What changed in this filing

/stocks — the workspaceLOADING

Item 2. Management’s Discussion and Analysis

2022-05-05 compared with 2022-02-03 · 287 added, 247 removed, 152 unchanged (78% of the section changed)

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 consolidated 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 financial statements and the related notes and other financial

information appearing elsewhere in this report.

COMPANY OVERVIEW

2 unchanged sentences

(“Company,” “Pro-Dex,”

“we,” “our,” or “us”) for the three-month and six-month periods ended December 31, 2021 and 2020.

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.

The cautionary statements included herein should be read as being applicable to all related

forward-looking statements wherever they may appear.

“we,” “our,” or “us”) for the three-month and nine-month periods ended March 31, 2022 and 2021.

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

in this report.

This report contains certain forward-looking statements and information.

The cautionary statements included herein should be read as being applicable to all related forward-looking statements wherever they may

Our actual future results could differ materially from those discussed herein.

1 unchanged sentence

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, 2021.

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.

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, 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, 2021.

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.

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

13 unchanged sentences

Basis of Presentation

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, 2022, 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.

Unless otherwise stated, all dates refer to our fiscal

year and those fiscal quarters.

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, 2022, 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.

Unless otherwise stated, all dates refer to our fiscal year and those

fiscal quarters.

Critical Accounting Estimates and Judgments

7 unchanged sentences

Actual results may differ from these estimates.

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

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

1 unchanged sentence

Management believes that there have been no significant changes during

the three and six months ended December 31, 2021, to the items that we disclosed as our critical accounting policies in Management’s

the three and nine months ended March 31, 2022 to the items that we disclosed as our critical accounting policies in Management’s

Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended June

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 and thoracic markets.

Additionally, we have other significant engineering projects under

way described more fully below under “Results of Operations”.

In November 2020, we purchased an

approximate 25,000 square foot industrial building in Tustin, California (the “Franklin

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 and thoracic markets.

Additionally, we have other significant engineering

projects under way described more fully below under “Results of Operations.”

In November 2020, we purchased

an approximate 25,000 square foot industrial building in Tustin, California (the “Franklin

This building is located approximately four miles from our Irvine, California headquarters and was acquired to provide

4 unchanged sentences

Currently, we are actively engaged in various verification and validation

activities so that we can move certain employees and operations into the new building .

We expect that we will begin certain operations

in the new facility this fiscal year.

activities and we moved certain employees into the new building during the third quarter of this fiscal year.

In summary, our current objectives

19 unchanged sentences

· Curtailed business travel;

· Multiple, staggered work shifts have been implemented

in order to achieve effective social distancing;

· Provided training, education and appropriate

personal protective equipment;

· Monthly 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.

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 certain of our customers, including our principal customer.

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

supporting our customers according to their priorities and working with them to the degree that we can offer relief in the form of delayed

We are focused on continuity of supply by working with our suppliers, some of whom have delivered our orders late and are quoting

longer lead times.

While the COVID-19 pandemic has

not materially adversely affected our financial results and business during calendar 2021, we began to see some challenges in our supply

chain in the form of delayed shipments, longer lead times, and surcharges, much of which our suppliers indicate have been caused by the

COVID-19 pandemic.

During early calendar 2022, we are seeing these conditions persist and worsen such that we expect them to negatively

impact our financial performance in the third quarter and possibly the fourth quarter of fiscal 2022, reflected as a reduction in net

We continue to implement plans and processes to mitigate these challenges that many manufacturers similarly face.

Our long-term

prospects remain positive, and we believe these challenges will negatively impact us only in the short-term.

· Multiple, staggered work shifts

have been implemented in order to achieve effective social distancing;

· Provided training, education

and appropriate personal protective equipment;

· Company-wide COVID-19 testing

on a periodic basis.

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

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 any recommended deferrals of elective procedures by governments and other authorities, we would expect

to see a decline in demand from certain of our customers, including our principal customer.

We are focused on the health

and safety of all those we serve – our customers, our communities, our employees, and our suppliers.

We are supporting our customers

according to their priorities and working with them to the degree that we can offer relief in the form of delayed shipments.

We are focused

on continuity of supply by working with our suppliers, some of whom have delivered our orders late and are quoting longer lead times.

While the COVID-19 pandemic

has not materially adversely affected our financial results and business during calendar 2021, we began to see some challenges in our

supply chain in the form of delayed shipments, longer lead times, and surcharges, much of which our suppliers indicate has been caused

by the COVID-19 pandemic.

As previously disclosed, during early calendar 2022, we saw these conditions persist and worsen such that we

expected them to negatively impact our financial performance in the third quarter and possibly the fourth quarter of fiscal 2022, reflected

as a reduction in net sales.

While we did see a decline in our third quarter sales compared to sales during our fiscal first and second

quarter, we were able to largely mitigate our biggest concerns by sourcing replacement chips through alternative suppliers, albeit at

much higher prices, for many of our printed circuit board assemblies.

We continue to implement plans and processes to mitigate these challenges

that many manufacturers similarly face.

Our long-term prospects remain positive, and we believe these challenges will negatively impact

us only in the short-term.

Description of Business Operations

4 unchanged sentences

Three Months Ended

Six Months Ended

Nine Months Ended

Medical device products

1 unchanged sentence

Dental and component

NRE & Prototype

Discounts and other

NRE & Proto-type

Repairs and other

of our medical device products utilize proprietary designs developed by us under exclusive

development and/or supply agreements.

development and supply agreements.

All of our medical device

2 unchanged sentences

Three Months Ended

Six Months Ended

Nine Months Ended

Medical device sales:

of our medical device products increased $2.0 million, or 31%, for the three months ended December 31, 2021, and increased $3.5 million,

or 27%, for the six months ended December 31, 2021, compared to the corresponding periods of the prior fiscal year.

The majority, or $2.9

million, of our increase in medical device sales for the six months ended December 31, 2021, relates to sales of the orthopedic surgical

handpiece that we sell to our largest customer.

Sales of our CMF products increased $2.3 million for the six months ended December 31,

2021, compared to the corresponding period of the prior fiscal year, in part due to the launch of a new driver to our existing

largest customer during the third quarter of the prior fiscal year.

Offsetting this increase, thoracic

revenue decreased approximately $1.7 million for the six months ended December 31, 2021, compared to the corresponding period of

the prior fiscal year, due primarily as a result of our customer filling the near-term requirements of its distribution network.

of our medical device products decreased $4.1 million, or 39%, and $558,000, or 2%, respectively, for the three and nine months ended

March 31, 2022, respectively, compared to the corresponding periods of the prior fiscal year.

Our medical device revenue to our largest

customer, included in orthopedic sales above, decreased $1.5 million and increased $1.2 million, respectively, for the three and nine

months ended March 31, 2022 compared to the corresponding periods of the prior fiscal year .

In the third quarter of this fiscal

year there was a delay in shipping due to the release of our largest customer’s next generation device, which disruption we do not

expect to recur.

Additionally, recurring revenue from distributors of CMF drivers increased $27,000 and $2.4 million, respectively, for

the three and nine months ended March 31, 2022, compared to the corresponding periods of the prior fiscal year in

part due to the launch of a new driver to our existing largest customer during the third quarter of the prior fiscal year.

thoracic sales revenue decreased $2.8 million and $4.6 million, respectively, for the three and

nine months ended March 31, 2022, respectively, compared to the corresponding periods of the prior fiscal year , due primarily as

a result of our customer filling the near-term requirements of its distribution network.

of our compact pneumatic air motors, reported as industrial and scientific sales above, increased

$17,000, or 8%, and $69,000, or 18%, for the three and six months ended December 31, 2021, respectively, compared to the corresponding

$113,000, or 54%, and $182,000, or 31%, respectively, for the three and nine months ended March 31, 2022, compared to the corresponding

periods of the prior fiscal year.

1 unchanged sentence

substantive marketing efforts .

revenue remained relatively flat for the three and six months ended December 31, 2021, compared to the corresponding periods of the prior

fiscal year and are primarily comprised of repairs of handpieces for our largest customer.

December 2021, we had a backlog of approximately $6.0 million, of which $5.7 million is scheduled to be delivered in the third and fourth

quarters of fiscal 2022 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.

We may experience variability in our new order bookings due to various reasons, including, but not

limited to, the timing of major new product launches and customer planned inventory builds.

As an example, currently our largest customer

is delaying issuance of purchase orders to us because they are releasing a next generation of their handpiece, but we expect to receive

orders for the balance of the fiscal year shortly.

However, we do not typically experience seasonal fluctuations in our shipments and

of our dental products and components increased $179,000, or 746%, and $250,000, or 255%, respectively, for the three and nine months

ended March 31, 2022, compared to the corresponding periods of the prior fiscal year.

The increase was primarily related to sales to our

largest customer of component inventory used in their legacy design which we do not expect to recur.

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.

cessation of our dental line of products did not 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.

revenue increased $858,000, or 106%, and $284,000, or 7%, for the three and nine months ended March 31, 2022, 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.

March 31, 2022, we had a backlog of approximately $21.2 million, of which $7.9 million is scheduled to be delivered in the fourth quarter

of fiscal 2022 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.

may experience variability in our new order bookings due to various reasons, including, but not limited to, the timing of major new product

launches and customer planned inventory builds.

However, we do not typically experience seasonal fluctuations in our shipments and revenues.

Cost of Sales and Gross Margin

1 unchanged sentence

Three Months Ended

Six Months Ended

Nine Months Ended

Cost of sales:

3 unchanged sentences

Three Months Ended

Six Months Ended

Nine Months Ended

Year over Year

of sales for the three months ended December 31, 2021, increased $1.1 million, or 19%, compared to the corresponding period of the prior

fiscal year, due primarily to the 23% increase in sales for the same period and reduced COVID-19 compensated absences in the three months

ended December 31, 2021, compared to the corresponding period of the prior fiscal year.

profit increased by $808,000, or 31%, for the three months ended December 31, 2021, compared to the corresponding period of the prior

fiscal year, primarily as a result of the increase in revenue for the same period.

Gross margin as a percentage of sales increased by

approximately three percentage points compared to the corresponding period of the prior fiscal year due primarily to the increased sales,

described above.

of sales for the six months ended December 31, 2021, increased by $2.5 million, or 24%, compared to the corresponding period of the prior

of sales for the three months ended March 31, 2022, decreased $947,000, or 13%, compared to the corresponding period of the prior fiscal

The decrease in total costs of sales was caused by the 21% decrease in revenue for the same period.

Under-absorption of manufacturing

costs increased by $410,000 for the three months ended March 31, 2022, compared to the corresponding period of the prior fiscal year due

in part to our inability absorb our fixed costs, which were not reduced in the third quarter, in anticipation of future revenue growth.

Costs relating to inventory and warranty charges increased $178,000 for the third quarter ended March 31, 2022 compared to the third quarter

of the prior fiscal year, largely due to sourcing components for our printed circuit board assemblies at prices higher than usual.

previously disclosed, our supply chain has incurred many disruptions that suppliers indicate have been caused by the COVID-19 pandemic.

profit decreased by approximately $1.5 million, or 35%, for the three months ended March 31, 2022, compared to the corresponding period

of the prior fiscal year, consistent with the overall decrease in revenue.

Gross margin as a percentage of sales decreased by approximately

6 percentage points compared to the corresponding period of the prior fiscal year due primarily to reduced sales, increased under-absorption

of manufacturing costs as a result of decreased sales and the increases in inventory and warranty charges, which relates mostly to component

inventory write-downs to net realizable value as many of these component price increases cannot be passed on to our customers,

many of whom have price protections in place under long-term contracts .

of sales for the nine months ended March 31, 2022 increased by $1.6 million, or 9%, compared to the corresponding period of the prior

fiscal year, consistent with the increased revenue of 3% for the same period, the reasons for which are discussed above.

Additionally,

during the six months ended December 31, 2020, we had higher compensated absences related to COVID-19 than the corresponding period of

the current fiscal year.

profit increased by $761,000, or 13%, for the six months ended December 31, 2021, compared to the corresponding period of the prior fiscal

year, primarily as a result of increased sales to our largest customer.

Gross margin for the six months ended December 31, 2021, decreased

to 34% compared to 36% for the corresponding period of the prior fiscal year, due to price concessions to our largest customer.

total cost of sales reflects a $161,000 increase in under-absorbed manufacturing costs due to actual production hours being less than

Inventory and warranty charges increased by approximately $122,000, or 22%, for the nine months ended March 31, 2022, compared

to the corresponding period of the prior fiscal year, due to component inventory write-downs to net realizable value.

profit decreased by $767,000, or 7%, for the nine months ended March 31, 2022, compared to the corresponding period of the prior fiscal

year, primarily as a result of the increase in cost of sales described above.

Gross margin for the nine months ended March 31, 2022, decreased

by 4 percentage points compared to the corresponding period of the prior fiscal year.

Operating Expenses

2 unchanged sentences

Three Months Ended

Six Months Ended

Nine Months Ended

Year over Year % Change

7 unchanged sentences

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 six months ended

December 31, 2021, decreased $128,000, or 85%, and $221,000, or 79%, compared to the corresponding periods of fiscal 2021.

is primarily due to decreased personnel and related expenses due to combining our Director of Business Development position with our Director

of Engineering position in the first quarter of fiscal 2022.

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, 2022, decreased $116,000, or 85%, and $336,000, or 81%, respectively, compared to the corresponding periods of

The decrease is primarily due to decreased personnel and related expenses due to combining our Director of Business Development

position with our Director of Engineering position in the first quarter of fiscal 2022.

General and administrative expenses

(“G&A”) consists of salaries and other personnel-related expenses of our accounting, finance and human resource personnel,

(“G&A”) consist 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 $229,000 and $616,000, respectively, during the three and six months ended December

31, 2021, when compared to the corresponding periods of the prior fiscal year.

The increases relate primarily to non-cash compensation

expense related to the non-qualified stock options granted in the prior fiscal year.

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, 2021, decreased $374,000 and $484,000, respectively, compared to the corresponding periods of the prior fiscal year.

decreases are primarily due to increased spending on billable development projects.

When our engineers are engaged in a billable project

as opposed to an internal project, costs get shifted to cost of sales instead of research and 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 34% 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 internal projects

under development is summarized below (in thousands):

Three and Six Months Ended December 31, 2021

Three and Six Months Ended December 31, 2020

Market Launch (1)

Annual Revenue

Total Research & Development costs:

G&A decreased $135,000 and increased $480,000, respectively, during the three and nine months

ended March 31, 2022, when compared to the corresponding periods of the prior fiscal year.

The decrease in general and administrative

expenses for the three months ended March 31, 2022, compared to the corresponding period of fiscal 2021 relates primarily to reduced non-cash

compensation expense because 62,000 stock options granted in February 2021 vested in June 2021 and therefore compensation expense for

those awards ceased in fiscal 2021.

The increase in general and administrative expenses for the nine months ended March 31, 2022, compared

to the corresponding period of fiscal 2021 relate primarily to higher non-cash stock-based compensation expense related to the remaining

awards granted in the prior and current fiscal year.

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, 2022, decreased $446,000 and $930,000, respectively, compared to the corresponding periods of the prior fiscal

These decreases are primarily due to increased spending on billable development projects.

When our engineers are engaged in a billable

project as opposed to an internal project, costs get shifted to cost of sales instead of research and 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.

Many of our product development efforts are undertaken only upon completion of an analysis

of the size of the market, our ability to differentiate our product from our competitors’, as well as an analysis of our specific

sales prospects with new and/or existing customers.

The research and development costs represent between 36% and 49% 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):

and Nine Months Ended

March 31, 2022 Three

and Nine Months Ended

March 31, 2021

Total Research & Devel opment costs:

Products in development:

2 unchanged sentences

(1) Represents the calendar quarter of expected market launch.

The internal projects currently under development

have been delayed because we have been engaged by our customers to complete several billable non-recurring engineering projects.

(2) The products in development include risks that they could be abandoned in the future prior to completion,

they could fail to become commercialized, or the actual annual revenue realized may be less than the amount estimated.

(3) The CMF Driver was completed in the third quarter of fiscal 2021 and began shipping to our existing largest

customer under a distribution agreement we executed in the first quarter of fiscal 2021.

As we introduce new products into

the market, we expect to see an increase in sustaining and other engineering expenses.

Typical examples of sustaining engineering activities

include, but are not limited to, end-of- life component replacement, especially in electronic components found in our printed circuit

board assemblies, analysis of customer complaint data to improve process and design, replacement and enhancement of tooling and fixtures

used in our machine shop, assembly operations, and inspection areas to improve efficiency and through-put.

Additionally, these costs include

development projects that may be in their infancy and may or may not result in a full-fledged product development effort.

As we introduce new products

into the market, we expect to see an increase in sustaining and other engineering expenses.

Typical examples of sustaining engineering

activities include, but are not limited to, end-of- life component replacement, especially in electronic components found in our printed

circuit board assemblies, analysis of customer complaint data to improve process and design, replacement and enhancement of tooling and

fixtures used in our machine shop, assembly operations, and inspection areas to improve efficiency and through-put.

Additionally, these

costs include development projects that may be in their infancy and may or may not result in a full-fledged product development effort.

Interest & Other Income

Interest income for the three and

six months ended December 31, 2021 and 2020, includes interest and dividends from our money market accounts and investment portfolio.

Interest income for the three

and nine months ended March 31, 2022 and 2021, includes interest and dividends from our money market accounts and investment portfolio.

Interest Expense

2 unchanged sentences

elsewhere in this report.

Unrealized gain (loss)

on marketable equity investments

The unrealized gain (loss) on

marketable equity investments relates to our investment portfolio more fully described in Note 5 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

During the quarter ended March

31, 2021, we sold several of the stocks in our portfolio of equity investments receiving proceeds of $2.9 million and recording a gain

on the sale in the amount of $783,000.

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

and six months ended December 31, 2021, is slightly less than our combined expected federal and applicable state corporate income tax

rates due to federal and state research credits.

The effective tax rate for the three and six months ended December 31, 2020, is significantly

less than our combined expected federal and applicable state corporate income tax rates due to significant unrealized gains on our marketable

equity investments, 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.

The effective tax rate for the

three and nine months ended March 31, 2022, is slightly less than our combined expected federal and applicable state corporate income

tax rates due to federal and state research credits.

The effective tax rate for the three and nine months ended March 31, 2021, is 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 9 to the condensed consolidated financial statements contained elsewhere in this

report, as well as unrealized gains on our marketable equity investments.

Liquidity and Capital Resources

Cash and cash equivalents at December

31, 2021, increased $1.5 million to $5.2 million as compared to $3.7 million at June 30, 2021.

The following table includes a summary

of our condensed statements of cash flows contained elsewhere in this report.

As of and For the Six Months Ended December 31,

Cash and cash equivalents at

March 31, 2022, increased $1.0 million to $4.8 million as compared to $3.7 million at June 30, 2021.

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,

(in thousands)

7 unchanged sentences

Operating Activities

Net cash provided by operating activities

was $4.2 million for the six months ended December 31, 2021, primarily due to net income of $2.0 million and non-cash stock-based compensation

and depreciation and amortization of $575,000 and $366,000, respectively.

Although we experienced an influx of cash in the amount of $2.1

million in collections from receivables during the six months ended December 31, 2021, our inventory increased by $848,000.

Net cash provided by operating activities

was $1.1 million for the six months ended December 31, 2020, primarily due to net income of $2.9 million and non-cash depreciation and

amortization of $320,000 offset by unrealized gains on marketable securities in the amount of $1.3 million and 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 $4.4 million for the nine months ended March 31, 2022, primarily due to net income of $2.4 million and non-cash depreciation

and amortization of $546,000, share-based compensation of $932,000 and unrealized losses on marketable securities in the amount of $427,000

as well as an increase in accounts payable and accrued expenses of $673,000, deferred revenue of $746,000 and a decrease in accounts receivable

in the amount of $2.3 million.

Offsetting these sources of cash, our inventory increased by $3.4 million primarily due to replenishment

of sub-assemblies and long-lead time parts.

Net cash used in operating activities

was $2.8 million for the nine months ended March 31, 2021, primarily due to net income of $5.0 million and non-cash depreciation and amortization

of $502,000 and share-based compensation of $508,000 offset by an unrealized gain on marketable securities in the amount of $1.4 million

and an increase in accounts receivable in the amount of $6.8 million due to our largest customer changing their payment terms from net

30 to net 90 in conjunction with a contract extension.

Additionally, our net income included $795,000 of realized gains from the sales

of stock in our marketable securities portfolio.

Investing Activities

Net cash used in investing activities

for the six months ended December 31, 2021, was $1.4 million and related to an investment in marketable securities of $334,000 and equipment

and improvements primarily for the Franklin Property of $1.1 million.

During the second quarter ended

December 31, 2020, we closed on our acquisition of the Franklin Property.

We substantially completed the build-out of the property in

the first quarter of this fiscal year.

Currently, we are actively engaged in various verification and validation activities so that we

can move certain employees and operations into the new building.

We expect that we will begin certain operations in the new facility this

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.

for the nine months ended March 31, 2022, was $1.6 million and related to purchases of equipment and improvements primarily for the Franklin

Property in the amount of $1.3 million and investments in marketable equity securities of publicly traded companies in the amount of $334,000.

Net cash used in investing activities

for the nine months ended March 31, 2021, was $4.4 million and related primarily to the purchase of the Franklin Property acquired during

the second quarter of fiscal 2021 for a purchase price of $6.5 million as well as expenditures related to machinery and equipment totaling

Offsetting these uses of cash, we sold some of our marketable securities during the nine months ended March 31, 2021 for $3.0

Financing Activities

Net cash used in financing activities

for the six months ended December 31, 2021, totaled $1.3 million and related primarily to the $672,000 repurchase of 27,952 shares of

our common stock pursuant to our share repurchase program as well as $616,000 of principal payments on our loans from MBT.

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 10 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

for the nine months ended March 31, 2022, totaled $1.8 million and related primarily to the $1.3 million repurchase of 52,718 shares of

our common stock pursuant to our share repurchase program as well as $561,000 of principal payments on our term loan from Minnesota Bank

and Trust (“MBT”) more fully described in Note 11 to the condensed consolidated financial statements contained elsewhere in

Net cash provided by financing

activities for the nine months ended March 31, 2021, totaled $4.6 million and included $9.1 million in various loans from MBT more fully

described in Note 11 to the condensed consolidated financial statements contained elsewhere in this report, offset by $4.0 million related

to the repurchase of 161,291 shares of our common stock pursuant to our share repurchase program, $307,000 of principal payments on our

loans with MBT, 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.

Financing Facilities & Liquidity Requirements for the Next Twelve

As of December 31, 2021, our working

Financing Facilities & Liquidity Requirements for the next

twelve months

As of March 31, 2022, our working

capital was $20.4 million.

3 unchanged sentences

from operations.

We may also borrow against our $2.0 million Revolving Loan with MBT (See Note 10 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.

As we execute on our current strategy, however, we may require debt and/or equity

capital to fund our working capital needs and requirements for capital equipment to support our manufacturing and inspection processes.

We may also liquidate some or all of our investment portfolio or borrow against our $2.0 million Revolving Loan with

MBT (see Note 11 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.

As we execute on our current strategy, however, we may require debt and/or

equity capital to fund our working capital needs and requirements for capital equipment to support our manufacturing and inspection processes.

In particular, we have experienced negative operating cash flow in the past, especially as we procure long-lead time materials to satisfy

2 unchanged sentences

we can do so by selling additional shares of our common stock under the ATM Agreement.

(See Note 11 to condensed consolidated financial

statements contained elsewhere in this report).

Investment Strategy

We invest surplus cash from time

to time through our Investment Committee, which is comprised of one management director, Richard Van Kirk, and two non-management directors,

Raymond Cabillot and Nicholas Swenson, who chairs the committee.

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,

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 $3.2 million of

marketable public equity securities that we held at December 31, 2021.

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 $2.9 million of marketable public equity

securities held at March 31, 2022.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET

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 2. Management’s Discussion and Analysis