-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LXD3V/ZrBWGJ46eQhVMx6gFZwXGPXlTJ+UfbMvpr2Vb8NH9s14k2SGeswFHO2Rzj uAL9eIiHhHesMFMp69P0Pw== 0000788920-99-000001.txt : 19990217 0000788920-99-000001.hdr.sgml : 19990217 ACCESSION NUMBER: 0000788920-99-000001 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990216 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRO DEX INC CENTRAL INDEX KEY: 0000788920 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-MEDICAL, DENTAL & HOSPITAL EQUIPMENT & SUPPLIES [5047] IRS NUMBER: 841261240 STATE OF INCORPORATION: CO FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10QSB SEC ACT: SEC FILE NUMBER: 000-14942 FILM NUMBER: 99538413 BUSINESS ADDRESS: STREET 1: 1401 WALNUT ST STE 500 CITY: BOULDER STATE: CO ZIP: 80302-5333 BUSINESS PHONE: 3034438165 MAIL ADDRESS: STREET 1: 1401 WALNUT STREET STREET 2: SUITE 540 CITY: BOULDER STATE: CO ZIP: 80302 10QSB 1 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 December 31, 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 February 11, 1999, 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 December 31, June 30, 1998 1998 ----------- ----------- (unaudited) Current assets: Accounts receivable, net of allowance for doubtful accounts of $34,659 and $29,194 $2,553,513 $3,363,433 Inventories, net 4,855,919 4,451,802 Deferred taxes 480,000 480,000 Prepaid expenses 662,254 220,770 Total current assets 8,551,686 8,516,005 Property and equipment 5,701,192 5,196,935 Less accumulated depreciation (2,578,391) (2,331,113) Net property and equipment 3,122,801 2,865,822 Other assets: Long-term receivables, net of allowance for doubtful accounts of $87,002 and $50,000 944,214 1,847,076 Investment 900,000 Deferred taxes 440,000 440,000 Other 610,481 423,428 Intangibles, net 8,114,416 8,746,254 Total other assets 11,009,111 11,456,758 Total assets $22,683,598 $22,838,585 See "Notes to Consolidated Financial Statements." F-1 CONSOLIDATED BALANCE SHEETS - CONTINUED LIABILITIES & SHAREHOLDERS' EQUITY December 31, June 30, 1998 1998 ----------- ----------- (unaudited) Current liabilities: Current portion of long-term debt $1,432,766 $1,394,994 Accounts payable 1,251,028 1,013,576 Accrued expenses 934,823 1,149,307 Total current liabilities 3,618,617 3,557,877 Long-term debt, net of current portion 7,383,337 6,120,922 Total liabilities 11,001,954 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; 8,737,300 shares issued and outstanding 14,837,694 14,837,695 Accumulated deficit (3,288,440) (1,810,649) ----------- ----------- 11,832,244 13,310,036 Receivable for stock purchase (150,600) (150,250) Total shareholders' equity 11,681,644 13,159,786 Total liabilities and shareholders'equity $22,683,598 $22,838,585 See "Notes to Consolidated Financial Statements." F-2 CONSOLIDATED STATEMENTS OF OPERATIONS Quarter ended December 31, 1998 1997 (unaudited) (unaudited) Net sales $4,298,323 $6,329,448 Cost of sales (includes rent paid to a director of $85,728 and $84,712 for 1998 and 1997) 2,389,700 2,627,477 Gross profits 1,908,623 3,701,971 Operating expenses: Selling 1,339,826 1,229,052 General and administrative 1,025,037 1,169,485 Research and development 403,895 340,824 Amortization 195,839 225,246 Unusual charges 0 Total operating expenses 2,964,597 2,964,607 Income (loss) from operations (1,055,974) 737,364 Other income (expense): Interest (expense) (224,691) (238,723) Other income, net 13,400 17,709 Total (211,291) (221,014) Income (loss) before income taxes (credits) (1,267,265) 516,350 Income taxes (credits) (506,906) 180,723 Net income (loss) $(760,359) $335,627 Basic and diluted net earnings (loss) per common and common equivalent share $(0.09) $0.04 Weighted average number of common and common equivalent shares outstanding 8,787,300 9,001,646 See "Notes to Consolidated Financial Statements." F-3 CONSOLIDATED STATEMENTS OF OPERATIONS Quarter ended December 31, 1998 1997 Net sales $8,869,093 $12,147,367 Cost of sales (includes rent paid to a director of $171,457 and $169,424 for 1998 and 1997) 4,462,211 4,882,008 Gross profits 4,406,882 7,265,359 Operating expenses: Selling 2,441,111 2,210,515 General and administrative 2,042,601 2,350,488 Research and development 747,261 692,919 Amortization 391,676 450,492 Unusual charges 838,833 Total operating expenses 6,461,482 5,704,414 Income (loss) from operations (2,054,600) 1,560,945 Other income (expense): Interest (expense) (434,900) (496,278) Other income (expense), net 27,157 19,786 Total (407,743) (476,492) Income (loss) before income taxes (credits) (2,462,343) 1,084,453 Income taxes (credits) (984,553) 396,535 Net income (loss) $(1,477,790) $687,918 Basic and diluted net earnings (loss) per common and common equivalent share $(0.17) $0.08 Weighted average number of common and common equivalent shares outstanding 8,787,300 9,001,646 See "Notes to Consolidated Financial Statements." F-4 CONSOLIDATED STATEMENTS OF CASH FLOWS Six months ended December 31, 1998 1997 (unaudited) (unaudited) CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $(1,477,790) 687,918 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 702,058 753,296 Provision for doubtful accounts 42,467 (39,209) Change in working capital components net of effects from purchases and divestitures: (Increase) decrease in accounts receivable 769,965 (913,598) (Increase) decrease in inventories (404,117) 213,669 (Increase) decrease in prepaid expenses (441,484) 362,300 Decrease in other assets 53,109 60,763 Increase in accounts payable and accrued expense 1,007,903 19,055 Increase (decrease) in income taxes payable (984,937) 377,380 Net cash provided by (used in) operating activities (732,826) 1,521,574 CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment (567,361) (374,076) Net cash flows (used in) investing activities (567,361) (374,076) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from long-term borrowing 1,950,000 0 Principal payments on long-term borrowing (649,813)(1,922,018) Net cash flows provided by (used in) financing activities 1,300,187 (1,922,018) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 0 (774,520) Cash and cash equivalents, beginning of period 0 851,112 Cash and cash equivalents, end of period 0 76,592 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash payments for interest $434,900 $496,278 Cash payments for income taxes $ 3,600 $ 5,175 See "Notes to Consolidated Financial Statements." F-5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For The Six Months Ended December 31, 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 six months ended December 31, 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. NOTE 4 - LONG TERM DEBT The Company is required to meet certain financial covenants including minimum tangible net worth, fixed charge coverage, and cash flow. In addition, the credit facility limits the amount of dividends and capital expenditures in any one year. At June 30, 1998 and December 31, 1998, the Company did not meet some of the financial covenants; however, on September 24, 1998, the bank waived the current covenants. Management is working with the bank to structure a covenant package to bring the Company into compliance. Item 2. Management's Discussion and Analysis Results of Operations Forward Looking Statements. All forward looking statements in this form 10Q involve important risks and uncertainties that significantly affect expected results in the future from those expressed in these forward looking statements. These risks and uncertainties involve the Company's assumptions regarding factors to include, but not be limited to, (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 December 31, 1998 Compared to the Quarter Ended December 31, 1997. Net sales by subsidiary follows: Increase/ 1998 1997 (Decrease) ---- ---- ------------ Biotrol $2,176,950 $2,426,820 $ (249,870) Challenge 559,723 484,841 74,882 Micro Motors 1,478,893 2,120,778 (641,885) Oregon Micro Systems 517,083 1,729,914 (1,212,831) Inter-company sales) (434,326) (432,905) (1,421) ----------- ----------- ------------ $4,298,323 $6,329,448 $(2,031,125) =========== =========== ============ Consolidated sales decreased 32.1% for the quarter ended December 31, 1998, over the quarter ended December 31, 1997. At Biotrol, sales for the quarter decreased 10.3%. The merger of three of Biotrol's largest customers continues to hamper sales growth due to the reduction of warehouse locations and corresponding reduction in inventory quantities carried by these customers. Further evidence of this trend is indicated by the fact that sales of Biotrol products by its customers to dentists exceeded sales of Biotrol products to its distributors for the quarter ended December 31, 1998. Sales of Biotrol products to the end user dentists are increasing, therefore, as 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 15.4% over the previous year's comparable quarter. Inter-company sales of its preventative dental products to Biotrol decreased 38.4% for the quarter ended December 31, 1998 compared to the quarter ended December 31, 1997, primarily due to consolidation of inventory levels of Biotrol's customers. Private label and OEM sales at Challenge increased 69.5% to $410,187 for quarter ended December 31, 1998 compared to $241,994 for quarter ended December 31, 1997. At Micro Motors sales decreased by 30.3% for the quarter ended December 31, 1998 compared to the quarter ended December 31,1997. On July 1, 1998, Micro Motors made the conversion to new manufacturing and accounting software. Due to difficulties experienced during the conversion process, Micro experienced significant parts shortages in the current quarter that created a backorder situation. As of December 31, 1998, Micro had orders totaling $520,000 that could not be shipped due to the shortage of parts. It is anticipated that the problems related to the parts shortages will be solved, and the backorder situation should be cleaned up by the end of the third fiscal quarter. Sales to Micro's key private label customers in the endodontic and implant industries continued to fall below the previous year. Micro has been developing a new line of controllers to improve its marketing position in the endodontic and implant dental segments. The new controller has enabled Micro to enter the medical microsurgery market. In January 1999, the Company announced that Micro Motors received an initial order for electric controllers from a major medical supplier. The order is valued at $500K and is scheduled for shipment beginning in February. Revenue at Oregon Micro Systems declined by 70.1% for the quarter ended December 31, 1998 compared to the previous year's same quarter. The decrease at OMS was a significant reason for the decline in revenue and profitability of the Company. 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. Industry experts indicate that the semiconductor industry may have hit bottom in October of 1998. Orders received in the past two months for January and February delivery have been higher than the level of activity over the previous nine months. Gross profits by subsidiary follows: Increase/ 1998 1997 (Decrease) ---- ---- ------------ Biotrol $1,153,737 $1,372,523 $ (218,786) Challenge 188,795 175,162 13,633 Micro Motors 282,165 836,491 (554,326) Oregon Micro Systems 283,926 1,317,795 (1,033,869) ---------- ---------- ------------ $1,908,623 $3,701,971 $(1,793,348) ========== ========== ============ Overall gross profit dollars decreased by 48.4% for the quarter ended December 31, 1998, compared to the quarter ended December 31, 1997, due to the decline in revenue. The conversion to new manufacturing software at Micro beginning on July 1, 1998 disclosed inventory valuation discrepancies under the new system. As a result Micro took a charge of $220,000 to cost of sales in the current quarter to correct the discrepancies. Overall gross profit percentage declined due to lower revenue absorbing fixed manufacturing overhead. Gross profit percentage for the quarter ended December 31, 1998, was 44.4% compared to 58.5% for the quarter ended December 31, 1997. Operating expenses for the quarter ended December 31, 1998, were $2,964,597 (69% of net sales) compared to $2,964,607 (46.8% of net sales) for the quarter ended December 31, 1997. Selling expenses were higher for the quarter because sales of Biotrol products out of the dealer warehouses were higher than the previous quarter. Sales to the dealers were lower due to inventory consolidation caused by the merger of three of Biotrol's largest customers. Research and development expense increased to $403,895 for the quarter ended December 31, 1998, compared to $340,824 for the quarter ended December 31, 1997, an 18.5% increase. The development of new products at Micro Motors has enabled them to expand into the medical microsurgery market. In addition to the $500K order Micro received from one major medical device supplier, several other potential medical device customers are currently reviewing the new products. Loss from operations for the quarter ended December 31, 1998, was ($1,055,974) compared to income of $737,364 for the quarter ended December 31, 1997. Several factors contributed to the decline in profitability for the quarter. At Biotrol, as previously mentioned, inventory consolidation resulting from the merger of three of Biotrol's largest customers caused the decline in revenue in the quarter. Sales of Biotrol's products out of the dealer warehouses are ahead of last year's revenue, but sales to the dealer warehouses are below last year. Revenue is expected to return to normal levels once the desired inventory levels are attained. At Micro Motors problems related to the new computer software conversion created a parts shortage that prevented Micro from building and shipping $520,000 of orders scheduled for November and December delivery. It is anticipated that the shortages will be corrected in the third fiscal quarter, and those shipments will be completed. In addition, demand for products from several key private label customers is below the previous year's level. Industry consolidation as well as a decline in the endodontic and implant segments of the dental market are attributed to the slowdown in revenue. Over the past six months, Micro has invested significant dollars in research and development to update its product line for these markets as well as the medical microsurgery market. The development is complete, and the new products are being demonstrated to both old and potential new customers. Finally, the semiconductor industry has experienced a major slowdown during all of 1998. Revenue at OMS for the quarter was down more than 70% over the previous year. Net operating income from OMS was down $946,858 to a loss of ($214,998) for the quarter ended December 31, 1998 compared to a profit of $731,860 for the quarter ended December 31, 1997. Recent new order activity has signaled a potential end to the semiconductor industry slump. In addition, OMS has gained new customers in other motion control related industries. Net loss for the quarter ended December 31, 1998 was ($760,359) compared to net income for the quarter ended December 31, 1997 of $335,627. Results of Operations for the Six Months Ended December 31, 1998 Compared to the Six Months Ended December 31, 1997. Net sales by subsidiary follows: Increase/ 1998 1997 (Decrease) ---- ---- ------------ Biotrol $4,303,830 $4,415,683 $ (111,853) Challenge 1,193,634 872,298 321,336 Micro Motors 2,970,179 4,382,844 (1,412,665) Oregon Micro Systems 1,368,887 3,399,586 (2,030,699) Inter-company sales) (967,437) (923,044) (44,393) ----------- ------------ ------------ $8,869,093 $12,147,367 $(3,278,274) =========== ============ ============ Consolidated sales from continuing operations decreased 27% for the six months ended December 31, 1998, compared to the six months ended December 31, 1997. At Biotrol, sales for the six months decreased 2.5%, primarily due to inventory consolidation caused by the merger of three of its largest customers. Biotrol is able to track sales of its products out of its customers' warehouses. For the six-month period ended December 31, 1998 sales of Biotrol products out of dealer warehouses was approximately $600K higher than sales to its dealer customers during the same period. Sales for the six months at Challenge increased 36.8% over the same six-month period in the previous year. Overall, the combined sales of dental products by Biotrol and Challenge increased by 4% over the previous year in spite of the inventory consolidation occurring within the industry. Challenge experienced a 79.8% increase in private label sales for the six months ended December 31, 1998 compared to the six months ended December 31, 1997. Sales at Micro Motors declined 32.2% for the six months ended December 31, 1998, compared to the six months ended December 31, 1997. Problems encountered during the implementation of new MRP software caused a parts shortage that prevented the unit from shipping $520,000 of orders scheduled for November and December delivery. A decline in demand for products from Micro's endodontic and implant customers also contributed to the decrease in revenue. Revenue at Oregon Micro Systems declined 59.7% for the six months ended December 31, 1998 compared to the same six months of the previous year. A severe slump in the demand for semiconductor fabrication equipment was the main reason for the decline. Approximately 80% of revenue at OMS comes from the semiconductor fabrication equipment market. OMS has made progress through its research and development efforts to enter the systems integrator, medical, and factory automation markets. Gross profits by subsidiary follows: Increase/ 1998 1997 (Decrease) ---- ---- ----------- Biotrol $2,201,591 $2,437,028 $ (235,437) Challenge 463,925 342,405 121,520 Micro Motors 852,769 1,871,094 (1,018,325) Oregon Micro Systems 888,597 2,614,832 (1,726,235) ---------- ---------- ------------ $4,406,882 $7,265,359 $(2,858,477) ========== ========== ============ The Company's consolidated gross profit from continuing operations for the six months ended December 31, 1998, decreased by 39.3% compared to the six months ended December 31, 1997. Gross profit percentage decreased to 49.7% for the six months ended December 31, 1998 from 59.8% for the six months ended December 31, 1997. The significant decline in revenue without a corresponding proportionate decline in fixed manufacturing overhead was the main reason for the reduction in gross profit percentage. Inventory discrepancies detected at Micro Motors as a result of the new manufacturing software conversion caused Micro to take a charge to cost of sales of $220,000 during the six month period ended December 31, 1998. Operating expenses without unusual charges decreased 1.4% to $5,622,649 for the six months ended December 31, 1998, from $5,704,414 for the six months ended December 31, 1997. The Company spent approximately $200,000 during the six months ended December 31, 1998 on the implementation of its information technology systems. Operating expenses with unusual charges included increased to $6,461,482 for the six months ended December 31, 1998 compared to $5,704,414 for the six months ended December 31, 1997. The Company took an unusual charge in the current six months 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 six months 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 six months in the amount of ($525,337). Loss from operations was ($2,054,600) which included unusual charges of ($838,833) for the six months ended December 31, 1998, compared to income from operations of $1,560,945 for the six months ended December 31, 1997. Loss from operations at OMS for the six months ended December 31, 1998 was ($395,506) compared to income from operations for the six months ended December 31, 1997 of $1,507,256, or a decrease in income from operations of $1,902,762. The decrease in income at OMS is directly related to a decline in revenue from its semiconductor industry customers. At Biotrol net income from operations for the six months ended December 31, 1998 was $74,048 compared to $577,602 for the same six month period in the previous year. Significant inventory consolidation resulting from the merger of three of Biotrol's largest customers was the primary reason for the decline in operating income. At Micro Motors loss from operations for the six months ended December 31, 1998 was ($695,773) compared to income from operations of $359,511 for the six months ended December 31, 1997. Micro experienced a parts shortage problem that prevented it from shipping $520,000 of orders during November and December of 1998. Revenue from key customers declined from the previous year due to disruption caused by ownership changes. Research and development expenditures at Micro Motors were $401,977 for the six months ended December 31, 1998 compared to $263,202 for the same six month period in the previous year, or an increase of 52.7%. Significant enhancements and upgrades were needed for certain components of the product line, and Micro finished developing its new line of high speed hand-pieces during the period. At Challenge, operating income increased to $213,839 for the six months ended December 31, 1998 from $87,467 for the six months ended December 31, 1997, a 144.5% increase. Increases in sales to existing private label customers, as well as sales to new private label customers contributed to the increase in profitability. The Company's effective tax rate is 40% for the six months ended December 31, 1998, compared to 36.6% for the prior year's six month period. The Company was able to utilize deferred tax assets in the prior year to lower its tax rate. Net loss for the six months was ($1,477,790), or ($.17) per share, compared to net income of $687,918, or $.08 per share for the six months ended December 31, 1997. Net loss for the six months included a net loss from unusual charges of ($.06) per share. Liquidity and Capital Resources As of December 31, 1998, the Company had liquid resources consisting of credit available on an existing credit line of $250,000. Management believes that funds generated from operations along with funds available under the credit line may not be 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. Management has discussed the current financial condition with its principal lender about additional funding should the need arise. The bank has indicated that it would entertain such a request under certain conditions which management feels it can meet. 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. 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. 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. In response to its poll of vendors, customers, and general service providers, the Company is developing contingency plans for 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. In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: December 31, 1998 /s/ Kent E. Searl -------------------------- Kent E. Searl, Chairman Date: December 31, 1998 /s/ George J. Isaac -------------------------- George J. Isaac, Chief Financial Officer EX-27 2
5 6-MOS JUN-30-1999 DEC-31-1998 0 0 2,588,172 71,661 4,855,919 8,514,684 5,542,113 2,578,391 22,683,598 3,618,617 0 0 282,990 14,782,694 (95,600) 22,683,598 8,869,093 8,869,093 4,462,211 0 6,461,482 0 434,900 (2,462,343) (984,553) (1,477,790) 0 0 0 (1,477,790) (0.17) (0.17)
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