Dynatronics Corporation
Q3 2013 Earnings Call Transcript

Published: 14 May 2013

[Kelvyn Cullimore:]

We would like to welcome everybody to our conference call today. We will be talking about the Third Quarter of our Fiscal Year 2013 Financial Results. The purpose of the conference call is to discuss the results for the quarter ended March 31st and for the nine-month period ending March 31st. 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, I will update you on Dynatronics results for the third quarter ended March 31st and following my presentation, we will open the call up for questions and answers. We did release our press release this morning. Hopefully you’ve all seen that. Since you’re on the call that you did since that’s how you got the information for the call. Let me review the results of the quarter and the nine-month period. And it’s kind of a bad news, good news and better news approach. Let me start with some of the bad news. Sales were down about 7.6% or $600,000 for the quarter dropping from $7,654,000 last year to $7,070,000 this year. This continues a trend of lower quarter-over-quarter sales that began about a year-ago. They seem to be flattened out right in the 7% range. Sales for the nine-months were down 6.9%, dropping a $1,650,000 from about $24 million down to about $22,300,000. The decline in sales is reflective of weakness and sales primarily of distributed products. These are products that we purchase from other manufacturers and then sell to our customers. And those sales account for more than 50% of our sales. And there is a specific weakness we’ve identified in distributed capital, capital equivalent meaning items costing more than $200. It seems to be the predominant area of weakness. The reason for that we believe is continued uncertainty with Healthcare reform and the general economic weakness that basically put it damper on any growth of new clinics or expansion of services. It’s all basically come to a [prowl] and we’re seeing this industry wide. Bright Spot however in our sales report is that thanks to our introduction of our new Solaris Plus, product line sales of our manufacturer therapy devices is actually up about 9% over the last year. While the increase in the sales has not been sufficient to over come the decreases in the distributed capital, its still reassuring that our strategy of developing new products is stimulating sales in another way stagnant market. Sales down about $600,000 for the quarter, we obviously had a corresponding decrease in gross profit margin of about $225,000 for the quarter. And about $630,000 for the nine-month period fortunately gross profit margins have remained constant at just over 37%. We obviously had hoped for better outcomes that would allow us to achieve closer to break even for the quarter. However, we did see an increase in back log of orders, yet to be shipped which will push sales into the fourth quarter instead of the third quarter and specifically the end of March we had over $700,000 in orders. We’ve received and not yet – that are not yet shift which was about $125,000 more than the year before. The delays in shipments were mostly due to customer request for delayed deliveries. So the bad news is that our sales continue to be down and about to 7% range. The good news is that despite having $225,000 less in gross profit margins for the quarter, our pre-tax loss actually decreased 61% when compared to the same quarter last year. Pre-tax loss was reduced from $245,000 last year to $95,000 this year and the net loss for the same period deceased from a $117,000 to about $61,000. Pre-tax loss for the nine-months was reduced from $279,000 last year to a profit of $31,000 this year. That’s a $310,000 improvement despite our $630,000 in our gross profit margins in the nine-month period. The net loss to the nine months last year was about $140,000 compared to a net profit this year with almost $29,000. The reasons for overcoming $630,000 less than gross profit is still achieving a $310,000 improvement over the prior-year, which is about a $1 million overall turnaround through nine months had to do primarily with our austerity program that we have introduced last fourth quarter. That a year-ago right now. We announced that we will try and cut about $750,000 in annual expenses. So far up to nine months, SG&A and R&D expenses are down $374,000 for the quarter and almost $940,000 for the nine months. So as you can see the pace we’re on with our austerity program was so over a $1 million in annual expense reductions compared to the $750,000 we targeted. And we believe, if sales don’t increase, obviously commissions will be reduced, we should add to that. We achieved all of this in spite of paying about $40,000 this quarter, and medical device taxes. That’s a new tax that is imposed as part of healthcare reform began in January. And I will address that little bit more in just a minute. The cost reductions of course have left us operating in a very lean position, which has been good. And certainly it positions us well for the future. So if the van is with the sales, we’re down about 7%. The good news is that we’ve reduced expenses sufficiently to improve our overall bottom line performance by 61%. The pre-tax loss line, the better news is what is coming in the future. Our new product and marketing strategy focusing on our strength is manufactured and distributors are going to help us move the needle forward in the coming quarters. Specifically, our new catalogue that has been in production for over a year. We’re going to working on it diligent was released in April JJ. That new catalogue contains over a 1,000 new products, and in all the catalogue now contains over $13,000 products that we offer to our customers. Over 600 pages of medical devices and supplies are featured in the catalogue, including treatment tables, rehab equipment, hot and cold therapy products, exercise equipment, clinical accessories, nutritional supplements and wound care products. We really expect the introduction with new catalogue to be an excellent marketing tool to help us boost sales in the coming months and year. The catalogue has helped us specifically focus on the area of distributor products that has shown some weakness of life. The next step in our strategy is to expand distribution. We are preparing to embarking one of the most aggressive expansions and distribution in our history. That is going to be accomplished through the recruitment of new dealers and sales reps in the coming six months who will help provide us a much more significant geographic coverage. Right now we have areas that are strong, areas that are weak. We want to make more of our weak areas strong and have some strategic initiatives ready to implement, to make that happen and are confident of the outcomes that we’ll be able to achieve. All of this will be supported by the third prong of our attack here, which is the new products. We previously announced that this year would be our most productive year in new product introductions. Last fall the first part of this fiscal year, we introduced the new Solaris pipeline, which has been very well received and help to drive the increase in sales of our therapeutic products. We introduced the new ultra therapeutic tables in December. We will be introducing another family of new products in June. And we will also introduce in the coming months, one of the most unique and innovative devices our industry has seen in many years. Again, sustaining the reputation that Dynatronics has always had as an innovator in this market. And we believe the introduction of that device will help to further enhance not only sales of that device in itself, but also other devices within the product offering, and to help attract additional distribution that we talked about earlier. We have several other products beyond that, that are on the drawing board that will be introduced in lateral half of 2013 and 2014. So the 18 to 24 months period starting April a year-ago expanding to April of next year, we will be the most prolific time in our history for new product introductions. The R&D investment of the last two years, which has certainly dampened profitability, has allowed us to build the technology platform that will facilitate introduction of these new products in the next six months. With out, significant additional R&D expenditures. So the strategic plan is to stimulate sales by introducing new attractive and innovative products. New cars sell even in a down economy not because transportation needs demanded, because of the new models attractive and we believe a similar strategy will help promote sales of our new products. The combination of the new catalogue, along with the introduction of the new products and the expansion of distribution should help us reverse the trend of declining sales. In addition, the new products have also opened up some opportunities for us on the international market, opportunities that have not presented in the past. As we’ve disclosed in the past, we’ve note had great success, sort of 400 markets particularly in Europe. However, the new products we believe will open some doors that previously were closed to us in distribution channels in those markets. That’s a little bit longer term project, it will take 6 to 12 months to achieve the approvals, necessary to take the new products into those markets. Let me turn for a minute to healthcare reform. As you may be aware, one of the tenants of healthcare reform was they were about 45 new taxes that were introduced to help fund because of healthcare reform. One of those taxes was a tax on medical device manufacturers. It’s a 2.3% tax on sales not on profits. Fortunately for us the medical device tax that was implemented in January of this year has proven not to be quite as owner as we had anticipated. Still we believe, it will be cost of $150,000 to $200,000 per year as currently calculated. Through pricing adjustments we’ve been able to pass along a portion of that and cant recapture some of that tax in higher sales. But we doubt, we will ever be able to capture the entire tax even over time. This is an egregious tax that has already cost jobs in our industry and will stifle innovation that’ll negatively impact shareholders. It will cause healthcare cost to rise as manufacturers try to find ways to pass the costs along to their customers. The good news is that both the house and the senate have voted to repeal the taxes separate pieces of legislation. We are hopeful therefore that it will be repealed altogether by the end of the year. They have signed some piece of legislation to which they can attach that amendment, but presently both the House and Senate have overwhelmingly voted for repeal. If it isn’t repeal, we anticipate the annual impact us to be in the range of $200,000 because the only effects about 25% of our product sales. And the reason for that are exemptions and exclusions that are included in the legislation. We are hopeful that over the coming years as more of the uninsured obtain coverage that we will see an increasing demand for our products. I think everybody in our industry is hopeful of that. However, few studies are predicting significant increases in demand for most devices as a result of healthcare reforms. So, any increase that may be occurring will be modest, and will probably take several years to develop as the uninsured versus absorbed into the new system. Nevertheless we remain confident and hopeful that the Medical Device Tax in and of itself will be repealed which will be important for Dynatronics and for our industry as a whole. Let me address for a minute as everyone is aware, in December our shareholders approved the one for five reverse split of our stock, so all of the data that we’re sharing in our press releases and in our filings have been adjusted for this split. With the improvements over the next year, we believe the value of the stock should increase. The present value -- operating value of the stock contemplates a profit of about $250,000 a year. For fiscal year 2014, that begins this coming July we’re targeting significantly higher profits than that. So we believe there is room for the stock to improve. So in summary; since about a year ago sale’s primarily distributed product’s has been down about 7%. Sales of our proprietary therapeutic devices however are actually up almost 10% proving that even in a down economy sales can be driven with innovative new products. Lower expenses of $375,000 offset about $225,000 in lower gross profit in the quarter to achieve the 60% reduction in reported pre-tax loss from $245,000 last year to $95,000 this year. Likewise lower expenses of approximately $940,000 offset $630,000 of lower gross profit for the nine month period resulting in a pre-tax profit of $31,000 this year compared to $279,000 loss last year through nine months, a $310,000 improvement. The plan to aggressively expand distribution and introduce new products over the coming six to nine months, we believe will further stimulate sales and profitability. And then the ongoing cost savings instituted last year will continue and help us to further improve results. We will explore opportunities for international sales in the coming year once regulatory approvals have been achieved, but our focus is on our proprietary manufactured products not to the total exclusion of our distributed products, but we believe the introduction of new innovative products along with our new catalogue will be the driving force to help improve sales and distribution in the coming six to nine months, and we believe as a result of that we will see significant improvements in our performance during those periods of time. So with report, we’ll ask the operator to go ahead and open the line for questions, and we’ll be happy to take your questions.

[Operator:]

Thank you. (Operator Instructions) And we do have a question coming from the line of Paul Sleight. Please go ahead.

[Unidentified Analyst:]

Yes, good afternoon. I had a question concerning your proprietary products. Did you say that your devices were up 9% in sales during the quarter compared to last year?

[Kelvyn Cullimore:]

That’s correct.

[Unidentified Analyst:]

Okay.

[Kelvyn Cullimore:]

On that segment of products.

[Unidentified Analyst:]

And in other conference calls you’ve always indicated that these were a much higher margin than the consumables and distributed products, and it's kind of curious you’re puzzling to me then, why your gross profit percentages as percentage of sales is not up from the third quarter of 2012 or even year-to-date. Would you care to give us some color insight as to why that is? I realize also you have the 40k and medical taxes you paid during the quarter I believe are year-to-date but still, I suspected that your margins or profit margins would go up after the launch of the Solaris line a lot of these products you were so excited about.

[Kelvyn Cullimore:]

We still hope that we will see some of that coming forward. Some of the issues that are affecting that are; number one, you already identified the medical device tax which actually is reported as account for sales issues, so it's a reduction in sales; that definitely affects the margin. The other thing is, is that our proprietary products as a percentage of the overall products is only about a third of total product sales. And so as a result, if we are down significantly on the other products they still represent two thirds of the blend. And so it is difficult to push that number up as much as we would like. Some of the items that are lower margin or higher margin products on the distributed side are the ones that we’re seeing a decline in as well, and so that affects the overall, the product mix is the main reason why we’re not seeing that increase. In other words if you have, the exercise equipment that where you make a 30% margin on, and that’s a part of the blend and it drops in sales compared to sales that are maybe a 20% margin then you still have to overcome that as a part of the blend. The other thing that has affected is especially in the third quarter, is that we had significantly higher sales to dealers as opposed to retail. So, what that has the affect of doing is, when we sell to a dealer we’re selling at wholesale. When we sell to retail -- we are I mean, sell to a customer I’ll be selling at retail. And in this particular quarter our sales to dealers were significantly higher than they were in prior quarters. That would have accounted for a big part of that drop in percentage and why it did not increase as much. On the flip side of that of course, we don’t pay commissions on sales to dealers. And so the cost would be lower, our expenses would be lower as a result of that which was the case in this quarter. So, I would say there were three factors primarily contributing to that, and number one is the fact that the medical device tax did have an impact on the margin. Number two, the product mix of the distributed items versus the proprietary items, and number three, the mix of sales to dealers as opposed to direct sales through our reps.

[Unidentified Analyst:]

Okay. A follow-up question; can I do that – a couple of more questions?

[Kelvyn Cullimore:]

You got the floor. Okay.

[Unidentified Analyst:]

I get the impression, you indicated you’re adding a 1000 new products, distributed products that were included in the probably the website and its Catalogue too. So does that imply that you’re going from 12,000 products you offer up to 13,000?

[Kelvyn Cullimore:]

That’s correct.

[Unidentified Analyst:]

You must have a lot of products included in the 13,000 that are not very good sellers, and at what point you weed them out and -- because your inventory levels continue to go up and, it just seems -- it sounds great you’re adding products, but what you need is best sellers. You know what I mean?

[Kelvyn Cullimore:]

Well, as with any -- you’ve got an 80-20 rule where you got 20% of your products making up 80% of the sales and vice versa, and we definitely have products that we did not include in this catalogue, I mean that what you’re talking about we actually did, there were 100’s of products that were eliminated.

[Unidentified Analyst:]

Okay, all right.

[Kelvyn Cullimore:]

(Indiscernible) things that you’re talking about. So the net increase was a 1000, but we actually added more than that because we actually dropped products that were not selling. And I would comment, I mean, if you look at our inventory levels over the last year they’ve been very consistent, they don’t change much between $6 million and $6.3 million in inventory, it just -- it's been very flat. If you see any bump up or down it may have to do with the timing of when we’re bringing a shipment in from overseas or something like that distributed product. But our inventories would remain pretty constant and of the 1000 products that we’re adding by far the majority of those are what we call drop ship items. They’re not things that we bring into our inventory. They are products that we offer, and we’re the agent for the manufacturer. But when they order them from us, we drop ship them directly from the manufacturer that we’re representing.

[Unidentified Analyst:]

Do you have any internal forecast between you and marketing us to what the net effect, annual effect run rate on sales would be if you add 1000 new products? So if you go from lets say, if you increase your product offering the number off SKUS that you sell by 8%. What kind of a sales increase do you model out or project that isn’t good for you?

[Kelvyn Cullimore:]

It is definitely not a one to one ratio; it was more like a 25% ratio, a 20% to 25% ratio. So the hope would be that you would see sales increase in the 1% to 2% range.

[Unidentified Analyst:]

Okay. Getting back to your distribution model, you’re trying to add new dealers and sales reps. Do you have a forecasted annual run rate for additional costs that would cost you -- that’s going to cost the company, and that does not include their commissions, you know what I mean, or maybe drive some (indiscernible) and so forth. How big of a drag on your cost structure will that or increase in your cost structure you anticipate that will make?

[Kelvyn Cullimore:]

We don’t anticipate it will be very significant. We think it will be less than $200,000 a year once we get up and running because it will be primarily infrastructure support. It will be adding another sales manager here to help manage the additional dealers and reps that will be brought on. It will be support -- providing the support through our sales associates and things of that nature. We believe that the strategy that we’ll be implementing will be very low cost, but very high yields.

[Unidentified Analyst:]

I assume your new catalogue it's probably going to look pretty dramatic and exciting 600 pages. How do you expense that? Do you expense it over -- during the quarter it's introduced or do you do it over one year or two years cycle or ….

[Kelvyn Cullimore:]

You’re required to treat it like inventory.

[Unidentified Analyst:]

Okay.

[Kelvyn Cullimore:]

In other words we printed 150,000 or so of the catalogues to be used over the next two years. But because you ship a whole bunch of them in the fourth quarter as your first promotion you have to take a hit on that in the quarter that you ship them, and so there will be some added expense in Q4, and then there will be a rated expense over the following quarters as the catalogues are distributed.

[Unidentified Analyst:]

Okay, final question. It's good to know your backlog was up 125k at the end of the third quarter from 2012.

[Kelvyn Cullimore:]

Right.

[Unidentified Analyst:]

Can you give us any kind of guidance, mostly through the fourth quarter here or (indiscernible) a bit? How are your sales do you think are going to track in the fourth quarter of 2013 compared to 2012 percentage increase.

[Kelvyn Cullimore:]

Well, what I can tell you right now -- what I know right now is that through the end of April that backlog jumped up to over $900,000. We saw an increase in order flow of about 5% over last year in the month of April. We’re hoping that even if we maintain sales flow equal to last year with the extra sales that were brought in, by comparison $900,000 at the end of April this year compared to $350,000 end of April last year, and so you can see that we have got some significant large orders, back orders that are coming in, and we believe the majority of that will have a significant amount of that $900,000 will ship by the end of June. And if we maintain sales especially with the new products that we’re going to introduce in June, I’m a little shy of saying we should do as well, I mean, we’ve got to overcome our run rate right now about 7% decline on some of the distributed products and so, with everything else that’s happening we are hopeful that we will do that. But right now we’re only about half way through and we’re running at about a 5% improvement over last year. How that falls out in actual sales that are invoiced for the quarter has yet to be determined. So, we will definitely improve on the run rate over the last two quarters where we were down 7% on sales, but I don’t know if we’ll make up all of that ground in the fourth quarter.

[Unidentified Analyst:]

Okay. That’s all my questions. Best of luck to you guys. Thanks a lot.

[Kelvyn Cullimore:]

Paul, those are good questions. Thank you very much.

[Unidentified Analyst:]

All right.

[Kelvyn Cullimore:]

Thanks for taking the time to study it.

[Unidentified Analyst:]

Sure.

[Operator:]

Thank you. And the next question comes from the line of Bob Johnson. Please go ahead.

[Unidentified Analyst:]

Yeah, I was interrupted. You may have already answered this; I’ve just got one quick question for you. Your proprietary products and Solaris Plus sales were up approximately 9%. What percent of overall revenues do your proprietary products compose?

[Kelvyn Cullimore:]

They’re a little bit less than a third.

[Unidentified Analyst:]

Little less than a third, okay. Okay, thank you.

[Kelvyn Cullimore:]

Yeah. Thank you, Bob.

[Operator:]

At this time there are no further questions over the phone lines.

[Kelvyn Cullimore:]

Okay. We’ll, in case you all were, anyone was late joining the call, we’d be happy to answer questions if you want to call us directly. If you do have a question you would like to ask, I’ll as the operator one more time to just give the instructions of how to ask the questions, and then if there are none after that we’ll call it good. So, if you’ll give the instructions one more time on how to ask a question.

[Operator:]

Thank you. (Operator Instructions) And there are currently no further questions.

[Kelvyn Cullimore:]

All right; well we appreciate Paul and Bob for asking their questions and hope that the information was helpful. We are anxious to move forward with the plan that we’ve announced with continuing to keep our costs low, but bringing sales and margins back up through the promotion of our new proprietary products and the expansion with distribution of both proprietary and distributed products. And doing so, we fully expect to see the kinds of improvements we have all been waiting for in the coming year. We appreciate your support and welcome your questions should you have any further. Thank you for being on the call today.

[Operator:]

Thank you, ladies and gentlemen, that does conclude today’s conference call. We thank you for your participation and ask that you please disconnect. Have a great day.