Pro-Dex Inc (PDEX) 2011 Q4 法說會逐字稿

Greetings, and welcome to the Pro-Dex fiscal 2011 fourth quarter and full-year conference call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded. Please note that the comments made on this call may include statements that are forward-looking within the meanings of securities law. These forward-looking statements may include, without limitation, statements related to anticipated industry trends, the Company's plans, products, perspectives and strategies, both preliminary and projected. Actual results or trends could differ materially.

We undertake no obligation to revise or publicly revise the results of any revision to be forward-looking statements or in light of new information or future events. For more information, please refer to the risk factors discussed in the Company's Form 10K for the year ended June 30, 2011, in the Form 8-K filed with the SEC today, along with the attached press release. Copies can be obtained from the SEC or by visiting our website at www.Pro-Dex.com. It is now my pleasure to introduce your host, Mr. Mark Murphy, CEO of Pro-Dex. Thank you. Mr. Murphy, you may begin.

Thank you, Doug, and thank you all for joining us to review Pro-Dex's results for our fourth quarter and full-year ended June 30, 2011. In today's call, Hal Hurwitz, our CFO, will provide us with a synopsis of our operating results, after which I will comment on various aspects of the Company. How those results were produced, what is happening in the Company today and what our objectives are moving forward. Then, as Doug mentioned, we will open up the call to your questions. Let's get started with Hal.

Thank you, Mark. Sales for the quarter ended June 30, 2011 increased 31%, to $7.5 million from $5.7 million for the corresponding quarter in 2010, resulting primarily from an increase in sales of the Company's medical device products to its 3 largest customers. For the year ended June 30, 2011, sales increased 17% to $27.1 million from $23.2 million for fiscal year 2010, resulting from increases in sales of the Company's medical device products to our largest medical device customer and from growth in sales of motion control products. Gross margin for the 2011 fourth quarter was 41%, an increase from gross margin of 38% in the fourth quarter of 2010. For the year ended June 30, 2011, gross margin improved to 39% from 36% for fiscal year 2010. This improvement was attributable to a shift in the mix of our business toward more profit of products and to cost reductions. Total operating expenses for the quarter ended June 30, 2011 were $1.9 million, an increase of only 1% from the corresponding quarter in 2010.

For the year ended June 30, 2011, operating expenses were $7.3 million, relatively unchanged from $7.2 million of operating expenses before impairment charges incurred during fiscal year 2010. The increased sales, improved gross margin and controlled operating expenses resulted in appreciably higher operating income, which increased 283% in the quarter ended June 30, 2011 to $1.1 million compared to $296,000 before impairment charges in the 2010 fourth quarter. Similarly, for the year ended June 30, 2011, operating income increased 167% to $3.2 million compared to $1.2 million before impairment charges for the fiscal year 2010. Net income for the 2011 fourth quarter was $1 million, or $0.31 per fully diluted share, a 498% improvement from net income of $172,000, or $0.05 per fully diluted share before the after-tax effect of impairment charges in the corresponding 2010 quarter. For the year ended June 30, 2011, net income was $2.6 million, or $0.80 per diluted share, an increase of 111% from net income of $1.2 million, or $0.38 per diluted share before the after-tax effect of impairment charges in fiscal year 2010. You might have noted from my comments regarding operating income and net income that we have chosen to compare our fiscal 2011 results to comparable results in fiscal 2010 before the effects of impairment charges in that year. These impairment charges, which amounted to $4.3 million in the fourth quarter, and $4.4 million for the full year of fiscal 2010, related to write offs of goodwill and intangible assets and to a reduction in the carrying value of our Carson City Nevada facility. Since these 2010 charges were nonrecurring, we believe it is more meaningful to compare our 2011 results to what the 2010 results would have been without the effects of these charges.

In the year ended June 30, 2011, we generated $2.9 million of cash from operations as compared to fiscal year 2010 in which we generated operating cash of $3.2 million. Noteworthy in this comparison, however, is that our aggregate investments in accounts receivable and inventory in fiscal 2011 were $882,000 greater than in fiscal 2010 due to the increased sales volume in 2011. In addition, the fiscal 2010 cash increase included collection of a federal income tax receivable amounting to $548,000. In light of these comparative factors, test generation in 2011 was considerable. Cash on hand at June 30, 2011 was $4.7 million as compared to $3.8 million at June 30, 2010, which is noteworthy when considering that in the current fiscal year, we paid off the remaining $1.5 million balance on the mortgage collateralized by our Carson City property, fully retiring that debt. At June 30, 2011, our backlog stood at $14.3 million compared with a backlog of $11.2 million at June 30, 2010. Although the amount of the backlog at June 30, 2011 is at the high end of our range, the increase between years is due to normal fluctuations in the timing of receiving shipments of orders. With that, I will turn the call back over to Mark for his review and outlook comments.

Thank you, Hal. Fiscal 2011's results are notable, not only in terms of profitability, but also in terms of establishing a benchmark. While the top line in gross margin improvements were largely attributable to orders from our largest medical device customer, the ability to control operating expenses amidst significantly increase shipments is an accomplishment that we are certainly proud of. As you remember, we made substantial adjustments during the 2008 to 2010 recession. And while we have reinvested very strategically in key elements of our infrastructure system, especially in the area of sales and marketing, we have intentionally resisted returning to previous overall spending levels, controlling expenditures carefully amidst record high revenues.

Drilling a little deeper to each operational area of the Company, we saw a decrease in motor sales more than offset by increases in motion control and medical device revenues. Our motor sales posted an 8% year-over-year decrease from fiscal 2010. Despite the disappointing year, we have strong bookings in place over the next several months, having recently signed a long-term purchase agreement with our second largest motor customer. We also have several new motor proposals in the works. Motion control products delivered year-over-year sales increases with revenues up 25% for the year ended June 30, 2011 as compared to 2010. Such increases continue to represent the recovery of our top line from the significant revenue drop experienced during the recession. The biggest contributor of our top line was our medical device business, with sales up $3.7 million, or 21% for the year ended June 30, 2011 compared to 2010. As mentioned, these sales were driven by orders from our largest customer, whom I will discuss in a few minutes.

August 31 was my five year anniversary as the CEO of your Company. When I think back about where we were in 2006 versus today in terms of engineering capability, regulatory understanding, product reliability, balance sheet metrics, facilities, cost structure, a collaborative culture and a myriad of other factors, it is like night and day difference. We are so much more capable in all areas, and I am deeply grateful to the Pro-Dex associates who made it happen and to the shareholders who have patiently allowed us to transform the Company.

Not too many companies have an opportunity to actually see what their future looks like at a particular revenue level. We just did. Pro-Dex delivered $3.2 million of operating income, the best performance in the Company's history. And it generated $2.9 million in cash during a year that we invested heavily in receivables and inventory. While it's great to celebrate this single year accomplishment, the more important factor is that 2011 results show us what our future can be. Many companies are guessing on what their P&L would look like on higher revenues, but we have had an opportunity to see ours. This visibility will serve to drive and motivate us as we face yet another challenge as the building of our customer base.

As I mentioned, our largest customer drove substantial revenues in 2011. It built inventory of Pro-Dex products in preparation for its transition for its own in-house hand pieces to replace the two units we currently manufacture for them. In June, this customer informed us, as we then publicly disclosed, that it planned to purchase all the products it has on order with us in fiscal 2012, but did not plan to place any further orders with us. In addition, the customer indicated that it plans to limit repair requests from us to those units that are covered by our product warranty. At June 30, 2011, our backlog from this customer amounted to approximately $5 million, all of which we expect to ship in this fiscal year. Based on what the customer is communicated to us to date, it is probable that our sales to the customer will decline in the first half of this current fiscal year, 2012, and decline to a negligible amount, or 0, by the end of this fiscal year. Since November of 2009 we first learned about their potential plan, we have been the beneficiary of this customer's increased market success in selling the products we make for them. This success has provided us with strong financial results, the ability to build up cash and time to identify and attract additional revenue sources.

Despite the continuing sluggish economy, we've made significant investments in sales and marketing to define and deploy an expanded value proposition with the objective of substantially growing, or in this case, regrowing our top line. Part of this was the shift from being a relatively narrow company who can provide, quote, a custom-designed powered surgical hand piece, unquote, to a broader company who can service large medical device OEMs that have requirements for machining, assembly, design, motors, controls and a pristine regulatory profile. This offering greatly expands our value proposition by deploying this expanded offering through our redeveloped website, trade advertising, increased trade show presence, participation in industry conferences, published articles in multiple publications, strategic partnerships, social media such as Linked In and a new senior sales executive, we have far more hooks in the water than ever before. As a result, Pro-Dex is currently responding to more requests for proposals from existing and prospective customers then at any time in the last several years. These requests have come to us from a variety of sources, as the following examples will illustrate.

The first example is an existing customer who is a major medical device OEM. In past years, we have successfully participated in several programs for one of this OEMs divisions, we have received accolades on specific projects, scored high marks on the regulatory audits scoreboard and establish relationships with a core group of engineers. With Paul Rudzinski's arrival of Pro-Dex in March of 2011 as our vice president of global sales, we have been able to leverage our existing and his additional contacts which include individuals in other divisions of the same OEM, creating multiple points of contact within this OEM and a much greater visibility of Pro-Dex. The result has been our receipt of requests for contract manufacturing proposals on several part numbers and an active proposal for one of this OEMs major new programs.

The second example relates to a different major medical device OEM who has not historically been a Pro-Dex customer but who has been a customer of Paul's over several years. With Paul's contact base as a foundation, we were able to build a network within the OEM that has led to a request for proposal last week. In a different division of the same major OEM, we had engineers visit our booth at an orthopedic trade show inquiring about a new motor for one of their hand pieces. And presenting our overall capability of follow up meeting, the customer was intrigued with our design knowledge and machining assembly capabilities, resulting in our submission of proposals for both the motor project and a contract manufacturing opportunity.

The third and last example is a second-tier medical device company who has designed their own powered surgical hand piece and is looking for a contract manufacturer to produce it for them starting sometime in calendar year 2013. Understanding the level of effort that goes into testing and qualifying a device like this, Pro-Dex has submitted a proposal for this work and is actively engaged in conversations with this prospect who worked with us several years ago and renewed their awareness of us through advertising and trade show presence. In all cases, the conversation starts with us understanding what the prospect is trying to accomplish. There appears to be a potential fit to provide them with a comprehensive overview of Pro-Dex's capabilities including our engineering, regulatory and manufacturing capabilities in motors, controls and complex medical devices. Our comprehensive set of competencies typically interest the client into further exploration of which parts of our capability might best serve their needs. From there, we begin the journey to identify a specific product or projects where they need help to create a proposal opportunity.

While Paul is doing a wonderful job in driving many conversations forward, I must also acknowledge and thank our director of marketing and strategic partnerships, Tricia Rodewald, who has done a masterful job at creating our brands and ensuring that it permeates the space we operate in. Several prospects have commented that it seems like Pro-Dex is everywhere. We have been refining the message and deployment methods for over a year now, and we are beginning to see traction in our sales engine as indicated above. As we all know, the proof is in the pudding, and the pudding in this case is purchase orders. I look forward to the day when I can begin to announce that some of these conversations and proposals have advanced to hard orders.

As we prepare to enter into this transition phase, from notable results, both primarily upon the concentrated customer base to rebuilding for similar result on a diversified customer base, we are preparing for the long haul. We will not count on a significant windfall of new business to save the day. We have over $4 million of cash in the bank and are committed to preserving it, except for critical investments needed to create our future. Financial conservatism will keep time on our side. In case it takes 4, 6 or even 8 more quarters to rebuild our top line.

I was concerned that the sales activity we have been at for so long may just be yielding lots of conversations, but no traction. I now see some of these conversations maturing and many more getting started. The new sales and marketing engine is starting to engage. Despite this, I fully expect that our revenue line will go down before it will go back up. We will take the actions necessary to get through the bottom of the trough so that when we reemerge, as we expect we will, with steadily growing sales over the next few years, our target is clear. To repeat fiscal 2011 performance with a top line that allows products to generate the kind of results that we now know it is capable of generating. Overall, I feel very good about our long-term future. Please know that your leadership team is committed to doing the work we need to do to realize it. We will now open the line for any questions you may have.

Thank you. (Operator Instructions). One moment while we poll for questions. [Seth Barkett], a private investor.

First of all, I want to congratulate you both on a great quarter. Obviously, that was very impressive.

Thank you.

I guess I'd like to try to better understand the sales cycle. It sounds like you're working on some pretty interesting new projects. The third project that you mentioned on the call sounds like it wouldn't start until 2013. Can you just add a little more color regarding the first 2, or a typical sales cycle or the types of products that you manufacture?

Sure. The shortest sales cycle that we would probably experience would be on a straight contract manufacturing basis where somebody provides the print, and as short as 3 months later, we've been through the regulatory qualification and are able to machine that part. We've done the equipment qualifications, software qualifications, et cetera, and a relatively straightforward machining operation. The next level might be 6 months if it was a complex assembly, but no power involved. And then it could be as long as 18 months if -- 18, maybe even 24, depending on clinical trials, if somebody is coming to us with a napkin and saying I'd like to create a medical device, can you help me design it? And there is 12 to 14 months of design and then x months of clinical trials and then an initial release of products to go to manufacturing before shipment happens.

So, 1 of the big shifts or expansions of the value proposition is that a couple of years ago, we were pretty much exclusively those engineered products, and the sales cycle was a year-and-a-half to 2 years. And so we've been looking more and more for the contract manufacturing work. Obviously, when you've got a custom engineered product, the margin is going to be higher. When you're just machining a part for somebody, it is going to be lower. We've been delighted to find some in the middle where somebody comes and says the product is engineered, but -- so there's not that in there. But it does require contract manufacturing and therefore, there is a full value proposition available that requires regulatory and manufacturing and maybe a little engineering detail working out. And so that is the big mix. I will add something, Seth, that you didn't ask, because I think it is important. And that is that this largest customer which is departing has typically been a $6 million to $7 million customer in a normal year with $12 million in this year as they exit with big inventory builds. And most of the agreements that we're looking at are small agreements, $250,000, a nice one is $1 million, and then there's a couple of them that were looking at that might be a couple million. So, it is going to take several of them to even rebuild the $6 million to $7 million 2010, lets say, base we had, and even more than that to replace the $12 million hyper-sales in 2011.

Okay. Is Paul -- does he focus more on the medical industry? Or is he out there trying to drum up your industrial, aerospace type of business as well?

Paul focuses exclusively on medical.

Okay.

When he is in a large medical OEM, he will talk about motors and he will talk about motion control, but he would never sell an aerospace motor that's going to go on a Boeing aircraft or anything like that.

Got it. So, do you have somebody else within the organization that is focusing on those markets? Or how are those accounts being currently managed?

We have a business development engineer in Carson City who would address medical and nonmedical motor sales who works with our VP of Ops and GM of Carson City, Rick Van Kirk, to build the motor sales. And then we have a dedicated sales resource for Scott Frederick, who works with Phil Brown, GM of motion control, and that's a completely separate selling activity to develop motion control prospects. The only thing Paul might get involved in, again, is if a hand piece, a medical hand piece or some system that we're developing; the client also wants a control for the device, then he would pull in our Beaverton operation to get the synergy there.

Okay. I'm not sure if I am taking up too much time here, but if you will allow me I'd like to ask you more.

Sure, I think the queue is okay, so -- we'll tell you when we think somebody else wants in.

Great, great. Well, thank you. So, you mentioned $5 million roughly in the backlog, the majority of that being product B for the large customer that is leaving. How will that shake out over the next 2 quarters? Will it be front end weighted? Back end weighted? Has that customer given you any additional transparency or guardian product B?

They've been pretty transparent, as we disclosed, and the product A orders are through September and the product B orders go through April. There will be a layering, I would expect without any forecasting that not much is going to change at Pro-Dex through September. And then, starting October, November, December, we will experience a quarter without product A, and then product B will continue through April and then we will be pretty much in the full impact of their departure.

Okay. So, it is through April?

Through April, yes.

Great.

Project B orders do go through April.

Okay, all right. Was that new information, or --?

I think on our 8-K in June it was through February, and they recently filled some orders between January and February to through March and April.

That's great.

Same orders, but just extended time. So --

Okay.

But that's all that just came out.

Perfect. All right, any -- I assume with the cash that's being generated, as revenue starts to decline over the coming quarters, cash will continue to build. Do you have any plans for the cash? I assume you probably want to build up the war chest. Any specific plans?

We are finding that our contract manufacturing value proposition is presenting some requirements for investments in specific types of equipment. For example, potentially EDM and a corded measuring machine and some things like that we did need to put some investment into. And we're completely happy, we're delighted to write checks for anything that creates a future. So, I think from an investment standpoint, certainly some CapEx, that would be more than just more of the same, but a little bit of expansion of our capability exists. Probably not in an acquisitive mode right now for obvious reasons, and not much we can do with $5 million that wouldn't require that and debt. So, that's probably obvious where that sits. And I think that the balance is to make sure that we don't lean on our cash balance to give ourselves permission to hemorrhage or bleed it away slowly thinking that tomorrow will be brighter. To basically run the Company based on the bread that is on the table today, and earn a dollar and not burn cash when we -- with that. And then as more bread comes on the table from future revenues, then to rebuild accordingly to accommodate them.

Okay, great. As I put projections together for next year, have you -- you guys have a capital budget in mind, you've been bringing around about the $250,000 mark annually for CapEx. Are you going to be running around that level or a little higher, closer to $500,000? Or is that very much dependent on the work?

It is dependent on new work, and my expectation is that it wouldn't be the same or lower. I don't want to put a number out, because we haven't put a number out of what it is. But it's obviously not going to be $3 million, and probably going to be a little more investments than the $250,000 historical run rate.

Okay. And then lastly, and then I'll let you go, I appreciate the time. R&D going forward, will we see that drop off at all? Increase? Or status quo as well we can model out?

In terms of our investment in R&D, it should remain consistent. We would not -- I view engineering as a huge key to our future, so that would not be an area we would look to save. But -- and I think the other question that's related to that is will there be some compensated customer R&D dollars coming in? And that depends on if the revenue replacement that we land, our customers' napkin sketches that they need engineered, then we would see some development revenues coming in and might even see an increase in our spending offset by those dollars coming in, so a net same. And the revenues coming in our more contract manufacturing that don't have revenues associated with the engineering, then we would just continue to monitor what we have now in similar amounts. But I would not anticipate a significant decline there.

Great, great. Well, thanks again, guys, I appreciate. Mark and Hal, excellent quarter. The stock is definitely cheap here, and I expect it to go up tomorrow.

Thanks, Seth, we appreciate it.

(Operator Instructions). Gentlemen, it appears there are no further questions. Would you like to make some closing remarks?

Thank you, Doug. Appreciate everyone joining us for the call and for Seth's questions. I am sure he asked a lot of the questions that other shareholders on the call and who will be listening to it later would have had. So, we appreciate your time and support of the Company, and we'll talk to you in November, fairly quickly, at the end of Q1. Have a great day.

Ladies and gentlemen this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.