Quarterly Report

10-Q 1 pdex_10q.htm QUARTERLY REPORT Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

———————

FORM 10-Q


þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended DECEMBER 31, 2019
OR
¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________

Commission file number: 0-14942

PRO-DEX, INC.

(Exact name of registrant as specified in its charter)

———————


COLORADO	84-1261240
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

2361 McGaw Avenue, Irvine, California 92614

(Address of principal executive offices and zip code)

(949) 769-3200

(Registrant's telephone number, including area code)

———————

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, no par value	PDEX	NASDAQ Capital Market

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer þ	Smaller reporting company þ
	Emerging growth company ¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ

Indicate the number of shares outstanding of each of the registrant’s classes of common stock outstanding as of the latest practicable date: 3,872,756 shares of common stock, no par value, as of February 4, 2020.

PRO-DEX, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED DECEMBER 31, 2019

TABLE OF CONTENTS


	Page
PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (Unaudited)	1

Condensed Balance Sheets as of December 31, 2019 and June 30, 2019	1
Condensed Statements of Operations and Comprehensive Income for the Three and Six Months Ended December 31, 2019 and 2018	2
Condensed Statements of Shareholders’ Equity for the Three and Six Months Ended December 31, 2019 and 2018	3
Condensed Statements of Cash Flows for the Six Months Ended December 31, 2019 and 2018	4
Notes to Condensed Financial Statements	6

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	15

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	21

ITEM 4. CONTROLS AND PROCEDURES	21

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS	23

ITEM 1A. RISK FACTORS	23

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	23

ITEM 6. EXHIBITS	23

SIGNATURES	24

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PRO-DEX, INC.

CONDENSED BALANCE SHEETS

(Unaudited)

(In thousands, except share amounts)


	December 31, 2019		June 30, 2019
ASSETS
Current Assets:
Cash and cash equivalents	$	6,175	$	7,742
Investments		3,540		2,649
Accounts receivable, net of allowance for doubtful accounts of $17 and $0 at December 31, 2019 and at June 30, 2019, respectively		2,683		4,100
Deferred costs		492		430
Inventory		7,808		6,239
Prepaid expenses and other current assets		193		623
Total current assets		20,891		21,783
Equipment and leasehold improvements, net		2,768		2,726
Right of use asset, net		3,107		—
Intangibles, net		145		129
Deferred income taxes, net		163		260
Investments		1,610		582
Other assets		42		40
Total assets	$	28,726	$	25,520

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable	$	1,672	$	1,996
Accrued expenses		1,287		1,437
Deferred revenue		360		215
Note payable and capital lease obligations		633		622
Total current liabilities		3,952		4,270
Deferred rent		—		146
Lease liability, net of current portion		2,937		—
Income taxes payable		352		162
Notes and capital leases payable, net of current portion		3,613		3,934
Total non-current liabilities		6,902		4,242
Total liabilities		10,854		8,512
Shareholders’ equity:
Common shares; no par value; 50,000,000 shares authorized; 3,884,098 and 4,039,491 shares issued and outstanding at December 31, 2019 and June 30, 2019, respectively		13,634		15,815
Accumulated other comprehensive income (loss)		100		(549	)
Retained earnings		4,138		1,742
Total shareholders’ equity		17,872		17,008
Total liabilities and shareholders’ equity	$	28,726	$	25,520

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

PRO-DEX, INC.

CONDENSED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME

(Unaudited)

(In thousands, except per share amounts)


	Three Months Ended December 31,						Six Months Ended December 31,
	2019			2018			2019			2018

Net sales	$	7,961		$	6,399		$	15,201		$	13,314
Cost of sales		5,097			4,150			9,557			8,339
Gross profit		2,864			2,249			5,644			4,975

Operating (income) expenses:
Selling expenses		135			97			277			130
General and administrative expenses		664			633			1,327			1,197
Gain from disposal of equipment		—			—			—			(7	)
Research and development costs		397			326			881			735
Total operating expenses		1,196			1,056			2,485			2,055

Operating income		1,668			1,193			3,159			2,920
Interest expense		(63	)		(69	)		(122	)		(89	)
Interest and other income		33			93			68			168
Gain on sale of investments		—			356			—			356

Income from operations before income taxes		1,638			1,573			3,105			3,355
Income tax expense		(389	)		(394	)		(751	)		(827	)
Net income	$	1,249		$	1,179		$	2,354		$	2,528
Other comprehensive income (loss), net of tax:
Unrealized income (loss) from marketable equity investments		705			(494	)		649			(349	)
Comprehensive income	$	1,954		$	685		$	3,003		$	2,179

Basic net income per share:
Net income	$	0.32		$	0.28		$	0.59		$	0.59
Diluted net income per share:
Net income	$	0.31		$	0.28		$	0.58		$	0.59


Weighted average common shares outstanding:
Basic		3,950			4,195			3,979			4,263
Diluted		4,053			4,242			4,082			4,303
Common shares outstanding		3,884			4,143			3,884			4,143

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

PRO-DEX, INC.

CONDENSED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the Three and Six Months Ended December 31, 2019 and 2018

(Unaudited)

(In thousands)


	Three Months Ended December 31,						Six Months Ended December 31,
	2019			2018			2019			2018
*Common shares:*
Balance, beginning of period	$	15,161		$	18,639		$	15,815		$	19,835
Share-based compensation expense		8			8			19			18
Share repurchases		(1,535	)		(1,445	)		(2,215	)		(2,560	)
Shares withheld from common stock issued to pay employee payroll taxes		—			—			—			(101	)
Exercise of stock options		—			7			—			7
ESPP shares issued		—			—			15			10
Balance, at end of period	$	13,634		$	17,209		$	13,634		$	17,209

*Accumulated other comprehensive income (loss):*
Balance, beginning of period	$	(605	)	$	145		$	(549	)	$	(153	)
Net change in unrealized gain (loss) from marketable securities, net of taxes		705			(494	)		649			(196	)
Balance, at end of period	$	100		$	(349	)	$	100		$	(349	)

*Retained earnings/(accumulated deficit):*
Balance, beginning of period	$	2,889		$	(1,057	)	$	1,742		$	(2,406	)
Cumulative effect of change in accounting principle		—			—			42			—
Net income		1,249			1,179			2,354			2,528
Balance, at end of period	$	4,138		$	122		$	4,138		$	122

Total shareholders’ equity	$	17,872		$	16,982		$	17,872		$	16,982

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

PRO-DEX, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)


	Six Months Ended December 31,
	2019			2018
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	2,354		$	2,528
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		282			195
Gain from disposal of equipment		—			(7	)
Share-based compensation		19			18
Non-cash lease expense		22			—
Amortization of loan fees		4			—
Gain on sale of investments		—			(356	)
Deferred income taxes		97			742
Bad debt expense (recovery)		17			(13	)
Changes in operating assets and liabilities:
Accounts receivable and other current receivables		1,400			(838	)
Deferred costs		(62	)		(143	)
Inventory		(1,569	)		(147	)
Prepaid expenses and other assets		430			(46	)
Accounts payable and accrued expenses		(771	)		(301	)
Deferred revenue		145			(1	)
Income taxes payable		190			(123	)
Net cash provided by operating activities		2,558			1,508

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments		(1,271	)		(1,365	)
Purchases of equipment and leasehold improvements		(317	)		(540	)
Proceeds from sale of investments		—			1,905
Proceeds from sale of equipment		—			7
Increase in intangibles		(23	)		(14	)
Net cash used in investing activities		(1,611	)		(7	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Repurchases of common stock		(2,215	)		(2,560	)
Proceeds from exercise of options and ESPP contributions		15			17
Payment of employee payroll taxes on net issuance of common stock		—			(101	)
Proceeds from Minnesota Bank & Trust long-term debt, net of fees		—			4,942
Principal payments on notes payable and capital lease		(314	)		(116	)
Net cash provided by (used in) financing activities		(2,514	)		2,182

Net increase (decrease) in cash and cash equivalents		(1,567	)		3,683
Cash and cash equivalents, beginning of period		7,742			5,188
Cash and cash equivalents, end of period	$	6,175		$	8,871

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

PRO-DEX, INC.

CONDENSED STATEMENTS OF CASH FLOWS - CONTINUED

(Unaudited)

(In thousands)


	Six Months Ended December 31,
	2019		2018
Supplemental disclosures of cash flow information:

Cash paid during the period for:
Interest	$	103	$	66
Income taxes	$	13	$	305

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

PRO-DEX, INC.

NOTES TO CONSDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited condensed financial statements of Pro-Dex, Inc. (“we,” “us,” “our,” “Pro-Dex,” or the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and with applicable rules of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These financial statements should be read in conjunction with the financial statements presented in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. The results of operations for such interim periods are not necessarily indicative of the results that may be expected for the full year. For further information, refer to the financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended June 30, 2019.

RECENTLY ADOPTED ACCOUNTING STANDARDS

On July 1, 2019, we adopted ASU 2016-02 (Topic 842) “Leases,” using a modified retrospective approach through a cumulative effect adjustment to retained earnings as of the beginning of fiscal 2020. The objective of this update is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The impact of adoption was an increase to long-term assets and total liabilities of approximately $3.3 million as of July 1, 2019.

NOTE 2. DESCRIPTION OF BUSINESS

We specialize in the design, development and manufacture of autoclavable, battery-powered and electric, multi-function surgical drivers and shavers used primarily in the orthopedic and maxocranial facial markets. We have patented adaptive torque-limiting software and proprietary sealing solutions which appeal to our customers, primarily medical device distributors. We also manufacture and sell rotary air motors to a wide range of industries.

NOTE 3. COMPOSITION OF CERTAIN FINANCIAL STATEMENT ITEMS

Inventory

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


	December 31, 2019		June 30, 2019
Raw materials /purchased components	$	3,649	$	3,132
Work in process		2,394		1,511
Sub-assemblies/finished components		1,586		1,524
Finished goods		179		72
Total inventory	$	7,808	$	6,239

Investments

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


	December 31, 2019		June 30, 2019
Marketable equity securities - short-term	$	3,540	$	2,649
Marketable equity securities - long-term		1,610		582
Total marketable equity securities	$	5,150	$	3,231

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

Investments at December 31, 2019 and June 30, 2019 had an aggregate cost basis of $5,050,000 and $3,780,000, respectively. At December 31, 2019, the investments included net unrealized gains of $100,000 (gross unrealized gains of $329,000 offset by gross unrealized losses of $229,000). During the quarter ended December 31, 2019, we incurred net unrealized gains of $705,000. At June 30, 2019, the investments included net unrealized losses of $549,000 and no unrealized gains.

Of the total marketable equity securities at December 31, 2019 and June 30, 2019, $1,410,000 and $938,000, respectively, represent an investment in the common and preferred stock of Air T, Inc. Two of our Board members are also board members of Air T, Inc. and both either individually or through affiliates own an equity interest in Air T, Inc. Our Chairman, one of the two Board members aforementioned, also serves as the Chief Executive Officer and Chairman of Air T, Inc. The common stock was purchased through 10b5-1 Plans, and the purchased preferred stock was purchased through the exercise of issued warrants and in both cases, in accordance with our internal policies regarding the approval of related party transactions, purchases were approved by our three Board members that are not affiliated with Air T, Inc.

We invest surplus cash from time to time through our Investment Committee, which is comprised of one management director, Mr. Van Kirk, and two non-management directors, Mr. Cabillot and Mr. Swenson, who chairs the committee. Both Mr. Cabillot and Mr. Swenson are active investors with extensive portfolio management expertise. We leverage the experience of these committee members to make investment decisions for the investment of our surplus operating capital or borrowed funds. Additionally, many of our securities holdings include stocks of public companies that either Messrs. Swenson or Cabillot or both may own from time to time either individually or through the investment funds that they manage, or other companies whose boards they sit on, such as Air T, Inc.

Intangibles

Intangibles consist of the following (in thousands):


	December 31, 2019			June 30, 2019
Patent-related costs	$	198		$	175
Less accumulated amortization		(53	)		(46	)
	$	145		$	129

Patent-related costs consist of legal fees incurred in connection with both patent applications and a patent issuance, and will be amortized over the estimated life of the product(s) that is or will be utilizing the technology, or expensed immediately in the event the patent office denies the issuance of the patent. Since we do not know when, or if, our patent applications will be issued, the future amortization expense is not predictable.

NOTE 4. WARRANTY

The warranty accrual is based on historical costs of warranty repairs and expected future identifiable warranty expenses and is included in accrued expenses in the accompanying balance sheets. As of December 31, and June 30, 2019, the warranty reserve amounted to $141,000 and $136,000, respectively. Warranty expenses are included in cost of sales in the accompanying statements of operations. Changes in estimates to previously established warranty accruals result from current period updates to assumptions regarding repair costs and warranty return rates and are included in current period warranty expense. Warranty expense relating to new product sales and changes to estimates for the three months ended December 31, 2019 and 2018 was $44,000 and $16,000, respectively, and for the six months ended December 31, 2019 and 2018 was $56,000 and $30,000, respectively.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

Information regarding the accrual for warranty costs for the three and six months ended December 31, 2019 and 2018 are as follows (in thousands):


	As of and for the Three Months Ended December 31,
	2019			2018
Beginning balance	$	126		$	95
Accruals during the period		28			25
Changes in estimates of prior period warranty accruals		16			(9	)
Warranty amortization		(29	)		(12	)
Ending balance	$	141		$	99


	As of and for the Six Months Ended December 31,
	2019			2018
Beginning balance	$	136		$	107
Accruals during the period		53			54
Changes in estimates of prior period warranty accruals		3			(24	)
Warranty amortization		(51	)		(38	)
Ending balance	$	141		$	99

NOTE 5. NET INCOME PER SHARE

The Company calculates basic net income per share by dividing net income by the weighted-average number of common shares outstanding during the reporting period. The weighted-average number of common shares outstanding reflects the effects of potentially dilutive securities, in income generating periods, which consist entirely of outstanding stock options and performance awards.

The following table presents reconciliations of the numerators and denominators of the basic and diluted earnings per share computations for net income. In the tables below, income amounts represent the numerator, and share amounts represent the denominator (in thousands, except per share amounts):


	Three Months Ended December 31,				Six Months Ended December 31,
	2019		2018		2019		2018
Basic:
Net income	$	1,249	$	1,179	$	2,354	$	2,528
Weighted average shares outstanding		3,950		4,195		3,979		4,263
Basic income per share	$	0.32	$	0.28	$	0.59	$	0.59
Diluted:
Net income	$	1,249	$	1,179	$	2,354	$	2,528
Weighted average shares outstanding		3,950		4,195		3,979		4,263
Effect of dilutive securities – stock options		103		47		103		40
Weighted average shares used in calculation of diluted earnings per share		4,053		4,242		4,082		4,303
Diluted income per share	$	0.31	$	0.28	$	0.58	$	0.59

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 6. INCOME TAXES

Deferred income taxes are provided on a liability method whereby deferred tax assets and liabilities are recognized for temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

Significant management judgment is required in determining our provision for income taxes and the recoverability of our deferred tax assets. Such determination is based primarily on our historical taxable income, with some consideration given to our estimates of future taxable income by jurisdictions in which we operate and the period over which our deferred tax assets would be recoverable.

As of December 31, 2019, we have accrued $479,000 of unrecognized tax benefits related to federal and state income tax matters. None of this balance is expected to reduce the Company’s income tax expense if recognized.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):


	As of and for the Six Months Ended December 31,
	2019			2018
Beginning balance	$	490		$	462
Additions based on tax positions related to the current year		12			10
Reductions based on tax positions related to prior years		(23	)		—
Ending balance	$	479		$	472

We recognize accrued interest and penalties related to unrecognized tax benefits when applicable. As of December 31, 2019, no interest or penalties applicable to our unrecognized tax benefits have been accrued since we have sufficient tax attributes available to fully offset any potential assessment of additional tax.

We are subject to U.S. federal income tax, as well as income tax of multiple state tax jurisdictions. We are currently open to audit under the statute of limitations by the Internal Revenue Service for the years ended June 30, 2016 and later. Our state income tax returns are open to audit under the statute of limitations for the years ended June 30, 2015 and later. We do not anticipate a significant change to the total amount of unrecognized tax benefits within the next 12 months.

NOTE 7. SHARE-BASED COMPENSATION

Through June 2014, we had two equity compensation plans, the Second Amended and Restated 2004 Stock Option Plan (the “Employee Stock Option Plan”) and the Amended and Restated 2004 Directors’ Stock Option Plan (the “Directors’ Stock Option Plan”) (collectively, the “Former Stock Option Plans”). The Employee Stock Option Plan and Director’s Stock Option Plan were terminated in June 2014 and December 2014, respectively.

In September 2016, our Board approved the establishment of the 2016 Equity Incentive Plan, which was approved by our shareholders at the November 29, 2016 Annual Meeting. The 2016 Equity Incentive Plan provides for the award of up to 1,500,000 shares of our common stock in the form of incentive stock options, nonstatutory stock options, stock appreciation rights, restricted shares, restricted stock units, performance awards, and other stock-based awards. As of December 31, 2019, we have granted performance awards under the 2016 Equity Incentive Plan for up to 200,000 shares of our common stock, of which 40,000 shares have vested as further described below under the heading “Performance Awards.”

Stock Options

No options were granted during the three or six months ended December 31, 2019 and 2018.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

As of December 31, 2019, there was no unrecognized compensation cost under the Former Stock Option Plans, as all outstanding stock options are fully vested. As of December 31, 2019, the options outstanding had a weighted average remaining contractual life of 1.5 years and an intrinsic value of $847,000. Following is a summary of stock option activity for the six months ended December 31, 2019 and 2018:


	2019				2018
	Number of Shares		Weighted-Average Exercise Price		Number of Shares			Weighted-Average Exercise Price
Outstanding at July 1,		54,000	$	1.86		57,000		$	1.88
Options granted		—		—		—			—
Options exercised		—		—		(3,000	)		2.14
Options forfeited		—		—		—			—
Outstanding at end of period		54,000	$	1.86		54,000		$	1.86
Stock Options Exercisable at December 31,		54,000	$	1.86		54,000		$	1.86

Performance Awards

In December 2017, the Compensation Committee of the Board of Directors granted performance awards to our employees, for an aggregate of up to 200,000 shares of our common stock. Whether any performance awards vest, and the amount that does vest, is tied to the completion of service periods that range from 7 months to 9.5 years and the achievement of our common stock trading at certain pre-determined prices. The weighted average fair value of the performance awards granted was $4.46, calculated using the weighted average fair market value for each award, using a Monte Carlo simulation. We recorded share-based compensation expense of $8,000 for each of the three months ended December 31, 2019 and 2018, and $16,000 for each of the six months ended December 31, 2019 and 2018, related to these performance awards. On December 31, 2019, there was approximately $50,000 of unrecognized compensation cost related to these non-vested performance awards expected to be expensed over the weighted-average period of 3.37 years.

On July 1, 2018, it was determined by the Compensation Committee of our Board of Directors that the first of five tranches of performance awards had been achieved and participants were awarded 40,000 shares of common stock. Each participant elected a net issuance to cover their individual withholding taxes and therefore we issued 24,727 shares of common stock and paid $101,000 of participant related payroll tax liabilities.

Employee Stock Purchase Plan

In September 2014, our Board approved the establishment of an Employee Stock Purchase Plan (the “ESPP”), which was approved by our shareholders at the December 3, 2014 Annual Meeting. The ESPP conforms to the provisions of Section 423 of the Internal Revenue Code, has coterminous offering and purchase periods of six months, and bases the pricing to purchase shares of our common stock on a formula so as to result in a per share purchase price that approximates a 15% discount from the market price of a share of our common stock at the end of the purchase period. The Board of Directors also approved the provision that shares formerly reserved for issuance under the Former Stock Option Plans in excess of shares issuable pursuant to outstanding options under those plans, aggregating 704,715 shares, be reserved for issuance pursuant to the ESPP.

During the three months ended December 31, 2019 and 2018, we did not record any share-based compensation expense relating to the ESPP, due to the fact that no six-month offering period ended during either quarter. During the six months ended December 31, 2019 and 2018, 1,292 and 1,820 shares of our common stock were purchased under the ESPP, respectively, and allocated to employees based upon their contributions at prices of $11.76 and $5.51, respectively, per share. On a cumulative basis, since the inception of the ESPP, employees have purchased a total of 20,158 shares of our common stock. During the six months ended December 31, 2019 and 2018, we recorded share-based compensation expense in the amount of $3,000 and $2,000, respectively, relating to the ESPP.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 8. MAJOR CUSTOMERS AND SUPPLIERS

Information with respect to customers that accounted for sales in excess of 10% of our total sales in either of the three-month and the six-month periods ended December 31, 2019 and 2018 is as follows (in thousands, except percentages):


	Three Months Ended December 31,
	2019					2018
	Amount		Percent of Total			Amount		Percent of Total
Net sales	$	7,961		100	%	$	6,399		100	%

Customer concentration:
Customer 1	$	5,655		71	%	$	4,135		64	%
Customer 2		797		10	%		365		6	%
Total	$	6,452		81	%	$	4,500		70	%


	Six Months Ended December 31,
	2019					2018
	Amount		Percent of Total			Amount		Percent of Total
Net sales	$	15,201		100	%	$	13,314		100	%

Customer concentration:
Customer 1	$	11,067		74	%	$	8,449		64	%
Customer 2		1,340		9	%		845		6	%
Total	$	12,407		82	%	$	9,294		70	%

Information with respect to accounts receivable from those customers who comprised more than 10% of our gross accounts receivable at either December 31, 2019 or June 30, 2019, is as follows (in thousands, except percentages):


	December 31, 2019				June 30, 2019
Total gross accounts receivable	$	2,700	100	%	$	4,100	100	%

Customer concentration:
Customer 1	$	1,754	65	%	$	2,587	63	%
Customer 3		237	9	%		780	19	%
Total	$	1,991	74	%	$	3,367	82	%

During the three months ended December 31, 2019 and 2018, we had two suppliers accounting for 10% or more of total inventory purchases. During the six months ended December 31, 2019, we had two suppliers that accounted for more than 10% of our total inventory purchases, and during the six months ended December 31, 2018, we had one supplier that accounted for more than 10% of our total inventory purchases. Amounts owed to the fiscal 2020 significant suppliers at December 31, 2019 totaled $306,000 and $117,000, respectively, and at June 30, 2019 totaled $304,000 and $373,000, respectively.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 9. NOTES PAYABLE AND FINANCING TRANSACTIONS

Minnesota Bank & Trust

On September 6, 2018, we entered into a Credit Agreement with Minnesota Bank & Trust, a Minnesota state banking corporation (“MBT”), providing for a $5,000,000 term loan (the “Term Loan”) as well as a $2,000,000 revolving loan (the “Revolving Loan” and together with the Term Loan, collectively the “Loans”), evidenced by a Term Note A and a Revolving Credit Note made by us in favor of MBT. The Loans are secured by substantially all of our assets pursuant to a Security Agreement entered into on September 6, 2018 between us and MBT. We paid loan origination fees to MBT in the amount of $60,000.

The Term Loan matures on October 1, 2025 and bears interest at a fixed rate of 5.53% per annum. An initial payment of interest only in the amount of $18,433 was paid on October 1, 2018. Commencing November 1, 2018 and continuing on the first day of each subsequent month thereafter until the maturity date, we are required to make payments of principal and interest on the Term Loan of approximately $72,000, plus any additional accrued and unpaid interest through the date of payment. The balance owed on the Term Loan at December 31, 2019 is $4.2 million, net of unamortized loan fees. The Revolving Loan had an original maturity date of September 6, 2019 and has since been extended to November 6, 2020 and bears interest at the greater of (a) 4.5% or (b) the difference of the prime rate as published in the Money Rates section of the Wall Street Journal minus 0.50%. Commencing on the first day of each month after we initially borrow against the Revolving Loan, which we have yet to do, and each month thereafter until maturity, we are required to pay all accrued and unpaid interest on the Revolving Loan through the date of payment. Any principal on the Revolving Loan that is not previously prepaid shall be due and payable on the maturity date (or earlier termination of the Revolving Loan). As we have yet to borrow under the Revolving Loan, the balance owed under it at December 31, 2019 was $0.

Any payment on the Loans not made within seven days after the due date is subject to a late payment fee equal to 5% of the overdue amount. Upon the occurrence and during the continuance of an event of default, the interest rate of both Loans will be increased by 3% and MBT may, at its option, declare the Loans immediately due and payable in full.

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

NOTE 10. COMMON STOCK

Share Repurchase Program

In December 2019, our Board approved a new share repurchase program authorizing us to repurchase up to 1 million shares of our common stock, as the prior repurchase plan authorized by the Board in 2013 was nearing completion. In accordance with, and as part of, these share repurchase programs, our Board approved the adoption of several prearranged share repurchase plans intended to qualify for the safe harbor provided by Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (“10b5-1 Plan” or “Plan”). During the three and six months ended December 31, 2019, we repurchased 106,897 and 156,685 shares, respectively, at an aggregate cost, inclusive of fees under the plan, of $1,535,000 and $2,215,000, respectively. During the three and six months ended December 31, 2018, we repurchased 109,366 and 217,454 shares, respectively, at an aggregate cost, inclusive of fees under the plan, of $1,445,000 and $2,560,000, respectively. On a cumulative basis, since implementation of the share repurchase program in 2013, we have repurchased a total of 744,736 shares under the share repurchase program at an aggregate cost of $7.3 million. All repurchases under the 10b5-1 Plans were administered through an independent broker.

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

At The Market Offering Agreement

In February 2017, our Board approved an ATM Agreement with Ascendiant Capital Markets, LLC (“Ascendiant”). The ATM Agreement allows us to sell shares of our common stock pursuant to specific parameters defined by us as well as those defined by the SEC and the ATM Agreement. During the three and six months ended December 31, 2019 and 2018 we did not issue any shares under the ATM. From the inception of the ATM in February 2017 through December 31, 2017, during periods when we did not make purchases under our share repurchase program, we sold 340,465 shares of common stock for gross proceeds of $2,311,000 net of commissions and fees paid to Ascendiant totaling $72,000. In December 2017, the Board suspended the ATM indefinitely. The Board has the discretion to reactivate the ATM prior to February 16, 2020, the expiration of the ATM Agreement, unless earlier terminated by Ascendiant or us. However, we do not anticipate that the ATM will be reactivated prior to its expiration.

NOTE 11. LEASES

Effective July 1, 2019, we adopted the new lease accounting standard using the modified retrospective method of applying the new standard at the adoption date. In addition, we elected the practical expedient which allowed us to carry forward the historical lease classification of our sole operating lease for our corporate office, which includes our manufacturing and research and development facilities. Adoption of this standard resulted in the recording of net operating lease right-of-use (“ROU”) asset and corresponding operating lease liability of $3.3 million. Our financial position for reporting periods beginning on or after July 1, 2019 is presented under the new guidance, while prior period amounts are not adjusted and continue to be reported in accordance with previous guidance.

Our operating lease ROU asset and long-term liability are presented separately on our Condensed Balance Sheet. The current portion of our operating lease liability as of December 31, 2019, in the amount of $297,000, is presented within accrued expenses on the Condensed Balance Sheet.

As of December 31, 2019, the maturity of our lease liability is as follows:


	Operating Lease
Fiscal Year:
2020	$	232
2021		475
2022		489
2023		504
2024		519
Thereafter		1,796
Total lease payments		4,015
Less imputed interest:		(782	)
Total	$	3,233

PRO-DEX, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

As of December 31, 2019, our operating lease has a remaining lease term of seven years and nine months and an imputed interest rate of 5.3%. Cash paid for amounts included in the lease liability for the three and six months ended December 31, 2019 was $116,000 and $229,000, respectively. As previously disclosed in our 2019 Annual Report on Form 10-K and under the previous lease accounting standard, future minimum lease payments for our only operating lease having an initial or remaining noncancellable lease term in excess of one year would have been as follows:


	Operating Leases at June 30, 2019
Fiscal Year:
2020	$	461
2021		475
2022		489
2023		504
2024		519
Thereafter		1,796
Total minimum lease payments	$	4,244

NOTE 12. COMMITMENTS AND CONTINGENCIES

Legal Matters

We are from time to time a party to various legal proceedings incidental to our business. There can be no certainty, however, that we may not ultimately incur liability or that such liability will not be material and adverse.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

COMPANY OVERVIEW

The following discussion and analysis provides information that management believes is relevant to an assessment and understanding of the results of operations and financial condition of Pro-Dex, Inc. (“Company,” “Pro-Dex,” “we,” “our,” or “us”) for the three-month and six-month periods ended December 31, 2019 and 2018. This 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 appear. Our actual future results could differ materially from those discussed herein.

Except for the historical information contained herein, the matters discussed in this report, including, but not limited to, discussions of our product development plans, business strategies, strategic opportunities and market factors influencing our results, are forward-looking statements that involve certain risks and uncertainties. Actual results may differ from those anticipated by us as a result of various factors, both foreseen and unforeseen, including, but not limited to, our ability to continue to develop new products and increase sales in markets characterized by rapid technological evolution, consolidation within our target marketplace and among our competitors, competition from larger, better capitalized competitors, 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, 2019.

Our principal headquarters are located at 2361 McGaw Avenue, Irvine, California 92614 and our phone number is (949) 769-3200. Our Internet address is www.pro-dex.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and other SEC filings are available free of charge through our website as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. In addition, our Code of Ethics and other corporate governance documents may be found on our website at the Internet address set forth above. Our filings with the SEC may also be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov and company specific information at www.sec.gov/edgar/searchedgar/companysearch.html.

Basis of Presentation

The condensed results of operations presented in this report are not audited and those results are not necessarily indicative of the results to be expected for the entirety of the fiscal year ending June 30, 2020 or any other interim period during such fiscal year. 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 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, 2019, other than the required adoption of ASU 2016-02 (Topic 842), Leases, 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 30, 2019.

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.

Our patented adaptive torque-limiting software has been very well received in the CMF market and we have continued investment in this area with research and development focused on applying this technology to thoracic surgical applications. We have invested significantly since fiscal 2018 on a thoracic driver utilizing adaptive torque-limiting software, and in early fiscal 2019 entered a development contract with a current significant customer to private-label this driver for their unique specifications. We anticipate sales to this existing customer will increase late in fiscal 2020 as we add this product to their existing CMF driver and ancillary products that we currently supply.

In summary, our current objectives are focused primarily on maintaining our relationships with our current medical device customers, investing in research and development activities to design Pro-Dex branded drivers to leverage our torque-limiting software, and promoting active product development proposals to new and existing customers for both orthopedic shavers and screw drivers for a multitude of surgical applications, while monitoring closely the progress of all these individual endeavors. Our research and development, selling and general and administrative expenses have increased disproportionately to our growth in revenue as we focus on new product development and we anticipate this to continue in the near term. These expenditures are being made in an effort to release new products and garner new customer relationships. While we expect revenue growth in the future, it may not be a consistent trajectory but rather periods of incremental growth that current expenditures are helping to create. However, there can be no assurance that we will be successful in any of these objectives.

Description of Business Operations

Revenue

The majority of our revenue is derived from designing, developing and manufacturing surgical devices for the medical device industry. The proportion of total sales by type is as follows (in thousands, except percentages):


	Three Months Ended December 31,										Six Months Ended December 31,
	2019					2018					2019					2018
			% of Revenue					% of Revenue					% of Revenue					% of Revenue
Net Sales:
Medical device products	$	6,122		77	%	$	5,965		93	%	$	11,491		76	%	$	12,305		92	%
Industrial and scientific		182		2	%		196		3	%		345		2	%		484		4	%
Dental and component		23		—			111		2	%		94		2	%		239		2	%
NRE & Proto-type		114		2	%		83		1	%		267		—			133		1	%
Repairs and other		1,520		19	%		44		1	%		3,004		20	%		153		1	%
	$	7,961		100	%	$	6,399		100	%	$	15,201		100	%	$	13,314		100	%

Certain of our medical device products utilize proprietary designs developed by us under exclusive development and supply agreements. All of our medical device products utilize proprietary manufacturing methods and know-how, and are manufactured in our Irvine, California facility, as are our industrial products.

Sales of our medical device products increased $0.2 million, or 3%, for the three months ended December 31, 2019 and decreased $0.8 million, or 7%, for the six months ended December 31, 2019 compared to the corresponding periods of the prior fiscal year. Our medical device revenue to our largest customer increased $15,000 and decreased $270,000, respectively, for the three and six months ended December 31, 2019 compared to the corresponding periods of the prior fiscal year, due to contractual price concessions offset by slight volume increases. Additionally, revenue from two legacy medical device customers decreased approximately $789,000 and $1.0 million, respectively, for the three and six months ended December 31, 2019 compared to the corresponding periods of the prior fiscal year. Offsetting these decreases we sold approximately $350,000 and $525,000, respectively, in CMF drivers for the three and six months ended December 31, 2019 to a distributor that had not ordered from us since fiscal 2017. Additionally, recurring revenue from two other significant distributors of CMF drivers had combined increases in sales for the three and six months ended December 31, 2019 of $580,000 and $92,000, respectively, compared to the corresponding periods of the prior fiscal year.

Sales of our compact pneumatic air motors, reported as Industrial and scientific sales above, decreased $14,000, or 7%, and $139,000, or 29% for the three and six months ended December 31, 2019 compared to the corresponding periods of the prior fiscal year. The revenue decline relates to a lack of marketing efforts for these legacy products.

Sales of our dental products and components declined for the three and six months ended December 31, 2019 compared to the corresponding periods of the prior fiscal year and we expect future declines in this area as we are no longer manufacturing dental products, but rather are simply selling remaining component inventory. As previously discussed, in January 2018, we sent notification to our dental product customers that we were discontinuing the manufacture of these products. The cessation of our dental line of products is not expected to have a material impact on our financial position or results of operations and reflected a conscious decision to increase capacity for our medical device products.

Repair revenue increased $1.5 million and $2.9 million for the three and six months ended December 31, 2019, 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. Typically, upon initial product launch, repair revenue is minimal as most repairs are typically covered under warranty, but as the products mature in the marketplace and after a certain number of routine duty cycles in the operating room, repairs generally increase. We expect repair revenue for the remaining quarters of fiscal 2020 to be comparable to the revenue generated during the quarter ended December 31, 2019.

At December 2019, we had a backlog of approximately $15.8 million, of which $15.7 million is scheduled to be delivered in the third and fourth quarters of fiscal 2020 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. 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 December 31,										Six Months Ended December 31,
	2019					2018					2019					2018
			% of Total					% of Total					% of Total					% of Total
Cost of sales:
Product cost	$	5,027		99	%	$	3,988		96	%	$	9,497		99	%	$	8,070		97	%
Under(over)-absorption of manufacturing costs		14		—			94		2	%		1		—			95		1	%
Inventory and warranty charges		56		1	%		68		2	%		59		1	%		174		2	%
Total cost of sales	$	5,097		100	%	$	4,150		100	%	$	9,557		100	%	$	8,339		100	%


	Three Months Ended December 31,						Six Months Ended December 31,						Year over Year ppt Change
	2019			2018			2019			2018			Three Months		Six Months

Gross margin		36	%		35	%		37	%		37	%		1		—

Cost of sales for the three months ended December 31, 2019 increased $947,000 or 23% compared to the corresponding period of the prior fiscal year. The increase in total costs of sales is consistent with the 24% increase in revenue for the same period. Under-absorption of manufacturing costs decreased by $80,000 for the three months ended December 31, 2019 compared to the corresponding period of the prior fiscal year due primarily to adjustments made to our standard labor and overhead rates at the beginning of fiscal 2020 in anticipation of higher spending in our machine shop and quality departments. Costs relating to inventory and warranty charges decreased by $12,000 for the second quarter ended December 31, 2019 compared to the second quarter of the prior fiscal year.

Gross profit increased by approximately $615,000, or 27%, for the three months ended December 31, 2019 compared to the corresponding period of the prior fiscal year, primarily as a result of the increase in repair revenue discussed above. Gross margin as a percentage of sales increased by approximately 1 percentage point compared to the corresponding period of the prior fiscal year due primarily to the increased revenue, which allows us to better absorb our fixed manufacturing costs.

Cost of sales for the six months ended December 31, 2019 increased by $1.2 million, or 15%, compared to the corresponding period of the prior fiscal year, consistent with the increased revenue of 14% for the same period, the reasons for which are discussed above. Additionally, total cost of sales reflects a $94,000 decrease in under-absorbed manufacturing costs. We adjusted our standard labor and over-head rates at the beginning of fiscal 2020 in anticipation of higher spending in our machine shop and quality departments.

Gross profit increased by $669,000, or 13%, for the six months ended December 31, 2019 compared to the corresponding period of the prior fiscal year, primarily as a result of the increase in repair revenue discussed above. Gross margin for the six months ended December 31, 2019 remained flat at 37% compared to the corresponding period of the prior fiscal year.

Operating Expenses

Operating Costs and Expenses
(in thousands except % change)


	Three Months Ended December 31,										Six Months Ended December 31,										Year over Year % Change
	2019					2018					2019					2018					Three Months			Six Months
			% of Net Sales					% of Net Sales					% of Net Sales					% of Net Sales
Operating expenses:
Selling expenses	$	135		2	%	$	97		2	%	$	277		2	%	$	130		1	%		39	%		113	%
General and administrative expenses		664		8	%		633		10	%		1,327		9	%		1,197		9	%		5	%		11	%
Research and development costs		397		5	%		326		5	%		881		6	%		735		6	%		22	%		20	%
	$	1,196		15	%	$	1,056		17	%	$	2,485		16	%	$	2,062		16	%		13	%		21	%

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, 2019 increased $38,000, or 39%, and $147,000, or 113%, compared to the corresponding periods of fiscal 2019. These increases relate primarily to personnel-related expenses as we filled the previously vacant position of Director of Business Development during the first quarter of fiscal 2019.

General and administrative expenses (“G&A”) consists of salaries and other personnel-related expenses of our accounting, finance and human resource personnel, as well as costs for outsourced information technology services, professional fees, directors’ fees, and other costs and expenses attributable to being a public company. G&A increased $31,000 and $130,000, respectively, during the three and six months ended December 31, 2019 when compared to the corresponding periods of the prior fiscal year. The increases relate primarily to increased legal fees related to intellectual property matters, increased personnel-related expenses, a new scholarship program implemented to award college scholarships to children of our employees, as well as higher bad debt expense, and IT related expenses.

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, 2019 increased $71,000 and $146,000, respectively, compared to the corresponding periods of the prior fiscal year. These increases are primarily due to increased personnel-related expense and increased spending on internal development projects.

Although the majority of our research and development costs relate to sustaining activities related to products we currently manufacture and sell, we have created a product roadmap to develop future products. The research and development costs represent between 31% and 36% of total operating expenses for all periods presented and are expected to increase in the future as we continue to invest in the business. The amount spent on projects under development is summarized below (in thousands):


	Three and Six Months ended December 31, 2019				Three and Six Months ended December 31, 2018				Market Launch	Est Annual Revenue
Total Research & Development costs:	$	397	$	881	$	326	$	735

Products in development:
Thoracic Driver	$	17	$	37	$	33	$	107	03/20	$	4,000
Arthroscopic Shaver⁽¹⁾		3		11		38		60	06/21	$	600
ENT Shaver		66		155		—		—	01/21	$	2,000
Arthroscopic Attachment		—		—		9		16	⁽²⁾	$	150
CMF Driver		29		46		2		3	06/20	$	350
Sustaining & Other		282		632		244		549
Total	$	397	$	881	$	326	$	735

Customer CMF Driver ⁽³⁾	$	81	$	181	$	152	$	217	06/20	$	2,500


⁽¹⁾	This project has been internally pushed back to focus on our new internal Pro-Dex branded ENT shaver.
⁽²⁾	Internal development of this project is now complete, but we are looking for the most attractive sales channel.
⁽³⁾	Costs incurred related to customer contracts are included in costs of sales and deferred costs and are not included in research and development costs.

The completion of our thoracic driver is currently a priority for our engineering team. The costs in the table above represent our costs related to our Pro-Dex branded driver, which is substantially complete. As we previously discussed, in early fiscal 2019 we entered a development contract with a current significant customer to private-label this driver for their unique specifications. We have had technical delays related to performance of this driver with a specific customer attachment. We currently believe that we will launch this product later this third quarter of this fiscal year and have delayed the anticipated launch of most other products to focus on the completion of this thoracic driver.

Interest & Other Income

Interest income for the three and six months ended December 31, 2019 includes interest and dividends from our money market accounts and investment portfolio. During the three and six months ended December 31, 2019 we also recorded $8,500 and $17,000, respectively, of miscellaneous income related to cash collected related to note receivable extensions granted on a note we previously wrote off. The fiscal 2019 interest income related primarily to a loan participation note receivable that has since been paid in full, as well as approximately $28,000 and $39,000, respectively, for the three and six months ended December 31, 2018 in interest and dividend income from our money market accounts and investments.

Interest Expense

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

Gain on Sale of Investments

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

Income Tax Expense

The effective tax rate for the three and six months ended December 31, 2019 and 2018 is slightly less than our combined expected federal and applicable state corporate income tax rates due to federal and state research credits and the new foreign-derived intangible income deduction.

Liquidity and Capital Resources

Cash and cash equivalents at December 31, 2019 decreased $1.6 million to $6.2 million as compared to $7.7 million at June 30, 2019. 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,
	2019			2018
	(in thousands)
Cash provided by (used in):
Operating activities	$	2,558		$	1,508
Investing activities	$	(1,611	)	$	(7	)
Financing activities	$	(2,514	)	$	2,182

Cash and Working Capital:
Cash and cash equivalents	$	6,175		$	8,871
Working Capital	$	16,939		$	18,100

Operating Activities

Net cash provided by operating activities was $2.6 million for the six months ended December 31, 2019 primarily due to net income of $2.4 million and non-cash depreciation and amortization of $282,000. Although we experienced an influx of cash in the amount of $1.4 million in collections from receivables during the six months ended December 31, 2019, our inventory increased by $1.6 million primarily related to the thoracic driver that we plan to launch later this third quarter of fiscal 2020.

Net cash provided by operating activities was $1.5 million for the six months ended December 31, 2018 primarily due to net income of $2.5 million offset by an increase in accounts receivable of $838,000, reflecting a slower payment trend from our largest customer.

Investing Activities

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

During the six months ended December 31, 2018, we sold one of the stocks in our investment portfolio and received proceeds of $1.9 million, including a gain in the amount of $356,000. Offsetting this cash inflow, we also invested $1.4 million in marketable equity securities and purchased $540,000 in machinery and equipment.

Financing Activities

Net cash used in financing activities for the six months ended December 31, 2019 totaled $2.5 million and related primarily to the $2.2 million repurchase of 156,685 shares of our common stock pursuant to our share repurchase program as well as $314,000 of principal payments on our term loan from Minnesota Bank and Trust (“MBT”) more fully described in Note 9 to the condensed financial statements contained elsewhere in this report.

Net cash provided by financing activities for the six months ended December 31, 2018 included $5.0 million in a term loan from MBT, offset by $2.6 million related to the repurchase of 217,454 shares of our common stock pursuant to our share repurchase program.

Financing Facilities & Liquidity Requirements for the next twelve months

As of December 31, 2019, our working capital was $16.9 million. We currently believe that our existing cash and cash equivalent balances together with our accounts receivable balances will provide us sufficient funds to satisfy our cash requirements as our business is currently conducted for at least the next 12 months. In addition to our cash and cash equivalent balances, we expect to derive a portion of our liquidity from our cash flows from operations. We may also borrow against our $2.0 million Revolving Loan with MBT (See Note 9 to condensed financial statements contained elsewhere in this report).

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

Investment Strategy

Pro-Dex invests surplus cash from time to time through its Investment Committee which was formed in April 2013. The committee is comprised of one management director, Mr. Van Kirk, and two non-management directors, Mr. Cabillot and Mr. Swenson, who chairs the committee. Both Mr. Cabillot and Mr. Swenson are active investors with extensive portfolio management expertise. We leverage the experience of these committee members to make investment decisions for the investment of our surplus operating capital or borrowed funds. Additionally, many of our securities holdings include stocks of public companies that either Messrs. Swenson or Cabillot or both may own from time to time either individually or through the investment funds that they manage, or other companies whose boards they sit on. The Investment Committee approved each of the investments comprising the $5.2 million of marketable public equity securities held at December 31, 2019.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer (the principal executive officer and principal financial officer, respectively) conducted an evaluation of the design and operation of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)). The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures also include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.

In accordance with SEC rules, an evaluation was performed under the supervision and with the participation of our Principal Executive Officer and Principal Financial Officer of the effectiveness, as of December 31, 2019, of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). “Internal control over financial reporting” includes those policies and procedures that:

(1)

pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the issuer;

(2)

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and directors of the issuer; and

(3)

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the issuer’s assets that could have a material effect on the financial statements.

Based on that evaluation as of December 31, 2019, our Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective.

Internal Control over Financial Reporting

During the three months ended December 31, 2019, there were no changes in our internal controls over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

Inherent Limitations on the Effectiveness of Controls

In designing and evaluating our disclosure controls and procedures, our management recognized that any system of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See Note 12 of Notes to condensed financial statements contained elsewhere in this report.

ITEM 1A. RISK FACTORS

Our business, future financial condition and results of operations are subject to a number of factors, risks and uncertainties, which are disclosed in Item 1A, entitled “Risk Factors” in Part I of our Annual Report on Form 10-K for our fiscal year ended June 30, 2019 as well as any amendments thereto or additions and changes thereto contained in this quarterly report on Form 10-Q for the quarter ended December 31, 2019. Additional information regarding some of those risks and uncertainties is contained in the notes to the condensed financial statements included elsewhere in this report and in Item 2, entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I of this report. The risks and uncertainties disclosed in our Form 10-K, our quarterly reports on Form 10-Q and other reports filed with the SEC are not necessarily all of the risks and uncertainties that may affect our business, financial condition and results of operations in the future.

There have been no material changes to the risk factors as disclosed in our annual report on Form 10-K for the fiscal year ended June 30, 2019, except as provided in any amendments thereto.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Repurchases by us of our common stock during the quarter ended December 31, 2019 were as follows:


Period	Total Number of Shares Purchased	Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
October 1, 2019 to October 31, 2019	16,110	$14.08	16,110	96,051
November 1, 2019 to November 30, 2019	32,388	$12.83	32,388	63,663
December 1, 2019 to December 31, 2019	58,399	$15.28	58,399	1,000,000

All repurchases were made pursuant to our previously announced repurchase programs.

ITEM 6. EXHIBITS


Exhibit		Description
31.1		Certification of Principal Executive Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Principal Financial Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32		Certifications of Principal Executive Officer and Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema Document
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF		XBRL Taxonomy Extension Definition
101.LAB		XBRL Taxonomy Extension Label Linkbase Document
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


	PRO-DEX, INC.

Date: February 6, 2020	By:	/s/ Richard L. Van Kirk
		Richard L. Van Kirk
		Chief Executive Officer (principal executive officer)


Date: February 6, 2020	By:	/s/ Alisha K. Charlton
		Alisha K. Charlton
		Chief Financial Officer (principal financial officer and principal accounting officer)

EXHIBIT INDEX


Exhibit		Description
31.1		Certification of Principal Executive Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Principal Financial Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32		Certifications of Principal Executive Officer and Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema Document
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF		XBRL Taxonomy Extension Definition
101.LAB		XBRL Taxonomy Extension Label Linkbase Document
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document