COMPANY OVERVIEW

The following discussion and analysis provides information that the Company's management believes is relevant to an assessment and understanding of our results of operations and financial condition for each of the three month periods ended September 30, 2008 and 2007. 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 included herein should be read as being applicable to all related forward-looking statements wherever they may appear. Our actual future results could differ materially from those discussed herein. Our critical accounting policies relate to inventory valuation for slow moving items, impairment of goodwill, warranty reserves, and recoverability of deferred income taxes.

Except for the historical information contained herein, the matters discussed in this Quarterly Report on Form 10-Q, including discussions of our product development plans, business strategies and market factors influencing our results, are forward-looking statements that involve certain risks and uncertainties. Actual results may differ from those anticipated by us as a result of various factors, both foreseen and unforeseen, including, but not limited to, our ability to continue to develop new products and increase systems sales in markets characterized by rapid technological evolution, consolidation within our target marketplace and among our competitors, and competition from larger, better capitalized competitors. Many other economic, competitive, governmental and technological factors could impact our ability to achieve our goals. Interested persons are urged to review the risks described herein, as well as in our other public disclosures and filings with the Securities and Exchange Commission. We refer you to the risk factors and cautionary language contained in our reports filed with the Securities and Exchange Commission from time to time, including, but not limited to, those risks and uncertainties which may be listed in our Annual Report on Form 10-K or 10-KSB.

Pro-Dex, Inc. ("Company," "Pro-Dex", "we," "our,", "us"), with operations in Irvine, California, Beaverton, Oregon and Carson City, Nevada, provides a pathway to product solutions never envisioned by customers. A unique blend of creativity and systemic discipline enables us to develop and manufacture innovative designs that powerfully complete a customer's strategic product offering. Pro-Dex leverages extraordinary human collaboration and superior technical capability to power and control products used in medical, aerospace, military, research and industrial applications requiring high precision in harsh environments. With expertise in multi-axis motion control, fractional horsepower motors and rotary drive systems, we identify and create unexpected value for our customers.

Pro-Dex's products are found in hospitals, dental offices, medical engineering labs, commercial and military aircraft, scientific research facilities and high tech manufacturing operations around the world. The names of Micro Motors, Oregon Micro Systems, and Astromec are used for marketing purposes as brand names.

Pro-Dex's principal headquarters changed April 28, 2008 and we are located at 2361 McGaw Avenue, Irvine, California 92614 and our phone number also changed to 949-769-3200. Our Internet address is www.pro-dex.com . Our annual reports on Form 10-KSB, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and other SEC filings, are available free of charge through our website as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. In addition, our Code of Ethics and other corporate governance documents may be found on our website at the Internet address set forth above. Our filings with the SEC may also be read and copied at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov .

Description of Business

The majority of our revenue is derived from designing, developing and manufacturing rotary drive systems for the medical device and dental industries, motion control software and hardware for industrial and scientific applications and fractional horsepower DC motors for aerospace, medical and military applications. A large part of the revenue of the Company has been driven by developing and selling numerous types of private label rotary drive systems for use in dental procedures, as well as cranial, spinal, arthroscopic and orthopedic surgery. The Company distributes its own line of pneumatic and electric dental hand pieces sold under the Micro Motors name utilizing a network of independent sales representatives across North America. Other revenue sources include designing and manufacturing miniature pneumatic motors, fractional horsepower DC motors and motion control systems for industrial applications in the automotive, aerospace, and apparel industries.

Company-funded research and development supports the development of generic rotary drive, motion control, and electric motor technology platforms. Company-funded research and development projects are generally expected to convert to customer-funded projects within six to eighteen months. Company funded project costs not associated with signed contracts or purchase orders are expensed as incurred.

In the three months ended September 30, 2008, $731,000 was expensed for company-funded research and development; an increase of $156,000 from the $575,000 expensed in the three months ended September 30, 2007. The increase was attributable to increased labor costs for medical and small motor product development, improvement and validation.

We seek customer-funded projects to customize these platforms to specific customer requirements. For customer-funded development projects, costs are capitalized and recognized as a cost of sales when specific deliverables within the development contracts are earned, matching the costs to the revenue.

               Customer-funded      Three Months Ended September 30,
             development ($'000)         2008                2007
             Revenue              $     132            $    92
             Cost of Sales               57                 31
             Gross margin         $      75      57%   $    61      66%

Customer-funded research and development fees increased in the quarter ended September 30, 2008 due to work being completed on projects signed in the preceding 12 months. The results of customer-funded development work are intended to provide long-term exclusive manufacturing agreements and may provide the customer with the retention of the intellectual property developed. The identity of our customers is generally protected by a non-disclosure agreement.

The Company's revenue is derived from five main customer types. The proportion of total sales to each customer type and sales by location are noted in the tables below (unaudited):

                                         Three months Ended September 30,
        Sales by customer type ($'000)        2008               2007
        Dental                          $     731     13%   $     963   16%
        Medical                             2,676     47%       2,918   49%
        Industrial                            944     17%       1,001   17%
        Aerospace                             765     14%         563    9%
        Government, repairs and other         540     10%         547    9%
        Total Sales                     $   5,656    100%   $   5,992  100%

Medical product sales represent the manufacture of products that utilize proprietary designs developed by us under exclusive design and supply agreements. Our dental products are primarily sold to original equipment manufacturers and dental product distributors. An independent dealer network markets our own branded line of dental products; including the IntraflowTMdental anesthesia product. We also design and manufacture embedded multi-axis motion controllers used to regulate the motion of servo and stepper motors, predominantly for the factory automation, scientific research, and medical analysis equipment industries. The controllers support the platforms for PCI, VME, ISA, and cPCI busses as well as stand-alone requirements. In addition, we make and sell pneumatic motors for industrial applications that are marketed directly to end-users and through industrial supply distributors. The Carson City products include high reliability fractional horsepower DC motors designed for harsh environments, primarily for the aerospace and medical markets.

We hold the following three independently verified certifications: ISO 9001:2000, ISO 13485 revised 1998, and Medical Device Directive 93\42\EEC Annex II company.

At the present time, we are generally able to fill orders within sixty (60) days. At September 30, 2008, we had a backlog, including orders for delivery beyond 60 days, of $8.0 million compared with a backlog of $9.4 million at September 30, 2007 and $10.4 million at June 30, 2008. We expect to ship most of our backlog in fiscal year 2009 and the remainder in fiscal year 2010. The decreased backlog compared to September 2007 and June 2008 is due to normal fluctuations in the timing of receipt and shipment of orders. We do not typically experience seasonal fluctuations in our new order bookings, but may experience variability in our new order bookings due to the timing of major new product launches. Similarly, we do not typically experience seasonal fluctuations in our shipments and revenues.

RESULTS OF OPERATIONS

For the Three-Month periods ended September 30, 2008 and 2007

The following table sets forth the periods indicated and the percentage of net revenues represented by each item in our Consolidated Statements of Operations.

  (In Thousands)                                 Three Months Ended September 30,
                                                      2008               2007
  Net sales:                                    $   5,656    100%   $   5,992  100%
  Cost of sales                                     3,902     69%       3,839   64%
  Gross Profit                                      1,754     31%       2,153   36%

  Selling, general and administrative expenses      1,179     21%       1,058   18%
  Research and development costs                      731     13%         575   10%
  Income from Operations                             (156)    -3%         520    9%

  Net interest and other expense                       59      1%          35    1%

  Earnings before provision for income taxes         (215)    -4%         485    8%

  Provision for income taxes                          (97)    -2%         159    3%
  Net income                                    $    (118)    -2%   $     326    5%

Net Sales. Consolidated sales decreased from $5,992,000 to $5,656,000 ($336,000 or 6%) for the quarter ended September 30, 2008 compared to the quarter ended September 30, 2007. The decrease was due to a reduced volume of a single medical customer, offsetting increases in revenues to the aerospace customers.

Although selective price increases and decreases were implemented in response to market conditions, the majority of the sales changes for each product line are due primarily to changes in sales volume, not the effect of price changes.

Gross Profit and Gross Profit Percentage of Sales. Our consolidated gross profit for the quarter ended September 30, 2008 decreased $399,000 or 19% over the same quarter in the previous year due to the lower level of sales and a less favorable sales mix. Gross profit as a percentage of sales decreased to 31% for the quarter ended September 30, 2008 compared to 36% for the quarter ended September 30, 2007. Gross profit margins were reduced approximately 5 margin points also due to a less favorable sales mix. Gross profit and gross profit as a percentage of sales were as follows:

                                      Three Months Ended September 30,
                                           2008               2007        Decrease
   Gross Profit                      $      1,754,000   $      2,153,000     -19%
   Gross Profit Percentage of Sales               31%                36%

Selling, General and Administrative Costs (S, G&A). Consolidated S, G & A expenses increased to $1,180,000 for the quarter ended September 30, 2008 from $1,058,000 for the quarter ended September 30, 2007. The increase in selling expense is mainly due to higher labor and labor related costs ($14,000) and higher advertising costs ($10,000). The increase in G & A costs was due to higher labor costs ($50,000) and costs associated with Sarbanes Oxley compliance ($61,000). As a percentage of sales, S, G&A expenses increased to 21% of sales from 18% of sales for the quarters ended September 30, 2008 and 2007, respectively. S, G&A costs were as follows:

                                   Three Months Ended September 30,
                                        2008               2007        Increase
      Selling                     $        344,000   $        323,000       7%
      General and administrative  $        836,000   $        735,000      14%
      Total S, G&A                $      1,180,000   $      1,058,000      12%
      S, G&A Percentage of Sales               21%                18%

Research and Development (R&D) Costs. Company-funded research and development expenses increased $156,000 to $731,000 for the quarter ended September 30, 2008 from $575,000 for the quarter ended September 30, 2007, an increase of 27%. The increase was due to approximately $125,000 in higher labor and related costs and $22,000 in independent research project costs associated with engineers working on company-funded projects. As a percentage of sales, company-funded research & development expenses increased to 13% of sales from 10% of sales for the quarters ended September 30, 2008 and 2007, respectively. Company-funded research and development costs were as follows:

                                     Three Months Ended September 30,
                                          2008               2007        Increase
    Research and Development costs  $        731,000   $        575,000      27%
    R & D Percentage of Sales                    13%                10%

Operating Profit (loss) and Operating Profit (loss) Percentage of Sales. Our consolidated operating loss for the quarter ended September 30, 2008 was ($156,000) compared to an operating profit of $520,000 for the same quarter in the previous year. The decrease in operating profit was due to a lower gross profit caused by lower sales as previously described,, higher R&D costs and higher S,G&A. Consequently, operating loss as a percentage of sales was -3% for the quarter ended September 30, 2008 compared to a 9% profit for the quarter ended September 30, 2007. Operating profit and margin were as follows:

                                       Three Months Ended September 30,     Increase
                                            2008               2007        (Decrease)
Operating Profit                      $        (156,000)  $       520,000      -130%
Operating Profit Percentage of Sales                -3%                9%

Royalties and Other Income. We received $1,600 in royalty income in the three months ended September 30, 2008 compared to $5,800 in the same period during the prior year.

Net Interest Expense. Net interest expense for the quarter ended September 30, 2008 was $61,000 compared to $43,000 in the quarter ended September, 2007, due to the higher debt levels through the quarter ended September 30, 2008.

Income Tax (Benefit) Provision. Our estimated effective combined federal and state tax rate on income from operations for the quarter ended September 30, 2008 resulted in a 45% credit of earnings before tax compared to a 33% provision of earnings before tax for the quarter ended September 30, 2007. The 2008 rate is reduced by a recalculation of the FIN 48 estimated tax and interest liability and the 2007 rate is reduced due to the use of estimated R&D state tax credits.

Net (Loss) Income. Our net (loss) income for the three months ended September 30, 2008 was ($118,000) or ($0.01) per share on a basic and diluted basis, as compared to a net income of $326,000 or $0.03 per share on a basic and diluted basis for the three months ended September 30, 2007.

Liquidity and Capital Resources



The following table presents selected financial information as of the end of
quarters ended September 30, 2008 and 2007 as well as of the year ended June 30,
2008:


                                                As of September 30,         As of
                                                 2008         2007      June 30, 2008
Cash and cash equivalents                    $   384,000  $   781,000   $     517,000
Working Capitalı                             $ 4,544,000  $ 6,621,000   $   4,586,000
Credit Line outstanding balance              $ 2,600,000  $         0   $   2,000,000
Tangible book value/common share²            $      0.92  $      0.91   $        0.93
Number of days of sales outstanding (DSO) in
accounts receivable at end of quarter³                51           45              48

1 Working Capital = Ending Current Assets less Ending Current Liabilities.

2 Tangible book value/common share = (Total shareholders' equity - Net intangible asset (patents) - Goodwill) / (basic outstanding shares).

3 DSO = Ending Net Accounts Receivable balance / (Previous Quarter Sales / 91).

Our working capital at September 30, 2008 decreased to $4.5 million compared to $6.6 million at September 30, 2007 and $4.6 million at June 30, 2008. Cash flow used by operations was $458,000 in the three months ended September 30, 2008 compared to a cash flow provided by operations of $1,092,000 for the three months ended September 30, 2007. The decrease in working capital and reduction in operating cash flow was due to an increase in A/R, a reduction in payables and accrued expenses within our normal payment processing cycle.

On November 1, 2007, our existing credit facility with Wells Fargo was replaced with an expanded facility with a total borrowing capacity of $6,562,500. Included in the increase is an increase in the credit line borrowing availability from $2,000,000 to $4,000,000. The credit line's terms require monthly interest payments at the prime rate of interest (5.00% at September 30, 2008); or LIBOR (4.0% at September 30, 2008) plus 1.75%, at our discretion, based on outstanding borrowings. The total effective interest rate at September 30, 2008 for borrowings on the credit line was 5.0%. The credit facility expires on November 1, 2009. In addition to the credit line, a term commitment is available for borrowings for amounts up to $2,000,000. We can take advances against this commitment through November 1, 2008, at which time the outstanding borrowings against this commitment will be converted to a term loan, to be amortized and repaid over 60 months. The term commitment's terms require monthly interest payments at the prime rate of interest; or LIBOR plus 2.0%, at our discretion, based on outstanding borrowings. The borrowings from this term commitment were used for construction financing of tenant improvements for our Irvine, California facility. The term loan that was entered into in January 2006 to finance the Astromec purchase remains in place. As of September 30, 2008, there was a principal balance on this term loan of $333,333 which is required to be fully paid-off in January 2010, in accordance with its amortization schedule. The term loan's terms require monthly interest payments at the prime rate of interest; or LIBOR plus 2.5%, at our discretion, based on outstanding borrowings, with no minimum interest charge. The total effective interest rate at September 30, 2008 for borrowings on the term loan was 5.0%. All assets of the Company except our Carson City land and building secure the outstanding borrowings from Wells Fargo. There was $2,600,000 borrowed under the credit line and nothing borrowed against term commitment facility as of September 30, 2008. The total eligible additional borrowing capacity at September 30, 2008 was $3,400,000.

At September 30, 2008, we had cash and cash equivalents of $384,000. We believe that our cash and cash equivalents on hand, together with cash flows from operations, if any, and amounts available under the credit facilities will be sufficient to meet our working capital and capital expenditure requirements for this and the next year.

In September 2002, our Board of Directors authorized the repurchase on the open market of up to 500,000 shares of our outstanding Common Stock at a share price no greater than $1.25, subject to compliance with applicable laws and regulations. There is no requirement that we repurchase all or any portion of such shares. The maximum total value of the repurchase is not to exceed $500,000. From the inception of the repurchase authorization through the fiscal year-end date of June 30, 2003, we repurchased 75,700 shares of Common Stock for $43,741, at an average price of $0.58 per share. No additional shares were repurchased in fiscal years 2004 through 2008. We started repurchasing shares again in the first quarter of fiscal year 2009. During the quarter, we repurchased 64,929 shares of common stock for $58,924, at an average price of $.91 per share. Since the initiation of the buyback in 2002 through September 30, 2008, we have repurchased 140,299 shares for $102,665 at an average price of $0.73 per share.