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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
|X| Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002.
OR
| | Transitional report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transitional period from ________ to _______
COMMISSION FILE NUMBER 0-20127
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ESCALON MEDICAL CORP.
(exact name of Registrant as specified in its charter)
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PENNSYLVANIA 33-0272839
(state or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
351 EAST CONESTOGA ROAD, WAYNE, PA 19087
(Address of principal executive offices, including zip code)
(610) 688-6830
(Registrant's telephone number, including area code)
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 shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the last 90 days. YES |X| NO | |
Indicate the number of shares of outstanding stock of each of the issuer's
classes of Common Stock, as of the latest practicable date.
Date: NOVEMBER 14, 2002 Shares of Common Stock, $0.001 par value: 3,345,851
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ESCALON MEDICAL CORP.
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
Page
----
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements 3
Condensed Consolidated Balance Sheets as of September 30,
2002 and June 30, 2002 3
Condensed Consolidated Statements of Operations for the Three
Months Ended September 30, 2002 and 2001 4
Condensed Consolidated Statements of Cash Flows for the Three
Months Ended September 30, 2002 and 2001 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
And Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 25
PART II OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 26
2
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, June 30,
2002 2002
------------ ------------
(Unaudited) (Audited)
ASSETS
Current assets:
Cash and cash equivalents $ 164,842 $ 220,826
Accounts receivable, net 2,112,298 2,093,877
Inventory, net 1,707,723 1,572,067
Other current assets 419,539 400,820
------------ ------------
Total current assets 4,404,402 4,287,590
------------ ------------
Long-term note receivable 150,000 150,000
597,795 626,377
Furniture and equipment, net 10,591,795 10,591,795
Goodwill 601,806 601,806
Trademarks and trade names, net 236,231 246,988
License and distribution rights, net 190,858 193,541
Patents, net 129,874 214,344
Other assets ------------ ------------
$ 16,902,761 $ 16,912,441
Total assets ============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Line of credit $ 1,400,000 $ 1,250,000
Current portion of long-term debt 2,314,419 2,085,963
Accounts payable 622,422 531,665
Accrued compensation 448,169 498,954
Other current liabilities 189,081 161,115
------------ ------------
Total current liabilities 4,974,091 4,527,697
Long-term debt, net of current portion 4,476,160 5,191,393
------------ ------------
Total liabilities 9,450,251 9,719,090
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 shares authorized; 3,345,851
shares issued and outstanding at September 30, 2002 and June 30, 2002 3,346 3,346
Additional paid-in capital 46,228,710 46,228,710
Accumulated deficit (38,779,546) (39,038,705)
------------ ------------
Total shareholders' equity 7,452,510 7,193,351
------------ ------------
Total liabilities and shareholders' equity $ 16,902,761 $ 16,912,441
============ ============
See notes to condensed consolidated financial statements
3
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
September 30,
2002 2001
----------- -----------
Revenues, net $ 3,008,340 $ 2,915,715
----------- -----------
Costs and expenses:
Cost of goods sold 1,078,919 1,228,262
Research and development 190,318 122,786
Marketing, general and administrative 1,288,128 1,145,598
----------- -----------
Total costs and expenses 2,557,365 2,496,646
----------- -----------
Income from operations 450,975 419,069
----------- -----------
Other income and expenses:
Equity in loss of unconsolidated joint venture -- (8,601)
Interest income 650 889
Interest expense (192,466) (207,042)
----------- -----------
Total other income and expenses (191,816) (214,754)
----------- -----------
Net income $ 259,159 $ 204,315
=========== ===========
Basic net income per share $ 0.077 $ 0.062
=========== ===========
Diluted net income per share $ 0.076 $ 0.062
=========== ===========
Weighted average shares - basic 3,345,851 3,292,184
=========== ===========
Weighted average shares - diluted 3,403,863 3,302,379
=========== ===========
See notes to condensed consolidated financial statements
4
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Three months ended September 30,
2002 2001
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 259,159 $ 204,315
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 87,899 49,944
Disposal of furniture and equipment 927 --
Equity in net loss of unconsolidated joint venture -- 8,601
Change in operating assets and liabilities:
Accounts receivable, net (18,421) 212,052
Inventory, net (135,656) 133,502
Other current and long-term assets 65,751 96,175
Accounts payable, accrued and other liabilities 67,938 (79,830)
--------- ---------
Net cash provided by operating activities 327,597 624,759
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Advances to unconsolidated joint venture, net -- 186,058
Purchase of fixed assets (18,348) (21,698)
--------- ---------
Net cash (used in) / provided by investing activities (18,348) 164,360
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Line of credit borrowing / (repayment), net 150,000 (326,009)
Principal payments on term loans (515,233) (350,000)
--------- ---------
Net cash used in financing activities (365,233) (676,009)
--------- ---------
Net (decrease) / increase in cash and cash equivalents (55,984) 113,110
Cash and cash equivalents, beginning of period 220,826 80,830
--------- ---------
Cash and cash equivalents, end of period $ 164,842 $ 193,940
========= =========
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Interest paid $ 142,249 $ 233,725
========= =========
See notes to condensed consolidated financial statements
5
ESCALON MEDICAL CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Escalon Medical Corp. and its subsidiaries Sonomed, Inc. ("Sonomed"), Escalon
Vascular Access, Inc. ("Vascular"), Escalon Digital Vision, Inc. ("Digital"),
Sonomed EMS Srl ("Sonomed EMS") and Escalon Pharmaceutical, Inc. (jointly
referred to as "Escalon" or the "Company") have been prepared in accordance with
the rules and regulations of the United States Securities and Exchange
Commission (the "SEC").
Certain information and footnote disclosures normally included in
financial statements presented in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, the financial statements reflect all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of financial position, results of operations and cash flows
for the interim periods presented. Operating results for interim periods are not
indicative of the results that may be expected for the fiscal year ending June
30, 2003.
For more complete financial information, the accompanying condensed
financial statements should be read in conjunction with the audited consolidated
financial statements for the year ended June 30, 2002 included in the Company's
annual report on Form 10-K.
2. COMPANY OVERVIEW
The following discussion should be read in conjunction with the interim
condensed consolidated financial statements and the notes thereto, which are set
forth elsewhere in this report on Form 10-Q.
Escalon Medical Corp. ("Escalon") was incorporated in California in 1987
as Intelligent Surgical Lasers, Inc. Escalon's present name was adopted in
August 1996. Escalon reincorporated in Delaware in November 1999, and then
reincorporated in Pennsylvania in November 2001. Within this document, the
"Company" collectively shall mean Escalon and its wholly-owned subsidiaries:
Sonomed, Inc. ("Sonomed"), Sonomed EMS Srl. ("Sonomed EMS"), Escalon Vascular
Access, Inc. ("Vascular"), Escalon Digital Vision, Inc. ("Digital") and Escalon
Pharmaceutical, Inc. ("Pharmaceutical"). The Company operates in the healthcare
market, specializing in the development, manufacture, marketing and distribution
of ophthalmic medical devices, pharmaceuticals and vascular access devices.
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 ultrafast laser systems designed for the treatment of ophthalmic
disorders. As a result of the EOI acquisition, Escalon changed its market focus
and is no longer developing laser technology. In October 1997, the Company
licensed its intellectual laser properties to a privately held company in return
for an equity interest and future royalties on sales of products relating to the
laser technology. The privately held company undertook responsibility for
funding and developing the laser technology through to commercialization. The
privately held company began selling products related to the laser technology
during fiscal 2002.
6
To further diversify its product portfolio, in January 1999, the Company's
Vascular subsidiary acquired the vascular access product line from Endologix,
Inc. ("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; however, the Company began marketing the
products in the area of oncology during fiscal 2002. In January 2000, the
Company purchased Sonomed, a privately held manufacturer of ophthalmic
ultrasound diagnostic equipment. In April 2000, Digital formed a joint venture,
Escalon Medical Imaging, LLC ("Imaging") with MegaVision, Inc. ("MegaVision"), a
privately held company, to develop and market a digital camera back for
ophthalmic photography. The Company terminated its joint venture with MegaVision
and commenced operations within its Digital business unit on January 1, 2002.
3. NEW PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 144 ("SFAS No. 144), "Accounting
for the Impairment or Disposal of Long Lived Assets." SFAS No. 144 supercedes
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of." SFAS No. 144 retains the previously
existing accounting requirements related to the recognition and measurement of
the impairment of long-lived assets to be held and used, while expanding the
measurement requirements of long-lived assets to be disposed of by sale to
include discontinued operations. It also expands the previously existing
reporting requirements for discontinued operations to include a component of an
entity that either has been disposed of or is classified as held for sale. The
Company adopted SFAS No. 144 on July 1, 2002, which did not have a material
impact on the Company's financial position or results of operations. In January
2002, the SEC issued an interpretive release on disclosure related to liquidity
and capital resources, including off-balance sheet arrangements. The Company
does not have material off-balance sheet arrangements or related party
transactions and is not aware of factors that are reasonably likely to adversely
affect liquidity trends, other than those risk factors presented in this and
other Company filings.
In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145 ("SFAS No. 145"), "Rescission of FASB Statements No. 4, 44 and 64,
Amendment of FASB Statement No. 13, and Technical Corrections." This Statement
updates, clarifies and simplifies existing pronouncements related primarily to
accounting for the extinguishment of debt and for leases. SFAS No. 145 is
effective for fiscal years beginning after May 15, 2002. The Company is
currently evaluating the impact of adopting SFAS No. 145, but does not expect it
to have a material impact on its results of operations or its financial
condition.
In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 ("SFAS No. 146"), "Accounting for Cost Associated with Exit or Disposal
Activities." This Statement addresses financial accounting and reporting for
costs associated with exit or disposal activities and nullifies Emerging Issues
Task Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS No. 146 is effective for exit or
disposal activities initiated after December 31, 2002. The Company does not
expect the adoption of SFAS No. 146 to have a material impact on its results of
operations or its financial condition.
7
4. PER SHARE INFORMATION
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,
2002 2001
---------- ----------
Numerator:
Numerator for basic and diluted
earnings per share:
Net income $ 259,159 $ 204,315
---------- ----------
Denominator:
Denominator for basic earnings per
share - weighted average shares 3,345,851 3,292,184
Effect of dilutive securities:
Employee stock options 58,012 10,195
---------- ----------
Denominator for diluted earnings
per share - weighted average and
assumed conversion 3,403,863 3,302,379
========== ==========
Basic earnings per share $ 0.077 $ 0.062
========== ==========
Diluted earnings per share $ 0.076 $ 0.062
========== ==========
5. INVENTORIES
Inventories, stated at the lower of cost (determined on a first-in,
first-out basis) or market, consisted of the following:
September 30, June 30,
2002 2002
------------- -----------
Raw Materials/Work in Process $ 1,307,326 $ 1,273,611
Finished Goods 445,350 343,409
----------- -----------
1,752,676 1,617,020
Valuation Allowance (44,953) (44,953)
----------- -----------
Total inventory $ 1,707,723 $ 1,572,067
=========== ===========
8
6. GOODWILL AND OTHER INTANGIBLE ASSETS
In accordance with SFAS No. 142, effective July 1, 2001, Escalon
discontinued the amortization of goodwill and identifiable intangible assets
that have indefinite lives. Intangible assets that have finite lives will
continue to be amortized over their useful lives. Goodwill will be assessed
annually for impairment. The standard required this impairment assessment to be
completed by December 31, 2001. In November 2001, the Company engaged an
independent professional appraiser to assist management in evaluating whether
the intangible assets were impaired and to review the allocation of intangible
assets related to the purchase of Sonomed as of the January 2000 acquisition
date, when the purchase price was allocated based on information available at
that time. The independent appraisal concluded in December 2001 that the
intangible assets acquired with the purchase of Sonomed should be allocated as
$10,547,488 to goodwill and $665,000 to trademarks and trade names. In light of
the independent appraisal, management has determined that the original
classification was incorrect, and therefore should be restated to that of the
independent appraisal. The result of this correction is solely a
reclassification of the intangible assets among customer lists, trademarks and
trade names and goodwill. The total reported value of the intangible assets has
not changed. Therefore, this correction had no affect on reported earnings, net
worth or cash flows for any prior fiscal years.
The independent professional appraiser engaged by the Company in November
2001 evaluated whether the goodwill and other non-amortizable intangible assets
in the Sonomed and Vascular business units were impaired. The appraiser
concluded that the carrying value of goodwill and other intangible assets did
not exceed their fair values and therefore were not impaired. The Company
evaluated the carrying value of goodwill as compared to its fair value in the
Medical / Trek business and concluded that its carrying value did not exceed its
fair value and therefore was not impaired. The Company made this conclusion
after evaluating the discounted cash flow of the Medical / Trek business unit.
In accordance with SFAS 142, the Company's intangible assets will be assessed on
an annual basis.
9
Goodwill and other intangible assets as of September 30, 2002, as
allocated by reportable segment are as follows:
Gross Net
Carrying Accumulated Carrying
GOODWILL Amount Amortization Amount
----------- ----------- -----------
Medical / Trek $ 272,786 $ (147,759) $ 125,027
Sonomed 10,547,488 (1,021,938) 9,525,550
Vascular 1,149,813 (208,595) 941,218
----------- ----------- -----------
Total $11,970,087 $(1,378,292) $10,591,795
=========== =========== ===========
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
----------- ----------- -----------
AMORTIZED INTANGIBLE ASSETS
Patents
Medical / Trek $ 257,301 $ (103,358) $ 153,943
Vascular 36,915 -- 36,915
----------- ----------- -----------
Total $ 294,216 $ (103,358) $ 190,858
=========== =========== ===========
License and distribution rights
Medical / Trek $ 180,182 $ (150,153) $ 30,029
Pharmaceutical 272,185 (65,983) 206,202
----------- ----------- -----------
Total $ 452,367 $ (216,136) $ 236,231
=========== =========== ===========
UNAMORTIZED INTANGIBLE ASSETS
Trademarks and trade names
Sonomed $ 665,000 $ (63,194) $ 601,806
----------- ----------- -----------
Total $ 665,000 $ (63,194) $ 601,806
=========== =========== ===========
10
Amortization expense for the three-month periods ended September 30, 2002
and 2001, as allocated by business segment are as follows:
For the three-month period
ended September 30,
--------------------------
2002 2001
-------- --------
Goodwill amortization
Medical / Trek $ -- $ --
Sonomed -- --
Vascular -- --
Patent amortization
Medical / Trek $ 2,683 $ 2,683
Vascular -- --
License and distribution rights
amortization
Medical / Trek $ 5,631 $ 5,631
Pharmaceutical 5,126 4,727
Trademarks and trade names
Sonomed $ -- $ --
Net income $259,159 $204,315
7. LINE OF CREDIT AND LONG-TERM DEBT
On January 14, 2000, Escalon replaced its $2,000,000 credit facility
obtained in January 1999. PNC Bank, N.A. (the "Bank") granted a new $12,000,000
credit facility to assist with the Sonomed acquisition. This included a
$7,000,000 five-year term loan, a $5,000,000 line of credit and the release of
the requirement to maintain a $1,000,000 certificate of deposit with the Bank.
The interest rate on the term loan was based on prime plus 1.0% and the line of
credit was based on prime plus 0.75%. Escalon paid $100,000 in finance fees
related to this refinancing. Interest rate cap agreements were used to reduce
the potential impact of increases in interest rates on the floating-rate term
loan and line of credit. The Company incurred $122,800 in fees related to these
rate cap agreements. At September 30, 2002, Escalon remained party to an
interest rate cap agreement covering the term loan through January 1, 2003. The
agreement entitles the Company to receive from the Bank, the counter-party to
the agreement, on a monthly basis, the amounts, if any, by which the Company's
interest payments exceed 10.0% for the period from October 1, 2002 through
January 1, 2003. The finance and interest rate cap fees are being amortized over
the term of the loans using the effective interest method. The unamortized
finance and interest rate cap fees offset the outstanding balance of the loans.
11
On November 28, 2001, Escalon amended its loan agreement with the Bank.
The amendment included converting the existing balances on the term loan and the
line of credit into a $7,900,000 term loan and $2,000,000 available line of
credit. The aggregate balance of debt outstanding did not change as a result of
this refinancing. As of September 30, 2002, the amount outstanding against this
line of credit was $1,400,000. Principal payments due on the term loan were
amended such that the balance remains due within the five-year term of the
original agreement, including a $2,000,000 balloon payment due on June 30, 2004.
Interest rates on the term loan and line of credit were increased to prime plus
1.75% and prime plus 1.50%, respectively. At September 30, 2002, the interest
rates applicable to the term loan and the line of credit were 6.50% and 6.25%,
respectively. The Bank's prime rate at September 30, 2002 was 4.75%. In
connection with the amended agreement, Escalon issued to the Bank, warrants to
purchase 60,000 shares of the Company's Common Stock at an exercise price of
$3.66 per share. The warrants were valued at $4,800 using the Black-Sholes
option pricing method with the following assumptions: risk-free interest rate of
5.0%, expected volatility of .18, expected warrant life of 42 months from
vesting and an expected dividend rate of 0.0%. The Company also paid a $50,000
facility fee upon execution of the loan agreement, which is being amortized over
the life of the loans. The unamortized balance offsets the outstanding balance
of the loans. Pursuant to the amended agreement, on March 1, 2002, the Company
began paying a 1.0% facility fee that is payable quarterly through June 30,
2004, and is calculated based on the aggregate principal amount outstanding
under the term loan and line of credit on January 1 of each year. All of the
Company's assets collateralize this amended agreement.
The term loan and line of credit contain various covenants among which is
a requirement to maintain a defined ratio of earnings before interest, taxes,
depreciation and amortization ("EBITDA") to debt. Escalon did not achieve the
EBITDA to debt ratio, resulting in a technical default under the amended loan
agreement. The Bank waived this requirement of the amended agreement as of
September 30, 2002, and for the twelve-month period ending October 1, 2003.
8. LITIGATION
As previously reported in reports filed with the SEC, on or about June 8,
1995, a purported class action complaint captioned George Kozloski v.
Intelligent Surgical Lasers, Inc. et al., 95 Civ. 4299, was filed in the U.S.
District Court for the Southern District of New York as a "related action" to In
Re Blech Securities Litigation (a litigation matter to which the Company is no
longer a party). The plaintiff purports to represent a class of all purchasers
of the Company's stock from November 17, 1993, to and including September 21,
1994. The complaint alleges that the Company, together with certain of its
officers and directors, David Blech and D. Blech & Co., Inc. issued a false and
misleading prospectus in November 1993 in violation of Sections 11, 12 and 15 of
the Securities Act of 1933. The complaint also asserts claims under section
10(b) of the Securities Exchange Act of 1934 and common law. Actual and punitive
damages in an unspecified amount are sought, as well as constructive trust over
the proceeds from the sale of stock pursuant to the offering.
On June 6, 1996, the court denied a motion by the Company and the named
officers and directors to dismiss the Kozloski complaint and, on July 22, 1996,
the Company filed an answer to the complaint denying all allegations of
wrongdoing and asserting various affirmative defenses.
In an effort to curtail its legal expenses related to this litigation,
while continuing to deny any wrongdoing, the Company reached an agreement to
settle this action on its behalf and on the behalf of its former and present
officers and directors, for $500,000. The Company's directors and officers
insurance carrier agreed to fund a significant portion of the settlement amount.
Both the Company and the insurance carrier deposited such funds in an escrow
account in 1996. The court approved the settlement after a fairness hearing on
September 11, 2002.
12
9. REVENUE, NET
Revenue, net includes quarterly payments earned in connection with the
sale of the Adatosil(R) 5000 Silicone Oil ("Silicone Oil") product line. For the
three-month periods ended September 30, 2002 and 2001, this revenue totaled
$443,000 and $444,000, respectively. Included in accounts receivable as of
September 30, 2002 and June 30, 2002 were $443,000 and $457,000, respectively.
10. SEGMENTAL INFORMATION
During the three-month periods ended September 30, 2002 and 2001,
Escalon's operations were classified into four principal reporting segments that
provide different products or services. Separate management of each segment is
required because each business segment is subject to different marketing,
production and technology strategies.
For the three-month periods ended September 30,
(all numbers in the table below are reported in thousands)
------------------------------------------------------------------------------------------------------
Sonomed Vascular Medical / Trek Digital Total
-------------------- ------------------ --------------- -------------- --------------------
2003 2002 2003 2002 2003 2002 2003 2002 2003 2002
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Revenue, net $ 1,389 $ 1,527 $ 666 $ 658 $ 840 $ 731 $ 113 $ -- $ 3,008 $ 2,916
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Income from operations 184 192 21 15 258 212 (12) -- 451 419
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Other income and
expenses:
Equity in loss of
unconsolidated JV -- -- -- -- -- -- -- (9) -- (9)
Interest income -- -- -- -- 1 1 -- -- 1 1
Interest expense (184) (192) (9) (15) -- -- -- -- (193) (207)
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Income before taxes -- -- 12 -- 259 213 (12) (9) 259 204
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Income taxes -- -- -- -- -- -- -- -- -- --
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Net income (loss) -- -- 12 -- 259 213 (12) (9) 259 204
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Depreciation and
amortization 5 31 10 10 67 9 6 -- 88 50
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Assets 12,073 11,981 2,458 2,465 2,093 2,205 279 261 16,903 16,912
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Expenditures for long-
lived assets -- 15 -- 6 18 -- -- -- 18 21
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
The Company operates in the healthcare market, specializing in the
development, manufacture, marketing and distribution of ophthalmic medical
devices, pharmaceuticals and vascular access devices. The business segments
reported above are the segments for which separate financial information is
available and for which operating results are evaluated regularly by executive
management in deciding how to allocate resources and assessing performance. The
accounting policies of the business segments are the same as those described in
the summary of significant accounting policies disclosed on the Company's most
recently filed Form 10-K. For the purposes of this illustration, corporate
expenses, which principally consist of executive management and administrative
support functions, are allocated across the business segments based primarily on
each segments net revenue. These expenses are otherwise included in the Medical
/ Trek business unit.
13
During the three-month periods ended September 30, 2002 and 2001, Sonomed
derived its revenues from the sale of A-Scans, B-Scans and pachymeters. These
products are used for diagnostic or biometric applications in ophthalmology.
Vascular derived its revenues from the sale of PD Access(TM) and SmartNeedle(TM)
monitors, needles and catheter products. These products are used by medical
personnel to assist in gaining access to arteries and veins in difficult cases.
Medical / Trek derived its revenues from the sale of ISPAN(TM) gas products,
various disposable ophthalmic surgical products, revenues derived from Bausch &
Lomb's sales of Silicone Oil and royalty revenues derived from a privately held
entity. Commencing January 1, 2002, Digital derived its revenues from the sales
of the CFA digital imaging system and related products.
During the three-month periods ended September 30, 2002 and 2001, Escalon
had one entity, Bausch & Lomb; from which greater than 10% of consolidated net
revenues were derived. Revenues were $573,000, or 19.05% of consolidated net
revenues for the three-month period ended September 30, 2002 and were $501,000,
or 17.18% of consolidated net revenues for the three-month period ended
September 30, 2001. This revenue is included in the Medical / Trek business
unit. Of the consolidated revenues reported above, $543,000, $31,000, $10,000
and $32,000 were derived internationally in Sonomed, Vascular, Medical / Trek
and Digital, respectively, during the three-month period ended September 30,
2002; and $573,000, $42,000 and $9,000 were derived internationally in Sonomed,
Vascular and Medical / Trek during the three-month period ended September 30,
2001.
11. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries, Sonomed, Vascular, Pharmaceutical, Digital
and Sonomed EMS. All intercompany transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make certain estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Although these
estimates are based on management's knowledge of current events and actions
management may undertake in the future, actual results in the future may
ultimately differ from those estimates presently being made.
REVENUE RECOGNITION
The Company recognizes revenue from the sales of its products at the time
of shipment when title and risk of loss transfer. With respect to additional
consideration related to the sale of the Company's Silicone Oil product line and
the licensing of the Company's intellectual laser property, revenue is
recognized after notification from the customers of sales associated with the
product line and intellectual property.
STOCK-BASED COMPENSATION
As permitted by Financial Accounting Standards Board Statement No.123,
"Accounting for Stock-Based Compensation," the Company has elected to follow
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees ("APB 25"), and related interpretations in accounting for its employee
stock option plans. Under APB 25, no compensation expense is recognized at the
time of the option grant because the exercise price of the Company's employee
stock option equals the fair market value of the underlying common stock on the
date of the grant.
14
INTANGIBLE ASSETS
The Company follows Statement of Financial Accounting Standards No. 142
("SFAS No. 142"), "Goodwill and Other Intangible Assets," which discontinues the
amortization of goodwill and identifiable intangible assets that have indefinite
lives.
RECLASSIFICATIONS
Certain amounts in the 2002 financial statements have been reclassified to
conform to the 2003 presentation.
12. FORMATION OF SUBSIDIARY AND JOINT VENTURE
The Company formed Sonomed EMS, Srl. ("Sonomed EMS") on September 26, 2002
as a wholly owned subsidiary. Sonomed EMS, based in Milan, Italy, is in the
process of completing its organization under Italian law. Sonomed EMS will
operate as a marketing division of Sonomed in Europe. The Company is forming a
joint venture with one of its Asian distributors to expand its presence in the
market. Sonoscan Holdings, Inc. ("Sonoscan") will be a British Virgin Island
Company and Escalon will have a fifty percent share in its ownership. The
formation of Sonoscan is in the preliminary stages, but the joint venture should
assist Sonomed in making further progress in the Asian market.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
Certain statements contained in this Form 10-Q Report and other written
and oral statements made from time to time by the Company do not relate strictly
to historical or current facts. As such, they are considered "forward-looking
statements" 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," "protect," "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 plans to
file applications with the Food and Drug administration (the "FDA"), the
development of joint venture opportunities, the effects of competition on the
structure of the markets in which the Company competes and defending itself in
litigation matters. One 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
investors, therefore should not consider any list of such factors to be an
exhaustive statement of all risks, uncertainties or potentially inaccurate
assumptions. The Company undertakes no obligation to update any forward-looking
statement. Although it is not possible to create a comprehensive list of all
factors that may cause actual results to differ from the Company's
forward-looking statements, the most important factors include, without
limitation, the following:
15
FUTURE CAPITAL NEEDS AND THE UNCERTAINTY OF ADDITIONAL FUNDING
Escalon's liquidity is affected by many factors, some of which arise from
fluctuations related to global markets and economies and some of which are based
on the normal ongoing operations of the Company's businesses. For instance, the
Company's current term loan with the Bank provides for quarterly principal
payments, which increase every six months, including a $2,000,000 final balloon
payment, which is due on June 30, 2004. Cash on hand, cash generated from
operations and cash available from the line of credit may be sufficient to
satisfy the Company's working capital, debt service, capital expenditures and
research and development until the balloon payment is due. The Company will be
required to secure additional debt or equity financing in order to satisfy the
balloon payment, and management cannot assure that such financing will be
available when required on acceptable terms.
CONCENTRATION OF REVENUES
The Company realized 19.05% and 17.18% of its net revenue during the
three-month periods ended September 30, 2002 and 2001, respectively, from Bausch
& Lomb's sale of Silicone Oil. While management does not expect this revenue to
decline rapidly in the foreseeable future, any such decrease would have a
significant impact on the Company's consolidated financial position; results of
operations and cash flows; and the Company's stock price could be negatively
impacted.
ECONOMIC AND REGULATORY CONDITIONS AND THE COMPETITIVE NATURE OF THE INDUSTRIES
IN WHICH THE COMPANY COMPETES
It is difficult to ascertain if the current economic downturn has affected
the Company's results. Management believes any effect has been limited to the
Sonomed business unit. Any further decline in customers' markets or further
decline in general economic conditions could result in reduction in demand for
Escalon's products and services and could harm the Company's consolidated
financial position, results of operations, cash flows and stock price. Should it
become necessary due to economic climate, management cannot assure you that the
Company will be able to reduce expenditures quickly enough to maintain
profitability and service the Company's current debt. In addition, there is a
risk that cost-cutting initiatives would impair Escalon's ability to effectively
develop and market products and remain competitive in the industries in which
the Company competes. These measures could have long-term effects on Escalon's
business by reducing the Company's pool of technical talent, decreasing or
slowing improvements in products, making it more difficult for the Company to
respond to customers, limiting the Company's ability to increase production
quickly if and when the demand for Escalon's products increases and limiting the
Company's ability to hire and retain key personnel. These circumstances could
cause Escalon's earnings to be lower than they otherwise might be.
The Company could be affected by trends toward managed care, health-care
cost containment, and other changes in government and private sector
initiatives, in the United States and other countries in which the Company does
business, that are placing increased emphasis on the delivery of more
cost-effective medical therapies. Changes in governmental laws, regulations and
accounting standards and the enforcement thereof and agency or government
actions or investigations involving the industry in general or the Company in
particular may be adverse to the Company.
16
THE ABILITY OF THE COMPANY TO SUCCESSFULLY DEVELOP AND MARKET NEW PRODUCTS
The Company generally sells its products in industries that are
characterized by rapid technological changes, frequent new product introductions
and changing industry standards. Without timely introduction of new products and
enhancements, the Company's products will become technologically obsolete over
time, in which case the Company's revenue and operating results would suffer.
The success of the Company's new product offerings will depend on several
factors, including the Company's ability to: (i) properly identify customer
needs, (ii) innovate and develop new technologies, services and applications,
(iii) successfully commercialize new technologies in a timely manner, (iv)
manufacture and deliver Company products in sufficient volumes on time, (v)
differentiate Company offerings from competitors' offerings, (vi) price Company
products competitively, and (vii) anticipate competitors' announcements of new
products, services or technological innovations.
DEPENDENCE ON KEY PERSONNEL
The Company's future success depends partly on the continued service of
key research, engineering, sales, marketing, manufacturing, executive and
administrative personnel. If the Company fails to retain and hire a sufficient
number of these personnel, the Company will not be able to maintain or expand
its business.
ACQUISITIONS, STRATEGIC ALLIANCES, JOINT VENTURES AND DIVESTITURES MAY RESULT IN
FINANCIAL RESULTS THAT ARE DIFFERENT THAN EXPECTED
In the normal course of business, the Company engages in discussions with
third parties relating to, strategic alliances, joint ventures and divestitures.
As a result of such transactions, the Company's financial results may differ
from the investment community's expectations in a given quarter. In addition,
strategic alliances may require the Company to integrate a different company
culture, management team and business infrastructure. The Company may have
difficulty developing, manufacturing and marketing the products of a strategic
alliance or joint venture in a way that enhances the performance of the product
lines to realize the value from expected synergies. Depending on the size and
complexity of an strategic alliance or joint venture, the Company's successful
integration of the entity depends on a variety of factors including: (i) the
retention of key employees, (ii) the management of facility employees in
separate geographical areas. All of these efforts require varying levels of
management resources, which may divert the Company's attention from other
business operations. If the Company does not realize the expected benefits or
synergies of such transactions, the Company's consolidated financial position,
results of operations and stock price could be negatively impacted.
THE OUTCOME OF LITIGATION MATTERS AND UNCERTAIN PROTECTION OF PATENTED AND
PROPRIETARY INFORMATION
Increased public interest in recent years in product liability claims in
the medical device industry could affect the Company should it become directly
involved. Recent events have made the investing public particularly sensitive to
listed companies reporting practices and accounting policies in general. The SEC
could make regulatory changes that could have a direct affect on the Company.
Additionally, the Company may find it necessary to enforce its legal right with
respect to patented and proprietary information. The outcome of any of these
matters and the financial impact they may have on the Company cannot be
foreseen.
17
VOLATILITY OF STOCK PRICE AND THE ABILITY OF THE COMPANY TO MAINTAIN ITS LISTING
ON THE NASDAQ SMALLCAP MARKET
The public stock markets have experienced significant volatility in stock
prices in recent years, which could cause the Company's stock price to
experience severe price changes that are unrelated or disproportionate to the
operating performance of the Company. The trading price of the Company's Common
Stock could be subject to wide fluctuations in response to, among other factors,
quarter to quarter variations in operating results, announcements of
technological innovations or new products by the Company or its competitors,
announcements of new strategic relationships by the Company or its competitors,
general conditions in the healthcare industry or the global economy generally,
or market volatility unrelated to the Company's business and operating results.
The Company's Common Stock is currently listed on the Nasdaq SmallCap
Market. In order to continue to be listed on the Nasdaq SmallCap Market, certain
listing requirements must be met. If the Company's securities were delisted,
investors could find it more difficult to dispose of them, or to obtain accurate
quotations as to the market value of the Company's securities.
COMPANY OVERVIEW
The following discussion should be read in conjunction with the interim
condensed consolidated financial statements and the notes thereto, which are set
forth elsewhere in this report on Form 10-Q.
Escalon Medical Corp. ("Escalon") was incorporated in California in 1987
as Intelligent Surgical Lasers, Inc. Escalon's present name was adopted in
August 1996. Escalon reincorporated in Delaware in November 1999, and then
reincorporated in Pennsylvania in November 2001. Within this document, the
"Company" collectively shall mean Escalon and its wholly-owned subsidiaries:
Sonomed, Inc. ("Sonomed"), Sonomed EMS Srl. ("Sonomed EMS"), Escalon Vascular
Access, Inc. ("Vascular"), Escalon Digital Vision, Inc. ("Digital") and Escalon
Pharmaceutical, Inc. ("Pharmaceutical"). The Company operates in the healthcare
market, specializing in the development, manufacture, marketing and distribution
of ophthalmic medical devices, pharmaceuticals and vascular access devices.
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 ultrafast laser systems designed for the treatment of ophthalmic
disorders. As a result of the EOI acquisition, Escalon changed its market focus
and is no longer developing laser technology. In October 1997, the Company
licensed its intellectual laser properties to a privately held company in return
for an equity interest and future royalties on sales of products relating to the
laser technology. The privately held company undertook responsibility for
funding and developing the laser technology through to commercialization. The
privately held company began selling products related to the laser technology
during fiscal 2002.
To further diversify its product portfolio, in January 1999, the Company's
Vascular subsidiary acquired the vascular access product line from Endologix,
Inc. ("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; however, the Company began marketing the
products in the area of oncology during fiscal 2002. In January 2000, the
Company purchased Sonomed, a privately held manufacturer of ophthalmic
ultrasound diagnostic equipment. In April 2000, Digital formed a joint venture,
Escalon Medical Imaging, LLC ("Imaging") with MegaVision, Inc. ("MegaVision"), a
privately held company, to develop and market a digital camera back for
ophthalmic photography. The Company terminated its joint venture with MegaVision
and commenced operations within its Digital business unit on January 1, 2002.
18
The Company expects that results of operations may fluctuate from quarter
to quarter for a number of reasons, including: (i) anticipated order and
shipment patterns of the Company's products; (ii) lead times to produce the
Company's products; (iii) general competitive and economic conditions of the
healthcare market; and (iv) availability of component parts and supplies from
suppliers.
RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 144 ("SFAS No. 144"),
"Accounting for the Impairment or Disposal of Long-Lived Assets to be Disposed
of." SFAS No. 144 retains the previously existing accounting requirements
related to the recognition and measurement of the impairment of long-lived
assets to be held and used, while expanding the measurement requirements of
long-lived assets to be disposed of by sale to include discontinued operations.
It also expands the previously existing reporting requirements for discontinued
operations to include a component of an entity that either has been disposed of
or is classified as held for sale. The Company adopted SFAS No. 144 on July 1,
2002, which did not have a material impact on the Company's financial position
or results of operations.
In January 2002, the SEC issued an interpretive release on disclosure
related to liquidity and capital resources, including off-balance sheet
arrangements or related party transactions and is not aware of factors that are
reasonably likely to adversely affect liquidity trends, other than those risk
factors presented in this report and in other Company filings.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements requires management to make
estimates and assumptions that affect amounts reported therein. The most
significant of those involve the application of SFAS No. 142, discussed above in
Footnote 11. The financial statements are prepared in conformity with generally
accepted accounting principles, and, as such, include amounts based on informed
estimates and judgments of management. For example, estimates are used in
determining valuation allowances for uncollectible receivables, obsolete
inventory, deferred income taxes 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.
THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2002 AND 2001
Product revenues increased $92,000, or 3.16%, to $3,008,000 for the
three-month period ended September 30, 2002 as compared to $2,916,000 for the
same period last fiscal year. Revenues in the Sonomed business unit decreased
$138,000, or 9.04%, to $1,389,000. This decrease is primarily attributed to a
soft domestic market, where revenues have decreased $108,000, as well as in
Europe, where revenues decreased $92,000. These decreases are offset by a
$52,000 increase in the Asian market. Revenues in the Vascular business unit,
which remained relatively flat, increased $8,000, or 1.22%, to $666,000.
Revenues in the Medical / Trek business unit increased $109,000, or 14.91%, to
$840,000. The increase primarily relates to a $73,000 increase in OEM revenue
from a single customer. Revenues in the Digital business unit were $113,000 for
the three-month period ended September 30, 2002. The Company terminated its
joint venture and commenced operations within its Digital business unit on
January 1, 2002.
19
Cost of goods sold totaled $1,079,000, or 35.87% of net revenue for the
three-month period ended September 30, 2002 as compared to $1,228,000, or 42.11%
of net revenue for the same period last fiscal year. Cost of goods sold in the
Sonomed business unit totaled $579,000, or 41.68% of net revenue for the
three-month period ended September 30, 2002 as compared to $712,000, or 46.63%
of net revenue for the same period last fiscal year. This decrease relates
product mix as well as a decrease in sales to distributors to whom Sonomed
discounts its products resulting in lower unit sales prices. Cost of goods sold
in the Vascular business unit totaled $240,000, or 36.04% of net revenue for the
three-month period ended September 30, 2002 as compared to $345,000, or 52.43%
of net revenue for the same period last fiscal year. The decrease relates
primarily to a temporary increase in component costs that was experienced last
fiscal year. Cost of goods sold in the Medical / Trek business unit totaled
$217,000, or 25.83% of net revenue for the three-month period ended September
30, 2002 as compared to $171,000, or 23.39% of net revenue for the same period
last fiscal year. When Silicone Oil revenue and royalty revenue earned from a
privately held entity are excluded (no costs are associated with these revenue
streams), cost of goods sold as a percentage of net revenue was 62.90% of net
revenue and 59.58% of net revenue for the three-month periods ended September
30, 2002 and 2001, respectively. Cost of goods sold in the Digital business unit
totaled $43,000, or 38.05% of net revenue for the three-month period ended
September 30, 2002. The Company terminated its joint venture and commenced
operations within its Digital business unit on January 1, 2002.
Marketing general and administrative expenses increased $142,000, or
12.39%, for the three-month period ended September 30, 2002 as compared to the
same period last fiscal year. In the Sonomed business unit, marketing, general
and administrative expenses increased $42,000, or 13.50% for the three-month
period ended September 30, 2002 as compared to the same period last fiscal year.
Salaries and other personnel-related costs increased $19,000, primarily due to
the addition of a salesperson for the Latin America and Asia markets.
Commissions paid to independent sales representatives increased $17,000 due to
their increased volume. In the Vascular business unit, marketing, general and
administrative expenses increased $57,000, or 25.33% for the three-month period
ended September 30, 2002 as compared to the same period last fiscal year.
Salaries and other personnel-related costs increased $32,000, primarily due to
the addition of a clinical support specialist and incentive compensation
programs. Travel-related expenses increased $8,000 as a result of increased
headcount. Additionally, the Company began allocating to Vascular certain
expenses related to the Wisconsin facility that previously were included in the
Medical / Trek business unit. Marketing, general and administrative expenses in
the Medical / Trek business unit decreased $39,000, or 6.39% for the three-month
period ended September 30, 2002 as compared to the same period last fiscal year.
Corporate franchise taxes decreased $41,000 due to the reincorporation of the
Company from Delaware to Pennsylvania. Also contributing to the decrease, the
Company began allocating from the Medical / Trek business unit certain expenses
related to the Wisconsin facility to the Vascular business unit. Offsetting
these decreases was a $31,000 increase in corporate insurance premiums. The
increase relates to an audit of prior year premiums and premium increases being
instituted by the insurance industry in general. Marketing, general and
administrative expenses in the Digital business unit were $82,000 for the
three-month period ended September 30, 2002. The Company terminated its joint
venture and commenced operations within its Digital business unit on January 1,
2002.
Research and development expenses increased $67,000, or 54.47% for the
three-month period ended September 30, 2002 as compared to the same period last
fiscal year. The increase primarily relates to consulting expenses incurred in
connection with product redesign offset by a reduction in salaries and other
personnel-related expenses a result of reduced headcount.
The Company terminated its joint venture and commenced operations within
its Digital business unit on January 1, 2002. During the three-month period
ended September 30, 2001, the Company recognized a joint venture loss of $9,000.
Interest income remained unchanged for the three-month period ended
September 30, 2002 as compared to the same period last fiscal year. Interest
income was $1,000 for both periods.
20
Interest expense decreased $15,000 for the three-month period ended
September 30, 2002 as compared to the same period last fiscal year. The decrease
resulted from lower average balances in the Company's term loan and line of
credit with the Bank and the Company's note payable to Endologix, Inc.
There is no provision for federal income taxes for the periods presented
as a result of utilization of net operating loss carryforwards and related
changes in the deferred tax valuation allowance.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2002, Escalon had cash and cash equivalents of $165,000
as compared to $221,000 at June 30, 2002, a decrease of $56,000. Cash provided
from operations was $328,000. These funds, in addition to $150,000 provided by
additional borrowing on the line of credit with the Bank were used to pay down
the Company's term loan with the Bank and its note payable to Endologix, Inc. by
a combined $515,000. The Company also purchased $18,000 of fixed assets during
the three-month period ended September 30, 2002.
On January 14, 2000, Escalon replaced its $2,000,000 credit facility
obtained in January 1999. The Bank granted a new $12,000,000 credit facility to
assist with the Sonomed acquisition. This included a $7,000,000 five-year term
loan, a $5,000,000 line of credit and the release of the requirement to maintain
a $1,000,000 certificate of deposit with the Bank. The interest rate on the term
loan was based on prime plus 1.0% and the line of credit was based on prime plus
0.75%. Escalon paid $100,000 in finance fees related to this refinancing.
Interest rate cap agreements were used to reduce the potential impact of
increases in interest rates on the floating-rate term loan and line of credit.
The Company incurred $122,800 in fees related to these rate cap agreements. At
September 30, 2002, Escalon remained party to an interest rate cap agreement
covering the term loan through January 1, 2003. The agreement entitles the
Company to receive from the Bank, the counter-party to the agreement, on a
monthly basis, the amounts, if any, by which the Company's interest payments
exceed 10.0% for the period from October 1, 2002 through January 1, 2003. The
finance and interest rate cap fees are being amortized over the term of the
loans using the effective interest method. The unamortized finance and interest
rate cap fees offset the outstanding balance of the loans.
On November 28, 2001, Escalon amended its loan agreement with the Bank The
amendment included converting the existing balances on the term loan and the
line of credit into a $7,900,000 term loan and $2,000,000 available line of
credit. The aggregate balance of debt outstanding did not change as a result of
this refinancing. As of September 30, 2002, the amount outstanding against this
line of credit was $1,400,000. Principal payments due on the term loan were
amended such that the balance remains due within the five-year term of the
original agreement, including a $2,000,000 balloon payment due on June 30, 2004.
Interest rates on the term loan and line of credit were increased to prime plus
1.75% and prime plus 1.50%, respectively. At September 30, 2002, the interest
rates applicable to the term loan and the line of credit were 6.50% and 6.25%,
respectively. The Bank's prime rate at September 30, 2002 was 4.75%. In
connection with the amended agreement, Escalon issued to the Bank, warrants to
purchase 60,000 shares of the Company's Common Stock at an exercise price of
$3.66 per share. The warrants were valued at $4,800 using the Black-Sholes
option pricing method with the following assumptions: risk-free interest rate of
5.0%, expected volatility of .18, expected warrant life of 42 months from
vesting and an expected dividend rate of 0.0%. The Company also paid a $50,000
facility fee upon execution of the loan agreement that is being amortized over
the life of the loans. The unamortized balance offsets the outstanding balance
of the loans. Pursuant to the amended agreement, on March 1, 2002, the Company
began paying a 1.0% facility fee that is payable quarterly through June 30,
2004, and is calculated based on the aggregate principal amount outstanding
under the term loan and line of credit on January 1 of each year. All of the
Company's assets collateralize this amended agreement.
21
The term loan and line of credit contain various covenants among which is
a requirement to maintain a defined ratio of earnings before interest, taxes,
depreciation and amortization ("EBITDA") to debt. Escalon did not achieve the
EBITDA to debt ratio resulting in a technical default under the amended loan
agreement. The Bank waived this requirement of the amended agreement as of
September 30, 2002, and for the twelve-month period ending October 1, 2003.
On January 21, 1999, the Company's Vascular subsidiary and Endologix, Inc.
(formerly known as Radiance Medical Systems, Inc.) entered into an Assets Sale
and Purchase Agreement. Pursuant to this agreement, Escalon acquired for cash
the assets of Endologix's vascular access business, and also agreed to pay
royalties based on future sales of the products of the vascular access business
for a period of five years following the close of the sale, with a guaranteed
minimum royalty of $300,000 per year. On February 1, 2001, the parties amended
the agreement to provide an adjustment in the terms of the payment of the
royalties. Pursuant to the amendments Escalon paid $17,558 in cash to Endologix,
delivered a short-term note in the amount of $64,884 that was satisfied in
January 2002, and an additional note in the amount of $717,558, payable in
eleven quarterly installments that commenced April 15, 2002, and issued 50,000
shares of Escalon Common Stock to Endologix.
Cash on hand, cash generated from operations and cash available from the
line of credit may be sufficient to satisfy the Company's working capital, debt
service, capital expenditures and research and development until the balloon
payment is due. The Company may be required to secure additional debt or equity
financing in order to satisfy the balloon payment, and management cannot assure
you that such financing will be available when required on acceptable terms.
Additionally, the Company relies on the Silicone Oil revenues received from
Bausch & Lomb, which are expected to continue in varying amounts through fiscal
2005. While management does not expect this revenue to decline rapidly in the
foreseeable future, any such decrease would have a significant impact on the
Company's consolidated financial position; results of operations, cash flows and
stock price could be negatively impacted.
The Company's Common Stock is currently listed on the Nasdaq SmallCap
Market. In order to continue to be listed on the Nasdaq SmallCap Market, certain
listing requirements must be met. As of September 30, 2002, Escalon complied
with these requirements. If Escalon's securities were delisted, an investor
would find it more difficult to dispose of them, or obtain accurate quotations
as to the market value of the Company's securities.
22
SEGMENTAL REPORTING
During the three-month periods ended September 30, 2002 and 2001,
Escalon's operations were classified into four principal reporting segments that
provide different products or services. Separate management of each segment is
required because each business segment is subject to different marketing,
production and technology strategies.
For the three-month periods ended September 30,
(all numbers in the table below are reported in thousands)
------------------------------------------------------------------------------------------------------
Sonomed Vascular Medical / Trek Digital Total
-------------------- ------------------ --------------- -------------- --------------------
2003 2002 2003 2002 2003 2002 2003 2002 2003 2002
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Revenue, net $ 1,389 $ 1,527 $ 666 $ 658 $ 840 $ 731 $ 113 $ -- $ 3,008 $ 2,916
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Income from operations 184 192 21 15 258 212 (12) -- 451 419
Other income and
expenses:
Equity in loss of
unconsolidated JV -- -- -- -- -- -- -- (9) -- (9)
Interest income -- -- -- -- 1 1 -- -- 1 1
Interest expense (184) (192) (9) (15) -- -- -- -- (193) (207)
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Income before taxes -- -- 12 -- 259 213 (12) (9) 259 204
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Income taxes -- -- -- -- -- -- -- -- -- --
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Net income (loss) -- -- 12 -- 259 213 (12) (9) 259 204
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Depreciation and
amortization 5 31 10 10 67 9 6 -- 88 50
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Assets 12,073 11,981 2,458 2,465 2,093 2,205 279 261 16,903 16,912
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
Expenditures for long-
lived assets -- 15 -- 6 18 -- -- -- 18 21
-------- -------- ------- ------- ------ ------ ----- ----- -------- --------
The Company operates in the healthcare market, specializing in the
development, manufacture, marketing and distribution of ophthalmic medical
devices, pharmaceuticals and vascular access devices. The business segments
reported above are the segments for which separate financial information is
available and for which operating results are evaluated regularly by executive
management in deciding how to allocate resources and assessing performance. The
accounting policies of the business segments are the same as those described in
the summary of significant accounting policies disclosed in the Company's most
recently filed Form 10-K. For the purposes of this illustration, corporate
expenses, which principally consist of executive management and administrative
support functions, are allocated across the business segments based primarily on
each segment's net revenue. These expenses are otherwise included in the Medical
/ Trek business unit.
During the three-month periods ended September 30, 2002 and 2001, Sonomed
derived its revenues from the sale of A-Scans, B-Scans and pachymeters. These
products are used for diagnostic or biometric applications in ophthalmology.
Vascular derived its revenues from the sale of PD Access(TM) and SmartNeedle(TM)
monitors, needles and catheter products. These products are used by medical
personnel to assist in gaining access to arteries and veins in difficult cases.
Medical / Trek derived its revenues from the sale of ISPAN(TM) gas products,
various disposable ophthalmic surgical products, revenues derived from Bausch &
Lomb's sales of Silicone Oil and royalty revenues derived from a privately held
entity. Commencing January 1, 2002, Digital derived its revenues from the sales
of the CFA digital imaging system and related products.
23
During the three-month periods ended September 30, 2002 and 2001, Escalon
had one entity, Bausch & Lomb, from which greater than 10% of consolidated net
revenues were derived. Revenues were $573,000, or 19.05% of consolidated net
revenues for the three-month period ended September 30, 2002 and were $501,000,
or 17.18% of consolidated net revenues for the three-month period ended
September 30, 2001. This revenue is included in the Medical / Trek business
unit. Of the consolidated revenues reported above, $543,000, $31,000, $10,000
and $32,000 were derived internationally in Sonomed, Vascular, Medical / Trek
and Digital, respectively, during the three-month period ended September 30,
2002; and $573,000, $42,000 and $9,000 were derived internationally in Sonomed,
Vascular and Medical / Trek during the three-month period ended September 30,
2001.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The table below provides information about Escalon's financial
instruments, consisting primarily of debt obligations that are sensitive to
changes in interest rates. For debt obligations, the table represents principal
cash flows and related interest rates by expected maturity dates. Interest rates
are based upon the prime rate at September 30, 2002 plus 1.75% on the term loan,
1.50% on the line of credit and 1.00% on the Endologix note. An interest rate
cap agreement is used to reduce the potential impact of increases on the
floating-rate term loan. The interest rate cap agreement covers the term loan
through January 1, 2003.
Long-term debt classified as current as of September 30,
---------------------------------------------------------------------------------
2002 2003 2004 2005 Thereafter Total
---- ---- ---- ---- ---------- -----
Term loan - capped 450,000 -- -- -- -- 450,000
Interest rate - capped 6.50% -- -- -- --
Term loan - no cap 1,700,000 4,150,000 -- -- -- 5,850,000
Interest rate - no cap 6.50% -- -- -- --
Line of credit - no cap 1,400,000 -- -- -- -- 1,400,000
Interest rate - no cap 6.25% -- -- -- --
Endologix note 260,932 260,932 65,228 -- -- 587,092
Interest rate 5.75% 5.75% 5.75% -- --
Deferred finance fees (96,513) -- -- -- -- (96,513)
Total 3,810,932 4,410,932 65,228 -- -- 8,287,092
EXCHANGE RATE RISK
During the three-month periods ended September 30, 2002 and 2001,
approximately 20.48% and 21.40% of Escalon's consolidated net revenue was
derived from international sales. The price of all products sold overseas is
denominated in United States dollars and consequently the Company incurs no
exchange rate risk.
24
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures.
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Senior Vice President of
Finance, we evaluated the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-14(c) under the
Exchange Act) as of a date ("the Evaluation Date") within 90 days prior to
the filing date of this report. Based on that evaluation, the Chief
Executive Officer and the Senior Vice President of Finance concluded that,
as of the Evaluation Date, our disclosure controls and procedures were
effective in timely alerting them to the material information relating to
the Company (or the Company's consolidated subsidiaries) required to be
included in our periodic SEC filings.
(b) Changes in Internal Controls
There were no significant changes made in our internal controls during the
period covered by this report or, to management's knowledge, in other factors
that could significantly affect these controls subsequent to the date of their
evaluation.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information contained in Note 8 of the Notes to Condensed Consolidated
Financial Statements in Part I is incorporated herein by reference thereto.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit 99.1
Statement of Chief Executive Officer
Pursuant to Section 1350 of Title 18 of the United States Code
Pursuant to Section 1350 of Title 18 of the United States Code, I, Richard
J. DePiano, the Chairman and Chief Executive Officer of Escalon Medical Corp.
(the "Company"), hereby certify that, to the best of my knowledge:
1. The Company's Form 10-Q Quarterly Report for the period ended
September 30, 2002 (the "Report") fully complies with the
requirements of Section 13(a) of the Securities Act of 1934; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
Date: November 14, 2002 /s/ Richard J. DePiano
-----------------------
Richard J. DePiano
Chairman and Chief Executive Officer
25
Exhibit 99.2
Statement of Senior Financial Officer
Pursuant to Section 1350 of Title 18 of the United States Code
Pursuant to Section 1350 of Title 18 of the United States Code, I, Harry
M. Rimmer, the Senior Vice President - Finance of Escalon Medical Corp. (the
"Company"), hereby certify that, to the best of my knowledge:
3. The Company's Form 10-Q Quarterly Report for the period ended
September 30, 2002 (the "Report") fully complies with the
requirements of Section 13(a) of the Securities Act of 1934; and
4. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
Date: November 14, 2002 /s/ Harry M. Rimmer
--------------------
Harry M. Rimmer
Senior Vice President - Finance
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, 2002 By: /s/ Richard J. DePiano
----------------- -----------------------
Richard J. DePiano
Chairman and
Chief Executive Officer
Date: November 14, 2002 By: /s/ Harry M. Rimmer
----------------- --------------------
Harry M. Rimmer
Senior Vice-President - Finance
26
CERTIFICATION
I, Richard J. DePiano, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Escalon
Medical Corp.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the periods covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of the registrant's board of directors (or
persons performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weakness in internal controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Richard J. DePiano Date: November 14, 2002
-----------------------
Richard J. DePiano
Chairman and Chief Executive Officer
27
CERTIFICATION
I, Harry M. Rimmer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Escalon
Medical Corp.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the periods covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of the registrant's board of directors (or
persons performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weakness in internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Harry M. Rimmer Date: November 14, 2002
--------------------
Harry M. Rimmer
Senior Vice President - Finance
28