ITEM 1. FINANCIAL STATEMENTS
PRO-DEX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share amounts)
|
|
March 31,
2014
|
|
June 30,
2013
|
ASSETS
|
|
|
|
|
|
|
|
|
Current Assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
1,926
|
|
|
$
|
1,680
|
|
Accounts receivable, net of allowance for doubtful accounts of $42 and $24, respectively
|
|
|
1,102
|
|
|
|
1,339
|
|
Unbilled receivables
|
|
|
998
|
|
|
|
244
|
|
Other current receivables
|
|
|
68
|
|
|
|
34
|
|
Inventory
|
|
|
3,184
|
|
|
|
3,834
|
|
Prepaid expenses
|
|
|
206
|
|
|
|
157
|
|
Deferred income taxes
|
|
|
60
|
|
|
|
59
|
|
Total current assets
|
|
|
7,544
|
|
|
|
7,347
|
|
Investments
|
|
|
834
|
|
|
|
370
|
|
Equipment and leasehold improvements, net
|
|
|
1,682
|
|
|
|
2,065
|
|
Real estate held for sale
|
|
|
—
|
|
|
|
733
|
|
Intangibles
|
|
|
53
|
|
|
|
—
|
|
Other assets
|
|
|
77
|
|
|
|
80
|
|
Total assets
|
|
$
|
10,190
|
|
|
$
|
10,595
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
Current Liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
603
|
|
|
$
|
844
|
|
Accrued expenses
|
|
|
1,270
|
|
|
|
1,276
|
|
Deferred revenue
|
|
|
277
|
|
|
|
141
|
|
Income taxes payable
|
|
|
48
|
|
|
|
48
|
|
Capital lease obligations
|
|
|
7
|
|
|
|
5
|
|
Total current liabilities
|
|
|
2,205
|
|
|
|
2,314
|
|
Deferred income taxes
|
|
|
60
|
|
|
|
59
|
|
Deferred rent
|
|
|
245
|
|
|
|
270
|
|
Capital lease obligations, net of current portion
|
|
|
9
|
|
|
|
15
|
|
Total non-current liabilities
|
|
|
314
|
|
|
|
344
|
|
Total liabilities
|
|
|
2,519
|
|
|
|
2,658
|
|
Shareholders’ equity:
|
|
|
|
|
|
|
|
|
Common shares; no par value; 50,000,000 shares authorized; 3,343,954 and 3,348,184 shares issued and outstanding at March 31, 2014 and June 30, 2013, respectively
|
|
|
17,061
|
|
|
|
17,012
|
|
Accumulated other comprehensive income
|
|
|
202
|
|
|
|
5
|
|
Accumulated deficit
|
|
|
(9,592
|
)
|
|
|
(9,080
|
)
|
Total shareholders’ equity
|
|
|
7,671
|
|
|
|
7,937
|
|
Total liabilities and shareholders’ equity
|
|
$
|
10,190
|
|
|
$
|
10,595
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
PRO-DEX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(Unaudited)
(In thousands, except per share amounts)
|
|
Three Months Ended
March 31,
|
|
Nine Months Ended
March 31,
|
|
|
2014
|
|
2013
|
|
2014
|
|
2013
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
2,404
|
|
|
$
|
3,060
|
|
|
$
|
7,599
|
|
|
$
|
9,527
|
|
Cost of sales
|
|
|
1,864
|
|
|
|
2,177
|
|
|
|
5,564
|
|
|
|
6,376
|
|
Gross profit
|
|
|
540
|
|
|
|
883
|
|
|
|
2,035
|
|
|
|
3,151
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
Selling expenses
|
|
|
177
|
|
|
|
311
|
|
|
|
408
|
|
|
|
907
|
|
General and administrative expenses
|
|
|
420
|
|
|
|
853
|
|
|
|
1,304
|
|
|
|
2,087
|
|
Research and development costs
|
|
|
381
|
|
|
|
490
|
|
|
|
1,121
|
|
|
|
1,360
|
|
Total operating expenses
|
|
|
978
|
|
|
|
1,654
|
|
|
|
2,833
|
|
|
|
4,354
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(438
|
)
|
|
|
(771
|
)
|
|
|
(798
|
)
|
|
|
(1,203
|
)
|
Interest expense
|
|
|
(2
|
)
|
|
|
(2
|
)
|
|
|
(7
|
)
|
|
|
(8
|
)
|
Interest income
|
|
|
1
|
|
|
|
—
|
|
|
|
11
|
|
|
|
—
|
|
Realized gain on sale of investments
|
|
|
27
|
|
|
|
—
|
|
|
|
27
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations before income taxes
|
|
|
(412
|
)
|
|
|
(773
|
)
|
|
|
(767
|
)
|
|
|
(1,211
|
)
|
Income tax benefit
|
|
|
(54
|
)
|
|
|
(8
|
)
|
|
|
(88
|
)
|
|
|
(27
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
|
(358
|
)
|
|
|
(765
|
)
|
|
|
(679
|
)
|
|
|
(1,184
|
)
|
Income (loss) from discontinued operations,
net of income taxes
|
|
|
(27
|
)
|
|
|
18
|
|
|
|
167
|
|
|
|
72
|
|
Net loss
|
|
$
|
(385
|
)
|
|
$
|
(747
|
)
|
|
$
|
(512
|
)
|
|
$
|
(1,112
|
)
|
Other comprehensive income, net of tax:
Unrealized gain from marketable equity investments
|
|
|
20
|
|
|
|
—
|
|
|
|
225
|
|
|
|
—
|
|
Less: Reclassification of gains included in net loss
|
|
|
(27
|
)
|
|
|
—
|
|
|
|
(27
|
)
|
|
|
—
|
|
Comprehensive loss
|
|
$
|
(392
|
)
|
|
$
|
(747
|
)
|
|
$
|
(314
|
)
|
|
$
|
(1,112
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
$
|
(0.11
|
)
|
|
$
|
(0.23
|
)
|
|
$
|
(0.20
|
)
|
|
$
|
(0.36
|
)
|
Income (loss) from discontinued operations
|
|
|
(0.01
|
)
|
|
|
0.01
|
|
|
|
0.05
|
|
|
|
0.02
|
|
Net loss
|
|
$
|
(0.12
|
)
|
|
$
|
(0.22
|
)
|
|
$
|
(0.15
|
)
|
|
$
|
(0.34
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
3,342
|
|
|
|
3,341
|
|
|
|
3,344
|
|
|
|
3,313
|
|
Diluted
|
|
|
3,342
|
|
|
|
3,341
|
|
|
|
3,344
|
|
|
|
3,313
|
|
Common shares outstanding
|
|
|
3,344
|
|
|
|
3,341
|
|
|
|
3,344
|
|
|
|
3,341
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
PRO-DEX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH
FLOWS
(Unaudited)
(In thousands)
|
|
Nine Months Ended
March 31,
|
|
|
2014
|
|
2013
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
$
|
(679
|
)
|
|
$
|
(1,184
|
)
|
Adjustments to reconcile loss from continuing operations to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
398
|
|
|
|
443
|
|
Gain on sale of investments
|
|
|
(27
|
)
|
|
|
—
|
|
Loss on retirement of equipment
|
|
|
6
|
|
|
|
—
|
|
Share-based compensation
|
|
|
42
|
|
|
|
107
|
|
Allowance for doubtful accounts receivable
|
|
|
18
|
|
|
|
5
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable and other current receivables
|
|
|
189
|
|
|
|
86
|
|
Unbilled receivables
|
|
|
(754
|
)
|
|
|
—
|
|
Inventory
|
|
|
650
|
|
|
|
(955
|
)
|
Prepaid expenses and other assets
|
|
|
(46
|
)
|
|
|
(35
|
)
|
Accounts payable, accrued expenses and deferred rent
|
|
|
(272
|
)
|
|
|
134
|
|
Deferred revenue
|
|
|
136
|
|
|
|
—
|
|
Income taxes receivable and payable
|
|
|
(4
|
)
|
|
|
46
|
|
Net cash used in continuing operating activities
|
|
|
(343
|
)
|
|
|
(1,353
|
)
|
Income from discontinued operations
|
|
|
167
|
|
|
|
72
|
|
Adjustments to reconcile income from discontinued operations to net cash provided by discontinued operating activities:
|
|
|
|
|
|
|
|
|
Gain on sale of real estate held for sale
|
|
|
(167
|
)
|
|
|
—
|
|
Net cash provided by discontinued operating activities
|
|
|
—
|
|
|
|
72
|
|
Net cash used in operating activities
|
|
|
(343
|
)
|
|
|
(1,281
|
)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Purchases of investments
|
|
|
(327
|
)
|
|
|
—
|
|
Purchases of equipment and leasehold improvements
|
|
|
(25
|
)
|
|
|
(68
|
)
|
Proceeds from sale of equipment
|
|
|
4
|
|
|
|
—
|
|
Proceeds from sale of investments
|
|
|
88
|
|
|
|
—
|
|
Acquisition of intangibles
|
|
|
(53
|
)
|
|
|
—
|
|
Net cash used in continuing investing activities
|
|
|
(313
|
)
|
|
|
(68
|
)
|
Net cash provided by discontinued investing activities:
|
|
|
|
|
|
|
|
|
Proceeds from sale of real estate held for sale
|
|
|
900
|
|
|
|
—
|
|
Net cash provided by (used in) investing activities
|
|
|
587
|
|
|
|
(68
|
)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Proceeds from exercise of stock options
|
|
|
6
|
|
|
|
50
|
|
Principal payments on capital lease and bank term loan
|
|
|
(4
|
)
|
|
|
(774
|
)
|
Net cash provided by (used in) financing activities
|
|
|
2
|
|
|
|
(724
|
)
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
246
|
|
|
|
(2,073
|
)
|
Cash and cash equivalents, beginning of period
|
|
|
1,680
|
|
|
|
4,112
|
|
Cash and cash equivalents, end of period
|
|
$
|
1,926
|
|
|
$
|
2,039
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
PRO-DEX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH
FLOWS - CONTINUED
(Unaudited)
(In thousands)
|
|
Nine Months Ended
March 31,
|
|
|
2014
|
|
2013
|
Supplemental disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
|
Noncash investing and financing activities:
|
|
|
|
|
|
|
|
|
Capital lease agreement for the acquisition of equipment
|
|
$
|
—
|
|
|
$
|
22
|
|
|
|
|
|
|
|
|
|
|
Cash paid during the period for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
7
|
|
|
$
|
10
|
|
Income taxes
|
|
$
|
7
|
|
|
$
|
5
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The
accompanying unaudited condensed consolidated financial statements of Pro-Dex, Inc. (“we”, “us”, “our”,
“Pro-Dex” or the “Company”) have been prepared in accordance with accounting principles generally accepted
in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Regulation
S-K. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.
These financial statements should be read in conjunction with the consolidated financial statements presented in our Annual Report
on Form 10-K for the fiscal year ended June 30, 2013. 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 consolidated financial statements and footnotes
thereto included in our Annual Report on Form 10-K for the year ended June 30, 2013.
Recent Accounting
Standards
In
August 2013, the FASB issued ASU No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward,
a Similar Tax Loss, or a Tax Credit Carryforward Exists,” that sets forth circumstances in which an unrecognized tax benefit,
generally reflecting the difference between a tax position taken or expected to be taken on a company’s income tax return
and the benefit recognized on its financial statements, should be presented in the company’s financial statements as a liability
rather than as a reduction of a deferred tax asset. The ASU is effective for fiscal years, and interim periods within those years,
beginning after December 15, 2013, with early adoption permitted. The adoption of these provisions is not expected to have a material
impact on the consolidated financial statements of the Company.
Reclassifications
Certain prior period
balances have been reclassified to conform to the current period presentation. The reclassifications have no effect on previously
reported results of operations or accumulated deficit.
NOTE 2. COMPOSITION OF CERTAIN FINANCIAL STATEMENT ITEMS
Inventory
Inventory
is stated at the lower of cost (first-in, first-out) or market and consists of the following (in thousands):
|
|
March 31,
2014
|
|
June 30,
2013
|
Raw materials /purchased components
|
|
$
|
1,170
|
|
|
$
|
1,640
|
|
Work in process
|
|
|
700
|
|
|
|
572
|
|
Sub-assemblies /finished components
|
|
|
977
|
|
|
|
1,291
|
|
Finished goods
|
|
|
337
|
|
|
|
331
|
|
Total inventory
|
|
$
|
3,184
|
|
|
$
|
3,834
|
|
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Investments
Investments are stated at market value and consist of the following (in thousands):
|
|
March 31,
2014
|
|
June 30,
2013
|
Marketable equity securities
|
|
$
|
834
|
|
|
$
|
370
|
|
|
|
|
|
|
|
|
|
|
Investments
at March 31, 2014 and June 30, 2013 had an aggregate cost basis of $632,000 and $365,000, respectively, gross unrealized gains
aggregating $220,000 and $5,000, respectively, and unrealized losses of 18,000 and $0, respectively. During the three and nine
months ended March 31, 2014, we sold certain of our investments in marketable equity securities of publicly held companies and
recorded realized gains of $27,000.
Intangibles
Intangibles
at March 31, 2014 consist of legal fees incurred in connection with patent applications, and will be amortized over the life of
the applicable patent upon its issuance.
NOTE
3. 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 consolidated balance sheets. As of March 31, 2014 and June 30, 2013, the warranty reserve
related to continuing operations amounted to $224,000 and $321,000, respectively. Warranty expenses are included in cost of sales
in the accompanying consolidated 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. Total warranty expense for the three months ended March 31, 2014 and 2013 was $53,000 and $127,000, respectively,
and for the nine months ended March 31, 2014 and 2013 was $81,000 and $252,000, respectively.
Information
regarding the accrual for warranty costs for the three and nine months ended March 31, 2014 and 2013 are as follows (in thousands):
|
|
As of and for the
Three Months Ended
March 31,
|
|
|
2014
|
|
2013
|
Beginning balance
|
|
$
|
200
|
|
|
$
|
361
|
|
Accruals during the period
|
|
|
70
|
|
|
|
107
|
|
Changes in estimates of prior period warranty accruals
|
|
|
(17
|
)
|
|
|
20
|
|
Warranty amortization
|
|
|
(29
|
)
|
|
|
(89
|
)
|
Ending balance
|
|
$
|
224
|
|
|
$
|
399
|
|
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
|
|
As of and for the
Nine Months Ended
March 31,
|
|
|
2014
|
|
2013
|
Beginning balance
|
|
$
|
321
|
|
|
$
|
526
|
|
Accruals during the period
|
|
|
167
|
|
|
|
261
|
|
Changes in estimates of prior period warranty accruals
|
|
|
(86
|
)
|
|
|
(9
|
)
|
Warranty amortization
|
|
|
(178
|
)
|
|
|
(379
|
)
|
Ending balance
|
|
$
|
224
|
|
|
$
|
399
|
|
NOTE 4. NET INCOME (LOSS) PER SHARE
The Company calculates
basic net earnings (loss) per share by dividing net income (loss) by the weighted-average number of common shares outstanding during
the reporting period. Diluted earnings (loss) per share reflects the effects of potentially dilutive securities, which consist
entirely of outstanding stock options.
Potential common
shares of 38,771 and 27,019 have been excluded from diluted weighted average common shares for the three months ended March 31,
2014 and 2013, as the effect would have been anti-dilutive. Similarly, potential common shares of 25,648 and 13,487 have been excluded
from diluted weighted average common shares for the nine months ended March 31, 2014 and 2013, as the effect would have been anti-dilutive.
The following table
presents reconciliations of the numerators and denominators of the basic and diluted earnings (loss) per share computations for
net income (loss). In the tables below, income (loss) amounts represent the numerator, and share amounts represent the denominator
(in thousands, except per share amounts):
|
|
Three Months Ended
March 31,
|
|
Nine Months Ended
March 31,
|
|
|
2014
|
|
2013
|
|
2014
|
|
2013
|
Basic & Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
$
|
(358
|
)
|
|
$
|
(765
|
)
|
|
$
|
(679
|
)
|
|
$
|
(1,184
|
)
|
Weighted average shares outstanding
|
|
|
3,342
|
|
|
|
3,341
|
|
|
|
3,344
|
|
|
|
3,313
|
|
Basic and diluted loss per share from continuing operations
|
|
$
|
(0.11
|
)
|
|
$
|
(0.23
|
)
|
|
$
|
(0.20
|
)
|
|
$
|
(0.36
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from discontinued operations
|
|
$
|
(27
|
)
|
|
$
|
18
|
|
|
$
|
167
|
|
|
$
|
72
|
|
Weighted average shares outstanding
|
|
|
3,342
|
|
|
|
3,341
|
|
|
|
3,344
|
|
|
|
3,313
|
|
Basic and diluted earnings (loss) per share from discontinued operations
|
|
$
|
(0.01
|
)
|
|
$
|
0.01
|
|
|
$
|
0.05
|
|
|
$
|
0.02
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(385
|
)
|
|
$
|
(747
|
)
|
|
$
|
(512
|
)
|
|
$
|
(1,112
|
)
|
Weighted average shares outstanding
|
|
|
3,342
|
|
|
|
3,341
|
|
|
|
3,344
|
|
|
|
3,313
|
|
Basic and diluted loss per share
|
|
$
|
(0.12
|
)
|
|
$
|
(0.22
|
)
|
|
$
|
(0.15
|
)
|
|
$
|
(0.34
|
)
|
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
5. BANK DEBT
In
September 2012, we terminated a bank credit facility and, in connection with such termination, repaid the entire principal balance of a term loan, amounting to $685,000.
As
a result of the foregoing, we no longer have a credit facility with a financial institution.
NOTE
6. DISCONTINUED OPERATIONS AND REAL ESTATE HELD FOR SALE
In
February 2012, we completed the sale of our fractional horsepower motor product line, operating under the name Pro-Dex Astromec (“Astromec”) and located in Carson City, Nevada, to SL Montevideo Technology, Inc. (“MTI”),
a wholly owned subsidiary of SL Industries, Inc., pursuant to an Asset Purchase Agreement
(the “APA”).
Under
the terms of the APA, we may receive earnout payments based on revenues generated from the sale of (i) Astromec products and (ii)
MTI products to Astromec prospects (defined in the APA) (collectively, the “Earnout Sales Base”). Such earnout payments,
if and when earned, are paid by MTI to us within 30 days following the end of each of our fiscal quarters during the three years
subsequent to the February 2012 closing date, and amount to 6%, 4% and 2% of the Earnout Sales Base in the first, second and third
such years, respectively. The earnout payments are recognized in the quarter in which we become entitled to receive them. We recognized
income from earnout payments of $33,000 and $43,000 for the three months ended March 31, 2014 and 2013, respectively, and $103,000
and $135,000 for the nine months ended March 31, 2014 and 2013, respectively. We have recognized an aggregate of $334,000 in income
from such earnout payments since the February 2012 closing date.
In
addition, as a result of the sale of the Astromec product line, we listed for sale the land and building constituting the facility
in Carson City, Nevada, which was presented as real estate held for sale in the June 30, 2013 consolidated balance sheet with
an aggregate carrying amount of $733,000. On April 22, 2013, we entered into a Purchase Agreement with Aesthetic and Reconstructive Technologies, Inc., a Nevada corporation, whereby we agreed to sell the Carson City facility described above. On July 5, 2013,
we completed the sale and closed the Purchase Agreement in conformity with its terms. The sales price of the property was $980,000,
of which we received net proceeds of $900,000, after deductions for expenses related to the sale, primarily consisting of broker
commissions and fees, aggregating approximately $80,000, resulting in a gain of $167,000.
Based
on the foregoing, and in conformity with applicable accounting guidance, the Astromec product line qualifies as a discontinued
operation. Accordingly, financial results of Astromec have been reported as discontinued operations in the accompanying consolidated
statements of operations for all periods presented. Information regarding revenue and operating results of Astromec included in
discontinued operations is as follows (in thousands):
|
|
Three Months Ended
March 31,
|
|
|
2014
|
|
2013
|
Revenues
|
|
$
|
33
|
|
|
$
|
43
|
|
Income before provision for income taxes of $55,000 and $14,000, respectively
|
|
$
|
28
|
|
|
$
|
33
|
|
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
|
|
Nine Months Ended
March 31,
|
|
|
2014
|
|
2013
|
Revenues
|
|
$
|
103
|
|
|
$
|
135
|
|
Income before provision for income taxes of $91,000 and $39,000, respectively
|
|
$
|
258
|
|
|
$
|
111
|
|
Information regarding Astromec assets and
liabilities included in the accompanying consolidated balance sheets is as follows (in thousands):
|
|
March 31,
2014
|
|
June 30,
2013
|
Accounts receivable
|
|
$
|
32
|
|
|
$
|
31
|
|
Prepaid expenses
|
|
$
|
7
|
|
|
$
|
—
|
|
Accrued expenses
|
|
$
|
2
|
|
|
$
|
5
|
|
NOTE
7. 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 bases. 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 or loss, with some consideration given to our estimates
of future taxable income or loss by jurisdictions in which we operate and the period over which our deferred tax assets would
be recoverable. Due to cumulative taxable losses during the past three years, we maintained a valuation allowance of $3.4 million
against our deferred tax assets as of June 30, 2013.
As
of March 31, 2014, we have accrued $360,000 of unrecognized tax benefits related to federal and state income tax matters. The amount that would reduce the Company’s income tax expense if recognized and result in a corresponding decrease
in the Company’s effective tax rate is $47,000.
A
reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):
Balance at July 1, 2013
|
|
$
|
347
|
|
Additions based on tax positions related to the current year
|
|
|
18
|
|
Reductions for tax positions of prior years
|
|
|
(5
|
)
|
Balance at March 31, 2014
|
|
$
|
360
|
|
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
We
recognize accrued interest and penalties related to unrecognized tax benefits when applicable. As of March 31, 2014, 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.
Pro-Dex
and its subsidiaries 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, 2011 and
later. Our state income tax returns are open to audit under the statute of limitations
for the years ended June 30, 2010 and later. We do not anticipate a significant change to the total amount of unrecognized tax
benefits within the next 12 months.
NOTE 8. COMMON STOCK
Rights Offering
On December 17, 2013, we
publicly announced plans to complete a rights offering to existing holders of our Common Stock, and we commenced the rights offering
on March 24, 2014, pursuant to a registration statement on Form S-3 filed with the Securities and Exchange Commission (“SEC’).
The rights offering was made through the distribution to our existing shareholders as of March 20, 2014 of non-transferable subscription
rights to purchase their pro rata portion of newly issued shares of our Common Stock (the “Subscription Privilege”)
at a price of $1.90 per share (the “Subscription Price”). The subscription period for exercise of the rights commenced
on March 24, 2014 and expired on April 25, 2014.
Upon completion of the
rights offering, we received gross proceeds of approximately $1.65 million, before estimated expenses of $125,000, through shareholder
subscriptions for 868,732 shares of common stock.
Of the total amount of
shares issued, 317,231 and 156,189 shares were issued to AO Partners I, LP (“AO Partners”) and Farnam Street Partners,
L.P. (“Farnam Street Partners”), respectively, the Company’s two largest shareholders, who each exercised its
full pro-rata allotment of rights in the offering. AO Partners, LLC is the General Partner of AO Partners, and Nicholas J. Swenson,
a director of the Company, is the Managing Member of AO Partners. Raymond E. Cabillot, also a director of the Company, is the CEO
of Farnam Street Partners.
In connection with the
rights offering, we entered into a Standby Purchase Agreement with AO Partners, LLC and Farnam Street Capital, Inc. (each a beneficial
shareholder of our common stock; each a “Standby Purchaser” and collectively the “Standby Purchasers”)
pursuant to which the Standby Purchasers agreed to purchase, at the Subscription Price, any and all shares of Common Stock not
subscribed for by shareholders in connection with the rights offering, subject to reduction by us as described below. Messrs. Swenson
and Cabillot have the power to direct the affairs of AO Partners, LLC and Farnam Street Capital, respectively. No fees or other
consideration were paid by us to the Standby Purchasers in exchange for their commitment to purchase any and all unsubscribed shares
of Common Stock following the rights offering.
In the event that the exercise
by a shareholder of the Subscription Privilege or the purchase of our common stock under the Standby Purchase Agreement could,
in our sole discretion, have potentially resulted in a limitation of our ability to utilize our tax attributes, such as the annual
utilization of net operating loss or tax credit carry forwards (see Note 7), we had the ability to reduce the exercise by such
shareholder of the Subscription Privilege or the amount purchased under the Standby Purchase Agreement to such number of shares
of our Common Stock as we determined advisable in order to preserve our ability to utilize such tax attributes. On
the basis of the Company’s analysis of tax attributes, the Company did not reduce the subscriptions of any shareholder in
the rights offering, but did reduce to zero the number of shares the Standby Purchasers could have otherwise purchased pursuant
to the Standby Purchase Agreement. As a result, no shares were issued to AO Partners, LLC or Farnam Street Capital, Inc. pursuant to the Standby Purchase Agreement.
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
We intend to use the net
proceeds of the rights offering to pursue strategic opportunities that may present themselves from time to time or, if not used
to pursue strategic opportunities, for working capital and general corporate purposes, including to fund ongoing research and development
and product initiatives. Also, to the extent the net proceeds are not deployed, some of the funds may be invested in accordance
with the terms of our Surplus Capital Investment Policy.
Share Repurchase Program
In
September 2013, our Board approved a share repurchase program authorizing the Company, at the direction of the Investment Committee
of the Board, to repurchase up to 750,000 shares of our common stock under parameters to be determined by the Investment Committee.
The repurchase program has no stated expiration date and there have been no purchases under the program.
NOTE 9. SHARE-BASED COMPENSATION
We
have two equity compensation plans, the Second Amended and Restated 2004 Stock Option Plan (the “Employees Stock Option
Plan”) and the Amended and Restated 2004 Directors Stock Option Plan (the “Directors Stock Option Plan”) (collectively,
the “Stock Option Plans”), pursuant to which (i) options to purchase shares of common stock, or (ii) restricted shares
of common stock, may be granted up to an aggregate amount of 1,333,333 common shares, with 1,066,667 and 266,666 shares distributed
between the Employees Stock Option Plan and the Directors Stock Option Plan, respectively. The Stock Option Plans are substantially
similar, providing for a strike price equal to the closing price for a share of our common stock as of the last business day immediately
prior to the grant date, vesting periods as determined by the Board for the Employees Stock Option Plan and six months for the
Directors Stock Option Plan, and terms of up to ten years, subject to forfeit 30 days after the holder ceases to be an employee
or 90 days after the holder ceases to be a director, as the case may be. At March 31, 2014, 527,214 and 173,334 shares under the
Employees Stock Option Plan and the Directors Stock Option Plan, respectively, are available to grant in future years. Share-based
compensation expense under the Stock Option Plans for the three months ended March 31, 2014 and 2013 was $10,000 and $42,000,
respectively, and for the nine months ended March 31, 2014 and 2013 was $42,000 and $107,000, respectively.
Stock
Options
The
following assumptions were used in the calculation of share-based compensation expense for options granted during the three and
nine months ended March 31, 2013:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
March 31, 2013
|
|
March 31, 2013
|
Dividend rate
|
|
None
|
|
None
|
Price volatility
|
|
92%
|
|
89%
|
Risk-free interest rate
|
|
0.8%
|
|
0.86%
|
Expected Life
|
|
5.2 years
|
|
5.7 years
|
No
options were granted during the three or nine months ended March 31, 2014.
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
As
of March 31, 2014, there was an aggregate of $19,000 of unrecognized compensation cost under the Stock Option Plans related to
26,667 non-vested outstanding stock options with a per share weighted average value of $1.76. The unrecognized expense is anticipated
to be recognized on a straight-line basis over a weighted average period of 11.5 months. Following is a summary of stock option
activity for the nine months ended March 31, 2014 and 2013:
|
|
2014
|
|
2013
|
|
|
Number of Shares
|
|
Weighted-Average
Exercise Price
|
|
Number of Shares
|
|
Weighted-Average
Exercise Price
|
|
|
Outstanding at beginning of period
|
|
|
292,504
|
|
|
$
|
2.35
|
|
|
|
591,672
|
|
|
$
|
2.48
|
|
Options granted
|
|
|
—
|
|
|
|
—
|
|
|
|
60,000
|
|
|
|
1.90
|
|
Options exercised
|
|
|
(4,695
|
)
|
|
|
1.96
|
|
|
|
(33,334
|
)
|
|
|
1.50
|
|
Options forfeited
|
|
|
(118,640
|
)
|
|
|
2.09
|
|
|
|
(213,334
|
)
|
|
|
2.35
|
|
Outstanding at end of period
|
|
|
169,169
|
|
|
$
|
2.43
|
|
|
|
405,004
|
|
|
$
|
2.34
|
|
Stock Options Exercisable at March 31,
|
|
|
142,502
|
|
|
$
|
2.55
|
|
|
|
274,726
|
|
|
$
|
2.88
|
|
Weighted-average fair value per option granted during the period
|
|
|
|
|
|
$
|
—
|
|
|
|
|
|
|
$
|
1.34
|
|
|
Following
is a summary of information regarding options outstanding and options exercisable at March 31, 2014:
|
|
Options Outstanding
|
|
Options Exercisable
|
|
Range of
Exercise Prices
|
|
Number Outstanding
|
|
Weighted-Avg. Remaining Contractual Life
|
|
Weighted-Avg. Exercise Price
|
|
Aggregate. Intrinsic Value
|
|
Number
Outstanding
|
|
Weighted-Avg. Remaining Contractual Life
|
|
Weighted-Avg.
Exercise Price
|
|
Average
Intrinsic
Value
|
|
$0 to 2.50
|
|
|
|
147,500
|
|
|
|
7.50
|
|
|
$
|
1.87
|
|
|
$
|
19,950
|
|
|
|
120,833
|
|
|
|
7.38
|
|
|
$
|
1.89
|
|
|
$
|
13,833
|
|
|
2.5 to 5.00
|
|
|
|
3,334
|
|
|
|
3.13
|
|
|
|
4.38
|
|
|
|
—
|
|
|
|
3,334
|
|
|
|
3.13
|
|
|
|
4.38
|
|
|
|
—
|
|
|
5.01 to 7.50
|
|
|
|
10,001
|
|
|
|
0.24
|
|
|
|
5.61
|
|
|
|
—
|
|
|
|
10,001
|
|
|
|
0.24
|
|
|
|
5.61
|
|
|
|
—
|
|
|
7.51 to 10.00
|
|
|
|
8,334
|
|
|
|
1.77
|
|
|
|
7.65
|
|
|
|
—
|
|
|
|
8,334
|
|
|
|
1.77
|
|
|
|
7.65
|
|
|
|
—
|
|
|
Total
|
|
|
|
169,169
|
|
|
|
6.70 years
|
|
|
$
|
2.43
|
|
|
$
|
19,950
|
|
|
|
142,502
|
|
|
|
6.46
|
|
|
$
|
2.55
|
|
|
$
|
13,833
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Restricted Stock
The
following is a summary of restricted share activity for the nine months ended March 31, 2014 and 2013:
|
|
2014
|
|
2013
|
|
|
Number of
Shares
|
|
Weighted-Average
Grant Date
Fair Value
|
|
Number of
Shares
|
|
Weighted-Average
Grant Date
Fair Value
|
|
Outstanding at beginning of period
|
|
|
|
32,500
|
|
|
$
|
1.73
|
|
|
|
—
|
|
|
$
|
1.73
|
|
|
Granted
|
|
|
|
—
|
|
|
|
—
|
|
|
|
35,000
|
|
|
|
—
|
|
|
Vested
|
|
|
|
(9,166
|
)
|
|
|
1.73
|
|
|
|
—
|
|
|
|
—
|
|
|
Forfeited
|
|
|
|
(8,334
|
)
|
|
|
1.73
|
|
|
|
—
|
|
|
|
—
|
|
|
Outstanding at end of period
|
|
|
|
15,000
|
|
|
$
|
1.73
|
|
|
|
35,000
|
|
|
$
|
1.73
|
|
As
of March 31, 2014, there was $10,000 in unrecognized compensation cost related to non-vested outstanding restricted shares. The
unrecognized expense is anticipated to be amortized over the next 1.45 years.
NOTE
10. MAJOR CUSTOMERS
Information
with respect to one customer (“Customer 1”), who accounted for sales in excess of 10% of our total sales in both the
three-month periods and the nine-month periods ended March 31, 2014 and 2013, is as follows (in thousands, except percentages):
|
|
Three Months Ended March 31,
|
|
|
2014
|
|
2013
|
|
|
Amount
|
|
Percent of
Total
|
|
Amount
|
|
Percent of
Total
|
|
|
|
Total revenue
|
|
$
|
2,404
|
|
|
|
100
|
%
|
|
$
|
3,060
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer concentration:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer 1
|
|
$
|
1,201
|
|
|
|
50
|
%
|
|
$
|
1,759
|
|
|
|
58
|
%
|
|
|
$
|
1,201
|
|
|
|
50
|
%
|
|
$
|
1,759
|
|
|
|
58
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended March 31,
|
|
|
2014
|
|
2013
|
|
|
Amount
|
|
Percent of Total
|
|
Amount
|
|
Percent of Total
|
|
|
|
Total revenue
|
|
$
|
7,599
|
|
|
|
100
|
%
|
|
$
|
9,527
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer concentration:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer 1
|
|
$
|
3,593
|
|
|
|
47
|
%
|
|
$
|
4,830
|
|
|
|
51
|
%
|
|
|
$
|
3,593
|
|
|
|
47
|
%
|
|
$
|
4,830
|
|
|
|
51
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Information with
respect to Customer 1, accounts receivable from whom comprised more than 10 percent of our gross accounts receivable at March
31, 2014 and June 30, 2013 is as follows (in thousands, except percentages):
|
|
March 31, 2014
|
|
June 30, 2013
|
Total gross accounts receivable
|
|
$
|
1,144
|
|
100%
|
|
$
|
1,363
|
|
100%
|
|
|
|
|
|
|
|
|
|
|
|
Customer concentration:
|
|
|
|
|
|
|
|
|
|
|
Customer 1
|
|
$
|
388
|
|
34%
|
|
$
|
417
|
|
31%
|
|
|
$
|
388
|
|
34%
|
|
$
|
417
|
|
31%
|
NOTE
11. COMMITMENTS AND CONTINGENCIES
Change
of Control Agreements
We
have Change of Control Agreements with our Chief Executive Officer and Chief Financial Officer, Harold A. Hurwitz, and our Chief
Operating Officer, Richard L. Van Kirk. The Change of Control Agreements provide that, if the individual’s employment with
us involuntarily terminates (as such term is defined in the Change of Control Agreements) within 12 months after a change of control
(also as such term is defined in the Change of Control Agreements), the individual will receive, subject to signing a release
of claims, (i) a lump sum amount equal to 30 weeks base compensation of the individual at the time of such termination and (ii)
100% Company-paid insurance coverage as provided to the individual immediately prior to his termination of employment for a period
equal to the earlier of (i) 12 months following termination or (ii) until the individual becomes covered under another employer’s
insurance plan. In addition, the individual shall be entitled to receive bonus or compensation award payments, if any, in accordance
with the terms of our incentive compensation plans in which the individual was an eligible participant at the time of the termination.
No changes of control have taken place that would result in the potential payment of benefits under the terms of the Change of
Control Agreements as described herein. The Change of Control Agreements expire in July 2014.
Legal
Matters
In
February 2011, we became aware of a report entitled “Site Discovery Report, Southeast Santa Ana Project DTSC – Cypress
Region,” dated February 2010 (the “Report”), that was prepared by the Cypress regional office of the Cal/EPA
Department of Toxic Substances Control (“DTSC”) for Region 9 of the U.S. Environmental Protection Agency (“USEPA”)
under an agreement between the two agencies. The purpose of the Report was to identify sites within an area of southeast Santa
Ana, California that may be sources of groundwater contamination previously detected in that area. The Report identified 25 sites,
including our former Santa Ana site, for further screening by DTSC staff. DTSC has informed us that no further evaluation of our
former site has taken place subsequent to the Report’s issuance. It is uncertain whether future developments, if any, from
DTSC’s screening process would have any application to our former site.
In
general, we are from time to time a party to various legal proceedings incidental to our business, none of which we consider may
be material. There can be no certainty, however, that we may not ultimately incur liability or that such liability will not be
material and adverse.
NOTE
12. 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
PRO-DEX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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. As such, investments are classified within Level
1 of the valuation hierarchy.
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 its valuation methods are appropriate.
NOTE
13. SUBSEQUENT EVENTS
We
have evaluated events or transactions that occurred after the balance sheet date of March 31, 2014 and have identified no such
events or transactions which required adjustment to, or disclosure in, these Condensed Consolidated Financial Statements other
than as presented in such financial statements and the Notes thereto, including Note 8, “Common Stock.”
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 consolidated financial statements and
the related notes and other financial information appearing elsewhere in this report.
COMPANY OVERVIEW
The
following discussion and analysis provides information that management believes is relevant to an assessment and understanding
of the results of operations and financial condition of Pro-Dex, Inc. (“Company”, “Pro-Dex”, “we”,
“our” or “us”) for the three and nine-month periods ended March 31, 2014 and 2013. This discussion should
be read in conjunction with the Condensed Consolidated Financial Statements and the Notes thereto included elsewhere in this report.
This report contains certain forward-looking statements and information. The cautionary statements included herein should be read
as being applicable to all related forward-looking statements wherever they may appear. 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, 2013 and our Prospectus in connection with our rights offering (see Note 8 of Notes to Condensed Consolidated
Financial Statements contained elsewhere in this Report) filed with the SEC on March 24, 2014.
With
operations in Irvine, California and Beaverton, Oregon, we provide products used in medical, research and industrial applications.
Experience in surgical devices and multi-axis motion control applications allows us to develop products that require high precision
in harsh environments.
Our
products are found in hospitals, dental offices, medical engineering labs, scientific research facilities and high tech manufacturing
operations around the world. The names Micro Motors and Oregon Micro Systems are used for marketing purposes as brand names.
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 consolidated
results of operation presented in this report are not audited and those results are not necessarily indicative of the results to
be expected for the entirety of the fiscal year ending June 30, 2014 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
consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States
(“GAAP”). 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.
Revenue Recognition
Revenue
on product sales is recognized upon shipment to the customer when risk of loss and title transfer to the customer and all other
conditions required by GAAP, as promulgated by the Financial Accounting Standards Board (“FASB”) in Accounting Standards
Codification (“ASC”) Section 605 (formerly Staff Accounting Bulletin No. 104,
Revenue Recognition
), have been
satisfied.
Revenue
from billable product development service portions of development and supply contracts is generally recognized upon completion
of such product development services, in conformity with ASC Section 605. Accordingly, revenue from product development milestone
billings to our customers under such contracts is deferred.
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. When it is probable that total costs from the development portion of such contracts will exceed product development
service revenue, the expected loss is recognized immediately in cost of sales.
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 or 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 factors such as return rates and repair costs, which factors
are reviewed quarterly.
Warranty
expenses, including changes of estimates, are included in cost of sales in our consolidated statements of operations.
Inventory
Inventory
is stated at the lower of cost (first-in, first-out) or market value. 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 usage over the prior 12 months as well
as future demand supported by our materials requirement planning.
Accounts Receivable and Unbilled Receivables
Trade
receivables are stated at their original invoice amounts, less an allowance for doubtful accounts. Management determines the allowance
for doubtful accounts based on facts and circumstances related to specific accounts, and on historical experience related to 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.
Unbilled
receivables reflect revenues from product development services not yet billable to customers under the terms of the related development
and supply contracts.
Investments
Investments
consist of marketable equity securities of publicly held companies. Management intends to hold such securities for a sufficient
period in which to realize a reasonable return, although there is no assurance that positive returns will be realized or that
such securities will not be liquidated in a shorter-than-expected time frame to accommodate our liquidity requirements. Accordingly,
investments have been classified as non-current and available-for-sale in conformity with ASC Section 320. Investments are marked
to market at each measurement date, with unrealized gains and losses presented as adjustments to accumulated other comprehensive
income or loss.
Equipment and Leasehold Improvements
We
review the recoverability of equipment and leasehold improvements when events or changes in circumstances occur that indicate
carrying values may not be recoverable.
Intangibles
Intangibles
consist of legal fees incurred in connection with patent applications, and will be amortized over the life of the applicable patent
upon its issuance.
Stock-Based Compensation
We
recognize compensation expense for all share-based awards made to employees and directors by estimating the fair value of share-based
awards at the grant date and recognizing compensation expense over the requisite service period.
For
stock options, fair value is estimated using the Black-Scholes option-pricing model. The portion that is ultimately expected to
vest is recognized as compensation cost over the requisite service period using the straight-line single option method.
The
determination of fair value using the Black-Scholes model is affected by our stock price as well as assumptions regarding a number
of complex and subjective variables, including expected stock price volatility, risk-free interest rate, expected dividends and
projected stock option exercise behavior. We currently estimate stock price volatility based upon historical activity, with future
volatility expected to approximate past volatility. The expected time to exercise is based on a simplified model of the vesting
term of the option plus one-half the option life.
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 loss and tax credit carryovers.
Deferred
tax assets at March 31, 2014 and June 30, 2013 consisted primarily of basis differences related to research and development tax
credit utilization, net operating loss carryovers, intangible assets, accrued expenses and inventory.
Significant
management judgment is required in determining our provision for income taxes and the recoverability of our deferred tax assets.
Such determination is based on our historical taxable income or loss, with consideration given to our estimates of future taxable
income or loss 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. At March 31, 2014 and June 30, 2013, we maintained a valuation allowance against the
entire balance of our deferred tax assets, net of deferred tax liabilities.
Description of Business
Revenue
The
majority of our revenue is derived from designing, developing and manufacturing surgical devices for the medical device and dental
industries and motion control software and hardware for industrial and scientific applications. The proportion of total sales
by customer type is as follows (in thousands, except percentages):
|
|
Three Months Ended
March 31,
|
|
Nine Months Ended
March 31,
|
|
|
2014
|
|
2013
|
|
2014
|
|
2013
|
|
|
|
|
% of Revenue
|
|
|
|
% of Revenue
|
|
|
|
% of Revenue
|
|
|
|
% of Revenue
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medical device
|
|
$
|
1,385
|
|
|
|
58
|
%
|
|
$
|
2,044
|
|
|
|
67
|
%
|
|
$
|
4,712
|
|
|
|
62
|
%
|
|
$
|
6,338
|
|
|
|
67
|
%
|
Industrial
|
|
|
633
|
|
|
|
26
|
%
|
|
|
628
|
|
|
|
21
|
%
|
|
|
1,650
|
|
|
|
22
|
%
|
|
|
1,965
|
|
|
|
21
|
%
|
Dental
|
|
|
297
|
|
|
|
12
|
%
|
|
|
304
|
|
|
|
10
|
%
|
|
|
1,019
|
|
|
|
13
|
%
|
|
|
788
|
|
|
|
8
|
%
|
Government and other
|
|
|
89
|
|
|
|
4
|
%
|
|
|
84
|
|
|
|
2
|
%
|
|
|
218
|
|
|
|
3
|
%
|
|
|
436
|
|
|
|
4
|
%
|
|
|
$
|
2,404
|
|
|
|
100
|
%
|
|
$
|
3,060
|
|
|
|
100
|
%
|
|
$
|
7,599
|
|
|
|
100
|
%
|
|
$
|
9,527
|
|
|
|
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 dental products, which are sold primarily
to original equipment manufacturers and dental product distributors. We design and manufacture embedded multi-axis motion controllers
in our facility in Beaverton, Oregon.
Shipments
to our largest customer, accounted for in medical device revenue, decreased $600,000 and $1.2 million for the three and nine months
ended March 31, 2014, respectively from their corresponding periods in 2013. The decrease between the comparative three-month
periods is due to the revised ordering terms negotiated with the customer in December 2013 following its suspension of orders
from March through November of 2013. Such revised terms provided for lower monthly shipments in the 2014 period, relative to the
2013 period prior to the suspension. The decrease between the comparative nine-month periods reflects the effects of the aforementioned
suspension during the first five months of the nine-month period in 2014. Additionally, repair revenue from our former largest
medical device customer declined approximately $278,000 for the nine months ended March 31, 2014 compared to the corresponding
period of the prior fiscal year, and we do not expect to receive further repair orders from this former customer.
At
March, 2014, we had a backlog of $4.1 million. 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
March 31,
|
|
Nine Months Ended
March 31,
|
|
|
2014
|
|
2013
|
|
2014
|
|
2013
|
|
|
|
|
% of Total
|
|
|
|
% of Total
|
|
|
|
% of Total
|
|
|
|
% of Total
|
Cost of sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product cost
|
|
$
|
1,646
|
|
|
|
88
|
%
|
|
$
|
1,924
|
|
|
|
88
|
%
|
|
$
|
5,137
|
|
|
|
92
|
%
|
|
$
|
5,596
|
|
|
|
88
|
%
|
Under-absorption of manufacturing costs
|
|
|
120
|
|
|
|
7
|
%
|
|
|
53
|
|
|
|
3
|
%
|
|
|
282
|
|
|
|
5
|
%
|
|
|
272
|
|
|
|
4
|
%
|
Inventory and warranty charges
|
|
|
98
|
|
|
|
5
|
%
|
|
|
200
|
|
|
|
9
|
%
|
|
|
145
|
|
|
|
3
|
%
|
|
|
508
|
|
|
|
8
|
%
|
|
|
$
|
1,864
|
|
|
|
100
|
%
|
|
$
|
2,177
|
|
|
|
100
|
%
|
|
$
|
5,564
|
|
|
|
100
|
%
|
|
$
|
6,376
|
|
|
|
100
|
%
|
|
|
Three Months Ended
March 31,
|
|
Nine Months Ended
March 31,
|
|
Year over Year
ppt Change
|
|
|
|
2014
|
|
|
2013
|
|
|
2014
|
|
|
2013
|
|
Three Months
|
|
Nine Months
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
|
22%
|
|
|
29%
|
|
|
27%
|
|
|
33%
|
|
(7)
|
|
(6)
|
Cost
of sales for the three months ended March 31, 2014 decreased by $313,000 or 14 percent compared to the corresponding period of
the prior fiscal year, primarily due to the decline in revenue for the same period. Additionally, under-absorption of manufacturing
costs increased by $67,000 for the three months ended March 31, 2014 compared to the corresponding period of the prior year due
primarily to reduced manufacturing volume in 2014. Also included in product cost was an accrual of $47,000 for anticipated losses
from the development services portion of certain contracts, which did not occur during the prior fiscal year. Costs relating to
inventory and warranty charges decreased by $102,000 for the quarter ended March 31, 2014 compared to the third quarter of the
prior fiscal year. The warranty accrual estimate, although based upon a number of factors, generally declines in periods of lower
sales revenue.
Gross
profit declined by approximately $343,000 or 39 percent for the three months ended March 31, 2014 compared to the corresponding
period of the prior fiscal year, primarily as a result of the decreases in revenue and cost of sales discussed above. Gross margin
as a percentage of sales declined by approximately 7 percentage points compared to the corresponding period of the prior year
due primarily to the effects of the under-absorption of manufacturing costs and accruals discussed above.
Cost
of sales for the nine months ended March 31, 2014 decreased by $812,000 or 13 percent compared to the corresponding period of
the prior fiscal year, primarily due to the decline in revenue for the same period. Additionally, cost of sales reflects a $475,000
increase in unfavorable production variances due to reduced manufacturing volumes. Product cost for the nine months ended March
31, 2014 includes an accrual of approximately $278,000 relating to estimated contract losses for certain engineering development
projects that are on-going, for which we have not yet recognized revenue. No similar costs were incurred in the corresponding
period of the prior fiscal year.
Gross
profit declined by approximately $1.1 million or 35 percent for the nine months ended March 31, 2014, primarily as a result of
the decreases in revenue and cost of sales discussed above. Gross margin declined by approximately 6 percentage points, compared
to the corresponding period of the prior year, due primarily to the effects of the unfavorable production variances and accruals
discussed above.
Operating Expenses
Operating Costs and Expenses
(in thousands except % change)
|
|
Three Months Ended
March 31,
|
|
Nine Months Ended
March 31,
|
|
Year over Year % Change
|
|
|
2014
|
|
2013
|
|
2014
|
|
2013
|
|
Three Months
|
|
Nine Months
|
|
|
|
|
% of
Revenue
|
|
|
|
% of
Revenue
|
|
|
|
% of
Revenue
|
|
|
|
% of
Revenue
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling expenses
|
|
$
|
177
|
|
|
|
7
|
%
|
|
$
|
311
|
|
|
|
10
|
%
|
|
$
|
408
|
|
|
|
5
|
%
|
|
$
|
907
|
|
|
|
10
|
%
|
|
|
(43
|
%)
|
|
|
(55
|
%)
|
General and administrative expenses
|
|
|
420
|
|
|
|
18
|
%
|
|
|
853
|
|
|
|
28
|
%
|
|
|
1,304
|
|
|
|
17
|
%
|
|
|
2,087
|
|
|
|
22
|
%
|
|
|
(50
|
%)
|
|
|
(38
|
%)
|
Research and development costs
|
|
|
381
|
|
|
|
16
|
%
|
|
|
490
|
|
|
|
16
|
%
|
|
|
1,121
|
|
|
|
15
|
%
|
|
|
1,360
|
|
|
|
14
|
%
|
|
|
(22
|
%)
|
|
|
(17
|
%)
|
|
|
$
|
978
|
|
|
|
41
|
%
|
|
$
|
1,654
|
|
|
|
54
|
%
|
|
$
|
2,833
|
|
|
|
37
|
%
|
|
$
|
4,354
|
|
|
|
45
|
%
|
|
|
(41
|
%)
|
|
|
(35
|
%)
|
Selling
expenses consist of salaries and other personnel-related expenses for our business development department as well as trade show
attendance, advertising and marketing expenses, and travel and related costs incurred in generating and maintaining our customer
relationships. Selling expenses for the three and nine months ended March 31, 2014 decreased $134,000, or 43 percent, and
$499,000, or 55 percent, respectively, compared to the corresponding periods of fiscal 2013. The decreases are primarily attributable
to a reduction in personnel related costs of approximately $76,000 and $320,000 for the three and nine months ended March 31,
2014, respectively, compared to the three and nine months ended March 31, 2013. Additionally, costs incurred for advertising and
trade show related expenses declined approximately $55,000 and $157,000 for the three and nine months ended March 31, 2014, respectively,
compared to the corresponding periods of the prior fiscal year.
General
and administrative expenses (“G&A”) consists of salaries and other personnel-related expenses of our accounting
and finance personnel, as well as costs for out-sourced human resource services, professional fees, directors’ fees, and
other costs and expenses attributable to being a public company. G&A decreased by $433,000 and $783,000, for the three and
nine months ended March 31, 2014, respectively, when compared to the corresponding periods of the prior fiscal year. These decreases
relate to severance payments to a former Chief Executive Officer in the amount of $171,000 as well as increased legal and shareholder
reporting costs aggregating $135,000 incurred in connection with the contested election of directors at our 2012 Annual Meeting
of Shareholders held in January 2013, which costs did not recur in 2014. Additionally other professional service fees, board of
director fees and stock compensation expense decreased on a combined basis by approximately $110,000 and $297,000 for the three
and nine months ended March 31, 2014, respectively, compared to the corresponding periods of the prior fiscal year. In addition,
for the nine months ended March 31, 2014, combined salaries and related expense decreased approximately $110,000 primarily as
a result of a change in the Chief Executive Officer, compared to the corresponding period of the prior fiscal year.
Research
and development costs generally consist of salaries, employer paid benefits, and other personnel related costs of our engineering
and support personnel, as well as allocated facility and information technology costs, professional and consulting fees, patent-related
fees, lab costs, materials, and travel and related costs incurred in the development and support of our products. Research and
development costs for the three and nine months ended March 31, 2014 decreased by $109,000, or 22 percent, and by $239,000,
or 17 percent, respectively, compared to the corresponding period of the prior fiscal year due primarily to continued utilization
of engineering resources in contractual development projects, the costs of which are reflected in cost of sales. Additionally
salaries and related expenses, including severance expense, increased approximately $55,000 and $160,000 for the three and nine
months ended March 31, 2014, respectively, compared to the corresponding period of the prior year. These increases are substantially
offset by decreases in recruiting fees and other research and development project costs of $77,000 and $156,000 for the three
and nine months ended March 31, 2014, respectively, compared to the corresponding periods of fiscal 2013.
Interest
Expense
Interest
expense consists primarily of interest expense related to capital lease obligations for leased office equipment, and did not materially
differ for the three and nine months need March 31, 2014 when compared to corresponding periods in 2013.
Realized
Gain on Sale of Investments
During
the three and nine months ended March 31, 2014, we sold certain of our investments in marketable equity securities of publicly
held companies and recorded realized gains of $27,000. We did not sell any investments during the prior fiscal year.
Income
Tax Benefit
The
effective tax rates for the three and nine months ended March 31, 2014 and 2013 are lower than statutory tax rates due to our
inability to fully recognize the benefits of federal and state loss carryforwards prior to their utilization. (See Note 7 of Notes
to Condensed Consolidates Financial Statements contained elsewhere in this report.)
Liquidity
and Capital Resources
Cash
and cash equivalents at March 31, 2014 increased $200,000 to $1.9 million as compared to $1.7 million at June 30, 2013.
The following table is a summary of our condensed consolidated statements of cash flows contained elsewhere in this report.
|
|
As of and For the Nine
Months Ended March 31,
|
|
|
2014
|
|
2013
|
|
|
(in thousands)
|
Cash provided by (used in):
|
|
|
|
|
|
|
|
|
Operating activities
|
|
$
|
(343
|
)
|
|
$
|
(1,281
|
)
|
Investing activities
|
|
$
|
587
|
|
|
$
|
(68
|
)
|
Financing activities
|
|
$
|
2
|
|
|
$
|
(724
|
)
|
|
|
|
|
|
|
|
|
|
Cash and Working Capital:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
1,926
|
|
|
$
|
2,039
|
|
Working Capital
|
|
$
|
5,339
|
|
|
$
|
6,026
|
|
Operating
Activities
Cash
used in operating activities was $343,000 for the nine months ended March 31, 2014 resulting primarily from our net loss of $512,000,
an increase in unbilled receivables of $754,000 related to the development phase of certain contracts that have not yet reached
the billable stage, and a decrease in accounts payable and accrued expenses of $247,000, partially offset by non-cash depreciation
and amortization of $398,000 and decreases in inventory of $650,000 resulting from resumption of shipments to our largest customer
in the second quarter of our current fiscal year.
Cash
used in operating activities was $1.3 million for the nine months ended March 31, 2013, resulting primarily from our net loss
from continuing operations of $1.2 million and an increase in inventory of $1.0 million. The inventory increase related to the
purchase of components required to fulfill firm customer purchase orders in backlog as well as prepaid and warranty orders and
to build our stock of components related to certain of our products with the objective of shortening lead times when forecasted
purchase orders are received. Partially offsetting these uses of cash was non-cash depreciation and stock-based compensation expense
aggregating
$550,000,
a decrease in accounts receivable and other current receivables in the amount of $86,000, an increase in accounts payable and
accrued liabilities of $134,000 related primarily to the aforementioned increase in inventories, and a reduction in income taxes
receivable of $46,000, representing a refund of taxes paid in the prior year.
Investing
Activities
During
the nine months ended March 31, 2014, we purchased $327,000 of public company common stock and received $88,000 in proceeds from
the sale of other such investments in conformity with our Surplus Capital Investment Policy described in more detail below. Additionally,
we purchased equipment for $25,000 and we expended $53,000 in legal fees related to internally developed intellectual property.
Additionally, during the period we received proceeds of $900,000 from the sale of land and building from our former Astromec operations.
During the nine months
ended March 31, 2013 we purchased $68,000 of equipment.
Financing
Activities
Cash
flows from financing activities during the nine months ended March 31, 2014 were not material.
Cash
used in financing activities during the nine months ended March 31, 2013, consisted primarily of repayment in full of our former
term loan discussed below.
We
believe that our existing cash and cash equivalent balances and investments in equity securities will be sufficient to fund our
operations for the next twelve months.
Changes
in Bank Debt and Credit Facilities
As
described in Note 5 of Notes to Condensed Consolidated Financial Statements contained elsewhere in this report, in September 2012,
we terminated a bank credit facility and, in connection with such termination,
repaid
the entire principal balance of a term loan, amounting to $685,000.
As
a result of the foregoing, we no longer have a credit facility with a financial institution. Should we be unable to achieve anticipated
cash flows from operations, we may be required to seek new financing. However, there is no assurance that such financing will
be available on acceptable terms, if at all.
Reduction
in Directors’ Compensation
At
our 2012 Annual Meeting held on January 17, 2013, our shareholders elected four new members to our Board of Directors. At a meeting
of the newly constituted Board on February 4, 2013, three of those newly elected directors, Messrs. Swenson, Cabillot and Farrell,
each opted to waive, through the date of our 2013 Annual Meeting of Shareholders, (a) receipt of stock options they were otherwise
entitled to receive under the provisions of the directors’ compensation plan then in effect (the “2010 Plan”),
and (b) any cash retainers or meeting fees they were otherwise entitled to receive under the 2010 Plan in excess of $200 per meeting
and $2,000 per year.
At
its meeting on May 2, 2013, our Board replaced the 2010 Plan with the 2013 Directors’ Compensation Plan (the “2013
Plan”) that provides for the following:
•
|
|
Fees of $200 for participation in Board or Committee meetings, to a maximum of $2,000
per fiscal year;
|
•
|
|
An annual retainer of $23,000 for the Audit Committee Chair (which may be modified
in compensating any future Audit Committee Chair)
|
The
2013 Plan has no provision for (a) retainers other than that described above, or (b) grants of options to purchase shares of our
common stock.
Surplus Capital Investment Policy
At
its April 17, 2013 meeting, our Board approved a Surplus Capital Investment Policy (the “Policy”) that provides, among
other items, for the following:
|
(a)
|
Determination by our Board of Directors of
(i) our surplus capital balance and (ii) the portion of such surplus capital balance to be invested according to the Policy;
|
|
(b)
|
Selection of
an Investment Committee
responsible for implementing
the Policy; and
|
|
(c)
|
Objectives and criteria under which investments may be made.
|
The
composition of the Investment Committee is Messrs. Swenson (Chair), Cabillot and Hurwitz.
In
June 2013, the Investment Committee approved investments aggregating $500,000, and approved an additional $500,000 in July 2013.
At March 31, 2014, $632,000 had been invested in marketable public equity securities, having a market value at March 31, 2014
of $834,000, and $406,000 was invested in money market funds. Additionally, during the three and nine months ended March 31, 2014,
we sold equity securities with a cost basis of $61,000, for $88,000, resulting in a realized gain of $27,000.
In
September 2013, our Board approved a share repurchase program authorizing the Company, at the direction of the Investment Committee,
to repurchase up to 750,000 shares of our common stock under parameters to be determined by the Investment Committee. The repurchase
program has no stated expiration date and there have been no purchases under the program.
Rights Offering
On
December 17, 2013, we publicly announced plans to complete a rights offering to existing holders of our Common Stock, and we commenced
the rights offering on March 24, 2014, pursuant to a registration statement on Form S-3 filed with the Securities and Exchange
Commission (“SEC’). The rights offering was made through the distribution to our existing shareholders as of March
20, 2014 of non-transferable subscription rights to purchase their pro rata portion of newly issued shares of our Common Stock
(the “Subscription Privilege”) at a price of $1.90 per share (the “Subscription Price”). The subscription
period for exercise of the rights commenced on March 24, 2014 and expired on April 25, 2014.
Upon
completion of the rights offering, we received gross proceeds of approximately $1.65 million before estimated expenses of $125,000,
through shareholder subscriptions for 868,732 shares of common stock.
Of
the total amount of shares issued, 317,231 and 156,189 shares were issued to AO Partners I, LP (“AO Partners”) and
Farnam Street Partners, L.P. (“Farnam Street Partners”), respectively, the Company’s two largest shareholders,
who each exercised its full pro-rata allotment of rights in the offering. AO Partners, LLC is the General Partner of AO Partners,
and Nicholas J. Swenson, a director of the Company, is the Managing Member of AO Partners. Raymond E. Cabillot, also a director
of the Company, is the CEO of Farnam Street Partners.
In
connection with the rights offering, we entered into a Standby Purchase Agreement with AO Partners, LLC and Farnam Street Capital,
Inc. (each a beneficial shareholder of our common stock; each a “Standby Purchaser” and collectively the “Standby
Purchasers”) pursuant to which the Standby Purchasers agreed to purchase, at the Subscription Price, any and all shares
of Common Stock not subscribed for by shareholders in connection with the rights offering, subject to reduction by us as described
below. Messrs. Swenson and Cabillot have the power to direct the affairs of AO Partners, LLC and Farnam Street Capital, respectively.
No fees or other consideration were paid by us to the Standby Purchasers in exchange for their commitment to purchase any and
all unsubscribed shares of Common Stock following the rights offering.
In
the event that the exercise by a shareholder of the Subscription Privilege or the purchase of our common stock under the Standby
Purchase Agreement could, in our sole discretion, have potentially resulted in a limitation of our ability to utilize our tax
attributes, such as the annual utilization of net operating loss or tax credit carry forwards (see Note 7 of Notes to Condensed
Consolidated Financial Statements contained elsewhere in this report), we had the ability to reduce the exercise by such shareholder
of the Subscription Privilege or the amount purchased
under
the Standby Purchase Agreement to such number of shares of our Common Stock as we determined advisable in order to preserve our
ability to utilize such tax attributes. On the basis of the Company’s analysis of tax attributes, the Company did not reduce
the subscriptions of any shareholder in the rights offering, but did reduce to zero the number of shares the Standby Purchasers
could have otherwise purchased pursuant to the Standby Purchase Agreement. As a result, no shares were issued to AO Partners,
LLC or Farnam Street Capital, Inc. pursuant to the Standby Purchase Agreement.
We intend to use the net
proceeds of the rights offering to pursue strategic opportunities that may present themselves from time to time or, if not used
to pursue strategic opportunities, for working capital and general corporate purposes, including to fund ongoing research and development
and product initiatives. Also, to the extent the net proceeds are not deployed, some of the funds may be invested in accordance
with the terms of our Surplus Capital Investment Policy.