Pro-Dex, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended December 31, 2022. The interim financial statements are unaudited. Dollar amounts below are in millions unless stated otherwise.
Business context
Pro-Dex designs and manufactures surgical drivers and shavers, primarily for orthopedic, thoracic, and cranio-maxillofacial markets. It also sells rotary air motors. Medical device distributors are its primary customers.
Financial performance
| Metric | Three months ended Dec. 31, 2022 | Prior year | Six months ended Dec. 31, 2022 | Prior year |
|---|---|---|---|---|
| Net sales | $11.282 | $10.173 | $22.369 | $20.161 |
| Gross profit | $2.623 | $3.404 | $5.578 | $6.832 |
| Gross margin | 23% | 34% | 25% | 34% |
| Operating income | $1.137 | $1.602 | $2.086 | $2.920 |
| Net income | $0.879 | $0.925 | $1.955 | $1.988 |
| Diluted earnings per share | $0.24 | $0.25 | $0.53 | $0.53 |
| Cash provided by operating activities | Not separately stated for the quarter | $2.497 | $4.219 |
Quarterly sales rose 11%, while six-month sales rose 11%. Profitability declined: gross margin fell 11 percentage points for the quarter and 9 points for the six-month period. Management attributed the pressure mainly to costly handpiece repairs for its largest customer and higher indirect manufacturing costs. Operating expenses declined 18% for the quarter and 11% for the six-month period.
Repair revenue increased 33% in the quarter and 43% for six months; NRE and prototype revenue also grew substantially. Medical device product sales increased 4% for the quarter but were slightly lower for the six-month period. Three customers represented 93% of quarterly sales and 94% of six-month sales; the largest customer alone accounted for 66% and 67%, respectively.
Financial position and liquidity
- At December 31, cash and cash equivalents were $0.382, versus $0.849 at June 30, 2022. Working capital was $19.722.
- Current assets were $31.387 and current liabilities were $11.665. Inventory increased to $15.135 from $12.678; management said inventory purchases reflected a customer forecast that was later reduced, though the inventory was expected to be purchased contractually.
- Notes payable totaled approximately $12.7, compared with $13.535 at June 30. The company also reported lease liabilities. Six-month financing cash use was $2.366, including $1.349 of share repurchases and principal payments.
- Six-month investing cash use was $0.598, primarily for equipment and improvements. Operating cash flow was $2.497, down from $4.219 a year earlier, with inventory investment a significant use of cash.
- The company had $1.8 drawn on its $7.0 amended revolving credit facility and no borrowings on a separate $3.0 supplemental line as of December 31. The lines mature December 29, 2024; their interest rate is the greater of 5% or one-month SOFR plus 2.5%.
Management believes cash, receivable collections, operating cash flows, and available borrowing capacity will be sufficient for at least the next 12 months. It also noted that additional debt or equity capital could be needed to support working capital and equipment needs.
Outlook, commentary, and risks
- Backlog was approximately $20.7 at December 31, with $12.0 scheduled for delivery in the second half of fiscal 2023; the remainder was scheduled for next fiscal year and beyond. Backlog is firm purchase orders and excludes some revenue expected under existing contracts.
- Management expected increased repair revenue for the rest of fiscal 2023. An enhanced repair program began in December with an agreed repair price, which management expects to improve margins in the second half. The company was still negotiating recovery of excess repair costs incurred in the first half.
- The company expected to begin operations at its new Tustin facility during fiscal Q3, after verification and validation activities. FDA authorization to commence manufacturing had been received in fiscal Q1.
- Management cited supply-chain delays, longer lead times, higher prices, and surcharges. Alternative sourcing of electronic components helped address supply concerns but increased costs. It described the impact as expected to be short-term, while noting outcomes are uncertain.
- The largest customer’s supply agreement extends through calendar 2025, but customer concentration, changes to forecasts or shipment timing, and dependence on major suppliers remain important risks. Management reported no material changes to the risk factors in its fiscal 2022 Form 10-K.
- The company held $2.860 of marketable equity securities, including thinly traded long-term holdings, and reported net unrealized gains of $0.146 at December 31. Some investments and investment decisions involve relationships with directors, including Air T, Inc.; review the related-party and investment disclosures.
- Management reported that it believed the company was in compliance with debt covenants at December 31. It disclosed no subsequent events requiring disclosure and described legal proceedings as ordinary-course matters without specifying a material claim.
Important facts for investors to verify
- Whether the enhanced repair pricing and any recovery of prior repair costs deliver the expected margin improvement.
- Whether the largest customer’s orders, inventory forecasts, and scheduled backlog shipments remain on track, given the high customer concentration.
- Whether supply-chain costs, manufacturing under-absorption, and supplier concentration improve or continue to pressure margins and cash flow.
- Progress in validating and commencing operations at the Tustin facility, and the timing and cost of any remaining work.
- Available liquidity and covenant compliance, including borrowing availability, variable-rate costs, and debt maturities.
- Performance, liquidity, and governance considerations associated with the company’s marketable equity investments.