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Edited Transcript of DYNT earnings conference call or presentation 12-Nov-19 1:30pm GMT

Q1 2020 Dynatronics Corp Earnings Call

COTTONWOOD HEIGHTS Jan 4, 2020 (Thomson StreetEvents) -- Edited Transcript of Dynatronics Corp earnings conference call or presentation Tuesday, November 12, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian D. Baker

Dynatronics Corporation - President, CEO & Director

* David A. Wirthlin

Dynatronics Corporation - CFO & Corporate Secretary

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Conference Call Participants

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* Anthony V. Vendetti

Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst

* Jeffrey Scott Cohen

Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research

* Nathan S. Weinstein

Aegis Capital Corporation, Research Division - Analyst

* Scott Robert Henry

Roth Capital Partners, LLC, Research Division - MD, Senior Research Analyst & Head of Pharmaceuticals Research

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Presentation

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Operator [1]

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Ladies and gentlemen, hello, and thank you all for joining this Dynatronics First Quarter 2020 Earnings Call. (Operator Instructions) As a reminder, today's session is being recorded. And now for opening remarks and introductions, I am pleased to turn the floor over to your host, Mr. Brian Baker. Welcome, Brian.

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [2]

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Good morning, and thank you for participating in today's call. I'm Brian Baker, President and Chief Executive Officer; and with me is our Chief Financial Officer, David Wirthlin. We issued a press release this morning announcing the financial results of our quarter ended September 30, 2019. Today, I will provide a brief commentary, and then I will turn it over to David for a financial report. I will follow David's report by confirming our guidance on the 2020 fiscal year. At the conclusion, the operator will open the phone lines for questions.

I will now ask David to remind you of our reliance on the safe harbor under the federal securities laws.

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David A. Wirthlin, Dynatronics Corporation - CFO & Corporate Secretary [3]

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Thank you, Brian. Before we begin, let me remind you that during the course of this call, we will make forward-looking statements regarding our current expectations, plans, projections and financial performance relating to our business. These forward-looking statements reflect our view as of today only, and they involve risks and uncertainties that could cause our actual results to differ materially from those discussed today.

Important factors that could cause actual results to differ materially from those projected or implied by our forward-looking statements today are included in our most recent 10-K and other reports filed 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.

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [4]

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Thank you, David. Dynatronics delivered a profitable quarter that reflects the continued execution of our operating plan and achievement of our guidance. My team's focus on operational improvements and cost reductions contributed to reduced SG&A, reduced cost of goods sold and improved cash flow from operations. Management's actions have created an improved foundation to scale the business for organic revenue growth and future acquisitions.

While many of these changes are not fully reflected in our financial statements, our progress can be seen through the $572,000 reduction in SG&A and $178,000 increase in operating income compared to the first quarter of the prior fiscal year. These incremental improvements have led to our highest level of operating income in 2 years.

As an example of our operational changes we are making, over the last year, we have qualified a contract manufacturer to produce our Solaris product line. We have transferred approximately 50% of our demand to this vendor. In addition, we've moved manufacturing of cut-and-sew products and a large portion of our wood products from our Tennessee facility to our Minnesota and New Jersey plants.

Our aim is to create centers of excellence across the organization that eliminate redundant manufacturing, enhanced supply chain processes and standardize quality systems while maintaining the highest level of customer care.

As we look forward to growth in the business, we will add 2 senior leadership positions to accelerate our organic and M&A growth strategies. These individuals will be joining me in Minnesota, where we have begun to concentrate much of our senior leadership team.

To drive organic growth, we have created the role of Senior Director of Sales Operations. The short-term objectives for the role are to assess the competitive landscape, product positioning and appropriate pricing strategies. In addition, the position will lead initiatives to refresh product content and launch marketing campaigns to drive new product demand.

We have also created a General Counsel role that will support our M&A strategy, specifically in contract negotiations, due diligence and integration. We will share more information on these positions in the coming months. It is worth noting that the cost of these positions is reflected in our guidance.

Today, we are providing a report on our quarter ended September 30, 2019. Let me start by focusing on a few highlights. First, in the first quarter, we generated $2 million in positive cash flow from operating activities. We continue to manage the company without the need of outside capital to support ongoing operations.

Second, as I mentioned earlier, we have improved operational effectiveness and reduced costs. This is reflected by $572,000 reduction in SG&A compared with the same period of the prior year.

Third, we delivered on our most recent guidance. We believe the consistent achievement of our guidance will build confidence with the investment community, our customers and employees.

Our overall strategy for the company remains steady. We aim to become the recognized standard in restorative solutions. For our fiscal year 2020, we will continue to focus on executing on our operational plan, positioning the company for modest mid-single-digit organic growth and integrating future acquisitions. David will now provide a financial report.

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David A. Wirthlin, Dynatronics Corporation - CFO & Corporate Secretary [5]

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Thanks, Brian, and good morning, everyone. I am pleased now to review the financial performance during the quarter. Net sales for the quarter ended September 30, 2019, decreased $676,000 or 4%, to $16.4 million compared to $17.1 million in the same quarter of the prior year. The decrease was primarily due to a reduction in sales of physical therapy and rehabilitation products in our direct channel.

Gross profit for the quarter decreased $393,000 or 7.1% to $5.2 million, representing 31.4% of sales, compared to $5.5 million or 32.5% of sales in the same quarter of the prior year. Lower sales was the primary cause of the decrease, reducing gross profit by approximately $220,000. The decrease in gross margin percentage to 31.4% from 32.5%, contributed about $173,000 to the reduction in gross profit driven primarily by lower sales volume in our physical therapy product line and a lower portion of sales through our direct channel.

Selling, general and administrative expenses, which includes research and development, for the quarter decreased approximately $572,000 or 10.4% to $4.9 million compared to $5.5 million in the same quarter of the prior year. The decrease includes lower selling expenses of $302,000, consisting primarily of lower fixed sales management salaries and lower commissions and a decrease of $270,000 in other general and administrative expenses.

Net income for the quarter was approximately $99,000 compared to net income of $316,000 in the same quarter of the prior year, which included $375,000 in other income associated with the revaluation of the acquisition earn-out.

Operating income improved $178,000 for the first quarter of fiscal 2020, compared to the first quarter of fiscal 2019. As of September 30, 2019, we had cash balances of approximately $475,000. We have an $11 million asset-based line of credit, pursuant to which we had borrowed $5.1 million. This is a $1.4 million reduction from the $6.5 million balance at June 30, 2019, and reflects decreases in our working capital accounts and positive cash flow from operating activities since June 30.

Our line of credit balance is currently averaging about $5.5 million, and we have availability on our line of credit of about $2 million based on our current borrowing base. By the end of the second quarter, ending December 31, 2019, we will have paid off all remaining earnout liabilities from our prior transactions.

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

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [6]

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Thank you, David. In terms of our guidance for fiscal year 2020, we expect consolidated net sales to be in the range of $58 million to $62 million. We expect the distribution of our revenue between quarters to align with historical trends.

Consistent with the past 2 fiscal years, we expect to generate positive cash flow from operating activities in fiscal 2020, with some volatility in quarters based on working capital changes. We expect gross margin to be in the 31% range and SG&A to be about 31% of sales for the current fiscal year, including approximately $1.8 million or 3% of sales in noncash charges. We believe there continues to be opportunity to improve in all of our financial metrics.

The number of common shares outstanding as of September 30, 2019 was approximately 8.7 million. We expect our outstanding shares to increase in the range of 240,000 per quarter, depending on our share price. Again, this guidance is based on our current operations and does not include the impact of any potential acquisitions. All guidance is also subject to the risk factors and other forward-looking statements and uncertainties contained in our filings with the SEC.

In my role as President and CEO, I continue to visit key customers to form stronger partnerships to gain greater access to the markets we serve. Our quality brands continue to drive value with our distribution partners, and they will provide greater opportunity in the future.

As a reminder, our focus for the current fiscal year is to lay the operational foundation to scale the business. This foundation will position the company for mid-single-digit organic revenue growth and enable our M&A strategy going forward.

I mentioned in my opening remarks, 2 positions we are adding to the senior leadership team to support our growth strategy, those being Senior Director of Sales Operations and a General Counsel. These roles have been identified specifically to help drive our organic growth plans and M&A strategy. We also anticipate adding resources to support our selling initiatives and to create opportunities. We are being thoughtful and deliberate in our actions and are confident in our ability to achieve our long-term objectives.

We appreciate and thank our investors and employees for their ongoing support. We are committed to effectively serving our customers by providing restorative solutions. I will now turn it over to the operator for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll hear first from Jeffrey Cohen at Ladenburg.

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Jeffrey Scott Cohen, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research [2]

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So a few questions I wanted to address. So firstly, what's in the Tennessee facility now? I know you've made some changes operationally as far as Minnesota, New Jersey and Salt Lake, so what's currently being run out of Tennessee?

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [3]

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Jeff, so I'll come back to what I discussed in my earlier remarks. We did transfer cut-and-sew products, that's mostly orthopedic soft bracing, to Minnesota. And then a large portion of our wood products were transferred to New Jersey such as training stairs, taping stations and treatment tables.

And with that move, what we did, Jeff, is took those products out of a low manufacturing environment and put them into higher manufacturing environments with the New Jersey and Minnesota site that helped with getting our costs on those products down.

So what's left in Tennessee is there's some small volume of wood manufacturing that still exists there, some hot and cold therapy products. And then just to remind you, Jeff, a large portion of what we distribute goes out of that site as well, around 200 -- 250 shipments a day.

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Jeffrey Scott Cohen, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research [4]

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Got it. Okay. And then secondly, could you give us a better sense of the revenue composition from direct as well as distribution partners for the quarter or any general trends we should think about?

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [5]

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Sure. So I'll ask David to answer that question, Jeff.

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David A. Wirthlin, Dynatronics Corporation - CFO & Corporate Secretary [6]

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Yes. Jeff, we really don't report channel mix because the way you would define that at each of the brands is a little bit different, and we just don't report channel mix. But we did note that the channel mix shifted more towards dealer in the quarter compared to the prior year.

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Jeffrey Scott Cohen, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research [7]

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Got it. Okay. And then lastly, could you talk a little bit about the R&D, and if there's any new product introductions that you're expecting? And along with that can you discuss a little bit about M&A strategy going forward versus what's been done thus far?

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [8]

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Yes. Jeff, for the physical therapy product line, we have moved that to an outsourcing model. And all of the R&D activity, we do go through those third parties, it's just a more cost-effective way of how we develop new products.

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Jeffrey Scott Cohen, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research [9]

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Okay. Perfect. And any commentary on M&A generally speaking?

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [10]

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M&A, we're still focusing on the same strategy and criteria, Jeff. We're continuing to target acquisitions with valuation of 6 to 8x EBITDA. We have been focused on smaller transactions, so we can use cash opposed to stock. We'll look at larger transactions down the road when our initiatives are reflected in our share price.

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Operator [11]

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And next, we'll hear from the line of Scott Henry with Roth Capital.

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Scott Robert Henry, Roth Capital Partners, LLC, Research Division - MD, Senior Research Analyst & Head of Pharmaceuticals Research [12]

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Just a couple of questions. First, could you kind of remind me of why we see the seasonality in a strong first quarter, a quarter ending in September that we've seen in the past couple of years?

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [13]

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Sure. So I'll let Dave comment a little detail but before Dave comments, I'll just remind you that we do sell into the athletic training market. As we come into the fall season, that's when athletic trainers are spending their budgets. And so that does have a contribution to that.

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David A. Wirthlin, Dynatronics Corporation - CFO & Corporate Secretary [14]

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Right. And so the effect of that, Scott, is that our sales are a little bit higher in the first quarter and the fourth quarter and sales are a little lower in the second and third quarters.

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Scott Robert Henry, Roth Capital Partners, LLC, Research Division - MD, Senior Research Analyst & Head of Pharmaceuticals Research [15]

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Okay. And how is the macro environment? Are you getting any impact from that, either internationally or in the U.S.? Just curious how that backdrop is affecting the business.

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [16]

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Yes. We're not really focused on international markets right now, Scott. If we look at the U.S. market, the markets we're selling into -- athletic training, chiropractic, physical therapy, long-term care -- all of those markets are growing. And so we do have some tailwinds within those markets. I should remind you that we are making that shift from a direct sales model to a dealer sales model. And so that does have an effect on our revenue.

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Scott Robert Henry, Roth Capital Partners, LLC, Research Division - MD, Senior Research Analyst & Head of Pharmaceuticals Research [17]

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Okay. And just a kind of final question. What would the time line or what sort of time line would you expect to start to see growth on an organic basis? Meaning, when will we expect to start to see positive comps with the current business, so not including any sort of M&A? I wanted to get your sense on that, in terms of when the rationalization will be done, and we will start to see growth.

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [18]

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Sure. Yes, when we look at beyond our guidance, we are, I'll emphasize, still targeting those mid-single-digit organic growth, 40% gross margin and 10% EBITDA. More specifically, a comment that I have been out there working with some of our strong distribution partner.

And our products are really well-known in the market. They are respected brands. And so as we're opening up broader distribution for our differentiated products, for example, like Solaris, we are starting to see clear opportunities to increase volume through these channels.

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Scott Robert Henry, Roth Capital Partners, LLC, Research Division - MD, Senior Research Analyst & Head of Pharmaceuticals Research [19]

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Okay. So -- I mean I guess the thought would be, if you rationalize starting in kind of late -- your fiscal 2019, by the time you're through '20, we should start to see apples-to-apples comps in your fiscal year 2021? Is that kind of a reasonable way to look at the business?

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [20]

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Yes. I think as we go into the next fiscal year that we're going to see an opportunity -- I believe, an opportunity to move into those modest single-digit growth organically. And then as we get further into the fiscal year 2021 that we'll be able to start moving towards those mid-single-digit growth opportunities.

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Operator [21]

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(Operator Instructions) Next, we'll hear from Nathan Weinstein at Aegis.

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Nathan S. Weinstein, Aegis Capital Corporation, Research Division - Analyst [22]

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If you wouldn't mind, and I know you already addressed this to some extent. But when we think about the M&A environment, can you just maybe make further comments about the funnel? What you're seeing? If there's still companies out there and that could be interesting?

And then what gets you to a place where you could make an acquisition? Is it adding these additional headcount in the organization to be able to do that? Or do prices have to come down? I mean what would it take to get a deal done?

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [23]

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I would say, Nathan, starting out with we do maintain a strong pipeline of companies. Those pipelines have been built up over several years. And we continue to be at various stages of conversations with those companies.

Coming to your question on the new positions. The General Counsel position was added specifically to support our M&A strategy. I'll also say that the General Counsel also elevates our day-to-day business activity as we wanted to elevate our legal needs, it's a large organization. So that position we did look at specifically for M&A. The other position is really to support the organic growth of the company, focusing on those objectives that I stated earlier in my prepared remarks.

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Nathan S. Weinstein, Aegis Capital Corporation, Research Division - Analyst [24]

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Okay. And I guess just one more for me. I mean looking at the net income profitability this quarter and something you've shown in prior quarters. Given the run rate you're at now, is it possible that through cost cutting, it would be -- you could run a profitable business through all 4 quarters if that's what you're interested in doing?

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David A. Wirthlin, Dynatronics Corporation - CFO & Corporate Secretary [25]

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We're -- we -- our guidance is -- I'm just going to reiterate the guidance. We expect gross margin at 31% and gross -- and SG&A at 31% with $1.8 million of noncash charges. So we expect cash flow to be -- positive cash flow from operations to be positive for the year with some volatility. How that plays out exactly on the net income line, we're going to have a little bit of volatility there. We did have profitability in this quarter.

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Operator [26]

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(Operator Instructions) We'll hear next from Anthony Vendetti at Maxim Group.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [27]

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Just on -- we talked about the rationalization, so I guess I'll follow-up on that. I believe you're largely done with the culling of the products that no longer make sense, either they're duplicative or low margin or unprofitable. Approximately, if you had to gauge it, where are you in that process? Are you 90% done? Or are you 80% done?

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [28]

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Yes. For the activity that we went through, Anthony, we are done with what we've rationalized. But I'll come back to -- as a normal course of business, we need to always look at product life cycle management. That's going to be an ongoing process within the business.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [29]

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Okay. So the rationalization is done, but there might be still some products out in the dealer networks that you still have to run through. Is that correct?

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [30]

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Yes. I'll -- again, Anthony, just talk about normal course of business. We always have to evaluate the products that we're selling and the value that that's bringing to the company. And I just look at that as part of our product life cycle management process that what we went through with rationalizing product, that is essentially done but ongoing. We always have to evaluate our product lines and how they're contributing to the business.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [31]

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Sure, understood. And then you mentioned on the call that you're outsourcing approximately 50% of the products through contract manufacturer. Has that already started? And then b, why 50%? Is it because you can produce the other products cheaper, more efficient? Or are you going to look to continue to outsource more products as you move forward?

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [32]

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Yes. We selected 50% of the volume, Anthony, to qualify to the supplier, and we are going through that process right now of establishing that history to get them fully qualified. And as we go through the process, we will look at how we ship more volume to that outsourcing partner. And we believe in that shift, we will find additional opportunities to reduce our overhead in Salt Lake City.

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Operator [33]

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And ladies and gentlemen, at this time, there are no further questions in the queue. We thank you all for your interest and your questions today. I will turn it back to our leadership team and Mr. Baker for any additional or closing remarks.

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Brian D. Baker, Dynatronics Corporation - President, CEO & Director [34]

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Thank you for the questions and for your interest in Dynatronics. If you have any further questions, please direct them to our Investor Relations contact, Jim Ogilvie. Operator, you may end the call.

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Operator [35]

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Ladies and gentlemen, this does conclude today's announcement. We thank you all for your participation. You may now disconnect your lines, and we hope that you enjoy the rest of your day.