UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A No. 2
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
For the quarterly period ended December 31, 2010
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
FOR THE TRANSITION PERIOD FROM TO .
Commission File Number 0-14942
PRO-DEX, INC.
(Exact name of registrant as specified in its charter)
| Colorado | 84-1261240 | |
| (State or Other Jurisdiction of Incorporation or Organization) |
(IRS Employer Identification No.) |
2361 McGaw Avenue, Irvine, California 92614
(Address of Principal Executive Offices)
Registrant’s telephone number: 949-769-3200
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company under Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer | ¨ | Accelerated filer | ¨ | |||
| Non-accelerated filer | ¨ | Smaller reporting company | x | |||
Indicate whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the Registrant’s classes of Common Stock outstanding as of the latest practicable date: 3,272,350 shares of Common Stock, no par value, as of February 10, 2011.
EXPLANATORY NOTE
On February 10, 2011, Pro-Dex, Inc. (the “Company) filed its Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2010 with the Securities and Exchange Commission. On May 6, 2011, the Company filed Form 10-Q/A No. 1 with the Securities and Exchange Commission to amend the aforementioned Quarterly Report on Form 10-Q for the following:
| • | In Item 4T of the Form 10-Q, the conclusions of the Company’s principal executive and principal financial officers regarding the effectiveness of the Company’s disclosure controls and procedures were made “for the quarter ended December 31, 2010,” rather than “as of December 31, 2010” as required by Item 307 of Regulation S-K. In the Form 10-Q/A No. 1, the effective period covered by the conclusions regarding the Company’s controls, as described above, has been corrected. |
| • | The second paragraph of Item 4T of the Form 10-Q addressed “direct changes in our internal controls over financial reporting” whereas Item 308(c) of Regulation S-K does not limit the disclosure requirement to “direct” changes. As there were no changes in our internal controls over financial reporting as of December 31, 2010, the word “direct” has been deleted from the second paragraph of Item 4T in the Form 10-Q/A No. 1. |
| • | In Item 2 in the Form 10-Q, the Company described its accounting policy for recording owned land and buildings as “at the value of their best and highest use.” In the Form 10-Q/A No. 1, the description of this policy has been clarified to indicate that “property, plant, equipment and leasehold improvements is recorded at historical cost.” |
| • | In Exhibits 31.1 and 31.2 to the Form 10-Q, certain wording was not in conformity with the requirements of Exchange Act Rule 13a-14(a). In the Form 10-Q/A No. 1, such wording has been corrected. |
This Form 10-Q/A No. 2 is being filed to amend the aforementioned Form 10-Q, as amended by Form 10-Q/A No. 1, for the following:
| • | The disclosure on the cover page of the aforementioned Quarterly Report on Form 10-Q pertaining to the date as of which the Company disclosed the number of shares of its common stock outstanding contained a typographical error that has been corrected in this Form 10-Q/A No. 2. |
| • | The complete text of each of the Items in the aforementioned Quarterly Report on Form 10-Q that were affected by the changes described above in connection with the Company’s filing of the Form 10-Q/A No. 1 has been provided in this Form 10-Q/A No. 2 in conformity with Item 307 of Regulation S-K. |
Other than the changes described in this Explanatory Note, the Company is not amending or updating any information contained within its Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2010 (the “Initial Filing”).
Therefore, this Form 10-Q/A No. 2 should be read in conjunction with the Company’s other filings made with the Securities and Exchange Commission subsequent to the date of the Initial Filing.
2
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
COMPANY OVERVIEW
The following discussion and analysis provides information that our 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 each of the three and six-month periods ended December 31, 2010 and 2009. 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. Our critical accounting policies relate to revenue recognition, inventory valuation for slow moving items, warranty reserves, and recoverability of deferred income tax assets.
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 for our fiscal year ended June 30, 2010.
With operations in Irvine, California, Beaverton, Oregon and Carson City, Nevada, we provide power and control products used in medical, aerospace, military, research and industrial applications. Experience in multi-axis motion control, fractional horsepower motors and rotary drive systems allows us to develop products that require high precision in harsh environments.
Our products are found in hospitals, dental offices, medical engineering labs, commercial and military aircraft, scientific research facilities and high tech manufacturing operations around the world. The names of Micro Motors, Oregon Micro Systems, and Astromec are used for marketing purposes as brand names.
Our principal headquarters is 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.
3
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. The significant accounting policies that are believed to be the most critical to fully understanding and evaluating our reported financial results include revenue recognition, inventory valuation for slow moving items, warranty reserves and the recoverability of deferred income tax assets.
Revenue Recognition
Revenue on product sales is recognized upon shipment to the customer based on its terms of FOB shipping point, where the risk of loss and title transfer to the customer. We record sales in accordance with ASC 605. Under these guidelines, revenue is recognized when all of the following exist: persuasive evidence that a sale arrangement exists, delivery of the product has occurred, the price is fixed or determinable, and payment is reasonably assured. We sell some of our products with a warranty that provides for repairs or replacement of any defective parts for a period after the sale, which is generally one year. At the time of the sale, the Company accrues an estimate of the cost of providing the warranty based on prior experience but the Company does not accrue an allowance for sales returns as there have been minimal returns for credit. The Company recognizes revenue under research and development agreements as certain deliverables are met as specified in each development contract.
Inventories
We determine our inventory value at the lower of cost (first-in, first-out) or market value, which is determined based on the age and quantity of inventory on hand. Generally, slow-moving inventory will be written down when the quantity of inventory on hand exceeds the sum of (i) orders on hand and (ii) estimated 12 months of usage.
Accounts Receivable
We determine an allowance for doubtful accounts based the length of time that has passed since the related sale was recognized as revenue. An allowance for doubtful accounts is generally established for accounts receivable more than 90 days old or for those accounts receivable subject to identified collection risk subsequent to recognition of the related sale. The allowance varies from 10% to 100% of the amount of the related receivable, depending on credit and collection history. Accounts receivable are charged against the allowance when it is determined that the receivable is uncollectible.
Warranties
The warranty accrual is based on the estimated return rates of products in the field and the estimated costs to repair such returned good. These assumptions are reviewed quarterly.
4
Property, Plant, Equipment & Leasehold Improvements, Net
Property, plant, equipment and leasehold improvements is recorded at historical cost.
| December 31, 2010 | June 30, 2010 | |||||||
| Land |
$ | 279,000 | $ | 279,000 | ||||
| Building |
641,000 | 641,000 | ||||||
| Leasehold Improvements |
2,286,000 | 2,286,000 | ||||||
|
Equipment |
6,762,000 | 6,745,000 | ||||||
| Total |
9,968,000 | 9,951,000 | ||||||
|
Accumulated Depreciation |
(6,201,000 | ) | (5,859,000 | ) | ||||
| Total property, plant & equipment, net |
$ | 3,767,000 | $ | 4,092,000 | ||||
Depreciation is calculated based on a straight-line method over the estimated useful lives of the assets as follows:
| Building |
39 years | |
| Leasehold improvements |
Term of the lease or estimated useful life, whichever is shorter | |
| Equipment |
Three to ten years |
Stock-Based Compensation
We are subject to ASC 718 (formerly FASB Statement No. 123 (R) “Accounting for Stock-Based Compensation,” as revised December 2004). This standard establishes the accounting standards for equity compensation, and applies to us in the recognition of the cost of stock options awarded based on the grant-date fair value of those awards.
Income Taxes
As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating the actual current tax liabilities together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. The most significant deferred tax assets are future deductions that may arise from the realization of inventory currently reserved and from available net operating loss carry forwards and available research and development tax credits. We must then assess the likelihood that the deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, a valuation allowance must be established.
Significant management judgment is required in determining our provision for income taxes and the recoverability of our deferred tax assets. Such determination is based primarily on our historical taxable income, with consideration given to our estimates of future taxable income by jurisdictions in which we operate and the period over which our deferred tax assets will be recoverable. We carry a valuation allowance against our deferred tax assets and changes in this allowance are reflected through the provision for income taxes.
5
Description of Business
The majority of our revenue is derived from the following sources: designing, developing and manufacturing rotary drive systems for the medical device and dental industries that are manufactured in our Irvine, California facility; multi-axis motion control hardware and software used to regulate the motion of servo and stepper motors, predominantly for the factory automation, scientific research, and medical analysis equipment industries manufactured in our Beaverton, Oregon facility; and high-reliability fractional horsepower DC motors designed for harsh environments, aerospace and military and medical applications manufactured in our Carson City, Nevada facility.
Our revenue is derived from five main customer types. The sales and proportion of total sales (including repair sales) related to each customer type are noted in the table below:
| Three months Ended December 31, | Six months Ended December 31, | |||||||||||||||||||||||||||||||||||
| Customer type | 2010 | 2009 | 2010 | 2009 | ||||||||||||||||||||||||||||||||
| (Dollars in thousands) | (Dollars in thousands) | |||||||||||||||||||||||||||||||||||
| Dental |
$ | 619 | 10 | % | $ | 468 | 8 | % | $ | 1,079 | 9 | % | $ | 1,060 | 9 | % | ||||||||||||||||||||
| Medical |
3,962 | 64 | % | 3,641 | 64 | % | 7,689 | 64 | % | 7,532 | 66 | % | ||||||||||||||||||||||||
| Industrial |
752 | 12 | % | 713 | 13 | % | 1,697 | 14 | % | 1,230 | 11 | % | ||||||||||||||||||||||||
| Aerospace |
803 | 13 | % | 827 | 15 | % | 1,406 | 12 | % | 1,447 | 13 | % | ||||||||||||||||||||||||
| Other |
21 | 0 | % | 47 | 1 | % | 115 | 1 | % | 60 | 1 | % | ||||||||||||||||||||||||
| Total sales |
$ | 6,157 | 100 | % | $ | 5,696 | 100 | % | $ | 11,986 | 100 | % | $ | 11,329 | 100 | % | ||||||||||||||||||||
Our Irvine, California facility bears a U.S. FDA Establishment Registration and a State of California Device Manufacturing License (Dept. of Public Health Food and Drug Branch), and is Certified to ISO 13485:2003, Medical Device Directive 93/42/EEC – Annex II, and the Canadian Medical Device Conformity Assessment System (CMDCAS). Our Carson City, Nevada facility is Certified to ISO 9001:2003.
Presently, we are generally able to fill orders within sixty days. At December 31, 2010, we had a backlog, including orders for delivery beyond sixty days, of $10.5 million, compared with a backlog of $11.8 million at December 31, 2009. We expect to ship most of our backlog in fiscal year 2011 and the remainder in fiscal years 2012 and 2013. The decrease in backlog is due to normal fluctuations in the timing of receipt and shipment of orders. We may experience variability in our new order bookings due 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.
6
RESULTS OF OPERATIONS
Comparison of the three-month periods ended December 31, 2010 and 2009
The following table sets forth the relationships in dollars and as a percentage of net sales of our operations:
| Three Months Ended December 31, | ||||||||||||||||
| 2010 | 2009 | |||||||||||||||
| Dollars in thousands | ||||||||||||||||
| Net sales |
$ | 6,157 | 100 | % | $ | 5,696 | 100 | % | ||||||||
| Cost of sales |
3,733 | 61 | % | 3,696 | 65 | % | ||||||||||
| Gross profit |
2,424 | 39 | % | 2,000 | 35 | % | ||||||||||
| Selling, general and administrative expenses |
1,248 | 20 | % | 1,152 | 20 | % | ||||||||||
| Impairment of intangible asset |
- | 0 | % | 140 | 2 | % | ||||||||||
| Research and development costs |
605 | 10 | % | 576 | 10 | % | ||||||||||
| Income from operations |
571 | 9 | % | 132 | 2 | % | ||||||||||
| Net interest and other expense
|
|
22
|
|
|
0
|
%
|
|
51
|
|
|
1
|
%
| ||||
| Income before provision (benefit) for income taxes |
549 | 9 | % | 81 | 1 | % | ||||||||||
| Provision (benefit) for income taxes |
148 | 2 | % | (499 | ) | -9 | % | |||||||||
| Net income |
$ | 401 | 7 | % | $ | 580 | 10 | % | ||||||||
Net sales for the three months ended December 31, 2010 increased $461,000 to $6,157,000 from $5,696,000 for the three months ended December 31, 2009, which is attributable primarily to an increase in sales of our medical device products to our largest customer, and to growth in sales of our dental products.
Gross profit for the three months ended December 31, 2010 increased $424,000 or 21% compared to the corresponding period in 2009. Gross profit as a percentage of sales improved 4 basis points to 39% for the three months ended December 31, 2010 compared to 35% for the three months ended December 31, 2009. The dollar increase in gross profit results in approximate equal parts from (a) the increase in the gross profit percentage, and (b) higher sales volumes, as discussed above. The increase in gross profit as a percentage of sales was due to (a) a change in mix toward sales of medical device products with relatively higher margins, (b) cost savings in warranty repair costs and (c) reductions in rework and scrap expense.
Selling expenses decreased $2,000 to $351,000 for the three months ended December 31, 2010 from $353,000 for the corresponding period in 2009. This change was attributable in part to increases in selling expenses between periods for costs of improvements made in the 2010 period to our website amounting to $56,000 and increased participation in trade shows that resulted in an increase of $13,000 from 2009 to 2010. These increases in 2010 were offset by a decrease from 2009 to 2010 in salary expense amounting to $71,000 arising from a current vacancy in our Vice President Sales position.
General and administrative expenses decreased $42,000, or 4%, to $897,000 for the three months ended December 31, 2010 from $939,000 for the corresponding period in 2009, due primarily to the patent impairment charge of $140,000 recognized during the 2009 period. In addition, severance expense increased by $112,000 in the 2010 period over the 2009 period.
7
Research and development cost increased $29,000, or 5%, to $605,000 for the three months ended December 31, 2010 from $576,000 for the three months ended December 31, 2009. The increase was due primarily to increased small motor development costs of $33,000.
As a result of the foregoing, operating income for the three months ended December 31, 2010 increased to $571,000 compared to $132,000 for the corresponding period in 2009.
Net interest expense for the three months ended December 31, 2010 was $22,000 compared to $53,000 for the three months ended December 31, 2009. The decrease was due to interest savings in connection with our repayment and retirement, prior to its maturity, of the mortgage collateralized by the land and building owned in Carson City.
Income Tax Provision. Our estimated effective combined federal and state tax rate on income from operations resulted in a tax provision of 27% compared to a tax benefit to earnings of 616% before tax for the three-month periods ended December 31, 2010 and 2009, respectively. The increased tax rate in 2010 arises from the increase in operating income, as discussed above, and primarily from the realization, in the 2009 period, of a portion of our then-available federal net operating loss carryovers generated in the year ended June 30, 2009 which were carried back against taxable income from prior years.
Based on the fluctuations discussed above, net income for the three months ended December 31, 2010 was $401,000, or $0.12 per share on a basic and diluted basis, respectively, as compared to net income of $580,000, or $0.18 per share on a basic and diluted basis, for the three months ended December 31, 2009.
Comparison of the six-month periods ended December 31, 2010 and 2009
The following table sets forth the periods indicated and the percentage of net revenues represented by each item in our Consolidated Statements of Operations.
| For the six months ended December 31, | ||||||||||||||||
| (In Thousands) | 2010 | 2009 | ||||||||||||||
| Dollars in Thousands | ||||||||||||||||
| Net sales: |
$ | 11,986 | 100 | % | $ | 11,329 | 100 | % | ||||||||
| Cost of sales |
7,378 | 62 | % | 7,456 | 66 | % | ||||||||||
| Gross profit |
4,608 | 38 | % | 3,873 | 34 | % | ||||||||||
| Selling, general and administrative expenses |
2,435 | 20 | % | 2,167 | 19 | % | ||||||||||
| Impairment of intangible asset |
- | 0 | % | 140 | 1 | % | ||||||||||
| Research and development costs |
1,196 | 10 | % | 1,197 | 11 | % | ||||||||||
| Income from operations |
977 | 8 | % | 369 | 3 | % | ||||||||||
| Net interest and other expense |
(80 | ) | -1 | % | (100 | ) | -1 | % | ||||||||
| Income before provision (benefit) for income taxes |
897 | 7 | % | 269 | 2 | % | ||||||||||
| Provision (benefit) for income taxes |
154 | 1 | % | (494 | ) | -4 | % | |||||||||
| Net income |
$ | 743 | 6 | % | $ | 763 | 7 | % | ||||||||
8
Net sales for the six months ended December 31, 2010 increased $657,000 to $11,986,000 from $11,329,000 for the six months ended December 31, 2009 resulting primarily from growth in sales of our medical device and motion control products.
Gross profit for the six months ended December 31, 2010 increased $735,000 or 19% compared to the corresponding period in 2009. Gross profit as a percentage of sales improved 4 basis points to 38% for the six months ended December 31, 2010 compared to 34% for the six months ended December 31, 2009. The dollar increase in gross profit results from (a) the increase in the gross profit percentage, and (b) higher sales volumes, as discussed above. The increase in gross profit as a percentage of sales was due to (a) a change in mix toward sales of medical device and motion control products with relatively higher margins, (b) cost savings in warranty repair costs and (c) reductions in rework and scrap expense.
Selling expenses increased $134,000 to $775,000 for the six months ended December 31, 2010 from $641,000 for the corresponding period in 2009. Costs of improvements to our website, increased advertising expenses, and increased participation in trade shows resulted in increases of $121,000, $70,000 and $36,000, respectively, from 2009 to 2010. These increases were offset by a decrease in salary expense, amounting to $115,000, arising from a current vacancy in our Vice President of Sales position.
General and administrative expenses decreased $6,000 to $1,660,000 for the six months ended December 31, 2010 from $1,666,000 for the corresponding period in 2009, due primarily to the patent impairment charge of $140,000 recognized during the 2009 period. In addition, bonus accruals and employee stock option expense decreased by $69,000 and $59,000, respectively, in the three-month period ended December 31, 2010 from the corresponding period in 2009, and severance and legal expenses increased by $112,000 and $82,000, respectively, in the 2010 period over the 2009 period.
Research and development costs were relatively unchanged, decreasing $1,000 to $1,196,000 for the six months ended December 31, 2010 from $1,197,000 for the six months ended December 31, 2009.
As a result of the foregoing, operating income for the six months ended December 31, 2010 increased to $977,000 compared to $369,000 for the corresponding period in 2009.
Net interest expense for the six months ended December 31, 2010 was $80,000 compared to $103,000 for the six months ended December 31, 2009. The decrease was due to interest savings in connection with our repayment and retirement, prior to its maturity, of the mortgage collateralized by the land and building owned in Carson City offset by early retirement fees associated with the same retirement during the 2010 period.
Income Tax Provision. For the six-month period ended December 31, 2010, our estimated effective combined federal and state tax rate on income from operations resulted in a tax provision of 17%, compared to a tax benefit of 184% for the corresponding period in 2009. The increased tax rate in 2010 arises from the increase in operating income, as discussed above, and primarily from the realization, in the 2009 period, of a portion of our then-available federal net operating loss carryovers generated in the year ended June 30, 2009 which were carried back against taxable income from prior years.
Based on the fluctuations discussed above, net income for the six months ended December 31, 2010 was $743,000, or $0.23 per share on a basic and diluted basis, as compared to net income of $763,000, or $0.24 per share on a basic and diluted basis, for the six months ended December 31, 2009.
9
Liquidity and Capital Resources
The following table presents selected financial information as of December 31, 2010, December 31, 2009 and June 30, 2010:
| December 31, | ||||||||||||
| 2010 | 2009 | June 30, 2010 | ||||||||||
| Cash and cash equivalents |
$ | 2,019,000 | $1,790,000 | $ | 3,794,000 | |||||||
| Working capital |
$ | 5,884,000 | $5,624,000 | $ | 6,369,000 | |||||||
| Credit line outstanding balance |
$ | - | $ | - | $ | - | ||||||
| Net debt (cash) |
$ | (852,000 | ) | $1,322,000 | $ | (899,000 | ) | |||||
| Tangible book value per common share |
$ | 2.57 | $0.86 | $ | 2.36 | |||||||
| Number of days of sales outstanding (DSO) in accounts receivable at end of quarter | 37 | 37 | 43 | |||||||||
Working capital as of December 31, 2010 was $5.9 million compared to $5.6 million as of December 31, 2009 and $6.4 million as of June 30, 2010. The increase in working capital from December 31, 2009 was due primarily to an increase in inventories, partially offset by related increases in accounts payable. The decrease in working capital from June 30, 2010 results primarily from the repayment and retirement of the mortgage loan collateralized by the Carson City property, discussed above.
Net cash used by operating activities during the six months ended December 31, 2010 was $58,000 compared to cash provided by operating activities amounting to $971,000 during the six months ended December 31, 2009. The decrease between periods was comprised primarily of (a) an increase in inventories in the 2010 period of $678,000 as compared to a decrease in the corresponding 2009 period of $148,000, combined with (b) a decrease in accounts payable and accrued liabilities of $597,000 during the six months ended December 31, 2010 as compared to a decrease in the corresponding 2009 period of $68,000. The increase in inventory in the six months ended December 31, 2010 resulted from purchases, primarily in the first three months of the period, to fulfill a correspondingly larger amount of customer orders for product deliveries due during the six months ended December 31, 2010 and in future months. The decreases in accounts payable and accrued expenses during the six months ended December 31, 2010 resulted from vendor payments, primarily during the last three months of the period, for the inventory purchases described above, and from the payment of bonuses, amounting to $507,000, which were accrued at June 30, 2010 and paid in October 2010.
Net cash used in investing activities for the six months ended December 31, 2010 was $16,000 as compared to $90,000 in the corresponding 2009 period. Investing activities consist mainly of capital expenditures for manufacturing equipment which can vary widely as equipment is upgraded or replaced.
Net cash used in financing activities for the six months ended December 31, 2010 was $1.7 million, as compared to $216,000 in the corresponding 2009 period. This increased use of cash is due to our payment, during the 2010 period, of the remaining $1,519,000 balance due on the Union Bank mortgage, fully retiring such indebtedness (see Note 5 of Notes to Condensed Consolidated Financial Statements).
10
Potential 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 hand pieces which are functionally comparable to the products we currently provide to the customer. We have been the exclusive manufacturer of these products since they were developed.
We currently provide this Customer with two products (“Product A” and “Product B”) and repair services for such products. Sales for each of these categories for the three and six months ended December 31, 2010 and 2009 were as follows:
| Six months ended December |
Three months 31, 2010 |
Average share of total |
Six months ended December 31, 2009 |
Three months 31, 2009 |
Average share of total |
|||||||||||||||||||||||
| Product A |
$ | 2,447,000 | $ | 805,000 | 37 | % | $ | 1,976,000 | $ | 627,000 | 40 | % | ||||||||||||||||
| Product B |
2,383,000 | 1,489,000 | 49 | % | 2,007,000 | 1,083,000 | 53 | % | ||||||||||||||||||||
| Repairs |
642,000 | 395,000 | 13 | % | 368,000 | 119,000 | 7 | % | ||||||||||||||||||||
| Total |
$ | 5,472,000 | $ | 2,689,000 | 100 | % | $ | 4,351,000 | $ | 1,829,000 | 100 | % | ||||||||||||||||
The Customer has indicated that it has released its version of Product A and is currently shipping such product to new accounts. The Customer has also indicated that it intends to continue to purchase Product A from us in sufficient levels to support (i) replacement units for its existing customers in the U.S. and Europe for the foreseeable future, (ii) all its requirements for customers in the U.S. and Europe who also use Product B until such time as the Customer’s version of Product B is marketable, and (iii) all its requirements in the South American market until this product is properly registered in this market.
Product B is a more complex device. The Customer has indicated that its first “beta units” were placed into field testing in December 2010, and that it believes it will take six to nine months to determine whether this design is robust enough to withstand the operating environment in which the product must function.
In addition, the Customer has indicated that it intends to continue to use our repair services for Products A and B for an undetermined period, except in South America, where it will purchase components from us to do its own repairs locally.
Based on the foregoing, it is possible that revenue otherwise attributable to this Customer could begin to decline during the second half of calendar year 2011. However, the Customer is not obligated either to abide by the timetables it has communicated to us or to update us as to the status of its product development efforts. Accordingly, we are unable to know or predict the status of the Customer’s initiatives on an ongoing basis. The Customer could accelerate, delay or terminate its transition to its own products at any time and without notice to us, which could have a material impact on our revenues. The identity of the Customer is protected by a confidentiality agreement.
We have implemented the initial steps of a strategic plan, the objective of which is to identify and capture additional revenue opportunities. There can be no assurance, however, as to either the timing or success of achieving this objective, and it would be our intent to reduce operating costs, if and as necessary, to minimize the impact of a revenue reduction, should it occur. In the event that the Customer’s future purchases are reduced beyond the realization of such opportunities or cost reductions, the Company is likely to experience a material and adverse impact on its business.
11
Changes in Bank Debt and Credit Facilities
During the six months ended December 31, 2010, we had a mortgage loan with Union Bank of California, N.A (“Union Bank”) and a credit facility with Wells Fargo Bank, N.A. (“Wells Fargo”), described as follows:
Union Bank Mortgage
In March 2006, we entered into a ten-year mortgage with Union Bank for $1,650,000. The principal balance of the mortgage bore interest at a fixed annual rate of 6.73%. Payments on the mortgage were $11,379 per month (based on a 25-year amortization), with the balance of $1,291,666 in principal due on April 1, 2016. The mortgage was collateralized by our Carson City land and building. On September 16, 2010, we paid the remaining $1,519,000 balance due on the Union Bank mortgage, fully retiring such indebtedness.
Wells Fargo Credit Facility
The Wells Fargo credit facility had two components:
| — | A revolving credit line of up to $1,000,000 in borrowing availability, under which no amounts were outstanding at either November 1, 2010 (the date of expiration of the credit line as further discussed below) or June 30, 2010; and |
| — | A five-year term loan with an initial balance of $2,000,000, of which $1,167,000 and $1,367,000 was outstanding at December 31, 2010 and June 30, 2010, respectively. |
If borrowings under the credit line were to have exceeded $500,000, the maximum amount of borrowing was limited to the lesser of $1,000,000 or 70% of the eligible accounts receivable plus 40% of the eligible inventories. Its terms required monthly interest payments at either (i) the prime rate of interest (3.25% at December 31, 2010) plus 1.50%, or (ii) three month LIBOR (0.290% at December 31, 2010) plus 2.50%, at our discretion, based on outstanding borrowings. The line of credit expired on November 1, 2010. We had been charged an unused credit line fee of 1.50% per annum payable quarterly on the average balance of the line of credit that was not used.
The term loan had an initial balance of $2,000,000, the borrowings from which were used for construction of tenant improvements in our Irvine, California facility. Its terms require monthly principal and interest payments over the 60-month life of the loan, based on outstanding borrowings. The interest rate is fixed at 5.72% over the life of the loan.
All assets of the Company except our Carson City land and building collateralize the outstanding borrowings under the Wells Fargo credit facility.
There are certain financial and non-financial covenants that we were required to meet to be in compliance with the terms of the Wells Fargo credit facility. As a result of write-offs we recorded in the fourth quarter of our fiscal year ended June 30, 2010, we were in violation of covenants that were based on 12-month historical profitability computations as of that quarter, and as of the succeeding quarters ended September 30 and December 31, 2010. On October 8, 2010, we were informed by Wells Fargo that the bank would not renew the revolving credit line, which then expired in conformity with its terms on November 1, 2010. With respect to the covenant violations, Wells Fargo waived by letter agreements the rights it would have otherwise had as of June 30 and September 30, 2010. As further discussed below, on February 4, 2011, we replaced the Wells Fargo credit facility, including a refinancing of the term loan, with a credit facility agreement we have entered into
12
with Union Bank. The current and non-current portions of the term loan in the accompanying December 31, 2010 consolidated balance sheet reflect the terms of the refinancing, whereas the presentation in the accompanying June 30, 2010 balance sheet reflect the Wells Fargo credit facility terms.
Union Bank Credit Facility
On February 4, 2011, we entered into a credit facility agreement with Union Bank that provides for the following:
| — | A revolving credit line of up to $1,500,000 in borrowing availability; |
| — | A non-revolving credit line of up to $350,000 in borrowing availability for the purchase of equipment; and |
| — | A term loan of $1.25 million. |
The maximum amount of borrowing under the revolving credit line is the lesser of:
(a) $1,500,000; or
(b) the sum of 80% of eligible domestic accounts receivable, plus the lesser of:
(i) $400,000; or
(ii) 15% of the eligible raw materials and finished goods inventories.
The revolving credit line’s terms require monthly interest payments based on borrowed amounts at a floating interest rate, calculated as Union Bank’s Reference Rate plus 0.5% (an aggregate interest rate of 3.75% at February 4, 2011). The line’s initial term expires on December 15, 2012, after which it is renewable annually at Union Bank’s option. Should Union Bank decide not to renew the line, it must give us a 60-day notice of such decision.
The terms of the non-revolving credit line, which is to be used for equipment purchases, require monthly interest payments based on borrowed amounts at a floating interest rate, calculated as Union Bank’s Reference Rate plus 0.5% (an aggregate interest rate of 3.75% at February 4, 2011). The line has a one-year term, after which amounts outstanding under the line at the end of the term will automatically convert into a three-year term loan at a floating interest rate calculated as described above with respect to the non-revolving credit line.
The terms of the $1.25 million term loan, the proceeds of which were used to pay off in full the Wells Fargo term loan described above, require monthly principal payments of $29,762, plus interest over its 42-month term. The term loan bears interest at a floating rate, calculated as Union Bank’s Reference Rate plus 0.5% (an aggregate interest rate of 3.75% at February 4, 2011).
All personal property assets of the Company collateralize the outstanding borrowings under the Union Bank credit facility.
The Union Bank credit facility contains financial covenants that require us to comply with minimum quarterly liquidity and annual profitability thresholds, non-financial covenants that include quarterly and annual reporting requirements, and certain operational restrictions.
13
Item 4. Controls and Procedures
The Chief Executive Officer and Chief Financial Officer (the principal executive officer and principal financial officer, respectively) conducted an evaluation of the design and operation of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)). Based on that evaluation as of December 31, 2010, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective.
During the three and six months ended December 31, 2010, there were no changes in our internal controls over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
14
| Item 6. Exhibits. |
Exhibits:
| 31.1 | Certification of Chief Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 31.2 | Certification of Chief Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
15
In accordance with the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Date: May 19, 2011 |
Date: May 19, 2011 |
|||||
| PRO-DEX INC. |
PRO-DEX INC. |
|||||
| By: /s/ Mark Murphy |
By: /s/ Harold A. Hurwitz |
|||||
| Mark Murphy |
Harold A. Hurwitz |
|||||
| Chief Executive Officer (Principal Executive Officer) |
Secretary and Chief Financial Officer (Principal Financial and Accounting Officer) |
|||||
16