Dynatronics' (DYNT) CEO Kelvyn Cullimore on Q2 2016 Results - Earnings Call Transcript

| About: Dynatronics Corporation (DYNT)

Dynatronics Corporation (NASDAQ:DYNT)

Q2 2016 Earnings Conference Call

February 16, 2016, 04:30 PM ET

Executives

Kelvyn Cullimore - Chairman, President and Chief Executive Officer

Analysts

Kelvyn Cullimore

Welcome, everybody. This is Kelvyn Cullimore, President and CEO of Dynatronics Corporation. I welcome you to our quarterly call to review the financial results for the fiscal quarter ending December 31, 2015, and the six months also then ended.

Before we begin, as a reminder, during the course of this 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.

So today we're going to talk specifically about the results from the quarter and six months ended December 31, 2015. When I am through with my presentation, we'll have the operator open up the call for any questions that you might have, and then we'll conclude the call.

Talking about the quarter first, quarterly sales increased about 2.4% or $172,000 to $7.5 million compared to $7.3 million for the year before. Coincidently, year-to-date sales also increased by the same amount 2.4% or $353,000 to $14.9 million for the six months compared to $14.5 million.

Primary growth driver in this particular quarter was sales of our proprietary therapeutic devices, the SolarisPlus family of products, which jumped about 26% in Q2. And of course, this is one of our primary focuses of our organic growth strategy is to emphasize the sale of these higher margin proprietary products.

Our continued positive performance reflects not only the overall improving market conditions, but more specifically initiatives that we embarked on in the quarter, incentivizing sales of our core modalities. We had an annual sales meeting at the end of September and introduce some initiatives that began in Q2, and those initiatives encouraged sales representatives to expand their efforts to new accounts and even some new markets. And in addition provided incentive for them to renew contact with dormant former customers, and that incentive program seems to have paid off well.

In Q1, ending in September, the period before this one, sales of exercise equipment in Medland where treatment tables were leading growth categories, while this quarter it was sales of our higher margin therapeutic modalities that led the way. Those combined to create different impacts on gross profit margin for the period.

Gross profit for the quarter just ended increased 8.7% to $2.7 million compared to $2.5 million in Q2 of fiscal 2015. The strong sales of our SolarisPlus units in Q2 is what really drove the higher gross profit margin. Gross profit percentage for the quarter was 35.8% compared to 33.7% during the same quarter last year. This jump in gross profit margin takes us to the highest gross profit margin percentage we've had in the past seven quarters. So it was a significant step forward.

Gross profit percentage for the six months was 34.9% compared to 34.7%. That differential is not as strong as it was for the most recent quarter, because profit margins in Q1 were driven more by lower margin sales of therapeutic tables and distributed capital, whereas the second quarter was driven by the higher margin therapeutic modalities.

Going forward, we will continue to implement plans to increase gross profits. We're going to do that in two ways. We will continue to focus on the company's proprietary therapeutic devices, which are sold by our sales reps and dealers and carry the higher margins. That will be accomplished through continued incentives and encouraging exploration of other markets besides physical therapy as well as deeper dives into the existing physical therapy market as we did in the second quarter.

We are also focusing on reducing cost of manufacturing of proprietary products, including a benefit that we will receive from the temporary suspension of the medical device tax. Those who have followed our industry know that in 2012 as part of healthcare reform a medical device tax was imposed.

That medical device tax is captured in our financial statements in the cost of goods sold, with the suspension of that beginning in January of this year for the next two years at least. That will have a positive impact on our gross profit margins to the tune of approximately $160,000 a year. So we are thrilled to see that come about. It's a great benefit to our industry and removes a very onerous tax.

Our SG&A expenses did increase in the quarter by about $89,000 and in the six months period by $193,000. In the comparable quarter and six months last year, we also recorded cost associated with the terminated acquisition of $143,000 and $220,000 for the six month period.

The increase in SG&A expenses over last year were attributable to the following items. First of all, we recorded approximately $87,000 in the quarter and $182,000 in the six month for expenses that are directly related to the implementation of our strategic plans.

As everyone is aware, we received an investment in last June and partnered with pretty big partners to help transform the company and to grow the platform both organically and through carefully planned acquisitions. The structure to accomplish that did carry some expenses with them, things like hiring a Director of Business Development, new sales person, consulting and professional fees that have all contributed to that overhead, some of which we expect will bear fruit in coming quarters, as we get more aggressive in our strategy for the M&A side of our strategy.

Labor expense was the other large contributor to increased cost during the period. Last year during this quarter and six month period, we had an anomaly occur with several vacancies in the company that went unfilled for a period of time. Those were subsequently filled primarily in Q3 of last year, and so we now are seeing the full impact of those vacancies being filled as well as higher health insurance cost. And we did incur, because of significant demand for our custom wood products, some significant overtime during the quarter, which contributed to the higher labor expense.

Our sales expenses increased approximately $40,000, much of that was just higher commissions associated with the higher sales. And then, we also had an increase in our R&D expense. In Q2, R&D expense increased about $19,000 compared to last year's Q2, and R&D expense for the six month period increased about $68,000.

And the reason for those increases is that R&D are engaging in engineering projects design to reduce the cost of manufacturing of current products and introducing new or redesigned products to the market. And we anticipate introducing two to three new proprietary products in the market in the next quarter. And we believe that developing new products is a key element of our strategy and critical to moving the selling momentum in a positive direction in the future.

Increased R&D expenses in the current quarter are also related to development of new products that will not be introduced until next fiscal year. So we believe the R&D expenditures, while not a significant increase, are important to sustaining an important R&D pipeline.

As a result of what I've just explained, our pre-tax loss for the quarter was about $119,000 compared to $226,000 in Q2 of 2015, that's almost a 50% improvement for the period, and our pre-tax loss was $306,000 compared to $170,000 last year. The decrease in pre-tax loss for the quarter was primarily attributable to the higher gross profit that was generated during the period and offset by the higher SG&A and R&D expenses as explained. Of course, for the six month period we incorporate the higher losses that were incurred in Q1, which caused that number to turn around from what we did in the second quarter.

The income tax provisions, it can be very confusing in reviewing the income tax provisions. Essentially it comes down to this, because of prior year losses, accounting rules essentially require that we place a 100% valuation allowance on our net deferred tax assets, which we have done, which basically means we can record no tax benefit from losses that are incurred.

Typically, if you incur losses, you record a tax benefit in the tax expense line, representing a deferred tax asset that would be used in the future period. But with a history of losses, accounting rules put in question, whether those will be used.

And so while we do record them, we also record a valuation allowance against that, netting that out to zero for the six month period, but still having that deferred tax asset on the books, which means that in the future, if we are successful in achieving our objectives and turning to profitability, those deferred tax assets can be utilized to offset tax expense and will come back on as an income item on the statements. So that's mainly a timing difference. But bottomline on income tax provision, until we return to profitability, that will essentially be zero on that line going forward.

The net loss, of course, given all the factors, we generated about $125,000 net loss compared to $134,000 last year. Again, the absence of a tax benefit is the biggest differential there. For the six month period, our net loss was $306,000 compared to $93,000 last year.

And of course, with the investment by the affiliates of Prettybrook, we do have outstanding preferred stock on which we pay a dividend every quarter. That dividend is paid in stock as opposed to in cash. And we had dividends that accrued on convertible stock were $81,000 in the quarter and $161,000 in the six month period, and those get added to the net losses to arrive at the net loss applicable to common shareholders of $205,000 for the quarter, and $467,000 for the sixth month period.

So going forward, our strategic plan is fairly straight forward. We are focusing on expanding our sales efforts both geographically and numerically, looking to add new sales representatives. In fact, during just after the end of the quarter we announced the adding of Tyler Oglesby, who is going to help head up our efforts in Post-Acute Care. He is a very experienced sale representative and should help contribute significantly to our sales for the next few years.

We are looking at adding others as well and trying to expand into certain territories, where we are underrepresented. Along with that though, we are focusing our incentive programs and sales efforts on our core products, as we did in the second quarter, in order to help bring about a better margins and sales of those products that have the best profits.

We also continue to focus on international sales. This is an elusive challenge for us, it has been, but we are making progress, although not as rapidly as we hoped. We did obtain the CE Mark on our SolarisPlus and 25 Series product lines in the first quarter of this fiscal year and have begun efforts in Europe. Again, we've established two distributors there that are starting to make in-roads, but it is slow and there is lots of territory yet to cover.

We did receive regulatory approvals in Singapore and Peru, which we announced. That just helps extend our geographic reach. We don't expect either of those to be huge markets. But again that's adding singles every now and then with an occasional double and at times a home run. And so Singapore and Peru may be singles, but we'll take them.

We anticipate obtaining product approvals in other foreign markets, including China, Southeast Asia and Mexico late this year. We have been told by our distributors in China and in Mexico that the approvals are imminent that we have been hearing that now for about 60 days. And so we're not sure what the definition is of imminent, but we are hopeful that that will occur in this quarter, so that we can hopefully begin sales in those markets by Q4 ending in June.

Our distributor in China is particularly active right now and we are working with them to develop plans for moving forward. And they have been selling over $1 million annually of physical therapy devices in the past, and we expect them to be a very good partner for us in that part of the world. We have certainly been hampered by these approvals, but we are undaunted and continued to purse those markets and believe that they will be productive for us in the near future.

And improving our support of existing reps is another strategic plan we have, by providing better sales management tools and facilities. This was made possible partly through the investment of capital received from Prettybrook, and that we've already begun those efforts, which are starting to bear fruit with our sales force.

One thing that has become is growing in popularity for us is they focus on specially and custom made wood products, particularly for the professional sports and university market to improve their training facilities. We've done facilities recently at Stanford University, Vanderbilt University and several others, University of Utah, all of whom are very pleased with the products that they have received and we believe that represents a market that has some great potential for expansion.

All of these factors will not only help increase sales, but will also help increase gross profit margins. In addition, gross margins will be improved by efforts to reduce the cost of manufacturing, our core product lines, as was described in talking about our R&D efforts and also the elimination of medical device tax that we discussed.

We are continuing to pursue the new introduction of products as discussed, and more importantly we are focusing on our M&A strategy. We are currently evaluating a number of exciting opportunities, of course, as anyone who has been involved in that market knows, it's how unpredictable. Just when you think you've got something working, something comes up and sometimes when you least expect it, an opportunity comes your way. And we continue to be very active in seeking those opportunities and pursuing them. And we are certainly hopeful that some time in this calendar year, we'll be able to make an announcement of an acquisition, all things working to our good, that is.

And then we continue to focus also on trying to support getting the story out about what we are doing. Last month, we attended meetings in San Francisco. We were on the JPMorgan Conference and had meetings with several money managers analyst. We've also been able to hold several non-deal roadshows in New York and coming up in Chicago and Minneapolis, and meeting with Wall Street types to expose them to the Dynatronics story and create greater awareness.

So with that discussion of our strategic plans, let me kind of summarize of what we are, what to expect. We are focused on increasing our sales and focusing on increased sales of our higher margin therapeutic products. We are also expecting to improve our gross margins as has been described. We are working on the international sales growth.

We are working on the strategic acquisitions and growth initiatives that are being facilitated by the capital infusion from Prettybrook. We are looking at the introduction of the new products that we have been working on, both, in this fiscal year and in next fiscal year and also into expanding our distribution capabilities.

Overall, fiscal year '16 will continue to be a building year as we begin to implement these strategies. Expenses incurred to support the new strategy that we've talked about will begin to bear fruit later in this fiscal year and also into fiscal '17, but the growth is expected as we -- is expected to accelerate as the year progresses and as we begin to make better in-roads on the acquisition strategies that we're implementing.

So overall, the whole plan that was devised when we partnered with Prettybrook is moving forward as expected, adding the three decades of our corporate infrastructure building, brand names, et cetera, with the business acumen and access to capital and deal flow provided by our new investors, provides still a very compelling story going forward. Of course, it's all going to be judged on the execution of the plan. And we believe over the next few quarters, that execution will become clearer, as we achieve some of these objectives that we have set forward.

Some steps we have already taken to accomplish that: obviously, the hiring of a business development officer; restructuring of our management to allow for a new VP of Sales that will be focused more on the specific growth strategies that we are devising; and we have, as been announced recently, added some new Board members, who have great experience in these arenas and we're excited about the contributions they are already making; and we are budgeting funds to cover canvassing cost to identify target candidates.

So in summary, we're experiencing momentum in the business, as we begin to execute on these strategies. The costs to do so are well within our expectations. And as we begin to move forward we hope that the future will help all of you realize that being involved with us has been a good thing and will continue to be a good thing.

So with that, we express our appreciation to you for your interest in being on this call today. We also appreciate very much the support that we have received from our partners at Prettybrook, who have been very engaged with us in helping to devise our strategies and to provide the guidance on execution of those strategies.

And the changes that have been made have been well received within the organization and also within the investment community, and we believe it positions us very well for accomplishing the strategic objectives that have been described here.

So with that, I'd be happy to open the call. I'll ask operator, Charlene, if you'll open the lines for any questions, explain to them how to pose those questions and we'll fuel to any questions they may have.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of [ph] Jeffrey Collin.

Unidentified Analyst

So my first two questions were answered, because I see your Q was filed and see the share count now. Do you expect that the additional shares from the financing will convert in the third quarter or is that fairly open and they're going forward from the 2.7 up to 4.1 shares?

Kelvyn Cullimore

Yes. I think that's fairly open, Jeff. I think the execution of any conversion will probably be dependent upon execution of our strategies.

Unidentified Analyst

So can you talk about x U.S. revenue from the second quarter, I know it's not 10%, because you're not breaking it out yet, but can you give us approximation of a percentage number?

Kelvyn Cullimore

Revenue international sales for Q2 were down from where they were in Q1. And I've asked if we've got those numbers here. If I can't pull them up really quickly, we can get those to you. But my belief is in Q2, there were certainly under $200,000 for the quarter and in Q1 they were probably double of what they were in Q2.

I guess the point being, we believe that international sales could be a significant contributor to sales increases during the fiscal year. We had really hoped that we would see some of that starting in Q2 -- or was it Q1. And with that we would see some more of that in Q2 moving forward, but some of those have been delayed. And so I'm just being told that our numbers in Q1, our sales in interest internationals were $336,000, in Q2 they were about a $130,000, so significant fall off in Q2.

I will say we did have one large order for about a $100,000 that was supposed to ship in Q2 to international customer that's still pending. They had problems with fraud on their wire transfer and it was been delayed, but it is still active, so the loss in Q2 will carryover into Q3.

Unidentified Analyst

Can you talk about Solaris during the second quarters? I see it was strong because you called it out. Could you talk about pricing and where there any -- did you take any price increases, if you can disclose a number of units that were shipped? And can you also talk about the specific options and tips that you're seeing any trends for or what was ordered?

Kelvyn Cullimore

What we saw in Q2, as I mentioned at the end of Q1, we introduced an incentive program inviting our reps to do certain activities to help boost those kinds of the sales. And that seems to have born fruit, because in the quarter, which is always a big quarter for capital, I will say that, so it was a combination of things.

But we saw about a 26% increase in sales of the SolarisPlus family of products during the quarter. And key among those was an increase in accessory sales like light pads and light probes, there was about a 62% increase in the sale of those products. And the reason that's significant is because our margins on the accessory products are about 50% higher than the base units, and so it's a very important part of our sales strategy to accomplish that. So that was very exciting.

If you just talk about total unit sales, we had about 460 units that were sold in Q2 and that was up from 415 in Q1. And so that 457 units sold with the 26% increase, so you can see that we were up from under 400 units sold in the same period the year before. And that was without any significant international sales of those units.

Unidentified Analyst

And could you talk about ASPs for the Solaris for the quarter? Did you take any price increases?

Kelvyn Cullimore

We did not. Pricing did not change. What did changed during the quarter was we a saw significant increase in sales by our direct representative network as opposed to our dealer network. So the direct rep channel was more productive for us than the dealer channel was during that period. So that would, on average, make it appear that there was an increase in average selling price because, of course, the sales reps sell at retail whereas the dealers sell at wholesale.

Unidentified Analyst

And for outside U.S., could you remind us your current -- you have two distributors thus far in CE countries, could you remind us what countries you're selling into? And talk a little bit about China, Southeast Asia and Mexico, when you have an approval? What would be your selling channel? And who will be ready to sell?

Kelvyn Cullimore

Yes. So right now, we have a distributor in United Kingdom and we have one in Portugal. The one in Portugal is quite active. The one in Great Britain or in United Kingdom is just getting started, so we're hopeful that that will bear better fruit coming in future quarters.

The Mexico, we have two distributors set up, ready to place orders, as soon as the approval comes through. And we've been working with one of those distributors to get that approval. And so they are very vested in that process and are confident that they will be successful with our products once it's approved.

If you were to believe what they're telling us, it should be in the next 30 days, but I heard that at the end of December as well. So hard for me to say for sure, Jeff, on Mexico when that will come through, but if we do know that all of the review process has been done. It is now in the administrative approval part of the process.

And the same thing in China, we have a very good distributor there who has been very prominent in the physical therapy market in the past and continues to be. And they not only have distribution in China, they've also helped us in Singapore and other places in Southeast Asia where they are active. And so they're a very broad distributor in that regard and I believe will be a great partner for us once we get that approval.

And again, like Mexico, that partner is working with us directly in securing that approval, so they are vested in obtaining that. They have actually invested dollars to make that happen, and so they're anxious to get a return on their investment as well, and I believe are doing everything they can to help expedite that process. And they tell us that there is no more testing of the products and everything is passed, it's just now in the administrative phase. So we're just waiting for the actual letters to be issued saying that we have the approvals.

Operator

Your next question comes from the line of [ph] Raymond Myers.

Unidentified Analyst

Kelvyn, can I pick up where Jeff left off there, and ask more specifically about your expectations for the sales levels of China and Mexico. You kind of, I think, implied that it might be more than some of the other countries that you had picked up for the best?

Kelvyn Cullimore

That's correct. I believe both of them are going to be, if you classify Peru and Singapore as a single, I would at least have to classify Mexico as a double and China as a potential homerun if everything goes as it should over time. China, we know that China was previously representing one of our competitors.

And in the last year, they only represented them for a couple of years, is my understanding. In the last year, they had between the $1 million and $2 million worth of purchases from them. And so we would be hopeful that we could over the next year or two build to that same level. That's the only benchmark [Multiple Speakers].

Unidentified Analyst

$1 million to $2 million run rate over a couple of years?

Kelvyn Cullimore

Yes.

Unidentified Analyst

That's a pretty good though in one country.

Kelvyn Cullimore

Yes. And Mexico, it's hard to say for sure, I really don't have any benchmark to measure against. I know one of these distributors in the past has ordered, as much as back before approvals were required in Mexico, they ordered as much as $80,000 to $150,000 worth of product in one year. And now we've got two distributors, one that's even bigger than that one. So trying to extrapolate that is difficult, but perhaps somewhere between $200,000 and $500,000 once we get on our run rate.

Unidentified Analyst

And then you mentioned coming potentially two or three proprietary new products launched in the current fiscal quarter, can you touch on what those are and what the impact of those might be?

Kelvyn Cullimore

They are redesigns pretty much of existing products that will help position us better in the market for those products. I prefer not to go into too much detail on those right now. I think we'd like to give the opportunity of protecting the proprietary nature of those. But there are those products, and then a reengineering of the existing product lines that should significantly reduce our cost of goods sold or I should say, materially reduce our cost of goods sold.

All of those are expected to be introduced in this fiscal year. I don't know that any of the new products per se that we're introducing will generate significant additional sales. One of them we expect to be in the $200,000 to $300,000 year range of sales. And then another one should facilitate sales of $100,000 to $200,000 a year, things of that nature. That's our expectation.

We are working on some new products that will be introduced in the next fiscal year. One of which right now seems to be, using the baseball analogy instead of the singles, that we might be introducing in this fiscal year, could be a double or triple in the next fiscal year.

Unidentified Analyst

How many sales people do you have in the company now?

Kelvyn Cullimore

Total sales people on the fields including employee [ph] employed and 1,099 reps, because we have some that are direct sales reps and some that are independent sales reps. It's about 50, and of that 50, there is probably half that are generating the majority of the sales and half that are occasional sales people.

Unidentified Analyst

And then in your prepared remarks you wrote something that caught my eye. You said, you continue to benefit from the better market environment today. You're probably one of the few companies reporting earnings this week that reporting a better market environment. Can you elaborate on that, which better amongst the marketing environment for Dynatronics?

Kelvyn Cullimore

Well, put it in a perspective, Ray, from the introduction of healthcare reform in January of 2012 until about June of 2014, we saw year-over-year declines of 7%. The market was just almost in a free fall for us. And so in the last 18 months, we've seen a reversal of that where instead of declining, everything is on the upswing and there seems to be optimism and there seems to be opportunities for new clinics opening and we're hearing of large orders coming down the pike, things of that nature, that just simply didn't exist in the 30 months prior to that. I mean there was nothing.

And so from our position, I think our particular market segment went through some real difficult times from 2012 through about half way 2014. And then as the smoke started to clear on healthcare reform and we could see winners and losers kind of coming out of that, it started to become apparent that physical therapy was a potential winner in all of that. And I think our confidence started to build and people have begun to again expand and try and meet the demand that is growing out there as part of the demand for both pre-habilitation and rehabilitation.

Operator

You have a follow-up question from [ph] Jeffrey Collin.

Unidentified Analyst

Kelvyn, just a quick one for you, if I may. You talked about the medical device tax benefiting the company approximately $130,000 in the second quarter, could you talk about that? Is that 2.3% going back to the company applying for all of your products --

Kelvyn Cullimore

No.

Unidentified Analyst

Or just a particular portion of the products.

Kelvyn Cullimore

Only about a third of our products were subject to the medical device tax. Thank goodness, [Multiple Speakers] very bad otherwise.

Unidentified Analyst

So round about $10 million, that would be $230,000?

Kelvyn Cullimore

Yes. And it was actually only $160,000 a year is what we actually paid, because international sales don't count and a lot of the type of products we did also were excluded, so it may have been closer to 25% of our sales. And that means that there's about a $160,000 a year that was being absorbed into cost of goods sold that will now go away and reduce that cost of goods sold by an equivalent amount.

Unidentified Analyst

So if one was assuming, call it, 34% of margins, a third of those margins would be benefited by 230 basis points.

Kelvyn Cullimore

Right, that's a good way to look at it. That's a good way to look at it, or you could just simply say we're going to drop in the equivalent of $40,000 of extra gross margin in a quarter. And we charge double if you ask two questions.

Unidentified Analyst

Send me the bill.

Operator

And I show no questions in queue.

Kelvyn Cullimore

Anybody else have any follow-up questions, we'll give you one more opportunity. If you do press star one. If nobody presses star one, we'll call it good. Anybody else, Charlene?

Operator

No sir, I'm showing no one in queue.

End of Q&A

Kelvyn Cullimore

We will thank everyone for being on the call today. We are truly excited about the new Dynatronics and the direction that we are going, again with our partnership with Prettybrook and their investors and the infusion of capital and the infusion of business acumen and opportunities, we are thrilled with where we are and the position that we are in and where we are headed.

We hope that you are catching that same vision and we appreciate you're being on the call today to be updated. We look forward to doing this again in three months. If you have any questions in the meantime, please feel free to call us. You can call myself or Bob Cardon, we'll be happy to try and answer your questions. Thanks for being on the call today.

Operator

Thank you for your participation. This concludes today's conference call. You may now disconnect.

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