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, 1997. [ ] 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 January 30, 1998, was 8,712,300. 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 Income F-3 & F-4 Consolidated Statements of Cash Flows F-5 Notes to Consolidated Financial Statements 8 Item 2. Management Discussion and Analysis 9 SIGNATURES 14 EXHIBITS NONE Page 2 of 14 Pages CONSOLIDATED BALANCE SHEETS ASSETS December 31, June 30, 1997 1997 (unaudited) Current assets: Cash and cash equivalents $ 76,592 $ 51,108 Accounts receivable, net 4,270,545 3,496,479 Inventories, net 4,022,400 4,236,069 Deferred taxes 475,000 475,000 Refundable income taxes 645,613 Prepaid expenses 470,300 186,987 Total current assets 9,314,837 9,891,256 Property and equipment 4,763,415 4,388,890 Less accumulated depreciation (2,025,091) (1,721,838) Net property and equipment 2,738,324 2,667,052 Other assets: Long-term trade receivables 1,258,699 1,079,957 Deferred taxes 505,000 505,000 Other 322,824 383,586 Intangibles, net 9,201,202 9,651,695 Total other assets 11,287,725 11,620,238 Total assets $23,340,886 $24,178,546 See "Notes to consolidated financial statements." F-1 CONSOLIDATED BALANCE SHEETS - CONTINUED LIABILITIES & SHAREHOLDERS' EQUITY December 31, June 30, 1997 1997 (unaudited) Current liabilities: Current portion of long-term debt $ 1,221,230 $ 1,211,999 Accounts payable 819,506 797,071 Accrued expenses 921,024 973,705 Income taxes payable 426,680 Total current liabilities 3,388,440 2,982,775 Long-term debt, net of current portion 6,513,296 8,444,545 Total liabilities 9,901,736 11,427,320 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; 8,712,300 shares issued and outstanding 14,632,444 14,632,445 Additional paid in capital 10,000 10,000 Accumulated deficit (1,427,171) (2,115,095) 13,498,263 12,810,340 Receivable from employee stock ownership plan (ESOP) (59,113) (59,114) Total shareholders' equity 13,439,150 12,751,226 Total liabilities and shareholders' equity $23,340,886 $24,178,546 See "Notes to consolidated financial statements." F-2 CONSOLIDATED STATEMENTS OF INCOME Quarter ended December 31, 1997 1996 (unaudited) (unaudited) Net sales (net of sales from discontinued operations of $0 and $517,514) $ 6,329,448 $ 4,776,596 Cost of sales 2,627,477 1,941,397 Gross profits 3,701,971 2,835,199 Operating expenses: Selling 1,229,052 978,940 General and administrative 1,169,485 1,180,253 Research and development 340,824 225,572 Amortization 225,246 215,692 Total operating expenses 2,964,607 2,600,457 Income from operations 737,364 234,742 Other income (expense): Interest expense (238,723) (306,515) Other income (expense), net 17,709 13,050 Total (221,014) (293,465) Income (loss) before income taxes (credits) and loss from discontinued operations 516,350 (58,723) Income taxes (benefits) 180,723 (30,900) Income (loss) before (loss) from discontinued operations 335,627 (27,823) (Loss) from discontinued operations (net of tax benefit) (140,664) Net income (loss) $ 335,627 $ (168,487) Basic and diluted earnings (loss) per share: Income (loss) from continuing operations $ 0.04 $ (0.00) (Loss) from discontinued operations (0.02) Net income (loss) per share $ 0.04 $ (0.02) Weighted average number of common and common equivalent shares outstanding 9,001,646 9,080,783 See "Notes to consolidated financial statements." F-3 CONSOLIDATED STATEMENTS OF INCOME Six months ended December 31, 1997 1996 (unaudited) (unaudited) Net sales (net of sales from discontinued operations of $0 and $1,111,777) $12,147,367 $ 9,208,722 Cost of sales 4,882,008 3,745,913 Gross profits 7,265,359 5,462,809 Operating expenses: Selling 2,210,515 2,007,822 General and administrative 2,350,488 2,376,020 Research and development 692,919 419,807 Amortization 450,492 457,082 Total operating expenses 5,704,414 5,260,731 Income from operations 1,560,945 202,078 Other income (expense): Interest expense (496,278) (559,174) Other income (expense), net 19,786 27,227 Total (476,492) (531,947) Income (loss) before income taxes (credits) and loss from discontinued operations 1,084,453 (329,869) Income taxes (credits) 396,535 (98,900) Income (loss) before (loss) from discontinued operations 687,918 (230,969) (Loss) from discontinued operations (net of tax benefit) (277,564) Net income (loss) $ 687,918 $ (508,533) Basic and diluted earnings (loss) per share: Income (loss) from continuing operations $ 0.08 $ (0.03) (Loss) from discontinued operations (0.03) Net income (loss) per share $ 0.08 $ (0.06) Weighted average number of common and common equivalent shares outstanding 9,001,646 9,080,783 See "Notes to consolidated financial statements." F-4 CONSOLIDATED STATEMENTS OF CASH FLOWS Six months ended December 31, 1997 1996 (unaudited) (unaudited) CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) 687,918 (508,533) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 753,296 809,392 Provision for doubtful accounts (39,209) 69,480 Change in working capital components net of effects from purchases and divestitures: (Increase) in accounts receivable (913,598) (197,156) (Increase) decrease in inventories 213,669 (354,158) (Increase) in deferred taxes (217,800) (Increase) decrease in prepaid expenses and refundable income taxes 362,300 (343,268) (Increase) decrease in other assets 60,763 (260,161) Increase (decrease) in accounts payable and accrued expense 19,055 (154,426) Increase in deferred revenue 3,336 Increase (decrease) in income taxes payable 377,380 (568,602) Net cash provided by (used in) operating activities 1,521,574 (1,721,896) CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment (374,076) (348,923) Net cash flows (used in) investing activities (374,076) (348,923) CASH FLOWS FROM FINANCING ACTIVITIES Net borrowing on revolving credit agreements 89,597 Proceeds from long-term borrowing 2,120,362 Principal payments on long-term borrowing (1,922,018) (186,849) Issuance of common stock 7,501 Net cash flows provided by (used in) financing activities (1,922,018) 2,030,611 (DECREASE) IN CASH AND CASH EQUIVALENTS (774,520) (40,208) Cash and cash equivalents, 851,112 407,722 beginning of period Cash and cash equivalents, end of period 76,592 367,514 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash payments for interest 496,278 559,174 Cash payments for income taxes 5,175 699,545 See "Notes to consolidated financial statements." F-5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For The Six Months Ended December 31, 1997 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, 1997, are not necessarily indicative of the results that may be expected for the year ended June 30, 1998. 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, 1997. NOTE 2 - EARNINGS PER SHARE Basic earnings per share are computed by dividing net income available to common shareholders by the weighted-average number of shares outstanding during the period. Fully diluted earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period plus the incremental shares that would have been outstanding assuming the exercise of dilutive stock options, and the assumed conversion of preferred shares. NOTE 3 - RECLASSIFICATIONS Certain items in the December 31, 1996 financial statement have been reclassified to be comparable with the financial statement classifications for the six months ending December 31, 1997. These classifications have no effect on shareholders' equity or net income as of and for the six months ending December 31, 1996. NOTE 4 - DISCONTINUED OPERATIONS On April 25, 1997, consistent with the decision of the Board of Directors, the Company completed the rescission of its previous acquisition of the assets of Pnu-Light Tool Works, Inc. ("Pnu-Light"). In accordance with the applicable unwind provision, the 368,483 shares of the Company's common stock that were originally issued as consideration for the acquisition were returned to the Company. Losses sustained by Pnu-Light are reported as discontinued operations for the six months ended December 31, 1996, and amounted to approximately $210,300 net of related tax benefit of $90,100. 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. On September 10, 1997, the Company finalized the arrangement for collection of the accounts receivable with the purchaser. As consideration for the performance of continuing service obligations on those accounts, the Company has agreed to the following. Proceeds from collection of the accounts receivable shall be paid to the Company commencing September 30, 1997, in the amount of $50,000. Thereafter, the purchaser shall pay to Pro-Dex $150,000 quarterly beginning on January 1, 1998, until the 1.8 million dollar balance is paid in full. Losses sustained by the DCM operation are reported as discontinued operations for the six months ended December 31, 1996, and amounted to approximately $67,000 net of related tax benefit of $29,000. 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 December 31, 1997 Compared to the Quarter Ended December 31, 1996. ----------------------------------------------------- Net sales by subsidiary follows: Increase/ 1997 1996 (Decrease) ----------- ----------- ----------- Biotrol $2,426,820 $1,652,664 $ 774,156 Challenge 484,841 381,854 102,987 Micro Motors 2,120,778 2,042,608 78,170 Oregon Micro Systems 1,729,914 915,140 814,774 (Inter-company sales) (432,905) (215,670) (217,235) ----------- ----------- ----------- $6,329,448 $4,776,596 $1,552,852 Sales from continuing operations increased 32.5% for the quarter ended December 31, 1997 compared to the quarter ended December 31, 1996. At Biotrol, the increase in the sales force from 11 to 16 people contributed to the rise in revenue of both infection control products and the preventive dental care product line. At Challenge sales increased by 27% for the quarter, primarily due to additional sales to its private label customers. Sales at Micro Motors were flat for the quarter. Significant management personnel changes occurred at Micro Motors during the quarter. Effective January 12, 1998, a new general manager was hired to complete the transition to a professionally managed operation at that subsidiary. In addition, a new director of engineering and a manufacturing manager were added to the new team in January. Revenue at OMS increased by 89% for the quarter ended December 31, 1997, compared to the quarter ended December 31, 1996. Continued strong growth in the semiconductor industry provided the substantial rise in business. OMS continues to add new customers because of its increased sales and marketing efforts. Gross profits by subsidiary follows: Increase/ 1997 1996 (Decrease) ---------- ---------- ----------- Biotrol $1,372,523 $ 910,966 $ 461,557 Challenge 175,162 133,926 41,236 Micro Motors 836,491 1,064,321 (227,830) Oregon Micro Systems 1,317,795 725,986 591,809 ---------- ---------- ----------- $3,701,971 $2,835,199 $ 866,772 Overall gross profit dollars increased by 30.6% for the quarter ended December 31, 1997, compared to the quarter ended December 31, 1996, due to increased revenue. More sales of lower margin products and negative inventory adjustments made during the quarter caused the decline in gross profit at Micro Motors. Gross profit percentage for the quarter ended December 31, 1997, was 58.5% compared to 59.4% for the quarter ended December 31, 1996. Operating expenses for the quarter ended December 31, 1997, were $2,964,607 (46.8% of net sales) compared to $2,600,457 (54.4% of net sales) for the quarter ended December 31, 1996. Selling and marketing expenses were higher for the quarter because of higher year-end sales rebates paid to customers who purchased more than forecasted orders. Selling and marketing expenses as a percentage of sales declined to 19.4% for the quarter ended December 31, 1997, compared to 20.5% for the quarter ended December 31, 1996, due to higher sales volume. General and administrative expense for the quarter ended December 31, 1997, included a one-time search fee of $50,000 incurred to find a new general manager for Micro Motors. As previously mentioned, the search was successful, and a new general manager along with new engineering and manufacturing management personnel were hired in January, 1998, for that operation. Research and development expense increased to $340,824 for the quarter ended December 31, 1997, compared to $225,572 for the quarter ended December 31, 1996, a 51.1% increase. Income from operations for the quarter ended December 31, 1997, was $737,364 compared to $234,742 for the quarter ended December 31, 1996, a 214.2% increase. Higher sales volume and gross profit were the main reason for the increase in income from operations. Interest expense declined for the quarter as improved cash flow from increased profits enabled the Company to reduce debt and interest expense. Income from continued operations for the quarter ended December 31, 1997 increased to $335,627 from a (loss) of ($27,823) for the quarter ended December 31, 1996. Losses from discontinued operations as a result of the disposition in fiscal year ended June 30, 1997, of the Company's Pnu-Light operation, and its dental clinic management business, were ($140,664), net of tax benefit of ($60,250) for the quarter ended December 31, 1996. Results of Operations for the Six Months Ended December 31, 1997 Compared to the Six Months Ended December 31, 1996. -------------------------------------------------------- Net sales by subsidiary follows: Increase/ 1997 1996 (Decrease) ------------ ----------- ------------- Biotrol $ 4,415,683 $ 3,082,214 $ 1,333,469 Challenge 872,298 719,713 152,585 Micro Motors 4,382,844 3,909,067 473,777 Oregon Micro Systems 3,399,586 1,872,809 1,526,777 (Inter-company sales) (923,044) (375,081) (547,963) ------------ ------------ ------------ $12,147,367 $ 9,208,722 $ 2,938,645 Consolidated sales from continuing operations increased 31.9% for the six months ended December 31, 1997, compared to the six months ended December 31, 1996. At Biotrol, sales for the six months increased 43.3%, primarily due to increases in sales of its infection control products and preventative dental care products. The increase in the sales force at Biotrol from 11 to 16 personnel, which was completed in the quarter ended September 30, 1997, provided greater market penetration and revenue for its products. Sales for the six months at Challenge increased 21.2%. An increase in inter-company sales of its preventative dental products to Biotrol comprised 66% of the sales increase for the six months. The remainder of the increase is attributed to a 34% rise in sales to its private label customers. At Micro Motors the increase in sales to its private label and OEM dental customers of 32.5% contributed to the overall increase in sales for the six months of 12.1%, net of inter- company sales. Micro began to market its branded hand-piece line through the sales force at Biotrol on July 1, 1997. Revenue at Oregon Micro Systems grew by 81.5% for the six months ended December 31, 1997, compared to the six months ended December 31, 1996. Continued strength in the semiconductor industry fueled the growth at OMS. The customer base and increase in sales is broader based, but continues to be heavily dependent on the semiconductor industry. Gross profits by subsidiary follows: Increase/ 1997 1996 (Decrease) ---------- ---------- ----------- Biotrol $2,437,028 $1,691,840 $ 745,188 Challenge 342,405 301,412 40,993 Micro Motors 1,871,094 2,009,298 (138,204) Oregon Micro Systems 2,614,832 1,460,259 1,154,573 ---------- ---------- ----------- $7,265,359 $5,462,809 $1,802,550 The Company's consolidated gross profit from continuing operations for the six months ended December 31, 1997, grew 33% over the six months ended December 31, 1996. Gross profit percentage increased to 59.8% for the six months ended December 31, 1997 from 59.3% for the six months ended December 31, 1996. Sales of higher margin products at Biotrol and Oregon Micro Systems was largely responsible for the rise. Gross profit dollars increased primarily due to the increase in revenue. Operating expenses increased 8.4% from $5,260,731 for the six months ended December 31, 1996, to $5,704,414 for the six months ended December 31, 1997. Selling and marketing expense increased by $202,693, or 10.1% for the six months ended December 31, 1997, compared to the six months ended December 31, 1996. Year-end rebates paid to customers for purchases in excess of forecasted orders, was the principal reason for the increase. Research and development expense rose 65.1% for the six months ended December 31, 1997, to $692,919 from $419,807 for the six months ended December 31, 1996. General and administrative expense included a one time $50,000 search fee to find a new general manager for the Micro Motors operation. Operating income for the six months ended December 31, 1997, increased to $1,560,945 from $202,078 for the six months ended December 31, 1996, mainly due to the increase in sales and gross profit for the six months. Income (loss) from continuing operations increased $918,887 to $687,918, or $0.08 per share for the six months ended December 31, 1997, from a loss of ($230,969), or ($0.03) per share for the six months ended December 31, 1996. During fiscal year ended June 30, 1997, the Company disposed of its Pnu-Light operations as well as its Dental Clinic Management business. Losses sustained by these two businesses are reported as discontinued operations for the six months ended December 31, 1996, and amounted to $277,564 or, ($0.03) per share, net of related tax benefit of $118,900. Liquidity and Capital Resources - ------------------------------- As of December 31, 1997, the Company had liquid resources consisting of cash, cash equivalents, and credit available on an existing credit line totaling $2,326,000. Cash flow continues to be strong as earnings before interest, taxes, depreciation, and amortization (EBITDA) for the six months ended December 31, 1997, were $2,334,027, as compared to $860,033 for the same six-month period of the previous year, an increase of 171%. 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. Accounting Changes - ------------------ Effective for annual and interim periods ending after December 15, 1997, the Financial Accounting Standards Board (FASB) has issued Statement No. 128, "Earnings Per Share," which supercedes APB Opinion No. 15. Statement No. 128 requires the presentation of earnings per share by all entities that have common stock or potential common stock, such as options, warrants and convertible securities outstanding that trade in a public market. Those entities that have only common stock outstanding are required to present basic 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. The adoption of Statement No. 128 would have no effect on reported income (loss) per share for the quarters ending September 30, 1997, and 1996, respectively. The FASB has also issued Statement No. 131 "Disclosure about Segments of an Enterprise and Related Information". Statement No. 131 modifies the disclosure requirements for reportable segments and is effective for the Company's year ending June 30, 1999. The Company has not determined the effect the adoption of this Statement would have on the Company's reported segments. 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. Other Matters - ------------- Presently the Company's information technology systems are inadequate to handle year 2000 requirements. Management is reviewing recommendations to upgrade the Company's and each subsidiary's entire information technology system. Many of the software applications at each subsidiary will be improved and made to comply with the year 2000 requirements. The operating plan for fiscal year ended June 30, 1998, includes the estimated cost to accomplish the improvements to the Company's information technology capabilities. 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, 1997 /s/ Kent E. Searl _______________________________ Kent E. Searl, Chairman Date: December 31, 1997 /s/ George J. Isaac _______________________________ George J. Isaac, Chief Financial Officer