Pro-Dex Inc (PDEX) 2008 Q3 法說會逐字稿

Ladies and gentlemen, welcome to today's Pro-Dex call to discuss the Company's fiscal 2008 third quarter financial results and a review of current corporate development. 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. 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 change, 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.

Thank you very much and thanks to all of you for joining us to review Pro-Dex's third quarter results for the fiscal year ended June 30, 2008.

We will start with Jeff Ritchey, our Chief Financial Officer, summarizing our financial results. After that I will comment on our progress since our last conversation in February. We will then invite your questions. I will now turn the call over to Jeff.

Thank you, Mark. We had strong revenue in the third quarter of fiscal 2008 as sales were up by 29% to $7.6 million from $5.9 million in the third quarter of fiscal 2007. Year-to-date revenues for the nine months ended March 31st, 2008 grew by 25% to $19.7 million from 15.8 million for the nine months ending March 31st, 2007. Sales growth was driven by medical product sales which were positively impacted by an annual stocking order from one of our major customer's backup device program and a high level of shipments from another major customer who will fill the requirements of their distribution channels.

The consolidated gross profit for the quarter ended March 31st, 2008 increased 3% to $2.2 million compared to $2.2 million in the same quarter last year. Gross profit increased by 22% to $6.7 million compared to $5.5 million for the same nine-month period last year.

Profit, gross profit as a percent of sales decreased to 29% from 36% for the quarter and to 34% from 35% for the nine months ended March 31st, 2008. The decrease in margins for the quarter is primarily due to a onetime $301,000 charge for changing inventory reserve methodology. Other contributing factors include a shift in sales mix from premium margin software products to normal margin medical products. For the nine-month period the 1 point gross margin reduction was due to the change in the reserve method. The change in the inventory reserve method reflects our product mix moving to a higher [weighting] of customer medical devices -- custom medical devices.

Warranty expense totaled $426,000 for the total quarter or 6% of sales compared to $195,000 for the prior year's third quarter for 3% of sales. This increase in a warranty cost as a percent of sales reflects the fact that this -- the substantial increase in sales this quarter was attributable to the shipment of higher volumes of medical products which are warranty-eligible. Year-to-date warranty expense was $1,058,000 in the nine months ended March 31st, 2008 versus $715,000 in the nine months ended March 31st, 2007, each representing approximately 5% of sales.

Total operating expenses for the quarter ending March 31st, 2008 increased 12% or $213,000 to $2,018,000 compared to $1,805,000 for the quarter ending March 31st, 2007. As a percentage of sales, operating expenses decreased to 27% from 31%. Comparing the nine months ended March 31st, 2008 to 2007, operating expenses increased by $468,000 from $5 million to $5,503,000 from $5,035,000 but, as a percentage of sales, were also reduced to 28% of sales from 32% of sales.

The increase in operating expense for the prior year for the quarter was primarily due to higher labor costs and for the nine-month period was due to higher labor in SOx and other accounting compliance costs. These increases were partially offset by decreases in advertising and Company-funded engineering development expenses. Operating income for the quarter was $208,000 or 3% of sales as compared to operating income of $351,000 or 6% of sales in the third quarter of fiscal 2007. Without the inventory reserve adjustment operating income would have remained at 6% of sales.

For the comparable nine-month periods, ending March 31st, 2008 and 2007, operating income was $1,229,000 or 6% of sales compared to last year's operating income of only $471,000 or 3% of sales. The effective tax rate incurred in the third quarter of fiscal year 2008 was approximately 24%, the same rate incurred in the third quarter of fiscal year 2007.

The 2008 rate was reduced from the statutory 35% rate by recalculation of our FIN 48 estimated tax liability, and the 2007 rate was reduced by a onetime retroactive tax credit of $64,000 due to the reinstatement of a Federal Research development tax credit for expenses incurred after December 31st, 2005. The rates in both periods were reduced by our normal state tax credits.

As a result the Company's net income for those three months ended March 31st, 2008 was $99,000 or $0.01 per share on a basic and diluted basis compared to net income of $216,000 or $0.02 per share on a basic and diluted basis for the three months ended March 31st, 2007. For the nine-month period ended March 31st, 2008, net income was $729,000 or $0.08 per share on a basic and $0.07 per share on a diluted basis compared to net income of $319,000 or $0.03 per share on basic and diluted basis for the nine months ended March 31st, 2007.

We had cash flow from operations of $2,128,000 in the nine months ended March 31st, 2008 compared to operating cash flow of $298,000 for the prior year's comparable nine months. The increase was primarily due to increased profitability and higher payables and accruals at the end of the period due to the timing of month end [and] our processing cycle coupled with the slow growth in inventory.

Cash on hand grew slightly as of March 31st, 2008, we had $529,000 in cash on hand, compared to $403,000 from cash on hand at June 30th, 2007 and $319,000 at March 31st, 2007 a year ago.

We ended the quarter with $500,000 borrowed from our $4 million credit line availability, up from $300,000 borrowed on the line at June 30th, 2007. Net debt was $2.1 million at March 31st, 2008, a reduction of $300,000 compared to $2.4 million at June 30th, 2007, and a net debt reduction of $1.4 million and the $3.5 million of net debt that we had a March 31st, 2007. We believe that our working capital and capital expenditure needs over the next 12 months will continue to be adequately supported by our current operations and the total remaining credit facility availability.

As of March 31st, 2008, our backlog stood at $9.6 million compared to $9.3 million in backlog last year, well within our historic backlog range even after the high shipment levels.

In summary, sales were strong; gross profit dollars were increased to the high sales levels; and as a percentage of sales margins were reduced by the more appropriate method of valuing our inventory as well as the sales mix change. Operating expenses grew at less than half the rate of sales increase as we continued to be diligent in their control. We continued to generate strong operating cash. We are carrying over $1.3 million less debt than we were a year ago at March 31st, 2007, while investing almost $1.8 million in our new facility, and machinery and equipment.

Despite the reported net income number for the quarter, these continue to be solid indicators 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 can tell there are a lot of moving parts right now at Pro-Dex. Sales were strong this quarter. Profit was weakened by onetime inventory reserve adjustment and we were preparing during the quarter for a facility move which has now occurred.

As a result it is important that we try to separate the base business from the noise. Let me first run through each of the areas of the business for you, highlighting what is going on operationally. After that I will tie it all together with some comments about what the base business looks like, distinct from the onetime events that have impacted the third quarter and will impact the fourth quarter.

Beginning with Carson City, our motor sales were up 17% over Q3 of last year and the ending backlog remained strong at $1.9 million. Dramatically improved supplier deliveries to us have enabled far more efficient flow for internal operations and our customer deliveries. Shipments were strong in the Military and Commercial Aircraft markets with a 22% increase over Q3 last year, representing 73% of this quarter's motor sales as we caught up on our delivery commitment.

Medical sales, which account for 27% of our [Astromec] topline, represented a 14% increase over Q3 last year. These increases were driven by existing customers and do not yet reflect the anticipated growth in volumes for sales to our Irvine operation, scheduled to begin in September of 2008. Astromec has eight active engineering projects underway in the medical market. Three of those are for Irvine as previously mentioned. Three more are with an existing customer to further improve our current line of medical motors by applying what we have learned in the European market regarding more stringent cleaning and sterilization processes.

The last two projects are for another existing customer to develop two new medical device motors. The Irvine projects cumulatively represent $0.5 million in forecasted annual sales and the outside projects represent approximately the same.

Switching to our Motion Control business, topline sales in Beaverton were off 10% from last quarter, due primarily to a temporary slowdown with a key account. We expect to gain some ground in the next few months in other segments, including Medical Diagnostics and International Sales where we have already seen some positive activity. We are actively recruiting a national sales manager to help grow this valuable business.

Regarding IntraFlow, we introduced in March an updated version of the IntraFlow disposable which was enthusiastically received by current and new users at the recent annual session of the American Association of Endodontists. The previous version of the IntraFlow disposable was not designed by Pro-Dex, and our engineering group was able to bring several critical design enhancements to the product.

We also saw in March the publishing of research conducted at Baylor University in the Journal of Endodontics, citing the significant improvement in clinical efficacy of the IntraFlow system over conventional anesthesia techniques. Both of these developments add value to this unique product as we continue to search for the right business partnered with effective dental distribution to help exploit its full potential.

This brings us to the Medical Device business and our Santa Ana, now Irvine, operation. Starting with sales and marketing, our strong shipments for the quarter were driven primarily by this business unit, complemented slightly by Carson City strength. Sales from Santa Ana increased $1.2 million or 26% over the previous quarter, due to accelerated shipments required by two of our large customers. As Jeff mentioned, such accelerated requirements have now been fulfilled and we expect demand in the next two quarters to return to normalized historical rates.

As a result of the significant shipments during Q3, our Medical Device backlog decreased by $2.1 million during the quarter but remained level compared to the end of the third quarter last year. On April 16th, we announced the booking of a third new development agreement that we entered into this fiscal year. Upon successful completion, this agreement is projected to provide development fees of approximately $250,000 over the next 12 months and first-year product sales of approximately $2.4 million. These sales -- these product sales are not yet reflected in our current backlog as those orders are not placed until product development is complete.

Our customer intends to introduce this product in March 2009 at the annual meeting of the American Academy of Orthopedic Surgeons.

We are in final negotiations of a new supply agreement associated with the first development agreement we entered into this fiscal year. Development services related to this agreement are progressing well and initial product shipments are projected to begin in September of 2008 pending our customer's receipt of final regulatory approval of their new surgical procedure. First-year sales of this new product for the Spine segment of the orthopedic market are anticipated to be between $1.5 million and $3 million.

We also continue to make good progress on the second development project we entered into. In the next 60 days, we will be delivering proof of concepts through this customer, a milestone that will lead to final product configuration. As this is a very complex and expensive project, development efforts will continue for approximately 12 more months, providing development fees but no product sales during that time.

These three development projects will collectively generate approximately $1.3 million in development fees of between $4 million and $6 million in first-year product sales. They have already produced $400,000 in revenue from Development Services this fiscal year. All three projects involve 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 medical, the medical and dental industries. Following a recent visit to all three of our facilities, including our new corporate headquarters in Irvine, one of our major customers has requested that we provide them with a proposal on a new project that could represent approximately $3 million in new revenue. We are currently preparing this proposal.

To assist in other accelerate our business development efforts and ultimately our topline sales, we also announced on April 16th the hiring of Jim McKenney, a returning Pro-Dex associate as a regional director of business development. While only back with us for six weeks, Jim is already making an impact, identifying new business opportunities in the Medical Device market in segments where Pro-Dex does not currently have a strong presence.

Jim is based on the East Coast, where several of our large customers and project prospects are headquartered.

Our Engineering Group continues to ramp up to meet the product development opportunities by filling two open positions. Both a senior electoral engineer and a contract mechanical engineer have been added, enhancing both our capability and capacity to deliver on our commitments. The engineering team is making excellent progress on our three major development efforts as we have delivered clinical trial units to one, our close to proof of concept units to the second and completing the initial design phase for the third most recently signed agreement.

The Santa Ana Manufacturing Group delivered record shipments in the third quarter. In January, we recorded our first $2 million shipping month and followed immediately in February with another $2 million month. We are pleased that these repeatable results demonstrate that we have developed the systems and infrastructure to support significant growth. In addition to shipments out the door, we were able to build up component inventory to support the assembly of products during our move, and finished goods inventory to provide uninterrupted customer delivery.

Our Quality and Regulatory Group was busy this quarter with the annual assessment by our notified body, DQS. This work resulted in our continued certification for ISO 13485 medical devices, CE marketing and Canadian regulatory compliance. We implemented a decision this quarter to incorporate all repair activities into our [QARA] department. This allows us better controls over the return process as well as the ability to integrate all return data for better analysis, reporting and improvement.

Our senior leadership team from all three divisions began a training program specifically designed for executives who lead medical device companies; and all associates in Irvine were trained in our quality policy in 2008 quality objective.

Let me spend a couple of minutes discussing with you our recent facility relocation. As you can imagine, there were a host of issues that arose but, overall, the team executed flawlessly. Ken McBride, our Director of Project Management, led the charge on a comprehensive 216-line item relocation plan with the full support of all of his teammates. We began the shutdown of our machine shop on Wednesday, April 16th, about a week before all other functions which shut down on Wednesday, April 23rd. The entire physical move was completed by Friday, April 25th, two days later. Our assembly operation was installed, wired, plumbed, and ready to begin qualification orders by Wednesday, April 30th.

The machine shop was about two days behind that as we continued to finalize electrical, air, balancing, aligning and our final recommissioned checklist for each machine. All validation work is completed and ready for assessment by May 9th and we began full work orders at that time. We were not able to actually shift such work until our factory was recertified by the state FDA with whom we had maintained communication regarding their expectations and requirements for relicensing throughout the process. A complete facility process validation plan for the Irvine facility was developed a month before the move, and executed in conjunction with all other move activity.

On Tuesday of this week just two days ago, the state FDA spent the day with us, reviewing all aspects of our new facility and system. The review resulted in zero nonconformances and the granting of a renewed manufacturing device license for the Irvine facility.

So we are officially back in full operation from the server room and office areas to the machine shop, assembly, repairs and all regulatory operations. It is not uncommon for a facility recertification of this magnitude to take multiple visits and several weeks. So the fact that we received immediate certification is a real testimony to the professionalism and diligence of our entire move, manufacturing and QA team who drove this process over the last several months. Their preparation, discipline and commitment to excellence were evident at every step. I would like to publicly acknowledge their efforts.

The new space turned out extremely well, reflecting a clean professional disciplined environment for producing surgical devices. The office areas are quite open and collaborative in nature, allowing for all functions to easily connect. Our new facility clearly communicates our capability as an organization to customers, prospective associates and all who visit us. I would encourage any shareholder or potential shareholder to come see your new facility if you find yourself nearby. We would be delighted to give you the full tour.

One other note on the corporate level is that we have begun a training program for all 150 of our associates in all three locations. The program is called Productive Interaction and is facilitated by a company named 2130 Partners. The course is designed to increase the collaboration and creative expression of all members of the Pro-Dex team. Our Beaverton and Carson City associates have recently completed the training, and our Irvine associates are two sessions in to a six-week course. We have received very positive feedback regarding the impact and benefit of this training so far.

With that as the detailed update of the major areas of the Company, let's shift gears to what it all means in the big picture. Basically we are currently capable of manufacturing enough product to ship over $7 million million per quarter demonstrating the scalability we have built into our operations. Our current demand appears to be stable and predictable at about $6 million per quarter. The fourth quarter may be slightly softer then that due to some lost shipping dates but not much. The fourth quarter will also bear the entire $500,000 move cost. That's hard cost and lost manufacturing efficiency.

So our objective for the remainder of the year is to minimize the fourth quarter loss. Looking forward to the first year, first quarter of fiscal 2009, we just begin early shipment of our first new product. So we don't expect extraordinary revenue growth yet. It will be subsequent quarters where those effects start to materialize.

When eliminating the impact of the move cost and the inventory reserve adjustment, our core business is currently operating at the 36% margin level. We remain committed to driving that up into the 40s. The increase in our operating expenses reflects the investments we have made in people, in systems and facilities. Along with these investments we have improved our balance sheet by adopting reserve policies for inventory and warranty accruals that more accurately reflect our current operations. While these adjustments have hurt our current financial performance, they do ensure the proper timing of expenses for future periods.

We continue to generate cash from operations and remain profitable during this major reconstruction phase of the Company. The bottom line of all of this is that we are well poised to begin fiscal 2009 with a company that is squeaky clean -- operationally, financially and culturally. I'm confident that our fiscal 2009 results will begin to reflect the substantial investment and improvements we have made. We will finish the last six weeks of this fiscal year with a sincere attempt to retain as much of our first three quarters earnings as possible, maximizing the offset to the onetime move impact.

Beyond Q4 we will continue to guide the Company towards sustainable growth and profitability.

I thank you for your patience and confidence as we make the moves necessary to deliver that.

I now invite you to ask any questions that you may have.

(OPERATOR INSTRUCTIONS) [Scott Hood].

I think the move went very well so congratulations on that. If you could just elaborate a little bit more. When you talk about $6 million per quarter these are recurring contracts that you foresee over the next few quarters or could you maybe talk a little bit more about what those are?

We did $6 million in the first quarter and $6.1 million in the second quarter and there's nothing that leads us to believe that this $6 million was an aberration. The $7.6 million was the aberration. It appears that this $6 million is kind of a fairly comfortable and predictable baseline. The only caveat we added to that is the fourth quarter itself might be slightly below that because of shipping days, but that appears to be -- you know.

If you go back a year a $6 million quarter would have been a home run, and it now appears that that is kind of where we are; and that is not counting any of the three new contracts that we have been referring to. Does that answer it, Scott, or --?

Yes I think -- and the breakdown by the types of products were they roughly the same -- well, minus the onetime, but versus -- does the $6 million sort of base, is that broken down by product roughly the same the last couple of quarters? (multiple speakers)

I would say that there's a general shift, a slight shift from a decrease in motion control offset by an increase in Medical Devices. You know 5% type, 7% shift. Something like that. So if the bottom line is -- not the bottom profit line but the sales line is staying the same but it's reflecting a little bit of a shift from motion control to medical.

I apologize if this is -- you already answered this, but if you could talk a little bit more about the change in inventory and cost of goods sold?

Yes, can you elaborate the question so we (multiple speakers) hit it?

Just a little bit -- maybe a little more specific on what the change really is, not specific as if you're talking to an accountant, but not as -- but a little more than what you had in the press release?

Sure. In general in the past, we were more I won't say commodities base, but a recurring base manufacturing company so if we didn't sell something this year it seemed like it was a year and a half old, it's okay, because somewhere somebody is going to buy it. So our reserve policies were kind of built around at a year we might start looking at it, at two years we start reserving for it. You know, kind of based on that business model.

We have seen that because we are shifting to a much more custom environment where the products that we make, if they are not used by this particular customer in this particular product, they are probably not going to get used but generating a fairly systematic amount of excess and obsolete inventory. So to kind of acknowledge that and get in front of that curve and anticipate the reserve that should be on our books now. we went to a much cleaner -- that says, if it's been on our books for more than a year we need to reserve for it. If not (inaudible) on our books for a year, if the amount that is on our book exceeds our estimate of what we are going to use in the next year and our estimate of what we're going to use in the next year is based on the greater of either a 12-month look back or 12-month look forward based on a hard POs, then we are going to reserve for it.

And so it's a much cleaner, more aggressive reserve methodology or conservative accounting policy, whichever way you want to look at it. If it just recognizes the fact that a lot of our inventory do have custom products and we have to manage them accordingly. And the actual details of course are explained in the Q. I don't want to replace the actual language in the ., but the gist of it is shifting to a 12-month view of our inventory.

That helps. And is it -- I mean it's really this quarter where we will see the -- sequentially, we are probably it will be apples and apples from here on out?

Correct. The $300,000 charge disk quarter was the catch-up to get all inventories at all three divisions restated into the new policy.

And is this at all related to any, maybe new, anything new and how you are doing things in Irvine? Either in higher managing inventory or supply? Is there any -- or is it just a coincidence it was this quarter and nothing to do with a change in processes or (multiple speakers) --?

No. Completely unrelated to the facility move. We started this process in January. We looked at it again in February. We refined it to kind of a final approach in March. So that was all well before we moved here. So it's not dependent on moving or anything like that.

It's just been kind of watching over the last year the amount of E&O that we actually had reserved for first is the amount of movement of some of those parts and the determination that we really do need to get (multiple speakers) it wasn't matching up.

Okay. That's good. Thank you.

(OPERATOR INSTRUCTIONS) Larry Brookes with Moloney Securities.

In reference to the obsolete material, is this something that you actually ordered too much of the product ahead of time or how does that actually come about?

There are a couple of reasons, a couple of things that drive that. Either a parts ordering quantity was a little high or higher than we actually needed for the order. Say they needed 50 parts and the ordering quantity break was at 75. So, we had 25 extras and maybe only 10 of those could be used for repairs or reconfigured or some other place. Some things were [are] obsoleted by revision changes where an engineering change comes through and a part is no longer reconfigurable or can't be used in the current configuration.

Some of that was with a conscious decision to make sure that we did not miss our order shipments based on having one short of a part or one part missing so in some cases we intentionally put extra parts on the books, extra parts on order due to various reasons with suppliers [or] as critical as the parts are to make sure we could deliver on time to our customers and our on-time percentage has gone, has greatly improved in the last six to nine months. So our late orders are down to a real record low right now. And now, we're just recognizing that that piece is accounting-wise not going to be used.

It may still be used in this 12th or the 13th or the 15th month but for our representation to make sure that we are matching up the cost correctly to the sales, we shifted the bar in the inventory reserve.

Larry, one other piece that's even potentially softer than this kind of issue that Jeff described is, we might in the past have said, "Okay. we got 100 of these parts whatever they are left over and I think we can sell those, I think we can get value for them." So we might in up previous policy not have reserve for those and the expectation that we will sell them in some way or use them in some product and then maybe a year later we still haven't sold them and they haven't been reserved, and now we are taking the reserve a year after that fact.

So under the new methodology it's like, if they exceed 12 months, we take a reserve for them and if we ultimately can use them in a product 18 months later or get value for them, then, that is great. They will come off the reserve and it will be a 100% profit margin at that point, but we're basically going to consider our inventories guilty until proven innocent as opposed to innocent until proven guilty, if that makes sense.

Do you expect that there is a chance you could recoup some of that, maybe 10% of it?

Could be, I am thinking that we might see a little bit more variability in that number month-to-month, but we don't know.

Yes. What about the warranty issue? I know in the past the failure rate for some of the product was 5%, sometimes even higher. What's happened with the warranty stuff going on?

The warranty, the warranty that's in the current financials is accrued at consistent rate but there's been no major catch-ups from previous warranties included in this quarter nor do we expect there to be. We expect our methodology is sufficient. The reason the warranty numbers are a significant factor in this quarter is simply because we shipped tremendous amount of warranty-related product. That's virtually 100% of the increase over the $6 million to the $7.6 million was that and obviously a portion of the $6 million is that too.

The warranty of all products is considered within industry standards. Two products that we shipped, that we are -- we ourselves do not consider our warranty rates to be acceptable. We want to lower those. We are continuing efforts and engineering efforts that are going into systematically reducing those [failure] rates and we have seen reductions in failure rates, pretty significant reductions in the last year. And we are continuing to go for additional reduction in those two products.

Do you have a percentage as far as what the product that had caused -- that has caused so much problem? What that failure rate presently is?

I do and I prefer not to share it. We haven't shared for confidentiality reasons with the customer and other. But I will say that what you and I are used to, what normal people are used to in the failure rate of a clock that we might buy or something like that is not the expected industry failure rate of a surgical device that is subjective, it has a motor, and a cable and electronics subjected to saline, high temperatures, water, bath and all kinds of factors.

It's effectively a submarine in a lot of ways with electronics and motors that have to be sealed. So part of it is that the numbers in that market would be higher than you expect but our customers understand that because they are used to those markets too.

So I think I'd rather just leave it that they have come down significantly and on those two products we are still working to make them come down more.

And lastly, the DSOs, what are they approximately?

Days outstanding on receivables are about 42 days. So they are about as good as they've been since I've been here. We used to run in the mid to high 50s and we've been able to, especially with a couple of big customers out there, get everybody reined in to pay on time the full amount. We solved this last quarter with our -- between our customers and our sales department resolved a big receivable that was outstanding and getting old for different products going back and forth and clean up did count a lot. So we are in good shape on our DSOs.

That's good. Thank you. I hope margins move up and earnings move up and good luck to you.

Thank you, Larry, we do too.

(OPERATOR INSTRUCTIONS). [Gary Simon] with [UBE Partners].

I have a follow-up to a prior question; we were talking about the inventory obsolescence. If more of your product is custom-built, why would you end up with additional or extra inventory that is not going to be purchased? If it is such a customized product, wouldn't they order and you produce to purchase orders?

Sometimes but not always. Sometimes the lead times of the components displayed the lead times of the POs. I would say in the last year has been much more militant about going to our customers and saying we can't order motors or cables or whatever those long lead items are unless we have a PO from you at least for the components that are long lead if not for the entire device. And in most cases our customers have been, I would say in nearly every case our customers have complied.

That was not always the case and there are some lingering items that -- and sometimes maybe the customer places an order and I mean it still is going to happen in the custom business, the customer places an order and then they are no longer creditworthy. So you have a choice between you got a hard PO from a customer you either write off the inventory at cost and turning into a final product and write out the receivable. So there'd still be some of that, but our intention is to also align our business practices with the accounting model that we're using.

Right, because it doesn't -- I mean you know the business better than I do, but it doesn't seem a good idea to be making a custom product for inventory and then having the risk that the customer is not going to take it or you're not going to want to ship to them.

I agree.

That's one reason we made the shift. Going from the more generic dental type products that had a broader sales market to the one or two offs here made us make a change.

You are right on the money, Gary, regarding the business practice.

If that's the case and you are shifting away from having that risk, then I would -- then that inventory reserve, that switch should have been more of a onetime event and it is probably on inventory that is sitting there today and you shouldn't have that percentage of obsolescence or custom inventory for no PO going forward. So with that being a onetime and the change, the warranty change, I'm just trying to look towards the fourth quarter compared to the third quarter and I understand the fourth quarter sales will be more back in line with the first couple of quarters of the year. And knowing that there is a $0.5 million, approximate $0.5 million move, for the move, when you offset that with close to $0.5 million of these onetime charges, it seems like you are more or less in the same ballpark, except you just have a little lower level of sales. Is that correct?

The sales level in the fourth quarter is going to be, our expectation at this point, slightly below what it was in the first and second quarter. Slightly below that $6 million baseline.

Slightly below? Okay. I thought it was going to be a little bit above.

Because of the number of days. You know we went from, what, April 25th to May 9th we were not making. We were not (multiple speakers). Because of move-related activities we were moving and then setting up and then requalifying for FDA and it wasn't until May 9th that we started producing again. So that's the reason (technical difficulties) slightly softer. We are obviously trying to catch up between May 9th and June 30th as much as we can of that with our new and wonderful manufacturing scalability.

It's more efficient so you should be able to do in six and nine weeks what you can only do in 12 weeks, huh?

That's the idea. (multiple speakers)

That's what I keep telling [Rick van Kirk] so -- but, anyway, the bottom line will be softer than probably the $6 million and you got the $500,000 move cost and you got some increase in operating expenses that are just, we just had a higher level of operating expense in Q4 than we did in Q1 before some of our infrastructure was built so that's kind of a soft combination of events that we're looking at.

Okay. Good luck.

There are no further questions at this time. Are there any closing remarks?

Just thank you very much and I know that we are all growing impatient with when is the machine going to start printing the cash and know that your senior leadership team is as impatient as you are; and when we get through these kind of balance sheet cleanups and move in other repositioning efforts we are fully committed to play for the gold. So thank you very much for your time and patience and have a great day.

Thank you. This concludes today's Pro-Dex Fiscal 2008 Third Quarter Financial Results and Review of Current Corporate Developments conference call. You may now disconnect.