Dynatronics Corporation (DYNT) on Q2 2022 Results - Earnings Call Transcript
Operator: Good morning, ladies and gentlemen. And welcome to the Dynatronics Second Quarter Fiscal Year 2022 Earnings Call. It is now my pleasure to turn the floor over to your host, Skyler Black, the company's Principal Accounting Officer. Skyler, the floor is yours.
Skyler Black: Thank you, operator. Before we begin, let me remind you that during the course of this call, we will make forward-looking statements regarding our current expectations, plans, projections and financial performance relating to our business. These forward-looking statements reflect our view 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 impact of the COVID-19 pandemic on our business results. 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 in the Investor Relations section of dynatronics.com. I will now turn the call over to John Krier, our President and Chief Executive Officer.
John Krier: Thanks, Skyler. Good morning, everyone. And thanks for joining Dynatronics' call today. On today's call, we will cover the recent highlights and achievements. Norm will provide commentary on the financials, and then we will have the operator open the phone lines for questions. Please turn to slide three. With me today are our Principal Accounting Officer, Skyler Black, and our Chief Financial Officer, Norm Roegner. You can see Norm's, Skyler's and my background on this slide. It provides some color as to our collective resources and the experience that we have brought to the company. Slide four highlights just a few of our more recent accomplishments, all of which drive the company's revenue growth to exceed the market and our baseline revenue expectation for the third consecutive quarter. Our accelerating transformation continues even with greater-than-expected disruption from COVID-19. Let me begin with three headline points. First and foremost, we have a clear line of sight to profitable growth and have a well defined strategy in place to execute against. We have been executing an ongoing business transformation and consistently performing each quarter to achieve our goals. Second, we are confident in our outlook. We maintain our fiscal year '22 net sales guidance. And third, our markets generate 5% to 6% organic growth per year. We plan to take market share and therefore, grow faster than the 5% to 6% organic growth our collective markets generate. Moving 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 impacts of COVID-19. We expect net sales in fiscal year '22 to be in the range of $40 million to $45 million, assuming similar procedure volume despite the recent surge in COVID-19 cases. The midpoint of this sales guidance represents a 15% growth rate relative to the $37 million annual continued product net sales baseline set in April 2021. Customer and dealer reaction to Dynatronics' transformation strategy continues to be overwhelmingly positive, demonstrating our new business model strength and providing us momentum, building upon the favorable tailwinds in the markets we compete. However, with significant volatility due to continuing challenges from COVID-19, we believe it is prudent to maintain our guidance for annual sales in fiscal year '22. The company expects the distribution of net sales 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 matched our expectations for Q2, consistent with our prior guidance. However, there may be some variability in this pattern as the company adjusts to ordering patterns in its rehabilitation market, given the transition to an exclusively dealer-based sales model. Slide six provides the guidance details. We are focused on the top line, but we also plan to drive margins over time. Our target is to achieve 40% gross margins over the longer term, which would be comparable to what we believe our peers achieve and reflects our long-term target. Our competitors, DJO, before they were acquired by Colfax, and Ossur when you breakout their bracing segment, maintain margins for bracing and supports of approximately 50% and for rehabilitation of roughly 30%. Our gross margin was 19.8% in Q2. It was 27.0% in fiscal year '21, including the exit activities associated with the discontinuation of third-party distributed products. Gross margin in Q2 was muted by the impact of COVID-19 and supply chain challenges, including extraordinarily high freight, raw materials and labor costs. Specifically, gross margin would have been 29.9% or 10 points higher without the COVID impacts in the second quarter. Excluding the additional freight, raw material and labor cost impacts, our gross margin was higher in the second quarter and first half versus the prior year. More generally, the company and its customers expect to experience supply chain and other challenges due to COVID-19, including rising raw material costs, higher delivery and shipment costs, supply chain disruptions, and extended handling times, similar to those reported by many companies. We are taking multiple actions to help offset these inflationary pressures, including price increases where appropriate, exploring alternate sourcing relationships and improving factory yields. We're going to do what it takes to keep serving demand from our customers. We have a very steady eye on the long-term to build a scalable platform to grow our customer and revenue base, deliver margin expansion, and strong cash flow from operations so that we can create value for shareholders. We have not yet provided gross margin guidance for fiscal year '22. We just finished our first full quarter in this new model, continue to face significant cost pressure headwinds due to COVID-19 supply chain disruption, and we need additional experience to feel comfortable discussing where margins might trend in fiscal year '22. That said, we do see opportunities to expand our gross margins over time by better capacity utilization. We are actively working on other process efficiencies to streamline our operations. We anticipate selling, general and administrative expenses of 30% to 35% of net sales in fiscal year '22. Q2 was a good example of the team managing SG&A appropriately in the face of mounting input cost pressures. As we gain revenue scale, we expect to continually leverage and improve our scale on this SG&A cost base. There continues to be opportunity to improve all of 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. Each of these bullets is important to our sustainable growth platform. I'm proud of our results and the great work of our team over the past several quarters. I want to provide context to the strategy driving the momentum we generate. Goal number one is to expand margins and cash flow over time. As a company, we focus on higher margin, differentiated products that we manufacture. We expect that over time, these changes will deliver higher annual net sales, gross margin, operating income and cash flow from operations that enable sustainable long-term growth. Drivers of future margin growth include dynamic price tiers, according to the loyalty share from the dealer and customer. The advantage there is to position the company to make the dealers' and customers' life as easy as possible, and make it easier to do business with us. Pricing that factors in relationship metrics such as full company loyalty share, in addition to product-based pricing, allows us to be much more competitive. Goal number two, is to strengthen the balance sheet via sustainable cash flow from operations, which can support additional investment in product development and/or M&A in target markets. The recent cost pressure has made this very difficult to achieve. However, we remain focused on what we can control as an organization. Goal number three, is to build a consistent cadence of new product introductions across both of our growth markets, rehabilitation and bracing and supports. By focusing our energy and resources on the products we manufacture, we are fostering an environment of consistent product portfolio innovation and product life cycle management. Moving to slide eight. The three takeaways about our recent new products are: one, ramped up cadence and expanded pipeline of product innovations. Two, in January 2022, under the umbrella of Return to Mobility, we launched an exclusive suite of products and additionally 3 new metal tables. And three, dealer and customer feedback drove the product releases. This expansion is additive to our dealer strategy by driving greater loyalty through our dynamic pricing approach. The more products within our product portfolio we offer to our dealers and customers, they are rewarded for buying more from us in our dynamic price tiers. I want to provide the highlights of each of these. Metal tables are a new product category for us. We launched our first company manufactured metal tilt table in January, filling a void in our product offering since late 2020. We are the only provider in the market that dealers and clinicians can get all 4 products in one place. Our four distinct products in the rehabilitation care pathway are tilt table, stand-in table, parallel bars and training stairs. We anticipate several new metal table product launches in the first half of fiscal year '23 to broaden our metal tables platform, thereby expanding our presence of metal tables in the rehabilitation market. We are currently a leading company in laminate or wood tables in the rehabilitation market, and this expansion is a natural next step. We anticipate that our expanded pipeline of new product innovations will lift our growth annually. Looking at slide nine, Brian Baker rejoined Dynatronics full-time as Chief Operating Officer in January 2022. He served as Chief Operating Officer from May 2019 until his promotion to Chief Executive Officer in August 2019. Brian held that position until July 2020 when he resigned due to health issues relating to COVID-19. Thankfully, he has fully recovered from the COVID-19 virus. Following his resignation as Chief Executive Officer, Brian continued as a member of the Dynatronics Board of Directors and a consultant to the company. He has continued to deliver significant accomplishments to drive growth and profitability during his tenure as a leader and then later as a consultant to Dynatronics. New leadership hires have been a major focus area. We implemented culture partners, leadership culture of accountability and focused our employee actions on overall organic revenue growth and consistent profitability. On slide 10, the markets that we serve are large, growing and highly fragmented. The industry research continues to indicate that the rehabilitation and bracing and supports markets exhibit attractive growth profiles. Opportunities exist across Dynatronics' primary brands to expand market share within existing customers as well as additional product offerings within the segments in which we compete. As we are all likely experiencing or reading about the statistics of facility activity, orthopedic procedures or other peripheral activities like team sports that create demand for our products are volatile based on COVID-19 activity and staffing shortages reported throughout the country. Building on the foundation in the markets we serve, let's move to Slide 11. Our M&A strategy is detailed here to give you an idea of what we will be looking for. We continue to have conversations and pursue acquisitions, innovation partnerships and other business ventures. We have the leadership team to execute on any that meet our well-defined criteria. Our focus criteria include greater than 40% gross margin and cash flow contribution within the first year. Our focus is on our current markets. Our near term targets are at the lower end of the $5 million to $30 million revenue range, we believe we can make a smaller acquisition and demonstrate post-acquisition success. We believe our share price is undervalued, and we want to unlock some of that value. I will now turn the call over to Norm.
Norm Roegner: Thanks, John. Please turn to slide 12, 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-Q. I will summarize some of the key financials here. Net sales were $10.5 million for the second quarter of the fiscal year. That compares to net sales of $12 million in the same quarter of the prior fiscal year. $10.5 million net sales in the second quarter exceeds the $9.25 million quarterly continued product net sales baseline set in April 2021. Our net sales across the quarters in fiscal year 2022 aligned with historical trends, lower in the second and third quarters, and higher in the first and fourth quarters. We continue to see an increase in overall activity compared to the prior year, which was impacted by COVID-19 shutdowns and other related disruptions. Gross profit for the second quarter of the fiscal year 2022 was $2.1 million or 19.8% of net sales compared to $3.3 million or 27.9% of net sales in the same quarter of the prior year. As John mentioned earlier, we are seeing COVID-19 and supply chain challenges, including extraordinarily high freight, raw materials and labor costs in the second quarter. Specifically, gross margin would have been 29.9% or 10 points higher without the impacts from COVID-19 in the second quarter. Selling, general and administrative expenses were $3.5 million for the second quarter. We delivered sequential and year-over-year SG&A cost savings as we continue to improve operational performance and leverage our resources on a company-wide basis. SG&A was $3.9 million in the same period last year and $4.1 million in the first quarter of fiscal year 2022. The decrease was due primarily to lower direct selling expenses and reduction in general business fees and administrative personnel costs. Net loss for the second quarter of this fiscal year was $1.4 million and that compares to a net loss of $0.7 million in the second quarter of fiscal year 2021. We expect our outstanding shares to increase in the range of 220,000 per quarter, depending on our share price. As of February 7, 2022, the number of common shares outstanding was approximately 17.9 million. The net cash balance was $3.6 million on December 31, 2021. We invested in inventory due to higher sales in Q2 and supply chain volatility that is causing longer lead times. As a result, the organization made a strategic decision to place additional orders on key raw materials and other supplies. The challenges we had with inventory over the last two quarters have caused the organization to incur additional cost. We expect to see improved throughput with the higher inventory levels in place. Inventory levels are expected to remain elevated until issues across the global supply chain returned to pre-pandemic levels. Cash used in operating activities was $1.8 million for the three months ended December 31, 2021, due to the company's working capital investment and the expected double-digit growth. Specifically, inventory related to serve customer demand, additional safety stock to help offset continued expected supply chain disruptions and new product introductions. We announced that we terminated our agreement with Millstone Medical Outsourcing for order fulfillment effective on January 1, 2022. Dynatronics order fulfillment will be shifted to our distribution center in Minnesota for most of its brands to drive gross margin expansion, consistent customer experience, and scale our fulfillment for growth. Before I turn the call back over to John, I will note, we continue to navigate a volatile landscape due to the continuing challenges from COVID-19, including higher raw material prices, delivery and shipment costs, supply chain disruption, extended handling times and delays or disruptions in procedure volume. At the same time, Dynatronics also expect some continued volatility from the company's business transformation. This concludes our summary of the financial and operating results. I will now turn the call back to John.
John Krier: Thank you, Norm. Slide 13 is the investment highlights for Dynatronics, each statement reflective of a set of actions designed to deliver results. Our clear focus is on driving organic revenue growth, profitability and cash flow from operations. We are well capitalized with approximately $3.6 million of cash on the balance sheet at the end of December and no debt. Strategically, we have clarified our position in the market with our well established brands and a leadership team focused on the future. We anticipate good progress in all of these key strategic areas in our fiscal year 2022. We are excited to be moving Dynatronics in a direction that will reward our shareholders and provide a consistently differentiated experience to our customers. We are actively sharing our story with the investment community as we move forward in our markets. We will be presenting and hosting one-on-one meetings at upcoming investor events. Information will be in press releases and on our Investor Relations website. We hope to meet with you. I will now turn it over for questions.
Operator: Your first question for today is coming from Jeffrey Cohen. Please announce your affiliation and pose your question.
Unidentified Analyst: Good morning, John, Norm, Skyler and Brian. How are you?
Skyler Black: Yeah. Well, Jeff. Good morning. So just a few from our side. So could you talk about some of your pricing elasticity and how that's been playing out over the past few quarters as compared to the marketplace in general as well as other products out there? Does it feel like the trend is toward more inelasticity or elasticity?
John Krier: As we have these conversations with our customers, Jeff, they understand the cost pressures that we're all seeing. And so that conversation goes with how do we generate more loyalty across all of our brands and a willingness to share in that conversation around price. So we've absolutely been able to have those and have been successful with that, and we'll continue to do that.
Unidentified Analyst: Got it. And talk a little bit about some of the impacts from this past quarter and how that plays out going forward. I know that the margin hit from the previous quarter was about 10%. And how much that play out as you aspirationally growing towards that 40% gross margins?
John Krier: Yes, that's right, that's proven to be the most difficult element. We've been able to achieve the top line now for 3 consecutive quarters, demonstrating that organic revenue growth. We've managed the SG&A base in line with that, using that to toggle. And the most difficult one is that gross margin. And the biggest factor for us is trying to understand when will some of these inflationary pressures begin to abate or how much of that can we share with our customers or get other efficiencies in the business. So we don't have any guidance going out forward, but those costs and those pressures have not stopped as we go into the next -- the back half of our year.
Unidentified Analyst: Yeah, okay. Got it. And then one more on your guide for the year in the range of $40 million to $45 million. How does that play into -- is that all inorganic or organic, and is it exclusive of any M&A transactions or how are you thinking about that as it relates to the guide?
John Krier: Yeah. Our guidance of $40 million to $45 million that we're continuing to demonstrate this part would be all organic. Any acquisitions would be additive to that, but organically, $40 million to $45 million.
Unidentified Analyst: Okay, perfect.
John Krier: Thank you, Jeff.
Operator: Your next question is coming from Scott Henry. Please announce your affiliation then pose your question.
Scott Henry: Roth Capital. Thank you. And good morning. A couple of questions. First, on the revenue growth how much of that do you think is volume versus price?
John Krier: At this point, relative to the market, all of that organic growth is largely going to be volume based. There may be a little bit of price that's in there. But for us, it's around volume and the demand that our customers are sharing with us.
Scott Henry: Okay. And 10% hit on the gross margin is significant for onetime events. How would you break that up? I mean, I guess, it sounds like a lot of it is freight, but I just want to get a sense of what factors are going into that kind of 10% gross margin hit?
Norm Roegner: This is Norm Roegner, Scott. Thanks for jumping on the call today. In terms of that breakout, we've talked about the higher freight and higher raw material costs as well as labor. We would say that 60% of that -- those 10 points are related to freight, the remainder is really raw material, labor and primarily on the raw material side.
Scott Henry: Now I mean, I would think, and this is why I asked the question to get your commentary on it. But if freight goes up, why wouldn't you pass that on to your customer or is that freight from the raw materials coming to you, is that the product being shipped to the customer? But it would seem like freight would be something you would have to pass on, if not immediately, eventually?
John Krier: Yes, Scott, this is John. It is something that we have to do over time. And then we really have to look at what are our contracts with our customers and how can we do that. They all vary. Some have more contractual obligations around timing than others. But we have to, because we can't continue to absorb those costs on the inbound side especially.
Scott Henry: Okay. And then I guess, final question with regards to that. Do you think this is the worst in terms of quarter in terms of this impact, do you think Q3 will it move along that bottom or would you start to see some improvement in Q3, Q4 next year? How should we think about that trajectory of when that might turn?
John Krier: I think that's the most difficult part for all of us in managing in this COVID environment and with all these cost pressures. We just do not have a feel for when will some of these pressures abate. So that's why one of the reasons we're not providing gross margin guidance for the going forward. At the same time, internally, we've said, look, we're going to have to operate in this environment, so we have to find other efficiencies, and we continue to work on those every day as well.
Scott Henry: Do you get a sense of what your competitors are doing? Are they raising price, are they exiting industries or exiting products? I mean at some point, someone has to absorb the higher cost, and I just try to get a sense of what you think your competitors are doing and is going on in the industry.
John Krier: I think we're all managing that same thing. As you look across our competitors, we're all reporting rising costs from freight and raw materials in our results. We're all reporting that we're having conversations with our customers about costs. Some industries or some of the products that have reimbursement caps on them or limitations, makes that harder, and others, it does not. And so we have to be able to pass that on. So I think we're all having these same conversations whether it be about cost and efficiency or about discussing price with our customers.
Scott Henry: Okay. And then I guess, final question on the acquisition side, and I guess it's a 2-part question. Given these dynamics, is it becoming a more favorable environment to look at targets? And then related question, do you think that you'd be able to pursue an acquisition largely debt based, given the current equity valuation it would seem less desirable to exchange equity for an acquisition at this price. How do you think of those 2 factors?
John Krier: Scott, our line of thinking is directly along your line, which is, we very much are sensitive to our share price and the value of our equity and not diluting that. And so we'd want to be looking to the strength of the candidate that we'd be acquiring and trying to avoid any further dilution of our share price in that terms. And we are continuing to have conversations and pursue whether they be acquisitions or innovation partnerships, because we do know that we have to continue to drive our portfolio broader to take more share with our customers. So those are continuing as well.
Scott Henry: Okay, great. Thank you for taking the questions.
John Krier: Absolutely. Thanks, Scott.
Operator: Your next question for today is coming from Anthony Vendetti. Please announce your affiliation, then pose your question.
Anthony Vendetti: Thanks. Maxim Group. How are you doing? I want to follow up on the gross margin and then sort of the pricing. From what I've heard so far, most of the - most of revenue growth is coming from volume. So it sounds like in terms of price elasticity, you don't have a lot of room to take price. Is that because of contracts you already have in place or is it because of competitive pressures, if you raise the price too much, you risk losing that business?
John Krier: It's going to be a combination of both. We compete in competitive markets and so we have to be mindful of that. And the more products we can offer to our customers, the greater share that they're going to reward from us. The first part you mentioned as well, we do have certain limitations around the timing of when we can increase price, because of third-party distribution contracts or hospital contracts that we might hold. We're acutely aware of the timing of those and executing those conversations with those customers as soon as - at the earliest possible chance that we can. But then once we have that conversation, there is an understanding that this is a unique environment, and the price increases are more than what they've been in the past from an industry perspective. But we are limited by the contractual nature of the timing.
Anthony Vendetti: Okay. That makes sense. In terms of, John - in terms of what you said about some of the new products, and I know they are long-term plan, and obviously, we're far from that right now based on the hit the gross margin took this quarter. But long-term plan is to get to 40% gross margin. And as you mentioned some of the new products on the table side and some of the others that you're contemplating, are those newer products, are they at that targeted 40% gross margin or near that? Or can you give us an idea as you're looking at some of these new products, what the threshold is? Or do all of them need to be at 40% on the new product side or some will be below that, some will be above it?
John Krier: The way to think about that, Anthony, is just like the way we think about our acquisition strategy. We want to acquire targets that have greater than 40% gross margin. The same exact logic has to prove out in our product innovation. We need to innovate products that are exceeding that target. Now time will tell. We have to be able to deliver that and improve that. So often we're asked, how do you get to that gross margin target over time? One, we got to get a little relief here from these COVID pressures. But two, releasing these new products over a consistent cadence of time that meet that requirement will also lift us up. And then, again, as we generate some revenue scale and have some scale on our facilities, we'll get some additional expansion.
Anthony Vendetti: Okay. That makes sense. Just in terms of - Norm, you outlined kind of the hit - the 10 percentage point hit to gross margin, 60% of that was freight, the rest was raw material and labor. Most of that being raw materials. Obviously, freight has been well documented. In terms of the raw materials, is that something that you think freight - I don't know how much is that going to abate and it's going to take some time. But raw materials, is that something that's more transitory and should resolve itself fairly soon or do you have an expectation there?
Norm Roegner: It's a tough one to answer. We - definitely it's more transitory, so we have seen some cases like plywood, for instance, where it spiked early in the first quarter has started to come down already and we're hoping that trend continues. Stainless steel is still on the higher side, I think. So it's going to depend on the commodity. I think over time, we're going to see it they'll come back down, I believe. I just can't say that timeframe what that looks like right now.
Anthony Vendetti: Okay, good. All right. Thanks very much. I'll hop in the queue. Appreciate it.
Norm Roegner: Thank you, Anthony.
Operator: There are no further questions in queue. I would now like to turn the floor back over to John for any closing comments.
John Krier: Thank you, operator. And thank you all for your interest in Dynatronics. We are actively sharing our story with the investment community as we move forward in our markets. We hope to meet with you at upcoming investor events. If you have any further questions, please direct them to Skyler Black or Jeff Christensen. Their contact information is in this presentation and our press releases. Have a great day. Operator, you may end the call.
Operator: Thank you, ladies and gentlemen. This does conclude today's event. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.
