ITEM 1A. RISK FACTORS
Investing in our common stock
involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information contained in
this report, before deciding whether to invest in shares of our common stock. If any of the following risks actually occur, our business,
financial condition, operating results, and prospects would suffer. In that case, the trading price of our common stock would likely decline
and you might lose all or part of your investment in our common stock. The risks described below are not the only ones we face. Additional
risks that we currently do not know about or that we currently believe to be immaterial may also impair our operations and business results.
Risks
Related to COVID-19
The COVID-19 pandemic, or the perception of its
effects, could have a material adverse effect on our business, financial condition, and results of operations.
To date, COVID-19 has not had a
material adverse impact on our business or results of operations, but due to the uncertainties surrounding this pandemic, it may adversely
impact us in the future. We have and may continue to experience disruptions in our supply chain and critical suppliers may delay or be
unable to deliver products we have ordered. Additionally, our customers could reduce planned orders, request cancelations of existing
orders, and/or delay payment to us due to financial hardship they may experience as a result of this healthcare and resulting economic
crisis. Therefore, it is impossible at this time to predict the ultimate short-term or long-term impact of the pandemic on our business,
financial condition, and results of operations.
The ability of our employees to work may be significantly
impacted by the COVID-19 crisis.
Our employees are being affected
by the COVID-19 pandemic. Some of our office and management personnel were continuing to work remotely during some of fiscal 2022, but
our employees engaged in manufacturing and assembly continued and are continuing to work at our corporate headquarters. The health of
our workforce is of primary concern and we may need to enact further precautionary measures to help minimize the risk of our employees
being exposed to the coronavirus. Further, our management team is focused on mitigating the adverse effects of the COVID-19 pandemic,
which has required and will continue to require a large investment of time and resources across the entire Company, thereby diverting
their attention from other priorities that existed prior to the outbreak of the pandemic. To date, several of our employees have had COVID-19,
but all have made full recoveries and returned to work. If more of our employees test positive for COVID-19, or these conditions worsen,
or last for an extended period of time, our ability to manage our business may be impaired, and operational risks, cybersecurity risks,
and other risks facing us even prior to the pandemic may be elevated.
Risks Related to Our Business and the Industry
in Which We Operate
A substantial portion of our revenue is derived
from a few customers. If we were to lose a key customer, it would have a material adverse effect on our business, financial condition,
and results of operations.
In fiscal 2022, our top three customers
accounted for 88% of our sales, with our current largest customer accounting for 66% of our sales. This customer has made purchase commitments
to us through a supply agreement to purchase surgical handpieces through calendar 2025. We provide this customer with a device used primarily
in elective surgeries and although this customer has not requested a reduction or delay to their planned shipments, if the COVID-19 pandemic
continues to adversely impact the United States and other markets where our products are sold, coupled with the recommended deferrals
of elective procedures by governments and other authorities, we would expect to see a decline in demand from our principal customer. The
loss of this customer or any of our significant customers would severely impact us, including having a material adverse effect on our
business, financial condition, cash flows, revenue, and results of operations.
A substantial portion of our business is derived
from our core business area that, if not serviced properly, may result in a material adverse impact upon our business, financial condition,
and results of operations.
In fiscal 2022, we derived 97% of
our revenue from sales of our medical device products and related services. We believe that a primary factor in the market acceptance
of our products and services is the value they create for our customers. Our future financial performance will depend in large part on
our ability to continue to meet the increasingly sophisticated needs of our customers through the timely development, and successful introduction
and implementation of new and enhanced products and services, while at the same time continuing to provide the value our customers have
come to expect from us. We have historically expended a significant percentage of our revenue on product development and believe that
significant continued product development efforts will be required to sustain our growth. Continued investment in our sales and marketing
efforts will also be required to support future growth.
There can be no assurance that we
will be successful in our product development efforts, that the market will continue to accept our existing products, or that new products
or product enhancements will be developed and implemented in a timely manner, meet the requirements of our customers, or achieve market
acceptance. If the market does not continue to accept our existing products, or our new products or product enhancements do not achieve
market acceptance, our business, financial condition, and results of operations could be materially adversely affected.
Our customers may cancel or reduce their orders, change production quantities,
or delay production, any of which would reduce our sales and adversely affect our results of operations.
Since
most of our customers purchase our products from us on a purchase order basis, they may cancel, change, or delay product purchase commitments
with little notice to us. As a result, we are not always able to forecast with certainty the sales that we will make in a given period
and sometimes we may increase our inventory, working capital, and overhead in expectation of orders that may never be placed, or, if placed,
may be delayed, reduced, or canceled.
The following factors, among others, affect our ability
to forecast accurately our sales and production capacity:
· Changes in the specific products or quantities our customers order; and
In addition to reducing our sales,
delayed, reduced, or canceled purchase orders also may result in our inability to recover costs that we incur in anticipation of those
orders, such as costs associated with purchased raw materials and write-offs of obsolete inventory.
In recent years, we have launched many new medical
device products and our estimates of warranty claims are based largely on our previous history from similar legacy products. If actual
warranty claims exceed our estimates, it could have an adverse effect on our results of operations and financial condition.
In recent years, we have completed
significant medical device development projects in the CMF and thoracic surgical segments for which we have made estimates of product
warranty claims based upon similar, legacy products. If the actual repair volumes or repair costs exceed the estimates that we have been
using, we may incur additional costs which could be materially adverse to our results of operations and financial condition.
We face significant competition from a number of
different sources, which could negatively impact our results of operations.
The markets for products in the
industries served by our customers are intensely competitive, and we face significant competition from a number of different sources.
Several of our competitors have significantly greater name recognition, as well as substantially greater financial, technical, product
development and marketing resources, than us.
We compete in all of our markets
with other major surgical device and related companies. As a provider of outsourced products and services, we also compete with our customers’
own internal development groups. Competitive pressures and other factors, such as new product or new technology introductions by us, our
customers’ internal development and manufacturing departments, or our competitors, may result in price or market share erosion that
could have a material adverse effect on our business, results of operations and financial condition. Also, there can be no assurance that
our products and services will achieve broad market acceptance or will successfully compete with other products.
The industry in which we operate is subject to
significant technological change and any failure or delay in addressing such change could adversely affect our competitive position or
could make our current products obsolete.
The medical device market is generally
characterized by rapid technological change, changing customer needs, frequent new product introductions and evolving industry standards.
The introduction of products incorporating new technologies and the emergence of new industry standards could render our existing products
obsolete and unmarketable. There can be no assurance that we will be successful in developing and marketing new products that respond
to technological changes or evolving industry standards.
New product development requires
significant research and development expenditures that we have historically funded through operations; however, we may be unable to do
so in the future. Any significant decrease in revenues or research funding could impair our ability to respond to technological advances
in the marketplace and to remain competitive. If we are unable, for technological or other reasons, to develop and introduce new products
in a timely manner in response to changing market conditions or customer requirements, our business, results of operations, and financial
condition may be materially adversely affected. Although we continue to target new markets for access, develop new products, and update
existing products, there can be no assurance that we will do so successfully or that, even if we are successful, such efforts will be
completed concurrently with or prior to the introduction of competing products. Any such failure or delay could adversely affect our competitive
position or could make our current products obsolete.
We rely heavily on our proprietary technology,
which, if not properly protected or if deemed invalid, could have a material adverse effect on our business, financial condition, and
results of operations.
We are dependent on the maintenance
and protection of our proprietary technology and rely on patent filings, exclusive development and supply agreements, confidentiality
procedures and employee nondisclosure agreements to protect it. There can be no assurance that the legal protections and precautions taken
by us will be adequate to prevent misappropriation of our technology or that competitors will not independently develop technologies equivalent
or superior to ours. Further, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the
laws of the United States and are often not enforced as vigorously as those in the United States.
We do not believe that our operations
or products infringe on the intellectual property rights of others. However, there can be no assurance that others will not assert infringement
or trade secret claims against us with respect to our current or future products. As an example, see Note 10 to the consolidated financial
statements contained elsewhere in this report. Assertions or claims by others, whether or not valid, could cause us to incur significant
legal costs defending our intellectual property rights and potentially require us to enter into a license agreement or royalty arrangement
with the party asserting the claim or to cease our use of the infringing technology, any of which could have a material adverse effect
on our business, financial condition and results of operations.
If our technology infrastructure is compromised,
damaged or interrupted by a cybersecurity incident, data security breach or other security problems, our results of operations and financial
condition could be adversely affected.
We use technology in substantially
all aspects of our business operations, and our ability to serve customers most effectively depends on the reliability of our technology
systems. We use software and other technology systems, among other things, to generate sales orders, job orders, and purchase orders and
to monitor and manage our business on a day-to-day basis. Cybersecurity incidents can include computer viruses, computer denial-of-service
attacks, worms, and other malicious software programs or other attacks, covert introduction of malware to computers and networks, impersonation
of authorized users, and efforts to discover and exploit any design flaws, bugs, security vulnerabilities or security weaknesses, as well
as intentional or unintentional acts by employees or other insiders with access privileges, intentional acts of vandalism by third parties
and sabotage.
In addition, our technology infrastructure
and systems are vulnerable to damage or interruption from natural disasters, power loss and telecommunications failures. Any such disruption
to our systems, or the technology systems of third parties on which we rely, the failure of these systems to otherwise perform as anticipated,
or the theft, destruction, loss, misappropriation, or release of sensitive and/or confidential information or intellectual property, could
result in business disruption, negative publicity, loss of customers, potential liability, including litigation or other legal actions
against us or the imposition of penalties, fines, fees or liabilities, which may not be covered by our insurance policies, and competitive
disadvantage, any or all of which would potentially adversely affect our customer service, decrease the volume of our business and result
in increased costs and lower profits. Moreover, a cybersecurity breach could require us to devote significant management resources to
address the problems associated with the breach and to expend significant additional resources to upgrade further the security measures
we employ to protect information against cyber-attacks and other wrongful attempts to access such information, which could result in a
disruption of our operations.
While we have invested, and continue
to invest, in technology security initiatives and other measures to prevent security breaches and cyber incidents, as well as disaster
recovery plans, these initiatives and measures may not be entirely effective to insulate us from technology disruption that could result
in adverse effects on our results of operations and financial condition.
To service our debt
obligations, we will require a significant amount of cash. However, our ability to generate cash depends on many factors beyond our control.
Our ability to make payments on,
and to refinance, our debt obligations and to fund capital expenditures, will depend on our ability to generate cash in the future, which,
in turn, is subject to general economic, financial, competitive, regulatory and other factors, many of which are beyond our control.
Our business may not generate sufficient
cash flow from operations, and we may not have available to us future borrowings in an amount sufficient to enable us to pay our debt
obligations or to fund our other liquidity needs. In these circumstances, we may need to refinance all or a portion of our debt obligations
on or before maturity. We may not be able to refinance any of our debt obligations, on commercially reasonable terms, or at all. Without
this financing, we could be forced to sell assets or secure additional financing to make up for any shortfall in our payment obligations
under unfavorable circumstances. However, we may not be able to secure additional financing on terms favorable to us or at all and, in
addition, the agreements governing our debt obligations limit our ability to sell assets. In addition, we may not be able to sell assets
quickly enough or for sufficient amounts to enable us to meet our obligations.
We periodically invest surplus cash in marketable
securities and other investments in order to realize a positive return, although there can be no assurance that a positive return will
be realized, and we could lose some or all of our investments, which could adversely affect our financial condition and results of operation.
We invest a significant portion
of our excess capital in marketable securities, including equity securities of publicly traded companies. At June 30, 2022, the fair value
of these marketable securities was approximately $2.5 million. Approximately $1.8 million of our investments at June 30, 2022 include
equity securities of companies that are thinly traded. As such, these investments are classified as long-term in nature, as we may not
be able to liquidate the investments in a timely manner even if we wish to sell them. While we intend to hold our investments, until such
time as we believe it is appropriate to sell them in accordance with our overall investment policy, we may have unexpected cash requirements
that could necessitate the sale of some or all of these marketable securities for a loss.
We may not be able to successfully integrate our business acquisitions,
which could adversely affect our business, financial condition, and results of operations.
We have acquired, and may acquire
in the future, businesses, products, and technologies that complement or expand our current operations. Acquisitions could require significant
capital investments and require us to integrate with companies that have different cultures, management teams, and business infrastructure.
Depending on the size and complexity of an acquisition, our successful integration of the acquisition could depend on several factors,
including:
· The retention of key employees;
· Management of facilities and employees in separate geographic areas;
· Successfully converting information and accounting systems; and
· Diversion of resources and management attention from our other operations.
If market conditions or other factors
require us to change our strategic direction, we may fail to realize the expected value from one or more of our acquisitions. Our failure
to successfully integrate any future acquisitions or realize the expected value from past or future acquisitions could harm our business,
financial condition, and results of operations.
We have experienced losses in the past, and we
cannot be certain that we will sustain our current profitability; we may need additional capital in the future to fund our businesses,
which we may not be able to obtain on acceptable terms.
We have experienced operating losses
in the past. Our ability to achieve or sustain profitability is based on a number of factors, many of which are out of our control, including
the material costs for our products and the demand for our products.
We currently anticipate that our
available capital resources, including our existing cash and cash equivalents and accounts receivable balances, will be sufficient to
meet our expected working capital and capital expenditure requirements as our business is currently conducted for at least the next 12 months.
We may also attempt to raise additional funds through public or private debt or equity financings, if such financings become available
on acceptable terms. We cannot be certain that any additional financing we may need will be available on terms acceptable to us, or at
all. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of opportunities,
develop new products, or otherwise respond to competitive pressures, and our operating results and financial condition could be adversely
affected.
Our operations are dependent upon our key personnel.
If such personnel were to leave unexpectedly, we may not be able to execute our business plan.
Our future performance depends in
significant part upon the continued service of our key technical and senior management personnel. Because we have a relatively small number
of employees when compared to other companies in the same industry, our dependence on maintaining our relationship with key employees
is particularly significant. We are also dependent on our ability to attract and retain high quality personnel, particularly in the areas
of product development, operations management, marketing and finance.
A high level of employee mobility
and the aggressive recruiting of skilled personnel characterize the medical device industry. There can be no assurance that our current
employees will continue to work for us. Loss of services of key employees could have a material adverse effect on our business, results
of operations, and financial condition. Furthermore, we may need to provide enhanced forms of incentive compensation to attract and retain
such key personnel, which could potentially dilute the holdings of other shareholders.
Risks Related to Ownership of Our Common Stock
Two of our directors hold voting power with respect
to a substantial portion of our outstanding common stock that enables them to have significant influence over the outcome of all matters
submitted to our shareholders for approval, which influence may conflict with our interests and the interests of other shareholders.
As of August 12, 2022, two of our
directors, Nicholas J. Swenson and Raymond E. Cabillot, directly or indirectly, controlled voting power over approximately 38% (28% and
10%, respectively) of the outstanding shares of our common stock. As a result of such voting control, these directors will have significant
influence over all matters submitted to our shareholders for approval, including the election of our directors and other corporate actions,
and may have interests that conflict with our interests and the interests of other shareholders.
Our quarterly results can fluctuate significantly
from quarter to quarter, which may negatively impact the price of our shares and/or cause significant variances in the prices at which
our shares trade.
Our sales have fluctuated in the
past, and may fluctuate in the future from quarter to quarter and period to period, as a result of a number of factors, including, without
limitation: the size and timing of orders from customers; the length of new product development cycles; market acceptance of new technologies;
changes in pricing policies or price reductions by us or our competitors; the timing of new product announcements and product introductions
by us or our competitors; the financial stability of major customers; our success in expanding our sales and marketing programs; acceleration,
deferral, or cancellation of customer orders and deliveries; changes in our strategy; revenue recognition policies in conformity with
accounting principles generally accepted in the United States (“U.S. GAAP”); personnel changes; and general market and economic
factors.
Because a significant percentage
of our expenses are fixed, a variation in the timing of sales can cause significant fluctuations in operating results from quarter to
quarter. As a result, we believe that interim period-to-period comparisons of our results of operations are not necessarily meaningful
and should not be relied upon as indications of future performance. Further, our historical operating results are not necessarily indicative
of future performance for any particular period.
In addition, it is possible that
our operating results in future quarters may be below the expectations of public market analysts and investors. In such an event, the
price of our common stock could be materially adversely affected.
Regulatory & Compliance Risks
Our operations are subject to a number of complex
government regulations, the violation of which could have a material adverse effect on our business.
The manufacture and distribution
of medical devices are subject to state and federal requirements set forth by various government agencies including the FDA and EPA. The
statutes, regulations, administrative orders, and advisories that affect our businesses are complex and subject to diverse, often conflicting,
interpretations. While we make every effort to maintain full compliance with all applicable laws and regulations, we are unable to eliminate
the ongoing risk that one or more of our activities may at some point be determined to be non-compliant. The penalties for non-compliance
could range from an administrative warning to termination of a portion of our business. Furthermore, even if we are subsequently determined
to have fully complied with applicable laws or regulations, the costs to achieve such a determination and the intervening loss of business
could adversely affect or result in the cessation of a portion of our business. A change in such laws or regulations at any time may have
an adverse effect on our operations.
The FDA designates all medical devices
into one of three classes (Class I, II, or III) based on the level of control necessary to assure the safety and effectiveness of the
device (with Class I requiring the lowest level of control and Class III requiring the greatest level of control). The surgical instrumentation
we manufacture is generally classified into Class I. The FDA has broad enforcement powers to recall and prohibit the sale of products
that do not comply with federal regulations and to order the cessation of non-compliant processes. No claim has been made to date by the
FDA regarding any of our products or processes. Nevertheless, as is common in the industry, certain of our products and processes are
from time to time subject to routine governmental reviews and investigations. We are also subject to EPA regulations concerning the disposal
of industrial waste.
While management believes that our
products and processes fully comply with applicable laws and regulations, we are unable to predict the outcome of any such future review
or investigation.
We face risks and uncertainties associated with
potential litigation by or against us, which could have a material adverse effect on our business, financial condition, and results of
operations.
We continually face the possibility
of litigation as either a plaintiff or a defendant (See Note 10 to the consolidated financial statements contained elsewhere in this report).
It is not reasonably possible to estimate the awards or damages, or the range of awards or damages, if any, that we might incur in connection
with such litigation.
Many of our products are complex
and technologically advanced. Such products may, from time to time, be the subject of claims concerning product performance and construction,
including warranty and patent infringement claims. While we are committed to investigating such concerns and correcting them, there is
no assurance that solutions will be found on a timely basis, if at all, to satisfy customer demands or to avoid potential claims or litigation.
Also, due to the location of our facilities, as well as the nature of our business activities, there is a risk that we could be subject
to litigation related to environmental remediation claims. We maintain insurance to protect against claims associated with the manufacture
and use of our products as well as environmental pollution, but there can be no assurance that our insurance coverage will adequately
cover any claim asserted against us.
The uncertainty associated with
potential litigation may have an adverse impact on our business. In particular, litigation could impair our relationships with existing
customers and our ability to obtain new customers. Defending or prosecuting litigation could result in significant legal costs and a diversion
of management’s time and attention away from business operations, either of which could have a material adverse effect on our business,
financial condition, and results of operations. There can be no assurance that litigation would not result in liability in excess of our
insurance coverage, that our insurance will cover such claims, or that appropriate insurance will continue to be available to us in the
future at commercially reasonable rates.
The agreements governing our various debt obligations
impose restrictions on our business and could adversely affect our ability to undertake certain corporate actions.
The agreements governing our
debt obligations include covenants imposing significant restrictions on our business. These restrictions may affect our ability to operate
our business and may limit our ability to take advantage of potential business opportunities as they arise. These covenants place restrictions
on our ability to, among other things:
· incur additional debt;
· declare or pay dividends to shareholders;
· create liens or use assets as security in other transactions;
· be acquired by a third party;
· pursue strategic acquisitions;
· engage in transactions with affiliates; and
· sell or transfer assets.
The agreements governing our
debt obligations also require us to comply with a number of financial ratios, borrowing base requirements and additional covenants.
Our ability to comply with these
covenants may be affected by events beyond our control, including prevailing economic, financial, and industry conditions. These covenants
could adversely affect our business by limiting our ability to take advantage of financing, merger and acquisition, or other corporate
opportunities. The breach of any of these covenants or restrictions could result in a default under our debt obligations. If we were unable
to repay our debt or are otherwise in default under any provision governing our secured debt obligations, our lender could proceed against
us and against the collateral securing that debt.
We are subject to changes in and interpretations
of financial accounting matters that govern the measurement of our performance, compliance with which could be costly and time consuming.
We are subject to changes in and
interpretations of financial accounting standards that govern the measurement of our performance. Based on our reading and interpretations
of relevant pronouncements, guidance, or concepts issued by, among other authorities, the Financial Accounting Standards Board, the SEC,
and the American Institute of Certified Public Accountants, management believes our performance, including current sales contract terms
and business arrangements, has been properly reported. However, there continue to be issued pronouncements, interpretations, and guidance
for applying the relevant standards to a wide range of contract terms and business arrangements that are prevalent in the industries in
which we operate. Future interpretations or changes by the regulators of existing accounting standards or changes in our business practices
may result in future changes in our accounting policies and practices that could have a material adverse effect on our business, financial
condition, cash flows, revenue, and results of operations.
Our evaluation of internal controls and remediation
of potential problems is costly and time consuming and could expose weaknesses in financial reporting.
Section 404 of the Sarbanes-Oxley
Act of 2002, as amended, requires management’s assessment of the effectiveness of our internal control over financial reporting.
This process is expensive and time consuming and requires significant attention of management. Management can give no assurance that material
weaknesses in internal controls will not be discovered. If a material weakness is discovered, corrective action may be time consuming
and costly, and could further divert the attention of management. The disclosure of a material weakness, even if quickly remedied, could
reduce the market’s confidence in our financial statements and harm our stock price, especially if a restatement of financial statements
for past periods is required.
General Risks
The global economic environment may impact our
business, financial condition, and results of operations.
Changes in the global economic environment
have caused, and may cause in the future, a general tightening in the credit markets, lower levels of liquidity, increases in rates of
default and bankruptcy, high rates of inflation, and extreme volatility in credit, equity and fixed income markets. These macroeconomic
developments could negatively affect our business, operating results or financial condition should they cause, for example, current or
potential customers to become unable to fund purchases of our products, in turn resulting in delays, decreases or cancellations of
purchases of our products and services, or causing the customer to not pay us or to delay paying us for previously purchased products
and services. In addition, financial institution failures may cause us to incur increased expenses or make it more difficult either to
obtain financing for our operations, investing activities (including the financing of any future acquisitions), or financing activities.
Additional economic risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and
adversely affect our business, financial condition, and results of operations.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our executive offices and manufacturing
facility are located at 2361 McGaw Avenue, Irvine, California 92614. We lease the 28,000 square foot facility from an unrelated third
party at a current base monthly lease rate of approximately $41,000 with 3% annual escalations through the expiration of the lease in
September 2027. The building is a one-story, stand-alone structure of concrete “tilt-up” construction, approximately 30 years
old and in good condition.
We are currently preparing the Franklin
Property, located at 14401 Franklin Avenue, Tustin, California 92780, for our move-in. We purchased this 25,000 square foot facility in
November 2020 from an unrelated third party through a loan (See Note 8 of to the consolidated financial statements contained elsewhere
in this report) and while we have moved some staff over there during fiscal 2022, we plan to move our assembly and repairs teams once
our validations are completed, currently expected in the third quarter of fiscal 2023. The building is a one-story, stand-alone structure
of concrete “tilt-up” construction, approximately 45 years old and in good condition.
We believe that our facilities
are adequate for our current and expected future needs and are in full compliance with applicable state, EPA and other agency environmental
standards.
ITEM 3. LEGAL PROCEEDINGS
See Note 10 to the consolidated
financial statements contained elsewhere in this report.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
Market Information
Our common
stock is quoted under the symbol “PDEX” on the automated quotation system of the Nasdaq Capital Market (“NASDAQ”).
The following table sets forth for the quarters indicated the high and low sales prices of our common stock as reported by NASDAQ. The
quotations reflect inter-dealer prices, without retail markup, markdown, or commissions, and may not necessarily represent actual transactions.
On September 6, 2022, the last sale price of our common stock as reported by NASDAQ was $19.68 per share.
High Low
Holders
As of September
6, 2022, there were 116 holders of record of our common stock. This number does not include beneficial owners including holders whose
shares are held in nominee, or “street,” name.
Dividends
We have
never paid a cash dividend with respect to our common stock. The current policy of our Board of Directors is to retain any future earnings
to provide funds for the operation and expansion of our business. Any determinations to pay dividends in the future will be at the discretion
of our Board of Directors.
Repurchases
During
the fourth quarter of fiscal 2022 and 2021, we repurchased 22,532 and 54,880 shares of our common stock, respectively, at an aggregate
cost of $350,000 and $1.5 million, respectively, through Board approved prearranged share repurchase plans intended to qualify for the
safe harbor under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. Repurchases
by us of our common stock by month during the quarter ended June 30, 2022, were as follows:
All
repurchases were made pursuant to our previously announced repurchase programs.
ITEM 6. RESERVED
The following discussion of our
financial condition and results of operations should be read in conjunction with our Financial Statements and the Notes thereto contained
elsewhere in this report, as well as the Risk Factors included in Item 1A of this report. The following discussion contains forward-looking
statements. (See “Cautionary Note Regarding Forward-Looking Statements” included in Part I of this report.)
Overview
The following
discussion and analysis provides information that management believes is relevant to an assessment and understanding of our results of
operations and financial condition for the fiscal years ended June 30, 2022 and 2021.
We specialize in the design, development,
and manufacture of autoclavable, battery-powered and electric, multi-function surgical drivers and shavers used primarily in the orthopedic,
thoracic, and CMF markets. Additionally, we provide engineering, quality, and regulatory consulting
services to our customers. We also sell rotary air motors. Our products are found in hospitals, medical engineering labs, scientific
research facilities, and high-tech manufacturing operations around the world. We are headquartered in Irvine, California.
COVID-19 Pandemic
We have adjusted certain policies
and procedures based on applicable national, state, and local emergency orders and safety guidance that may be issued from time to time,
in order to effectively manage our business during the pandemic, including:
· Curtailed business travel;
· Provided training, education and appropriate personal protective equipment;
· Daily temperature screenings and personal affidavits of wellness.
While we have yet to see any decline
in our customer orders, we have received and accepted some customer requests to delay the shipment of their existing orders. We provide
our largest customer with a device used primarily in elective surgeries and although this customer has not requested a reduction or delay
to their planned shipments, if this pandemic continues to adversely impact the United States and other markets where our products are
sold, coupled with the recommended deferrals of elective procedures by governments and other authorities, we would expect to see a decline
in demand from our principal customer.
We are
focused on the health and safety of all those we serve – our customers, our communities, our employees, and our suppliers. We are
supporting our customers according to their priorities and working with them to the degree that we can offer relief in the form of delayed
shipments. We are focused on continuity of supply by working with our suppliers, some of whom have delivered our orders late and are quoting
longer lead times.
While the COVID-19 pandemic did
not materially adversely affect our financial results and business during calendar 2021, we began to see some challenges in our supply
chain in the form of delayed shipments, longer lead times, and surcharges, much of which our suppliers indicate has been caused by the
COVID-19 pandemic. As previously disclosed, during early calendar 2022, we saw these conditions persist and worsen such that we expected
them to negatively impact our financial performance in the third quarter and possibly the fourth quarter of fiscal 2022, reflected as
a reduction in net sales. However, we did not end up experiencing this anticipated decline in our sales because we were able to largely
mitigate our biggest concerns by sourcing replacement chips through alternative suppliers, albeit at much higher prices, for many of our
printed circuit board assemblies. In so doing, our cost of sales increased during the third and fourth quarter of fiscal 2022. We continue
to implement plans and processes to mitigate these challenges that many manufacturers similarly face. Our long-term prospects remain positive,
and we believe these challenges will negatively impact us only in the short-term.
Critical Accounting Policies
Our financial
statements are prepared in accordance with U.S. 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
Under Accounting Standards Update
(“ASU”) 2014-09, (Topic 606) “Revenue From Contracts with Customers,” we recognize revenue from the sales
of products and services by applying the following steps: (1) identify the contract with a customer; (2) identify the performance obligations
in the contract; (3) determine the transaction price; (4) allocate the transaction price to each performance obligation in the contract;
and (5) recognize revenue when each performance obligation is satisfied. We primarily sell finished products and recognize revenue at
point of sale or delivery. However, we also perform services when we are engaged to design a product for a customer and there is more
judgment involved in determining the amount and timing of revenue recognition under those types of contracts. In fiscal 2022, the revenue
from non-recurring engineering (“NRE”) and prototype services represents approximately 2% of total revenue.
Returns of our product for credit
are not material; 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.
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
Most 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.
Warranty expenses, including changes
of estimates, are included in cost of sales in our statements of operations.
Inventories
Inventories are stated at the lower
of cost (first-in, first-out method) or net realizable value. Reductions to estimated net realizable 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.
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 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.
Deferred Costs
Deferred costs reflect costs incurred
related to non-recurring engineering services under the terms of the related development and supply contracts. These costs get recorded
to cost of sales in the period that the revenue is recognized.
Investments
Investments 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
in other income (expense) in our consolidated income statements. Some of our investments include the common stock of public companies
that are thinly traded. Certain of these investments are classified as long-term in nature, as we may not be able to liquidate the investments
in a timely manner even if we wish to sell them. Thinly traded investments were subject to a valuation analysis as of June 30, 2022 and
2021.
Long-lived Assets
We review the recoverability of
long-lived assets, consisting of building, equipment, and improvements, when events or changes in circumstances occur that indicate carrying
values may not be recoverable.
Building, equipment, and improvements
are recorded at historical cost and depreciation is provided using the straight-line method over the following periods:
Building Thirty years
Equipment Three to ten years
Intangibles
Other
intangibles consist of legal fees incurred in connection
with patent applications. The legal fees will be amortized over the estimated life of the product(s) that will be utilizing the technology
or expensed immediately in the event the patent office denies the issuance of the patent. 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 loss and tax credit carryovers. Deferred tax assets at 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. 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
on our historical taxable income, with consideration given to our estimates of future taxable income and the periods over which deferred
tax assets will be recoverable. In evaluating our ability to recover our deferred tax assets, we consider all available positive and negative
evidence, including reversals of deferred tax liabilities, projected future taxable income, and results of recent operations. The assumptions
about future taxable income require significant judgment and are consistent with the plans and estimates we are using to manage the underlying
business. In evaluating the objective evidence that historical results provide, we consider three years of cumulative operating income
(loss).
Results of Operations for the Fiscal Year Ended June 30, 2022 Compared
to the Fiscal Year Ended June 30, 2021
The following tables set forth results
from operations for the fiscal years ended June 30, 2022 and 2021:
Years Ended June 30,
Dollars in thousands
% of Net Sales % of Net Sales
Loss from disposal of equipment 35 — — —
Other income (loss), net (417 ) (1 %) 2,472 6 %
Net Sales
The
majority of our revenue is derived from designing, developing, and manufacturing powered
surgical instruments for medical device original equipment manufacturers. We also manufacture and
sell rotary air motors to a wide range of industries. The proportion of total sales by product/service
type is as follows:
Years Ended June 30, Increase (Decrease) From 2021 To
Dollars in thousands
% of Net Sales % of Net Sales
Net sales:
Net
sales in fiscal 2022 increased by $4.0 million, or 11%, as compared to fiscal 2021, due primarily to an increase
in medical device revenue of $1.9 million as well as a $1.7 million increase in repair revenue. Details of our medical device sales by
type is as follows:
Years Ended June 30, Increase (Decrease) From 2021 To
Dollars in thousands
% of Total % of Total
Medical device sales:
Sales
of our medical device products increased $1.9 million, or 6% during, fiscal 2022 as compared to fiscal 2021. During fiscal 2022, orthopedic
sales increased by $3.8 million to $21.9 million, up from $18.1 million in fiscal 2021, due primarily to increased sales to our largest
customer. Additionally, recurring revenue from distributors of CMF drivers increased $4.1 million in fiscal 2022 compared to fiscal
2021 in part due to the launch of a new driver to our existing largest customer during the
third quarter of fiscal 2021. Our fiscal 2022 thoracic sales revenue decreased $6.0 million compared to the prior fiscal year, due likely
as a result of our customer filling the near-term requirements of its distribution network. Currently, the thoracic driver is only sold
to one customer, although we are in discussions with other of our existing customers who have expressed an interest in this driver.
Sales
of our industrial and scientific products, which consist primarily of our compact pneumatic air
motors, increased $65,000, or 8%, for fiscal 2022 compared to fiscal 2021. The revenue increase relates to a continued interest in these
legacy products, but is not due to any substantive marketing efforts.
Sales
of our NRE & proto-type services increased $690,000 or 213% compared to fiscal 2021 and relates to billable engagement for multiple
engineering projects.
Sales
of our dental products and components in fiscal 2022 increased $304,000, or 189%, as compared to fiscal 2021. The increase in sales in
fiscal 2022 related to component sales of excess inventory directly to our largest customer due to the release of their next generation
device. We expect future declines in this area as we are no longer manufacturing dental products, but rather are simply selling remaining
component inventory.
Our
fiscal 2022 repair revenue has increased approximately $1.7 million, or 33%, over fiscal 2021 to $6.6 million, due to increased repairs
of the orthopedic handpiece we sell to our largest customer. We expect repair revenue to continue to increase based upon expected refurbishments
to upgrade the handpiece to the next generation, which was released in the third quarter of fiscal 2022. While we expect the volume of
repairs to increase, we expect the gross margin to deteriorate, at least in the near term, as we are currently upgrading these handpieces
at no additional cost while we continue to negotiate a new repair price with our largest customer in good-faith.
At June 30, 2022, we had a
backlog of $16.5 million compared with a backlog of $9.7 million at June 30, 2021. Our backlog represents firm purchase orders received
and acknowledged from our customers and does not include all revenue expected to be generated from existing customer contracts. Our entire
backlog at June 30, 2022, as well as certain purchase orders received subsequent to June 30, 2022, are expected to be delivered during
fiscal 2023. We have experienced, and may continue to experience, variability in our new order bookings due to, among other reasons, the
launch of new products, the timing of customer orders based on end-user demand, and customer inventory levels. We do not typically experience
seasonal fluctuations in our shipments and revenues.
Cost of Sales and Gross Margin
Years Ended June 30, Increase (Decrease) From 2021 To
Dollars in thousands
% of Net Sales % of Net Sales
Cost of sales:
NRE and Prototype services costs 774 2 % 395 1 % 96 %
Under (over)-absorption of manufacturing overhead 877 2 % 370 1 % 137 %
Inventory and warranty charges 962 2 % 596 2 % 61 %
Cost of sales in fiscal 2022 increased
$4.5 million, or 18%, from fiscal 2021, primarily due to the increase in product costs, consistent with the 11% increase in net sales,
coupled with higher material and labor costs. During fiscal 2021, we incurred costs of $395,000 to generate $324,000 in revenue related
to NRE and Prototype services, netting losses in the amount of $71,000 compared to netting profit of $240,000 in fiscal 2022. During fiscal
2022, we experienced $877,000 under-absorption of manufacturing costs compared to a $370,000 in fiscal 2021, due primarily to actual
production hours being less than planned. Costs related to inventory and warranty charges increased $366,000 in fiscal 2022 compared
to fiscal 2021, primarily due to sourcing components for our printed circuit board assemblies at prices higher than usual.
Operating Expenses
Years Ended June 30, Increase (Decrease) From 2021 To
(Dollars in thousands)
% of Net Sales % of Net Sales
Operating expenses:
Selling expenses consist of salaries
and other personnel-related expenses related to our business development department, as well as trade show attendance, advertising and
marketing expenses, and travel and related costs incurred in generating and maintaining customer relationships. Selling expenses decreased