10-Q
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 
 

 FORM 10-Q
QUARTERLY PERIOD PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 
 

For the Quarterly Period ended December 31, 2015
Commission File Number 0-20127

 
 

Escalon Medical Corp.
(Exact name of registrant as specified in its charter)

 
 

Pennsylvania
 
33-0272839
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
435 Devon Park Drive, Building 100, Wayne, PA 19087
(Address of principal executive offices, including zip code)
(610) 688-6830
(Registrant’s telephone number, including area code)

 
 

N/A
Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

 


Large accelerated filer
 
o
 
Accelerated filer
 
o
 
 
 
 
 
 
Non-accelerated filer
 
o (Do not check if a smaller reporting company)
 
Smaller reporting company
 
x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  o    No  x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 7,526,430 shares of common stock, $0.001 par value, outstanding as of February 12, 2016.




 
TABLE OF CONTENTS
 
 
Page
 
 
Item I.
 
 
Condensed Consolidated Balance Sheets as of December 31, 2015 and June 30, 2015 (Unaudited)
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
Item 1.
Item 1A.
Item 6.
 


1


Item 1. Condensed Consolidated Financial Statements
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 
December 31,
2015
 
June 30,
2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
860,862

 
$
1,516,761

Accounts receivable, net
1,348,697

 
1,785,928

Inventory, net
2,444,909

 
2,219,615

Other current assets
285,861

 
245,520

Total current assets
4,940,329

 
5,767,824

Property and equipment, net
98,031

 
48,013

Goodwill
125,027

 
125,027

Trademarks and trade names
605,006

 
605,006

Patents, net
2,400

 
3,200

Total assets
$
5,770,793

 
$
6,549,070

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
890,575

 
$
1,044,199

Accrued expenses
1,404,934

 
1,529,428

Current portion of accrued post-retirement benefits
101,891

 
101,891

Liabilities of discontinued operations
87,248

 
86,176

Total current liabilities
2,484,648

 
2,761,694

Accrued post-retirement benefits, net of current portion
832,791

 
797,431

Total long-term liabilities
832,791

 
797,431

Total liabilities
3,317,439

 
3,559,125

Shareholders' equity:
 
 
 
Common stock, $0.001 par value; 35,000,000 shares authorized; 7,526,430 issued and outstanding
7,526

 
7,526

Additional paid-in capital
69,651,590

 
69,629,889

Accumulated deficit
(67,205,762
)
 
(66,647,470
)
Total shareholders’ equity
2,453,354

 
2,989,945

Total liabilities and shareholders’ equity
$
5,770,793

 
$
6,549,070

See notes to condensed consolidated financial statements

2

ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

 
For the three months ended December 31,
For the six months ended December 31,
 
2015
 
2014
2015
 
2014
Net revenues:
 
 
 
 
 
 
Product revenue
$
2,988,835

 
$
3,699,654

$
5,770,157

 
$
6,329,974

Revenues, net
2,988,835

 
3,699,654

5,770,157

 
6,329,974

Costs and expenses:
 
 
 
 
 
 
Cost of goods sold
1,526,440

 
1,903,074

2,974,486

 
3,269,971

Marketing, general and administrative
1,344,746

 
1,489,627

2,611,482

 
2,869,008

Research and development
382,766

 
383,727

742,518

 
708,004

Total costs and expenses
3,253,952

 
3,776,428

6,328,486

 
6,846,983

Loss from operations
(265,117
)
 
(76,774
)
(558,329
)
 
(517,009
)
Other income(loss)
 
 
 
 
 
 
Interest income
17

 
26

37

 
65

Total other income (loss)
17

 
26

37

 
65

Loss from continuing operations
(265,100
)
 
(76,748
)
(558,292
)
 
(516,944
)
Income (loss) from discontinued operations
—

 
2,659

—

 
(16,104
)
Net (loss)
$
(265,100
)
 
$
(74,089
)
$
(558,292
)
 
$
(533,048
)
Net (loss) per share
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
Continuing operations
$
(0.04
)
 
$
(0.01
)
$
(0.07
)
 
$
(0.07
)
Discontinued operations
—

 
—

—

 
—

Net (loss)
$
(0.04
)
 
$
(0.01
)
$
(0.07
)
 
$
(0.07
)
Diluted:
 
 
 
 
 
 
Continuing operations
$
(0.04
)
 
$
(0.01
)
$
(0.07
)
 
$
(0.07
)
Discontinued operations
—

 
—

—

 
—

Net (loss)
$
(0.04
)
 
$
(0.01
)
$
(0.07
)
 
$
(0.07
)
Weighted average shares—basic
7,526,430

 
7,526,430

7,526,430

 
7,526,430

Weighted average shares—diluted
7,526,430

 
7,526,430

7,526,430

 
7,526,430

See notes to condensed consolidated financial statements

3


ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
FOR THE SIX MONTHS ENDED DECEMBER 31, 2015
(UNAUDITED)

 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Deficit
 
 
Total Shareholders' Equity
 
Shares
 
Amount
 
 
 
 
 
 
 
Balance at June 30, 2015
7,526,430

 
$
7,526

 
$
69,629,889

 
$
(66,647,470
)
 
 
$
2,989,945

Net loss
—

 
—

 
—

 
(558,292
)
 
 
(558,292
)
Compensation expense
—

 
—

 
21,701

 
—

 
 
21,701

Balance at December 31, 2015
7,526,430

 
$
7,526

 
$
69,651,590

 
$
(67,205,762
)
 
 
$
2,453,354

See notes to condensed consolidated financial statements

4

ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
For the six months ended December 31,
 
2015
 
2014
Cash Flows from Operating Activities:
 
 
 
Net loss
$
(558,292
)
 
$
(533,048
)
Adjustments to reconcile loss to cash (used in) operating activities of continuing operations:
 
 
 
 Loss from discontinued operations
—

 
16,104

 Depreciation and amortization
13,010

 
6,831

Compensation expense related to stock options
21,701

 
34,762

Change in operating assets and liabilities:
 
 
 
Accounts receivable, net
437,231

 
(340,044
)
Inventory, net
(225,294
)
 
526,097

Other current assets
(40,341
)
 
70,939

Accounts payable and accrued expenses
(278,118
)
 
(419,682
)
           Change in accrued post-retirement benefits
35,360

 
(30,052
)
Change in liabilities of discontinued operations
1,072

 
—

Net cash (used in) operating activities from continuing operations
(593,671
)
 
(668,093
)
Net cash (used in) operating activities from discontinued operations
—

 
—

Net cash (used in) operating activities
(593,671
)
 
(668,093
)
Cash Flows from Investing Activities:
 
 
 
Purchase of fixed assets
(62,228
)
 
(22,277
)
Net cash (used in) investing activities
(62,228
)
 
(22,277
)
Net (decrease) in cash and cash equivalents
(655,899
)
 
(690,370
)
Cash and cash equivalents, beginning of period
1,516,761

 
2,009,554

Cash and cash equivalents, end of period
$
860,862

 
$
1,319,184

See notes to condensed consolidated financial statements

5

Escalon Medical Corp. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(UNAUDITED)

1. Basis of Presentation

 Escalon Medical Corp. (“Escalon” or the “Company” ) is a Pennsylvania corporation initially incorporated in California in 1987, and reincorporated in Pennsylvania in November 2001. Within this document, the “Company” collectively shall mean Escalon and its wholly owned subsidiaries: Sonomed, Inc. (“Sonomed”), Trek, Inc. (“Trek”), Escalon Medical Europe GmbH (“EME”), Escalon Digital Solutions, Inc. (“EMI”), Escalon Pharmaceutical, Inc. (“Pharmaceutical” inactive), Escalon Holdings, Inc. (“EHI”), Escalon IP Holdings, Inc., Sonomed IP Holdings, Inc., Drew Scientific Holdings, Inc. (discontinued), Drew Scientific Inc. (discontinued), and Drew Scientific Group, Plc (“Drew”) and its subsidiaries (discontinued). All intercompany accounts and transactions have been eliminated.
    
The Company operates in the healthcare market, specializing in the development, manufacture, marketing, and distribution of medical devices and pharmaceuticals in the area of ophthalmology. The Company and its products are subject to regulation and inspection by the United States Food and Drug Administration (the “FDA”). The FDA and other governmental authorities require extensive testing of new products prior to sale and have jurisdiction over the safety, efficacy and manufacture of products, as well as product labeling and marketing.

2.               Stock-Based Compensation

Valuations are based upon highly subjective assumptions about the future, including stock price volatility and exercise patterns. The fair value of share-based payment awards was estimated using the Black-Scholes option pricing model. Expected volatilities are based on the historical volatility of the Company's stock. The Company uses historical data to estimate option exercise and employee terminations. The expected term of options granted represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

The Company has historically granted options under the Company's option plans with an option exercise price equal to the closing market value of the stock on the date of the grant and with vesting, primarily for Company employees, either in equal annual amounts over a two- to five-year period or immediately, and, primarily for non-employee directors, immediately.

As of December 31, 2015 and 2014 total unrecognized compensation cost related to non-vested share-based compensation arrangements granted to employees under the 2004 Equity Incentive Plan was $17,912 and $83,120, respectively. The remaining cost is expected to be recognized over a weighted average period of 0.34 years. For the three-month periods ended December 31, 2015 and 2014, $11,941 and $11,941 was recorded as compensation expense, respectively. For the six-month periods ended December 31, 2015 and 2014, $21,701 and $23,859 was recorded as compensation expense, respectively.
 
The Company did not receive any cash from share option exercises under stock-based payment plans for the three-month and six-month periods ended December 31, 2015 and 2014. The Company did not realize any tax effect, which would be a reduction in its tax rate, on options due to the full valuation allowances established on its deferred tax assets.

The Company measures compensation expense for non-employee stock-based compensation based on the fair value of the options issued, as this is more reliable than the fair value of the services received. Fair value is measured as the value of the Company's common stock on the date that the commitment for performance by the counterparty has been reached or the counterparty's performance is complete. The fair value of the equity instrument is charged directly to compensation expense and additional paid-in capital. There was $0 and $4,361 non-employee compensation expense for the three-month periods ended December 31, 2015 and 2014. There was $0 and $10,903 non-employee compensation expense for the six-month periods ended December 31, 2015 and 2014.

3. Net (Loss) earnings per Share

The following table sets forth the computation of basic and diluted net (loss) per share:

6

 
For the three months ended December 31,
 
For the six months ended December 31,
 
2015

 
2014

 
2015

 
2014

 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
  Numerator for basic and diluted earnings per share
 
 
 
 
 
 
 
(Loss) from continuing operations
$
(265,100
)
 
$
(76,748
)
 
$
(558,292
)
 
$
(516,944
)
Income (loss) from discontinued operations
—

 
2,659

 
—

 
(16,104
)
 Net (loss)
$
(265,100
)
 
$
(74,089
)
 
$
(558,292
)
 
$
(533,048
)
Denominator:
 
 
 
 
 
 
 
  Denominator for basic earnings per share - weighted average shares
7,526,430

 
7,526,430

 
7,526,430

 
7,526,430

  Effect of dilutive securities:
 
 
 
 
 
 
 
    Stock options and warrants
—

 
—

 
—

 
—

    Shares reserved for future exchange
—

 
—

 
—

 
—

 Denominator for diluted earnings per share - weighted average and assumed conversion

7,526,430

 
7,526,430

 
7,526,430

 
7,526,430

 
 
 
 
 
 
 
 
Net (loss) per share
 
 
 
 
 
 
 
   Basic:
 
 
 
 
 
 
 
      Continuing operations
$
(0.04
)
 
$
(0.01
)
 
$
(0.07
)
 
$
(0.07
)
      Discontinued operations
—

 
—

 
—

 
—

 
$
(0.04
)
 
$
(0.01
)
 
$
(0.07
)
 
$
(0.07
)
   Diluted:
 
 
 
 
 
 
 
      Continuing operations
$
(0.04
)
 
$
(0.01
)
 
$
(0.07
)
 
$
(0.07
)
      Discontinued operations
—

 
—

 
—

 
—

 
$
(0.04
)
 
$
(0.01
)
 
$
(0.07
)
 
$
(0.07
)

4. Legal Proceedings

The Company, from time to time, is involved in various legal proceedings and disputes that arise in the normal course of business. These matters have previously and may in the future pertain to intellectual property disputes, commercial contract disputes, employment disputes, and other matters. The Company does not believe that the resolution of any of these matters has had or is likely to have a material adverse impact on the Company's business, financial condition or results of operations.

5.     Recently Issued Accounting Standards
In April 2014 FASB issued Accounting Standards Update 2014-08 Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360) Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. Under the new provision only those disposals of components of an entity that represent a strategic shift that has (or will have) a major effect on an entity’s operations and financial results will be reported as discontinued operations in the financial statements; a business or nonprofit activity that, on acquisition, meets the criteria to be classified as held for sale is reported in discontinued operations; and a disposal of an equity method investment that meets the definition of discontinued operation is reported in discontinued operations. A public business entity and a non-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market should apply the amendments prospectively to all disposals that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. The adoption of this standard did not have a material impact to the Company’s consolidated financial statements.
In May 2014 FASB issued Accounting Standards Update 2014-09 Revenue from Contracts with Customers (Topic 606). Under the new provision, an entity should apply five steps for revenue recognition to depict the transfer of promised

7

goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. For a public entity, the amendments in this Update are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. In August 2015 FASB issued accounting Standards Update No. 2015-13 Revenue from Contracts with Customers (Topic 606) deferral of the effective date. The amendments in this Update defer the effective date of Update 2014-09 for all entities by one year. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in Update 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within the reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within the reporting period. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In June 2014 FASB issued Accounting Standards Update 2014-11 Compensation-Stock Compensation (Topic 718) Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The amendments require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. For all entities, the amendments in this Update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In August 2014 FASB issued Presentation of Financial Statements-Going Concern (Subtopic 205-40) Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The amendments require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards.The amendments in this Update are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In November 2014 FASB issued Derivatives and Hedging (Topic 815) Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity. For hybrid financial instruments issued in the form of a share, an entity should determine the nature of the host contract by considering the economic characteristics and risks of the entire hybrid financial instrument, including the embedded derivative feature that is being evaluated for separate accounting from the host contract.The amendments in this Update are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In January 2015, FASB issued Accounting Standards Update 2015-01 Income Statement - Extraordinary and Unusual Items Simplifying Income Statement presentation by eliminating the concept of extraordinary items. The amendment will be effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2015. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In February 2015, FASB issued Accounting Standards Update 2015-02 Consolidation Amendments to the Consolidation Analysis. The amendments affect those entities who are required to evaluate whether they should consolidate certain legal entities and affect the following areas: limited partnership and similar legal entities, evaluating fees paid to a decision maker or a service provider as a variable interest, the effect of fee arrangements on the primary beneficiary determination, the effect of related parties on the primary beneficiary determination, and certain investment funds. The amendments in this update are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. For all other entities, the amendments in this Update are effective for fiscal year beginning after December 15, 2016, and for interim periods within fiscal years beginning after December 15, 2017. Early adoption is permitted. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.    
In April 2015, FASB issued Accounting Standards Update 2015-03 Interest-Imputation of Interest to simply the presentation of debt issuance costs. For public business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal year. For all other entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15,2015, and interim periods within fiscal years beginning after December 15, 2016. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In April 2015, FASB issued Accounting Standards Update 2015-04 Compensation-Retirement Benefits (Topic 715) to provide practical expedient for the measurement date of an employer’s defined benefit obligation and plan assets. The amendments in this Update are effective for public business entities for financial statements issued for fiscal year beginning after December 15, 2015, and interim periods within those fiscal year. For all other entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within fiscal

8

years beginning after December 15, 2017. Earlier adoption is permitted. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In April 2015, FASB issued Accounting Standards Update 2015-05 Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40) to provide guidance to customers about whether a cloud computing arrangement includes a software license. For public business entities, the amendments will be effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. For all other entities, the amendments will be effective for annual periods beginning after December 15, 2015, and interim periods in annual periods beginning after December 15, 2016. Early adoption is permitted for all entities. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In April 2015, FASB issued Accounting Standards Update 2015-06 Earnings Per Share (Topic 260). The Amendments specify that for purposes of calculating historical earnings per unit under the two-class method, the earnings (losses) of a transferred business before the date of a dropdown transaction should be allocated entirely to the general partner. Qualitative disclosures about how the rights to the earnings (losses) differ before and after the dropdown transaction occurs for purposes of computing earnings per unit under the two-class method are required. The amendments are effective for fiscal year beginning after December 15, 2015, and interim periods within those fiscal years. Earlier application is permitted. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In May 2015, FASB issued Accounting Standards Update 2015-07 Fair Value Measurement (Topic 820). The amendments remove the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The amendments also remove the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. The amendments apply to reporting entities that elect to measure the friar value of an investment within the scope of paragraph 820-10-15-4 through 15-5 using the net asset value per share (or its equivalent) practical expedient in paragraph 820-35-59. The amendments in this Update are effective for public business entities for fiscal year beginning after December 15, 2015, and interim periods within those fiscal years. For all other entities, the amendments in this update are effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In May 2015, FASB issued Accounting Standard Update 2015-08 Business Combinations (Topic 805) as amendments to various SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In May 2015, FASB issued Accounting Standard Update 2015-09 Financial Services-Insurance (Topic 944). The amendments apply to all insurance entities that issue short-duration contracts as defined in Topic 944, Financial Service-Insurance. The amendments require insurance entities to provide additional disclosure for annual reporting periods about liability for unpaid claims and claim adjustment expenses. For public entities, the amendments in this Update are effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016. For all other entities, the amendments in this Update are effective for annual periods beginning after December 15, 2016, and interim periods within annual periods beginning after December 15, 2017. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In June 2015, FASB issued Accounting Standards Update 2015-10 Technical Correction and Update. The amendments affect wide variety of Topics in Codification in the following four categories: Amendments related to differences between original guidance and the codification, guidance clarification and reference corrections, simplification and minor improvements. The amendments in this Update that require transition guidance are effective for all entities for fiscal year, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In July 2015 FASB issued Accounting Standards Update No. 2015-11 Inventory simplifying the Measurement of Inventory. Inventory measured using any method other than LIFO or the retail or average cost shall be measured at the lower of cost and net realizable value. For public business entities, the amendments in this update are effective for fiscal year beginning after December 15, 2016, including interim periods within those fiscal Years. The amendments should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In July 2015 FASB issued Accounting Standards Update No. 2015-12 (Part I) Plan Accounting: Defined Contribution Pension Plans (Topic 962) Health and Welfare Benefit Plans (Topic 965) to reduce the complexity in employee benefit plan accounting. Under the amendments, fully benefit-responsive investment contracts are measured, presented, and disclosed only at contract value. The amendments in Part I of this Update are effective for fiscal years beginning after December 15, 2015.

9

Earlier application is permitted.The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In August 2015 FASB issued Accounting Standard Update No. 2015-13 Derivatives and Hedging (Topic 815) Application of the Normal Purchases and Normal Sales Scope Exception to Certain Electricity Contracts within Nodal Energy Markets. The amendments apply to entities that enter into contracts for the purchase or sale of electricity on a forward basis and arrange for transmission through, or delivery to a location within, a nodal energy market whereby one of the contracting parties incurs charges (or credits) for the transmission of that electricity based in part on locational marginal pricing differences payable to (or receivable from) an independent system operator. The amendments specify that the use of locational marginal pricing by the independent system operator does not constitute the net settlement of the contract. If the physical delivery criterion is met, along with all of the other criteria of the normal purchase and normal scales scope exception, an entity may elect to designate that contract as a normal purchase or normal sale. The amendments in the Update are effective upon issuance and should be applied prospectively. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In August 2015 FASB issued Accounting Standards Update No. 2015-15 Interest -Imputation of Interest (Subtopic 835-30). This update adds SEC paragraphs pursuant to the SEC Staff Announcement at the June 18, 2015 Emerging Issues Task Force (EIFF) meeting about the presentation of subsequent measurement of debt issuance costs associated with line-of-credit arrangements. Given the absence of authoritative guidance within Update 2015-03 for debt issuance costs related to line-of-credit arrangements, the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance cots ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In September 2015 FASB issued Accounting Standards Update No. 2015-16 Business Combinations (Topic 805) Simplifying the Accounting for Measurement-Period Adjustments. The amendments in this Update require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments require that the acquirer record in the same period’s financial statements the effect on earnings of changes in depreciation, amortization or other income effects, if any, as result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. Under this Update an entity must present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. For all other entities, the amendments in this Update are effective for fiscal years beginning after December 2016, and interim periods within fiscal years beginning after December 15, 2017. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In November 2015 FASB issued Accounting Standards Update No. 2015-17 Income Taxes (Topic 740) Balance Sheet Classification of Deferred Taxes to reduce complexity in accounting standards. The amendments require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. For public business entities, the amendments in this Update are effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. For all other entities, the amendments in this Update are effective for financial statements issued for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
In January 2016 FASB issued Accounting Standards Update No. 2016-01 Financial Instruments-Overall (Subtopic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities. Under the amendment, equity investments (with exceptions) must be evaluated at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Qualitative assessment is required for impairment assessment of equity investments without readily determinable fair values to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value. Public business entities are required to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. An entity must present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. Financial assets and financial liabilities must be presented separately by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements. For public business entities, the amendments in this

10

Update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For all other entities including not-for-profit entities and employee benefit plans within the scope of Topics 960 through 965 on plan accounting, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. All entities that are not public business entities may adopt the amendments in this Update earlier as of the fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of this standard is not expected to have a material impact to the Company’s consolidated financial statements.
6. Fair Value Measurements
On July 1, 2008, the Company adopted the FASB-issued authoritative guidance for the fair value of financial assets and liabilities. This standard defines fair value and establishes a hierarchy for reporting the reliability of input measurements used to assess fair value for all assets and liabilities. The FASB-issued authoritative guidance defines fair value as the selling price that would be received for an asset, or paid to transfer a liability, in the principal or most advantageous market on the measurement date. The hierarchy prioritizes fair value measurements based on the types of inputs used in the valuation technique. The inputs are categorized into the following levels:
Level 1—Observable inputs such as quoted prices in active markets for identical assets or liabilities.
Level 2—Directly or indirectly observable inputs for quoted and other than quoted prices for identical or similar assets and liabilities in active or non-active markets.
Level 3—Unobservable inputs not corroborated by market data, therefore requiring the entity to use the best available information available in the circumstances, including the entity’s own data.
Certain financial instruments are carried at cost on the consolidated balance sheets, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses.

7. Continuing Operations

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred recurring operating losses and negative cash flows from operating activities and these conditions raise substantial doubt about the Company’s ability to continue as a going concern. These  consolidated financial statements do not include any adjustments relating to the realization of the carrying value of assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

The Company's continuance as a going concern is dependent on its future profitability and on the on-going support of its shareholders, affiliates and creditors. In order to mitigate the going concern issues, the Company is actively pursuing business partnerships, managing our continuing operations and seeking to to sell certain assets. The Company may not be successful in any of these efforts.

The Company implemented a reduction in force in October 2015 which will reduce future annual expenses by approximately $770,000 to stem the recurring losses. If the Company is unable to achieve improvement in the near term, it is likely that our existing cash and cash flow from operations will not be sufficient to fund activities throughout the next 6 to 12 months without curtailing certain business activities.

The Company's Equity as of December 31, 2015 is below the NASDAQ Minimum Equity Listing Requirement. The Company expects to receive a delisting letter from NASDAQ shortly after the filing of this Form 10-Q. The Company is in the process of formulating a plan to regain compliance.

The Company’s forecast of the period of time through which its financial resources will be adequate to support its operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed in “Risk Factors” included in the Company's Form 10K for the year ended June 30, 2015. If the Company raises funds in the future, the Company may be required to raise those funds through public or private financings, strategic relationships or other arrangements at prices and other terms that my not be as favorable as they would without such qualification. The sale of additional equity and debt securities may result in additional dilution to the Company’s shareholders. Additional financing may not be available in amounts or on terms acceptable to the Company or at all.


8. Discontinued Operations

BH Holdings, S.A.S ("BHH")

On January 12, 2012 BHH initiated the filing of an insolvency declaration with the Tribunal de Commerce de Rennes, France ("Commercial Court").  The Commercial Court on January 18, 2012 opened the liquidation proceedings with continuation of BHH's activity for 3 months and named an administrator to manage BHH. Since Drew no longer had a controlling financial interest in BHH it was deconsolidated in the December 31, 2011 quarterly condensed consolidated financial statements and prior period amounts were presented as discontinued operations.
During fiscal year 2015 the Company was informed by French Counsel that the total amount claimed by the BHH landlord in the liquidation of BHH was approximately $86,000. The Company did not have insight into the French liquidation process due

11

to the Liquidator's reticence to communicate with the Company. As such, the Company had accrued the present value of the maximum amount potentially due under the lease guaranteed by the Company on behalf of BHH. The landlord's claim under liquidation can not be revisited by the landlord and can only be potentially increased by interest or sundry expenses. The Company recorded a decreased expense of approximately $3,000 and an increase of $1,000 for the three month and six month periods ended December 31, 2015, respectively, which is included in marketing, general and administrative expense. As of December 31, 2015 and June 30, 2015, the liability was approximately $87,000 and $86,000, respectively.
 
 
 
 
Assets and liabilities of discontinued operations of BHH included in the condensed consolidated balance sheets are summarized as follows at December 31, 2015 and June 30, 2015 (in thousands):
 
December 31,
 
June 30,
 
2015
 
2015
Assets
 
 
 
Total assets
$
—

 
$
—

Liabilities
 
 
 
Accrued lease termination costs
87

 
86

Total liabilities
87

 
86

Net liabilities of discontinued operations
$
(87
)
 
$
(86
)

The following tables summarize the results of discontinued operations of BHH for the three months and six months ended December 31, 2015 and 2014 (in thousands):
 
 
 
 
 
For the three months ended December 31,
2015
 
2014
Revenue, net
$
—

 
$
—

Cost of goods sold
—

 
—

Marketing, general and administrative
—

 
—

Research & development
—

 
—

Total costs and expenses
—

 
—

Other income
—

 
3

Net income
$
—

 
$
3


For the six months ended December 31,
2015
 
2014
Revenue, net
$
—

 
$
—

Cost of goods sold
—

 
—

Marketing, general and administrative
—

 
19

Research & development
—

 
—

Total costs and expenses
—

 
19

Other income
—

 
3

Net loss
$
—

 
$
(16
)

9. Inventory
(In thousands)
December 31,
 
June 30,
 
2015
 
2015
Inventories, net:
 
 
 
        Raw Material
$
1,153

 
$
1,112

        Work-In-Process
384

 
334

        Finished Goods
907

 
774

Total
$
2,445

 
$
2,220


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Forward Looking Statements

Certain statements contained in, or incorporated by reference in, this report are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, which provide current expectations or forecasts of future events. Such statements can be identified by the use of terminology such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “forecast,” “intend,” “may,” “plan,” “possible,” “project,” “should,” “will,” and similar words or expressions. The Company's forward-looking statements include certain information relating to general business strategy, growth strategies, financial results, liquidity, discontinued operations, research and development, product development, the introduction of new products, the potential markets and uses for the Company's products, the Company's ability to increase its sales campaign effectively, the Company's regulatory filings with the FDA, acquisitions, dispositions, the development of joint venture opportunities, intellectual property and patent protection and infringement, the loss of revenue due to the expiration on termination of certain agreements, the effect of competition on the structure of the markets in which the Company competes, increased legal, accounting and Sarbanes-Oxley compliance costs, compliance with Nasdaq continued listing qualifications, defending the Company in litigation matters and the Company's cost saving initiatives. The reader must carefully consider forward-looking statements and understand that such statements involve a variety of risks and uncertainties, known and unknown, and may be affected by assumptions that fail to materialize as anticipated. Consequently, no forward-looking statement can be guaranteed, and actual results may vary materially. It is not possible to foresee or identify all factors affecting the Company's forward-looking statements, and the reader therefore

12

should not consider the list of such factors contained in its periodic report on Form 10-K for the year ended June 30, 2015 and this Form 10-Q quarterly report to be an exhaustive statement of all risks, uncertainties or potentially inaccurate assumptions.


Executive Overview—Six-Months Ended December 31, 2015 and 2014.

The following highlights are discussed in further detail within this Form 10-Q. The reader is encouraged to read this
Form 10-Q in its entirety to gain a more complete understanding of factors impacting Company performance and financial
condition.

• Consolidated product revenue from continuing operations decreased approximately $560,000, or 8.8%, to $5,770,000 during the six-months ended December 31, 2015 as compared to same period of the last fiscal year. The decrease in revenue is attributed to a decrease of $525,000 in ultrasound products, a decrease of $125,000 in digital imaging cameras and AXIS image management systems and offset by an increase of $90,000 in surgical products.

• Consolidated cost of goods sold from continuing operations totaled approximately $2,974,000, or 51.5%, of product revenue from continuing operations for the six months ended December 31, 2015, as compared to $3,270,000, or 51.7%, of product revenue from continuing operations for the same period of the prior fiscal year. The decrease of 0.2% in cost of goods sold as a percentage of revenue is due mainly to the increased margin in ultrasound products.

• Total operating expenses decreased approximately $223,000, or 6.2%, during the six-month period ended December 31, 2015 as compared to the same period of prior fiscal year. This decrease was due to decreased marketing, general and administrative expenses of $258,000, or 9.0% and an increase of $35,000 or 4.9%, in research and development expenses.

• Net loss from continuing operations was approximately $558,000 for the six-months ended December 31, 2015. The Company implemented a reduction in force in October 2015 to reduce annual expenses by approximately $770,000 to stem the recurring losses.

Company Overview

The following discussion should be read in conjunction with interim condensed consolidated financial statements and
the notes thereto, which are set forth in Item 1 of this report.

The Company operates in the healthcare market specializing in the development, manufacture, marketing and distribution of medical devices and pharmaceuticals in the area of ophthalmology. The Company and its products are subject to regulation and inspection by the FDA. The FDA requires extensive testing of new products prior to sale and has jurisdiction over the safety, efficacy and manufacture of products, as well as product labeling and marketing. The Company's Internet address is www.escalonmed.com. Sonomed-Escalon develops, manufactures and markets ultrasound systems used for diagnosis or biometric applications in ophthalmology, develops, manufactures and distributes ophthalmic surgical products under the Trek Medical Products name, and manufactures and markets digital camera systems for ophthalmic fundus photography and image management systems.
Critical Accounting Policies
The preparation of financial statements requires management to make estimates and assumptions that impact amounts reported therein. The most significant of those involve the application of FASB-issued authoritative guidance concerning Revenue Recognition, Goodwill and Other Intangible Assets, discussed further in the notes to consolidated financial statements included in the Form 10-K for the year ended June 30, 2015. The financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, and, as such, include amounts based on informed estimates and judgments of management. For example, estimates are used in determining valuation allowances for deferred income taxes, uncollectible receivables, obsolete inventory, sales returns and rebates, warranty liabilities and valuation of purchased intangible assets. Actual results achieved in the future could differ from current estimates. The Company used what it believes are reasonable assumptions and, where applicable, established valuation techniques in making its estimates.
Revenue Recognition
The Company recognizes revenue from the sale of its products at the time of shipment, when title and risk of loss transfer. The Company provides products to its distributors at agreed upon wholesale prices and to the balance of its customers at set retail prices. Distributors can receive discounts for accepting high volume shipments. The discounts are reflected immediately in the net invoice price, which is the basis for revenue recognition. No further material discounts are given.
 

13

The Company's considerations for recognizing revenue upon shipment of product to a distributor are based on the following:
 
 
 
Persuasive evidence that an arrangement (purchase order and sales invoice) exists between a willing buyer (distributor) and the Company that outlines the terms of the sale (company information, quantity of goods, purchase price and payment terms). The buyer (distributor) does not have a right of return.
 
 
 
Shipping terms are ex-factory shipping point. At this point the buyer (distributor) takes title to the goods and is responsible for all risks and rewards of ownership, including insuring the goods as necessary.
 
 
 
The Company's price to the buyer (distributor) is fixed and determinable as specifically outlined on the sales invoice. The sales arrangement does not have customer cancellation or termination clauses.
 
 
 
The buyer (distributor) places a purchase order with the Company; the terms of the sale are cash, COD or credit. Customer credit is determined based on the Company's policies and procedures related to the buyer's (distributor's) creditworthiness. Based on this determination, the Company believes that collectibility is reasonably assured.
The Company assesses collectibility based on creditworthiness of the customer and past transaction history. The Company performs ongoing credit evaluations of its customers and does not require collateral from its customers. For many of the Company's international customers, the Company requires an irrevocable letter of credit to be issued by the customer before the purchase order is accepted.
Valuation of Intangible Assets
The Company annually, and as circumstances require, evaluates for impairment its intangible assets and goodwill in accordance with FASB guidance related to goodwill and other intangible assets, or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. These intangible assets include goodwill, trademarks and trade names. Recoverability of these assets is measured by comparison of their carrying amounts to future discounted cash flows the assets are expected to generate. If identifiable intangibles are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds its fair market value. The Company does not amortize intangible assets with indefinite useful lives, rather, such assets are required to be tested for impairment at least annually or sooner whenever events or changes in circumstances indicate that the assets may be impaired. The Company performs its intangible asset impairment tests on or about June 30, of each year. Any such impairment charge could be significant and could have a material adverse impact on the Company's financial statements if and when an impairment charge is recorded.
Income/(Loss) Per Share
The Company computes net income/(loss) per share under the provisions of FASB issued authoritative guidance.
Under the provisions of FASB issued authoritative guidance, basic and diluted net income/(loss) per share is computed by dividing the net income/(loss) for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net income/(loss) per share excludes potential common shares if the impact is anti-dilutive. Basic earnings per share are computed by dividing net income/(loss) by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share are determined in the same manner as basic earnings per share, except that the number of shares is increased by assuming exercise of dilutive stock options and warrants using the treasury stock method.

Taxes
Estimates of taxable income of the various legal entities and jurisdictions are used in the tax rate calculation. Management uses judgment in estimating what the Company's income tax will be for the year. Since judgment is involved, there is a risk that the tax rate may increase or decrease in any period.
In determining income/(loss) for financial statement purposes, management must make certain estimates and judgments. These estimates and judgments occur in the calculation of certain tax liabilities and in the determination of the recoverability of certain deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenue and expense. FASB issued authoritative guidance concerning accounting for income taxes also requires

14

that the deferred tax assets be reduced by a valuation allowance if, based on the available evidence, it is more likely than not that all or some portion of the recorded deferred tax assets will not be realized in future periods.
In evaluating the Company's ability to recover the Company's deferred tax assets, management considers all available positive and negative evidence including the Company's past operating results, the existence of cumulative losses and near-term forecasts of future taxable income that is consistent with the plans and estimates management is using to manage the underlying businesses.
Through December 31, 2015, the Company has recorded a valuation allowance against the Company's deferred tax assets arising from net operating losses due to uncertainty of their realization as a result of the Company's earnings history, the number of years the Company's net operating losses and tax credits can be carried forward, the existence of taxable temporary differences and near-term earnings expectations. The amount of the valuation allowance could decrease if facts and circumstances change that materially increase taxable income prior to the expiration of the loss carryforwards. Any reduction in the valuation allowance would result in an income tax benefit in the period such determination is made by the Company.
The Company has adopted FASB issued guidance related to accounting for uncertainty in income taxes, which provides a comprehensive model for the recognition, measurement, and disclosure in financial statements of uncertain income tax positions that a company has taken or expects to take on a tax return. Under the FASB guidance a company can recognize the benefit of an income tax position only if it is more likely than not (greater than 50%) that the tax position will be sustained upon tax examination, based solely on the technical merits of the tax position. Otherwise, no benefit can be recognized. The tax benefits recognized are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Additionally, companies are required to accrue interest and related penalties, if applicable, on all tax exposures for which reserves have been established consistent with jurisdictional tax laws. The Company has elected to recognize interest expense and penalties, if any, related to uncertain tax positions as a component of its provision for income taxes.
Stock-Based Compensation
Stock-based compensation expense for all stock-based compensation awards granted after July 1, 2006 is based on the grant-date fair value estimate in accordance with the provisions of the FASB issued guidance. The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award.
Valuations are based on highly subjective assumptions about the future, including stock price volatility and exercise patterns. The fair value of share-based payment awards was estimated using the Black-Scholes option pricing model. Expected volatilities are based on the historical volatility of the Company's stock. The Company uses historical data to estimate option exercise and employee terminations. The expected term of options granted represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.
Results of Operations
Three-month and Six-month periods Ended December 31, 2015 and 2014
The following table shows consolidated product revenue, as well as identifying trends in revenues for the three-month and six-month periods ended December 31, 2015 and 2014.
Table amounts are in thousands:
 
Three Months ended December 31,
 
Six Months ended December 31,
 
2015
 
2014
 
% Change
 
2015
 
2014
 
% Change
Product Revenue:
 
 
 
 
 
 
 
 
 
 
 
Sonomed-Escalon
$
2,989

 
$
3,700

 
(19.2
)%
 
$
5,770

 
$
6,330

 
(8.8
)%
Total
$
2,989

 
$
3,700

 
(19.2
)%
 
$
5,770

 
$
6,330

 
(8.8
)%
Consolidated product revenue from continuing operations decreased approximately $711,000, or 19.2%, to $2,989,000 during the three months ended December 31, 2015 as compared to same period of the last fiscal year. The decrease in revenue is attributed to a decrease of $639,000 in ultrasound products, a decrease of $109,000 in digital imaging cameras and AXIS image management systems and offset by an increase of $37,000 in surgical products. The Company encountered supply chain shortages during the quarter that increased back-logged orders to approximately $680,000 at December 31, 2015.
Consolidated product revenue from continuing operations decreased approximately $560,000 , or 8.8%, to $5,770,000 during the six months ended December 31, 2015 as compared to same period of the last fiscal year. The decrease in revenue is attributed to a decrease of $525,000 in ultrasound products, a decrease of $125,000 in digital imaging cameras and AXIS image management

15

systems and offset by an increase of $90,000 in surgical products. The Company encountered supply chain shortages during the quarter that increased back-logged orders to approximately $680,000 at December 31, 2015.

The following table presents consolidated cost of goods sold as a percentage of product revenues for the three months and six months ended December 31, 2015 and 2014. Table amounts are in thousands:
 
 
Three Months ended December 31,
 
Six Months ended December 31,
 
2015
 
%
 
2014
 
%
 
2015
 
%
 
2014
 
%
Cost of Goods Sold:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sonomed-Escalon
$
1,526

 
51.1
%
 
$
1,903

 
51.4
%
 
$
2,974

 
51.5
%
 
$
3,270

 
51.7
%
Total
$
1,526

 
51.1
%
 
$
1,903

 
51.4
%
 
$
2,974

 
51.5
%
 
$
3,270

 
51.7
%

Consolidated cost of goods sold from continuing operations totaled approximately $1,526,000, or 51.1%, of product revenue from continuing operations, for the three months ended December 31, 2015, as compared to $1,903,000, or 51.4%, of product revenue from continuing operations, for the same period of the prior fiscal year. The decrease of 0.3% in cost of goods sold as a percentage of revenue is due mainly to the increased margin on ultrasound products during Q2 2016.

Consolidated cost of goods sold from continuing operations totaled approximately $2,974,000, or 51.5%, of product revenue from continuing operations, for the six months ended December 31, 2015, as compared to $3,270,000, or 51.7%, of product revenue from continuing operations, for the same period of the prior fiscal year. The decrease of 0.2% in cost of goods sold as a percentage of revenue is due mainly to the increased margin on ultrasound products.
The following table presents consolidated marketing, general and administrative expenses as well as identifying trends in marketing, general and administrative expenses for the three months and six months ended December 31, 2015 and 2014. Table amounts are in thousands:
 
 
Three Months ended December 31,
 
Six Months ended December 31,
 
2015
 
2014
 
% Change 
 
2015
 
2014
 
% Change 
Marketing, General and Administrative:
 
 
 
 
 
 
 
 
 
 
 
Sonomed-Escalon
$
1,345

 
$
1,490

 
(9.6
)%
 
$
2,611

 
$
2,869

 
(9.0
)%
Total
$
1,345

 
$
1,490

 
(9.6
)%
 
$
2,611

 
$
2,869

 
(9.0
)%
Consolidated marketing, general and administrative expenses from continuing operations decreased $145,000, or 9.6%, to $1,345,000 during the three months ended December 31, 2015, as compared to the same period of the prior fiscal year. The decrease is due to a reduction in force in October 2015, decreased hiring expense, travel expense, reduced international consulting fees and advertising expense offset by the increased post retirement expense due to the discount rate adjustment in the current period.
Consolidated marketing, general and administrative expenses from continuing operations decreased $258,000, or 9.0%, to $2,611,000 during the six months ended December 31, 2015, as compared to the same period of the prior fiscal year. The decrease is due to a reduction in force, decreased hiring expense, reduced executive compensation, business tax, travel expense, reduced international consulting fees and advertising expense offset by the increased post retirement expense due to the discount rate adjustment in the current period.
The following table presents consolidated research and development expenses from continuing operations for the three-months and six-months ended December 31, 2015 and 2014. Table amounts are in thousands:
 
 
Three Months ended December 31,
 
Six Months ended December 31,
 
2015
 
2014
 
% Change  
 
2015
 
2014
 
% Change  
Research and Development:
 
 
 
 
 
 
 
 
 
 
 
Sonomed Escalon
$
383

 
$
384

 
(0.3
)%
 
$
743

 
$
708

 
4.9
%
Total
$
383

 
$
384

 
(0.3
)%
 
$
743

 
$
708

 
4.9
%


16

Consolidated research and development expenses from continuing operations decreased $1,000, or 0.3%, to $383,000 during the three-months ended December 31, 2015, as compared to the same period of the prior fiscal year. Research and development expenses were primarily expenses associated with the planned introduction of new or enhanced products. The decrease in prototype expense was offset by the increase in the consulting expense during the current period.
Consolidated research and development expenses from continuing operations increased $35,000, or 4.9%, to $743,000 during the six-months ended December 31, 2015, as compared to the same period of the prior fiscal year. Research and development expenses were primarily expenses associated with the planned introduction of new or enhanced products.
Discontinued Operations

For the three-months and six-months ended December 31, 2015 and 2014, the Company had a net income from discontinued operations of the BHH segment of $0 and $3,000. For the six-month period ended December 31, 2015 and 2014, the Company had a net loss from discontinued operations of the BHH segment of $0 and $16,000, respectively. Discontinued operations is related to a BHH lease guaranteed by the Company. During fiscal year 2015 the Company was informed by French Counsel that the total amount claimed by the BHH landlord in the liquidation of BHH was approximately $86,000. The Company did not have insight into the French liquidation process due to the Liquidator's reticence to communicate with the Company. As such, the Company had accrued the present value of the maximum amount potentially due under the lease guaranteed by the Company on behalf of BHH. The landlord's claim under liquidation can not be revisited by the landlord and can only be potentially increased by interest or sundry expenses. The company recorded a decrease of legal expense of approximately $3,000 and increase of $1,000 for the three month and six month periods ended December 31, 2015, respectively, which is included in marketing, general and administrative expense. As of December 31, 2015 and June 30, 2015, the liability was approximately $87,000 and $86,000, respectively.

Other Income
The Company did not have significant other income during the three-months and six-months ended December 31, 2015 and 2014.
Liquidity and Capital Resources
The following table presents overall liquidity and capital resources as of December 31, 2015 and June 30, 2015. Table amounts are in thousands:
 
 
December 31, 2015
 
June 30, 2015
Current Ratio:
 
 
 
Current assets
$
4,940

 
$
5,768

Less: Current liabilities
2,485

 
2,762

Working capital
$
2,455

 
$
3,006

Current ratio
2.0 to 1

 
2.1 to 1

Debt to Total Capital Ratio:
 
 
 
Note payable and long-term debt
$
—

 
$
—

Total debt
—

 
—

Total equity
2,453

 
2,990

Total capital
$
2,453

 
$
2,990

Total debt to total capital
—
%
 
—
%


Working Capital Position
Working capital decreased $551,000 as of December 31, 2015, and the current ratio was reduced to 2.0 from 2.1 when compared to June 30, 2015. Debt to Total Capital Ratio was 0% as of December 31, 2015 and June 30, 2015.

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred recurring

17

operating losses and negative cash flows from operating activities and these conditions raise substantial doubt about the Company’s ability to continue as a going concern. These  consolidated financial statements do not include any adjustments relating to the realization of the carrying value of assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
The Company's continuance as a going concern is dependent on its future profitability and on the on-going support of its shareholders, affiliates and creditors. In order to mitigate the going concern issues, the Company is actively pursuing business partnerships, managing our continuing operations and seeking to sell certain assets. The Company may not be successful in any of these efforts.

The Company implemented a reduction in force in October 2015 which will reduce future annual expense by approximately $770,000 to stem the recurring losses. If the Company is unable to achieve improvement in the near term, it is likely that our existing cash and cash flow from operations will not be sufficient to fund activities throughout the next 6 to 12 months without curtailing certain business activities.

The Company's Equity was approximately $2,453,000 as December 31, 2015 which is approximately $47,000 below the NASDAQ Minimum Equity Listing Requirement. The Company expects to receive a delisting letter from NASDAQ shortly after the filing of this Form 10-Q. The Company is in the process of formulating a plan to regain compliance.


The Company’s forecast of the period of time through which its financial resources will be adequate to support its operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed in “Risk Factors”.If the Company raises funds in the future, the Company may be required to raise those funds through public or private financings, strategic relationships or other arrangements at prices and other terms that may not be as favorable as they would without such qualification. The sale of additional equity and debt securities may result in additional dilution to the Company’s shareholders. Additional financing may not be available in amounts or on terms acceptable to the Company or at all.

Cash Used In or Provided By Operating Activities
During the six-month periods ended December 31, 2015 and 2014, the Company experienced cash outflows from continuing operating activities of $594,000 and $668,000, respectively. The net decrease in cash used in operating activities for the six-month period ended December 31, 2015, as compared to the same period in the prior fiscal year is due primarily to the following factors:
For the six-month period ended December 31, 2015, the Company had a net loss of $558,000, and experienced net cash in flows from a decrease in accounts receivable of $437,000, an increase in post-retirement benefits of $35,000 and an increase in non-cash expenditures on depreciation and amortization and compensation expense related to stock options of approximately $13,000 and $22,000, respectively. These cash in-flows were offset by a decrease in accounts payable and accrued expense and an increase in inventory of $278,000 and $225,000, respectively, and an increase in other current assets of $40,000.
For the six-month period ended December 31, 2014, the Company had a net loss of $533,000, which includes net loss from discontinued operations of $16,000, and experienced net cash in flows from a decrease in other current assets of $71,000, a decrease in inventory of $526,000, an increase in non-cash expenditures on depreciation and amortization and compensation expense related to stock options of approximately $7,000 and $35,000, respectively. These cash in-flows were offset by a decrease in accounts payable and accrued expense of $420,000, an increase in accounts receivable of $340,000 and a decrease in post-retirement benefits of $30,000.

Cash Flows Used In Investing and Financing Activities
Cash flows used in investing activities of $62,000 were due to the purchase of an injection mold for the new hand held GoVu pachymeter during the six-month period ended December 31, 2015.
Cash flows used in investing activities of $22,000 were due to the purchase of fixed assets during the six-month period ended December 31, 2014.
There were no cash flows used in or provided by financing activities during the six-month periods ended December 31, 2015 and 2014.

Continuing Operations


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The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred recurring operating losses and negative cash flows from operating activities and these conditions raise substantial doubt about the Company’s ability to continue as a going concern. These  consolidated financial statements do not include any adjustments relating to the realization of the carrying value of assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

The Company's continuance as a going concern is dependent on its future profitability and on the on-going support of its shareholders, affiliates and creditors. In order to mitigate the going concern issues, the Company is actively pursuing business partnerships, managing our continuing operations and seeking to sell certain assets. The Company may not be successful in any of these efforts.
    
The Company implemented a reduction in force in October 2015, which will reduce future annual expenses by approximately $770,000 to stem the recurring losses. If the Company is unable to achieve improvement in the near term, it is likely that our existing cash and cash flow from operations will not be sufficient to fund activities throughout the next 6 to 12 months without curtailing certain business activities.

The Company's Equity was approximately $2,453,000 as December 31, 2015 which is approximately $47,000 below the NASDAQ Minimum Equity Listing Requirement. The Company expects to receive a delisting letter from NASDAQ shortly after the filing of this Form 10-Q. The Company is in the process of formulating a plan to regain compliance.

The Company’s forecast of the period of time through which its financial resources will be adequate to support its operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed in “Risk Factors”. If the Company raises funds in the future, the Company may be required to raise those funds through public or private financings, strategic relationships or other arrangements at prices and other terms that may not be as favorable as they would without such qualification. The sale of additional equity and debt securities may result in additional dilution to the Company’s shareholders. Additional financing may not be available in amounts or on terms acceptable to the Company or at all.


Off-Balance Sheet Arrangements and Contractual Obligations

The Company was not a party to any off-balance sheet arrangements during the six-month periods ended December 31, 2015 and 2014.

The following table presents the Company's contractual obligations as of December 31, 2015 (excluding interest):

 
 
 
 
 Less than
 
 
 
3-5
 
More than
 
 
 Total
 
 1 Year
 
 2-3 Years
 
Years
 
 5 Years
 
 
 
 
 
 
 
 
 
 
 
Operating lease agreements
 
$
1,326,414

 
$
575,900

 
$
569,710

 
$
180,804

 
$
—

Total
 
$
1,326,414

 
$
575,900

 
$
569,710

 
$
180,804

 
$
—



Item 3.    Quantitative and Qualitative Disclosures About Market Risk

None

Item 4. Controls and Procedures

(A)    Evaluation of Disclosure Controls and Procedures

The Company's management, with the participation of the Company's Chief Executive Officer and Principal Financial and Accounting Officer, have established disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the officers who certify the Company's financial reports and to other members of senior management and the Board of Directors.

Based on their evaluation of the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2015, the Chief Executive Officer and Principal Financial and Accounting Officer of the Company have concluded that such disclosure controls and procedures are effective to ensure that the information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to the Company's management, including its Chief Executive Officer and Principal Financial and Accounting Officer, to allow timely decisions regarding required disclosure.

(B)    Internal Control over Financial Reporting

There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act), during the first fiscal quarter ended December 31, 2015 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. The Company is converting to the new COSO framework during fiscal year 2016.

Item 1.    Legal Proceedings

See footnote 4 of the notes to the condensed consolidated financial statements for further information regarding the Company's legal proceedings.

Item 1A. Risk Factors

There are no material changes from the risks previously disclosed in the Company's Annual Report on Form 10-K for the year ended June 30, 2015.


Item 6.    Exhibits
    
31.1    Certificate of Chief Executive Officer under Rule 13a-14(a).
31.2    Certificate of Principal Financial and Accounting Officer under Rule 13a-14(a).
32.1
Certificate of Chief Executive Officer under Section 1350 of Title 18 of the United States Code.

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32.2
Certificate of Principal Financial and Accounting Officer under Section 1350 of Title 18 of the United States Code
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
 
 
 
Escalon Medical Corp.
 
 
 
 
(Registrant)
 
 
 
 
 
 
 
Date: February 16, 2016
 
By:
 
/s/ Richard J. DePiano, Jr.
 
 
 
 
Richard J. DePiano, Jr.
 
 
 
 
Chief Executive Officer
 
 
 
 
 
Date: February 16, 2016
 
By:
 
/s/ Robert O’Connor
 
 
 
 
Robert O’Connor
 
 
 
 
Chief Financial Officer



20