Pro-Dex Inc (PDEX) 2008 Q2 法說會逐字稿

Ladies and gentlemen, welcome to today's Pro-Dex call to discuss the Company's fiscal 2008 second-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 that of Section 21-E of the Securities 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 in reports filed with the Securities and Exchange Commission. Other unforeseen factors not identified in this presentation could also have such an affect. We undertake an 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'd like to turn the call over to Mr. Murphy.

Thank you, Heather. Happy Valentine's Day, everyone, and thanks to all of you for joining us to review Pro-Dex's second-quarter results for fiscal year 2008.

To start today's call, I'm going to ask Jeff Ritchey, our Chief Financial Officer, to first review with you our financial results. After that, I will update you on what has happened in the Company since our last conference call in November. We will then open the call up for questions.

I will now turn the call over to Jeff.

Thank you, Mark.

We continued to show strong revenue growth for the second quarter of fiscal year 2008 as sales grew by 32% to $6.1 million from $4.6 million in the second quarter of fiscal 2007. In addition, this quarter's sales increased 2% over last quarter's sales of $6 million.

Year-to-date revenue for the six months ending December 31, 2007 grew by 22% to $12.1 million from $9.9 million for the six months ended December 31, 2006. Sales growth was driven by continued increases in medical products sales, which grew by $1.8 million, over 109%, as compared to last year's second quarter, and grew by $2.9 million, or over 74%, as compared to last year's first six months.

The consolidated gross profit for the quarter ended December 31, 2007 increased 72% to $2.4 million, compared to $1.4 million in the same quarter last year. Gross profit increased by 35% to $4.5 million, as compared to $3.4 million for the same six-month period last year. Gross profit as a percentage of sales increased to 38% for the quarter and at 37% for the six months ended December 31, 2007, compared to 30% in the same quarter and 34% in the same six months of last year. The increase in margins was due to inefficiencies related to higher volumes, improved manufacturing cost controls, and a favorable sales mix that included new product development fees.

Profits were impacted by warranty expense that totaled $238,000 for the quarter or 4% of sales. This is compared to expenses of approximately $311,000 for the prior year's second quarter or 7% of sales.

Last year's warranty -- year-to-date warranty expense was $605,000 in the six months ended December 31, 2007 and $503,000 in the six months ended December 31, 2006, each representing 5% of sales. Our warranty reserve for anticipated expenses at the end of the second quarter of fiscal year 2008 totaled $534,000, up from $443,000 at the end of last quarter and up from the $336,000 at the end of the second quarter in the last fiscal year. This reserve was increased by $91,000 this year due to the high volumes of new product shipments that are warranty-eligible.

Total operating expenses for the quarter ending December 31, 2007 increased 11%, or $188,000, to $1.853 million, representing 30% of sales, compared to $1.665 million or 36% of sales for the quarter ending December 31, 2006. Comparing the six months ending December 31, 2007 and 2006, operating expenses increased by $265,000 to $3.485 million from $3.220 million, but as a percentage of sales were reduced to 29% of sales from 33% of sales. The increase in operating expense from the prior year for both the quarter and the six-month period was primarily due to higher labor, information technology, and building occupancy costs. These increases were partially offset by decreases in company-funded engineering development expense.

With the higher sales, increased stability in operations and controlled expenses, we posted solid positive operating income in the second quarter of fiscal 2008 with operating income of $501,000 or 8% of sales, as compared to an operating loss of $296,000 or -6% of sales in the second quarter of fiscal 2007. For the comparable six-month period ending December 31, 2007 and 2006, operating income was $1.021 million compared to last year's operating income of $130,000, respectively, an improvement of over 700%.

The effective tax rate incurred for the second quarter of fiscal 2008 was approximately 42% compared to a benefit of 70% for the fiscal year 2007. In fiscal 2007 last year, we realized our normal state tax credits in addition to the loss and in addition to a one-time retroactive tax credit of $64,000 due to reinstatement of a federal research development tax credit for expenses incurred in the year 2006. As a result, the Company's net income for the three months ended December 31, 2007 was $305,000 or $0.03 per share on a basic and diluted basis, compared to a net loss of $138,000 or -$0.01 per share on a basic and diluted basis for the three months ended December 31, 2006. For the six-month period ending December 31, 2007, net income of $631,000 or $0.06 per share on basic and diluted basis, is compared to net income of $103,000 or $0.01 per share on a basic and diluted basis for the six months ended December 31, 2006.

We had positive cash flow from operations of $1.266 million for the six months ended December 3t, 2007, compared to the positive cash flow of $204,000 for the prior year's comparable six months, primarily due to the increased profitability, improved receivables collections, and a slower growth in inventory.

Cash on hand remains stable. As of December 31, 2007, we had $220,000 in cash on hand, compared to $403,000 in cash on hand last June 30, 2007 and $366,000 at December 31, 2006.

We ended the quarter with nothing borrowed on our $4 million total credit line ability, down from $300,000 borrowed at June 30, 2007. In addition to the elimination of the credit line debt, we further reduced our debt by $240,000 since the beginning of fiscal year by making early discounted payments on the deferred payable from the Intraflow patent purchase. We believe our working capital and capital expenditure needs over the next twelve months will be adequately supported by our current operations and the total credit facility availability.

As of December 31, 2007, our backlog stood at $11.7 million compared to $11.7 million in backlog last year, remaining at the higher end of our historic backlog range.

In summary, we delivered another quarter and six months in growth of sales and gross profit, both in dollar value and in a percentage of sales. We had a strong turnaround from last year's second-quarter losses in both operating and net income.

Our operating cash generation for the first six months is $1 million higher than the same period last year, and we are carrying over $1.7 million less debt than they were at December 31, 2006. These are all solid indications of improved operations at Pro-Dex.

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

Thank you, Jeff.

As you just heard, we posted very strong results for the three and six months ended December 31, 2007, and we're very pleased with our financial and operating performance through the first half of fiscal '08. We believe we have now established a reasonable base line of performance for Pro-Dex, one which we can build upon as we move forward.

As a general overview, the improvements in our financial performance are directly related to breakthroughs realized in our Santa Ana operation. Accordingly, I will provide a brief review of our other operations first, and then move to the areas of the most significant development.

Beginning with Carson City, Astromec sales were down 22% over Q2 of last year. However, the backlog remains strong at $2.4 million. This decline in top line was exclusively associated with operating challenges, including supplier deliveries and customer specification changes. We see no softness in the market.

Sales for the military and commercial aircraft industries continue to dominate our top line at 63% of sales, while medical customers represent 37%. Astromec recently completed the development of a new motor Santa Ana which decreases the motor size by 25% while maintaining the same torque. This size reduction, through power density, enables the surgical handpiece to be reduced in size and weight without altering its performance, a benefit highly valued by our customer.

On the strategic front, Astromec finished the definition and refinement of its core value proposition this quarter and is currently working toward the implementation of the tools and systems required to consistently deliver our core competency. For example, we installed a new CNC mill for making prototype parts as the next in streamlining our development process so that we can produce potent motors in substantially less time than our competitors.

Santa Ana is a very eager customer for the core competency that Astromec is developing, since its ability to develop a surgical handpiece quickly is highly reliant on its ability to acquire a custom motor quickly. Accordingly, Astromec is developing into not only a key supplier but a strategic enabler of Santa Ana's business model. This enablement is, by far, the most valuable synergy that exists between these two businesses, and it has already been captured in the form of multiple large development agreements.

Far less significant in amount but icing on the cake is that the additional manufacturing volume of these motors in Carson City will leverage Astromec's overhead. This amount may be $100,000 in fiscal 2009, as the first project has motors beginning volume manufacturing, and could grow to as high as $400,000 or $500,000 over the subsequent two years, as all three motors realize full manufacturing volume.

Shifting gears to our motion-control business in Beaverton, we've experienced some softening in topline sales in recent months, although this operation continues to provide very strong financial contribution. This level of fluctuation is consistent with the nature of this business. The leveraging of OMS' capable engineering resources in high-end electronic and software design continues to contribute to the success of our medical device projects in Santa Ana, similar to Astromec Synergy. It also broadens the core value of OMS' capabilities. OMS has added a senior-level engineer and is actively seeking a national sales manager as it prepares to aggressively expand its distribution channel.

In December, OMS relocated the business to its new facility, within a mile of the previous one. The new facility provides greater efficiency at a lower cost, as it is properly sized to the operation.

Our Intraflow product line continues to gain credibility and proven efficacy among dental thought leaders worldwide. We believe we have successfully integrated the product into a robust design with substantial marketing and training materials, evidence-based research findings, and excitement from dentists who are considered technology leaders. After experimentation with various types of distribution, we have also identified the specific selling model that best suits this product. Our next challenge will be to match this market-ready product and selling model with a scaled dental distribution channel that is optimally suited to capitalize upon it. We are currently considering all of our options with a firm aim toward maximizing the value of our investment in this breakthrough technology.

This brings us into the Santa Ana operation, which has made significant improvement on all fronts this quarter. Starting with sales and marketing, our backlog remained at near-record levels at the end of the second quarter. The strength is the result of continued reorders from existing customers, incremental orders for new business, and the booking of a new development agreement we announced on January 10. This is the second major development agreement we've entered into this fiscal year, which, upon successful completion, is projected at development fees of approximately $800,000 over the next 12 to 15 months and first-year product sales of approximately $2 million.

We are also negotiating a third development agreement with an existing medical device customer. This 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. The customer is targeting a January 2009 launch date. While this product will be a new version and therefore replace some of the current products that we currently make for them, our customer expects to transition to the new product over the course of three years, meaning that we do expect incremental revenue growth from this customer.

As you know, we began development work during 2007 on a new system for a major player in the spine segment of the orthopedic market. That project will be starting clinical validation next month and is projected to receive regulatory approval in the fall of this year. Our customer is targeting a September launch date, a four-month delay due to clinical factors unrelated to Pro-Dex. As a result, Pro-Dex now expects to finalize the negotiation of an exclusive supply agreement for this product within the next 60 days and begin full manufacturing in early summer, 2008. That supply agreement is expected to represent between $1.2 million and $2.4 million in incremental product sales during the first full year after release.

It very important to note that all three projects involve the coordinated efforts of our three business units fully leveraging the complete technical capabilities of Pro-Dex. Also, two of these projects will involve the sale of disposable components, creating recurring revenue that is typically more stable than capital equipment sales. In addition to these three large specific projects, we are actively proposing on other projects in both the dental and medical industries.

We had some great wins in engineering also. As announced last month, we have recruited an exceptional new Vice President of Engineering who completes our senior leadership team and significantly strengthens our engineering capability. Following an extensive 12-month search, we hired Mr. Dick Corrington for this critical position, setting the stage for our further growth. Dick brings to Pro-Dex 30 years of proven experience in building and leading teams of technical professionals in the accelerated development of reliable state-of-the-art products. He most recently served as the Senior Vice President of Engineering for Balboa Instruments, a manufacturer of sophisticated control electronics used in harsh environments. At Balboa, Dick built and led the team that redesigned an entire unreliable product line, including hardware, software and electronics, into the industry benchmark for quality and capability. Dick has a career-long legacy of delivering sound engineering through his technical leadership. As a leader, a technical resource and an individual, Dick is a strategically significant addition to our team, and while 12 months is a long time, I must say that he was worth the wait.

I would also like to restate my sincere appreciation to Rick Van Kirk, our VP of Manufacturing, who served as our interim engineering leader. Rick not only held the function and the team together, but he made significant improvements in both.

For a short time, we had all of our open engineering positions filled. However, with our growing list of product development opportunities in Santa Ana, Dick is now working to fill two additional engineering positions to complement the solid technical staff that is already in place. These adds will expand our engineering capacity to ensure success on existing projects and provide adequate resources for future wins.

The Santa Ana manufacturing group continues to prepare for a facility move while simultaneously increasing our monthly shipments. There is also significant maturation occurring in this area of the Company, as we lay the groundwork to support further growth in the form of infrastructure, processes, training and equipment that have been put in place. These collective efforts have enabled us to ship 30% to 50% more per month than just over a year ago.

While shipments have increased, we've also been able to build up component inventory to support us during the new facility move and start-up. Newly equipment has now been placed on order that will increase both are capacity and our manufacturing capabilities to support the design of new products. This equipment will come online concurrent with our move into the new building.

Our quality and regulatory function has certainly kept pace with our victories in sales engineering and manufacturing. We are close to the completion of a redesigned product development flow that will streamline and strengthen our design process. We are integrating all product returns under the [QA] function to gain better visibility into field feedback. We've implemented more stringent inspection criteria on critical components related to high warranty-claim products.

We have also improved the quality of our inspection talent. We're in the process of implementing a company-wide associate training matrix to ensure proper certification of all functions and improve our flexibility through cross-training.

Lastly, this quarter we successfully concluded a state FDA facility inspection to renew our medical device manufacturing license and submitted our application for the transfer of that license to our Irvine facility.

With regard to warranty expenses, this quarter contained no unusual charges. While we continue to reserve at current failure rates for all new products shipped, we had no increases in such reserves from prior-period adjustments. Our failure rates have reduced from painfully excessive to acceptable high. Our customer is very pleased with the existing revision of the product we're shipping, but we continue to invest in ways to reduce the failure rate further.

We're in the process of doing the tenant improvements in our new, larger Irvine facility, where we will move our Santa Ana manufacturing operation and corporate headquarters. For those of you who have toured our existing facility, you know that it no longer meets our needs to the point of adversely impacting our efficiency. I'm very pleased with our new location and am confident that it will facilitate our growth over the next several years. Our move is currently scheduled for mid-April, and we anticipate that we will incur between $250,000 and $350,000 in non-recurring expenses and operating inefficiencies, which will impact the fourth quarter of our fiscal year. As you can see from this quarter's results, such a charge would reduce but not eliminate our profitability in the fourth quarter if we can maintain our current operating performance. We will provide information on the move related to -- on the move-related expenses as they hit our income statement so investors can fully understand our pure operating results independent of such related one-time charges.

That wraps up my comments related to the operations of the Company. Shifting to our strategic direction, I have a few comments to share.

First, we announced, in December, that we added Mr. Bill Healey to our Board of Directors. After several interactions with Bill, both inside and outside the board room, I can tell you that he is a very strong addition for us. Bill brings a wealth of experience, wisdom, character and practicality to every discussion. He is an experienced operator who understands what it takes to build sustainable earnings. I look forward to his contribution on the many challenges we will face on our journey.

Second, we have recently completed a rebranding project in preparation for the significant revamping of our Web site. As you know, Pro-Dex Santa Ana has used such terms as "speed to market" and "rapid innovation extraordinary results" to describe itself, while OMS in Beaverton was called "the company emotion" and Astromec in Carson City did not have a clear branding statement. Our exploration of the commonalities among these three businesses revealed significant overlap. None of our operations played in markets of high-volume/low-cost. While all three do develop new technology, the ultimate distinction of all three business models is that we sell with our ears. In other words, we generally do not push a catalog of products into the market. We seek out needs for custom products, whether they be surgical hand pieces, motion controllers or fractional horsepower motors, listen for what the customer is trying to achieve, and then work closely with that customer to develop an elegant solution for them.

Because of our technical expertise, our disciplined design process and our exceptional human collaboration, we can consistently deliver these solutions faster than any other means available to them. Accordingly, our new corporate brand positioning is "Pro-Dex -- accelerating possibilities." These two words capture the essence of we are in all three markets.

We are dropping the reference to raw speed because it is difficult to define how fast is fast. But we are standing firmly and confidently upon our claim that we will always be faster than our customers' alternative. It is pure possibility that we are hired to realize. Customers who want off-the-shelf products and high volume for low prices will not choose to do business with us. But customers who have a custom requirement, whose market economics justified accelerated development and/or elegance in the final product, will find Pro-Dex to be a compelling alternative, as evidenced by our most recent development wins. It is our intention to build a company that is accelerating possibilities for its customers, its associates, and its shareholders.

In our last conference call, I declared the completion of Phase I of our journey, which was "the turnaround." I summarized this completion by pointing out that we had 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 design; from strained customer relationships to committing 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 to possibility.

With Phase I complete, Phase II is now underway. This is the phase where we refine our ability to consistently sell, engineer, manufacture and ship multiple new products successfully -- in other words, to prove that Pro-Dex can and will deliver the results it promises to its customers every time.

I hope that today's conversation confirms for you that Phase II is starting to show results already. We have all of the puzzle pieces in place, and we must exercise the impressive machine that we have created.

Phase III will then be about leveraging the model for growth. It will be about accelerating the possibility to scale the Company beyond the confines of organic expansion. I mentioned Phase III today only to provide the context of the road we're on, not to get ahead of ourselves.

In conclusion, we have come a long way. Our company has been very blessed with extraordinary opportunity and with a team of associates who are committed to capitalizing upon them. While the pace is hectic, the rewards are many. I am most appreciative to my fellow Pro-Dex senior leaders and associates who have delivered such impressive results.

I invite you to ask any questions that you may have at this time.

(OPERATOR INSTRUCTIONS). There are no audio questions at this time.

Okay. Well, thank you very much for your participation and interest in the Company, and have a great rest of the Valentine's Day. Bye-bye.

Thank you. This concludes today's conference call. You may now disconnect.