Dynatronics Corp (DYNT) 2012 Q3 法說會逐字稿

This is Kelvyn Cullimore, President and CEO of Dynatronics Corporation. We would like to welcome those on the call today to the conference call reporting our third-quarter fiscal 2012 financial results. The purpose of the call is to discuss those results for the quarter ended March 31, 2012.

Before we begin, as a reminder, during the course of this conference call, Management may make forward-looking statements regarding future events or the future financial performance of the Company. Those statements involve risks and uncertainties that could cause actual results to differ, perhaps materially, from the results projected in such forward-looking statements. We caution you that any such statements should be considered in conjunction with the disclosures, including specific risk factors and financial data, contained in the Company's most recent filings with the SEC, including its most recent annual report on Form 10-K.

Today, we will focus on the results for the third quarter ended March 31, 2012. Following my presentation, we will invite the operator to open the line for questions and answers and give you instructions on how to ask those questions. And we will proceed now with a brief report of the quarter.

The fact that you're on this call means that you've seen the press release and know of the results for the third quarter. At the end of the second quarter, the end of December, when we had this call, we were running slightly ahead of the prior year. Our progress was good. We were heading in the right direction. December was the best month we had, had in our history, and we were looking forward to the third quarter, because typically we see higher sales in the quarter ending in March, because it is the first calendar quarter of a new year and typically brings with it new budgets for purchase of capital equipment. And that's been the pattern over the past two years, with the third quarter last year being one of the best since we merged with our distributors five years ago.

However, this year, we saw just the opposite, as demand for capital equipment softened significantly, resulting in a sales decrease of 8.7% or $730,000 compared to the prior year. When we add the drop in the current quarter to the slight increase we had experienced for the first six months, it results in sales through the nine months being down about 2.4% compared to last year, or about $576,000 decrease for the year.

Obviously, this drop in sales for the quarter was disconcerting and unexpected. We saw that, that weakness that we experienced in the first three months continued through April, but it appears to be rebounding in May. So we're not exactly sure all of the reasons, but we have identified a few of them. We did have one particularly large customer that usually buys between $150,000 and $250,000 worth of product in a quarter, had financial difficulties and was not able to make additional purchases and is in the process of seeking a buyer for that company.

We also anticipate that there is some concern over health care reform as it is rapidly approaching, as well as reimbursement issues associated with that. I think the current situation over the Obamacare situation, especially with the Supreme Court holding out to make a decision, hopefully by the end of June, has left a lot of people concerned and wondering what direction to go and holding back on any major purchases. And we've also seen that general economic weakness for durable goods was reported during the same quarter. So there has been continued sputtering in the economy in general, which could also be a contributing factor. And one other factor that we think may be contributing is, there is some anticipation of the release of our new products that we are going to be announcing, and that could have had some restrictive effect on current purchases.

The gross profit for the quarter decreased 11.8% or by about $380,000, and margin percentages declined to about 37.2% from 38.5%. That decline in margin percentage is directly related to the fact that higher-margin capital equipment sales were a lower part of the overall sales mix for the quarter. Our SG&A expenses were $28,000 higher than last year, so not significantly higher, but they were a little bit higher, in part primarily due to higher selling expenses and efforts on our part to position ourselves for what we expected would be higher sales; investments that we made to support our e-commerce and IT infrastructure, to support higher sales, as well as sales personnel. And with that not occurring, that is being reconsidered.

R&D expenses, the other category of expense, was up about $23,000 over last year. But we were down about $50,000 compared to the last quarter. So we are seeing that downward trend that we expected to see with R&D as we approach the release of these new products. But even still, we're running at a level that is $50,000 to $75,000 a quarter higher than normalized R&D, prior to embarking on our current heavy R&D program that we've been in. We expect that R&D will continue to decline by as much as $30,000 to $40,000 in the next quarter compared to the current quarter, and drop again in the subsequent quarter by another $25,000 or $30,000 as we return back to more normalized levels.

The pre-tax loss for the quarter ending March 31 was $245,000, and that compared to the pre-tax profit of $195,000 last year. So that is about a $440,000 differential between the two quarters. 86% of that was directly attributable to lower margins stemming from lower sales. And so the loss of gross margin associated with those sales accounted for by far the majority of the differential between the two quarters. With the expected tax accrual, our net loss for the quarter is expected to be about $117,000, compared to the net income last year of $117,000, coincidentally, though one is a negative number, one is a positive number.

With that performance for the quarter, there are certain initiatives that we have undertaken. And while, admittedly, the lower sales this quarter caught us a bit off guard, we are pressing ahead with certain key initiatives that will help us return to profitability. First of all, the new product introduction that we've been talking about for several quarters and the investment in R&D that has weighed down the financial statements for the last year or so. We actually announced the first of those products, the QUAD7 device, recently. That is an exciting new product that provides heat, cold, compression, and electrical stimulation therapies.

We have worked with another device manufacturer to design this unit specifically for Dynatronics and the markets that we serve. And we are adding specific proprietary probes to that unit that we have designed, which will allow the delivery of heat and cold therapy from the QUAD7 and combine it with electrical stimulation therapy by coupling it with the Solaris device. This is a unique design with no other product like it on the market. It has shown once again our strength of being innovative in the market. And as the new probe becomes available in the coming weeks, we expect sales of this product to have a significant effect on the top line growth. There has been significant interest in the product from the field and a lot of anticipation of the release of this new probe.

We also have our new Solaris Plus line that includes five new combination therapy devices that combine seven wave forms, three frequencies of ultrasound, as well as light therapy, along with our new Solaris Tri-Wave Light Probe and Tri-Wave Light Pads. All are planned for introduction in the next 60 days. We anticipate shipments of the new product to begin before the end of our fiscal year on June 30. And we think these new products will infuse some needed excitement over capital equipment and jump start the pent-up demand for new capital equipment of this type.

This line will replace our existing Solaris line, but it has many updated features. Esthetically, it is very sexy, as these kinds of units go. It is much more user-friendly. And we are incorporating a new mobile cart for easy use that also makes the entire ensemble much more attractive for use within the clinical setting.

This new product -- basically, product line -- takes all of our technology and intellectual property developed over the last 20 years and consolidates it into a new family of devices. And we really do expect that it will rekindle the interest in capital equipment sales, even despite hesitancy created by market factors that we don't control. We do still have additional new products that are springing from the R&D efforts of the past two years that will be introduced in the next 12 months. So this 24-month period that we are in right now, fiscal '12 and fiscal '13, will see us bring more products to market than in any other similar period in our history. We believe those things will help give impetus to sales and profitability for the Company.

We have also implemented cost reductions as a result of the performance in the third quarter, recognizing that with the decrease in sales that we experienced in the third quarter, and despite our optimism about the new products we're introducing, we think it is appropriate to try and trim labor and overhead costs; and we have implemented a program that will do that to the tune of about $800,000 of annual cost savings, most of which come from reductions in force, which have already been implemented. Also, planned lower R&D expenses and lower overhead through improved operating efficiencies. We recognize that our expectations for growth this past year associated with GPOs and national accounts were likely overly optimistic. And the overhead we built to accommodate that anticipated growth is being scaled back to reflect the realities of our current experience.

We also are looking for ways to expand our market. We continue to look for the opportunities, both domestic and international, to expand our distribution network. Renewed focus is being given to recruiting sales reps and dealers, particularly in the private practice area, where we have been strong in the past. In addition, we have seen more success of late with international opportunities, and we will pursue those more aggressively. And while they are not expected to bear fruit immediately, we believe the international opportunities are better now than they have been in the past.

I would like to just talk for a second about the R&D situation and the GPO situation, since those are two very common questions we are asked. The R&D expenditures in fiscal year 2010, which is two fiscal years ago, were about $915,000. Last year, they jumped to $1.384 million, and for the first nine months of fiscal 2012, we've been on an annualized pace of $1.5 million. So the current pace of R&D expenditures is about $600,000 higher than what we experienced two years ago.

Now that we are near the end of the development cycle for all of these new products we have been planning, we are starting to see these expenditures return to more normalized levels. As I mentioned, R&D expenses in Q3 were $50,000 less than they were in Q2, and we expect to see that continue to step down over the next two quarters. Of course, because of that effort, calendar 2012, and if you include calendar 2013, will represent a 24-month period where we will introduce more new products than at any time in our history. And most of them will be introduced over the next 12 months.

The GPO business development continues to be challenging for us. Needless to say, it has been disappointing that we have not gotten as many contracts as we had hoped, and the contracts that we have achieved have had limited movement. We are finding that they are good gatekeepers, but once you are in the gate, you still have a lot of work to do to convert people over to the opportunity to do business with Dynatronics. And while we have seen increase in sales to GPO-related accounts year-over-year, the growth has not been anywhere near what we had hoped it would be. And so, as a result, we have not experienced the top line growth that may have been anticipated.

But we continue to pursue the opportunities with these gatekeeper organizations, the GPOs. The largest GPO in the country will be awarding the contract for physical therapy in mid-June. They were originally supposed to do that in January. They kept postponing it. We have now been told that the date is set for mid-June to review our bid, among others, to see if they would be willing to grant us a contract. Two other GPOs will also be starting their process of requesting bids later this calendar year, and we learn more with each effort, but also know that being awarded the contract does not mean business automatically increases.

There is a lot of work to do once that contract is achieved. But without the contract, there is no opportunity to expand that business. So we will continue to pursue the contracts and work at ways of utilizing our resources wisely and expanding the opportunities with these GPOs.

We also were asked about the NASDAQ deficiency with the stock, something that we have battled on and off for the last few years. We were granted an extension to comply with that dollar minimum bid rule until November 5 of this year. So if we can cure that deficiency by our stock trading above $1 for 10 days at any point between now and then. That is a situation we've been in before, and we're confident that we can, with the new products and things that we have coming out and the anticipated profitability of the coming quarters, should be able to turn that around.

So in summary, the decreased sales in the current quarter were quite unexpected. And the lost margin associated with those decreased sales accounts for 90% of the differential in performance when compared to the same quarter last year. We're taking the following steps to reverse the course of that situation with the new product introductions that are imminent over the next 60 days. The $800,000 campaign to reduce costs has been implemented, including the reduction in R&D expenditures. The GPO business still presents opportunities, although recognize that it is not growing at the pace we would like, but we continue to chip away at it. And refocusing on private practice by recruiting additional sales reps and dealers, as well as exploring the current opportunities we have for expanding international sales.

We believe that Q4 will begin to show the benefits of the improved sales and lower expenses with 2013, starting in July, being a return to more significant profitability. We are hopeful that we will be profitable in the fourth quarter, but it will be a modest profit, but we are hoping for that as well. So with that information, to the extent I have not answered questions you may have had, we will ask Chris to instruct those on the call how to place questions.

And we will now take your questions.

Thank you. (Operator Instructions). Our first question comes from the line of Joseph Levy. Your line is open. Please go ahead.

Yes, hi.

Hi, Joseph.

How are you doing?

Good.

You know, I just wanted to give you my observation in terms of -- and I don't know your business. The one thing I know is that you guys are very sincere in trying to do the right thing and build this Company, but where I see the real weakness is not that you spend too much money in certain areas. It is that you don't get the results that you should be getting, and that is mainly in the sales area. I think the first person I ever worked for taught me the best lesson in business, and that was that your sales people are your most important people in the organization. And without being able to sell your products, you can't really accomplish that much in business.

And my feeling is, especially the way you restructured the Company and brought it to a new level I thought was excellent, but I just feel there is a real weakness in your sales area, in being able to take advantage and move forward with growth. I think getting those GPOs, the contracts and everything, I think was a great step forward, but there has to be something wrong with the executive management in the sales area that is not being addressed. And that is just an observation on my part. I'm involved in a family business, and in that business, the president, who happens to be my daughter, she is the best salesperson in the organization. Not saying that every company has to be structured that way, but without a dynamic salesperson or leader in sales, the company will never really move forward and capture the potential that it has.

The cutting back on the R&D expenses, even if were you to cut back from 4.7% of sales to 3.3% of sales, it is only going to be a savings of $500,000 a year, which is not really going to make a difference in terms of taking you to where I think you want to get to. And then you run into the problem, too, when you cut back on R&D, that after you go through this cycle of new products, you are going to be probably back in the same situation again, where you are running out of new ideas to impress your customers with. But I really see your problem as an area that -- in the sales area.

I don't know. I think for your salespeople, going all the way back to your salespeople, the expectations that should be set for them and the hiring and recruiting of new people, replacing people that are not efficient, that, I would guess, is the biggest problem that Dynatronics has had in the last few years. And that's just an observation.

Well, that's a pretty astute observation for somebody who doesn't claim to know much about our business. That's clearly where our challenge is. Because to achieve the kind of profitability we need, we need higher sales and more margin. We cannot cut enough expenses to get there.

Of course.

We can cut enough expenses to be profitable, but not profitable enough to drive the stock to the levels we expect and things of that nature. So we've been doing a lot of introspection here about how do we change that model, because we -- we're the first to admit that we've -- by going into the GPO world, we have approached something that we did not have prior expertise with. And so I think that is showing. I think that shows that we have not been -- we did not have the expertise. That isn't the same selling pattern as what we are used to with the private practice side of the market. And there is some changes that we need to make, and for what it is worth, we are looking very seriously at that.

Okay. And I mean, I don't want to single anybody out or -- but I look at it from the standpoint that Larry Beardall is listed as the Executive Vice President of Sales and Marketing, and to me, the job is just not getting done. I'm just wondering whether that is an area that has to be looked into to see why Dynatronics is not achieving the potential that it should be achieving.

Your counsel is taken as given.

Okay. And again, there is nothing personal here. I mean, I have the same interest as you do, and as everybody, in fact, the same as Mr. Beardall, so I'm not --

Sure.

I know he has been granted stock and options and he has a great incentive to make this thing go. But it is just not happening, and I see the real weakness is in the area of sales.

Well, and if Mr. Beardall were on the call, he would be the first to tell that you he agrees that sales is where the effort needs to be, and he feels that pressure personally probably more than anyone. So, I don't think you are off base, Joe.

Okay. That's basically all I have to say.

Okay. It is good to talk to you. Thank you.

Okay.

Thank you. And our next question comes from the line of Todd St. Mary. Your line is open. Please go ahead.

Hi. I would just like to follow up on a comment that was just made. I agree with the previous caller 100%, but I would like to add a couple of things. You had made a comment about looking at international sales. I know that we've got the GPO initiative that we're working on and hopefully getting better with. But we've still got a lot to learn there, it sounds like.

We've got the new products, and many of them, it sounds like, will be rolling out this next year. And my main concern would be focus. You know, we're a $30 million, $35 million, maybe $40 million business. We have limited resources. And I think the best thing to do would be to sit down and really take a careful look at where you really think you can get the growth and then focus your resources in that area. Don't get diverted trying to sell a couple million dollars into a foreign country.

Right.

Try to really nail the areas where you're most confident. And then if you're successful there and you start generating a lot more profit, then you can start looking at other initiatives. But I wouldn't get spread too thin. So I am concerned about that, just based on what you shared up front on the call.

Well, I think you're -- again, another very astute comment, because one of the challenges we're finding with the GPO, expanding that business, is it can be very resource intensive. So we are -- while we are not -- we certainly feel like there are opportunities there, we are de-emphasizing some of that, because the amount of resources required to pursue the GPO contracts in a big way would require a total focus there. And I don't know that the return merits the kind of resource allocation it would take at this point in time. I think we have to learn a little more about that. I think we have to pursue that. We may need to get one more contract, maybe two, to really justify that.

And I'm just too far from it to know, and I'm sure all of us on the call probably are. I mean, you're involved with it every day. My point is simply you've got a lot of different opportunities in front of you, and there are going to be doors opened by all of the investments that have been made over the last year or two. So I'm just simply suggesting that you really, really hone in on one or two of those. Maybe even just forget about the other stuff and make sure you knock the cover off the ball in the areas that you believe you're most likely to be successful in.

I really think that is what would be best for the Company over the next year or two. You can always go to international markets and that later. But that is a -- I was a CFO of a multinational company when I used to work, and that's a whole new ball game. And it would be a major distraction, in my opinion. It would be one thing if you could double your sales and go up to 80 million or something like that.

Right. No, just to put a little color on that, maybe to put your mind a little more at ease, we have never been able to break into the European market, and mainly because we have never been able to find a distributor who would be willing to carry the products for us. And we are not willing to spend the resources to go over there and try and set up our own distribution. So what we have going is we do have the opportunity with some new distributors there who have expressed an interest in our products for the European market. So it would really be nothing more than adding a particular distributor who would then take the product into that market.

So it would be -- I agree with you 100%. If we begin to focus on international or focus too much on the GPO and expend resources in those areas, that is not where I believe our biggest bang for the buck will be. It is going to be continuing to enhance our private practice model, which is where we have lived for most of our corporate existence. And the new products that we have coming out that address those same markets is where the majority of the resources need to be focused.

Can you talk a little bit about the new products and whether or not you see them as giving you a competitive advantage because the products are superior to your competitors? Or are you just kind of catching up in terms of the product offering? Where are we at with that?

Thank you for that question. Let me see if I can clarify that. Dynatronics has always been recognized as a cutting-edge innovator. And these products represent just that. For instance, the QUAD7, there is no device that does everything that this one does. We were driven to do this because a similar device called a game ready device, which is kind of the -- recognized as a standard in the industry for cold and compression, changed the distribution model and made it more difficult for us to get their products. So we went and found an alternative and worked with another manufacturer to come up with the proprietary type of a unit that we could add to that makes our unit very unique and very price competitive with the existing unit. Ours offers not only cold and compression, but also heat therapy, as well as electrical stim, in combination form. And nobody does that. And so, it is very innovative, and it has created some real interest in the market, as being something new and innovative.

Likewise, the new Solaris Plus products that we are coming out with will replace our existing line, so there will be a great amount of cannibalization. But there will be an emphasis on the fact that this is the newest, latest, and greatest out there and will be capable of doing more and in a better way than any other product out there. So we are not -- we're usually the leader that people try and catch up to. And we think this is going to help us leapfrog ahead once again and make it so that others are trying to catch up.

What type of timeline do you think we're looking at for the customers to be educated on this offering to where they're actually -- word of mouth is spreading and they're really buying it? Do you think, based on your experience, that will happen fairly quickly?

Yes.

As the product is introduced?

Yes, it will. It will be 90 days. It will start to have the biggest effect. We have reps out there right now talking it up, and people are waiting to see the product. And as soon as it is available, we will start to see the sales. In fact, some people have already started buying the base QUAD7 unit even knowing that the probes, which are kind of the sexy part of the whole product, won't be available for several more weeks. But they're getting their product now so they can get in line for the probes.

Okay. I'm going to show that I'm a little naive on your products, but when you sell your products, are they -- is it 100% capital sale? Or are there some downstream sales you also get with the replacement parts or kind of like selling the razor to sell the razor blade? Is there any downstream benefit?

On the capital equipment side, there is very little of that. We do have electrodes and lead wires and disposables that go with it, but they aren't a significant part of the business. But we do sell supplies and other things not related to our capital. And that is another segment of our business.

Okay. Great. And what about your other products that you have in the queue? Are there any others that are like this one that would position you in a unique way compared to your competitors?

We believe so. We will be introducing those over the next 12 months, and they are all part of the fallout of the R&D effort of the past two years. And we believe there will be some additional unique products come out in fiscal 2013 that will further enhance our position as a technology leader in this field.

All right.

I won't go into detail on them, but I can tell you that they're more than on the drawing board. They are in the prototyping stage.

I know there is no way you can put any kind of exact numbers to this, but do these products have the potential over a three-, four-, five-year period of time of doubling the business?

No, they don't. They would not double the business. But they would hopefully significantly increase the profitability of the business. Our biggest challenge has been -- even though we've grown the top line, our challenge has been growing the bottom line. Our goal is to, with the introduction of these new products, and the streamlining of the business, is to get the Company up to a $0.10 a share level in the next couple of years, with that. I think that is a significant increase. But I don't want to mislead you. It is not going to double the top line. We're not going to see the Company go from $32 million to $60 million, but we don't think we need that to make significant improvement to the bottom line.

Okay. All right. And one last thing. I saw in your 10-K there was a note about developing a new product catalog as a sales tool for your people, and I was just wondering if that has been done or how that is coming.

That will be -- that is scheduled for release in September.

Okay.

So it will be including a bunch of new products from other manufacturers as well and updating our market, as a marketing tool, and updating our Web site as well. So it should be out in September.

All right. That's all I have. Thanks a lot.

Thank you. Appreciate it.

Thank you. And it appears we have no further questions at this time. Mr. Cullimore, I will turn the call back over to you.

Okay. Let's make one last call, if anyone else would like to have questions. Our last two callers were very thorough in their questions, and I think maybe they covered most of it. But if there is anyone else who would like to ask a question, we will give you one last chance here.

(Operator Instructions). And our question comes from the line of Jim Dull. Your line is open. Please go ahead.

Hi, Jim.

Hi. A couple of questions here. One is, you serve as mayor of Cottonwood Heights, and I was wondering if wearing two hats is really doable, taking time away from the Company to perform those duties as admirably as you do. That's one question. Can you do both jobs?

Well, I have been doing both jobs for the last seven years. So I am sure there are times when there might be those who would be critical of that, and I report to the Board frequently and review with them my obligations. I will say that I think we have good people here who assist me, and the type of job that I have as mayor is not a full-time Mayor. We have a form of government where I'm just a part-time mayor, and we have a full-time city manager and staff that actually run the city. So the demands on my time are not the same as what might traditionally be expected of a full-time mayor of a city.

Okay. My next question is, when I look back at where the stock was trading 18 years ago at like $2.31, and today, it is trading at $0.63. Have you sat down with your executives and asked, why haven't we added shareholder value over a long period of time? Why is the stock trading basically a fourth of what it was 18 years ago?

There are some -- there are some answers to that, not necessarily satisfactory answers. Of course, when we had did the mergers two years ago, and in the acquisitions we did back in 1996, we issued additional shares. So if you go back 18 years, you have to then update the number of outstanding shares. Back 18 years ago, we only had about 7 million shares outstanding, and today we have 13 million. So if you look at overall market capitalization, we are still below where we were 18 years ago. But it is not as dramatic as -- from 218 to 63, when you realize that we have almost double the number of shares outstanding.

That has been one of our biggest challenges, is that we had expected in that vertical integration five years ago that we would not only grow sales immediately as a result of that, but we would enable ourselves to use that as a platform for further growth and to move the needle even more. And while we have been battling that and have shown improvement over the last four years, this fiscal year, given the R&D expenditures and things of that nature, have not shown that we have been able to achieve the goals that we had wanted to. So, there is no question that stock value has suffered in the last year as a result of those factors. Our job now is to show that all the investment we've done over the last year and the positioning we've done can help us return that shareholder value.

Okay. Your goal is to add shareholder value, not just stay in business, and that is admirable to stay in business for 18 years. A lot of companies don't. A lot of companies come and go within two or three years. So you have been able to stay in business long-term. I guess your next challenge is to try and add value for shareholders and grow the Company.

And that's really what the challenge has been all along, is trying to find different ways of doing that as our market has evolved. Because in the 30 years we've been in business, we've gone from being a startup R&D company to where we are today. And the Company has migrated based on market forces, and we've been nimble enough to navigate those forces. But where I think we have not gotten to our ultimate goal is on that bottom line of consistently delivering year-over-year the kind of profitability that will sustain the stock price that is well over $1. And that is -- boy, we talk about that every management meeting.

Is one of the options, if your business plan doesn't work over the next few years and you can't grow the Company, to maybe sell it to another entity?

As a public Company, Jim, you probably know as well as anyone that you're always a target. And there are times when I think that is an appropriate thing to consider, to sell all or part of the Company. Those kinds of things are hard to dictate, because when you are down is not the time you want to sell, necessarily. You want to sell when you've got a position of strength, if are you going to sell at all. I've learned over the years, in both acquiring businesses and looking at when is an opportunity to consider strategic opportunities, things have to be just right. I mean, they don't just necessarily happen on cue. We would certainly be willing to explore any opportunity like that, that would be beneficial to our shareholders. That would be disingenuous for me to say otherwise. So I would say yes, if there were an opportunity like that, it would certainly be explored.

Those are my questions. Thank you very much.

Thank you, Jim. Good questions.

Thank you. And it appears once again we have no further questions.

Okay. Well, if there is nobody else registered, we will say going once, going twice. And if you do have additional questions, certainly, we are available, myself or Bob Cardin, are more than happy to try and respond directly to your questions. If you would like to call us privately, we will do the best we can to answer those questions as permitted under disclosure laws.

For now, we appreciate those who have been on the call and really appreciate the questions that were asked. I think they were very appropriate and hopefully we gave answers that were meaningful. Thank you for being on the call today. We look forward to our next call being a much more positive call, as we will have released all of these products we have been talking about and hopefully have seen the fruits of those labors. So, thank you for being on the call today.