, I think if there's some visibility into what the end game here is, because it's been going sideways for a while, and I commend you for stabilizing it coming out of COVID, but it just feels to me like it's time to set more boundaries direct goals on turning this into a profitable company and really moving forward to the next stage. I'm really just looking for your thoughts on that comment.
spk06: Yeah, I appreciate the candor, Scott. We are absolutely looking at our plan and how we're going to execute going forward. The first step was getting the company stable, as you mentioned, nine consecutive quarters of no debt. We've done that. We've got a great team propelling us forward with a good culture of accountability. We've demonstrated revenue growth on our manufactured products. We've controlled costs. The third step is we're now demonstrating that we can begin to grow gross margin. That is the next step towards profitability. And when I've talked to investors that are out there, they've been very clear with me. Nice job stabilizing the company. Nice job on growing revenue base, defining the products and where you're going. If you can demonstrate that you can grow gross margin, you're going to be profitable. With profitability will come the valuation, and then ultimately we can use this as an acquisition platform. So I do think that that's still the thesis, and one of the things that we hope to continue to share with people is that we're looking for long-term investors that want to get behind a potential leader in the market that we desire to be.
spk01: I think that's helpful, but I just think a direct plan, because keep in mind as well, over the past two years, Shares Outstanding has has went up about 20% to 25% too. So everything hasn't been great, but I think you've done a good job stabilizing it. But thank you for the comments, and thank you for taking the questions.
spk07: Appreciate it, Scott. Have a great day.
spk03: Once again, if there are any questions or comments,
spk02: please press star 1 on your phone at this time.
Disclaimer

This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.

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