Pro-Dex, Inc. — Form 10-Q Summary
Reporting period: Fiscal quarter and six months ended December 31, 2011. The filing is unaudited and compares results with the corresponding 2010 periods. Pro-Dex designs and manufactures products for medical, dental, aerospace, military, industrial, and research applications.
Financial performance
| Metric | Three months ended Dec. 31, 2011 | Six months ended Dec. 31, 2011 |
|---|---|---|
| Net sales | $4.907 million, down 20% | $10.937 million, down 9% |
| Gross profit / margin | $1.403 million / 29%, versus $2.424 million / 39% | $3.732 million / 34%, versus $4.608 million / 38% |
| Operating income (loss) | $(282,000), versus $571,000 | $176,000, versus $977,000 |
| Net income (loss) | $(292,000), or $(0.09) per share, versus $401,000, or $0.12 | $154,000, or $0.05 per share, versus $743,000, or $0.23 |
- Cash flow: Six-month operating cash flow was $(6,000), versus $(58,000) in 2010. Investing used $237,000, mainly for equipment, and financing used $179,000 for term-loan principal payments. Cash declined $422,000 to $4.267 million.
- Liquidity: Working capital was $7.941 million. Cash less bank debt was $3.315 million. Current assets were $11.696 million and current liabilities $3.755 million.
- Debt and facilities: Bank term debt totaled $952,000 ($357,000 current and $595,000 long-term). The company had not drawn on its $1.5 million revolving line or $350,000 equipment line. It reported compliance with facility covenants.
- Balance sheet: Total assets were $15.308 million and shareholders’ equity $10.511 million. Inventories rose to $4.733 million from $3.703 million at June 30, 2011.
Material changes and management commentary
- Quarterly sales fell primarily because of lower medical-device sales to the largest customer (down $783,000) and lower dental sales (down $386,000). For the six months, the largest customer’s sales declined $1.2 million; increased sales to the second-largest customer partly offset this and other sales declines.
- Gross margin contracted amid lower sales volume, weaker manufacturing efficiencies, and increased warranty costs. Warranty expense was $276,000 for the quarter and $510,000 for the six months, versus $78,000 and $182,000 in the comparable 2010 periods. The warranty reserve was $729,000 at period-end.
- Operating expenses decreased modestly over six months, but did not offset the gross-profit decline. Research and development expense increased 6% to $1.269 million.
- The two largest customers represented 57% of six-month sales. The largest customer accounted for 39% of sales in that period and has said it does not plan further orders for the products it intends to replace with its own devices. It had $1.929 million of scheduled orders as of January 2, 2012, but the customer’s transition timing is uncertain. Pro-Dex warned that its revenue from this customer could become negligible or zero by fiscal year-end 2012, with a potentially material adverse business impact.
- Backlog was $9.3 million at December 31, 2011. Management said cash balances and operating cash flows should fund operations for the next 12 months; it gave no specific revenue or earnings guidance. Management is pursuing additional revenue opportunities and may reduce costs if needed.
Risks, contingencies, and other items
- The largest-customer transition, customer concentration, and uncertainty around replacement-product registration and field testing are key risks. The customer may change its timetable without notice and may reduce out-of-warranty repair requests.
- A California environmental agency report listed the company’s former Santa Ana site for screening related to groundwater contamination in the area. The agency said it did not evaluate the site in fiscal 2011 and would not evaluate it in fiscal 2012; future implications remain uncertain.
- The company maintained a $2.344 million valuation allowance against deferred tax assets and reported $292,000 of unrecognized tax benefits. It did not anticipate a significant change in unrecognized benefits over the next 12 months.
- Management concluded disclosure controls were effective as of December 31, 2011; no material changes to internal control over financial reporting were reported. No subsequent events requiring adjustment or disclosure were identified.
Important facts for investors to verify
- Whether the largest customer follows through on its stated product transition, scheduled orders, and planned reduction in repair purchases.
- Whether Pro-Dex can replace potential lost customer revenue and sustain or improve gross margins as warranty costs and production volumes change.
- Whether backlog converts to shipments and cash collections, particularly given inventory growth and operating cash flow near break-even.
- Current borrowing availability, covenant compliance, and the effect of future cash needs on liquidity.
- Developments in warranty estimates, tax attributes and unrecognized tax benefits, and any further environmental review of the former Santa Ana site.