What changed in this filing

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Item 1. Financial Statements

2020-05-07 compared with 2020-02-06 · 176 added, 145 removed, 416 unchanged (44% of the section changed)

5 unchanged sentences

Cash and cash equivalents

Accounts receivable, net of allowance for doubtful accounts of $17 and $0 at December 31, 2019 and at June 30, 2019, respectively

Accounts receivable, net of allowance for doubtful accounts of $6 and $0 at March 31, 2020 and at June 30, 2019, respectively

Deferred costs

22 unchanged sentences

50,000,000 shares authorized;

3,884,098 and 4,039,491 shares issued and outstanding at December 31, 2019 and June 30, 2019, respectively

Accumulated other comprehensive income (loss)

3,837,490 and 4,039,491 shares issued and outstanding at March 31, 2020 and June 30, 2019, respectively

Accumulated other comprehensive loss

Retained earnings

4 unchanged sentences

CONDENSED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

AND COMPREHENSIVE INCOME (LOSS)

(In thousands, except per share amounts)

Three Months Ended

Six Months Ended

Nine Months Ended

Cost of sales

13 unchanged sentences

Unrealized income (loss) from marketable equity investments

Comprehensive income

Comprehensive income (loss)

Basic net income per share:

5 unchanged sentences

CONDENSED STATEMENTS OF SHAREHOLDERS EQUITY

For the Three and Six Months Ended December 31, 2019 and 2018

For the Three and Nine Months Ended March 31, 2020 and 2019

(In thousands)

Three Months Ended

Six Months Ended

Nine Months Ended

Common shares:

19 unchanged sentences

(In thousands)

Six Months Ended

Nine Months Ended

CASH FLOWS FROM OPERATING ACTIVITIES:

1 unchanged sentence

Depreciation and amortization

Amortization of loan fees

Gain from disposal of equipment

1 unchanged sentence

Non-cash lease expense

Amortization of loan fees

Gain on sale of investments

13 unchanged sentences

Proceeds from sale of investments

Proceeds from dividend reclassification as return of principal

Proceeds from collection of notes receivable

Proceeds from sale of equipment

15 unchanged sentences

(In thousands)

Six Months Ended

Nine Months Ended

Supplemental disclosures of cash flow information:

16 unchanged sentences

The objective of this update is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.

The impact of adoption was an increase to long-term assets and total liabilities of approximately $3.3 million as of July 1, 2019.

The impact of adoption was an increase to long-term assets and total liabilities each in the amount of approximately $3.3 million as of July 1, 2019.

DESCRIPTION OF BUSINESS

13 unchanged sentences

Total marketable equity securities

Investments at March 31, 2020 and June 30, 2019 had an aggregate cost basis of $5,592,000 and $3,780,000, respectively.

At March 31, 2020, the investments included net unrealized losses of $1,162,000 (gross unrealized losses of $1,384,000 offset by gross unrealized gains of $222,000).

At June 30, 2019, the investments included net unrealized losses of $549,000 and no unrealized gains.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Investments at December 31, 2019 and June 30, 2019 had an aggregate cost basis of $5,050,000 and $3,780,000, respectively.

At December 31, 2019, the investments included net unrealized gains of $100,000 (gross unrealized gains of $329,000 offset by gross unrealized losses of $229,000).

During the quarter ended December 31, 2019, we incurred net unrealized gains of $705,000.

At June 30, 2019, the investments included net unrealized losses of $549,000 and no unrealized gains.

Of the total marketable equity securities at December 31, 2019 and June 30, 2019, $1,410,000 and $938,000, respectively, represent an investment in the common and preferred stock of Air T, Inc.

Of the total marketable equity securities at March 31, 2020 and June 30, 2019, $930,000 and $938,000, respectively, represent an investment in the common and preferred stock of Air T, Inc.

Two of our Board members are also board members of Air T, Inc.

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The warranty accrual is based on historical costs of warranty repairs and expected future identifiable warranty expenses and is included in accrued expenses in the accompanying balance sheets.

As of December 31, and June 30, 2019, the warranty reserve amounted to $141,000 and $136,000, respectively.

As of March 31, 2020 and June 30, 2019, the warranty reserve amounted to $173,000 and $136,000, respectively.

Warranty expenses are included in cost of sales in the accompanying statements of operations.

Changes in estimates to previously established warranty accruals result from current period updates to assumptions regarding repair costs and warranty return rates and are included in current period warranty expense.

Warranty expense relating to new product sales and changes to estimates for the three months ended December 31, 2019 and 2018 was $44,000 and $16,000, respectively, and for the six months ended December 31, 2019 and 2018 was $56,000 and $30,000, respectively.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Information regarding the accrual for warranty costs for the three and six months ended December 31, 2019 and 2018 are as follows (in thousands):

Warranty expense relating to new product sales and changes to estimates for the three months ended March 31, 2020 and 2019 was $69,000 and $52,000, respectively, and for the nine months ended March 31, 2020 and 2019 was $125,000 and $82,000, respectively.

Information regarding the accrual for warranty costs for the three and nine months ended March 31, 2020 and 2019 are as follows (in thousands):

As of and for the

5 unchanged sentences

Ending balance

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

As of and for the

Six Months Ended

Nine Months Ended

Beginning balance

5 unchanged sentences

The Company calculates basic net income per share by dividing net income by the weighted-average number of common shares outstanding during the reporting period.

The weighted-average number of common shares outstanding reflects the effects of potentially dilutive securities, in income generating periods, which consist entirely of outstanding stock options and performance awards.

The weighted-average number of common shares outstanding used in the calculation of diluted income per share reflects the effects of potentially dilutive securities, in income generating periods, which consist entirely of outstanding stock options and performance awards.

The following table presents reconciliations of the numerators and denominators of the basic and diluted earnings per share computations for net income.

1 unchanged sentence

Three Months Ended

Six Months Ended

Nine Months Ended

Weighted average shares outstanding

1 unchanged sentence

Weighted average shares outstanding

Effect of dilutive securities stock options

Effect of dilutive securities

Weighted average shares used in calculation of diluted earnings per share

Diluted income per share

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Deferred income taxes are provided on a liability method whereby deferred tax assets and liabilities are recognized for temporary differences.

4 unchanged sentences

Such determination is based primarily on our historical taxable income, with some consideration given to our estimates of future taxable income by jurisdictions in which we operate and the period over which our deferred tax assets would be recoverable.

As of December 31, 2019, we have accrued $479,000 of unrecognized tax benefits related to federal and state income tax matters.

None of this balance is expected to reduce the Companys income tax expense if recognized.

As of March 31, 2020, we have accrued $489,000 of unrecognized tax benefits related to federal and state income tax matters.

None of this balance is expected to reduce our income tax expense if recognized.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

As of and for the

Six Months Ended

Nine Months Ended

Beginning balance

2 unchanged sentences

Ending balance

On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief and Economic Security Act ("CARES Act").

The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property (QIP).

Under ASC 740, the effects of new legislation are recognized upon enactment.

Accordingly, the effects of the CARES Act are effective for the period ending March 31, 2020.

As of March 31, 2020, we have, as a result of the technical amendments made by the CARES Act to QIP, accelerated tax depreciation expenses of approximately $92,000 which represents favorable temporary book-to-tax timing differences (i.e., no effective tax rate impact) for income tax purposes and are recorded as components within our deferred income tax assets and income tax receivable, included in prepaid expenses and other current assets, on our condensed consolidated balance sheets.

We are continuing to examine additional impacts that the CARES Act may have on our business.

We recognize accrued interest and penalties related to unrecognized tax benefits when applicable.

As of December 31, 2019, no interest or penalties applicable to our unrecognized tax benefits have been accrued since we have sufficient tax attributes available to fully offset any potential assessment of additional tax.

As of March 31, 2020, no interest or penalties applicable to our unrecognized tax benefits have been accrued since we have sufficient tax attributes available to fully offset any potential assessment of additional tax.

We are subject to U.S.

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The 2016 Equity Incentive Plan provides for the award of up to 1,500,000 shares of our common stock in the form of incentive stock options, nonstatutory stock options, stock appreciation rights, restricted shares, restricted stock units, performance awards, and other stock-based awards.

As of December 31, 2019, we have granted performance awards under the 2016 Equity Incentive Plan for up to 200,000 shares of our common stock, of which 40,000 shares have vested as further described below under the heading Performance Awards.

Stock Options

No options were granted during the three or six months ended December 31, 2019 and 2018.

As of March 31, 2020, we have granted performance awards under the 2016 Equity Incentive Plan for up to 200,000 shares of our common stock, of which 40,000 shares have vested as further described below under the heading Performance Awards.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

As of December 31, 2019, there was no unrecognized compensation cost under the Former Stock Option Plans, as all outstanding stock options are fully vested.

As of December 31, 2019, the options outstanding had a weighted average remaining contractual life of 1.5 years and an intrinsic value of $847,000.

Following is a summary of stock option activity for the six months ended December 31, 2019 and 2018:

Stock Options

No options were granted during the three or nine months ended March 31, 2020 and 2019.

As of March 31, 2020, there was no unrecognized compensation cost under the Former Stock Option Plans, as all outstanding stock options are fully vested.

As of March 31, 2020, the options outstanding had a weighted average remaining contractual life of 1.3 years and an intrinsic value of $774,000.

Following is a summary of stock option activity for the nine months ended March 31, 2020 and 2019:

Number of Shares

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Outstanding at end of period

Stock Options Exercisable at December 31,

Stock Options Exercisable at March 31,

Performance Awards

In December 2017, the Compensation Committee of the Board of Directors granted performance awards to our employees, for an aggregate of up to 200,000 shares of our common stock.

In December 2017, the Compensation Committee of the Board of Directors granted performance awards to certain of our employees, for an aggregate of up to 200,000 shares of our common stock.

Whether any performance awards vest, and the amount that does vest, is tied to the completion of service periods that range from 7 months to 9.5 years and the achievement of our common stock trading at certain pre-determined prices.

The weighted average fair value of the performance awards granted was $4.46, calculated using the weighted average fair market value for each award, using a Monte Carlo simulation.

We recorded share-based compensation expense of $8,000 for each of the three months ended December 31, 2019 and 2018, and $16,000 for each of the six months ended December 31, 2019 and 2018, related to these performance awards.

On December 31, 2019, there was approximately $50,000 of unrecognized compensation cost related to these non-vested performance awards expected to be expensed over the weighted-average period of 3.37 years.

The weighted average fair value of the performance awards granted in 2017 was $4.46, calculated using the weighted average fair market value for each award, using a Monte Carlo simulation.

In February 2020, the Compensation Committee of the Board of Directors reallocated 48,000 previously forfeited awards, having the same remaining terms and conditions, to certain current employees.

The weighted average fair value of the performance awards granted in 2020 was $16.90, calculated using the weighted average fair market value for each award, using a Monte Carlo simulation.

We recorded share-based compensation expense of $70,000 and $8,000 for the three months ended March 31, 2020 and 2019, respectively, and $86,000 and $24,000 for the nine months ended March 31, 2020 and 2019, respectively, related to these performance awards.

On March 31, 2020, there was approximately $437,000 of unrecognized compensation cost related to non-vested performance awards expected to be expensed over the weighted-average period of 3.11 years.

On July 1, 2018, it was determined by the Compensation Committee of our Board of Directors that the first of five tranches of performance awards had been achieved and participants were awarded 40,000 shares of common stock.

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The ESPP conforms to the provisions of Section 423 of the Internal Revenue Code, has coterminous offering and purchase periods of six months, and bases the pricing to purchase shares of our common stock on a formula so as to result in a per share purchase price that approximates a 15% discount from the market price of a share of our common stock at the end of the purchase period.

The Board of Directors also approved the provision that shares formerly reserved for issuance under the Former Stock Option Plans in excess of shares issuable pursuant to outstanding options under those plans, aggregating 704,715 shares, be reserved for issuance pursuant to the ESPP.

During the three months ended December 31, 2019 and 2018, we did not record any share-based compensation expense relating to the ESPP, due to the fact that no six-month offering period ended during either quarter.

During the six months ended December 31, 2019 and 2018, 1,292 and 1,820 shares of our common stock were purchased under the ESPP, respectively, and allocated to employees based upon their contributions at prices of $11.76 and $5.51, respectively, per share.

Our Board of Directors also approved the provision that shares formerly reserved for issuance under the Former Stock Option Plans in excess of shares issuable pursuant to outstanding options under those plans, aggregating 704,715 shares, be reserved for issuance pursuant to the ESPP.

During the three months ended March 31, 2020 and 2019, we recorded share-based compensation expense in the amount of $4,000 and $2,000, respectively, and 1,628 and 923 shares were purchased, respectively, and allocated to employees based upon their contributions at prices of $14.43 and $12.96, respectively, per share.

During the nine months ended March 31, 2020 and 2019, we recorded share-based compensation expense in the amount of $7,000 and $4,000, respectively, relating to the ESPP.

On a cumulative basis, since the inception of the ESPP, employees have purchased a total of 21,786 shares of our common stock.

During the six months ended December 31, 2019 and 2018, we recorded share-based compensation expense in the amount of $3,000 and $2,000, respectively, relating to the ESPP.

PRO-DEX, INC.

1 unchanged sentence

MAJOR CUSTOMERS AND SUPPLIERS

Information with respect to customers that accounted for sales in excess of 10% of our total sales in either of the three-month and the six-month periods ended December 31, 2019 and 2018 is as follows (in thousands, except percentages):

Three Months Ended December 31,

Information with respect to customers that accounted for sales in excess of 10% of our total sales in either of the three-month and the nine-month periods ended March 31, 2020 and 2019 is as follows (in thousands, except percentages):

Three Months Ended March 31,

Percent of Total

Customer concentration:

Six Months Ended December 31,

Nine Months Ended March 31,

Percent of Total

Customer concentration:

Information with respect to accounts receivable from those customers who comprised more than 10% of our gross accounts receivable at either December 31, 2019 or June 30, 2019, is as follows (in thousands, except percentages):

December 31, 2019

Information with respect to accounts receivable from those customers who comprised more than 10 % of our gross accounts receivable at either March 31, 2020 or June 30, 2019 is as follows (in thousands, except percentages):

March 31, 2020

June 30, 2019

1 unchanged sentence

Customer concentration:

During the three months ended December 31, 2019 and 2018, we had two suppliers accounting for 10% or more of total inventory purchases.

During the six months ended December 31, 2019, we had two suppliers that accounted for more than 10% of our total inventory purchases, and during the six months ended December 31, 2018, we had one supplier that accounted for more than 10% of our total inventory purchases.

Amounts owed to the fiscal 2020 significant suppliers at December 31, 2019 totaled $306,000 and $117,000, respectively, and at June 30, 2019 totaled $304,000 and $373,000, respectively.

During the three and nine months ended March 31, 2020, we had three suppliers accounting for 10% or more of total inventory purchases.

During the three and nine months ended March 31, 2019, we had one supplier that accounted for more than 10% of our total inventory purchases.

Amounts owed to the fiscal 2020 significant suppliers at March 31, 2020 and June 30, 2019 is as follows (in thousands, except percentages).

March 31, 2020

June 30, 2019

Total accounts payable

Supplier concentration:

Fischer Connectors, Inc.

Tadiran Batteries

PRO-DEX, INC.

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Commencing November 1, 2018 and continuing on the first day of each subsequent month thereafter until the maturity date, we are required to make payments of principal and interest on the Term Loan of approximately $72,000, plus any additional accrued and unpaid interest through the date of payment.

The balance owed on the Term Loan at December 31, 2019 is $4.2 million, net of unamortized loan fees.

The Revolving Loan had an original maturity date of September 6, 2019 and has since been extended to November 6, 2020 and bears interest at the greater of (a) 4.5% or (b) the difference of the prime rate as published in the Money Rates section of the Wall Street Journal minus 0.50%.

The balance owed on the Term Loan at March 31, 2020 is $4.1 million, net of unamortized loan fees.

The Revolving Loan had an original maturity date of September 6, 2019, which has since been extended to November 6, 2020, and bears interest at the greater of (a) 4.5% or (b) the difference of the prime rate as published in the Money Rates section of the Wall Street Journal minus 0.50%.

Commencing on the first day of each month after we initially borrow against the Revolving Loan, which we have yet to do, and each month thereafter until maturity, we are required to pay all accrued and unpaid interest on the Revolving Loan through the date of payment.

Any principal on the Revolving Loan that is not previously prepaid shall be due and payable on the maturity date (or earlier termination of the Revolving Loan).

As we have yet to borrow under the Revolving Loan, the balance owed under it at December 31, 2019 was $0.

As we have yet to borrow under the Revolving Loan, the balance owed under it at March 31, 2020 was $0.

Any payment on the Loans not made within seven days after the due date is subject to a late payment fee equal to 5% of the overdue amount.

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Share Repurchase Program

In December 2019, our Board approved a new share repurchase program authorizing us to repurchase up to 1 million shares of our common stock, as the prior repurchase plan authorized by the Board in 2013 was nearing completion.

In accordance with, and as part of, these share repurchase programs, our Board approved the adoption of several prearranged share repurchase plans intended to qualify for the safe harbor provided by Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (10b5-1 Plan or Plan).

During the three and six months ended December 31, 2019, we repurchased 106,897 and 156,685 shares, respectively, at an aggregate cost, inclusive of fees under the plan, of $1,535,000 and $2,215,000, respectively.

During the three and six months ended December 31, 2018, we repurchased 109,366 and 217,454 shares, respectively, at an aggregate cost, inclusive of fees under the plan, of $1,445,000 and $2,560,000, respectively.

During the three and nine months ended March 31, 2020, we repurchased 48,236 and 204,921 shares, respectively, at an aggregate cost, inclusive of fees under the plan, of $761,000 and $2,977,000, respectively.

During the three and nine months ended March 31, 2019 we repurchased 7,914 and 225,368 shares, respectively at an aggregate cost, inclusive of fees under the plan, of $115,000 and $2,675,000, respectively.

On a cumulative basis, since implementation of the share repurchase program in 2013, we have repurchased a total of 792,972 shares under the share repurchase program at an aggregate cost of $8.1 million.

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

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

At The Market Offering Agreement

In February 2017, our Board approved an ATM Agreement with Ascendiant Capital Markets, LLC (Ascendiant).

The ATM Agreement allows us to sell shares of our common stock pursuant to specific parameters defined by us as well as those defined by the SEC and the ATM Agreement.

During the three and six months ended December 31, 2019 and 2018 we did not issue any shares under the ATM.

The ATM Agreement allowed us to sell shares of our common stock pursuant to specific parameters defined by us as well as those defined by the SEC and the ATM Agreement.

During the three and nine months ended March 31, 2020 and 2019 we did not issue any shares under the ATM.

From the inception of the ATM in February 2017 through December 31, 2017, during periods when we did not make purchases under our share repurchase program, we sold 340,465 shares of common stock for gross proceeds of $2,311,000 net of commissions and fees paid to Ascendiant totaling $72,000.

In December 2017, the Board suspended the ATM indefinitely.

The Board has the discretion to reactivate the ATM prior to February 16, 2020, the expiration of the ATM Agreement, unless earlier terminated by Ascendiant or us.

However, we do not anticipate that the ATM will be reactivated prior to its expiration.

In December 2017, the Board suspended the ATM indefinitely and the ATM expired, pursuant to its terms, in February 2020.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Effective July 1, 2019, we adopted the new lease accounting standard using the modified retrospective method of applying the new standard at the adoption date.

In addition, we elected the practical expedient which allowed us to carry forward the historical lease classification of our sole operating lease for our corporate office, which includes our manufacturing and research and development facilities.

Adoption of this standard resulted in the recording of net operating lease right-of-use (ROU) asset and corresponding operating lease liability of $3.3 million.

Adoption of this standard resulted in the recording of net operating lease right-of-use (ROU) asset and corresponding operating lease liability each in the amount of $3.3 million.

Our financial position for reporting periods beginning on or after July 1, 2019 is presented under the new guidance, while prior period amounts are not adjusted and continue to be reported in accordance with previous guidance.

Our operating lease ROU asset and long-term liability are presented separately on our Condensed Balance Sheet.

The current portion of our operating lease liability as of December 31, 2019, in the amount of $297,000, is presented within accrued expenses on the Condensed Balance Sheet.

As of December 31, 2019, the maturity of our lease liability is as follows:

The current portion of our operating lease liability as of March 31, 2020, in the amount of $304,000, is presented within accrued expenses on the Condensed Balance Sheet.

As of March 31, 2020, the maturity of our lease liability is as follows:

Operating Lease

1 unchanged sentence

Less imputed interest:

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

As of December 31, 2019, our operating lease has a remaining lease term of seven years and nine months and an imputed interest rate of 5.3%.

Cash paid for amounts included in the lease liability for the three and six months ended December 31, 2019 was $116,000 and $229,000, respectively.

As of March 31, 2020, our operating lease has a remaining lease term of seven years and six months and an imputed interest rate of 5.3%.

Cash paid for amounts included in the lease liability for the three and nine months ended March 31, 2020 was $116,000 and $345,000, respectively.

As previously disclosed in our 2019 Annual Report on Form 10-K and under the previous lease accounting standard, future minimum lease payments for our only operating lease having an initial or remaining noncancellable lease term in excess of one year would have been as follows:

Operating Leases at June 30, 2019

Operating Leases at

June 30, 2019

Total minimum lease payments

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There can be no certainty, however, that we may not ultimately incur liability or that such liability will not be material and adverse.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

SUBSEQUENT EVENT

On April 7, 2020, as reported in our Current Report filed with the SEC on April 14, 2020, we entered into a Paycheck Protection Program Loan (the PPP Loan) sponsored by the Small Business Administration (SBA) through MBT, providing for $1,360,100 in proceeds, which amount was funded to the Company on April 10, 2020.

The PPP Loan was made pursuant to the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).

We repaid the loan on May 5, 2020, after careful consideration of additional guidance issued by the SBA and the Department of Treasury.

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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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 six-month periods ended December 31, 2019 and 2018.

(Company, Pro-Dex, we, our, or us) for the three-month and nine-month periods ended March 31, 2020 and 2019.

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

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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, competition from larger, better capitalized competitors, and our ability to realize returns on opportunities.

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, 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, consolidation within our target marketplace and among our competitors, competition from larger, better capitalized competitors, impacts of the COVID-19 pandemic on us or our business partners, including our customers and suppliers, 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, 2019.

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 and maxocranial facial markets.

We have patented adaptive torque-limiting software and proprietary sealing solutions which appeal to our customers, primarily medical device distributors.

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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 six months ended December 31, 2019, other than the required adoption of ASU 2016-02 (Topic 842), Leases, to the items that we disclosed as our critical accounting policies in Managements 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, 2019.

Management believes that there have been no significant changes during the three and nine months ended March 31, 2020, other than the required adoption of ASU 2016-02 (Topic 842), Leases, to the items that we disclosed as our critical accounting policies in Managements 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, 2019.

COVID-19 Pandemic

As publicly noted in a press release dated March 24, 2020, we are continuing our business operations under an exemption from California Governor Newsoms Executive Order N-33-20 (issued March 19, 2020) for essential critical infrastructure sectors based on our determination that we fall within the Healthcare and Public Health Sector exemption.

As we continue to operate, 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, including:

Non-essential employees that are able to work remotely are doing so;

Increased frequency of disinfectant cleanings, especially for high-touch surfaces;

Curtailed business travel;

Multiple, staggered work shifts have been implemented in order to achieve effective social distancing;

Provided training, education and appropriate personal protective equipment.

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

We provide our largest customer with a device used primarily in elective surgeries and although this customer has not requested a reduction or delay to their planned shipments, if this pandemic continues to adversely impact the United States and other markets where our products are sold, coupled with the recommended deferrals of elective procedures by governments and other authorities, we would expect to see a decline in demand from our principal customer.

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

We 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.

While the COVID-19 pandemic did not materially adversely affect our financial results and business operations in our third fiscal quarter ended March 31, 2020, economic and health conditions in the United States and across much of the globe have changed rapidly since the end of the quarter, and we cannot predict the full impact of the COVID-19 pandemic on our business.

Business Strategy and Future Plans

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Our patented adaptive torque-limiting software has been very well received in the CMF market and we have continued investment in this area with research and development focused on applying this technology to thoracic surgical applications.

We have invested significantly since fiscal 2018 on a thoracic driver utilizing adaptive torque-limiting software, and in early fiscal 2019 entered a development contract with a current significant customer to private-label this driver for their unique specifications.

We anticipate sales to this existing customer will increase late in fiscal 2020 as we add this product to their existing CMF driver and ancillary products that we currently supply.

We have invested significantly since fiscal 2018 on a thoracic driver utilizing adaptive torque-limiting software, and in early fiscal 2019 entered a development contract with an existing significant customer to private-label this driver for their unique specifications and we shipped this new driver, batteries and accessories during the third quarter ended March 31, 2020.

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 Pro-Dex branded drivers to leverage our torque-limiting software, 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.

Our research and development, selling and general and administrative expenses have increased disproportionately to our growth in revenue as we focus on new product development and we anticipate this to continue in the near term.

Our research and development, selling and general and administrative expenses have, in recent periods, increased disproportionately to our growth in revenue as we focus on new product development and we anticipate this to continue in the near term.

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

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Medical device products

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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.

Sales of our medical device products increased $0.2 million, or 3%, for the three months ended December 31, 2019 and decreased $0.8 million, or 7%, for the six months ended December 31, 2019 compared to the corresponding periods of the prior fiscal year.

Our medical device revenue to our largest customer increased $15,000 and decreased $270,000, respectively, for the three and six months ended December 31, 2019 compared to the corresponding periods of the prior fiscal year, due to contractual price concessions offset by slight volume increases.

Additionally, revenue from two legacy medical device customers decreased approximately $789,000 and $1.0 million, respectively, for the three and six months ended December 31, 2019 compared to the corresponding periods of the prior fiscal year.

Offsetting these decreases we sold approximately $350,000 and $525,000, respectively, in CMF drivers for the three and six months ended December 31, 2019 to a distributor that had not ordered from us since fiscal 2017.

Additionally, recurring revenue from two other significant distributors of CMF drivers had combined increases in sales for the three and six months ended December 31, 2019 of $580,000 and $92,000, respectively, compared to the corresponding periods of the prior fiscal year.

Sales of our compact pneumatic air motors, reported as Industrial and scientific sales above, decreased $14,000, or 7%, and $139,000, or 29% for the three and six months ended December 31, 2019 compared to the corresponding periods of the prior fiscal year.

Sales of our medical device products increased $0.4 million, or 6%, for the three months ended March 31, 2020 and decreased $0.5 million, or 2%, for the nine months ended March 31, 2020 compared to the corresponding periods of the prior fiscal year.

Our medical device revenue to our largest customer increased $69,000 and decreased $186,000, respectively, for the three and nine months ended March 31, 2020 compared to the corresponding periods of the prior fiscal year, due to contractual price concessions offset by slight volume increases.

Additionally, during the third quarter ended March 31, 2020, we completed the private-label effort for our thoracic driver and initial shipments to our customer in the third quarter totaled $1.5 million.

Offsetting this increase from the launch of the thoracic driver, revenue from two legacy medical device customers decreased approximately $256,000 and $1.2 million, respectively, for the three and nine months ended March 31, 2020 compared to the corresponding periods of the prior fiscal year.

Additionally, recurring revenue from two significant distributors of CMF drivers had combined decreases in sales for the three and nine months ended March 31, 2020 of $946,000 and $612,000, respectively, compared to the corresponding periods of the prior fiscal year.

Sales of our compact pneumatic air motors, reported as Industrial and scientific sales above, decreased $65,000, or 32%, and $204,000, or 30%, respectively, for the three and nine months ended March 31, 2020 compared to the corresponding periods of the prior fiscal year.

The revenue decline relates to a lack of marketing efforts for these legacy products.

Sales of our dental products and components declined for the three and six months ended December 31, 2019 compared to the corresponding periods of the prior fiscal year and we expect future declines in this area as we are no longer manufacturing dental products, but rather are simply selling remaining component inventory.

Sales of our dental products and components declined for the three and nine months ended March 31, 2020 compared to the corresponding periods of the prior fiscal year and we expect future declines in this area as we are no longer manufacturing dental products, but rather are simply selling remaining component inventory.

As previously discussed, in January 2018, we sent notification to our dental product customers that we were discontinuing the manufacture of these products.

The cessation of our dental line of products is not expected to have a material impact on our financial position or results of operations and reflected a conscious decision to increase capacity for our medical device products.

Repair revenue increased $1.5 million and $2.9 million for the three and six months ended December 31, 2019, 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.

Repair revenue increased $1.2 million and $4.1 million for the three and nine months ended March 31, 2020, 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.

Typically, upon initial product launch, repair revenue is minimal as most repairs are typically covered under warranty, but as the products mature in the marketplace and after a certain number of routine duty cycles in the operating room, repairs generally increase.

We expect repair revenue for the remaining quarters of fiscal 2020 to be comparable to the revenue generated during the quarter ended December 31, 2019.

At December 2019, we had a backlog of approximately $15.8 million, of which $15.7 million is scheduled to be delivered in the third and fourth quarters of fiscal 2020 and the balance is scheduled to be delivered next fiscal year.

We expect repair revenue for the remaining quarter of fiscal 2020 to be comparable to the revenue generated during the quarter ended March 31, 2020.

At March 2020, we had a backlog of approximately $14.8 million, of which $10.8 million is scheduled to be delivered in the fourth quarter of fiscal 2020 and the balance is scheduled to be delivered next fiscal year.

The backlog for the fourth quarter includes the balance in the amount of $2.3 million from the initial order of the thoracic driver and related accessories to our customer, and while we will endeavor to meet all scheduled deliveries, some of these items may not ship until the first quarter of fiscal 2021.

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.

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Cost of sales:

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Year over Year

Cost of sales for the three months ended December 31, 2019 increased $947,000 or 23% compared to the corresponding period of the prior fiscal year.

The increase in total costs of sales is consistent with the 24% increase in revenue for the same period.

Under-absorption of manufacturing costs decreased by $80,000 for the three months ended December 31, 2019 compared to the corresponding period of the prior fiscal year due primarily to adjustments made to our standard labor and overhead rates at the beginning of fiscal 2020 in anticipation of higher spending in our machine shop and quality departments.

Costs relating to inventory and warranty charges decreased by $12,000 for the second quarter ended December 31, 2019 compared to the second quarter of the prior fiscal year.

Gross profit increased by approximately $615,000, or 27%, for the three months ended December 31, 2019 compared to the corresponding period of the prior fiscal year, primarily as a result of the increase in repair revenue discussed above.

Gross margin as a percentage of sales increased by approximately 1 percentage point compared to the corresponding period of the prior fiscal year due primarily to the increased revenue, which allows us to better absorb our fixed manufacturing costs.

Cost of sales for the six months ended December 31, 2019 increased by $1.2 million, or 15%, compared to the corresponding period of the prior fiscal year, consistent with the increased revenue of 14% for the same period, the reasons for which are discussed above.

Cost of sales for the three months ended March 31, 2020 increased $707,000, or 15%, compared to the corresponding period of the prior fiscal year.

The increase in total costs of sales is caused by the 24% increase in revenue for the same period.

Under-absorption of manufacturing costs increased by $40,000 for the three months ended March 31, 2020 compared to the corresponding period of the prior fiscal year due primarily to adjustments made to our standard labor and overhead rates at the beginning of fiscal 2020 in anticipation of higher spending in our machine shop and quality departments.

Costs relating to inventory and warranty charges remained flat for the third quarter ended March 31, 2020 compared to the third quarter of the prior fiscal year.

Gross profit increased by approximately $947,000, or 42%, for the three months ended March 31, 2020 compared to the corresponding period of the prior fiscal year, primarily due to the thoracic driver product launch, which is a higher margin product due in part to the demand in the marketplace for adaptive torque limiting.

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 the increased revenue, which allows us to better absorb our fixed manufacturing costs.

Cost of sales for the nine months ended March 31, 2020 increased by $1.9 million, or 15%, compared to the corresponding period of the prior fiscal year, consistent with the increased revenue of 18% for the same period, the reasons for which are discussed above.

Additionally, total cost of sales reflects a $133,000 decrease in under-absorbed manufacturing costs.

We adjusted our standard labor and over-head rates at the beginning of fiscal 2020 in anticipation of higher spending in our machine shop and quality departments.

Gross profit increased by $669,000, or 13%, for the six months ended December 31, 2019 compared to the corresponding period of the prior fiscal year, primarily as a result of the increase in repair revenue discussed above.

Gross margin for the six months ended December 31, 2019 remained flat at 37% compared to the corresponding period of the prior fiscal year.

Inventory and warranty charges decreased by approximately $115,000, or 48%, for the nine months ended March 31, 2020, compared to the corresponding period of the prior fiscal year, due to decreased scrap and inventory charges in the amount of $148,000 offset by increased warranty expenses of $33,000.

Gross profit increased by $1.6 million, or 22%, for the nine months ended March 31, 2020 compared to the corresponding period of the prior fiscal year, primarily as a result of the increase in repair revenue discussed above as well as the launch of the thoracic driver in the third quarter of fiscal 2020.

Gross margin for the nine months ended March 31, 2020 increased by 1 percentage point compared to the corresponding period of the prior fiscal year, primarily due to increased revenue, as described above.

Operating Expenses

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% of Net Sales

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Year over Year

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 six months ended December 31, 2019 increased $38,000, or 39%, and $147,000, or 113%, compared to the corresponding periods of fiscal 2019.

Selling expenses for the three and nine months ended March 31, 2020 increased $39,000, or 32%, and $186,000, or 74%, respectively, compared to the corresponding periods of fiscal 2019.

These increases relate primarily to personnel-related expenses as we filled the previously vacant position of Director of Business Development during the first quarter of fiscal 2019.

General and administrative expenses (G&A) consists 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 increased $31,000 and $130,000, respectively, during the three and six months ended December 31, 2019 when compared to the corresponding periods of the prior fiscal year.

The increases relate primarily to increased legal fees related to intellectual property matters, increased personnel-related expenses, a new scholarship program implemented to award college scholarships to children of our employees, as well as higher bad debt expense, and IT related expenses.

G&A increased $84,000 and $214,000, respectively, during the three and nine months ended March 31, 2020 when compared to the corresponding periods of the prior fiscal year.

The increases relate primarily to increased personnel-related expenses, increased equity compensation due to the reallocation of previously forfeited performance awards and increased audit fees.

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 six months ended December 31, 2019 increased $71,000 and $146,000, respectively, compared to the corresponding periods of the prior fiscal year.

These increases are primarily due to increased personnel-related expense and increased spending on internal development projects.

Research and development costs for the three and nine months ended March 31, 2020 increased $17,000 and $164,000, respectively, compared to the corresponding periods of the prior fiscal year.

These increases are primarily due to increased personnel-related expense offset by decreased spending on internal development projects.

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.

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

Three and Six Months ended December 31, 2019

Three and Six Months ended December 31, 2018

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March 31, 2020

Three and Nine Months ended

March 31, 2019

Market Launch

Est Annual Revenue

Total Research & Development costs:

Products in development:

Thoracic Driver

Arthroscopic Shaver (1)

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Costs incurred related to customer contracts are included in costs of sales and deferred costs and are not included in research and development costs.

The completion of our thoracic driver is currently a priority for our engineering team.

The costs in the table above represent our costs related to our Pro-Dex branded driver, which is substantially complete.

As we previously discussed, in early fiscal 2019 we entered a development contract with a current significant customer to private-label this driver for their unique specifications.

We have had technical delays related to performance of this driver with a specific customer attachment.

We currently believe that we will launch this product later this third quarter of this fiscal year and have delayed the anticipated launch of most other products to focus on the completion of this thoracic driver.

As we previously discussed, in early fiscal 2019 we entered a development contract with a current significant customer to private-label our thoracic driver for their unique specifications.

We shipped initial launch quantities of this product during the third quarter ended March 31, 2020.

Interest & Other Income

Interest income for the three and six months ended December 31, 2019 includes interest and dividends from our money market accounts and investment portfolio.

Interest income for the three and nine months ended March 31, 2020 includes interest and dividends from our money market accounts and investment portfolio.

During the three and six months ended December 31, 2019 we also recorded $8,500 and $17,000, respectively, of miscellaneous income related to cash collected related to note receivable extensions granted on a note we previously wrote off.

The fiscal 2019 interest income related primarily to a loan participation note receivable that has since been paid in full, as well as approximately $28,000 and $39,000, respectively, for the three and six months ended December 31, 2018 in interest and dividend income from our money market accounts and investments.

The fiscal 2019 interest income related primarily to a loan participation note receivable that has since been paid in full, as well as approximately $4,000 and $43,000, respectively, for the three and nine months ended March 31, 2019 in interest and dividend income from our money market accounts and investments.

Interest Expense

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Income Tax Expense

The effective tax rate for the three and six months ended December 31, 2019 and 2018 is slightly less than our combined expected federal and applicable state corporate income tax rates due to federal and state research credits and the new foreign-derived intangible income deduction.

The effective tax rate for the three and nine months ended March 31, 2020 and 2019 is slightly less than our combined expected federal and applicable state corporate income tax rates due to federal and state research credits and the new foreign-derived intangible income deduction.

Liquidity and Capital Resources

Cash and cash equivalents at December 31, 2019 decreased $1.6 million to $6.2 million as compared to $7.7 million at June 30, 2019.

Cash and cash equivalents at March 31, 2020 decreased $3.3 million to $4.4 million as compared to $7.7 million at June 30, 2019.

The following table includes a summary of our condensed statements of cash flows contained elsewhere in this report.

As of and For the

Six Months Ended

As of and For the Nine Months Ended March 31,

(in thousands)

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Operating Activities

Net cash provided by operating activities was $2.6 million for the six months ended December 31, 2019 primarily due to net income of $2.4 million and non-cash depreciation and amortization of $282,000.

Although we experienced an influx of cash in the amount of $1.4 million in collections from receivables during the six months ended December 31, 2019, our inventory increased by $1.6 million primarily related to the thoracic driver that we plan to launch later this third quarter of fiscal 2020.

Net cash provided by operating activities was $1.5 million for the six months ended December 31, 2018 primarily due to net income of $2.5 million offset by an increase in accounts receivable of $838,000, reflecting a slower payment trend from our largest customer.

Net cash provided by operating activities was $2.3 million for the nine months ended March 31, 2020 primarily due to net income of $3.6 million and non-cash depreciation and amortization of $426,000.

Our inventory increased by $2.4 million primarily related to the thoracic driver that we began shipping during our third quarter ended March 31, 2020 as well as another customer CMF driver we plan to launch in the fourth quarter of fiscal 2020.

Net cash provided by operating activities was $3.1 million for the nine months ended March 31, 2019 primarily due net income of $3.3 million and non-cash depreciation and amortization totaling $309,000.

Uses of cash arose from an increase in accounts receivable of $773,000 as well as an increase in deferred costs related to the development of a CMF driver for one of our existing customers in the amount of $235,000.

Offsetting these uses of cash was a decrease in deferred taxes in the amount of $1.0 million.

Investing Activities

Net cash used in investing activities for the six months ended December 31, 2019 was $1.6 million and related to an investment in marketable securities of $1.3 million and machinery and equipment of $317,000.

During the six months ended December 31, 2018, we sold one of the stocks in our investment portfolio and received proceeds of $1.9 million, including a gain in the amount of $356,000.

Offsetting this cash inflow, we also invested $1.4 million in marketable equity securities and purchased $540,000 in machinery and equipment.

Net cash used in investing activities for the nine months ended March 31, 2020 was $2.3 million and related to investments in marketable equity securities of publicly traded companies in the amount of $1.8 million and purchases of machinery and equipment in the amount of $422,000.

Net cash used in investing activities for the nine months ended March 31, 2019 was $532,000 and related to investments in marketable equity securities of publicly traded companies in the amount of $2.6 million as well as capital expenditures primarily for manufacturing equipment in the amount of $1.0 million, offset by the sale of one of the securities in our portfolio of common stock of publicly traded companies in the amount of $1.9 million and the collection of $1.2 million from a loan participation note receivable.

Financing Activities

Net cash used in financing activities for the six months ended December 31, 2019 totaled $2.5 million and related primarily to the $2.2 million repurchase of 156,685 shares of our common stock pursuant to our share repurchase program as well as $314,000 of principal payments on our term loan from Minnesota Bank and Trust (MBT) more fully described in Note 9 to the condensed financial statements contained elsewhere in this report.

Net cash provided by financing activities for the six months ended December 31, 2018 included $5.0 million in a term loan from MBT, offset by $2.6 million related to the repurchase of 217,454 shares of our common stock pursuant to our share repurchase program.

Net cash used in financing activities for the nine months ended March 31, 2020 totaled $3.4 million and related primarily to the $3.0 million repurchase of 204,921 shares of our common stock pursuant to our share repurchase program as well as $471,000 of principal payments on our term loan from Minnesota Bank and Trust (MBT) more fully described in Note 9 to the condensed financial statements contained elsewhere in this report.

Net cash provided by financing activities for the nine months ended March 31, 2019 included $5.0 million in a term loan from MBT more fully described in Note 9 to the condensed consolidated financial statements contained elsewhere in this report, offset by $273,000 of principal payments on the MBT term loan and an equipment lease as well as $2.7 million related to the repurchase of 225,368 shares of our common stock pursuant to our share repurchase program.

Financing Facilities & Liquidity Requirements for the next twelve months

As of December 31, 2019, our working capital was $16.9 million.

As of March 31, 2020, our working capital was $16.1 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.

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Investment Strategy

Pro-Dex invests surplus cash from time to time through its Investment Committee which was formed in April 2013.

The committee is comprised of one management director, Mr.

Van Kirk, and two non-management directors, Mr.

Cabillot and Mr.

Pro-Dex invests surplus cash from time to time through its Investment Committee which was formed in April 2013.The committee is comprised of one management director, Richard L.

Van Kirk, our CEO, and two non-management directors, Raymond E.

Cabillot and Nicholas J.

Swenson, who chairs the committee.

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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 $5.2 million of marketable public equity securities held at December 31, 2019.

The Investment Committee approved each of the investments comprising the $4.4 million of marketable public equity securities held at March 31, 2020.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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What changed 10-Q

Item 1. Financial Statements