Pro-Dex, Inc. — Form 10-Q Summary
Period clarification: The filing is for the three and nine months ended March 31, 2019 (the company’s fiscal 2019 third quarter), not calendar 2018 Q3. Comparative periods ended March 31, 2018. Financial figures below are in millions of dollars unless stated otherwise.
Business context and results
Pro-Dex designs and manufactures powered surgical instruments, primarily for orthopedic and craniofacial markets, and also sells industrial air motors. Medical devices generated 92% of revenue in both the three- and nine-month periods. The company previously sold substantially all assets of its Fineline Molds division in May 2018.
| Metric | Three months ended Mar. 31, 2019 | Three months ended Mar. 31, 2018 | Nine months ended Mar. 31, 2019 | Nine months ended Mar. 31, 2018 |
|---|---|---|---|---|
| Revenue | $6.854 | $5.494 | $20.168 | $16.217 |
| Gross profit | $2.263 | $1.976 | $7.238 | $5.554 |
| Operating income | $0.897 | $0.632 | $3.818 | $1.857 |
| Net income | $0.732 | $0.480 | $3.260 | $1.453 |
| Diluted EPS | $0.17 | $0.11 | $0.75 | $0.34 |
| Gross margin | 33% | 36% | 36% | 34% |
Financial position, cash flow and liquidity
- Cash and cash equivalents were $9.661 million at March 31, 2019, versus $5.188 million at June 30, 2018. Working capital was $18.310 million.
- For the nine months, operating cash flow was $3.085 million, investing cash flow was negative $0.532 million, and financing cash flow was positive $1.920 million.
- Capital expenditures were $1.048 million. Financing included a $5.0 million term-loan draw, offset partly by principal payments and $2.675 million of share repurchases.
- Notes and capital lease obligations totaled $4.713 million on the balance sheet, including $0.622 million current. The term loan bears fixed interest at 5.53%, matures in October 2025, and requires monthly principal and interest payments. The unused $2.0 million revolving facility matures September 6, 2019.
- Management said cash, receivables and operating cash flow were expected to meet requirements for at least 12 months, while noting that future capital needs could require debt or equity financing.
Material changes and unusual items
- Revenue rose 25% in the quarter and 24% year to date, driven mainly by increased shipments of an orthopedic surgical handpiece to the largest customer. That customer represented 60% of quarterly sales and 62% of nine-month sales.
- Quarterly gross margin fell three percentage points, which management attributed primarily to contractual price concessions. Nine-month gross margin improved two percentage points, with higher sales volumes helping absorb manufacturing costs.
- Nine-month results included a $0.356 million gain on sale of investments. Net income also reflected higher interest expense following the MBT borrowing.
- The company repurchased 225,368 shares for $2.675 million in the nine months. Shares outstanding were 4.136 million at March 31, compared with 4.331 million at June 30, 2018.
- A $0.063 million accrual for replacement of batteries affected by a previously announced legacy-battery recall contributed to higher nine-month inventory and warranty charges. The warranty reserve was $0.136 million at March 31.
- A Fineline buyer’s note receivable was in default; the remaining $0.065 million was classified as current, with recovery expected through collateral sale in fiscal Q4 2019.
Outlook, risks and contingencies
- Backlog was approximately $19.7 million at March 31, of which $6.6 million was scheduled for delivery in fiscal 2019. Separately, a customer issued a $3.4 million material procurement commitment for thoracic drivers and accessories; it was not included in backlog, and the company hoped to deliver part of it in fiscal Q4.
- Management anticipated increased sales to an existing customer in fiscal 2020 as the thoracic driver is added to products already supplied. It also planned to develop direct sales channels for Pro-Dex-branded products and expected R&D spending to increase. These plans are forward-looking and not assured.
- Customer concentration is substantial: the three largest customers accounted for 89% of quarterly sales and 84% of nine-month sales. Management also cited variability in bookings and long-lead-time material needs.
- The company held approximately $3.0 million of marketable equity securities. A $0.234 million investment in thinly traded OTC stock was classified as long-term; it may be difficult to sell promptly or at full value and may require independent valuation or an impairment assessment. Air T stock holdings involve board-member relationships disclosed in the filing.
- The company disclosed routine legal proceedings but no specific material claim. It reported no material risk-factor changes other than the thinly traded investment risk. Management stated disclosure controls were effective as of March 31, 2019.
Important facts for investors to verify
- Whether the $3.4 million thoracic-driver commitment converts to firm orders, enters backlog, and is delivered on the expected schedule.
- Whether revenue growth and margins remain sustainable given reliance on a few customers and contractual pricing concessions.
- Collection or collateral recovery of the defaulted Fineline note, and the cost and resolution of the battery recall.
- Liquidity and valuation of the thinly traded investment, and the terms, covenants and refinancing status of the revolving facility approaching maturity.
- Whether planned product development and sales-channel expansion produce the expected sales, while monitoring increased R&D needs and working-capital requirements.