What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-05-04 compared with 2023-02-02 · 268 added, 233 removed, 153 unchanged (77% 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

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(“Company,” “Pro-Dex,”

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

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, 2023 and 2022.

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.

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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, 2022.

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, 2022.

We specialize in the design, development,

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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, 2023, 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 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, 2023.

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

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

We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the

circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not

readily apparent from other sources.

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.

We base our estimates on historical experience and various other assumptions that are believed

to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets

and liabilities that are not readily apparent from other sources.

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

the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably

likely to occur could materially change the financial statements.

Management believes that there have been no significant changes during

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

An accounting policy is

deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at

the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that

are reasonably likely to occur could materially change the financial statements.

Management believes that there have been no significant

changes during the three and nine months ended March 31, 2023 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

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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

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

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and new products.

We completed the build-out of the property during fiscal 2022 and we received U.S.

Food and Drug Administration authorization

to commence manufacturing activities during the first quarter of fiscal 2023.

We are currently performing various verification and validation

activities for both equipment and processes, which includes the validation of our new clean room and we expect that we will begin operations

in the new facility during the third quarter of this fiscal year.

We substantially completed the build-out of the property in the first quarter

of the prior fiscal year.

Currently, we are actively engaged in various verification and

validation activities and we expect we will begin operations in the new facility during the fourth quarter of this fiscal year.

In summary, our current objectives

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new customer relationships.

This fiscal year, however, the majority of our engineering efforts relate to customer funded NRE projects,

which costs are reclassified to cost of sales.

While we expect revenue growth in the future, it may not be a consistent trajectory but

rather periods of incremental growth that current expenditures are helping to create.

However, there can be no assurance that we will

be successful in any of these objectives.

This fiscal year, however, the majority of our engineering efforts relate to customer funded non-recurring

engineering (“NRE”) projects, which costs are reclassified to cost of sales.

While we expect revenue growth in the future,

it may not be a consistent trajectory but rather periods of incremental growth that current expenditures are helping to create.

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

COVID-19 Pandemic

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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.

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

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.

During fiscal 2022, we began to

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Three Months Ended

Six Months Ended

Nine Months Ended

Medical device products

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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

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Three Months Ended

Six Months Ended

Nine Months Ended

Medical device sales:

of our medical device products increased $0.4 million, or 4%, for the three months ended December 31, 2022, and decreased slightly by

$32,000 for the six months ended December 31, 2022, compared to the corresponding periods of the prior fiscal year.

of our medical device products increased $463,000, or 7%, and $432,000, or 2%, respectively, for the three and nine months ended March

31, 2023, compared to the corresponding periods of the prior fiscal year.

Our medical device revenue to our largest customer,

included in orthopedic sales above, increased $633,000 and $1.0 million, respectively, for the three and nine months ended March 31, 2023

compared to the corresponding periods of the prior fiscal year .

Additionally, recurring revenue from distributors of CMF drivers

increased $793,000 and $124,000, respectively, for the three and nine months ended March 31, 2023, 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.

Our thoracic sales revenue decreased $963,000 and $693,000,

for the three and nine months ended March 31, 2023, respectively, compared to the corresponding

periods of the prior fiscal year , due primarily as a result of our customer for our thoracic driver filling the near-term requirements

of its distribution network.

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

$30,000, or 13%, and $23,000, or 5%, respectively, for the three and six months ended December 31, 2022, compared to the corresponding

$61,000, or 19%, and $84,000, or 11%, respectively, for the three and nine months ended March 31, 2023, compared to the corresponding

periods of the prior fiscal year.

These are legacy products with no substantive marketing efforts .

Our non-recurring (“NRE”)

and proto-type revenue increased $368,000, or 320%, and $1.1 million, or 347%, for the three and six months ended December 31, 2022, compared

to the corresponding periods of the prior fiscal year, due to an increase in billable contracts for various NRE projects undertaken for

our customers.

revenue increased $521,000, or 33%, and $1.3 million, or 43%, respectively, for the three and six months ended December 31, 2022, compared

to the corresponding periods of the prior fiscal year, and are primarily comprised of repairs of handpieces for our largest customer.

This increase was expected as we have been asked to upgrade handpieces to the next generation, which design was released to manufacture

in the third quarter of fiscal 2022.

We expect to continue to see increases in repair revenue for the remainder of this fiscal year because

our largest customer has requested, beginning in December 2022, that we perform an enhanced repair on each handpiece, which includes the

advance replacement of certain components.

December 31, 2022, we had a backlog of approximately $20.7 million, of which $12.0 million is scheduled to be delivered in the third and

fourth quarters of fiscal 2023 and the balance is scheduled to be delivered next fiscal year and beyond.

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.

However, we do not typically

experience seasonal fluctuations in our shipments and revenues.

NRE and proto-type revenue increased $421,000, or 77%, and $1.5 million, or 175%, for the three and nine months ended March 31, 2023,

compared to the corresponding periods of the prior fiscal year, due to an increase in billable contracts for various NRE projects undertaken

for our customers.

of our dental products and components decreased $160,000, or 79%, and $166,000, or 48%, respectively, for the three and nine months ended

March 31, 2023, compared to the corresponding periods of the prior fiscal year.

In the prior fiscal year we sold component inventory to

our largest customer used in their legacy design which did not recur in the current fiscal year.

We expect future declines in this area

as we are no longer manufacturing dental products, but rather are simply selling remaining component inventory.

revenue increased $3.2 million or 189%, and $4.3 million, or 102%, for the three and nine months ended March 31, 2023, 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.

This increase was expected as we have been upgrading handpieces to the next generation, which design was released to manufacture in the

third quarter of fiscal 2022.

Additionally, we completed negotiations on repair pricing and terms with

this customer during the three months ended March 31, 2023, and received an additional $520,000 in compensation during the third quarter

of this fiscal year, for handpieces upgraded between July 2022 and December 2022 and reached an agreement for future consideration which

we expect to recognize in a future fiscal year.

We expect to continue to see increases in repair revenue, albeit at reduced margins,

for the remainder of this fiscal year because this customer has requested that we perform an enhanced repair on each handpiece, which

includes the advance replacement of certain components.

March 31, 2023, we had a backlog of approximately $18.8 million, of which $8.5 million is scheduled to be delivered in the fourth quarter

of fiscal 2023 and the balance is scheduled to be delivered next fiscal year and beyond.

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.

However, we do not typically experience seasonal

fluctuations in our shipments and revenues.

Cost of Sales and Gross Margin

(in thousands except percentages)

Three Months Ended

Six Months Ended

Cost of sales:

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Three Months Ended

Six Months Ended

Nine Months Ended

Year over Year

of sales for the three and six months ended December 31, 2022, increased $1.9 million, or 28%, and $3.5 million, or 26%, respectively,

compared to the corresponding periods of the prior fiscal year.

Although some of the increase in cost of sales is consistent with the

11% increase in revenue for the same periods, approximately $432,000 and $882,000, of the increases, respectively, relate to the more

costly repairs performed to upgrade the orthopedic handpieces we sell our largest customer to the newest release at no additional cost.

In late December 2022 we began an enhanced repair program, which has an agreed upon repair price, such that we should see improvement

in our margins in the second half of fiscal 2023.

That said, however, we are continuing to negotiate with our largest customer to recover

the additional cost of the repairs completed in the first half of this fiscal year.

Additionally, under-absorption for the three and six

months ended December 31, 2022, increased $448,000, or 180%, and $875,000, or 858%, respectively, compared to the corresponding periods

of the prior fiscal year, primarily due to the growth of indirect costs in our machine shop, materials, assembly and quality departments

outpacing actual production hours.

profit decreased by $781,000, or 23%, and $1.2 million, or 18%, for the three and six months ended December 31, 2022, respectively, compared

to the corresponding periods of the prior fiscal year, primarily as a result of the increase in repair costs for our largest customer’s

handpiece as well as higher indirect costs in our machine shop, assembly, materials and quality departments.

Gross margin as a percentage

of sales for the three and six months ended December 31, 2022 decreased by approximately eleven and nine percentage points, respectively,

compared to the corresponding periods of the prior fiscal year due to higher cost of sales described above.

of sales for the three months ended March 31, 2023, increased $2.9 million, or 45%, compared to the corresponding period of the prior

The increase in total costs of sales was caused by the 41% increase in revenue for the same period.

Under-absorption of manufacturing

costs increased by $201,000 for the three months ended March 31, 2023, compared to the corresponding period of the prior fiscal year due

in part to our inability to absorb our fixed costs, which were not reduced in the third quarter of the current fiscal year in anticipation

of future revenue growth.

Costs relating to inventory and warranty charges decreased $385,000 for the third quarter ended March 31, 2023

compared to the third quarter of the prior fiscal year, largely due to a reduction in warranty expenses.

profit increased by approximately $953,000, or 33%, for the three months ended March 31, 2023, compared to the corresponding period of

the prior fiscal year, consistent with the overall increase in revenue.

Gross margin as a percentage of sales decreased by approximately

2 percentage points compared to the corresponding period of the prior fiscal year due primarily to increased under-absorption of manufacturing

costs as a result of additional indirect costs in our manufacturing, assembly, and quality departments, especially related to ongoing

verification and validation activities for the Franklin Property.

of sales for the nine months ended March 31, 2023 increased by $6.3 million, or 32%, compared to the corresponding period of the prior

Although some of the increase in cost of sales is consistent with the 21% increase in revenue for the same period, the reasons

for which are discussed above, the enhanced repair program implemented for our largest customer includes the advance replacement of certain

components which has contributed to a $1.4 million increase in cost of sales.

Additionally, total cost of sales reflects a $1.1 million

increase in under-absorbed manufacturing costs due to actual production hours being less than planned as well as the additional indirect

costs in our manufacturing, assembly, and quality operations described above.

Inventory and warranty charges decreased by approximately

$383,000, or 57%, for the nine months ended March 31, 2023, compared to the corresponding period of the prior fiscal year, due to reduced

component inventory write-downs as a result of sourcing high priced components for our printed circuit board assemblies in the prior fiscal

profit decreased by $299,000, or 3%, for the nine months ended March 31, 2023, 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, 2023, decreased

by 7 percentage points compared to the corresponding period of the prior fiscal year.

Operating Expenses

Operating Costs and Expenses

(in thousands except % change)

Three Months Ended

Six Months Ended

Year over Year % Change

% of Net Sales

(in thousands except percentages)

over Year % Change

Operating expenses:

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Research and development costs

Selling expenses consist of salaries

and other personnel-related expenses for our business development department, as well as advertising and marketing expenses, and travel

and related costs incurred in generating and maintaining our customer relationships.

Selling expenses for the three and six months ended

December 31, 2022 increased $46,000 and $63,000, respectively, compared to the corresponding periods of fiscal 2022.

The increase is primarily

due to increased sales commissions.

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 decreased $214,000 and $282,000, respectively, during the three and six months ended December

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

The decreases relate primarily to reduced legal expenses

related to employment matters and reduced non-cash compensation expense related to stock compensation, offset by increased legal fees

related to intellectual property matters.

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, 2022 decreased $148,000 and $201,000, respectively, compared to the corresponding periods of the prior fiscal year.

decreases are primarily due to increased personnel related expenses offset by decreased spending on internal development projects.

our engineers are engaged in billable projects as opposed to internal projects, costs get shifted to cost of sales instead of research

and 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 nine

months ended March 31, 2023, increased $4,000, or 20%, and $67,000, or 85%, respectively, compared to the corresponding periods of fiscal

The increase is primarily due to increased sales commissions.

General and administrative

expenses (“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 decreased $136,000 and $419,000, respectively, during the three and nine

months ended March 31, 2023, when compared to the corresponding periods of the prior fiscal year.

The decreases relate primarily to reduced

legal and settlement expenses related to employment matters and reduced non-cash compensation expense related to stock compensation, offset

by increased legal fees related to intellectual property matters.

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 months

ended March 31, 2023, increased $55,000, or 8%, compared to the corresponding periods of the prior fiscal year.

Research and development

costs for the nine months ended March 31, 2023, decreased $145,000, or 6%, compared to the corresponding periods of the prior fiscal year.

This relates to increased personnel and related expense offset by decreased spending on internal engineering projects and a shift 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

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roadmap to develop future products.

The research and development costs represent between 31% and 41% 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, 2022

Three and Six Months Ended

December 31, 2021

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 41% of total operating expenses

for all periods presented and are expected to increase in the future as we continue to invest in product development efforts.

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

and Nine Months Ended March 31, 2023

and Nine Months Ended March 31, 2022

Annual Revenue (2)

Total Research & Development costs:

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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 or projects that

are later abandoned.

For instance, in prior filings we included expenses related to the VITAL ventilator product, which we have removed

from the table above because we did not spend any resources on this project in the first half of fiscal 2023 and we do not expect to in

the foreseeable future.

Interest & Other Income

Interest income for the three and

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

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

Interest & Other

Interest income for the three

and nine months ended March 31, 2023 and 2022, includes interest and dividends from our money market accounts and investment portfolio.

Interest Expense

Interest expense consists primarily

of interest expense related to our Minnesota Bank and Trust (“MBT”) loans described more fully in Note 10 to the condensed

consolidated financial statements contained elsewhere in this report.

of interest expense related to the notes payable described more fully in Note 10 to the condensed consolidated financial statements contained

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 4 to the condensed consolidated

financial statements contained elsewhere in this report.

Gain on Sale of Investments

During the first quarter ended

September 30, 2022, we sold some of the stocks in our portfolio of equity investments receiving proceeds of $88,000 and recording a gain

on the sale in the amount of $7,000.

Income Tax Expense

The effective tax rate for the three

and six months ended December 31, 2022 and 2021 is slightly less than our combined expected federal and applicable state corporate income

tax rates due to federal and state research credits.

Liquidity and Capital Resources

Cash and cash equivalents at December

31, 2022 decreased $467,000 to $382,000 as compared to $849,000 at June 30, 2022.

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

The effective tax rate

for the three and nine months ended March 31, 2023 and 2022, is slightly less than our combined expected federal and applicable state

corporate income tax rates due to federal and state research credits.

Additionally, the current year effective tax rate for the nine months

ended March 31, 2023 is less than our combined expected federal and applicable state corporate income tax rates due to a tax benefit recognized

as a result of common stock awarded to employees under previously granted performance awards in the first quarter of fiscal 2023 as described

more fully in Note 8 to the condensed consolidated financial statements contained elsewhere in this report, as well as unrealized gains

on our marketable equity investments.

Liquidity and Capital

Cash and cash equivalents

at March 31, 2023, increased $1.2 million to $2.1 million as compared to $849,000 at June 30, 2022.

The following table includes

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

and For the Nine Months Ended March 31,

(in thousands)

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Operating Activities

Net cash provided by operating activities

was $2.5 million for the six months ended December 31, 2022, primarily due to net income of $2.0 million and non-cash depreciation and

amortization of $385,000 offset by unrealized gains on marketable securities in the amount of $408,000.

Accounts receivable net collections

amounted to $3.2 million for the six months ended December 31, 2022, offset by expenditures of $2.5 million for inventory, based primarily

upon a forecast received from our largest customer, which later was reduced.

Although current inventory levels exceed immediate requirements

for this customer, they do not exceed the amounts that they will eventually purchase contractually.

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 $4.8 million for the nine months ended March 31, 2023, primarily due to net income of $3.3 million, non-cash

depreciation and amortization of $594,000, share-based compensation of $584,000, and collections of accounts receivable in the amount

of $4.8 million offset by a decrease in accounts payable and accrued expenses of $1.0 million, a decrease in deferred revenue of $956,000,

and an increase in inventory in the amount of $2.5 million.

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, 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, an increase in 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.

Investing Activities

Net cash used in investing activities

for the six months ended December 31, 2022 was $598,000 and related mostly to improvements and equipment primarily for the Franklin Property.

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.

Net cash used in investing

activities for the nine months ended March 31, 2023, was $733,000 and related primarily to the purchases of equipment and improvements

primarily for the Franklin Property totaling $822,000.

Offsetting this use of cash, we sold some of our marketable securities during the

nine months ended March 31, 2023 for $89,000.

Net cash used in investing

activities 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.

Financing Activities

Net cash used in financing activities

for the six months ended December 31, 2022 included net principal payments of $839,000 on our existing loans from MBT more fully described

in Note 10 to the condensed consolidated financial statements contained elsewhere in this report, the repurchase of $1.3 million of our

common stock pursuant to our share repurchase program, as well as $223,000 of employee payroll taxes related to the award of 37,500 shares

of common stock to employees under previously granted performance awards.

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.

Financing Facilities & Liquidity Requirements for the Next Twelve

As of December 31, 2022, our

working capital was $19.7 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 $7.0 million Amended Revolving Loan with MBT

(See Note 10 to the condensed consolidated financial statements contained elsewhere in this report).

Net cash used in financing

activities for the nine months ended March 31, 2023, totaled $2.9 million and related primarily to the $1.5 million repurchase of 86,422

shares of our common stock pursuant to our share repurchase program, $4.8 million of payments to Minnesota Bank and Trust (“MBT”)

as well as payment of $223,000 of employee payroll taxes related to the award of 37,500 shares of common stock to employees under previously

granted performance awards.

Offsetting these uses of cash we also borrowed $3.6 million from MBT under our amended revolving loan, and

collected $78,000 and $11,000, respectively, related to employee contributions to the ESPP plan and exercises of stock options.

Net cash used in financing

activities 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 loans from MBT more

fully described in Note 10 to the condensed consolidated financial statements contained elsewhere in this report.

Financing Facilities & Liquidity Requirements for the next

twelve months

As of March 31, 2023, our working

capital was $21.0 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

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 liquidate some or all of our investment portfolio or borrow further against our $7.0 million Amended Revolving

Loan with MBT (see Note 10 to condensed consolidated financial statements contained elsewhere in this report), under which we had availability

of $5.2 million as of March 31, 2023.

We are focused on preserving our

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We believe that if we need to raise additional capital to fund our operations

we can do so by borrowing against our Amended Revolving Loan or by selling additional shares of our common stock under the ATM Agreement.

(See Note 11 to the condensed consolidated financial statements contained elsewhere in this report).

beyond the cash available from the strategies mentioned above, 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.

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 $2.9 million of

marketable public equity securities that we held at December 31, 2022.

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 $2.7 million of marketable public equity

securities held at March 31, 2023.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET

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Item 2. Management’s Discussion and Analysis