UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-QSB
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended March 31, 2006.
[ ] Transition report pursuant to Section 13 or 15(d) of the securities
Exchange Act of 1934 for the transitional period from _________ to
__________.
Commission File Number 0-20127
----------
ESCALON MEDICAL CORP.
(Exact name of small business issuer as specified in its charter)
PENNSYLVANIA 33-0272839
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
565 EAST SWEDESFORD ROAD, SUITE 200
WAYNE, PA 19087
(Address of principal executive offices)
(610) 688-6830
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required by Section 13
or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or
for 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 [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
At April 28, 2006, 6,344,670 shares of common stock were outstanding.
Transitional Small Business Disclosure format. Yes [ ] No [X]
ESCALON MEDICAL CORP.
FORM 10-QSB QUARTERLY REPORT
TABLE OF CONTENTS
Part I. Financial Statements
Item 1. Condensed Consolidated Financial Statements 2
Condensed Consolidated Balance Sheets as of March 31, 2006
(Unaudited) and June 30, 2005 2
Condensed Consolidated Statements of Income for the three-
and nine-month periods ended March 31, 2006 and 2005
(Unaudited) 3
Condensed Consolidated Statements of Cash Flows for the
nine-month periods ended March 31, 2006 and 2005
(Unaudited) 4
Condensed Consolidated Statement of Shareholders' Equity
for the nine-month periods ended March 31, 2006 and 2005
(Unaudited) 5
Condensed Consolidated Statement of Other Comprehensive
Income (Loss) for the nine-month periods ended March 31,
2006 and 2005 (Unaudited) 6
Notes to the Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis or Plan of Operation 24
Item 3. Internal Controls and Disclosure Procedures 44
Part II. Other Information
Item 1. Legal Proceedings 45
Item 2. Unregistered Sales of Securities and Use of Proceeds 45
Item 6. Exhibits 45
1
PART I. FINANCIAL STATEMENTS
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, JUNE 30,
2006 2005
------------ ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 3,154,427 $ 5,115,772
Available for sale securities 69,600 1,207,317
Accounts receivable, net 5,180,361 4,752,310
Inventory, net 6,576,841 5,856,285
Notes receivable 500,000 100,000
Other current assets 225,940 633,214
------------ ------------
TOTAL CURRENT ASSETS 15,707,169 17,664,898
------------ ------------
Furniture and equipment, net 990,800 911,700
Goodwill 21,253,187 20,166,450
Trademarks and trade names, net 620,106 616,906
Patents, net 337,718 402,814
Other intangibles 267,925 0
Other assets 369,152 286,568
------------ ------------
TOTAL ASSETS $ 39,546,057 $ 40,049,336
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 243,957 $ 230,344
Accounts payable 1,694,137 1,135,680
Accrued expenses 2,176,494 2,685,670
------------ ------------
TOTAL CURRENT LIABILITIES 4,114,588 4,051,694
------------ ------------
Long-term debt, net of current portion 224,729 391,793
Accrued post-retirement benefits 1,087,000 1,087,000
------------ ------------
TOTAL LIABILITIES 5,426,317 5,530,487
------------ ------------
Shareholders equity:
Preferred stock, $0.001 par value; 2,000,000 shares authorized;
no shares issued Common stock, $0.001 par value; 35,000,000
share authorized; 6,344,670 and 5,963,477 issued and
outstanding at March 31, 2006 and June 30, 2005, respectively 6,345 5,964
Common stock warrants 1,601,346 1,601,346
Additional paid-in capital 65,699,370 63,898,190
Retained earnings (32,980,166) (32,136,487)
Accumulated other comprehensive (loss) income (207,155) 1,149,836
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 34,119,740 34,518,849
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 39,546,057 $ 40,049,336
============ ============
See notes to condensed consolidated financial statements
2
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
----------------------- -------------------------
2006 2005 2006 2005
---------- ---------- ----------- -----------
NET REVENUES:
Product revenue $7,286,704 $6,246,836 $20,895,553 $16,648,739
Other revenue 553,054 982,241 1,687,365 2,233,987
---------- ---------- ----------- -----------
REVENUES, NET 7,839,758 7,229,077 22,582,918 18,882,726
---------- ---------- ----------- -----------
COSTS AND EXPENSES:
Cost of goods sold 4,382,268 2,998,745 12,010,652 9,019,701
Research and development 717,920 463,808 2,135,950 1,257,132
Marketing, general and administrative 3,283,722 2,938,673 10,395,612 8,050,678
---------- ---------- ----------- -----------
TOTAL COSTS AND EXPENSES 8,383,910 6,401,226 24,542,214 18,327,511
---------- ---------- ----------- -----------
(LOSS) INCOME FROM OPERATIONS (544,152) 827,851 (1,959,296) 555,215
---------- ---------- ----------- -----------
OTHER (EXPENSE) AND INCOME:
Gain on sale of available for sale securities 0 0 1,157,336 0
Equity in Ocular Telehealth Management, LLC (18,508) (13,632) (69,972) (49,942)
Interest income 33,974 9,166 111,698 53,607
Interest expense (27,515) (15,915) (47,421) (42,534)
---------- ---------- ----------- -----------
TOTAL OTHER (EXPENSE) AND INCOME (12,049) (20,381) 1,151,641 (38,869)
---------- ---------- ----------- -----------
NET (LOSS) INCOME BEFORE TAXES (556,201) 807,470 (807,655) 516,346
---------- ---------- ----------- -----------
Provision for income taxes 20,024 63,912 36,024 83,938
---------- ---------- ----------- -----------
NET (LOSS) INCOME $ (576,225) $ 743,558 $ (843,679) $ 432,408
========== ========== =========== ===========
BASIC NET (LOSS) INCOME PER SHARE $ (0.092) $ 0.125 $ (0.138) $ 0.075
========== ========== =========== ===========
DILUTED NET (LOSS) INCOME PER SHARE $ (0.092) $ 0.119 $ (0.138) $ 0.069
========== ========== =========== ===========
WEIGHTED AVERAGE SHARES - BASIC 6,255,665 5,932,920 6,091,938 5,787,753
========== ========== =========== ===========
WEIGHTED AVERAGE SHARES - DILUTED 6,255,665 6,251,847 6,091,938 6,238,515
========== ========== =========== ===========
See notes to condensed consolidated financial statements
3
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED MARCH 31,
---------------------------
2006 2005
----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (843,679) $ 432,408
Adjustments to reconcile net (loss) income to net cash
(used in) operating activities:
Depreciation and amortization 338,829 316,913
Abandonment of leashold improvement 0 11,057
Gain on sale of available for sale securities (1,157,336) 0
Loss on Ocular Telehealth Management, LLC 69,972 49,942
Change in operating assets and liabilities:
Accounts receivable, net (428,051) (750,816)
Inventory, net (795,026) (1,377,461)
Other current and long-term assets 38,087 (340,351)
Accounts payable, accrued and other liabilities 24,281 (826,531)
----------- ------------
NET CASH (USED IN) OPERATING ACTIVITIES (2,752,923) (2,484,839)
----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Drew, net of cash acquired 0 (936,238)
Purchase of MRP (47,060) 0
Proceeds from the sale of available for sale securities 1,157,336 0
Investment in Ocular Telehealth Management, LLC 0 (256,000)
Purchase of distribution rights (181,856) 0
Purchase of fixed assets (295,027) (98,990)
----------- ------------
NET CASH PROVIDED BY/(USED IN) INVESTING ACTIVITIES 633,393 (1,291,228)
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Line of credit borrowing 0 (1,907,948)
Line of credit repayment 0 (4,374,481)
Principal payments on term loans (153,451) 0
Issuance of common stock - stock options 296,254 29,782
----------- ------------
NET CASH PROVIDED BY/(USED IN) FINANCING ACTIVITIES 142,803 (6,252,647)
----------- ------------
Effect of exchange rate changes on cash and cash
equivalents 15,381 (58,465)
----------- ------------
NET (DECREASE) IN CASH AND CASH EQUIVALENTS (1,961,345) (10,087,179)
----------- ------------
Cash and cash equivalents, beginning of period 5,115,772 12,601,971
----------- ------------
Cash and cash equivalents, end of period $ 3,154,427 $ 2,514,792
=========== ============
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Interest paid $ 47,121 $ 234,781
=========== ============
Income taxes paid $ 43,460 $ 394,469
=========== ============
Issuance of common stock for Drew acquisition $ 0 $ 7,190,355
=========== ============
Issuance of common stock for MRP acquisition $ 1,427,500 $ 0
=========== ============
(Decrease)/increase in unrealized appreciation on
available for sale securities $(1,137,717) $ 4,227,436
=========== ============
See notes to condensed consolidated financial statements
4
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED MARCH 31, 2006
(UNAUDITED)
ACCUMULATED
COMMON STOCK COMMON ADDITIONAL OTHER TOTAL
------------------ STOCK PAID-IN ACCUMULATED COMPREHENSIVE SHAREHOLDERS'
SHARES AMOUNT WARRANTS CAPITAL DEFICIT INCOME (LOSS) EQUITY
--------- ------ ---------- ----------- ------------ ------------- -------------
BALANCE AT JUNE 30, 2005 5,963,477 $5,964 $1,601,346 $63,898,190 $(32,136,487) $ 1,149,836 $34,518,849
Net (loss) 0 0 0 (843,679) 0 (843,679)
Exercise of stock options 131,193 131 0 296,123 0 0 296,254
Purchase of assets of MRP 250,000 250 1,427,250 1,427,500
Income tax benefit from exercise
of stock options 77,807 77,807
Change in unrealized gains on 0
available for sale securities 0 0 0 0 (1,137,717) (1,137,717)
Foreign currency translation 0 0 0 0 (219,274) (219,274)
--------- ------ ---------- ----------- ------------ ----------- -----------
BALANCE AT MARCH 31, 2006 6,344,670 $6,345 $1,601,346 $65,699,370 $(32,980,166) $ (207,155) $34,119,740
========= ====== ========== =========== ============ =========== ===========
See notes to condensed consolidated financial statements
5
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OTHER COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31, NINE MONTHS ENDED MARCH 31,
---------------------------- ---------------------------
2006 2005 2006 2005
--------- ----------- ----------- ----------
Net income (loss) $(576,225) $ 743,558 $ (843,679) $ 432,408
Change in unrealized gains on
available for sale securities 16,110 (1,702,086) (1,137,716) 4,227,436
Foreign currency translation (127,340) (28,480) (219,324) (83,683)
--------- ----------- ----------- ----------
COMPREHENSIVE (LOSS) INCOME $(687,455) $ (987,008) $(2,200,719) $4,576,161
========= =========== =========== ==========
See notes to condensed consolidated financial statements
6
ESCALON MEDICAL CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
include the accounts of Escalon Medical Corp. and its subsidiaries, collectively
referred to as "Escalon" or the "Company." Escalon's subsidiaries include
Sonomed, Inc. ("Sonomed"), Escalon Vascular Access, Inc. ("Vascular"), Escalon
Medical Europe GmbH ("EME"), Escalon Digital Vision, Inc. ("EMI"), Escalon
Pharmaceutical, Inc. ("Pharmaceutical"), Escalon Holdings, Inc. ("EHI") and Drew
Scientific Group, Plc ("Drew"), including its subsidiaries. All intercompany
accounts and transactions have been eliminated. Additionally, the Company's
investment in Ocular Telehealth Management, LLC ("OTM") is accounted for under
the equity method.
The Company operates in the healthcare market, specializing in the
development, manufacture, marketing and distribution of medical devices and
pharmaceuticals in the areas of ophthalmology, diabetes, hematology and vascular
access. The Company and its products are subject to regulation and inspection by
the United States Food and Drug Administration (the "FDA") or other regulatory
authorities. 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 accompanying condensed consolidated financial statements are unaudited
and are presented pursuant to the rules and regulations of the Securities and
Exchange Commission (the "SEC"). Accordingly, these consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto contained in the Company's 2005 Annual Report on
Form 10-K under the Securities Exchange Act of 1934 (the "Exchange Act"). In the
opinion of management, the accompanying consolidated financial statements
reflect all adjustments (which are of a normal recurring nature) necessary for a
fair presentation of the financial position, results of operations and cash
flows for the interim periods presented. The results of operations are not
necessarily indicative of the results that may be expected for the full year.
In connection with the presentation of the current period condensed
unaudited consolidated financial statements, certain prior period balances have
been reclassified to conform with the current period presentation.
2. ACQUISITIONS
DREW ACQUISITION
On July 23, 2004, the Company acquired approximately 67% of the outstanding
ordinary shares of Drew, a United Kingdom company, pursuant to the Company's
exchange offer for all of the outstanding ordinary shares of Drew, and since
that date has acquired all of the Drew shares. The results of Drew's operations
have been included in the consolidated financial statements, and the Company has
been operating Drew as an additional business unit since July 23, 2004.
The aggregate purchase price of Drew was $8,525,966, net of acquired cash
of $151,996, consisting of direct acquisition costs of $1,246,376, primarily for
investment banking, legal and accounting fees that were directly related to the
acquisition of Drew, and 900,000 shares of Escalon common stock valued at
$7,430,439. The value of the 900,000 shares issued was based on a five-day
average of the market price of the stock (two days before through two days after
the shares were exchanged).
The Company accounted for the purchase under FAS 141. Under FAS 141, the
Company paid a premium (i.e., goodwill) over the fair value of the net tangible
and identified intangible assets. The Company acquired Drew as part of its
strategy to diversify its business into the diagnostic medical devices
7
market. Drew afforded the Company a combined capital equipment product with a
continuing revenue stream product in the form of disposables. The application of
purchase accounting under FAS 141 requires that the total purchase price be
allocated to the fair value of assets acquired and liabilities assumed based on
their fair values at the acquisition date, with amounts exceeding the fair
values being recorded as goodwill. The allocation process requires an analysis
of acquired fixed assets, contracts, customer lists and relationships,
trademarks, patented technology, service markets, contractual commitments, legal
contingencies and brand value to identify and record the fair value of all
assets acquired and liabilities assumed. The Company engaged a third-party to
value the assets acquired and liabilities assumed. In valuing acquired assets
and assumed liabilities, fair values were based on expected discounted cash
flows, current replacement cost or other techniques as deemed appropriate.
The following table summarizes the purchase price allocation of estimated
fair values of assets acquired and liabilities assumed as of the date of
acquisition of Drew of July 23, 2004.
Current assets $ 3,859,771
Furniture and equipment 868,839
Patents 297,246
Other long-term assets 7,406
Goodwill 9,574,655
-----------
Total assets acquired $14,607,917
-----------
Line of credit $ 1,617,208
Current liabilities 3,392,286
Long-term debt 1,072,457
-----------
Total liabilities assumed $ 6,081,951
-----------
Net assets acquired $ 8,525,966
===========
The following pro forma results of operations information has been prepared
to give effect to the purchase of Drew as if such transaction had occurred at
the beginning of the period being presented. The information presented is not
necessarily indicative of results of future operations of the combined
companies.
8
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
----------------------- -------------------------
2006 2005 2006 2005
---------- ---------- ----------- -----------
Revenues, net $7,839,758 $7,229,077 $22,582,918 $18,882,726
Cost of goods sold 4,382,268 2,998,745 12,010,652 9,019,701
---------- ---------- ----------- -----------
GROSS PROFIT 3,457,490 4,230,332 10,572,266 9,863,025
---------- ---------- ----------- -----------
Operating expenses 4,001,642 3,402,481 12,531,562 9,307,810
Other (expense) and income (12,049) (20,381) 1,151,641 (38,869)
---------- ---------- ----------- -----------
NET (LOSS) INCOME BEFORE TAXES (556,201) 807,470 (807,655) 516,346
---------- ---------- ----------- -----------
Provision for income taxes 20,024 63,912 36,024 83,938
---------- ---------- ----------- -----------
NET (LOSS) INCOME $ (576,225) $ 743,558 $ (843,679) $ 432,408
========== ========== =========== ===========
BASIC NET (LOSS) INCOME PER SHARE $ (0.092) $ 0.125 $ (0.138) $ 0.075
========== ========== =========== ===========
DILUTED NET (LOSS) INCOME PER SHARE $ (0.092) $ 0.119 $ (0.138) $ 0.069
========== ========== =========== ===========
WEIGHTED AVERAGE SHARES - BASIC 6,255,665 5,932,920 6,091,938 5,787,753
========== ========== =========== ===========
WEIGHTED AVERAGE SHARES - DILUTED 6,255,665 6,251,847 6,091,938 6,238,515
========== ========== =========== ===========
MRP ACQUISITION
On January 30, 2006 EMI acquired substantially all of the assets of MRP
Group, Inc. ("MRP") in exchange for 250,000 shares of the Company's common stock
and approximately $47,000 in cash. The MRP business consists of ophthalmic
technology solutions offering two retinal imaging systems. Approximately 200 of
these systems have been installed at leading medical and retinal care centers.
The operating results of MRP are included as part of the Medical/Trek/EMI
business unit as of January 30, 2006.
The Company accounted for the purchase under FAS 141. Under FAS 141, the
Company paid a premium (i.e., goodwill) over the fair value of the net tangible
and identified intangible assets acquired to obtain a leading edge technology
platform in the digital imaging marketplace. The application of purchase
accounting under FAS 141 requires that the total purchase price be allocated to
the fair value of assets acquired and liabilities assumed based on their fair
values at the acquisition date, with amounts exceeding the fair values being
recorded as goodwill in the amount of $1,086,737. The allocation process
requires an analysis of acquired fixed assets, contracts, customer lists and
relationships, trademarks, patented technology, service markets, contractual
commitments, legal contingencies and brand value to identify and record the fair
value of all assets acquired and liabilities assumed. The values of certain
assets and liabilities are based on preliminary valuations and are subject to
adjustment as additional information is obtained. The Company will have 12
months from the closing of the acquisition to finalize the valuation. Business
unit disclosures and pro forma statement of operations data for 2006 and 2005 do
not include MRP operations and assets as they are not material in relation to
the consolidated financial statements.
3. STOCK-BASED COMPENSATION
The Company reports stock-based compensation through the disclosure-only
requirements of the statement of Financial Accounting Standards No. 123 ("SFAS
123"), "Accounting for Stock-Based Compensation," as amended by Statement of
Financial Accounting Standards No. 148 ("SFAS 148"), "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment to FASB No. 123."
Compensation expense for options is measured using the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"). Under APB 25, because the exercise price
of the Company's employee stock options is generally equal to
9
the market price of the Company's underlying stock on the date of grant, no
compensation expense is recognized.
SFAS 123 establishes an alternative method of expense recognition for
stock-based compensation awards based on fair values. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS 123.
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
-------------------- -----------------------
2006 2005 2006 2005
--------- -------- ----------- ---------
Net (loss) income, as reported $(576,225) $743,558 $ (843,679) $ 432,408
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (288,848) (75,442) (1,077,870) (435,802)
--------- -------- ----------- ---------
PRO FORMA NET (LOSS) INCOME $(865,073) $668,116 $(1,921,549) $ (3,394)
========= ======== =========== =========
(LOSS) EARNINGS PER SHARE:
BASIC - AS REPORTED $ (0.092) $ 0.125 $ (0.138) $ 0.075
========= ======== =========== =========
BASIC - PRO FORMA $ (0.138) $ 0.113 $ (0.315) $ (0.001)
========= ======== =========== =========
DILUTED - AS REPORTED $ (0.092) $ 0.119 $ (0.138) $ 0.069
========= ======== =========== =========
DILUTED - PRO FORMA $ (0.138) $ 0.107 $ (0.315) $ (0.001)
========= ======== =========== =========
The Company has followed the guidelines of SFAS 123 to establish the
valuation of its stock options. The fair value of these equity awards was
estimated at the date of grant using the Black-Scholes option pricing method.
For the purposes of pro forma disclosures, the estimated fair value of the
equity awards is amortized to expense over the options' vesting periods. No
options were granted during the three-month period ending March 31, 2006.
In December 2004, the FASB issued SFAS No.123R ("SFAS No.123R") (revised
2004), "Share-Based Payments" SFAS No. 123R is a revision of SFAS No. 123 and
supersedes ABP Opinion No. 25, which requires the Company to expense share-based
payments, including employee stock options. With limited exceptions, the amount
of compensation costs will be measured based on the grant date fair value of the
equity or liability instrument issued. Compensation cost will be recognized over
the period that the optionee provides service in exchange for the award. The
Company is a small business issuer as defined in Item 10 of Regulation S-B. As a
result, the Company will be required to adopt this standard in its fiscal year
beginning July 1, 2006. The adoption of this standard for the expensing of stock
options is expected to reduce pretax earnings in future periods. The impact of
adoption of SFAS No. 123R cannot be predicted at this time because it will
depend upon the level of share-based payments made in the future and the model
the Company elects to utilize.
10
4. EARNINGS PER SHARE
The Company follows Financial Accounting Standards Board Statement No. 128,
"Earnings Per Share," in presenting basic and diluted earnings per share. The
following table sets forth the computation of basic and diluted earnings per
share:
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
----------------------- -----------------------
2006 2005 2006 2005
---------- ---------- ---------- ----------
NUMERATOR:
Numerator for basic and diluted
earnings per share
NET (LOSS) INCOME $ (576,225) $ 743,558 $ (843,679) $ 432,408
---------- ---------- ---------- ----------
DENOMINATOR:
Denominator for basic earnings per
share - weighted average shares 6,255,665 5,932,920 6,091,938 5,787,753
Effect of dilutive securities:
Stock options and warrants 0 295,470 0 427,305
Shares reserved for future exchange 0 23,457 0 23,457
---------- ---------- ---------- ----------
DENOMINATOR FOR DILUTED EARNINGS PER
SHARE - WEIGHTED AVERAGE AND ASSUMED CONVERSION 6,255,665 6,251,847 6,091,938 6,238,515
---------- ---------- ---------- ----------
BASIC (LOSS) EARNINGS PER SHARE $ (0.092) $ 0.125 $ (0.138) $ 0.075
========== ========== ========== ==========
DILUTED (LOSS) EARNINGS PER SHARE $ (0.092) $ 0.119 $ (0.138) $ 0.069
========== ========== ========== ==========
The impact of dilutive securities were omitted from the earnings per share
calculation in 2006 as they would reduce the loss per share (anti-dilutive).
5. INVENTORY
Inventory, stated at lower of cost (determined on a first-in, first-out
basis) or market, consisted of the following:
MARCH 31, JUNE 30,
2006 2005
----------- ----------
(UNAUDITED)
Raw materials $4,000,651 $3,476,493
Work in process 805,877 473,252
Finished goods 2,061,981 2,073,208
---------- ----------
6,868,509 6,022,953
---------- ----------
Valuation allowance (291,668) (166,668)
---------- ----------
TOTAL INVENTORY $6,576,841 $5,856,285
========== ==========
11
6. NOTES RECEIVABLE
Escalon entered into an agreement with an individual who was involved in
the development of the Company's now discontinued Ocufit SR(R) drug delivery
system. The Company holds a note receivable from the individual in the amount of
$150,000 that was due in May 2005. The note was not paid when due, and the
individual is currently in default. The Company intends to pursue collection, is
currently evaluating collection alternatives and has recorded a $50,000 reserve
based upon its current estimate of cost to pursue collection.
In connection with a co-marketing agreement with Anka Systems, Inc.
("Anka"), in October 2005, the Company extended a $400,000 loan to Anka (See
note 16). Anka is an early stage privately held company. Under the terms of this
note, repayment is due within six months after written demand or immediately
upon an event of default. On February 16, 2006, the Company demanded repayment
in accordance with the terms of the note.
7. INTANGIBLE ASSETS
PATENTS
It is the Company's practice to seek patent protection on processes and
products in various countries. Patent application costs are capitalized and
amortized over their estimated useful lives, not exceeding 17 years, on a
straight-line basis from the date the related patents are issued. Costs
associated with patents no longer being pursued are expensed. Accumulated patent
amortization was $237,754 and $188,649 at March 31, 2006 and June 30, 2005,
respectively. Amortization expense for the three-month periods ended March 31,
2006 and 2005 was $25,652 and $26,478, respectively. Amortization expense for
the nine-month periods ended March 31, 2006 and 2005 was $76,500 and $89,615,
respectively.
The aggregate amortization expense for each of the next five years for
patents is estimated to be approximately $70,000 per year for each of the next
five fiscal years.
COVENANT NOT TO COMPETE AND CUSTOMER LIST
The Company recorded the value of a covenant not to compete and a customer
list as intangible assets as part of the acquisition of MRP (See note 2). The
valuation was based on the fair market value of these assets at the time of
acquisition. These assets are amortized over their estimate useful lives, not
exceeding 5 years, on a straight-line basis from the date of acquisition.
Accumulated amortization was $9,232 and $0 at March 31, 2006 and June 30, 2005,
respectively. Amortization expense for the three and nine-month periods ended
March 31, 2006 and 2005 was $9,232 and $0, respectively.
GOODWILL, TRADEMARKS AND TRADE NAMES
Goodwill, trademarks and trade names represent intangible assets obtained
from Escalon Opthalmics ("EOI"), Endologix, Inc. ("Endologix"), Sonomed, MRP
(See note 2) and Drew acquisitions. Goodwill represents the excess of purchase
price over the fair market value of net assets acquired.
In accordance with SFAS 142, effective July 1, 2001, the Company
discontinued the amortization of goodwill and identifiable intangible assets
that have indefinite lives. Intangible assets that have finite lives continue to
be amortized over their estimated useful lives. Management has evaluated the
carrying value of goodwill and its identifiable intangible assets that have
indefinite lives during each of the fiscal years subsequent to July 1, 2001,
utilizing discounted cash flows of the respective business unit. After
evaluating the discounted cash flow of each of its respective business units,
management concluded that the carrying value of goodwill and identifiable
intangible assets did not exceed their fair values and therefore were not
impaired. In accordance with SFAS 142, these intangible assets will continue to
be assessed on an annual basis, and impairment, if any, will be recorded as a
charge against income from operations.
12
The following table presents unamortized intangible assets by business unit
as of March 31, 2006 and June 30, 2005:
MARCH 31,
2006 JUNE 30, 2005
NET CARRYING NET CARRYING
AMOUNT AMOUNT
------------ -------------
(UNAUDITED)
GOODWILL
Sonomed $ 9,525,550 $ 9,525,550
Drew 9,574,655 9,574,655
Vascular 941,218 941,218
Medical/Trek/EMI 1,211,764 125,027
----------- -----------
TOTAL $21,253,187 $20,166,450
=========== ===========
MARCH 31,
2006 JUNE 30, 2005
NET CARRYING NET CARRYING
AMOUNT AMOUNT
------------ -------------
(UNAUDITED)
UNAMORTIZED INTANGIBLE ASSETS
Sonomed $616,906 $616,906
Medical/Trek/EMI 3,200 0
-------- --------
TOTAL $620,106 $616,906
======== ========
The following table presents amortized intangible assets by business unit
as of March 31, 2006:
ADJUSTED
GROSS GROSS
CARRYING CARRYING ACCUMULATED NET CARRYING
AMOUNT IMPAIRMENT AMOUNT AMORTIZATION VALUE
----------- ---------- -------- ------------ ------------
(UNAUDITED)
AMORTIZED INTANGIBLE ASSETS PATENTS
Drew $273,246 $0 $273,246 $ (74,936) $198,310
Vascular 36,925 0 36,925 (13,843) 23,082
Medical/Trek/EMI 265,301 0 265,301 (148,975) 116,326
-------- --- -------- --------- --------
TOTAL $575,472 $0 $575,472 $(237,754) $337,718
======== === ======== ========= ========
CUSTOMER LIST/COVENANT NOT TO COMPETE
Medical/Trek/EMI $277,157 $0 $277,157 $ (9,232) $267,925
-------- --- -------- --------- --------
TOTAL $277,157 $0 $277,157 $ (9,232) $267,925
======== === ======== ========= ========
13
The following table presents amortized intangible assets by business unit
as of June 30, 2005:
ADJUSTED
GROSS GROSS
CARRYING CARRYING ACCUMULATED NET CARRYING
AMOUNT IMPAIRMENT AMOUNT AMORTIZATION VALUE
-------- ---------- -------- ------------ ------------
AMORTIZED INTANGIBLE ASSETS PATENTS
Drew $297,246 $0 $297,246 $ (55,908) $241,338
Vascular (pending issuance) 36,916 0 36,916 0 36,916
Medical/Trek/EMI 257,301 0 257,301 (132,741) 124,560
-------- --- -------- --------- --------
TOTAL $591,463 $0 $591,463 $(188,649) $402,814
======== === ======== ========= ========
8. ACCRUED EXPENSES
The following table presents accrued expenses as of March 31, 2006 and June
30, 2005:
MARCH 31, JUNE 30,
2006 2005
---------- -----------
(UNAUDITED)
Accrued compensation $1,035,240 $1,276,639
Warranty accruals 321,244 201,413
Severance accruals 0 195,213
Legal accruals 221,369 251,000
Other accruals 598,641 761,355
---------- ----------
TOTAL ACCRUED EXPENSES $2,176,494 $2,685,620
========== ==========
Severance accruals as of March 31, 2006 and June 30, 2005 relate to certain
former directors and officers of Drew who management had the intent to terminate
as of the consummation date of the acquisition of Drew.
In addition to normal accruals, other accruals as of March 31, 2006 and
June 30, 2005 relate to the remaining lease payments on a facility that ceased
manufacturing operations prior to the Drew acquisition, accruals for litigation
existing prior to the Drew acquisition, franchise and ad valorem tax accruals
and other sundry operating expenses accruals.
Accrued compensation as of March 31, 2006 and June 30, 2005 primarily
relates to payroll, bonus and vacation accruals, and payroll tax liabilities.
9. LINE OF CREDIT AND LONG-TERM DEBT
The Company has two long-term debt facilities through its Drew subsidiary:
the Texas Mezzanine Fund and Symbiotics, Inc. The Texas Mezzanine Fund debt
provided for interest at fixed rate of 8% per annum until July 1, 2005. The
interest rate was then adjusted to the prime rate plus 4% per annum. Each June
1, the rate will be adjusted to the prime rate plus 4% per annum. The debt has a
minimum interest rate of 8% per annum to a maximum interest rate of 18% per
annum. The interest rate on the Texas Mezzanine Fund was 10.25% per annum and 8%
per annum as of March 31, 2006 and June 30, 2005, respectively. Drew is required
to pay the Texas Mezzanine Fund 1% of fiscal year revenues over $11,500,000 as
defined in a revenue participation agreement. The note is due in June 2008 and
is secured by certain assets of Drew. The outstanding balance of the note was
$318,683 and $405,471 as of March 31, 2006 and June 30, 2005, respectively. The
Symbiotics, Inc. term debt, which originated from the acquisition of a product
line from Symbiotics, Inc., is payable in monthly installments of $8,333 with
interest at a fixed rate of 5% per
14
annum. The outstanding balance of this note was $150,003 and $216,666 as of
March 31, 2006 and June 30, 2005, respectively.
The schedule below presents principal amortization for the next five years
under each of the Company's loan agreements as of March 31, 2006:
TWELVE MONTHS
ENDING TEXAS
MARCH 31, MEZZANINE SYMBIOTICS TOTAL
------------- --------- ---------- -----------
(UNAUDITED)
2006 $143,961 $ 99,996 243,957
2007 159,647 50,007 209,654
2008 15,075 0 15,075
2009 0 0 0
2010 0 0 0
-------- -------- --------
TOTAL $318,683 $150,003 468,686
======== ======== ========
Current portion of
long-term debt 243,957
--------
Long-term portion $224,729
========
10. OTHER REVENUE
Other revenue includes quarterly payments received from:
(1) Bausch & Lomb in connection with the sale of the Silicone Oil product
line, which contract expired on August 12, 2005 and from which the
Company will not receive any additional royalties;
(2) Royalty payments received from IntraLase Corp. ("IntraLase") relating
to the licensing of the Company's laser technology; and
(3) Royalty payments received from Bio-Rad Laboratories, Inc. ("Bio-Rad").
For the three-month periods ended March 31, 2006 and 2005, Silicone Oil
revenue totaled $0 and $364,000, respectively, IntraLase royalties totaled
$468,771 and $567,000, respectively, and the Bio-Rad royalties totaled $84,283
and $51,000, respectively. For the nine-month periods ended March 31, 2006 and
2005, Silicone Oil revenue totaled $203,124 and $1,119,000, respectively,
IntraLase royalties totaled $1,255,865 and $970,000, respectively, and the
Bio-Rad royalties totaled $228,376 and $144,000, respectively. Accounts
receivable as of March 31, 2006 and June 30, 2005 related to other revenue was
approximately $18,155 and $364,000, respectively.
15
BAUSCH & LOMB SILICONE OIL
The Company's agreement with Bausch & Lomb, which commenced on August 13,
2000, was structured so that the Company received consideration from Bausch &
Lomb based on its adjusted gross profit from its sales of Silicone Oil on a
quarterly basis. The consideration was subject to a factor, which stepped down
through the termination date (August 2005) according to the following schedule:
From 8/13/00 to 8/12/01 100%
From 8/13/01 to 8/12/02 82%
From 8/13/02 to 8/12/03 72%
From 8/13/03 to 8/12/04 64%
From 8/13/04 to 8/12/05 45%
INTRALASE: LICENSING OF LASER TECHNOLOGY
The material terms of the license of the Company's laser patents to
IntraLase (the "License Agreement"), which expires in 2013, provide that the
Company will receive a 2.5% royalty on product sales that are based on the
licensed laser patents, subject to deductions for third party royalties
otherwise due and payable, and a 1.5% royalty on product sales that are not
based on the licensed laser patents. The Company receives a minimum annual
license fee of $15,000 per year during the remaining term of the license. The
minimum annual License Agreement fee is offset against the royalty payments.
The material termination provisions of the License Agreement of the laser
technology are as follows:
1. Termination by the Company if IntraLase defaults in the payment of any
royalty;
2. Termination by the Company if IntraLase makes any false report;
3. Termination by the Company if IntraLase defaults in the making of any
required report;
4. Termination by either party due to the commission of any material
breach of any covenant or promise by the other party under the license
agreement; or
5. Termination by IntraLase after 90 days notice (if IntraLase were to
terminate, it would not be permitted to utilize the licensed
technology necessary to manufacture its current products).
BIO-RAD ROYALTY
The royalty received from Bio-Rad relates to a certain non-exclusive Eighth
Amendment to an OEM Agreement ("OEM Agreement") between the Company's Drew
subsidiary and Bio-Rad, dated July 19, 1994. Bio-Rad pays a royalty based on
sales of certain of Drew's products in certain geographic regions.
The material terms of the OEM Agreement, provided:
- Drew receives an agreed royalty per test;
- Royalty payments will be made depending on the volume of diagnostic tests
provided by Bio-Rad. If fewer than 3,750 tests per month are provided by
Bio-Rad, Bio-Rad will calculate the number of tests used on a quarterly
basis in arrears and pay Drew within 45 days of the end of the quarter. If
more than 3,750 tests per month are provided by Bio-Rad, Bio-Rad will pay
an estimated monthly royalty and within 45 days of the end of the quarter
will make final settlement upon the actual number of tests.
While the OEM Agreement, as amended by the Eighth Amendment, expired on May
15, 2005, the parties have continued to operate under the terms of the expired
agreement pending negotiation of a potential extension and/or revision.
16
11. COMMITMENTS AND CONTINGENCIES
COMMITMENTS
The Company leases its manufacturing, research and corporate office
facilities and certain equipment under non-cancelable operating lease
arrangements. The future amounts to be paid under these arrangements as of March
31, 2006 are as follows:
LEASE
TWELVE MONTHS ENDING OBLIGATIONS
-------------------- -----------
(UNAUDITED)
2006 $ 811,790
2007 466,051
2008 297,295
2009 290,686
2010 303,923
Thereafter 193,547
----------
TOTAL $2,363,292
==========
Rent expense charged to operations during the three-month periods ended
March 31, 2006 and 2005 was $234,557 and $231,608, respectively. Rent expense
charged to operations during the nine-month periods ended March 31, 2006 and
2005 was $692,188 and $640,190, respectively.
CONTINGENCIES
ROYALTY AGREEMENT: CLINICAL DIAGNOSTICS SOLUTIONS
Drew and Clinical Diagnostics Solutions, Inc. ("CDS") entered into a
Private Label/Manufacturing Agreement dated April 1, 2002, as amended and
restated on November 9, 2005, for the right to sell formulations or products of
CDS, including reagents, controls and calibrators ("CDS products"), on a private
label basis. The agreement has a term of 15 years, may be terminated by Drew at
any time with 18 months written notice, and if not terminated automatically
renews year-to-year thereafter. Drew is obligated to pay CDS a royalty of 7.5%
on all sales of CDS products produced from Drew's United Kingdom facility.
INTRALASE CORP. LEGAL PROCEEDINGS
In October 1997, the Company and IntraLase entered into a License Agreement
wherein the Company granted IntraLase the exclusive right to use the Company's
laser properties, including patented and non-patented technology, in exchange
for shares of IntraLase common stock as well as royalties based on a percentage
of net sales of future products. The shares of common stock were restricted for
sale until April 6, 2005 and, according to a Fourth Amended Registration Right
Agreement between the Company and IntraLase, were able to be sold. See
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the Notes to Condensed Consolidated Financial Statements for
discussions on the Company's sales of IntraLase common stock.
On June 10, 2004, the Company gave IntraLase notice of its intention to
terminate the License Agreement due to IntraLase's failure to pay certain
royalties that the Company believed were due under the License Agreement. On
June 21, 2004, IntraLase sought a preliminary injunction and temporary
restraining order with the United States District Court for the Central District
of California, Southern District against the Company to prevent termination of
the License Agreement. Contemporaneously, IntraLase filed an action for
declaratory relief asking the court to validate its interpretation of certain
terms of the License Agreement relating to the amount of royalties owed to the
Company ("First Action"). The parties mutually agreed to the entry of a
temporary restraining order, which was entered by the court
17
shortly thereafter. At the close of discovery, IntraLase and the Company filed
cross-motions for summary judgment. On May 5, 2005, the District Court, having
ruled on such motions, entered judgment in the First Action.
The court, in ruling on the parties' cross-motions for summary judgment,
did not agree with IntraLase's interpretation of certain terms and declared
that, under the terms of the License Agreement, IntraLase must pay the Company
royalties on revenue from maintenance contracts and one-year warranties.
Further, the court rejected IntraLase's argument that it is entitled to deduct
the value of non-patented components of its ophthalmic products, which it sells
as an integrated unit, from the royalties due the Company. Non-patented
components of the products include computer monitors, joysticks, keyboards,
universal power supplies, microscope assemblies, installation kits and syringes.
In addition, the court rejected IntraLase's assertion that accounts receivable
are not "consideration received" under the License Agreement and expressly ruled
that IntraLase must pay the Company royalties on IntraLase's accounts
receivable. The court also held that IntraLase must give the Company an
accounting of third-party royalties. The court agreed with IntraLase that it is
not required to pay royalties on research grants.
The court also agreed with the Company in finding that royalties are
"monies" and the default in the payment of royalties must be remedied within 15
days of written notice of the default. The court rejected IntraLase's position
concerning the effective date of the License Agreement holding that the
effective date of the License Agreement was dated October 17, 2000. IntraLase
has appealed the judgment to the Ninth Circuit Court of Appeals. The briefing
schedule was extended, and briefing is now scheduled to occur during July and
August, 2006.
IntraLase, after entry of the court's ruling, attempted to cure its default
under the License Agreement, but underpaid the amounts due to the Company based
upon a purported interpretation of "accounts receivable" that discounts the
receivables recorded on the sales substantially, and in a manner that appears to
directly contradict IntraLase's own published financial statements.
In May 2005, IntraLase filed a second suit against the Company in the
Central District of California, case number SAVC 05-440-AHS ("Second Action"),
again for declaratory relief as well as for reformation of the License
Agreement. In this action, IntraLase has asked the court to, among other things,
validate its interpretation of certain other terms of the License Agreement
relating to the amount of royalties owed to the Company and a declaration
concerning Escalon's audit rights under the License Agreement. On June 3, 2005,
after having been served with the Company's Complaint filed in the Delaware
Court of Chancery ("Delaware Action," described below), IntraLase filed an
Amended Complaint in the Second Action. The Company not having been served with
the Amended Complaint, filed a motion to dismiss the Complaint in the Second
Action on jurisdictional and substantive grounds. On June 6, 2005, the Company
filed a Motion to Dismiss the Amended Complaint on grounds virtually identical
to its first motion to dismiss. On January 11, 2006, the California Court
dismissed without prejudice the Second Action on the grounds that much of
IntraLase's lawsuit sought a ruling on issues already raised by the Company in
Escalon's Delaware Action. Accepting the Company's arguments for dismissal, the
California Court held that retaining jurisdiction would likely result in
duplicative litigation and an unnecessary entanglement between the federal and
state court actions.
As noted above, on May 15, 2005, the Company not having been served with
IntraLase's Second Action, initiated the Delaware Action by filing a Complaint
against IntraLase for, among other things, breach of contract, breach of
fiduciary duty arising out of IntraLase's bad faith conduct under, and multiple
breaches of, the License Agreement. In the Delaware Action, the Company seeks
declaratory relief, specified damages, and specific performance of its rights
under the License Agreement, including its express right under the License
Agreement to have independent certified accountants audit the books and records
of IntraLase to verify and compute payments due the Company.
On February 21, 2006, the Company again gave IntraLase notice of the
Company's intention to terminate the License Agreement due to IntraLase's
failure to pay certain royalties that the Company believed were due under the
License Agreement as well as IntraLase's refusal to permit Escalon to inspect
IntraLase's records and books of account in accordance with paragraph 5.3 of the
License Agreement.
18
IntraLase has steadfastly refused to permit inspections reasonably requested by
the Company to audit IntraLase's records and books of account and, instead,
conditions any inspection by the Company's auditors on unreasonable and
unnecessary confidentiality restrictions and unilateral limitations on the scope
of records and books of account that would be made available for inspection to
the Company. On the same day, the Company filed its First Amended Complaint in
the Delaware Action adding to its pending claims a claim for declaratory relief
wherein Escalon seeks a judgment declaring that the License Agreement terminated
fifteen days after IntraLase received the Company's notice of defaults and
intent to terminate and failed to cure those defaults.
On February 28, 2006, the Company agreed to suspend the cure periods
applicable to the alleged breaches set out in its February 21, 2006 letter while
the Company and IntraLase are engaged in mediation efforts. By order dated March
21, 2006, the Delaware Action was stayed while the Company and IntraLase
prepared for mediation. On May 5, 2006, mediation took place before Vice
Chancellor Donald F. Parsons, Jr. of the Delaware Court of Chancery, pursuant to
Chancery Court Rule 174. The mediation was unsuccessful. The Delaware Action
will proceed, and the applicable cure periods will begin to run, ten days after
the Court of Chancery enters an order lifting the stay.
Separately, on April 22, 2005, the Company as beneficial record holder of
common stock of IntraLase, made a formal written demand to inspect certain of
IntraLase's books and records pursuant to Section 220 of the Delaware General
Corporation Law. Shortly thereafter, EHI, as the record holder of common stock
of IntraLase, made the same written demand. IntraLase rejected both demands.
Thereafter, the Company and EHI filed an action in the Delaware Court of
Chancery against IntraLase seeking to enforce their shareholder rights to
inspect IntraLase's books and records ("220 Action"). The 220 Case is currently
in the discovery stage. By order dated March 21, 2006, the 220 Case was stayed
while the parties prepared for and proceeded to the unsuccessful mediation of
the Delaware Action. The 220 Case will now proceed ten days after the Court of
Chancery enters an order lifting the stay.
The Company is cognizant of the legal expenses and costs associated with
the IntraLase matter. The Company, however, is taking all necessary and
appropriate actions to protect its rights and interests under the License
Agreement. The Company expects expenses associated with this litigation to
adversely impact earnings in the near term. The Company believes that IntraLase
has sufficient funds to support such payments based on its filings with the SEC
and filings in connection with the First Action.
DREW LEGAL PROCEEDINGS
CARVER LITIGATION-CONNECTICUT ACTION
On December 17, 2002, Edward Carver, David DeCava and Diane Carver, former
principal shareholders of CDC Technologies, Inc. ("CDC Technologies"), filed a
complaint in the State of Connecticut, Superior Court, Judicial District of
Waterbury against CDC Acquisition, IV Diagnostics and certain other principal
shareholders of CDC Technologies seeking a total of approximately $420,000 for,
among other things, repayment of loans made to CDC Technologies, payment of past
wages and reimbursement of business expenses ("Connecticut Action"). The
plaintiffs' claims arose out of a certain asset purchase for stock transaction
in which CDC Acquisition, a wholly owned subsidiary of Drew, acquired the assets
of CDC Technologies and IV Diagnostics. CDC Acquisition and IV Diagnostics, also
a subsidiary of Drew, asserted counterclaims against the plaintiffs for, among
other things, breach of fiduciary duty, unfair trade and conversion. In
addition, CDC Acquisition and IV Diagnostics asserted cross-claims against the
other principal shareholders of CDC Technologies for indemnification pursuant to
the transaction agreements. A bench trial was held in June 2005. In August 2005
the court rendered a decision resulting in the court's award of only $76,000 to
plaintiffs. CDC Acquisition and IV Diagnostics filed a motion for
reconsideration of certain issues ruled upon by the court. The motion was
denied. Plaintiffs' counsel filed a motion for attorneys' fees seeking over
$181,000. The court granted such motion but awarded only $3,000 to plaintiffs'
counsel. On November 1, 2005, CDC Acquisition and IV Diagnostics timely appealed
the court's ruling that CDC Acquisitions and IV Diagnostics are liable to the
plaintiffs. CDC Acquisitions and IV Diagnostics and the plaintiffs in the
Connecticut Action have tentatively resolved their disputes. The Company will
pay approximately $81,000 to plaintiffs. The
19
Company's claims against certain of the former principal shareholders of CDC
Technologies, Inc. remain pending.
CARVER LITIGATION-SOURCE ONE LITIGATION
On December 30, 2002, Source One, a distributor of CDC Technologies filed
suit in state court in Minnesota ("Source One Litigation"), later removed to the
United States District Court in Minnesota, against CDC Technologies, Edward
Carver and CDC Acquisition, Inc. and IV Diagnostics, as successors in interest
to CDC Technologies. CDC Acquisition and IV Diagnostics asserted cross-claims
against Carver for indemnification of the amount of the judgment. The court
granted summary judgment to the Source One against defendants and awarded Source
One approximately $185,000 plus interest and costs. The court also found Carver
liable to CDC Acquisition for indemnification of the amount of the judgment.
Source One agreed to accept $140,000 from CDC Acquisition in settlement of its
claims. CDC Acquisition settled its Source One Litigation indemnification claim
against Carver for $75,000.
INSTITUTE OF CHILD HEALTH
Drew entered into a license agreement with the Institute of Child Health
("ICH") on May 10, 1993 to use ICH's intellectual property to manufacture,
lease, sell, use and sublicense certain products and all related consumables
used therein in the testing of blood and fluids. Under the license agreement
Drew was to pay royalties to ICH on the products and consumables. On January 23,
2006, the Company received a letter from ICH alleging that Drew has failed to
remit certain moneys due under the license agreement and has sought an
accounting to determine such amount due. Drew is reviewing this matter with
legal counsel and disputes the allegations for nonpayment.
DREW CORPORATE REORGANIZATION
During the reorganization of Drew's corporate structure, Drew had several
bank accounts for $330,809 not immediately available for withdrawal from a bank
in the United Kingdom. The Company anticipates that the funds will be available
for release by the bank on May 19, 2006.
OTHER 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
included intellectual property disputes, 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.
20
12. SEGMENTAL INFORMATION
During the three- and nine-month periods ended March 31, 2006 and 2005, the
Company operations were classified into four principal reportable business units
that provide different products or services. Drew became a reportable business
unit following its acquisition by the Company on July 23, 2004.
Separate management of each unit is required because each business unit is
subject to different marketing, production and technology strategies.
SEGMENTAL STATEMENTS OF OPERATIONS (IN THOUSANDS) - THREE MONTHS ENDED
MARCH 31, 2006
DREW SONOMED VASCULAR MEDICAL/TREK/EMI TOTAL
--------------- ---------------- -------------- ---------------- ----------------
2006 2005 2006 2005 2006 2005 2006 2005 2006 2005
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
REVENUES, NET:
Product revenue $ 3,870 $3,006 $ 2,001 $ 1,977 $ 893 $ 830 $ 522 $ 434 $ 7,286 $ 6,247
Other revenue 84 51 0 0 0 0 469 931 553 982
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
TOTAL REVENUE, NET 3,954 3,057 2,001 1,977 893 830 991 1,365 7,839 7,229
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
COSTS AND EXPENSES:
Cost of goods sold 2,622 1,700 966 662 447 379 348 258 4,383 2,999
Operating expenses 1,923 1,537 839 746 487 389 753 730 4,002 3,402
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
TOTAL COSTS AND EXPENSES 4,545 3,237 1,805 1,408 934 768 1,101 988 8,385 6,401
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
(LOSS) INCOME FROM OPERATIONS (591) (180) 196 569 (41) 62 (110) 377 (546) 828
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
OTHER (EXPENSE) AND
INCOME:
Gain on sale of available for
sale securities 0 0 0 0 0 0 0 0 0 0
Equity in OTM 0 0 0 0 0 0 (19) (14) (19) (14)
Interest income 0 0 0 0 0 0 34 9 34 9
Interest expense (26) (15) 0 (29) 0 0 0 29 (26) (15)
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
TOTAL OTHER (EXPENSE) AND
INCOME (26) (15) 0 (29) 0 0 15 24 (11) (20)
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
(LOSS) AND INCOME BEFORE TAXES (617) (195) 196 540 (41) 62 (95) 401 (557) 808
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
Income taxes 0 0 14 0 0 0 6 64 20 64
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
NET (LOSS) INCOME $ (617) $ (195) $ 182 $ 540 $ (41) $ 62 $ (101) $ 337 $ (577) $ 744
======= ====== ======= ======= ====== ====== ====== ======= ======= =======
Depreciation and amortization $ 65 $ 0 $ 6 $ 5 $ 28 $ 11 $ 23 $ 25 $ 122 $ 41
Assets $17,592 $8,975 $13,802 $13,499 $3,850 $2,172 $4,302 $16,084 $39,546 $40,730
Expenditures for long-lived
assets $ 33 $ 18 $ 1 $ 0 $ (0) $ 4 $ 35 $ 0 $ 69 $ 22
21
SEGMENTAL STATEMENTS OF OPERATIONS (IN THOUSANDS) - NINE MONTHS ENDED
MARCH 31, 2006
DREW SONOMED VASCULAR MEDICAL/TREK/EMI TOTAL
---------------- ----------------- --------------- ---------------- -----------------
2006 2005 2006 2005 2006 2005 2006 2005 2006 2005
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
REVENUES, NET:
Product revenue $11,071 $7,774 $ 5,802 $ 5,494 $2,703 $2,246 $1,319 $ 1,135 $20,895 $16,649
Other revenue 228 144 0 0 0 0 1,459 2,090 1,687 2,234
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
TOTAL REVENUE, NET 11,299 7,918 5,802 5,494 2,703 2,246 2,778 3,225 22,582 18,883
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
COSTS AND EXPENSES:
Cost of goods sold 7,091 4,866 2,955 2,360 1,105 1,069 860 725 12,011 9,020
Operating expenses 5,763 3,928 2,802 2,148 1,503 1,212 2,464 2,020 12,532 9,308
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
TOTAL COSTS AND EXPENSES 12,854 8,794 5,757 4,508 2,608 2,281 3,324 2,745 24,543 18,328
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
(LOSS) INCOME FROM
OPERATIONS (1,555) (876) 45 986 95 (35) (546) 480 (1,961) 555
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
OTHER (EXPENSE) AND
INCOME:
Gain on sale of available
for sale securities 0 0 0 0 0 0 1,157 0 1,157 0
Equity in OTM 0 0 0 0 0 0 (70) (50) (70) (50)
Interest income 0 4 0 0 0 0 112 50 112 54
Interest expense (46) (71) 0 0 0 (1) 0 29 (46) (43)
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
TOTAL OTHER (EXPENSE) AND
INCOME (46) (67) 0 0 0 (1) 1,199 29 1,153 (39)
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
(LOSS) AND INCOME BEFORE
TAXES (1,601) (943) 45 986 95 (36) 653 509 (808) 516
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
Income taxes 0 0 14 0 0 0 22 84 36 84
------- ------ ------- ------- ------ ------ ------ ------- ------- -------
NET (LOSS) INCOME $(1,601) $ (943) $ 31 $ 986 $ 95 $ (36) $ 631 $ 425 $ (844) $ 432
======= ====== ======= ======= ====== ====== ====== ======= ======= =======
Depreciation and
amortization $ 188 $ 97 $ 16 $ 19 $ 62 $ 34 $ 74 $ 80 $ 340 $ 230
Assets $17,592 $8,975 $13,802 $13,499 $3,850 $2,172 $4,302 $16,084 $39,546 $40,730
Expenditures for
long-lived assets $ 139 $ 26 $ 15 $ 23 $ 13 $ 11 $ 129 $ 39 $ 296 $ 99
13. SHAREHOLDERS' EQUITY
WARRANTS TO PURCHASE COMMON STOCK
In connection with debt issued by a former lender to Escalon in November
2001, the Company issued the lender warrants to purchase 60,000 shares of the
Company's common stock at $3.66 per share. The lender exercised the warrants on
December 13, 2004, in a cashless exercise, receiving 32,855 shares of the
Company's common stock in satisfaction of the warrants.
In connection with the private placement of the Company's common stock in
March 2004, the Company issued to several accredited investors warrants to
purchase 120,000 shares of the Company's common stock at $15.60 per share. The
warrants are currently exercisable and expire in March 2009. The fair market
value of the warrants was determined under the Black Scholes model and recorded
to additional paid-in capital in accordance with Emerging Issues Task Force
Issue Number 00-19, "Accounting for Derivative Financial Instruments Indexed to,
and Potentially Settled in, a Company's Own Stock" ("EITF 00-19").
14. RELATED-PARTY TRANSACTIONS
The Company and a member of the Company's Board of Directors are founding
and equal members of OTM. OTM is a diagnostic telemedicine company providing
remote examination, diagnosis and management of disorders affecting the human
eye. OTM's initial solution focuses on the diagnosis of diabetic retinopathy by
creating access and providing annual dilated retinal examinations for the
diabetic population. OTM was founded to harness the latest advances in
telecommunications, software and digital imaging in order to create greater
access and a more successful disease management for populations that are
susceptible to ocular disease. Through March 31, 2006, the Company had invested
$256,000 in OTM. As of March 31, 2006, Escalon owned 45% of OTM. The members of
OTM have agreed to review the operations of OTM after 24 months, at which time
the members each have the right to sell its membership
22
interest back to OTM at fair market value. The Company provides administrative
support functions to OTM. From inception through March 31, 2006, OTM had revenue
of approximately $16,200 and incurred expenses of approximately $213,500. This
investment is accounted for under the equity method of accounting and is
included in other assets.
Two relatives of a senior executive officer have provided legal services as
either an employee or a consultant to the Company. Expenditures related to these
individuals during the three-month periods ended March 31, 2006 and 2005, were
approximately $95,000 and $94,000, respectively. For the nine-month periods
ended March 31, 2006 and 2005, these expenditures were $273,000 and $277,000,
respectively.
15. INTRALASE INITIAL PUBLIC OFFERING
In October 1997, Escalon licensed its intellectual laser properties to
IntraLase in exchange for an equity interest of 252,535 shares of common stock
(as adjusted for splits), as well as royalties on future product sales. The
Company has historically accounted for these shares as having a $0 basis because
a readily determinable market value was previously not available. On October 7,
2004, IntraLase announced the initial public offering of shares of its common
stock at a price of $13.00 per share. The shares of common stock held by the
Company were restricted for a period of less than one year and were permitted to
be sold after April 6, 2005 pursuant to a certain Fourth Amended Registration
Rights Agreement between the Company and IntraLase. The Company sold 191,000
shares of IntraLase common stock in May 2005 at $17.9134 per share resulting in
net proceeds, after fees and commissions, of $3,411,761. As of June 30, 2005,
the Company's remaining 61,535 shares of IntraLase were classified as
available-for-sale securities and had a market value of $1,207,317.
On July 8, 2005, Company sold an additional 58,535 shares of IntraLase
common stock at $19.8226 per share resulting in gross proceeds of $1,160,316.
After paying broker commissions and other fees of $2,980, the Company received
net proceeds of $1,157,336. The net proceeds from the sale were recorded in
other income and expense. The Company's remaining 3,000 shares of IntraLase
common stock at March 31, 2006 are classified as available-for-sale securities
and had a market value of $69,600.
16. ANKA CO-MARKETING AGREEMENT
On October 11, 2005 the Company signed a non-exclusive co-marketing
agreement with privately held Anka, a provider of web-based connectivity
solutions for the ophthalmic physician. Anka's connectivity solutions are used
in major eye healthcare centers and provide seamless integration of data from
various clinical modalities commonly used in eye healthcare settings. The
co-marketing agreement will enable the Company to jointly market its existing
digital imaging hardware with Anka's connectivity solutions. By integrating the
sales and marketing efforts, the alliance should provide economies of operation
and a greater market reach. Anka is an early stage privately held company
located in the Washington, D.C. area.
In connection with the co-marketing agreement, Company extended a $300,000
loan in October 2005 and an additional loan of $100,000 in January 2006,
pursuant to demand notes, to Anka. Under the terms of these notes, repayment is
due within six months after written demand or immediately upon an event of
default. On February 16, 2006, the Company demanded repayment in accordance with
the terms of the notes and expects timely repayment.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
EXECUTIVE OVERVIEW - NINE-MONTH PERIOD ENDED MARCH 31, 2006
The following highlights are discussed in further detail within this
report. The reader is encouraged to read this report in its entirety to gain a
more complete understanding of factors impacting the Company's performance and
financial condition.
- On July 23, 2004, the Company acquired 67% of the outstanding ordinary
shares of Drew pursuant to the Company's exchange offer for all of the
outstanding ordinary shares of Drew, and since that date has acquired
all of the Drew shares. The Company has been operating Drew as a
separate business unit since its acquisition, and Drew's results of
its operations are included in the "Management's Discussion and
Analysis or Plan of Operation" for all periods since the acquisition
in July 2004. Prior to the acquisition, Drew's ability to obtain raw
materials and components was severely restricted due to prolonged
liquidity constraints. These constraints were pervasive throughout all
of Drew's locations and affected all aspects of Drew's operations. The
Company's operational priorities with respect to Drew have been to
stabilize and increase Drew's revenue base and to infuse Drew with
working capital in the areas of manufacturing, sales and marketing and
product development in an effort to remove the pre-acquisition
liquidity constraints.
- In connection with the acquisition of Drew, the Company issued 900,000
shares of its common stock during the fiscal year ended June 30, 2005,
of which 841,686 shares were issued in the six- month period ended
December 31, 2004. The balance of the shares were issued in the
six-month period ended June 30, 2005.
- Product revenue increased approximately 25.5% during the nine-month
period ended March 31, 2006 as compared to the same period last fiscal
year. The increase is primarily related to strong sales in the
Company's Drew, Sonomed, Vascular and Medical/Trek/EMI business units.
Sales at these business units increased approximately 42.4%, 5.6%,
20.4% and 16.2%, respectively, during the nine-month period ended
March 31, 2006 when compared to the same period last fiscal year.
- During July 2005, the Company sold 58,555 shares of IntraLase common
stock that had originally been received by the Company in connection
with the license of its laser properties to IntraLase in 1997. (See
note 15 of the notes to the condensed consolidated financial
statements.) The stock was sold at $19.8226 per share and yielded net
proceeds of $1,157,336 after the payment of brokers' commissions and
other fees. The net proceeds were recorded as other income in the
nine-month period ended March 31, 2006.
- Other revenue decreased approximately $547,000 or 24.5 % during the
nine-month period ended March 31, 2006 as compared to the same period
last fiscal year. The decrease primarily relates to a decrease in
royalty payments received from Bauch & Lomb in connection with the
Silicone Oil product line. During the nine-month periods ended March
31, 2006 and 2005, approximately .9% and 5.9%, respectively, of the
Company's net revenue was received from the Bauch & Lomb contract,
which expired in August 2005. Accordingly, the Company will receive no
additional revenue related to this contract. The decrease in royalties
from Bauch & Lomb was partially offset by increases in royalties from
IntraLase and Bio Rad.
- Cost of goods sold as a percentage of product revenue increased to
approximately 57.5% of revenues during the nine-month period ended
March 31, 2006, as compared to approximately 54.2% of product revenue
for the same period last fiscal year. Gross margins in the Drew
business unit have historically been lower than those in the Company's
other business units. The aggregate cost of goods sold as a percentage
of product revenue of the Sonomed, Vascular and Medical/Trek/EMI
business units during the nine-month period ended March 31, 2006
increased
24
slightly to approximately 50.0% of product revenue from approximately
46.8% in the same period last fiscal year.
- Operating expenses increased approximately 34.6% during the nine-month
period ended March 31, 2006 as compared to the same period in the
prior fiscal year. During the nine-month period ended March 31, 2006,
the Company incurred higher personnel costs to support the growth in
the Company's business operations, higher advertising, sales and
marketing salaries, travel and trade show costs related to the higher
sales volumes and higher expenses associated with the integration of
the MRP and existing EMI product lines. (The MRP acquisition closed on
January 30, 2006. See note 2 of the notes to the condensed
consolidated financial statements.) Research and development costs
also increased to support introductions and planned introductions of
new and or enhanced products, especially in the Drew and Sonomed
business units. In addition, the Company continues to experience a
high amount of legal and accounting fees primarily related to
IntraLase litigation costs, increased auditors fees in proportion to
the increase in the Company's size due to the acquisition of Drew and
costs related to compliance with the Sarbanes-Oxley Act of 2002. While
the Company expects these legal, accounting and compliance expenses to
impact earnings in the near term, it does not believe that all of
these expenses will continue in the future at such high levels.
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
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, product
development, the introduction of new products, the potential markets and uses
for the Company's products, the Company's regulatory filings with the FDA,
acquisitions, 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 and defending the
Company in litigation matters. 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 should not
consider the following list of such factors to be an exhaustive statement of all
risks, uncertainties or potentially inaccurate assumptions.
The Company cautions the reader to consider carefully these factors as well
as the specific factors discussed with each specific forward-looking statement
in this quarterly report and in the Company's other filings with the SEC. In
some cases, these factors have impacted, and in the future (together with other
unknown factors) could impact, the Company's ability to implement the Company's
business strategy and may cause actual results to differ materially from those
contemplated by such forward-looking statements. Any expectation, estimate or
projection contained in a forward-looking statement may not be achieved.
The Company also cautions the reader that forward-looking statements speak
only as of the date made. The Company undertakes no obligation to update any
forward-looking statement, but investors are advised to consult any further
disclosures by the Company on this subject in the Company's filings with the
SEC, in which the Company discusses in more detail various important factors
that could cause actual results to differ from expected or historical results.
Although it is not possible to create a comprehensive list of all factors that
may cause actual results to differ from the Company's forward-looking
statements, the most important factors include, without limitation, the
following:
25
ANY ACQUISITIONS, STRATEGIC ALLIANCES, JOINT VENTURES AND DIVESTITURES THAT
THE COMPANY EFFECTS COULD RESULT IN FINANCIAL RESULTS THAT DIFFER FROM
MARKET EXPECTATIONS.
In the normal course of business, the Company engages in discussions with
third parties regarding possible acquisitions, strategic alliances, joint
ventures and divestitures. As a result of any such transactions, the Company's
financial results may differ from the investment community's expectations in a
given quarter. In addition, acquisitions and alliances may require the Company
to integrate a different company culture, management team, business
infrastructure, accounting systems and financial reporting systems, although
such acquisitions or alliances may not occur. The Company may have difficulty
developing, manufacturing and marketing the products of a newly acquired company
in a way that enhances the performance of the Company's combined businesses or
product lines to realize the value from expected synergies. Depending on the
size and complexity of an acquisition, the Company's successful integration of
the entity depends on a variety of factors including the retention of key
employees and the management of facilities and employees in separate
geographical areas. These efforts require varying levels of management
resources, which may divert the Company's attention from other business
operations. The Company acquired Drew during the first quarter of fiscal 2005.
Drew does not have a history of producing positive operating cash flows and, as
a result, at the time of acquisition, was operating under financial constraints
and was under-capitalized and is expected to negatively impact the Company's
financial results in the short-term. As Drew is integrated into the Company,
management will be working to reverse the situation, while at the same time
seeking to strengthen Drew's market position. The Company loaned approximately
$9,476,000 to Drew. The funds have been primarily used to procure components to
build up inventory to support the manufacturing process, to pay off accounts
payable and debt of Drew, and to expand the sales and marketing and research and
development efforts, to fund new product development and underwrite operating
losses since its acquisition. The Company anticipates that further working
capital will likely be required by Drew. If the Company does not realize the
expected benefits or synergies of such transactions, the Company's consolidated
financial position, results of operations and stock price could be negatively
impacted. Also, the Company's results may be adversely impacted because of
acquisition-related costs, amortization costs for certain intangible assets and
impairment losses related to goodwill in connection with such transactions.
COSTS ASSOCIATED WITH INTRALASE LITIGATION MAY ADVERSELY IMPACT EARNINGS IN
THE NEAR TERM.
The Company is cognizant of the escalating legal expenses and costs
associated with the IntraLase matter. The Company, however, is taking all
necessary actions to protect its rights and interests under the License
Agreement. The Company expects expenses associated with this litigation to
adversely impact earnings in the near term.
THE COMPANY'S RESULTS FLUCTUATE FROM QUARTER TO QUARTER.
The Company has experienced quarterly fluctuations in operating results and
anticipates continued fluctuations in the future. A number of factors contribute
to these fluctuations:
- Acquisitions, such as Drew, and subsequent integration of the acquired
company, although such acquisitions may not occur;
- The timing and expense of new product introductions by the Company or
its competitors, although the Company might not successfully develop
new products and any such new products may not gain market acceptance;
- The cancellation or delays in the purchase of the Company's products;
- Fluctuations in customer demand for the Company's products;
- Fluctuations in royalty income;
- The gain or loss of significant customers;
- Changes in the mix of products sold by the Company;
- Competitive pressures on prices at which the Company can sell its
products; and
- Announcements of new strategic relationships by the Company or its
competitors.
26
The Company sets its spending levels in advance of each quarter based, in
part, on the Company's expectations of product orders and shipments during that
quarter. A shortfall in revenue, therefore, in any particular quarter as
compared to the Company's plan could have a material adverse impact on the
Company's results of operations and cash flows. Also, the Company's quarterly
results could fluctuate due to general market conditions in the healthcare
industry or global economy generally, or market volatility unrelated to the
Company's business and operating results.
FAILURE OF THE MARKET TO ACCEPT THE COMPANY'S PRODUCTS COULD ADVERSELY
IMPACT THE COMPANY'S BUSINESS AND FINANCIAL CONDITION.
The Company's business and financial condition will depend in part upon the
market acceptance of the Company's products. The Company's products may not
achieve market acceptance. Market acceptance depends on a number of factors
including:
- The price of the products;
- The receipt of regulatory approvals for multiple indications;
- The establishment and demonstration of the clinical safety and
efficacy of the Company's products; and
- The advantages of the Company's products over those marketed by the
Company's competitors.
Any failure to achieve significant market acceptance of the Company's
products will have a material adverse impact on the Company's business.
THE COMPANY NO LONGER RECEIVES REVENUE FROM THE SALE OF SILICONE OIL BY
BAUSCH & LOMB UNDER A CONTRACT THAT EXPIRED ON AUGUST 12, 2005.
The Company received approximately 1.4% and 6.5% of its net revenue during
the nine-month periods ended March 31, 2006 and 2005, respectively, from Bausch
& Lomb's sales of Silicone Oil. The Company was entitled to receive this revenue
from Bausch & Lomb, in varying amounts, through August 12, 2005. The Company
will not receive any future revenue related to the Silicone Oil royalty as the
contract expired on August 12, 2005.
THE COMPANY'S PRODUCTS ARE SUBJECT TO STRINGENT ONGOING REGULATION BY THE
FDA AND SIMILAR HEALTH CARE REGULATORY AUTHORITIES, AND IF THE FDA'S
APPROVALS OR CLEARANCES OF THE COMPANY'S PRODUCTS ARE RESTRICTED OR
REVOKED, THE COMPANY COULD FACE DELAYS THAT WOULD IMPAIR THE COMPANY'S
ABILITY TO GENERATE FUNDS FROM OPERATIONS.
The FDA and similar health care regulatory authorities in foreign countries
extensively regulate the Company's activity. The Company must obtain either
510(K) clearances or pre-market approvals and new drug application approvals
prior to marketing a product in the United States. Foreign regulation also
requires that the Company obtain other approvals from foreign government
agencies prior to the sale of products in those countries. Also, the Company may
be required to obtain FDA approval before exporting a product or device that has
not received FDA marketing clearance or approval.
The Company has received the necessary FDA approvals for all products that
the Company currently markets in the United States. Any restrictions on or
revocation of the FDA approvals and clearances that the Company has obtained,
however, would prevent the continued marketing of the impacted products and
other devices. The restrictions or revocations could result from the discovery
of previously unknown problems with the product. Consequently, FDA revocation
would impair the Company's ability to generate funds from operations.
The FDA and comparable agencies in state and local jurisdictions and in
foreign countries impose substantial requirements upon the manufacturing and
marketing of pharmaceutical and medical device equipment and related
disposables, including the obligation to adhere to the FDA's Good Manufacturing
Practice regulations. Compliance with these regulations requires time-consuming
detailed validation of manufacturing and quality control processes, FDA periodic
inspections and other procedures. If the FDA
27
finds any deficiencies in the validation processes, for example, the FDA may
impose restrictions on marketing the specific products until such deficiencies
are corrected.
The Company has received CE approval on several of the Company's products
that allows the Company to sell the products in the countries comprising the
European community. In addition to the CE mark, however, some foreign countries
may require separate individual foreign regulatory clearances. The Company may
not be able to obtain regulatory clearances for other products in the United
States or foreign markets.
The process for obtaining regulatory clearances and approvals underlying
clinical studies for any new products or devices and for multiple indications
for existing products is lengthy and will require substantial commitments of
Company's financial resources and Company's management's time and effort. Any
delay in obtaining clearances or approvals or any changes in existing regulatory
requirements would materially adversely impact the Company's business.
The Company's failure to comply with the applicable regulations would
subject the Company to fines, delays or suspensions of approvals or clearances,
seizures or recalls of products, operating restrictions, injunctions or civil or
criminal penalties, which would adversely impact the Company's business,
financial condition and results of operations.
THE SUCCESS OF COMPETITIVE PRODUCTS COULD HAVE AN ADVERSE IMPACT ON THE
COMPANY'S BUSINESS.
The Company faces intense competition in the medical device and
pharmaceutical markets, which are characterized by rapidly changing technology,
short product life cycles, cyclical oversupply and rapid price erosion. Many of
the Company's competitors have substantially greater financial, technical,
marketing, distribution and other resources. The Company's strategy is to
compete primarily on the basis of technological innovation, reliability, quality
and price of the Company's products. Without timely introductions of new
products and enhancements, the Company's products will become technologically
obsolete over time, in which case the Company's revenues and operating results
would suffer. The success of the Company's new product offerings will depend on
several factors, including the Company's ability to:
- Properly identify customer needs;
- Innovate and develop new technologies, services and applications;
- Establish adequate product distribution coverage;
- Obtain and maintain required regulatory approvals from the FDA and
other regulatory agencies;
- Protect the Company's intellectual property;
- Successfully commercialize new technologies in a timely manner;
- Manufacture and deliver the Company's products in sufficient volumes
on time;
- Differentiate the Company's offerings from the offerings of the
Company's competitors;
- Price the Company's products competitively;
- Anticipate competitors' announcements of new products, services or
technological innovations; and
- Anticipate general market and economic conditions.
The Company cannot ensure that the Company will be able to compete
effectively in the competitive environments in which the Company operates.
THE COMPANY'S PRODUCTS EMPLOY PROPRIETARY TECHNOLOGY, AND THIS TECHNOLOGY
MAY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF THIRD PARTIES.
The Company holds several United States and foreign patents for the
Company's products. Other parties, however, hold patents relating to similar
products and technologies. If patents held by others were adjudged valid and
interpreted broadly in an adversarial proceeding, the court or agency could deem
them
28
to cover one or more aspects of the Company's products or procedures. Any claims
for patent infringements or claims by the Company for patent enforcement would
consume time, result in costly litigation, divert technical and management
personnel or require the Company to develop non-infringing technology or enter
into royalty or licensing agreements. The Company cannot be certain that the
Company will not be subject to one or more claims for patent infringement, that
the Company would prevail in any such action or that the Company's patents will
afford protection against competitors with similar technology.
If a court determines that any of the Company's products infringes,
directly or indirectly, on a patent in a particular market, the court may enjoin
the Company from making, using or selling the product. Furthermore, the Company
may be required to pay damages or obtain a royalty-bearing license, if
available, on acceptable terms.
LACK OF AVAILABILITY OF KEY SYSTEM COMPONENTS COULD RESULT IN DELAYS,
INCREASED COSTS OR COSTLY REDESIGN OF THE COMPANY'S PRODUCTS.
Although some of the parts and components used to manufacture the Company's
products are available from multiple sources, the Company currently purchases
most of the Company's components from single sources in an effort to obtain
volume discounts. Lack of availability of any of these parts and components
could result in production delays, increased costs or costly redesign of the
Company's products. Any loss of availability of an essential component could
result in a material adverse change to the Company's business, financial
condition and results of operations. Some of the Company's suppliers are subject
to the FDA's Good Manufacturing Practice regulations. Failure of these suppliers
to comply with these regulations could result in the delay or limitation of the
supply of parts or components to the Company, which would adversely impact the
Company's financial condition and results of operations.
THE COMPANY'S ABILITY TO MARKET OR SELL THE COMPANY'S PRODUCTS MAY BE
ADVERSELY IMPACTED BY LIMITATIONS ON REIMBURSEMENTS BY GOVERNMENT PROGRAMS,
PRIVATE INSURANCE PLANS AND OTHER THIRD PARTY PAYORS.
The Company's customers bill various third party payors, including
government programs and private insurance plans, for the health care services
provided to their patients. Third party payors may reimburse the customer,
usually at a fixed rate based on the procedure performed, or may deny
reimbursement if they determine that the use of the Company's products was
elective, unnecessary, inappropriate, not cost-effective, experimental or used
for a non-approved indication. Third party payors may deny reimbursement
notwithstanding FDA approval or clearance of a product and may challenge the
prices charged for the medical products and services. The Company's ability to
sell the Company's products on a profitable basis may be adversely impacted by
denials of reimbursement or limitations on reimbursement, compared with
reimbursement available for competitive products and procedures. New legislation
that further reduces reimbursements under the capital cost pass-through system
utilized in connection with the Medicare program could also adversely impact the
marketing of the Company's products.
FUTURE LEGISLATION OR CHANGES IN GOVERNMENT PROGRAMS MAY ADVERSELY IMPACT
THE MARKET FOR THE COMPANY'S PRODUCTS.
In the past several years, the federal government and Congress have made
proposals to change aspects of the delivery and financing of health care
services. The Company cannot predict what form any future legislation may take
or its impact on the Company's business. Legislation that sets price limits and
utilization controls adversely impact the rate of growth of the markets in which
the Company participates. If any future health care legislation were to
adversely impact those markets, the Company's product marketing could also
suffer, which would adversely impact the Company's business.
THE COMPANY MAY BECOME INVOLVED IN PRODUCT LIABILITY LITIGATION, WHICH MAY
SUBJECT THE COMPANY TO LIABILITY AND DIVERT MANAGEMENT ATTENTION.
29
The testing and marketing of the Company's products entails an inherent
risk of product liability, resulting in claims based upon injuries or alleged
injuries or a failure to diagnose associated with a product defect. Some of
these injuries may not become evident for a number of years. Although the
Company is not currently involved in any product liability litigation, the
Company may be party to litigation in the future as a result of an alleged
claim. Litigation, regardless of the merits of the claim or outcome, could
consume a great deal of the Company's time and attention away from the Company's
core businesses. The Company maintains limited product liability insurance
coverage of $1,000,000 per occurrence and $2,000,000 in the aggregate, with
umbrella policy coverage of $5,000,000 in excess of such amounts. A successful
product liability claim in excess of any insurance coverage may adversely impact
the Company's financial condition and results of operations. The Company's
product liability insurance coverage may not continue to be available to the
Company in the future on reasonable terms or at all.
THE COMPANY'S INTERNATIONAL OPERATIONS COULD BE ADVERSELY IMPACTED BY
CHANGES IN LAWS OR POLICIES OF FOREIGN GOVERNMENTAL AGENCIES AND SOCIAL AND
ECONOMIC CONDITIONS IN THE COUNTRIES IN WHICH THE COMPANY OPERATES.
The Company derives a portion of its revenue from sales outside the United
States. Changes in the laws or policies of governmental agencies, as well as
social and economic conditions, in the countries in which the Company operates
could impact the Company's business in these countries and the Company's results
of operations. Also, economic factors, including inflation and fluctuations in
interest rates and foreign currency exchange rates, and competitive factors such
as price competition, business combinations of competitors or a decline in
industry sales from continued economic weakness, both in the United States and
other countries in which the Company conducts business, could adversely impact
the Company's results of operations.
THE COMPANY IS DEPENDENT ON ITS MANAGEMENT AND KEY PERSONNEL TO SUCCEED.
The Company's principal executive officers and technical personnel have
extensive experience with the Company's products, the Company's research and
development efforts, the development of marketing and sales programs and the
necessary support services to be provided to the Company's customers. Also, the
Company competes with other companies, universities, research entities and other
organizations to attract and retain qualified personnel. The loss of the
services of any of the Company's executive officers or other technical
personnel, or the Company's failure to attract and retain other skilled and
experienced personnel, could have a material adverse impact on the Company's
ability to maintain or expand businesses.
THE MARKET PRICE OF THE COMPANY'S STOCK HAS HISTORICALLY BEEN VOLATILE, AND
THE COMPANY HAS NOT PAID CASH DIVIDENDS.
The volatility of the Company's common stock imposes a greater risk of
capital losses on shareholders as compared to less volatile stocks. In addition,
such volatility makes it difficult to ascribe a stable valuation to a
shareholder's holdings of the Company's common stock. The following factors have
and may continue to have a significant impact on the market price of the
Company's common stock:
- Any acquisitions, strategic alliances, joint ventures and divestitures
that the Company effects;
- Announcements of technological innovations;
- Changes in marketing, product pricing and sales strategies or new
products by the Company's competitors;
- Changes in domestic or foreign governmental regulations or regulatory
requirements; and
- Developments or disputes relating to patent or proprietary rights and
public concern as to the safety and efficacy of the procedures for
which the Company's products are used.
Moreover, the possibility exists that the stock market, and in particular
the securities of technology companies such as Escalon, could experience extreme
price and volume fluctuations unrelated to operating performance.
30
The Company has not paid cash dividends on its common stock and does not
anticipate paying cash dividends in the foreseeable future.
THE IMPACT OF TERRORISM OR ACTS OF WAR COULD HAVE A MATERIAL ADVERSE IMPACT
ON THE COMPANY'S BUSINESS.
Terrorist acts or acts of war, whether in the United States or abroad,
could cause damage or disruption to the Company's operations, its suppliers,
channels to market or customers, or could cause costs to increase, or create
political or economic instability, any of which could have a material adverse
impact on the Company's business.
THE COMPANY'S CHARTER DOCUMENTS AND PENNSYLVANIA LAW MAY INHIBIT A
TAKEOVER.
Certain provisions of Pennsylvania law and the Company's Bylaws could delay
or impede the removal of incumbent directors and could make it more difficult
for a third party to acquire, or discourage a third party from attempting to
acquire, control of the Company. These provisions could limit the share price
that certain investors might be willing to pay in the future for shares of the
Company's common stock. The Company's Board of Directors is divided into three
classes, with directors in each class elected for three-year terms. The Bylaws
impose various procedural and other requirements that could make it more
difficult for shareholders to effect certain corporate actions. The Company's
Board of Directors may issue shares of preferred stock without shareholder
approval on such terms and conditions, and having such rights, privileges and
preferences, as the Board may determine. The rights of the holders of common
stock will be subject to, and may be adversely impacted by, the rights of the
holders of any preferred stock that may be issued in the future. The Company has
no current plans to issue any shares of preferred stock.
COMPANY OVERVIEW
The following discussion should be read in conjunction with interim
condensed consolidated financial statements and the notes thereto, which are set
forth elsewhere in this report.
The Company operates in the healthcare market specializing in the
development, manufacture, marketing and distribution of medical devices and
pharmaceuticals in the areas of ophthalmology, diabetes, hematology and vascular
access. 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.
In February 1996, the Company acquired substantially all of the assets and
certain liabilities of EOI, a developer and distributor of ophthalmic surgical
products. Prior to this acquisition, the Company devoted substantially all of
its resources to the research and development of ultra fast laser systems
designed for the treatment of ophthalmic disorders. As a result of the EOI
acquisition, Escalon changed its market focus and ceased developing laser
technology. In October 1997, the Company licensed its intellectual laser
property to IntraLase, in return for an equity interest and future royalties on
sales of products. IntraLase undertook responsibility for funding and developing
the laser technology through to commercialization. IntraLase began selling
products related to the laser technology during fiscal 2002 and announced its
initial public offering of its common stock in October 2004. (See notes 10, 11
and 15 of the notes to the condensed consolidated financial statements for
further information.) The Company is in dispute with IntraLase over royalty
payments owed to the Company. (See note 11 of the notes to the condensed
consolidated financial statements for further information.)
To further diversify its product portfolio, in January 1999, the Company's
Vascular subsidiary acquired the vascular access product line from Endologix,
formerly Radiance Medical Systems, Inc. Vascular's products use Doppler
technology to aid medical personnel in locating arteries and veins in difficult
circumstances. Currently, this product line is concentrated in the cardiac
catheterization market. In January 2000, the Company purchased Sonomed, a
privately held manufacturer of ophthalmic ultrasound diagnostic equipment.
31
On July 23, 2004, the Company acquired 67% of the outstanding ordinary
shares of Drew, a United Kingdom company, pursuant to the Company's exchange
offer for all of the outstanding ordinary shares of Drew, and since that date
has acquired all of the Drew shares. Drew is a diagnostics company specializing
in the design, manufacture and distribution of instruments for blood cell
counting and blood analysis. Drew is focused on providing instrumentation and
consumables for the physician office and veterinary office laboratories. Drew
also supplies the reagent and other consumable materials needed to operate the
instruments.
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 for SFAS 142, discussed further in
Note 7 of the notes to the condensed consolidated financial statements included
in this report. 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 and 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 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.
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 an immediate 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.
32
VALUATION OF INTANGIBLE ASSETS
The Company annually evaluates for impairment its intangible assets and
goodwill in accordance with SFAS 142, "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. Factors the Company considers important that could trigger an
impairment review include significant under-performance relative to historical
or projected future operating results or significant negative industry or
economic trends. If these criteria indicate that the value of the intangible
asset may be impaired, an evaluation of the recoverability of the net carrying
value of the asset is made. If this evaluation indicates that the intangible
asset is not recoverable, the net carrying value of the related intangible asset
will be reduced to fair value. 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. No impairment losses were recorded
for goodwill, trademarks and trade names during any of the periods presented
based on these evaluations.
INCOME/(LOSS) PER SHARE
The Company computes net income/(loss) per share under the provisions of
SFAS No. 128, Earnings per Share (SFAS 128), and Staff Accounting Bulletin, No.
98 (SAB 98).
Under the provisions of SFAS 128 and SAB 98, 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 effect 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 will be for the year. Since judgment is involved,
there is a risk that the tax rate may significantly 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 of the deferred tax assets, which arise from temporary
differences between the tax and financial statement recognition of revenue and
expense. SFAS 109 also requires 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 March 31, 2006, the Company has recorded a full valuation allowance
against the Company's net operating losses due to the 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 carry forwards. Any reduction would reduce (increase) the income tax
expense (benefit) in the period such determination is made by the Company.
33
THREE- AND NINE-MONTH PERIODS ENDED MARCH 31, 2006 AND 2005
The following table shows consolidated product revenue by business unit as
well as identifying trends in business unit product revenues for the three- and
nine-month periods ended March 31, 2006 and 2005. Table amounts are in
thousands:
THREE-MONTH PERIOD ENDED NINE-MONTH PERIOD ENDED
MARCH 31, MARCH 31,
-------------------------- ----------------------------
2006 2005 % CHANGE 2006 2005 % CHANGE
------ ------ -------- ------- ------- --------
PRODUCT REVENUE:
Drew $3,870 $3,006 28.7% $11,071 $ 7,774 42.4%
Sonomed 2,001 1,977 1.2% 5,802 5,494 5.6%
Vascular 893 830 7.6% 2,703 2,246 20.4%
Medical/Trek/EMI 522 434 20.3% 1,319 1,135 16.2%
------ ------ ---- ------- ------- ----
TOTAL $7,286 $6,247 16.6% $20,895 $16,649 25.5%
====== ====== ==== ======= ======= ====
Product revenue increased approximately $1,039,000, or 16.6%, to $7,286,000
during the three-month period ended March 31, 2006 as compared to the same
period last fiscal year. In the Drew business unit, product revenue increased
$864,000, or 28.7%, as compared to the same period last fiscal year. The
increase is primarily due to additional sales in the domestic market of
diabetics and hematology instruments, which offset a small decrease in
international sales of instruments. Sales of instruments increased by
approximately $600,000 in the three-month period ended March 31, 2006 as
compared to the same period last prior year. Sales of spare parts and reagents
and controls, which are used to operate the instruments, were both up slightly
during the period.
Product revenue increased $24,000, or 1.2%, at the Sonomed business unit as
compared to the same period last fiscal year. The increase in product revenue
was primarily caused by an increase in sales of the Company's EZ AB scan
ultrasound systems and an increase in export sales, which were partially offset
by a decrease in domestic sales and in demand for the Company's pachymeter
product. The domestic market for pachymeters had previously expanded in the
prior fiscal year due to enhanced techniques in glaucoma screening performed by
optometrists, who had historically not been users of the pachymeter. Domestic
demand for the pachymeter returned to historic levels during the fourth quarter
of fiscal 2005 due to market saturation and increased price competition within
the marketplace.
Product revenue increased $63,000, or 7.6%, to $893,000 in the Vascular
business unit during the three-month period ended March 31, 2006 as compared to
the same period last fiscal year. The increase in product revenue in the
Vascular business unit was primarily caused by an increase in direct sales to
end users by the Company's domestic sales team. These increases were partially
offset by decreases in revenue from the Company's distributor network and a
slight decrease in international sales. The Company terminated its relationship
with several of its distributors during the prior fiscal year. In the
Medical/Trek/EMI business unit, product revenue increased $88,000, or 20.3%, to
$522,000 during the three-month period ended March 31, 2006 as compared to the
same period last fiscal year. The increase in Medical/Trek/EMI product revenue
is primarily attributed to an increase in the Trek business unit revenue from
Bausch & Lomb and an increase in EMI sales of digital imaging systems.
Product revenue increased approximately $4,226,000, or 25.5%, to
$20,895,000 during the nine-month period ended March 31, 2006 as compared to the
same period last fiscal year. In the Drew business unit, product revenue
increased $3,297,000, or 42.4 %, as compared to the same period last fiscal
year. The increase is primarily due to additional sales in the domestic and
international markets of diabetics and hematology instruments. Sales of
instruments increased by approximately $2,300,000 in the nine-month period ended
March 31, 2006 as compared to the same period last prior year. Sales of spare
parts and
34
reagents and controls, which are used to operate the instruments, also increased
during the period to support the increase in the installed base of the related
instruments.
Product revenue increased $308,000, or 5.6%, at the Sonomed business unit
as compared to the same period last fiscal year. The increase in product revenue
was primarily caused by an increase in sales of the Company's EZ AB scan
ultrasound systems and an increase in export sales, which were partially offset
by a decrease in domestic sales and in demand for the Company's pachymeter
product. The domestic market for pachymeters had previously expanded due to
enhanced techniques in glaucoma screening performed by optometrists, who had
historically not been users of the pachymeter. Domestic demand for the
pachymeter returned to historic levels during the fourth quarter of fiscal 2004
due to market saturation and increased price competition within the marketplace.
Product revenue increased $457,000, or 20.4%, to $2,246,000 at the Vasuclar
business unit during the nine-month period ended March 31, 2006 as compared to
the same period last fiscal year. The increase in product revenue in the
Vascular business unit was primarily caused by an increase in direct sales to
end users by the Company's domestic sales team. These increases were partially
offset by decreases in revenue from the Company's distributor network. The
Company terminated its relationship with several of its distributors during the
prior fiscal year. In the Medical/Trek/EMI business unit, product revenue
increased $184,000 or 16.2% to $1,319,000 during the nine-month period ended
March 31, 2006 as compared to the same period last fiscal year. The increase in
Medical/Trek/EMI product revenue is primarily attributed to an increase in the
Trek business unit revenue from Bausch & Lomb and an increase in EMI sales of
digital imaging systems.
Other revenue decreased by approximately $429,000, or 43.7 %, to $553,000
during the three-month period ended March 31, 2006 as compared to the same
period last fiscal year. The decrease is primarily due to an approximately
$364,000 decrease in royalties received from Bausch & Lomb in connection with
their sales of Silicone Oil. The Company's contract with Bausch & Lomb called
for annual step-downs in the calculation of Silicone Oil revenue to be received
by the Company from 64% from August 13, 2003 to August 12, 2004 to 45% from
August 13, 2004 to August 12, 2005. The Company's contract with Bausch & Lomb
ended in August 2005, and accordingly, the Company received no royalties in the
three-month period ended March 31, 2006 and will receive no future royalties
under this agreement. (See note 10 of the notes to the condensed consolidated
financial statements for a description of the step-down provisions under the
contract with Bausch & Lomb.) Royalties from Bio-Rad related to an OEM agreement
between Bio-Rad and Drew increased by approximately $33,000 to $84,000 due to
higher sales of Drew's products in covered areas. While this agreement
terminated as of May 15, 2005, the parties have continued to operate under the
terms of the expired agreement pending negotiation of a potential extension
and/or revision. Also contributing to the decrease in other revenue was a
$98,000 reduction in royalty payments received from IntraLase related to the
licensing of the Company's intellectual laser technology. Royalties decreased
due to the method of calculating its royalty payments to the Company by
Intralase and is the subject of litigation. (See notes 10 and 11 of the notes to
the condensed consolidated financial statements.)
Other revenue decreased by approximately $547,000, or 24.5%, to $1,687,000
during the nine-month period ended March 31, 2006 as compared to the same period
last fiscal year. The decrease is primarily due to an approximately $916,000
decrease in royalties received from Bausch & Lomb in connection with their sales
of Silicone Oil. The Company's contract with Bausch & Lomb called for annual
step-downs in the calculation of Silicone Oil revenue to be received by the
Company from 64% from August 13, 2003 to August 12, 2004 to 45% from August 13,
2004 to August 12, 2005. The Company's contract with Bausch & Lomb ended in
August 2005, and, accordingly, the Company will receive no future royalties
under this agreement. (See note 10 of the notes to the condensed consolidated
financial statements.) The decrease in royalties from Bausch & Lomb was
partially offset by an approximately $286,000 increase in royalty payments
received from IntraLase related to the licensing of the Company's intellectual
laser technology. IntraLase royalties increased partially due to a court order
amending IntraLase's method of calculating its royalty payments to the Company
and revenue growth by IntraLase. (See notes 10 and 11 of the notes to the
condensed consolidated financial statements.) Also
35
offsetting the decrease in Bausch & Lomb royalties was an $85,000 increase from
Bio-Rad related to an OEM agreement between Bio-Rad and Drew.
The following table presents consolidated cost of goods sold by reportable
business unit and as a percentage of related unit product revenues for the three
and nine-month periods ended March 31, 2006 and 2005. Table amounts are in
thousands:
THREE-MONTH PERIOD ENDED MARCH 31, NINE-MONTH PERIOD ENDED MARCH 31,
---------------------------------- ---------------------------------
2006 % 2005 % 2006 % 2005 %
------ ---- ------ ---- ------- ---- ------ ----
COST OF GOODS SOLD:
Drew $2,622 67.8% $1,700 56.6% $ 7,091 64.1% $4,866 62.6%
Sonomed 966 48.3% 662 33.5% 2,955 50.9% 2,360 43.0%
Vascular 447 50.1% 379 45.7% 1,105 40.9% 1,069 47.6%
Medical/Trek/EMI 348 66.7% 258 59.5% 860 65.2% 725 63.9%
------ ---- ------ ---- ------- ---- ------ ----
TOTAL $4,383 60.2% $2,999 48.0% $12,011 57.5% $9,020 54.2%
====== ==== ====== ==== ======= ==== ====== ====
Cost of goods sold totaled approximately $4,383,000, or 60.2% of product
revenue, for the three-month period ended March 31, 2006 as compared to
$2,999,000, or 48.0% of product revenue, for the same period last fiscal year.
Cost of goods sold in the Drew business unit totaled $2,622,000, or 67.8% of
product revenue, for the three-month period ended March 31, 2006 as compared to
$1,700,000, or 56.6% of product revenue, for the same period last fiscal year.
The increase in the cost of goods sold as a percentage of revenue was due to a
shift in the mix of products sold and a decrease in manufacturing gains
experienced in the prior fiscal year. Instrument and OEM sales were a higher
percentage of total revenues than in the same period last fiscal year.
Instrument and OEM sales historically have lower margins than the sales of
reagents and controls, which are used to operate the instruments.
Cost of goods sold in the Sonomed business unit totaled $966,000, or 48.3%
of product revenue, for the three-month period ended March 31, 2006 as compared
to $662,000, or 33.5% of product revenue, for the same period last fiscal year.
The primary reason for the increase was an increase in the percentage of sales
during the period that were international sales. The Company historically
experiences a lower selling price per unit on its international product sales.
In addition, the Company experienced a significantly higher margin in the prior
year on pachymeters sales due to significant market demand. The demand returned
to normal commencing in the fourth quarter of fiscal 2005. Cost of goods sold in
the Vascular business unit totaled $447,000, or 50.1% of product revenue, for
the three-month period ended March 31, 2006 as compared to $379,000, or 45.7% of
product revenue, for the same period last fiscal year. The Company experienced
higher overtime and lower production efficiencies in the current period as
compared to the prior period. Cost of goods sold in the Medical/Trek/EMI
business unit totaled $348,000, or 66.7% of product revenue, during the
three-month period ended March 31, 2006 as compared to $258,000, or 59.5% of
product revenue, during the same period last fiscal year. Fluctuations in
Medical/Trek/EMI cost of goods sold primarily emanates from product mix, which
was primarily controlled by market demand. Further contributing to the increase
was the integration of MRP into the existing EMI product lines.
Cost of goods sold totaled approximately $12,011,000, or 57.5 % of product
revenue, for the nine-month period ended March 31, 2006 as compared to
$9,020,000, or 54.2% of product revenue, for the same period last fiscal year.
Cost of goods sold in the Drew business unit totaled $7,091,000, or 64.1% of
product revenue, for the nine-month period ended March 31, 2006 as compared to
$4,866,000, or 62.6% of product revenue, for the same period last fiscal year.
The increase in the cost of goods sold as a percentage of revenue was due to a
shift in the mix of products sold and a decrease in manufacturing gains
experienced in the prior fiscal year. Instrument sales were a higher percentage
of total revenues than in the same period last fiscal year. Instrument sales
historically have lower margins than the sales of reagents and controls which
are used to operate the instruments. These increases were partially offset by a
decrease in material costs resulting from the easing of pre-acquisition
liquidity constraints at Drew following its acquisition by
36
the Company and operating efficiencies gained through both manufacturing changes
implemented post-acquisition and higher production volumes during the nine-month
period ended March 31, 2006 as compared to the same period last fiscal year.
Cost of goods sold in the Sonomed business unit totaled $2,955,000, or
50.9% of product revenue, for the nine-month period ended March 31, 2006 as
compared to $2,360,000, or 43.0% of product revenue, for the same period last
fiscal year. The primary reason for the increase was an increase in the
percentage of sales during the period that were international sales. The Company
historically experiences a lower selling price per unit on its international
product sales. In addition, the Company experienced a significantly higher
margin in prior year on pachymeters sales due to market demand. Cost of goods
sold in the Vascular business unit totaled $1,105,000, or 45.7% of product
revenue, for the nine-month period ended March 31, 2006 as compared to
$1,069,000, or 47.6% of product revenue, for the same period last fiscal year.
The primary factor affecting the decrease in cost of goods sold as a percentage
of product revenue was the increase in direct sales to end users and
corresponding decrease in sales through the Company's distributor network where
the Company generally experiences lower price per unit on its products. The
percentage was slightly offset by an increase in overtime and lower production
efficiencies. Cost of goods sold in the Medical/Trek/EMI business unit totaled
$850,000, or 64.4% of product revenue, during the nine-month period ended March
31, 2006 as compared to $725,000, or 63.9% of product revenue, during the same
period last fiscal year. Fluctuations in Medical/Trek/EMI cost of goods sold
primarily emanates from product mix, which was primarily controlled by market
demand. Further contributing to the increase was the integration of MRP into the
existing EMI product lines.
The following table presents consolidated marketing, general and
administrative expenses as well as identifying trends in business unit
marketing, general and administrative expenses for the three and nine-month
periods ended March 31, 2006 and 2005. Table amounts are in thousands:
THREE-MONTH PERIOD ENDED NINE-MONTH PERIOD ENDED
MARCH 31, MARCH 31,
-------------------------- ---------------------------
2006 2005 % CHANGE 2006 2005 % CHANGE
------ ------ -------- ------- ------ --------
MARKETING, GENERAL AND ADMINISTRATIVE:
Drew $1,434 $1,184 21.1% $ 4,440 $3,129 41.9%
Sonomed 466 405 15.1% 1,597 1,068 49.5%
Vascular 365 327 11.9% 1,186 981 20.8%
Medical/Trek/EMI 1,018 1,020 -0.1% 3,173 2,871 10.5%
------ ------ ---- ------- ------ ----
TOTAL $3,284 $2,935 11.9% $10,396 $8,050 29.1%
====== ====== ==== ======= ====== ====
Marketing, general and administrative expenses increased $349,000, or
11.9%, to $3,284,000 during the three-month period ended March 31, 2006 as
compared to the same period last fiscal year. Marketing, general and
administrative expenses in the Drew business unit increased $250,000, or 21.1%,
to $1,434,000 as compared to the same period last fiscal year. The increase is
primarily due to higher personnel (approximately $331,000) and advertising costs
related to improving the image of the Drew brand with both customers and
distributors, improving the product distributor network and expanding the
management team, which ultimately helped contribute to the 28.7% increase in
product revenue when compared to the corresponding prior year period. Slightly
offsetting these expenses was a decrease in travel and trade show expenses by
$64,000 due to less travel between Company locations.
Marketing, general and administrative expenses in the Sonomed business unit
increased by $61,000, or 15.1%, to $466,000 as compared to the same period last
fiscal year. Marketing and sales salaries, and travel expenses related to
additional sales personnel, increased by approximately $40,000 as part of the
Company's focus on increasing domestic and foreign revenues. Advertising
expenses increased by approximately $30,000 related to exhibits and brochures
advertising the Company's Ultrasound Biomicrosopes instrument ("UBM").
Offsetting these increases were rent and utilities expense, which decreased by
$11,000 as the Company relocated to lower cost facilities in 2005.
37
Marketing, general and administrative expenses in the Vascular business
unit increased $39,000, or 11.9%, to $365,000 as compared to the same period
last fiscal year. Salaries and other personnel-related expenses increased
approximately $21,000 and travel related expenses increased by approximately
$10,000 when compared to the prior fiscal period. Both increases were related to
supporting a higher volume of business during the current period as compared to
the same period in the prior fiscal year.
Marketing, general and administrative expenses in the Medical/Trek/EMI
business unit slightly decreased $1,000, or .1%, to $1,018,000 as compared to
the same period last fiscal year. Accounting fees and sales and marketing
expenses related to the MRP product line increased by $54,000 and $77,000,
respectively. Accounting fees were higher due to audit fees related to
Sarbanes-Oxley compliance and higher third party consulting fees for tax and
temporary services. Sales and marketing expenses increased due to costs related
to the integration of the MRP with the EMI product lines, and the joint
marketing and integration of the Company's product line with Anka Systems as
part of a co-marketing agreement. (See notes 2 and 6 of the notes to the
condensed consolidated financial statements.) Offsetting these expenses were a
reduction in legal expenses and corporate salaries and benefits of $70,000 and
$43,000, respectively. Legal fees decreased as there has been less activity
related to the IntraLase litigation. The Company still anticipates these
litigation costs will continue to impact earnings in the near term. (See note 11
of the notes to the condensed consolidated financial statements for a
description of legal proceedings.) The remaining decrease was due to lower
period over period expenses in investor relations and insurance.
Marketing, general and administrative expenses increased $2,346,000, or
29.1%, to $10,396,000 during the nine-month period ended March 31, 2006 as
compared to the same period last fiscal year. Marketing, general and
administrative expenses in the Drew business unit increased $1,311,000, or
41.9%, to $4,440,000 as compared to the same period last fiscal year. The
increase is primarily due to higher personnel (approximately $609,000) and
travel, trade show and advertising costs (approximately $338,000) related to
improving the image of the Drew brand with both customers and distributors,
improving the product distributor network and expanding the management team,
which ultimately helped contribute to the 42.4% increase in product revenue when
compared to the corresponding prior year period.
Marketing, general and administrative expenses in the Sonomed business unit
increased $529,000, or 49.5%, to $1,597,000 as compared to the same period last
fiscal year. Marketing and sales salaries, commissions and other
personnel-related expenses, including amounts paid to independent agents
utilized primarily in Europe, increased approximately $233,000 as a result of
increased headcount related primarily to the Company's goal of increasing
domestic and international revenues. Sales, meeting and trade show expenses,
travel and lodging, and advertising increased by a combined amount of
approximately $243,000 related primarily to the focus on growing sales and the
introduction of the Company's new UMB, which was introduced at the American
Academy of Ophthalmology meeting in October 2005. Legal expenses increased by
$28,000 primarily due to fees incurred to resolve a dispute with a supplier and
fees related to researching intellectual property ownership issues currently
being evaluated for licensing for use in potential new products.
Marketing, general and administrative expenses in the Vascular business
unit increased $204,000, or 20.8%, to $1,186,000 as compared to the same period
last fiscal year. Sales salaries and other personnel-related expenses increased
approximately $89,000, travel related expenses for sales personnel increased by
approximately $41,000, advertising increased by approximately $11,000 and the
expense for customer samples increased by approximately $13,000 when compared to
the prior fiscal period. All of the increases were related to supporting a
higher volume of business during the current period as compared to the same
period in the prior fiscal year. Legal expenses increased $39,000 over the prior
period due to additional patent maintenance fees.
Marketing, general and administrative expenses in the Medical/Trek/EMI
business unit increased $302,000, or 10.5%, to $3,173,000 as compared to the
same period last fiscal year. Legal, accounting, sales and marketing expenses
and personnel related costs increased by approximately $130,000, $40,000 and
$200,000, respectively. Legal fees increased due to litigation costs with
IntraLase. The Company expects these litigation costs will continue to impact
earnings in the near term. (See note 11 of the notes to
38
the condensed consolidated financial statements for a description of legal
proceedings.) Sales and marketing expenses increased due to costs related to the
integration of the MRP with the EMI product lines, and the joint marketing and
integration of the Company's product line with Anka Systems as part of a
co-marketing agreement. (See notes 2 and 6 of the notes to the condensed
consolidated financial statements.) Accounting fees were higher due to audit
fees related to Sarbanes-Oxley compliance and higher third party consulting fees
for tax and temporary services. Slightly offsetting these increases were
decreases in investor relations and insurance expenses over the prior period.
Research and development expenses increased $251,000, or 53.9%, to $718,000
during the three-month period ended March 31, 2006 as compared to the same
period last fiscal year. Research and development expenses were primarily
expenses associated with the planned introduction of new and or enhanced
products in the Drew and EMI business units. Research and development expenses
in the Drew business unit increased $136,000, or 38.5%, to $489,000 as compared
to the same period last fiscal year. The increase is primarily due to additional
salaries and benefits and consulting fees associated with the development of
several new hematology and diabetic instruments. Research and development
expenses in the Medical/Trek/EMI business unit increased $128,000 to $133,000 as
compared to the same period last fiscal year. The increase is primarily due to
higher consulting (approximately $12,000), prototype (approximately $41,000) and
salary expenses (approximately $50,000) for the development of the Company's new
digital ophthalmic platform.
Research and development expenses increased $878,000, or 69.8%, to
$2,136,000 during the nine-month period ended March 31, 2006 as compared to the
same period last fiscal year. Research and development expenses were primarily
expenses associated with the planned introduction of new and or enhanced
products in the Drew, Sonomed and EMI business units. Research and development
expenses in the Drew business unit increased $524,000, or 65.6%, to $1,323,000
as compared to the same period last fiscal year. The increase is primarily due
to additional salaries and benefits and consulting fees associated with the
development of several new hematology and diabetic instruments. Research and
development expenses in the Medical/Trek/EMI business unit increased $293,000 to
$313,000 as compared to the same period last fiscal year. The increase is
primarily due to higher consulting (approximately $31,000), prototype
(approximately $48,000) and salary expenses (approximately $170,000) for the
development of the Company's new digital ophthalmic platform. Research and
development expenses in the Sonomed business unit increased $116,000 to $387,000
as compared to the same period last fiscal year. The increase is primarily due
to higher consulting (approximately $158,000) offset by lower salaries
(approximately $40,000) for development of the Company's new UMB machines and
enhancements to it current product line.
Gain on sale of available for sale securities was approximately $1,157,000
in the nine-month period ended March 31, 2006. The increase was due to the sale
of 58,585 shares of IntraLase common stock in July 2005. (See note 15 of the
notes to the condensed consolidated financial statements.) There were no sales
of available for sale securities during the three-month period ended March 31,
2006.
The Company recognized a loss of $18,000 and $13,000 related to its
investment in OTM during the three-month periods ended March 31, 2006 and 2005,
respectively, and $70,000 and $50,000 for the nine-month periods ended March 31,
2006 and 2005, respectively. Commencing July 1, 2005, the Company began
recognizing all of the losses of OTM in its consolidated financial statements.
OTM is an early stage privately held company. Prior to July 1, 2005, the share
of OTM's loss recognized by the Company was in direct proportion to the
Company's ownership equity in OTM. OTM began operations during the three-month
period ended September 30, 2004. (See note 14 of the notes to the condensed
consolidated financial statements.)
Interest income was $34,000 and $9,000 for the three-month periods ended
March 31, 2006 and 2005, respectively. The increase was due to a combination of
higher effective yields on investments and higher investable balances.
Interest income was $70,000 and $50,000 for the nine-month periods ended
March 31, 2006 and 2005, respectively. The increase was due to a combination of
higher effective yields on investments in the
39
current nine period. The higher yields were offset by lower average investable
balances due to the repayment of approximately $6,348,000 of debt in the second
quarter of fiscal 2005.
Interest expense was $28,000 and $16,000 for the three-month periods ended
March 31, 2006 and 2005, respectively, and $47,000 and $42,000 for the
nine-month periods ended March 31, 2006 and 2005, respectively. The Company paid
off several of its debt facilities to several entities in advance of their
maturities during the fiscal year ended June 30, 2005. Additionally, the Company
reversed accrued loan commitment fees as a result of the satisfaction of the
debt and the release by the lender of those fees. The fees were originally
accrued based on contract terms. The increase in interest expense during the
three-month period ended March 31, 2006 when compared to the same prior year
period is due to the non recurring reversal of loan commitment fees in the prior
fiscal period.
LIQUIDITY AND CAPITAL RESOURCES
Changes in overall liquidity and capital resources from continuing
operations during the three-month period ended March 31, 2006 are reflected in
the following table (in thousands):
MARCH 31, JUNE 30,
2006 2005
--------- ---------
CURRENT RATIO:
Current assets $ 15,707 $ 17,665
Less: Current liabilities 4,115 4,052
--------- ---------
WORKING CAPITAL $ 11,592 $ 13,613
========= =========
CURRENT RATIO 3.8 TO 1 4.4 TO 1
========= =========
DEBT TO TOTAL CAPITAL RATIO:
Notes payable and current maturities $ 244 $ 230
Long-term debt 225 392
--------- ---------
Total debt $ 469 $ 622
--------- ---------
Total equity 34,120 34,519
--------- ---------
TOTAL CAPITAL $ 34,589 $ 35,141
========= =========
TOTAL DEBT TO TOTAL CAPITAL 1.4% 1.8%
========= =========
WORKING CAPITAL POSITION
Working capital decreased approximately $2,021,000 as of March 31, 2006 and
the current ratio decreased to 3.8 to 1 from 4.4 to 1 when compared to June 30,
2005. The decrease in working capital was caused primarily by the loss from
operations of approximately $1,959,000 and cash used to fund fixed asset
additions of approximately $295,000, a deposit on a license for the right to
distribute a new instrument for the Drew business unit of approximately
$182,000, the pay off of several loans and the purchase of MRP during the
nine-month period ended March 31, 2006. Partially offsetting these uses of
working capital were proceeds of approximately $296,000 realized by the Company
for the exercise of employee stock options.
40
CASH USED IN OPERATING ACTIVITIES
During the nine-month periods ended March 31, 2006 and 2005, the Company
used approximately $2,753,000 and $2,485,000 of cash for operating activities.
The net increase in cash used for operating activities of approximately $268,000
for the nine-month period ended March 31, 2006 as compared to the same period in
the prior fiscal year is due primarily to the following factors:
- The Company employed significantly less cash to fund working capital
requirements during the nine months ended March 31, 2006 than it employed
in the same period in the prior fiscal year. Total working capital employed
was approximately $1,161,000 and $3,295,000, respectively, during the
nine-month periods ended March 31, 2006 and 2005, respectively. The
decrease is due to the fact that in the prior year period, the Company
utilized cash to begin to alleviate the liquidity constraints that Drew was
experiencing prior to its acquisition by the Company. The cash was utilized
to support increases in inventory and receivables and reduce payables and
outstanding draws on Drew's line of credit.
- The reduction in cash utilized to fund working capital was partially offset
by a reduction in income of approximately $1,275,000 for the nine-month
period ended March 31, 2006 when compared to the same prior year period.
CASH FLOWS PROVIDED BY (USED IN) INVESTING AND FINANCING ACTIVITIES
Cash flows generated by investing activities were approximately $633,000
during the nine-month period ended March 31, 2006 and relate primarily to the
net proceeds of approximately $1,157,000 realized from the sale of a majority of
the remaining shares of the IntraLase securities held by the Company as
available for sale securities. (See note 15 of the notes to the condensed
consolidated financial statements.) Partially offsetting the cash realized from
the securities sale was cash utilized for fixed asset additions of approximately
$295,000, a deposit on a license for the right to distribute a new instrument
for the Drew business unit of approximately $182,000 and cash outlays of
approximately $47,000 for the purchase of MRP. (See note 2 of the notes to the
condensed consolidated financial statements.) Any necessary capital expenditures
have generally been funded out of cash from financing activities, and the
Company is not aware of any factors that would cause historical capital
expenditure levels to not be indicative of capital expenditures in the future
and, accordingly, does not believe that the Company will have to commit material
resources to capital investment for the foreseeable future.
Cash flows provided by financing activities were approximately $143,000
during the nine-month period ended March 31, 2006. During the period, the
Company made scheduled long-term debt repayments of approximately $153,000.
Offsetting the debt repayments was approximately $296,000 received by the
Company from the exercise of stock options by directors and employees of the
Company.
DEBT HISTORY
On December 23, 2002, a lender acquired the Company's bank debt, which
consisted of term debt of $5,850,000 and $1,475,000 outstanding on a $2,000,000
available line of credit. On February 13, 2003, the Company entered into an
amended agreement with the lender. The primary amendments of the amended loan
agreement were to reduce quarterly principal payments, extend the term of the
repayments and to alter the covenants of the original bank agreement. On
September 30, 2004, the Company paid off and terminated both the remaining term
debt and the outstanding balance on the line of credit. In November 2001, the
Company issued 60,000 warrants to purchase the Company's common stock at $3.66
per share in connection with this debt. The warrants were exercised in December
2004.
On January 21, 1999, the Company's Vascular subsidiary and Endologix
entered into an Assets Sale and Purchase Agreement. Pursuant to this agreement,
the Company acquired for cash the assets of Endologix's vascular access business
in exchange and also agreed to pay royalties to Endologix based on future sales
of the vascular access business for a period of five years following the close
of the sale, with a guaranteed minimum of $300,000 per year. On February 1,
2001, the parties amended the agreement to
41
eliminate any future royalty payments to Endologix. Pursuant to this amendment,
the Company paid $17,558 in cash to Endologix, delivered a short-term note in
the amount of $64,884 that was satisfied in January 2002, delivered a note in
the amount of $717,558 payable in eleven quarterly installments that commenced
on April 15, 2002, and issued 50,000 shares of its common stock to Endologix. On
September 30, 2004, the Company paid off the balance of the term debt.
At the time of the acquisition of Drew by the Company, Drew had two lines
of credit aggregating approximately $2,700,000, one of which was with a domestic
financial institution, and one with a United Kingdom financial institution. At
the time of the acquisition, outstanding draws on the lines aggregated
approximately $1,643,000. The lines were paid off and terminated during the
quarter ended December 31, 2004.
Drew has long-term debt facilities through the Texas Mezzanine Fund and
through Symbiotics, Inc. The Texas Mezzanine Fund debt provides for interest at
fixed rate of 8% per annum until July 1, 2005. The interest rate was then
adjusted to the prime rate plus 4% per annum. Each June 1, the rate will be
adjusted to the prime rate plus 4% per annum. The debt has a minimum interest
rate of 8% per annum to a maximum interest rate of 18% per annum. The interest
rate on the Texas Mezzanine Fund was 10.25% per annum and 8% per annum as of
March 31, 2006 and June 30, 2005, respectively. Drew is required to pay the
Texas Mezzanine Fund 1% of fiscal year revenues over $11,500,000 as defined in a
revenue participation agreement. The note is due in June 2008 and is secured by
certain assets of Drew. The outstanding balance as of March 31, 2006 was
approximately $319,000. The Symbiotics, Inc. term debt, which originated from
the acquisition of a product line from Symbiotics, Inc., is payable in monthly
principal installments of $8,333 plus interest at a fixed rate of 5.00% per
annum. The outstanding balance as of March 31, 2006 was approximately $150,000.
BALANCE SHEET
The components of the balance sheet of the Company were increased as of
July 23, 2004 by the acquisition of Drew as follows:
Cash $ 150,849
Accounts receivable 1,439,120
Inventory 2,069,146
Other current assets 351,505
Furniture and equipment 868,839
Goodwill 9,574,655
Patents 297,246
Other long-term assets 7,406
Line of credit 1,617,208
Current liabilities 3,392,286
Long-term debt 1,072,457
Exchange of common stock 7,430,439
These amounts represents approximately a $113,000 net difference from the
amounts reported in the Company's Form 10-Q for the quarter ended December 31,
2004, which has been recorded as an increase in goodwill. The difference is the
result of additional facts obtained since the acquisition which impacted the
valuation of the assets acquired and liabilities assumed.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
The Company was not a party to any off-balance sheet arrangements during
the three-and nine-month periods ended March 31, 2006 and 2005.
42
The following table presents the Company's contractual obligations as of
March 31, 2006 (interest is not included in the table as it is immaterial):
LESS THAN 5-MAR MORE THAN
TOTAL 1 YEAR 1-3 YEARS YEARS 5 YEARS
---------- ---------- ---------- -------- ---------
Long-term debt $ 468,686 $ 243,957 $ 224,729 $ 0 $ 0
Operating lease agreements 2,363,292 811,790 1,054,032 497,470 0
---------- ---------- ---------- -------- ---
TOTAL $2,831,978 $1,055,747 $1,278,761 $497,470 $ 0
========== ========== ========== ======== ===
FORWARD-LOOKING STATEMENT ABOUT SIGNIFICANT ITEMS LIKELY TO IMPACT LIQUIDITY
On July 23, 2004, the Company acquired approximately 67% of the outstanding
ordinary shares of Drew, pursuant to the Company's exchange offer for all of the
outstanding ordinary shares of Drew, and since that date has acquired all of the
Drew shares. Drew does not have a history of producing positive operating cash
flows and, as a result, at the time of acquisition, was operating under
financial constraints and was under-capitalized. As Drew is integrated into the
Company, management will be working to reverse the situation, while at the same
time seeking to strengthen Drew's market position. As of March 31, 2006, the
Company has loaned approximately $9,476,000 to Drew. The funds have been
primarily used to procure components to build up inventory to support the
manufacturing process, to pay off accounts payable and debt of Drew, to fund new
product development and underwrite operating losses incurred since acquisition.
The Company anticipates that further working capital will likely be required by
Drew.
The Company realized approximately 0.0% and 5.0%, of its net revenue during
the three-month periods ended March 31, 2006 and 2005, and approximately 0.9%
and 5.9%, of its net revenue during the nine-month periods ended March 31, 2006
and 2005, respectively, from Bausch & Lomb's sale of Silicone Oil. This
agreement expired in August 2005 and the Company will not receive any future
royalties from this contract. Silicone Oil revenue was based on sale of the
product by Bausch & Lomb multiplied by a contractual factor that declines on an
annual basis due to a contractual step-down provision through its expiration
date which was August 12, 2005. As there were no costs associated with this
revenue, the expiration of the agreement will negatively impact gross margins,
operating income and cash flows in future periods. The Company has incurred and
anticipates continuing to incur higher than normal legal expenses related
primarily to protecting its rights and interests in intellectual property
licensed to IntraLase. (See note 11 of the notes to the condensed consolidated
financial statements.) These higher costs are likely to unfavorably impact
operating income and cash flows in future periods.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The table below provides information about the Company's financial
instruments consisting of both variable and fixed interest rate debt
obligations. For debt obligations, the table represents principal cash flows and
related interest rates by expected maturity dates. Interest rates as of March
31, 2006 were variable at prime plus 4%, currently 10.25% per annum, on the
Texas Mezzanine Fund debt, and were fixed at 5.00% per annum, on the Symbiotics,
Inc. term debt. (See note 9 of the notes to the condensed consolidated financial
statements for further information regarding the Company's debt obligations.)
43
2006 2007 2008 THEREAFTER TOTAL
-------- ------------ ------------ ---------- --------
Texas Mezzanine Fund Note $143,961 $159,647 $15,075 $ 0 $318,683
Interest rate 10.25% Prime Plus 4% Prime Plus 4% 0.00%
Symbiotics, Inc. Note $ 99,996 $ 50,007 $ 0 $ 0 $150,003
Interest rate 5.00% 5.00% 5.00% 0.00%
-------- ------------ ------------ ----- --------
TOTAL $243,957 $209,654 $15,075 $ 0 $468,686
======== ============ ============ ===== ========
EXCHANGE RATE RISK
During the three-month periods ended March 31, 2006 and 2005, approximately
35% and 36%, respectively, of the Company's consolidated net revenue was derived
from international sales. During the nine-month periods ended March 31, 2006 and
2005, approximately 35% and 36% of the Company's consolidated net revenue was
derived from international sales. Prior to the acquisition of Drew, the price of
all product sold overseas was denominated in United States Dollars and
consequently the Company incurred no exchange rate risk on revenue. However, a
portion of Drew's product revenue is denominated in United Kingdom Pounds and
Euros. During the three-month periods ended March 31, 2006 and 2005, Drew
recorded approximately $334,000 and $535,000 respectively, of revenue
denominated in United Kingdom Pounds and $26,000 and $3,000 in Euros,
respectively. During the nine-month periods ended March 31, 2006 and 2005, Drew
recorded approximately $1,187,000 and $1,885,000, respectively, of revenue
denominated in United Kingdom Pounds and $244,000 and $23,000 in Euros,
respectively.
Drew incurs a portion of its expenses denominated in United Kingdom Pounds.
During the three-month periods ended March 31, 2006 and 2005, Drew incurred
approximately $1,042,000 and $1,017,000, respectively, of expense denominated in
United Kingdom Pounds. For the nine-month periods ended March 31, 2006 and 2005,
these expenses totaled approximately $3,471,000 and $2,990,000, respectively.
The Company's Sonomed business unit incurs a portion of its marketing expenses
in the European market, the majority of which are transacted in Euros. For the
three-month periods ended March 31, 2006 and 2005, these expenses totaled
approximately $21,000 and $34,000, respectively. For the nine-month periods
ended March 31, 2006 and 2005, these expenses totaled approximately $160,000 and
$117,000, respectively. The Company's Vascular business unit began incurring
marketing expenses in the European market during the second quarter of fiscal
2004, the majority of which are transacted in Euros. For the three-month periods
ended March 31, 2006 and 2005, these expenses totaled approximately $34,000 and
$39,000, respectively. For the nine-month periods ended March 31, 2006 and 2005,
these expenses totaled approximately $111,000 and $124,000, respectively.
The Company may begin to experience fluctuations, beneficial or adverse, in
the valuation of currencies in which the Company transacts its business, namely
the United States Dollar, the United Kingdom Pound and the Euro.
ITEM 3. 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.
44
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 March 31, 2006, 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 March 31, 2006 that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See note 11 of the notes to the condensed consolidated financial statements
for further information regarding the Company's legal proceedings.
ITEM 2. UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS
As reported in note 2 of the notes to the condensed consolidated financial
statements, on January 30, 2006, the Company, through its subsidiary EMI,
acquired substantially all of the assets of MRP in exchange for 250,000 shares
of the Company's common stock and approximately $47,000 in cash. These shares
were issued pursuant to the private offering exemption afforded under Section
4(2) of the Securities Act of 1933.
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.
32.2 Certificate of Principal Financial and Accounting Officer under
Section 1350 of Title 18 of the United States Code.
45
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: May 15, 2006 By: /s/ Richard J. DePiano
------------------------------------
Richard J. DePiano
Chairman and Chief
Executive Officer
Date: May 15, 2006 By: /s/ David S. Berkowitz
------------------------------------
David S. Berkowitz
Principal Financial and Accounting
Officer
46