What changed in this filing

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Item 1. Financial Statements

2020-11-05 compared with 2020-05-07 · 253 added, 308 removed, 284 unchanged (66% of the section changed)

3 unchanged sentences

(In thousands, except share amounts)

September 30,

Current Assets:

Cash and cash equivalents

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

Accounts receivable, net of allowance for doubtful accounts of $9 and $6 at September 30, 2020 and at June 30, 2020, respectively

Deferred costs

12 unchanged sentences

Total current liabilities

Deferred rent

Lease liability, net of current portion

7 unchanged sentences

50,000,000 shares authorized;

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

3,858,251 and 3,811,137 shares issued and outstanding at September 30, 2020 and June 30, 2020, respectively

Accumulated other comprehensive loss

5 unchanged sentences

CONDENSED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

AND COMPREHENSIVE INCOME

(In thousands, except per share amounts)

Three Months Ended

Nine Months Ended

September 30,

Cost of sales

Operating (income) expenses:

Operating expenses:

Selling expenses

General and administrative expenses

Gain from disposal of equipment

Research and development costs

1 unchanged sentence

Operating income

Other income (expense):

Interest and miscellaneous income

Interest expense

Interest and other income

Gain on sale of investments

Income from operations before income taxes

Income tax expense

Total other income (expense)

Income before income taxes

Provision for income taxes

Other comprehensive income (loss), net of tax:

Unrealized income (loss) from marketable equity investments

Comprehensive income (loss)

Unrealized loss from marketable equity investments, net of taxes

Comprehensive income

Basic and diluted income per share:

Basic net income per share

5 unchanged sentences

CONDENSED STATEMENTS OF SHAREHOLDERS EQUITY

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

For the Three Months Ended September 30, 2020 and 2019

(In thousands)

Three Months Ended

Nine Months Ended

September 30,

COMMON SHARES:

1 unchanged sentence

Share-based compensation expense

Stock option exercise

Share repurchases

Shares withheld from common stock issued to pay employee payroll taxes

Exercise of stock options

Shares withheld from common stock issued to employees to pay employee payroll taxes

ESPP shares issued

Balance, at end of period

Balance, end of period

ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):

Balance, beginning of period

Net change in unrealized gain (loss) from marketable securities, net of taxes

Balance, at end of period

Retained earnings/(accumulated deficit):

Net change in unrealized loss from marketable securities, net of taxes

Balance, end of period

RETAINED EARNINGS:

Balance, beginning of period

6 unchanged sentences

(In thousands)

Nine Months Ended

Three Months Ended

September 30,

CASH FLOWS FROM OPERATING ACTIVITIES:

Adjustments to reconcile net income to net cash provided by operating activities:

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

Depreciation and amortization

Amortization of loan fees

Gain from disposal of equipment

Share-based compensation

Non-cash lease expense

Amortization of loan fees

Gain on sale of investments

Deferred income taxes

Bad debt expense (recovery)

Deferred income tax

Bad debt expense

Changes in operating assets and liabilities:

Accounts receivable and other current receivables

Accounts receivable and other receivables

Deferred costs

3 unchanged sentences

Income taxes payable

Net cash provided by operating activities

Net cash provided by (used in) operating activities

CASH FLOWS FROM INVESTING ACTIVITIES:

Purchases of equipment

Purchases of investments

Purchases of equipment and leasehold improvements

Proceeds from sale of investments

Proceeds from dividend reclassification as return of principal

Proceeds from collection of notes receivable

Proceeds from sale of equipment

Increase in intangibles

Net cash used in investing activities

Proceeds from sale of investments

Net cash provided by (used in) investing activities

CASH FLOWS FROM FINANCING ACTIVITIES:

Repurchases of common stock

Proceeds from exercise of options and ESPP contributions

Principal payments on capital lease and notes payable

Payment of employee payroll taxes on net issuance of common stock

Proceeds from Minnesota Bank & Trust long-term debt, net of fees

Principal payments on notes payable and capital lease

Net cash provided by (used in) financing activities

Net increase (decrease) in cash and cash equivalents

Proceeds from stock option exercises and ESPP contributions

Repurchases of common stock

Net cash used in financing activities

Net decrease in cash and cash equivalents

Cash and cash equivalents, beginning of period

4 unchanged sentences

(In thousands)

Nine Months Ended

Three Months Ended

September 30,

Supplemental disclosures of cash flow information:

Cash paid during the period for:

Income taxes, net of refunds

The accompanying notes are an integral part of these condensed financial statements.

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(we, us, our, Pro-Dex, or the Company) have been prepared in accordance with accounting principles generally accepted in the United States (U.S.

GAAP) for interim financial information and with applicable rules of the Securities and Exchange Commission.

GAAP) for interim financial information and with the instructions to Form 10-Q and Regulation S-K.

Accordingly, they do not include all of the information and footnotes required by U.S.

5 unchanged sentences

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 as of the beginning of fiscal 2020.

On July 1, 2019, we adopted Accounting Standards Update 2016-02, (Topic 842) Leases, using a modified retrospective approach through a cumulative effect adjustment to retained earnings 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 each in the amount of approximately $3.3 million as of July 1, 2019.

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

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 and maxocranial facial markets.

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

1 unchanged sentence

COMPOSITION OF CERTAIN FINANCIAL STATEMENT ITEMS

Inventory is stated at the lower of cost (first-in, first-out) or net realizable value and consists of the following (in thousands):

Raw materials /purchased components

Work in process

Sub-assemblies/finished components

Finished goods

Total inventory

Investments are stated at market value and consist of the following (in thousands):

Investments are stated at fair market value and consist of the following (in thousands):

September 30,

Marketable equity securities- short-term

1 unchanged sentence

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

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.

Investments at September 30, 2020 and June 30, 2020, had an aggregate cost basis of $6,380,000 and $6,483,000, respectively.

The long-term investments include equity investments of thinly traded securities that we classified as long term in nature because if we decide to sell these securities we may not be able to sell our position within one year.

At September 30, 2020, the investments included unrealized losses of $1,671,000 (gross unrealized losses of $1,903,000 offset by gross unrealized gains of $233,000).

At June 30, 2020, the investments included net unrealized losses of $1,563,000 (gross unrealized losses of $1,703,000 offset by gross and unrealized gains of $140,000).

Of the total long-term marketable equity securities at September 30, 2020 and June 30, 2020, $759,000 and $847,000, 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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Our Chairman, one of the two Board members aforementioned, also serves as the Chief Executive Officer and Chairman of Air T, Inc.

The common stock was purchased through 10b5-1 Plans, and the purchased preferred stock was purchased through the exercise of issued warrants and in both cases, in accordance with our internal policies regarding the approval of related party transactions, purchases were approved by our three Board members that are not affiliated with Air T, Inc.

The common stock was purchased through 10b5-1 Plans, and the preferred stock was purchased through the exercise of issued warrants and, in both cases, in accordance with our internal policies regarding the approval of related-party transactions, the purchases were approved by our three Board members that are not affiliated with Air T, Inc.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

We invest surplus cash from time to time through our Investment Committee, which is comprised of one management director, Mr.

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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, such as Air T, Inc.

Inventory is stated at the lower of cost (first-in, first-out) or net realizable value and consists of the following (in thousands):

September 30,

Raw materials/purchased components

Work in process

Sub-assemblies/finished components

Finished goods

Total inventory

Intangibles consist of the following (in thousands):

September 30,

Patent-related costs

3 unchanged sentences

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

As of September 30, 2020 and June 30, 2020, the warranty reserve amounted to $190,000 and $213,000, 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 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

Three Months Ended

Beginning balance

Accruals during the period

Changes in estimates of prior period warranty accruals

Warranty amortization

Ending balance

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Information regarding the accrual for warranty costs for the three months ended September 30, 2020 and 2019, are as follows (in thousands):

As of and for the

Nine Months Ended

Three Months Ended

September 30,

Beginning balance

1 unchanged sentence

Changes in estimates of prior period warranty accruals

Warranty amortization

Warranty amortization/utilization

Ending balance

1 unchanged sentence

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 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.

Diluted income per share reflects the effects of potentially dilutive securities, 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 income per share computations.

In the tables below, income amounts represent the numerator, and share amounts represent the denominator (in thousands, except per share amounts):

Three Months Ended

Nine Months Ended

September 30,

Weighted average shares outstanding

Basic income per share

Basic earnings per share

Weighted average shares outstanding

1 unchanged sentence

Weighted average shares used in calculation of diluted earnings per share

Diluted income per share

Diluted earnings per share

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

Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis.

Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases.

Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

1 unchanged sentence

Significant management judgment is required in determining our provision for income taxes and the recoverability of our deferred tax assets.

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 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.

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

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

Nine Months Ended

Beginning balance

Additions based on tax positions related to the current year

Reductions based on tax positions related to prior years

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 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.

As of September 30, 2020 and 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.

Our effective tax rate for the three months ended September 30, 2020 and 2019, is 18% and 25%, respectively.

The current year effective tax rate is less than the statutory rate due primarily to a tax benefit recognized as a result of the common stock awarded to our employees (See Note 7).

We are subject to U.S.

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Our state income tax returns are open to audit under the statute of limitations for the years ended June 30, 2016 and later.

However, because of research credit carryovers, substantially all of our tax years are subject to audit.

We do not anticipate a significant change to the total amount of unrecognized tax benefits within the next 12 months.

SHARE-BASED COMPENSATION

Through June 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).

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 Directors 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 the November 29, 2016 Annual Meeting.

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.

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 September 30, 2020, 200,000 performance awards have been granted under the 2016 Equity Incentive Plan.

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

Weighted-Average

Exercise Price

Number of Shares

Weighted-Average

Exercise Price

Outstanding at July 1,

Options granted

Options exercised

Options forfeited

Outstanding at end of period

Stock Options Exercisable at March 31,

There were no stock options granted during the three months ended September 30, 2020 and 2019.

As of September 30, 2020, there was no unrecognized compensation cost under our stock option plans as all outstanding stock options are fully vested.

As of September 30, 2020, there were 34,000 options outstanding at weighted-average exercise prices of $1.80 per share.

These outstanding options had a weighted average remaining contractual life of 1.2 years and an intrinsic value of $911,000.

During the first quarter ended September 30, 2020, 20,000 options were exercised at an exercise price of $1.97 per share.

Performance Awards

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 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.

In December 2017, the Compensation Committee of our Board of Directors granted 200,000 performance awards to our employees, which 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 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.

Each participant elected a net issuance to cover their individual withholding taxes and therefore we issued 24,727 shares of common stock and paid $101,000 of participant related payroll tax liabilities.

Employee Stock Purchase Plan

In September 2014, our Board approved the establishment of an Employee Stock Purchase Plan (the ESPP), which was approved by our shareholders at the December 3, 2014 Annual Meeting.

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 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.

We recorded share-based compensation expense of $21,000 and $8,000 for the three months ended September 30, 2020 and 2019, respectively, related to these performance awards.

On September 30, 2020, there was approximately $223,000 of unrecognized compensation cost related to these non-vested performance awards expected to be expensed over the weighted-average period of 3.74 years.

On July 1, 2020, it was determined by the Compensation Committee of our Board of Directors that the second of five tranches of 40,000 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 the Company issued 25,629 shares and paid $259,000 of participant-related payroll tax liabilities.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

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 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:

Nine Months Ended March 31,

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.

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, aggregating 704,715 shares, be reserved for issuance pursuant to the ESPP.

The ESPP was approved by our shareholders at our 2014 Annual Meeting.

During the first quarters ended September 30, 2020 and 2019, 1,485 and 1,292 shares were purchased, respectively, under the ESPP and allocated to employees based upon their contributions at discount prices of $16.94 and $11.76, respectively, per share.

On a cumulative basis, since the inception of the ESPP plan, employees have purchased a total of 23,271 shares.

During the three months ended September 30, 2020 and 2019, we recorded stock compensation expense in the amount of $5,000 and $4,000, respectively, relating to the ESPP.

MAJOR CUSTOMERS & SUPPLIERS

Information with respect to customers that accounted for sales in excess of 10% of our total sales in either of the three-month periods ended September 30, 2020 and 2019, is as follows (in thousands, except percentages):

Three Months Ended September 30,

Percent of Total

Total revenue

Customer concentration:

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

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

September 30, 2020

June 30, 2020

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Customer concentration:

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

During the three months ended September 30, 2020 and 2019, we had two suppliers that each accounted for more than 10% of total inventory purchases.

Amounts owed to the fiscal 2021 significant suppliers at September 30, 2020 totaled $200,000 and $113,000, respectively, and at June 30, 2020 totaled $161,000 and $245,000, respectively.

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 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%.

The Revolving Loan matures on November 6, 2020, which we plan to renew, 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 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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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.

We are currently working with MBT to obtain a credit facility to purchase commercial real estate and to refinance our existing notes payable, however there can be no assurance that we will be successful in these endeavors.

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 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.

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

During the quarter ended September 30, 2020, we did not repurchase any shares.

During the quarter ended September 30, 2019, we repurchased 49,788 shares at an aggregate cost, inclusive of fees under the plan, of $681,000.

On a cumulative basis, we have repurchased a total of 819,325 shares under the share repurchase programs at an aggregate cost, inclusive of fees, of $8.5 million.

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

At The Market Offering Agreement

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

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 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 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.

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.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

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 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

The current portion of our operating lease liability as of September 30, 2020, in the amount of $320,000, is presented within accrued expenses on the Condensed Balance Sheet.

As of September 30, 2020, our operating lease has a remaining lease term of seven years and an imputed interest rate of 5.3%.

Cash paid for amounts included in the lease liability was $116,000 for the three months ended September 30, 2020.

As of September 30, 2020, the maturity of our lease liability is as follows:

Total lease payments

Less imputed interest:

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

Total minimum lease payments

COMMITMENTS AND CONTINGENCIES

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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 nine-month periods ended March 31, 2020 and 2019.

(Company, Pro-Dex, we, our, or us) for the three-month periods ended September 30, 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, 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.

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, the impact of the COVID-19 pandemic on our suppliers, customers and us, consolidation within our target marketplace and among our competitors, competition from larger, better capitalized competitors, and our ability to realize returns on opportunities.

Many other economic, competitive, governmental, and technological factors could impact our ability to achieve our goals.

You are urged to review the risks, uncertainties, and other cautionary language described in this report, as well as in our other public disclosures and reports filed with the Securities and Exchange Commission (SEC) from time to time, including, but not limited to, the risks, uncertainties, and other cautionary language discussed in our Annual Report on Form 10-K for our fiscal year ended June 30, 2020.

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.

We specialize in the design, development, and manufacture of powered rotary drive surgical instruments used primarily in the orthopedic, thoracic, and maxocranial facial (CMF) markets.

Our principal headquarters are located at 2361 McGaw Avenue, Irvine, California 92614 and our phone number is (949) 769-3200.

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Basis of Presentation

The condensed results of operations presented in this report are not audited and those results are not necessarily indicative of the results to be expected for the entirety of the fiscal year ending June 30, 2020 or any other interim period during such fiscal year.

The condensed results of operation presented in this report are not audited and those results are not necessarily indicative of the results to be expected for the entirety of the fiscal year ending June 30, 2021, or any other interim period during such fiscal year.

Our fiscal year ends on June 30 and our fiscal quarters end on September 30, December 31, and March 31.

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Critical Accounting Estimates and Judgments

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States.

Our financial statements are prepared in accordance with U.S.

The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures.

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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 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.

Management believes that there have been no significant changes during the three months ended September 30, 2020, 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, 2020.

Business Strategy and Future Plans

Our business today is almost entirely driven by sales of our medical devices.

Many of our significant customers place purchase orders for specific products that were developed under various development and/or supply agreements.

Our customers may request that we design and manufacture a custom surgical device or they may hire us as a contract manufacturer to manufacture a product of their own design.

In either case, we have extensive experience with autoclavable, battery-powered and electric, multi-function surgical drivers, and shavers.

We continue to focus a significant percentage of our time and resources on providing outstanding products and service to our valued principal customers.

During the first quarter of fiscal 2021, our largest customer executed an amendment to our existing supply agreement such that we shall continue to supply their surgical handpieces to them through calendar 2025.

Simultaneously, we are working to build top-line sales through active proposals of new medical device products with new and existing customers.

Our patented adaptive torque-limiting software has been very well received in the CMF market and we have continued investment in this area with research and development focused on applying this technology most recently to thoracic surgical applications, and we launched our first thoracic driver in the third quarter of fiscal 2020.

Additionally, we have other significant engineering projects under way described more fully in results of operations.

As reported in our Current Report on Form 8-K filed with the SEC on September 8, 2020, we executed a Standard Offer, Agreement and Escrow Instructions For Purchase of Real Estate for the purchase of an approximate 25,230 square foot industrial building located at 14401 Franklin Avenue, Tustin, CA 92780.

We anticipate escrow will close on or around November 6, 2020, and this additional facility will provide us additional capacity for our expected continued future growth.

We anticipate that upon completion of initial improvements we will be able to execute on Phase I of our plan, which includes, among other things, the installation of a clean room to enable us to expand our capacity for batteries and new products.

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, expand our manufacturing capacity through the build-out of acquired commercial real estate, 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 investments in research and development have increased disproportionately to our growth in revenue 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.

While we expect revenue growth in the future, it may not be a consistent trajectory but rather periods of incremental growth that current expenditures are helping to create.

However, there can be no assurance that we will be successful in any of these objectives.

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.

We are continuing our business operations under the California exemption 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:

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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.

Implemented quarterly company-wide COVID-19 testing.

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

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

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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

Our business today is almost entirely driven by sales of our medical devices.

Many of our significant customers place purchase orders for specific products that were developed under various development and/or supply agreements.

Our customers may request that we design and manufacture a custom surgical device or they may hire us as a contract manufacturer to manufacture a product of their own design.

In either case, we have extensive experience with autoclavable, battery-powered and electric, multi-function surgical drivers and shavers.

We continue to focus a significant percentage of our time and resources on providing outstanding products and service to our valued principal customers.

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, 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.

While we expect revenue growth in the future, it may not be a consistent trajectory, but rather periods of incremental growth that current expenditures are helping to create.

However, there can be no assurance that we will be successful in any of these objectives.

Description of Business Operations

The majority of our revenue is derived from designing, developing and manufacturing surgical devices for the medical device industry.

To date, a total of six of our employees including one temporary agency worker have tested positive for COVID-19 and all of them have made full recoveries and returned to work as of August 18, 2020.

We have also implemented daily temperature screenings and personal affidavits of wellness.

On October 1, 2020, we sponsored an at work COVID-19 test for all of our employees and temporary agency workers and 100% of the individuals tested were negative.

While the COVID-19 pandemic has not materially adversely affected our financial results and business operations thus far, economic and health conditions in the United States and across much of the globe have changed rapidly since the end of our fiscal 2021 first quarter, and we cannot predict the full impact of the COVID-19 pandemic on our business.

Results of Operations

The following tables set forth results from continuing operations for the three months ended September 30, 2020 and 2019:

Three Months Ended September 30,

Dollars in thousands

% of Net Sales

Cost of sales

Selling expenses

General and administrative expenses

Research and development costs

Operating income

Other income (expense), net

Income before income taxes

Provision for income taxes

The majority of our revenue is derived from designing, developing, and manufacturing surgical devices.

We continue to sell our rotary air motors for industrial applications, but our focus remains in medical devices.

The proportion of total sales by type is as follows (in thousands, except percentages):

Three Months Ended

Nine Months Ended

Medical device products

Three Months Ended September 30,

Increase (Decrease) From 2019 To 2020

Dollars in thousands

% of Net Sales

Medical device

Industrial and scientific

Dental and component

NRE & Proto-type

NRE & proto-types

Repairs and other

Certain of our medical device products utilize proprietary designs developed by us under exclusive development and supply agreements.

All of our medical device products utilize proprietary manufacturing methods and know-how, and are manufactured in our Irvine, California facility, as are our industrial products.

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 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 $1.2 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.

All of our medical device products utilize proprietary manufacturing methods and know-how, and are manufactured in our Irvine, California facility.

Details of our medical device sales by type is as follows (in thousands, except percentages):

Three Months Ended September 30,

Increase (Decrease) From 2019 To 2020

Dollars in thousands

% of Med Device Sales

Medical device sales:

Our medical device revenue increased $1.4 million, or 26%, in the first quarter of fiscal 2021 compared to the corresponding period of the prior fiscal year due primarily to deliveries of our newest thoracic drivers to one of our largest customers in the amount of $1.5 million.

Sales of our compact pneumatic air motors, remained flat, as expected, due to limited efforts to market these legacy devices.

Sales of our dental products and components decreased $9,000, or 13%, in the first quarter of fiscal 2021 comparted to the corresponding quarter of the prior fiscal year.

We will continue to experience future declines in this area as we are no longer manufacturing dental products, but rather simply selling remaining inventory.

Our NRE and proto-type revenue decreased $143,000 in the first quarter of fiscal 2021 compared to the corresponding period of the prior fiscal year, due to negligible billable contracts in the current fiscal first quarter.

Repair revenue increased by $113,000 in the first quarter of fiscal 2021 compared to the corresponding period 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 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.

At September 30, 2020, we had a backlog of approximately $14.8 million, of which $14.7 million is scheduled for delivery during the remainder 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 and Gross Margin

(in thousands except percentages)

Three Months Ended

Nine Months Ended

Three Months Ended September 30,

Increase (Decrease) From 2019 To 2020

Dollars in thousands

% of Net Sales

Cost of sales:

Product costs

Under-(over) absorption of manufacturing costs

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Total cost of sales

Three Months Ended

Nine Months Ended

Year over Year

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.

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

Gross profit and gross margin

Cost of sales for the three-month period ended September 30, 2020 increased by $655,000, or 15%, compared to the corresponding period of the prior fiscal year, consistent with the 19% increase in revenue for the same period.

Product costs increased by 10% during the three months ended September 30, 2020, compared to the corresponding period of the prior fiscal year, due to higher overhead rates in both machine shop and assembly.

Costs related to inventory and warranty charges increased $103,000 in the first quarter of fiscal 2021 compared to the corresponding quarter of fiscal 2020, due primarily to a current year accrual for the replacement cost of batteries due to one of our customers.

No similar costs were incurred in the first quarter of fiscal 2020.

Gross profit increased by approximately $695,000, or 25%, for the three months ended September 30, 2020, compared to the corresponding period of the prior fiscal year, and gross margin as a percentage of sales increased by approximately two percentage points between such periods, primarily as a result of product mix.

Operating Costs and Expenses

(in thousands except % change)

Three Months Ended

Nine Months Ended

Year over Year

Three Months Ended September 30,

Increase (Decrease) From 2019 To 2020

Dollars in thousands

% of Net Sales

Operating expenses:

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Research and development costs

Selling expenses consist of salaries and other personnel-related expenses for our business development department, as well as advertising and marketing expenses, and travel and related costs incurred in generating and maintaining our customer relationships.

Selling expenses for the three and nine months ended March 31, 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 $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 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.

Selling expenses consist of salaries and other personnel-related expenses in support of business development, as well as trade show attendance, advertising and marketing expenses, and travel and related costs incurred in generating and maintaining our customer relationships.

Selling expenses for the three months ended September 30, 2020 decreased $12,000, or 9%, compared to the corresponding year-earlier period.

The decrease is primarily due to decreased travel and related expenses due to the COVID-19 pandemic.

General and administrative expenses (G&A) consist of salaries and other personnel-related expenses of our accounting, finance, and human resources personnel, professional fees, directors fees, and other costs and expenses attributable to being a public company.

G&A increased by $42,000 for the three months ended September 30, 2020, when compared to the corresponding period of the prior fiscal year.

The increase in total G&A expenses was primarily related to increased bonus accruals and increased costs associated with being a public company.

Research and development costs generally consist of compensation and other personnel-related costs of our engineering and support personnel, related professional and consulting fees, patent-related fees, lab costs, materials, and travel and related costs incurred in the development and support of our products.

Research and development costs increased $607,000 for the quarter ended September 30, 2020, compared to the corresponding prior year period.

The increase is due primarily to increased salaries and personnel-related costs in the amount of $198,000 due to an increase in engineering staff, as well as an increase in the amount of $403,000 in engineering projects for new product development.

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.

The research and development costs represent between 38% and 44% of total operating expenses for all periods presented and are expected to increase in the future as we continue to invest in the business.

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

Three and Nine Months ended

March 31, 2020

Three and Nine Months ended

March 31, 2019

Research and development costs represent between 38% and 57% of total operating expenses for all periods presented, and are expected to increase in the future as we continue to invest in product development.

The amount spent on projects under development, along with the current estimated commercial launch date and estimated recurring annual revenue, is summarized below (in thousands):

For the Three Months Ended

September 30,

Market Launch (1)

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Products in development:

Arthroscopic Shaver (1)

Arthroscopic Attachment

VITAL Ventilator

Sustaining & Other

Customer CMF Driver (3)

This project has been internally pushed back to focus on our new internal Pro-Dex branded ENT shaver.

Internal development of this project is now complete, but we are looking for the most attractive sales channel.

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

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 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 $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

Interest expense consists primarily of interest expense related to the notes payable described more fully in Note 9 to the condensed financial statements contained elsewhere in this report and capital lease obligations for leased equipment.

Gain on Sale of Investments

During the quarter ended December 31, 2018, we liquidated one of the stocks in our portfolio of equity investments receiving proceeds of $1.9 million and recording a gain on the sale in the amount of $356,000.

Represents the calendar quarter of expected market launch.

In the fourth quarter of fiscal 2020, we were one of eight US-based companies awarded a license to manufacture the Jet Propulsion Laboratorys Ventilator Intervention Technology Accessible Locally (VITAL), a high-pressure, lower cost ventilator.

In order to manufacture this product, we will require a full clean room, which we plan to install in our Tustin facility, (assuming we close on the property which is expected to occur on or around November 6, 2020).

We are also nearing completion on the verification and validation of a new CMF driver, which we will be selling to our existing largest customer under a distribution agreement, executed in the first quarter of fiscal 2021.

Finally, we also anticipate the release to manufacture of a new ENT Shaver in the spring of 2021 and our Director of Business Development is working with a promising medical device distributor to commercialize this product.

Other Income (Expense), net

The interest expense recorded during the quarters ended September 30, 2020 and 2019, relates to our Minnesota Bank and Trust (MBT) loan described more fully in Note 9 to the condensed financial statements contained elsewhere in this report.

The interest income recorded during the quarter ended September 30, 2020 and 2019, in the amount of approximately $41,000 and $27,000, respectively, consists primarily of interest and dividends from our investments and money market accounts.

The miscellaneous income recorded during the quarters ended September 30, 2020 and 2019, includes $12,000 of realized gains from the sale of marketable securities and $8,500 in interest income on a note receivable, respectively.

Income Tax Expense

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.

The effective tax rate for the three months ended September 30, 2020 and 2019, is 18% and 25%, respectively.

The current year effective tax rate is less than the statutory rate due primarily to a tax benefit recognized as a result of the common stock awarded to our employees described more fully in Note 7 to the condensed financial statements contained elsewhere in this report.

Liquidity and Capital Resources

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.

Cash and cash equivalents at September 30, 2020, decreased $1.2 million to $5.2 million as compared to $6.4 million at June 30, 2020.

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

As of and For the Nine Months Ended March 31,

As of and For the Three Months Ended September 30,

(in thousands)

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Operating Activities

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.

Net cash used by operating activities during the three months ended September 30, 2020, totaled $888,000.

The primary sources of cash arose from our net income for the quarter of $1,265,000, as well as non-cash depreciation and amortization of $150,000, offset by an increase in accounts receivable of $986,000 due to extended payment terms from our largest customers, a decrease in accounts payable and accrued expenses of $767,000, as well as payments for income taxes in the amount of $747,000.

Net cash provided by operating activities during the three months ended September 30, 2019, totaled $908,000.

The primary sources of cash arose from (a) our net income for the quarter of $1.1 million, as well as non-cash depreciation and amortization of $138,000, (b) a decrease of $931,000 in accounts receivable due to more timely collection of receivables from our largest customer, and (c) a decrease in prepaid expenses and other current assets of $391,000.

Uses of cash arose from primarily from a decrease of $1.0 million in accounts payable and accrued expenses, as well as an increase in inventory of $605,000 primarily related to the thoracic driver and related batteries and accessories.

Investing Activities

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.

Net cash provided by investing activities for the three months ended September 30, 2020, was $25,000 and related primarily to the sale of marketable equity securities in the amount of $115,000 offset by the purchase of capitalized equipment and software in the amount of $89,000.

Net cash used in investing activities for the three months ended September 30, 2019, was $1.3 million and related primarily to the purchase of marketable equity securities in the amount of $1.3 million and manufacturing equipment in the amount of $61,000.

Financing Activities

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.

Net cash used in financing activities for the three months ended September 30, 2020, included payments of $161,000 on our term loan from MBT more fully described in Note 9 to the condensed financial statements contained elsewhere in this report as well as $259,000 of employee payroll taxes related to the award of 40,000 shares of common stock to employees under previously granted performance awards.

Net cash used in financing activities for the three months ended September 30, 2019, included the repurchase of $681,000 of common stock pursuant to our share repurchase program, as well as payments of $159,000 on our term loan from MBT more fully described in Note 9 to the condensed financial statements contained elsewhere in this report.

Financing Facilities & Liquidity Requirements for the Next Twelve Months

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.

As of September 30, 2020, our working capital was $18.1 million.

We currently believe that our existing cash and cash equivalent balances together with our account 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.

Importantly, our largest customer changed their payment terms from net 30 to net 90 during the first quarter of fiscal 2021, in conjunction with a contract amendment, and we therefore anticipate an increase in receivables over the next fiscal quarter, which will adversely impact our cash flows from operations in the short term.

In addition to our cash and cash equivalent balances, we expect to derive a portion of our liquidity from our cash flows from operations.

We may also borrow against our $2.0 million Revolving Loan with MBT (See Note 9 to condensed financial statements contained elsewhere in this report).

We may also borrow against our $2.0 million Revolving Loan with Minnesota Bank & Trust, which we plan to renew.

(See Note 9 to condensed financial statements contained elsewhere in this report).

We are focused on preserving our cash balances by monitoring expenses, identifying cost savings, and investing only in those development programs and products that we believe will most likely contribute to our profitability.

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In particular, we have experienced negative operating cash flow in the past, especially as we procure long-lead time materials to satisfy our backlog, which can be subject to extensive variability.

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, Richard L.

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

Cabillot and Nicholas J.

Swenson, who chairs the committee.

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.

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

What changed 10-Q

Item 1. Financial Statements