-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FEApLrvzmkeIC+QtDh07aBGCUnRKV9vb4DD039G5qU98zr5k8ZABtPqwYsIp/oLP z3vIkUUtA1XFQs6DbdvETQ== 0001016514-99-000030.txt : 19991227 0001016514-99-000030.hdr.sgml : 19991227 ACCESSION NUMBER: 0001016514-99-000030 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990928 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRO DEX INC CENTRAL INDEX KEY: 0000788920 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-MEDICAL, DENTAL & HOSPITAL EQUIPMENT & SUPPLIES [5047] IRS NUMBER: 841261240 STATE OF INCORPORATION: CO FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-14942 FILM NUMBER: 99718169 BUSINESS ADDRESS: STREET 1: 1401 WALNUT ST STE 500 CITY: BOULDER STATE: CO ZIP: 80302-5333 BUSINESS PHONE: 3034438165 MAIL ADDRESS: STREET 1: 1401 WALNUT STREET STREET 2: SUITE 540 CITY: BOULDER STATE: CO ZIP: 80302 10KSB 1 ============================================================================== U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ________________ FORM 10-KSB [X]Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Fee Required) For the fiscal year ended June 30, 1999 [ ]Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (No Fee Required) Commission File Number 0-14942 _______________________ PRO-DEX, INC. (Name of small business issuer in its charter) Colorado 84-1261240 -------- ---------- (State or other jurisdiction of (I.R.S. Employer ID No.) incorporation or organization) 1401 Walnut St., Ste., 540, Boulder, Colorado 80302 (Address of principal executive offices) Issuer's telephone number: (303) 443-6136 Securities registered under Section 12(b) of the Exchange Act: Name of each exchange Title of each class on which registered - ------------------- ------------------- None None Securities registered under Section 12(g) of the Exchange Act: Common stock, no par value (Title of class) Check whether the issuer (1) has filed all reports required by Section 13 or 15(d) of the Exchange Act during the past 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X] Issuer's revenues for its most recent fiscal year was $ 18,342,000. The aggregate market value of the voting stock held by non-affiliates computed by reference to the average of the bid and asked as of September 13, 1999 was $ 7,583,716. The number of shares of the Registrant's no par value common stock outstanding as of September 13, 1999 was 8,787,300. DOCUMENTS INCORPORATED BY REFERENCE: Certain Exhibits, as set forth in the Exhibit Index. Exhibit index begins on sequentially numbered page 39. ============================================================================== PART I Item 1. Business Forward-Looking Statements When used in this Report on Form 10-KSB, the words "expects, "anticipates", "estimates", "believes", "hopes", "intends", "forecasts" and similar expressions are intended to identify forward-looking statements. These statements which are not historical or current facts are made pursuant to the safe harbor provisions of Section 27A of the Securities Act and Section 21E of the 1934 Act and the Company intends that such forward-looking statements be subject to those safe harbor provisions for such statements. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date of this report. While forward-looking statements represent management's best judgment as to what may occur in the future, they are subject to risks, uncertainties and important factors beyond the control of the Company that could cause actual results and events to differ materially from historical results of operations and events as well as those presently anticipated or projected. These factors include adverse economic conditions, entry of new and stronger competitors, capital availability, unexpected costs and failure to capitalize upon access to new clientele. Other risks and uncertainties which may affect forward-looking statements about the Company's business and prospects include, but are not limited to, the ramifications of the continued industry consolidation of dental dealers and distributors, managed health care, increasingly limited acquisition opportunities, the Company's ability to effectively integrate operations of acquired companies, dealer acceptance and support of new products, maintaining favorable supplier relationships, Y2K issues of various customers and vendors, the inability to engage qualified human resources as needed, and general economic conditions. The Company disclaims any obligations subsequently to revise any forward-looking statements to reflect events or circumstances after the date of such statement or to reflect the occurrence of anticipated or unanticipated events. General Pro-Dex, Inc. (or the "Company") is a Colorado based holding company doing business through four wholly owned operating subsidiaries, Biotrol International, Inc. ("Biotrol"), Challenge Products, Inc. ("Challenge"), Micro Motors, Inc. ("Micro"), and Oregon Micro Systems, Inc. ("OMS"). Biotrol is located in Louisville, Colorado, and manufactures and distributes infection control products, and distributes preventive products, handpieces, ultrasonic scalers and a full line of hand care products for the dental industry. Challenge is located in Osage Beach, Missouri, and manufactures fluoride and related products for preventive dentistry, as well as cosmetic bleaching materials for home use which are dispensed by the dentist. Micro, of Santa Ana, California, manufactures a complete line of handpieces for the dental industry, and miniature pneumatic motors with dental, medical and industrial applications. OMS is headquartered in Beaverton, Oregon where it designs and manufactures motion controllers used to control the motion of servo and stepper motors, predominantly for the medical analysis equipment and semiconductor industries. In 1996 the Company obtained a $10,000,000 credit facility from Harris Bank. The credit facility requires that the Company meet certain financial covenants. On June 30, 1999, the Company did not meet certain of the financial covenants and Harris Bank has requested that the Company find alternative financing sources to replace the Harris facility. See "Item 6 - Management's Discussion and Analysis". The Company incurred unusual charges of $7,389,000 for the year ended June 30, 1999. The charges include the write-off of goodwill at the Micro subsidiary for $4.8 million, the write off of a receivable from the sale of a former segment of the business in the amount of approximately $1.75 million, and charges to operations for the remaining portion of employment, consulting, and non-compete contracts deemed to have no future value to the Company. See "Pro-Dex Consolidated Financial Statements - Note 6." Pro-Dex, Inc. was organized in March 1978 as a California corporation. It was reincorporated in May 1994 as a Colorado corporation. The Company's principal headquarters are located at 1401 Walnut Street, Suite 540, Boulder, Colorado 80302. Divestitures On June 12, 1997, the Company completed the sale of certain assets of its dental clinic management ("DCM") subsidiary in California. The Company retained ownership of approximately $1,800,000 in net accounts receivable. During 1998, the purchaser collected $650,000 of the receivables, but due to financial difficulties was only able to remit $50,000 to the Company. In October 1998, the purchaser was reorganized and in consideration of the successor to the purchaser's guarantee of the collection of the full net amount of the accounts receivable, the Company agreed to restructure the balance owed of $1,750,000 in exchange for a five year 6% promissory note totaling $850,000, 5% cumulative preferred stock in the successor entity then valued at $900,000, and warrants to acquire common stock in the successor entity. The financial condition of the purchaser of the dental centers is poor, and management believes that it is unlikely it will be able to collect the 6% promissory note of $850,000. Nor does it believe that the convertible preferred stock of $900,000 has any future value. Consequently, the Company has taken an unusual charge for the write-off of the promissory note and the convertible preferred stock in the amount of $1,750,000 in the fourth quarter of 1999. See "Pro-Dex, Inc. Consolidated Financial Statements - Note 6." In April 1997, the Company completed the unwinding of its acquisition of Pnu-Light Tool Works, Inc. ("Pnu-Light"). The Company acquired the assets of Pnu-Light, a developer of patented pneumatic lighting mechanisms for hand tools, in May 1996 in exchange for 368,483 shares of the Company's common stock. The Company anticipated that Pnu-Light's patented lighting apparatus would complement the pneumatic motors used in dental handpieces manufactured by Micro. The anticipated synergy between Pnu-Light and Micro did not meet the Company's expectations. Accordingly, and pursuant to the procedures contained in the Pnu-Light Asset Purchase Agreement, all of the shares of its common stock issued in the transaction for the Pnu-Light assets were returned to the Company. In exchange for the reconveyance of its shares, the Company assigned the patent covering the pneumatic lighting apparatus to Pnu-Light's successor entity, while retaining a nonexclusive, fully paid, worldwide license to the technology. In conjunction with its previously announced intent to make acquisitions as part of its long-term commitment to the growth and development, the Company retained the investment banking firm of Cleary Gull Reiland & McDevitt, Inc. (now, Tucker Anthony Cleary Gull). Tucker Cleary is currently acting as the Company's financial advisor and assisting the Company in evaluating strategic options in its ongoing effort to grow through acquisitions and to attract greater institutional and retail participation in its stock. Description of Subsidiary Business Biotrol Biotrol is a manufacturer, distributor and marketer of dental and related products. Biotrol specializes in infection control products, preventive dental products, handpieces, ultrasonic scalers, and hand care products. Its infection control products work effectively as a system for eliminating cross-contamination of infectious organisms in the dental operatory. Biotrol's infection control system includes five major categories of products: surface cleaners and disinfectants; instrument immersion cleaners and disinfectants; a dental evacuation system cleaner; general barrier, and a full line of hand care products. Biotrol markets an extensive line of professional preventive dental products manufactured for Biotrol by Challenge under the name "Perfect Choice(tm)". These products include fluoride gels and rinses, in addition to prophy pastes and related preventive dental products. In July 1997, Biotrol began offering a full line of dental handpieces manufactured by Micro. Biotrol also markets an extensive line of ultrasonic scalers manufactured in Sweden. Biotrol products are distributed exclusively through dental dealers. Two distribution companies control more than fifty percent (50%) of the sales of dental products through dealers. Forty six percent (46%) of Biotrol's sales are attributable to these two companies with whom Biotrol has maintained longstanding relationships. Biotrol has no plans to discontinue these relationships, nor does it believe these customers have any plans to discontinue their relationship with Biotrol. Any material adverse change in the relationship with these two customers may be financially detrimental to Biotrol. Relationships with its various suppliers and manufacturers are considered to be excellent. Biotrol does not intend to terminate any relationship at this time, nor does its management believe any relationships will be terminated by a supplier or manufacturer. Biotrol holds no franchises and has no exclusive arrangements with its suppliers or manufacturers, excepting only its exclusive right to market Amdent ultrasonic scalers in North America. Biotrol has surveyed its suppliers, manufacturers, and customers to determine whether or not each of them will be Y2K compliant in an effort to minimize the impact of that event. It has developed contingency plans to include, but not be limited to, the identification of new suppliers and capability of implementing manual systems should the need arise. Should such contingency plans fail for any reason, such failure could have a negative impact on Biotrol's business. At the present time, Biotrol is usually able to fill orders within 48 hours. At June 30, 1999, Biotrol had no significant order backlog, and had no backlog at June 30, 1998. Biotrol does not typically experience seasonal fluctuations in its orders. Challenge Challenge manufactures products used by dentists for the prevention of dental disease and home use tooth brightening products which are dispensed by the dentist. The majority of its business is the formulation and manufacture of gels, pastes, rinses, and whiteners for in-office and/or home treatments for the prevention of dental diseases and improvement in cosmetic appearance. Its products are sold under the Challenge labels of "Perfect Choice(tm)", "Dual X(tm)", "Dentalite(tm)", and "Prophy Gems(tm)", which are marketed under the "Perfect Choice(tm)" label. Biotrol markets Challenge's branded products through Biotrol's sales force and distributors. Fifty eight percent (58%) of Challenge's products are formulated, packaged, and sold under private label agreements through dental manufacturers and distributors other than Biotrol. Such manufacturers/distributors represent a significant percentage of Challenge's private label sales, however, these relationships are longstanding and Challenge has no plans to discontinue these relationships, nor does it believe that these customers have any plans to discontinue their relationships with Challenge. Any material adverse change in the relationships with either of the two customers representing significant percentages of Challenge's private label sales may be financially detrimental to Challenge. Seventy percent (70%) of Challenge's revenues are derived from sales to its three largest customers. The largest portion of such revenues, constituting thirty seven percent (37%) of total sales are attributable to Biotrol. Management considers that the inter-company nature of the relationship with Biotrol affords somewhat greater security of continuity of relationship than could ordinarily be expected. Nevertheless, if any material adverse change were to occur in Challenge's volume of business with either of its three largest customers, such change may be detrimental to Challenge. Challenge's relationships with its various suppliers and distributors are considered to be excellent. It does not intend to terminate any relationship at this time, nor does its management believe any relationships will be terminated by a supplier or distributor. Challenge holds no franchises and has no exclusive arrangements with any of its suppliers or distributors, excepting only that license from Dunhall Pharmaceuticals, Inc. for the manufacture of tooth whitening products. Challenge has surveyed its suppliers, manufacturers, and customers to determine whether or not each of them will be Y2K compliant in an effort to minimize the impact of that event. It has developed contingency plans to include, but not be limited to, the identification of new suppliers and capability of implementing manual systems should the need arise. Should such contingency plans fail for any reason, such failure could have a negative impact on Challenge's business. Challenge usually fills orders for its branded "Perfect Choice(tm)" and "Prophy Gem(tm)" products within 30 days. Private label customers usually anticipate a 30 to 60-day lead-time for the delivery of products. As of June 30, 1999, Challenge had no backlog. Future orders not yet due for shipment were $273,626 on June 30, 1999. At June 30, 1998, Challenge had no backlog and future orders of $260,261. Challenge does not typically experience seasonal fluctuations in its orders, and expects to fill all of its orders during the current fiscal year. Micro Motors Micro manufactures and distributes a complete line of dental handpieces for the dentist and hygienist, as well as miniature pneumatic motors for use in dental, medical, and industrial devices. The branded handpiece line is sold by Biotrol to dental distributors, who in turn market directly to the dentist. Micro products are sold under the trademarks "Dynatorq(tm)", "Dynapro(tm)", "Dynalite(tm)", "Dynasurg(tm)", and "Micro Handpiece(tm)". Micro's industrial products are sold directly to original equipment manufacturers. Sixty five percent (65%) of Micro's sales in the year ended June 30, 1999 were accounted for by sales of dental handpieces. Approximately twenty nine percent (29%) of Micro's sales in the year ended June 30, 1999 consisted of sales of miniature pneumatic motors for industrial and medical applications. Micro's pneumatic motors are marketed through an independent distribution network. Micro considers its relationships with its various suppliers and manufacturers to be excellent. It does not intend to terminate any relationship at this time, nor does its management believe any relationships will be terminated by a supplier or manufacturer. Micro holds no franchises and has no exclusive arrangements with any of its suppliers or manufacturers. Micro has surveyed its suppliers, manufacturers, and customers to determine whether or not each of them will be Y2K compliant in an effort to minimize the impact of that event. It has developed contingency plans to include, but not be limited to, the identification of new suppliers and capability of implementing manual systems should the need arise. Should such contingency plans fail for any reason, such failure could have a negative impact on Micro's business. At the present time, Micro is usually able to fill orders within sixty (60) days. At June 30, 1999, Micro had a backlog of $406,371. Future orders of approximately $1.2 million had been placed as of June 30, 1999. At June 30, 1998, Micro had a backlog of approximately $2.2 million which reflected future orders as well. Micro expects to fill all of its backlog of orders during the current fiscal year. Micro does not typically experience seasonal fluctuations in its orders. OMS OMS designs and manufactures motion controllers to control the motion of motors used predominantly in medical analysis equipment and semiconductor equipment. OMS's products are profitably marketed at prices, which compare favorably with any alternative products. As in any high-technology area, it is important for OMS to continue development efforts to achieve continued market acceptance. Last year OMS introduced a new generation of motion control products in its PC 104 line. The development and introduction of the PC 104 line has allowed OMS to retain its position within the motion control industry. OMS believes its PC 104 technology has been well accepted and plans to continue the introduction of advanced products. The introduction of the PC 104 line and the planned introduction of PCI will reduce impact that the highly volatile semi-conductor industry has had on OMS, as well as to significantly broaden OMS's market in less cyclical industries. OMS's two largest customers account for forty three percent (43%) of its sales, with the largest of such customers accounting for twenty eight percent (28%) of sales. These relationships are well established. OMS has no plans to discontinue the relationships, and has no reason to believe that these customers have any plans to discontinue their relationships with OMS. Nevertheless, any material adverse change in the relationship with any customer representing a significant percentage of OMS sales may be financially detrimental to OMS. The Asian monetary crisis that negatively impacted OMS in fiscal 1998 appears to have abated resulting in the return to more normal ordering patterns within the industry. Future orders at OMS have rebounded to almost pre-Asian monetary crisis levels. OMS considers its relationships with its various suppliers and manufacturers to be excellent. It does not intend to terminate any relationship at this time, nor does its management believe any relationships will be terminated by a supplier or manufacturer. OMS holds no franchises and has no exclusive arrangements with any of its suppliers or manufacturers. OMS has surveyed its suppliers, manufacturers, and customers to determine whether or not each of them will be Y2K compliant in an effort to minimize the impact of that event. It has developed contingency plans to include, but not be limited to, the identification of new suppliers and capability of implementing manual systems should the need arise. Should such contingency plans fail for any reason, such failure could have a negative impact on OMS's business. At the present time, OMS is usually able to fill its orders within 24 hours. At June 30, 1999, OMS had virtually no backlog and future orders of approximately $675,322 as compared to $574,016 as of June 30, 1998. OMS does not typically experience seasonal fluctuations in its orders, although there are fluctuations in demand resulting from cyclical activity in the industries it serves. Competition Certain products manufactured and distributed by the Company's subsidiaries are comparable to competing products offered by several other manufacturers and distributors. Intensified competition resulting from the consolidation occurring within the dental industry may result in price reductions, reduced revenues and profit margins, and loss of market share, which would adversely affect the Company's business, consolidated results of operations, and financial condition. Research and Development The Company maintains research and development programs in its various subsidiaries. The Company considers these product development programs to be of importance in both maintaining and improving its market position. The amounts spent on research and development activities in 1999 and 1998 were approximately $1,700,000 and $1,410,000, respectively. Micro increased research and development expenses in anticipation of expanding its customer base to the medical device industry. Challenge increased research and development expenditures in order to service existing OEM customers as well as broaden their product lines to take advantage of new market opportunities. Employees At June 30, 1999, the Company had approximately 151 full and part-time employees (excluding independent contractors). At that time, four full-time employees were assigned to corporate headquarters, and devoted substantially all of their time to the operations of the Company. Challenge employed approximately 19 persons, Biotrol employed approximately 36 persons, and Micro employed 72 persons, four of which were part-time. OMS employed 20 persons. Employees of the Company have not entered into any collective bargaining agreements with the Company. The Company considers its relations with its employees to be good. Government Regulations The manufacture and distribution of dental products such as the Micro handpieces, the infection control products and ultrasonic scalers marketed by Biotrol, and the dental prophylaxis and bleaching products manufactured by Challenge are subject to a number of state and federal regulatory bodies, including state dental boards, the Environmental Protection Agency ("EPA"), and the Food and Drug Administration ("FDA"). The statutes, regulations, administrative orders, and advisories which affect the Company's businesses are complex and subject to diverse, often conflicting, interpretations. While the Company's management and management of each of the Company's operating subsidiaries make every effort to maintain full compliance with all applicable laws and regulations, the Company is unable to eliminate an ongoing risk that one or more of its activities may at some point be determined to have been non-compliant. The penalties of non-compliance could range from an administrative warning to termination of a portion of the Company's business. Further, even if the Company is subsequently determined to have fully complied with applicable law or regulation, its costs achieving such a determination and intervening loss of business could adversely affect or even terminate a portion of the Company's business. Further, a change in regulations at any time may have an adverse effect on the Company's operations. Notwithstanding the risks inherent in the Company's business sectors, management believes that each of the Company's subsidiaries deservedly enjoys a good reputation for compliance with applicable regulations. Several of Biotrol's products fall under the EPA's jurisdiction and are registered with the EPA. The FDA has jurisdiction over Biotrol products that are considered medical devices or drugs. Both EPA and FDA have broad enforcement power to recall and prohibit the sale of non-complying products. As is common in the industry, certain of Biotrol's products and processes have been periodically the subject of routine reviews and investigations by the EPA and FDA. Although certain products have been subject to action by the EPA in the past, those actions were resolved to the satisfaction of Biotrol's management and without recall or other interference with the operations of Biotrol. While the Company's management is confident that Biotrol products and processes fully comply with applicable laws and regulations, the Company is unable to predict the outcome of any such investigation or review, pending its completion. Management believes that Biotrol follows Quality System Regulation (QSR). The FDA has jurisdiction over Challenge products that are considered medical devices or drugs. As noted above, the FDA has broad enforcement power to recall and prohibit the sale of non-complying products. No claim has been made to date by FDA against Challenge or any of its products or processes. Nevertheless, as is common in the industry, certain of Challenge's products and processes have been the subject of routine reviews and investigations. While the Company's management is confident that Challenge's products and processes fully comply with applicable laws and regulations, the Company is unable to predict the outcome of any such investigation or review, pending its completion. Management believes that Challenge follows QSR. Micro's dental and medical handpieces are regulated by the FDA as Class 1 medical devices and certain materials processed by Micro are regulated by EPA. Again, both the FDA and EPA have broad enforcement power to recall and prohibit the sale of products, which do not comply with federal regulations, and to order the cessation of non-compliant processes. No claim has been made to date by FDA or EPA regarding any Micro products or processes. Nevertheless, as is common in the industry, certain of Micro's products and processes have been the subject of routine reviews and investigations. While the Company's management is confident that Micro's products and processes fully comply with applicable laws and regulations, the Company is unable to predict the outcome of any such investigation or review, pending its completion. Management believes that Micro follows QSR. Management believes that OMS's business in the manufacture and distribution of multi-axis circuit boards, including the processes and materials, is conducted in a manner consistent with EPA regulations governing disposition of industrial waste materials. Although the semiconductor and computer chip industries are significantly impacted by the EPA regulations applicable to the processes and materials used in production of computer chips and computer chip components, OMS's management has undertaken measures, where possible, to reduce OMS's exposure to risk of non-compliance. Most significantly, OMS acquires pre-manufactured boards as platforms upon which to place OMS technology. While the Company's management is confident that OMS products and processes fully comply with applicable laws and regulations, the Company is unable to predict the outcome of any investigation or review which may in the future be undertaken respecting OMS or its products or processes. Management believes that OMS follows QSR. All Pro-Dex subsidiaries maintain ISO 9001 certified facilities, and Biotrol has received EN 46001 certification. Patents, Trademarks, and Licensing Agreements The Company holds letters patent relating to the multi-axis motion controllers manufactured by OMS, to the prophy ring technology utilized by Challenge, and has made application to patent Challenge's new "bubble pack" for bleaching materials. In addition, Micro holds letters patent relating to its miniature pneumatic motor products. Patents held by the Company and Micro have varying expiration dates, none of which will expire earlier than 2005. Further, the Company has retained a non-exclusive, paid up, worldwide license to the letters patent relating to the pneumatic light for incorporation into hand-tools. The Company conducted a limited review of the letters patent acquired in connection with the OMS and Micro acquisitions and believes that the use of such letters patent is neither infringed upon by any third party, nor infringes on any prior art of any third party. The Company is unable to assess the validity, scope, or defensibility of its letters patent, and any challenge to or claim of infringement relating to the Company's letters patent could adversely affect the Company's Challenge, Micro and OMS operations. Prior to the Company's acquisition of OMS, OMS and its founder entered into a worldwide, fully paid, limited use license of certain letters patent with Abbott Laboratories. The founder of OMS has agreed to indemnify the Company for any further duties to be performed in connection with the license to Abbott Laboratories, which are the obligation of such individual as sole recipient of related royalties. The Company's Micro subsidiary has certain trademarks relating to its miniature pneumatic motor products, including "Dynatorq(tm)", "Dynapro(tm)", "Dynalite(tm)", "Dynasurg(tm)", and "Micro Handpiece(tm)". Challenge's products are sold under the trade name "Dentalite(tm)", in the United States and Canada. In addition, Challenge offers its line of preventive dental products under its "Perfect Choice(tm)" tradename. Challenge also markets its "Prophy Gems(tm)" dental prophylaxis product under its "Perfect Choice(tm)" trademark in both the United States and Canada. Biotrol has filed for federal trademark protection for "Biotrol International, Inc.(tm)", "Birexse(tm)", and "Perfect Care(tm)", as has OMS for "OMS-EZ". Challenge is a party to an agreement with Dunhall Pharmaceuticals, Inc. pursuant to which Challenge has a non-exclusive license to extend to its customers a patented method for brightening teeth under a variety of product names. Except as noted above, the Company has not entered into any licensing or franchising agreements and has no present plans to do so. Item 2. Properties The Company's Executive offices are located at 1401 Walnut Street, Suite 540, Boulder, Colorado 80302. The Company leases these offices for $4,192 per month, on a month to month basis, under a sub-lease from Professional Sales Associates, Inc., a dental equipment marketing firm for which two of the Company's directors are also directors and shareholders. The per square foot cost of the Company's spaces under its sub-lease equals the per-square foot cost of the master lease, and the Company's sublease is subject to the terms of the master lease. The master lease under which the Company sub-leases expires January 31, 2000. The Company's sub-tenancy has been ratified by a disinterested majority of the Board of Directors, which does not feel that the Company's operations would be unduly inconvenienced were the Company required to relocate. Although the Board of Directors believes that the monthly rental for its Boulder office facility is comparable to rents charged for comparable properties in the market area, the terms of such lease may not be the same as might have been negotiated with a third party in an arms' length transaction. See "Item 12 - Certain Relationships and Related Party Transactions." Biotrol's office, assemblage, and warehouse facility are located at 650 South Taylor Avenue, Suite 20, Louisville, Colorado 80027. Biotrol leases 21,600 square feet from a non-affiliated organization. Biotrol currently pays a monthly rental of $14,846, which will escalate to $18,300 per month during the final year of the lease term which expires in December 2003. Biotrol is also responsible for its proportionate share of common expenses. Challenge owns an office and manufacturing facility located at 1100 Bluff Drive, Osage Beach, Missouri 65065. The office and manufacturing facility is approximately 14,000 square feet on 1.2 acres of land. In addition, a new 4,000 square foot warehouse has recently been constructed on an adjacent 8.8 acre parcel owned by Challenge. Micro's office and manufacturing facility is located at 151 East Columbine Avenue, Santa Ana, California 92707. Micro leases the facility under a previously existing lease from Mr. Ronald G. Coss, currently a director of the Company, at a monthly rental of $29,147. The lease expires March 31, 2001. The Company's management believes that the monthly rental is comparable to rents charged for comparable properties in the market area, but the terms of the lease may not be the same as might have been negotiated with a third party in an arms' length transaction. The property upon which the Micro plant is located contains ground water monitoring devices in order to comply with applicable California and EPA regulations relating to activities of a prior owner of the property. Such monitoring activity has not to date indicated a requirement for remedial action. Micro and the Company require full compliance by the lessor with applicable California and EPA standards. See "Item 12 - Certain Relationships and Related Party Transactions." OMS's offices and manufacturing facilities are located at 1800 N.W. 169th Place, Suite C100, Beaverton, Oregon 07005. OMS leases the facility from an unrelated third party, at a monthly lease rate of $7,498, which lease has been extended to September 2000. Item 3. Legal Proceedings On January 21 1999, oral arguments were presented to the Tenth Circuit Court of Appeals in Cottrell, Ltd. v. Pro-Dex, Inc. and Biotrol International, Inc. The matter is on appeal from the December 1, 1997 decision of U.S. District Judge Daniel B. Sparr dismissing an action filed against the Company and Biotrol by Cottrell, Ltd. ("Cottrell"). Judge Sparr held that the resolution of the complaint would require the Court to interpret and apply regulations within the exclusive jurisdiction of EPA. Accordingly, the Court granted the Company's and Biotrol's Motion to Dismiss, denied Cottrell's Motion for Leave to Amend its Complaint, and dismissed the case in its entirety. On the 10th of September 1999, the United States Court of Appeals for the Tenth Circuit reversed the decision of Judge Daniel B. Sparr by which he dismissed an action filed against the Company and Biotrol in the U.S. District Court for Colorado by Cottrell, Ltd. ("Cottrell"). The Court agreed with the Company with respect to its assertion that Cottrell should not be permitted to bring a FIFRA action by simply identifying the same as a Lanham Act claim, and, accordingly, that claim was dismissed. The Court disagreed, however, with the Company stating that Cottrell had alleged sufficient facts to support a Lanham Act claim independent of FIFRA. The case was remanded to the District Court for further proceedings. See "Pro-Dex Consolidated Financial Statements - Note 3." On June 12, 1997 the Company sold the assets of its DCM dental clinic management subsidiary to Professional Dental Management, LLC. Subsequent to that sale, Professional Dental Management, LLC was restructured and the survivor, Consolidated Dental Management, Inc., among other things, assumed liability for leases of dental clinic offices situated in Sears' store in north-central California. On May 9, 1999, due to the poor financial condition of the Consolidated, Sears required the Company to guaranty Consolidated's performance under those leases. See "Pro-Dex Consolidated Financial Statements - - Note 3." Plaut V. Biotrol, et al, D'Meo et al. Biotrol is one of 16 named defendants, excluding John Does 1-100, in these two matters which are part of what has been designated "New Jersey Latex Litigation" cases. The cases have been centralized and are proceeding under the terms of a variety of case management orders. Plaut v. Biotrol has been selected as one of three "Bellwether" cases and is expected to proceed to trial in February 2000. The claim has been submitted to Biotrol's product liability carrier, Chubb Insurance Companies. Defense counsel has been assigned and is defending the Biotrol subsidiary. See "Pro-Dex Consolidated Financial Statements - Note 3." In 1998, Micro successfully settled a civil action alleging patent infringement by Micro. On July 6, 1998, Miyad, Inc., a California corporation ("Miyad"), filed a patent infringement action in the U.S. District Court against Implant Technologies, Ltd. ("ITL"), its principal, Courtney Emery ("Emery"), and Micro. The complaint alleged contributory infringement, inducement of infringement, and breach of a confidentiality agreement. The matter was dismissed with prejudice by the U. S. District Court on November 28, 1998. The manufacture and distribution of certain products by subsidiaries of the Company involves a risk of legal action, and, from time to time, the Company and its subsidiaries are named as defendants in lawsuits. While the Company's management is confident that these matters will not have a material adverse impact on the financial condition of the Company, there can be no certainty that the Company may not ultimately incur liability. Item 4. Submission of Matters to a Vote of Security Holders During the Year Ended June 30, 1999 No matter was submitted to a vote of the Company's shareholders during the fourth quarter ended June 30, 1999. PART II The Company's no par value common stock is quoted under the symbol "PDEX" on the automated quotation system of the National Association of Securities Dealers Small Cap Market ("NASDAQ"). The range of the high and low quarterly sales prices quotations for the Company's common stock as quoted by NASDAQ for the past two fiscal years is provided below. Item 5. Market for Registrant's Common Stock and Related Stockholder Matters Fiscal Year - 1999 High Low ---------------------------------------------------- First quarter $2.06 $1.25 Second quarter 2.25 1.18 Third quarter 1.87 1.18 Fourth quarter 2.00 1.21 Fiscal Year - 1998 High Low ---------------------------------------------------- First quarter $2.56 $1.75 Second quarter 3.50 2.31 Third quarter 2.94 2.06 Fourth quarter 2.31 1.75 On September 13, 1999, the last sale price of the common stock as reported by NASDAQ was $1.50 per share. The last sale price reported on NASDAQ on June 30, 1999, was $1.34 per share. At June 30, 1999, the approximate number of holders of record of the Company's common stock was 377. This number does not include beneficial owners including holders whose shares are held in nominee or "street" name. The Company has not paid a cash dividend with respect to its common stock, and has no present intention to pay cash dividends in the foreseeable future. The current policy of the Company's board of directors is to retain earnings to provide funds for the operation and expansion of its business. Future dividends, if any, will be determined by the Board of Directors in light of the circumstances then existing, including the Company's earnings and financial requirements and general business conditions. The Company's credit arrangements with Harris Bank restrict the right of the Company to declare and pay cash dividends without prior consent. On June 30, 1999, the Company did not meet NASDAQ's tangible net equity requirements of $2,000,000. Management believes that future profits and an equity contribution will bring the Company into compliance within the current fiscal year. Item 6. Management's Discussion and Analysis The following discussion and analysis provide information that the Company's management believes is relevant to an assessment and understanding of the Company's results of operations and financial condition for the two years ended June 30, 1999 compared to the same periods of the prior years. This discussion should be read in conjunction with the Consolidated Financial Statements and the Notes thereto included elsewhere in this Report. This Report contains certain forward-looking statements and information. The cautionary statements should be read as being applicable to all related forward-looking statements wherever they may appear. The Company's actual future results could differ materially from those discussed herein. Selected Financial Data The following table sets forth selected financial data regarding the Company's financial position and operating results. This data should be read in conjunction with the Company's Consolidated Financial Statements and the Notes thereto and "Management's discussion and Analysis." (All amounts in thousands except per share data) Year ended June 30, 1999 1998 ---- ---- Statement of Operations Data Net sales $ 18,342 $ 22,648 Cost of sales 9,763 10,018 ----------- ----------- Gross profit 8,579 12,630 Unusual charges 7,389 Operating expenses 11,444 11,243 ----------- ----------- Net operating income (loss) (10,254) 1,387 Net interest (expense) (971) (882) Income tax (expense) credit 2,291 (151) ----------- ----------- Net income (loss) $ (8,934) $ 354 =========== =========== Results of Operations for Fiscal Year Ended June 30, 1999, Compared to Fiscal Year Ended June 30, 1998 Net sales by subsidiary follows: Increase/ 1999 1998 (Decrease) - ------------------------------------------------------------------------------ Biotrol $ 8,170,000 $ 8,457,000 $ (287,000) Challenge 2,176,000 1,753,000 423,000 Micro Motors 6,019,000 8,394,000 (2,375,000) Oregon Micro Systems 3,713,000 5,768,000 (2,055,000) (Intercompany sales) (1,736,000) (1,724,000) (12,000) -------------- -------------- -------------- $ 18,342,000 $ 22,648,000 $ (4,306,000) ============== ============== ============== Net sales decreased $4.3 million (19.0%) to $18.3 million for the year ended June 30, 1999 from $22.6 million for the year ended June 30, 1998. Sales at Biotrol for the year ended June 30, 1999 decreased by 3.4% over the year ended June 30, 1998. The decline is mainly attributable to the following two circumstances: Biotrol attempted to increase its export business by offering its products at discounted prices to existing and new export customers. Soon after the export business increased, management discovered that a majority of its new export business was being resold to Biotrol's domestic customers on the gray market. Many domestic customers notified Biotrol's management that they were able to buy Biotrol products on the gray market. The favorable pricing to exporters was immediately terminated, and the exporters ceased purchasing products. Management estimates that approximately $600K of revenue was lost during the year to domestic customers because of the gray market sales. In addition, within the past year, three of Biotrol's four largest customers merged resulting in an overstock condition for Biotrol's products. By the end of the current fiscal year the situation seems to have stabilized, and order quantities from the merged customers have reverted to pre-merger levels. Sales to the merged customer were approximately $542,000 below sales to the three separate customers during the same period in the prior year. There is evidence that the disruption in distribution of products to Biotrol's customers has not hurt the demand for its products by the end user. Biotrol's independent market share information source indicates that Biotrol increased its market share of key products for the year ended June 30, 1999 over the year ended June 30, 1998. At Challenge Products, sales for the year ended June 30, 1999 increased by 24.1% over the year ended June 30, 1998. Sales to private label customers and wholesale customers of Challenge increased by 57.4% to $1,365,000 for the year ended June 30, 1999, from $867,000 for the year ended June 30, 1998. New products and increased marketing efforts to new private label customers are the main reasons for the increase in sales. Inter-company sales to Biotrol decreased 8.5% to $811,000 for the year ended June 30, 1999 from $887,000 for the year ended June 30, 1998, primarily due to the inventory consolidation condition experienced by Biotrol. At Micro Motors, sales for the year ended June 30, 1999 decreased $2,375,000 or 28.3% from the year ended June 30, 1998, partly due to the affects of the consolidation of its major customers. New management was installed at the beginning of the current fiscal year to improve internal systems, upgrade and innovate the product portfolio, and to uncover new markets for its core products. During the year Micro completed the integration of a state of the art operating system that will also facilitate a major portion of its Y2K compliance plan. Completion of the certification process to the Medical Device Directive in conjunction with ISO 9001 Certification placed Micro Motors in a position to self-certify products with the CE mark required for European distribution. Lastly, the product portfolio was enhanced with the development of two major projects; the highspeed dental handpiece, and the ModSquad electric motor controller system. The ModSquad electric controller is capable of opening up significant opportunities in both the dental and medical markets. Since the end of the current year Micro has received over $1 million in orders for its new ModSquad products. Sales at OMS decreased by 35.6% from the previous year. OMS continues to depend heavily on the semiconductor industry for its revenue base. During the current year that industry suffered a severe slump due to an over supply of computer chips on the market. This in turn caused a decrease in the demand for semiconductor fabrication equipment. In addition, many customers of OMS sell heavily into the Asian semiconductor market. Due to the monetary crisis experienced by Asia during 1998, sales of fabrication equipment to Asian customers declined. Orders and sales for the last quarter of the current fiscal year indicate that the slump in demand for semiconductor fabrication equipment has ended. It was reported by Semiconductor Equipment and Materials International (SEMI) that the North American-based manufacturers of semiconductor equipment posted a June 1999 Book-to-Bill ratio of 1.24 as compared to a .6 ratio as of June 1998. A book-to-bill of 1.24 means $124 in orders were received for each $100 worth of products shipped. OMS is employing a business strategy to reduce its exposure to the cycles of the semiconductor equipment manufacture industry. Included in that strategy has been the development of a family of embedded motion control products, and expansion into new distribution channels. The new products will enable OMS to compete in new industries such as industrial controls, aerospace, communication, and food processing equipment. They are priced competitively, are easy to use, and are manufactured with the latest surface mount technology. The distribution channels for dental products continue to contract and consolidate. Two distribution companies control more than 50% of the sales of dental products sold through dealers. These large distributors are demanding among other things that suppliers are ISO 9000 certified, Y2K compliant, and have EDI and bar coding capabilities. To meet customer demands the company is currently implementing new information technology that will facilitate Y2K compliance, and provide EDI capabilities. Since Pro-Dex sells its dental products exclusively through dealers, management is committed to providing the necessary technology and regulatory support to satisfy its dealer customers. Gross profits by subsidiary follows: Increase/ 1999 1998 (Decrease) - ------------------------------------------------------------------------------ Biotrol $ 3,984,000 $ 4,543,000 $ (559,000) Challenge 789,000 559,000 230,000 Micro Motors 1,108,000 3,271,000 (2,163,000) Oregon Micro Systems 2,698,000 4,257,000 (1,559,000) -------------- -------------- -------------- $ 8,579,000 $ 12,630,000 $ (4,051,000) ============== ============== ============== Consolidated gross profit dollars decreased by 32.1% for the year ended June 30, 1999 compared to the year ended June 30, 1998 mainly due to a decline in revenue. At Micro Motors, the decrease in gross profit dollars was also due to inefficiencies in manufacturing combined with a declining revenue base. In addition, Micro increased its reserve for slow moving and obsolete goods by $594,000 during the year. Gross profit as a percentage of sales decreased 9.0 percentage points to 46.8% for the year ended June 30, 1999 compared to 55.8% for the year ended June 30, 1998. The decline in gross profit percentage was caused mainly by the absorption of fixed manufacturing overhead over a lower revenue base. Operating expenses before unusual charges as a percentage of revenue were 62.4% for the year ended June 30, 1999 compared to 49.6% for the year ended June 30, 1998. Operating expenses before unusual charges increased 1.8% to $11,444,000 compared to $11,243,000 for the year ended June 30, 1998. During 1999, the Company incurred several one-time unusual charges that management does not expect to incur in the future totaling approximately $7.4 million. The charges include the write-off of goodwill at the Micro subsidiary for $4.8 million, the write-off of a receivable from the sale of a former segment of the business amounting to $1.75 million, and charges of $839,000 to operations for the remaining portion of employment, consulting, and non-compete contracts deemed to have no future value to the Company. See Note 6 to the financial statements for a further discussion of unusual charges. During the year ended June 30, 1999, the Company continued the implementation of its new information technology systems to modernize its accounting and manufacturing processes as well as implement its Y2K plan. The costs associated with the implementation totaled approximately $200,000 during the year ended June 30, 1999. During the year ended June 30, 1998, the Company incurred charges related to training and maintenance costs associated with a major overhaul of its information technology systems, and costs to achieve ISO 9001 certification for all its divisions. The Company's growth plans require the development of new products. Consistent with that goal the Company increased its commitment to research and development by spending $1,700,000 during fiscal year ended June 30, 1999, compared to $1,410,000 for year ended June 30, 1998, a 20.6% increase. The Company incurred other operating expenses during the year that, while not unusual, management considers excessive as a result of the significant restructuring that occurred within the operating units. Some of the items include severance costs of $92,000, consulting fees of $186,000, and sales and marketing expenses related to export problems of $96,000. For 1999, loss from continuing operations was $2,865,000 before unusual charges of $7,389,000. Loss from continuing operations for the year ended June 30, 1999 was ($10,254,000) including unusual charges compared to income from operations of $1,387,000 for the year ended June 30, 1998. Loss from operations at the Micro Motors subsidiary before unusual charges was ($2,005,000) or 70.0% of the total loss from operations before unusual charges. Micro Motors loss resulted from reduced revenue, increased R & D expense totaling $1,113,000 for the year ended June 30, 1999 compared to $580,000 for the year ended June 30, 1998, and several costs related to management and organization changes made during the year. Interest expense for the year ended June 30, 1999 was $1,032,000 compared to $931,000 for the year ended June 30, 1998. Included in interest expense for the current year are additional charges for the acceleration of the write-off of loan fees for $65,000, and the payment for the waiver of loan covenant violations for $100,000. The Company's effective tax rate on income (loss) from operations was 20.4% in 1999, and 29.9% in 1998. The effective tax rate is lower than anticipated for fiscal year ended June 30, 1999 because no deferred tax asset is recorded for the write-off of $4,800,000 of goodwill. The effective tax rate is lower for fiscal year ended June 30, 1998 due to the elimination of a valuation allowance against existing deferred tax assets. Management expects future effective tax rates to approximate 40%. At June 30, 1999, management believes it is more likely than not that the recorded tax assets of $2,900,000 will be realized based on its expectation of future profitability combined with tax planning strategies (See Note 4 to the financial statements). The amount of tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income are reduced. Net loss for the year ended June 30, 1999 was $8,934,000 or $1.02 per share. The unusual charges discussed above had the effect of increasing net losses in 1999 by $6,353,000 or $0.72 per share. The write-off of $4,800,000 in goodwill in the current year will reduce amortization expense in future years by $240,000 annually or $.02 per share. Liquidity and Capital Resources The operations of the Company are conducted principally through its wholly owned subsidiaries. The Company's financial position at June 30, 1999 is weak, with working capital on that date of approximately negative $4,000,000. On July 26, 1996, the Company obtained a $10,000,000 credit facility from Harris Bank secured by all assets of the Company and guaranteed by each of the Company's subsidiaries. The facility consists of a $6,000,000 term loan with a five-year amortization period, and a $4,000,000 revolving line of credit with a termination date on December 31, 1999. Both facilities require monthly interest payments at the prime rate plus one-half percent. The term loan portion is payable in equal quarterly installments of $200,000 through December 31, 1999, when the full amount of the then unpaid balance of the note will be due. The term loan had an outstanding balance on June 30, 1999, of $3,800,000. The revolver portion of the facility had an outstanding balance at June 30, 1999, of $4,000,000. At June 30, 1999, there was no availability under the revolver. Harris Bank has requested that the Company find alternative financing services to replace their facility. As a condition of the credit facilities, the Company is required to meet certain financial covenants, including minimum tangible net worth, debt to total capitalization, interest coverage, fixed charge coverage, and cash flow. In addition, the credit facility limits the amount of dividends and capital expenditures in any one year. At June 30, 1999, the Company did not meet certain of the financial covenants of the credit facilities. On July 24, 1999, the bank waived the current covenants and amended the future covenants. However, at July 31, 1999, the Company did not meet the amended net tangible worth covenant due to the write off of the $1.75 million receivable from a former segment. Other than the net worth covenant, management believes the Company will be in compliance with these covenants in the future. Management is currently investigating financing options which would replace their current banking relationship and has engaged an outside investment banker to assist them in locating and securing this financing. These options include the issuance of additional preferred stock of between $2 to $4 million. It is believed that with such additional financing, the Company could secure a traditional asset-based lending structure to replace the remaining bank debt. Management is also investigating a possible synergistic merger partner. Should the Company be unable to secure replacement financing, the Board has authorized management to pursue the sale of one of its operating subsidiaries in order to raise sufficient funds to satisfy the current working capital needs of the Company as well as pay down the bank debt as necessary. Management is currently evaluating this option. During the year the Company has been unable to make timely payments to some of its creditors. Management has maintained communication with these vendors and due, in part, to the mostly excellent relationships with the same, deferred payment terms have been negotiated with most vendors. To date no vendors have suspended parts deliveries or services needed by the Company. Accounting Changes In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". SFAS No. 130 requires that an enterprise report, by major components and as a single total, the change in its net assets during the period from non-owner sources; and SFAS No. 131 establishes annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas and major customers. Adoption of these Statements did not impact the Company's financial position, results of operations or cash flow. Both Statements were adopted for fiscal year 1999, with earlier application permitted. Impact of Inflation and Changing Prices The industries in which the Company competes are labor intensive, often involving personnel with high level technical or sales skills. Wages and other expenses increase during periods of inflation and when shortages in the marketplace occur. The Company expects its subsidiaries to face somewhat higher labor costs, as the market for personnel with the skills sought by the Company becomes tighter in a period of full employment. In addition, suppliers pass along rising costs to the Company's subsidiaries in the form of higher prices. Further, the Company's credit facility with Harris Bank involves increased costs if domestic interest rates rise. To some extent, the Company's subsidiaries have been able to offset increases in operating costs by increasing charges, expanding services and implementing cost control measures. Nevertheless, each of the Company's subsidiaries' ability to increase prices is limited by market conditions, including international competition in many of the Company's markets. Year 2000 Systems Assessments and Preparedness The Year 2000 problem arises because many information systems and devices containing embedded technology use two digits rather than four digits to identify a year. Calculations in date-sensitive systems using two digits could result in system failures and errors that disrupt normal business operations as the Year 2000 approaches. Early in 1998, Pro-Dex conducted an assessment of Year 2000 compliance of all of its major information technology systems, non-information technology systems with date-sensitive software and embedded microprocessors and products the Company manufactures or sells to customers. Pro-Dex developed detailed plans to resolve all major issues by the end of Fiscal 1998. As of June 30, 1999, the Company estimates that it is over 90% complete with its efforts to remediate current systems or implement new systems that are Year 2000 compliant. The majority of the remaining efforts are anticipated to be completed before the end of the third quarter of 1999. Pro-Dex has substantially completed its effort to assess non-compliant embedded technology including its assessment of the products it has delivered to customers. Pro-Dex expects that only one of its four company units will be involved in any significant compliance efforts in 1999. Continuing projects include the completion of lower priority information technology systems. Efforts in fiscal year 2000 will shift from systems projects to identifying areas of other business risk and developing contingency plans where appropriate. The Company and its subsidiaries initiated formal communications with key suppliers and service providers to determine the potential risk to its operations in the event these third parties fail to resolve Year 2000 issues. Pro-Dex and each division have substantially completed assessment of suppliers and service providers. If Pro-Dex determines that there is a risk to its operations due to a third party Year 2000 compliance failure, appropriate contingency plans will be implemented to address such risk. The extent of this risk, however, cannot be determined with any degree of certainty due to the number of small suppliers and service providers used by the Company and its subsidiaries, and the reliance of all operations on basic utility service providers. Pro-Dex's investment in information technology represented a significant percentage of capital expenditures for the year ending June 30, 1999. The Company estimates that total capital expenditures related to the implementation of its Enterprise Resource Planning ("ERP") system will be approximately $1.7 million over 3 - 5 years, and that it incurred approximately $40,000 per quarter in expense related to Year 2000 efforts. Pro-Dex has incurred approximately 90% of the capital expenditures as of June 30, 1999. The majority of these expenditures relate to new systems installations. Although the timing of new systems installations was influenced by the Year 2000 problem, the Company would have installed these systems in any event. While it is possible that the Company will not complete the systems projects scheduled in 1999 due to a variety of factors, including but not limited to the significant shortage of qualified information systems personnel, the Company is taking actions it believes necessary for the timely completion of those projects. Management believes that it is unlikely that such projects will be delayed to the extent that the Company suffers any material adverse effects due to noncompliance. In the unlikely event, however, that the remaining systems projects are not completed prior to experiencing significant noncompliance ramifications, results of operations could be adversely affected. In addition to the Company's internal risks and of those posed by third parties with whom the Company deals with directly, there remain additional Year 2000 risks and uncertainties that could affect Pro-Dex. These risks include utility and communication failures and governmental, economic and market responses to the Year 2000 issue. While Pro-Dex continues to believe that these Year 2000 matters will not have a material adverse impact on its results of operations, liquidity or financial condition, the ultimate impact on Pro-Dex of the Year 2000 problem remains uncertain. The foregoing statements regarding both our internal and external Year 2000 goals are forward looking statements. Pro-Dex's Year 2000 project capital expenditures, estimated percentage of completion and estimated completion dates are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the availability of certain resources, third-party modification plans and other factors. There can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Item 7. Financial Statements and Supplemental Data Independent Auditor's Report F-1 Consolidated Balance Sheet F-2 & F-3 Consolidated Statements of Operations F-4 Consolidated Statements of Shareholders' Equity F-5 Consolidated Statements of Cash Flows F-6 Notes to Consolidated Financial Statements F-7 Item 8. Changes and Disagreements with Accountants on Accounting and Financial Disclosures none INDEPENDENT AUDITOR'S REPORT To the Board of Directors Pro-Dex, Inc. Boulder, Colorado We have audited the accompanying consolidated balance sheet of Pro-Dex, Inc. and Subsidiaries (the "Company") as of June 30, 1999, and the related consolidated statements of operations, shareholders' equity and cash flows for the years ended June 30, 1999 and 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of June 30, 1999, and the results of their operations and their cash flows for the years ended June 30, 1999 and 1998, in conformity with generally accepted accounting principles. /s/ McGladrey & Pullen, LLP McGladrey & Pullen, LLP Anaheim, California August 27, 1999 PRO-DEX, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET June 30, 1999 ASSETS Current assets: Cash and cash equivalents $ 107,000 Accounts receivable, net of allowance for doubtful accounts of $40,000 3,157,000 Inventories, net 4,699,000 Deferred taxes 1,200,000 Prepaid expenses 148,000 --------------- Total current assets 9,311,000 --------------- Property and equipment: Land 103,000 Buildings 542,000 Equipment 5,095,000 Leasehold improvements 313,000 --------------- Total property and equipment 6,053,000 Less accumulated depreciation (2,942,000) --------------- Net property and equipment 3,111,000 --------------- Other assets: Deferred taxes 1,700,000 Other 354,000 Intangibles, net 3,222,000 --------------- Total other assets 5,276,000 --------------- Total assets $ 17,698,000 =============== See "Notes to Consolidated Financial Statements." F-2 - --- PRO-DEX, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET - CONTINUED June 30, 1999 LIABILITIES & SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 8,691,000 Accounts payable 3,048,000 Accrued expenses 1,590,000 --------------- Total current liabilities 13,329,000 Long-term debt, net of current portion 143,000 --------------- Total liabilities 13,472,000 --------------- Commitments and contingencies Shareholders' equity: Series A convertible preferred shares, no par value; 10,000,000 shares authorized; 78,129 shares issued and outstanding 283,000 Common shares, no par value; 50,000,000 shares authorized; 8,787,300 shares issued and outstanding 14,838,000 Accumulated deficit (10,744,000) --------------- 4,377,000 Receivable for stock purchase (151,000) --------------- Total shareholders' equity 4,226,000 --------------- Total liabilities and shareholders' equity $ 17,698,000 =============== See "Notes to Consolidated Financial Statements." F-3 - --- PRO-DEX, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Years Ending June 30, 1999 and 1998 1999 1998 --------------- -------------- Net sales $ 18,342,000 $ 22,648,000 Cost of sales (Includes rent paid to a director of $340,000 for 1999 and 1998.) 9,763,000 10,018,000 --------------- --------------- Gross profits 8,579,000 12,630,000 --------------- --------------- Operating expenses: Selling 4,604,000 4,315,000 General and administrative 4,356,000 4,613,000 Research and development 1,700,000 1,410,000 Amortization 784,000 905,000 Unusual charges 7,389,000 --------------- --------------- Total operating expenses 18,833,000 11,243,000 --------------- --------------- Income (loss) from operations (10,254,000) 1,387,000 --------------- --------------- Other income (expense): Interest income 61,000 49,000 Interest (expense) (1,032,000) (931,000) --------------- --------------- Total (971,000) (882,000) --------------- --------------- Income (loss) before income taxes (credits) (11,225,000) 505,000 Income taxes (credits) (2,291,000) 151,000 --------------- --------------- Net income (loss) $ (8,934,000) $ 354,000 --------------- --------------- Basic and diluted earnings (loss) per common and common equivalent share $ (1.02) $ 0.04 See "Notes to Consolidated Financial Statements." F-4 - --- PRO-DEX, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years Ending June 30, 1999 and 1998
Preferred Shares Common Shares ----------------------------------------------- Number Number Additional Receivable Of of Paid-In Accumulated for Stock Shares Amount Shares Amount Capital Deficit Purchase Total -------------------------------------------------------------------------------------------------- Balance, June 30, 1997 78,129 $283,000 8,712,300 $14,632,000 $10,000 ($2,115,000) ($59,000) $12,751,000 Exercise of stock options - - 25,000 44,000 - - (44,000) -- Exercise of stock warrants - - 50,000 107,000 - - (107,000) -- Stock-based compensation - - 55,000 - - - 55,000 Termination of ESOP - - - - (10,000) (49,000) 59,000 -- Net income - - - - - 354,000 - 354,000 ------ -------- --------- ----------- -------- ------------- ---------- ------------ Balance, June 30, 1998 78,129 283,000 8,787,300 14,838,000 -0- (1,810,000) (151,000) 13,160,000 Net (loss) - - - - - (8,934,000) - (8,934,000) ------ -------- --------- ----------- -------- ------------- ---------- ------------ Balance, June 30, 1999 78,129 $283,000 8,787,300 $14,838,000 $ -0- ($10,744,000) ($151,000) $4,226,000 ====== ======== ========= =========== ======== ============= ========== ============
See "Notes to Consolidated Financial Statements." F-5 - --- PRO-DEX, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ending June 30, 1999 and 1998 1999 1998 --------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ (8,934,000) $ 354,000 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 1,430,000 1,516,000 Provision for doubtful accounts 10,000 16,000 Loss on note receivable 1,750,000 -- Goodwill impairment 4,800,000 -- Stock-based compensation - 55,000 Deferred taxes (1,980,000) 60,000 Change in working capital components net of effects from purchases and divestitures: (Increase) decrease in accounts receivable 195,000 (650,000) (Increase) in inventories (247,000) (216,000) Decrease in prepaid expenses 73,000 612,000 (Increase) decrease in other assets 93,000 (40,000) Increase in accounts payable and accrued expense 2,474,000 392,000 --------------- -------------- Net cash provided by (used in) operating activities (336,000) 2,099,000 --------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment (875,000) (810,000) --------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES Net (payments) borrowings on revolving credit agreements 1,950,000 (250,000) Proceeds from long-term borrowings 267,000 189,000 Principal payments on long-term borrowings (899,000) (2,079,000) --------------- -------------- Net cash flows provided by (used in) financing activities 1,318,000 (2,140,000) --------------- -------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 107,000 (851,000) Cash and cash equivalents, beginning of period -0- 851,000 --------------- -------------- Cash and cash equivalents, end of period $ 107,000 $ -0- --------------- -------------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash payments for interest $ 702,000 $ 798,000 Cash payments for income taxes 22,000 6,000 Issuance of common stock for a note receivable - 151,000 See "Notes to Consolidated Financial Statements." F-6 - --- PRO-DEX, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999 AND 1998 NOTE 1 - SUMMARY OF ACCOUNTING POLICIES Nature of Business Pro-Dex, Inc. (the Company) is the parent of four operating subsidiaries, Biotrol International, Inc. (Biotrol), Challenge Products, Inc. (Challenge), Micro Motors, Inc. (Micro), and Oregon Micro Systems, Inc. (OMS). Biotrol is a manufacturer and supplier of infection control products for the dental industry. Challenge manufactures and sells fluoride products for preventive dentistry, along with a complementary line of products used for cleaning, whitening, and protecting teeth. Micro manufactures miniature pneumatic motors used in dental, medical, and industrial devices worldwide as well as a complete line of dental handpieces. OMS designs, develops and manufactures motion control products used predominantly in the computer chip manufacturing industry. A surplus of semiconductor production capacity and the Asian economic crisis has significantly reduced the computer chip fabrication equipment industry. OMS is heavily dependent on this industry for its revenue, and has experienced a decline in sales from 1998. The Company extends credit to its customers, all on an unsecured basis, on terms that it establishes for individual customers. Customers are located predominately in the United States. Many of the Company's products are regulated by a number of state and federal regulatory bodies, including the Environmental Protection Agency ("EPA") and the Food and Drug Administration ("FDA"). While the Company's management and management of each of the Company's operating subsidiaries make every effort to maintain full compliance with all applicable laws and regulations, there exists an ongoing risk that one or more of its activities may at some point be determined to be non-compliant. Notwithstanding the risks inherent in the Company's business sectors, management believes that each of the Company's subsidiaries enjoys a good reputation for compliance with applicable regulations. Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its subsidiaries. All significant inter-company accounts and transactions have been eliminated. Revenue Recognition Revenue on product sales is recognized upon shipment to the customer. The Company sells some of its products with a warranty that provides for repairs or replacement of any defective parts for a period after the sale. At the time of the sale, the Company accrues an estimate of the cost of providing the warranty based on prior experience. Cash and Cash Equivalents The Company considers highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Inventories Inventories are stated at the lower of cost (the first-in, first-out method) or market and consist of the following: F-7 Raw materials $ 852,000 Work in process 486,000 Finished goods 4,249,000 ---------------- Total 5,587,000 Reserve for slow moving inventories (888,000) ---------------- Total inventories, net $ 4,699,000 ================ Property and Equipment Property and equipment are recorded at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets as follows: Buildings-- generally 40 years; equipment-- 3-10 years; leasehold improvements-- 7 years. Leasehold improvements are depreciated over the shorter of the term of the lease or their estimated useful lives. Intangible Assets Intangible assets include patents, non-compete contracts and the cost of net assets acquired in excess of fair value which are amortized on a straight-line basis over their estimated useful lives ranging from 5 to 20 years. Intangible assets are stated net of accumulated amortization of $3,005,000. The Company evaluates impairment of its long-lived assets and certain intangible assets whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. An asset is deemed impaired if the sum of the expected future cash flows is less than the carrying amount of the asset. Impaired assets are valued at the lower of recorded cost or fair value. Advertising The Company expenses the cost of advertising the first time the advertising takes place. The Company's balance sheet contains no deferred advertising costs. The Company incurred advertising expenses of approximately $397,000 and $507,000 in 1999 and 1998, respectively. Income Taxes Deferred income taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable 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. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-8 Earnings Per Share Basic earnings per common share data has been computed on the basis of the weighted-average number of common shares outstanding during each period presented. Diluted per share amounts assume the conversion, exercise or issuance of all potential common stock instruments unless the effect is to reduce a loss or increase the income per common share from continuing operations. Fair Value of Financial Instruments The method and assumptions used to estimate the fair value of long-term debt, which approximates the carrying value, is based on interest rates for instruments with similar terms and remaining maturities. Stock-based Compensation The Company accounts for stock-based employee compensation under the requirements of Accounting Principles board (APB) Opinion No. 25, which does not require compensation to be recorded if the consideration to be received is at least equal to fair value at the measurement date. Non-employee stock-based transactions are accounted for under the requirements of the Financial Accounting Standards Board's (FASB) Statement of Financial Accounting Standard (SFAS) No. 123 "Accounting for Stock Based Compensation" which requires compensation to be recorded based on the fair value of the securities issued or the services received, whichever is more reliably measurable. The Company determines fair value at the measurement date based upon the trading price of its stock. The Company considers outside directors as employees for the purpose of applying this Statement. Segment Information Effective January 1, 1998, the Company adopted FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information. Statement No. 131 superseded FASB Statement No. 14, Financial Reporting for Segments of a Business Enterprise. Statement No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. Statement No. 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. The adoption of Statement No. 131 did not affect results of operations or financial position, but did affect the disclosure of segment information. See Note 7 for disclosures about the Company's operating segments. NOTE 2 - LONG-TERM DEBT Following is a summary of long-term debt: Revolving/term loan from bank (a) $ 7,800,000 Secured note bearing interest at 11%, maturing August 2000, payable at $14,728 per month (b) 147,000 Secured note to former owner of acquired business bearing interest at 12.25%, payments of $40,000 quarterly, including interest to October 2000 183,000 F-9 Mortgage payable secured by land and building, bearing interest at 1% over prime, maturing $2,321 monthly, including interest, due November 12, 1999 This note is normally renewed for successive one-year terms. 156,000 Notes payable to officers of the Company bearing interest at rates ranging from 8.5% to 9.1%, due on demand 267,000 Other secured notes at various interest rates and various maturities 281,000 ---------------- Total 8,834,000 Less current portion 8,691,000 ---------------- Total long-term debt $ 143,000 ================ (a) The Company has obtained a $10,000,000 credit facility from Harris Bank secured by all assets of the Company and guaranteed by each of the Company's subsidiaries. The facility consists of a $6,000,000 term loan with a five-year amortization period, and a $4,000,000 revolving line of credit with a termination date of December 31, 1999. The revolving line of credit is subject to a borrowing base limit equal to the sum of 80% of eligible receivables, 50% of eligible inventories, 60% of eligible fixed assets and an intangible asset advance amount of $1,400,000. Both facilities require monthly interest payments at the prime rate (7.75% at June 30, 1999). The term loan portion is payable in equal quarterly installments of $200,000 through December 31, 1999, when the full amount of the then unpaid balance of the note will be due. In addition, all proceeds from the sale of long-term assets in excess of $50,000 and all proceeds from the issuance of equity securities shall be applied to reduce the term loan. The term loan had an outstanding balance at June 30, 1999, of $3,800,000. The revolver portion of the facility had an outstanding balance at June 30, 1999, of $4,000,000. At June 30, 1999, no amounts were available under the revolver/term loan. The Company is required to meet certain financial covenants including minimum tangible net worth, debt to total capitalization, interest coverage, fixed charge coverage, and cash flow. In addition, the credit facility limits the amount of dividends and capital expenditures in any one year. At June 30, 1999, the Company did not meet certain of the financial covenants; however on July 24, 1999, the bank waived the current covenants and amended the future covenants. In addition, the amendment requires the payment of a fee of $140,000 in July 1999, August 1999, and September 1999, if the Company is not in compliance with certain provisions of the agreement. (b) This amount is due to the former owner of Micro Motors and the Company's largest shareholder and are subordinated to the bank debt discussed above. Aggregate annual maturities on long-term debt for the next five years are as follows: 2000, $8,691,000; and 2001, 143,000. NOTE 3 - COMMITMENTS AND CONTINGENCIES Micro Motors leases office and warehouse facilities from the Company's largest shareholder. The Company and its subsidiaries also lease other office and warehouse facilities from unrelated parties under lease agreements expiring through March 2001. These leases generally require the Company to pay insurance, taxes, and other expenses related to the leased space. Total rent expense was $764,000 and $970,000, including approximately $340,000 paid to the Company's largest shareholder for the years ended June 30, 1999 and F-10 1998, respectively. For the years ending June 30, 1999 and 1998, the Company received $0 and $307,000 of sublease payments from DCM, the purchaser of its dental center operations. Management believes the Company is no longer obligated under the dental center leases and these obligations were assumed by DCM. Future minimum lease payments for the years ending June 30, are; 2000, $641,000; 2001, $501,000; 2002, $214,000; 2003, $110,000; for a total of $1,466,000, including $612,000 to the Company's largest shareholder. On the 10th of September 1999, the United States Court of Appeals for the Tenth Circuit reversed the decision of Judge Daniel B. Sparr by which he dismissed an action filed against the Company and Biotrol in the U.S. District Court for Colorado by Cottrell, Ltd. ("Cottrell"). The Court agreed with the Company with respect to its assertion that Cottrell should not be permitted to bring a FIFRA action by simply identifying the same as a Lanham Act claim, and, accordingly, that claim was dismissed. The Court disagreed, however, with the Company stating that Cottrell had alleged sufficient facts to support a Lanham Act claim independent of FIFRA. The case was remanded to the District Court for further proceedings. On June 12, 1997 the Company sold the assets of its DCM dental clinic management subsidiary to Professional Dental Management, LLC. Subsequent to that sale, Professional Dental Management, LLC was restructured and the survivor, Consolidated Dental Management, Inc., among other things, assumed liability for leases of dental clinic offices situated in Sears' store in north-central California. On May 9, 1999, due to the poor financial condition of the Consolidated, Sears required the Company to guaranty Consolidated's performance those leases of up to approximately $200,000. Biotrol is one of 16 named defendants, excluding John Does 1-100, in these two matters which are part of what has been designated "New Jersey Latex Litigation" cases. The cases have been centralized and are proceeding under the terms of a variety of case management orders. Plaut v. Biotrol has been selected as one of three "Bellwether" cases and is expected to proceed to trial in February 2000. The claim has been submitted to Biotrol's product liability carrier, Chubb Insurance Companies. The Company and its subsidiaries are currently party to other disputes, which involve or may involve litigation and claim unspecified damages. Management believes that the outcome of the above matters will not have a material adverse effect on the consolidated financial statements of the Company. However, the ultimate outcome in any litigation involves uncertainty. Management is unable to estimate the magnitude of the exposure to the Company in these matters. No accruals have been provided for in the accompanying consolidated financial statements. NOTE 4 - INCOME TAXES The provision for income taxes (credits) for the years ended June 30, 1999 and 1998 is as follows: 1999 1998 --------------- -------------- Current state taxes (credits) $ (11,000) $ 91,000 Deferred taxes (credits) (2,280,000) 60,000 --------------- -------------- $ (2,291,000) $ 151,000 =============== ============== F-11 A reconciliation of expected tax expense (credit) to the amount computed by applying the federal statutory income tax rates to income (loss) before income taxes (credits) is as follows: 1999 1998 --------------- -------------- Federal income taxes (credits), computed at the statutory rate $ (3,929,000) $ 177,000 Change in valuation allowance - (285,000) State income taxes (credits) (337,000) 91,000 Non-deductible items, primarily goodwill 2,064,000 164,000 Other (89,000) 4,000 --------------- -------------- $ (2,291,000) $ 151,000 =============== ============== Deferred income tax assets and liabilities in the accompanying balance sheet at June 30, 1999 consist of the following: Assets: Net operating loss carryforwards $ 1,835,000 Contract payable 80,000 Accrued expenses 247,000 Intangible assets 710,000 Inventories 298,000 Other 71,000 -------------- Total deferred tax assets 3,241,000 Liabilities, property and equipment (341,000) -------------- Net deferred tax assets $ 2,900,000 ============== Net deferred tax assets total $2,900,000 of which $1,200,000 are included in the accompanying consolidated balance sheet as a current asset with the remaining $1,700,000 included as long-term assets. A portion of these deferred tax assets reflects the benefit of a $5,300,000 tax loss carryforward, of which approximately $250,000 expires in 2003; $150,000 expires in 2004 and the balance of $4,900,000 expires in 2019. Realization of these deferred tax assets relating to the net operating loss carryforwards is dependent on the Company generating sufficient taxable income prior to the expiration of the loss carryforwards. The remaining deferred tax assets do not expire until such time as they become deductible losses at which point they will expire in 20 years from the date they are deducted on the Company's income tax returns. The Company will need to generate taxable income of approximately $7.3 million in order to fully realize the deferred tax assets. Although realization is not assured, management believes it is more likely than not that the net deferred tax assets will be realized based on its projected taxable income and the implementation, if necessary, of tax planning strategies. During 1999, the Company incurred several one-time expenses which management does not expect to incur in the future. These expenses total approximately $7.4 million and include the write off of goodwill at the Micro subsidiary, the write off of a receivable from the sale of a former segment of business, and charges to operations for the remaining portion of employment, consulting and non-compete contracts deemed to have no future value to the Company. (See "Note 6."). Management also believes the merger of three of its customers, which resulted in a delay in orders from this newly consolidated customer, negatively impacted the Company's 1999 results. Considering these items, management has forecasted an increase in sales in 2000 of at least $3.5 million or 19%. Sales for the first two months of 2000 are above 1999 comparable sales by approximately 21%. As a result of the one-time expenses and the forecasted increased sales levels, management has projected that 2000 will generate a pre-tax profit of at least $1.6 million. At this income level the deferred tax assets would be realized prior to the expiration of the carryforward period. F-12 Management and the Company's Board of Directors have also concluded that should the Company not meet these projections, the Company would implement a tax planning strategy to utilize the deferred tax assets prior to their expiration. This strategy involves the sale of the OMS subsidiary to a third party. Management has estimated that the value of this subsidiary is sufficient to recover the entire amount of the recorded deferred tax asset. The costs to implement this strategy are estimated at approximately $360,000 net of related income taxes. No reserve for these costs have been included in the accompanying financial statements as management believes that it will not be necessary to implement this strategy. Net realizable deferred tax assets could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced or if the estimated fair value of OMS is reduced. Also, future changes in ownership of the Company could limit the Company's ability to realize these assets. NOTE 5 - STOCKHOLDERS' EQUITY Stock Options and Warrants The Board of Directors and the shareholders of the Company have approved and adopted three plans, pursuant to which options to purchase 2,150,000 shares of common stock can be granted to officers, directors, employees and to others expected to provide significant services to the Company. There are 775,639 shares remaining in the option plans, which are available for grant in future years. In addition, the Company has issued warrants to acquire 133,000 shares, exercisable at a weighted-average price of $2.20 and with a weighted-average remaining contractual life of 2.5 years. The Company recorded expenses of $55,000 related to the grant of 60,000 warrants during 1998. Transactions involving the stock options are summarized as follows: 1999 1998 ------------------------------------------- Weighted- Weighted- Average Average Exercise Exercise Fixed Options Shares Price Shares Price - ------------------------------------------------------------------------------ Outstanding at beginning of year 1,249,361 $ 2.22 918,636 $ 2.28 Granted 255,000 1.58 405,000 2.11 Exercised - - (25,000) 1.75 Forfeited (230,000) 2.18 (49,275) 2.50 ------------------------------------------- Outstanding at end of year 1,274,361 $ 2.10 1,249,361 $ 2.22 ------------------------------------------- Exercisable at end of year 1,078,529 $ 1.88 916,028 $ 2.27 ------------------------------------------- Weighted-average fair value per option granted during the year $ 0.84 $ 0.92 ------------ ------------ F-13 A further summary about fixed options outstanding June 30, 1999, is as follows:
Options Outstanding Options Exercisable -------------------------------------------------------------------------------------------- Weighted- Weighted- Weighted- Average Average Average Range of Number Remaining Exercise Number Exercise Exercise Price Outstanding Contractual Life Price Exercisable Price - ------------------------------------------------------------------------------------------------------------- $1.25 to $1.70 160,000 9.7 years $ 1.33 55,001 $ 1.33 $1.75 to $2.50 1,082,607 7.2 years 2.20 991,774 2.24 $2.85 to $2.90 31,754 7.3 years 2.90 31,754 2.65 --------- ------ --------- ------- 1,274,361 $ 2.10 1,078,529 $ 2.21 ========= ====== ========= =======
The three option plans are substantially similar and call for the vesting as approved by the Board of Directors, and allow for the options to be outstanding for a period of ten years. Grants under the Company's stock option plans are accounted for following APB Opinion No. 25 and related interpretations. Accordingly, no compensation cost has been recognized for grants under the plans. Had compensation cost for the stock-based compensation plans been determined based on the grant date fair values of awards (the method described in FASB Statement No. 123), reported net income (loss) and basic and diluted earnings (loss) per common share would have been adjusted to the pro forma amounts shown below: 1999 1998 --------------- -------------- Net income (loss) As reported $ (8,934,000) $ 354,000 Pro forma (9,037,000) 314,000 Basic and diluted earnings (loss) per common share As reported $ (1.02) $ 0.04 Pro forma (1.03) 0.04 The fair value of each grant is estimated at the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions: no dividend rate for all years; price volatility of 55% in 1999, and 35% in 1998; risk-free interest rates of approximately 5.5% in 1999 and 6.0% in 1998; and expected lives of five years. Preferred Shares Holders of Series A preferred shares have no voting, dividend, or redemption rights. In the event of liquidation or dissolution, preferred shareholders are entitled to receive $3.60 per share. Each preferred share is convertible into one common share at the option of the holder. Employee Stock Purchase Plan In July 1998, the Company adopted an Employee Stock Purchase Plan, under which up to 200,000 shares of common stock may be issued to substantially all full-time employees, if they choose to participate. Employees can choose each year to have between 1% and 10% of their defined earnings withheld to purchase the Company's common stock at a price that is 85% of the lower of the market price at July 1 and January 1 of each year or the date on which the shares are fully paid by the employee. The minimum purchase price under the plan is $2.00 per share, unless the Company's Stock Purchase Plan Committee determines a lower price is appropriate. During 1999, no shares were purchased under the F-14 plan. As is permitted by generally accepted accounting principles, the Company follows the provisions of APB Opinion No. 25 in accounting for the plan and, accordingly, no compensation expense is recognized. NOTE 6 - UNUSUAL CHARGES On June 12, 1997, the Company completed the sale of certain assets of its dental clinic management (DCM) subsidiary operation in California and recorded the loss on this sale as discontinued operations. In connection with the sale and in subsequent re-negotiations, the Company received a promissory note for $850,000 and convertible preferred stock in California Dental Management (CDM), the predecessor to DCM, totaling $900,000 plus warrants to acquire additional common stock. CDM has continued to perform poorly and during the fourth quarter of 1999, management determined that the receivable and the preferred stock were worthless and accordingly, charged operations for approximately $1,750,000. At June 30, 1999, no assets of the discontinued operations remain on the balance sheet of the Company. During the fourth quarter of 1999, management determined that the intangible assets of Micro were impaired based on Micro's recent financial performance. For 1999, Micro reported net losses of approximately $1.2 million prior to charges for interest, depreciation and amortization and unusual charges. In addition, management determined that the estimated future cash flows from this operation were not expected to be sufficient to recover the recorded amount of all long-term assets. In connection with other activities, management had engaged an investment banker to determine the value of Micro. Management compared the value determined by the investment banker, net of anticipated disposal costs, to the recorded value of Micro's assets. As a result, management determined that intangible assets of Micro totaling $6.6 million were impaired and wrote them down in the fourth quarter of 1999 by $4.8 million. This charge to operations is included in unusual charges in the Company's consolidated statement of operations. In addition, during the first quarter of 1999, management determined that a consulting agreement and related non-compete agreement entered into during the acquisition of OMS had no future value. Accordingly, management has included in unusual charges the write off of these agreements totaling approximately $314,000. Also, during the first quarter of 1999, management amended the duties of an executive officer under an existing employment contract entered into during the acquisition of Micro. Management determined the value of the new position is less than the previous position of the executive; however, the Company is required to honor its obligation under the contract, which obligation expires in 2000. As a result, management charged operations for approximately $525,000, which represents the excess of the payments required under the contract compared to the value established for the new position. NOTE 7 - SEGMENT INFORMATION The Company's reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. There are four reportable segments: infection control products, preventive dentistry products, medical/dental equipment, and electronic motion controllers. The accounting policies applied to determine the segment information are the same as those described in the summary of significant accounting policies. Interest expense is allocated based upon the specific identification of debt incurred by the individual segment. Corporate overhead and the provision for income taxes are not allocated to the individual reported segments. Intersegment sales and transfers are accounted for at F-15 amounts that management believes provides the transferring segment with fair compensation for the products transferred, considering their condition, market demand, and, where appropriate, a reasonable profit that recognized which segment will be responsible for marketing costs. Management evaluates the performance of each segment based on income (loss) before income taxes. Financial information with respect to the reportable segments follows (in thousands):
Infection Preventive Medical/ Electronic Control Dentistry Dental Motion 1999 Products Products Equipment Controllers Total - ---------------------------------------------------------------------------------------------------------------- Sales from external customers $8,170 $1,365 $5,094 $3,713 $18,342 Intersegment sales - 811 925 - 1,736 Depreciation and amortization 73 100 726 473 1,372 Unusual charges - - 131 314 445 Interest expense 15 96 481 29 621 Segment profit (loss) (188) 183 (2,565) 352 (2,218) Segment assets 3,273 1,657 7,260 2,787 14,977 Expenditure for segment assets 157 283 317 20 777 Infection Preventive Medical/ Electronic Control Dentistry Dental Motion 1998 Products Products Equipment Controllers Total - ---------------------------------------------------------------------------------------------------------------- Sales from external customers $8,457 $ 867 $ 7,556 $5,768 $22,648 Intersegment sales - 886 838 - 1,724 Depreciation and amortization 42 123 732 598 1,495 Interest expense - 85 410 45 540 Segment profit (loss) 980 12 (98) 1,976 2,870 Segment assets 2,761 1,270 12,334 2,540 18,905 Expenditure for segment assets 73 96 273 80 522
The following schedules are presented to reconcile amounts in the foregoing segment information to the amounts reported in the Company's consolidated financial statements (in thousands): F-16
1999 1998 ---------------------------------------------------------------------------- Profit/(loss) Assets Profit/(loss) Assets ---------------------------------------------------------------------------- Total for reportable segments $ (2,218) $14,977 $2,870 $18,905 Intersegment / profit 10 - (105) -- Unallocated amounts: Corporate (1,621) 2,721 (1,872) 3,934 Unusual charges (6,944) - - -- Other expense, net (452) - (388) - --------- ------- ------- ------- Consolidated (11,225) 17,698 505 22,839 --------- ------- ------- -------
Reconciliation of other significant items:
1999 1998 ------------------------------------------------------------------------------------- Reportable Reconciling Reportable Reconciling Segments Items Consolidated Segments Items Consolidated ------------------------------------------------------------------------------------- Depreciation and amortization $1,372 $ 58(B) $1,430 $1,495 $ 21(B) $1,516 Unusual items 445 6,944(A) 7,389 - - -- Interest expense 621 411(B) 1,032 540 391(B) 931 Expenditures for segment assets 777 98(B) 875 522 288(B) 810
(A) Includes write off of goodwill, write off of DCM receivable, and a portion of the amendment of an executive's position, which is not allocated to a reportable segment. (B) Amounts allocated to corporate. The Company had foreign sales in the amount of $1,745,000 in 1999 and $1,140,000 in 1998, primarily in Canada and Japan. During 1999, three of the Company's customers merged into one company. Sales to this consolidated customer for 1999 and 1998 were $2,362,000 and $3,100,000, respectively. No other single customer generated in excess of 10% of consolidated sales. NOTE 8 - EARNINGS PER SHARE The weighted-average number of common shares and common share equivalents outstanding during the year used to compute basic and diluted earnings/(loss) per common share is as follows: 1999 1998 --------------- -------------- Weighted-average common shares used in computation of basic earnings (loss) per share 8,787,300 8,712,660 Effect of dilutive securities: Common stock options and warrants * 56,565 Convertible preferred stock * 39,065 --------------- -------------- Weighted-average common and common share equivalents used in the computation of diluted earnings (loss) per share 8,787,300 8,808,290 =============== ============== F-17 *Common shares issuable upon exercise of the employee stock options and common stock warrants (see Note 5) and upon the conversion of 78,129 shares of preferred shares have not been included in the computation because their inclusion would have been antidilutive. NOTE 9 - MANAGEMENT PLANS For the year ended June 30, 1999, the Company reported a loss from operations of approximately $2.9 million prior to $7.4 million of unusual charges discussed in Note 6. In addition, as of June 30, 1999, the Company had negative working capital of approximately $4.0 million. As a result of the poor operating performance in 1999, the Company's primary bank has requested that the Company find alternative financing sources and has requested repayment of its outstanding debt by December 31, 1999. Management believes the 1999 results were negatively affected by several factors. Biotrol reported a segment loss of $188,000 versus a profit for 1998 of $980,000. Management believes that this was primarily due to the consolidation of three of its customers which resulted in a delay in orders and by certain favorable pricing to foreign exporters. Management believes that the effect of the consolidation of its larger customers has passed. In addition, favorable pricing to exporters has ceased. Management has reduced certain sales and marketing expenses and is currently investigating the utilization of other cost saving measures. Accordingly, management believes Biotrol will return to profitable operations in 2000. Micro reported a segment loss for 1999 of $2.6 million compared to a segment loss in 1998 of $98,000. The increased losses is primarily attributable to a 33% decline in sales. Management has replaced the local management team at Micro and has taken steps to improve engineering and delivery times, quality control and pricing concerns. In addition, management has introduced new products to the market as well as attempting to open new markets for its existing products. With these changes in place, management believes Micro will improve its financial results in 2000. OMS reported a segment profit of $352,000 in 1999 versus a segment profit of $2.0 million in 1998. Management attributes the decline in profitability to a 35% decline in sales due to the slump in the Asian semiconductor industry. Most of OMS's customers depend heavily on the Asian semiconductor fabrication equipment market. Since March 1999, sales at OMS have indicated a possible increase in the semiconductor fabrication industry. Future orders since June 30, 1999 have increased as activity from customers is returning to pre-slump levels; according, management believes OMS will return to its previous profitability level. Although no assurances can be given, considering all of the above factors management has forecasted an increase in consolidated sales of 19% or $3.5 million and a pretax profit of approximately $1.6 million. Management is currently investigating financing options which would replace their current banking relationship and has engaged an outside investment banker to assist them in locating and securing this financing. These options include the issuance of additional preferred stock of between $2 to $4 million. It is believed that with such additional financing, the Company could secure a traditional asset-based lending structure to replace the remaining bank debt. Management is also investigating a possible synergistic merger partner. Should the Company be unable to secure replacement financing, the Board has authorized management to pursue the sale of one of its operating subsidiaries in order to raise sufficient funds to satisfy the current working capital needs of the Company as well as pay down the bank debt as necessary. Management is currently evaluating this option. F-18 PART III Item 9. Directors, Executive Officers, Promoters, and Control Persons; Compliance with 16(a) of the Securities Exchange Act of 1934 Officers and Directors As of June 30, 1999, the officers and directors of the Company were as follows: NAME AGE POSITION - ------------------------------------------------------------------------------ Kent E. Searl 58 Chairman of the Board, Director Ronald G. Coss 62 Vice Chairman, Director George J. Isaac 54 Vice President, Director Richard N. Reinhardt 67 Director Robert A. Hovee 57 Director John B. Zaepfel 63 Director Kent E. Searl is a co-founder of the Company and currently serves as Chairman of the Board, Chief Executive Officer, and President. He has served as a director of the Company and its predecessor, since its inception in 1978. In addition to serving as Chairman of the Board, Mr. Searl is a member of the Executive Committee of the Board of Directors. Since August 1969, he has also served on the Board of Directors of Professional Sales Associates, Inc. ("PSA"), a national dental equipment manufacturers' representative, which he co-founded. PSA acted as marketing representative for dental handpiece products of the Micro subsidiary until June 30, 1997, at which time Biotrol began marketing those products. Mr. Searl was elected by the shareholders of the Company to serve as a Class III Director until the year 2000 annual shareholders' meeting, or the election and qualification of his successor. Ronald G. Coss founded Micro Motors, Inc. in 1971 and served as its Chairman since its organization. He currently serves as the Vice-Chairman of the Company's Board of Directors, and also serves as an ex officio non-voting member of the Compensation Committee of the Board of Directors. He also acts as Chief Technology Officer to the Company. Mr. Coss has been the primary engineer in the development of Micro's products since its inception and invented the technologies which are the subject of the letters patent now owned by Micro. Mr. Coss was elected by the shareholders of the Company to serve as a Class III Director until the year 2000 annual shareholders' meeting or the election and qualification of his successor. George J. Isaac has served as a consultant to the Company and its predecessor since 1978, and became a member of the Company's Board of Directors on July 26, 1995. He serves as an ex officio member of both the Audit and Compensation Committees of the Board of Directors, and is Vice President, Secretary/Treasurer, and Chief Financial Officer of the Company. Mr. Isaac is a certified public accountant and was a principal in the Certified Public Accounting firm of Joseph B. Cohan and Associates, Worcester, Massachusetts. Mr. Isaac is a former director of Professional Sales Associates, Inc. ("PSA"). Mr. Isaac received a B.S. degree in Business Administration from Clark University in Worcester, Massachusetts. Mr. Isaac was elected by the shareholders of the Company to serve as a Class I Director until the 2001 annual shareholders' meeting, or the election and qualification of his successor. Richard N. Reinhardt has served as a director of the Company and its predecessor since 1990. He is a member of the Compensation Committee of the Board of Directors. Mr. Reinhardt has served as President and a director of Professional Sales Associates, Inc. ("PSA") since he co-founded that firm in 1969. PSA is a national manufacturers' representative organization that represents manufacturers in the dental equipment market. He attended Cornell College and received a B.A. degree in Business Administration from Northwestern University. Mr. Reinhardt was elected by the shareholders of the Company to serve as a Class II director until the 1999 annual shareholders' meeting, or the election and qualification of his successor. Robert A. Hovee began serving on the Company's Board of Directors on February 27, 1996. He serves as a member of both the Audit and Compensation Committees. Currently, Mr. Hovee serves as President of the Orange County Biomedical Industry Council and the Orange County Biocommerce Association, both California non-profit associations. Formerly, Mr. Hovee was Chief Executive Officer and President of Life Support Products, Inc., a maker of emergency medical products, of which he was a co- founder, prior to its acquisition by Allied Healthcare Products, Inc. He has also served as a director and chairman of Infrasonic, Inc., an infant respirator manufacturer. Mr. Hovee, who is active in many charities, serves as a co-chair of a University of California-Irvine Center for the Health Sciences fund-raising project. Mr. Hovee received a B.A. degree in Business Administration and a B.A. degree in International Business from the University of Washington in Seattle, Washington, as well as a Masters Degree in International Management from the American Graduate School of International Management (Thunderbird) where he was the Barton Kyle Yount Scholar, in Glendale, Arizona. Mr. Hovee was elected by the Board of Directors to serve as a Class II Director until the first to occur of the 1999 annual shareholders' meeting or the election and qualification of his successor. John B. Zaepfel has served as director of the Company from August 27, 1996 until his resignation effective June 15, 1999. He served on the Company's Audit Committee and on the Advisory Committee advising the Board of Directors of Micro Motors, Inc. prior to its merger into Micro in July 1995. Mr. Zaepfel spent fifteen years as a CEO, most recently as Chief Executive Officer of CPG International, Inc., which he founded in 1985 in a leveraged buy-out of a division of four subsidiaries of Times Mirror, Inc. Prior to its private sale in 1989, CPG International, Inc. was a $90 million operating company, manufacturing and marketing art, engineering, and media supplies. Prior to forming CPG International, Inc., Mr. Zaepfel was President and CEO of Chartpak and Picket Industries, wholly owned subsidiaries of Times Mirror, Inc. Mr. Zaepfel previously served as a director of Ideal School Supplies, Inc., when it was a publicly traded company, and was director of six privately held companies. Mr. Zaepfel has previously served as a director of other public companies. Mr. Zaepfel is a graduate of the University of Washington, and holds a Master in Business Administration degree from the University of Southern California. Mr. Zaepfel served as a Class II Director. The Board is currently seeking a suitable candidate to succeed Mr. Zaepfel. Business Experience of Key Management of Subsidiaries Set forth below is information concerning certain key management personnel of the Company's operating subsidiaries: Daniel S. Reinhardt joined Biotrol International, Inc. as a sales representative in September 1988. He was promoted to National Sales Manager in January 1991, and, effective January 1, 1997, Mr. Reinhardt was made Vice President and Chief Operating Officer of Biotrol International, Inc. Charles L. Bull founded Challenge Products, Inc. in 1978 and served as its President and Chief Executive Officer since its inception as a dental products business. Mr. Bull has developed more than 40 chemical products used in the industry, as well as a process for high speed filling of a patented prophy ring. Gary G. Garleb has served as Vice President and General Manager of Oregon Micro Systems, Inc., since its acquisition by the Company in July 1995. Prior to that time, he served as Vice President for Operations and Manufacturing of Micro Motors, Inc. from 1974 to 1995. George M. Saiz has served as Vice President and General Manager of Micro Motors, Inc. since January 1998. Mr. Saiz has significant experience in the medical device manufacturing arena, having served as General Manager of Shutt Medical Technologies, part of the Bristol-Myers Squibb Companies since 1991. Compliance With Section 16(a) Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers, directors and persons who own 10% or more of the Company's outstanding common stock, to file reports of ownership and changes in ownership with the Securities and Exchange Commission ("SEC"). Officers, directors and owners of 10% or more of the Company's outstanding common stock are required by SEC regulations to furnish the Company with a copy of all Section 16(a) forms they file. Based solely upon a review of the Forms 3 and 4 and any amendments thereto furnished to the Company during the Company's fiscal year ended June 30, 1999, and Forms 5 and amendments thereto furnished to the Company with respect to such fiscal year, or written representations that no Forms 5 were required to be filed by such persons, the Company is not aware of any failure of any officer, director or beneficial owner of 10% or more of the Company's outstanding common stock during the fiscal year ended to make timely filings in accordance with the requirement of Section 16(a). Item 10. Executive Compensation The following table summarizes executive compensation paid by the Company during the last three fiscal years to the Company's Chairman and the four other most highly compensated executives. SUMMARY COMPENSATION TABLE
Annual Compensation Long Term Compensation Awards - -------------------------------------------------------------------------------------------------------------------- Other Re- Securities All Annual stricted Underlying LTIP Other Name and Compen- Stock Options/ Pay- Compen- Principal Position Year Salary Bonus Sation Awards SAR(#) outs Ation(4) - -------------------------------------------------------------------------------------------------------------------- Kent E. Searl 1999 $162,528 - - - None - - Chairman/CEO/ 1998 174,858 - - - None - - President 1997 160,000 - - - None - - Ronald G. Coss(1) 1999 $359,062 - $39,619 - 100,000(2) - $1,593 Vice Chairman 1998 325,163 - $35,406 - None - $1,671 Chief Technical Officer 1997 364,320 - - - N/A - - George J. Isaac(3) 1999 $195,436 - - - None - $1,466 Vice President, Chief Financial 1998 189,269 - - - None - - Officer, Secretary-Treasurer, 1997 180,000 - - - None - - Director Charles L. Bull 1999 $100,000 $39,089 - - None - $1,739 General Manager 1998 100,000 28,563 - - None - 1,633 Challenge Products, Inc. 1997 100,000 13,276 - - None - - Gary G. Garleb 1999 $124,271 - $ 9,986 - None - $1,467 General Manager 1998 118,563 - $15,539 - None - $1,350 Oregon Micro Systems, Inc. 1997 111,435 - - - None - -
(1) The Company is obligated to pay Mr. Coss $1 million over five years, commencing on July 26, 2001, under a Non-Competition Agreement, in connection with the merger of Micro Motors, Inc. with and into the Company's Micro Acquisition subsidiary. In addition, the Company assumed two notes of Micro Motors, Inc. payable to Mr. Coss in the aggregate amount of $938,450, relating to termination of Mr. Coss's long term employment agreement with Micro Motors, Inc. and prior unpaid earned compensation (2) On April 8, 1999, Mr. Coss was granted an option to purchase 100,000 shares of the Company's common stock under the 1994 Stock Option Plan in consideration for his agreement to restructure his employment agreement effectively relieving the Company of the obligation to pay any bonus contemplated by his previous agreement. (3) Mr. Isaac was granted an option to purchase 50,000 shares under the 1994 Stock Option Plan in connection with his acceptance of employment by the Company. (4) Employer contributions to the Pro-Dex, Inc. 401(k) Plan. Employment Agreements, Termination of Employment, and Change of Control Arrangements The Compensation Committee of the Board of Directors has renewed employment agreements with certain executive officers of the Company entered into on July 26, 1995, which expired on June 30, 1998. During the 1999 fiscal year, the Company also renegotiated its agreement with Mr. Coss previously scheduled to expire on June 30, 2000. Effective April 1, 1999, Mssrs. Searl, Isaac and Coss agreed to salary reductions of 10% due to the financial condition of the Company, which reductions shall remain effective until such time as the Company's financial condition improves. The remaining employment agreement with Mr. Bull expires December 31, 2001. The Company accrued salaries in an aggregate amount of $717,026 to its executive officers for the year ended June 30, 1999. Kent E. Searl serves as the Chairman, Chief Executive Officer and President of the Company. He is the co-founder of the Company, and has served as a director of the Company since its organization. For the year ending June 30, 1999, Mr. Searl was paid a salary of $162,528. Pursuant to his three year employment agreement, effective July 1, 1998, Mr. Searl is entitled to an annual salary of $180,000. Mr. Searl is also entitled to reimbursement of reasonable expenses and to such other benefits as the Company's Board of Directors approved for executive management. Mr. Searl is located in the Company's Boulder, Colorado executive offices and travels frequently to all the Company's subsidiaries. George J. Isaac has served as the Company's Vice President and Chief Financial Officer since July 26, 1995. On November 5, 1998, he was re-elected the Company's Secretary-Treasurer by the Board of Directors. Mr. Isaac's three year employment agreement effective July 1, 1998 provides that he receive an annual salary of $195,000 during the term of the agreement as well as reimbursement of reasonable expenses and to such other benefits as the Company's Board of Directors approved for executive management. Ronald G. Coss currently serves as Vice Chairman and Chief Technology Officer of the Company. Mr. Coss had, prior to the merger, been compensated by Micro Motors, Inc. at a salary of $560,000 for the fiscal year ended March 31, 1995 and $456,000 for the fiscal year ended March 31, 1994. Under his current Agreement, annual base compensation to Mr. Coss was $360,000, adjustable upward for inflation each July 1. The agreement accords Mr. Coss six weeks annual leave which he may elect to take in cash in lieu of leave, provides that he receive use of a Company vehicle for business purposes, and certain other perquisites comparable to with those received prior to the merger. In addition to compensation to Mr. Coss under his employment agreement, the Company is obligated to pay Mr. Coss $1 million over five years, commencing on July 26, 2001, under a Non-Competition Agreement, in connection with the merger. Upon the merger, the Company also assumed two notes payable by Micro Motors, Inc. to Mr. Coss relating to termination of Mr. Coss's long term employment agreement with Micro Motors, Inc. and prior unpaid earned compensation. See "CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS." On August 1, 1993, the Company entered into an employment agreement with Mr. Charles L. Bull, former President of Challenge Products. An agreement was recently reached to extend that contract on the same terms and conditions through December 31, 2001. Compensation Committee Report on Executive Compensation The Compensation Committee develops and recommends to the Board of Directors the compensation policies of the Company. It also recommends the compensation to be paid to the executive officers of the Company. The Compensation Committee consists of three directors, two of whom are not current or former employees of the Company and one of whom is a non-voting member and the Company's Chief Financial Officer. The basic compensation philosophy of the Board of Directors has been to provide competitive salaries and competitive incentives to achieve financial goals. Compensation to Directors Directors who are employees of the Company do not receive additional compensation for services as directors, except for reimbursement of reasonable meeting attendance expenses. Non- employee directors each receive a $3,000 quarterly fee, $1,000 for each meeting attended and $500 for each board of directors committee meeting attended on a date other than a regular meeting of the Board. Non-employee directors unanimously elected to waive their fee for the quarter ended June 30, 1999. The Company accrued an aggregate of $53,000 as non- employee director compensation, of which $38,000 has been paid, for the year ended June 30, 1999. The Company has a shareholder approved Director's Stock Option Plan (the "Directors' Plan") pursuant to which non-employee directors may be granted options to purchase shares of the Company's common stock. In accordance with the Directors' Plan's provisions, the Board of Directors previously adopted a policy to grant each outside director an option to purchase 20,000 shares of common stock on the date of his commencement of service as a director and an option to purchase 15,000 shares annually, exercisable at the average closing price on NASDAQ for the month of November of the year of grant, on the anniversary date of such service. The maximum term of each option is ten years. During the fiscal year ended June 30, 1999, the Company's three outside directors, Messrs. Reinhardt, Hovee and Zaepfel, each were granted options to purchase 15,000 shares of common stock exercisable at $2.00, $2.00, and $2.50 respectively. Option Grants and Exercises in the Last Fiscal Year The following tables set forth information regarding stock options granted to and exercised by the named executive officers during the fiscal year ended June 30, 1999: INDIVIDUAL OPTIONS/SAR GRANTS IN LAST FISCAL YEAR Number of Percent of Securities Total Options Underlying Granted to Exercise Options Employees in Price Expiration Name Granted Fiscal Year Per Share Date - ------------------------------------------------------------------------------ Kent E. Searl None - - - Ronald G. Coss(1) 100,000 46% $ 1.25 04/07/09 George J. Isaac None - - - (1) On April 8, 1999, Mr. Coss was granted an option to purchase 100,000 shares of the Company's common stock under the 1994 Stock Option Plan in consideration for his agreement to restructure his employment agreement effectively relieving the Company of the obligation to pay any bonus contemplated by his previous agreement. AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES(1) Value of Number of Securities Unexercised Underlying Unexercised Options In-the-Money Options at Fiscal Year-End at Fiscal Year-End(1) ------------------------------------------------------------- Name Exercisable/Unexercisable Exercisable/Unexercisable - ------------------------------------------------------------------------------ Kent E. Searl 202,051 -0- -0- -0- Ronald G. Coss(2) 50,000 50,000 $4,500 $4,500 George J. Isaac 250,000 -0- -0- -0- (1) The indicated value of the unexercised In-the-Money Options was determined by multiplying the number of unexercised options (that were In-the-Money on June 30, 1999) by the closing sales of the Company's common stock on June 30, 1999 (as reported on NASDAQ) and from that total, subtracting the total exercise price. (2) On April 8, 1999, Mr. Coss was granted an option to purchase 100,000 shares of the Company's common stock under the 1994 Stock Option Plan in consideration for his agreement to restructure his employment agreement effectively relieving the Company of the obligation to pay any bonus contemplated by his previous agreement. 1988 Stock Option Plan In 1988, the Company adopted its 1988 Stock Option Plan (the "Plan"), pursuant to which the Company's Board of Directors was authorized to issue options to purchase up to 150,000 shares of the Company's common stock to employees, directors, and consultants of the Company. The option exercise price must equal fair market value of the common stock on the date of grant. No options to purchase shares of common stock were granted under the 1988 Plan during the fiscal year ended June 30, 1999. At June 30, 1999, 50,000 shares were available for grant and no options to purchase were outstanding under this Plan. 1994 Stock Option Plan The 1994 Stock Option Plan was adopted to advance the interests of the Company and its shareholders by affording employees an opportunity for investment in the Company. Under the plan, 1.5 million shares have been reserved. The Compensation Committee has sole discretion to select which employees of the Company will be granted options; the number of shares subject to option; the timing of such option grants; when the options may be exercised; and the exercise price. The exercise price of options must be at least equal to the fair market value of the common stock on the date of grant. The maximum term of options granted under the Plan is ten years. As of June 30, 1999 there were outstanding options under the 1994 Stock Option Plan to acquire 1,138,505 shares of the Company's common stock. Directors' Stock Option Plan The Plan was adopted to advance the interests of the Company and its shareholders by attracting qualified non-employee directors, whose participation and guidance contribute to the successful operation of the Company. Under the plan, 500,000 shares have been reserved. As of June 30, 1999, there were outstanding options under the Directors' Stock Option Plan to acquire 135,856 shares of the Company's common stock. A disinterested majority of the Board has voted, in furtherance of the Board's decision respecting the remuneration of non-employee directors, in favor of the additional automatic grant each year during the term of service to purchase 15,000 shares of the Company's common stock, which grants are reflected in the foregoing total of outstanding options. Item 11. Security Ownership of Certain Beneficial Owners and Management Set forth in the following table is information as of June 30, 1999, with respect to the beneficial shareholdings of the Company's common stock, by all directors, individually, and all officers and directors as a group, and beneficial owners of 5% or more of such common stock. BENEFICIAL SHAREHOLDINGS OF DIRECTORS, OFFICERS AND OWNERS OF MORE THAN 5% OF COMMON STOCK Name and Address Number of Shares Percent of Class (1) - ------------------------------------------------------------------------------ Kent E. Searl 1401 Walnut St., Suite 540 Boulder, CO 80302 950,680(2)(3)(4) 10.81% Ronald G. Coss 1401 Walnut St., Suite 540 Boulder, CO 80302 2,511,104(5) 28.57% Richard N. Reinhardt 1401 Walnut St., Suite 540 Boulder, CO 80302 560,884(2)(3)(4)(6)(7)(8) 6.38% George J. Isaac 1401 Walnut St., Suite 540 Boulder, CO 80302 255,500(3) 2.90% Robert A. Hovee 1401 Walnut St., Suite 540 Boulder, CO 80302 65,000(6)(7)(8) 0.74% John B. Zaepfel 1401 Walnut St., Suite 540 Boulder, CO 80302 50,000(6) 0.56% All officers and directors as a group (6 persons) 4,056,639(2)(3)(4)(5)(6)(7)(8) 50.00% (1) Calculated pursuant to Rule 13d-3 under Securities Exchange Act of 1934. (2) Includes 250,000 shares of common stock; 58,229 shares of preferred stock convertible share-for-share into common stock at any time; and Warrants to acquire 13,000 shares of common stock owned of record by Professional Sales Associates, Inc. ("PSA"). Messrs. Searl and Reinhardt are officers and directors of PSA and may be deemed to beneficially own PSA's shares. Mr. Searl, individually, owns of record 407,200 shares of common stock and 19,900 shares of preferred stock. Mr. Reinhardt, individually, owns of record 41,850 shares. In addition, Mr. Reinhardt's spouse, individually, owns 29,000 shares, which are attributed to him in this chart. (3) Includes options held by Messrs. Searl, Reinhardt, and Isaac to purchase 50,000 shares each shares of the Company's common stock at $2.50 per share. Also includes options held by Messrs. Searl and Reinhardt to purchase 50,000 shares each at $1.75 per share. Also includes options held by Messrs. Searl and Isaac to purchase 100,000 and 200,000, respectively, of the Company's common stock at $2.13 per share. These shares have been added to outstanding shares in calculating applicable individual percentage of beneficial ownership. (4) Includes options held by Messrs. Searl and Reinhardt to purchase 2,051 shares each of the Company's common stock at $2.43 per share and Mr. Reinhardt to purchase 1,754 shares of the Company's common stock at $2.85 per share. These shares have been added to outstanding shares in calculating applicable individual percentage of beneficial ownership. (5) Includes 547,953 shares of the Company's common stock distributed from the Micro Motors Employee Stock Ownership Plan during the year, and options held by Mr. Coss to purchase 100,000 shares of the Company's common stock at $1.25 per share. (6) Includes automatic grant options to outside directors Messrs. Reinhardt, Hovee, and Zaepfel to purchase 20,000 shares each of the Company's common stock at $2.44 per share and 15,000 shares at $2.90 per share. (7) Includes automatic grant of options of outside directors Messrs. Reinhardt and Hovee to acquire 15,000 shares each of the Company's common stock at $2.50 per share and 15,000 shares a $2.00 per share. (8) The officers and directors as a group had in the aggregate, as of June 30, 1999, together with their affiliates, voting power with respect to 3,144,654 currently issued and outstanding shares of common stock, not including in such number the convertible preferred stock or options treated as shares of common stock attributed to them for the purpose of this chart. Set forth in the following table is information as of June 30, 1998 with respect to the beneficial shareholdings of all directors, individually, and all officers and directors as a group, and beneficial owners of more than five percent of the Company's Series A Preferred Stock. BENEFICIAL SHAREHOLDINGS OF DIRECTORS, OFFICERS, AND OWNERS OF MORE THAN 5% OF PREFERRED STOCK Name and Address Number of Shares Percent of Class (1) - ------------------------------------------------------------------------------ Kent E. Searl 1401 Walnut Street, Suite 540 Boulder, CO 80302 78,129(1) 100.0% Richard N. Reinhardt 1401 Walnut Street, Suite 500 Boulder, CO 80302 58,229(1) 74.5% All officers and directors as a group (3 persons) 78,129(1) 100.0% Professional Sales Associates, Inc. 1401 Walnut Street, Suite 500 Boulder, CO 80302 58,229 74.5% (1) Includes 58,229 shares owned of record by Professional Sales Associates, Inc. ("PSA"). Messrs. Searl and Reinhardt are officers and directors of PSA and may be deemed to beneficially own PSA's shares. Mr. Searl, individually, owns of record 19,900 shares (24.2% of the outstanding shares of preferred stock). Mr. Reinhardt owns no shares of preferred stock individually. Item 12. Certain Relationships and Related Party Transactions Pursuant to the merger of Micro with the Company's subsidiary, Ronald G. Coss entered into a Non-Competition Agreement, pursuant to which he is to be paid $1 million over five years, with payment commencing in the sixth year after closing. In addition, Mr. Coss executed an employment agreement with the Company, pursuant to which he is to be paid a base salary of $360,000 annually as Vice Chairman of the Company under his employment agreement, adjustable upward for inflation, representing a reduction from the more than $560,000 which he had been paid as the Chairman of Micro, despite his greater responsibilities with the Company. In addition to compensation payable under the employment agreement between the Company and Mr. Coss, he is entitled to certain executive employee benefits and perquisites. During the first quarter of 1999, management amended his duties under that employment contract. Management determined the value of the new position is less than the previous position of the executive; however, the Company is required to honor its obligation under the contract. As a result, management charged operations for approximately $525,000, which represents the excess of the payments required under the contract compared to the value established for the new position. The Company leases its offices in Boulder, Colorado from PSA, a firm for which Messrs. Searl, Reinhardt, and Isaac are directors, as sub-lessees under a master lease between PSA and a third party unrelated to PSA or the Company. The sublease between the Company and PSA is on a month to month basis. The Company's monthly lease payments are $2,198, which is equal to the amount of the lease payments due from PSA to the third party lessor, on a per square foot basis. The Company's management believes that the monthly rental is comparable to rents charged for comparable properties in the market area. Nevertheless, the terms of the sub-lease, including price, may not be as favorable to the Company as lease terms which might have been negotiated with a third party in an arm's length transaction. Micro leases its offices and manufacturing facility in Santa Ana, California from Ronald G. Coss, currently a director of the Company, at a monthly rental of $29,147. The Company's management believes that the monthly rental is comparable to rents charged for comparable properties in the market area. Nevertheless, the terms of the lease, including price, may not be as favorable to the Company as lease terms which might have been negotiated with a third party in an arm's length transaction. On April 25, 1997, the Company unwound the acquisition of Pnu- Light Tool Works, Inc. ("Pnu-Light"). The Company acquired the assets of Pnu-Light, a developer of patented pneumatic lighting mechanisms for hand tools in May 1996, in exchange for 368,483 shares of the Company's common stock. The Company anticipated that Pnu-Light's patented lighting apparatus would complement the pneumatic motors used in dental handpieces manufactured by Micro. The anticipated synergy between Pnu-Light and Micro did not meet the Company's expectations. Accordingly, and pursuant to the procedures contained in the Pnu-Light Asset Purchase Agreement, all of the shares of its common stock issued in the transaction for the Pnu-Light assets were returned to the Company. In exchange for the reconveyance of its shares, the Company assigned the patent covering the pneumatic lighting apparatus to Pnu-Light's successor entity, while retaining a nonexclusive, fully paid, worldwide license to the technology. On June 12, 1997, the Company completed the sale of certain assets of its dental clinic management (DCM) subsidiary operation in California and recorded the loss on this sale as discontinued operations. In connection with the sale and in subsequent re-negotiations, the Company received a promissory note for $850,000 and convertible preferred stock in California Dental Management (CDM), the predecessor to DCM, totaling $900,000 plus warrants to acquire additional common stock. CDM has continued to perform poorly and during the fourth quarter of 1999, management determined that the receivable and the preferred stock were worthless and accordingly, charged operations for approximately $1,750,000. At June 30, 1999, no assets of the discontinued operations remain on the balance sheet of the Company. On March 8, 1999, the Company distributed shares of Pro-Dex, Inc. common stock owned by the Micro Motors Employee Ownership Plan (the "Plan"). The Company previously made application for and received a favorable determination from the Internal Revenue Service with respect to the termination of the Plan and distribution of its shares. The shares, acquired by the Plan in conjunction with the 1995 merger of Micro Motors, Inc. into a wholly owned subsidiary of the Registrant, were issued without restriction to non-affiliate participants. Of the 1,042,195 shares transferred to participants, 481,513 are held by affiliates of the Registrant. EXHIBIT INDEX Sequentially Exhibit Numbered No. Document Pages - ------------------------------------------------------------------------------ 3.1 Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to Pro-Dex, Inc. Registration Statement No. 33-74397). 3.2 Bylaws (incorporated herein by reference to Exhibit 3.2 to Pro-Dex, Inc. Registration Statement No. 33-74397). 7.1 Pro-Dex, Inc. Form 8-K dated July 26, 1995 (incorporated herein by reference to the Company's Form 8-K dated July 26, 1995) and Financial Supplement to Form 8-K dated July 26, 1995 (incorporated herein by reference to the Company's Form 10-KSB, dated June 30, 1995, and Supplement to Form 8-K, contained therein). 7.2 Merger Agreement between Pro-Dex, Inc., Micro Systems Acquisition Corporation, and Micro Motors, Inc., dated July 26, 1995 (incorporated herein by reference to Exhibit 7.1 to the Company's Form 8-K dated July 26, 1996). 7.3 Acquisition Agreement between Pro-Dex, Inc., Oregon Micro Systems, Inc. and L. Wayne Hunter dated July 26, 1996 (incorporated herein by reference to Exhibit 7.2 to the Company's Form 8-K dated July 26, 1996). 7.4 Pro-Dex, Inc. Form 8-K dated May 11, 1996 (incorporated herein by reference to the Company's Form 8-K dated May 11, 1996). 10.1 Form of Turnkey Management Agreement between Pro-Dex, Inc. and its Contracting Dentists (incorporated herein by reference to Exhibit 10.1 to Pro-Dex, Inc. Registration Statement No. 33-35790). 10.2 Lease Agreement dated December 1, 1984 between Sears Roebuck and Co. and Pro-Dex, Inc. (Sun Valley) and amendment thereto dated as of November 9, 1987 (incorporated herein by reference to Exhibits 10.8 and 10.29 to Pro-Dex, Inc. Registration Statement No. 33-35790). 10.2(a) Agreement to Extend Lease Agreement (Exhibit 10.2 Sun Valley) dated May 5, 1994. 10.3 Leaseback Agreement dated December 19, 1985 between Pro-Dex, Inc. and Fowler/Searl Partnership (incorporated herein by reference to Exhibit 10.13 to Pro-Dex, Inc. Registration Statement No. 33-6623). 10.4 Lease Agreement dated November 24, 1986 between Sears Roebuck and Co. and Pro-Dex, Inc. (Santa Rosa) and amendment thereto dated as of January 7, 1988 (incorporated herein by reference to Exhibits 10.16 and 10.28 to Pro-Dex, Inc. Registration Statement No. 33-35790). 10.4(a) Agreement to Extend Lease Agreement (Exhibit 10.4 Santa Rosa) dated May 4, 1994. 10.5 Pro-Dex, Inc. 1988 Stock Option Plan (incorporated herein by reference to Exhibit 10.23 to Pro-Dex, Inc. Form 10-K for the year ended June 30, 1988 File No. 0-14942). 10.6 Lease Agreement dated March 2, 1988 between Sears Roebuck and Co. and Pro-Dex, Inc. (Sunrise Mall), and extension/ amendment dated May 2, 1991 (incorporated herein by reference to Exhibits 10.25 and 10.25(a) to Pro-Dex, Inc. Registration Statement No. 33-35790). 10.6(a) Agreement to Extend Lease Agreement (Exhibit 10.6 Sunrise Mall) dated July 6, 1994. 10.7 Lease Agreement dated March 2, 1988 between Sears Roebuck and Co. and Pro-Dex, Inc. (Florin Mall) and extension/ amendment dated May 2, 1991 (incorporated herein by reference to Exhibits 10.26 and 10.26(a) to Pro-Dex, Inc. Registration Statement No. 33-35790). 10.7(a) Agreement to Extend Lease Agreement (Exhibit 10.6 Florin Mall) dated July 6, 1994. 10.8 Lease Agreement effective as of December 1, 1988 between Sears Roebuck and Co. and Pro-Dex, Inc. (Arden Fair) and amendment thereto effective as of April 1, 1989 (incorporated herein by reference to Exhibits 10.32 and 10.33 to Pro-Dex, Inc. Registration Statement No. 33-35790). 10.9 Employment Agreement between Pro-Dex, Inc. and M. Larry Kyle, D.D.S. dated June 28, 1990 (incorporated herein by reference to Exhibit 10.34 to Pro-Dex, Inc. Registration Statement No. 33-35790). 10.13 Lease Agreement between Equity Colorado Phase II and Biotrol International, Inc. dated August 1991 (incorporated herein by reference to Exhibit 10.40 to Pro-Dex, Inc. Registration Statement No. 33-35790). 10.13(a) First Amendment to Lease (Exhibit 10.13) dated January 31, 1994. 10.14 Loan Agreement between Biotrol International, Inc. and A-T Realty Co. dated May 29, 1991 (incorporated herein by reference to Exhibit 10.43 to Pro-Dex, Inc. Registration Statement No. 33-35790). 10.15 Employment Agreement dated effective August 1, 1993 between Challenge Products, Inc. and Charles L. Bull (incorporated herein by reference to Exhibit 10.15 to Pro-Dex, Inc. Registration Statement No. 33-74397). 10.16 Prophy Ring Patent License Agreement dated and effective July 1, 1993 between Challenge Products, Inc. and Charles L. Bull (incorporated herein by reference to Exhibit 10.17 to Pro-Dex, Inc. Registration Statement No. 33-74397). 10.17 1994 Stock Option Plan (incorporated herein by reference to Exhibit 10.21 to Pro-Dex, Inc. Registration Statement No. 33-74397). 10.18 Director's Stock Option Plan (incorporated herein by reference to Exhibit 10.22 to Pro-Dex, Inc. Registration Statement No. 33-74397). 10.19 Lease Agreement dated December 29, 1993 between Fuoti Insurance Agency, Inc. & James C. & Susan E. Fuoti and Pro-Dex, Inc. & M. Larry Kyle, DDS. (Incorporated herein by reference to the Exhibit 10.23 to the Company's Form 10-KSB dated June 30, 1994). 10.20 Consulting Agreement and Non-Competition Agreement, between Pro-Dex, Inc. and L. Wayne Hunter, dated July 26, 1995 (incorporated herein by reference to Exhibit 10.1 to the Company's Form 8-K dated July 26, 1996). 10.21 Employment Agreement between Ronald G. Coss and Pro-Dex, Inc., dated July 26, 1995 (incorporated herein by reference to Exhibit 10.2 to the Company's Form 8-K dated July 26, 1996). 10.22 Agreement to Terminate Long Term Employment Agreement between Micro Motors, Inc. and Ronald G. Coss dated July 26, 1995 (incorporated herein by reference to Exhibit 10.3 to the Company's Form 8-K dated July 26, 1996). 10.23 Asset Purchase Agreement between Pro-Dex, Inc., Pnu-Light Acquisition Corporation, and Marty J. Anderson, dated May 11, 1996. 10.24 Letter Agreement, regarding rescission of Royalty Agreement between Pro-Dex, Inc., Challenge Products, Inc. and Charles Bull dated June 1996, together with Assignment of Patent. 10.25 Employee Stock Purchase Plan In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: June 30, 1999 /s/ Kent E. Searl ___________________________________ Kent E. Searl, Chairman Date: June 30, 1999 /s/ George J. Isaac ___________________________________ George J. Isaac, Chief Financial Officer EX-10.25 2 PRO-DEX, INC. AND SUBSIDIARIES EMPLOYEE STOCK PURCHASE PLAN 1401 Walnut Street, Suite 540 Boulder, CO 80302 (303) 443-6136 200,000 SHARES/NO PAR VALUE ARTICLE ONE - PURPOSE AND DEFINITIONS Section 1.1 Purpose. The purpose of this Employee Stock Purchase Plan is to encourage eligible employees of Pro-Dex, Inc. and its Subsidiaries to acquire ownership of Pro-Dex, Inc. Common Stock thereby affording them the opportunity to share in the economic growth and success of the Company by the purchase the Company's Common Stock through payroll deductions. Section 1.2 Definitions. Whenever used in the Plan, unless the context clearly indicates otherwise, the following terms shall have the following meanings: a. "Beneficiary", with respect to a Participant, means the beneficiary designated by the Participant under the health, dental, and life insurance plan maintained by the Company or such other beneficiary as may be designated by a Participant for purposes of this Plan. b. " Board of Directors" means the Board of Directors of Pro-Dex, Inc. c. "Code" means the Internal Revenue Code of 1986, as amended, and references thereto shall include the valid Treasury regulations issued thereunder. d. "Committee" means the Company Stock Purchase Plan Committee appointed by the Board of Directors of Pro-Dex, Inc. and charged with the administration of the Plan. e. "Common Stock" means shares of the no par value Common Stock of the Company and any other stock or securities resulting from the adjustment thereof or substitution therefor as described in Section 3.4. f. "Company" means Pro-Dex, Inc., or any successor by merger, purchase or otherwise . g. "Compensation" means the all cash compensation received by an employee for services. h. "Effective Date" means 1 July 1998. i. "Employee" means any person who receives regular compensation from the Company or a Subsidiary thereof for services rendered as an employee and does not include any person who is receiving compensation from the Company or a Subsidiary thereof in the form of any type of a pension, severance, retainer, or fee under contract. j. "Exercise Date" means the date on which the employee completes the payment requirement and is entitled to delivery of the shares so purchased. k. "Fair Market Value", with respect to a share of Common Stock, means the last reported sale price for the Common Stock on NASDAQ, or the closing price for the Common Stock if the same is listed on any other national securities exchange on the applicable date during an Offering Period or, if there are no sales on said date, then on the next preceding date on which there were sales of the Company's Common Stock l. "Offering" means the offering of shares of Common Stock to Participants pursuant to this Plan. m. "Offering Date" means the 1st day of July and January of each year commencing with 1 July 1998; provided, however, that in the discretion of the Committee, an additional or substitute offering date may be selected, which may result in no offering date in any particular year. If any such date shall fall other than on a business day, the Offering Date shall be the next succeeding business day. n. "Offering Period" means the period from an Offering Date until the immediately succeeding Offering Date, unless otherwise determined by the Committee. o. "Option" means the right of an employee to purchase Common Stock under the Plan. p. "Participant" means an Employee (other than excluded persons pursuant to Section 2.2) who has elected to participate in the Plan. q. "Plan" means the Pro-Dex, Inc. Employee Stock Purchase Plan, an "employee stock purchase plan" within the meaning of Section 423(b) of the Code, together with any and all amendments thereto. r. "Stock Purchase Account", with respect to a Participant, means the account established on the books and records of the Company or a Subsidiary thereof for such Participant representing the payroll deductions credited to such account in accordance with the provisions of the Plan. s. "Subsidiary" means any corporation, fifty (50%) or more of the total combined voting power of all classes of stock of which is beneficially owned, directly or indirectly, by the Company. ARTICLE TWO - PARTICIPATION Section 2.1 Participation Requirements. a. Commencement of Participation. Subject to Section 2.2 and Section 3.2(b), each person who is an Employee on the Effective Date may elect, pursuant to Article Four, to become a Participant in the Plan on such date. Each person who becomes an Employee after the Effective Date may become a Participant in the Plan on the Offering Date coinciding with or next following the date on which such person becomes an eligible Employee, subject to the exclusions in Section 2.2 below. b. Eligibility of Former Participants. If a person terminates employment with the Company after becoming a Participant and subsequently resumes employment with the Company, such person will again become eligible to participate on the Offering Date coinciding with or next following such resumption of employment with the Company. c. Leave of Absence. For purposes of participation in the Plan, unless otherwise determined by the Committee, a person on leave of absence shall be deemed to be an Employee for the first 90 days of such leave of absence and such Employee's employment shall be deemed to have terminated at the close of business on the 90th day of such leave of absence unless such Employee shall have returned to regular full-time or part-time employment (as the case may be) prior to the close of business on such 90th day. Termination by the Company of any Employee's leave of absence, other than termination of such leave of absence on return to full-time or part-time employment, shall terminate an Employee's employment for all purposes of the Plan and shall terminate such Employee's participation in the Plan and right to exercise any option. Section 2.2 Exclusions. Notwithstanding any provision of the Plan to the contrary, in no event shall the following persons be eligible to participate in the Plan: a. Any Employee who has been employed for less than six (6) months; b. Any Employee whose customary employment is twenty (20) hours or less per week; c. Any Employee whose customary employment is for not more than five (5) months in any calendar year; d. Any Employee who, as of the last day of an Offering Period, owns stock possessing five percent (5%) or more of the total combined voting power or value of all classes of stock of the Company or a subsidiary; provided, however, that stock owned directly, indirectly, or through attribution of stock ownership from brothers, sisters, spouses, ancestors, and lineal descendants pursuant to Code Section 424(d) or any successor thereto shall be considered for purposes of this determination; or e. Certain highly compensated employees as designated by the Committee prior to each Offering Date. ARTICLE THREE - OFFERING OF COMMON STOCK Section 3.1 Reservation of Common Stock. The Board of Directors has reserved 200,000 shares of Common Stock for the Plan, subject to adjustment in accordance with Section 3.4. Section 3.2 Offering of Common Stock. a. General. Subject to Section 3.2(b), each Participant in the Plan on an Offering Date shall be entitled to purchase shares of Common Stock on the last day of the Offering Period beginning with such Offering Date. Such purchase shall be made by having the purchase price for such shares deducted from Participant's compensation during such Offering Period pursuant to Article Four. The purchase price for such shares of Common Stock shall be determined under Section 3.3 of this Plan. b. Limitations. (1) Prior to each Offering Date, the Committee shall determine the total number of shares for which options may be granted during the Offering Period, not to exceed the total number of share reserved pursuant to Section 3.1, less shares issued or issuable upon exercise of outstanding options, (2) the Committee may, in its discretion, provide that the amount of stock that may be purchased by any employee shall bear a uniform relationship to total compensation, and (3) notwithstanding Section 3.2(a), the maximum number of shares of Common Stock a Participant may purchase within the same calendar year, under all "employee stock purchase plans" within the meaning of Section 423(b) of the Code sponsored by the Company or an Subsidiary thereof, shall be limited to that number of shares having a total fair market value (determined as of the date of each Offering) that does not exceed Twenty Five Thousand ($25,000.00) Dollars for any one calendar year during which the Plan is in effect. Section 3.3 Option Provisions. a. Determination of Purchase Price of Offered Common Stock. The purchase price per share of the shares of Common Stock offered to Participants pursuant to an Offering shall be the lower of eighty-five (85%) of the Fair Market Value of a share of Common Stock as of the first day of the Offering Period for such Offering or, eighty-five (85%) of the Fair Market Value of a share of Common Stock on the Exercise Date, however, in no event shall the purchase price be less than $2.00 per share, unless the Committee in its discretion so determines. b. Option Term. Options granted under the Plan cannot be exercised after the expiration of the Offering Period. Section 3.4 Effect of Certain Transactions. The number of shares of Common Stock reserved for the Plan pursuant to Section 3.1, the maximum number of shares of Common Stock offered pursuant to Section 3.2b, and the determination under Section 3.3 of the purchase price per share of the shares of Common Stock offered to Participants pursuant to an Offering shall be appropriately adjusted to reflect any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, a consolidation of shares, the payment of a stock dividend, or any other capital adjustment affecting the number of issued shares of Common Stock. In the event that the outstanding shares of Common Stock shall be changed into or exchanged for a different number or kind of shares of stock or other securities of the Company or another corporation, whether through reorganization, recapitalization, merger, consolidation, or otherwise, then there shall be substituted for each share of Common Stock reserved for issuance under the Plan but not yet purchased by Participants, the number and kind of shares of stock or other securities into which each outstanding share of Common Stock shall be so changed or for which each such share shall be exchanged. ARTICLE FOUR - PAYROLL DEDUCTIONS Section 4.1 Payroll Deduction Elections. Any Employee eligible to participate in the Plan may elect to have the Company deduct from the Compensation payable to such Employee during each Offering Period any amount between one percent (1%) and ten percent (10%) of such Participant's Compensation, in whole multiples of one percent (1%). Such election shall be made by delivering to the Company during the thirty day period preceding such Offering Period a written direction to make such deductions. Such election shall become effective as of the first date of such Participant's first pay period that begins on or after the first day of such Offering Period and shall remain effective for each successive pay period and for each subsequent Offering until changed or terminated pursuant to this Article Four. The percentage deduction specified by the Participation will be deducted from each payment of Compensation made to the Participant. Section 4.2 Election to Increase or Decrease Payroll Deductions. Subject to Section 4.4, a Participant who has a payroll deduction election in effect under Section 4.1 may prospectively increase or decrease during an Offering Period the percentage amount of the deductions being made by the Company from such Participant's Compensation (including a decrease to zero) by delivering to the Company written direction to make such change. Such change shall become effective as soon as practicable after the Company's receipt of such written direction and shall remain in effect until changed or terminated pursuant to this Article Four. A Participant shall be permitted to increase or decrease the percentage amount of the deductions being made from such Participant's Compensation only once during an Offering Period; provided, however, a Participant may terminate the deductions being made from such Participant's Compensation at any time during an Offering Period notwithstanding any prior change in the amount of such Participant's Compensation deductions during an Offering Period. If a Participant terminates deductions, such Participant cannot resume deductions during that Offering Period. Section 4.3 Elections During Leave of Absence. If a Participant goes on leave of absence, such Participant shall have the right to elect: a. to withdraw the balance in his or her account pursuant to Section 5.3, b. to discontinue contributions to the Plan but remain a participant in the Plan, c. to remain a Participant in the Plan during such leave of absence, authorizing deductions to be made from payments by the Company to the Participant during such leave of absence and undertaking to make cash payments to the Plan, in care of the Company, at the end of each payroll period to the extent that amounts payable by the Company to such Participant are insufficient to meet such Participant's authorized Plan deductions, or d. to remain a Participant in the Plan during such leave of absence, undertaking to make cash payments to the Plan, in care of the Company, to exercise such Participant's options. Section 4.4 Termination of Election Upon Termination of Employment. The termination of employment of a Participant for any reason shall automatically terminate the election of such Participant to have amounts deducted from such Participant's Compensation pursuant to this Article Four that is then in effect. Such termination shall be effective immediately following the pay period during which such termination of employment occurs, but shall not affect the deduction from Compensation for the pay period. Section 4.5 Form of Elections. Any written direction by any Participant with respect to any deductions from Compensation pursuant to this Article Four shall be on a form furnished by the Company for such purpose and shall be made by having such Participant complete, sign, and file such form with the Company in the manner prescribed from time to time by the Company. ARTICLE FIVE - STOCK PURCHASE ACCOUNTS AND PURCHASE OF COMMON STOCK Section 5.1 Stock Purchase Accounts. A Stock Purchase Account shall be established and maintained on the books and records of the Company for each Participant. Amounts deducted from a Participant's Compensation pursuant to Article Four shall be credited to such Participant's Stock Purchase Account. No interest or other increment shall accrue or be payable to any Participant with respect to any amounts credited to such Stock Purchase Accounts. All amounts credited to such Stock Purchase Accounts shall be withdrawn, paid, or applied toward the purchase of Common Stock pursuant to the provisions of this Article Five. Section 5.2 Purchase of Common Stock. a. General. As of the last day of each Offering Period, the amount to the credit of a Participant in such Participant's Stock Purchase Account shall be used to purchase from the Company on such Participant's behalf the largest number of whole shares of Common Stock that can be purchased at the price determined under Section 3.3 with the amount then credited to such Participant's Stock Purchase Account, subject to the limitations set forth in Article Three on the maximum number of shares of Common Stock such Participant may purchase. As of such date, such Participant's Stock Purchase Account shall be charged with the aggregate purchase price of the shares of Common Stock purchased on such Participant's behalf. No brokerage or other fees are to be charged upon a purchase. Stock transfer taxes, if any, shall be paid by the Company. The remaining balance, if any, credited to such Participant's Stock Purchase Account shall be carried forward and used to purchase shares of Common Stock in the next succeeding Offering Period. b. Issuance of Common Stock. The shares of Common Stock purchased for a Participant on the last day of an Offering Period shall be deemed to have been issued by the Company for all purposes as of the close of business on such date. Prior to such date, none of the rights and privileges of a shareholder of the Company shall exist with respect to such shares of Common Stock. As soon as practicable after the end of an Offering Period the Company shall issue and deliver, or shall cause its stock transfer agent to issue and deliver, a certificate for the number of shares of Common Stock purchased for a Participant, which certificate shall be issued in the Participant's name or, if so specified by the Participant, in the name of the Participant and such other person as the Participant shall designate as joint tenants with the right of survivorship. In lieu of issuing a certificate, the Company may elect to deliver to the Participant a statement which shall indicate the number of shares of Common Stock purchased for such Participant on the last day of such Offering Period and the aggregate number of shares of Common Stock held on behalf of such Participant under the Plan. c. Insufficient Common Stock Available. If, as of the last day of any Offering Period, the aggregate Stock Purchase Accounts available for the purchase of shares of Common Stock pursuant to Section 5.2a would purchase a number of shares of Common Stock in excess of the number of shares of Common Stock then available for purchase under the Plan, then (1) the number of shares of Common Stock that would otherwise be purchased for each Participant on such date shall be reduced proportionately to the extent necessary to eliminate such excess, (2) the remaining balance to the credit of each Participant in each such Participant's Stock Purchase Account shall be distributed to each Participant, and (3) the Plan shall terminate automatically upon the distribution of the remaining balance in such Stock Purchase Accounts. Section 5.3 Withdrawal From Plan Prior to Purchase of Common Stock. In the event (a) a Participant elects in writing for any reason to withdraw from the Plan during an Offering Period, (b) a Participant's employment with the Company or a Subsidiary thereof terminates due to death, retirement, or disability prior to the end of an Offering Period, or (c) a Participant's employment with the Company terminates for any reason other than death, retirement, or disability prior to the end of such an Offering Period, then the entire amount to the credit of such Participant in such Participant's Stock Purchase Account shall be distributed to such Participant (or, if such Participant is deceased, to such Participant's Beneficiary) as soon as administratively practicable after such termination of employment or withdrawal (as the case may be). ARTICLE SIX - COMMITTEE Section 6.1 Powers of the Committee. The Committee shall administer the Plan. The Committee shall have all powers necessary to enable it to carry out its duties under the Plan properly. Not in limitation of the foregoing, the Committee shall have the authority and complete discretion to construe and interpret the Plan and to determine all questions that shall arise thereunder. The decision of the Committee upon all matters within the scope of its authority shall be final and conclusive on all persons. Section 6.2 Indemnification of the Committee. The Company agrees to indemnify and hold harmless the members of the Committee against any liabilities, loss, costs, or damage that they may incur in acting as such members and to assume the defense of any and all allocations, suits, or proceedings against the members of the Committee, to the extent permitted by applicable law. ARTICLE SEVEN - AMENDMENT AND TERMINATION Section 7.1 Amendment of Plan. The Company expressly reserves the right, at any time and from time to time, to amend in whole or in part any of the terms and provisions of the Plan; provided, however, no amendment may, without the approval of the shareholders of the Company, (a) increase the number of shares of Common Stock reserved under the Plan, (b) change the method of determining the purchase price for shares of Common Stock, (c) materially increase the benefits accruing to Participants, or (d) materially change the eligibility requirement for participation in the Plan. Section 7.2 Termination/Suspension of the Plan. The Company expressly reserves the right, at any time and for whatever reason it may deem appropriate, to terminate or suspend the Plan. If not sooner terminated (a) pursuant to the preceding sentence, or (b) pursuant to Section 5.2c, the Plan shall continue in effect through 30 June 2002. Upon any termination of the Plan, the entire amount credited to the Stock Purchase Account of each Participant shall be distributed to each such Participant. Section 7.3 Procedure for Amendment, Termination or Suspension. Any amendment to the Plan or termination/suspension of the Plan may be retroactive to the extent not prohibited by applicable law. Any amendment to the Plan or termination/suspension of the Plan shall be made by the Company by resolution of the Committee or the Board of Directors (subject to Section 7.1) and shall not require the approval or consent of any Participant or Beneficiary in order to be effective. ARTICLE EIGHT - MISCELLANEOUS Section 8.1 Adoption by a Subsidiary. A Subsidiary may, with the approval of the Board of Directors and the board of directors of such Subsidiary, elect to adopt the Plan as of a date mutually agreeable to the Board of Directors and the board of directors of such Subsidiary. Any such adoption of the Plan by a Subsidiary shall be evidenced by an appropriate instrument of adoption executed by such Subsidiary. Section 8.2 Authorization and Delegation to the Board of Directors. Each Subsidiary which is or hereafter adopts the Plan authorizes and empowers the Board of Directors (a) to amend or terminate/suspend the Plan without further action by said Subsidiary as provided in Article Seven and (b) to perform such other acts and to do such other things as the Board of Directors is expressly directed, authorized, or permitted to perform or do as provided herein. Section 8.3 Transferability of Rights. Rights under the Plan are not transferable by a Participant other than by will or the laws of descent and distribution and are exercisable during a Participant's lifetime only by the Participant. Section 8.4 No Employment Rights. Participation in the Plan shall not give any employee of the Company or any Subsidiary any right to remain employed or, upon termination of employment, any right or interest in the Plan, except as expressly provided herein. Section 8.5 Compliance with Law. No shares of Common Stock shall be issued under the Plan prior to compliance by the Company to the satisfaction of its special securities counsel with any applicable law. Section 8.6 Effectiveness and Approval of Plan. This Plan shall become effective on 1 July 1998, provided it is approved and ratified by the shareholders of the Company. In the event that the Plan is not so approved, all amounts deducted from the Compensation of Participants and credited to each Participant's Stock Purchase Account shall be refunded to each such Participant without interest as soon as administratively practicable. Section 8.7 Construction. Article, Section and paragraph headings have been inserted in the Plan for convenience of reference only and are to be ignored in any construction of the provisions hereof. If any provisions of the Plan shall be invalid or unenforceable, the remaining provisions shall nevertheless be valid, enforceable, and fully effective. It is the intent that the Plan shall at all times constitute an "employee stock purchase plan" within the meaning of Section 423(b) of the Code, and the Plan shall be construed, administered, regulated, and governed by the laws of the United States to the extent applicable, and to the extent such laws are not applicable, by the laws of the State of Colorado. Section 8.8 Administration. The Secretary of the Company shall maintain a copy of the Plan, and any amendments thereto. By:_______________________________ By:____________________________ Kent E. Searl, Acting PresidentGeorge J. Isaac, Secretary EX-27 3
5 12-MOS JUN-30-1999 JUN-30-1999 107,038 0 3,196,654 39,522 4,699,467 9,311,250 6,052,775 2,942,057 17,697,842 13,328,465 0 0 282,990 14,782,694 (95,600) 17,697,842 18,342,049 18,342,049 9,761,424 0 18,834,460 0 1,032,117 (11,224,812) (2,291,919) (8,932,893) 0 0 0 (8,932,893) (1.02) (1.02)
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