PRO DEX INC — Interim / Quarterly Report 1998

Nov 13, 1998

U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------------- FORM 10-QSB (Mark One) [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 1998. [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Commission File Number 0-14942 PRO-DEX, INC. ---------------------------- (Name of small business issuer in its charter) Colorado 84-1261240 -------- ---------- (State or other jurisdiction of (I.R.S. Employer ID No.) incorporation or organization) 1401 Walnut St., Ste., 540, Boulder, Colorado 80302 --------------------------------------------------- (Address of principal executive offices) Issuer's telephone number: (303) 443-6136 Securities registered under Section 12(b) of the Exchange Act: Name of each exchange Title of each class on which registered ------------------- --------------------- None None Securities registered under Section 12(g) of the Exchange Act: Common stock, no par value -------------------------- (Title of class) The number of shares of the Registrant's no par value common stock outstanding as of November 12, 1998, was 8,787,300. DOCUMENTS INCORPORATED BY REFERENCE: None. Table of Contents Page No. PART I Financial Information Item 1. Financial Statements Consolidated Balance Sheets F-1 & F-2 Consolidated Statements of Operations F-3 Consolidated Statements of Cash Flow F-4 Notes to Consolidated Financial Statements F-5 Item 2. Management Discussion and Analysis 8 SIGNATURES 12 EXHIBITS NONE Page 2 of 12 Pages CONSOLIDATED BALANCE SHEETS ASSETS September 30, June 30, 1998 1998 (unaudited) Current assets: Accounts receivable, net of allowance for doubtful accounts of $15,443 and $29,194 $ 2,804,349 $ 3,363,433 Inventories, net 4,637,979 4,451,802 Deferred taxes 480,000 480,000 Prepaid expenses 665,759 220,770 Total current assets 8,588,087 8,516,005 Property and equipment 5,471,198 5,196,935 Less accumulated depreciation (2,483,313) (2,331,113) Net property and equipment 2,987,885 2,865,822 Other assets: Long-term receivables, net of allowance for doubtful accounts of $50,000 939,317 1,847,076 Investment 900,000 Deferred taxes 440,000 440,000 Other 660,971 423,428 Intangibles, net 8,310,255 8,746,254 Total other assets 11,250,543 11,456,758 Total assets $ 22,826,515 $ 22,838,585 CONSOLIDATED BALANCE SHEETS - CONTINUED LIABILITIES & SHAREHOLDERS' EQUITY September 30, June 30, 1998 1998 (unaudited) Current liabilities: Current portion of long-term debt $ 1,492,882 $ 1,394,994 Accounts payable 1,059,108 1,013,576 Accrued expenses 1,245,436 1,149,307 Total current liabilities 3,797,426 3,557,877 Long-term debt, net of current portion 6,587,086 6,120,922 Total liabilities 10,384,512 9,678,799 Commitments and contingencies Shareholders' equity: Series A convertible preferred shares, no par value; 10,000,000 shares authorized; 78,129 shares issued and outstanding 282,990 282,990 Common shares, no par value; 50,000,000 shares authorized; 8,787,300 shares issued and outstanding 14,837,694 14,837,695 Accumulated deficit (2,528,081 (1,810,649) 12,592,603 13,310,036 Receivable for stock purchase (150,600) (150,250) Total shareholders' equity 12,442,003 13,159,786 Total liabilities and shareholders' equity $ 22,826,515 $ 22,838,585 CONSOLIDATED STATEMENTS OF OPERATIONS Quarter Ended September 30, 1998 1997 (unaudited) (unaudited) Net sales $ 4,570,770 $ 5,817,919 Cost of sales (Includes rent paid to a director of $85,000 for 1998 and 1997) 2,072,511 2,254,531 Gross profits 2,498,259 3,563,388 Operating expenses: Selling 1,101,285 981,463 General and administrative 1,016,099 1,181,003 Research and development 343,366 352,095 Amortization 195,837 225,246 Unusual charges 838,833 Total operating expenses 3,495,420 2,739,807 Income (loss) from operations (997,161) 823,581 Other income (expense): Interest (expense) (211,674) (257,555) Other income, net 13,757 2,077 Total (197,917) (255,478) Income (loss) before income taxes (credits) (1,195,078) 568,103 Income taxes (credits) (477,647) 215,812 Net income (loss) $ (717,431) $ 352,291 Basic and diluted net earnings (loss) per common and common equivalent share: $ (0.08) $ 0.04 Weighted average number of common and common equivalent shares outstanding 8,787,300 8,842,000 CONSOLIDATED STATEMENTS OF CASH FLOWS Quarter Ended September 30, 1998 1997 (unaudited) (unaudited) CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ (717,431) $ 352,291 Adjustments to reconcile net income (loss)to net cash provided by (used in) operating activities: Depreciation and amortization 347,784 371,674 Provision for doubtful accounts (13,751) (406) Change in working capital components net of effects from purchases and divestitures: (Increase) decrease in accounts receivable 580,244 (436,922) (Increase) decrease in inventories (186,177) 99,337 (Increase) in prepaid expenses (444,989) (75,918) Decrease in other assets 2,619 51,197 Increase in accounts payable and accrued expense 619,692 86,095 Increase (decrease) in income taxes payable (478,031) 196,657 Net cash provided by (used in) operating activities (290,040) 644,005 CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment (274,010) (74,303) Net cash flows (used in) investing activities (274,010) (74,303) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from long-term borrowing 1,375,000 0 Principal payments on long-term borrowing (810,950) (933,080) Net cash flows provided by (used in) 564,050 (933,080) financing activities (DECREASE) IN CASH AND CASH EQUIVALENTS 0 (363,378) Cash and cash equivalents, beginning of period 0 851,112 Cash and cash equivalents, end of period $ 0 $ 487,734 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash payments for interest $ 211,674 $ 257,555 Cash payments for income taxes $ 3,600 $ 5,175 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For Quarter Ended September 30, 1998 NOTE 1 - BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instruction to Form 10-Q and Article 10 of regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the quarter ended September 30, 1998, are not necessarily indicative of the results that may be expected for the year ended June 30, 1999. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended June 30, 1998. NOTE 2 - EARNINGS PER SHARE The Financial Accounting Standards Board has issued Statement No. 128, "Earnings per Share" which supercedes APB Opinion No. 15. Statement No. 128 requires the presentation of basic and diluted earnings per share amounts. Diluted per share amounts assume the conversion, exercise or issuance of all potential common stock instruments unless the effect is to reduce a loss or increase the income per common share from continuing operations. NOTE 3 - DISCONTINUED OPERATIONS On June 11, 1997, the Company completed the sale of its Dental Clinic Management ("DCM") operations of its California subsidiary, Pro-Dex Management, Inc. In exchange for inventory and equipment, the purchaser assumed approximately $670,000 of the Company's liabilities. The Company retained ownership of the existing net accounts receivable of $1,800,000 related to the DCM operation. During 1998, the purchaser collected approximately $650,000 of the $1.8 million of accounts receivable, but due to financial difficulties was only able to remit $50,000 of the amount collected to the Company. In September 1998, in conjunction with a reorganization by the purchaser, and in consideration for guaranteeing collection of the full net amount of the accounts receivable, the Company agreed to restructure the balance owed of $1,750,000 in exchange for the following: a five year, 6% promissory note totaling $850,000, 5% convertible preferred stock of the purchaser's entity valued at $900,000, and warrants to acquire common stock in DCM's purchaser. Item 2. Management's Discussion and Analysis Results of Operations Forward Looking Statements. All forward looking statements in the following discussion of management's analysis of results of operation, liquidity and capital requirements, and the possible effect of inflation, as well as elsewhere in the Company's assumptions regarding factors such as (1) market acceptance of the products of each subsidiary, including brand and name recognition for quality and value in each of the Company's subsidiaries' markets, (2) existence, scope, defensibility and non-infringement of patents, trade-secrets and other trade rights, (3) each subsidiary's relative success in achieving and maintaining technical parity or superiority with competitors, (4) interest rates for domestic and Eurofunds, (5) the relative success of each subsidiary in attracting and retaining technical and sales personnel with the requisite skills to develop, manufacture and market the Company's products, (6) the non- occurrence of general economic downturns or downturns in any of the Company's market regions or industries ( such as dental products and tools or computer chip manufacturers), (7) the relative competitiveness of products manufactured by the Company's facilities, including any contractors in the global economy, (8) the non-occurrence of natural disasters, (9) a stable regulatory environment in areas of significance to each of the Company's subsidiaries, (10) the Company's success in managing its regulatory relations and avoiding any adverse determinations, (11) the availability of talented senior executives for the parent and each of the subsidiaries, (12) other factors affecting the sales and profitability of the Company in each of its markets. Should any of the foregoing assumptions or other assumptions not listed fail to be realized, the forward-looking statements herein may be inaccurate. In making forward looking statements in this and other Sections of the Company's report on Form 10-QSB, the Company relies upon recently promulgated policies of the Securities and Exchange Commission and statutory provisions, including Section 21E of the Securities Exchange Act of 1934, which provide a safe-harbor for forward looking statements. Results of Operations for the Quarter Ended September 30, 1998 Compared to Quarter Ended September 30, 1997. Net sales by subsidiary follows: 1998 1997 Increase/ (Decrease) Biotrol $ 2,126,880 $ 1,988,863 $ 138,017 Challenge 633,911 387,457 246,454 Micro Motors 1,491,286 2,262,066 (770,780) Oregon Micro Systems 851,804 1,669,672 (817,868) (Inter-company sales) (533,111) (490,139) (42,972) $ 4,570,770 $ 5,817,919 $(1,247,149) Consolidated sales decreased 21.4% for the quarter ended September 30, 1998, over the quarter ended September 30, 1997. At Biotrol, sales for the quarter increased 6.9%, primarily due to increases in sales of its infection control products and preventive dental care products. The merger of two of Biotrol's largest customers continues to hamper sales growth due to the reduction of warehouse locations and corresponding significant inventory consolidation. As the inventories of Biotrol products continue to move out of the dealers' warehouses, orders should increase in the future. Sales for the quarter at Challenge increased 63.6%. Inter-company sales of its preventive dental products to Biotrol increased 42.2% for the quarter ended September 30, 1998 compared to the quarter ended September 30, 1997. Private label and OEM sales at Challenge increased 96.1% to $301,696 for quarter ended September 30, 1998 compared to $153,873 for quarter ended September 30, 1997. At Micro Motors sales decreased by 34.1% for the quarter ended September 30, 1998 compared to the quarter ended September 30, 1997. Several of Micro's key private label customers experienced a decline in business during the quarter ended September 30, 1998. In addition, two of Micro's largest OEM customers changed ownership during the quarter causing a temporary disruption in business. Micro has been developing a new line of controllers to improve its marketing position in the endodontic and implant dental segments. The new controller will also enable Micro to enter the medical microsurgery market. Development of the product is due to be completed in the second quarter of the current fiscal year. Revenue at Oregon Micro Systems declined by 49% for the quarter ended September 30, 1998 compared to the previous year's same quarter. Revenue at OMS continues to be heavily dependent on the semiconductor industry. Continued over capacity of memory products and the Asian monetary crisis are the principle reasons for the reduction in revenue at OMS. Gross profits by subsidiary follows: 1998 1997 Increase/ (Decrease) Biotrol $ 1,069,407 $ 1,064,505 $ 4,902 Challenge 264,353 160,457 103,896 Micro Motors 559,828 1,041,389 (481,561) Oregon Micro Systems 604,671 1,297,037 (692,366) $ 2,498,259 $ 3,563,388 $(1,065,129) The Company's consolidated gross profit for the quarter ended September 30, 1998, fell 29.9% from the quarter ended September 30, 1997 primarily due to the decrease in revenue. Gross profit as a percentage of sales decreased to 54.7% for the quarter ended September 30, 1998 compared to 61.2% for the quarter ended September 30, 1997. The decline is attributed to lower revenue without a corresponding decrease in fixed manufacturing overhead, and a change in the sales mix to lower margin products. Operating expenses without unusual charges decreased 0.3% to $2,656,587 for the quarter ended September 30, 1998, from $2,739,807 for the quarter ended September 30, 1997. The Company spent approximately $75,000 during the current quarter on the implementation of its information technology systems. Operating expenses with unusual charges included increased to $3,495,420 for the quarter ended September 30, 1998 compared to $2,739,807 for the quarter ended September 30, 1997. The Company took an unusual charge in the current quarter totaling $838,833. Effective July 1, 1998, management determined that payments made for consulting services and a non-compete arrangement to an individual related to a prior acquisition by the Company have no future value, and has taken a charge to earnings in the current quarter in the amount of $313,496. In addition, the Company has amended the duties of an executive under an existing employment agreement. Management has determined that the value of the new position will be less than the previous position, but will continue to honor its obligation under the contract. The Company is taking a charge for the excess in the current quarter in the amount of $525,337. Loss from operations was ($997,161) which included unusual charges of $838,833 for the quarter ended September 30, 1998, compared to income from operations of $823,581 for the quarter ended September 30, 1997. Loss from operations was mainly attributed to the decline in operating income at the Company's OMS subsidiary. Operating income at OMS declined $680,351, or 87.7% for the quarter ended September 30, 1998, compared to the quarter ended September 30, 1997. Continued slowness in the semiconductor industry was the main factor contributing to the decrease. The Company's effective tax rate is 40% for the quarter ended September 30, 1998, compared to 38% for the prior year's quarter. The Company was able to utilize deferred tax assets in the prior year to lower its tax rate. Net loss for the quarter was ($717,431), or ($.08) per share, compared to net income of $352,291, or $.04 per share for the quarter ended September 30, 1997. Net loss for the quarter included a net loss from unusual charges of ($.06) per share. Liquidity and Capital Resources As of September 30, 1998, the Company had liquid resources consisting of credit available on an existing credit line of $1,350,000. Management believes that funds generated from operations along with funds available under the credit line are sufficient to cover anticipated operating needs as well as capital expenditure requirements for the current year. Capital expenditures for the Company's operations for the year ended June 30, 1999 are presently anticipated to be approximately $850,000. In the fourth quarter of fiscal 1998, the Company entered into a $1.2 million lease credit facility to partially finance these expenditures. Accounting Changes In June 1996, the FASB issued SFAS No. 130 "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". SFAS No. 130 requires that an enterprise report, by major components and as a single total, the change in its net assets during the period from non-owner sources; and SFAS No. 131 establishes annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas and major customers. Adoption of these Statements will not impact the Company's financial position, results of operations or cash flows and any effect will be limited to the form and content of its disclosures. Both Statements are effective for fiscal years beginning after December 15, 1997, with earlier application permitted. Impact of Inflation and Changing Prices The industries in which the Company competes are labor intensive, often involving personnel with high level technical or sales skills. Wages and other expenses increase during periods of inflation and when shortages in the marketplace occur. The Company expects its subsidiaries to face somewhat higher labor costs, as the market for personnel with the skills sought by the Company becomes tighter in a period of full employment. In addition, suppliers pass along rising costs to the Company's subsidiaries in the form of higher prices. Further, the Company's credit facility with Harris Bank involves increased costs if domestic interest rates rise or there are other adverse changes in the international interest rates, exchange rates, and/or Eurocredit availability. To some extent, the Company's subsidiaries have been able to offset increases in operating costs by increasing charges, expanding services and implementing cost control measures. Nevertheless, each of the Company's subsidiaries' ability to increase prices is limited by market conditions, including international competition in many of the Company's markets. Year 2000 Compliance Pro-Dex has developed a Corporate Information Technology ("IT") Strategic Plan specifically addressing Year 2000 ("Y2K") compliance issues. Defined areas for Y2K compliance include IT systems, facilities' systems, vendor and customer systems, contractual agreements, legal, human resources, etc., throughout the Company and its subsidiaries. In addition, the IT Strategic Plan addresses the issue of due diligence with respect to Y2K compliance within organizations under review for acquisition. The Company has adopted the following six phase compliance program. (1) The survey of all facility systems and equipment that use computers or embedded microprocessors. This effort includes reviewing equipment inventory, preventive maintenance lists, and vendor service contracts. (2) Identification of potential building systems or equipment compliance issues. Equipment, service and inventory vendors have been asked for compliance verification and testing procedures. (3) Investigate the issues identified through reviews with site personnel and vendors; identify potential impact; develop a strategy for modification or replacement and develop cost estimates. (4) Determine funding needs and develop strategy. (5) Implementation by purchasing required hardware or software (new or upgrades) and install/implement. (6) Validate by developing testing procedures to confirm compliance of current and upgraded hardware, software, and facilities' systems on an ongoing basis. In accordance with the IT Strategic Plan, Phases 1 through 4 listed above have been completed. Phase 5 is in process with a scheduled completion date of September 1999, in relation to current upgraded or implemented systems to validate Y2K compliance. Full implementation is scheduled to be complete in Fiscal Year 2001. Subsidiaries not fully implemented by the compliance completion date of September 1999 will have current systems upgraded prior to that date. The IT staff, in conjunction with the operations staff at each subsidiary, is in the process of implementing compliant upgrades to all other internal systems to include phone systems/voice mail, time clocks, burglar and fire alarms systems, postal and fax machines, etc., for Y2K compliance. In accordance with the IT Strategic Plan, all outside systems and suppliers have been directed to provide documentation validating compliance in an effort to minimize liability with respect to systems and suppliers. The Company is developing an internal strategic outline to include locating alternative sources of services and products if the current supplier is unable to meet compliance. This includes but is not limited to all outside suppliers of raw materials, payroll services, parts, shipping companies, phone/alarm companies, utilities, among other considerations. The Company has estimated the cost of replacement of the aging IT systems at all units with implementation of a new system to be $1.7 million dollars, of which $700,000 has been expended to date. It is anticipated that approximately $470,000 will be spent on the complete replacement of software, including upgrading all operating systems, application software, and general office automation software. Approximately $335,000 has been designated for the upgrade or replacement of hardware. Approximately $100,000 dollars will be spent between now and the year 2000 on facilities to meet Y2K compliance. The project is being funded through the Company's operations. The Company has not deferred other IT projects in favor of Y2K compliance. The Company has made inquiry of vendors and customers in respect to their general state of Y2K readiness. The Company has learned, through such polling of vendors, customers and general service providers, that a majority of those responding can not provide validated assurances of Y2K compliance at this time. The Company anticipates responses to its poll by this calendar year end, at which time it will, to the extent possible, develop contingency plans for any reported non-readiness. The Company, as are all other businesses, is at risk of experiencing business interruption due to the failure of general service providers, to include but not be limited to, electric power, water, gas, communications services rail services trucking lines and governmental agencies to be prepared for the year 2000. The nature of the foregoing discussion requires the use of forward looking statements that involve assumptions, risks, and uncertainties that could cause outcomes to be substantially different from those projected. Date: September 30, 1998 /s/ Kent E. Searl ____ Kent E. Searl, Chairman Date: September 30, 1998 /s/ George J. Isaac ____ George J. Isaac, Chief Financial Officer