Business context and reporting period
Pro-Dex, Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2012, the third quarter of its fiscal year, and the nine months then ended. The filing’s business discussion focuses on continuing operations: surgical devices for medical and dental markets and motion-control products for industrial and scientific uses. The Astromec fractional-horsepower motor product line was sold on February 27, 2012 and is presented as a discontinued operation. The request metadata says “2011 Q3,” but the filing itself reports the quarter ended March 31, 2012.
Financial results and liquidity
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Continuing-operations net sales | $4.539 million, down 34% from $6.876 million | $13.601 million, down 21% from $17.314 million |
| Gross profit / margin | $1.203 million / 27%, versus $2.794 million / 41% | $4.558 million / 34%, versus $7.222 million / 42% |
| Continuing-operations income (loss) | $(513,000), versus $909,000 | $(427,000), versus $1.869 million |
| Net income (loss), including discontinued operations | $(487,000), or $(0.15) per diluted share, versus $868,000, or $0.26 | $(332,000), or $(0.10) per diluted share, versus $1.611 million, or $0.49 |
| Operating cash flow | Not provided as a quarterly figure | $621,000, versus $1.812 million |
- At March 31, cash was $4.879 million; working capital was $7.635 million. Total assets were $14.400 million and total liabilities were $4.335 million.
- Bank term debt totaled $863,000 ($357,000 current and $506,000 non-current); the $1.5 million revolving line was undrawn, with approximately $1.4 million available. Cash less bank debt was $4.016 million.
- Nine-month investing cash use was $163,000 and financing cash use was $268,000, principally term-loan payments. Cash increased $190,000 over the nine months.
- Warranty expense from continuing operations was $570,000 for nine months, versus $437,000; the March 31 continuing-operations warranty reserve was $599,000.
Material changes versus the comparable period
- Sales declines, especially to the two largest customers, and less favorable product mix reduced gross profit and margins. Management also cited lower manufacturing efficiency in the quarter and higher warranty costs over nine months.
- Two customers represented 72% of quarterly sales and 74% of nine-month sales in 2012. The largest customer alone represented 40% and 45%, respectively.
- General and administrative expense rose $264,000 in the quarter, primarily reflecting $339,000 accrued for the former CEO’s departure. Excluding that accrual, quarterly G&A declined $75,000; nine-month G&A excluding it declined $169,000.
- Cash from operations was lower year over year. Receivables and inventories provided cash, while lower payables/accruals and an increase in income taxes receivable used cash.
Outlook, commentary, risks and unusual items
- Management reported a $5.9 million backlog, primarily scheduled for fiscal Q4 2012 and the first half of fiscal 2013. The filing gives no numerical earnings or revenue guidance.
- The largest customer said it did not plan further orders for Products A and B as it develops replacement products; its transition timing is uncertain. The company said revenue from this customer could fall to negligible levels by fiscal year-end 2012. The customer’s current orders included $313,000 for Product A and $325,000 for non-warranty repairs, scheduled for delivery in the June 2012 quarter.
- Management believed fiscal 2012 results were likely to cause noncompliance with one or more annual bank financial covenants. A default could make facility debt immediately due; management nevertheless believed existing cash and operating cash flows could fund the next 12 months and repay the debt if needed. The company said it was compliant at March 31.
- The Astromec sale generated $756,000 of proceeds against $302,000 of direct sale costs, including severance and professional fees; the costs were recorded as a loss in discontinued operations. Potential earnout payments depend on future sales. The Carson City property was reclassified as held for sale at $733,000; management found no carrying-value adjustment necessary.
- After quarter-end, CEO and President Mark Murphy resigned, effective April 20, 2012. The company accrued $339,000 for severance and related costs, and agreed to pay $5,000 monthly for consulting through October 23, 2012, subject to early termination. Michael Berthelot became CEO and President at a $300,000 annual base salary; an option grant for up to 200,000 shares was approved subject to the stated terms.
- MTI gave notice to terminate the Astromec transition production agreement effective May 10, 2012. The filing also notes potential environmental screening of a former Santa Ana site; DTSC said it would not evaluate the site during fiscal 2012, and future implications remain uncertain.
- The company maintained a $2.3 million valuation allowance against deferred tax assets and reported $304,000 of unrecognized tax benefits. Management said it did not anticipate a significant change in those benefits within 12 months.
Most important facts for investors to verify
- Whether the largest customer’s planned shift to internally manufactured products proceeds, and the resulting impact on orders, repairs, revenue and margins.
- Fiscal-year covenant calculations, any actual breach or waiver, and the availability and terms of alternative financing if required.
- Backlog conversion and new customer/product opportunities sufficient to offset concentrated customer losses.
- Completion and timing of the Carson City property sale, earnout receipts, and remaining obligations connected with the Astromec divestiture.
- Whether the reported warranty reserve and tax assets/unrecognized tax benefits remain appropriate as estimates and operating results change.