Pro-Dex, Inc. — Form 10-Q Summary
Business and period: Pro-Dex designs and manufactures powered surgical instruments, primarily for medical-device customers, and also sells industrial air motors. This report covers the three and six months ended December 31, 2018—its fiscal 2019 second quarter—and compares results with the corresponding 2017 periods. Amounts below are in millions unless stated otherwise.
Financial performance and liquidity
| Metric | Three months ended Dec. 31 | Six months ended Dec. 31 |
|---|---|---|
| Net sales | $6.399 vs. $5.560; up 15% | $13.314 vs. $10.723; up 24% |
| Gross profit / margin | $2.249 / 35% vs. $1.717 / 31% | $4.975 / 37% vs. $3.578 / 33% |
| Operating income | $1.193 vs. $0.350 | $2.920 vs. $1.225 |
| Net income | $1.179 vs. $0.345; diluted EPS $0.28 vs. $0.08 | $2.528 vs. $0.973; diluted EPS $0.59 vs. $0.23 |
| Cash from operating activities | $1.508 for six months vs. $1.303 |
Revenue growth was led by medical devices and services, including increased shipments of a surgical handpiece to the largest customer. Management attributed improved gross margins mainly to higher sales supporting fixed-cost absorption. Second-quarter net income included a $0.356 gain on sale of an investment; marketable securities also generated a $0.494 after-tax unrealized loss in other comprehensive income for the quarter.
At December 31, cash and cash equivalents were $8.871, marketable investments $1.842, working capital $18.1, and total assets $24.026. The company generated $1.508 of operating cash, while accounts receivable growth of $0.838 reflected slower payments from its largest customer. Financing cash flow included a $4.942 net term-loan proceeds amount and $2.560 of share repurchases. The $5.0 term loan bears fixed interest of 5.53%, matures in 2025, and had a $4.9 balance; the separate $2.0 revolving facility was undrawn. The loans are secured by substantially all company assets. Balance-sheet notes and capital lease obligations totaled approximately $4.9.
Changes, outlook, and material matters
- Medical-device revenue rose $0.9 in the quarter and $2.5 for the half year. The largest customer accounted for 64% of sales in both periods, up from 55% and 57%, respectively, in the prior-year comparisons. The top two customers represented 80% of receivables at December 31.
- Backlog was approximately $25.0 at December 2018, with $13.3 scheduled for delivery in the second half of fiscal 2019. Backlog comprises acknowledged firm purchase orders and does not include all expected revenue under existing contracts.
- Management said it expects sales to an existing customer to increase in fiscal 2020 as a private-label thoracic driver is added to current products, but stated that anticipated sales were not in backlog and no purchase orders had yet been received at the time of the discussion. A subsequent event disclosed that on February 4, 2019 the customer authorized $3.4 of material procurement to support production orders; shipments were expected in calendar 2019.
- Management expects sufficient cash, receivables, and operating cash flow for at least the next 12 months, while noting that additional debt or equity capital may be needed to support working capital and equipment if required. It also plans to expand sales channels and diversify customer concentration; success is not assured.
- The company repurchased 217,454 shares for $2.560 during the half year. The fiscal 2019 10b5-1 repurchase plans had terminated after reaching their purchase-price limits.
- The $1.197 current loan-participation receivable relates to a hotel property loan bearing 22% interest; repayment had been extended, and the company expected full repayment in fiscal Q3 2019. The company also disclosed uncertainty about collection of the Fineline sale note.
- Marketable equity investments were exposed to market-value fluctuations; $0.809 was invested in Air T, Inc., where certain Pro-Dex directors have board or ownership affiliations. Management disclosed an auditor-independence violation involving a review partner’s tenure; the review was reperformed, the Audit Committee concluded objectivity was not impaired, and Moss Adams remained engaged.
- Adoption of revenue-recognition guidance had no financial-statement impact. Management expected lease-accounting adoption to materially increase reported assets and liabilities. The filing reported no material changes to previously disclosed risk factors and no material change in internal control over financial reporting.
Investor verification priorities
- Confirm whether the $3.4 material authorization converted into production orders and shipments, and track the timing of backlog conversion and thoracic-driver revenue.
- Monitor customer concentration, especially the largest customer’s share of sales and receivables, and collection timing.
- Verify repayment of the hotel loan-participation receivable and assess collectability of the Fineline note.
- Track term-loan amortization, covenant compliance, and available liquidity, including any use of the undrawn revolver or ATM offering.
- Assess the recurring earnings contribution apart from investment gains and the volatility of the company’s marketable securities.