Pro-Dex, Inc. — Form 10-Q Summary
Reporting period: Three and six months ended December 31, 2016 (fiscal Q2 2017). Unaudited results. Pro-Dex designs and manufactures powered surgical and dental instruments, with additional engineering services and injection-mold operations. OMS, its motion-control division, was sold after quarter-end and is reported as a discontinued operation.
Financial performance
Amounts below are in millions, except per-share data and percentages.
| Metric | Three months 2016 | Three months 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $4.599 | $5.231 | $9.728 | $9.023 |
| Gross profit / margin | $1.311 / 28% | $1.425 / 27% | $2.733 / 28% | $2.329 / 26% |
| Operating income | $0.269 | $0.486 | $0.562 | $0.421 |
| Continuing-operations pretax income | $0.276 | $0.481 | $0.570 | $0.409 |
| Net income | $3.194 | $0.391 | $3.480 | $0.265 |
| Diluted net income per share | $0.78 | $0.09 | $0.85 | $0.06 |
| Operating cash flow | Not separately provided for quarter | $0.760 | $(0.328) |
- Net income was unusually elevated by an income tax benefit reported as $2.859 million for the quarter and $2.852 million for the six-month period. Management said it released a valuation allowance of approximately $3.8 million after concluding deferred tax assets were more likely than not realizable. Pretax continuing-operations income was substantially lower than reported net income.
- Second-quarter sales declined 12% year over year, while six-month sales rose 8%. Quarterly operating income fell 45%; six-month operating income increased 33%.
- Cash and cash equivalents were $2.180 million at December 31, versus $2.294 million at June 30. Working capital was $7.506 million. Current assets were $10.225 million and current liabilities $2.719 million.
- Total liabilities were $2.833 million. Notes and capital lease obligations totaled approximately $148,000, including current and noncurrent amounts. No Summit Loan borrowings were outstanding at December 31. Cash plus investments was approximately $2.471 million.
Material changes and business developments
- Medical-device and services revenue was $3.964 million for the quarter, down $93,000, and $7.860 million for six months, up $1.2 million. Higher sales to the largest customer were partly offset by a roughly $900,000 quarterly decline from a former major customer that brought a product in-house.
- Gross margin improved year over year, which management attributed partly to machinery investments enabling in-house production of previously outsourced parts. Quarterly gross profit nevertheless fell 8% as revenue declined.
- General and administrative expense rose 34% for the quarter, primarily due to legal costs related to litigation and bonus expense. The company recorded a $113,000 impairment of the Huber customer-list intangible during the first quarter.
- Sales were highly concentrated: the largest customer represented 54% of quarterly sales and 48% of six-month sales. At December 31, three customers accounted for 84% of gross accounts receivable, including amounts due from the factor.
- On January 27, 2017, Pro-Dex sold OMS assets and operations for $640,000, subject to an adjustment based on OMS receivables. Management expected to record an approximately $300,000 gain in fiscal Q3. The stated purpose was to support investment in core medical-device development.
Cash, outlook, risks and contingencies
- Six-month operating cash flow was $760,000. Receivables and deferred costs used $493,000 and $344,000, respectively; the deferred costs related to a development contract not yet eligible for revenue recognition. Investing cash outflow was $693,000, including $376,000 of capital expenditures and a $300,000 investment in marketable equity securities. Financing cash outflow was $181,000, including $168,000 for share repurchases.
- Management said existing cash and receivables were expected to meet requirements for at least 12 months, while cautioning that customer cancellations or late payment could pressure cash flows. It also noted possible future need for debt or equity financing and uncertainty about availability on acceptable terms.
- The Summit receivables facility, with capacity of up to $1.0 million, was scheduled to terminate March 9, 2017; the company had notified Summit of its intent to terminate and was in preliminary discussions with its bank about replacement financing. No replacement facility was then available, and there was no assurance one would be obtained.
- Management cited a backlog of approximately $16.8 million, with $8.9 million scheduled for delivery in fiscal 2017; $11.5 million related to the largest customer. It anticipated completing a significant engineering project in fiscal Q3 and continued to invest in surgical-device development. No quantified earnings or revenue guidance was provided.
- Management expected repair revenue to remain below the prior year for the rest of fiscal 2017, as a former customer’s product transition reduced repairs and newer products remained under warranty. New orders may vary with product launches and customer inventory plans.
- Pro-Dex and parties associated with former Riverside operations filed competing lawsuits in October 2016 alleging, among other claims, breach of contract and wrongful eviction. Damages were unspecified; a former Riverside president had previously sought $250,000 to settle. The company said it would pursue its claims and defend against the others, but could not assure the outcome.
- Other relevant items include a warranty reserve of $418,000, up from $365,000 at June 30, and a $459,000 balance of unrecognized tax benefits. The company reported no material changes to its previously disclosed risk factors and said disclosure controls were effective.
Important facts for investors to verify
- How much of reported earnings is attributable to the tax valuation-allowance release, and what future taxable income supports realization of deferred tax assets?
- Whether the OMS sale proceeds are adjusted for receivables as expected, and whether the approximately $300,000 gain is recognized in fiscal Q3.
- Whether the company secures replacement revolving credit before the Summit facility ends, and how working-capital needs evolve as it fulfills backlog.
- Whether sales and receivables concentration in the largest customer persist, and whether backlog converts to shipments and cash on schedule.
- The financial exposure and resolution timeline for the Riverside-related litigation, and whether warranty costs or customer repair trends change materially.