Pro-Dex Inc (PDEX) 2007 Q3 法說會逐字稿

Ladies and gentlemen, welcome to today's Pro-Dex call to discuss the company's fiscal 2007 third quarter financial results and a review of current corporate developments. Your speakers today are Mr. Mark Murphy, Chief Executive Officer, and Mr. Jeff Ritchey, Chief Financial Officer. Today's call will be limited to one hour. Before I turn the call over to Mr. Murphy and Mr. Ritchey, I want to read a statement concerning forward-looking statements. Listeners are cautioned that statements made in this presentation that are not historical in nature or that state our management's intentions, hopes, beliefs, expectations or predictions of the future may constitute forward-looking statements within the meaning of section 21E of the Securities and Exchange Act of 1934 as amended. Such forward-looking statements involve risks, uncertainties, and assumptions.

It is important to note that any such performance and actual results, financial condition, or business could differ materially from those expressed in such forward-looking statements. Factors that could cause or contribute include to such differences, but are not limited to: those discussed in this presentation, as well as those discussed elsewhere in reports filed with the Securities and Exchange Commission. Of those foreseen factors not identified in this presentation could also have such an effect. We undertake no obligation to update or revise forward-looking statements, reflect current assumptions, the occurrence of unanticipated events or changes in future operating results, financial conditions or business over time. With that said, I'd like to turn the call over to Mr. Murphy.

Thank you, Sara, and thanks to all of you for joining us to review Pro-Dex's third quarter results for fiscal year 2007. To start today's call, I'm going to ask Jeff Ritchey, our CFO, to first review with your our financial results. After that, I will update you on what has happened in the company since our last conference call in February. We will then open the call up for questions. I will now turn the call over to Jeff to discuss the financial results for the third quarter.

Thank you, Mark. And good afternoon, everyone. Revenue for the third quarter fiscal year 2007 grew by 40% to $5.9 million as compared to the third quarter fiscal 2006. The sales for that quarter were approximately $4.2 million. Year to date revenue for the nine months ending March 31st, 2007, grew by 35% to $15.8 million. That's compared to the nine months ending March 31st, 2006. The sales for that nine-month period were approximately $11.7 million. Sales growth was driven by strong increases in medical sales which grew $1.2 million over 90% as compared to last year's third quarter and grew $1.4 million over 29% as compared to last year's first nine months. Of the remaining amount of sales growth, $455,000 of the quarter's growth and $838,000 of the year to date growth was in the higher sales of our traditional dental products. The consolidated gross profit for the quarter ended March 31st, 2007, increased 24% to $1.8 million compared to the $1.4 million in the same quarter last year.

On a year to date basis gross profit increased 13% compared to the same nine-month period last year from $4.9 million to $5.5 million. Gross profit as a percentage of sales increased to 36% for the quarter compared to 35% in the same quarter last year, but decreased to 35% for the nine months ended March 31st, 2007, compared to 42% in the same nine-month period of last year. As in earlier periods margins were diluted by expenses related to warranty repairs for a portion of our medical device product line. The quarter to quarter margin increase was due to overhead efficiencies gained with the higher sales level and a lower relative warranty expenses compared to the sales level. Warranty expense totaled approximately $195,000 for the quarter and $715,000 year to date, which reduced the gross margin percentages by 3% and 5% respectively.

The other factors contributing to the year to date gross margin decline included increase in return upgrade sales at lower margins and then historic -- lower margins than the historical new product margins and the continued drag on manufacturing and efficiency inherent in the warranty work. Our warranty reserve for anticipated expenses at the end of the third quarter totaled $402,000 up from the $336,000 at the end of last quarter and from the $309,000 at the end of last fiscal year, then compared to $275,000 at March 31st, 2006. At this point last year, we were making our initial attempts to quantify the warranty's economic impact based on what we knew of the product at the time. The fluctuation in warranty expense is also driven to a large extent by the timing of when units are received from the field, a factor that is somewhat beyond our control.

As of March 31st, 2007, the $402,000 in warranty reserves can be fully divided into two parts. $124,000 for products in-house and $278,000 for potential returns for products still in the field. The reserve for products in-house declined by 26 -- $27,000 since last quarter. This is offset by the increase in the estimate for potential returns. This has grown from $185,000 to$ 278,000 as we increased the estimate for product returns for the two remaining products from the same family that continue to produce high warranty claims. As we become more knowledgeable about the extent of the problem, we have continued to refine our forecasting model to estimate future cost exposure. But by nature, this part of the estimate will have more variability. As mentioned in the last few calls, the (lingering) effects of our historical warranty issues remain and will take time for those effects to be complete.

Total operating expenses for the quarter ending March 31st, 2007, increased 24% for $358,000 to $1.8 million, representing 30% of sales, compared to $1.4 million or 34% of sales for the quarter ending March 31st, 2006. Comparing the nine months ended March 31st, 2007, to 2006, operating expenses increased nominally by $1.1 million to $5 million from $3.9 million, though the percentage of sales were reduced to 32% of sales from 34% of sales. The increase in operating expense from the prior year's third quarter was due to increased new product development and expensing of new -- of previously capitalized product development costs, higher sales and marketing activities and $113,000 recorded for equity-based compensation expense due to the adoption of FAS 123(R), which we implemented this year. For the nine-month period ending March 31st, 2007, the increased expenditures were of similar characterization.

In addition to the consolidation of Astromec, operating expenses account for $349,000 or about $33,000 or 33% of the total $1.1 million expense increase compared to March 31st, 2006. The remainder of this increase was again due to increased product development, sales and marketing expenses and $199,000 recorded for equity-based compensation year to date due to the adoption of FAS 123(R). We return to positive operating income for the third quarter of fiscal 2007, after last quarter's loss with an income of $351,000, as well as compared to operating profit of only $8,000 in the third quarter of fiscal 2006. For the comparable nine-month period ending March 31st, 2007 and 2006, operating income was $471,000 compared to last year's operating profit of $912,000 respectively.

The effective tax rate incurred for the third quarter of fiscal 2007 was approximately 24% and was 3% year to date compared to a small benefit in the third quarter of 2006 on break-even earnings before tax and compared to the 39% last year to date. In fiscal 2007 we realized our normal state tax credits in addition to a one-time retroactive tax credit of $64,000 due to the reinstatement of federal research and development tax credit for expenses incurred after December 31st, 2005. As a result, the company's net income for the three months ended March 20 -- March 31st, 2007, was $216,000 or $0.02 per share on a basic and diluted basis compared to income of $6,000 or $0.00 per share on a basic and diluted basis for the three months ended March 31st, 2006. The same tax benefits apply to the nine-month tax calculation. On a -- effective 40% benefit as opposed to a 39% expense which resulted in a net income for the nine months ended March 31st, 2007, of $319,000 or $0.03 per share on a basic and diluted basis compared to $596,000 or $0.06 on a basic and diluted basis for the nine months ended March 31st, 2006. The company's working capital at March 31st, 2007, increased to approximately $6.5 million from the $6.0 million at March 31st, 2006. Increased working capital is due to the investment inventory and other prepaid expenses needed to officially meet our customer's critical delivery needs.

We had positive cash flow from operations of $298,000 for the nine months ended March 31st, 2007, compared to the use of operating cash of $154,000 for the nine months ended March 31st, 2006, primarily due to slower growth in inventory in fiscal year 2007 as compared to fiscal 2006. At March 31st, 2007, we kept our operating cash level stable. We had $319,000 in cash on hand compared to $358,000 in cash on hand at June 30th, 2006, and $409,000 at March 30 -- a year ago, March 31st, 2006. We ended the quarter with $1.2 million borrowed out of our $2 million total credit line availability up from $900,000 borrowed at June 30th.

As collections from the third quarter sales have been made, we have made additional payments on our line of credit and it currently has an outstanding balance of only $600,000. We believe that the company's working capital needs over the next 12 months will be adequately supported by our current operations and the remaining credit line availability. We intend to continue to use the credit line -- credit line wisely and monitor its use as a key metric for operating cash generation in order to continue to wisely invest in our infrastructure for potential internal and external growth opportunities.

As of March 31st, 2007, our backlog stood at $9.3 million as compared to $10.7 million in backlog at March 31st, 2006. The decline in backlog is a result of the higher sales level in the quarter not yet been offset by new orders. However, we have had increased order levels and maintained an equivalent high preliminary sales level in April to increase the backlog at April 30th to $10.3 million. In summary, while our third quarter sales showed significant growth over the same quarter last year, while reduced warranty and inventory pressures were the drive that increased sales to the bottom line and return to profitable cash generating operations. With that, I'll turn the call back over to Mark for his review and outlook comments.

Thank you, Jeff. I will start my review with a brief look at our Motion Control business in Beaverton and our motor business in Carson City. I will then share with you my perspective on our Santa Ana operations, including the areas (skill), engineering, quality and manufacturing. I will end my comments with a brief story about our consolidated value propositions before opening up the line to questions.

Our motion control business continues to perform well financially on stable sales. With sales stability as represented by slight erosion in our legacy semi-conductor segment, offset by growth in both medical diagnostics and government research facilities. Specifically in government research, we are beginning to see greater international sales to the U.K, Switzerland, France, and Taiwan. Our new MAX (net) Motion Control was introduced and well received at the advanced photons source APS users meeting at Argon National Laboratories last week.

Besides medical and government, there's activity in the factory automation segment that has not yet made it to our sales line as we work with these customers through their development cycle. We continue to leverage the electronic expertise of our [vivids] and organization and the production of many of the electronic circuit board and console assemblies that were previously built in California. Although the synergies between our different business units are not yet profound we are very cognizant of every synergy opportunity that can benefit our customers and our shareholders.

Moving to our motor business in Carson City. We just completed our first quarter where we have full three months of Astromec in both this and the previous year's numbers. Astromec sales were up 8% over Q3 of last year and our backlogs remained strong at $2.7 million. In addition we are currently working on projects to develop motors for two different medical device manufacturers and we just received our first purchase order for a medical device motor that we previously developed for a new customer. Astomec continues to aggressively implement its lean initiative, having completed two company-wide training efforts this quarter. Some of the initial pay back from this effort includes notable improvements in both supplier on-time delivery to us and our on-time shipments to customers.

Let's now shift to our medical dental device business in Santa Ana and start with sales. As Jeff mentioned Pro-Dex's substantial top line in third quarter was driven by impressive medical and dental product sales from our Santa Ana operations with revenues in the quarter of just over $4 million, Santa Ana's top line is 20% higher than last year on a nine-month year to date basis. During the third quarter, our Santa Ana operations began shipping two new product line extensions which collectively represent $1 million to $2 million in incremental annual revenue. In addition there's a third line extension targeted to start shipping in the fourth quarter. As engineering resources continued to free up, we were able to accelerate business development during the third quarter.

This has resulted in the receipt of a purchase order for the first product development fee the company has received in more than a year, related to the [iterative] design of an existing medical device. Although the amount is small, the direction is important. We are also actively negotiating our first major product development proposal for an existing medical device customer, a project that will be a combined effort of our Santa Ana, Beaverton, and Carson City operations. It is estimated that the annual revenue potential for this project is between $2 million and $4 million. If we win this contract we anticipate the develop -- that the development would take place during the first half of 2008 and the product shipments would be scheduled for the second half of fiscal '08.

Finally, our clinical, marketing and sales efforts related to the IntraFlow system continued during the third quarter, including participation in several dental industry trade shows, clinical symposiums and presentation of the product at educational institutions throughout North America. This has resulted in the near doubling of sales compared to last year. The product received a very favorable reception at a recent annual meeting of the American Endodontic Society and we expect fourth quarter sales to continue to grow. Regarding engineering we continue the process of recruiting a new senior executive to head up this important function. This is a key role for us and our process is appropriately rigorous. In the meantime, we have successfully completed several previously lingering projects including the product line extensions mentioned earlier. As we check these off the list, we simultaneously create shippable product and free up engineering resources.

This quarter has been extremely productive in our making headway. Last night we received approval from a customer on the third product line extension mentioned above, which represents an additional $400,000 in annualized revenues. In addition to our search for engineering leadership, we continue to seek for -- talented design engineers. We are pleased to announce that we have hired a new senior design engineer who will join us in June. His arrival adds depth -- depth and strength to the department to better support the development of new business that we secure. In addition, the engineering department is heavily involved in addressing the warranty cost issue. The team is thoroughly investigating root cause and corrective actions for opportunities to improve design issues and reduce the return -- the return rate of our two -- of our key products.

Turning now to quality -- to the quality and regulatory function. We have completed the following. One, revised our quality manual. Two, established aggressive quality objectives. Three, successfully completed on March 2007 ISO assessment for ISO 13485, which is medical device CE and Canadian certification. Four, implemented corrections necessary to close out a significant number of open corrective actions. And five, implemented a new design control process system to ensure efficient project management while addressing all required system and regulatory elements. Most importantly, we are not just doing paperwork behind the scenes of these initiatives. We are continually increasing our associate's knowledge of and appreciation for the reasons that drive what we do. Our level of "quality maturity" as an organization continues to increase. As with sales and engineering, I am quite pleased with the substantial progress we are making in this critical area of the company.

The last functional area in Santa Ana I would like to touch upon is manufacturing. Our monthly quality capacity remains strong and capable of supporting our second half requirements. In recent months we have produced and shipped our highest top line numbers in quite some time. In addition to generating top line, we are further strengthening our manufacturing engineering capabilities and are in negotiations with a potential candidate for that area. We have also benefited by performing manufacturing process audits during the last quarter. Lastly, our manufacturing team is working seamlessly with our engineering teams to improve both the quality and quantity of product we can make. That wraps up the specifics of each function in the company, but does not quite convey the holistic value of what is happening.

Let me share with you a story about what perhaps was the most fun I've had since joining Pro-Dex. It occurred two weeks ago as we prepared our first major product development proposal in over a year as mentioned earlier. The first part was an afternoon, evening conference call with our internal development team consisting of motor development capability from Carson City, electronics and control capability from Beaverton, and mechanical design capability from Santa Ana. Also present was representation from quality regulatory, manufacturing, business development, and project management. I smiled contentedly throughout the meeting as I observed highly capable individuals completely surround and attack the design issues inside of a disciplined process and a highly collaborate environment. Each person brought a critical piece of value to the solution and all were committed to the same goal of how to most expeditiously develop a safe and effective product for this name brand customer. After several hours, we had developed our best shot at what was involved in the product and were prepared to discuss the multi-page specification with the customer.

The next morning the same team was teleconference called -- was conference called in to a spec review meeting with the customer. On the customer's side were representatives from engineering, purchasing, marketing, product management and regulatory. As we reviewed the spec together and questions arose, we were consistently able to provide perspective based on our experience and knowledge of all of the disciplines involved in this product from raw motor technology to safe and specific regulatory issues. It was easy to sense that the members of the customer's team were quite impressed with our team's ability and comprehensive approach to developing their product. It was equally clear that they had many elements of their overall system design to address, and that this particular piece of their puzzle was one that they preferred to outsource to experts in that field, rather than take on this work themselves and learn from scratch.

My point is that on these two days I got to actually experience our value proposition. I got to sit inside the vision of Pro-Dex and see with my own eyes what we offer our customers, and I must tell you that it was powerful. So often, one has to build a company around a vision based on some level of blind faith. Because until all of the elements are in place to actually prove the model, there is no way to test drive it. In this case, however, we have all of the elements. We must simply clean up the lingering issues, continue to invest in our infrastructure to optimize our profitability -- our probability of success and then get back in the game.

Whether we actually land this particular project or not, it is clear to me that our company provides value to its customers and that value is significant, especially relative to what it enables in their strategy. I wish I could tell you that we were completely out of the woods. We are not. But my comments are intentionally more future based this quarter, because there has been an important shift from a 100% myopic preoccupation with recovering from the past to a simultaneously -- simultaneous commitment. We remain committed to cleaning up open issues and moving forward powerfully. Along this journey our financial results are certainly not guaranteed. But this quarter has been a great combination of facilitating the shift while creating a stable financial performance, a true testament to all of our associates. We will continue to do our best as your leadership team and we appreciate the overwhelming support we've received from your, our shareholders. At this time we will open up the phone lines to questions.

(OPERATOR INSTRUCTIONS) We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Larry Brooks with Maloney Securities.

Yes. Great job in the quarter. I'm particularly interested in the pipeline. Of course, I know what your backlog is. But beyond that how do the -- how does that look as far as what you could be bidding on or the chances of landing some other things that aren't included on your backlog?

Hi, Larry. The -- there are about four projects that we are currently working on. They range from small, $300,000 to $500,000 a year type projects to the one I mentioned which is $2 million to $4 million a year. I'd say that we have -- given our shift from past to future, we now have enough. If we had any more, I don't think we could digest it right now. But we have enough to be working on with the resources that we have available to be looking forward and Patrick has been released.

I think getting back in the game and getting -- having engineering resources available to him to actively engage in some of those conversations. He's enjoying that a lot. So, we're not satisfied, we're never going to be satisfied when we've got more than we can handle. We don't need to sell anymore. I'd say we're at the initial stages of looking forward and we're not looking at an empty glass at all. We're looking at just about right for where we are right now and continuing to look for more.

What about the staffing levels? What's the number of employees that you have now, and do you have any hiring plans beyond the existing number?

We've got about -- just over 125 people in the company. There's about -- about -- around 80 or so in Santa Ana. The rest are up in Beaverton and Carson City. We've got six or seven spots open I think of right now in dental sales and engineering. A couple production folks. Customer service spots. So we are -- we're on the growth mode on the employee side.

I'd say that primarily the key spots, the director of dental sales, a manufacturing engineer to beef up that issue, a quality engineer, one to two design engineers, the VP of engineering. So that's where -- we're not on a hiring mode to increase our manufacturing associate base by 30%. It's kind of filling in positions that have either been lost or positions that need to beef up that infrastructure to deliver on these projects.

I'm wondering in reference to your customers, you're seeing some strong sales, medical sales of course now. Are your customers suggesting that that trend looks pretty strong right now? In other words, the industry trends in general are they -- how are they looking at this stage?

Strong. There's no -- no indication of any downturns in terms of what our customer sales are experiencing.

Our customers tend to move in orders -- I can't remember the last time anyone has moved out an order.

That can change, but at least at this point we've seen no indication of that.

Well, good. Well, good going. And let's hope the turn around continues and then all the best and congratulations to you and the staff, the employees. So, thank you.

Thank you, Larry. Thanks.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Michael Potter with Monarch Capital.

Hi, Michael.

Hi, guys. Really a great quarter. And I really like the improvement. This is -- you may have said this on the call. I was in and out. I apologize. But with the pipeline that you've been able to maintain, do -- is this quarter going to be indicative do you think of basically a base that we should be able to grow off of, and should we continue to see sequential improvement in our margins and operating efficiencies as we, I guess, no longer are spending time and money on the reengineering a product?

My answer to that is not yet. I would not go so far as to say that this represents a base or a floor or that everything from here on out is going to be upwards and onwards. I'm trying to be as proactively positive as I can in terms of communicating the shift that's occurring underneath the hood in the engine that the shareholders wouldn't have an opportunity to see without suggesting that the turnaround is complete, we're out of the woods, everything is fixed, the warranties are going to improve, the margins are going to improve and are we're on our way. We are very cautiously -- have one foot in the past and trying to clean those up while getting on with creating a powerful future. So my profound answer yet, Michael, would be we're working it carefully. But I would not advise -- I would not suggest that this order will necessarily be indicative of the future. I'm also not suggesting that this quarter is not indicative.

If I were to say anything, I would be making a forward-looking statement, But I think from an operation (inaudible) the correct answer is we had a good quarter. We're happy with it. We're going to try and keep the financials performing while we do the turnaround. But the focus is on the turnaround and the financial results may vary as they say at the end of the advertisement.

Okay, okay. And any -- what's the CapEx plan for Q4?

It's pretty minimal.

Okay.

Just the normal repair and replacements of some of our IT infrastructure. A couple servers. Things like that. Not so -- it won't be very big.

But we should have, I guess, a more normalized, if you will, free cash flow generation?

Yes. It's pretty normal now. Our CapEx was not that big this quarter, or this year, hasn't been that expensive.

No. Certainly, it's been lower this year than last. But -- and can you bring us up to date on that, I guess, you announced last quarter, or the quarter before, the loss of the one large customer on one line, they were going to bring the assembly back in house. Where does that currently stand? And what kind of effect do you think that will have on 2008?

Where it currently stands is actually no change from before. The customer has placed some parts orders with us for components which they may be using in repairs or may be using to do pilot test builds of new product, but we've got no indication from them that they're for sure committed and ready to go on January 1, 2008, as they said or that they won't. At this point, we're planning as if those product lines will disappear for us -- and by the way, it's only two products of the multiple products we make for them. From all indications it looks like we'll be the ones providing the parts to do that. The parts represent half the value of the bill of the cost of the product. So there should be a negative affect, but not a devastating one.

Okay. Okay. Alright. Terrific, guys. Thanks for the update.

Thanks, Michael.

(OPERATOR INSTRUCTIONS) At this time, there are no further questions. Mr. Murphy, are there any closing remarks?

No, just thank you very much for attending the call, and we appreciate your support. This ends the call.

Thanks a lot.