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Item 7. Management’s Discussion and Analysis

2026-09-03 compared with 2025-09-04 · 142 added, 132 removed, 220 unchanged (55% of the section changed)

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

The following discussion of

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in the orthopedic, thoracic, and CMF markets.

Additionally, we provide engineering, quality, and regulatory consulting

services to our customers.

Additionally, we provide engineering, quality, and regulatory consulting services to

our customers.

We also sell rotary air motors to a wide range of industries;

however, these motors comprise a de minimis

portion of our business.

Our products are found in hospitals, medical engineering labs, scientific research facilities, and high-tech

manufacturing operations around the world.

however, these motors comprise a de minimis portion of our

Beginning in fiscal 2026, we began selling precision machined parts and assemblies for the aerospace and defense industries

through our newly acquired subsidiary, APM.

Our products are found in hospitals, medical engineering labs, scientific research facilities,

and high-tech manufacturing operations around the world.

We are headquartered in Irvine, California.

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from the measurement date.

Investments consist of marketable

equity securities of publicly held companies.

The investments were made to realize a reasonable return, although there is no assurance

that positive returns will be realized.

Investments are marked to market at each measurement date, with unrealized gains and losses presented

in other income (expense) in our consolidated income statements.

Some of our investments include the common stock of public companies

that are thinly traded.

Certain of these investments are classified as long-term in nature, as we may not be able to liquidate the investments

in a timely manner even if we wish to sell them.

All of our investments were subject to a valuation analysis as of June 30, 2025 and 2024.

Long-lived Assets

Investments currently consist

of marketable equity securities of publicly held companies as well as preferred stock of a private company.

The investments were made

to realize a reasonable return, although there is no assurance that positive returns will be realized.

Investments are marked to market

at each measurement date, with unrealized gains and losses presented in other income (expense) in our consolidated income statements.

Some of our investments include the common stock of public companies that are thinly traded.

Certain of these investments are classified

as long-term in nature, as we may not be able to liquidate the investments in a timely manner even if we wish to sell them.

investments were subject to a valuation analysis as of June 30, 2026 and 2025.

Long-lived Assets & Intangible Assets

We review the recoverability

of long-lived assets, consisting of building, equipment, and improvements, when events or changes in circumstances occur that indicate

carrying values may not be recoverable.

Building, equipment, and

improvements are recorded at historical cost and depreciation is provided using the straight-line method over the following periods:

of long-lived assets, consisting of building, equipment, and improvements, and definite-lived intangibles when events or changes in circumstances

occur that indicate carrying values may not be recoverable.

We assess the impairment of indefinite-lived intangibles annually, and more

frequently, if events or changes in circumstances indicate that it is more likely than not that the asset is impaired.

Building, equipment, and improvements

are recorded at historical cost and definite-lived intangibles are recorded at estimated fair value and depreciation is provided using

the straight-line method over the following periods:

Customer relationships

Three to ten years

Shorter of the remaining life of the underlying building, lease term, or the asset’s estimated useful life

Business Combinations

Accounting for a business

combination requires us to estimate the fair value of consideration paid and the individual assets acquired and liabilities assumed, which

involves a number of judgments, assumptions and estimates that could materially affect the amount and timing of costs recognized in subsequent

We estimate the fair value of assets acquired, and liabilities assumed based upon assumptions we believe to be reasonable, but

which are inherently uncertain and, as a result, actual results may differ from estimates.

Estimates associated with the accounting for

acquisitions may change as additional information becomes available.

Due to the subjectivity of and reliance on forward-looking inputs,

these acquisition-related estimates qualify as critical accounting estimates.

We recognize deferred tax

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Income tax expense

The majority of our revenue is derived from designing, developing,

manufacturing and repairing powered surgical instruments for medical device original equipment manufacturers.

We also manufacture and

sell rotary air motors to a wide range of industries.

The proportion of total sales by product/service type is as follows:

Ended June 30,

majority of our revenue is derived from designing, developing, manufacturing and

repairing powered surgical instruments for medical device original equipment manufacturers.

also manufacture and sell rotary air motors to a wide range of industries and precision machined parts and assemblies for the aerospace

and defense industries through our newly acquired subsidiary APM.

The proportion of total sales by product/service

type is as follows:

Years Ended June 30,

(Decrease) From 2025 To 2026

Dollars in thousands

% of Net Sales

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NRE & Prototype services

Dental and component

Discounts & Other

sales in fiscal 2026 increased by $11.0 million, or 16%, as compared to fiscal 2025, due primarily to an increase in medical device revenue

of $10.8 million and an increase in repair revenue of $2.1 million.

of $14.4 million, offset by a decrease in repair revenue of $6.0 million.

Details of our medical device sales by type is as follows:

Ended June 30,

% of Net Sales

From 2025 To 2026

Medical Device sales:

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to the launch of that customer’s next generation handpiece.

As previously disclosed, late in the third quarter of fiscal 2025 the

customer requested we hold off on next generation handpiece shipments in favor of continued shipments and enhanced repair of the legacy

During the fourth quarter of fiscal 2025, the customer requested that we resume production and shipments of the next generation

While this pause negatively impacted our fourth quarter results, we do not anticipate any additional delays in shipment of

the next generation handpiece.

During fiscal 2025, thoracic sales increased by $1.3 million to $4.3

million, up from $3.0 million in fiscal 2024.

Recurring revenue from distributors of CMF drivers decreased $391,000 in fiscal 2025

compared to fiscal 2024.

We do not have much visibility into our customers’ distribution networks, but these fluctuations are within

expected levels.

of our industrial and scientific products, which consist primarily of our compact pneumatic air

motors, increased $96,000, or 13%, for fiscal 2025 compared to fiscal 2024.

These are legacy products with no substantive marketing or

sales efforts.

of our NRE & prototype services decreased $88,000, or 11%, during fiscal 2025 as compared to fiscal 2024 and relates to a reduction

As previously disclosed, our largest customer executed a contract amendment

which extends the contract through 2028 and also provides for higher volumes of their newest surgical handpiece.

Therefore, we expect

to see similar levels of revenue reported in orthopedic sales through 2028.

During fiscal 2026,

thoracic sales decreased by $2.2 million to $2.1 million, down from $4.3 million in fiscal 2025.

Recurring revenue from distributors

of CMF drivers increased $1.3 million in fiscal 2026 compared to fiscal 2025.

We do not have much visibility into our customers’

distribution networks, but these fluctuations are within expected levels.

and scientific sales increased $652,000, or 76%, for fiscal 2026 compared to fiscal 2025 primarily due to the inclusion of APM sales from

the acquisition date of February 9, 2026.

of our NRE & prototype services increased $952,000, or 136%, during fiscal 2026 as compared to fiscal 2025 and relates to an increase

in the number of billable engagements for various NRE projects undertaken for our customers.

of our dental products and components in fiscal 2025 decreased $7,000, or 4%, as compared to fiscal 2024.

The decrease is as expected

and we expect future declines in this area as we are no longer manufacturing dental products, but rather are simply selling remaining

component inventory.

fiscal 2025 repair revenue increased approximately $2.1 million, or 13%, to $18.6 million, as compared to fiscal 2024, due to increased

fiscal 2026 repair revenue decreased approximately $6.0 million, or 33%, to $12.5 million, as compared to fiscal 2025, due to decreased

repairs of the legacy orthopedic handpiece we sold to our largest customer.

This increase relates to the continuation of the previously

disclosed enhanced repair program.

We anticipate that repair revenue may decline in future periods as this customer transitions to the

next generation handpiece in lieu of enhancements of the legacy handpiece.

This decrease relates to the customers transition to their

next generation handpiece.

We anticipate that repair revenue may continue to decline in future periods as this customer continues to transition

to the next generation handpiece in lieu of enhancements of the legacy handpiece.

However, beginning in fiscal 2027 we expect to commence

billable repairs of our customer’s next generation handpiece but we do not know yet at what volumes.

At June 30, 2026, we

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among other reasons, the launch of new products, the timing of customer orders based on end-user demand, and customer inventory levels.

We do not typically experience seasonal fluctuations in our shipments and revenues.

While the June 30, 2026 backlog is significantly less than the backlog from one year ago, we attribute this simply to timing.

typically experience seasonal fluctuations in our shipments and revenues.

Cost of Sales and Gross Margin

Ended June 30,

(Decrease) From 2025 To 2026

% of Net Sales

Costs of sales

Product costs

NRE and Prototype services costs

Under (over)-absorption of manufacturing overhead

Cost of sales:

Under absorption of manufacturing overhead

Inventory and warranty charges

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in net sales.

During fiscal 2025, we experienced $2.5 million of under-absorption of manufacturing costs compared to $74,000 of over-absorption

in fiscal 2024, due primarily to an increase in our indirect manufacturing costs in fiscal 2025.

Costs related to inventory and warranty charges decreased $180,000 in fiscal 2025 compared to fiscal 2024, primarily due to decreased

inventory reserves .

During fiscal 2026, we experienced $2.0 million of under-absorption of manufacturing costs compared to $2.5 million in fiscal

Costs related to inventory and warranty charges increased $858,000 in fiscal 2026 compared

to fiscal 2025, primarily due to increased inventory reserves relating to a complex machined part used in our largest customer’s

next generation handpiece .

Operating Expenses

Ended June 30,

From 2025 To 2026

in thousands)

% of Net Sales

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Selling expenses increased

$227,000, or 194%, compared to fiscal 2024, primarily due to recruiting fees and personnel costs related to our new Director of Business

Development who we hired in December 2024 as well as increased advertising and related expenses.

$172,000, or 50%, compared to fiscal 2025, primarily due to a $349,000 bad debt expense offset by reduced personnel and advertising expenses

of $80,000 and $92,000, respectively.

General and administrative

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associated with being a public company.

The $769,000 increase in G&A expenses from fiscal 2024 to 2025 is due primarily to $441,000

in increased bonus accruals, $249,000 in increased personnel costs, and $270,000 in increased legal and information technology expenses,

offset by $157,000 in decreased audit fees.

Fiscal 2026 G&A expenses increased $2.6 million, or 55%, compared to fiscal 2025, primarily

due to $449,000 in increased bonus accruals, $620,000 in increased personnel costs, $668,000 related to APM’s separate general and

administrative expenses since the date of acquisition, $500,000 in non-recurring consulting fees paid to the former owner of APM and $133,000

in increased non-cash equity 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.

Fiscal 2025 research and development costs increased

$447,000 from fiscal 2024 due to increased spending on internal product development projects of $378,000 as well as reduced billable project

expenditures which get reclassified to cost of sales.

The majority of our research and development expenditures incurred in fiscal 2025

and 2024 relates to our 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.

well as allocated facility and information technology (“IT”) 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.

Fiscal 2026 research and development

costs decreased $291,000 from fiscal 2025 due to a $155,000 reduction in legal expenses related to intellectual property matters and $76,000

and $35,000 in decreased recruiting and IT expenses, respectively, as well as increased spending on billable project expenditures which

get reclassified to cost of sales.

The majority of our research and development expenditures incurred in fiscal 2026 and 2025 relates

to our sustaining activities related to products we currently manufacture and sell.

Typical examples of sustaining engineering activities

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income earned in fiscal 2026 and 2025 includes income earned from our interest-bearing money market accounts and portfolio of equity investments.

Unrealized gain (loss)

on investments

The unrealized gain (loss)

on investments relates to our investment portfolio.

Additional information related to the nature of our investments is more fully described

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

Gain on Sale of Investments

During fiscal 2025, we liquidated

some of the investments in our portfolio of equity investments receiving proceeds of $1.9 million and recording a gain of $595,000.

fiscal 2024, our investment sales were immaterial.

Gain on marketable investments,

As described in Note 5 to

the consolidated financial statements contained elsewhere in this report, during the second quarter of fiscal 2026, Zimmer Biomet acquired

Monogram Technologies, Inc.

(“Monogram”) and upon consummation of the acquisition we received proceeds of $8.9 million and

realized a gain on our investment of $6.8 million.

Additionally, during the third quarter ended March 31, 2026, Monogram successfully

completed the first of five milestones such that we earned and recorded an additional gain in the amount of $2.3 million.

During fiscal

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.

In addition to these realized gains, during fiscal 2026 and 2025, we also recorded unrealized gains and

losses to adjust our investment holdings to estimated fair value as well as eliminating the previously recorded unrealized gains on our

Monogram investment during the second quarter of fiscal 2026 in conjunction with recording the realized gain.

Interest Expense

Interest expense incurred

in fiscal 2025 and 2024 consists primarily of interest expense related to our debt with Minnesota Bank & Trust (“MBT”)

described more fully in Note 8 to the consolidated financial statements contained elsewhere in this report.

in fiscal 2026 and 2025 consists primarily of interest expense related to our debt with UMB Bank N.A.

(“UMB”) described more

fully in Note 9 to the consolidated financial statements contained elsewhere in this report.

The effective tax rate for

the fiscal years ended June 30, 2025 and 2024 was 26% and 19%, respectively, slightly less than our combined expected federal and applicable

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

Our pre-tax income in fiscal 2025 was $12.0 million

compared to $2.6 million in fiscal 2024.

The impact of our tax credits is more significant when pre-tax income is lower.

the fiscal years ended June 30, 2026 and 2025 was 24% and 26%, respectively.

Our effective tax rate is slightly lower in fiscal 2026 compared

to 2025 due to our expansion into Florida and Indiana for income tax purposes, which states have a lower state income tax rate than California.

Liquidity and Capital Resources

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Cash Flows from Operating Activities

Cash provided by operating

activities during fiscal 2026 totaled $7.2 million.

Our net income was $13.7 million, which includes $5.7 million of net gains on equity

investments, as well as $1.4 million of depreciation and amortization and $688,000 of non-cash stock compensation.

Additionally, at June

30, 2026 compared to June 30, 2025, our accounts receivable increased by $4.7 million corresponding with our increased revenue, offset

by our inventory decreasing by $1.6 million.

Cash used in operating activities

during fiscal 2025 totaled $1.7 million.

Our net income was $9.0 million, which includes $1.5 million of unrealized gains on certain equity

investments, $595,000 of realized gains on the sale of certain equity investments as well as $1.2 million of depreciation and amortization

and $555,000 of non-cash stock compensation.

Additionally, at June 30, 2025 compared to June 30, 2024, our accounts receivable increased

by $2.5 million corresponding with our increased revenue, our income tax accounts reflect a $1.5 million outlay of cash mostly related

to higher estimated income tax payments, and our inventory increased by $6.9 million in anticipation of increased sales to support our

largest customer’s release of their next generation orthopedic handpiece.

Cash provided by operating

activities totaled $6.2 million during fiscal 2024.

Our fiscal 2024 net income was $2.1 million, which includes $4.1 million of unrealized

losses on certain equity investments, as well as non-cash stock compensation expense and depreciation and amortization expense in the

amount of $605,000 and $1.2 million, respectively.

Additionally, our accounts payable and accrued expenses at June 30, 2024 increased

by $2.4 million and our inventory decreased by $898,000 as compared to June 30, 2023.

Offsetting these inflows of cash, our accounts receivable

and deferred tax assets at June 30, 2024 grew by $3.9 million and $1.6 million, respectively, compared to June 30, 2023.

Our net income was $9.0 million, which included $2.1 million of gains on certain equity investments,

as well as $1.2 million of depreciation and amortization and $555,000 of non-cash stock compensation.

Additionally, at June 30, 2025 compared

to June 30, 2024, our accounts receivable increased by $2.5 million corresponding with our increased revenue, our income tax accounts

reflected a $1.5 million outlay of cash mostly related to higher estimated income tax payments, and our inventory increased by $6.9 million

in anticipation of increased sales to support our largest customer’s release of their next generation orthopedic handpiece.

Cash Flows from Investing Activities

Net cash provided by investing

activities for fiscal 2026 was $3.9 million and relates primarily to the proceeds received from the Zimmer Biomet acquisition of Monogram

previously disclosed in the amount of $11.2 million offset by our acquisition of APM in the amount of $6.5 million described further in

Note 3 to the consolidated financial statements contained elsewhere in this report.

Additionally, we spent $483,000 on the purchase of

capital equipment and $350,000 related to Series A Preferred Stock of a privately held technology company.

Net cash used in investing

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During the 2025 fiscal year, we made capital expenditures in the amount of $1.2 million and exercised

warrants to purchase common stock and preferred stock of Monogram Technologies, Inc., formerly Monogram Orthopaedics Inc.

for cash in the amount of $899,000 (See Note 4 to the consolidated financial statements contained elsewhere in this report) offset by

proceeds of $1.9 million from the sales of marketable equity securities.

Net cash used in investing

activities in fiscal 2024 was $2.2 million and related to the exercise of the warrant to purchase Monogram common stock for cash in the

amount of $1,250,000 (See Note 4 to the consolidated financial statements contained elsewhere in this report) as well as equipment and

improvements purchases in the amount of $983,000.

warrants to purchase common stock and preferred stock of Monogram for cash in the amount of $899,000 (See Note 5 to the consolidated financial

statements contained elsewhere in this report) offset by proceeds of $1.9 million from the sales of marketable equity securities.

Cash Flows from Financing Activities

Net cash used in financing

activities for fiscal 2025 totaled $292,000 and included $3.5 million in net borrowings on various notes payable to MBT, more fully described

activities for fiscal 2026 totaled $3.4 million and relates primarily to the repurchase of 79,898 shares of our common stock pursuant

to our share repurchase program.

Net cash used in financing

activities for fiscal 2025 totaled $292,000 and included $3.5 million in net borrowings on various notes payable to UMB, more fully described

in Note 9 to the consolidated financial statements contained elsewhere in this report, offset by $3.5 million related to the repurchase

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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 fiscal 2024 totaled $4.3 million and related primarily to the $3.5 million repurchase of 184,901 shares of our common stock

pursuant to our share repurchase program, as well as $841,000 of net principal payments related to our various loans from MBT more fully

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

Liquidity Requirements for the Next 12 Months

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We may also liquidate some or all of our investment portfolio

or borrow against our revolving loan with MBT (See Note 8 to consolidated financial statements contained elsewhere in this report), under

or borrow against our revolving loan with UMB (See Note 9 to consolidated financial statements contained elsewhere in this report), under

which we had availability of $11.0 million as of June 30, 2026.

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may own from time to time either individually or through the investment funds that they manage, or other companies whose boards they sit

The Investment Committee approved each of the investments comprising the $6.9 million of investments in marketable public equity securities

held at June 30, 2025, which amount includes unrealized holding gains in the amount of $3.3 million at June 30, 2025.

The Investment Committee approved each of the investments comprising the $1.7 million of investments held at June 30, 2026, which

amount includes unrealized holding losses in the amount of $97,000 at June 30, 2026.

In December 2019, our Board

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All repurchases under the 10b5-1 Plans were administered through an independent broker.

QUANTITATIVE AND QUALITATIVE DISCLOSURES

ABOUT MARKET RISK

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As a smaller reporting company, we are

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis