Dynatronics Corp (DYNT) 2021 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Dynatronics Third Quarter 2021 Earnings Call. (Operator Instructions)

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.

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 today are included in our most recent 10-Q and other reports filed with the SEC and include uncertainties and risks related to the impact of COVID-19 pandemic on the 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. We have included a slide deck as part of our presentation, which is available on the webcast if you have registered for it. If you have not, you can find it easily on our Investor Page at dynatronics.com. It's directly in the middle of our Investor Relations homepage.

Thank you, Skyler. Good morning, and thank you for participating in today's call. I'm John Krier, President and Chief Executive Officer of Dynatronics. And with me today are our Principal Accounting Officer, Skyler Black; and our Chief Financial Officer, Norm Roegner.

On today's call, we will cover the highlights and achievements of the quarter year-to-date, and we will also discuss the transformational projects that we announced on April 22, just a few weeks ago. Norm will provide commentary on the financials, and then we will have the operator open the phone lines for questions.

First, I want, again, to thank our employees, partners, customers and all stakeholders for their continued hard work and perseverance during the COVID-19 disruptions. Health and safety for our team and partners remain top of mind, and we work hard to preserve our business and protect our people here at Dynatronics. We are committed to responding responsibly to the challenges of the global pandemic.

We issued a press release this morning announcing the financial results of our fiscal year 2021 third quarter ended March 31, 2021. We have been planning and executing an ongoing business transformation over the past 9 months, while simultaneously dealing with a global pandemic that has impacted our business significantly. We continue to experience gradual reopenings and an uptake in rescheduled procedures at the facilities we serve. And we believe this bodes well for our future growth.

Skyler has reviewed the forward-looking statements on Slide 2 of the presentation materials. So let's go straight to Slide 3, which we think is worth revisiting at this stage of the turnaround. Our transformation is being led by a new management team at Dynatronics. You can see Norm's and my background on this slide. Last quarter, we introduced Norm Roegner as our Chief Financial Officer. He brings over 20 years of executive financial and operational leadership to the company and was most recently Vice President of Finance for the Medical Pharma Solutions division of Phillips-Medisize, a Molex company. Norm has brought operating discipline and planning talent to Dynatronics and led the team that developed a streamlining plan that we announced on April 22.

Moving to Slide 4. The markets that we serve are large, growing and fragmented. Dynatronics is building a scalable platform to grow its customer and revenue base and generate sustainable cash flow so that we create value for our shareholders. The industry research indicates that the rehabilitation and bracing and support markets continue to exhibit an attractive growth profile. And as I mentioned at the beginning, the statistics of facility reopenings, orthopedic procedures and other activities that create demand for our products are on the rise.

Please turn to Slide 5. While each of these bullets is very important to our growth platform, I am going to primarily discuss the 3 emphasized points, which are described in more detail on Slide 6.

Looking at Slide 6. Goal #1 is to drive sales growth and better partner with customers. To better allow us to accomplish this goal, we are eliminating approximately 1,600 SKUs of low-margin, third-party distributed products with annual revenues of approximately $11 million in our rehabilitation segment. These products were low or no growth, carried low or unacceptable margins and were not our own manufactured products. The forward-looking strategy is to: one, focus sales and marketing resources on products manufactured by Dynatronics; and two, streamline sales exclusively to dealers, thereby eliminating perceived competition with customers from historic direct sales efforts. Moving to the dealer channel is a strategic move to simplify our business, strengthen our revenue platform and generate cash. Over the past few weeks, I and my team have been able to discuss this change with our dealer partners, and the response has been overwhelmingly positive.

Goal #2 is to expand margins and profitability. As a company, we are going to focus on higher-margin, differentiated products that we manufacture. We will be consolidating support functions to reflect this focus, and we will be targeting significant increases in EBITDA and profitability. Eliminating $11 million worth of revenues that generated the low margins is going to have a positive effect on our company's gross and EBITDA margins. Goal #3 is to strengthen the balance sheet via sustainable cash flow from operations, which can support additional investment and/or M&A in target markets.

Norm will get to the balance sheet. But it's very important to note that in addition to the cash we show as of March 31, 2021, we are expecting additional cash to come in through the Employee Retention Credit that we detailed in the press release, and proceeds from the announced sale of our Tennessee facility.

Slide 7 is a snapshot of the before and after picture from our announced projects. The consolidation of our facilities will reduce our facility overhead by 40%. We have executed a purchase and sale agreement on the Tennessee facility, as I've mentioned. We are eliminating satellite offices in Michigan and Texas that supported our distributed products operations and are reducing our Utah footprint by nearly 75%.

Second, let's focus on brand emphasis and simplification. Here is what transitioning to a full dealer model means. First, we are not trying to do something that hasn't been done before. Currently, approximately 65% of our rehabilitation revenue is transacted with dealers. And in moving fully to a dealer model, we are following what we see being done by the most successful medical products companies in our businesses. Enhancing 100% of our management focus on our brands will lead to additional support to our customers and product innovation opportunities so that we can provide the greatest experience to our customers.

Looking to Slide 8, accomplishments. Rather than go through the slide frame by frame, I'll talk about what I'm hearing from our customers as we've approached them about the new focus. In each of the conversations, it is clear that this is a welcome change. By sharpening our focus on our dealers, we have the opportunity to build our industry-leading brands and generate new sales. We are continuing to add leadership talent, strengthen our balance sheet and take necessary actions to begin our fiscal year 2022 with a clear path to organic revenue growth and profitability.

Building on the foundation these accomplishments provide, let's move to Slide 9, M&A strategy. We continue to pursue acquisitions, innovation partnerships and other business ventures and have the balance sheet and leadership team to execute on any that meet our well-defined criteria.

I'd like to now turn the call over to Norm to go through the financial details that include a rundown of sales, gross margins, operating expenses and the bottom line.

Thanks, John. Please turn to Slide 10, which contains our quarterly financial highlights. The full income statement and management discussion and analysis can be found in the 10-Q, and I will summarize them here. Net sales of $11.5 million for the quarter ended March 31, 2021, were down from $13.7 million in last year's quarter, which was a 16.4% decline. For the 9 months ended March 31, 2021, net sales were $35.6 million compared to $45.3 million. The year-over-year decrease is primarily due to COVID-19 precaution and associated changes in elective procedures, which reduced demand for our products.

Gross profit for the 3 months ended March 31, 2021, decreased $0.6 million to $3.3 million, or 28.8% of sales compared to $3.9 million or 28.8% of net sales. Gross profit for the 9 months ended March 31, 2021, decreased $3.1 million to $10.5 million or 29.7% of sales compared to $13.6 million or 30.2% of net sales. The year-over-year decrease in gross profit and gross margin percent was primarily attributable to lower sales and COVID-19 impact, which reduced gross profit and changes in the mix of sales in our major product categories. Excluding the $75,000 attributable to the Employee Retention Credit, gross profit for the quarter ended March 31, 2021, was $3.2 million or 28.2% of sales.

Selling, general and administrative expenses of $3.9 million represent a 20% year-over-year decrease from $4.9 million in last year's period. For the 9-month period, SG&A was down $2.4 million compared to the prior year period, due primarily to lower commission expenses on lower sales and decreased payroll and benefit costs as a result of headcount reductions. Excluding the $98,000 attributable to the Employee Retention Credit, SG&A for the quarter ended March 31, 2021, was $4 million.

Getting to the bottom line. Net income was $0.1 million for the quarter compared to a loss of $1.1 million in last year's same quarter. Net loss was $0.9 million for the 9 months ended March 31, 2021, compared to a net loss of $1.1 million for the 9 months ended March 31, 2020. The improved net loss was attributable to a benefit from the Employee Retention Credit, decrease in SG&A and interest expense, offsetting a decrease in gross profit. Excluding the $1 million attributable to the Employee Retention Credit, net loss for the quarter ended March 31, 2021, was $0.8 million. $747,000 of the Employee Retention Credit remains due at March 31, 2021, and will be received in cash in the coming months.

The balance sheet is in a strong position with a net cash position. In our 10-Q, you'll see a Paycheck Protection Program, or PPP, loan of approximately $3.5 million on the balance sheet. Based on our review of the loan forgiveness rules, we believe this amount will be forgiven in full, and thus, we're not including it in our net debt calculation.

You will see that our share count is up as well. In addition to the dividend paid with 225,000 shares of common stock, we also took advantage of the conditions in the market in late February to draw on our ATM. We sold 2.2 million shares with an average sale price of $1.61, recognizing $3.5 million in net proceeds.

Cash improved to $4.5 million at the end of Q3 FY '21, up 103% from June 30, 2020. We have a 0 balance on our line of credit and a borrowing base of approximately $4.5 million as of the end of Q3 fiscal year '21.

Also, you will see in the balance sheet, a held for sale line item of $845,000, which is the book asset value of the Tennessee facility that we are in contract to sell with the purchase and sale agreement executed on April 2, 2021. The contract sales price for the facility is $1.75 million, and we expect to close no later than June 30, 2021.

Moving to Slide 11. Here is what we see for the future outlook related to the business optimization announcement on April 22. John will talk to the strategic points again in his wrap-up, but here are the technical points.

Moving to fiscal year 2022, we are planning for a reduction of approximately $11 million in annualized net sales as we finalize this transition. The company expects to record approximately $1.2 million in restructuring charges, of which $0.4 million is expected to result in cash expenditures. The majority of these costs will be in our Q4 FY '21 financial results. More generally, the company and its customers expect to experience continued challenges due to COVID-19, including reduced capacity in operating hours, supply chain disruption and extended handling times.

We expect some continued volatility ahead due to the ongoing pandemic and the business changes announced in late April. Given the ongoing disruption and execution of the changes announced, it will be reasonable to expect choppiness in the coming quarter. As a result, we will continue our recent practice of not providing forward-looking guidance.

This concludes our summary of operating results. I will now turn the call back to John.

Thank you, Norm. As I reflect on Slide 12 and the investment highlights for Dynatronics, each statement is reflective of a set of actions designed to deliver results. Our business optimization plans remained our top priority during the quarter, with a clear focus on driving organic revenue growth, profitability and cash flow from operations. We are well capitalized with $4.5 million of cash on the balance sheet and additional cash infusions coming from the sale of our Tennessee facility, receipt of proceeds from the Employee Retention Credit and operating a business that generates consistent cash flow from operations.

Overall, 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 both reward our shareholders and provide a consistently differentiated experience to our customers.

I will now turn it over to the operator for questions.

(Operator Instructions)

Our first question today is coming from Jeffrey Cohen.

So bunch of questions here. So Norm, you're talking about the sale of the building, hopefully, closing in next quarter by June. What was the commentary about the purchase and sale? Was there a leaseback? Or do you expect the $1.75 million just to flow through into the balance sheet directly?

Yes. So thanks, Jeff. Yes, we plan to close this quarter, and it will flow back to the balance sheet. Net proceeds will be just under $1.7 million.

Okay. Got it. And can you walk me through how the Employee Retention Credits are working? You mentioned $747,000.

Yes, that's what's remaining for the ERC collection in our other receivables at the quarter end.

Okay. Got it. And then you sold some shares, what was the 1.61 million shares? Or 2.2 million shares at $1.61?

Yes.

Yes. We did -- we sold an aggregate of 2.2 million shares common stock under the equity distribution agreement in the ATM at average sale price of $1.61 per share. Net proceeds from the sale of the shares totaled $3.5 million. Proceeds were used to strengthen the company's liquidity and working capital position. The ATM is still available. However, we have not had any additional activity since the February transaction.

Okay. Got it. And so share count this quarter is 15.8 million. Did all that conclude by the end of March and you expect the share count to be similar in the fourth quarter?

Yes. So our current share count is 17.4 million shares after those transactions.

Got it. Okay. So that will be the Q4 number, presumably, or as of today?

Yes. Yes.

Okay. Got it. And then 2 of these charges for Q4, the $400,000 cash and the $800,000 noncash restructuring. Where will I see that? Will the $400,000 cash show up under -- will be included in SG&A in the fourth quarter? And then the noncash restructuring will show up where?

Jeff, we're still working on what those charges are actually going to be and determining what those charges are is important to determine the location, if they're related to impairments or severance, they might be presented differently. So we'll provide an update in the next filing on that.

Okay. Got it. So -- and is any production or current business being concluded out of Tennessee now? Or has the building been largely vacated and ready for sale?

Jeff, this is John. We were vacated and ready for sale at the end of December and then we ad-ed actively on the market. So there's no activity being conducted in the facility.

Okay. And as far as SKUs, have those already been paired down? You talked about, John, a reduction of 1,600 of those. Has that largely been concluded or it's underway now?

It is not concluded. It is underway now. Our intention and goal -- stated goal is to have that complete by the end of our fiscal year, but we're actively working on that as we speak.

Okay. It looks like the Q3 margins were slightly higher over Q2, and I see in one of your slides, aspirationally, 40-ish percent, call it. So how might that look over the next 5 quarters or so? Do you expect that to be a gradual tick up? Or do you expect to be step like in fashion?

So I think we're still evaluating the impact of the announcement on April 22. And what that's going to do with our margin. So we do expect the margins to improve at fiscal year '22 over fiscal year '21. There should be an improvement, but we aren't giving any guidance exactly how that will look or what those numbers will be at this point.

Our next question today is coming from Scott Henry.

ROTH Capital. Just a couple of questions. First, for my background knowledge, what exactly is an Employee Retention Credit?

Yes. So it's a program that was developed by the government. And it's essentially a credit based on your employees' salaries over a quarter that is meant to credit the company to encourage employers to keep their payrolls full during the pandemic.

Okay. And you have another -- I think did you say another $740,000 coming from that program? And should we get all of that in your fiscal Q4?

Yes. So we -- so of the original $963,000 we took in the third quarter, there's still $747,000 outstanding that we should be refunded from the government over and during the fourth quarter. Additionally, there is the ability to earn similar retention credits during our fourth quarter of fiscal year '21. I mean, in terms of the calculation, how that works. The amount of the credit and the calculation is based on employee payroll in the quarter and whether the company experiences a revenue decline greater than 20% in the quarter compared to the same quarter in calendar year 2019. In addition, there's a mechanism in the rules and regulation that allows companies to calculate for future quarters based on the prior quarter.

Okay. Great. That's helpful. And then when we think about fiscal fourth quarter, I mean, should we expect -- I know you're going to do all this pruning of the SKUs. But some of that may come on the last day of fiscal fourth quarter, some may come on the first quarter. Should we think of the fourth quarter is short of a transition from say, the current run rate to the 2022 run rate, so probably somewhere in the middle there? Is that the right way to think about that? And on the cost side, are those -- the costs like the SG&A cutbacks, is that typically a lag and perhaps we'll see that more in 2022 than fiscal fourth quarter? Just trying to think of how we should -- how it should sequentially change next quarter?

Right. So I think the way to think about it, we run in about $12 million in sales on average over the last 3 quarters. And prior to the discontinued product announcement on April 22, we're planning for fourth quarter to be similar at that level. And obviously, with the discontinuation of products, that number will be impacted by that. In terms of the timing of it, I mean, we're going to, over the quarter, continue to obsolete products, take them out of the mix as they sell out of inventory. So there will be some impact in our fourth quarter, and it should bring it down from that average. Overall, from an SG&A perspective, we're going to evaluate it throughout the quarter, continuing to make some changes to align our operating cost with the new go-forward model. But it will happen over the quarter and be in effect for the first quarter of fiscal year '21 -- excuse me, fiscal year '22.

Okay. Great. And then maybe a bigger-picture question for John. You've got the cash balance built up, which is helpful as you look for acquisitions. How do you view kind of the time frame on acquisitions? I mean, are you heavily active now? Or are you getting through the restructuring right now? And would you expect to do something over the next 6 months? Obviously, there's no guarantees, but would that be a goal of yours?

Scott, we're actively involved in those conversations and those activities need to run in parallel. Meaning the execution of this transformation and discontinuation of these products we announced in April, get those wrapped up by the end of this fiscal year is our -- certainly our intention. And then if the right opportunity presents itself, we'd like to take advantage of the acquisition.

On the timing front, that's always unpredictable because it takes 2 parties to make that happen, as you noted. But the other point that I would just emphasize is our balance sheet is the strongest that it's been with 0 on the line of credit, the cash, plus the cash coming in. So as the opportunity presents, we feel good about the chance to execute one.

Okay. Perfect. I guess just one final is, when should we expect the 10-Q to be filed?

Scott, the 10-Q has been filed just right before this call.

Our next question today is coming from Anthony Vendetti.

Maxim Group. Sure. So I know the SKU rationalization should be done by June. But John, I just want to understand it, right, because this is the second SKU rationalization, one before -- your watch -- and I guess, is it going to be an ongoing process. I know this is a big move, 1,600. But how often do you review your SKUs because obviously, you have a lot of them. And after June, is it just going to be some slight pruning or could there be even more SKU rationalization after June?

Anthony, it's a good question. My standard answer always in these conversations as a well-run medical device, medical products company, active product life cycle management is just part of what you need to do on a daily basis. That being said, this was much different. This was a significant review of the SKUs in our rehabilitation portfolio, where we drive value, where our customers are leaning from us, where our opportunities and margin are. Any changes from here, I would see likely more in the innovation where we're adding, but there would always be some slight tweaks to the overall product portfolio.

On the orthopedics, bracings and support, I think we would have a little bit more opportunity, not only on the innovation side, but in streamlining, but nothing as material as what we announced today. So I would view the go-forward look being more of just the traditional active product life cycle management.

Okay. Great. That was actually a good lead into my question, you already started to talk about innovation. So as you're going through the SKU rationalization, you're looking at innovation, and I think you mentioned you're looking at higher-margin products or at least at the current margin or better going forward. Can you give us an idea of how many particular products you're looking at? Is it a handful? Is it 10 to 20 on the innovation side?

I would think that from a cadence perspective, we want to be in the routine nature of releasing new products or enhancing the existing products we have. We don't have a specific number in mind. But we're going to be targeting where we see opportunities in the market. We released the 2 new products in early January, which were part of our Q3 and we've put in place the resources and the mechanisms to be able to release products going forward. So we should start to see a more routine cadence of new products coming out to add to our organic revenue growth.

Okay. Great. And then just lastly, a follow-up on the acquisition front. Do you have a range in terms of the value of an acquisition. In other words, could you do a fairly large acquisition versus a bolt-on acquisition? And if so, how would you finance that?

When we look at acquisitions, the size will obviously be determined by where the company fits into our portfolio and the strategic angle of it, the cash on our balance sheet, the line of credit availability that we would have. We can certainly expand the line of credit under the $11 million facility based on the assets of the entity that we may acquire. So I think the exact financing structure would be dependent on it. If it is a larger deal, we'd have to look at variable financing options to be able to do that. If it's a deal that's within our current assets that we have, meaning the balance sheet, the line of credit, we could execute that with what we have available. So we'll tailor the exact financing to the target.

Okay. Great. And then just a last question on COVID. As we go through our medical device portfolio, most facilities are open. Most medical practices have reopened for the ones that are reopening. Access to hospitals is opening up. It's not fully. There's still some hospitals where you have limited access. But would you say that the COVID headwinds are largely behind you?

I don't know that I would say they're largely behind us. I would say that they're definitely easing in terms of exactly what you just described, the uptick in procedures, the uptick in patient volumes, there's also a good portion of our business that, whether it be school sports and not just the proteins that get all the publicity out there that they're returning, but we also need the colleges and the lower-level colleges and the high schools to resume to that full activity level that drives some of our activity in the athletic training room or even some of our bracing and supports products. So I wouldn't say that they're behind us. I would say that we definitely see them easing as we all do with the momentum, and we think that, that bodes well for our future growth.

Our next question today is coming from Evan Greenberg.

LegendCap Opportunity Fund. Congratulations on all the great work you've done in the restructuring. I'm very excited to be a shareholder and looking forward to buying more stock now. One of the questions I have, I'm very glad you sold the property. I really don't think companies should be in the real estate business where -- when they're in the product business.

Have you thought about other mechanisms other than the ATM, such as perpetual preferred for potential financing so that you don't need to dilute the common equity? Perpetual preferred has actually been one of the great enhances of shareholder value that I've seen. And there are numerous investors out there looking for yield. And the great thing about it is it sits on the balance sheet as equity. It doesn't go on there as a debt, even though you are paying a dividend.

Evan, thank you for your question. We'll continually evaluate all of the available options to make sure it's a good fit for us. So I appreciate that comment there, and that is something we'll always keep looking at as the right financing options for the organization.

Okay. And one more thing. Can you give me an idea of what kind of margins the products you eliminated were creating? Because obviously that was a detriment to the company. It was not a very, very good use of cash to continue to sell those products. And how much do you expect this rationalization of product to increase gross margins by? Is it 5%? Is it 10%? Is it more than that? I would hope it would be significantly more than like 100 or 200 basis points.

No Evan, the way that I would consider that is that when you look at our run rate of our gross margin coming through the end of Q3 and then these products we've characterized as low or unacceptably no margins that are in there. So having the fact that those relieved from it, we should be able to certainly grow our margins. We're not providing any guidance as to what that is at this point while we work through the transition.

Okay. Okay. But what -- can you give me an idea of what kinds of gross margins were being provided on an average SKU from the ones from the products you eliminated?

What I would say to that, Evan, is that given the overall percentage and that these were on the lower end of that spectrum, it would stand to reason that they're going to be lower than our current average that we present in the quarter.

That is all the time we have for questions today. Mr. Krier, do you have any closing comments you'd like to finish with?

Thank you, Kate, and thank you all for the questions and for your interest in Dynatronics. If you have any further questions, please direct them to Skyler Black or Peter Seltzberg. Their contact information is in this presentation and in the press release issued earlier this morning. Operator, you may end the call.

Thank you. Ladies and gentlemen, this does conclude today's event. You may disconnect at this time, and have a wonderful day. Thank you for your participation.