Pro-Dex Inc (PDEX) 2008 Q1 法說會逐字稿

Ladies and gentlemen, welcome to today's Pro-Dex call to discuss the Company's fiscal 2008 first 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 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.

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 to such differences include, but are not limited to those discussed in this presentation as well as those discussed elsewhere and reports filed with the Securities and Exchange Commission.

Other unforeseen factors not identified in this presentation could also have such an effect. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results, financial condition, or business over time.

With that said, I would like to turn the call over to Mr. Murphy. Please go ahead, sir.

Thank you, Vanessa, and thank you to all of you for joining us to review Pro-Dex's first quarter results for the fiscal year ended June 30, 2008.

We'll start with Jeff Ritchey, our Chief Financial officer, summarizing our financial results. After that I will comment on our progress since our last conversation. We will then invite your questions.

I now turn the call over to Jeff.

Thank you, Mark, and good afternoon, everyone.

We again had substantial growth in revenue for the first quarter of fiscal year 2008. Compared to a strong first quarter last year, revenues rose 14% to $6 million, up from $5.3 million, and up another 4% compared to last quarter's sales of $5.8 million. Sales growth was driven by strong year-over-year increases in medical sales which grew $748,000, over 34% compared to last year's first quarter.

Due to the higher sales levels achieved, consolidated gross profit for the quarter ended June--September 30,2007 increased 9% to $2.2 million compared to $2.0 million the same quarter last year, and up 16% from the $1.9 million gross profit last quarter. Gross profit as a percentage of sales was 36% in the quarter, down two points from the 38% in the first quarter of last year. Compared to last year, the gross profit percentage increased four points from 32%.

The variation in margins was due to expenses related to warranty repairs for two products in our medical device product line. Our warranty reserve for the anticipated expenses at the end of the first quarter of fiscal year 2008 totaled $443,000, down from $469,000 at the end of last quarter, but up from $321,000 at the end of the first quarter of last fiscal year. This reserve was reduced by $26,000 this year, primarily due to improvements in recently shipped product offset by increases in our estimates of the amount of future returns for older products.

Total operating expenses for the quarter ended September 30, 2007 increased 10% to $1.633 million representing 27% of sales compared to $1.554 million or 30% of sales for the quarter ending September 30, 2006, and then compared to last quarter, operating expenses increased $144,000, and as a percentage of sales, increased from 26% of sales due to the timing of activities associated with normal fiscal year end shareholder reporting activities. The increased operating expense from prior year was primarily due to higher labor and equity based compensation costs. These increases were partially offset by decreases in outside consulting and company-funded engineering development expenses.

With the higher sales and controlled expenses, we posted another quarter of solid positive operating income in the first quarter of fiscal 2008 with operating income of $520,000, or 9% of sales, as compared to an operating income of $427,000 or 8% of sales in the first quarter of fiscal '07, and increase from last year's fourth quarter operating profit of $371,000 or 6% of sales. The effect of tax rate incurred for the first quarter 2008 was approximately 33% compared to 36% last year. This rate is slightly lower in 2008 due to the realization of a greater proportion of research and development tax credits.

As an ending result, the Company's net income for the three months ended September 30, 2007, was $326,000, or $0.03 per share on a basic and diluted basis, compared to net income of $242,000, or $0.03 per share on basic, $0.02 per share diluted basis for the three months ended September 30, 2006. We generated $1.092 million of positive cash flow from operations for the quarter ended September 30, 2007 compared to $691,000 for the quarter ended September 30, 2006, primarily due to better collections and reduction in inventory. As an indication of our collection efforts, our day sales outstanding, or DSO, is at a historic low at 45 days of sales as compared to 61 days at the end of the first quarter last year and 59 days at the end of last quarter.

We ended the quarter with nothing borrowed on our $2 million total credit line availability, down from $300,000 borrowed at June 30, 2007. As evidence of our strong financial position we recently were able to double our credit line availability from $2 million to $4 million and added an additional $2 million facility financed to (inaudible) improvements and process at our new Southern California location. This expended credit line Wells Fargo is also at lower interest rates.

At September 30, 2007, we grew our cash levels on hand from $403,000, to $781,000, all the while paying the remaining balance on our credit line and making initial deposits on our tenant improvements. We belive that the Company's working capital needs over the next 12 months will be adequately supported by our current operations and our total credit facility availability. As of September 30, 2007, our backlog stood at $9.4 million as compared to $10.1 million in backlog at June 30, 2007, reflecting our normal fluctuations in bookings and continued high sales level. The Company's backlog has ranged between $9.1 million and $11.7 million over recent periods. In summary, we delivered growth in sales, gross profits, operating and net income and cash generation.

With that, I'll turn the call back over to Mark for his review and outlook comments.

Thank you, Jeff.

As all of you know, we had an extensive year-end update just two months ago on September 13th and my shareholder letter was issued less than three weeks ago on October 24th. So we have reported much about our progress in the recent past. Given this, my objective today is to give you the latest update on what is happening, and then speak a little bit about the bigger picture.

Starting with Santa Ana sales and marketing our backlog is currently approaching record level. The strength in this number is the result of robust reorders from existing customers, incremental orders from new business, and as recently as yesterday, a $2.4 million purchase order from a customer who had previously indicated their intent to do their own manufacturing and repair of the products we make for them.

We reported in our September conference call that they were reconsidering their decision to bring the work in-house and reported in our shareholder letter that they had signed a letter of intent to continue to use us, but there is nothing like a $2.4 million purchase order to confirm that we have completely rebuilt this relationship. Receipt of this order brings our total company backlog to approximately $11.5 million.

Two weeks ago our team met with this same customer to develop a specification for their next-generation product, and we are currently negotiating the development and supply agreement for that work. The agreement represents approximately $250,000 in development revenue in calendar year 2008, and product sales of between $2 million and $4 million during calendar year 2009. While a portion of these sales will replace current revenue dollars, our customer expects to transition to the new product over a period of three years, meaning new product sales will create incremental growth for us with this customer.

In our last conference call we also announced the recent signing of our first major development agreement in sometime, a project that is now progressing nicely toward clinical testing and regulatory approval. Our customer on this project, a major player in the spine segment of the orthopedic market, is targeting a May 1st launch. In order to support that launce date, Pro-Dex expects to finalize the negotiation of an exclusive supply agreement for this product before the end of this calendar year and begin full manufacturing in early 2008. As previously reported this project is estimated to provide $275,000 in development revenue this fiscal year and generate between $1.2 million and $2.4 million in product sales during the first full year after release. This will be additive to our current recurrent product sales.

We are also in final negotiation on a third major product development project, with estimated development fees of approximately $650,000, and first year product sales of over $2 million. Again, these sales would additive to our current product sales. Anticipating that this new development agreement will be signed before the end of this calendar year, our development work on this project will take place during calendar year 2008, with initial product shipments in calendar year 2009.

It's very important to note that all three of these projects involve the coordinated efforts of our three business units fully leveraging the complete technical capabilities of Pro-Dex. It is also anticipated that at least two of these projects will involve the sale of disposable components creating recurring revenue from our capital equipment sales, as that capital equipment is increasingly utilized. Beyond these specific projects, we are in the process of developing proposals for several other customers in the medical device and dental industries. Proposals that we anticipate will lead to additional development and manufacturing opportunity that we'll further leverage the synergies of our three business units.

Let's shift now to engineering. As evidence of our continued commitment to improvement, we have made several organizational changes that have increased the capability and capacity of our engineering group. These changes include the hiring of two very seasoned medical products design engineers. Upon filling the two remaining positions for a Vice President and an electrical design engineer this critical team will be fully constructed.

In the meantime, the department continues to fire on all cylinders under the leadership of Rick Van Kirk, our Vice President of Manufacturing. Rick and the engineering team are working very closely with Joe Rotino and our quality group to ensure the successful completion of project after project. Our manufacturing group at Santa Ana is also keeping pace, delivering a very strong quarter, averaging $1.4 million per month in shipments.

Our increased efforts in manufacturing engineering including the hiring of a very experienced manufacturing engineer are paying off in two areas. First, the improvement of processes and procedures that increase the consistent quality of our legacy products, and second, facilitating the launch of new products into production. We are also gaining ground on our inventory build in preparation for our facility move so that interruption of shipments is minimized. Our manufacturing team is in the process of working with key suppliers to increase the flow of critical components so we can meet the increased volume requirements of a key customer.

Now let's move on to our regulatory and quality area. We continue to refine our design control process from the project planning stage all the way through the risk management and failure mode effects analysis stages. We have studied our returns more closely to learn about and fix as much as possible during our corrective actions process. We have tightened our controls over engineering orders which released change--which released new or change existing products. To assist us in this work, we have hired an experienced medical device quality engineer.

By the way, you have heard me correctly, we have brought four senior engineers into Pro-Dex over the last few months. Two design engineers, one manufacturing engineer, and one quality engineer. Each of them took us six to nine months to find. They were hand picked from a long list of candidates. Their qualifications include not only their impressive technical background but also their ability to deliver results in a collaborative and dynamic team environment. We have already begun to enjoy the impact of these key players on our company. The Santa Ana facility relocation is now scheduled for February/March 2008. Our new landlord must pull additional power to the building and Southern California Edison is setting the pace for all other activities. This delay is providing us with additional time to plan for the lowest impact move possible.

Lastly, let me update you object the Santa Ana warranty issue related to one customer's surgical hand pieces. We continue to review our method for warranty accrual to ensure that we have the most accurate estimate of our future liability, fully accrued for our balance sheet. While we increased our reserve this quarter for earlier generation engineering revisions that shipped prior to March of 2007, we continue to experience lower failure rates on the most recent revision that began shipping in March, and we continue to test an even newer version that has yet to be released.

Slowly but surely we are refining this product, and our customer is quite pleased with the current performance. Besides their invaluable support of and collaboration with our medical products group in Santa Ana, both Astromec in Carson City and OMS in Beaverton continue to build value independently. Astromec has begun production of its improved [auto-placeable] motor design that will enhance our motor survivability during both the pre-cleaning and auto-cleaning sterilization process of the medical device that our motor goes into.

Astromec's backlog remains strong at over $2.5 million with 65% of our sales coming from aerospace applications and 35% from medical. We continue to invest in the development of new motors for medical applications. In fact, Astromec is close to the completion of the development of a motor for a high speed surgical application. Prototypes are expected to ship in November and evaluation units in January. Operationally, Astromec's on-time delivery has improved considerably as we continue to implement lean manufacturing practices in that facility.

OMS continues to deliver solid financial results. Sales into the medical diagnostics market were 50% higher this quarter than Q1 last year. We have also seen growth in our sales to research facilities in Europe and Asia. The semiconductor segment remains soft for us. OMS' work for Santa Ana not only contributes to the completion of the medical product, but broadens OMS' offering to include motor control. OMS will be moving into its new leased space near its current Beaverton location in December providing greater efficiency at a lower monthly cost.

So that's it for the detailed update. Zooming out to the larger picture, let me summarize what has been accomplished so far. Page one of any redirection is to neutralize negative momentum and gradually gain positive traction. In the most critical areas of the Company, this has been accomplished. We have moved from confusion to alignment, from an unclear future to a crystal clear vision.

From open positions, to valued associates, from unreliable products to substantially improved designs. From strained customer relationships to committed partnerships. From zero sales activity to significant bookings and future opportunity. From a daunting engineering backlog to completed projects. From a waning quality system to disciplined processes. From manufacturing variability, to consistent quality and volume. From three separate divisions to a single company and from fear and fatigue, the possibility. All of this adds up to the completion of Phase I for Pro-Dex's growth. Phase II which we are beginning will be refinement and exercise.

For the next year our goal will be to finalize and refine these improvements to consistently complete multiple projects successfully, to prove that Pro-Dex can and will deliver the results it promises to its customers. Phase III will then be about accelerating the scalability of the proven model and I will save that conversation for a later date when we get closer to that future. For now, it is time to complete the model and perfect its execution.

At this time, we invite you to ask any questions that you may have.

(OPERATOR INSTRUCTIONS)

Your first question comes from the line of Michael Porter.

Hey, guys.

Hey, Michael. How are you?

I'm doing okay. Congratulations. Very nice quarter.

Thank you.

Just a few follow-up questions, Mark. I was a little confused on the warranty expense, when you started giving the numbers. Can you just tell me what those numbers were again?

I'm going to let Jeff go through the math, and then you can ask the clarifying questions.

Okay.

We ended our reserve at $443,000, we expensed $366,000.

OKay, so the reserve is up to $443,000, and you--and so that was an increase of 366?

Well, it was--at the end of June we were at 469. So this will be the math. We were at 469. We spent 392, and accrued an additional 366.

So 366 hit the P&L, and then the accrual on the balance sheet went down from 469 to 443, and primarily related to fewer of those hand pieces installed in the field.

Okay.

That were under warranty.

So I guess my question is why is it, why are we--why did we spend so much, why are we still accruing as much as it seems that we have over the past couple quarters, or when do you anticipate these numbers are going to start going down?

Well, it's great question, Michael, and we believe that we were going to stop having to do this this quarter. In our year-end conference call, I made the comment that I thought we were done playing catch-up for previously shipped versions, and that our estimate was finally robust enough, or conservative enough, or whatever, and that we would now have a clean P&L going forward. It turns out that in the data that came up in this quarter relative to previously shipped products, nothing to do with anything that's been shipped in the last few months, our reserves were inadequate, and we booked again to cover for those, but it's not something that's related to the products that we're shipping currently.

So I would renew--if I learn my lesson to say never make a prediction about an unknown, like an estimate, I would just defer and say I don't know when, but in fairness to your question, which is a very reasonable one, I think Jeff and I would say we think, we hope, we believe that what we've shipped in the past is fully accrued for, and that going forward we're only going to have to accrue for the things that we ship as we go, and the confirmation of our belief will be reflected 90 days from now at our next conference call.

Okay.

Fair enough?

Yes, just so if memory serves me correctly, I guess the auditors look at it as a six-month--they look at it in reverse, if you will, to see what the product returns are?

These actually have about a year warranty on them. So we have to look at what our experiences over the full year.

Okay.

And so if things move higher in the later months or go to straight line, that's what we're learning and refining our models with, and so we just have to use the best information we have at the time as now we're a few more months into this, we keep refining our estimates and seeing what the actual experience is.

Okay. How is Astromec doing on its own, is there organic growth there?

It's flat, generally flat, profitable. I would say that the best news about Astromec in terms of an asset of Pro-Dex is its--in increasing order of importance, one is cleaning up its act in the lean front and getting better, quicker, faster on its feet. Two, it's getting a very clear value proposition relative to medical products which have a shorter lead time for developing new contracts than the aerospace for sure, like a year to get a motor into production instead of four or five years. And three, the most significant contribution is the enablement of the Santa Ana business model. Indescribable in terms of Patrick's ability to go out and get a surgical device contract and being able to say I can develop a motor from scratch, winding up to meet your speed, torque, power requirements in six weeks, if that's what I have to do, if I have to create a custom motor for the handpiece.

So that's where--that enablement is significant. Beaverton is stepping up in that same enablement on an electronics and battery powered side giving us really the ability to kind of not just construct the handpiece hardware itself, but we need to buy motors here and batteries there and cables there and at that point our business model is very constrained by our suppliers. So I don't want to skirt the issue of Astromec on itself--by itself it's doing fine. It's not hemorrhaging, it's not doing poorly, it's not losing money, but it's not the most--it's not the fastest growing or most rapidly profitable--most wildly profitable entity, but it's doing fine supporting itself and really enabling Santa Ana is where the juice is.

So we're finally getting the--what we had hoped for when the acquisition was made initially, some integration where--by allowing them to design and manufacture the motors for the medical side?

That is correct.

And you said this will go into beta test in December?

There's already units that exist with our customer right now that have Astromec motors in them. We'd be looking at probably April of '08 to go into production with that--April to May of '08.

Okay, so you're planning right now to start using their motors for production?

That is correct. There are certain devices and certain motors that we can use them for, and others that we can't, and we are planning to use them for every motor that we can use them for, and this new project that we're discussing is one of those.

What does this mean in cost savings or an increase in gross profits to the Company?

Not quantifiable yet, and if it were, I wouldn't make a forward-looking statement about it. I think at this point one thing that's clear any time we bring volume to Astromec, we're going to spread their fixed costs over a greater volume, and that's--when you're a $3 million or $4 million company you've got a certain amount of critical mass fixed costs that are going to get spread over a higher volume, so our goal is to spread that and--and as that becomes clearer, and if it's advisable, we'll try to put a number to that for you on--in the coming call.

I'd like to--okay. IntraFlow. What is going on with IntraFlow, what's the plan, are there any product sales at all?

There are product sales continuing, and we're continuing to invest in that. That is a minuscule piece of the Company, and one that I've even stopped mentioning in every conference call because of its relative significance in revenue. It's a very small piece of the business, and we're continuing to nurture it, but it's not contributing big profits, it's not contributing big losses, it's incubating, and when it becomes interesting and worth discussing, exciting, and there's something to say about, I'll definitely bring it up, but at this point we're continuing to go to trade shows, we're continuing to win doctors over to the technology, we're continuing to profess the benefits of Intraosseous Anesthesia, we're continuing to have people see that we can deliver Intraosseous Anesthesia in the most simplistic way, and it's a long road to hoe in that--in the dental market to bring a new technology to commercialization.

Have we pursued any sort of joint venture or licensing out the technology to perhaps a larger organization?

We'll refrain from comment. I just need to.

Okay. Did the wildfires have any effect on the business?

No. They were mainly south of here, and had no impact. A few smoky days, and a few people calling in sick, but nothing major. None of our associates were affected.

We had pretty good luck with that. Fires were close to some of our associates, but nobody had any losses or significant damages.

That's good. All right, I'll get back in queue. Thanks, guys. Keep up the good work.

Thanks, Michael.

(OPERATOR INSTRUCTIONS)

Your next question is a follow-up question from Mr. Potter.

Hi, Mike.

I guess this is a good segue into my next question, and that is, you seem to have your arms around the situation, done a fantastic job certainly on managing the cash and the receivables. Where do we stand on being a little bit more visible again, having a more active investor relations program, creating a more efficient market for the stock?

I haven't started that yet. Until we have clarity of the impacts of our balance sheet on our P&L, the last thing that I want to do is create any type of investor expectations, have the stock run to $1.75, $2.00, $2.50, and then have bad news and lose credibility. So we have done nothing.

It has not been our IR firm's fault or Jeff's fault or anybody but my decision to say we're going to focus on developing operating results that are consistent, that are reliable, that we're no longer worried about having to go to the street and announcing a disaster. And when the Company is running well like that, my feeling is we got--we have one shot, maybe it's--I have one shot at credibility, and I'm not going to fire that bullet prematurely.

Are you still concerned about waking up and having a disaster?

Absolutely, for sure.

Because it seems that you've gotten past that stage.

Mike, you just asked me five minutes ago why we're still accruing warranty expenses that I told you eight weeks ago I didn't think we should be. So am I worried that I'm going to wake up one day and get on a conference call and tell you that we lost $0.05 and that we spent a $1 million in cash? No. But do I feel like the Company is on a clean, proven track record of escalating revenues and profits and pretty rock solid? No.

So there will never come a day when we're risk-free, right? Any day that a customer could call and cancel a big contract, or it could be an earthquake, that's the risk factors of the business, but I think there's been a conscious decision by me to make sure that when we go to the street and tell people that it's time, that it is, in fact, time.

And the other question about the urgency of doing that, is that when we move to Phase III, and we get into the scalability of the model, which will undoubtedly involve some M&A activity that's when we need to make sure we're being properly valued for the results we're delivering. Until then, it's-- it's not the highest priority of the Company to make sure that--it's a fiduciary duty to the shareholders which I don't take lightly, but I want to make sure that when we go it's built on a solid rock of credibility.

Okay. Thanks, guys.

Thank you, Michael. Appreciate it.

(OPERATOR INSTRUCTIONS)

At this time, there are no further questions. I will now like to turn the call back over to the presenters for closing remarks.

Thank you very much. We appreciate your attendance at the call and your patience with the Company, and all signals are positive, and we will keep you posted as we try to drive through Phase II and move toward Phase III. Have a great day.

Thanks.

This concludes today's Pro-Dex financial 2008 first quarter earnings call. Thank you for your participation. You may now disconnect.