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PDEX > SEC Filings for PDEX > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for PRO DEX INC

Form 10-Q for PRO DEX INC


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

COMPANY OVERVIEW

The following discussion and analysis provides information that management believes is relevant to an assessment and understanding of the results of operations and financial condition of Pro-Dex, Inc. ("Company", "Pro-Dex", "we", "our" or "us") for the three month periods ended September 30, 2012 and 2011. This discussion should be read in conjunction with the Condensed Consolidated Financial Statements and the Notes thereto included elsewhere in this report. This report contains certain forward-looking statements and information. The cautionary statements included herein should be read as being applicable to all related forward-looking statements wherever they may appear. Our actual future results could differ materially from those discussed herein.

Except for the historical information contained herein, the matters discussed in this report, including, but not limited to, discussions of our product development plans, business strategies and market factors influencing our results, are forward-looking statements that involve certain risks and uncertainties. Actual results may differ from those anticipated by us as a result of various factors, both foreseen and unforeseen, including, but not limited to, our ability to continue to develop new products and increase sales in markets characterized by rapid technological evolution, consolidation within our target marketplace and among our competitors, and competition from larger, better capitalized competitors. Many other economic, competitive, governmental and technological factors could impact our ability to achieve our goals. You are urged to review the risks, uncertainties and other cautionary language described in this report, as well as in our other public disclosures and reports filed with the Securities and Exchange Commission ("SEC") from time to time, including, but not limited to, the risks, uncertainties and other cautionary language discussed in our Annual Report on Form 10-K, as amended, for our fiscal year ended June 30, 2012.

With operations in Irvine, California and Beaverton, Oregon, we provide products used in medical, research and industrial applications. Experience in surgical devices and multi-axis motion control applications allows us to develop products that require high precision in harsh environments.

Our products are found in hospitals, dental offices, medical engineering labs, scientific research facilities and high tech manufacturing operations around the world. The names of Micro Motors and Oregon Micro Systems are used for marketing purposes as brand names.

On February 27, 2012, we completed the sale of our fractional horsepower motor product line, operating under the name Pro-Dex Astromec ("Astromec") and located in Carson City, Nevada, to SL Montevideo Technology, Inc., a wholly owned subsidiary of SL Industries, Inc. The Astromec product line has been treated as a discontinued operation in the Condensed Consolidated Financial Statements and the Notes thereto included elsewhere in this report for all periods presented. The following discussion and analysis provides information solely with respect to our continuing operations, which excludes Astromec, unless otherwise indicated.


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Our principal headquarters are located at 2361 McGaw Avenue, Irvine, California 92614 and our phone number is 949-769-3200. Our Internet address is www.pro-dex.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and other SEC filings, are available free of charge through our website as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. In addition, our Code of Ethics and other corporate governance documents may be found on our website at the Internet address set forth above. Our filings with the SEC may also be read and copied at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov and company specific information at www.sec.gov/edgar/searchedgar/companysearch.html.

Critical Accounting Estimates and Judgments

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

Revenue Recognition

Revenue on product sales is recognized upon shipment to the customer when risk of loss, title transfer to the customer and all other conditions required by GAAP, as promulgated by the Financial Accounting Standards Board ("FASB") in Accounting Standards Codification ("ASC") Section 605 (formerly Staff Accounting Bulletin No. 104, Revenue Recognition), have been satisfied.

Returns of our product for credit are minimal; accordingly, we do not establish a reserve for product returns at the time of sale.

Warranties

Certain of our products are sold with a warranty that provides for repairs or replacement of any defective parts for a period, generally one year, after the sale. At the time of the sale, we accrue an estimate of the cost of providing the warranty based on prior experience with such factors as return rates and repair costs, which factors are reviewed quarterly.

Warranty expenses, including changes of estimates, are included in cost of sales in our consolidated statements of operations.

Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market value. Reductions to estimated market value are recorded, and charged to cost of sales, when indicated based on a formula that compares on-hand quantities to estimated demand over the ensuing 12 months from the measurement date.

Accounts Receivable

Trade receivables are stated at their original invoice amounts, less an allowance for portions of such amounts, the collection of which is believed to be doubtful. Management determines the allowance for doubtful accounts based on facts and circumstances related to specific accounts, and on historical experience related to the age of accounts. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously reserved are offset against the allowance when received.

Long-lived Assets and Real Estate Held for Sale

We review the recoverability of long-lived assets, consisting primarily of equipment and leasehold improvements, and of real estate held for sale, when events or changes in circumstances occur that indicate carrying values may not be recoverable.


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Stock-Based Compensation

We recognize compensation expense for all share-based awards made to employees and directors by estimating the fair value of share-based awards at the grant date and recognizing compensation expense over the requisite service period.

For stock options, fair value is estimated using the Black-Scholes option-pricing model. The portion that is ultimately expected to vest is recognized as compensation cost over the requisite service period using the straight-line single option method.

The determination of fair value using the Black-Scholes model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables, including expected stock price volatility, risk-free interest rate, expected dividends and projected employee stock option exercise behavior. We currently estimate stock price volatility based upon historical activity, with future volatility expected to approximate past volatility. The expected time to exercise is based on a simplified model of the vesting term of the option plus one-half the option life.


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Income Taxes

We recognize deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities along with net operating loss and tax credit carryovers. Deferred tax assets at September 30, 2012 and June 30, 2012 consisted primarily of basis differences related to net operating loss and research and development tax credit carryovers, intangible assets, accrued expenses and inventories.

Significant management judgment is required in determining our provision for income taxes and the recoverability of our deferred tax assets. Such determination is based on our historical taxable income, with consideration given to our estimates of future taxable income and the periods over which deferred tax assets will be recoverable. We record a valuation allowance against deferred tax assets to reduce the net carrying value to an amount that we believe is more likely than not to be realized. When we establish or reduce the valuation allowance against deferred tax assets, the provision for income taxes will increase or decrease, respectively, in the period such determination is made. At September 30, 2012 and June 30, 2012, we maintained a valuation allowance against the entire balance of our deferred tax assets, net of deferred tax liabilities.

Description of Business

The majority of our revenue is derived from designing, developing and
manufacturing surgical devices for the medical device and dental industries and
motion control software and hardware for industrial and scientific applications.
The proportion of total sales by customer type is as follows:



                                         Three months ended September 30,
            Customer type                   2012                     2011
                                              (Dollars in thousands)
            Medical                $   2,369           68 %    $ 4,121        82 %
            Industrial                   761           22 %        643        13 %
            Dental                       206            6 %        205         4 %
            Government and other         125            4 %         76         1 %

            Total sales            $   3,461          100 %    $ 5,045       100 %

Our medical device products utilize proprietary designs developed by us under exclusive design and supply agreements and are manufactured in our Irvine, California facility, as are our dental products, which are sold primarily to original equipment manufacturers and dental product distributors. We design and manufacture embedded multi-axis motion controllers in our facility in Beaverton, Oregon.

At September 30, 2012, we had a backlog of $6.9 million. We may experience variability in our new order bookings due to various reasons, including, but not limited to, the timing of major new product launches and customer planned inventory builds. However, we do not typically experience seasonal fluctuations in our shipments and revenues.


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RESULTS OF OPERATIONS

Comparison of the three-month periods ended September 30, 2012 and 2011

The following table sets forth financial data and the percentage of net sales
regarding our financial position and operating results:



                                                             Three Months Ended September 30,
                                                              2012                       2011
                                                                   Dollars in thousands
Net sales                                            $   3,461          100 %     $ 5,045         100 %
Cost of sales                                            2,225           64 %       2,937          58 %

Gross profit                                             1,236           36 %       2,108          42 %
Selling expenses                                           274            8 %         374           8 %
General and administrative expenses                        608           18 %         816          16 %
Research and development costs                             406           12 %         561          11 %

Income (loss) from operations                              (52 )         -2 %         357           7 %
Interest expense and other, net                             (6 )          0 %         (10 )         0 %

Income (loss) before provision for income taxes            (58 )         -2 %         347           7 %
Provision for income taxes                                   1            0 %           1           0 %

Income (loss) from continuing operations                   (59 )         -2 %         346           7 %
Income from discontinued operations                         42            1 %         100           2 %

Net income (loss)                                    $     (17 )         -1 %     $   446           9 %

Net sales for the three months ended September 30, 2012 decreased $1.6 million, or 31%, to $3.5 million from $5.0 million for the three months ended September 30, 2011. Medical device sales decreased $1.8 million, or 43%, due primarily to a decrease of $2.3 million in sales to our former largest medical device customer, which was partially offset by net increased sales of $548,000 from our Irvine, California facility, primarily to the rest of our medical device customer base, and $138,000 of our motion control product line.

Gross profit for the three months ended September 30, 2012 decreased $872,000, or 41%, compared to the corresponding period in 2011, resulting primarily from $626,000 related to the sales volume decrease discussed above and the remainder attributable to the related effects on manufacturing at lower sales volumes. As a percentage of sales, gross margin decreased to 36% for the three months ended September 30, 2012 from 42% for the corresponding period in 2011, due primarily to the effects on manufacturing at lower sales volumes.

Selling expenses decreased $100,000, or 27%, to $274,000 for the three months ended September 30, 2012, from $374,000 for the corresponding period in 2011. This decrease is attributable primarily to decreases in advertising and market research expenses of $60,000 and in payroll and bonus expenses of $23,000.

General and administrative expenses decreased $208,000, or 26%, to $608,000 for the three months ended September 30, 2012, from $816,000 for the corresponding period in 2011, due primarily to decreases in 2012 related to employee training, payroll and bonus expenses of $105,000, and in legal expenses of $77,000.

Research and development costs decreased $155,000, or 28%, to $406,000 for the three months ended September 30, 2012, from $561,000 for the three months ended September 30, 2011, due primarily to decreases in project costs of $82,000 and in payroll and bonus expenses of $43,000.

Net interest expense for the three months ended September 30, 2012 was $6,000, which was not materially changed from $10,000 for the three months ended September 30, 2011.

The provision for income taxes for the three months ended September 30, 2012 and 2011 consisted primarily of state franchise taxes resulting in effective tax rates of 1.7% and 0.3%, respectively. In 2012, the effective rate differed from marginal statutory tax rates due to our inability to recognize the benefits of federal and state loss carryforwards prior to their utilization. In 2011, the effective tax rate was lower than marginal statutory rates due to the utilization of tax credits, previously established as deferred tax assets, to reduce the current tax provision. Because our deferred tax assets are fully reserved by a valuation allowance, realization of such deferred tax assets triggered a corresponding reduction in the valuation allowance, thus resulting in no deferred tax provision. (See Note 7 of Notes to Condensed Consolidated Financial Statements.)


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As a result of the foregoing, loss from continuing operations for the three months ended September 30, 2012 was $59,000, as compared to income from continuing operations of $346,000 for the three months ended September 30, 2011.

Liquidity and Capital Resources

The following table presents selected financial information as of September, 30
2012 and June 30, 2012:



                                                   September 30, 2012          June 30, 2012
Cash and cash equivalents                         $          3,125,000        $     4,112,000
Working capital                                   $          6,739,000        $     6,618,000
Cash and cash equivalents, net of bank debt       $          3,125,000        $     3,338,000

Net cash used in operating activities during the three months ended September 30, 2012 amounted to $172,000. Our operations, excluding the balance sheet changes discussed below in this paragraph, provided cash amounting to $158,000 after adjustment for non-cash items. Uses of cash arose from an increase in accounts receivable amounting to $212,000, due primarily to the timing of sales by us and related payments to us within the three-month period, and an increase in inventories of $691,000, primarily due to the purchase of components required to fulfill firm customer purchase orders in backlog as well as repair and warranty orders, and to build our stock of components related to certain of our products with the objective of shortening lead times when forecasted purchase orders are received. Partially offsetting these cash uses were sources of cash from increases in accounts payable and accrued liabilities of $511,000, resulting primarily of growth in accounts payable that correlates with the increase in inventories discussed above in this paragraph, and a reduction in income taxes receivable of $42,000 (representing a refund of taxes paid in the prior year).

Net cash provided by operating activities during the three months ended September 30, 2011 amounted to $349,000. Our operations, excluding the balance sheet changes discussed below in this paragraph, provided cash amounting to $628,000 after adjustment for non-cash item. The primary source of cash arose from a decrease in receivables of $785,000, resulting primarily from the lower level of sales in the three-month period ended September 30, 2011, relative to the three months ended June 30, 2011 (thus resulting in a lower level of accounts receivable at September 30, 2011), and from the collection during the three-month period ended September 30, 2011 of accounts receivable during the period from sales to our then-largest customer in June 2011.

Net cash used in investing activities for the three months ended September 30, 2012 and 2011 was $41,000 and $42,000, respectively, and consisted primarily of capital expenditures for manufacturing equipment.

Net cash used in financing activities for the three months ended September 30, 2012 was $774,000 as compared to $89,000 in the corresponding 2011 period. This increase reflects our payment, in September 2012, of the remaining balance due, amounting to $685,000, on the Union Bank term loan, fully retiring such indebtedness (see Note 5 of Notes to Condensed Consolidated Financial Statements and "Changes in Bank Debt and Credit Facilities" below).

We believe that existing cash balances and cash flows from operations will be sufficient to fund operations for the next twelve months.

Reduction in Large Customer Orders

In December 2009, our largest customer informed us that it was in the process of developing, and planned to eventually manufacture, its own surgical devices which were functionally comparable to the products we provided to the customer at that time. We had been the exclusive manufacturer of these products since they were developed. The resulting reduction in orders from our largest customer and its expected future impact on our business is more fully described in Note 9 of Notes to Condensed Consolidated Financial Statements.


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Changes in Bank Debt and Credit Facilities

As more fully described in Note 5 of Notes to Condensed Consolidated Financial Statements, on February 4, 2011, we entered into a credit facility agreement with Union Bank that provided for (a) a revolving credit line of up to $1.5 million, (b) a non-revolving credit line of up to $350,000 for the purchase of equipment, and (c) a term loan of $1.25 million. The proceeds of the term loan were used to pay off in full the Wells Fargo term loan previously outstanding.

The credit facility agreements contained various covenants, including certain covenants measured annually based on fiscal year results, concerning our financial performance. At June 30, 2012, we were in violation of profitability-based covenants, for which the bank had the right to declare us in default of the bank credit facility agreements and the entire amount owing under the facility, consisting of the term loan, to become immediately due and payable.

On August 30, 2012, we notified the bank of our intent to terminate the credit facility agreements and repay the term loan in full, on or before September 30, 2012. By letter to us dated September 4, 2012, the bank waived, through October 1, 2012, the rights it otherwise would have had pursuant to the covenant violations described above. In conformity with the correspondence described in this paragraph, on September 24, 2012, we repaid the entire principal balance of the term loan, amounting to $685,000 and the credit facility agreements were terminated.

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