Earnings Transcript for DYNT - Q1 Fiscal Year 2023

Operator: Good morning, ladies and gentlemen and welcome to Dynatronics First Quarter Fiscal Year 2023 Earnings Call. As a reminder, this conference call is being recorded today, November 10, 2022. Following today’s presentation, there will be a question-and-answer session. It is now my pleasure to turn the floor over to your host, John Krier, the company’s President, Chief Executive Officer and Chief Financial Officer. John, the floor is yours.

John Krier: Thank you, operator. Good morning, everyone and welcome to Dynatronics first quarter earnings call. Before we begin, I will call your attention to our Safe Harbor statement. I remind you that the discussions during this conference call will include forward-looking statements. Factors that could cause actual results to differ materially are discussed in the company’s most recent filings with the SEC. We caution you not to place undue reliance on forward-looking statements we make this morning. We undertake no obligation to update or revise forward-looking statements. During our prepared remarks, we will be referring to slides that are available for viewing in the webcast and posted on our Investor Center page at dynatronics.com. On today’s call, we will cover the highlights and achievements of the first quarter of fiscal year 2023 as well as provide commentary on the financials and then we will have the Operator open the phone lines for questions. Slide 3 highlights just a few of our recent accomplishments, which enabled the company to exceed our baseline continued product net sales expectation set in April 2021 and advanced many of our strategic priorities. Three key takeaways for our first quarter

Operator: [Operator Instructions] Your first question for today is coming from Jeffrey Cohen at Ladenburg Thalmann.

Jeffrey Cohen: Hi, John, how are you?

John Krier: Good, Jeff, good morning.

Jeffrey Cohen: So a couple of questions. First, congrats on the margins less than 30% and it looks like your Slide 6, you’re targeting $30 million to $35 million for the full year. I’m sorry, that’s SG&A. So on the margin side, should we – or could we expect that to increase? Is 30% the new baseline?

John Krier: It’s certainly a great quarter in terms of the gross margin improvement. I’m really proud of the organization as a whole for executing our path to gross margin improvement. As it relates to the full year, we’re still deferring guidance as we understand the timing of all of the inflationary costs rolling through inventory and what to expect going forward. But we do expect that we will continue our progression towards our longer-term target of 40%. There may be some up and downs as we go through that, which is why we’re not providing specific guidance on it, but we’re certainly happy with the 30.2% for the quarter.

Jeffrey Cohen: Okay. Got it. Could you talk about the inventory a little bit, still up there at around $11.9 million, is that going to be a focus for the year? Would you anticipate over the coming quarters that would be worked down a little bit?

John Krier: That’s absolutely our target. That’s a key lever for us in terms of driving cash flow from operations. We drove $0.4 million of cash flow from operations in the first quarter. That’s a very important precursor, if you will, to profitability. Brian Baker and the team are focused on that throughout the year. We also have to modulate that with the strong demand that we continue to see with the double-digit growth that we’ve had in the past. We have new product introductions coming, and so we have to manage all of that. But you should expect that we will manage that down through the year to drive some cash flow from operations.

Jeffrey Cohen: And as long as you brought that up, could you talk about some of the new product introductions that are anticipated organically?

John Krier: Absolutely. Over the last year, we’ve had about seven releases and really, it was only 6 months ago that we leased our three new tables in the Mammoth collection, and that’s going to be a longer-term project in a collection. Those results are just starting to make its way into our financials from a revenue perspective yet we had to build up inventory to support the launch. So you can expect more releases throughout the fiscal year. No details that I have today to share about it, but I know that Sarah Mealman and our marketing team are very focused on listening to our customers who have given us some great ideas, and we look forward to releasing more throughout the year. It will be a driver of our longer-term growth. We have to take market share with good execution. We have to launch new products. And then eventually, when the time is right, ideally land an acquisition or two.

Jeffrey Cohen: And our final question about the M&A environment out there, which you just mentioned. What’s changed over the past few quarters as far as availability, pricing and what you’ve been looking at?

John Krier: It’s still the same environment. I enjoyed the conversations that we have. There is some great organizations out there that are trying to determine what they think the inflationary pressures are going to mean to their business long-term. Where are they at with being able to now differentiate in our new normal of supply chain challenges. Is it better to partner with an organization like us. So I wouldn’t say that the market has changed as much as ongoing dialogue, prices are still dependent on a willing buyer and a willing seller. But we’re looking for them and hopefully, at some point, we will be able to do that.

Jeffrey Cohen: Got it. Okay, thanks for taking our questions, John.

John Krier: Thanks, Jeff. Have a good day.

Operator: Your next question is coming from Brooks O’Neil at Lake Street Capital Markets.

Brooks O’Neil: Good morning, John. Congratulations on the margin expansion, that’s really terrific. So a couple of quick questions. First, obviously, you expanded the inventory strategically to address the supply chain challenges. Do you see risk in the inventory position now related to the inflationary environment and/or the demand environment you see out there in the market today?

John Krier: It’s certainly something we have to watch for Brooks in general, just like everybody that’s out there today. The point that I would call attention to for Dynatronics is that we made a strategic shift to focus on our manufactured products. And that allows the fact that we’re not reliant on somebody else’s distributed products that may go in or out of vogue with our customers. These are our core products that our customers are ordering day-to-day. So we will have the tail to be able to drive those through. So it’s a much less risk than maybe other organizations have that do not sell their own manufactured products. It’s a key strategic advantage we have.

Brooks O’Neil: Great. That’s makes sense. Let me ask you one more question that I think is on the mind of a lot of the investors that are out there in the world today. You mentioned that you see your share price is undervalued today. How do you and the Board think about issuing shares for the preferred as opposed to borrowing money and/or using cash?

John Krier: We are very sensitive to share count and dilution of our overall value. Today, when you look at the share count, the enterprise market value and you look at our working capital, you see that our working capital is in excess of that. It’s one of the reasons we think that we’re undervalued with our overall revenue. When we look at cash or we look at capital allocation, whether it be in the form of shares or paying the dividend on the preferred or exercising the business, we’re looking at all of those factors and making sure that we make the right decisions. So wherever we can deploy cash for growth, drive EBITDA, drive profitability, we’re going to do that but I will tell you that we are very focused on our overall share count, and it’s something that we do consider.

Brooks O’Neil: Good. I appreciate that. Let me ask one last one. Any thoughts about hiring a CFO or how do you and the Board think about that?

John Krier: We certainly look at it from a managing of a risk perspective. When I first joined the organization, I came in as the CFO and coming from a financial background, starting my career at Deloitte, I have an advantage of being able to do both. And as we look at it today as a company with roughly $50 million of revenue and designing a path to profitability, we’re making strategic investments on personnel. And so today, as long as I can continue to perform both roles, perform them adequately, we will continue to make investments in marketing or engineering or supply chain. Those things that propel growth as opposed to potentially a financial leader. But we will bring a financial leader in when we think it’s the right time.

Brooks O’Neil: Great. Thank you very much for taking my questions.

John Krier: Thanks, Brooks.

Operator: Your next question for today is coming from Scott Henry at ROTH Capital.

Scott Henry: Thank you, and good morning. First, in observation, the spot is getting really small in the press release. My eyes are starting to struggle. You might want to increase that font. But moving on to more relevant questions and comments, the SG&A in the quarter is a little higher than maybe I expected, but that seems to be happening on a seasonal basis. Would I expect meaning higher in the first quarter and the fourth quarter, lower in the middle of the year. With regards to SG&A, would you expect that trend to continue?

John Krier: Good morning, Scott. That is absolutely the trend that you should expect. Our first quarter is usually our highest from an SG&A spend, primarily related to our fiscal year audit costs and other professional fees that are largely borne in the first quarter. So you should expect that. It is still under the 35%. I think we landed at 34% for the quarter. So it’s within our range that we’ve provided, but you should expect that this will be the higher end of it.

Scott Henry: Okay. And then I know you don’t want to give gross margin guidance, and I think the first question was directed towards it. But I guess the question is, is the gross margin in the first quarter? Is there anything unusual in that number? Is there any reason to think that, that was a stronger than typical quarter and there would be some reversion to the mean? Or is that a normal quarter, and we hope it stays there or we will see where the variance is?

John Krier: The way that I interpret that, Scott, is it’s a very strong quarter for us. Nothing abnormal in the quarter that I would point to in general, but we are starting to see signs of our overall gross margin improvement plan come to life. The challenge in being able to provide guidance going forward is there is still a number of shocks and disruptions out there that were unable to fully get the timing right on in terms of communicating, which is why we’re deferring it. But that doesn’t mean we’re not executing against our plan. The first thing we did was rationalized our products last year. That’s an ongoing. We’ve rationalized our pricing and our customers. We just started the new product launches that are making their way into revenue for the first time. And now we’re moving our way into manufacturing efficiencies and revenue scale. So we have a 6 point gross margin improvement plan. You’re starting to see the benefit from it. Where this will ultimately land time will tell. But I’m certainly really proud of the team and the organization for Q1.

Scott Henry: Okay. And is it still pretty heavily dependent on just the total revenues in the quarter. meaning is there a big fixed component of it such that if they see better gross margins in the higher revenue quarter? Or is it variable? How should we think about those?

John Krier: We should think about it like most organizations. Revenue scale is the fifth lever we pull on gross margin improvement. So the higher the revenue, we’re going to generate more scale. It doesn’t materially drop with lower revenue, but it does suffer. So it is dependent on revenue. I don’t know whether it’s more or less than other organizations. But we will benefit from higher revenue. It will not go down as much on lower revenue.

Scott Henry: Okay. Great. And I guess the final question and kind of line of discussion is, John, I think you’ve done a great job stabilizing the company coming out of COVID. And we’re seeing your beating numbers, stabilizing the business, the cash flow situation is good. But the market cap is kind of in the no one cares category. I mean, for a $50 million revenue company or approximately $50 million. No one cares, no is paying attention. Do you think it’s time to really set a plan, whatever it be, a three-year plan, a 3-point plan with the idea of, hey, it’s time to turn this into a profitable company. And we’re going to do – we’re either going to acquire, we’re going to have organic growth or we’re going to sell this company. Just with the idea being that I think if there is some visibility into what the end game here is because it’s been going sideways for a while. And I commend you for stabilizing it coming out of COVID. But it just feels to me like it’s time to set more direct goals on turning this into a profitable company and really moving forward to the next stage. I’m really just looking for your thoughts on that comment.

John Krier: I appreciate the candor, Scott. We are absolutely looking at our plan and how we’re going to execute going forward. The first step was getting the company stable, as you mentioned, nine consecutive quarters of no debt. We’ve done that. We’ve got a great team propelling us forward with a good culture of accountability. We’ve demonstrated revenue growth on our manufactured products. We’ve controlled costs. The third step is we’re now demonstrating that we can begin to grow gross margin. That is the next step towards profitability. When I’ve talked to investors that are out there, they have been very clear with me. Nice job on stabilizing the company, nice job on growing revenue base, defining the products and where you’re going, if you can demonstrate that you can grow gross margin, you’re going to be profitable with profitability will come to valuation. And then ultimately, we can use this as an acquisition platform. So I do think that, that’s still the thesis. And one of the things that we hope to continue to share with people is that we’re looking for long-term investors that want to get behind a potential leader in the market that we desire to be.

Scott Henry: Yes. I think that’s helpful, but I just make a direct plan. Just keep in mind as well, over the past 2 years shares outstanding has went up about 20% to 25%, too. So everything hasn’t been great, but I think you’ve done a good job stabilizing it. But thank you for the comments and thank you for taking the question.

John Krier: I appreciate it, Scott. Have a great day.