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 SEPTEMBER 30, 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 [ ] Accelerated filer [ ] Non-accelerated filer [X]
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: 6,389,315 shares of common
stock, $0.001 par value, outstanding as of November 6, 2007.
ESCALON MEDICAL CORP.
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of September 30, 2007
(Unaudited) and June 30, 2007 2
Condensed Consolidated Statements of Income for the three-
month periods ended September 30, 2007 and 2006 (Unaudited) 3
Condensed Consolidated Statements of Cash Flows for the three-
month periods ended September 30, 2007 and 2006 (Unaudited) 4
Condensed Consolidated Statement of Shareholders' Equity for the
three-month period ended September 30, 2007 (Unaudited) 5
Condensed Consolidated Statement of Other Comprehensive Income
(Loss) for the three-month periods ended September 30, 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 of Operations 12
Item 3. Quantitive and Qualitative Disclosures about Market Risk 22
Item 4. Controls and Procedures 23
Part II. Other Information
Item 1. Legal Proceedings 23
Item 1A Risk Factors 24
Item 6. Exhibits 24
1
PART I. FINANCIAL STATEMENTS
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, JUNE 30,
2007 2007
------------- ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 7,628,173 $ 8,879,462
Accounts receivable, net 4,516,354 4,653,073
Inventory, net 7,472,252 7,761,370
Other current assets 273,847 469,107
------------ ------------
TOTAL CURRENT ASSETS 19,890,626 21,763,012
------------ ------------
Furniture and equipment, net 899,122 873,191
Goodwill 21,072,260 21,072,260
Trademarks and trade names, net 620,106 620,106
Patents, net 199,297 216,228
Covenant not to compete and customer list, net 302,698 326,860
Other assets 275,008 145,556
------------ ------------
TOTAL ASSETS $ 43,259,117 $ 45,017,213
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 94,657 $ 150,200
Accounts payable 1,584,495 1,626,274
Accrued expenses 1,891,654 2,748,133
------------ ------------
TOTAL CURRENT LIABILITIES 3,570,805 4,524,607
Accrued post-retirement benefits 1,087,000 1,087,000
------------ ------------
TOTAL LIABILITIES 4,657,805 5,611,607
------------ ------------
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; 6,389,315 and 6,386,857 shares
issued and outstanding at September 30,
2007 and June 30, 2006, respectively 6,390 6,387
Common stock warrants 1,601,346 1,601,346
Additional paid-in capital 66,065,419 66,045,050
Retained earnings (29,036,615) (28,207,824)
Accumulated other comprehensive (loss) (35,228) (39,353)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 38,601,312 39,405,606
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 43,259,117 $ 45,017,213
============ ============
See notes to condensed consolidated financial statements
2
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED
SEPTEMBER 30,
-----------------------
2007 2006
---------- ----------
NET REVENUES:
Product revenue $6,833,350 $6,543,586
Other revenue $ 59,921 624,574
---------- ----------
REVENUES, NET 6,893,271 7,168,160
---------- ----------
COSTS AND EXPENSES:
Cost of goods sold $3,922,586 3,630,380
Research and development $ 923,361 713,605
Marketing, general and administrative $2,939,908 3,555,900
---------- ----------
TOTAL COSTS AND EXPENSES 7,785,855 7,899,885
---------- ----------
LOSS FROM OPERATIONS (892,584) (731,725)
---------- ----------
OTHER (EXPENSE) AND INCOME:
Equity in Ocular Telehealth Management, LLC (34,111) (18,543)
Interest income 101,697 45,436
Interest expense (3,793) (9,285)
---------- ----------
TOTAL OTHER INCOME 63,793 17,608
---------- ----------
NET (LOSS) BEFORE TAXES (828,791) (714,117)
---------- ----------
Provision for income taxes 0 0
---------- ----------
NET (LOSS) $ (828,791) $ (714,117)
========== ==========
BASIC NET (LOSS) PER SHARE $ (0.13) $ (0.11)
========== ==========
DILUTED NET (LOSS) PER SHARE $ (0.13) $ (0.11)
========== ==========
WEIGHTED AVERAGE SHARES - BASIC 6,388,086 6,344,657
========== ==========
WEIGHTED AVERAGE SHARES - DILUTED 6,388,086 6,344,657
========== ==========
See notes to condensed consolidated financial statements
3
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS
ENDED SEPTEMBER 30,
-------------------------
2007 2006
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) $ (828,791) $ (714,117)
Adjustments to reconcile net (loss) to net cash (used in)
operating activities:
Depreciation and amortization 145,083 135,279
Compensation expense related to stock options 12,934 0
Loss on Ocular Telehealth Management, LLC 34,111 18,543
Change in operating assets and liabilities:
Accounts receivable, net 136,719 (237,802)
Inventory, net 289,118 (553,845)
Other current and long-term assets 65,808 (181,490)
Accounts payable, accrued and other liabilities (898,259) 251,364
----------- -----------
NET CASH (USED IN) OPERATING ACTIVITIES (1,043,277) (1,282,068)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in Ocular Telehealth Management, LLC (18,000) --
Purchase of fixed assets (129,921) (36,966)
----------- -----------
NET CASH (USED IN) INVESTING ACTIVITIES (147,921) (36,966)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on term loans (55,543) (59,669)
Issuance of common stock - stock options 7,438 0
Income Tax Benefit from exercise of stock options 0 98,412
----------- -----------
NET CASH (USED IN)/PROVIDED BY FINANCING ACTIVITIES (48,105) 38,743
----------- -----------
Effect of exchange rate changes on cash and cash equivalents (11,986) 49,621
----------- -----------
NET (DECREASE) IN CASH AND CASH EQUIVALENTS (1,251,289) (1,230,670)
----------- -----------
Cash and cash equivalents, beginning of period 8,879,462 3,379,710
----------- -----------
Cash and cash equivalents, end of period $ 7,628,173 $ 2,149,040
=========== ===========
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Interest paid $ 3,793 $ 7,939
=========== ===========
Income taxes paid $ 0 $ 0
=========== ===========
Increase in unrealized appreciation on available for sale securities $ 0 $ 8,910
=========== ===========
See notes to condensed consolidated financial statements
4
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 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, 2007 6,386,857 $6,387 $1,601,346 $ 66,045,050 $(28,207,824) $(39,353) $39,405,606
Net (loss) 0 0 0 (828,791) 0 (828,791)
Exercise of stock options
of stock options 2,458 3 7,435 7,438
Compensation expense 0 0 12,934 0 0 12,934
Foreign currency translation 0 0 0 0 4,125 4,125
--------- ------ ---------- ------------ ------------ -------- -----------
BALANCE AT SEPTEMBER 30, 2007 6,389,315 $6,390 $1,601,346 $ 66,065,419 $(29,036,615) $(35,228) $38,601,312
========= ====== ========== ============ ============ ======== ===========
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 SEPTEMBER 30,
---------------------
2007 2006
--------- ---------
Net (loss) $(828,791) $(714,117)
Change in unrealized gains on
available for sale securities 0 8,910
Foreign currency translation 4,125 126,234
--------- ---------
COMPREHENSIVE (LOSS) $(824,666) $(578,973)
========= =========
See notes to condensed consolidated financial statements
6
ESCALON MEDICAL CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
Escalon Medical Corp. ("Escalon" or the "Company") is a Pennsylvania
corporation initially incorporated in California in 1987, and reincorporated in
Pennsylvania in November 2001. Within this document, the "Company" collectively
shall mean Escalon and its wholly owned subsidiaries: Sonomed, Inc. ("Sonomed"),
Escalon Vascular Access, Inc. ("Vascular"), Escalon Digital Vision, Inc.
("EMI"), Escalon Holdings, Inc. ("EHI"), Escalon IP Holdings, Inc., Escalon
Vascular IP Holdings, Inc., Sonomed IP Holdings, Inc., Drew Scientific Holdings,
Inc., and Drew Scientific Group, Plc ("Drew") and its subsidiaries. All
inter-company accounts and transactions have been eliminated.
The Company operates in the healthcare market, specializing in the
development, manufacture, marketing and distribution of medical devices and
pharmaceuticals in the 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") and 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 2007 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.
2. STOCK-BASED COMPENSATION
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. Prior to fiscal 2007 the Company was a small business issuer as
defined in Item 10 of Regulation S-B. As a result, 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.
As of September 30, 2007 and 2006, there was $114,118 and $0 of total
unrecognized compensation cost related to non-vested share-based compensation
arrangements under the 2004 Equity Incentive Plan. There was no unrecognized
compensation cost on September 30, 2006 because the Company accelerated the
vesting of all of its outstanding options effective June 30, 2006, and no stock
options were issued during the three-month period ended September 30, 2006. The
cost is expected to be recognized over a weighted average period of four years.
7
Cash received from share option exercises under stock-based payment
plans for the three months ended September 30, 2007 and 2006 was $7,435 and $0,
respectively. 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 Service." 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 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.
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 ENDED
SEPTEMBER 30,
-----------------------
2007 2006
---------- ----------
NUMERATOR:
Numerator for basic and diluted
earnings per share
NET (LOSS) $ (828,791) $ (714,117)
---------- ----------
DENOMINATOR:
Denominator for basic earnings per
share - weighted average shares 6,388,086 6,344,657
Effect of dilutive securities:
Stock options and warrants 0 0
DENOMINATOR FOR DILUTED EARNINGS PER
SHARE - WEIGHTED AVERAGE AND
---------- ----------
ASSUMED CONVERSION 6,388,086 6,344,657
---------- ----------
BASIC (LOSS) EARNINGS PER SHARE $ (0.13) $ (0.11)
========== ==========
DILUTED (LOSS) EARNINGS PER SHARE $ (0.13) $ (0.11)
========== ==========
The impact of dilutive securities were omitted from the earnings per
share calculation in 2007 and 2006 as they would reduce the loss per share (and
thus were anti-dilutive).
8
4. LEGAL PROCEEDINGS
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 obligated to pay royalties to ICH on the products and
consumables. On January 23, 2006, the Company received a letter from ICH
alleging that Drew had failed to remit certain monies due under the license
agreement and has sought an accounting to determine such amount due.
The parties agreed to settle this matter in October 2007 for $23,304.
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.
9
5. SEGMENTAL INFORMATION
During the three-month periods ended September 30, 2007 and 2006, the
Company's operations were classified into five principal reportable business
units that provide different products or services.
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
SEPTEMBER 30, 2007 AND 2006
MEDICAL/TREK/
DREW SONOMED VASCULAR EHI EMI TOTAL
---------------- ---------------- -------------- -------------- -------------- ----------------
2007 2006 2007 2006 2007 2006 2007 2006 2007 2006 2007 2006
------- ------- ------- ------- ------ ------ ------ ------ ------ ------ ------- -------
REVENUES, NET:
Product revenue $ 3,035 $ 2,785 $ 2,233 $ 2,293 $ 804 $ 817 $ 383 $ 365 $ 377 $ 283 $ 6,832 $ 6,543
Other revenue 60 70 0 0 0 0 0 555 0 0 60 625
------- ------- ------- ------- ------ ------ ------ ------ ------ ------ ------- -------
TOTAL REVENUE, NET 3,095 2,855 2,233 2,293 804 817 383 920 377 283 6,892 7,168
------- ------- ------- ------- ------ ------ ------ ------ ------ ------ ------- -------
COSTS AND EXPENSES:
Cost of goods sold 1,902 1,759 1,257 1,187 283 313 254 254 227 118 3,923 3,631
Research & Development 604 458 164 77 85 22 (2) 89 72 68 923 714
Marketing, General & Admin 1,004 1,383 812 807 408 530 559 755 157 80 2,940 3,555
------- ------- ------- ------- ------ ------ ------ ------ ------ ------ ------- -------
TOTAL COSTS AND EXPENSES 3,509 3,600 2,233 2,071 776 865 811 1,098 456 266 7,785 7,900
------- ------- ------- ------- ------ ------ ------ ------ ------ ------ ------- -------
(LOSS) INCOME FROM
OPERATIONS (414) (745) 0 222 28 (48) (428) (178) (79) 17 (893) (732)
------- ------- ------- ------- ------ ------ ------ ------ ------ ------ ------- -------
OTHER (EXPENSE) AND
INCOME:
Gain on sale of available
for sale securities 0 0 0 0 0 0 0 0 0 0 0
Equity in OTM 0 0 0 0 0 0 (34) (19) 0 (34) (19)
Interest income 0 0 0 0 0 0 102 45 0 102 45
Interest expense (3) (8) 0 0 0 0 0 0 0 (3) (8)
------- ------- ------- ------- ------ ------ ------ ------ ------ ------ ------- -------
TOTAL OTHER (EXPENSE) INCOME (3) (8) 0 0 0 0 68 26 0 0 65 18
------- ------- ------- ------- ------ ------ ------ ------ ------ ------ ------- -------
(LOSS) INCOME BEFORE TAXES (417) (753) 0 222 28 (48) (360) (152) (79) 17 (828) (714)
------- ------- ------- ------- ------ ------ ------ ------ ------ ------ ------- -------
Income taxes 0 0 0 0 0 0 0 0 0 0 0 0
------- ------- ------- ------- ------ ------ ------ ------ ------ ------ ------- -------
NET (LOSS) INCOME $ (417) $ (753) $ 0 $ 222 $ 28 $ (48) $ (360) $ (152) $ (79) $ 17 $ (828) $ (714)
======= ======= ======= ======= ====== ====== ====== ====== ====== ====== ======= =======
Depreciation and
amortization $ 68 $ 86 $ 0 $ 6 $ 0 $ 25 $ 0 $ 18 $ 24 $ 68 $ 159
Assets $17,037 $17,404 $13,892 $13,784 $1,889 $2,101 $8,647 $3,092 $1,795 $1,843 $43,260 $38,224
Expenditures for
long-lived assets $ 53 $ 35 $ 0 $ 0 $ 1 $ 1 $ 0 $ 9 $ 0 $ 54 $ 45
6. RELATED-PARTY TRANSACTIONS
The Company and a member of the Company's Board of Directors are
founding and equal members of Ocular Telehealth Management ("OTM"). OTM is a
diagnostic telemedicine company providing remote examination, diagnosis and
management of disorders affecting the human eye. OTM's initial focus is on the
diagnosis of diabetic retinopathy by creating access and providing annual
dilated retinal examinations for the diabetic population. Through September 30,
2007, the Company has invested $306,000 in OTM, including $18,000 invested
during the three-month period ended September 30, 2007. As of September 30,
2007, Escalon owned 37.7% of OTM. The Company provides administrative support
functions to OTM. From inception through September 30, 2007, OTM had revenue of
approximately $28,100 and incurred expenses of approximately $431,000.
Two relatives of a senior executive officer have provided legal
services as either an employee or a consultant to the Company. Richard DePiano,
Jr. (son of the Chief Executive Officer ("CEO")) is Chief Operating Officer and
General Counsel to the Company, Mr. DePiano's salary plus bonus for the
three-month periods ended September 30, 2007 and 2006 were $31,364 and $30,900,
respectively. Caryn Lindsey (daughter-in-law of the CEO) acted as a consultant
and employee for the Company in 2006. For
10
the three-month periods ended September 30, 2007 and 2006 Ms. Lindsey received
consulting fees and salary of $0 and $16,250, respectively.
7. RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2006, the Financial Accounting Standards Board ("FASB"),
issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes -
an interpretation of FASB Statement No. 109 ("FIN 48"). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise's
financial statements. This Interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in the tax return. The Company
adopted the provisions of FIN 48 on July 31, 2007. As of the date of adoption,
the 2003-2006 tax years remain subject to examination by major tax
jurisdictions.
As a result of the implementation of FIN 48, the Company recognized no
material adjustments in the liability for unrecognized income tax benefits and,
at the adoption date of July 1, 2007, the Company had no unrecognized tax
benefits that would affect its effective tax rate if recognized. At September
30, 2007, the Company also had no unrecognized tax benefits. If uncertain tax
positions had been recorded, the Company would have recognized interest and
penalties related to uncertain tax positions in income tax expense. As of
September 30, 2007, no accrued interest related to uncertain tax positions has
been recorded.
In September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements ("SFAS No. 157"). SFAS No. 157 establishes a framework for
measuring fair value and expands the disclosures on fair value measurements.
SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.
The Company is currently evaluating the impact of the adoption of SFAS No. 157
on its consolidated financial statements. However, it does not expect the effect
to be significant.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option
for Financial Assets and Financial Liabilities Including an amendment of FASB
Statement No. 115 ("SFAS No. 159"). SFAS No. 159 permits a company to choose to
measure many financial instruments and other items at fair value that are not
currently required to be measured at fair value. The objective is to improve
financial reporting by providing a company with the opportunity to mitigate
volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. SFAS No. 159 will be effective for fiscal years that begin after
November 15, 2007. The Company is currently evaluating the impact of the
adoption of SFAS No. 159 on its consolidated financial statements. However, the
Company does not expect the effect to be significant.
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
11
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-K for the year ended June 30, 2007 to be an exhaustive statement of all
risks, uncertainties or potentially inaccurate assumptions.
EXECUTIVE OVERVIEW - THREE-MONTH PERIOD ENDED SEPTEMBER 30, 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 the
Company's performance and financial condition.
- Product revenue increased approximately 4% during the three-month
period ended September 30, 2007 as compared to the same period last
fiscal year. Revenue at Sonomed and Vascular decreased 3% and 2%,
respectively, during the three-month period ended September 30, 2007
when compared to the same period last fiscal year. These decreases
were offset by strong sales in the Company's Drew, Medical/Trek and
EMI business units. Sales at Drew, Medical/Trek and EMI increased
approximately 9%, 5% and 33%, respectively, during the three-month
period ended September 30, 2007 compared to the same period last
fiscal year.
- Other revenue decreased approximately $565,000 or 90% during the
three-month period ended September 30, 2007 as compared to the same
period last fiscal year. The decrease is attributable to decreased
royalties received from the IntraLase License Agreement as a result of
the settlement agreement between the Company and IntraLase dated
February 27, 2007. Under the settlement agreement, IntraLase made a
lump sum payment to the Company of $9,600,000 in exchange for which
all pending litigation between the parties was dismissed, the parties
exchanged general releases, the company's ownership of all patents and
intellectual property formerly licensed to IntraLase from the Company
was obtained by IntraLase, and the license agreement has terminated.
In addition, the payment from IntraLase satisfies all outstanding
past, current and future royalties owed or alleged to be owed by
IntraLase to the Company.
- Cost of goods sold as a percentage of product revenue increased to
approximately 57% of revenues during the three-month period ended
September 30, 2007, as compared to approximately 55% 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 and EMI business units during the three-month period
ended September 30, 2007 was approximately 53% in the current period
as compared to 51% in the same period last fiscal year.
- Operating expenses decreased approximately 17% during the three-month
period ended September 30, 2007 as compared to the same period in the
prior fiscal year. During the three-month period ended September 30,
2007, the Company realized the full affect of the cost reduction plan
implemented in the prior fiscal year. In addition, the prior period
included higher than usual legal costs related to the then ongoing
Intralase litigation.
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.
12
In February 1996, the Company acquired substantially all of the assets
and certain liabilities of Escalon Ophthalmics, Inc. ("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, the Company 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.
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.
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 acquired all of
the Drew shares during fiscal 2006. 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 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.
13
- 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.
(LOSS) PER SHARE
The Company computes net (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
(loss) per share is computed by dividing the net (loss) for the period by the
weighted average number of shares of common stock outstanding during the period.
The calculation of diluted net (loss) per share excludes potential common shares
if the effect is anti-dilutive. Basic earnings per share are computed by
dividing net (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 (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.
14
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 September 30, 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-MONTH PERIODS ENDED SEPTEMBER 30, 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-month periods ended September 30, 2007 and 2006. Table amounts are in
thousands:
THREE-MONTH PERIOD ENDED
SEPTEMBER 30,
--------------------------
2007 2006 % CHANGE
------ ------ --------
PRODUCT REVENUE:
Drew $3,036 $2,786 9%
Sonomed 2,233 2,293 -3%
Vascular 804 817 -2%
Medical/Trek 383 365 5%
EMI 377 283 33%
------ ------ ---
TOTAL $6,833 $6,544 4%
====== ====== ===
Consolidated product revenue increased approximately $289,000, or 4%,
to $6,833,000 during the three-month period ended September 30, 2007 as compared
to the same period last fiscal year.
In the Drew business unit, product revenue increased $250,000, or 9%,
as compared to the same period last fiscal year. The increase is primarily due
to the introduction of the new FDA Trilogy instrument and increased reagent
revenues generated from Drew's United Kingdom facility. Drew anticipates that
its new D3 instrument will be ready for sale in the second quarter of fiscal
2008.
Product revenue decreased $60,000, or 3%, at the Sonomed business unit
as compared to the same period last fiscal year. The decrease in product revenue
was primarily caused by an increase in sales discounts during the period as a
result of a large increase in sales to the more price sensitive international
market combined with a decrease in overall domestic sales of the Company's new
Vumax II ultrasound systems and by a decrease in domestic sales and in demand
for the Company's pachymeter product.
Product revenue decreased $13,000, or 2%, to $804,000 in the Vascular
business unit during the three-month period ended September 30, 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 direct sales to end
users by the Company's domestic sales team. Overall sales have remained flat as
the existing Vascular product line has matured. Vascular anticipates introducing
a combination ultrasound/doppler guided vascular access product during the
second half of fiscal 2008.
15
In the Medical/Trek business unit, product revenue increased $18,000,
or 5%, to $383,000 during the three-month period ended September 30, 2007 as
compared to the same period last fiscal year. The increase in Medical/Trek
product revenue is attributed to an increase in the sale of Medical/Trek's
mature product line of Ispan Intraocular gases and fiber optic light sources.
Product revenue increased $94,000, or 33%, in the EMI business unit
when compared to the same period last year. This increase is due to the sale of
digital imaging systems from the January 2006 acquisition of MRP.
The following table presents consolidated other revenues by reportable
business unit for the three-month periods ended September 30, 2007 and 2006.
Table amounts are in thousands:
THREE-MONTH PERIOD ENDED
SEPTEMBER 30,
------------------------
2007 2006 %CHANGE
---- ---- -------
OTHER REVENUE:
Drew $60 $ 70 -14%
Sonomed 0 0 0%
Vascular 0 0 0%
Medical/Trek 0 555 -100%
EMI 0 0 0%
--- ---- ----
TOTAL $60 $625 -90%
=== ==== ====
Other revenue decreased by approximately $565,000, or 90%, to $60,000
during the three-month period ended September 30, 2007 as compared to the same
period last fiscal year. The decrease is primarily due to the settlement reached
with IntraLase on February 27, 2007. Under the settlement agreement, IntraLase
made a lump sum payment to Escalon of $9,600,000 in exchange for which all
pending litigation between parties was dismissed, the parties exchanged general
releases, the Company transferred to IntraLase its ownership of patents and
intellectual property formerly licensed to IntraLase by the Company and the
License Agreement was terminated. In addition, the payment from IntraLase
satisfied all outstanding past, current and future royalties owed or alleged to
be owed by IntraLase to the Company. As such, $0 was received in the current
period as compared to $555,000 in the same period last year. Royalties from
Bio-Rad related to an OEM agreement between Bio-Rad and Drew decreased by
approximately $10,000 to $60,000 due to lower sales of Drew's products in
covered areas. While this agreement terminated as of May 15, 2006, the parties
have continued to operate under the terms of the expired agreement pending
negotiation of a potential extension and/or revision.
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-month periods ended September 30, 2007 and 2006. Table amounts are
in thousands:
16
THREE-MONTH PERIOD ENDED
SEPTEMBER 30,
---------------------------
2007 % 2006 %
------ --- ------ ---
COST OF GOODS SOLD:
Drew $1,902 63% $1,758 63%
Sonomed 1,257 56% 1,187 52%
Vascular 283 35% 313 38%
Medical/Trek 254 66% 254 70%
EMI 227 60% 118 42%
------ --- ------ ---
TOTAL $3,923 57% $3,630 55%
====== === ====== ===
Consolidated cost of goods sold totaled approximately $3,923,000, or
57% of product revenue, for the three-month period ended September 30, 2007 as
compared to $3,630,000, or 56% of product revenue, for the same period last
fiscal year.
Cost of goods sold in the Drew business unit totaled $1,902,000, or
63% of product revenue, for the three-month period ended September 30, 2007 as
compared to $1,758,000, or 63% of product revenue, for the same period last
fiscal year. The increase in the cost of goods sold of 8% corresponds to a like
increase in sales of 9%. Drew's 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 $1,257,000, or
56% of product revenue, for the three-month period ended September 30, 2007 as
compared to $1,187,000, or 52% of product revenue, for the same period last
fiscal year. The primary reason for the increase in cost of goods sold as a
percentage of product revenue was a large increase in lower margin international
sales combined with an overall decrease in unit sales in the higher margin
domestic market on the Vumax II's as compared to the same period last year.
Cost of goods sold in the Vascular business unit totaled $283,000, or
35% of product revenue, for the three-month period ended September 30, 2007 as
compared to $313,000, or 38% of product revenue, for the same period last fiscal
year. The Company experienced lower overtime and higher production efficiencies
in the current period as compared to the prior period.
Cost of goods sold in the Medical/Trek business unit totaled $254,000,
or 66% of product revenue, during the three-month period ended September 30,
2007 as compared to $254,000, or 70% of product revenue, during the same period
last fiscal year. Fluctuations in Medical/Trek cost of goods sold primarily
emanates from product mix.
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-month periods ended
September 30, 2007 and 2006. Table amounts are in thousands:
17
THREE-MONTH PERIOD ENDED
SEPTEMBER 30,
--------------------------
2007 2006 % CHANGE
------ ------ --------
MARKETING, GENERAL AND ADMINISTRATIVE:
Drew $1,004 $1,384 -27%
Sonomed 812 807 1%
Vascular 408 530 -23%
Medical/Trek 559 755 -26%
EMI 157 80 96%
------ ------ ---
TOTAL $2,940 $3,556 -17%
====== ====== ===
Consolidated marketing, general and administrative expenses decreased
$616,000, or 17%, to $2,940,000 during the three-month period ended September
30, 2007 as compared to the same period last fiscal year.
Marketing, general good and administrative expenses in the Drew
business unit decreased $380,000 or 27%, to $1,004,000 as compared to the same
period last fiscal year. The reduction is primarily related to the Company
realizing the full affect of the cost reduction plan implemented in the prior
fiscal year.
Marketing, general and administrative expenses in the Sonomed business
unit remained relatively constant increasing $5,000, or 1%, to $812,000 as
compared to the same period last fiscal year.
Marketing, general and administrative expenses in the Vascular
business unit decreased $122,000, or 23%, to $408,000 as compared to the same
period last fiscal year. The decrease is related primarily to a decrease of
salaries, commissions and health insurance related to a decrease in headcount, a
decrease in consulting fees for recruitment and a decrease in meeting/exhibit
and marketing sample expenses due to less participation in shows and exhibits
during the three month period ended September 30, 2007.
Marketing, general and administrative expenses in the Medical/Trek
business unit decreased $196,000, or 26%, to $559,000 as compared to the same
period last fiscal year. The decrease is related to the high level of legal fees
incurred during the prior fiscal period related to the then on going litigation
with Intralase.
Marketing, general and administrative expenses in the EMI business
unit increased $77,000, or 96%, to $157,000 as compared to the same period last
fiscal year. The increase is primarily related to marketing efforts related to
increasing the sales of digital imaging systems acquired from the MRP
acquisition by 33% over the prior period.
The following table presents consolidated research and development
expenses as well as identifying trends in business unit research and development
expenses for the three-month periods ended September 30, 2007 and 2006. Table
amounts are in thousands:
18
THREE MONTH PERIOD ENDED
SEPTEMBER 30,
------------------------
2007 2006 % CHANGE
---- ---- --------
RESEARCH AND DEVELOPMENT:
Drew $604 $458 32%
Sonomed 164 77 113%
Vascular 85 22 286%
Medical/Trek (2) 89 -102%
EMI 72 68 6%
---- ---- ----
TOTAL $923 $714 29%
==== ==== ====
Consolidated research and development expenses increased $209,000, or 29%,
to $923,000 during the three-month period ended September 30, 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 Vascular business units.
Research and development expenses in the Drew business unit increased
$146,000, or 32%, to $604,000 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 increased
$87,000, or 113%, to $164,000 as compared to the same period last fiscal year.
The increase is primarily due to additional salaries and benefits and consulting
fees associated with upgrading and enhancing of existing products and continued
research into new products.
Research and development expenses in the Vascular business unit increased
$63,000, or 286%, to $85,000 as compared to the same period last fiscal year.
The increase is primarily due to additional prototype expenses associated with
the VascuViewTM, a new visual ultrasound device, which Vascular hopes to
introduce in the second half of the current fiscal year.
Research and development expenses in the Medical/Trek business unit
decreased $91,000 to ($2,000) as compared to the same period last fiscal year.
The decrease is primarily due to decreased salaries related to the full
realization of the cost reduction initiatives implemented in the prior year.
Research and development expenses in the EMI business unit increased
$4,000, or 6%, to $72,000 as compared to the same period last fiscal year. The
increase is related to the continued upgrading of our digital imaging product
offering.
The Company recognized a loss of $34,000 and $19,000 related to its
investment in OTM during the three-month periods ended September 30, 2007 and
2006, respectively. Commencing July 1, 2006, 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, 2006, 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 6 of the notes to the condensed consolidated
financial statements.)
Interest income was $102,000 and $45,000 for the three-month periods ended
September 30, 2007 and 2006, respectively. The increase was due to a combination
of higher effective yields on investments and higher investable balances.
19
Interest expense was $4,000 and $9,000 for the three-month periods ended
September 30, 2007 and 2006, respectively. The decrease reflects the reduction
in outstanding debt balance as of September 30, 2007 as compared to the prior
period.
LIQUIDITY AND CAPITAL RESOURCES
Changes in overall liquidity and capital resources from continuing
operations during the three-month period ended September 30, 2007 are reflected
in the following table (in thousands):
SEPTEMBER 30, JUNE 30,
2007 2007
------------- ---------
CURRENT RATIO:
Current assets $ 19,891 $ 21,763
Less: Current liabilities 3,571 4,525
--------- ---------
WORKING CAPITAL $ 16,320 $ 17,238
========= =========
CURRENT RATIO 5.6 TO 1 4.8 TO 1
========= =========
DEBT TO TOTAL CAPITAL RATIO:
Notes payable and current maturities $ 95 $ 150
Long-term debt 1,087 1,087
--------- ---------
Total debt $ 1,182 $ 1,237
--------- ---------
Total equity 38,601 39,406
--------- ---------
TOTAL CAPITAL $ 39,783 $ 33,100
========= =========
TOTAL DEBT TO TOTAL CAPITAL 3.0% 3.7%
--------- ---------
WORKING CAPITAL POSITION
Working capital decreased approximately $918,000 as of September 30, 2007,
and the current ratio decreased to 5.6 to 1 from 4.8 to 1 when compared to June
30, 2007. The decrease in working capital was caused primarily by the loss from
operations of approximately $829,000 and cash used to fund fixed asset additions
of approximately $130,000.
CASH USED IN OPERATING ACTIVITIES
During the three-month periods ended September 30, 2007 and 2006, the
Company used approximately $1,043,000 and $1,282,000 of cash for operating
activities. The net decrease in cash used for operating activities of
approximately $239,000 for the three-month period ended September 30, 2007 as
compared to the same period in the prior fiscal year is due primarily to the
following factors:
For the period ended September 30, 2007 the Company had a net loss of
$829,000 and experienced net cash out flow from a decrease in accounts payable
of $898,000. These cash out flows were partially offset by decreases in accounts
receivable, inventory, other current and long-term assets and non-cash
expenditures on depreciation and amortization of approximately $137,000,
$289,000, $66,000 and $145,000, respectively. In the prior fiscal period the
cash used in operating activities of $1,282,000 was related to net loss in the
prior year of $714,000 and increases in accounts receivable and inventory of
20
approximately $$238,000 and $554,000, respectively. These cash out flows were
partially offset by an increase in accounts payable of $251,000.
CASH FLOWS USED IN INVESTING AND FINANCING ACTIVITIES
Cash flows used in investing activities of $148,000 is related to fixed
asset purchases during the three-month period ended September 30, 2007. The
decrease in cash flows from investing activities from the prior fiscal period
was $37,000. The change relates primarily to increased fixed asset purchases.
Cash flows used in financing activities were approximately $48,000 during
the three-month period ended September 30, 2007. During the period, the Company
made scheduled long-term debt repayments of approximately $56,000 and had cash
in-flow from the issuance of common stock options of approximately $7,000. The
increase in cash flows from financing activities from the prior fiscal period
was approximately $39,000, due to net cash out-flows of approximately $60,000
for scheduled long-term debt repayments and receiving an income tax benefit of
$98,000 by amending its fiscal 2006 state tax returns to deduct the exercise of
stock options during fiscal 2006.
DEBT HISTORY
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 a long-term debt facility through the Texas Mezzanine Fund. The
Texas Mezzanine Fund debt provides for interest at fixed rate of 8% per annum
until July 1, 2006. 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 September 30, 2007 and June 30,
2007, 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 September 30, 2007 was approximately
$95,000.
The Symbiotics, Inc. term debt, which originated from the acquisition of a
product line from Symbiotics, Inc., was payable in monthly principal
installments of $8,333 plus interest at a fixed rate of 5.00% per annum. The
Symbiotics, Inc. term debt was paid off during the period ended September 30,
2007.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
The Company was not a party to any off-balance sheet arrangements during
the three-month periods ended September 30, 2007 and 2006.
21
The following table presents the Company's contractual obligations as of
September 30, 2007 (interest is not included in the table as it is immaterial):
LESS THAN
TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS
---------- --------- ---------- ---------
Long-term debt $ 94,657 $ 94,657 -- --
Operating lease agreements $2,746,090 $657,452 $1,378,755 $709,883
TOTAL $2,840,747 $752,109 $1,378,755 $709,883
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 acquired all of the remaining Drew
shares during fiscal 2006. 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 September 30,
2006, the Company has loaned approximately $16,725,000 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.
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
September 30, 2007 were variable at prime plus 4%, currently 10.25% per annum,
on the Texas Mezzanine Fund debt.
2008
--------------
Texas Mezzanine Fund Note $ 94,657
Interest rate Prime Plus 4%
-------------
TOTAL $ 94,657
=============
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 September 30, 2007 and 2006, Drew recorded approximately $884,000
and $325,000 respectively, of revenue denominated in United Kingdom Pounds and
Euros, respectively.
22
Drew incurs a portion of its expenses denominated in United Kingdom Pounds.
During the three-month periods ended September 30, 2007 and 2006, Drew incurred
approximately $911,000 and $1,265,000, respectively, of expense denominated in
United Kingdom Pounds. 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.
THREE MONTHS ENDED
---------------------------------------
TOTAL FOREIGN SALES SEPTEMBER 30, 2007 SEPTEMBER 30, 2006
------------------- ------------------ ------------------
DREW UK 884,000 325,000
THREE MONTHS ENDED
---------------------------------------
EXPENSES SEPTEMBER 30, 2007 SEPTEMBER 30, 2006
-------- ------------------ ------------------
DREW UK 911,000 1.265,000
The Company experiences 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, have
established disclosure controls and procedures to ensure that material
information relating to the Company, including its consolidated subsidiaries, is
made known to the officers who certify the Company's financial reports and to
other members of senior management and the Board of Directors.
Based on their evaluation of the effectiveness of the Company's disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Exchange Act), as of September 30, 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 first fiscal quarter ended September 30, 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
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See note 5 of the notes to the condensed consolidated financial statements
for further information regarding the Company's legal proceedings.
ITEM 1A. RISK FACTORS
There are no material changes from the risks previously disclosed in the
Company's Annual Report on Form 10-K for the period ended June 30, 2007.
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.
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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: November 14, 2007 By: /s/ Richard J. DePiano
------------------------------------
Richard J. DePiano
Chairman and Chief
Executive Officer
Date: November 14, 2007 By: /s/ Robert O'Connor
------------------------------------
Robert O'Connor
Chief Financial Officer
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