Item 1. Business
ITEM 1. BUSINESS
Company Overview
Pro-Dex, Inc. (“Company,”
“Pro-Dex,” “we,” “our,” “us”) specializes in the design, development, and manufacture
of autoclavable, battery-powered and electric, multi-function surgical drivers and shavers used primarily in the orthopedic, thoracic,
and craniomaxillofacial (“CMF”) markets. We have patented adaptive torque-limiting technology and proprietary sealing
solutions which appeal to our customers, primarily medical device distributors. We also manufacture and sell rotary air motors to a wide
range of industries.
Our patented adaptive torque-limiting
software has been very well received in the CMF and thoracic markets and we have continued investment in this area with research and development
focused on applying this technology to other surgical applications.
In November 2020, we purchased
an approximate 25,000 square foot industrial building in Tustin, California (the “Franklin
Property”). This building is located approximately four miles from our Irvine, California headquarters and was acquired to provide
us additional capacity for our expected continued future growth. We substantially completed the build-out of the property during fiscal
2022 and concluded various verification and validation activities during fiscal 2023. We moved our entire assembly and repairs operations
to the new facility in the fourth quarter of fiscal 2023 and we are now fully operational in the new facility. We believe the new facility
will create additional capacity for our expected continued growth over the next several years.
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O ur
principal headquarters are 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 certain other Securities and Exchange Commission (“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 .
All years relating to financial
data herein shall refer to fiscal years ended June 30, unless indicated otherwise.
Description of Business
The
majority of our revenue is derived from designing, developing and manufacturing surgical
devices for the medical device industry. The proportion of total sales by type is as follows
(in thousands, except percentages):
Years
Ended June 30,
2024
2023
(In thousands)
% of Revenue
% of Revenue
Medical devices
$ 36,979
69 %
$ 30,740
66 %
Industrial and scientific
765
1 %
865
2 %
NRE & Prototypes
786
1 %
2,695
6 %
Dental and component
201
—
257
1 %
Repairs
16,505
31 %
12,617
27 %
Discounts & Other
(1,392 )
(2 %)
(1,087 )
(2 %)
Total Sales
$ 53,844
100 %
$ 46,087
100 %
Our medical device products utilize
proprietary designs developed by us primarily under exclusive development and supply agreements and are currently machined in our Irvine,
California facility, and assembled in our Tustin, California facility, as are our rotary air motors. Our medical device products are sold
primarily to original equipment manufacturers and our air motors are sold primarily to a wide range of distributors and end users.
In fiscal 2024, our top
three customers accounted for 88% of our sales compared to 92% in fiscal 2023. In fiscal 2024, we had one customer, included in both medical
device and repairs revenue above, that accounted for 71% of sales with our next largest customer accounting for 12% of sales. This compares
to fiscal 2023, when these same two customers accounted for 67% and 16%, respectively, of our total sales. In many cases, including our
largest customers, disclosure of customer names is prohibited by confidentiality agreements with such entities. We have no plans to discontinue
the sales relationships with our existing significant customers, nor does management have any knowledge that any existing significant
customer intends to terminate its relationship with us.
Our business today is almost entirely
driven by sales of our medical devices. Many of our significant customers place purchase orders for specific products that were developed
under various development and/or supply agreements. Our customers may request that we design and manufacture a custom surgical device
or they may hire us as a contract manufacturer to manufacture a product of their own design. In either case, we have extensive experience
with autoclavable, battery-powered and electric, multi-function surgical drivers and shavers. We continue to focus a significant percentage
of our time and resources on providing outstanding products and service to our valued principal customers. During the first quarter of
fiscal 2021, our largest customer executed an amendment to our existing supply agreement such that we will continue to supply their surgical
handpieces to them through calendar 2025 and, during the fourth quarter of fiscal 2021, they executed a product development agreement
and related statement of work for our assistance with the next generation of this handpiece. Additionally, we continue to invest in property
and equipment as well as personnel to expand our capacity to achieve higher sales volumes.
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To that end, we purchased the
Franklin Property in November 2020. This building is located approximately four miles from our Irvine, California headquarters and was
acquired to provide us additional capacity for our expected continued future growth. We began operations in the new facility during the
fourth quarter of fiscal 2023. While we believe that the efforts we completed to bring the facility operational will allow us ample capacity
to increase revenues significantly in future years, there can be no assurance that we will increase revenue.
Simultaneously, we are working
to build top-line sales through active proposals of new medical device products with new and existing customers. Our patented adaptive
torque-limiting software has been very well received in the CMF and thoracic markets.
The majority of the raw materials
and components used to manufacture our products are purchased and are available from several sources, including through our own in-house
machining capabilities. Portescap, Fischer Connectors, and Tadiran Batteries are examples of key suppliers. We have no exclusive arrangements
with any of our suppliers, but in several instances only one supplier is used for certain high-value components. In most of such instances,
secondary suppliers have been identified, although it is likely that any transition to a new or different supplier would result in a delay
in the supply chain. We consider our relationships with our suppliers and manufacturers to be good, however, since fiscal 2022 and continuing
through fiscal 2024, many of our suppliers have increased lead times, experienced delays in shipments and raised prices or temporarily
added surcharges. We do not intend to terminate any such relationship at this time, nor does management have knowledge that any supplier
or manufacturer intends to terminate its relationship with us.
Our commitment to product
design, manufacturing, and quality systems are supported by our compliance with several regulatory agency requirements and standards.
We hold a U.S. Food and Drug Administration (“FDA”) Establishment Registration and a State of California Device Manufacturing
License (Department of Public Health Food and Drug Branch) with respect to our Irvine and Tustin, California facilities. In addition,
both facilities produce products that are certified to ISO 13485:2016, Medical Device Directive 93/42/EEC – Annex II.
At June 30, 2024,
we had a backlog of $19.8 million compared with a backlog of $41.6 million at June 30, 2023. Our backlog represents firm purchase orders
received and acknowledged from our customers and does not include all revenue expected to be generated from existing customer contracts.
Substantially all of our backlog at June 30, 2024, as well as certain purchase orders received subsequent to June 30, 2024, are expected
to be delivered during fiscal 2025. We have experienced, and may continue to experience, variability in our new order bookings due to,
among other reasons, the launch of new products, the timing of customer orders based on end-user demand, and customer inventory levels.
We do not expect a reduction in fiscal 2025 revenue as compared to fiscal 2024 revenue and believe that the decline in backlog at June
30, 2024 compared to June 30, 2023 is related to timing of customer orders, although there can be no assurance that there will not be
a decline in future revenue. Additionally, $10.2 million of our backlog at June 30, 2023 related to orders expected to be delivered in
fiscal 2025. We do not typically experience seasonal fluctuations in our shipments and revenues.
Segments
We have only one operating
segment as our business is currently operated. We have reached this conclusion because the our Chief Executive Officer (“CEO”)
allocates resources, assesses performance, and manages our business as one segment. Additionally, 99% of our business relates to designing,
manufacturing, and repairing medical devices. We primarily design, sell, and repair handheld medical devices and accessories. We provide
medical devices, NRE and proto-type services, as well as repairs to all our customers and we utilize one machine shop and purchasing team
to procure and manufacture all the products that we sell. The CEO utilizes consolidated operating income to analyze our business operations.
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Competition
The markets for products in the
industries served by our customers are intensely competitive, and we face significant competition from a number of different sources.
Several of our competitors have significantly greater name recognition, as well as substantially greater financial, technical, product
development, and marketing resources, than us.
We compete in all of our
markets with other major medical device companies. As a provider of outsourced services, we also compete with our customers’ own
internal development and manufacturing groups. Competitive pressures and other factors, such as new product or new technology introductions
by us, our customers’ internal development and manufacturing departments, or our competitors, may result in price or market share
erosion that could have a material adverse effect on our business, results of operations, and financial condition. Also, there can be
no assurance that our products and services will achieve broad market acceptance or will successfully compete with other products targeting
the same customers.
Research and Development
We conduct research and
development activities to both maintain and improve our market position. Our research and development efforts involve the design and manufacture
of products that perform specific applications for our existing and prospective customers. Our research and development activities are
focused on:
· expanding our knowledge base in the medical device industry to solidify our products with current customers
and expand our customer base;
· advancing applicable technologies;
· introducing new products; and
· enhancing our existing product lines.
In certain instances, we may share
research and development costs with our customers by billing for non-recurring engineering (“NRE”) services often provided
for under development portions of certain contracts. Revenue recognized for NRE services represented 1% of our revenue in fiscal 2024
and 6% of our revenue in fiscal 2023.
During the fiscal years
ended June 30, 2024 and 2023, we incurred research and development expenses amounting to $3.2 million and $2.8 million, respectively,
which costs exclude labor and related expenses of approximately $224,000 and $724,000 in fiscal 2024 and 2023, respectively, that were
reimbursed by our customers through billings for NRE services.
Human Capital Management
Our employees are among
our most critical assets. The success and growth of our business depends on our ability to attract, reward, retain and develop talent
in all levels of our organization, including, but not limited to, machine operators, assembly technicians, engineers, and management.
In order to attract and
retain highly qualified employees, we offer the following:
· Competitive, reasonable, and equitable compensation programs;
· Comprehensive and highly competitive health and welfare benefits to promote our employees’ physical
health, as well as a 401(k) plan to support our employees’ financial health;
· An Employee Stock Purchase Plan and equity compensation to provide financial value, align employee’s
interests with those of our shareholders, and incentivize retention;
· Flexible paid vacation and sick time, as well as paid volunteer time; and
· Education/tuition reimbursement and referral programs.
Our employee turnover for
the fiscal years ended June 30, 2024 and 2023 was 21% and 16%, respectively. We consider the turnover rate a valuable metric to measure
the effectiveness of our programs and to assist in developing new programs.
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Employees
At June 30, 2024, we had
148 employees, two of whom were part time, and all of our employees were working at one or both of our facilities in Irvine, California
and Tustin, California. At June 30, 2023, we had 146 employees, one of whom was part-time, and all were working at either our Irvine,
California facility or our Tustin, California facility, except for one employee who worked remotely out of state. None of our employees
are a party to any collective bargaining agreements with us. We consider our relationships with our employees to be good.
Government Regulations
The manufacture and distribution
of medical devices are subject to state and federal requirements set forth by various agencies, including the FDA, and state medical boards.
The statutes, regulations, administrative orders, and advisories that affect our businesses are complex and subject to diverse, often
conflicting, interpretations. While we make every effort to maintain full compliance with all applicable laws and regulations, we are
unable to eliminate the ongoing risk that one or more of our activities or devices may at some point be determined to be non-compliant.
The penalties for non-compliance could range from an administrative warning to termination of a portion of our business. Furthermore,
even if we are subsequently determined to have fully complied with applicable laws or regulations, the costs to achieve such a determination
and the intervening loss of business could adversely affect or result in the cessation of a portion of our business. A change in such
laws or regulations at any time may have an adverse effect on our operations.
The FDA designates all medical
devices into one of three classes (Class I, II, or III) based on the level of control necessary to assure the safety and effectiveness
of the device (with Class I requiring the lowest level of control and Class III requiring the greatest level of control). The surgical
instrumentation we manufacture is generally classified into Class I. The FDA has broad enforcement powers to recall and prohibit the sale
of products that do not comply with federal regulations and to order the cessation of non-compliant processes. No claim has been made
to date by the FDA regarding any of our products or processes. Nevertheless, as is common in the industry, certain of our products and
processes have been the subject of routine governmental reviews and investigations.
The total cost of providing
health care services has been and will continue to be subject to review by governmental agencies and legislative bodies in the major world
markets, including the United States, which are faced with significant pressure to lower health care costs. Downward pressure on health
care costs could result in reduced pricing or demand for our products.
We believe that our business
is conducted in a manner consistent with the Environmental Protection Agency (“EPA”) and other agency regulations governing
disposition of industrial waste materials.
While we believe that our
products and processes fully comply with applicable laws and regulations, we are unable to predict the outcome of any investigation or
review which may be undertaken in the future with respect to our products or processes.
Management believes that
each of our facilities has manufacturing systems and processes that are based on established Quality Management System standards. In addition,
we believe that both our Irvine, California and Tustin, California facilities are compliant with applicable Good Manufacturing Practices
promulgated by the FDA and are compliant with applicable ISO standards set forth by the International Organization for Standardization.
Patents, Trademarks, and Licensing Agreements
We hold US and foreign patents
relating to our handheld medical devices and torque-limiting screwdrivers. Our patents have varying expiration dates. The near-term expiration
of the patents, if any, is not expected to cause any change in our revenue-generating operations as changing the legal manufacturer of
medical devices is a significant undertaking and the expiration of a patent would offer minimal inducement to make such a change.
We have no reason to believe
that our activities infringe upon the intellectual property of any third party. With respect to our own patents, we have no reason to
believe that our patents are invalid, and we believe that at least some of our patents cover certain aspects of our products. Although
we are currently unaware of any reason that would cause us to assert or defend a claim of patent infringement, any such assertion or defense
could materially and adversely affect our business and results of operations due to the costs involved.
We have certain federally
registered trademarks relating to our products, including Pro-Dex ® , along with a number of other common law trademarks.
We have not entered into
any franchising agreements. We have not granted, nor do we hold any, third-party licenses having terms under which we earn revenue or
incur expense in material amounts.
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