Business context and reporting period
Pro-Dex, Inc. filed this unaudited Form 10-Q for its fiscal second quarter and first six months ended December 31, 2015. The company manufactures medical and dental devices, motion-control products and injection molds, and provides engineering services. Amounts below are in millions of dollars unless otherwise stated.
Financial performance and liquidity
| Metric | Three months ended Dec. 31, 2015 | Prior-year quarter | Six months ended Dec. 31, 2015 | Prior-year six months |
|---|---|---|---|---|
| Net sales | $5.439 | $2.792 | $9.535 | $5.387 |
| Gross profit | $1.539 | $0.696 | $2.597 | $1.524 |
| Gross margin | 28% | 25% | 27% | 28% |
| Operating income (loss) | $0.396 | $(0.393) | $0.278 | $(0.583) |
| Net income (loss) | $0.391 | $(0.192) | $0.265 | $(0.362) |
| Diluted earnings (loss) per share | $0.09 | $(0.05) | $0.06 | $(0.09) |
- Quarterly sales increased 95% year over year; six-month sales increased 77%. Medical-device sales and related services were the main growth driver.
- Six-month operating cash flow was negative $0.328, compared with positive $0.263 a year earlier. Cash at December 31 was $1.053, up from $0.697 at June 30, 2015. Investing cash flow was positive $0.183 and financing cash flow positive $0.501.
- Working capital was $6.894. Current assets were $10.021 and current liabilities $3.127 at December 31.
- Notes payable totaled approximately $0.580, including $0.522 current and $0.058 noncurrent. The $0.500 Fortitude loan bears 12% interest and matures March 15, 2016, subject to two optional three-month extensions. The $1.0 million Summit receivables facility had no borrowings outstanding at December 31; $0.912 of receivables had been assigned to the factor, with Pro-Dex retaining customer non-payment risk.
- Total assets were $12.167 and shareholders’ equity $8.766 at December 31, versus $12.516 and $8.478, respectively, at June 30.
Material changes versus prior period
- Medical-device and services revenue rose to $4.057 for the quarter from $1.406, and to $6.657 for six months from $2.932. New orthopedic and cranio-maxillofacial product launches drove much of the increase.
- Quarterly gross margin improved three percentage points, partly due to lower warranty and contract-loss charges. Six-month gross margin declined one percentage point, reflecting product mix and cost pressures.
- The company recognized $0.660 of previously deferred development revenue after completing a cranial-driver project and shipped approximately $0.550 of the newly developed product.
- Customer concentration remained significant: three customers represented 68% of quarterly sales; four represented 68% of six-month sales. One customer alone accounted for 25% of six-month sales.
- Pro-Dex took possession of Riverside Manufacturing collateral in October after Riverside ceased operations. It collected $0.277 from liquidation of collateral during the quarter and reclassified the Ramsey property and related notes as current assets.
Outlook, management commentary and risks
- Management said existing cash, receivables and Summit borrowing capacity were expected to fund operations for at least 12 months, assuming business conditions as then conducted. It also warned that negative operating cash flow may recur, including as the company buys long-lead materials to meet backlog.
- Management planned to use proceeds from the Ramsey asset liquidation to repay the Fortitude loan, with any excess available for working capital. A January 6, 2016 contract called for sale of the property for $1.653, subject to buyer due diligence and other contingencies; a 6% broker commission and other transaction costs are payable at closing.
- Backlog was approximately $10.6 at December 2015, of which $2.7 was scheduled for fiscal 2017; most of the balance was scheduled for delivery in the current fiscal year. Management noted bookings may vary with product launches and customer inventory plans.
- Management is pursuing cost reductions on newer products, which have lower margins partly because of assembly learning-curve labor and overhead. It also cited ongoing product-development projects, customer retention, acquisition integration and diversification through engineering services as priorities. No specific earnings or revenue guidance was provided.
- Key risks include reliance on major customers and their ability to pay, product-launch and development execution, lower margins on newer products, possible delay or failure of the Ramsey property sale, and the availability and terms of any additional financing. Management reported disclosure controls were effective and no material changes to internal control over financial reporting during the quarter. It reported no material changes to the previously disclosed risk factors.
- The company maintained a $3.9 valuation allowance against deferred tax assets due to cumulative taxable losses over the prior three years. It reported $0.434 of unrecognized tax benefits and did not anticipate a significant change in that balance over the next 12 months.
Important facts for investors to verify
- Whether the Ramsey property sale closes as contracted, its net proceeds after commissions and costs, and the resulting repayment of the Fortitude loan.
- Whether strong product-driven sales and the $10.6 backlog convert to shipments and cash collections on schedule, particularly given customer concentration.
- Whether operating cash flow improves despite receivables, inventory and supplier-payment needs, and whether additional financing becomes necessary.
- Whether cost-reduction efforts improve margins on newer medical products and whether development projects support the planned product launches.
- Whether warranty estimates, the valuation of Ramsey collateral and the recoverability of deferred tax assets remain appropriate as circumstances change.