PRO DEX INC 10-K

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA PRO-DEX, INC. INDEX TO FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm 24 Financial Statements: Balance Sheets, June 30, 2020 and 2019 25 Statements of Operations and Comprehensive Income, Years Ended June 30, 2020 and 2019 26 Statements of Shareholders’ Equity, Years Ended June 30, 2020 and 2019 27 Statements of Cash Flows, Years Ended June 30, 2020 and 2019 28 Notes to Financial Statements 30 23 Report of Independent Registered Public Accounting Firm To the Shareholders and the Board of Directors Pro-Dex, Inc. Opinion on the Financial Statements We have audited the accompanying balance sheets of Pro-Dex, Inc. (the “Company”) as of June 30, 2020 and 2019, the related statements of operations and comprehensive income, shareholders’ equity and cash flows for each of the two years in the period ended June 30, 2020, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2020 and 2019, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Change in Accounting Principle As disclosed in Note 2 to the financial statements, the Company changed its method of accounting for leases for the year ended June 30, 2020, due to the adoption of Accounting Standards Codification Topic No. 842. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Moss Adams LLP Moss Adams LLP Irvine, California September 10, 2020 We have served as the Company’s auditor since 2003. 24 PRO-DEX, INC. BALANCE SHEETS (In thousands, except share data) June 30, 2020 2019 ASSETS Current assets: Cash and cash equivalents $ 6,421 $ 7,742 Investments 2,560 1,711 Accounts receivable, net of allowance for doubtful accounts of $6 and $0 at June 30, 2020 and 2019, respectively 5,155 4,100 Deferred costs 155 430 Inventory 8,238 6,239 Prepaid expenses and other current assets 145 623 Total current assets 22,674 20,845 Plant, equipment and leasehold improvements, net 2,686 2,726 Right of use asset, net 2,943 — Intangibles, net 162 129 Deferred income taxes, net 259 260 Investments 2,360 1,520 Other assets 42 40 Total assets $ 31,126 $ 25,520 LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities: Accounts payable $ 1,965 $ 1,996 Accrued liabilities 2,411 1,437 Deferred revenue 200 215 Note payable and capital lease obligations 651 622 Total current liabilities 5,227 4,270 Non-current liabilities: Deferred rent — 146 Lease liability, net of current portion 2,750 — Income taxes payable 804 162 Notes and capital lease payable, net of current portion 3,283 3,934 Total non-current liabilities 6,837 4,242 Total liabilities 12,064 8,512 Commitments and Contingencies: Shareholders’ equity: Common stock, no par value, 50,000,000 shares authorized; 3,811,137 and 4,039,491 shares issued and outstanding at June 30, 2020 and 2019, respectively 12,752 15,815 Accumulated other comprehensive loss (1,586 ) (549 ) Retained earnings 7,896 1,742 Total shareholders’ equity 19,062 17,008 Total liabilities and shareholders’ equity $ 31,126 $ 25,520 See notes to financial statements . 25 PRO-DEX, INC. STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (In thousands, except per share data) Years Ended June 30, 2020 2019 Net sales $ 34,834 $ 27,172 Cost of sales 21,692 17,392 Gross profit 13,142 9,780 Operating (income) expenses: Selling expenses 577 415 General and administrative expenses 3,189 2,492 Gain on disposal of equipment (5 ) (7 ) Research and development costs 2,315 1,882 Total operating expenses 6,076 4,782 Operating income 7,066 4,998 Other income (expense): Interest and dividend income 95 268 Other income 952 45 Gain on sale of investments 25 356 Interest expense (236 ) (220 ) Total other income 836 449 Income before income taxes 7,902 5,447 Income tax expense 1,790 1,299 Net income 6,112 4,148 Other comprehensive loss, net of tax: Unrealized loss from marketable equity investments, net of income taxes (1,037 ) (396 ) Comprehensive income $ 5,075 $ 3,752 Basic & Diluted income per share: Basic net income per share $ 1.56 $ 0.99 Diluted net income per share $ 1.50 $ 0.97 Weighted-average common shares outstanding: Basic 3,910,940 4,192,365 Diluted 4,078,087 4,298,332 See notes to financial statements . 26 PRO-DEX, INC. STATEMENTS OF SHAREHOLDERS’ EQUITY For The Years Ended June 30, 2020 and 2019 (In thousands, except share data) Common Shares Accumulated Other Retained Earnings/ Number of Comprehensive (Accumulated Shares Amount Income (Loss) Deficit) Total Balance at June 30, 2018 4,331,089 $ 19,835 $ (153 ) $ (2,406 ) $ 17,276 Net income — — — 4,148 4,148 Exercise of stock options 3,000 6 — — 6 Net change in unrealized gain/(loss) from marketable equity investments, net of tax of $0 — — (396 ) — (396 ) ESPP shares issued 2,743 22 — — 22 Shares issued in connection with performance award vesting 40,000 — — — — Shares withheld from common stock issued to pay employee payroll taxes (15,273 ) (101 ) — — (101 ) Share-based compensation — 37 — — 37 Share repurchases (322,068 ) (3,984 ) — — (3,984 ) Balance at June 30, 2019 4,039,491 $ 15,815 $ (549 ) $ 1,742 $ 17,008 Net income — — — 6,112 6,112 Net change in unrealized gain/(loss) from marketable equity investments, net of tax of $(23) — — (1,037 ) — (1,037 ) ESPP shares issued 2,920 39 — — 39 Cumulative effect of change in accounting principle 42 42 Share-based compensation — 286 — — 286 Share repurchases (231,274 ) (3,388 ) — — (3,388 ) Balance at June 30, 2020 3,811,137 $ 12,752 $ (1,586 ) $ 7,896 $ 19,062 See notes to financial statements . 27 PRO-DEX, INC. STATEMENTS OF CASH FLOWS (In thousands) Years Ended June 30, 2020 2019 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 6,112 $ 4,148 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 573 438 Gain on collection of note receivable (952 ) — Gain on sale of investments (25 ) (356 ) Non-cash lease expense 41 — Gain on sale or disposal of equipment (5 ) (7 ) Amortization of loan fees 9 7 Share-based compensation 286 37 Deferred income taxes (22 ) 1,418 Bad debt expense (recovery) 6 (14 ) Changes in operating assets and liabilities: Accounts receivable (1,061 ) (1,131 ) Deferred costs 275 (398 ) Inventory (1,999 ) (1,846 ) Prepaid expenses and other assets 476 (326 ) Accounts payable, accrued expenses and deferred rent 604 1,133 Deferred revenue (15 ) 184 Income taxes payable 642 39 Net cash provided by operating activities 4,945 3,326 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of equipment and leasehold improvements (519 ) (1,387 ) Proceeds from dividend reclassified as return of principal 15 23 Proceeds from sale of equipment 5 7 Proceeds from collection of notes receivable 952 1,219 Proceeds from sale of investments 128 1,905 Increase in intangibles (46 ) (11 ) Purchase of investments (2,822 ) (2,978 ) Net cash used in investing activities (2,287 ) (1,222 ) CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments on capital lease and note payable (630 ) (433 ) Borrowing from Minnesota Bank & Trust, net of loan origination fees — 4,940 Repurchases of common stock (3,388 ) (3,984 ) Payments of employee taxes on net issuance of common stock — (101 ) Proceeds from exercise of stock options and ESPP contributions 39 28 Net cash provided by (used in) financing activities (3,979 ) 450 Net increase (decrease) in cash and cash equivalents (1,321 ) 2,554 Cash and cash equivalents, beginning of year 7,742 5,188 Cash and cash equivalents, end of year $ 6,421 $ 7,742 See notes to financial statements . 28 PRO-DEX, INC. STATEMENTS OF CASH FLOWS - CONTINUED (In thousands) Years Ended June 30, 2020 2019 Supplemental disclosures of cash flow information: Cash paid during the period for: Income taxes, net of refunds $ 683 $ 320 Interest $ 218 $ 199 See notes to financial statements . 29 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS 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 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. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The summary of significant accounting policies presented below is designed to assist the reader in understanding our financial statements. Such financial statements and related notes are the representations of management, who is responsible for their integrity and objectivity. In the opinion of management, these accounting policies conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”) in all material respects, and have been consistently applied in preparing the accompanying financial statements. Revenue Recognition Revenue from product sales is recognized as promulgated by the Financial Accounting Standards Board (“FASB”) in Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers once our contract(s) with a customer and the performance obligations in the contract have been identified, and the transaction price has been allocated to the performance obligations and revenue is recorded when (or as) we satisfy each performance obligation, generally upon shipment. Revenue from services, typically non-recurring engineering services related to the design or customization of a medical device, is typically recognized over-time. Returns of our product for credit are minimal; accordingly, we do not establish a reserve for product returns at the time of sale. Estimated Losses on Product Development Services Cost and revenue estimates related to the product development service portions of development and supply contracts are reviewed and updated quarterly. An expected loss on development service contracts is recognized immediately in cost of sales. Owing to the complexity of many of the contracts we have undertaken, the cost estimation process requires significant judgment. It is based upon the knowledge and experience of our project managers, engineers, and finance professionals. Factors that are considered in estimating the cost of work to be completed and ultimate profitability of the fixed price product development portion of development and supply contracts include the nature and complexity of the work to be performed, availability and productivity of labor, the effect of change orders, the availability of materials, performance of subcontractors, and expected costs for specific regulatory approvals. Warranties Certain of our products are sold with a warranty that provides for repairs or replacement of any defective parts for a period, generally one to two years, after the sale. At the time of the sale, we accrue an estimate of the cost of providing the warranty based on prior experience with such factors as return rates and repair costs, which factors are reviewed quarterly. 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. 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. 30 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS Cash and Cash Equivalents We consider all highly liquid investments with an original maturity of ninety days or less to be cash equivalents. At June 30, 2020 and 2019, cash equivalents consisted of investments in money market funds. Accounts Receivable Trade receivables are stated at their original invoice amounts, less an allowance for doubtful portions of such accounts. Management determines the allowance for doubtful accounts based on facts and circumstances related to specific accounts and the age of accounts. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously reserved are offset against the allowance when received. Deferred Costs Deferred costs reflect costs incurred related to non-recurring engineering services under the terms of the related development and/or supply contracts. These costs get recorded to cost of sales in the period that the revenue is recognized. Inventories Inventories are stated at the lower of cost (first-in, first-out method) or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Reductions to estimated market value are recorded, and charged to cost of sales, when indicated based on a formula that compares on-hand quantities to both historical usage and estimated demand over the ensuing 12 months from the measurement date. On an on-going basis, we evaluate inventory for obsolescence and slow-moving items. This evaluation includes analysis of historical sales and usage, existing demand, as well as specific factors known to management. As of June 30, 2020 and 2019, there was approximately $303,000 and $276,000, respectively, of inventory in-transit. Investments Investments at June 30, 2020 and 2019, 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, net of income taxes, presented as adjustments to accumulated other comprehensive income or loss. Our long-term investments consist of common stocks of public companies that are thinly traded. These investments were subject to an independent valuation as of June 30, 2020. Long-lived Assets We review the recoverability of long-lived assets, consisting of equipment and leasehold improvements, when events or changes in circumstances occur that indicate carrying values may not be recoverable. Equipment and leasehold improvements are recorded at historical cost and depreciation is provided using the straight-line method over the following periods: Equipment Three to ten years Leasehold improvements Shorter of the lease term or the asset’s estimated useful life Intangibles Intangibles consist of legal fees incurred in connection with patent applications. Certain of our patent costs are being amortized over a period of seven years, the estimated life of the product that is currently utilizing the patented technology. The remaining patent costs will be amortized over the estimated life of the product(s) that will be utilizing the technology or expensed immediately in the event the patent office denies the issuance of the patent. The expense associated with the amortization of the patent costs is recognized in research and development costs. 31 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS Income Taxes We recognize deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities along with net operating losses and tax credit carryovers. Deferred tax assets at both June 30, 2020 and 2019, consisted primarily of basis differences related to unrealized gain/loss related to investments, fixed assets, accrued expenses, and inventories. Significant management judgment is required in determining the provision for income taxes and the recoverability of deferred tax assets. Such determination is based on historical taxable income, with consideration given to estimates of future taxable income and the periods over which deferred tax assets will be recoverable. We record a valuation allowance against deferred tax assets to reduce the net carrying value to an amount that we believe is more likely than not to be realized. When we establish or reduce the valuation allowance against deferred tax assets, the provision for income taxes will increase or decrease, respectively, in the period such determination is made. Uncertain Tax Positions We record uncertain tax positions in accordance with Accounting Standards Codification (“ASC”) 740 on the basis of a two-step process whereby (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position, and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. Shipping and Handling Payments from customers for shipping and handling are included in net sales . Shipping expenses, consisting primarily of payments made to freight companies, are included in cost of sales. Concentration of Credit Risk Financial instruments that potentially subject us to credit risk consist principally of cash, cash equivalents, and trade receivables. We place our cash and cash equivalents with major financial institutions. At June 30, 2020 and 2019, and throughout the fiscal years then ended, we had deposits in excess of federally insured limits. Credit sales are made to original equipment manufacturers and resellers throughout the world, and sales to such customers account for a substantial portion of our trade receivables. While such receivables are not collateralized, we evaluate their collectability based on several factors including customers’ payment histories. Compensation Plans We recognize compensation expense for the share-based awards that vest subject to market conditions under ASC 718, Compensation-Stock Compensation by estimating their fair value using a Monte Carlo simulation. The fair value using a Monte Carlo simulation model is affected by assumptions regarding a number of complex judgments including expected stock price volatility, risk free interest rates, and the forecasted future value and trading volume of our stock. The awards are considered granted for accounting purposes on the date the awards were approved by the Compensation Committee and we recognize compensation expense, based on the estimated fair value of the award, on a straight-line basis over the requisite service period. Use of Estimates The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 32 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS Our operations are affected by numerous factors including market acceptance of our products, changes in technologies, and new laws, government regulations, and policies. We cannot predict what impact, if any, the occurrence of these or other events might have on our operations. Significant estimates and assumptions made by management include, but are not limited to, revenue recognition, share-based compensation, the allowance for doubtful accounts, accrued warranty expense, inventory valuation, the carrying value of long-lived assets, the recoverability of notes receivable, and the recovery of deferred income tax assets. Basic and Diluted Per Share Information Basic per share amounts are computed on the basis of the weighted-average number of common shares outstanding during each period presented. Diluted per share amounts assume the issuance of all potential common stock equivalents, consisting of outstanding stock options and performance awards as discussed in Note 9, unless the effect of such exercise is to increase income, or decrease loss, per common share. Fair Value Measurements Fair value is measured based on the prices that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions. Cash and cash equivalents: The carrying value of cash and cash equivalents is considered to be representative of their fair values based on the short-term nature of these instruments. As such, cash and cash equivalents are classified within Level 1 of the valuation hierarchy. Investments: Investments consist of marketable equity securities of publicly held companies. As such, most of our investments are classified within Level 1 of the valuation hierarchy. Our long-term marketable securities consist of investments of common stock of publicly traded companies that are thinly traded. Due to the thinly traded nature of these stocks they are classified within Level 2 of the valuation hierarchy. The fair value of these investments was based upon an independent valuation. Although the methods above may produce a fair value calculation that may not be indicative of the net realizable value or reflective of future fair values, we believe our valuation methods are appropriate. Advertising Advertising costs are charged to selling or general and administrative expense as incurred and amounted to $1,000 and $2,000 for the fiscal years ended June 30, 2020 and 2019, respectively. Recently Adopted Accounting Standards On July 1, 2019, we adopted ASU 2016-02, (Topic 842) “ Leases ,” using a modified retrospective approach through a cumulative effect adjustment to retained earnings in the amount of $42,000 as of the beginning of fiscal 2020. 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. 33 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS Effective July 1, 2018, we adopted new revenue recognition guidance issued by the FASB related to contracts with customers. Under ASU 2014-09, (Topic 606) “ Revenue From Contracts with Customers ,” we recognize revenue from the sales of products and services by applying the following steps: (1) identify the contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to each performance obligation in the contract; and (5) recognize revenue when each performance obligation is satisfied. We utilized the modified retrospective method of adoption and there was no impact on our financial statements as a result of adopting Topic 606 for the year ended June 30, 2019. We primarily sell finished products and recognize revenue at point of sale or delivery and the timing of revenue recognition has not changed with the adoption of the new guidance. However, we also perform services when we are engaged to design a product for a customer and there is more judgment involved in determining the amount and timing of revenue recognition under those types of contracts. In order to disclose the amount of revenue related to these services, where more judgment is required, we have added “NRE & Prototypes” to our net sales table included under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report, which in our prior reports had been reflected in “Medical device and services”. Reclassifications We have reclassified certain of our marketable equity securities from current to long-term, to conform to the current year presentation, as we have concluded that these marketable securities are thinly traded. This balance sheet reclassification had no impact on our net income. 3. COMPOSITION OF CERTAIN FINANCIAL STATEMENT ITEMS Investments Investments are stated at market value and consist of the following (in thousands): June 30, 2020 June 30, 2019 Marketable equity securities – short-term $ 2,560 $ 1,711 Marketable equity securities – long-term 2,360 1,520 Total Marketable equity securities $ 4,920 $ 3,231 Investments at June 30, 2020 and 2019, had an aggregate cost basis of $6,483,000 and $3,780,000, respectively. The long-term investments include equity securities of public companies that are thinly traded and therefore we classified the assets as long term in nature because even if we decide to sell the stocks we may not be able to sell our position within one year. At June 30, 2020, the investments included net unrealized losses of $1,563,000 (gross unrealized losses of $1,703,000 offset by gross unrealized gains of 140,000). At June 30, 2019, the investments included gross unrealized losses of $549,000 and no unrealized gains. Of the total long-term marketable equity securities at June 30, 2020 and 2019, $847,000 and $938,000, respectively, represent an investment in the common and preferred stock of Air T, Inc. Two of our Board members Messrs. Swenson and Cabillot, are also Board members of Air T, Inc. and both either individually or through affiliates own an equity interest in Air T, Inc. Mr. Swenson, our Chairman, also serves as the chief executive officer and chairman of Air T, Inc. The shares have been purchased through 10b5-1 Plans, which in accordance with our internal policies regarding the approval of related-party transactions, was approved by our three Board members that are not affiliated with Air T, Inc. We invest surplus cash from time to time through our Investment Committee, which is comprised of one management director, Mr. Van Kirk, and two non-management directors, Mr. Cabillot and Mr. Swenson, who chairs the committee. Both Mr. Cabillot and Mr. Swenson are active investors with extensive portfolio management expertise. We leverage the experience of these committee members to make investment decisions for the investment of our surplus operating capital or borrowed funds. Additionally, many of our securities holdings include stocks of public companies that either Messrs. Swenson or Cabillot or both may own from time to time either individually or through the investment funds that they manage, or other companies whose boards they sit on, such as Air T, Inc. 34 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS Inventory Inventory is stated at the lower of cost (first-in, first-out) or net realizable value and consists of the following (in thousands): June 30, 2020 2019 Raw materials /purchased components $ 4,241 $ 3,132 Work in process 2,339 1,511 Sub-assemblies /finished components 1,438 1,524 Finished goods 220 72 Total inventory $ 8,238 $ 6,239 Equipment and Leasehold Improvements Equipment and leasehold improvements consist of the following (in thousands): June 30, 2020 2019 Office furnishings and fixtures $ 2,143 $ 2,067 Machinery and equipment 5,382 5,119 Automobiles 21 21 Leasehold improvements 2,359 2,276 Total 9,905 9,483 Less: accumulated depreciation and amortization (7,219 ) (6,757 ) $ 2,686 $ 2,726 Depreciation expense for the years ended June 30, 2020 and 2019, amounted to $559,000 and $416,000, respectively. During fiscal 2020, fully depreciated assets in the amount of $58,000 were retired and an additional $39,000 of fully depreciated assets were sold. During fiscal 2019, fully depreciated assets in the amount of $103,000 were retired and an additional $280,000 of fully depreciated assets were sold. Intangibles Intangibles consist of the following (in thousands): June 30, 2020 June 30, 2019 Patent-related costs $ 222 $ 175 Less accumulated amortization (60 ) (46 ) $ 162 $ 129 Amortization expense for the years ended June 30, 2020 and 2019, amounted to $14,000 and $22,000, respectively. Patent-related costs consist of legal fees incurred in connection with both patent applications and a patent issuance, and will be amortized over the estimated life of the product(s) that is or will be utilizing the technology, or expensed immediately in the event the patent office denies the issuance of the patent. Since we do not know when, or if, our patent applications will be issued, the future amortization expense is not predictable. 35 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS Accrued Liabilities Accrued liabilities consist of the following (in thousands): June 30, 2020 2019 Payroll and related items $ 689 $ 480 Accrued inventory in transit 303 276 Accrued legal and professional fees 141 130 Accrued bonuses 570 221 Current portion of lease liability 339 — Warranty 213 136 Accrued losses on development contracts — 83 Accrued sales, use and excise taxes 7 2 Other 149 109 $ 2,411 $ 1,437 4. WARRANTY ACCRUAL Information relating to the accrual for warranty costs for the years ended June 30, 2020 and 2019, is as follows (in thousands): June 30, 2020 2019 Balance at beginning of year $ 136 $ 107 Accruals during the year 204 119 Change in estimates of prior period accruals (27 ) (18 ) Warranty amortization (100 ) (72 ) Balance at end of year $ 213 $ 136 Warranty expense relating to new product sales and changes to estimates was $177,000 and $101,000, respectively, for the fiscal years ended June 30, 2020 and 2019. 5. INCOME TAXES 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. As of June 30, 2020, we have, as a result of the technical amendments made by the CARES Act to QIP, accelerated tax depreciation expenses of approximately $94,000, 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 balance sheets. We do not expect the other provisions of the CARES Act to materially impact our business or our tax provision. The provision for income taxes consists of the following amounts (in thousands): Years Ended June 30, 2020 2019 Current: Federal $ 1,542 $ (140 ) State 270 21 Deferred: Federal (243 ) 1,079 State 221 339 Income tax expense $ 1,790 $ 1,299 36 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS The effective income tax rate from income (loss) from continuing operations differs from the United States statutory income tax rates for the reasons set forth in the table below (in thousands, except percentages). Years Ended June 30, 2020 2019 Amount Percent Pretax Income Amount Percent Pretax Income Income before income taxes $ 7,902 100 % $ 5,447 100 % Computed “expected” income tax expense on income before income taxes $ 1,659 21 % $ 1,135 21 % State tax, net of federal benefit 440 6 % 281 5 % Tax incentives (85 ) (1 %) (85 ) (1 %) Change in valuation allowance (227 ) (3 %) 11 — Tax law changes — — (8 ) — Domestic production deduction — — 8 — Other 3 — (43 ) (1 %) Income tax expense $ 1,790 23 % $ 1,299 24 % Deferred income taxes reflect the net effects of loss and credit carryforwards and temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities for federal and state income taxes are as follows (in thousands): June 30, 2020 2019 Deferred tax assets: Federal & state NOL carryforward $ 21 $ 23 Research & other credits 65 347 Reserves and accruals 438 431 Stock based compensation 110 9 Unrealized losses 455 — Inventory 334 357 Other intangibles — 37 Other — 147 Total gross deferred tax assets $ 1,423 $ 1,351 Less: valuation allowance (543 ) (477 ) Total deferred tax assets 880 874 June 30, 2020 2019 Deferred tax liabilities: Property and equipment, principally due to differing depreciation methods $ (577 ) $ (527 ) Deferred state tax (33 ) (81 ) Other (11 ) (6 ) Total gross deferred tax liabilities (621 ) (614 ) Net deferred tax assets $ 259 $ 260 Realization of our deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. As of June 30, 2020, our deferred tax asset valuation allowance primarily consists of unrealized capital loss for investments held and the state net operating loss carryforwards for states in which we have filed a final return. For the year ended June 30, 2020, we recorded a net increase to our valuation allowance of $66,000, on the basis of management’s reassessment of the amount of our deferred tax assets that are more likely than not to be realized. 37 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS As of June 30, 2020, we did not have any net operating losses for federal and state income tax purposes for state jurisdictions in which we currently operate. We have no federal research and development and alternative minimum tax credit carry forwards at June 30, 2020. State tax research credit carry forwards at June 30, 2020, amount to $65,000, the majority of which do not expire. As of June 30, 2020, we have accrued $524,000 of unrecognized tax benefits related to federal and state income tax matters that would reduce our income tax expense if recognized. If we are eventually able to recognize our uncertain tax positions, our effective tax rate would be reduced. Any adjustment to our uncertain tax positions would result in an adjustment of our tax credit carryforwards rather than resulting in a cash outlay. Information with respect to our accrual for unrecognized tax benefits is as follows (in thousands): June 30, 2020 2019 Unrecognized tax benefits: Beginning balance $ 490 $ 462 Additions based on federal tax positions related to the current year 15 11 Additions based on state tax positions related to the current year 13 11 Additions for tax positions of prior years 55 6 Reductions due to lapses in statutes of limitation (49 ) — Ending balance $ 524 $ 490 Although it is reasonably possible that certain unrecognized tax benefits may increase or decrease within the next twelve months due to tax examinations, settlement activities, expirations of statute of limitations, or the impact on recognition and measurement considerations related to the results of published tax cases or other similar activities, we do not anticipate any significant changes to unrecognized tax benefits over the next twelve months. We recognize accrued interest and penalties related to unrecognized tax benefits in income tax expense when applicable. As of June 30, 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. federal income tax, as well as income tax of California, Maryland, Massachusetts, and Colorado. We are currently open to audit under the statute of limitations by the Internal Revenue Service for the years ended June 30, 2017, and later. However, because of our prior net operating losses and research credit carryovers, substantially all of our tax years are open to audit. 6. NOTES PAYABLE AND FINANCING TRANSACTIONS Minnesota Bank & Trust On September 6, 2018, we entered into a Credit Agreement with Minnesota Bank & Trust, a Minnesota state banking corporation (“MBT”), providing for a $5,000,000 term loan (the “Term Loan”) as well as a $2,000,000 revolving loan (the “Revolving Loan” and together with the Term Loan, collectively the “Loans”), evidenced by a Term Note A and a Revolving Credit Note made by us in favor of MBT. The Loans are secured by substantially all of our assets pursuant to a Security Agreement entered into on September 6, 2018, between us and MBT. We paid loan origination fees to MBT in the amount of $60,000, which is being amortized to loan fees over the term of the underlying debt. 38 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS The Term Loan matures on October 1, 2025, and bears interest at a fixed rate of 5.53% per annum. An initial payment of interest only in the amount of $18,433 was paid on October 1, 2018. 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 June 30, 2020, is $3.9 million, net of unamortized loan fees. The Revolving Loan matures on November 6, 2020, unless earlier terminated pursuant to its terms 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). 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. Upon the occurrence and during the continuance of an event of default, the interest rate of both Loans will be increased by 3% and MBT may, at its option, declare the Loans immediately due and payable in full. The Credit Agreement and Security Agreement contain representations and warranties, affirmative, negative and financial covenants, and events of default that are customary for loans of this type. Scheduled maturities of our Term Loan, exclusive of unamortized loan origination fees, for future fiscal years ending June 30 are as follows (in thousands): Term Loan Payments Fiscal Year: 2021 $ 660 2022 697 2023 737 2024 778 2025 822 Thereafter 284 Total principal payments $ 3,978 Jules & Associates/Hitachi Capital America Corporation On July 21, 2016, we entered a master equipment lease agreement with Jules and Associates, Inc. to lease a specific machine used in our inspection process. The cost of the equipment was approximately $106,000 and the lease provided for 36 monthly payments in the amount of $3,121, as well as interim rent in the amount of $7,388. The lease was subsequently assigned to Hitachi Capital America Corporation. The lease was paid off in full during the first quarter of fiscal 2020. 7. LEASES 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 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. 39 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS Our operating lease ROU asset and long-term liability are presented separately on our balance sheet. The current portion of our operating lease liability, exclusive of imputed interest, as of June 30, 2020, in the amount of $339,000, is presented within accrued expenses on the balance sheet. As of June 30, 2020, the maturity of our lease liability is as follows: Operating Lease Fiscal Year: 2021 $ 475 2022 489 2023 504 2024 519 2025 535 Thereafter 1,261 Total lease payments 3,783 Less imputed interest: (694 ) Total $ 3,089 As of June 30, 2020, our operating lease has a remaining lease term of seven years and three months and an imputed interest rate of 5.3%. Cash paid for amounts included in the lease liability for the year ended June 30, 2020, was $461,000. 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, 2020 Fiscal Year: 2021 $ 475 2022 489 2023 504 2024 519 2025 535 Thereafter 1,261 Total minimum lease payments $ 3,783 8. COMMITMENTS AND CONTINGENCIES Leases We lease our office, production and warehouse facility in Irvine, California, (our “corporate office”) under an agreement that expires in September 2027. Our corporate office lease requires us to pay insurance, taxes, and other expenses related to the leased space. Rent expense in fiscal 2020 and 2019 was $561,000 and $548,000, respectively. Compensation Arrangements Retirement Savings 401(k) Plan The Pro-Dex, Inc. Retirement Savings 401(k) Plan (the “401(k) Plan”) is a defined contribution plan we administer that covers substantially all our employees and is subject to the provisions of the Employee Retirement Income Security Act of 1974, as amended. Employees are eligible to participate in the 401(k) Plan when they have attained 19 years of age and then can enter into the 401(k) Plan on the first day of each calendar quarter. Participants are eligible to receive non-discretionary matching contributions by the Company equal to 25% of their contributions up to 5% of eligible compensation. For the fiscal years ended June 30, 2020 and 2019, we recognized compensation expense amounting to $67,000 and $42,000, respectively, in connection with the 401(k) Plan. During our fiscal year ended June 30, 2020 and 2019, we used approximately $7,000 and $16,000, respectively, of forfeited match contributions to reduce our match expense. 40 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS Legal Matters We are from time to time a party to various legal proceedings incidental to our business. There can be no certainty, however, that we may not ultimately incur liability or that such liability will not be material and adverse. 9. SHARE-BASED COMPENSATION Stock Option Plans Through 2014, we had two equity compensation plans, the Second Amended and Restated 2004 Stock Option Plan (the “Employee Stock Option Plan”) and the Amended and Restated 2004 Directors’ Stock Option Plan (the “Directors’ Stock Option Plan”) (collectively, the “Former Stock Option Plans”). The Employee Stock Option Plan and Director’s Stock Option Plan were terminated in June 2014 and December 2014, respectively. In September 2016, our Board approved the establishment of the 2016 Equity Incentive Plan, which was approved by our shareholders at our, 2016 Annual Meeting. 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. Stock Options There were no stock options granted during the fiscal years ended June 30, 2020 and 2019. As of June 30, 2020, there was no unrecognized compensation cost under the Former Stock Option Plans as all outstanding stock options are fully vested. The intrinsic value of stock options outstanding and exercisable at June 30, 2020, was approximately $862,000 with a weighted-average remaining contractual term of 1.03 years at June 30, 2020. The following is a summary of stock option activity under the stock option plans for the fiscal years ended June 30, 2020 and 2019: 2020 2019 Number of Shares Weighted-Average Exercise Price Number of Shares Weighted-Average Exercise Price Outstanding at July 1, 54,000 $ 1.86 57,000 $ 1.88 Options granted — — — — Options exercised — — (3,000 ) 2.14 Options forfeited — — — — Outstanding at end of period 54,000 $ 1.86 54,000 $ 1.86 Stock Options Exercisable at June 30, 54,000 $ 1.86 54,000 $ 1.86 Performance Awards In December 2017, the Compensation Committee of our Board of Directors granted 200,000 performance awards to our employees, which upon vesting, will generally be paid in 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 at inception 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. In February 2020, the Compensation Committee 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 $279,000 and $33,000 for the fiscal years ended June 30, 2020 and 2019, respectively, related to these performance awards. On June 30, 2020, there was approximately $244,000 of unrecognized compensation cost related to these non-vested performance awards expected to be expensed over the weighted-average period of 2.86 years. 41 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS On July 1, 2018, it was determined by the Compensation Committee that the first of five tranches of the performance awards had been achieved and participants were awarded 40,000 shares of common stock. Each participant elected a net issuance to cover their individual withholding taxes and therefore we issued 24,727 shares. On July 1, 2020, it was determined by the Compensation Committee that the second of five tranches of the performance awards had been achieved and participants were awarded 40,000 shares of common stock. Each participant elected a net issuance to cover their individual withholding taxes and therefore we issued 25,629 shares with an effective date of July 16, 2020, coinciding with the pay date that included July 1, 2020. Employee Stock Purchase Plan In September 2014, our Board approved the establishment of an Employee Stock Purchase Plan (the “ESPP”). 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. 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, aggregating 704,715 shares, be reserved for issuance pursuant to the ESPP. The ESPP was approved by our shareholders at our 2014 Annual Meeting. On February 2, 2015, the Company filed a Registration Statement on Form S-8 registering the 704,715 shares issuable under the ESPP under the Securities Act of 1933. During the fiscal years ended June 30, 2020 and 2019, shares totaling 2,920 and 2,743, respectively, were purchased pursuant to the ESPP and allocated to participating employees based upon their contributions at weighted- average prices of $13.25 and $8.02, respectively. On a cumulative basis, since the inception of the ESPP, employees have purchased a total of 21,786 shares. During the fiscal years ended June 30, 2020 and 2019, we recorded stock compensation expense in the amount of $7,000 and $4,000, respectively, relating to the ESPP. 10. MAJOR CUSTOMERS & SUPPLIERS Customers that accounted for sales in excess of 10% of our total sales in either of fiscal year 2020 or 2019, is as follows (in thousands, except percentages): Years Ended June 30, 2020 2019 Amount Amount Total revenue $ 34,834 100 % $ 27,172 100 % Customer concentration: Customer 1 $ 22,675 65 % $ 17,091 63 % Customer 2 5,869 17 % 3,489 13 % Customer 3 3,499 10 % 2,352 8 % Total $ 32,043 92 % $ 22,932 84 % Information with respect to accounts receivable from those customers who comprised more than 10% of our gross accounts receivable at either June 30, 2020 or June 30, 2019, is as follows (in thousands, except percentages): June 30, 2020 June 30, 2019 Total gross accounts receivable $ 5,161 100 % $ 4,100 100 % Customer concentration: Customer 1 $ 2,205 42 % $ 2,587 63 % Customer 2 1,593 31 % 780 19 % Customer 3 972 19 % 231 6 % Total $ 4,770 92 % $ 3,598 88 % 42 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS During fiscal 2020 and 2019, we had two suppliers that accounted for more than 10% of total inventory purchases, as follows (in thousands, except percentages): June 30, 2020 June 30, 2019 Total inventory purchases $ 12,829 100 % $ 12,234 100 % Supplier concentration: Portescap $ 2,444 19 % $ 2,184 18 % Fischer Connectors Inc. 1,971 15 % 1,800 15 % Total $ 4,415 34 % $ 3,984 33 % Information with respect to accounts payable due to the suppliers who comprised more than 10% of our accounts payable at either June 30, 2020 or June 30, 2019, is as follows (in thousands, except percentages): June 30, 2020 June 30, 2019 Total accounts payable $ 1,965 100 % $ 1,996 100 % Supplier concentration: Portescap $ 245 13 % $ 373 19 % Fischer Connectors Inc. 161 8 % 304 15 % Total $ 406 21 % $ 677 34 % 11. NET INCOME PER SHARE We calculate basic earnings per share by dividing net income by the weighted-average number of common shares outstanding during the reporting period. Diluted earnings per share reflects the effects of potentially dilutive securities. The summary of the basic and diluted earnings per share calculations for the years ended June 30, 2020 and 2019, is as follows (in thousands, except per share data): Years Ended June 30, 2020 2019 Basic: Net income $ 6,112 $ 4,148 Weighted-average shares outstanding 3,911 4,192 Basic earnings per share $ 1.56 $ 0.99 Diluted: Net income $ 6,112 $ 4,148 Weighted-average shares outstanding 3,911 4,192 Effect of dilutive securities – stock options & performance awards 167 106 Weighted-average shares used in calculation of diluted earnings per share 4,078 4,298 Diluted earnings per share $ 1.50 $ 0.97 12. COMMON STOCK – 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 our 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 fiscal year ended June 30, 2020, we repurchased 231,274 shares at an aggregate cost, inclusive of fees under the Plan, of $3.4 million. During the fiscal year ended June 30, 2019, we repurchased 322,068 shares at an aggregate cost, inclusive of fees under the Plan, of $4.0 million. On a cumulative basis, we have repurchased a total of 819,325 shares under the share repurchase programs at an aggregate cost, inclusive of fess under the Plan, of $8.5 million. All repurchases under the 10b5-1 Plans were administered through an independent broker. 43 PRO-DEX, INC. NOTES TO FINANCIAL STATEMENTS 13. SUBSEQUENT EVENT As reported in our Current Report filed with the SEC on September 8, 2020, we executed a Standard Offer, Agreement and Escrow Instructions For Purchase of Real Estate (the “Purchase Agreement”) for the purchase of an approximate 25,230 square foot industrial building located at 14401 Franklin Avenue, Tustin CA 92780 on September 2, 2020. The aggregate purchase price is $6,509,340. The initial deposit in the amount of $75,000 was made on September 3, 2020. Pursuant to the terms of the Purchase Agreement, we have 30 days to obtain financing of up to 90% of the purchase price. The deposit is refundable to us during the up to 30-day due diligence period. We plan to use this facility to expand our operations to satisfy requirements of our expected future growth. 44 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.