What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-11-02 compared with 2023-05-04 · 244 added, 305 removed, 116 unchanged (83% of the section changed)

DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion

and analysis should be read in conjunction with our unaudited interim condensed financial statements and the related notes and other financial

information appearing elsewhere in this report.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and

analysis should be read in conjunction with our unaudited interim condensed consolidated financial statements and the related notes and

other financial information appearing elsewhere in this report.

COMPANY OVERVIEW

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(“Company,” “Pro-Dex,”

“we,” “our,” or “us”) for the three-month and nine-month periods ended March 31, 2023 and 2022.

discussion should be read in conjunction with the condensed financial statements and the notes thereto included elsewhere

“we,” “our,” or “us”) for the three-month periods ended September 30, 2023 and 2022.

This discussion

should be read in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere

in this report.

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of our product development plans, business strategies, strategic opportunities, and market factors

influencing our results, including uncertainties related to the COVID-19 pandemic, are forward-looking

statements that involve certain risks and uncertainties.

Actual results may differ from those anticipated

by us as a result of various factors, both foreseen

and unforeseen, including, but not limited to, our ability to continue to develop

new products and increase sales in markets characterized

by rapid technological evolution, the impact of the COVID-19 pandemic on our suppliers, customers,

and us, consolidation within our target marketplace and among our competitors, competition from larger, better capitalized competitors,

and our ability to realize returns on opportunities.

Many other economic, competitive, governmental,

and technological factors could impact our ability to achieve our goals.

You are urged to review

the risks, uncertainties, and other cautionary language described in this report, as well as in our

other public disclosures and reports filed with the Securities and Exchange Commission (“SEC”) from time to time, including,

but not limited to, the risks, uncertainties, and other cautionary language discussed in our Annual Report on Form 10-K for our fiscal

year ended June 30, 2022.

We specialize in the design, development,

and manufacture of autoclavable, battery-powered and electric, multi-function surgical drivers and shavers used primarily in the orthopedic,

influencing our results, are forward-looking statements

that involve certain risks and uncertainties.

Actual results may differ from those anticipated by us as a result

of various factors, both foreseen and unforeseen, including, but not limited to, our ability

to continue to develop new products and increase

sales in markets characterized by

rapid technological evolution, the impact of the COVID-19 pandemic on our suppliers, customers and us, consolidation within our target

marketplace and among our competitors, competition from larger, better capitalized competitors, and our ability to realize returns on

opportunities.

Many other economic, competitive, governmental, and

technological factors could impact our ability to achieve our goals.

You are urged to review the risks, uncertainties, and other cautionary

language described in this report, as well as in our other public disclosures and reports

filed with the Securities and Exchange Commission (“SEC”) from time to time, including, but not limited to, the risks, uncertainties,

and other cautionary language discussed in our Annual Report on Form 10-K for our fiscal year ended June 30, 2023.

specialize in the design, development, and manufacture of powered rotary drive surgical instruments used primarily in the orthopedic,

thoracic, and maxocranial facial (“CMF”) markets.

We have patented adaptive torque-limiting software 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.

principal headquarters are located at 2361 McGaw Avenue, Irvine, California 92614 and our phone number is (949) 769-3200.

address is www.pro-dex.com.

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current

reports on Form 8-K, amendments to those reports and other SEC filings are available free of charge through our website as soon as reasonably

practicable after such reports are electronically filed with, or furnished to, the SEC.

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 other SEC filings are available free of charge through our website as soon

as reasonably practicable after such reports are electronically

filed with, or furnished to, the SEC.

In addition, our Code of Ethics and other corporate

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copied at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C.

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

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.

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The condensed consolidated

results of operations presented in this report are not audited and those results are not necessarily indicative of the results to be

expected for the entirety of the fiscal year ending June 30, 2023.

Our fiscal year ends on June 30 and our fiscal quarters end on September

30, December 31, and March 31.

Unless otherwise stated, all dates refer to our fiscal year and those fiscal quarters.

results of operations presented in this report are not audited and those results are not necessarily indicative of the results to be expected

for the entirety of our fiscal year ending June 30, 2024, or any other interim period during such fiscal year.

Our fiscal year ends on

June 30 and our fiscal quarters end on September 30, December 31, and March 31.

Unless otherwise stated, all dates refer to our fiscal

year and those fiscal quarters.

Critical Accounting Estimates and Judgments

Our consolidated

financial statements are prepared in accordance with accounting principles generally accepted in the United States.

The preparation of

our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities,

revenues, expenses and related disclosures.

We base our estimates on historical experience and various other assumptions that are believed

to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets

and liabilities that are not readily apparent from other sources.

Our financial

statements are prepared in accordance with U.S.

The preparation of our financial statements requires management to make estimates

and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures.

We base our estimates

on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which

form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

Actual results may differ from these estimates.

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Management believes that there have been no significant

changes during the three and nine months ended March 31, 2023 to the items that we disclosed as our critical accounting policies in Management’s

Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended June

changes during the three months ended September 30, 2023, to the items that we disclosed as our critical accounting policies in Management’s

Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for our fiscal year ended June

Business Strategy and Future Plans

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Many of our significant customers place purchase orders for specific products that were developed

under various development and/or supply agreements.

by us under various development and/or supply agreements.

Our customers may request that we design and manufacture a custom surgical device

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and new products.

We substantially completed the build-out of the property in the first quarter

of the prior fiscal year.

Currently, we are actively engaged in various verification and

validation activities and we expect we will begin operations in the new facility during the fourth quarter of this fiscal year.

We began operations in the new facility during the fourth quarter of fiscal 2023 and believe that the additional capacity

will allow for our continued expected growth.

In summary, our current objectives

are focused primarily on maintaining our relationships with our current medical device customers, expanding our manufacturing capacity

with the addition of the Franklin Property, investing in research and development activities to design Pro-Dex branded drivers to leverage

our torque-limiting software, and promoting active product development proposals to new and existing customers for orthopedic shavers,

screw drivers for a multitude of surgical applications, and other medical devices, while monitoring closely the progress of all these

individual endeavors.

Our investments in research and development have historically increased disproportionately to our growth in revenue

and we anticipate this may continue in future periods.

These expenditures are being made in an effort to release new products and garner

new customer relationships.

This fiscal year, however, the majority of our engineering efforts relate to customer funded non-recurring

engineering (“NRE”) projects, which costs are reclassified to cost of sales.

While we expect revenue growth in the future,

it may not be a consistent trajectory but rather periods of incremental growth that current expenditures are helping to create.

there can be no assurance that we will be successful in any of these objectives.

COVID-19 Pandemic

We have adjusted certain policies

and procedures based on applicable national, state, and local emergency orders and safety guidance that may be issued from time to time,

in order to effectively manage our business during the pandemic and to keep our employees safe.

These measures have changed over time

and continue to change as our specific circumstances change.

While we have yet to see any significant

decline in our customer orders, we have received and accepted some customer requests to delay the shipment of their existing orders.

are focused on the health and safety of all those we serve – our customers, our communities, our employees, and our suppliers.

are supporting our customers according to their priorities and working with them to the degree that we can offer relief in the form of

delayed shipments.

We are focused on continuity of supply by working with our suppliers, some of whom have delivered our orders late and

are quoting longer lead times.

During fiscal 2022, we began to

see some challenges in our supply chain in the form of delayed shipments, longer lead times, higher prices, and surcharges, much of which

our suppliers indicate have been caused by the COVID-19 pandemic.

We have largely been able to mitigate our biggest supply chain concerns

by sourcing replacement chips through alternative suppliers, albeit at much higher prices, for many of our printed circuit board assemblies.

In so doing, our cost of sales increased during the second half of fiscal 2022 and thus far in fiscal 2023.

We continue to implement plans

and processes to mitigate these challenges that many manufacturers similarly face.

Our long-term prospects remain positive, and we believe

these challenges will negatively impact us only in the short-term.

Description of Business Operations

are focused primarily on maintaining our relationships with our current medical device customers, investing in research and development

activities to design unique medical devices as well as Pro-Dex branded drivers to leverage our torque-limiting software, expansion of

our manufacturing capacity through the commencement of operations at the Franklin Property, and promoting active product development proposals

to new and existing customers for both orthopedic shavers and screw drivers for a multitude of surgical applications, while monitoring

closely the progress of all these individual endeavors.

While we expect revenue growth in the future, it may not be a consistent trajectory

but rather periods of incremental growth that current expenditures are helping to create.

However, there can be no assurance that we will

be successful in any of these objectives.

Results of Operations

The following tables set

forth results from continuing operations for the three months ended September 30, 2023, and 2022 (in thousands, except percentages):

Months Ended September 30,

(as restated)

Dollars in thousands

% of Net Sales

Cost of sales

Selling expenses

General and administrative expenses

Research and development costs

Operating income

Other income (loss), net

Income before income taxes

Provision for income taxes

Net income (loss)

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):

Three Months Ended

Nine Months Ended

Medical device products

We continue to sell our rotary air motors for industrial and scientific applications, but our focus remains in medical devices.

The proportion of total sales by type is as follows (in thousands, except percentages):

Months Ended September 30,

(Decrease) From 2022 To

Dollars in thousands

% of Net Sales

Medical device

Industrial and scientific

Dental and component

NRE & Proto-type

Repairs and other

NRE & proto-types

Discounts and other

of our medical device products utilize proprietary designs developed by us under exclusive

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All of our medical device

products utilize proprietary manufacturing methods and know-how, and are manufactured in our Irvine, California facility, as are our industrial

products utilize proprietary manufacturing methods and know-how, and are manufactured in our Irvine, California facility and assembled

in our Tustin, California facility.

Details of our medical device sales by type is as follows (in thousands, except percentages):

Three Months Ended

Nine Months Ended

Months Ended September 30,

(Decrease) From 2022 To

Dollars in thousands

% of Med Device Sales

Medical device sales:

of our medical device products increased $463,000, or 7%, and $432,000, or 2%, respectively, for the three and nine months ended March

31, 2023, compared to the corresponding periods of the prior fiscal year.

Our medical device revenue to our largest customer,

included in orthopedic sales above, increased $633,000 and $1.0 million, respectively, for the three and nine months ended March 31, 2023

compared to the corresponding periods of the prior fiscal year .

Additionally, recurring revenue from distributors of CMF drivers

increased $793,000 and $124,000, respectively, for the three and nine months ended March 31, 2023, compared to the corresponding periods

of the prior fiscal year in part due to the launch of a new driver to our existing largest

customer during the third quarter of the prior fiscal year.

Our thoracic sales revenue decreased $963,000 and $693,000,

for the three and nine months ended March 31, 2023, respectively, compared to the corresponding

periods of the prior fiscal year , due primarily as a result of our customer for our thoracic driver filling the near-term requirements

of its distribution network.

of our compact pneumatic air motors, reported as industrial and scientific sales above, decreased

$61,000, or 19%, and $84,000, or 11%, respectively, for the three and nine months ended March 31, 2023, compared to the corresponding

periods of the prior fiscal year.

These are legacy products with no substantive marketing efforts .

NRE and proto-type revenue increased $421,000, or 77%, and $1.5 million, or 175%, for the three and nine months ended March 31, 2023,

compared to the corresponding periods of the prior fiscal year, due to an increase in billable contracts for various NRE projects undertaken

for our customers.

of our dental products and components decreased $160,000, or 79%, and $166,000, or 48%, respectively, for the three and nine months ended

March 31, 2023, compared to the corresponding periods of the prior fiscal year.

In the prior fiscal year we sold component inventory to

our largest customer used in their legacy design which did not recur in the current fiscal year.

We expect future declines in this area

as we are no longer manufacturing dental products, but rather are simply selling remaining component inventory.

revenue increased $3.2 million or 189%, and $4.3 million, or 102%, for the three and nine months ended March 31, 2023, respectively, compared

to the corresponding periods of the prior fiscal year due to increased repairs of the orthopedic handpiece we sell to our largest customer.

This increase was expected as we have been upgrading handpieces to the next generation, which design was released to manufacture in the

third quarter of fiscal 2022.

Additionally, we completed negotiations on repair pricing and terms with

this customer during the three months ended March 31, 2023, and received an additional $520,000 in compensation during the third quarter

of this fiscal year, for handpieces upgraded between July 2022 and December 2022 and reached an agreement for future consideration which

we expect to recognize in a future fiscal year.

We expect to continue to see increases in repair revenue, albeit at reduced margins,

for the remainder of this fiscal year because this customer has requested that we perform an enhanced repair on each handpiece, which

includes the advance replacement of certain components.

March 31, 2023, we had a backlog of approximately $18.8 million, of which $8.5 million is scheduled to be delivered in the fourth quarter

of fiscal 2023 and the balance is scheduled to be delivered next fiscal year and beyond.

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.

We may experience variability in our new order bookings due to various reasons, including, but not

limited to, the timing of major new product launches and customer planned inventory builds.

However, we do not typically experience seasonal

fluctuations in our shipments and revenues.

medical device revenue decreased $79,000, or 1%, in the first quarter of fiscal 2024 compared to the corresponding period of the prior

fiscal year .

Our orthopedic sales decreased $797,000 in the first quarter of fiscal 2024 compared to the first quarter of fiscal

2023, due in part, to our largest customer shifting priorities to an enhanced repair program (described under the discussion of repair

revenue below).

Recurring revenue from distributors of CMF drivers decreased $449,000 in fiscal 2024 compared to fiscal 2023.

do not have much visibility into our customers’ distribution networks, we do know that one of our distributors is selling some legacy

products in their inventory which has caused a reduction in demand for the CMF driver they procure from us.

We anticipate higher purchase

volumes from this customer in the future.

Our thoracic sales increased by $1.2 million for the three months ended September 30, 2023 compared

to the corresponding period of the prior fiscal year because of the launch of a new product in the

first quarter of this fiscal year.

of our compact pneumatic air motors decreased $83,000, or 37%, in the first quarter of fiscal

2024 compared to the corresponding period of the prior fiscal year.

The revenue decrease is consistent with our lack of substantive marketing

Sales of our dental products and components decreased $64,000 in the first

quarter of fiscal 2024 compared to the corresponding quarter of the prior fiscal year, which is expected given our prior disclosures that

we are no longer pursuing this line of business.

Our non-recurring engineering (“NRE”) and proto-type revenue decreased

$717,000 in the first quarter of fiscal 2024 compared to the corresponding period of the prior fiscal year, due to a decline in billable

Our NRE and proto-type revenue is typically a small percentage of our total revenue and can vary significantly from quarter

revenue increased by $1.8 million in the first quarter of fiscal 2024 compared to the corresponding period of the prior fiscal year, due

to an increased number of repairs of the orthopedic handpiece we sell to our largest customer.

This increase relates to the continuation

of the previously disclosed enhanced repair program that we began last fiscal year.

and other decreased by $23,000 in the first quarter of fiscal 2024 compared to the corresponding period of the prior fiscal year, due

to volume rebates related to the orthopedic handpiece we sell to our largest customer, which they negotiated in conjunction with our contract

extension through 2025.

30, 2023, we had a backlog of approximately

$35.7 million, of which $25.4 million is s cheduled for delivery during the remainder of fiscal 2024.

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

We may experience

variability in our new order bookings due to various reasons, including, but not limited to, the timing of major new product launches

and customer planned inventory builds.

However, we do not typically experience seasonal fluctuations

in our shipments and revenues.

Cost of Sales and Gross Margin

(in thousands except percentages)

Months Ended September 30,

(Decrease) From 2022 To

Cost of sales:

% of Net Sales

Product costs

Under-(over) absorption of manufacturing costs

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Total cost of sales

Three Months Ended

Nine Months Ended

Year over Year

of sales for the three months ended March 31, 2023, increased $2.9 million, or 45%, compared to the corresponding period of the prior

The increase in total costs of sales was caused by the 41% increase in revenue for the same period.

Under-absorption of manufacturing

costs increased by $201,000 for the three months ended March 31, 2023, compared to the corresponding period of the prior fiscal year due

in part to our inability to absorb our fixed costs, which were not reduced in the third quarter of the current fiscal year in anticipation

of future revenue growth.

Costs relating to inventory and warranty charges decreased $385,000 for the third quarter ended March 31, 2023

compared to the third quarter of the prior fiscal year, largely due to a reduction in warranty expenses.

profit increased by approximately $953,000, or 33%, for the three months ended March 31, 2023, compared to the corresponding period of

the prior fiscal year, consistent with the overall increase in revenue.

Gross margin as a percentage of sales decreased by approximately

2 percentage points compared to the corresponding period of the prior fiscal year due primarily to increased under-absorption of manufacturing

costs as a result of additional indirect costs in our manufacturing, assembly, and quality departments, especially related to ongoing

verification and validation activities for the Franklin Property.

of sales for the nine months ended March 31, 2023 increased by $6.3 million, or 32%, compared to the corresponding period of the prior

Although some of the increase in cost of sales is consistent with the 21% increase in revenue for the same period, the reasons

for which are discussed above, the enhanced repair program implemented for our largest customer includes the advance replacement of certain

components which has contributed to a $1.4 million increase in cost of sales.

Additionally, total cost of sales reflects a $1.1 million

increase in under-absorbed manufacturing costs due to actual production hours being less than planned as well as the additional indirect

costs in our manufacturing, assembly, and quality operations described above.

Inventory and warranty charges decreased by approximately

$383,000, or 57%, for the nine months ended March 31, 2023, compared to the corresponding period of the prior fiscal year, due to reduced

component inventory write-downs as a result of sourcing high priced components for our printed circuit board assemblies in the prior fiscal

profit decreased by $299,000, or 3%, for the nine months ended March 31, 2023, compared to the corresponding period of the prior fiscal

year, primarily as a result of the increase in cost of sales described above.

Gross margin for the nine months ended March 31, 2023, decreased

by 7 percentage points compared to the corresponding period of the prior fiscal year.

Operating Expenses

Gross profit and gross margin

Cost of sales for the three-month

period ended September 30, 2023 increased by $149,000, or 2%, compared to the corresponding period of the prior fiscal year.

some of the increase in cost of sales is consistent with the 8% increase in revenue for the same period, approximately $450,000 of the

prior year product costs included the repairs we performed to upgrade the orthopedic handpieces we sell our largest customer to the newest

release at no additional cost.

Product costs increased by $932,000, or 12%, during the three months ended September 30, 2023, compared

to the corresponding period of the prior fiscal year, due to higher material costs, predominantly related to the repairs discussed above.

During the first quarter of fiscal 2024 we experienced $285,000 of over-absorbed manufacturing costs compared to an under-absorption of

$362,000 in the first quarter of fiscal 2023, primarily due to increases in our standard labor and overhead rates which are made in an

attempt to minimize our over-under absorption.

Costs related to inventory and warranty charges decreased $136,000 in the first quarter

of fiscal 2024 compared to the corresponding quarter of fiscal 2023, due primarily to a reduction in warranty expenses due to the shift

to enhanced repairs we perform on orthopedic handpieces we sell to our largest customer.

profit increased by approximately $702,000, or 24%, for the three months ended September 30, 2023 compared to the corresponding period

of the prior fiscal year, and gross margin as a percentage of sales increased by four percentage points between such periods, primarily

as a result of a more favorable product mix of sales during the three months ended September 30, 2023 compared to the corresponding

period of the prior fiscal year, coupled with reduced inventory and warranty charges.

Operating Costs and Expenses

(in thousands except percentages)

over Year % Change

Months Ended September 30,

(Decrease) From 2022 To

% of Net Sales

Operating expenses:

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Selling expenses consist

of salaries and other personnel-related expenses for our business development department, as well as advertising and marketing expenses,

and travel and related costs incurred in generating and maintaining our customer relationships.

Selling expenses for the three and nine

months ended March 31, 2023, increased $4,000, or 20%, and $67,000, or 85%, respectively, compared to the corresponding periods of fiscal

The increase is primarily due to increased sales commissions.

of salaries and other personnel-related expenses in support of business development, as well as trade show attendance, advertising and

marketing expenses, and travel and related costs incurred in generating and maintaining our customer relationships.

Selling expenses for

the three months ended September 30, 2023 decreased $28,000, or 53%, compared to the corresponding year-earlier period.

The decrease relates

to a reduction in sales commissions and tradeshow expenses, which was partially offset by higher payroll expenses.

General and administrative

expenses (“G&A”) consist of salaries and other personnel-related expenses of our accounting, finance and human resource

personnel, as well as costs for outsourced information technology services, professional fees, directors’ fees, and other costs

and expenses attributable to being a public company.

G&A decreased $136,000 and $419,000, respectively, during the three and nine

months ended March 31, 2023, when compared to the corresponding periods of the prior fiscal year.

The decreases relate primarily to reduced

legal and settlement expenses related to employment matters and reduced non-cash compensation expense related to stock compensation, offset

by increased legal fees related to intellectual property matters.

Research and development

costs generally consist of salaries, employer-paid benefits, and other personnel- related costs of our engineering and support personnel,

as well as allocated facility and information technology costs, professional and consulting fees, patent-related fees, lab costs, materials,

and travel and related costs incurred in the development and support of our products.

Research and development costs for the three months

ended March 31, 2023, increased $55,000, or 8%, compared to the corresponding periods of the prior fiscal year.

Research and development

costs for the nine months ended March 31, 2023, decreased $145,000, or 6%, compared to the corresponding periods of the prior fiscal year.

This relates to increased personnel and related expense offset by decreased spending on internal engineering projects and a shift to increased

spending on billable development projects.

When our engineers are engaged in a billable project as opposed to an internal project, costs

get shifted to cost of sales instead of research and development.

Although the majority of our research

and development costs relate to sustaining activities related to products we currently manufacture and sell, we have created a product

roadmap to develop future products.

Many of our product development efforts are undertaken only upon completion of an analysis of the

size of the market, our ability to differentiate our product from our competitors’, as well as an analysis of our specific sales

prospects with new and/or existing customers.

The research and development costs represent between 36% and 41% of total operating expenses

for all periods presented and are expected to increase in the future as we continue to invest in product development efforts.

spent on internal projects under development is summarized below (in thousands):

and Nine Months Ended March 31, 2023

and Nine Months Ended March 31, 2022

expenses (“G&A”) consist of salaries and other personnel-related expenses of our accounting, finance, and human resources

personnel, professional fees, directors’ fees, and other costs and expenses attributable to being a public company.

G&A decreased

by $29,000, or 3%, for the three months ended September 30, 2023, when compared to the corresponding period of the prior fiscal year.

The decrease in total G&A was a result of non-cash compensation expense related to the non-qualified stock options granted in the

prior fiscal year and reduced professional fees, partially offset by higher payroll and personnel expenses.

Research and development costs

generally consist of compensation and other personnel-related costs of our engineering and support personnel, related professional and

consulting fees, patent-related fees, lab costs, materials, and travel and related costs incurred in the development and support of our

Research and development costs decreased $124,000, or 13%, for the quarter ended September 30, 2023, compared to the corresponding

prior year period.

The decrease is due primarily to a $242,000 reduction in internal engineering project spending, partially offset by

a reduction in billable offsets reclassed to costs of sales of approximately $87,000 and an increase in legal expense related to IP matters

Although the majority of our

research and development costs relate to sustaining activities related to products we currently manufacture and sell, we have created

a product roadmap to develop future products.

Many of our product development efforts are undertaken only upon completion of an analysis

of the size of the market, our ability to differentiate our product from our competitors’, as well as an analysis of our specific

sales prospects with new and/or existing customers.

Research and development costs represent between 44% and 46% of total operating expenses

for all periods presented and are expected to remain relatively flat the remainder of this fiscal year.

The amount spent on projects under

development, along with the current estimated commercial launch date and estimated recurring annual revenue, is summarized below (in

For the Three Months Ended

September 30,

Annual Revenue (2)

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Products in development:

Sustaining & Other

(1) Represents the calendar quarter of expected market launch.

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board assemblies, analysis of customer complaint data to improve process and design, replacement and enhancement of tooling and fixtures

used in our machine shop, assembly operations, and inspection areas to improve efficiency and through-put.

used in the machine shop, assembly operations, and inspection areas to improve efficiency and through-put.

Additionally, these costs include

development projects that may be in their infancy and may or may not result in a full-fledged product development effort.

Interest & Other

Interest income for the three

and nine months ended March 31, 2023 and 2022, includes interest and dividends from our money market accounts and investment portfolio.

development projects that may be in their infancy and may or may not result in a full-fledged product development effort or projects that

are later abandoned.

Other Income (Expense), net

Interest and Dividend Income

The interest and dividend income

recorded during the quarters ended September 30, 2023 and 2022, consists primarily of interest and dividends from our investments and

money market accounts.

One of the investments in our portfolio paid a $204,000 cash dividend in the first quarter of fiscal 2023, and

no such dividend was paid during the current fiscal year.

Unrealized Gain (Loss) on Investments

The unrealized gain or (loss)

on marketable securities for the quarters ended September 30, 2023 and 2022, relates to our portfolio of investments described more fully

in Note 4 to the condensed consolidated financial statements contained elsewhere in this report.

Interest Expense

Interest expense consists primarily

of interest expense related to the notes payable described more fully in Note 10 to the condensed consolidated financial statements contained

elsewhere in this report.

Unrealized gain (loss)

on marketable equity investments

The unrealized

gain (loss) on marketable equity investments relates to our investment portfolio more fully described in Note 4 to the condensed consolidated

financial statements contained elsewhere in this report.

Gain on Sale of Investments

During the first quarter ended

September 30, 2022, we sold some of the stocks in our portfolio of equity investments receiving proceeds of $88,000 and recording a gain

on the sale in the amount of $7,000.

The interest expense recorded

during the quarters ended September 30, 2023 and 2022, relates to our Minnesota Bank and Trust (“MBT”) loans described more

fully in Note 10 to the condensed consolidated financial statements contained elsewhere in this report.

Income Tax Expense

The effective tax rate

for the three and nine months ended March 31, 2023 and 2022, is slightly less than our combined expected federal and applicable state

corporate income tax rates due to federal and state research credits.

Additionally, the current year effective tax rate for the nine months

ended March 31, 2023 is less than our combined expected federal and applicable state corporate income tax rates due to a tax benefit recognized

as a result of common stock awarded to employees under previously granted performance awards in the first quarter of fiscal 2023 as described

more fully in Note 8 to the condensed consolidated financial statements contained elsewhere in this report, as well as unrealized gains

on our marketable equity investments.

for the three months ended September 30, 2023 and 2022, is 26% and 18%, respectively.

The prior year effective tax rate is less than the

current year rate due primarily to a tax benefit recognized as a result of the common stock awarded to our employees described more fully

in Note 8 to the condensed consolidated financial statements contained elsewhere in this report.

Liquidity and Capital

Cash and cash equivalents

at March 31, 2023, increased $1.2 million to $2.1 million as compared to $849,000 at June 30, 2022.

at September 30, 2023 decreased $1.0 million to $1.9 million as compared to $2.9 million at June 30, 2023.

The following table includes

a summary of our condensed statements of cash flows contained elsewhere in this report.

and For the Nine Months Ended March 31,

and For the Three Months Ended September 30,

(in thousands)

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Operating Activities

Net cash provided

by operating activities was $4.8 million for the nine months ended March 31, 2023, primarily due to net income of $3.3 million, non-cash

depreciation and amortization of $594,000, share-based compensation of $584,000, and collections of accounts receivable in the amount

of $4.8 million offset by a decrease in accounts payable and accrued expenses of $1.0 million, a decrease in deferred revenue of $956,000,

and an increase in inventory in the amount of $2.5 million.

Net cash provided

by operating activities was $4.4 million for the nine months ended March 31, 2022, primarily due to net income of $2.4 million, non-cash

depreciation and amortization of $546,000, share-based compensation of $932,000 and unrealized losses on marketable securities in the

amount of $427,000, as well as an increase in accounts payable and accrued expenses of $673,000, an increase in deferred revenue of $746,000,

and a decrease in accounts receivable in the amount of $2.3 million.

Offsetting these sources of cash, our inventory increased by $3.4

million primarily due to replenishment of sub-assemblies and long-lead time parts.

Net cash provided by operating

activities during the three months ended September 30, 2023 totaled $392,000.

This is primarily because our net loss of $615,000 for the

three months ended September 30, 2023 included non-cash unrealized loss on investments, share-based compensation and depreciation and

amortization of $2.6 million, $188,000 and $283,000, respectively.

Uses of cash arose primarily from an increase in accounts receivable

of $1.1 million related to increased sales and our increase in income tax assets of $874,000.

Net cash provided by operating

activities during the three months ended September 30, 2022 totaled $2.9 million.

The primary sources of cash arose from (a) our net income

for the quarter of $1.2 million, as well as non-cash share-based compensation and depreciation and amortization of $207,000 and $193,000,

respectively, (b) a decrease of $4.3 million in accounts receivable due to more timely collection of receivables from our largest customer,

and (c) an increase in accounts payable and accrued expenses of $273,000.

Uses of cash arose primarily from an increase in inventory of

$3.0 million primarily related to building up inventory in anticipation of our transfer of assembly and repairs to the Franklin Property.

Investing Activities

Net cash used in investing

activities for the nine months ended March 31, 2023, was $733,000 and related primarily to the purchases of equipment and improvements

primarily for the Franklin Property totaling $822,000.

Offsetting this use of cash, we sold some of our marketable securities during the

nine months ended March 31, 2023 for $89,000.

activities for the three months ended September 30, 2023 was $126,000 and related to the purchase of equipment and improvements.

Net cash used in investing

activities for the nine months ended March 31, 2022, was $1.6 million and related to purchases of equipment and improvements primarily

for the Franklin Property in the amount of $1.3 million and investments in marketable equity securities of publicly traded companies in

the amount of $334,000.

activities for the three months ended September 30, 2022 was $90,000 and related primarily to the purchase of equipment and improvements

at the Franklin Property in the amount of $178,000, partially offset by the sale of marketable securities in the amount of $88,000.

Financing Activities

Net cash used in financing

activities for the nine months ended March 31, 2023, totaled $2.9 million and related primarily to the $1.5 million repurchase of 86,422

shares of our common stock pursuant to our share repurchase program, $4.8 million of payments to Minnesota Bank and Trust (“MBT”)

as well as payment of $223,000 of employee payroll taxes related to the award of 37,500 shares of common stock to employees under previously

granted performance awards.

Offsetting these uses of cash we also borrowed $3.6 million from MBT under our amended revolving loan, and

collected $78,000 and $11,000, respectively, related to employee contributions to the ESPP plan and exercises of stock options.

activities for the three months ended September 30, 2023 included principal payments of $1.3 million on our loans from MBT, which included

a $1 million payment against our revolving loan.

Net cash used in financing

activities for the nine months ended March 31, 2022, totaled $1.8 million and related primarily to the $1.3 million repurchase of 52,718

shares of our common stock pursuant to our share repurchase program as well as $561,000 of principal payments on our loans from MBT more

fully described in Note 10 to the condensed consolidated financial statements contained elsewhere in this report.

activities for the three months ended September 30, 2022 included net principal payments of $318,000 on our existing loans from MBT more

fully described in Note 10 to the condensed consolidated financial statements contained elsewhere in this report, the repurchase of $354,000

of common stock pursuant to our share repurchase program, as well as $223,000 of employee payroll taxes related to the award of 37,500

shares of common stock to employees under previously granted performance awards.

Financing Facilities & Liquidity Requirements for the Next

Twelve Months

As of March 31, 2023, our working

capital was $21.0 million.

We currently believe that our existing cash and cash equivalent balances together with our accounts receivable

As of September 30, 2023, our working capital

was $23.1 million.

We currently believe that our existing cash and cash equivalent balances together with our account receivable

balances will provide us sufficient funds to satisfy our cash requirements as our business is currently conducted for at least the next

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from operations.

We may also liquidate some or all of our investment portfolio or borrow further against our $7.0 million Amended Revolving

Loan with MBT (see Note 10 to condensed consolidated financial statements contained elsewhere in this report), under which we had availability

of $5.2 million as of March 31, 2023.

We are focused on preserving our

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our backlog, which can be subject to extensive variability.

We believe that if we need to raise additional capital to fund our operations

beyond the cash available from the strategies mentioned above, we can do so by selling additional shares of our common stock under the

ATM Agreement.

(See Note 11 to condensed consolidated financial statements contained elsewhere in this report).

Investment Strategy

We invest surplus cash from time

to time through our Investment Committee, which is comprised of one management director, Mr.

Van Kirk, and two non-management directors,

Cabillot and Mr.

Swenson, who chairs the committee.

Cabillot and Mr.

Swenson are active investors with extensive portfolio

management expertise.

We leverage the experience of these committee members to make investment decisions for the investment of our surplus

operating capital or borrowed funds.

Additionally, many of our securities holdings include stocks of public companies that either Messrs.

Swenson or Cabillot or both may own from time to time either individually or through the investment funds that they manage, or other companies

whose boards they sit on.

The Investment Committee approved each of the investments comprising the $2.7 million of marketable public equity

securities held at March 31, 2023.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET

Not applicable.

We believe that if we need additional capital to fund our operations, we can

borrow against our MBT revolver.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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What changed 10-Q

Item 2. Management’s Discussion and Analysis