Earnings Transcript for PDEX - Q2 Fiscal Year 2013

Operator: Greetings, and welcome to the Pro-Dex Update Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Michael Berthelot, Chief Executive Officer of Pro-Dex. Thank you, you may begin. :

Michael J. Berthelot: Thank you, Manny, and thank you all for joining us to review the results for the second quarter and first 6 months of fiscal year 2013.

On today's call, Hal Hurwitz, our CFO, will provide us with a synopsis of our operating results, after which, I will share my comments.:

Then, as Manny mentioned, we will open up the call to your questions. Hal? :

Harold Hurwitz: Thank you, Mike. Before beginning my comments, I ask our participants and listeners to note that the comments made on this call may include statements that are forward-looking within the meaning of securities law. These forward-looking statements may include, without limitation, statements related to anticipated industry trends and 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 the forward-looking statements in light of new information or a future event. For more information, please refer to the risk factors discussed in the company's Form 10-K for the year ended June 30, 2012, our Form 10-Q that we expect to file within the next few weeks, and the Form 8-K we are filing with the SEC today, along with the attached press release issued today, all of which can be obtained from the SEC or by visiting our website at www.pro-dex.com.

My discussion of our results for the fiscal year 2013 second quarter and the first 6 months will relate to our continuing operations, meaning that the results of our former Astromec motor product line, which was sold in February 2012, will be excluded. :

First of all, we'll talk about the second quarter. Sales for the quarter ended December 31, 2012, decreased 25% to $3 million from $4 million for the corresponding quarter in 2011. As the company has previously discussed, this decrease was primarily the result of reductions in purchases of the companies powered surgical instrument products by its former largest customer, partially offset by increases in such surgical instrument sales to other customers. :

Excluding sales to the company's former largest customer, which represented the reduction of $1.5 million in last year's second quarter, sales increased $524,000, or 25%, in the second quarter of fiscal 2013.:

Gross profit for the quarter ended December 31, 2012, was $1 million or 34%, compared to gross profit of $1.2 million or 31% for the year-ago period. The increase in gross profit as a percentage of sales from 2011 to 2012 was due primarily to a reduction in warranty costs and improvements in manufacturing efficiencies, partially offset by unfavorable changes in product mix.:

Operating expenses, which includes selling, general and administrative and research and development expenses, for the quarter ended December 31, 2012, decreased 10% to $1.4 million from $1.6 million in the prior year's corresponding quarter. :

Sales and marketing expenses decreased 13% from last year's second quarter, while R&D expenses decreased 9% over that period.:

R&D expenses were lower primarily due to the classification of some R&D expenses to cost of goods sold in instances where customers pay engineering charges for new product development. :

General and administrative expenses included $42,000 of cost associated with the contested election of directors without which, such costs, the reduction in operating expenses, would've been 12%.:

Loss from continuing operations was $364,000 for the quarter, compared to a loss from continuing operations of $329,000, in the corresponding 2011 period.:

Net loss for the 2012 quarter was $348,000 or $0.11 per diluted share, compared to a net loss of $292,000 or $0.09 per diluted share for the corresponding quarter in 2011.:

EBITDA for the second quarter of fiscal 2013 was a loss of $196,000 compared to a loss of $130,000 in the corresponding quarter 1 year ago. :

During the quarter ended December 31, 2012, we used $619,000 of cash in operating activities. This use of cash reflects, primarily, payments made in the second fiscal quarter for the build up of inventory in the first fiscal quarter, in anticipation of customer orders and pursuant to one of the pillars of our operating plants, which is to reduce production lead time. :

Now we'll speak about the first 6 months. Sales for the 6 months ended December 31, 2012, decreased 29% to $6.9 million, from $9.1 million in the corresponding 6-month period in 2011, also the result of reductions in the purchases of the company's powered surgical instrument products by our former largest customer, and partially offset by increases in such surgical instrument sales to other customers. :

Excluding sales to the company's former largest customer, which represented a reduction of $3.8 million in last year's first half, sales increased $1.2 million or 25% in the first half of fiscal 2013, compared to the corresponding period last year.:

During the first half of fiscal 2013, the company received new orders of $9.4 million, compared to $2.8 million in last year's first half, excluding orders received from the former largest customer. The book-to-bill ratio for the first half of fiscal 2013 was 1.5.:

For the 6 months ended December 31, 2012, gross profit was $2.3 million or 35%, compared to $3.4 million and 37% respectively, for the corresponding period in 2011. The decrease in gross profit as a percentage of sales from the first half of 2011 to 2012, resulted primarily from reduced manufacturing efficiencies and unfavorable changes in product mix, partially offset by a reduction in warranty costs. :

Operating expenses for the 6 months ended December 31, 2012, decreased 19% to $2.7 million from $3.3 million in the corresponding 6-month period of 2011. These decreases were attributable to the effects of reduced employee compensation, other operating expense cuts and the utilization of engineering resources in contractual revenue-producing activity.:

For the 6 months ended December 31, 2012, loss from continuing operations was $418,000, compared to income from continuing operations of $17,000, for the corresponding period in 2011.:

Net loss for the 2012 6-month period was $365,000, or $0.11 per diluted share as compared to net income of $154,000, or $0.05 per diluted share for the corresponding period in 2011.:

EBITDA for the first half of fiscal 2013, was a loss of $55,000, compared to income of $473,000 in the corresponding period 1 year ago.:

During the 6 months ended December 31, 2012, we used $791,000 of cash in operating activity. This use of cash reflects, primarily, the previously mentioned build-up of inventory in the first fiscal quarter. :

In addition, as announced previously, in September 2012, we repaid the entire outstanding balance on the term loan from Union Bank, amounting to $685,000. As a result of the foregoing, cash on hand as of December 31, 2012, were $2.5 million, compared to $4.1 million at June 30, 2012. :

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

Michael J. Berthelot: Thank you, Hal. As we noted in today's release, we believe that the second fiscal quarter shows continuing progress in our effort to move Pro-Dex forward.

Although sales for the quarter were down $1 million from last year's second quarter, our operating loss was only $35,000 more than last year. Our gross margin was stronger, our operating expenses were lower, our quoting activity was up, our bookings were strong and our backlog continues to grow. :

We believe that based on our backlog and shipping schedule for the third and fourth fiscal quarters, and the fact that during the second quarter, both of our facilities were closed for 2 full weeks, during the Thanksgiving, Christmas and New Year holidays, the second quarter should be our weakest in fiscal 2013.:

Hal has already given you the financial details for the quarter and 6 months, but I will spend a little time adding some color to what is going on in our business and talking about the activities we are undertaking with regards to our four-pillared strategy. Our focus on 2 pillars: increasing sales and innovating our products and quality, continues to gain traction. Our VP of sales and director of marketing, along with our R&D and quality team, have spent considerable time pursuing opportunities for powered surgical instrument sales.

We actively participate in industry trade shows and it is through conversations at these shows that the majority of our new business contacts begin. Although, we do occasionally receive leads generated through our website and various industry publications in which we advertise. :

During the first half of fiscal 2013, we made significant quotes or proposals for new business to 8 potentially new customers. So far, we have won one of those proposals, lost 2 and 5 remain under consideration or are in negotiation with customers. :

The sales cycle for our products is long and complicated. In the instance of the project we recently won, the first team meeting was to then potential customers took place in August. The proposal was submitted in October and negotiations and discussions lasted through the end of December. :

The prototype products are due in calendar year 2013 with production expected to begin in early 2014, under a 7-year manufacturing contract if, of course, the prototype is accepted by the customer, following design review, testing and regulatory approval. :

The long-term goal for us is the 7 years of manufacturing for the ultimate product, to which we will own all IP, so it cannot be resourced elsewhere absent a license from us. Even though we own all of the IP involved in the new product which is the derivative of an existing product, our customer will pay us a non-recurring engineering fee based on specific milestones, which will reimburse us for a significant amount of our engineering costs. :

We are also finalizing a study relative to the expansion of our dental product line and relaunch of the complete line of dental hand pieces, which we began in the fourth quarter of last fiscal year. :

Engineering is complete on the project. Test and evaluation units are being built and a marketing and sales plan has been developed. Our target if the test and evaluation process proceed smoothly, is to launch the resurgent dental product line in our fourth fiscal quarter.:

All of this, along with our encouragement of customers to enter in the frame contract, has led to a solid level of bookings. A book-to-bill ratio of 1.5 for the first half of this fiscal year, and a backlog at the end of December of $9 million. All factors, which we believe, portend well for the future. :

When the sales cycle is as long as ours, since [ph] I described a few minutes ago, shortened lead times can have a dramatic impact on several levels. First, we can now supply potential customers with sample units to evaluate and test on an almost immediate basis. Second, for those customers who wish to do a broader market test or purchase an off the shelf solution, we can meet their needs in a reasonably short period of time. For our standard Pro-Driver we are now shipping orders within 2 days for small quantities, and because we keep a small level of critical components in inventory, we can ship large orders in 2 weeks.:

For customers who have entered into frame contracts, we have scheduled our delivery of key components that line up with our production schedule so that we can meet customer expectation, reduce our purchase component cost and yet minimize the amount of inventory we carry. :

The increase in our inventory levels over the first half of this fiscal year is primarily the result of our moving from 0 to 60 miles per hour on this program. We do not expect to see continuing increases in inventory level due to our efforts to reduce lead times. In fact, inventory levels at the end of Q1 and Q2, were relatively unchanged. :

Our cost control and reduction efforts continue to be fruitful. In the second quarter, our gross operating expenses were 10% lower than those reported in last year's second quarter. :

After adjusting for the $42,000 of unusual costs associated with the contested election of directors in the current quarter, the reduction in operating costs would've been 12%. :

In addition, in the second quarter, we have significantly greater expenses associated with our patents and trademark applications and renewals, as well as greater legal fees associated with the reviews of agreements with new customers. While these expenses both are included in general and administrative expense, we believe that they represent money well spent to protect our intellectual property and future manufacturing revenue. :

More importantly, our manufacturing costs remained constant and reflect the rightsizing of our labor and overhead structure to match our new revenue base. :

In my experience, it is very unusual that a company could lose 25% of its revenues, yet see an increase in its gross margin. I attribute this accomplishment to the fine work done by our operations team to be more efficient and effective by doing more with less. We believe that their can-do, do-better attitude will serve us well in the future. :

Overall, we are ahead of our operating plan for the fiscal year, in terms of revenues, gross margin and operating expense levels. We believe that the second half of our fiscal year will be stronger than the first half and we are excited about what the future holds for our company. :

One last thing, based on the advice of our counsel regarding the application of proxy regulation to communications related to the pending proxy contest for election of directors at our upcoming annual meeting, we will not be addressing any questions with respect to the proxy contest on this call. :

The company has filed its proxy statement with the SEC, as well as several other shareholder communications that address the proxy solicitation and we refer you to those materials and to future supplemental material that we will file for information relating to the proxy solicitation. :

We are now prepared to field any questions you might have with regard to the quarter, first half or our business operations. :

With that, I'll turn the call back over to Manny for Q&A. :

Operator: [Operator Instructions] Our first question is from Mark Murphy [ph] a private investor.

Unknown Attendee: I'm wondering if the non-large customer revenues were scheduled to be, I think you guys said, $12 million to $14 million this year, and you had a booking half of $9 million, run rate of $18 million, do you see that -- can you add any color to that $9 million of bookings in terms of whether it came from long lead orders of existing customers, let's say somebody ordering something out 2 or 3 years versus how much, if any, of it came from the traction you're getting under sales color?

Michael J. Berthelot: Okay. Well, to -- a multipart question, and I'll answer each part of it. First, the operating target that we shared with everyone back in May was, I believe, revenues of $11 million for fiscal 2013. Our breakeven point is approximately $13 million to $14 million depending on margin. So that's where those 2 numbers come from. The bookings and the backlog and frame contracts -- the longest frame contract we have entered into was for 18 months, and that covered the lead time to get the components in to begin manufacturing. So we gave ourselves 6 months to get all the components and then we will start shipping out over the next 12 months. So none of the frame contracts sell out to 3 years, they are generally for a 12-year -- 12 months of manufacturing.

Unknown Attendee: So, in the -- in an $11 million non-revenue -- non-large customer revenue, with $9 million of bookings in 6 months, is any of that related to traction of new customers or new products?

Michael J. Berthelot: It's related to both. And we'll -- if we use the word, new products, let's say it's derivations of old products, but products that have new numbers on them, shall we say. So if we treat it as a newly developed product, so that's just part of it.

Unknown Attendee: That makes sense. That $9 million, so staggering, so incredible, which is great, and yet the sharing of [indiscernible] sales puller was -- we've landed one account, that's 2 years away from generating revenue and yet, in the last 6 months, you've booked $9 million of new revenue, hard-core, so I'm just trying to somehow have those dots connect. You're obviously doing something right, but that $9 million booking number is incredible.

Michael J. Berthelot: Well, yes. The group is here, Mark, as you know well, it's a really good group of people. And they have done an incredible job of identifying opportunities and going after them. That backlog does not include, I don't believe, any revenue from that one product that we won.

Unknown Attendee: Okay.

Michael J. Berthelot: So these are all hard-core. We are manufacturing these products. We have definite shipping dates and it just makes throughput much, much easier. I would caution anyone, in fact, I would say just, flat don't do it, don't multiply that $9 million times 2.

Unknown Attendee: Okay.

Michael J. Berthelot: Okay, that is not sustainable based on where we are in this program. We're going to win some more projects and we'll have some more things but I wouldn't multiply at this stage.

Operator: We have no further questions in the queue at this time. And now, would you like to make any additional or closing remarks?

Michael J. Berthelot: Yes, thank you, Manny. I would like to thank everybody for joining us today. We appreciate your interest, your time and your support for the company and we look forward to speaking with you in April when we report our third quarter fiscal financial results. Thank you.

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