PDEX - NASDAQ

Hal Hurwitz - Chief Executive Officer

Greetings and welcome to the Pro-Dex Fiscal 2014 Second Quarter 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. I would now like to turn the conference over to your host, Hal Hurwitz, CEO. Thank you, Mr. Hurwitz. You may begin.

Thank you, Rob and thank you all for joining us to review the results for the fiscal 2014 second quarter and six months ended December 31, 2013. On today’s call, I will provide a synopsis of our operating results as well as some comments. Then as Rob mentioned, we will open up the call for your questions. Before beginning however, 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 laws. 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 future events. For more information, please refer to the risk factors discussed in the company’s Form 10-K for the year ended June 30, 2013, which has been filed with the SEC and Form 10-Q for the quarter ended December 31, 2013 filed with the SEC today and the Form 8-K filed 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. And now, let’s cover the quarter’s results. Net sales for the three months ended December 31, 2013 decreased $367,000 or 12% to $2.6 million from $3.0 million for the three months ended December 31, 2012 due primarily to decreases of $428,000 in medical device development and manufacturing revenues and $48,000 in motion control product revenues, which were partially offset by an increase of $152,000 in dental product revenues. Contributing to the $428,000 decrease related to the company’s medical device product line was a $275,000 decrease in repair revenues from its former largest customer, which was partially offset by an increase of $161,000 in product and repair revenues from our current largest customer. Pursuant to an agreement with our former largest customer, which commits that customer to a minimum amount of inventory purchases at the agreement’s termination in June 2014, the company expects sales to that customer to continue to decline through the agreement’s term, after which it expects no further revenues from that customer. The increase in sales to our current largest customer reflects the resumption of orders from that customer, which had been curtailed since March 2013. We expect to continue receiving such orders through December 2014, the termination date of that customer’s current purchase commitment. Negotiations for future arrangements with that customer have not yet commenced. Medical device sales to other customers decreased $181,000 and medical device design revenues decreased $133,000. Gross profit for the three months ended December 31, 2013 decreased $484,000 or 47% to $549,000 from $1.0 million for the same period in 2012. Contributing to this decrease were the reduction in sales volume, described above – I am sorry, described in my previous remarks and the effects of unfavorable changes in the mix of product sales, which reduced gross profit by $126,000 and $139,000 respectively. Also contributing to the decrease in gross profit was an increase of $199,000 in the accrual for anticipated losses from the development services portion of certain contracts and an increase of $166,000 in unfavorable production variances related to reduced manufacturing volumes. These were partially offset by a decrease of $60,000 in warranty expense. Other than the reduction in sales volume, the factors affecting gross profit as I have just described them also resulted in a decrease of gross margin as a percentage of sales to 21% for the three months ended December 31, 2013 from 34% for the corresponding period in 2012. Operating expenses, which include selling, general and administrative, and research and development expenses for the quarter ended December 31, 2013 decreased 35% to $925,000 from $1.4 million in the prior year’s corresponding quarter, reflecting primarily the effects of the company’s cost reduction program. Loss from continuing operations for the quarter ended December 31, 2013 was $338,000 compared to a loss from continuing operations of $364,000 in the corresponding quarter in 2012. Net loss for the quarter ended December 31, 2013 was $338,000 or $0.10 per diluted share compared to a net loss of $348,000 or $0.11 per diluted share for the corresponding quarter in 2012. Turning to the six months period, net sales for the six months ended December 31, 2013 decreased $1.3 million or 20% to $5.2 million from $6.5 million for the six months ended December 31, 2012 due primarily to decreases of $1.2 million in medical device development and manufacturing revenues and $341,000 in motion control product revenues, which were partially offset by an increase of $246,000 in dental product revenues. The $1.2 million decrease related to our medical device product line was comprised of a $201,000 decrease in repair revenues from our former largest customer and a $679,000 decrease in revenues from our current largest customer. As I discussed in greater previously, we expect sales to our former customer to decline to zero over the balance of this fiscal year 2014 and sales to our current largest customer in fiscal 2014 to exceed prior year amounts pursuant to the resumption of orders from this customer, which commenced in December 2013 after having been curtailed since March 2013. Also contributing to the decrease in medical device revenues was a $130,000 decrease in product sales to other medical device customers and a $175,000 decrease in medical device design revenues. Gross profit for the six months ended December 31, 2013 decreased $775,000 or 34% to $1.5 million from $2.3 million for the same period in 2012. Contributing to this decrease were the reduction in sales volume that I previously described and the effects of unfavorable changes in mix of product sales, which reduced gross profit by $493,000 and $143,000, respectively. Also contributing to the decrease in gross profit was an increase of $212,000 in the accrual for anticipated losses from the development services portion of certain contracts and an increase of $198,000 in unfavorable production variances related to reduced manufacturing volumes, which were partially offset by a decrease of $213,000 in warranty expense resulting from lower sales volume in the 2013 period relative to the 2012 period and the warranty expiration in the 2013 period related to units sold in prior years. Other than the reduction in sales volume, the factors I have just described that affected gross profit also resulted in a decrease of gross margin as a percentage of sales to 29% for the six months ended December 31, 2013 from 35% for the corresponding period in 2012. Operating expenses, which include selling, general and administrative, and research and development expenses, for the six months ended December 31, 2013 decreased 32% to $1.8 million from $2.7 million in the prior year’s corresponding period, reflecting primarily the effects of the company’s cost reduction program. Loss from continuing operations for the six months ended December 31, 2013 was $320,000 compared to a loss from continuing operations of $418,000 for the corresponding period in 2012. Net loss for the six months ended December 31, 2013 was $126,000, or $0.04 per diluted share compared to a net loss of $365,000, or $0.11 per diluted share for the corresponding period in 2012. Also during the six months of 2013, we received net proceeds of $900,000 from the sale of our former facility in Carson City, Nevada. Cash and cash equivalents which exclude our investments in public company equity securities at December 31, 2013 were $1.6 million compared to $1.7 million at June 30, 2013. With all of that, now some brief commentary. As I stated in today’s press release, our results for the quarter ended December 31, 2013 were materially influenced by factors adversely affecting gross margins. As we have previously publicly discussed, much of our activity this fiscal year relates to the engineering phase of projects to develop a next-generation platform for powered surgical instruments that we believe will result in manufacturing revenues commencing at the end of fiscal 2014 or early fiscal 2015. Most development efforts of this nature, however, have inherent unexpected costs and the projects in which we are engaged are no different. We anticipate that our development project costs will exceed the development project revenues we expect to earn. Accordingly, we recorded accruals for these excess costs, amounting to $199,000 for the quarter and $212,000 for the six months ended December 31, 2013 that eroded gross margins for those respective periods. In addition, we incurred unfavorable manufacturing variances for the quarter and six months ended December 31, 2013 as a consequence of our relatively low sales volumes that also eroded gross margins. While it is desirable to maintain manufacturing capacity in anticipation of future activity, we may reduce this capacity as necessary to staunch these unfavorable variances. With our cost footprint now right-sized, as evidenced by our year-over-year operating expense performance, the fundamental agenda for Pro-Dex is unchanged to rebuild our revenue base. To this end, we have restructured our business development capabilities this fiscal year to more efficiently identify and pursue additional business opportunities, and I look forward to reporting on the results of these initiatives in the future. I am now happy to invite any questions you might have with regard to the quarter or our business operations. And with that, I will turn the call back over to Rob for Q&A.

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Thank you. Our first question is from (indiscernible) with Apex Asset Management. Please proceed with your question.

Hi. There is lot of moving parts with accruals and such, just wondering can you give us a sense of what normalized gross margins might look like?

Historically, the company Jesse has run in the mid 30% range, give or take a couple of points either way.

Is there any reason to believe that won’t be what the future looks like as well?

I don’t have any reason to believe that. That’s why I emphasized in my remarks the accruals that we have made, because these accruals we certainly hold are not recurring. We have made an accrual in the first fiscal quarter and certainly we made a very large accrual in this fiscal quarter, but it’s not something that we hope to have recurred for the future. And does not relate to, again that relates to our non-recurring engineering services, the portion of – the engineering portion of contracts that we have going on that have not yet hit manufacturing. So these accruals have nothing to do with manufacturing. Now, I also mentioned that we did have some manufacturing variances that came as a result of low volumes going through our manufacturing floor during the quarter and we’ll assess though, because as I mentioned we do have some ability to adjust our capacity for manufacturing in order to reduce those variances.

Okay, thank you. Do you expect future business with a largest customer post 2014? You said that the contract last until December, is it normal course of business that renegotiate and extend that into the future?

It has been. We go from year to year with them. And generally, those conversations haven’t commenced until at most I think six months before the end of their current purchase period. So I would anticipate that sometime during the summer and perhaps into the fall is one we would have our conversations with that longstanding customer.

So, no reason to read anything negative into those remarks?

No, there was nothing intended of negative.

No, I was surprised in the press release, it seemed a little worrisome, but I guess I am glad it’s not. And then just maybe could you give us sense of the opportunities that you are looking at, if there is any quantification you could put around them?

They really run the gamut. Our revenue base can really – can be segmented into two parts, the more traditional product lines that the product had before getting into medical device both being industrial and dental primarily have a shorter sales cycle, but also on a per transaction basis, our lower sales volume relative to medical device. Medical devices I have commented on for many, many quarters as have my predecessors, that is a much longer sales cycle, but the reward at the end are much larger revenues per transaction.

Okay. And then just…..

Because we are pursuing both segments at the same time and so it’s difficult to look forward and give any sense especially on the medical device side again because of the long sales cycle. It’s not unusual to become aware of a promising medical device customer prospects and not have that germinate into manufacturing revenues for perhaps a two or three-year period.

And then just one last question, I assume there is no buyback which you have authorized. Can you clarify that banking on one hand, you have it looks like excess cash you announced a repurchase program, but on the other hand, you announced the rights offering and could you give an update on that and just maybe the thinking of yourself or the board with both the repurchase and the rights offering out there?

Well, I am going to disappoint you a little bit, because I can’t share a whole lot. Obviously with respect to the rights offering, we are mid registration right now. And so it wouldn’t be appropriate for me to comment on that other than to refer you to the use of proceeds section in the F3 that we filed. With respect to the repurchase program, again it’s – it’s very much in line with what we have already disclosed that with the initiation of our investment committee, there were a variety of approved investments that, that committee could consider. And the board felt it was appropriate to include as one of those potential approved investments, our own stock if market condition is so warranted.

Okay, great. Thank you very much for your time.

Thank you.

Thank you. (Operator Instructions) Thank you. Mr. Hurwitz, as there are no further questions at this time, I would like to turn the floor back to you for additional comments.

Okay, thank you, Rob and I thank all of you for joining us today. All of us at Pro-Dex appreciate your interest, your time, and your support of the company and we look forward to speaking with you in May when we report our fiscal 2014 third quarter and nine months financial results. Thank you very much.