PRO-DEX, INC. — Form 10-Q Summary
Reporting period: Fiscal second quarter and first six months ended December 31, 2017; year-over-year comparisons are to the periods ended December 31, 2016. Pro-Dex designs and manufactures powered surgical and dental instruments and operates Fineline, a plastic injection-molding business. Results are unaudited.
Financial results
| Metric | Three months ended Dec. 31, 2017 | Three months ended Dec. 31, 2016 | Six months ended Dec. 31, 2017 | Six months ended Dec. 31, 2016 |
|---|---|---|---|---|
| Net sales | $5.560 million | $4.599 million | $10.723 million | $9.728 million |
| Gross profit / margin | $1.717 million / 31% | $1.311 million / 28% | $3.578 million / 33% | $2.733 million / 28% |
| Operating income | $347,000 | $269,000 | $1.210 million | $562,000 |
| Net income | $345,000 | $3.194 million | $973,000 | $3.480 million |
| Diluted earnings per share | $0.08 | $0.78 | $0.23 | $0.85 |
| Cash from operating activities | Not separately reported for quarter | $1.282 million | $760,000 |
Net income in the prior-year periods included a substantial tax benefit: the company released approximately $3.8 million of valuation allowance in the second quarter of fiscal 2017. Therefore, year-over-year net income and EPS comparisons are not representative of underlying operating trends.
- Cash and liquidity: Cash and cash equivalents were $5.262 million at December 31, 2017, versus $4.205 million at June 30, 2017. Working capital was $11.965 million. Management believes cash, receivables and operating cash flows will cover needs for at least 12 months.
- Debt: Notes and capital lease obligations totaled approximately $91,000, including current and long-term amounts. The $500,000 revolving facility was undrawn at quarter-end and matured in March 2018; management said it planned to renew it.
- Cash flows and funding: Six-month investing cash outflow was $2.474 million, mainly for $1.5 million in notes receivable and $713,000 of equipment purchases. Financing provided $2.249 million, primarily from $2.262 million of net ATM share-sale proceeds. Cash increased by $1.057 million.
- Balance sheet changes: Total assets were $18.813 million, up from $16.351 million at June 30, 2017. Shareholders’ equity was $16.745 million; 4,360,481 shares were outstanding at December 31, 2017. The ATM was suspended indefinitely in December.
Material changes and management commentary
- Quarterly sales rose 21%; six-month sales rose 10%. Medical-device and related-services revenue increased $1.1 million for the quarter and $1.9 million for the half year. Higher shipments to the largest customer, including a surgical handpiece, and growth in CMF screw drivers at the second and third largest customers were key contributors.
- Gross margin improved by 3 percentage points for the quarter and 5 points for the half year. Management cited higher sales and improved absorption of fixed manufacturing costs; savings from bringing certain machining in-house also benefited year-to-date results.
- Research and development expense increased to $478,000 for the quarter and $885,000 for the half year, primarily reflecting internal development of a Pro-Dex-branded thoracic surgical driver using adaptive torque-limiting technology. Management intends to continue investing in this and other medical-device development efforts.
- Fineline goodwill and related customer-list/trade-name assets were impaired by $229,000 after declining revenue and lapsed proposals indicated reduced value. Goodwill and the Fineline customer list were fully impaired; $30,000 of trade name remained.
- The company reported a $65,000 interest-income contribution in the quarter from its participation in a high-interest loan. It also recognized a $229,000 impairment charge and a $78,000 income tax expense for the quarter.
- Dental product sales declined 45% for the six-month period. In January 2018, Pro-Dex notified customers it would discontinue manufacturing those products and accepted final orders for delivery over the following six months; management does not expect the cessation to materially affect financial position or results.
Outlook, risks and contingencies
- December backlog was approximately $7.4 million, with $6.7 million scheduled for delivery in fiscal 2018. In January 2018, the largest customer increased an order by approximately $2.9 million for fourth-quarter delivery and signed a three-year extension for 150 units per month through the end of calendar 2021. These are forward-looking expectations, not guarantees of future results.
- Management said Monogram Orthopaedics is a long-term strategic investment that may take several years to generate meaningful revenue, if at all. Pro-Dex advanced $800,000 under a 4% convertible note; it is on nonaccrual status because conversion to equity is considered likely. The company also invested $1.15 million in a 50% participation in a third-party loan bearing an initial 22% rate. Pro-Dex has no direct recourse against the borrower, and a director is affiliated with the loan’s originating partnership.
- Customer concentration is significant: three customers generated 79% of quarterly and six-month sales; the largest represented 55% and 57%, respectively. Two customers accounted for 75% of gross receivables at December 31, 2017.
- Management cited risks including order and backlog variability, long-lead-time material requirements, customer inventory builds and product-launch timing, competition, technological change, and the ability to develop products and realize returns on strategic opportunities. Additional capital may be needed; management noted the option to seek debt or equity funding.
- The Tax Cuts and Jobs Act reduced the U.S. corporate rate to 21% effective January 1, 2018. The company recorded a $31,000 discrete tax benefit and expected a fiscal 2018 annual effective tax rate of approximately 28%.
- Legal proceedings are described as incidental to the business; the filing says liability could nevertheless be material. Management reported no material changes to previously disclosed risk factors. Disclosure controls were concluded effective as of December 31, 2017, while staff responsibility changes temporarily reduced segregation of duties.
Important facts for investors to verify
- Whether the largest-customer order increase and three-year delivery extension convert into shipments and revenue on the stated timing and volumes.
- Whether customer concentration and backlog variability affect sales, cash conversion, or production needs.
- Fineline’s future performance and the assumptions behind the $229,000 impairment; further impairment may depend on revised forecasts and fair-value estimates.
- Recoverability, repayment timing and valuation of the Monogram convertible note and the third-party loan participation, including the participation’s limited recourse structure.
- Whether the revolving facility was renewed and whether additional financing becomes necessary; the ATM was suspended indefinitely.
- Effects of the dental product discontinuation, R&D spending, and adoption of new accounting standards, particularly lease accounting, which management expected to materially increase recorded assets and liabilities.