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 provides 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 and nine-month periods ended March 31, 2025 and 2024. 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, our ability to optimize our operations at our Franklin facility, consolidation within our target marketplace and among our competitors, the impact of tariffs on the cost of our raw materials and purchased components, 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 autoclavable, battery-powered, and electric, multi-function surgical drivers and shavers 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. 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 the fiscal year ending June 30, 2025. 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. 18 Critical Accounting Estimates and Judgments Our condensed 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. 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 and nine months ended March 31, 2025 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 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 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 and we are currently in discussions with them to renew the agreement. 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. 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 continuation 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. 19 Description of Business Operations Revenue 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): Three Months Ended March 31, Nine Months Ended March 31, 2025 2024 2025 2024 % of Revenue % of Revenue % of Revenue % of Revenue Net Sales: Medical device products $ 11,913 68 % $ 9,782 68 % $ 34,057 69 % $ 26,536 68 % Industrial and scientific 265 2 % 211 1 % 576 1 % 591 2 % Dental and component 45 — 62 1 % 118 — 146 — NRE & Proto-type 186 1 % 234 2 % 274 1 % 762 2 % Repairs 5,099 29 % 4,433 31 % 15,096 31 % 11,749 30 % Discounts and other (94 ) — (429 ) (3 %) (1,022 ) (2 %) (965 ) (2 %) $ 17,414 100 % $ 14,293 100 % $ 49,099 100 % $ 38,819 100 % 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 are assembled in our Tustin, California facility, along with our industrial products. Details of our medical device sales by type is as follows (in thousands, except percentages): Three Months Ended March 31, Nine Months Ended March 31, 2025 2024 2025 2024 % of Total % of Total % of Total % of Total Medical device sales: Orthopedic $ 8,607 72 % $ 6,765 69 % $ 24,631 72 % $ 17,136 65 % CMF 2,354 20 % 2,247 23 % 6,395 19 % 6,641 25 % Thoracic 952 8 % 770 8 % 3,031 9 % 2,759 10 % Total $ 11,913 100 % $ 9,782 100 % $ 34,057 100 % $ 26,536 100 % Sales of our medical device products increased $2.1 million, or 22%, and $7.5 million, or 28%, respectively, for the three and nine months ended March 31, 2025, compared to the corresponding periods of the prior fiscal year. Our medical device revenue to our largest customer, included in orthopedic sales above, increased $1.8 million and $7.5 million, respectively, for the three and nine months ended March 31, 2025, compared to the corresponding periods of the prior fiscal year due primarily to the launch of that customer’s next generation handpiece. As can be common with new product launches in the industry, the customer’s internal design of the next generation handpiece continues to evolve, and the customer has recently informed us that it is holding off on next generation handpiece shipments in favor of continued shipments and enhanced repair of the legacy handpieces as the customer continues to refine the next generation handpiece’s design. Although we cannot predict the timing of the customer’s further transition to the next generation handpiece at this time, we fully anticipate a resumption of shipments of the next generation handpiece once the design enhancements are finalized, coupled with larger orders of the legacy handpiece during the interim. Additionally, recurring revenue from distributors of thoracic drivers increased $182,000 and $272,000, respectively, for the three and nine months ended March 31, 2025, compared to the corresponding periods of the prior fiscal year. Our CMF sales revenue increased $107,000 and decreased $246,000, for the three and nine months ended March 31, 2025, respectively, compared to the corresponding periods of the prior fiscal year. While we do not have much visibility into our customers’ distribution networks, this level of change in thoracic and CMF sales (whether an increase or decrease) is not uncommon and fluctuations occur based upon required inventory levels. Sales of our compact pneumatic air motors, reported as industrial and scientific sales above, increased $54,000, or 26%, and decreased $15,000, or 3%, respectively, for the three and nine months ended March 31, 2025, compared to the corresponding periods of the prior fiscal year. These are legacy products with no substantive marketing efforts . Our NRE and proto-type revenue decreased $48,000, or 21%, and $488,000, or 64%, for the three and nine months ended March 31, 2025, compared to the corresponding periods of the prior fiscal year, due to a decrease in billable contracts for various NRE projects undertaken for our customers. Sales of our dental products and components decreased $17,000, or 27%, and $28,000, or 19%, respectively, for the three and nine months ended March 31, 2025, compared to the corresponding periods of the prior 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. Repair revenue increased $666,000 or 15%, and $3.3 million, or 29%, for the three and nine months ended March 31, 2025, respectively, compared to the corresponding periods of the prior fiscal year primarily 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. 20 At March 31, 2025, we had a backlog of approximately $49.5 million, of which $12.8 million is scheduled to be delivered in the fourth quarter of fiscal 2025 and the balance is scheduled to be delivered next fiscal year. 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 (in thousands except percentages) Three Months Ended March 31, Nine Months Ended March 31, 2025 2024 2025 2024 % of Total % of Total % of Total % of Total Cost of sales: Product cost $ 10,997 95 % $ 9,815 95 % $ 30,799 93 % $ 28,156 99 % Under(over)-absorption of manufacturing costs 424 3 % 170 2 % 1,983 6 % (146 ) — Inventory and warranty charges 195 2 % 306 3 % 298 1 % 347 1 % Total cost of sales $ 11,616 100 % $ 10,291 100 % $ 33,080 100 % $ 28,357 100 % Three Months Ended March 31, Nine Months Ended March 31, Year over Year ppt Change 2025 2024 2025 2024 Three Months Nine Months Gross margin 33 % 28 % 33 % 27 % 5 6 Cost of sales for the three months ended March 31, 2025, increased $1.3 million, or 13%, compared to the corresponding period of the prior fiscal year. The increase in total costs of sales is consistent with the 22% increase in revenue for the same period. Under-absorption of manufacturing costs increased by $254,000 for the three months ended March 31, 2025, compared to the corresponding period of the prior fiscal year. During the third quarter of fiscal 2025 we increased our assembly department labor and overhead rates to reduce the under absorption of our indirect costs. Costs relating to inventory and warranty charges decreased $111,000 for the three months ended March 31, 2025, compared to the corresponding period of the prior fiscal year, due to a slight decrease in both inventory reserves and warranty accruals. Gross profit increased by approximately $1.8 million, or 45%, for the three months ended March 31, 2025, compared to the corresponding period of the prior fiscal year, primarily as a result of the increase in medical device and repair revenue for the same periods as described above. Gross margin as a percentage of sales increased by approximately 5 percentage points compared to the corresponding period of the prior fiscal year due primarily to favorable product mix. Cost of sales for the nine months ended March 31, 2025, increased by 4.7 million, or 17%, compared to the corresponding period of the prior fiscal year. The increase in total costs of sales is consistent with the 27% increase in revenue for the same period. Under-absorption of manufacturing costs increased by $2.1 million for the nine months ended March 31, 2025, compared to the corresponding period of the prior fiscal year and as discussed above we have increased our assembly labor and overhead rates to better absorb our indirect manufacturing costs. Inventory and warranty charges decreased slightly by approximately $49,000, or 14%, for the nine months ended March 31, 2025, compared to the corresponding period of the prior fiscal year. 21 Gross profit increased by $5.6 million, or 53%, for the nine months ended March 31, 2025, compared to the corresponding period of the prior fiscal year, primarily as a result of the increase in medical device and repair revenue for the same periods as described above. Gross margin as a percentage of sales increased by 6 percentage points compared to the corresponding period of the prior fiscal year primarily related to a more favorable product mix. Operating Expenses Operating Costs and Expenses (in thousands except percentages) Three Months Ended March 31, Nine Months Ended March 31, Year over Year % Change 2025 2024 2025 2024 Three Months Nine Months % of Net Sales % of Net Sales % of Net Sales % of Net Sales Operating expenses: Selling expenses $ 113 1 % $ 17 — $ 211 — $ 79 — 565 % 167 % General and administrative expenses 1,098 6 % 1,012 7 % 3,732 8 % 3,208 9 % 9 % 16 % Research and development costs 947 5 % 760 5 % 2,731 6 % 2,353 6 % 25 % 16 % $ 2,158 12 % $ 1,789 12 % $ 6,674 14 % $ 5,640 15 % 21 % 18 % 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, 2025, increased $96,000, or 565%, and $132,000, or 167%, respectively, compared to the corresponding periods of fiscal 2024. The increase relates primarily to recruiting fees and personnel costs related to our new Director of Business Development who we hired in December, 2024. General and administrative expenses (“G&A”) consist of salaries and other personnel-related expenses of our accounting, finance, facilities, business systems, 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 increased $86,000 and $524,000, respectively, during the three and nine months ended March 31, 2025, when compared to the corresponding periods of the prior fiscal year. The increases relate primarily to increased bonus accruals, personnel costs, and legal expenses, offset by decreased audit fees and stock compensation expense. 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 and nine months ended March 31, 2025, increased $187,000, or 25%, and $378,000, or 16%, compared to the corresponding periods of the prior fiscal year. This relates to an increase in legal fees related to intellectual property matters as well as an increase in spending related to in-house battery production and sustaining engineering efforts related to our existing products. The majority of our research and development costs relate to sustaining activities related to products we currently manufacture and sell, but we also 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 41% and 44% 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. 22 Interest & Other Income Interest income for the three and nine months ended March 31, 2025 and 2024, includes interest and dividends from our money market accounts and investment portfolio. Interest Expense Interest expense consists primarily of interest expense related to the notes payable described more fully in Note 11 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. All of these investments are recorded at estimated fair value and as of March 31, 2025, all of these investments relate to common stock of publicly traded companies whose stock price is subject to significant volatility. Gain on Sale of Investments During the third quarter ended March 31, 2025, we sold some of the stocks in our portfolio of equity investments receiving proceeds of $1.9 million and recording a gain on the sale in the amount of $595,000. Income Tax Expense The effective tax rate for each of the three months ended March 31, 2025 and 2024 was 28%. These tax rates are consistent with our combined expected federal and applicable state corporate income tax rates. The effective tax rate for the nine months ended March 31, 2025 and 2024 was 26% and 23%, respectively, and 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 2025 as described more fully in Note 9 to the condensed consolidated financial statements contained elsewhere in this report, and to the release of a valuation allowance in the prior fiscal year related to previously recognized unrealized losses on investments. Liquidity and Capital Resources Cash and cash equivalents at March 31, 2025, increased $1.9 million to $4.5 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 Nine Months Ended March 31, 2025 2024 (in thousands) Cash provided by (used in): Operating activities $ (1,509 ) $ 5,179 Investing activities $ 754 $ (2,126 ) Financing activities $ 2,597 $ (2,770 ) Cash and Working Capital: Cash and cash equivalents $ 4,473 $ 3,219 Working capital $ 31,626 $ 25,538 23 Operating Activities Net cash used in operating activities was $1.5 million for the nine months ended March 31, 2025, primarily due to net income of $7.8 million including realized gains on the sale of investments in the amount of $595,000 offset by an $8.2 million increase in inventory and a $2.0 million increase in receivables. Offsetting these uses of cash, accounts payable and accrued expenses increased by $1.6 million. The increases in these balance sheet accounts reflect our continued and expected future revenue growth. Net cash provided by operating activities was $5.2 million for the nine months ended March 31, 2024, primarily due to net income of $540,000, non-cash unrealized losses on marketable equity investments of $3.8 million, depreciation and amortization of $854,000, share-based compensation of $588,000 as well as a decrease in inventory of $1.9 million. Offsetting these sources of cash, our accounts receivable increased by $2.6 million consistent with our increase in revenue. Investing Activities Net cash provided by investing activities for the nine months ended March 31, 2025, was $754,000 and relates to the sale of some of our marketable securities for $1.9 million offset by purchases of capital equipment and improvements of $1.2 million. Net cash used in investing activities for the nine months ended March 31, 2024, was $2.1 million and related to the exercise of the Monogram Warrant for cash in the amount of $1,250,000 (See Note 4 to the condensed consolidated financial statements contained elsewhere in this report) as well as equipment and improvements purchases in the amount of $876,000. Financing Activities Net cash provided by financing activities for the nine months ended March 31, 2025, totaled $2.6 million and related primarily to the net increase in borrowings of $6.4 million from Minnesota Bank & Trust (“MBT”) more fully described in Note 11 to the condensed consolidated financial statements contained elsewhere in this report offset by $3.5 million attributable to the repurchase of 130,148 shares of our common stock pursuant to our share repurchase program. Net cash used in financing activities for the nine months ended March 31, 2024, totaled $2.8 million and related primarily to the $1.8 million repurchase of 96,890 shares of our common stock pursuant to our share repurchase program as well as $990,000 of net principal payments on our loans from MBT more fully described in Note 11 to the condensed consolidated financial statements contained elsewhere in this report. Financing Facilities & Liquidity Requirements for the next twelve months As of March 31, 2025, our working capital was $31.6 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 may also liquidate some or all of our investment portfolio or borrow further against our $11.0 million Amended Revolving Loan with MBT (see Note 11 to condensed consolidated financial statements contained elsewhere in this report), which we amended in April 2025 in order to provide us additional borrowing capacity. 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 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. 24 Investment Strategy We invest surplus cash from time to time through our Investment Committee, which is comprised of one management director, Richard Van Kirk, and two non-management directors, Raymond Cabillot and Nicholas Swenson, who chairs the committee. Both Messrs. Cabillot and 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. Cabillot or Swenson 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 $5.5 million of marketable public equity securities held at March 31, 2025. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable.