NOTES TO FINANCIAL STATEMENTS
| 1. | 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, thoracic, and craniomaxillofacial markets. We have patented adaptive torque-limiting technology
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.
In August 2020, we formed a wholly
owned subsidiary, PDEX Franklin, LLC (“PDEX Franklin”), to hold title for an approximate 25,000 square foot industrial building
in Tustin, California (the “Franklin Property”) that we acquired on November 6, 2020, in order to allow for the continued
growth of our business. The consolidated financial statements include the accounts of the Company and PDEX Franklin and all significant
inter-company accounts and transactions have been eliminated. This subsidiary has no separate operations.
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
The summary
of significant accounting policies presented below is designed to assist the reader in understanding our consolidated financial statements.
Such consolidated financial statements and related notes are the representations of management, who is responsible for their integrity
and objectivity. In the opinion of management, these accounting policies conform to accounting principles generally accepted in the United
States of America (“U.S. GAAP”) in all material respects and have been consistently applied in preparing the accompanying
consolidated financial statements.
Revenue Recognition
Revenue from product sales is recognized
as promulgated by the Financial Accounting Standards Board (“FASB”) in Accounting Standards Update (“ASU”) 2014-09,
Revenue from Contracts with Customers once our contract(s) with a customer and the performance obligations in the contract have
been identified, and the transaction price has been allocated to the performance obligations and revenue is recorded when (or as) we satisfy
each performance obligation, generally upon shipment.
Revenue
from services, typically non-recurring engineering services related to the design or customization of a medical device, is typically recognized
over time. The customer funding for costs incurred for non-recurring engineering services is deferred and subsequently recognized as revenue
as under-lying products or services are delivered to the customers. Additionally, expenses incurred, up to the customer agreed funding
amount, are deferred as an asset and recognized as cost of sales when the under-lying products or services are delivered to the customer.
The deferred customer funding and costs result in recognition of deferred costs (asset) and deferred revenue (liability) on our consolidated
balance sheets.
One of our customer contracts can
give rise to variable consideration due to volume rebates. We estimate variable consideration at the most likely amount we will receive
from our customer. Our estimates of variable consideration are based on an assessment of our anticipated performance and all information
(historical, current, and forecasted) that is reasonably available to us.
Returns of our product for credit
are minimal; accordingly, we do not establish a reserve for product returns at the time of sale.
Estimated Losses on Product Development Services
Cost
and revenue estimates related to the product development service portions of development and supply contracts are reviewed and updated
quarterly. An expected loss on development service contracts is recognized immediately in cost of sales. Losses recorded in fiscal 2022
and 2021 related to these services totaled $0 and $71,000, respectively.
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Owing
to the complexity of many of the contracts we have undertaken, the cost estimation process requires significant judgment. It is based
upon the knowledge and experience of our project managers, engineers, and finance professionals. Factors that are considered in estimating
the cost of work to be completed and ultimate profitability of the fixed price product development portion of development and supply contracts
include the nature and complexity of the work to be performed, availability and productivity of labor, the effect of change orders, the
availability of materials, performance of subcontractors, and expected costs for specific regulatory approvals.
Warranties
Certain of our products are sold
with a warranty that provides for repairs or replacement of any defective parts for a period, generally one to two years, after the sale.
At the time of the sale, we accrue an estimate of the cost of providing the warranty based on prior experience with such factors as return
rates and repair costs, which factors are reviewed quarterly.
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. 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.
Cash and Cash Equivalents
We consider all highly liquid investments
with an original maturity of ninety days or less to be cash equivalents. At June 30, 2022 and 2021, cash equivalents consisted of investments
in money market funds.
Accounts Receivable
Trade receivables are stated at
their original invoice amounts, less an allowance for doubtful portions of such accounts. Management determines the allowance for doubtful
accounts based on facts and circumstances related to specific accounts and the age of accounts. Trade receivables are written off when
deemed uncollectible. Recoveries of trade receivables previously reserved are offset against the allowance when received.
Deferred Costs
Deferred costs reflect costs incurred
related to non-recurring engineering services under the terms of the related development and/or supply contracts. These costs get recorded
to cost of sales in the period that the revenue is recognized.
Inventories
Inventories are stated at the lower
of cost (first-in, first-out method) or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the
purchase and production of inventories. Reductions to estimated market value are recorded and charged to cost of sales, when indicated
based on a formula that compares on-hand quantities to both historical usage and estimated demand over the ensuing 12 months from the
measurement date. On an ongoing basis, we evaluate inventory for obsolescence and slow-moving items. This evaluation includes analysis
of historical sales and usage, existing demand, as well as specific factors known to management. As of June 30, 2022 and 2021, there was
approximately $177,000 and $128,000, respectively, of inventory in-transit from suppliers.
Investments
Investments at June 30, 2022 and
2021, consist of marketable equity securities of publicly held companies. The investments were made to realize a reasonable return, although
there is no assurance that positive returns will be realized. Investments are marked to market at each measurement date, with unrealized
gains and losses presented separately within other income and expense on the consolidated income statement. Certain investments consist
of common stocks of public companies that are thinly traded. These investments were subject to a valuation analysis as of June 30, 2022
and 2021.
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Long-lived Assets
We review the recoverability of
long-lived assets, consisting of the land and building that we own, equipment, and improvements, including leasehold improvements, when
events or changes in circumstances occur that indicate carrying values may not be recoverable.
Our building, equipment and improvements
are recorded at historical cost and depreciation is provided using the straight-line method over the following periods:
Schedule of building, equipment and improvements |
|
Building |
Thirty years |
Equipment |
Three to ten years |
Improvements |
Shorter of the remaining life of the underlying building, lease term, or the asset’s estimated useful life |
Intangibles
Intangibles
consist of legal fees incurred in connection
with patent applications. Our patent costs are being amortized over a period of four 4 to 7 seven years. The expense associated with
the amortization of the patent costs is recognized in research and development costs.
Income Taxes
We recognize deferred tax assets
and liabilities for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities along
with net operating losses and tax credit carryovers. Deferred tax assets at both June 30, 2022 and 2021 consisted primarily of basis
differences related to unrealized gain/loss related to investments, stock-based compensation, fixed assets, accrued expenses, and inventories.
Significant management judgment
is required in determining the provision for income taxes and the recoverability of deferred tax assets. Such determination is based on
historical taxable income, with consideration given to estimates of future taxable income and the periods over which deferred tax assets
will be recoverable. We record a valuation allowance against deferred tax assets to reduce the net carrying value to an amount that we
believe is more likely than not to be realized. When we establish or reduce the valuation allowance against deferred tax assets, the provision
for income taxes will increase or decrease, respectively, in the period such determination is made.
Uncertain Tax Positions
We record uncertain tax positions
in accordance with Accounting Standards Codification (“ASC”) 740 on the basis of a two-step process whereby (1) we determine
whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position, and
(2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that
is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.
Shipping and Handling
Payments from customers for shipping
and handling are included in net sales. Shipping expenses, consisting primarily of payments made to freight companies, are included
in cost of sales.
Concentration of Credit Risk
Financial instruments that potentially
subject us to credit risk consist principally of cash, cash equivalents, and trade receivables. We place our cash and cash equivalents
with major financial institutions. At June 30, 2022 and 2021, and throughout the fiscal years then ended, we had deposits in excess
of federally insured limits. Credit sales are made to medical device distributors, original equipment manufacturers, and resellers throughout
the world, and sales to such customers account for a substantial portion of our trade receivables. While such receivables are not collateralized,
we evaluate their collectability based on several factors including customers’ payment histories.
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Compensation Plans
We recognize compensation expense
for the share-based awards that vest subject to market conditions under ASC 718, Compensation-Stock Compensation by estimating
their fair value using a Monte Carlo simulation. The fair value using a Monte Carlo simulation model is affected by assumptions regarding
a number of complex judgments including expected stock price volatility, risk free interest rates, and the forecasted future value and
trading volume of our stock. The awards are considered granted for accounting purposes on the date the awards were approved by the Compensation
Committee of our Board of Directors and we recognize compensation expense, based on the estimated fair value of the award, on a straight-line
basis over the requisite service period.
Use of Estimates
The preparation of financial statements
requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Our operations are affected by numerous
factors including market acceptance of our products, supply chain disruptions, changes in technologies, and new laws, effects from the
COVID-19 pandemic, government regulations, and policies. We cannot predict what impact, if any, the occurrence of these or other events
might have on our operations. Significant estimates and assumptions made by management include, but are not limited to, revenue recognition,
share-based compensation, the allowance for doubtful accounts, accrued warranty expense, investments, inventory valuation, the carrying
value of long-lived assets, and the recoverability of deferred income tax assets.
Basic and Diluted Per Share Information
Basic per share amounts are computed
on the basis of the weighted-average number of common shares outstanding during each period presented. Diluted per share amounts assume
the issuance of all potential common stock equivalents, consisting of outstanding stock options and performance awards as discussed in
Note 11, unless the effect of such exercise is to increase income, or decrease loss, per common share.
Fair Value Measurements
Fair value is measured based on
the prices that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants
at the measurement date. Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair
value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs
other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs
for which little or no market data exists, therefore requiring an entity to develop its own assumptions.
Cash and cash equivalents: The
carrying value of cash and cash equivalents is considered to be representative of their fair values based on the short-term nature of
these instruments. As such, cash and cash equivalents are classified within Level 1 of the valuation hierarchy.
Investments: Investments
consist of marketable equity securities of publicly held companies. Our long-term marketable securities consist of investments of common
stock of publicly traded companies that are thinly traded. Due to the thinly traded nature of these stocks, they are classified within
Level 2 of the valuation hierarchy. The fair value of all of our investments at June 30, 2022 was based upon an independent valuation.
Although the methods above may produce
a fair value calculation that may not be indicative of the net realizable value or reflective of future fair values, we believe our valuation
methods are appropriate.
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Advertising
Advertising costs are charged to
selling or general and administrative expense as incurred and amounted to $1,000 and $4,000 for the fiscal years ended June 30, 2022
and 2021, respectively.
Reclassifications
Certain
prior year amounts have been reclassified to conform to the current year presentation.
Recently Issued and Adopted Accounting Standards
In
June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13,
Financial Instruments—Credit Losses (Topic 326). ASU 2016-13 revises the impairment model to utilize an expected loss methodology
in place of the currently used incurred loss methodology, which will result in more timely recognition of losses on financial instruments,
including, but not limited to, available for sale debt securities and accounts receivable. The guidance is effective for the Company’s
annual reporting period beginning after December 15, 2022 and interim reporting periods within that annual reporting period. The Company
does not expect the adoption of this ASU to have a material impact on the consolidated financial statements.
In
December 2019, the FASB issued ASU 2019-12 Income Taxes (Topic 740) – Simplifying the
Accounting for Income Taxes, to remove certain exceptions related to the approach for intraperiod tax allocation, recognition of deferred
tax liabilities for outside basis differences and requiring that an entity reflect the effect of an enacted change in tax laws or rates
in the annual effective tax rate computation in the interim period that includes the enactment date. The amendments in this update are
effective for us beginning with fiscal year 2022. The adoption of the amendments has not had a material impact on our consolidated financial
statements.
In
October 2020, the FASB issued ASU No. 2020-10, Codification Improvements, which updates various codification topics by clarifying disclosure
requirements to align with the SEC's regulations. The guidance is effective for the Company’s annual reporting period beginning
after December 15, 2020 and interim reporting periods within the annual period beginning after December 15, 2020. The adoption of the
amendments has not had a material impact on the consolidated financial statements or related footnote disclosures.
| 3. | REVISION OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS FOR CORRECTION OF IMMATERIAL ERRORS |
We failed to timely adopt ASU 2016-01
– Accounting for Financial Instruments – Classification and Measurement, which states in part that changes in fair value of
equity investments must be recognized in net income. We have completed an evaluation of the quantitative and qualitative impact of this
error in our historical financial statements and concluded that our historical financial statements are not materially misstated. We concluded
that our historical financial statements are not materially misstated for several reasons, including the fact that the cumulative three-year
error had a negative impact to historical net income in the amount of $61,000, an amount we deem immaterial, as well as the fact that
the amounts did not contain a calculation error but rather amounts were presented on an incorrect line item within the financial statements.
We also considered the fact that this error did not impact cash or operating income for any historical period, which we believe is important
to our investors. Accordingly, the prior year financial statements have been revised to reflect the impact of ASU 2016-1. The revised
classification and reported values of our unrealized gains (losses) on marketable equity investments as accounted for under ASU 2016-01
are included in the consolidated financial statements herein. The impact to net income for the year ended June 30, 2021, was an increase
of $1.4 million with a corresponding decrease in unrealized gain on marketable equity securities of $1.4 million, previously presented
in other comprehensive income (loss). The revision resulted in an increase to basic earnings per share of $0.36 and diluted earnings per
share of $0.35 for the year ended June 30, 2021. As of June 30, 2021, the revision reclassified the remaining accumulated other comprehensive
loss of $215,000 to retained earnings.
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the
disaggregation of net sales by revenue recognition model (in thousands):
Schedule of disaggregation of net sales | |
| | | |
| | |
| |
Year ended June 30, | |
| |
2022 | | |
2021 | |
Net Sales: | |
| | | |
| | |
Over-time revenue recognition | |
$ | 1,014 | | |
$ | 324 | |
Point-in-time revenue recognition | |
| 41,027 | | |
| 37,705 | |
Total net sales | |
$ | 42,041 | | |
$ | 38,029 | |
The timing of revenue recognition,
billings, and cash collections results in billed accounts receivables, unbilled receivables (presented as deferred costs on our consolidated
balance sheets) and customer advances and deposits (presented as deferred revenue on our consolidated balance sheets), where applicable.
Amounts are generally billed as work progresses in accordance with agreed upon milestones. The over-time revenue recognition model consists
of non-recurring engineering (“NRE”) and prototype services and typically relates to NRE services related to the evaluation,
design or customization of a medical device and is typically recognized over time utilizing an input measure of progress based on costs
incurred compared to the estimated total costs upon completion. During the fiscal years ended June 30, 2022 and 2021, we recorded $98,000
and $50,000, respectively, of revenue that had been included in deferred revenue in the prior year. The revenue recognized from the contract
liabilities consisted of satisfying our performance obligations during the normal course of business. Our entire deferred revenue balance
of $1.0 million at June 30, 2022, is currently expected to be recognized in the next 12-months.
The following tables summarize our
contract assets and liability balances (in thousands):
Schedule of contract assets and liability | |
| | | |
| | |
| |
June 30, | |
| |
2022 | | |
2021 | |
Contract assets at beginning of year | |
$ | 193 | | |
$ | 155 | |
Expenses incurred during the year | |
| 1,319 | | |
| 458 | |
Amounts reclassified to cost of sales | |
| (774 | ) | |
| (395 | ) |
Amounts allocated to discounts for standalone selling price | |
| (28 | ) | |
| (25 | ) |
Contract assets at end of year | |
$ | 710 | | |
$ | 193 | |
| |
June 30, | |
| |
2022 | | |
2021 | |
Contract liabilities at beginning of year | |
$ | 150 | | |
$ | 200 | |
Payments received from customers | |
| 1,482 | | |
| — | |
Amounts reclassified to revenue | |
| (619 | ) | |
| (50 | ) |
Contract liabilities at end of year | |
$ | 1,013 | | |
$ | 150 | |
| 5. | COMPOSITION OF CERTAIN FINANCIAL STATEMENT ITEMS |
Investments
Investments
are stated at market value and consist of the following (in thousands):
Schedule of investments | |
| | | |
| | |
| |
June 30, 2022 | | |
June 30, 2021 | |
Marketable equity securities – short-term | |
$ | 755 | | |
$ | 1,295 | |
Marketable equity securities – long-term | |
| 1,779 | | |
| 1,704 | |
Total Marketable equity securities | |
$ | 2,534 | | |
$ | 2,999 | |
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Investments
at June 30, 2022 and 2021 had an aggregate cost basis of $2,796,000
and $3,204,000,
respectively. Both current and long-term investments include equity securities of public companies that are thinly traded. We
classified certain investments as long term in nature because even if we decide to sell the stocks we may not be able to sell our
position within one year. At June 30, 2022, the investments included net unrealized losses of $262,000
(gross unrealized losses of $369,000
offset by gross unrealized gains of $107,000).
At June 30, 2021, the investments included net unrealized losses of $205,000
(gross unrealized losses of $376,000
offset by gross unrealized gains of $171,000).
Of the total marketable equity securities
at June 30, 2022 and 2021, $755,000 and $847,000, respectively, represent an investment in the common stock of Air T, Inc. Two of our
Board members, Messrs. Swenson and Cabillot, are also board members of Air T, Inc. and both either
individually or through affiliates own an equity interest in Air T, Inc. Mr. Swenson, our Chairman, also serves as the chief executive
officer and chairman of Air T, Inc. Another of our Board members is employed by Air T as its Chief of Staff. The shares have been purchased
through 10b5-1 Plans that, in accordance with our internal policies regarding the approval of related-party transactions, were approved
by our then 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.
Inventory
Inventory
is stated at the lower of cost (first-in, first-out) or net realizable value and consists of the following (in thousands):
Schedule of inventory | |
| | | |
| | |
| |
June 30, | |
| |
2022 | | |
2021 | |
Raw materials /purchased components | |
$ | 6,323 | | |
$ | 3,967 | |
Work in process | |
| 3,463 | | |
| 2,218 | |
Sub-assemblies /finished components | |
| 2,118 | | |
| 1,738 | |
Finished goods | |
| 774 | | |
| 514 | |
Total inventory | |
$ | 12,678 | | |
$ | 8,437 | |
Land and Building
Land and building consist of the
following (in thousands):
Schedule of Land and Building | |
| | | |
| | |
| |
June 30, 2022 | | |
June 30, 2021 | |
Land | |
$ | 3,684 | | |
$ | 3,684 | |
Building | |
| 2,815 | | |
| 2,815 | |
Total | |
| 6,499 | | |
| 6,499 | |
Less: accumulated depreciation | |
| (156 | ) | |
| (62 | ) |
| |
$ | 6,343 | | |
$ | 6,437 | |
On
November 6, 2020, we acquired the Franklin Property for a total purchase price of $6.5 million, of which we paid $1.3 million in cash
and the balance of $5.2 million we financed through Minnesota Bank & Trust (“MBT”) (see Note 8). We substantially completed
the build-out of the property in the first quarter of fiscal 2022. Currently, we are actively engaged in various verification and validation
activities and we moved certain of our employees into the new building during the third quarter of fiscal 2022. The building is being
amortized on a straight-line basis over a period of 30 years.
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Equipment and Improvements
Equipment and improvements consist
of the following (in thousands):
Schedule of equipment and improvements | |
| | | |
| | |
| |
June 30, | |
| |
2022 | | |
2021 | |
Office furnishings and fixtures | |
$ | 2,224 | | |
$ | 2,173 | |
Machinery and equipment | |
| 6,661 | | |
| 5,895 | |
Automobiles | |
| 21 | | |
| 21 | |
Improvements | |
| 4,271 | | |
| 3,536 | |
Total | |
| 13,177 | | |
| 11,625 | |
Less: accumulated depreciation and amortization | |
| (8,344 | ) | |
| (7,780 | ) |
| |
$ | 4,833 | | |
$ | 3,845 | |
Depreciation
expense for the years ended June 30, 2022 and 2021 amounted to $616,000 and $609,000, respectively. During fiscal 2022, $87,000 of assets
were retired either due to physical disposal or major part replacement with a net book value of $35,000 recorded as a loss on disposal
of equipment in our consolidated income statement. During fiscal 2021, fully depreciated assets in the amount of $49,000 were retired.
Intangibles
Intangibles consist
of the following (in thousands):
Schedule of intangibles | |
| | | |
| | |
| |
June 30, 2022 | | |
June 30, 2021 | |
Patent-related costs | |
$ | 208 | | |
$ | 260 | |
Less accumulated amortization | |
| (90 | ) | |
| (74 | ) |
| |
$ | 118 | | |
$ | 186 | |
Amortization
expense for the years ended June 30, 2022 and 2021 amounted to $16,000 and $14,000, respectively.
Patent-related
costs consist of legal fees incurred in connection with both patent applications and patent issuances, 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. During fiscal 2022, we impaired $84,000 of previously capitalized legal fees due to uncertainty relating to
future benefit. This impairment expense is included in research and development costs in our consolidated income statement. Future amortization
expense is estimated to be no more than $30,000 per year and all remaining costs are expected to be fully amortized within four years.
Accrued Liabilities
Accrued liabilities consist of the
following (in thousands):
Schedule of accrued liabilities | |
| | | |
| | |
| |
June 30, | |
| |
2022 | | |
2021 | |
Payroll and related items | |
$ | 509 | | |
$ | 505 | |
Accrued inventory in transit | |
| 177 | | |
| 128 | |
Accrued legal and professional fees | |
| 275 | | |
| 124 | |
Accrued bonuses | |
| 430 | | |
| 300 | |
Current portion of lease liability | |
| 379 | | |
| 344 | |
Warranty | |
| 340 | | |
| 221 | |
Accrued customer rebate | |
| 517 | | |
| 394 | |
Other | |
| 124 | | |
| 182 | |
Total accrued expenses | |
$ | 2,751 | | |
$ | 2,198 | |
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information
relating to the accrual for warranty costs for the years ended June 30, 2022 and 2021, is as follows (in thousands):
Schedule of accrual warranty costs | |
| | | |
| | |
| |
June 30, | |
| |
2022 | | |
2021 | |
Balance at beginning of year | |
$ | 221 | | |
$ | 213 | |
Accruals during the year | |
| 177 | | |
| 339 | |
Change in estimates of prior period accruals | |
| 54 | | |
| (27 | ) |
Warranty amortization/utilization | |
| (112 | ) | |
| (304 | ) |
Balance at end of year | |
$ | 340 | | |
$ | 221 | |
Warranty expense relating to new product sales and changes
to estimates was $231,000 and $312,000, respectively, for the fiscal years ended June 30, 2022 and 2021.
The
provision for income taxes consists of the following amounts (in thousands):
Schedule of provision for income taxes | |
| | | |
| | |
| |
Years Ended June 30, | |
| |
2022 | | |
2021 | |
Current: | |
| | | |
| | |
Federal | |
$ | 733 | | |
$ | 1,040 | |
State | |
| 451 | | |
| 340 | |
Deferred: | |
| | | |
| | |
Federal | |
| (187 | ) | |
| (186 | ) |
State | |
| (146 | ) | |
| (18 | ) |
Income tax expense | |
$ | 851 | | |
$ | 1,176 | |
The effective income tax rate from
income from continuing operations differs from the United States statutory income tax rates for the reasons set forth in the table below
(in thousands, except percentages).
Schedule of reconciliation federal statutory income tax rates | |
| | | |
| | | |
| | | |
| | |
| |
Years Ended June 30, | |
| |
2022 | | |
2021 | |
| |
Amount | | |
Percent
Pretax
Income | | |
Amount | | |
Percent
Pretax
Income | |
Income before income taxes | |
$ | | |
| | % | |
$ | | |
| | % |
| |
| | | |
| | | |
| | | |
| | |
Computed “expected” income tax expense on income before income taxes | |
$ | 976 | | |
| 21 | % | |
$ | 1,181 | | |
| 17 | % |
State tax, net of federal benefit | |
| 202 | | |
| 4 | % | |
| 279 | | |
| 4 | % |
Tax incentives | |
| (205 | ) | |
| (4 | %) | |
| (169 | ) | |
| (3 | %) |
Uncertain tax position | |
| (76 | ) | |
| (2 | %) | |
| — | | |
| — | |
Stock based compensation | |
| — | | |
| — | | |
| (93 | ) | |
| (1 | %) |
Other | |
| (46 | ) | |
| (1 | %) | |
| (22 | ) | |
| — | |
Income tax expense | |
$ | 851 | | |
| 18 | % | |
$ | 1,176 | | |
| 17 | % |
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred income taxes reflect the
net effects of loss and credit carryforwards and temporary differences between the carrying amount of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities for
federal and state income taxes are as follows (in thousands):
Schedule of deferred income tax assets and liabilities | |
| | | |
| | |
| |
June 30, | |
| |
2022 | | |
2021 | |
Deferred tax assets: | |
| | | |
| | |
Federal and state NOL carryforward | |
$ | 22 | | |
$ | 20 | |
Research and other credits | |
| 65 | | |
| 65 | |
Reserves | |
| 163 | | |
| 120 | |
Accruals | |
| 322 | | |
| 293 | |
Stock based compensation | |
| 651 | | |
| 268 | |
Unrealized losses | |
| 35 | | |
| 61 | |
Lease liability | |
| 713 | | |
| 788 | |
Inventory | |
| 514 | | |
| 371 | |
Total gross deferred tax assets | |
$ | 2,485 | | |
$ | 1,986 | |
Less: valuation allowance | |
| (98 | ) | |
| (158 | ) |
Total deferred tax assets | |
| 2,387 | | |
| 1,828 | |
Deferred tax liabilities: | |
| | | |
| | |
Property and equipment, principally due to differing depreciation methods | |
$ | (820 | ) | |
$ | (523 | ) |
Right of use asset | |
| (658 | ) | |
| (740 | ) |
Deferred state tax | |
| (77 | ) | |
| (38 | ) |
Other | |
| (35 | ) | |
| (64 | ) |
Total gross deferred tax liabilities | |
| (1,590 | ) | |
| (1,365 | ) |
Net deferred tax assets | |
$ | 797 | | |
$ | 463 | |
Realization of our deferred tax
assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. As of June 30, 2022, our deferred tax
asset valuation allowance primarily consists of unrealized capital loss for investments held and the state net operating loss carryforwards
for states in which we have filed a final return. For the fiscal year ended June 30, 2022, we recorded a net decrease to our valuation
allowance of $60,000 on the basis of management’s reassessment of the amount of our deferred tax assets that are more likely than
not to be realized.
As of June 30, 2022, we did not
have any net operating losses for federal and state income tax purposes for state jurisdictions in which we currently operate. We have
no federal or state research and development and alternative minimum tax credit carry forwards at June 30, 2022.
As of June 30, 2022, we have
accrued $509,000 of unrecognized tax benefits related to federal and state income tax matters that would reduce our income tax expense
if recognized. If we are eventually able to recognize our uncertain tax positions, our effective tax rate would be reduced. Any adjustment
to our uncertain tax positions would result in an adjustment of our tax credit carryforwards rather than resulting in a cash outlay.
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information with respect to our
accrual for unrecognized tax benefits is as follows (in thousands):
Schedule of accrual unrecognized tax benefits | |
| | | |
| | |
| |
June 30, | |
| |
2022 | | |
2021 | |
Unrecognized tax benefits: | |
| | | |
| | |
Beginning balance | |
$ | 550 | | |
$ | 524 | |
Additions based on federal tax positions related to the current year | |
| 33 | | |
| 30 | |
Additions based on state tax positions related to the current year | |
| 26 | | |
| 20 | |
Additions for tax positions of prior years | |
| 9 | | |
| 6 | |
Reductions due to lapses in statutes of limitation | |
| (109 | ) | |
| (30 | ) |
Ending balance | |
$ | 509 | | |
$ | 550 | |
Although it is reasonably possible
that certain unrecognized tax benefits may increase or decrease within the next twelve months due to tax examinations, settlement activities,
expirations of statute of limitations, or the impact on recognition and measurement considerations related to the results of published
tax cases or other similar activities, we do not anticipate any significant changes to unrecognized tax benefits over the next twelve
months.
We recognize accrued interest and
penalties related to unrecognized tax benefits in income tax expense when applicable. As of June 30, 2022, 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 California, Colorado, and Massachusetts. We are currently open to audit under the statute of limitations
by the Internal Revenue Service for the years ended June 30, 2019, and later. However, because of our prior net operating losses
and research credit carryovers, our tax years from June 30, 2007, years are open to audit.
| 8. | NOTES PAYABLE AND FINANCING TRANSACTIONS |
Minnesota Bank & Trust
On
November 6, 2020 (the “Closing Date”), PDEX Franklin, a newly created wholly owned subsidiary of the Company, purchased the
Franklin Property. A portion of the purchase price was financed by a loan from MBT to PDEX Franklin in the principal amount of approximately
$5.2 million (the “Property Loan”) pursuant to a Loan Agreement, dated as of the Closing Date, between PDEX Franklin and MBT
(the “Property Loan Agreement”) and corresponding Term Note (the “Property Note”) issued by PDEX Franklin in favor
of MBT on the Closing Date. The Property Loan is secured by the Franklin Property pursuant to a Deed of Trust with Assignment of Leases
and Rents, Security Agreement and Fixture Filing in favor of MBT (the “Deed”) and by an Assignment of Leases and Rents by
PDEX Franklin in favor of MBT (the “Rents Assignment”). We paid loan origination fees to MBT on the Closing Date in the amount
of $26,037.
The
Property Loan bears interest at a fixed rate of 3.55% per annum, which is subject to a 3% increase upon an event of default. Accrued interest
was paid on December 1, 2020, and both principal and interest in the amount of approximately $30,000 are due and payable on the first
day of each subsequent month until the maturity date of November 1, 2030 (the “Maturity Date”), at which time a balloon payment
in the amount of $3.1 million is due. Any prepayment of the Property Loan (other than monthly scheduled interest and principal payments),
is subject to a prepayment fee equal to 4% of the principal amount prepaid for any prepayment made during the first or second year, 3%
of the principal amount prepaid for any prepayment made during the third or fourth year, 2% of the principal amount prepaid for any prepayment
made during the fifth or sixth year, and 1% of the principal amount prepaid for any prepayment made during the seventh or eighth year.
The Property Loan Agreement, Property Note, Deed, and Rents Assignment each contain representations, warranties, covenants, and events
of default that are customary for a loan of this type. The balance owed on the Property Loan at June 30, 2022 is $4,935,000.
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On
the Closing Date, we also entered into an Amended and Restated Credit Agreement with MBT (the “Amended Credit Agreement”),
providing for a $7,525,000 amended and restated term loan (the “Term Loan A”), a $1,000,000 term loan (the “Term Loan
B”), and a $2,000,000 amended and restated revolving loan (the “Revolving Loan” and, together with the Term Loan A and
the Term Loan B, collectively, the “Loans”), evidenced by an Amended and Restated Term Note A (“Term Note A”),
a Term Note B, and an Amended and Restated Revolving Credit Note (the “Revolving Note”) made by us in favor of MBT. The Loans
are secured by substantially all of the Company’s assets pursuant to a Security Agreement entered into on September 6, 2018 between
the Company and MBT. The Term Note A had an outstanding principal balance of $3,770,331 as of the Closing Date and could be borrowed against
through May 30, 2021 (the “Commitment Period”). During the third quarter ended March 31, 2021, we borrowed an additional $3,000,000
against Term Note A for the purpose of repurchasing our common stock as described in Note 14. The Term Note B had a zero balance as of
the Closing Date and we borrowed the full $1,000,000 during the third quarter ended March 31, 2021, for the purpose of making improvements
to the Franklin property described in Note 5.
The
Term Loan A matures on November 1, 2027 and bears interest at a fixed rate of 3.84% per annum. Initial payments on the Term Loan A of
interest only were due on December 1, 2020 through June 1, 2021. Commencing July 1, 2021 and continuing on the first day of each month
thereafter until the maturity date, we are required to make payments of principal and interest on Term Loan
A of approximately $97,000 plus any additional accrued and unpaid interest through the date of payment. The balance owed on Term Loan
A as of June 30, 2022, is $5,792,000.
The
Term Loan B matures on November 1, 2027 and bears interest at a fixed rate of 3.84% per annum. Initial payments on the Term Loan B of
interest only were due on December 1, 2020 through June 1, 2021. Commencing July 1, 2021 and continuing on the first day of each month
thereafter until the maturity date, we are required to make payments of principal and interest on Term Loan B of approximately $15,000,
plus any additional accrued and unpaid interest through the date of payment. As of March 31, 2021, we had drawn fully against Term Note
B and the balance outstanding on Term Note B was $862,000 on June 30, 2022.
The
Revolving Loan may be borrowed against from time to time through its maturity date of November 5, 2023, unless earlier terminated pursuant
to its terms, and bears interest at an annual rate equal to the greater of (a) 2.75% or (b) the prime rate minus 0.5% as published in
the Money Rates section of the Wall Street Journal. Commencing on the first day of each month after we initially borrow against the Revolving
Loan and each month thereafter until maturity, we are required to pay all accrued and unpaid interest on the Revolving Loan through the
date of payment. Any principal on the Revolving Loan that is not previously prepaid shall be due and payable in full on the maturity date
(or earlier termination of the Revolving Loan). During the fourth quarter of fiscal 2022 we borrowed $2,000,000 against the Revolving
Loan.
Any
payment on the Loans not made within seven days after the due date is subject to a late payment fee equal to 5% of the overdue amount.
Upon the occurrence and during the continuance of an event of default, the interest rate of all Loans will be increased by 3% and MBT
may, at its option, declare the Loans immediately due and payable in full.
The
Amended Credit Agreement, Security Agreement, Term Note A, Term Note B, and Revolving Note contain representations and warranties, affirmative,
negative and financial covenants, and events of default that are customary for loans of this type. As of June 30, 2022, we failed one
of the financial covenants required by our Amended Credit Agreement, but we obtained a waiver of default from MBT. Although there can
be no assurances, we anticipate that we will be in compliance with our debt covenants for at least the next fiscal year, and therefore
we do not believe we will require any future waivers of default from MBT.
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Scheduled
principal maturities of our loans, exclusive of unamortized loan origination fees in the amount of $55,000, for future fiscal years ending
June 30 are as follows (in thousands):
Schedule of Maturities of Term Loan for Future Fiscal Years | |
| | |
| |
Term Loan Principal
Payments | |
Fiscal Year: | |
| | |
2023 | |
$ | 3,293 | |
2024 | |
| 1,344 | |
2025 | |
| 1,397 | |
2026 | |
| 1,451 | |
2027 | |
| 1,508 | |
Thereafter | |
| 4,597 | |
Total principal payments | |
$ | 13,590 | |
Our operating lease ROU asset and
long-term liability are presented separately on our balance sheet. The current portion of our operating lease liability, exclusive of
imputed interest, as of June 30, 2022, in the amount of $379,000, is presented within accrued expenses on the balance sheet. As of June
30, 2022, the maturity of our lease liability is as follows:
Schedule of Maturities of Lease Liabilities | |
| | |
| |
Operating
Lease | |
Fiscal Year: | |
| | |
2023 | |
$ | 504 | |
2024 | |
| 519 | |
2025 | |
| 535 | |
2026 | |
| 551 | |
2027 | |
| 567 | |
Thereafter | |
| 143 | |
Total lease payments | |
| 2,819 | |
Less imputed interest: | |
| (386 | ) |
Total | |
$ | 2,433 | |
As of June 30, 2022, our operating
lease has a remaining lease term of five years and three months and an imputed interest rate of 5.3%. Cash paid for amounts included in
the lease liability for the fiscal years ended June 30, 2022 and 2021 was $489,000 and $475,000, respectively.
| 10. | COMMITMENTS AND CONTINGENCIES |
Leases
We lease our office, production,
and warehouse facility in Irvine, California (our “corporate office”) under an agreement that expires in September 2027. Our
corporate office lease requires us to pay insurance, taxes, and other expenses related to the leased space.
Rent expense in fiscal 2022 and
2021 was $559,000 and $558,000, respectively.
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Compensation Arrangements
Retirement Savings 401(k) Plan
The Pro-Dex, Inc. Retirement Savings
401(k) Plan (the “401(k) Plan”) is a defined contribution plan we administer that covers substantially all our employees and
is subject to the provisions of the Employee Retirement Income Security Act of 1974, as amended. Employees are eligible to participate
in the 401(k) Plan when they have attained 19 years of age and then can enter into the 401(k) Plan on the first day of each calendar quarter.
Participants are eligible to receive non-discretionary matching contributions by the Company equal to 25% of their contributions up to
5% of eligible compensation. For the fiscal years ended June 30, 2022 and 2021, we recognized compensation expense amounting to $72,000
and $81,000, respectively, in connection with the 401(k) Plan. During our fiscal years ended June 30, 2022 and 2021, we used approximately
$25,000 and $17,000, respectively, of forfeited match contributions to reduce our match expense.
Legal Matters
On August 24, 2021, one of our customers,
through its counsel, sent notice that it is seeking indemnification from Pro-Dex regarding a pending complaint filed by a third-party
claiming patent infringement on one of the products which we manufacture for this customer. Our position is that there is no infringement
and/or that the patent at issue is invalid. We have not accrued any amounts related to this claim. On August 26, 2022, the third-party
voluntarily dismissed all of its claims with prejudice.
In addition to the above matter,
we may be involved in legal proceedings arising either in the ordinary course of our business or 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 or adverse.