Thank you for standing by. This is the conference operator. Welcome to the Dynatronics Third Quarter Results for Fiscal 2023 Conference Call. As a reminder, all participants are in listen-only mode, and the conference is being recorded. After the presentation, there will be an opportunity to ask questions.

[Operator Instructions] I would now like to turn the conference over to John Krier, President and CEO of Dynatronics. Please go ahead..

Thank you, operator. Good morning, everyone, and welcome to Dynatronics’ third quarter earnings call. Before we begin, I will call your attention to our safe harbor statement found on Slide 2. 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 may 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 third 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 from our analysts. Slide 3 highlights key takeaways for Dynatronics’ third quarter of fiscal year 2023.

I want to begin by highlighting three external market events, which have impacted us this quarter.

First, competitive acquisitions by one of our rehabilitation customers; second, a reduction of specific SKUs from an OEM bracing customer; and finally, general market choppiness have caused us to reexamine our assumptions for the back half of fiscal year 2023.

Net sales are expected to be $7.5 million to $8.5 million for Q4 of fiscal year 2023 and $39.5 million to $40.5 million for the full fiscal year. As I have stated earlier and despite any external events, we remain firmly focused on gross margin improvement.

Due to the external market events, we now anticipate lower revenue in our fiscal fourth quarter than previously planned. However, that has not changed. In fact, it heightens the focus on continued gross margin expansion. In Q3, despite lower revenue, Dynatronics delivered a gross margin of 23.9% versus 22.4% in the prior year.

Finally, we have made significant cost structure changes and reductions in response to the lower anticipated revenue. Using the baseline run rate of costs through March 2023, we have made approximately $1.5 million to $2 million of cost reductions to selling, general and administrative expenses to be realized in fiscal year 2024. Moving to Slide 4.

As a reminder, the full income statement and management discussion and analysis can be found in the 10-Q. I will summarize some of the key financials here. Net sales were $9.2 million for the third quarter of fiscal year ‘23 compared to net sales of $10.3 million in the prior year period.

Gross profit for the quarter was $2.2 million, or as I noted earlier, 23.9% of net sales compared to $2.3 million or 22.4% of net sales in the same period the prior year. The increase in gross profit as a percentage of net sales was driven by the continued combination of net price realization and better overall product mix.

We remain cautious about the external outlook and have modeled cost pressures to continue for the remainder of calendar 2023. Selling, general and administrative expenses decreased $0.3 million or 8.1% to $3.4 million for the quarter ended March 31, 2023, compared to $3.7 million for the quarter ended March 31, 2022.

Reductions in salaries and benefits were the primary drivers of the decrease. Net loss for Q3 fiscal year ‘23 was $1.2 million compared to a net loss of $1.5 million in the same period of fiscal year 2022. Outstanding shares will increase approximately 120,000 per quarter, depending on our share price.

The approximately 120,000 shares per quarter is based on a share price of $1.40 per share. The net cash balance was approximately $0.7 million on March 31, 2023, the same as on June 30, 2022. We reduced our inventory balance by approximately $2.4 million from our June 2022 levels to $9.7 million.

We will continue to strategically optimize our inventory while preparing for new product introductions and seasonal demands in our upcoming quarters.

Cash generated by operating activities was $0.4 million for the first nine months of our fiscal year 2023, which compares to cash used by operating activities of $3.3 million in the same nine months of the prior year. This concludes our summary of the financial and operating results. Turning to Slide 5.

As stated earlier, gross margin expansion remains a key focus. Gross margin increased to 23.9% in Q3, a 1.5 percentage point increase from the prior year gross margin of 22.4%.

Sequentially, the decrease in gross margin of 4.2 percentage points from Q2 reflects the customer disruption previously discussed, coupled with macroeconomic supply chain challenges. We are continuing to execute against our 6-point gross margin plan.

Number one, price rationalization; number two, rationalized product; three, new product introductions; four, manufacturing efficiencies; five, revenue scale; and six, mergers and acquisitions. Slide 6 provides the fiscal year ‘23 guidance details. I discussed our net sales guidance range for fiscal year ‘23 of $39.5 million to $40.5 million.

Effectively, we have reset the baseline net sales performance to approximately $9.25 million per quarter and align the performance to our historical seasonality trends. Historical seasonality trends tend to be highest in the first and fourth quarters of our fiscal year.

The company is continuing its recent trend of not providing forward-looking gross margin guidance due to the choppy nature of the business transformation and the impact of the noted external events. We anticipate selling, general and administrative expenses of 35% to 40% of net sales in Q4 of fiscal year ‘23.

As we move through the upcoming quarters, we expect to continually leverage and improve our scale on this SG&A cost base and return to our targeted range of 30% to 35% of net sales in fiscal year ‘24.

This guidance is based on our current operations and is subject to the risk factors and other forward-looking statements and uncertainties contained in this presentation and in our filings with the SEC. Turning to Slide 7. Refreshing our product portfolio is a key part of our growth plan.

The Dynatronics team has reached approximately 6% of revenue coming from products released in the past three years and has been able to maintain this level for four consecutive quarters. Slide 8 shows the investment highlights for Dynatronics.

The markets we serve, rehabilitation and bracing have opportunities for Dynatronics to expand its product profiles. We target improvement in gross margin in the coming quarters despite the revenue disruption and overall macroeconomic environment.

We have approximately $0.7 million of cash and $9.7 million of inventory on the balance sheet at the end of March with no debt. Dynatronics has not borrowed against its asset base of inventory or accounts receivable since July 2020, representing 11 consecutive quarters of no debt.

Dynatronics is focused on ensuring financial flexibility by evaluating additional working capital reductions, a possible asset-based line of credit and potentially using our ATM facility as appropriate. We will continue to share our progress and updates as we move through our fiscal year 2023. I will now turn it over for questions..

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Brooks O’Neil of Lake Street Capital Markets. Please go ahead..

Good morning, John. I’m hoping perhaps you could give us just a little bit more color on the specific customer. I mean I don’t need to know the name of the customer, but I’m just curious, the nature of the – of what happened to disrupt your business with these customers..

Not a problem. Good morning, Brooks. When we look at the revenue and the disruption that we faced, it’s really a tale of two stories. We did have an acquisition of – by a customer of ours of one of our competitors in our rehabilitation space. And so that’s our Hausmann brands, that’s our Dynatronics brands of therapeutic modalities.

And if you look at it quarter-over-quarter, our bracing product category was roughly flat, and that’s despite being impacted by some of our OEM business and some disruption in that part of the channel.

Where we had the significant disruption in terms of quarter-over-quarter was in our Rehabilitation segment, and that’s where you see the fact that a significant customer is now vertically integrating with a competitor of ours.

So that’s really the disruption that’s there, that appeared in the quarter, and we’re planning for that moving forward as well to be disruptive..

Okay. And just help me with the bracing.

Did they just – customer just eliminate some line items?.

That’s correct. These are customers that have looked – historically, ordered certain products from us that we also sell under our Bird & Cronin brand, and they made the decision to eliminate and streamline those through their portfolio..

Okay.

And then second question is, did any of that as well as sort of the general macro uncertainty change your assessment of your ability to sell down the inventory you’re holding?.

It does not change that assessment. The good part about our inventory, because we built it up over the last year, going from $6.5 million to $12 million and now down to $9.7 million, it’s very fresh inventory. It’s inventory that can continue to be sold through our customer base.

If anything, it might provide us an opportunity to potentially reduce it more over time. But it’s still our inventory, our manufactured products, very healthy and does not impact our ability to sell through it..

Great. And then one last question.

I’m just curious, as you think about new product activity, are there any specific highlights you’d offer that might give us some encouragement about the future and your opportunity to grow your business?.

Yes. The good part about what we’ve done with nine new product releases since the early part of 2021, and all of those products are doing well in the marketplace. They’re very much accepted. Our brands are still healthy and strong with where we compete.

So that opportunity still exists to refresh the product portfolio, introduce new products like we did with the Mammoth collection.

And that’s really – what we’ve seen up to this year is our growth in the rehabilitation side of our business was driven by our new products, and that’s where we had leaned into all of our investment and with the decline quarter-over-quarter in revenue, when you have an acquisition in that space.

We’ve said before, we also need to expand that product introductions into the bracing segment, which will continue to refresh that portfolio as well. So we’re certainly still excited about the opportunity that we have to refresh our products..

Great. Thank you very much for taking my questions..

Thank you, Brooks..

Our next question comes from Jeffrey Cohen of Ladenburg Thalmann. Please go ahead..

Hey, John, good morning.

How are you?.

Good, good. Good morning, Jeff..

A couple of questions. So on Slide 5, you’d talked about a facility build plan.

Could you elaborate on that, please?.

Yes. So if we take a look at from a manufacturing efficiency perspective, we’re continuing to ensure that we get our facilities rightsized for the revenue that’s coming through them. That’s going to allow us to improve our manufacturing efficiencies, and it’s one element of our gross margin plan..

Okay, got it.

And could you talk a little bit about – is this a follow-on to the business transformation largely from last year? Or is this a 2023 business transformation?.

I would look at it as a resetting and more of a 2023 business transformation. Back in 2021, what we said was we want to focus on our own manufactured products. So we eliminated our third-party distributed products that were at the lower end of our margin profile. And then as we continued up to this point, that has continued to be our pace.

So that part of the strategy is not changing. However, given the fact that one of our customers is now vertically integrating greater, that’s going to impact our revenue going forward. And so we have to plan for that and that’s where we’re resetting it.

So it’s a bit of a continuation of what we did in April ‘21, but resetting the revenue expectation because of those competitive acquisitions..

Okay, got it. And one more on the product side.

Could you talk a little bit about the difference between the Solaris platform and the 25 Series, the 925 series?.

Yes. The biggest strength about the Solaris platform, which is our most sought after product is the ability to have our accessories. That’s our ThermoStim products. It’s our light therapy products. Very well received in the athletic training room and the physical training centers out there. Those are not available in our 25 Series models.

Our 25 Series models tend to be our entry, if you will, into our combination units, but our Solaris is what our customers really demand out there. They’re our highest running products, and it’s based on those accessories..

And the ASP differential is Solaris 2x or 3x the price of the 25 Series?.

It is not 2 or 3x. That sort of pricing elasticity doesn’t exist in our market, but it does command a premium ASP compared to the baseline series..

Okay, got it.

And Solaris comes with the ability to purchase more than one handset, handpiece?.

It does. It does..

Okay. Perfect. That does it for us. Thank for taking the questions..

Thank you, Jeff..

Our next question comes from Scott Henry of ROTH Capital. Please go ahead..

Thank you, and good morning. I just want to follow up on a few of Brooks questions, just a little more detail. So the first issue was one of your customers was acquired by a competitor, which vertically integrated in.

What percent of sales was that customer of your total sales, or approximate?.

Yes, we do not disclose the – yes, the approximate – it’s significant customers the way that I would term it, Scott. So it’s going to have an impact on our revenue and something that we’re going to have to plan for going forward..

By significant, would you say greater than 5%?.

I wouldn’t say a number specifically, but I would say that it’s less than 10%, and it’s going to be in the single digits..

Okay. All right. That’s helpful. And then another customer reduced the number of SKUs on the bracing. Would you put that as about the same magnitude of impact as the first issue? Just trying to get some quantitative metrics around each of these events..

Yes. I would say that it’s going to be less impactful than the first issue, which was one of our customers acquiring a competitor. Overall, in that part of the segment, we’ve been rationalizing our product and our price, which has had an impact in that business year-over-year.

And so it will be less than the first issue, but it will still impact us going into our new fiscal year..

Okay. And then the third issue was market choppiness. What do you mean by market choppiness? How should I – that’s a pretty vague term.

Just if you could give us some – within your sector or overall economically, just how do we think about that term?.

Yes, I would – let me put a little more context to it. If we were coming into this fiscal year, we talked about our markets, our customer base, our products tending to grow at the 2%, 3%, 4% year-over-year basis.

When you look at the materials we talked about today on our investment highlights on Page 8, we talk about that our customers, our products, our markets we’re competing in are more in line of being flat, sort of 0% to 1%.

When we look at some of the competitive information that’s out there with public reports of folks like Novus and others in our segments, if you look at their Q4 of the calendar year going into Q1, you’re seeing numbers like 0%, 1%, 2% overall growth.

Now that – and when I refer to choppiness, but at the same time, we also see some elements of procedure volumes still being in the mid-single digits or patient therapy visits showing up in the mid-single digits.

So the choppiness I’m referring to is that there’s no one consistent trend where those patient visits are showing up in demand for products, whether they’d be ours or our competitors at the same level.

And that’s what we’re experiencing in our business is trying to understand when is the volume going to show up in our products and when will that choppiness smooth out..

So if I’m interpreting that correctly, and maybe I am – I’m not.

Are you saying that the pie is growing slower than originally expected?.

That is our expectation in our market. That’s what we are seeing..

Okay.

So the pie is – now is your market share within that pie as expected? Or is it a little lower or it could even be higher?.

It’s – I would say it’s more – it’s not materially changed one way or the other in that segment. But we do benefit – what we’ve talked about up to this point is we should grow at the market rate on its own. And then if we’re taking share, we’ll be able to grow above that.

And we’ve been able to do that for every quarter up to this one, which was impacted by this competitive acquisition and this specific customer issue. So that’s what we expect going forward. We’re going to have to now take some additional share if we’re going to beat the market.

If the market is growing at 0% to 1%, if we want to grow, we’re going to have to take some share. But for right now, I would say that there’s no material change in our share, but we believe that the market pie is sort of flat, if you will, at this point..

Okay, great. And then the final question, which may have some follow-ups to it. The big picture here, $40 million in revenues is a pretty good amount of revenues.

The question is, can – do you believe you’re at scale to be a cash flow positive company at $40 million in revenues? Or does that number need to be higher? Or can you make adjustments? You would think you could be profitable with that size depending on pricing, depending on how competitive you are as far as gross margins.

I guess the question stems into what’s the master plan to turn cash flow positive? And what’s the timing on that?.

Yes. We believe we have to make the reductions in the business or the changes in the business necessary to be cash flow positive at this revenue level. That’s what running a good business looks like to us.

We took significant steps in the fourth quarter to do that by reducing our SG&A on the range of $1.5 million to $2 million that will appear in FY ‘24. We still need to expand our gross margin. So we are going to operate the company in a manner that will put us on a path to being cash flow positive.

I’m not able to give you an exact time line on that, Scott. I think having that appear in FY ‘24 is certainly a target for us. However, we need to make sure that just day-to-day, we’re executing on that..

Okay. So when we look at the – I mean the positive is you’re not losing a lot of money, which is preferred. When we look at EBITDA in 2024, the size of the loss. How should we think about it relative to the current losses or it looks like they’re all generally around $1 million right now, maybe a little higher, maybe a little lower.

Do you think those losses will at least maintain those levels? Or might they jump a little bit during this transition?.

Our expectation, as we move into the new fiscal year, even at this reset revenue level of, call it, $37 million annualized will be that we will reduce the EBITDA loss or targeting to reduce the EBITDA loss in the new fiscal year.

If you look at it up to this point, call it, $2 million or so of an EBITDA loss for the year, by making the SG&A reductions that we have made and that we’re targeting, we should be able to reduce that. There’s still uncertainty out there in terms of the choppiness that I mentioned in the market, the flattening of the market.

But it is our plan to reduce that going into the new year..

Okay, great. I’m just going to ask one follow-up just out of curiosity because it’s such a buzzword nowadays.

Do you think you can utilize AI in your business in any ways to reduce costs?.

There may be ways that are out there that are appropriate for our business.

But for us, with the products that we have and the products that we compete in, the scale that we have, the number of customer transactions that we have, the single best opportunity for us is just to continue to manufacture quality products, stay lean, run a very clean business for our customers is likely the most successful path for us..

Okay.

And does that entail being more of a brand and less of a commodity to some extent? I mean is that how you think about maybe more differentiated, higher-margin products?.

Yes. We need to just continue to be very relevant in our customers’ minds with our brands. Our brands are roughly 50, 60 years old, very well respected in the markets that we compete in. We’re known for quality. We’re known for quality for cost. We’re going to continue to just deliver those on time, deliver them with qualities.

And our customers have said, if you just do that, do the basics, we’re going to reward you, absent these unique events or external events of say an acquisition by one of our customers..

Okay, great. Thank you for taking the questions..

Thank you, Scott..

This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Krier for any closing remarks..

Thank you, operator, and thank you all for your interest in Dynatronics. If you have any further questions, please direct them to ir@dynatronics.com. Have a great day..

This concludes today’s conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day..