UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
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Mark One
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED March 31, 2007
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
Commission File Number: 0-20127
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ESCALON MEDICAL CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
PENNSYLVANIA 33-0272839
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
565 EAST SWEDESFORD ROAD, SUITE 200
WAYNE, PA 19087
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(610) 688-6830
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
N/A
FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE
LAST REPORT
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of
the Exchange Act).
Large accelerated filer Yes [ ] No [ ] Accelerated filer Yes [ ] No [ ]
Non-accelerated filer 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]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: 6,370,657 shares of common
stock, $0.001 par value, outstanding as of May 8, 2007.
ESCALON MEDICAL CORP.
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
Part I. Financial Statements
Item 1. Condensed Consolidated Financial Statements (unaudited) 2
Condensed Consolidated Balance Sheets as of March 31, 2007
(Unaudited) and June 30, 2006 2
Condensed Consolidated Statements of Income for the three- and
nine-month periods ended March 31, 2007 and 2006 (Unaudited) 3
Condensed Consolidated Statements of Cash Flows for the
nine-month periods ended March 31, 2007 and 2006 (Unaudited) 4
Condensed Consolidated Statement of Shareholders' Equity for the
nine-month periods ended March 31, 2007 and 2006 (Unaudited) 5
Condensed Consolidated Statement of Other Comprehensive Income
(Loss) for the nine-month periods ended March 31, 2007 and
2006 (Unaudited) 6
Notes to the Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results Operations 13
Item 3. Quantitive and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 25
Part II. Other Information
Item 1. Legal Proceedings 26
Item 1A Risk Factors 26
Item 6. Exhibits 26
1
PART I. FINANCIAL STATEMENTS
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ESCALON MEDICAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, JUNE 30,
2007 2006
------------ ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 9,548,207 $ 3,379,710
Available for sale securities 75,000 50,220
Accounts receivable, net 4,198,133 3,996,243
Inventory, net 8,301,816 7,122,916
Other current assets 267,171 362,160
------------ ------------
TOTAL CURRENT ASSETS 22,390,327 14,911,249
------------ ------------
Furniture and equipment, net 912,024 969,956
Goodwill 21,072,260 21,072,260
Trademarks and trade names, net 620,106 620,106
Patents, net 240,498 313,702
Covenant not to compete and customer list, net 351,023 420,073
Other assets 142,709 337,421
------------ ------------
TOTAL ASSETS $ 45,728,947 $ 38,644,767
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 198,966 $ 232,837
Accounts payable 1,707,663 1,558,501
Accrued expenses 2,089,556 2,503,771
------------ ------------
TOTAL CURRENT LIABILITIES 3,996,185 4,295,109
------------ ------------
Long-term debt, net of current portion 14,113 162,551
Accrued post-retirement benefits 1,087,000 1,087,000
------------ ------------
TOTAL LIABILITIES 5,097,298 5,544,660
------------ ------------
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; 6,386,857 and 6,344,657
issued and outstanding at March 31, 2007
and June 30, 2006, respectively 6,387 6,345
Common stock warrants 1,601,346 1,601,346
Additional paid-in capital 66,006,248 65,699,370
Retained earnings (27,035,185) (34,122,427)
Accumulated other comprehensive (loss) income 52,853 (84,527)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 40,631,649 33,100,107
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 45,728,947 $ 38,644,767
============ ============
See notes to condensed consolidated financial statements
2
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED MARCH 31, NINE MONTHS ENDED MARCH 31,
---------------------------- ---------------------------
2007 2006 2007 2006
----------- ---------- ----------- -----------
NET REVENUES:
Product revenue $ 6,900,461 $7,286,704 $20,477,907 $20,895,553
Other revenue 9,658,299 553,054 10,885,753 1,687,365
----------- ---------- ----------- -----------
REVENUES, NET 16,558,760 7,839,758 31,363,660 22,582,918
----------- ---------- ----------- -----------
COSTS AND EXPENSES:
Cost of goods sold 4,036,285 4,382,268 11,544,879 12,010,652
Research and development 843,858 717,920 2,638,413 2,135,950
Marketing, general and administrative 3,361,582 3,283,722 10,062,093 10,395,612
----------- ---------- ----------- -----------
TOTAL COSTS AND EXPENSES 8,241,725 8,383,910 24,245,385 24,542,214
----------- ---------- ----------- -----------
INCOME (LOSS) FROM OPERATIONS 8,317,035 (544,152) 7,118,275 (1,959,296)
----------- ---------- ----------- -----------
OTHER (EXPENSE) AND INCOME:
Gain on sale of available for sale securities 0 0 0 1,157,336
Equity in Ocular Telehealth Management, LLC (25,191) (18,508) (55,889) (69,972)
Interest income 54,451 33,974 113,385 111,698
Interest expense (8,676) (27,515) (23,615) (47,421)
----------- ---------- ----------- -----------
TOTAL OTHER INCOME (EXPENSE) 20,584 (12,049) 33,881 1,151,641
----------- ---------- ----------- -----------
NET INCOME (LOSS) BEFORE TAXES 8,337,619 (556,201) 7,152,156 (807,655)
----------- ---------- ----------- -----------
Provision for income taxes 66,157 20,024 64,914 36,024
----------- ---------- ----------- -----------
NET INCOME (LOSS) $ 8,271,462 $ (576,225) $ 7,087,242 $ (843,679)
=========== ========== =========== ===========
BASIC NET INCOME (LOSS) PER SHARE $ 1.30 $ (0.09) $ 1.11 $ (0.14)
=========== ========== =========== ===========
DILUTED NET INCOME (LOSS) PER SHARE $ 1.29 $ (0.09) $ 1.10 $ (0.14)
=========== ========== =========== ===========
WEIGHTED AVERAGE SHARES - BASIC 6,378,757 6,255,665 6,363,251 6,091,938
=========== ========== =========== ===========
WEIGHTED AVERAGE SHARES - DILUTED 6,435,106 6,255,665 6,421,321 6,091,938
=========== ========== =========== ===========
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,
---------------------------
2007 2006
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ 7,087,242 $ (843,679)
Adjustments to reconcile net (loss) income to net cash (used in)
operating activities:
Depreciation and amortization 418,916 338,829
Gain on sale of available for sale securities 0 (1,157,336)
Loss on Ocular Telehealth Management, LLC 55,889 69,972
Change in operating assets and liabilities:
Accounts receivable, net (536,633) (428,051)
Inventory, net (1,129,712) (795,026)
Other current and long-term assets 285,723 38,087
Accounts payable, accrued and other liabilities 164,270 24,281
----------- -----------
NET CASH (USED IN) OPERATING ACTIVITIES 6,345,695 (2,752,923)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of MRP 0 (47,060)
Proceeds from the sale of available for sale securities 0 1,157,336
Purchase of distribution rights 0 (181,856)
Purchase of fixed assets (196,180) (295,027)
----------- -----------
NET CASH PROVIDED BY/(USED IN) INVESTING ACTIVITIES (196,180) 633,393
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on term loans (182,309) (153,451)
Issuance of common stock - stock options 157,779 296,254
----------- -----------
NET CASH PROVIDED BY/(USED IN) FINANCING ACTIVITIES (24,530) 142,803
----------- -----------
Effect of exchange rate changes on cash and cash equivalents 43,512 15,382
----------- -----------
NET (DECREASE) IN CASH AND CASH EQUIVALENTS 6,168,497 (1,961,345)
----------- -----------
Cash and cash equivalents, beginning of period 3,379,710 5,115,772
----------- -----------
Cash and cash equivalents, end of period $ 9,548,207 $ 3,154,427
=========== ===========
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Interest paid $ 23,615 $ 47,121
=========== ===========
Income taxes (refund) paid $ (98,412) $ 43,460
=========== ===========
Issuance of common stock for MRP acquisition $ -- $ 1,427,500
=========== ===========
(Decrease)/increase in unrealized appreciation on available for sale
securities $ 24,780 $(1,137,717)
=========== ===========
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, 2007
(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, 2006 6,344,657 $6,345 $1,601,346 $65,699,370 $(34,122,427) $(84,527) $33,100,107
Net (loss) 0 0 0 7,087,242 0 7,087,242
Refund of income taxes related
to exercise of stock options 98,412 98,412
Exercise of stock options 42,200 42 0 84,692 0 0 84,734
Compensation expense 123,774 123,774
Change in unrealized gains on 0
available for sale securities 0 0 0 0 24,780 24,780
Foreign currency translation 0 0 0 0 112,600 112,600
--------- ------ ---------- ----------- ------------ -------- -----------
BALANCE AT MARCH 31, 2007 6,386,857 $6,387 $1,601,346 $66,006,248 $(27,035,185) $ 52,853 $40,631,649
========= ====== ========== =========== ============ ======== ===========
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,
---------------------------- ---------------------------
2007 2006 2007 2006
---------- --------- ---------- -----------
Net income (loss) $8,271,462 $(576,225) $7,087,242 $ (843,679)
Change in unrealized gains on
available for sale securities $ 15,870 16,110 24,780 (1,137,716)
Foreign currency translation (7,764) (127,340) 112,600 (219,324)
---------- --------- ---------- -----------
COMPREHENSIVE INCOME (LOSS) $8,279,568 $(687,455) $7,224,622 $(2,200,719)
========== ========= ========== ===========
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, Inc. and Drew Scientific Group, Plc (collectively "Drew"). 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"). The FDA and
agencies in other jurisdictions require 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 2006 Annual Report on
Form 10-KSB 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. STOCK-BASED COMPENSATION
In December 2004, the FASB issued SFAS No.123R ("SFAS No.123R") (revised
2004), "Share-Based Payments". SFAS No. 123(R) is a revision of SFAS No. 123 and
supersedes ABP Opinion No. 25. SFAS No. 123(R) 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. As a small business issuer as defined in Item 10 of Regulation S-B,
the Company was 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.
For the three-month and nine-month periods ended March 31, 2006, the
Company accounted for its stock-based awards to employees using the intrinsic
value method under Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees and related Interpretations.
7
Stock-based awards to non-employees were recorded using the fair value method in
accordance with SFAS No. 123, Accounting for Stock-Based Compensation.
If the computed fair value of the awards had been amortized to expense over
the vesting period of the awards under SFAS No. 123, net income would have been
as follows for the period ended:
THREE NINE
MONTHS MONTHS
ENDED ENDED
MARCH 31, MARCH 31,
2006 2006
--------- -----------
Net (loss) as reported $(576,225) $ (843,679)
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (288,848) (1,077,870)
--------- -----------
PRO FORMA NET (LOSS) INCOME $(865,073) $(1,921,549)
========= ===========
(LOSS) EARNINGS PER SHARE:
BASIC - AS REPORTED $ (0.09) $ (0.14)
========= ===========
BASIC - PRO FORMA $ (0.14) $ (0.32)
========= ===========
DILUTED - AS REPORTED $ (0.09) $ (0.14)
========= ===========
DILUTED - PRO FORMA $ (0.14) $ (0.32)
========= ===========
SFAS No. 123 requires the disclosure of pro forma net income had the
Company adopted the fair value method in accounting for employee stock-based
awards. Under SFAS No. 123, the fair value of stock-based awards to employees is
calculated through the use of option-pricing models, even though such models
were developed to estimate the fair value of freely tradable, fully transferable
options without vesting restrictions, which significantly differ from the
Company's stock-option awards. These models also require subjective assumptions,
including future stock price volatility and expected time to exercise which
affect the calculated values. 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 applying SFAS 123, the estimated per share value of the
options granted during the three-month and nine-month periods ended March 31,
2006 were $2.65 and $4.93, respectively. The fair value was estimated using the
following assumptions: dividend yield of 0.0%; volatility ranging between 109%
and 251%; risk free interest ranging between 4.5% and 4.6%; and expected life of
10 years. The volatility assumption is based on historical volatility seen in
the Company's stock. There is no reason to believe that future volatility will
compare to historic volatility.
As of March 31, 2007, there was $139,986 of total unrecognized compensation
cost related to non-vested share-based compensation arrangements under the plan.
The cost is expected to be recognized over a weighted average period of four
years.
Cash received from share option exercises under stock-based payment plans
for the nine months ended March 31, 2007 was $157,779. The Company did not
realize any tax effect, which would be a reduction in its tax rate, on options
due to the full valuation allowances established on its deferred tax assets.
The Company measures compensation expense for its non-employee stock-based
compensation under the Financial Accounting Standards Board (FASB) Emerging
Issues Task Force (EITF) Issue No. 96-18, "Accounting for Equity Instruments
that are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services." The fair value of the option issued is used to
measure the transaction, as this is more reliable than the fair value of the
services received. Fair value is measured as the
8
value of the Company's common stock on the date that the commitment for
performance by the counterparty has been reached or the counterparty's
performance is complete. The fair value of the equity instrument is charged
directly to compensation expense and additional paid-in capital. For the
three-month and nine-month periods ended March 31, 2007, $147,808 was recorded
as compensation expense.
3. 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 NINE MONTHS
ENDED MARCH 31, ENDED MARCH 31,
----------------------- -----------------------
2007 2006 2007 2006
---------- ---------- ---------- ----------
NUMERATOR:
Numerator for basic and diluted
earnings per share
NET INCOME (LOSS) $8,271,462 $ (576,225) $7,087,242 $ (843,679)
---------- ---------- ---------- ----------
DENOMINATOR:
Denominator for basic earnings per
share - weighted average shares 6,378,757 6,255,665 6,363,251 6,091,938
Effect of dilutive securities:
Stock options and warrants 56,349 0 58,020 0
Shares reserved for future
exchange 0 0 0 0
---------- ---------- ---------- ----------
DENOMINATOR FOR DILUTED EARNINGS
PER SHARE - WEIGHTED AVERAGE AND
ASSUMED CONVERSION 6,435,106 6,255,665 6,421,321 6,091,938
---------- ---------- ---------- ----------
BASIC EARNINGS (LOSS) PER SHARE $ 1.30 $ (0.09) $ 1.11 $ (0.14)
========== ========== ========== ==========
DILUTED EARNINGS (LOSS) PER SHARE $ 1.29 $ (0.09) $ 1.10 $ (0.14)
========== ========== ========== ==========
The impact of dilutive securities were omitted from the earnings per share
calculation in the prior period presented as they would reduce the loss per
share (anti-dilutive).
9
4. 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,
2007 2006
----------- ----------
(UNAUDITED)
Raw materials $5,405,590 $4,219,836
Work in process 701,713 809,807
Finished goods 2,447,225 2,345,985
---------- ----------
8,554,528 7,375,628
---------- ----------
Valuation allowance (252,712) (252,712)
---------- ----------
TOTAL INVENTORY $8,301,816 $7,122,916
---------- ----------
5. OTHER REVENUE
For the three-month periods ended March 31, 2007 and 2006, royalties
totaled $9,658,000 and $553,000, respectively. For the nine-month periods ended
March 31, 2007 and 2006, royalties totaled $10,886,000 and $1,687,000,
respectively. These large changes are related to the settlement to the Intralase
Corp. ("Intralase") lawsuit which generated a $9,600,000 settlement during the
quarter (see footnote 6). As the settlement covers all past and future
royalties no additional royalties will be received in subsequent quarters
related to the Intralase License Agreement.
6. LEGAL PROCEEDING
INTRALASE
In 1997, IntraLase and Escalon entered into an agreement under which
IntraLase became the exclusive licensee of certain patents, technology and
intellectual property owned by Escalon Medical. This agreement was amended and
restated in October 2000. The original and amended license agreement is referred
to as the "License Agreement." Disputes arose between the parties culminating
in litigation between the parties.
On February 27, 2007 Escalon entered into an agreement with IntraLase to
settle all outstanding disputes and litigation between the parties. Under the
settlement agreement, IntraLase made a lump-sum payment to Escalon of
$9,600,000 in exchange for which all pending litigation between the parties was
dismissed, the parties exchanged general releases, Escalon transferred to
IntraLase it's ownership of all patents and intellectual property formerly
licensed to IntraLase by Escalon, and the license agreement was terminated. In
addition, the payment from IntraLase satisfies all outstanding past, current
and future royalties owed or alleged to be owed by IntraLase to Escalon.
7. SEGMENTAL INFORMATION
During the three-month and nine-month periods ended March 31, 2007 and
2006, the Company's operations were classified into four principal reportable
segments that provide different products or services.
10
Separate management of each segment 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, 2007 AND 2006
DREW SONOMED VASCULAR MEDICAL/TREK/EMI TOTAL
----------------- ----------------- --------------- ---------------- -----------------
2007 2006 2007 2006 2007 2006 2007 2006 2007 2006
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
REVENUES, NET:
Product revenue $ 3,220 $ 3,870 $ 2,183 $ 2,001 $ 914 $ 893 $ 583 $ 522 $ 6,900 $ 7,286
Other revenue 59 84 0 0 0 0 9,600 469 9,659 553
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
TOTAL REVENUE, NET 3,279 3,954 2,183 2,001 914 893 10,183 991 16,559 7,839
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
COSTS AND EXPENSES:
Cost of goods sold 2,131 2,622 1,190 966 351 447 364 348 4,036 4,383
Operating expenses 1,842 1,923 975 839 609 487 779 753 4,205 4,002
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
TOTAL COSTS AND EXPENSES 3,973 4,545 2,165 1,805 960 934 1,143 1,101 8,241 8,385
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
(LOSS) INCOME FROM
OPERATIONS (694) (591) 18 196 (46) (41) 9,040 (110) 8,318 (546)
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
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 (25) (19) (25) (19)
Interest income 0 0 0 0 0 0 54 34 54 34
Interest expense (8) (26) 0 0 0 (1) 0 0 (8) (27)
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
TOTAL OTHER (EXPENSE) AND
INCOME (8) (26) 0 0 0 (1) 29 15 21 (12)
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
INCOME (LOSS) BEFORE TAXES (702) (617) 18 196 (46) (42) 9,069 (95) 8,339 (558)
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
Income taxes 0 0 37 14 1 0 28 6 66 20
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
NET INCOME (LOSS) $ (702) $ (617) $ (19) $ 182 $ (47) $ (42) $ 9,041 $ (101) $ 8,273 $ (578)
======= ======= ======= ======= ====== ====== ======= ====== ======= =======
Depreciation and
amortization $ 86 $ 65 $ 5 $ 6 $ (30) $ 28 $ 33 $ 23 $ 94 $ 122
Assets $17,562 $17,592 $14,088 $13,802 $3,717 $3,850 $10,362 $4,302 $45,729 $39,546
Expenditures for
long-lived assets $ 50 $ 33 $ 15 $ 1 $ 6 $ 0 $ 120 $ 34 $ 191 $ 68
11
SEGMENTAL STATEMENTS OF OPERATIONS (IN THOUSANDS) -
NINE MONTHS ENDED MARCH 31, 2007 AND 2006
DREW SONOMED VASCULAR MEDICAL/TREK/EMI TOTAL
----------------- ----------------- --------------- ---------------- -----------------
2007 2006 2007 2006 2007 2006 2007 2006 2007 2006
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
REVENUES, NET:
Product revenue $ 8,722 $11,071 $ 7,208 $ 5,802 $2,527 $2,703 $ 2,020 $1,319 $20,477 $20,895
Other revenue 184 228 0 0 0 0 10,702 1,459 10,886 1,687
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
TOTAL REVENUE, NET 8,906 11,299 7,208 5,802 2,527 2,703 12,722 2,778 31,363 22,582
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
COSTS AND EXPENSES:
Cost of goods sold 5,812 7,091 3,597 2,955 969 1,105 1,167 860 11,545 12,011
Operating expenses 5,835 5,763 2,705 2,802 1,609 1,503 2,553 2,464 12,702 12,532
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
TOTAL COSTS AND EXPENSES 11,647 12,854 6,302 5,757 2,578 2,608 3,720 3,324 24,247 24,543
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
(LOSS) INCOME FROM
OPERATIONS (2,741) (1,555) 906 45 (51) 95 9,002 (546) 7,116 (1,961)
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
OTHER (EXPENSE) AND
INCOME:
Gain on sale of available
for sale securities 0 0 0 0 0 0 0 1,157 0 1,157
Equity in OTM 0 0 0 0 0 0 (56) (70) (56) (70)
Interest income 0 0 0 0 0 0 113 112 113 112
Interest expense (23) (46) 0 0 0 (1) 0 0 (23) (47)
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
TOTAL OTHER (EXPENSE) AND
INCOME (23) (46) 0 0 0 (1) 57 1,199 34 1,152
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
(LOSS) AND INCOME BEFORE
TAXES (2,764) (1,601) 906 45 (51) 94 9,059 653 7,150 (809)
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
Income taxes 0 0 37 14 1 0 27 22 65 36
------- ------- ------- ------- ------ ------ ------- ------ ------- -------
NET (LOSS) INCOME $(2,764) $(1,601) $ 869 $ 31 $ (52) $ 94 $ 9,032 $ 631 $ 7,085 $ (845)
======= ======= ======= ======= ====== ====== ======= ====== ======= =======
Depreciation and
amortization $ 228 $ 188 $ 16 $ 16 $ 62 $ 62 $ 74 $ 74 $ 380 $ 340
Assets $17,562 $17,592 $14,088 $13,802 $3,717 $3,850 $10,362 $4,302 $45,729 $39,546
Expenditures for
long-lived assets $ 139 $ 139 $ 15 $ 15 $ 7 $ 13 $ 129 $ 129 $ 290 $ 296
8. 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 that provides
remote examination, diagnosis and management of disorders affecting the human
eye. OTM's initial product 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, 2007, Escalon had invested
$271,000 in OTM. As of March 31, 2007, Escalon owned 45% of OTM. The Company
provides administrative support functions to OTM. From inception on October 22,
2003 through March 31, 2007, OTM had revenue of approximately $21,400 and
incurred expenses of approximately $264,000.
Two relatives of a senior executive officer have provided legal services as
either an employee or a consultant to the Company. Richard DePiano, Jr. is the
son of the Chief Executive Officer ("CEO") and serves as Chief Operating Officer
and General Counsel to the Company. His salary plus bonus for the nine-month
periods ended March 31, 2007 and 2006 were $152,000 and $135,115, respectively.
Caryn Lindsey, the daughter-in-law of the CEO, acted as a consultant and
employee for the Company in 2005. For the nine-month periods ended March 31,
2007 and 2006 Ms. Lindsey received consulting fees and salary of $0 and $68,954,
respectively.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
Certain statements contained in, or incorporated by reference in, this
report are forward-looking statements made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995, which
provide current expectations or forecasts of future events. Such statements can
be identified by the use of terminology such as "anticipate," "believe,"
"could," "estimate," "expect," "forecast," "intend," "may," "plan," "possible,"
"project," "should," "will," and similar words or expressions. The Company's
forward-looking statements include certain information relating to general
business strategy, growth strategies, financial results, liquidity, 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 list of such factors contained in its periodic report on Form
10-KSB for the year ended June 30, 2006 to be an exhaustive statement of all
risks, uncertainties or potentially inaccurate assumptions.
EXECUTIVE OVERVIEW - NINE-MONTH PERIOD ENDED MARCH 31, 2007
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 Company performance and
financial condition.
- Product revenue decreased approximately 2% during the nine-month
period ended March 31, 2007 as compared to the same period last fiscal
year. The decrease is primarily related to decreases in the Drew and
Vascular business units. Revenue at Drew and Vascular decreased 21.2%
and 6.5%, respectively, during the nine-month period ended March 31,
2007 when compared to the same period last fiscal year. These
decreases were offset by strong sales in the Company's Sonomed and
Medical/Trek/EMI business units. Sales at Sonomed and Medical/Trek/EMI
increased approximately 24.2% and 53.1%, respectively, during the
nine-month period ended March 31, 2007 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. 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 increased approximately $9,199,000, or 545.3%, during
the nine-month period ended March 31, 2007 as compared to the same
period last fiscal year. The increase is attributable to increased
royalties received from the IntraLase License Agreement as a result
of the settlement agreement. Under the settlement agreement, IntraLase
made a lump sum payment to Escalon of $9,600,000 in exchange for which
all pending litigation between the parties was dismissed, the parties
exchanged general releases, Escalon transferred to IntraLase its
ownership of patents and intellectual property formerly licensed to
IntraLase by Escalon, and the License Agreement has terminated. In
addition,the payment from IntraLase satisfied all outstanding past,
current and future royalties owed or alleged to be owed by IntraLase
to Escalon.
13
- Cost of goods sold as a percentage of product revenue decreased
slightly to approximately 58.5% of revenues during the nine-month
period ended March 31, 2007, as compared to approximately 60.2% 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, 2007, remained steady at approximately 50.0% of product
revenue.
- Operating expenses decreased approximately 1.9% during the nine-month
period ended March 31, 2007 as compared to the same period in the
prior fiscal year. The decrease was due to a significant decrease in
legal fees related to the IntraLase litigation, offset by an increase
in research and development related to Drew.
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.
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. 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.
14
- Shipping terms are ex-factory shipping point. At this point the buyer
(distributor) takes title to the goods and is responsible for all
risks and rewards of ownership, including insuring the goods as
necessary.
- The Company's price to the buyer (distributor) is fixed and
determinable as specifically outlined on the sales invoice. The sales
arrangement does not have customer cancellation or termination
clauses.
- The buyer (distributor) places a purchase order with the Company; the
terms of the sale are cash, COD or credit. Customer credit is
determined based on the Company's policies and procedures related to
the buyer's (distributor's) creditworthiness. Based on this
determination, the Company believes that collectibility is reasonably
assured.
The Company assesses collectibility based on creditworthiness of the
customer and past transaction history. The Company performs ongoing credit
evaluations of its customers and does not require collateral from its customers.
For many of the Company's international customers, the Company requires an
irrevocable letter of credit to be issued by the customer before the purchase
order is accepted.
VALUATION OF INTANGIBLE ASSETS
The Company annually 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 are 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
15
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, 2007, 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.
THREE- AND NINE-MONTH PERIODS ENDED MARCH 31, 2007 AND 2006
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, 2007 and 2006. Dollar amounts are in
thousands:
THREE-MONTH PERIOD ENDED MARCH 31, NINE-MONTH PERIOD ENDED MARCH 31,
---------------------------------- ---------------------------------
2007 2006 % CHANGE 2007 2006 % CHANGE
------ ------ -------- ------- ------- --------
PRODUCT REVENUES, NET
Drew $3,220 $3,871 -16.8% $ 8,722 $11,071 -21.2%
Sonomed 2,183 2,001 9.1% 7,208 5,802 24.2%
Vascular 914 893 2.4% 2,527 2,703 -6.5%
Medical/Trek/EMI 583 522 11.7% 2,021 1,320 53.1%
------ ------ ----- ------- ------- -----
TOTAL $6,900 $7,287 -5.3% $20,478 $20,896 -2.0%
====== ====== ===== ======= ======= =====
Product revenue decreased approximately $387,000, or 5.3%, to $6,900,000
during the three-month period ended March 31, 2007 as compared to the same
period last fiscal year.
In the Drew business unit, product revenue decreased $651,000, or 16.8%, as
compared to the same period last fiscal year. The decrease is primarily due to a
reduction of approximately $900,000 in international sales of diabetic and
hematology instruments. This decrease was partially off set by a significant
increase in sales of spare parts. Reagents and controls sales remained constant
during the period.
Product revenue increased $182,000, or 9.1%, at the Sonomed business unit
as compared to the same period last fiscal year. The increase in product revenue
was caused by an increase in sales of the Company's EZ AB scan ultrasound
systems, primarily into international markets.
Product revenue increased $21,000, or 2.4%, to $914,000 in the Vascular
business unit during the three-month period ended March 31, 2007 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
16
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 $61,000,
or 11.7%, to $583,000 during the three-month period ended March 31, 2007 as
compared to the same period last fiscal year. The increase in Medical/Trek/EMI
product revenue is primarily attributed to an increase of approximately $108,000
in EMI sales of digital imaging systems.
Product revenue decreased approximately $418,000, or 2.0%, to $20,478,000
during the nine-month period ended March 31, 2007 as compared to the same period
last fiscal year.
In the Drew business unit, product revenue decreased $2,349,000, or 21.2 %,
as compared to the same period last fiscal year. As in the three-month period
ended March 31, 2007, the decrease is primarily due a reduction in international
sales of diabetics and hematology instruments, partially offset by a significant
increase in sales of spare parts, with reagents and controls sales remaining
flat.
Product revenue increased $1,406,000, or 24.2%, 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, primarily in international markets, as well as continued
demand for Sonomed's existing product line.
Product revenue decreased $176,000, or 6.5%, to $2,527,000 at the Vascular
business unit during the nine-month period ended March 31, 2007 as compared to
the same period last fiscal year. The decrease in product revenue in the
Vascular business unit was primarily caused by a decrease in revenue from the
Company's distributor network and decreased foreign 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 $701,000,
or 53.1%, to $2,021,000 during the nine-month period ended March 31, 2007 as
compared to the same period last fiscal year. The increase in Medical/Trek/EMI
product revenue is primarily due to an increase of approximately $722,000 in EMI
sales of digital imaging systems as a result of the January 30, 2006 acquisition
of MRP Group, Inc. ("MRP").
Other revenue increased by approximately $9,106,000 to $9,659,000 during
the three-month period ended March 31, 2007 as compared to the same period last
fiscal year. The increase is primarily due to a settlement of $9,600,000 with
IntraLase. (See note 6 the notes to the condensed consolidated financial
statements.)
Other revenue increased by approximately $9,199,000 to $10,886,000 during
the nine-month period ended March 31, 2007 as compared to the same period last
fiscal year. The increase is primarily due to a settlement of $9,600,000 with
IntraLase. (See note 6 of the notes to the condensed consolidated financial
statements.)
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, 2007 and 2006. Dollar amounts are
in thousands:
THREE-MONTH PERIOD ENDED MARCH 31 NINE-MONTH PERIOD ENDED MARCH 31
--------------------------------- --------------------------------
2007 2006 2007 2006
------------ ------------ ------------- -------------
$ % $ % $ % $ %
----- ---- ----- ---- ------ ---- ------ ----
COST OF GOODS SOLD
Drew 2,131 66.2 2,622 67.7 5,812 66.6 7,091 64.1
Sonomed 1,190 54.5 965 48.2 3,597 49.9 2,955 50.9
Vascular 351 38.4 447 50.1 969 38.3 1,105 40.9
Medical/Trek/EMI 364 62.4 348 66.7 1,167 57.7 860 65.2
----- ---- ----- ---- ------ ---- ------ ----
TOTAL 4,036 58.5 4,382 60.1 11,545 56.4 12,011 57.5
===== ==== ===== ==== ====== ==== ====== ====
17
Cost of goods sold totaled approximately $4,036,000, or 58.5% of product
revenue, for the three-month period ended March 31, 2007 as compared to
$4,382,000, or 60.2% of product revenue, for the same period last fiscal year.
Cost of goods sold in the Drew business unit totaled $2,131,000, or 66.2%
of product revenue, for the three-month period ended March 31, 2007 as compared
to $2,622,000, or 67.7% of product revenue, for the same period last fiscal
year. The decrease in the cost of goods sold as a percentage of revenue was due
to increased sales of high margin spare parts during the current period.
Cost of goods sold in the Sonomed business unit totaled $1,190,000, or
54.5% of product revenue, for the three-month period ended March 31, 2007 as
compared to $965,000, or 48.2% of product revenue, for the same period last
fiscal year. The primary reason for the increase as a percentage of revenue 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.
Cost of goods sold in the Vascular business unit totaled $351,000, or 38.4%
of product revenue, for the three-month period ended March 31, 2007 as compared
to $447,000, or 50.1% of product revenue, for the same period last fiscal year.
The Company experienced a significant decrease in overtime and higher production
efficiencies in the current period as compared to the prior period.
Cost of goods sold in the Medical/Trek/EMI business unit totaled $364,000,
or 62.4% of product revenue, during the three-month period ended March 31, 2007
as compared to $348,000, or 66.7% of product revenue, during the same period
last fiscal year. The decrease as a percentage of revenues is due primarily to
the integration of MRP into the existing EMI product lines and the resultant
cost of goods sold for EMI of 49.5% of product revenues as compared to 76.4% of
product revenue for the same period last fiscal year.
Cost of goods sold totaled approximately $11,545,000, or 56.4 % of product
revenue, for the nine-month period ended March 31, 2007 as compared to
$12,011,000, or 57.5% of product revenue, for the same period last fiscal year.
Cost of goods sold in the Drew business unit totaled $5,812,000, or 66.6%
of product revenue, for the nine-month period ended March 31, 2007 as compared
to $7,091,000, or 64.1% of product revenue, for the same period last fiscal
year. The increase in Drew's cost of goods sold as a percentage of revenue was
due to the product mix during the period, which consisted of lower margin sales
of Drew's aging product line combined with higher margin spare part sales.
Cost of goods sold in the Sonomed business unit remained relatively
unchanged over the same period last year, totaling $3,597,000 or 49.9% of
product revenue, for the nine-month period ended March 31, 2007 as compared to
$2,955,000, or 50.9% of product revenue, for the same period last fiscal year.
Vascular business unit totaled $969,000, or 38.3% of product revenue, for
the nine-month period ended March 31, 2007 as compared to $1,105,000, or 40.9%
of product revenue, for the same period last fiscal year. The primary factors
affecting the decrease in cost of goods sold as a percentage of product revenue
were 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.
Cost of goods sold in the Medical/Trek/EMI business unit totaled
$1,167,000, or 57.7% of product revenue, during the nine-month period ended
March 31, 2007 as compared to $860,000, or 65.2% of
18
product revenue, during the same period last fiscal year. The decrease as a
percentage of revenues is due primarily to the integration of MRP into the
existing EMI product lines and the resultant cost of goods sold for EMI of 45.2%
of product revenues as compared to 71.0% of revenues for the same period last
fiscal year.
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, 2007 and 2006. Dollar amounts are in thousands:
THREE-MONTH PERIOD ENDED MARCH 31, NINE-MONTH PERIOD ENDED MARCH 31,
---------------------------------- ---------------------------------
2007 2006 % CHANGE 2007 2006 % CHANGE
------ ------ -------- ------- ------- --------
MARKETING, GENERAL AND ADMINISTRATIVE
Drew $1,313 $1,434 -8.4% $ 3,973 $ 4,440 -10.5%
Sonomed 813 784 3.7% 2,382 2,415 -1.4%
Vascular 547 411 33.1% 1,489 1,390 7.1%
Medical/Trek/EMI 689 655 5.2% 2,218 2,151 3.1%
------ ------ ---- ------- ------- -----
TOTAL $3,362 $3,283 2.4% $10,062 $10,396 -3.2%
====== ====== ==== ======= ======= =====
Marketing, general and administrative expenses increased $78,000, or 2.4%,
to $3,362,000 during the three-month period ended March 31, 2007 as compared to
the same period last fiscal year.
Marketing, general and administrative expenses in the Drew business unit
decreased $121,000, or 8.4%, to $1,313,000 as compared to the same period last
fiscal year. The Drew decrease is primarily due to the realization of previously
announced cost reductions initiated during the first quarter of fiscal year
2007.
Marketing, general and administrative expenses in the Sonomed business unit
increased by $29,000, or 3.7%, to $813,000 as compared to the same period last
fiscal year. Marketing and sales salaries and travel expenses, related to
additional sales personnel, increased by approximately $90,000 as part of the
Company's focus on increasing domestic and foreign revenues. During the
three-month period ended March 31,2006 the Company incurred advertising expenses
of approximately $30,000 related to exhibits and brochures for the Company's
Ultrasound Biomicrosopes instrument ("UBM"). Such expenditures were not incurred
during the same period this fiscal year.
Marketing, general and administrative expenses in the Vascular business
unit increased $136,000, or 33.1%, to $547,000 as compared to the same period
last fiscal year. This increase is made up mainly of increases in salaries and
other personnel-related expenses 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 increased $34,000, or 5.2%, to $689,000 as compared to the same
period last fiscal year. Administrative expenses increased approximately
$89,000. Corporate salaries and related expenses increased nearly $41,000, due
primarily to the addition of additional accounting personnel. Legal fees
increased approximately $35,000, due primarily to expenditures related to
finalizing the settlement with IntraLase (see note 6 to the notes to condensed
consolidated financial statements). Investor relations and insurance
expenditures increased by $57,000 and $18,000, respectively. These increases
were partially offset by decreases in outside accounting fees of approximately
$56,000. The outside accounting decrease was primarily due to a reduction on
Sarbanes-Oxley work in view of the compliance extension for non-accelerated
filers such as the Company. Sales and marketing expenses increased $39,000 due
primarily to costs related to the trade show booth for the American Academy of
Ophthalmology meeting.
19
Marketing, general and administrative expenses decreased $334,000, or 3.2%,
to $10,062,000 during the nine-month period ended March 31, 2007 as compared to
the same period last fiscal year.
Marketing, general and administrative expenses in the Drew business unit
decreased $467,000, or 10.5%, to $3,973,000 as compared to the same period last
fiscal year. As in the period ended March 31, 2007, the reduction is primarily
due to the realization of cost reductions initiated during the first quarter of
fiscal year 2007.
Marketing, general and administrative expenses in the Sonomed business unit
decreased $33,000, or 1.4%, to $2,382,000 as compared to the same period last
fiscal year. Marketing and sales salaries and related expenses decreased
approximately $74,000 due to the temporary reduction of the in-house sales
force. This reduction was partially offset by an increase of approximately
$62,000 in amounts paid to independent agents utilized primarily in Europe
related to the Company's goal of continuing to increase international revenues.
Commissions decreased approximately $56,000 due to increases in direct and
distributor sales. Advertising decreased nearly $40,000 due mainly to
nonrecurring spending that occurred during 2006 for start-up expenses relating
to the Company's new UBM. Legal fees decreased approximately $32,000. This
decrease is primarily due to the non-recurrence of fees incurred during 2006 to
resolve a dispute with a supplier and fees related to researching intellectual
property ownership issues for licensing for use in potential new products.
Marketing, general and administrative expenses in the Vascular business
unit increased $99,000, or 7.1%, to $1,489,000 as compared to the same period
last fiscal year. Administrative salaries and related expenses increased nearly
$66,000 reallocation of personnel to properly reflect time contributed to
Vascular. Sales travel and related expenditures increased approximately $40,000
as part of efforts to increase direct domestic sales while show expenses
increased $14,000.
Marketing, general and administrative expenses in the Medical/Trek/EMI
business unit increased $67,000, or 3.1%, to $2,218,000 as compared to the same
period last fiscal year. Legal fees increased approximately $180,000, due
primarily to expenditures related to finalizing the settlement with IntraLase.
See note 6 of the notes to the condensed consolidated financial statements.
Accounting fees increased $43,000, mainly due to higher third party consulting
fees for tax and temporary services. Amortization expense, related mainly to the
MRP acquisition, increased $63,000. Also, the 2007 nine month period includes
approximately $125,000 expensed under SFAS No. 123(R) related to options granted
to members of the Board of Directors. Offsetting these increases was an increase
in corporate allocations to the subsidiaries as well as, decreases in
consulting, corporate travel and related expenses, business taxes and exhibit
expenses of $34,000, $48,000, $26,000 and $61,000, respectively.
The following table presents consolidated research and development expenses
as well as identifying trends in business unit research and development expenses
for the three- and nine-month periods ended March 31, 2007 and 2006. Dollar
amounts are in thousands:
THREE-MONTH PERIOD NINE-MONTH PERIOD
ENDED MARCH 31, ENDED MARCH 31,
---------------------- --------------------------
2007 2006 % CHANGE 2007 2006 % CHANGE
---- ---- -------- ------ ------ --------
RESEARCH AND DEVELOPMENT
Drew $529 $489 8.2% $1,862 $1,323 40.7%
Sonomed 161 54 198.1% 323 387 -16.5%
Vascular 62 42 47.6% 120 113 6.2%
Medical/Trek/EMI 92 133 -30.8% 333 313 6.4%
---- ---- ----- ------ ------ -----
TOTAL $844 $718 17.5% $2,638 $2,136 23.5%
==== ==== ===== ====== ====== =====
Research and development expenses increased $126,000, or 17.5%, to $844,000
during the three-month period ended March 31, 2007 as compared to the same
period last fiscal year.
20
Research and development expenses related primarily expenses associated
with the planned introduction of new and/or enhanced products in the Drew
business unit. Research and development expenses in the Drew business unit
increased $40,000, or 8.2%, to $529,000 as compared to the same period last
fiscal year. The increase is primarily due to additional salaries, benefits and
consulting fees associated with the development of several new hematology and
diabetic instruments.
Research and development increased approximately $107,000 in the Sonomed
business unit due primarily to an increase of nearly $91,000 in consulting fees
related to additional UBM improvements.
Research and development expenses in the Medical/Trek/EMI business unit
decreased $41,000 to $92,000 as compared to the same period last fiscal year.
Expenditures were reduced by approximately $107,000 due to the realization of
cost reductions initiated during the first quarter of fiscal year 2007. This
decrease was partially offset by an increase of approximately $67,000 related
to expenditures for the development of the Company's new digital ophthalmic
platform.
Research and development expenses increased $502,000, or 23.5%, to
$2,638,000 during the nine-month period ended March 31, 2007 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
$539,000, or 40.7%, to $1,862,000 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 Sonomed business unit decreased
$64,000 to $323,000 as compared to the same period last fiscal year. The
decrease is primarily due to a reduction of consulting (approximately $38,000)
and prototype expenses (approximately $16,000) for development of the Company's
new UBM machines completed during 2006.
Research and development expenses in the Medical/Trek/EMI business unit
increased $20,000 to $333,000 as compared to the same period last fiscal year.
The increase is primarily due to $196,000 higher expenditures relate to
development of the Company's new digital ophthalmic program off set partially by
the reduction in corporate expenditures of approximately $165,000 due to the
realization of cost reductions initiated during the first quarter of fiscal year
2007.
Gain on sale of available for sale securities was approximately $1,157,000
in the nine-month period ended March 31, 2006 due to the sale of 58,585 shares
of IntraLase common stock in July 2005. There was no similar transaction during
the same period of the current fiscal year. There were no sales of available-
for-sale securities during the nine-month period ended March 31, 2007.
The Company recognized a loss of $25,000 and $19,000 related to its
investment in OTM during the three-month periods ended March 31, 2007 and 2006,
respectively, and $56,000 and $70,000 for the nine-month periods ended March 31,
2007 and 2006, 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.
Interest income was $54,000 and $34,000 for the three-month periods ended
March 31, 2007 and 2006, respectively, and 113,000 and $112,000 for the
nine-month periods ended March 31, 2007 and 2006, respectively. The increase was
due to higher effective yields on investments.
21
Interest expense was $9,000 and $28,000 for the three-month periods ended
March 31, 2007 and 2006, respectively, and $24,000 and $47,000 for the
nine-month periods ended March 31, 2007 and 2006, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Changes in overall liquidity and capital resources from continuing
operations during the three-month period ended March 31, 2007 are reflected in
the following table (in thousands):
MARCH 31, JUNE 30,
2007 2006
--------- ---------
CURRENT RATIO:
Current assets $ 22,390 $ 14,911
Less: Current liabilities 3,996 4,295
--------- ---------
WORKING CAPITAL $ 18,394 $ 13,613
========= =========
CURRENT RATIO 5.6 TO 1 3.5 TO 1
========= =========
DEBT TO TOTAL CAPITAL RATIO:
Notes payable and current maturities $ 199 $ 233
Long-term debt 14 163
--------- ---------
Total debt $ 213 $ 396
--------- ---------
Total equity 40,632 33,100
--------- ---------
TOTAL CAPITAL $ 40,845 $ 33,496
========= =========
TOTAL DEBT TO TOTAL CAPITAL 0.5% 1.8%
========= =========
WORKING CAPITAL POSITION
Working capital increased approximately $4,781,000 as of March 31, 2007 and
the current ratio increased to 5.6 to 1 from 3.5 to 1 when compared to June 30,
2006. The increase in working capital was primarily related to the settling of
the Intralase litigation (see note 6 of the notes to condensed consolidated
financial statements).
CASH USED IN OPERATING ACTIVITIES
During the nine-month periods ended March 31, 2007 and 2006, the Company
generated/(used) approximately $6,346,000 and $(2,753,000) of cash for operating
activities, respectively. The net decrease in cash used for operating activities
of approximately $9,099,000 for the nine-month period ended March 31, 2007 as
compared to the same period in the prior fiscal year is due primarily to the
following factors:
The Company had net income of $7,087,000 and experienced net cash out flows
from increases in accounts receivable and inventory of approximately $537,000
and $1,130,000, respectively. These cash out flows were partially offset by an
increase in accounts payable of $164,000 and non-cash expenditures on
depreciation and amortization of $418,000. In the prior fiscal period the cash
used in operating activities of $2,753,000 was related to net loss in the prior
year of $844,000 and by a gain on sale of marketable securities in the amount of
$1,157,000, along with increases in inventory and accounts receivable of
$795,000 and $428,000, respectively, offset by $338,000 in non-cash items.
22
CASH FLOWS (USED IN) PROVIDED BY INVESTING AND FINANCING ACTIVITIES
Cash flows used in investing activities of $215,000 is related to fixed
asset purchases during the nine-month period ended March 31, 2007. The decrease
in cash flows from investing activities from the prior fiscal period was
$848,000. The change relates 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.
Partially offsetting the cash realized from the securities sale was cash
utilized for fixed asset additions and for distribution rights of approximately
$476,000.
Cash flows used by financing activities were approximately $24,000 during
the nine-month period ended March 31, 2007. During the period, the Company made
scheduled long-term debt repayments of approximately $182,000 and received
$158,000 from the exercise of stock options during the period.
DEBT HISTORY
Drew has long-term debt facilities through the Texas Mezzanine Fund and
through Symbiotics, Inc. The Texas Mezzanine Fund term debt is payable in
monthly installments of $14,200, which includes interest at a fixed rate of
8.00%. The note is due in April 2008 and is secured by certain assets of Drew.
The outstanding balance as of March 31, 2007 was $171,000. 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%. The outstanding balance as of March 31, 2007
was $42,000.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
The Company was not a party to any off-balance sheet arrangements during
the three- and six-month periods ended March 31, 2007 and 2006.
The following table presents the Company's contractual obligations as of
March 31, 2007 (interest is not included in the table as it is immaterial):
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
---------- ---------- ---------- ---------- ---------
Long-term debt $ 213,079 $198,966 $ 14,113 $ 0 $ 0
Operating lease agreements 2,316,297 785,366 1,105,807 425,124 0
---------- -------- ---------- -------- ---
TOTAL $2,529,376 $984,332 $1,119,920 $425,124 $ 0
========== ======== ========== ======== ===
SIGNIFICANT ITEMS LIKELY TO IMPACT LIQUIDITY
Drew does not have a history of producing positive operating cash flows
and, as a result, at the time of acquisition in 2005, was operating under
financial constraints and was undercapitalized. As Drew is integrated into the
Company, management has been working to reverse the situation, while at the same
time seeking to strengthen Drew's market position. As of March 31, 2007, the
Company has loaned approximately $13,200,000 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.
23
ITEM 3: 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, 2007 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.
2007 2008
-------- -------------
Texas Mezzanine Fund Note $ 99,896 $ 71,183
Interest rate 10.25% Prime Plus 4%
Symbiotics, Inc. Note $ 42,000 $ 0
Interest rate 5.00% 5.00%
-------- ------------
TOTAL $141,896 $ 71,183
======== ============
EXCHANGE RATE RISK
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, 2007 and 2006, Drew recorded approximately $985,000 and
$881,000 respectively, of revenue denominated in United Kingdom Pounds and
Euros, respectively. During the nine-month periods ended March 31, 2007 and
2006, Drew recorded approximately $2,525,000 and $3,046,000, respectively, of
revenue denominated in United Kingdom Pounds and Euros, respectively.
Drew incurs a portion of its expenses denominated in United Kingdom Pounds.
During the three-month periods ended March 31, 2007 and 2006, Drew incurred
approximately $957,000 and $931,000, respectively, of expense denominated in
United Kingdom Pounds. During the nine-month periods ended March 31, 2007 and
2006, Drew recorded approximately $3,101,000 and $3,325,000, respectively, of
expense denominated in United Kingdom Pounds and Euros, respectively. The
Company's Sonomed and Vascular business units incur an immaterial portion of
their marketing expenses in the European market, the majority of which are
transacted in Euros.
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 4. CONTROLS AND PROCEDURES
(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company's management, with the participation of the Company's Chief
Executive Officer and Principal Financial and Accounting Officer, has
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.
24
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, 2007, 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 fiscal quarter ended March 31, 2007 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 6 of the notes to the condensed consolidated financial statements
for further information regarding the Company's legal proceedings.
ITEM 1A. RISK FACTORS
Drew has received notice from the FDA that certain deficiencies were noted
during the FDA's recent audit of the Company's United Kingdom facility. Drew has
addressed the deficiencies and believes that it has bought the facility into
compliance with FDA regulations. Drew is communicating with the FDA concerning
its remediation of the deficiencies, however, Drew may face further adverse
findings, rulings and fines from the FDA, which may result in the delay or
delivery of certain products. Drew has alternative sources for the products
manufactured at the Drew United Kingdom facility. In the event of any adverse
FDA action the use of Drew's alternative suppliers will have an adverse effect
on gross margins.
There are no other material changes from the risks previously disclosed in
our Annual Report on Form 10-KSB for the period ended June 30, 2006.
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.
25
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, 2007 By: /s/ Richard J. DePiano
------------------------------------
Richard J. DePiano
Chairman and Chief Executive Officer
Date: May 15, 2007 By: /s/ Robert O'Connor
------------------------------------
Robert O'Connor
Chief Financial Officer
26