The following discussion and analysis provides information that management believes is relevant to an assessment and understanding of the Company's results of operations and financial condition for each of the two years ended June 30, 2009 and 2008, respectively. 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.

Critical Accounting Estimates and Judgments

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. The significant accounting policies that are believed to be the most critical to fully understanding and evaluating the reported financial results include revenue recognition, warranty reserve, inventory valuations for slow moving items, impairment of goodwill, and the recovery of deferred income tax assets.

We recognize sales and associated cost of sales, upon shipment, FOB origin. There have been minimal returns for credit, so no reserve for product returns has been established.

We determine our inventory value at the lower of cost (first-in, first-out method) or market value. We determine a reduced market value of our inventory based on the age of inventory on hand. We define "aging of inventory" as inventory that exceeds an estimated 12 months of usage and exceeds orders on hand.

We determine the reserve for our accounts receivable by examining the aging of the receivables. We define "aging of receivables" as time passed since the sale was completed, revenue was recognized and the receivable was established. If the receivable is aged over 90 days old, or has a known collection risk, it is reserved from 10% of its value up to 100%. The actual amount reserved may vary depending on account credit and collection history.

The warranty accrual is determined by reviewing the return rates and warranty repair costs for warranty-eligible products. We accrue an amount of expected repair cost based on these factors projected for the remaining applicable warranty period. If actual return rates or repair costs differ from our estimates, warranty expense could vary from the projected accrual. The repair return rates and cost assumptions are reviewed quarterly. The potential return amount is based on historical return and repair cost data. At June 30, 2009 we had $518,000 in accrued warranty reserves, as compared to $861,000 in accrued warranty reserves at June 30, 2008. The decrease is due to lower shipment levels in the warranty-eligible product line in 2009 as compared to 2008, coupled with lower assumed return rates and lower assumed costs to repair returned product.

In accordance with Statement of Financial Accounting Standards ("SFAS"), SFAS No. 144, "Accounting for the Impairment or Disposal for Long-Lived Assets" ("SFAS 144") long-lived assets and intangible assets with definite lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment indicators include, among other conditions, cash flow deficits, historic or anticipated declines in revenue or operating profit and adverse legal or regulatory developments. If it is determined that such indicators are present and the review indicates that the assets will not be fully recoverable, based on undiscounted estimated cash flow over the remaining amortization periods, their carrying values are reduced to estimated fair market value. Estimated fair market value is determined primarily using the anticipated cash flow discounted at a rate commensurate with the risk involved. For the purposes of identifying and measuring impairment, long-lived assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flow are largely independent of the cash flow of other assets and liabilities." The triggering event is explained in further detail in note 10 of the Notes to the Financial Statements. Our standard annual impairment testing is done April 1 of each year.

We monitor current market conditions and review for potential triggering events quarterly to determine if there is a need for interim impairment testing. We did not determine that a triggering event for the Astromec and Micro Motors goodwill occurred in the past 12 months. We did however; determine that a triggering event occurred with the patent intangible asset.

In determining if a triggering event has occurred, we consider not only expectations for growth in the entire US economy, but also expectations for regional growth specific to our sales markets and specific to our industry and product lines. While our operating units are influenced by changes in the general economic outlook of the United States, they are most heavily influenced by changes specific to the medical device industry. Furthermore, the magnitude of economic changes within the industry is viewed alongside the outlooks and forecasts specific to the reporting units to obtain a better sense of the likelihood that goodwill may be impaired. Declines within the industry's outlook are reflected in the unit's revenue projections.

We identify two reporting units for purposes of our annual goodwill impairment testing arising from its acquisitions of Micro Motors and Astromec. In accordance with SFAS No. 142, goodwill is not amortized and is assessed annually for impairment (as of April 1) or whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Our Carson City reporting unit corresponds to the operations resulting from the Astromec acquisition, while our Irvine reporting unit corresponds to the operations resulting from the Micro Motors acquisition. Our intangible asset is related to the interosseous patents associated with the "Intraflow" acquisition.

Goodwill and Intangible assets are tested for impairment using a discounted cash flow analysis. The discounted cash flow analysis relies upon estimates of the entity's future revenue and expenses to ultimately project the future cash flows resulting from the business activity of each entity. The projected future cash flows are discounted to present value at an appropriate discount rate. An appropriate discount rate is reached by calculating the weighted average cost of capital "WACC," which is determined by the assumptions underlying the Capital Asset Pricing Model "CAPM" and is considered to reflect the view of "Market Participants," as required under SFAS 157. The inputs used in calculating the WACC are described below.

a. The assumed capital structure is based upon the Company's actual capital structure and debt to equity ratio at the time of analysis.

b. The cost of debt is based on the Company's actual contracted rates.

c. The cost of equity is equal to the risk free rate represented by the 10 year Treasury note, plus the Company's historical correlation to market movement "beta" times the historical equity risk premium, plus an additional small stock premium.

d. In valuing the Company's patents, an additional risk premium is added to reflect the increased risk inherent in intangible assets.

e. Also in valuing the patents, an expected value calculation was performed that weighted the values of different scenarios based on their expected probability of occurrence.

We performed separate calculations to determine the sensitivity of our intangible asset impairment conclusions to increases in the assumed discount rates. In the case of Astromec, the goodwill impairment test is not failed until the discount rate is increased to 33 percent. In the case of Micro Motors, the goodwill impairment test is not failed until the discount rate is increased to 240 percent.

Additionally, the material assumptions relied upon in the discounted cash flow analysis used to value the Company's Intraflow patents are shown below.

a. The patent is valued from the perspective of "Market Participants," which are believed to possess sales and marketing expertise in the dental and medical device field. Management's financial analysis of the intangible asset was performed from the perspective of a potential acquirer and estimates what a Market Participant would be willing to pay for the asset. This methodology is consistent with FAS 157 requirements for Fair Value estimates to be estimates of the price that would be received to sell an asset, or an "Exit Price." In these scenarios, the patents' value is based on the assumed greater distribution capabilities and lower incremental costs that would be held by Market Participants.

b. The patent was also valued as a ongoing product line without any additional distribution partner or "Market Participant" value.

c. A premium for the increased riskiness of intangible assets was included in the asset's discount rate.

d. We performed separate calculations to determine the sensitivity of the asset's impairment conclusion to variances in sales growth, gross margin, and discount rate. Sales growth forecasts ranged from growth of 6 times to 12 times 2008 levels.

e. There were transaction and/or start-up costs associated with the Market Participants valuation.

The material assumptions relied upon in the discounted cash flow analysis used to value the goodwill held in the Carson City reporting unit are shown below.

a. Goodwill resulting from the Company's acquisition of Astromec is tested for impairment under its Carson City motor manufacturing operations.

b. Motor sales of existing products are assumed to decline as products age, but are more than replaced by revenue growth from new products and increased intercompany sales for medical hand piece products.

c. The existing fixed cost structure of the motor manufacturing operations will be better absorbed by the higher forecasted volume of production, resulting in increased profit margins.

d. In addition to the value of the goodwill held in the Carson City reporting unit as if it stands alone, an additional analysis is performed to estimate a value to Pro-Dex of having an in-house motor manufacturer for the medical device product line. This captive capability enables development speed and focus, which produces revenue in other operating units.

e. The value of the Carson City manufacturing operation is added to the value of the additional capability provided to Pro-Dex for the total value of the goodwill.

The material assumptions relied upon in the discounted cash flow analysis used to value the goodwill held in the Micro Motors reporting unit are shown below.

a. Goodwill resulting from the Company's acquisition of Micro Motors is tested for impairment under its Irvine reporting unit, which houses the operations resulting from the base technology acquired from Micro Motors.

b. Sales to existing customers are assumed to decline, but are more than replaced by revenue growth from new customers.

The existing fixed cost structure of the Irvine operations will be better absorbed by the higher forecasted volume of medical products, resulting in increased profit margins.

Given the company's lack of a direct dental distribution channel, it has stopped actively promoting the product based on the intangible asset resulting from the purchase of certain assets from IntraVantage, Inc. in October 2005. Any substantial future value therefore stems from the possibility that a company with a direct dental distribution channel (a "Market Participant") might be interested in access to the technology through product purchases, licenses, acquisition, joint venture, or other means. Given the current economic environment, the general lack of investment in new products, the limited number of Market Participants to whom this technology relates, the time and expense necessary to consummate a transaction, and other factors considered by management, there is also a significant possibility that no distribution partner will be found, resulting in effectively no value of the asset. Given this change in circumstance, in accordance with FAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets," management tested the carrying amount of the intangible asset for recoverability as of March 31, 2009. The result of management's analysis based on several scenarios (with varying probability of occurring) was that the asset's expected value at that date was $150,000 and, accordingly a charge of $997,280 was taken in the fiscal 2009 third quarter. The asset continued to amortize its remaining value over the remaining patent's life. As to June 30, 2009, the patent's intangible carrying value was $147,000. Management remains committed to optimizing the value of this technology for our shareholders, and will continue to pursue any opportunity to accomplish that end.

For the Astromec reporting unit's impairment testing there was an assumption of decreased external sales growth compared to 2008, which was more than offset by an increased sales growth rate of motors for internal (Pro-Dex) use. In addition to the value of the reporting unit as an internal supplier and stand alone business, the unit has additional strategic value by enabling Pro-Dex to gain additional customers under other reporting units that is considered in the valuation. It should be noted that the unit passes its goodwill impairment test without the inclusion of this additional "enablement" value.

For the Micro Motors reporting unit's impairment testing, there was an assumption of a slower than historical sales growth rate than in the previous valuation. The total 5 year growth rate in the 2008 valuation was equal to the historical 5 year growth rate of the Company, but the growth rate was reduced by 50% for the 2009 valuation. The reason for the reduced sales growth is the current and forecast near and medium term market conditions. The effect of this sales growth decrease was to decrease the unit's calculated value, but not to an extent that it fails the goodwill impairment test. The computed reporting unit value exceeds the carrying value of the unit by more than 100 percent.

We are subject to the revised requirements of the Statement of Financial Accounting Standards ("SFAS") No. 123 (R) Accounting for Stock-Based Compensation as revised December 2004. This standard establishes the accounting standards for equity compensation, and applies to us in the recognition of the cost of stock options awarded based on the grant-date fair value of those awards

As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating the actual current tax liabilities together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. The most significant tax assets are future deductions from the amortization of intangibles over the next ten years, inventory reserves and net operating loss carry forwards. Tax assets also result from net operating losses and research and development tax credits. We must then assess the likelihood that the deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, a valuation allowance must be established. To the extent we establish a valuation allowance or increase or decrease this allowance in a period, the impact will be included in the tax provision in the statement of operations.

Significant management judgment is required in determining our provision for income taxes and the recoverability of our deferred tax asset. Such determination is based primarily on our historical taxable income, with some consideration given to our estimates of future taxable income by jurisdictions in which we operate and the period over which our deferred tax assets will be recoverable. Due to cumulative taxable losses during the past three years, we recorded $2,241,000 valuation allowance against our deferred tax assets in the year ended June 30, 2009. This reduction in deferred tax assets is adjusted through income tax expense.

As a company with a very small market capitalization and a limited shareholder base, our market capitalization has been negatively affected by the very unusual economic and market environment of late. We believe our market capitalization may not reflect the true value of the Company and or be indicative of the true economic value of our assets. Some of the indications of disproportionate effect on our company include studies that show a strong difference in the valuations of the companies based on total market capitalization, with the small caps being most adversely affected. One recent study [The Bi-Weekly Fusion:
Orthopedic Company Update by SMH Capital, for the two weeks ended February 13, 2009] examined valuation metrics for orthopedic and medical device companies. The companies classified as "Large Cap" are trading at 70% of their 52 week high, 2.4 times revenues and 7.9 times EBITDA. The 15 companies classified as "Mid-Caps" were as expected, in the middle of the trading multiple, trading at 54% of their 52 week high, 1.5 times revenues and 8.2 times EBITDA, "Small Cap" companies are trading at 29% of their 52 week high, 1.5 times revenues and 11.4 times EBIDTA. The EBITDA multiple can be misleading for the small caps as of the 15 companies in the sample size, only four had a positive EBITDA, of which Pro-Dex was one. Of the large caps, all seven companies exhibited a positive EBITDA. In an updated study [The Bi-Weekly Fusion: Orthopedic Company Update by SMH Capital, for the two weeks ended June 19, 2009], Large-Caps and Mid-Caps were trading at 64% of their 52 week high and Small-Caps were trading at 40% of their all time high. We feel these analyses confirm that the current market environment exhibits a significant disproportionately unfavorable effect against small public companies in general, including Pro-Dex.

Year in Review

Fiscal year 2009 was a difficult year for the world's economy and Pro-Dex was not immune to its effects. Our consolidated sales for 2009 declined by 16% as compared to 2008, and approximately even with 2007 sales levels. Over the longer term, we maintained a cumulative average growth rate of almost 10%/year since fiscal year 2003. The motion control business was particularly adversely affected as our high margin products associated with this business are used by capital equipment providers, and these orders came to a sudden standstill in our third quarter (Jan-March 2009). This part of the business remained low in the subsequent quarter, and there are no indications yet for a strong structural resumption of business to previous levels. In response to the adverse environment for these products, we sensed an opportunity to gain market share and added additional sales resources in January to aggressively pursue new customers and new sales channels. The medical products also had a year-over-year decline, as the 2008 sales were high due to two major product launches that were not repeated in 2009. As the economy stalled, so did our customers' appetite for new projects. We continued the work on two of the major development projects initiated last year, and expect to see new revenue from them in fiscal year 2010 and beyond. In spite of the sales decline, our backlog of orders remains relatively flat, down by 6% compared to the end of last year.

We initiated strong responses to the top-line sales decline, and reduced our associate headcount by 10% since the end of fiscal year 2008. Our efforts to improve our product quality began to show benefits in fiscal year 2009 and warranty cost was reduced by over 50% from $1.3 million in fiscal year 2008 to $664 thousand in fiscal year 2009. Our operating costs in fiscal year 2009 (including a non-cash impairment expense of $997,000) were $8.2 million up 6% over the prior year's expenses of $7.8 million. In addition, we consolidated the management and business development efforts of our Carson City operations with those at Irvine. The cost savings introduced by this move allowed for additional investment in developing new motor technology and accelerate the improvements in this part of the business. There were one-time costs associated with these transitional actions, and the actions were phased through the year, but our basic cost structure was improved to better match the lower sales levels.

The new facilities for both our Beaverton and the Southern California operations have met our expectations. They are providing for more conducive facilities for engineering, development, and production efforts and contributing to efficiencies gained through collaborative workspaces. The Irvine space has allowed us to in-source much of our previously outsourced machining work, which in addition to providing better utilization of the facility, has proven to add to our competitive advantage in responding quickly to our customer's needs.

Combined with the lower sales levels, our net income was negatively affected by two large non-cash charges realized in our third quarter that resulted in a large loss for the year. First, due to our inability to find a distribution partner for our Intraflow products, we realized a $997 thousand pre-tax impairment loss from writing down the value of the associated patent. We are not actively marketing the product, but continue the search for a distribution partner to help realize the product's full potential. The second charge was a $2 million tax allowance reducing the book value of our deferred tax assets. We decided to take this allowance as the recent history of the Company's taxable income, especially in consideration of the intangible write-off, made the near-term realization of the deferred tax assets less assured.

We maintained the Company's strong financial position by generating over $1.7 million in operating cash for the 2009 fiscal year, in addition to the $2.0 million generated the prior year. Our net debt was reduced by over 33% to $2.2 million from $3.5 million at the end of 2008. Due to the reported GAAP losses, the terms of our credit facility were reduced to allow for $1 million of borrowing on our credit line. This is a significant reduction in availability, but we have not had any amounts borrowed under the facility since early in calendar 2009 and ended the year with over $1.1 million in cash on hand, so the reduction has had no effect on operations to date.

Entering 2010, we have a lower cost structure, greatly improved legacy product performance, two major product launches in the pipeline and a stable backlog. We remain committed to return the Company to profitable operations and providing a higher level of earnings in the coming years. We continue to drive costs out of the business and reliably design products that exceed our customers' expectations. As the economy becomes stronger, we anticipate that more customers will be launching new products again and we will participate in some of those launches. We also look forward to the markets for capital equipment products improving and our motion control top line returning to more normal levels.

Results of Operations

Results of Operations for Fiscal Year Ended June 30, 2009, Compared to Fiscal
Year Ended June 30, 2008



The following table sets forth financial data and the percentage of net revenues
regarding the Company's financial position and operating results.



     (In Thousands)                                 Fiscal Year ended June 30,
                                                       2009            2008
     Net sales:                                   $ 21,122  100%  $ 25,126  100%
     Cost of sales                                  14,374   68%    16,917   67%
     Gross Profit                                    6,748   32%     8,209   33%

     Selling, general and administrative expenses    4,452   21%     5,021   20%
     Intangible Impairment                             997    5%         -     -
     Research and development costs                  2,791   13%     2,732   11%
     Income (Loss) from Operations                  (1,492)  (7%)      456    2%

     Net interest (expense) and net other income       212    1%       138    1%

     (Benefit) / Provision for Income Taxes         (1,100)  (5%)        1    0%
     Allowance for deferred tax asset                2,241   11%         -    0%
     Net Income (Loss)                            $ (2,845) (13%) $    317    1%

Net Sales. Consolidated sales decreased 16% or $4,004,000 to $21,122,000 from $25,126,000 for 2009 as compared to 2008. Medical sales were lower by $3,014,000 or 21%, due to lower sales to our two largest customers by $1,742,000 driven by a return to stable shipping levels to these two customers after their previous year's inventory build. Shipments to dental customers decreased by $670,000 or 20% as we strategically reduced sales of certain low profit products. Sales to industrial customers decreased by $169,000 or 25% reflecting a slowdown in our motion control business. Sales related to government research related products and product repairs were up with a year over year increase of $270,000 due primarily to an increase in repair and upgrade work for products that were not warranty eligible which offset the decline in government agency related work. Aerospace sales were up $242,000 or 10% due to higher commercial aircraft motor shipments.

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

The amount of Pro-Dex total sales to each customer type and the year-to-year change is noted in the table below:

                                       Fiscal Year ended June 30,    Increase/
      Sales by customer type ($'000)      2009            2008       (Decrease)
      Dental                          $       2,620   $       3,290       (20%)
      Medical                                11,107          14,121       (21%)
      Industrial                              2,448           3,279       (25%)
      Aerospace                               2,624           2,382        10%
. . .