PDEX - NASDAQ

Greetings, and welcome to the Pro-Dex Fiscal 2012 Second Quarter Conference Call. [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 meaning 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 release the results of any revision to the forward-looking statements in the light of new information or future events. For more information, please refer to risk factors discussed in the company's Form 10-K for the year ended June 30, 2011, and 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 P. Murphy, CEO for Pro-Dex. Thank you, Mr. Murphy, you may begin.

Thank you, Doug, and thank you all for joining us to review the results for the quarter and 6 months ended December 31, 2011. 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 Doug mentioned, we will open up the call to your questions. So let's get started with Hal.

Thank you, Mark. As a result of decreases in sales of our medical device products to our largest customer, which we have disclosed and discussed previously, sales for the quarter ended December 31, 2011 decreased 20% to $4.9 million from $6.2 million for the corresponding quarter in 2010. Similarly, for the 6 months ended December 31, 2011, sales decreased 9% to $10.9 million from $12 million for the 6 months ended December 31, 2010. Offsetting the decrease in sales to our largest customer, was an increase in medical device products sales to our second largest customers. Gross profit for the quarter ended December 31, 2011, decreased 42% to $1.4 million from $2.4 million in the corresponding quarter in 2010, and gross profit as a percentage of sales decreased 10 points to 29% for the quarter ended December 31, 2011, compared to 39% for the corresponding quarter in 2010. For the 6 months ended December 31, 2011, gross profit decreased 19% to $3.7 million from $4.6 million for the 6 months ended December 31, 2010, and gross profit as a percentage of sales decreased 4 points to 34% for the 6 months ended December 31, 2011, compared to 38% for the corresponding 6-month period in 2010. This decreases resulted primarily from the year-over-year decrease in sales, higher warranty expenses due to an increase in the estimated per unit cost to repair units that may be returned within the warranty period and with respect to the 3 months period ended December 31, 2011, reduced manufacturing efficiencies commensurate with the lower sales volume. Regarding these deficiencies, Mark will have further comments following my remarks. Total operating expenses for the quarter ended December 31, 2011 were $1.7 million, a decrease of 9% from operating expenses of $1.9 million in the corresponding quarter in 2010. For each of the 6-month periods ended December 31, 2011, and 2010, operating expenses were $3.6 million. The decreased sales and reduced gross margin partially offset by controlled operating expenses, resulted in the $282,000 operating loss for the quarter ended December 31, 2011, compared to operating income of $571,000 for the quarter ended December 31, 2010. For the 6 months ended December 31, 2011, the same sales margin and expense factors resulted in operating income of $176,000 compared to $977,000 for the corresponding period in 2010. Net loss for the quarter ended December 31, 2011, was $292,000 or $0.09 per diluted share, compared to net income of $401,000 or $0.12 per diluted share in the corresponding 2010 quarter. For the 6 months ended December 31, 2011, net income was $154,000 or $0.05 per diluted share compared to net income of $743,000 or $0.23 per diluted share for the 6 months ended December 31, 2010. During the 6 months ended December 31, 2011, we used $6,000 of cash for operations compared to a use of $58,000 of operating cash in the corresponding 2010 period. Cash on hand at December 31, 2011 was $4.3 million compared to $2 million at December 31, 2010. At December 31, 2011 our backlog stood at $9.3 million. With that, I will turn the call back over to Mark for his review and outlook comments.

Thank you, Hal. The quarter ended December 31, 2011 was the first in which the anticipated decrease in sales for our largest medical device customer was actually reflected in our financial results. Our medical device products, sales experienced a 27% decrease in the quarter as compared to the corresponding quarter in 2010, partially offset, as Hal mentioned, by an increase in sales to our second largest medical device customer. Sales of motion control products and fractional horsepower motors were relatively flat on a year-over-year basis decreasing 3% and 2%, respectively, when compared to the 2010 quarter. As Hal mentioned, lower sales volume during the quarter was accompanied by diminished manufacturing economies of scale. As a result, midway through the quarter, we affected a reduction in force bringing down our Irvine direct and indirect labor headcount by 20%. This reduction, as any reduction of this magnitude, was painful, but consistent with our commitment to do what is necessary to manage the business at appropriate cost levels, while continuing to make prudent investments for our future. Regarding our future, I need to first announce that Mr. Paul Rudzinski, previously our VP of Sales, is no longer with the company. In terms of new projects and prospects, I am happy to give you the following update. In our previous conference call, I discussed our award from a major medical device OEM of $191,000 purchase order at the first installment on a program that is expected to exceed $2 million over the next 2 years. Last week, we received a second purchase order valued at approximately $260,000 for additional units under the same program, which all target shipping dates within this current fiscal year. On another front in January, we executed a supply agreement with a medical device OEM for the manufacture of a new instrument. The release of which is projected by the OEM to take place in late 2014. Under the terms of the agreement, the OEM will buy units from Pro-Dex with a value of $8.7 million over a 5-year period. If the OEM decides to manufacture the instrument either internally or through another supplier, we will be paid up to $3 million of cancellation fees against unmet minimum. In addition, we have submitted proposals for the same OEM to be its supplier on 3 attachments to the instrument covered by the supply agreement. While we clearly have much more work to do the offset our drop in revenue, these 2 developments I've described represent steps in the right direction. We look forward to the opportunity to build upon these initial successes in future quarters. While we continue to work diligently on identifying future revenue sources, we are also preparing for the likelihood that our revenues will decline before they increase and your leadership team remains committed to navigating carefully through this challenging times. We will now open the lines for any questions you may have.

[Operator Instructions] Our first question comes from the line of Seth Barkett from RDA Capital.

Well, I guess, I am little surprised by the quarter. I would have expected, I guess, a better performance for this quarter and declining performance going forward. Can you give a little bit more clarity regarding product be -- it looks like you're building inventory? Do you anticipate selling more product [ph] to your largest customers in the coming quarter or 2 before that product expires completely? Or are we kind of running at a run rate now where the revenue going forward will continue to decline?

We can answer your first question but not your second. We've disclosed that revenue from the largest customer is backlogged through April. So we expect January, February, March to be continuing and I think [ph], we've disclosed exactly how much backlog that is. So -- but their feels [ph] run out in April.

Got it. I looked at gross profit margin for the quarter, obviously, there was a pretty significant decline. I can see that a lot of that is due to a loss of revenue. Did the loss of revenue -- did it surprise you at all? And why -- I guess I'm trying to better understand why it took the first half of the quarter before you started making the appropriate adjustments to the cost structure?

Well, some of that is timing relative to production requirements to meet the delivery. So you have to time when will we have this product built and able to, if we cut too early. We won't -- we still have shipments making cuts in November. We still have products that are being delivered through April. So a lot of that is just timing of when you can release people and still make your commitments.

Okay. Can you give me anymore, I can probably dig this up. I guess, I'll ask the question anyway. Regards to your term loan covenant, are there any covenants regarding profitability?

The -- Seth, this is Hal. The covenant regarding profitability in light of this quarter's loss, we only have an annual covenant. We do have covenants along the way, we are not in violation of those. But the profitability covenant per se is only an annual measurement at June 30.

One more point on that, just for those who may not be as familiar with our balance sheet as others, that total indebtedness covered by that covenant is $900,000 and then a cash balance of $4.3 million. So while it's something we obviously want to be aware of, it is in proportion to the balance, I guess.

Right. And then lastly, I guess, what was the reason for Paul leaving the company? Did he leave by his own accord? Or can you give any insight into that situation?

I'll just say, company's choice. We'll leave it that.

[Operator Instructions] Gentlemen there are no further questions in the queue at this time.

All right. Thank you all for joining us today for the call and thank you, Doug, for moderating it. We appreciate your time and support of the company. I look forward to speaking with you in May when we report our Q3 results. Have a great day.