PRO DEX INC 10-Q

ITEM 2. 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 The following discussion and analysis provide information that management believes is relevant to an assessment and understanding of the results of operations and financial condition of Pro-Dex, Inc. (“Company,” “Pro-Dex,” “we,” “our,” or “us”) for the three-month periods ended September 30, 2024 and 2023. This discussion should be read in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this report. This report contains certain forward-looking statements and information. The cautionary statements included herein should be read as being applicable to all related forward-looking statements wherever they may appear. Our actual future results could differ materially from those discussed herein. Except for the historical information contained herein, the matters discussed in this report, including, but not limited to, discussions of our product development plans, business strategies, strategic opportunities, and market factors 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, consolidation within our target marketplace and among our competitors, employee turnover, 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, 2024. We specialize in the design, development, and manufacture of powered rotary drive surgical instruments used primarily in the orthopedic, thoracic, and maxocranial facial (“CMF”) markets. Our 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 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. Basis of Presentation 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 our fiscal year ending June 30, 2025, 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 financial statements are prepared in accordance with U.S. GAAP. 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. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur could materially change the financial statements. Management believes that there have been no significant changes during the three months ended September 30, 2024, to the items that we disclosed as our critical accounting policies and estimates 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 30, 2024. Business Strategy and Future Plans 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 by us 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 shall continue to supply their surgical handpieces to them through calendar 2025. 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. 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, including anticipated expanded capacity for the manufacture of batteries and new products. 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, investing in research and development activities to design unique medical devices as well as Pro-Dex branded drivers to leverage our torque-limiting software, expanding 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, 2024, and 2023 (in thousands, except percentages): Three Months Ended September 30, 2024 2023 Dollars in thousands % of Net Sales % of Net Sales Net sales $ 14,892 100 % $ 11,938 100 % Cost of sales 9,742 65 % 8,280 69 % Gross profit 5,150 35 % 3,658 31 % Selling expenses 48 — 25 — General and administrative expenses 1,246 8 % 995 8 % Research and development costs 843 6 % 805 7 % 2,137 14 % 1,825 15 % Operating income 3,013 20 % 1,833 15 % Other income (loss), net 306 2 % (2,662 ) (22 %) Income before income taxes 3,319 22 % (829 ) (7 %) Provision for income taxes 853 6 % (214 ) (2 %) Net income (loss) $ 2,466 17 % $ (615 ) (5 %) Revenue The majority of our revenue is derived from designing, developing, and manufacturing surgical devices. 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): Three Months Ended September 30, Increase (Decrease) From 2023 to 2024 2024 2023 Dollars in thousands % of Net Sales % of Net Sales Net sales: Medical device $ 9,912 67 % $ 7,808 65 % 27 % Industrial and scientific 143 1 % 141 1 % 1 % Dental and component 42 — 39 — 8 % NRE & proto-types 48 — 190 2 % (75 %) Repairs 5,136 35 % 4,023 34 % 28 % Discounts and other (389 ) (3 %) (263 ) (2 %) 48 % $ 14,892 100 % $ 11,938 100 % 25 % Certain of our medical device products utilize proprietary designs developed by us under exclusive development and supply agreements. All of our medical device 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 September 30, Increase (Decrease) From 2023 to 2024 2024 2023 Dollars in thousands % of Med Device Sales % of Med Device Sales Medical device sales: Orthopedic $ 6,695 68 % $ 4,838 62 % 38 % CMF 2,201 22 % 1,634 21 % 35 % Thoracic 1,016 10 % 1,336 17 % (24 %) $ 9,912 100 % $ 7,808 100 % 27 % Our medical device revenue increased $2.1 million, or 27%, for the three months ended September 30, 2024 compared to the corresponding period of the prior fiscal year . Our orthopedic sales increased $1.9 million, or 38%, for the three months ended September 30, 2024 compared to the corresponding period of the prior fiscal year, due in part, to our largest customer requesting shipment of their next generation handpiece, or end-effector, to satisfy quantities requested for a limited market release. We expect production shipments of this newest generation to ramp up in the third and fourth quarters of fiscal 2025. Recurring revenue from distributors of CMF drivers increased $567,000, or 35%, for the three months ended September 30, 2024 compared to the corresponding period of the prior fiscal year. While we do not have much visibility into our customers’ distribution networks, this level of change (whether an increase or decrease) is not uncommon and fluctuations occur based upon required inventory levels. Our thoracic sales decreased by $320,000, or 24% for the three months ended September 30, 2024, compared to the corresponding period of the prior fiscal year. Sales of our compact pneumatic air motors increased $2,000, or 1%, for the three months ended September 30, 2024 compared to the corresponding period of the prior fiscal year. The relatively flat sales volume is consistent with our lack of substantive marketing efforts . Sales of our dental products and components increased $3,000, or 8%, for the three months ended September 30, 2024 compared to the corresponding period of the prior fiscal year, which negligible increase 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 $142,000, for the three months ended September 30, 2024 compared to the corresponding period of the prior fiscal year, due to a decline in billable contracts. Our NRE and proto-type revenue is typically a small percentage of our total revenue and can vary significantly from quarter to quarter. Repair revenue increased by $1.1 million, or 28%, for the three months ended September 30, 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. Discounts and other increased by $126,000 in the first quarter of fiscal 2025 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. At September 30, 2024, we had a backlog of approximately $56.8 million, of which $45.6 million is s cheduled for delivery during the remainder of fiscal 2025. 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. Cost of Sales and Gross Margin Three Months Ended September 30, Increase (Decrease) From 2023 to 2024 2024 2023 Dollars in thousands Cost of sales : % of Net Sales % of Net Sales Product costs $ 9,347 63 % $ 8,543 71 % 9 % Under-(over) absorption of manufacturing costs 325 2 % (285 ) (2 %) 214 % Inventory and warranty charges 70 — 22 — 218 % Total cost of sales $ 9,742 65 % $ 8,280 69 % 18 % Gross profit and gross margin $ 5,150 35 % $ 3,658 31 % 41 % Cost of sales for the three months ended September 30, 2024, increased by $1.5 million, or 18%, compared to the corresponding period of the prior fiscal year. The increase in cost of sales is consistent with the 25% increase in revenue for the same period. Product costs increased by $804,000, or 9%, during the three months ended September 30, 2024, compared to the corresponding period of the prior fiscal year, which is consistent with higher revenue generated in the first quarter of fiscal 2025. During the three months ended September 30, 2024 we experienced under-absorption of $325,000 in manufacturing costs compared to $285,000 over-absorption during the corresponding period of the prior fiscal year. We anticipate growth in our direct labor costs this fiscal year such that our absorption will stabilize without the need to increase our labor and overhead rates. Costs related to inventory and warranty charges increased $48,000 for the three months ended September 30, 2024 compared to the corresponding period of the prior fiscal year, due primarily to an increase in warranty reserves. Gross profit increased by approximately $1.5 million, or 41%, for the three months ended September 30, 2024 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, 2024 compared to the corresponding period of the prior fiscal year. Operating Costs and Expenses Three Months Ended September 30, Increase (Decrease) From 2023 to 2024 2024 2023 Dollars in thousands % of Net Sales % of Net Sales Operating expenses: Selling expenses $ 48 — $ 25 — 92 % General and administrative expenses 1,246 8 % 995 8 % 25 % Research and development costs 843 6 % 805 7 % 5 % $ 2,137 14 % $ 1,825 15 % 17 % Selling expenses consist 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, 2024 increased $23,000, or 92%, compared to the corresponding period of the prior fiscal year. The increase relates to recruiting fees related to an ongoing search for a director of business development. General and administrative 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 expenses increased by $251,000, or 25%, for the three months ended September 30, 2024, when compared to the corresponding period of the prior fiscal year. The increase in total G&A expenses relates to higher payroll and personnel expenses including higher bonus accruals. 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 products. Research and development costs increased $38,000, or 5%, for the three months ended September 30, 2024 compared to the corresponding period of the prior fiscal year. The increase is due primarily to an increase in internal project spending and a reduction in billable project offsets, partially offset by a reduction in personnel-related expenses. The majority of our research and development costs relate to sustaining activities related to products we currently manufacture and sell. As we introduce new products into the market, we expect to see an increase in sustaining and other engineering expenses. Typical examples of sustaining engineering activities include, but are not limited to, end-of-life component replacement, especially in electronic components found in our printed circuit board assemblies, analysis of customer complaint data to improve process and design, replacement and enhancement of tooling and fixtures used in the machine shop, assembly operations, and inspection areas to improve efficiency and through-put. Other Income (Expense), Net Interest and Dividend Income The interest and dividend income recorded during the three months ended September 30, 2024 and 2023, consists primarily of interest and dividends from our investments and money market accounts. Unrealized Gain (Loss) on Investments The unrealized gain or (loss) on marketable securities for the quarters ended September 30, 2024 and 2023, 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 The interest expense recorded during the three months ended September 30, 2024 and 2023, 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 both the three months ended September 30, 2024 and 2023, is 26%. and is slightly less than our combined expected federal and applicable state corporate income tax rates due primarily to federal and state research credits. Liquidity and Capital Resources Cash and cash equivalents at September 30, 2024 increased $450,000 to $3.1 million as compared to $2.6 million at June 30, 2024. The following table includes a summary of our condensed statements of cash flows contained elsewhere in this report. As of and For the Three Months Ended September 30, 2024 2023 (in thousands) Cash provided by (used in): Operating activities $ 1,887 $ 392 Investing activities $ (431 ) $ (126 ) Financing activities $ (1,006 ) $ (1,298 ) Cash and working capital: Cash and cash equivalents $ 3,081 $ 1,904 Working capital $ 27,217 $ 23,143 Operating Activities Net cash provided by operating activities during the three months ended September 30, 2024 totaled $1.9 million. Our net income was $2.5 million, which includes $433,000 of unrealized gains on our marketable securities as well as non-cash depreciation and amortization and stock-based compensation in the amount of $302,000 and $113,000, respectively. Additionally, our inventory and income taxes payable increased by $1.3 million and $209,000, respectively. Offsetting these outflows of cash, our accounts receivable decreased by $428,000 and accounts payable and accrued expenses increased by $579,000. 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 $873,000. Investing Activities Net cash used in investing activities for the three months ended September 30, 2024 was $431,000 and related to the purchase of equipment and improvements. Net cash used in investing activities for the three months ended September 30, 2023 was $126,000 and related to the purchase of equipment and improvements. Financing Activities Net cash used in financing activities for the three months ended September 30, 2024 included the repurchase of $2.3 million of common stock pursuant to our share repurchase program, and proceeds of $5.0 million from a new term loan from MBT, offset by principal payments totaling $3.4 million. Additionally, we paid $273,000 of employee payroll taxes related to the award of 40,000 shares of common stock to employees under previously granted performance awards. Net cash used in financing activities for the three months ended September 30, 2023 included principal payments of $1.3 million on our loans from MBT, which included a $1.0 million payment against our revolving loan. Financing Facilities & Liquidity Requirements for the Next Twelve Months As of September 30, 2024, our working capital was $27.2 million. We currently believe that our existing cash and cash equivalent balances together with our accounts receivable balances will provide us sufficient funds to satisfy our cash requirements as our business is currently conducted for at least the next 12 months. In addition to our cash and cash equivalent balances, we expect to derive a portion of our liquidity from our cash flows from operations. We are focused on preserving our cash balances by monitoring expenses, identifying cost savings, and investing only in those development programs and products that we believe will most likely contribute to our profitability. As we execute on our current strategy, however, we may require debt and/or equity capital to fund our working capital needs and requirements for capital equipment to support our manufacturing and inspection processes. In particular, we have experienced negative operating cash flow in the past, especially as we procure long-lead time materials to satisfy our backlog, which can be subject to extensive variability. We believe that if we need additional capital to fund our operations, we can borrow against our MBT revolver. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable.