What changed in this filing

/stocks — the workspaceLOADING

Item 1. Financial Statements

2021-02-04 compared with 2020-11-05 · 313 added, 254 removed, 283 unchanged (67% of the section changed)

1 unchanged sentence

PRO-DEX, INC.

CONDENSED BALANCE SHEETS

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

September 30,

Current Assets:

Cash and cash equivalents

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

Accounts receivable, net of allowance for doubtful accounts of $4 and $6 at December 31, 2020 and at June 30, 2020, respectively

Deferred costs

1 unchanged sentence

Total current assets

Land and building, net

Equipment and leasehold improvements, net

18 unchanged sentences

50,000,000 shares authorized;

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

Accumulated other comprehensive loss

3,860,639 and 3,811,137 shares issued and outstanding at December 31, 2020 and June 30, 2020, respectively

Accumulated other comprehensive income (loss)

Retained earnings

1 unchanged sentence

Total liabilities and shareholders equity

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

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

PRO-DEX, INC.

CONDENSED STATEMENTS OF OPERATIONS

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

1 unchanged sentence

Three Months Ended

September 30,

Six Months Ended

Cost of sales

5 unchanged sentences

Operating income

Other income (expense):

Interest and miscellaneous income

Interest expense

Total other income (expense)

Income before income taxes

Provision for income taxes

Other comprehensive income (loss), net of tax:

Unrealized loss from marketable equity investments, net of taxes

Interest and other income

Gain on sale of investments

Income from operations before income taxes

Income tax expense

Other comprehensive income, net of tax:

Unrealized income from marketable equity investments

Comprehensive income

Basic and diluted income per share:

Basic net income per share:

2 unchanged sentences

Common shares outstanding

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

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

PRO-DEX, INC.

CONDENSED STATEMENTS OF SHAREHOLDERS EQUITY

For the Three Months Ended September 30, 2020 and 2019

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY

For the Three and Six Months Ended December 31, 2020 and 2019

(In thousands)

Three Months Ended

September 30,

Six Months Ended

Common shares:

1 unchanged sentence

Share-based compensation expense

Stock option exercise

Share repurchases

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

Shares withheld from common stock issued to pay employee payroll taxes

Exercise of stock options

ESPP shares issued

Balance, end of period

Balance, at end of period

Accumulated other comprehensive income (loss):

Balance, beginning of period

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

Balance, end of period

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

Balance, at end of period

Retained earnings:

3 unchanged sentences

Total shareholders equity

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

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

PRO-DEX, INC.

CONDENSED STATEMENTS OF CASH FLOWS

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

Three Months Ended

September 30,

Six Months Ended

CASH FLOWS FROM OPERATING ACTIVITIES:

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

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

Depreciation and amortization

3 unchanged sentences

Gain on sale of investments

Deferred income tax

Bad debt expense

Deferred income taxes

Bad debt expense (recovery)

Changes in operating assets and liabilities:

Accounts receivable and other receivables

Accounts receivable and other current receivables

Deferred costs

3 unchanged sentences

Income taxes payable

Net cash provided by (used in) operating activities

Net cash provided by operating activities

CASH FLOWS FROM INVESTING ACTIVITIES:

Purchases of equipment

Purchases of investments

Increase in intangibles

Purchases of equipment and leasehold improvements

Proceeds from sale of investments

Net cash provided by (used in) investing activities

Purchase of land and building

Increase in intangibles

Net cash used in investing activities

CASH FLOWS FROM FINANCING ACTIVITIES:

Principal payments on capital lease and notes payable

Payment of employee payroll taxes on net issuance of common stock

Proceeds from stock option exercises and ESPP contributions

Repurchases of common stock

Net cash used in financing activities

Proceeds from exercise of options and ESPP contributions

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 decrease in cash and cash equivalents

1 unchanged sentence

Cash and cash equivalents, end of period

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

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

PRO-DEX, INC.

CONDENSED STATEMENTS OF CASH FLOWS - CONTINUED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

(In thousands)

Three Months Ended

September 30,

Six Months Ended

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.

Non-cash investing and financing activity:

Cashless stock option exercise

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

PRO-DEX, INC.

NOTES TO CONSDENSED FINANCIAL STATEMENTS

NOTES TO CONSDENSED CONSOLIDATED FINANCIAL STATEMENTS

BASIS OF PRESENTATION

The accompanying unaudited condensed financial statements of Pro-Dex, Inc.

The accompanying unaudited condensed consolidated financial statements of Pro-Dex, Inc.

(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 the instructions to Form 10-Q and Regulation S-K.

GAAP) for interim financial information and 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 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.

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.

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.

4 unchanged sentences

We also manufacture and sell rotary air motors to a wide range of industries.

In August 2020, we formed a wholly-owned subsidiary, PDEX Franklin, LLC (PDEX Franklin), to hold title for an approximate 25,000 square foot industrial building in Tustin, California (the Franklin Property) that we acquired on November 6, 2020 in order to allow for the continued growth of our business.

The consolidated financial statements include the accounts of the Company and PDEX Franklin and all significant inter-company accounts and transactions have been eliminated.

This subsidiary has no separate operations.

COMPOSITION OF CERTAIN FINANCIAL STATEMENT ITEMS

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

September 30,

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

PRO-DEX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

Marketable equity securities - short-term

1 unchanged sentence

Total marketable equity securities

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

Investments at December 31, 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.

At December 31, 2020, the investments included net unrealized losses of $258,000 (gross unrealized losses of $789,000 offset by gross unrealized gains of $531,000).

During the quarter ended December 31, 2020, we incurred net unrealized gains of $1,413,000.

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

Of the total marketable equity securities at December 31, 2020 and June 30, 2020, $1,510,000 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.

2 unchanged sentences

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.

7 unchanged sentences

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

Land and building

Land and building consist of the following (in thousands):

accumulated depreciation

On November 6, 2020 we acquired the Franklin Property for a total purchase price of $6.5 million, of which we paid $1.3 million in cash and the balance of $5.2 we financed through Minnesota Bank & Trust (MBT) (see Note 9).

As of the date of this filing, we are continuing our build-out of the property, which we expect to complete in the fourth quarter of this fiscal year.

The building is being amortized on a straight-line basis over a period of 30 years.

PRO-DEX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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 September 30, 2020 and June 30, 2020, the warranty reserve amounted to $190,000 and $213,000, respectively.

As of December 31 and June 30, 2020, the warranty reserve amounted to $347,000 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.

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):

Warranty expense relating to new product sales and changes to estimates for the three months ended December 31, 2020 and 2019 was $182,000 and $44,000, respectively, and for the six months ended December 31, 2020 and 2019 was $254,000 and $56,000, respectively.

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

As of and for the

Three Months Ended

September 30,

Beginning balance

1 unchanged sentence

Changes in estimates of prior period warranty accruals

Warranty amortization/utilization

Warranty amortization

Ending balance

As of and for the

Six 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 CONSOLIDATED FINANCIAL STATEMENTS

NET INCOME PER SHARE

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.

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.

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

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

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

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

Three Months Ended

September 30,

Six Months Ended

Weighted average shares outstanding

Basic earnings per share

Basic income per share

Weighted average shares outstanding

1 unchanged sentence

Weighted average shares used in calculation of diluted earnings per share

Diluted earnings per share

Diluted income 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 bases.

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

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 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

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.

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

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).

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

We are subject to U.S.

2 unchanged sentences

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.

PRO-DEX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SHARE-BASED COMPENSATION

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).

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).

The Employee Stock Option Plan and Directors Stock Option Plan were terminated in June 2014 and December 2014, respectively.

1 unchanged sentence

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

Stock Options

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.

As of December 31, 2020, 200,000 performance awards and 310,000 non-qualified stock options have been granted under the 2016 Equity Incentive Plan.

Former Stock Option Plans

No options were granted under the Former Stock Option Plans during the three or six months ended December 31, 2020 and 2019.

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

As of December 31, 2020, the options outstanding had a weighted average remaining contractual life of 0.92 years and an intrinsic value of $919,000.

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

Six Months Ended December 31,

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 December 31,

Performance Awards

2 unchanged sentences

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 $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.

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

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

During the three months ended December 31, 2020 and 2019, we recorded share-based compensation expense of $21,000 and $8,000, respectively, related to outstanding performance awards.

During the six months ended December 31, 2020 and 2019, we recorded share-based compensation expense of $42,000 and $16,000, respectively, related to outstanding performance awards.

On December 31, 2020, there was approximately $202,000 of unrecognized compensation cost related to non-vested performance awards expected to be expensed over the weighted-average period of 3.49 years.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Each participant elected a net issuance to cover their individual withholding taxes and, therefore, we issued 25,629 shares and paid $259,000 of participant-related payroll tax liabilities.

Non-Qualified Stock Options

In December 2020, the Compensation Committee of our Board of Directors granted 310,000 stock options to our directors and certain employees under the 2016 Equity Incentive Plan.

Whether any stock options vest, and the amount that does vest, is tied to the completion of service periods that range from 18 months to 10.5 years at inception and the achievement of our common stock trading at certain pre-determined prices.

We recorded compensation expense of $18,000 for the three and six months ended December 31, 2020, related to these options.

The weighted average fair value of the stock option awards granted was calculated using a Monte Carlo simulation.

Employee Stock Purchase Plan

In September 2014, our Board approved the establishment of an Employee Stock Purchase Plan (the ESPP).

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

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

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

During the three months ended December 31, 2020 and 2019, we did not record any share-based compensation expense relating to the ESPP, due to the fact that no six-month offering period ended during either quarter.

During the six months ended December 31, 2020 and 2019, 1,485 and 1,292 shares of our common stock were purchased under the ESPP, respectively, and allocated to employees based upon their contributions at prices of $16.94 and $11.76, respectively, per share.

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

During the six months ended December 31, 2020 and 2019, we recorded share-based compensation expense in the amount of $4,000 and $3,000, respectively, relating to the ESPP.

MAJOR CUSTOMERS AND SUPPLIERS

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

Three Months Ended December 31,

Customer concentration:

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

PRO-DEX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended December 31,

Customer concentration:

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

December 31, 2020

June 30, 2020

1 unchanged sentence

Customer concentration:

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.

NOTES TO CONDENSED FINANCIAL STATEMENTS

During the three months ended December 31, 2020, we had three suppliers accounting for 10% or more of total inventory purchases, and during the six months ended December 31, 2020, we had two suppliers that accounted for more than 10% of our total inventory purchases.

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

Amounts owed to the fiscal 2021 two most significant suppliers at December 31, 2020 totaled $656,000 and $345,000, respectively, and at June 30, 2020 totaled $161,000 and $245,000, respectively.

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.

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 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).

On November 6, 2020 (the Closing Date), PDEX Franklin, a newly created wholly owned subsidiary of the Company, purchased the Franklin Property.

A portion of the purchase price was financed by a loan from MBT to PDEX Franklin in the principal amount of $5,207,472 (the Property Loan) pursuant to a Loan Agreement, dated as of the Closing Date, between PDEX Franklin and MBT (the Property Loan Agreement) and corresponding Term Note (the Property Note) issued by PDEX Franklin in favor of MBT on the Closing Date.

The Property Loan is secured by the Franklin Property pursuant to a Deed of Trust with Assignment of Leases and Rents, Security Agreement and Fixture Filing in favor of MBT (the Deed) and by an Assignment of Leases and Rents by PDEX Franklin in favor of MBT (the Rents Assignment).

We paid loan origination fees to MBT on the Closing Date in the amount of $26,037.

PRO-DEX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Property Loan bears interest at a fixed rate of 3.55% per annum, which is subject to a 3% increase upon an event of default.

Accrued interest is payable monthly beginning on December 1, 2020 and both principal and interest in the amount of approximately $30,000 are due and payable on the first day of each subsequent month until the maturity date of November 1, 2030 (the Maturity Date), at which time a balloon payment in the amount of $3.1 million is due.

Any prepayment of the Property Loan (other than monthly scheduled interest and principal payments), is subject to a prepayment fee equal to 4% of the principal amount prepaid for any prepayment made during the first or second year, 3% of the principal amount prepaid for any prepayment made during the third or fourth year, 2% of the principal amount prepaid for any prepayment made during the fifth or sixth year, and 1% of the principal amount prepaid for any prepayment made during the seventh or eighth year.

The Property Loan Agreement, Property Note, Deed, and Rents Assignment each contain representations, warranties, covenants, and events of default that are customary for a loan of this type.

On the Closing Date, we also entered into an Amended and Restated Credit Agreement with MBT (the Amended Credit Agreement), providing for a $7,525,000 amended and restated term loan (the Term Loan A), a $1,000,000 term loan (the Term Loan B), and a $2,000,000 amended and restated revolving loan (the Revolving Loan and, together with the Term Loan A and the Term Loan B, collectively, the Loans), evidenced by an Amended and Restated Term Note A (Term Note A), a Term Note B, and an Amended and Restated Revolving Credit Note (the Revolving Note) made by us in favor of MBT.

The Loans are secured by substantially all of the Companys assets pursuant to a Security Agreement entered into on September 6, 2018 between the Company and MBT.

The Term Note A had an outstanding principal balance of $3,770,331 as of the Closing Date and may be borrowed against through May 30, 2021 (the Commitment Period).

The Term Note B has a zero balance as of the Closing Date and may be borrowed against through the Commitment Period.

We plan to draw against the Term Note B during the Commitment Period for the purpose of making improvements to the Franklin property described in Note 3.

The Term Loan A matures on November 1, 2027 and bears interest at a fixed rate of 3.84% per annum.

Initial payments on the Term Loan A of interest only are due on December 1, 2020 through June 1, 2021.

Commencing July 1, 2021 and continuing on the first day of each month thereafter until the maturity date, we are required to make payments of principal and interest on Term Loan A of $109,168.18 (if the outstanding principal balance on June 1, 2021 is the full $7,525,000) and proportionately reduced if the principal balance is less than that amount plus any additional accrued and unpaid interest through the date of payment.

As of the date of this filing, we have not borrowed any additional amounts against Term Loan A.

The balance owed on Term Loan A as of December 31, 2020 is $3.7 million.

The Term Loan B matures on November 1, 2027 and bears interest at a fixed rate of 3.84% per annum.

Initial payments on the Term Loan B of interest only are due on December 1, 2020 through June 1, 2021.

Commencing July 1, 2021 and continuing on the first day of each month thereafter until the maturity date, we are required to make payments of principal and interest on Term Loan B of $14,507.40, (if the outstanding principal balance on June 1, 2021 is the full $1,000,000) and proportionately reduced if the principal balance is less than that amount plus any additional accrued and unpaid interest through the date of payment.

As of December 31, 2020, we had not made any draws against Term Note B.

The Revolving Loan may be borrowed against from time to time through its maturity date of November 5, 2021, unless earlier terminated pursuant to its terms, and bears interest at an annual rate equal to the greater of (a) 3.25% or (b) the prime rate as published in the Money Rates section of the Wall Street Journal.

Commencing on the first day of each month after we initially borrow against the Revolving Loan 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 in full on the maturity date (or earlier termination of the Revolving Loan).

No amounts have been drawn against 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.

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.

Upon the occurrence and during the continuance of an event of default, the interest rate of all Loans will be increased by 3% and MBT may, at its option, declare the Loans immediately due and payable in full.

The Amended Credit Agreement, Security Agreement, Term Note A, Term Note B, and Revolving Note contain representations and warranties, affirmative, negative and financial covenants, and events of default that are customary for loans of this type.

PRO-DEX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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 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.

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

During the three and six months ended December 31, 2020, we did not repurchase any shares under the repurchase program.

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

On a cumulative basis, since implementation of the share repurchase program in 2013, we have repurchased a total of 819,325 shares under the share repurchase program 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 December 2020, our Board approved an ATM Agreement with Ascendiant Capital Markets, LLC (Ascendiant).

The ATM Agreement allows us to sell shares of our common stock in transactions that are deemed to be at-the-market equity offerings as defined in Rule 415 under the Securities Act of 1933, as amended, including sales made by means of ordinary brokers transactions, including on Nasdaq.

In connection with the ATM Agreement, we entered into a prearranged stock sales plan with Ascendiant, which is intended to qualify for the safe harbor under Rule 10b5-1 under the Exchange Act (ATM 10b5-1 Plan).

No sales of common stock have been made under the ATM Agreement as of the date of this report, but future sales may occur pursuant to the parameters of the ATM 10b5-1 Plan or otherwise at the direction of our Board in accordance with the terms of the ATM Agreement.

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.

1 unchanged sentence

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 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:

Our operating lease ROU asset and long-term liability are presented separately on our condensed consolidated balance sheet.

The current portion of our operating lease liability as of December 31, 2020, in the amount of $328,000, is presented within accrued expenses on the condensed consolidated balance sheet.

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

Operating Lease

Total lease payments

Less imputed interest:

PRO-DEX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of December 31, 2020, our operating lease has a remaining lease term of six years and nine months and an imputed interest rate of 5.53%.

Cash paid for amounts included in the lease liability for the three and six months ended December 31, 2020 totaled $120,000 and $236,000, respectively, and for December 31, 2019 totaled $116,000 and $229,000, respectively.

COMMITMENTS AND CONTINGENCIES

3 unchanged sentences

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with our unaudited interim condensed financial statements and the related notes and other financial information appearing elsewhere in this report.

The following discussion and analysis should be read in conjunction with our unaudited interim condensed consolidated financial statements and the related notes and other financial information appearing elsewhere in this report.

COMPANY OVERVIEW

The following discussion and analysis provides information that management believes is relevant to an assessment and understanding of the results of operations and financial condition of Pro-Dex, Inc.

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

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

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

This report contains certain forward-looking statements and information.

5 unchanged sentences

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

We specialize in the design, development, and manufacture of autoclavable, battery-powered and electric, multi-function surgical drivers and shavers used primarily in the orthopedic, thoracic, and maxocranial facial (CMF) markets.

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

We also manufacture and sell rotary air motors to a wide range of industries.

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

6 unchanged sentences

Basis of Presentation

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.

The condensed consolidated results of operations presented in this report are not audited and those results are not necessarily indicative of the results to be expected for the entirety of the fiscal year ending June 30, 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.

1 unchanged sentence

Critical Accounting Estimates and Judgments

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

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

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

2 unchanged sentences

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 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.

Management believes that there have been no significant changes during the three and six months ended December 31, 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

8 unchanged sentences

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.

Additionally, as previously disclosed, on November 6, 2020, we purchased an approximate 25,000 square foot industrial building in Tustin, California (the Franklin Property).

This building is located approximately four miles from or Irvine, California headquarters and was acquired to provide us additional capacity for our expected continued future growth.

Currently, we are continuing with our build-out of the property and have yet to transition any of our employees into the facility.

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 the manufacture of batteries and new products.

We expect that we will begin operations in the new facility some time during the fourth quarter of this fiscal year.

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 the Franklin Property, and promoting active product development proposals to new and existing customers for orthopedic shavers, screw drivers for a multitude of surgical applications, and other medical devices, 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.

10 unchanged sentences

Provided training, education and appropriate personal protective equipment;

Implemented quarterly company-wide COVID-19 testing.

Implemented quarterly, now monthly, company-wide COVID-19 testing;

Daily temperature screenings and personal affidavits of wellness.

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.

3 unchanged sentences

We are focused on continuity of supply by working with our suppliers.

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.

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 second quarter, and we cannot predict the full impact of the COVID-19 pandemic on our business.

Description of Business Operations

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

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

Three Months Ended September 30,

Increase (Decrease) From 2019 To 2020

Dollars in thousands

% of Net Sales

Medical device

Three Months Ended

Six Months Ended

Medical device products

Industrial and scientific

Dental and component

NRE & proto-types

NRE & Prototype

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.

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.

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

Three Months Ended

Six Months Ended

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.

Sales of our medical device products increased $0.3 million, or 4%, for the three months ended December 31, 2020 and increased $1.6 million, or 14%, for the six months ended December 31, 2020 compared to the corresponding periods of the prior fiscal year.

The majority, or $2.4 million, of our increase in medical device sales for the six months ended December 31, 2020 relates to sales of our first thoracic driver as well as related accessories that were not sold during the corresponding period of the prior fiscal year.

Offsetting this increase, revenue to two of our legacy medical device customers decreased approximately $524,000 and $352,000, respectively, for the six months ended December 31, 2020 compared to the corresponding period of the prior fiscal year.

Sales of our compact pneumatic air motors, reported as Industrial and scientific sales above, increased $39,000, or 21%, and $40,000, or 12% for the three and six months ended December 31, 2020 compared to the corresponding periods of the prior fiscal year.

The revenue increase relates to a continued interest in these legacy products but is not due to any substantive marketing efforts.

Sales of our dental products and components continued to decline for the three and six months ended December 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.

Repair revenue remained flat and increased $131,000 for the three and six months ended December 31, 2020, respectively, compared to the corresponding periods of the prior fiscal year due almost exclusively to repairs of handpieces for 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.

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.

We expect repair revenue for the remaining quarters of fiscal 2021 to decrease to some degree based upon a downward trend we have seen in repair units of the orthopedic handpiece we sell to our largest customer, coupled with price concessions that went into effect on January 1, 2021.

At December 2020, we had a backlog of approximately $16.6 million, of which $15.9 million is scheduled to be delivered in the third and fourth quarters of fiscal 2021 and the balance is scheduled to be delivered next fiscal year.

Our backlog represents firm purchase orders received and acknowledged from our customers and does not include all revenue expected to be generated from existing customer contracts.

2 unchanged sentences

Cost of Sales and Gross Margin

Three Months Ended September 30,

Increase (Decrease) From 2019 To 2020

Dollars in thousands

% of Net Sales

(in thousands except percentages)

Three Months Ended

Six Months Ended

Cost of sales:

Product costs

Under(over)-absorption of manufacturing costs

1 unchanged sentence

Total cost of sales

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.

Three Months Ended

Six Months Ended

Year over Year

Cost of sales for the three months ended December 31, 2020 increased $572,000 or 11% compared to the corresponding period of the prior fiscal year.

While revenue increased 4% during this same period, the increase in total cost of sales is primarily related to increased under-absorption of manufacturing costs and inventory and warranty charges.

Under-absorption of manufacturing costs increased by $261,000 for the three months ended December 31, 2020 compared to the corresponding period of the prior fiscal year due in part to COVID-19 related payroll costs.

We have incurred paid absences in our machine shop, assembly and quality operations that reduce our ability to absorb our fixed costs because total production hours are reduced.

Costs relating to inventory and warranty charges increased by $150,000 for the second quarter ended December 31, 2020 compared to the second quarter of the prior fiscal year due to higher warranty accruals for two significant products.

Gross profit decreased by $268,000, or 9%, for the three months ended December 31, 2020 compared to the corresponding period of the prior fiscal year, primarily as a result of the increase in under-absorption of manufacturing costs and inventory and warranty charges discussed above.

Gross margin as a percentage of sales decreased by approximately 5 percentage points compared to the corresponding period of the prior fiscal year due primarily to the increased cost of sales, which are higher than the corresponding increase in revenue for the reasons described above.

Cost of sales for the six months ended December 31, 2020 increased by $1.2 million, or 13%, compared to the corresponding period of the prior fiscal year, consistent with the increased revenue of 11% for the same period, the reasons for which are discussed above.

Additionally, total cost of sales reflects a $351,000 increase in under-absorbed manufacturing costs and a $253,000 increase in inventory and warranty charges due to reduced production hours resulting in part from paid absences related to COVID-19 and additional warranty accruals for several isolated warranty issues.

Gross profit increased by $427,000, or 8%, for the six months ended December 31, 2020 compared to the corresponding period of the prior fiscal year, primarily as a result of the increase in thoracic driver and accessory sales discussed above.

Gross margin for the six months ended December 31, 2020 decreased to 36% compared to 37% for the corresponding period of the prior fiscal year.

Operating Expenses

Operating Costs and Expenses

Three Months Ended September 30,

Increase (Decrease) From 2019 To 2020

Dollars in thousands

% of Net Sales

(in thousands except % change)

Three Months Ended

Six Months Ended

Year over Year

Operating expenses:

2 unchanged sentences

Research and development costs

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.

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

Selling expenses for the three and six months ended December 31, 2020 increased $15,000, or 11%, and $3,000, or 1%, compared to the corresponding periods of fiscal 2020.

These increases relate primarily to personnel-related expenses and consulting expenses offset by reduced travel expenses due to the COVID-19 pandemic.

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 $272,000 and $314,000, respectively, during the three and six months ended December 31, 2020 when compared to the corresponding periods of the prior fiscal year.

The increases relate primarily to relocation and operating expenses of the Franklin Property, increased legal fees related to intellectual property matters and our debt refinancing in combination with our Property Loan, increased personnel-related expenses including bonus accruals, as well as higher insurance expense, and stock compensation expense.

Research and development costs generally consist of salaries, employer paid benefits, and other personnel related costs of our engineering and support personnel, as well as allocated facility and information technology costs, professional and consulting fees, patent-related fees, lab costs, materials, and travel and related costs incurred in the development and support of our products.

Research and development costs for the three and six months ended December 31, 2020 increased $592,000 and $1.2 million, respectively, compared to the corresponding periods of the prior fiscal year.

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

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.

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)

Est Annual Revenue

The research and development costs represent between 33% and 52% of total operating expenses for all periods presented and are expected to increase in the future as we continue to invest in our business.

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

Three and Six Months ended

December 31, 2020

Three and Six Months ended

December 31, 2019

Total Research & Development costs:

2 unchanged sentences

Sustaining & Other

Recently completed products:

Customer CMF Driver (2)

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.

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

This project was completed in the prior fiscal year and the product initially shipped in the fourth quarter of fiscal 2020.

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

Additionally, as previously disclosed, we anticipate the release to manufacture of a new ENT Shaver in the fall of 2021 and our Director of Business Development is working with a promising medical device distributor to potentially commercialize this product.

Interest & Other Income

Interest income for the three and six months ended December 31, 2020 and 2019 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.

Interest Expense

Interest expense consists primarily of interest expense related to the notes payable described more fully in Note 9 to the condensed consolidated financial statements contained elsewhere in this report.

Gain on Sale of Investments

During the quarter ended September 30, 2020 we liquidated two of the stocks in our portfolio of equity investments, receiving proceeds of $115,000 and recording a gain on the sale in the amount of $12,000.

Income Tax Expense

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.

The effective tax rate for the three and six months ended December 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, as well as a tax benefit recognized as a result of common stock awarded to employees under previously granted performance awards in the first quarter of fiscal 2021 as described more fully in Note 7 to the condensed consolidated financial statements contained elsewhere in this report.

Liquidity and Capital Resources

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.

Cash and cash equivalents at December 31, 2020 decreased $0.9 million to $5.5 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 Three Months Ended September 30,

As of and For the Six Months Ended December 31,

(in thousands)

7 unchanged sentences

Operating Activities

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.

Net cash provided by operating activities was $1.1 million for the six months ended December 31, 2020 primarily due to net income of $1.6 million and non-cash depreciation and amortization of $320,000 offset by an increase in inventory of $913,000, reflecting purchases for existing demand as well as long-lead time parts for products in development.

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

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

Investing Activities

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.

During the second quarter ended December 31, 2020, we closed on our acquisition of the Franklin Property.

We are currently investing in the build-out of the necessary improvements and expect to transfer some of our employees from our corporate headquarters to this new facility in the fourth quarter of fiscal 2021.

In addition to our acquisition of the Franklin Property, we also invested $316,000 in machinery and equipment during the six months ended December 31, 2020.

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

Financing Activities

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.

Net cash provided by financing activities for the six months ended December 31, 2020 included proceeds of $5.2 million from a Property Loan with MBT, offset by $261,000 of principal payments on our term loan with MBT more fully described in Note 9 to the condensed consolidated financial statements contained elsewhere in this report, as well as payment of $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 six months ended December 31, 2019 totaled $2.5 million and related primarily to the $2.2 million repurchase of 156,685 shares of our common stock pursuant to our share repurchase program as well as $314,000 of principal payments on our term loan from MBT.

Financing Facilities & Liquidity Requirements for the Next Twelve 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.

As of December 31, 2020, our working capital was $17.8 million.

We currently believe that our existing cash and cash equivalent balances together with our accounts receivable balances will provide us sufficient funds to satisfy our cash requirements as our business is currently conducted for at least the next 12 months.

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

We may also 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 may also borrow against our $2.0 million Revolving Loan with MBT (See Note 9 to condensed consolidated 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.

1 unchanged sentence

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.

We believe that if we need to raise additional capital to fund our operations we can do so by selling additional shares of our common stock under the ATM Agreement.

Investment Strategy

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.

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 $6.1 million of marketable public equity securities that we held at December 31, 2020.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

1 unchanged sentence

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