PDEX - NASDAQ

Greeting, and welcome to the Pro-Dex Fiscal 2012 Third 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 laws. These forward-looking statements may include, without limitation, statements related to the 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 light of new information or future events. For more information, please refer to the risk factors discussed in the company’s Form 10-K for the year ended June 3, 2011, or Form 10-Qs filed subsequent to that date, and the Form 8-K we are filing 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. Michael Berthelot, CEO of Pro-Dex. Thank you. You may begin.

Thank you, Louis, and thank you all for joining us to review the results for the quarter and 9 months ended March 31, 2012. 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 Louis mentioned, we will open up the call for your questions. Hal?

Thank you, Mike. My discussion of our results for the fiscal quarter and 9 months ended March 31, 2012, and 2011, 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. Sales for the quarter ended March 31, 2012, decreased 34% to $4.5 million from $6.9 million for the corresponding quarter in 2011. For the 9 months ended March 31, 2012, sales decreased 21% to $13.6 million from $17.3 million for the 9 months ended March 31, 2011. As we have disclosed previously, the decreases in sales were primarily the result of the continuation of a reduction in purchases of our medical device products by our largest customer. Gross profit for the quarter ended March 31, 2012, was $1.2 million or 27% compared to gross profit of $2.8 million or 41% for the year-ago period. For the 9 months ended March 31, 2012, gross profit was $4.6 million or 34% compared to $7.2 million or 42% for the corresponding 9-month period in 2011. These decreases resulted primarily from the year-over-year decreases in sales and a commensurate change in sales mix to products with lower gross margins. Also contributing to the 2012 gross margin decreases for the 3-month period were reductions in manufacturing efficiencies due to the lower sales volume. In addition, higher warranty expenses contributed to the decreased gross margin in the 2012 9-month period due to higher estimated per-unit repair costs for units that remain under warranty. Operating expenses, which include selling, general and administrative, and research and development expenses, for the third fiscal quarter of 2012, increased 20% to $1,875,000 from $1,568,000 in the prior year’s quarter. For the 9 months ended March 31, 2012, operating expenses were $5.1 million, an increase from the prior year’s 9-month period of $330,000 or 7% from $4.8 million. These increases were primarily attributable to the payment of severance costs associated with the change in our Chief Executive Officers as we announced last month. The decreased sales, reduced gross margin and increased operating expenses resulted in a pre-tax loss from continuing operations of $680,000 for the quarter, compared to pre-tax income from continuing operations of $1.2 million in the corresponding 2011 period. For the 9 months ended March 31, 2012, pre-tax loss from continuing operations was $592,000 compared to pre-tax operating income of $2.3 million for the corresponding 2011 9-month period. Net loss for the quarter ended March 31, 2012, was $487,000 or $0.15 per diluted share, compared to net income of $868,000 or $0.26 per diluted share in the corresponding 2011 quarter. For the 9 months ended March 31, 2012, net loss was $332,000 or $0.10 per diluted share compared to net income of $1.6 million or $0.49 per diluted share for the 9 months ended March 31, 2011. During the 9 months ended March 31, 2012, we generated $190,000 of cash compared to a use of $16,000 of cash in the corresponding 2011 period. Cash on hand at March 31, 2012 was $4.9 million compared to $4.7 million at March 31, 2011. With that, I will turn the call back over to Mike for his review and outlook comments.

Thank you, Hal. First, let me say that I’m honored and proud to have been asked to take on the challenge of moving Pro-Dex to the next phase of its development. I would like to thank my predecessor, Mark Murphy, for all he did for our company during his 6 years as CEO. He has given us a strong foundation upon which to build, and we greatly appreciate it. It is never an easy thing to change top leadership, but Mark and the board felt that such a change would be the best thing for the company and its shareholders, and we are all working to make the transition as smooth and possible. Now, I’ve only been in this position for 2 weeks. So we are still in the early phase of developing our business plan for the future. In my observations so far, I can see that Pro-Dex has a solid core from which to grow. We have a strong reputation for engineering medical-quality rotary instruments. We have great products. We have a great group of associates. We have an experienced management team. We have a modern and well equipped facility. We have a strong balance sheet. But we also have some weaknesses, which I believe can be overcome and, in the process, lead to growth and the creation of shareholder value. There are times when we are difficult to do business with. We can be too slow. We can be too internally focused. We can become obsessed with minor short-term costs to the detriment of a profitable long-term future. Last Friday, we made the final new product shipment to our former number one customer. Our results for the quarter show the impact of this loss. Last quarter, we sold off our Motor business, which, while never achieving profitability, accounted for approximately 20% of our fiscal 2011 revenues. As a result of these 2 events, revenue-wise we are now half the size we were in 2011. As I said, we are developing our business plan for fiscal 2013 now and expect to have it completed by the end of next month. Replacing the sales lost by the departure of our largest customer will not be easy. Offsetting the distorted cost structure, which has resulted from the loss of volume through our factory, cannot be done solely through cost reduction, lest we cut costs and resources to the point that we cannot recover and thus enter a death spiral. We will have to buckle down, work hard to increase sales while controlling costs, and accept that we will not get back to profitability until we can accomplish these 2 tasks in a balanced manner. We have identified 4 key operational areas upon which we will focus in order to accomplish this balance, and do so quickly. First, we will improve our sales process so that we have resources dedicated to the identification and capture of new business. We will review our quoting process with a focus on winning long-term business rather than making short-term profit at the expense of that long-term relationship. My background in the aerospace industry has taught me that, once you’re on an aircraft, you are on it forever unless you screw up, as it is just too difficult and expensive to change out a small vendor on a big project. But you have to get on the airplane at the beginning, because if you don’t, you will never get a second shot at doing so. We have to get on the airplane during the design thing. Second, we will focus on reducing our lead time so that we exceed customer expectations. We can better match our production with our customers’ need and simultaneously better control of flow of work through our factory, improve our buying leverage, reduce our costs, accelerate our cash flow and delight our customers. Third, we will focus on controlling our cost structure, not only during this short-term period of transition caused by our reduced volume, but also for the long term. We will look at alternative sources of supply, better purchasing patterns, streamlined production flow and increased training and development of our associates. Any manufacturing operation working out of Southern California is at a cost disadvantage, and we must constantly strive to remain competitive by providing our customers with superior value. Fourth, we will increase our focus on quality and innovation. There are a number of exciting opportunities to enhance and expand our product offerings by moving a step to the right or left without moving far from the center of our core products. New surgical areas are transitioning to power and present rich submarkets for us to enter. While the quality of our products leads the industry, we believe that there is room for improvement that would establish a new threshold for the industry and open even more opportunities for us. Lastly, we know that we have a substantial amount of cash on our balance sheet, and that cash belongs to our shareholders. Over the past 2 years, we have been a careful husband of that cash and we are ever mindful of the need to not take it for granted or be wasteful of it. As we prepare our plan for 2013, we will give consideration as to how that cash can best be used to benefit our shareholders, while continuing to provide an adequate base for our company to grow. I strongly believe that if we can do all of these things successfully and quickly, we will create strong customer relationships, rewarding careers and lives for our associates and sustainable, long-term value for our shareholders. Each quarter, I will report to you on our progress on each of these initiatives. I appreciate your confidence and faith in our management team and our company. I look forward to speaking with you at the end of the fourth quarter. We will now open the line for any questions you may have.

[Operator Instructions] Our first question comes from the line of Benjamin Sexson with First Wilshire Securities Management.

I had 2 questions. The first was, could you talk a little bit more about just the segment results, how Beaverton did in the quarter, and your outlook for that business?

Ben, as you know, we don’t disclose specific numbers in connection with the product lines, but you will see in our discussion when we file our 10-Q that they did have a year-over-year decrease for the quarter.

Okay. Maybe you could talk maybe just more qualitatively about that business. Is it -- do you see it slowing down into Q2, or sorry, Q4? What’s qualitatively, maybe you could talk a little bit more about it?

Yeah, I think what can be best said about it, Ben, is that it is -- the customers for Beaverton's products are sensitive to the economy, and so their ordering patterns can differ with the continued uncertainty of the economy in that space. So for the last couple quarters, we’ve noticed some slowdown in ordering patterns. Whether or not that continues into the future is yet to be seen.

Okay. Can you just help us clarify, in the G&A expense, how much of that was one-time? Can you help us make sure we have it broken out properly?

Yes, we accrued almost $340,000 in connection with the change in CEO. That was accrued at the March 31 quarter.

[Operator Instructions] Our next question comes from Seth Barkett of Groveland Capital.

My first question, I guess, piggybacks off the last question. When was Mark let go? What was the exact date? I’m just trying to better understand why the $339,000 was accrued in the last quarter versus this quarter?

Well, that relates to discussions that commenced prior to the end of the quarter, and I probably can’t and shouldn’t get into more detail than that.

Okay.

Seth, the official date of Mark's resignation was April 20, but the decision had been made prior to the end of the quarter, although no agreements had been entered into.

Got it. Got it. What about the cash then, does the March 31 balance sheet reflect the cash that was paid out or no?

No, it does not the accrual was made, but the payments were not made until April.

Got it. All right. I guess my second question, I’m trying to better understand the transaction costs related to the Astromec sale. So on an $830,000 sale, it looks like there was about $325,000 of transaction costs. Can you provide a little bit of insight into, why was the brokerage fee so high? I mean $100,000 for an $800,000 sale?

Well, that’s something that had been negotiated a while back when we first engaged the broker to go out and shop for potential buyers. So it was done at a time when no one knew exactly what that business would fetch.

Okay. What about the employee-related cost, can you provide any color regarding the -- I don't know what it was, $150,000 or so, $200,000?

Our associates that were in effect let go as a result of the sale were compensated in terms of severance pay according to a company severance policy that we have based on seniority and their rate of pay, et cetera.

Okay. That was severance. All right. That makes sense. My next question, depreciation expense for the latest quarter, is it safe to assume that, that was in line with historical depreciation, about $170,000?

Yeah. There’s nothing unusual about depreciation expense for the quarter.

Okay. And just trying to also better understand the backlog at the end of the quarter for the former largest customer.

Well, as Mike mentioned, we made our final shipments to that customer in April. The backlog coming into Q4 was not -- I think it’s fair to say not appreciable.

Okay. Yeah, I’m just trying to get a feel for sales from that customer in that latest quarter. All right. And then I assume the inventory drop is largely a function of the Astromec sale. There was a decent amount of inventory included in that transaction purchase price?

It’s actually twofold. And by the way, you will have a lot more color on the last several questions when we do file our Q, because obviously we have good footnote disclosure in there. But the drop in inventory was in part related to the sale and was in part related to our recognition of the need to reduce inventories, obviously commensurate with the loss of that large customer.

Okay. My last question, is it safe to assume that the SG&A run rate, excluding obviously the one-time severance pay for Mark, should -- going forward it should look like the last quarter or is it going to look different?

We’ve resisted, as you well know, to comment on what things look like going forward. But I think from our comments, one thing you can see is that without the one-time payments, G&A pretty much held the line year-over-year. And our trend has been a good record of cost control. And certainly looking forward, given Mike's comments, cost control is going to be pretty high on the list of items to look out for.

Okay, great. And then, I guess this is a question for Mike. And I know I said one last question and I guess I’ll throw one more at you. But Mike, in terms of the first 2 items that you identified, a better sales process, doing a review of the quoting process, is that going to take more manpower or is that something that the existing team will be able to accomplish?

Well, let me tell you that, to start with, we do not have a sales force. So the only way we can increase sales is to at least have one sales person.

So you are still looking for a VP of sales, that's safe to assume?

That is correct. Now we do not anticipate building out a sales force in terms of any number of people, but we do have to have at least one person. And right now, we're only thinking about one person.

Okay, that’s fair and that helps understand. Do you have a timeframe for making a hire? I assume you’re interviewing candidates?

We are in active negotiations to try to bring a person on board.

There are no further questions at this time. I’d like to hand the floor back over to Mr. Berthelot for closing comments.

Well, thank you all for joining us today for the call, and thank you, Louis, for moderating it. We appreciate your time and support of the company and look forward to speaking with you in September, when we report our fiscal 2012 results.