Dynatronics Corporation

Good morning, ladies and gentlemen, and welcome to the Dynatronics fourth quarter fiscal year 2022 earnings call. It is now my pleasure to turn the floor over to your host, John Crear, the company's president, chief executive officer, and chief financial officer. John, the floor is yours.

Thank you, operator. Good morning, everyone, and thanks for joining Dynatronics call today. Before we begin, I will call your attention to our safe harbor statement. Please note that during this call, we will make forward-looking statements regarding our current expectation, plans, projections, and financial performance relating to our business. These forward-looking statements reflect our views as of today only, and they involve risks and uncertainties that could cause actual results to differ materially from those discussed today. Important factors that could cause actual results to differ materially from those projected or implied by our forward-looking statements are included in our most recent 10-K and other reports filed with the SEC and include uncertainties and risks related to the broader economic environment and the impact of the COVID-19 global pandemic on our business results. We caution you not to place undue reliance on forward-looking statements we may 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 fourth quarter and full year fiscal 2022, 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 more recent accomplishments, all of which enabled the company to exceed the market growth rates for the fifth consecutive quarter and demonstrate progress toward our strategic goals. For starters, let me begin with three headline points. First, we have a clear line of sight to profitable growth and a well-defined strategy. Each step we take is designed to be incrementally accretive to reaching our long-term goals of organic revenue growth and consistent profitability. Second, our fourth quarter net sales represent the fifth consecutive quarter of exceeding the market and our baseline sales expectation. And third, we are choosing a strictly managed growth strategy that utilizes a clean balance sheet with no debt as the primary mechanism to manage the increased demand for our products, and the inventory levels required due to the current supply chain environment. Please turn to slide four, which contains our quarterly financial and business highlights. As a reminder, the full income statement and management discussion and analysis can be found in the 10-K. I will summarize some of the key financials here. Net sales were $44.3 million for the fiscal year 22. That compares to net sales of 47.8 million in fiscal year 21. The year-over-year decrease is primarily due to a reduction in sales of third-party distributed products which have been discontinued. This was partially offset by revenue from new products and an increase in customer demand compared to the prior year period in which we experienced the impact of COVID-19 precautions and associated deferral on elective procedures which reduced demand for our products. Our net sales across the quarters of fiscal year 22 aligned with historical trends, lower in the second and third quarters and higher in the first and fourth quarters. Gross profit for fiscal year 2022 was 10.7 million or 24.1% of net sales compared to 12.9 million or 27% of net sales in the prior year. We experienced COVID-19 and supply chain challenges, including extraordinarily high freight, raw materials and labor costs throughout the fiscal year. While we have seen a slowing of inflationary costs over the last quarter in both freight and raw materials, we expect cost pressures to continue for the remainder of calendar year 2022 and to be more pronounced in the first half of fiscal year 23. Selling, general and administrative expenses decreased by 7.2% to $15.4 million in fiscal year 22, compared to $16.6 million in the prior fiscal year. We delivered year-over-year SG&A cost savings as intended, with the discontinuation of distributed products, and we continued to improve operational performance and leverage our resources on a company-wide basis. The decrease was primarily in general business fees and administrative personnel costs. Net loss for fiscal year 22 was $4 million. That compares to a net income of $2 million in fiscal year 21. The change was primarily attributable to a decrease of $2.2 million in gross profit and a decrease of $5.0 million in net other income, partially offset by a decrease of $1.2 million in SG&A. The decrease in net other income is primarily due to one, a 717,000 gain on the sale of property and equipment, principally our Tennessee property in the prior year period. Two, a 783,000 decrease in employee retention credit for funds received or receivable from the U.S. federal government under the CARES Act. And three, a 3.5 million gain on extinguishment of debt as a result of the forgiveness of our Paycheck Protection Program loan. Outstanding shares will increase approximately $300,000 per quarter depending on our share price. As of June 30, 2022, the number of common shares outstanding was approximately $18.2 million. The net cash balance was $0.7 million on June 30, 2022. We invested in inventory due to the double-digit higher sales in each quarter of fiscal year 22. Supply chain volatility continues to cause longer lead times, and as a result, the organization made a strategic decision to place additional orders on key raw materials and other supplies. Cash used in operating activities was $4.9 million for the fiscal year, due to the company's working capital investment on the expected double-digit growth. specifically 5.6 million or 85% increase, build an inventory to serve customer demand, add additional safety stock to offset continued expected supply chain disruption, and new product introduction. This concludes our summary of the financial and operating results. Turning to slide five, we will continue to provide guidance on metrics that we are confident with. While managing the choppy nature of this business transformation, and the broader economic environment, including the impacts of COVID-19. We expect net sales in fiscal year 23 to be in the range of 45 million to 48 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. Dynatronic's transformation strategy continues to be well received by our customers. demonstrating our new business model strength and providing us momentum into fiscal year 23. 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. This pattern matches our results in fiscal year 22. Over the past two years, we have assumed that if we only maintain market share, we should deliver annual net sales growth of 5% to 6%. Of recent, market research and competitive publicly released materials are acknowledging market growth rates of approximately 3% to 4% in the product categories we compete in. We have updated our market growth rate targets and target higher annual net sales growth by continuing to take market share and releasing new products. Strategic inventory investments in the products we manufacture allowed Dynatronics to meet our customers' expectations and the double-digit higher sales growth delivered in fiscal year 22. Specifically, our inventory is elevated to meet customer demand and the current market and supply chain conditions. The sequential improvement in gross margin in Q4 was achieved despite the persistent headwinds to margin expansion, including higher material and freight costs, supply chain disruptions, and longer handling times. Inventory levels are a regular topic of discussion among our customers and leadership team in today's supply chain environment. To provide more context, our target is the proper utilization of appropriate inventory levels that have been strategically built over the past few quarters. On the higher sales I discussed, inventory as of the end of fiscal year 22 was 12.1 million compared to 11.6 million at the end of Q3 fiscal year 22. These investments were designed specifically to serve customer demand, maintain additional safety stock, to help offset continued supply chain disruptions, and to drive new product introductions. Importantly, we are getting our products to our customers expeditiously, which is a strategic competitive advantage in the supply chain challenged environment, and our customers continue to recognize and reward us for delivering. The cash used in operating activities of $4.9 million for fiscal year 22 was primarily due to the company's working capital investment in inventory of $5.5 million. The headwinds we have faced over the last three quarters have caused the organization to incur additional costs, impacting the pace of our gross margin expansion. However, we expect to see improved throughput with the inventory levels in place. Inventory levels will remain elevated until issues across the global supply chain subside. Moving to slide six, gross margin expansion remains our focus. Gross margin improved to 23.4% in Q4, a 1% sequential increase from the Q3 gross margin of 22.4%, and a 3.6% improvement from the Q2 gross margin of 19.8%. This improvement came primarily from the adoption of price increases that we implemented and the new products launched. We expect our gross margin in Q1 of fiscal year 23 to show continued expansion as we benefit from price increases for our products. Cash flow from operations in fiscal year 23 should begin to benefit from the sell-down of inventory strategically built over the past year. 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 what we believe our peers achieved. Gross margin in each quarter of fiscal year 22 was impacted by the effects of COVID-19 and supply chain challenges, including extraordinarily high freight, raw materials, and labor costs. Without the additional freight, raw materials, and labor costs we experienced in Q4 of fiscal year 22 of approximately 0.45 million as a result of COVID-19 and inflationary pressures, our gross margin would have been 27.4%. Excluding these additional costs, our gross margin was higher in each quarter of fiscal year 22 relative to the prior year. We have taken and will continue to take multiple actions to offset these costs, including selective price increases, exploring alternate sourcing relationships, and improving factory yields. We are fortunate that 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 an option to accept our standard price increases or to buy more products from all of our brands and be rewarded with lower price increases. We anticipate that price increases will offset some of our inflationary cost pressures over time. Slide 7 provides fiscal year 23 guidance details. As we have routinely discussed, we intend to provide guidance on metrics that we are confident with. Net sales are expected to be in the range of $45 million to $48 million. The midpoint of this range, $46.5 million, represents 5% organic revenue growth, which would exceed the market expectation for the full year. We continue to be reluctant to provide gross margin guidance given the persistent inflationary pressure, ongoing impacts of COVID-19, and supply chain challenges. That said, we do expect Q1 of fiscal year 23 to continue the sequential 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 23. As we gain revenue scale, We expect to continually leverage and improve our scale on this SG&A cost base. We're going to do what it takes to keep serving demand from our customers. We have a solid understanding of 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. there continues to be opportunity to improve all our financial metrics. This guidance is based on our current operation 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 eight, the Dynatronics Growth Platform targets initiatives in each of these strategic priorities. I am continually impressed by the great work of our teams. and the accelerating pace of our improvement. Each quarter, I want to provide context to the strategy driving the momentum we generate. Fiscal year 22 was a challenging year to recover from the significant cost pressures impacting our gross margin. The team has made solid strides with our second and seem to be third consecutive quarter of sequential gross margin expansion. 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 years, we have demonstrated an ability to grow sales and appropriately manage our selling, general, and administrative cost base. But we have only recently demonstrated we can expand gross margin. We expect that the changes we have made to deliver higher annual net sales will begin to deliver higher annual gross margin. operating income and cash flow from operations as we move through fiscal year 23. let's move to slide nine we have delivered sales growth for five consecutive quarters well above market growth and above our 9.25 million continued net product sales baseline set in april 2021. dynatronics has multiple levers to drive sales growth at a macro level capturing market share developing product innovations and through acquisitions. The markets we serve exhibit attractive growth profiles, approximately three to four percent. In addition to this market growth, we plan to continue to take market share from our competitors and introduce new products that will enable us to grow faster than the market. Please turn to slide 10 on winning market share. We win market share through one, superior commercial execution. make the dealers and our customers lives as easy as possible and make it easier to do business with us and two favorable mix shift to product innovations we have delivered double digit revenue growth in five consecutive quarters using this formula 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. Moving to slide 11, Mike Withers joined Dynatronics in May 2022 as Chief Information Officer. Mike brings the company the needed leadership and execution experience for information technology initiatives. His background in multinational ERP implementations, along with his recent work leading sales collaboration and analytics transformations, aligned with our corporate vision of enabling scale and efficiency within our teams and providing an exceptional customer experience. With the addition of Mike to the team, I took the opportunity to reshape the leadership team for the needs in the coming fiscal years. The streamlined leadership team is built to accelerate the organic growth trend and generate profit expansion at a faster pace. As you can see, new leadership hires have been a major focus area at Dynatronics. and we are willing to shape the team to meet the needs of the future. We have implemented a culture of accountability at the company and focused our employees on overall organic sales growth and consistent profitability. Let's move to slide 12. Our M&A strategy is detailed here to give you an idea of what we look for. We have the leadership team to execute on any opportunities that meet our well-defined criteria. We continue to have conversations and pursue acquisitions, innovation partnerships, and other business ventures. Our focused 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 million 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 want to unlock some of that value. Slide 13 is the investment highlights for Dynatronics. The markets we serve, rehabilitation, and bracing have attractive growth profiles. Sales growth has been driven by customer and dealer reaction to the business transformation. We are winning market share. Sales have exceeded the market in five consecutive quarters. We target improvement in gross margin in fiscal year 23. We have approximately $0.7 million of cash, $12.1 million of inventory on the balance sheet at the end of June with no debt. Dynatronics has not borrowed against its asset base of inventory or accounts receivable since July 2020. Dynatronics is moving in a direction that will reward our shareholders and provide a consistently differentiated experience to our customers. 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. We hope to meet with you. I will now turn it over for questions.

Thank you, John. Ladies and gentlemen, the floor is now open for questions. If you have any questions or comments, please press star 1 on your phone at this time. We ask that while posing your question, you please pick up your handset, if listening on a speakerphone, to provide optimum sound quality. Please hold whilst we poll for questions. Thank you. Your first question is coming from Scott Henry of Roth Capital. Scott, please ask your question.