Pro-Dex, Inc. — FY2018 Form 10-K Summary
Business context and reporting period
Pro-Dex designs and manufactures powered surgical drivers and shavers, primarily for orthopedic and craniomaxillofacial markets, and also sells rotary air motors. This 10-K covers the fiscal year ended June 30, 2018, compared with fiscal 2017. Medical devices and related services generated 90% of sales. The company sold its Fineline molding business in May 2018, had previously sold its OMS division in January 2017, and is focusing substantially on medical devices.
Financial performance and liquidity
| Metric | FY2018 | FY2017 |
|---|---|---|
| Net sales | $22.465 million | $21.943 million |
| Gross profit / margin | $7.943 million / 35% | $7.186 million / 33% |
| Operating income | $2.392 million | $2.737 million |
| Net income | $1.621 million | $5.084 million |
| Diluted earnings per share | $0.37 | $1.25 |
| Cash from operating activities | $3.096 million | $3.235 million |
| Cash and cash equivalents at year-end | $5.188 million | $4.205 million |
| Working capital at year-end | $13.695 million | $9.703 million |
Sales rose 2%, led by a $1.7 million increase in medical-device sales; the largest customer alone contributed $12.5 million. Gross margin improved, mainly from manufacturing cost savings after bringing some production in-house. Operating income declined as research and development and impairment costs increased. Net income fell sharply from FY2017, which included a $3.3 million deferred-tax valuation-allowance benefit; FY2018 also included $989,000 of income-tax expense and $1.029 million of asset impairments.
Operating cash flow was positive, but inventory increased $1.3 million, partly reflecting expected demand from the largest customer. Investing used $4.115 million, including equipment purchases, marketable securities and loan investments. Financing provided $2.002 million, principally from $2.3 million of net ATM share-sale proceeds, partly offset by share repurchases. At June 30, 2018, total liabilities were $2.641 million, including approximately $41,000 of capital-lease obligations; there was no bank borrowing outstanding.
Material changes and outlook
- Revenue mix shifted further toward medical devices: medical-device and service sales increased 9% to $20.282 million, while dental and component sales fell 24%. Pro-Dex notified dental customers it would discontinue the product line.
- Fineline contributed $358,000 of FY2018 sales before its sale. The company recorded impairment charges for the Fineline goodwill and certain intangible assets, and fully impaired its $800,000 Monogram investment after the startup’s financing difficulties.
- Backlog increased to $12.3 million from $8.7 million and was expected to be delivered during FY2019. Backlog represents firm acknowledged orders, not all revenue expected under existing contracts.
- Management reported no formal revenue or earnings guidance. It anticipated increased sales late in FY2019 from a thoracic surgical driver under development with a significant existing customer. Two development contracts were expected to generate about $700,000 of non-recurring engineering revenue in FY2019.
- Management believed existing cash, receivables and operating cash flow would fund expected needs for at least 12 months. Subsequent to year-end, the company entered into a $5 million term loan and a $2 million revolving facility, secured by substantially all assets; the term loan carries a fixed 5.53% rate and matures in 2025.
Risks, contingencies and unusual items
- Customer concentration is a central risk: the top 20 customers represented 97% of FY2018 sales, and the largest customer represented 56%. The major customer’s supply agreement for surgical handpieces runs through calendar 2021, but loss or reduced orders could materially affect results.
- On September 10, 2018, the company identified a supplier quality issue in a legacy battery requiring a product recall. It had sold $338,000 of the batteries in FY2018. The affected lots, costs, potential supplier recovery and insurance recovery were still being assessed; recall insurance has a $50,000 deductible and a $1 million limit.
- The $1.15 million participation in a hotel-related loan generated $199,000 of interest income in FY2018. The company has no direct recourse against the borrower, and the filing describes exposure through its participation agreement.
- Other risks include customer order cancellations or delays, competition and technological change, warranty costs, supplier interruptions, medical-device regulatory compliance, and dependence on key personnel. The company also disclosed that two directors controlled approximately 39% of voting power as of August 1, 2018.
- The company expected adoption of the new lease accounting standard to materially increase balance-sheet assets and liabilities. It expected the new revenue standard to have no material financial-statement impact, apart from expanded disclosures.
Most important facts for investors to verify
- Whether the largest customer sustains demand and whether the $12.3 million backlog converts to FY2019 shipments and cash collection.
- The scope, expense, insurance coverage and supplier recovery associated with the battery recall.
- Monogram and Fineline note recoverability, including the collectability of the $280,000 Fineline promissory note.
- The terms, borrowing status and covenant requirements of the post-year-end bank facilities, and the company’s cash needs as production and inventory change.
- Execution and commercial adoption of the thoracic driver and development contracts, alongside rising research and development spending.
The independent auditor issued an unqualified opinion on the financial statements. Management concluded that disclosure controls and internal control over financial reporting were effective as of June 30, 2018; the auditor did not provide an internal-control attestation.