Pro-Dex Inc (PDEX) 2010 Q4 法說會逐字稿

Welcome, ladies and gentlemen. My name is Gerald, and I will be your conference operator. At this time, I would like to welcome everyone to Pro-Dex, Inc.'s fourth-quarter and full-year fiscal 2010 earnings call. (Operator Instructions).

Before we begin, a note about forward-looking statements. Statements herein concerning the Company's plans, growth and strategies may include forward-looking statements within the context of the federal securities laws. Statements regarding the Company's future events, developments and future performance, as well as management's expectations, beliefs, plans, estimates or projections relating to the future, are forward-looking statements within the meaning of these laws.

The Company's actual results may differ materially from those suggested as a result of various factors. Interested parties should refer to the disclosure concerning the operational and business concerns of the Company set forth in the Company's filings with the Securities and Exchange Commission.

I would now like to turn the conference over to Mr. Mark Murphy. Sir, you may begin.

Thank you, Gerald, and thank you all for joining us to review Pro-Dex's fourth-quarter and year-end results for the fiscal year ended June 30, 2010.

In today's call, Jeff Ritchey, our CFO, will provide us with a synopsis of our operating results, and then I will comment on various aspects of the Company and how those results were produced. Lastly, as Gerald mentioned, we will open the call up to your questions.

So let's get started with Jeff providing a brief summary of the numbers. Jeff?

Thank you, Mark. First, we'll review the fourth quarter ending June 30, 2010, with last year's fourth quarter, then we'll compare the full year's fiscal 2010 and fiscal 2009.

Starting with the quarterly comparison, consolidated revenue for the fourth quarter fiscal 2010 increased by $100,000 to $5.7 million or 2.2% over last year's fourth quarter. This increase is due to increased shipments of medical devices and motion control products, offset by declines in our small motor sales.

The sales increases in the high margin businesses drove our consolidated gross margin for the fourth quarter to 38% compared to 35% in the previous year's fourth quarter. Operating costs in the fourth quarter, before the impairment and valuation charges that I'll discuss next, were $1.9 million, approximately $200,000 higher than the $1.7 million in last year's fourth quarter, due to higher marketing costs.

The resulting quarterly operating income in 2010 before impairments was $297,000 compared to $239,000 in last year's fourth quarter. The fourth quarter of 2010 included charges of $3 million for the remaining Astromec and Micro Motors goodwill, and $1.3 million for writing down the Carson City real property value for a total of $4.3 million of non-cash impairment and real property value reduction charges.

These charges were reflected on our GAAP financials as operating expenses. Taking into consideration these charges, our 2010 fourth-quarter operating loss was $4 million versus income of $239,000 in the 2009 fourth quarter. As a result, net income was a loss per share of $1.20 in the fourth quarter of 2010 compared to earnings per share of $0.02 in last year's fourth quarter.

Comparing the full fiscal year results of 2010 with 2009, consolidated revenue for fiscal year 2010 increased by 10%, as total medical shipments, led by sales to our two largest customers, increased by 24%. Our consolidated gross margin for the year was 36%, 4 percentage points higher than the 32% in 2009. Operating costs for fiscal 2010 before the impairment and valuation charges were $7.1 million, approximately even with the $7.2 million last year for the 2009 impairment charge.

The resulting operating income before impairments was $1.2 million in 2010 versus an operating loss of $494,000 in 2009. The full years 2010 and 2009 did include goodwill impairment charges for writing off the value associated with the Interpol patent of $140,000 in 2010 and $997,000 in 2009. Total impairment and property value reduction charges realized in 2010 were $4,444,000 and in 2009 were $997,000.

Following the recognition of these items, our balance sheet has no remaining intangible assets. Taking into consideration these full-year non-cash charges, our 2010 operating loss was $3.2 million versus a loss of $1.5 million in 2009. Net loss per share in 2010 was $0.92, where last year's loss per share was $0.88. In 2010, we provided cash from operations of $570,000 for the fourth quarter and $3.2 million for the whole year, compared to providing $878,000 for last year's fourth quarter and providing $1.7 million for the prior full-year.

Cash on-hand grew to $3.8 million at June 30, 2010, compared to $1.1 million at June 30, 2009. Our cash levels continued to exceed our debt levels, and at the end of 2010, we had net cash of $900,000 compared to net debt of $2.2 million at June 30, 2009. And then subsequent to year-end, we paid off the remaining $1.5 million balance on a real estate loan on the Carson City property, leaving a good current cash balance of over $2 million after the repayment.

Our tenant improvement loan is the only remaining debt outstanding, with a balance of $1.3 million as of today, and there remains nothing borrowed on our credit line. As of June 30, 2010, our backlog stood at $1.2 million compared to $9.8 million in backlog at the same time last year. Both amounts are within our historical operating backlog range of $9 million to $12 million.

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

Thank you, Jeff. I have organized my comments into three areas. One, the historical performance of the Company, excluding the impairment and property valuation amounts. In other words, how did the fundamental operating engine of the Company perform?

Two, what about the write-offs? What are they for and what do they mean?

And three, where are we today and what are our strategic objectives?

Starting with the historical performance, excluding impairment and property valuation adjustments, our Irvine business made $2.2 million in fiscal year 2010, compared to only $289,000 in fiscal year 2009. This 7.5 times increase in operating profit was produced by 14% higher sales, 4.3 additional margin points, and just under $0.5 million less in SG&A spending. The Irvine medical device business has never before achieved this level of profitability.

Beaverton's operating income climbed from $460,000 to $560,000, a 22% increase in earnings on flat sales by achieving 8.5 additional margin points while investing $106,000 more in SG&A spending. Carson City's performance improved on 4% lower sales through decreased SG&A spending.

In fiscal 2010, we generated $3.2 million in operating cash, the highest level achieved in the last 10 years. So, operationally, we produced excellent results in fiscal year 2010. Our customers seem to have finished burning down their inventories and are placing orders for product as they require it. Such orders are now smaller, just-in-time PO's, except for our two largest customers who continue to place blanket orders.

In some cases, the smaller order sizes have improved our margins due to lower volume pricing. Though, yes, there were no changes expected in our base business, I would say that we are in excellent shape -- but more on that in a few moments.

Now let's talk about the write-offs. Starting with our Carson City operation, we wrote off two separate amounts. For the business itself, the entire amount of $1.9 million in goodwill was written off. Our acquisition of this business in 2006 and our subsequent carrying value of it was premised on our ability to create certain synergies with the Irvine operation, primarily in the form of internal motor purchases.

Our inability to achieve those synergies resulted in our elimination of the goodwill value. Consequently, the facilities used to support that operation were also restated to their current fair market value. As with most land and building in the United States, the value of ours is substantially less today than it was four years ago when we purchased it, resulting in a $1.3 million valuation write-down.

Lastly, we wrote off the full $1.1 million of our Micro Motors goodwill on the Irvine operation. Given our largest customer's plans to develop its own version of the two products we sell to such customer, we must develop alternative revenue streams to preserve the value of the goodwill in our books. As we have not yet been successful in securing these ultimate revenue streams, the goodwill value has been written off.

The total of these charges are $4.3 million for the fourth quarter and $4.4 million for all of fiscal 2010, including the $140,000 final IntraFlow write-off in the second quarter. As Jeff mentioned, there are no remaining intangible assets on the Company's balance sheet as of June 30, 2010.

Moving lastly to our current outlook, we cannot rest on our historical results. Given our largest customer's intentions, our most compelling initiative is to identify and secure new business. Even though such customer has recently indicated to us that the introduction of their second product will be at least six months later than was originally planned, we remain committed to replacing this business.

With a backlog at June 30, 2010 of $11.2 million, 14% higher than it was at the end of fiscal 2009, the immediate outlook remains positive. Also, all motion control sales continue to recover as the economy picks up. Our primary challenge, therefore, is looking out toward the second half of this fiscal year to protect our top-line.

Since our legacy business model of custom product development does not typically produce short-term revenues, due to the development cycle, we are augmenting our sales efforts with services that involve a shorter sales cycle, primarily contract manufacturing. In the past, we have viewed our ISO 1345 certified manufacturing and regulatory capabilities as simply necessary tools to deliver on our entire value proposition of accelerated product development. We are learning, however, that these capabilities have value in and of themselves.

As the FDA increases responsibilities around supplier controls, customers are becoming much more demanding of existing and new suppliers. This bodes well for Pro-Dex, as our quality systems and manufacturing processes are best-of-class. While this is still a new market that we are learning about daily, initial indications are that we can provide true value here.

Some of our specific efforts have been in the following areas. We are currently working to become a key supplier for two large medical device OEMs. The qualification route will be through supporting them on a new product release, but we expect the relationships to expand to more contract manufacturing. We have not signed definitive agreements with either party yet.

Second, we are targeting a project which involves consumables to bolster some annuity sales.

Third, we have stepped up our marketing efforts considerably, doubling our attendance at trade shows, increasing our advertising presence significantly, developing new brochures and collateral material for all of our businesses, writing thought leadership articles for several leading industry publications, and shooting extensive video and photos of our facilities to highlight our capabilities. All of this material and information will be featured in our new website and online social media strategy, which will go live in the month of October.

Lastly, we have retained an executive recruiter to identify and hire a senior sales executive with medical device contract manufacturing experience. We hope to have this person in place by the end of calendar 2010.

While we work to capitalize on every opportunity before us, we will continue to treat cash as king. Having generated $3.2 million in operating cash during fiscal '10, we have strengthened our balance sheet in addition to our operations and are well-prepared for the challenges that face us. Please know that your leadership team is fully engaged in ensuring continued strong performance.

We will now open the phone lines up to answer any questions that you may have.

(Operator Instructions). Vincent Staunton, Wedbush.

In terms of a timeline, what is the expected timeline for, I guess, the two products by your largest customer to, I guess, drop off?

Based on indications from them, there's three categories. There's Product A, Product B, and Repairs. Repairs have been indicated to us that they will remain -- that Pro-Dex will continue to repair the Pro-Dex hand pieces. So that has the longest timeline.

The next longest timeline is Product B, which has been indicated that we should continue to receive normal volumes of sales through calendar year 2011 -- sorry, December of 2011 -- 15 months from now; and then after 2011, no visibility as to will it continue/will it stop on that date? But kind of a sense that, given where they are in the development timeframe, that's where they are.

And then Product A, they have indicated that they are satisfied with the initial testing of their product and are beginning to place it into customers at this point. However, there are two situations when they would continue to sell a Pro-Dex product into a new situation.

One is for their South American markets, where it can take up to two years to get those products qualified in South America. And the second case is if there is an existing hospital that has, let's say, seven or 10 Pro-Dex hand pieces and they need to replace two of them. The highest likelihood is that they would just replace those with Pro-Dex hand pieces, so as not to mix and match in an existing account.

So the new hand pieces, the new Product A's, if you will, being developed by the customer themselves, would only be being placed into new accounts. All that math has done in the 10-K and how that all averages, and how much is Product A, Product B, and Repairs? But that's the general gist.

I will say that the customer has been just quite cooperative in giving us as much visibility as they have, and the relationships between the two companies are very positive, and they're doing what they need to do and we're doing what we need to do to support them in the interim. And as they have updates, although they have an obligation to continue in the future, they have at least historically been as informative as they can be with us, once they know.

Okay. Thanks, guys. I appreciate it.

You're welcome.

Michael Potter, Monarch Capital.

Just a quick question. Is -- the motion control business, has -- where is that relatives to run rates comp that the operation was running at, let's say, 2007 and 2008?

Roughly, it went -- let's call those levels 100%. It dropped down in the -- precipitously in January of 2009 to 25%. It has worked its way back up to the fourth quarter that's being reported here, to about 75% to 80% of those revenues.

So it's come back quite a ways?

Come back quite a ways. Not quite to the full level, but it's certainly providing some wind beneath the wings in the numbers that you've seen in the third and fourth quarter.

Is it -- do you anticipate that it's going to continue to trend upward?

We think -- we're not counting on the fact that it's going to get back to 100% based on legacy sales. We're putting some pretty good investment into sales and marketing to make that last 20% happen through new sales.

We've seen some blips here and there, where a legacy customer that had gone dark for awhile or minimal sales and then they placed a big order. And it's been a nice kind of recovery, but we're not counting on the [systemic] old business getting back to 100%. I think 80% is where we feel we can count on, if you will.

And how is the new sales and marketing strategy working there? Have we been able to add new customers? Or it's really old customers coming back (multiple speakers) and increasing their order rates?

(multiple speakers) Oh, it's all geared toward new customers; but at that business, even more so than at Irvine, is very much we're going to create this new piece of equipment that we need to control the motion on. We're looking at three vendors to be that.

Can you send us two cards, you know, two motion controllers and we're going to try it. Even in the cases where we've been selected, and sell you guys one, they then develop their machine working with us and we provide the controller. That might take 12 months, 18 months to develop the machine and then we're designed in. Nobody's going to -- the motion controller is the brain of a machine; nobody's going to rip the brain out of the machine.

So, once they start shipping machines, if it's a hit, we're going to sell a lot of controllers. So, we've gotten a lot of activity, much more activity than we have in the past, relative to you're in the bidding process. We've made it further and we have had a couple of nods that you're the one, but nothing that's hit the -- other than three boards there, five boards there, maybe a few prototypes, nothing that's hit the 50 boards a month consistently-type revenue line yet.

Okay. But the pipeline is continuing to expand?

The pipeline is continuing to expand, yes.

Okay. And I'm a little confused on Carson City. We've taken the big write-offs there. What is the status of their operation?

In what way?

I guess what's the revenue run rate? Are we looking to completely fold that into Irvine? Are we looking to resurrect -- if not, are we looking to resurrect sales and marketing there? What is the strategy there?

I would say that, given the fairly recent conversation about the synergies with Irvine and it not being the right arm of Irvine that we are looking at everything. We're looking at if we increase the revenues there, if we -- you know, can we reduce the cost structure? It's not a hemorrhaging business, but it's certainly not a strategic component. So I would say I don't have a good answer for you today, Michael, but hopefully, in the next three to six months, we'll have a more definitive answer.

Okay. And then, I guess back to Pro-Dex core, with regards to, again, to Sales and Marketing, we hired an executive recruiting firm to find a new head of Sales and Marketing. What's the current status of that process? And when do you anticipate having someone in that seat?

The process started about four weeks ago, and target in the seat is the end of this year, the end of this calendar year. So, hopefully, February 1, we're in the ground running.

Got it. Got it. Okay. Thanks, guys.

Benjamin Sexson, First Wilshire.

I didn't hear your comments about the backlog. Can you restate those, please?

Our backlog at the end of the year was about $11.2 million, which is still pretty healthy compared to historically or historical run rates; it's at the higher end of the range. So it looks -- bodes well for the next six months of business there. And as Mark mentioned, that after, say, the beginning of calendar 2011, that's when it gets a little cloudy.

The general range is $9 million to $12 million, Ben. And we've been as low as $8.6 million and we've been as high as $12.6 million, as kind of a record. And so, last year, I think we were at $9.7 million at the end of the year and this year, we're at $11.2 million. So we're at the upper end, but not blowout, but we're certainly not anemic at the backlog, just for some historical perspective.

This is Scott. Can you did just give us a feeling for what cash flow was for the full year, taking out, like, maybe tax items or anything that might be extraordinary, just to give us a feel of cash flow?

This is Jeff, Scott. We had the $3.2 million and the only extraordinary item in there was about a $550,000 receipt of a tax refund, based on the net operating loss carryback that we got in the second quarter. So the rest of that's just profitability and a little bit on the inventory.

Great. On motion control, is there anything you can say sort of how that 80% affects your bottom-line? Just how that business affects the bottom-line?

We can't say too much without getting into segment reporting and stuff, but I would say that it's fair to say that the motion control products are our most profitable. They've got the highest software content. So when those revenues drop from 100% to 25%, even though it's only a few million dollars at the top-line of [23%], we would feel that a lot more in our operating line than we would in our top-line, if that makes sense. So, I -- without getting into specifics, I'd say it's a very leveraged impact.

Okay. Can you maybe talk a little bit about just what constitutes the $11.2 million of backlog? Is that -- maybe you can't give an exact percentage, but is there growth for motion control in that backlog or --?

Motion control is -- let's see.

I would say not much.

Not much. Motion control -- the up's in the medical at Irvine.

Motion control by the nature of the business doesn't normally place long-lead deals, and especially with the -- so, I would say two years ago, they would have a few customers that placed a few. We would have a few customers at Beaverton. Then, when everybody went into inventory reduction mode, nobody bought anything. And now, especially in Beaverton, I talked to our GM there yesterday, and he was the one indicating that they are just seeing a lot more hand-to-mouth. They're seeing, you know, we need five controllers, we need eight, we need these in the next 30 days.

Okay.

They're not seeing -- so, in that $11.2 million is probably minuscule amounts for Beaverton.

Okay. Is the Sales and Marketing executive that you're going to hire, will they have any experience with motion control products? Or are they going to be focused mostly on the medical space?

Mostly on the medical. In January of 2009, we hired a gentleman out of Parker that was -- that is -- exclusively works on motion control. And that was the month that the thing went into the tank, in terms of our revenue outlook, the 25% of 100 month. And we hired that person against the grain and he's spent since then looking for every opportunity.

So we have what we'd consider to be the best motion control top-line resource we've had in the Company in a long time, and who is dedicated only to that. And this person that we're looking to hire is going to primarily be bringing the contract manufacturing and the medical device side, the high-value domestic contract manufacturing on the medical device side to the table.

This is Scott again. Can you just refresh memory on the debt? I guess it's all related to the new facility?

That's all that's left. When we moved into the new facility, we (multiple speakers) --

In Irvine.

-- in Irvine, we -- that was about two and half years ago. We took on [about] $2 million worth of debt on a five-year note. So we're about halfway through that right now. There's a one point -- just over $1.3 million left on that.

What's the rate?

That's fixed at 5.7%.

Okay. Can you refi that? That's sort of confidential, I suppose, but what could you do there?

Well, there'd be some prepayment penalties on that one, so we could refinance it. Right now we're holding tight by paying down our mortgage first. That had a higher rate. That had 6.7% less [the] prepayment penalties.

Okay, thanks.

Great. That's all of my questions. Thank you.

(Operator Instructions). And gentlemen, there are currently no additional questions in the queue.

Alright. Thank you, everyone, for joining us. We appreciate it, and have a great rest of your day. Bye-bye.

Ladies and gentlemen, this does conclude Pro-Dex, Inc.'s fourth-quarter and full-year fiscal 2010 earnings call. You may now all disconnect.