UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
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 December 31, 2004.
[ ] 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
------------------------------
ESCALON MEDICAL CORP.
(Exact name of Registrant as specified in its charter)
PENNSYLVANIA 33-0272839
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
565 EAST SWEDESFORD ROAD, SUITE 200
WAYNE, PA 19087
(Address of principal executive
offices, including zip code)
(610) 688-6830
(Registrant's telephone number, including area code)
575 EAST SWEDESFORD ROAD, SUITE 100
WAYNE, PA 19087
(Former address of principal executive
offices, including zip code)
Indicate by check mark whether the Registrant (1) has filed all reports
required 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 past 90 days. Yes [X] No[ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
At February 4, 2005, 5,934,857 shares of common stock were outstanding.
ESCALON MEDICAL CORP.
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheet as of December 31, 2004
(Unaudited) and June 30, 2004. 2
Condensed Consolidated Statement of Operations for the three and
six-month periods ended December 31, 2004 and 2003 (Unaudited) 3
Condensed Consolidated Statement of Cash Flows for the three and
six-month periods ended December 31, 2004 and 2003 (Unaudited) 4
Condensed Consolidated Statement of Shareholders' Equity for the
three and six-month periods ended December 31, 2004 and 2003
(Unaudited) 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk 36
Item 4. Controls and Procedures 37
Part II. Other Information
Item 1. Legal Proceedings 38
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 39
Item 4. Submission of Matters to a Vote of Security Holders 39
Item 5. Other Information 39
Item 6. Exhibits 39
1
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
December 31, June 30,
2004 2004
------------ ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 3,707,122 $ 12,601,971
Available for sale Securities 5,929,522 -
Accounts receivable, net 4,034,547 2,492,689
Inventory, net 4,976,244 1,781,592
Note receivable 150,000 150,000
Other current assets 979,061 539,508
------------ ------------
Total current assets 19,776,496 17,565,760
------------ ------------
Furniture and equipment, net 1,086,731 409,187
Goodwill 20,053,197 10,591,795
Trademarks and trade names, net 616,906 616,906
Patents, net 604,959 172,078
Other assets 225,257 101,389
------------ ------------
Total assets $ 42,363,546 $ 29,457,115
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Line of credit $ - $ 250,000
Current portion of long-term debt 236,164 1,621,687
Accounts payable 2,160,375 499,242
Accrued expenses 3,555,491 1,229,498
------------ ------------
Total current liabilities 5,952,030 3,600,427
Long-term debt, net of current portion 522,469 2,396,019
------------ ------------
Total liabilities 6,474,499 5,996,446
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; 5,905,163 and 5,017,122
shares issued and outstanding at
December 31, 2004 and June 30, 2004,
respectively 5,906 5,018
Common stock warrants 1,601,346 1,601,346
Additional paid-in capital 63,301,230 56,438,903
Accumulated deficit (34,893,754) (34,584,598)
Accumulated other comprehensive income 5,874,319 -
------------ ------------
Total shareholders' equity 35,889,047 23,460,669
------------ ------------
Total liabilities and shareholders' equity $ 42,363,546 $ 29,457,115
============ ============
See notes to condensed consolidated financial statements
2
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
Three Months Ended Six Months Ended
December 31, December 31,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Product revenue $ 5,742,848 $ 3,144,034 $ 10,388,801 $ 5,985,160
Other revenue 595,296 613,891 1,251,000 1,184,407
------------ ------------ ------------ ------------
Revenues, net 6,338,144 3,757,925 11,639,801 7,169,567
------------ ------------ ------------ ------------
Costs and expenses:
Cost of goods sold 3,337,468 1,249,660 6,013,333 2,462,459
Research and development 474,779 225,992 791,478 433,122
Marketing, general and administrative 2,916,770 1,321,653 5,105,729 2,535,285
------------ ------------ ------------ ------------
Total costs and expenses 6,729,017 2,797,305 11,910,540 5,430,866
------------ ------------ ------------ ------------
(Loss)/income from operations (390,873) 960,620 (270,739) 1,738,701
------------ ------------ ------------ ------------
Other income and expenses:
Equity in Ocular Telehealth Management, LLC (7,109) - (36,310) -
Interest income 12,349 282 44,441 961
Interest expense (29,934) (107,880) (26,521) (226,439)
------------ ------------ ------------ ------------
Total other income and expenses (24,694) (107,598) (18,390) (225,478)
------------ ------------ ------------ ------------
(Loss)/income before income taxes (415,567) 853,022 (289,129) 1,513,223
Income taxes 7,058 32,061 20,027 69,106
------------ ------------ ------------ ------------
Net (loss)/income $ (422,625) $ 820,961 $ (309,156) $ 1,444,117
============ ============ ============ ============
Basic net (loss)/income per share $ (0.072) $ 0.243 $ (0.054) $ 0.429
============ ============ ============ ============
Diluted net (loss)/income per share $ (0.072) $ 0.196 $ (0.054) $ 0.357
============ ============ ============ ============
Weighted average shares - basic 5,869,028 3,371,920 5,716,748 3,368,643
============ ============ ============ ============
Weighted average shares - diluted 5,869,028 4,187,117 5,716,748 4,046,118
============ ============ ============ ============
See notes to condensed consolidated financial statements
3
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Six Months Ended
December 31,
2004 2003
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ (309,156) $ 1,444,117
Adjustments to reconcile net (loss)/income to net cash (used in)/
provided by operating activities:
Depreciation and amortization 188,584 128,422
Loss of Ocular Telehealth Management, LLC 36,310 -
Change in operating assets and liabilities:
Accounts receivable, net (218,629) 325,803
Inventory, net (538,243) (69,178)
Other current and long-term assets (207,391) 169,744
Accounts payable, accrued and other liabilities (539,664) (387,810)
-------------- --------------
Net cash (used in)/provided by operating activities (1,588,189) 1,611,098
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Drew, net of cash 151,996 -
Acquisition costs related to Drew (1,020,139)
Investment in Ocular Telehealth Management, LLC (193,000) -
Purchase of fixed assets (76,582) (36,876)
-------------- --------------
Net cash used in investing activities (1,137,725) (36,876)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Line of credit borrowing - 153,981
Line of credit repayment (1,900,774) (878,981)
Principal payments on term loans (4,305,265) (784,442)
Issuance of common stock, stock options 29,795 59,430
-------------- --------------
Net cash used in financing activities (6,176,244) (1,450,012)
-------------- --------------
Effect of exchange rate changes on cash & cash equivalents 7,309 -
Net (decrease)/increase in cash and cash equivalents (8,894,849) 124,210
Cash and cash equivalents, beginning of period 12,601,971 298,390
-------------- --------------
Cash and cash equivalents, end of period $ 3,707,122 $ 422,600
============== ==============
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Interest paid $ 222,198 $ 222,696
============== ==============
Income taxes $ 184,300 $ -
============== ==============
Accounts receivable $ 1,286,019 $ -
============== ==============
Inventory $ 2,635,897 $ -
============== ==============
Other current assets $ 178,261 $ -
============== ==============
Furniture and equipment $ 736,179 $ -
============== ==============
Patents $ 461,779 $ -
============== ==============
Other long-term assets $ 7,406 $ -
============== ==============
Line of credit $ 1,643,473 $ -
============== ==============
Current liabilities $ 4,068,461 $ -
============== ==============
Shares reserved for future issuance included in accrued liabilities $ 597,019 $ -
============== ==============
Long-term debt $ 756,427 $ -
============== ==============
Issuance of Common Stock $ 6,833,420 $ -
============== ==============
Increase in unrealized appreciation on available for sale securities $ 5,929,522 $ -
============== ==============
See notes to condensed consolidated financial statements
4
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED DECEMBER 31, 2004
(UNAUDITED)
Accumulated
Common Stock Common Additional Other Total
----------------------- Stock Paid-in Accumulated Comprehensive Shareholders'
Shares Amount Warrants Capital Deficit Loss Equity
--------- ------------ ------------ ------------ ------------ ------------- -------------
Balance at June 30, 2004 5,017,122 $ 5,018 $ 1,601,346 $ 56,438,903 $(34,584,598) $ - $ 23,460,669
Acquisition of Drew 841,686 842 - 6,832,578 - - 6,833,420
Exercise of common stock
purchase warrants 32,855 33 - (33) - - -
Exercise of stock options 13,500 13 - 29,782 - - 29,795
Increase in investment
based on a readily available
market value becoming available - - - - - 3,282,955 3,282,955
Unrealized gains on securities - - - - - 2,646,567 2,646,567
Foreign currency translation - - - - - (55,203) (55,203)
Net income - - - - (309,156) - (309,156)
--------- ------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2004 5,905,163 $ 5,906 $ 1,601,346 $ 63,301,230 $(34,893,754) $ 5,874,319 $ 35,889,047
========= ============ ============ ============ ============ ============ ============
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 Company operates in the healthcare market, specializing in the
development, manufacture and marketing of (1) ophthalmic medical devices and
pharmaceuticals; (2) instrumentation and consumables for use in human and
veterinary hematology; (3) instrumentation and consumables for the diagnosing
and monitoring of diabetes; and (4) vascular access devices.
The accompanying unaudited condensed consolidated financial statements
include the accounts of Escalon Medical Corp. and its subsidiaries, collectively
referred to as "Escalon" or the "Company."
Additionally, the Company's investment in Ocular Telehealth Management,
LLC ("OTM") is accounted for under the equity method. All intercompany accounts
and transactions have been eliminated.
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 2004 Annual Report on
Form 10-K. 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. ACQUISITION OF DREW SCIENTIFIC GROUP, PLC
On July 23, 2004, Escalon acquired approximately 67% of the outstanding
ordinary shares of Drew Scientific Group, Plc ("Drew"), a United Kingdom
Company, pursuant to the Company's exchange offer for all of the outstanding
ordinary shares of Drew. As of December 31, 2004, Escalon owns approximately 94%
the ordinary shares of Drew. During the remainder of fiscal 2005, Escalon
expects to compel Drew shareholders to tender all of the remaining outstanding
Drew shares pursuant to procedures under United Kingdom laws and regulations.
The results of Drew's operations have been included in the consolidated
financial statements since July 23, 2004.
Drew is a diagnostics company specializing in the design, manufacture and
distribution of analytical systems for laboratory testing worldwide. Drew is
focused on providing instrumentation and consumables for diagnosis and
monitoring of medical disorders in the areas of diabetes and hematology. In
addition, Drew supplies diagnostic systems that perform blood component tests.
Escalon has been operating Drew as a subsidiary since July 23, 2004.
The aggregate purchase price of Drew was $8,298,583, net of acquired cash
of $151,996, consisting of direct acquisition costs of $1,020,140, primarily for
investment banking, legal and accounting fees that were directly related to the
acquisition of Drew, and 900,000 shares of Escalon Common Stock valued at
$7,430,439. The value of the 900,000 shares issued was based on the market price
on the date of acquisition. The remaining shares to be exchanged are recorded as
a liability.
6
The following table summarizes the preliminary purchase price allocation
of estimated fair values of assets acquired and liabilities assumed as of the
date of acquisition of Drew on July 23, 2004. Escalon is in the process of
obtaining additional data, identifying and valuing intangible assets acquired,
obtaining third party appraisals of tangible and intangible assets, and valuing
certain pre-acquisition legal contingencies. Therefore, the allocation of the
purchase price is subject to future refinement, which is expected to be
completed no later than June 30, 2005.
Current assets $ 4,100,178
Furniture and equipment 736,179
Patents 461,779
Other long-term assets 7,406
Goodwill 9,461,402
-----------
Total assets acquired $14,766,944
-----------
Line of credit $ 1,643,473
Current liabilities 3,778,696
Long-term debt 1,046,192
-----------
Total liabilities assumed $ 6,468,361
-----------
Net assets acquired $ 8,298,583
===========
The following pro forma results of operations information has been
prepared to give effect to the purchase of Drew as if such transaction had
occurred at the beginning of the period being presented. The information
presented is not necessarily indicative of results of future operations of the
combined companies.
Three Months Ended Six Months Ended
December 31, December 31,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Revenues $ 6,338,144 $ 7,861,647 $ 12,332,141 $ 15,377,012
Cost of goods sold 3,337,468 4,072,978 6,464,476 8,109,095
------------ ------------ ------------ ------------
Gross profit 3,000,676 3,788,669 5,867,665 7,267,917
Operating expenses 3,391,549 3,201,278 6,237,452 6,275,672
Other expense 24,694 187,065 25,608 384,412
------------ ------------ ------------ ------------
Net income before taxes (415,567) 400,326 (395,395) 607,833
Provision for income taxes 7,058 6,167 20,027 17,318
------------ ------------ ------------ ------------
Net income $ (422,625) $ 394,159 $ (415,422) $ 590,515
============ ============ ============ ============
Basic net (loss)/income per share $ (0.072) $ 0.117 $ (0.073) $ 0.175
============ ============ ============ ============
Diluted net (loss)/income per share $ (0.072) $ 0.094 $ (0.073) $ 0.146
============ ============ ============ ============
Weighted average shares - basic 5,869,028 3,371,920 5,716,748 3,368,643
============ ============ ============ ============
Weighted average shares - diluted 5,869,028 4,187,117 5,716,748 4,046,118
============ ============ ============ ============
7
3. STOCK-BASED COMPENSATION
The Company reports stock-based compensation through the disclosure-only
requirements of the Statement of Financial Accounting Standards No. 123 ("SFAS
123"), "Accounting for Stock-Based Compensation," as amended by Statement of
Financial Accounting Standards No. 148 ("SFAS 148"), "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment to FASB No. 123."
Compensation expense for options is measured using the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"). Under APB 25, because the exercise price
of the Company's employee stock options is generally equal to the market price
of the Company's underlying stock on the date of grant, no compensation expense
is recognized.
SFAS 123 establishes an alternative method of expense recognition for
stock-based compensation awards based on fair values. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS 123.
Three-Months Ended Six-Months Ended
December 31, December 31,
2004 2003 2004 2003
----------- ------------ ----------- ------------
Net Income, as reported $ (422,625) $ 820,961 $ (309,156) $ 1,444,117
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (75,688) (292,554) (360,359) (310,657)
----------- ------------ ----------- ------------
Pro forma net income $ (498,313) $ 528,407 $ (669,515) $ 1,133,460
=========== ============ =========== ============
Earnings per share:
Basic - as reported $ (0.072) $ 0.243 $ (0.054) $ 0.429
=========== ============ =========== ============
Basic - pro forma $ (0.085) $ 0.157 $ (0.117) $ 0.336
=========== ============ =========== ============
Diluted - as reported $ (0.072) $ 0.196 $ (0.054) $ 0.357
=========== ============ =========== ============
Diluted - pro forma $ (0.085) $ 0.126 $ (0.117) $ 0.280
=========== ============ =========== ============
The Company has followed the guidelines of SFAS 123 to establish the
valuation of its stock options. The fair value of these equity awards was
estimated at the date of grant using the Black-Scholes option pricing method.
For the purposes of pro forma disclosures, the estimated fair value of the
equity awards is amortized to expense over the options' vesting period. For the
purposes of applying SFAS 123, the estimated per share value of the options
granted during the six-month period ended December 31, 2004 was between $4.92
and $5.06. The fair value was estimated using the following assumptions:
dividend yield of 0.0%, volatility of 0.78; risk-free interest rate of 3.30%;
and expected life of 10 years. The volatility assumption is based on volatility
seen in the Company's stock over the last five years. This assumption was made
according to the guidance of SFAS 123. There is no reason to believe that future
volatility will compare with the historical volatility.
8
4. EARNINGS PER SHARE
The Company follows Financial Accounting Standards Board Statement No.
128, "Earnings Per Share," in presenting basic and diluted earnings per share.
The following table sets forth the computation of basic and diluted earnings per
share:
Three-Months Six-Months
Ended December 31, Ended December 31,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Numerator:
Numerator for basic and diluted
earnings per share:
Net income $ (422,625) $ 820,961 $ (309,156) $ 1,444,117
------------ ------------ ------------ ------------
Denominator:
Denominator for basic earnings per
share - weighted average shares 5,869,028 3,371,920 5,716,748 3,368,643
Effect of dilutive securities:
Stock options and warrants - 815,197 - 677,475
Shares reserved for future exchange - - - -
------------ ------------ ------------ ------------
Denominator for diluted earnings
earnings per share - weighted average and
assumed conversion 5,869,028 4,187,117 5,716,748 4,046,118
------------ ------------ ------------ ------------
Basic earnings per share $ (0.072) $ 0.243 $ (0.054) $ 0.429
============ ============ ============ ============
Diluted earnings per share $ (0.072) $ 0.196 $ (0.054) $ 0.357
============ ============ ============ ============
5. INVENTORY
Inventory, stated at lower of cost (determined on a first-in, first-out
basis) or market, consisted of the following:
December 31, June 30,
2004 2004
------------- -------------
Raw materials $ 3,701,771 $ 1,132,331
Work in process 533,956 287,276
Finished goods 1,113,429 367,110
------------- -------------
5,349,156 1,786,717
Valuation allowance (372,912) (5,125)
------------- -------------
Total inventory $ 4,976,244 $ 1,781,592
============= =============
6. NOTE RECEIVABLE
Escalon entered into an agreement with an individual who was involved in
the development of a drug delivery system. The Company holds a note receivable
from the individual in the amount of $150,000 that is due in May 2005.
9
7. INTANGIBLE ASSETS
ACQUIRED LICENSE AND DISTRIBUTION RIGHTS
In connection with the Company's acquisition of assets of Escalon
Ophthalmics, Inc. ("EOI") in February 1996, a portion of the purchase price was
allocated to certain license and distribution agreements. This cost allocation
was based on an evaluation by management, with such costs being amortized over
an eight-year period using the straight-line method. The value of these assets
is reevaluated periodically to determine if the estimated lives continue to be
appropriate.
Accumulated amortization of license and distribution rights was $180,182
and $180,182 at December 31, 2004 and June 30, 2004, respectively. Amortization
expense for the three-month periods ended December 31, 2004 and 2003 was $-0-
and $5,631, respectively. Amortization expense for the six-month periods ended
December 31, 2004 and 2003 was $-0- and $11,261, respectively.
PATENTS
It is the Company's practice to seek patent protection on processes and
products in various countries. Patent application costs are capitalized and
amortized over their estimated useful lives, not exceeding 17 years, on a
straight-line basis from the date the related patents are issued. Costs
associated with patents no longer being pursued are expensed. Accumulated patent
amortization was $185,276 and $122,139 at December 31, 2004 and June 30, 2004,
respectively. Amortization expense for the three-month periods ended December
31, 2004 and 2003 was $23,502 and $2,683, respectively. Amortization expense for
the six-month periods ended December 31, 2004 and 2003 was $42,319 and $5,366,
respectively.
The aggregate amortization expense for each of the next five years for
acquired license and distribution rights and patents is as follows:
Year Ending
June 30,
-----------
2005 $ 94,008
2006 94,008
2007 88,125
2008 41,332
2009 30,532
----------
Total $ 348,005
==========
GOODWILL, TRADEMARKS AND TRADE NAMES
Goodwill, trademarks and trade names represent intangible assets obtained
from the EOI, Endologix, Inc. ("Endologix"), Sonomed and Drew acquisitions.
Goodwill represents the excess of purchase price over the fair market value of
net assets acquired.
10
The following table presents unamortized intangible assets by business
unit as of December 31, 2004:
Adjusted
Gross Gross
Carrying Carrying Accumulated Net Carrying
GOODWILL Amount Impairment Amount Amortization Value
------------ ---------- ------------- ------------ ------------
Sonomed $ 10,547,488 $ - $ 10,547,488 $ (1,021,938) $ 9,525,550
Drew 9,461,402 - 9,461,402 - 9,461,402
Vascular 1,149,813 - 1,149,813 (208,595) 941,218
Medical/Trek 272,786 - 272,786 (147,759) 125,027
------------ ---------- ------------- ------------ ------------
Total $ 21,431,489 $ - $ 21,431,489 $ (1,378,292) $ 20,053,197
============ ========== ============= ============ ============
Adjusted
Gross Gross
UNAMORTIZED INTANGIBLE Carrying Carrying Accumulated Net Carrying
ASSETS Amount Impairment Amount Amortization Value
------------ ---------- ------------- ------------ ------------
Sonomed $ 665,000 $ - $ 665,000 $ (63,194) $ 601,806
Sonomed EMS 15,100 - 15,100 - 15,100
------------ ---------- ------------- ------------ ------------
Total $ 680,100 $ - $ 680,100 $ (63,194) $ 616,906
============ ========== ============= ============ ============
The following table presents unamortized intangible assets by business
unit as of June 30, 2004:
Adjusted
Gross Gross
Carrying Carrying Accumulated Net Carrying
GOODWILL Amount Impairment Amount Amortization Value
------------ ---------- ------------- ------------ ------------
Sonomed $ 10,547,488 $ - $ 10,547,488 $ (1,021,938) $ 9,525,550
Vascular 1,149,813 - 1,149,813 (208,595) 941,218
Medical/Trek 272,786 - 272,786 (147,759) 125,027
------------ ---------- ------------- ------------ ------------
Total $ 11,970,087 $ - $ 11,970,087 $ (1,378,292) $ 10,591,795
============ ========== ============= ============ ============
Adjusted
Gross Gross
UNAMORTIZED INTANGIBLE Carrying Carrying Accumulated Net Carrying
ASSETS Amount Impairment Amount Amortization Value
------------ ---------- ------------- ------------ ------------
Sonomed $ 665,000 $ - $ 665,000 $ (63,194) $ 601,806
Sonomed EMS 15,100 - 15,100 - 15,100
------------ ---------- ------------- ------------ ------------
Total $ 680,100 $ - $ 680,100 $ (63,194) $ 616,906
============ ========== ============= ============ ============
The following table presents amortized intangible assets by business unit
as of December 31, 2004:
Adjusted
AMORTIZED INTANGIBLE Gross Gross
ASSETS Carrying Carrying Accumulated Net Carrying
PATENTS Amount Impairment Amount Amortization Value
-------- ---------- ------------- ------------ ------------
Drew $496,018 $ - $ 496,018 $ (57,772) $ 438,246
Vascular (pending
issuance) 36,916 - 36,916 - 36,916
Medical/Trek 257,301 - 257,301 (127,504) 129,797
Sonomed EMS - - - - -
-------- ---------- ------------- ------------ ------------
Total $790,235 $ - $ 790,235 $ (185,276) $ 604,959
======== ========== ============= ============ ============
11
The following table presents amortized intangible assets by business unit
as of June 30, 2004:
Adjusted
AMORTIZED INTANGIBLE Gross Gross
ASSETS Carrying Carrying Accumulated Net Carrying
PATENTS Amount Impairment Amount Amortization Value
-------- ---------- ------------- ------------ ------------
Vascular (pending issuance) $ 36,916 $ - $ 36,916 $ - $ 36,916
Medical/Trek 257,301 - 257,301 (122,139) 135,162
Sonomed EMS - - - - -
-------- ---------- ------------- ------------ ------------
Total $294,217 $ - $ 294,217 $ (122,139) $ 172,078
======== ========== ============= ============ ============
8. ACCRUED EXPENSES
The following table presents accrued expenses as of December 31, 2004 and
June 30, 2004:
December 31, June 30,
2004 2004
------------ ----------
(unaudited)
Accrued compensation $ 852,877 $ 908,568
Acquisition expense accruals 747,559 -
Severance accruals 434,907 -
Shares reserved for future exchange 597,019 -
Other accruals 923,130 320,930
------------ ----------
Total $ 3,555,491 $1,229,498
============ ==========
Accrued compensation as of December 31, 2004 primarily relates to payroll,
bonus and vacation accruals and payroll tax liabilities.
Acquisition expense accruals as of December 31, 2004 primarily relate to
professional fees (attorneys, accountants and other consultants) accruals
related directly to the acquisition of Drew.
Severance accruals as of December 31, 2004 relate to certain former
directors and officers of Drew who management had the intent to terminate as of
the consummation date of the transaction.
Shares reserved for future exchange as of December 31, 2004 relate to the
remaining 58,314 shares that Escalon expects to issue to Drew shareholders who
are compelled to exchange their Drew shares pursuant to procedures under United
Kingdom laws and regulations. This liability has been valued using the market
price of Escalon on September 22, 2004, the date Escalon could begin to compel
Drew shareholders to tender all remaining shares. This liability will be reduced
as the shareholders exchange the remaining shares.
In addition to normal accruals, other accruals as of December 31, 2004
relate to the remaining lease payments on a facility that had been vacated prior
to the acquisition, accruals for litigation existing prior to the acquisition,
franchise and ad valorem tax accruals, royalty accruals and other sundry
operating expenses and accruals.
9. LINE OF CREDIT AND LONG-TERM DEBT
During the three-month period ended December 31, 2004, the Company paid
off and terminated an overdraft line of credit with a United Kingdom financial
institution. The amount available on the line of credit was $689,720. The line
was secured by certain of Drew's assets and was personally guaranteed by
12
certain of Drew's current and former directors. During the three-month period
ended December 31, 2004, the Company also paid off and terminated a line of
credit with a domestic financial institution. The amount available on the line
of credit was $2,000,000. During the six-month period ended December 31, 2004,
total repayments on these two lines of credit totaled $1,900,774.
The Company has two long-term debt facilities through its Drew subsidiary:
the Texas Mezzanine Fund and Symbiotics, Inc. The Texas Mezzanine Fund term debt
is payable in monthly installments of $14,200, which includes interest at a
fixed rate of 8.00%. The note is due in April 2008 and is secured by certain
assets of Drew. The outstanding balance as of December 31, 2004 was $483,630.
The Symbiotics, Inc. term debt, which originated from the acquisition of a
product line from Symbiotics, Inc., is payable in monthly installments of $8,333
with interest at a fixed rate of 5.00%. The outstanding balance as of December
31, 2004 was $275,003.
The schedule below presents principal amortization for the next five years
under each of the Company's loan agreements as of December 31, 2004:
Twelve Months Ending Texas
December 31, Mezzanine Symbiotics Total
- -------------------- --------- ---------- ---------
2005 $ 136,168 $ 99,996 $ 236,164
2006 147,633 99,996 247,629
2007 160,063 75,011 235,074
2008 39,766 - 39,766
2009 - - -
--------- ---------- ---------
Total $ 483,630 $ 275,003 758,633
========= ==========
Current portion of long-term debt 236,164
---------
Long-term portion $ 522,469
=========
10. OTHER REVENUE
Other revenue includes quarterly payments received from:
(1) Bausch & Lomb in connection with the sale of the Silicone Oil
product line;
(2) Royalty payments received from IntraLase Corp. ("IntraLase")
relating to the licensing of the Company's intellectual laser
technology; and
(3) Royalty payments received from Bio-Rad Laboratories, Inc.
("Bio-Rad").
For the three-month periods ended December 31, 2004 and 2003, Silicone Oil
revenue totaled $338,550 and $525,556, respectively, Intralase royalties totaled
$164,593 and $88,335, respectively, and the Bio-Rad royalty was $92,153. For the
six-month periods ended December 31, 2004 and 2003, Silicone Oil revenue totaled
$755,338 and $1,034,338, respectively, Intralase royalties totaled $403,509 and
$150,068, respectively, and the Bio-Rad royalty was $92,153. Accounts receivable
as of December 31, 2004 and June 30, 2004 related to other revenue was $432,544
and $459,727, respectively.
13
BAUSCH & LOMB SILICONE OIL
The agreement with Bausch & Lomb, which commenced on August 13, 2000, is
structured such that the Company receives consideration from Bausch & Lomb based
on its adjusted gross profit from their sales of Silicone Oil on a quarterly
basis. The consideration is subject to a factor, which steps down through the
termination date (August 2005) according to the following schedule:
From 8/13/00 to 8/12/01 100%
From 8/13/01 to 8/12/02 82%
From 8/13/02 to 8/12/03 72%
From 8/13/03 to 8/12/04 64%
From 8/13/04 to 8/12/05 45%
INTRALASE: LICENSING OF LASER TECHNOLOGY
The material terms of the license of the Company's laser patents to
IntraLase, which expires in 2014, provide that the Company will receive a 2.5%
royalty on product sales that are based on the licensed laser patents, subject
to deductions for third party royalties otherwise due and payable to the
Company, and a 1.5% royalty on product sales that are not based on the licensed
laser patents. The Company receives a minimum annual license fee of $15,000 per
year during the remaining term of the license. The minimum annual license fee is
offset against the royalty payments. In addition, the Company owns 252,535
common shares of IntraLase issued pursuant to the license agreement. See also
Note 11 Commitments and Contingencies.
The license was dated October 23, 1997, and was amended and restated in
October 2000 and expires on the latest of the following events:
- The last to expire of the laser patents;
- Ten years from the effective date of the amended and restated
agreement;
- The fifth anniversary date of the first commercial sale.
The material termination provisions of the license of the laser technology
are as follows:
- The Company has the right to terminate if IntraLase defaults in the
payment of any royalty;
- The Company has the right to terminate if Intralase makes any false
report;
- The Company has the right to terminate if IntraLase defaults in the
making of any required report;
- The commission of any material breach of any covenant or promise
under the license agreement; or
- The termination of the license by IntraLase after 90 days notice (if
IntraLase were to terminate, it would not be permitted to utilize
the licensed technology necessary to manufacture its current
products).
See Note 11 of the Footnotes to the Condensed Consolidated Financial
Statements for a description of the Company's legal proceedings with Intralase.
BIO-RAD ROYALTY
The royalty received from Bio-Rad relates to a certain non-exclusive
Eighth Amendment to OEM Agreement ("OEM Agreement") between the Company's Drew
subsidiary and Bio-Rad, dated July 19, 1994. Bio-Rad pays a royalty based on
sales of certain of Drew's products in certain specifically identified
geographic regions.
The material terms of the OEM Agreement, which expires May 15, 2005,
provide as follows:
- Drew receives a royalty of 19.5 cents per test;
14
- The royalty payments are due 30 days after the end the month.
- Royalty payments will be made depending on the volume of tests provided by
Bio-Rad, if less than 3,750 tests per month, Bio-Rad will calculate the
number of tests used on a quarterly basis in arrears and pay Drew within
45 days of the end of the quarter. If more than 3,750 tests per month are
provided by Bio-Rad, Bio-Rad will pay an estimated monthly royalty and
within 45 days of the end of the quarter will make final settlement upon
actual number of tests.
11. COMMITMENTS AND CONTINGENCIES
COMMITMENTS
Escalon leases its manufacturing, research and corporate office facilities
and certain equipment under non-cancelable operating lease arrangements. The
Company has also entered into an agreement whereby the Company is obligated to
purchase a contracted minimum amount of product from the other party to the
agreement. The future amounts to be paid under these arrangements as of December
31, 2004 are as follows:
Twelve Months Ending Lease Purchase
December 31, Obligations Commitments Total
- -------------------- ----------- ----------- ----------
2005 $ 799,727 $ 560,000 $ 1,359,727
2006 743,993 - 743,993
2007 490,775 - 490,775
2008 286,616 - 286,616
2009 271,240 - 271,240
Thereafter 514,780 - 514,780
------------------------------------------
Total $ 3,107,131 $ 560,000 $3,667,131
==========================================
Rent expense charged to operations during the three-month periods ended
December 31, 2004 and 2003 was $154,064 and $86,424. Rent expense charged to
operations during the six-month periods ended December 31, 2004 and 2003 was
$313,571 and $183,904.
CONTINGENCIES
ROYALTY AGREEMENT: CLINICAL DIAGNOSTIC SOLUTIONS
Drew and Clinical Diagnostics Solutions, Inc. ("CDS") entered into a
Private Label/Manufacturing Agreement dated April 1, 2002 for the right to sell
formulations or products of CDS including reagents, controls and calibrators
("CDS products") on a private label basis. The agreement term is 15 years and
automatically renews year-to-year thereafter. Drew is obligated to pay CDS a
royalty of 7.5% on all sales of CDS products produced from Drew's United Kingdom
facility.
LEGAL PROCEEDINGS: INTRALASE
On June 10, 2004, Escalon provided notice to IntraLase of the Company's
intention to terminate the license agreement with IntraLase due to IntraLase's
failure to pay certain royalties that the Company believes are due under the
license agreement. On June 21, 2004, IntraLase sought a preliminary injunction
and a temporary restraining order with the United States District Court for the
Central District of California, Southern District against Escalon to prevent the
termination of the license agreement with IntraLase. The parties subsequently
agreed to stipulate to the temporary restraining order to prevent a termination
of the license agreement and, on July 6, 2004, as mutually agreed by IntraLase
and Escalon, the same district court entered a stipulation and order to remove
from the trial list the hearing on the preliminary injunction. The litigation
will continue in accordance with the court order.
15
Escalon is cognizant of the escalating legal expenses and cost associated with
the Intralase matter. Escalon, however, is taking all necessary actions to
protect its rights and interests under the license agreement. Escalon expects
expenses associated with this litigation to adversely impact earnings in the
near term. If Escalon is successful in the litigation, there is a cure feature
written into the stipulation to the temporary restraining order, which would
enable IntraLase to continue to pay royalties Escalon believes are due under the
License Agreement. Escalon believes that IntraLase has sufficient funds to
support such payments based upon its filings with the Securities and Exchange
Commission and filings in connection with this litigation. If IntraLase is
successful in the litigation, they would continue to pay royalties under their
calculations.
LEGAL PROCEEDINGS: DREW
Escalon is aware of three lawsuits involving Drew. Two were settled during
the quarter. The first lawsuit (not settled) involves the principal shareholders
of an entity previously acquired by Drew for the collection of unpaid expenses.
A counterclaim was filed by Drew for Breach of intellectual property rights and
for breach of the principal shareholders' covenants not to compete. This action
was filed in the state courts of Connecticut. The second lawsuit was filed in
the state court of Minnesota, but transferred to the Federal District Court of
Minnesota. This action was brought by a distributor against an entity previously
acquired by Drew claiming a breach of a marketing and distribution agreement.
The parties have reached a settlement of this matter. The distributor has agreed
to settle this matter for the sum of $140,000 in exchange or a full, final ands
complete release of all claims. The settlement permits Escalon's subsidiary, CDC
Acquisition Corp. to retain its claims, which include indemnification, against a
principal shareholder of an entity previously acquired by CDC Acquisition Corp.
Such principal shareholder is also involved in the previously mentioned
Connecticut action. The third action involved a suit instituted in California in
connection with a dispute from a customer claiming a refund for a product
purchase. The parties have reached a settlement of this matter. The distributor
has agreed to settle this matter for the sum of $8,000 in exchange for a full,
final and complete release of all claims and the return of the equipment. The
Company does not believe that these matters have had or are likely to have a
material adverse impact on the Company's business, financial condition or future
results of operations.
OTHER LEGAL PROCEEDINGS
Escalon, 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 effect on the
Company's business, financial condition or results of operations.
12. SEGMENTAL INFORMATION
During the three and six-month periods ended December 31, 2004 and 2003, the
Company operations were classified into four principal reportable segments that
provide different products or services. This represents a change from fiscal
2004. The Company acquired Drew on July 23, 2004, and subsequently, Drew has
been added as an additional business segment. During the first quarter of fiscal
2005, management also changed the structure of its internal organization that
caused Medical/Trek and EMI to be reported as one reportable segment. The
corresponding interim period has been restated to present comparative
information. Separate management of each segment is required because each
business unit is subject to different marketing, production and technology
strategies.
16
SEGMENTAL STATEMENTS OF OPERATIONS (IN THOUSANDS) - THREE MONTHS ENDED DECEMBER 31,
Drew Sonomed Vascular Medical/Trek/EMI Total
2004 2003 2004 2003 2004 2003 2004 2003 2004 2003
--------------- ------------------ ---------------- ----------------- ------------------
Product revenue $ 2,841 $ - $ 1,872 $ 1,965 $ 721 $ 729 $ 309 $ 450 $ 5,743 $ 3,144
Other revenue 91 - - - - - 504 613 595 613
--------------- ------------------ ---------------- ----------------- ------------------
Total revenue 2,932 - 1,872 1,965 721 729 813 1,063 6,338 3,757
--------------- ------------------ ---------------- ----------------- ------------------
Costs and expenses:
Cost of goods sold 1,903 - 839 698 370 284 225 268 3,337 1,250
Operating expenses 1,437 - 762 782 413 441 780 323 3,392 1,546
--------------- ------------------ ---------------- ----------------- ------------------
Total costs and expenses 3,340 - 1,601 1,480 783 725 1,005 591 6,729 2,796
--------------- ------------------ ---------------- ----------------- ------------------
Income from operations (408) - 271 485 (62) 4 (192) 472 (391) 961
Other income and
expenses:
Equity in OTM - - - - - - (7) - (7) -
Interest income - - - - - - 12 - 12 -
Interest expense (30) - - (104) - (4) - - (30) (108)
--------------- ------------------ ---------------- ----------------- ------------------
Total other income and
expenses (30) - - (104) - (4) 5 - (25) (108)
--------------- ------------------ ---------------- ----------------- ------------------
Income before taxes (438) - 271 381 (62) - (187) 472 (416) 853
Income taxes - - - - - 7 32 7 32
--------------- ------------------ ---------------- ----------------- ------------------
Net income (loss) $ (438) $ - $ 271 $ 381 $ (62) $ - $ (194) $ 440 $ (423) $ 821
=============== ================== ================ ================= ==================
Depreciation and
amortization $ 52 $ - $ 7 $ 6 $ 11 $ 11 $ 27 $ 9 $ 97 $ 26
Assets $ 15,797 $ - $ 12,961 $ 12,027 $ 2,130 $ 2,211 $ 11,476 $ 2,280 $ 42,364 $ 16,518
Expenditures for
long-lived assets $ 6 $ - $ 4 $ - $ - $ - $ 28 $ 21 $ 38 $ 21
SEGMENTAL STATEMENTS OF OPERATIONS (IN THOUSANDS) - SIX MONTHS ENDED DECEMBER 31,
Drew Sonomed Vascular Medical/Trek/EMI Total
2004 2003 2004 2003 2004 2003 2004 2003 2004 2003
--------------- ------------------ ---------------- ----------------- ------------------
Product revenue $ 4,754 $ - $ 3,517 $ 3,670 $ 1,416 $ 1,463 $ 702 $ 852 $ 10,389 $ 5,985
Other revenue 92 - - - - - 1,159 1,184 1,251 1,184
--------------- ------------------ ---------------- ----------------- ------------------
Total revenue 4,846 - 3,517 3,670 1,416 1,463 1,861 2,036 11,640 7,169
--------------- ------------------ ---------------- ----------------- ------------------
Costs and expenses:
Cost of goods sold 3,158 - 1,698 1,379 690 580 467 504 6,013 2,463
Operating expenses 2,382 - 1,402 1,494 823 875 1,291 599 5,898 2,968
--------------- ------------------ ---------------- ----------------- ------------------
Total costs and expenses 5,540 - 3,100 2,873 1,513 1,455 1,758 1,103 11,911 5,431
--------------- ------------------ ---------------- ----------------- ------------------
Income from operations (694) - 417 797 (97) 8 103 933 (271) 1,738
Other income and
expenses:
Equity in OTM - - - - - - (36) - (36) -
Interest income 4 - - - - - 40 1 44 1
Interest expense (54) - 29 (218) (1) (8) - - (26) (226)
--------------- ------------------ ---------------- ----------------- ------------------
Total other income and
expenses (50) - 29 (218) (1) (8) 4 1 (18) (225)
--------------- ------------------ ---------------- ----------------- ------------------
Income before taxes (744) - 446 579 (98) - 107 934 (289) 1,513
Income taxes - - - - - 20 69 20 69
--------------- ------------------ ---------------- ----------------- ------------------
Net income (loss) $ (744) $ - $ 446 $ 579 $ (98) $ - $ 87 $ 865 $ (309) $ 1,444
=============== ================== ================ ================= ==================
Depreciation and
amortization $ 97 $ - $ 14 $ 12 $ 23 $ 22 $ 55 $ 57 $ 189 $ 91
Assets $ 15,797 $ - $ 12,961 $ 12,027 $ 2,130 $ 2,211 $ 11,476 $ 2,280 $ 42,364 $ 16,518
Expenditures for
long-lived assets $ 8 $ - $ 23 $ - $ 7 $ - $ 39 $ 37 $ 77 $ 37
17
13. SHAREHOLDERS' EQUITY
WARRANTS TO PURCHASE COMMON STOCK
In connection with debt issued by a former lender to Escalon in November
2001, the Company issued the lender warrants to purchase 60,000 shares of the
Company's common stock at $3.66 per share. The lender exercised the warrants on
December 13, 2004, in a cashless exercise receiving 32,855 shares of the
Company's common stock in satisfaction of the warrants.
In connection with the private placement of Escalon's common stock in
March 2004, the Company issued to several accredited investors warrants to
purchase 120,000 shares of the Company's common stock at $15.60 per share. The
warrants are currently exercisable and expire in March 2009.
EXCHANGE OFFER FOR DREW SCIENTIFIC GROUP, PLC
During the three-month period ended September 30, 2004, the Company issued
841,686 shares of its common stock pursuant to its exchange offer for all of the
outstanding shares of Drew, and had acquired approximately 94% of the
outstanding shares as of that date. No further shares were issued during the
three-month period ended December 31, 2004 pursuant to the exchange offer.
During the remainder of fiscal 2005, Escalon expects to compel Drew shareholders
to tender all of the remaining outstanding Drew shares pursuant to procedures
under United Kingdom laws and regulations. A total of 58,314 shares are reserved
for future issuance in connection with this final exchange.
14. RELATED PARTY TRANSACTIONS
Escalon and a member of the Company's Board of Directors are founding and
equal members of Ocular Telehealth Management, LLC ("OTM"). OTM is a diagnostic
telemedicine company providing remote examination, diagnosis and management of
disorders affecting the human eye. OTM's initial solution focuses on the
diagnosis of diabetic retinopathy by creating access and providing annual
dilated retinal examinations for the diabetic population. OTM was founded to
harness the latest advances in telecommunications, software and digital imaging
in order to create greater access and a more successful disease management for
populations that are susceptible to ocular disease. Through December 31, 2004,
Escalon has invested $193,000 in OTM and has committed to invest an additional
$63,000 through March 2005. As of December 31, 2004, Escalon owned 50% of OTM.
The members of OTM have agreed to review the operations of OTM after 24 months,
at which time the members each have the right to sell their membership interest
back to OTM at fair market value. The Company will provide administrative
support functions to OTM. Through December 31, 2004, OTM had revenue of $620 and
incurred expenses of $73,421. This investment is accounted for under the equity
method of accounting and is included in other assets.
Commencing July 2004, a relative of a senior executive officer of Escalon
began providing legal services to the Company in connection with various legal
proceedings. Expenditures related to this individual during the three and
six-month periods ended December 31, 2004 were $10,000 and $23,062,
respectively.
15. INTRALASE INITIAL PUBLIC OFFERING
In October 1997, Escalon licensed its intellectual laser properties to
IntraLase in exchange for an equity interest of 252,535 shares of common stock
(as adjusted for splits), as well as royalties on future product sales. On
October 7, 2004, IntraLase announced the initial public offering of shares of
its common stock at a price of $13.00 per share. The shares of common stock are
restricted for a period of less than one year and may be sold after April 4,
2005 pursuant to a certain Fourth Amended Registration Rights Agreement between
the Company and IntraLase. The Company has historically accounted for these
shares at $0 basis because a readily determinable market value was not
available. As of December 31, 2004, the shares have been classified as
available-for-sale and have a market value of $5,929,522.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXECUTIVE OVERVIEW - SIX-MONTH PERIOD ENDED DECEMBER 31, 2004
The following highlights are discussed in further detail within this Form
10-Q. The reader is encouraged to read this Form 10-Q in its entirety to gain a
more complete understanding of factors impacting Company performance and
financial condition.
- On July 23, 2004, Escalon acquired approximately 67% of the outstanding
ordinary shares of Drew pursuant to the Company's exchange offer for
all of the outstanding ordinary shares of Drew, and since that date has
acquired 94% of the Drew shares. During the remainder of fiscal 2005,
Escalon expects to compel Drew shareholders to tender all of the
remaining outstanding Drew shares pursuant to procedures under United
Kingdom laws and regulations. Drew's revenue during the period from
July 24, 2004 through December 31, 2004 was $4,846,000 and Drew's
operations resulted in a net loss of $745,000. Prior to acquisition,
Drew's ability to obtain raw materials and components was severely
restricted due to prolonged liquidity constraints. These constraints
were pervasive throughout all of Drew's locations and affected all
aspects of Drew's operations. Escalon's operational priorities with
respect to Drew have been to stabilize and increase Drew's revenue base
and to infuse Drew with the working capital in the areas of
manufacturing, sales and marketing and product development in an effort
to remove the pre-acquisition liquidity constraints.
- In connection with the acquisition of Drew, the Company issued 841,686
shares of its common stock during the six-month period ended December
31, 2004. As of December 31, 2004, 58,314 shares of the Company's
common stock remain reserved for future exchange for Drew shares.
- During the six-month period ended December 31, 2004, the Company paid
off all of its term debt that existed prior to the acquisition of Drew
as well as the outstanding line of credit that existed prior to the
acquisition. During the six-month period ended December 31, 2004, the
Company also paid off and terminated the outstanding line of credit
Drew maintained with a domestic financial institution as well as the
overdraft line of credit Drew maintained with a United Kingdom
financial institution. During the six-month period ended December 31,
2004 the Company paid off debt of $6,206,000.
- When Drew is excluded, product revenue decreased 7.70% during the
six-month period ended December 31, 2004 as compared to the same period
last fiscal year. The decrease is primarily related to the Sonomed and
the Medical/Trek/EMI business units. The decrease in the Sonomed
business unit was primarily caused by a decrease in demand for the
Company's pachymeter product. The decrease in the Medical/Trek/EMI
business unit was primarily related to a decrease in sales of the
Company's CFA digital imaging system and related consumables.
- Other revenue increased 5.66% during the six-month period ended
December 31, 2004 as compared to the same period last fiscal year. The
increase primarily relates to an increase in royalty payments received
from IntraLase. During the six-month period ended December 31, 2004,
6.49% of the Company's other revenue was received from Bausch & Lomb in
connection with the Silicone Oil product line. The Bausch & Lomb
contract for this revenue expires in August 2005.
- When Drew is excluded, cost of goods sold as a percentage of product
revenue increased to 49.41% during the six-month period ended December
31, 2004, as compared to 39.76% of product revenue, for the same period
last fiscal year. The increase is primarily related to the Sonomed
business unit. The primary factors affecting Sonomed were product mix,
most notably the decrease in pachymeter sales, in addition to an
increase in international sales, where the Company generally
experiences lower price per unit on its products.
19
- When Drew is excluded, operating expenses increased 18.43% during the
six-month period ended December 31, 2004 as compared to the same period
last fiscal year. During the six-month period ended December 31, 2004,
the Company incurred an unusually high amount of legal and accounting
fees primarily related to the Company's first quarterly filing with the
Securities and Exchange Commission subsequent to the Drew acquisition
as well an unusually high amount of litigation costs. The Company does
not believe that these expenses will continue in the future at such
unusually high levels. The increase in operating expenses also relates
to the Company's continuing efforts to strengthen its sales channels
domestically and overseas as well as increases in administrative
headcount.
- Interest expense decreased during the six-month period ended December
31, 2004 as compared to the same period last fiscal year. The Company
paid off several of its debt facilities to several entities in advance
of their maturity dates. Additionally, the Company reversed accrued
loan commitment fees as a result of the satisfaction of the debt and
release by the lender of those fees. The fees were originally accrued
based on contractual terms.
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
Certain statements contained in, or incorporated by reference in, this
Quarterly Report on Form 10-Q 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
United States Food and Drug Administration (the "FDA"), acquisitions, the
development of joint venture opportunities, the effect of competition on the
structure of the markets in which the Company competes and defending the Company
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 one therefore should not consider the following list of such
factors to be an exhaustive statement of all risks, uncertainties or potentially
inaccurate assumptions.
The Company cautions the reader to consider carefully these factors as
well as the specific factors discussed with each specific forward-looking
statement in this quarterly report and in the Company's other filings with the
Securities and Exchange Commission. In some cases, these factors have impacted,
and in the future (together with other unknown factors) could impact the
Company's ability to implement the Company's business strategy and may cause
actual results to differ materially from those contemplated by such
forward-looking statements. No assurance can be made that any expectation,
estimate or projection contained in a forward-looking statement can be achieved.
The Company also cautions the reader that forward-looking statements speak
only as of the date made. The Company undertakes no obligation to update any
forward-looking statement, but investors are advised to consult any further
disclosures by the Company on this subject in the Company's filings with the
Securities and Exchange Commission, especially on Forms 10-K, 10-Q and 8-K, in
which the Company discusses in more detail various important factors that could
cause actual results to differ from expected or historical results. The Company
intends to take advantage of the safe harbor provisions of the Private
Securities Reform Act of 1995 regarding the Company's forward-looking
statements, and are including this sentence for the express purpose of enabling
the Company to use the protections of the safe harbor with respect to all
forward-looking statements. 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:
20
ANY ACQUISITIONS, STRATEGIC ALLIANCES, JOINT VENTURES AND DIVESTITURES
THAT THE COMPANY EFFECTS COULD RESULT IN FINANCIAL RESULTS THAT DIFFER
FROM MARKET EXPECTATIONS.
In the normal course of business, the Company engages in discussions with
third parties regarding possible acquisitions, strategic alliances, joint
ventures and divestitures. As a result of any such transactions, the Company's
financial results may differ from the investment community's expectations in a
given quarter. In addition, acquisitions and alliances may require the Company
to integrate a different company culture, management team, business
infrastructure, accounting systems and financial reporting systems. The Company
may have difficulty developing, manufacturing and marketing the products of a
newly acquired company in a way that enhances the performance of the Company's
combined businesses or product lines to realize the value from expected
synergies. Depending on the size and complexity of an acquisition, the Company's
successful integration of the entity depends on a variety of factors including
the retention of key employees and the management of facilities and employees in
separate geographical areas. These efforts require varying levels of management
resources, which may divert the Company's attention from other business
operations. The Company acquired Drew during the first quarter of fiscal 2005.
Drew does not have a history of producing positive operating cash flows and, as
a result, at the time of acquisition, was operating under financial constraints
and was under-capitalized and is expected to negatively impact the Company's
financial results in the short-term. 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.
COST ASSOCIATED WITH INTRALASE LITIGATION MAY ADVERSELY IMPACT EARNINGS IN
THE NEAR TERM.
Escalon is cognizant of the escalating legal expenses and cost associated with
the Intralase matter. Escalon, however, is taking all necessary actions to
protect its rights and interests under the license agreement. Escalon expects
expenses associated with this litigation to adversely impact earnings in the
near term. If Escalon is successful in the litigation, there is a cure feature
written into the stipulation to the temporary restraining order, which would
enable IntraLase to continue to pay royalties Escalon believes are due under the
License Agreement. Escalon believes that IntraLase has sufficient funds to
support such payments based upon its filings with the Securities and Exchange
Commission and filings in connection with this litigation. If IntraLase is
successful in the litigation, they would continue to pay royalties under their
calculations.
THE COMPANY'S RESULTS FLUCTUATE FROM QUARTER TO QUARTER.
The Company has experienced quarterly fluctuations in operating results
and anticipates continued fluctuations in the future. A number of factors
contribute to these fluctuations:
- Acquisitions, such as Drew, and subsequent integration of the acquired
company;
- The timing and expense of new product introductions by the Company or its
competitors;
- The cancellation or delays in the purchase of the Company's products;
- Fluctuations in customer demand for the Company's products;
- Fluctuations in royalty income;
- The gain or loss of significant customers;
- Changes in the mix of products sold by the Company;
- Competitive pressures on prices at which the Company can sell its
products; and
- Announcements of new strategic relationships by the Company or its
competitors.
The Company sets its spending levels in advance of each quarter based, in
part, on the Company's expectations of products orders and shipments during that
quarter. A shortfall in revenue, therefore, in any particular quarter as
compared to the Company's plan could have a material adverse effect on the
Company's results of operations and cash flows. Also, the Company's quarterly
results could fluctuate due to general market conditions in the healthcare
industry or global economy generally, or market volatility unrelated to the
Company's business an operating results.
FAILURE OF THE MARKET TO ACCEPT THE COMPANY'S PRODUCTS COULD ADVERSELY
IMPACT THE COMPANY'S BUSINESS AND FINANCIAL CONDITION.
The Company's business and financial condition will depend upon the market
acceptance of the Company's products. The Company cannot assure that the
Company's products will achieve market acceptance. Market acceptance depends
upon a number of factors including:
- The price of the products;
- The receipt of regulatory approvals for multiple indications;
- The establishment and demonstration of the clinical safety and efficacy of
the Company's products; and
- The advantages of the Company's products over those marketed by the
Company's competitors.
21
Any failure to achieve significant market acceptance of the Company's
products will have a material adverse effect on the Company's business.
THE COMPANY WILL NO LONGER RECEIVE REVENUE FROM THE SALE OF SILICONE OIL
BY BAUSCH & LOMB AFTER AUGUST 12, 2005.
The Company realized 6.49% and 14.43% of its net revenue during the six
month periods ended December 31, 2004 and 2003, respectively, from Bausch &
Lomb's sales of Silicone Oil. The Company is entitled to receive this revenue
from Bausch & Lomb, in varying amounts, through August 12, 2005. The agreement
with Bausch & Lomb, which commenced on August 13, 2000, is structured so that
the Company receives consideration from Bausch & Lomb based on its adjusted
gross profit from its sales of Silicone Oil on a quarterly basis. The
consideration is subject to a factor, which declines according to the following
schedule:
From 8/13/00 to 8/12/01 100%
From 8/13/01 to 8/12/02 82%
From 8/13/02 to 8/12/03 72%
From 8/13/03 to 8/12/04 64%
From 8/13/04 to 8/12/05 45%
The revenue associated with the sale of Silicone Oil by Bausch & Lomb
has no associated expense and consequently provides a gross margin of 100%. Any
significant reduction in this revenue can have a significant negative impact on
gross margin. The Company will not receive revenue related to the Silicone Oil
royalty after August 12, 2005.
THE COMPANY'S PRODUCTS ARE SUBJECT TO STRINGENT ONGOING REGULATION BY THE
FDA AND SIMILAR HEALTH AUTHORITIES, AND IF THE FDA'S APPROVALS OR
CLEARANCES OF THE COMPANY'S PRODUCTS ARE RESTRICTED OR REVOKED, THE
COMPANY COULD FACE DELAYS THAT WOULD IMPAIR THE COMPANY'S ABILITY TO
GENERATE FUNDS FROM OPERATIONS.
The FDA and similar health authorities in foreign countries extensively
regulate Escalon's activity. The Company must obtain either 510(K) clearances or
pre-market approvals and new drug application approvals prior to marketing a
product in the United States. Foreign regulation also requires that Escalon
obtain other approvals from foreign government agencies prior to the sale of
products in those countries. Also, Escalon may be required to obtain FDA
approval before exporting a product or device that has not received FDA
marketing clearance or approval.
Escalon has received the necessary FDA approvals for all products that the
Company currently markets. Any restrictions on or revocation of the FDA
approvals and clearances that the Company has obtained, however, would prevent
the continued marketing of the impacted products and other devices. The
restrictions or revocations could result from the discovery of previously
unknown problems with the product. Consequently, FDA revocation would impair the
Company's ability to generate funds from operations.
The FDA and comparable agencies in state and local jurisdictions and in
foreign countries impose substantial requirements upon the manufacturing and
marketing of pharmaceutical and medical device equipment and related
disposables, including the obligation to adhere to the FDA's Good Manufacturing
Practice regulations. Compliance with these regulations requires time-consuming
detailed validation of manufacturing and quality control processes, FDA periodic
inspections and other procedures. If the FDA finds any deficiencies in the
validation processes, for example, the FDA may impose restrictions on marketing
the specific products until such deficiencies are corrected.
Escalon has received CE approval on several of the Company's products that
allows the Company to sell the products in the countries comprising the European
community. In addition to the CE mark, however, some foreign countries may
require separate individual foreign regulatory clearances. Escalon
22
cannot assure that the Company will be able to obtain regulatory clearances for
other products in the United States or foreign markets.
The process for obtaining regulatory clearances and approvals underlying
clinical studies for any new products or devices and for multiple indications
for existing products is lengthy and will require substantial commitments of
Escalon's financial resources and Escalon's management's time and effort. Any
delay in obtaining clearances or approvals or any changes in existing regulatory
requirements would materially adversely impact the Company's business.
Escalon's failure to comply with the applicable regulations would subject
the Company to fines, delays or suspensions of approvals or clearances, seizures
or recalls of products, operating restrictions, injunctions or civil or criminal
penalties, which would adversely impact the Company's business, financial
condition and results of operations.
THE SUCCESS OF COMPETITIVE PRODUCTS COULD HAVE AN ADVERSE IMPACT ON THE
COMPANY'S BUSINESS.
The Company faces intense competition in the medical device and
pharmaceutical markets, which are characterized by rapidly changing technology,
short product life cycles, cyclical oversupply and rapid price erosion. Many of
the Company's competitors have substantially greater financial, technical,
marketing, distribution and other resources. The Company's strategy is to
compete primarily on the basis of technological innovation, reliability, quality
and price of the Company's products. Without timely introductions of new
products and enhancements, the Company's products will become technologically
obsolete over time, in which case the Company's revenues and operating results
would suffer. The success of the Company's new product offerings will depend on
several factors, including the Company's ability to:
- Properly identify customer needs;
- Innovate and develop new technologies, services and applications;
- Establish adequate product distribution coverage;
- Obtain and maintain required regulatory approvals from the FDA and other
regulatory agencies;
- Protect the Company's intellectual property;
- Successfully commercialize new technologies in a timely manner;
- Manufacture and deliver the Company's products in sufficient volumes on
time;
- Differentiate the Company's offerings from the offerings of the Company's
competitors;
- Price the Company's products competitively;
- Anticipate competitors' announcements of new products, services or
technological innovations; and
- General market and economic conditions.
The Company cannot ensure that the Company will be able to compete
effectively in the competitive environments in which the Company operates.
THE COMPANY'S PRODUCTS EMPLOY PROPRIETARY TECHNOLOGY, AND THIS TECHNOLOGY
MAY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF THIRD PARTIES.
The Company holds several United States and foreign patents for the
Company's products. Other parties, however, hold patents relating to similar
products and technologies. If patents held by others were adjudged valid and
interpreted broadly in an adversarial proceeding, the court or agency could deem
them to cover one or more aspects of the Company's products or procedures. Any
claims for patent infringements or claims by the Company for patent enforcement
would consume time, result in costly litigation, divert technical and management
personnel or require the Company to develop non-infringing technology or enter
into royalty or licensing agreements. The Company cannot be certain that the
Company will not be subject to one or more claims for patent infringement, that
the Company would
23
prevail in any such action or that the Company's patents will afford protection
against competitors with similar technology.
If a court determines that any of the Company's products infringes,
directly or indirectly, on a patent in a particular market, the court may enjoin
the Company from making, using or selling the product. Furthermore, the Company
may be required to pay damages or obtain a royalty-bearing license, if
available, on acceptable terms.
LACK OF AVAILABILITY OF KEY SYSTEM COMPONENTS COULD RESULT IN DELAYS,
INCREASED COSTS OR COSTLY REDESIGN OF THE COMPANY'S PRODUCTS.
Although some of the parts and components used to manufacture the
Company's products are available from multiple sources, the Company currently
purchases most of the Company's components from single sources in an effort to
obtain volume discounts. Lack of availability of any of these parts and
components could result in production delays, increased costs, or costly
redesign of the Company's products. Any loss of availability of an essential
component could result in a material adverse change to Escalon's business,
financial condition and results of operations. Some of the Company's suppliers
are subject to the FDA's Good Manufacturing Practice regulations. Failure of
these suppliers to comply with these regulations could result in the delay or
limitation of the supply of parts or components to the Company, with would
adversely impact the Company's financial condition and results of operations.
THE COMPANY'S ABILITY TO MARKET OR SELL THE COMPANY'S PRODUCTS MAY BE
ADVERSELY IMPACTED BY LIMITATIONS ON REIMBURSEMENTS BY GOVERNMENT
PROGRAMS, PRIVATE INSURANCE PLANS AND OTHER THIRD PARTY PAYORS.
The Company's customers bill various third party payors, including
government programs and private insurance plans, for the health care services
provided to their patients. Third party payors may reimburse the customer,
usually at a fixed rate based on the procedure performed, or may deny
reimbursement if they determine that the use of the Company's products was
elective, unnecessary, inappropriate, not cost-effective, experimental or used
for a non-approved indication. Third party payors may deny reimbursement
notwithstanding FDA approval or clearance of a product and may challenge the
prices charged for the medical products and services. The Company's ability to
sell the Company's products on a profitable basis may be adversely impacted by
denials of reimbursement or limitations on reimbursement, compared with
reimbursement available for competitive products and procedures. New legislation
that further reduces reimbursements under the capital cost pass-through system
utilized in connection with the Medicare program could also adversely impact the
marketing of the Company's products.
FUTURE LEGISLATION OR CHANGES IN GOVERNMENT PROGRAMS MAY ADVERSELY IMPACT
THE MARKET FOR THE COMPANY'S PRODUCTS.
In the past several years, the federal government and Congress have made
proposals to change aspects of the delivery and financing of health care
services. The Company cannot predict what form any future legislation may take
or its impact on the Company's business. Legislation that sets price limits and
utilization controls may adversely impact the rate of growth of the markets in
which the Company participates. If any future health care legislation were to
adversely impact those markets, the Company's product marketing could also
suffer, which would adversely impact the Company's business.
THE COMPANY MAY BECOME INVOLVED IN PRODUCT LIABILITY LITIGATION, WHICH MAY
SUBJECT THE COMPANY TO LIABILITY AND DIVERT MANAGEMENT ATTENTION.
The testing and marketing of the Company's products entails an inherent
risk of product liability, resulting in claims based upon injuries or alleged
injuries or a failure to diagnose associated with a product defect. Some of
these injuries may not become evident for a number of years. Although the
Company is not currently involved in any product liability litigation, the
Company may be party to litigation in the future as a result of an alleged
claim. Litigation, regardless of the merits of the claim or outcome, could
consume a great deal of the
24
Company's time and attention away from the Company's core businesses. The
Company maintains limited product liability insurance coverage of $1,000,000 per
occurrence and $2,000,000 in the aggregate, with umbrella policy coverage of up
to $5,000,000 in excess of such amounts. A successful product liability claim in
excess of any insurance coverage may adversely impact the Company's financial
condition and results of operations. The Company cannot assure you that product
liability insurance coverage will continue to be available to the Company in the
future on reasonable terms or at all.
THE COMPANY'S INTERNATIONAL OPERATIONS COULD BE ADVERSELY IMPACTED BY
CHANGES IN LAWS OR POLICIES OF FOREIGN GOVERNMENTAL AGENCIES AND SOCIAL
AND ECONOMIC CONDITIONS IN THE COUNTRIES IN WHICH THE COMPANY OPERATES.
The Company derives a portion of its revenue from sales outside the United
States. Changes in the laws or policies of governmental agencies, as well as
social and economic conditions, in the countries in which the Company operates
could affect the Company's business in these countries and the Company's results
of operations. Also, economic factors, including inflation and fluctuations in
interest rates and foreign currency exchange rates, and competitive factors such
as price competition, business combinations of competitors or a decline in
industry sales from continued economic weakness, both in the United States and
other countries in which the Company conducts business, could adversely impact
the Company's results of operations.
THE COMPANY IS DEPENDENT ON ITS MANAGEMENT AND KEY PERSONNEL TO SUCCEED.
The Company's principal executive officers and technical personnel have
extensive experience with the Company's products, the Company's research and
development efforts, the development of marketing and sales programs and the
necessary support services to be provided to the Company's customers. Also, the
Company competes with other companies, universities, research entities and other
organizations to attract and retain qualified personnel. The loss of the
services of any of the Company's executive officers or other technical
personnel, or the Company's failure to attract and retain other skilled and
experienced personnel, could have a material adverse impact on the Company's
ability to maintain or expand its businesses.
THE MARKET PRICE OF THE COMPANY'S STOCK HAS HISTORICALLY BEEN VOLATILE,
AND THE COMPANY HAS NOT PAID CASH DIVIDENDS.
The volatility of the Company's common stock imposes a greater risk of
capital losses on shareholders as compared to less volatile stocks. In addition,
such volatility makes it difficult to ascribe a stable valuation to a
shareholder's holdings of the Company's common stock. The following factors have
and may continue to have a significant impact on the market price of the
Company's common stock:
- Any acquisitions, strategic alliances, joint ventures and divestitures
that the Company effects;
- Announcements of technological innovations;
- Changes in marketing, product pricing and sales strategies or new products
by the Company's competitors;
- Changes in domestic or foreign governmental regulations or regulatory
requirements; and
- Developments or disputes relating to patent or proprietary rights and
public concern as to the safety and efficacy of the procedures for which
the Company's products are used.
Moreover, the possibility exists that the stock market, and in particular
the securities of technology companies such as Escalon, could experience extreme
price and volume fluctuations unrelated to operating performance. The Company
has not paid any cash dividends on its common stock and does not anticipate
paying cash dividends in the foreseeable future.
25
THE IMPACT OF TERRORISM OR ACTS OF WAR COULD HAVE A MATERIAL ADVERSE
IMPACT ON THE COMPANY'S BUSINESS.
Terrorist acts or acts of war, whether in the United States or abroad,
could cause damage or disruption to the Company's operations, its suppliers,
channels to market or customers, or could cause costs to increase, or create
political or economic instability, any of which could have a material adverse
impact on the Company's business.
THE COMPANY'S CHARTER DOCUMENTS AND PENNSYLVANIA LAW MAY INHIBIT A
TAKEOVER.
Certain provisions of Pennsylvania law and the Company's Bylaws could
delay or impede the removal of incumbent directors and could make it more
difficult for a third party to acquire, or discourage a third party from
attempting to acquire, control of the Company. These provisions could limit the
share price that certain investors might be willing to pay in the future for
shares of the Company's common stock. The Company's Board of Directors is
divided into three classes, with directors in each class elected for three-year
terms. The Bylaws impose various procedural and other requirements that could
make it more difficult for shareholders to effect certain corporate actions. The
Company's Board of Directors may issue shares of preferred stock without
shareholder approval on such terms and conditions, and having such rights,
privileges and preferences, as the Board may determine. The rights of the
holders of common stock will be subject to, and may be adversely affected by,
the rights of the holders of any preferred stock that may be issued in the
future. The Company has no current plans to issue any shares of preferred stock.
COMPANY OVERVIEW
The following discussion should be read in conjunction with interim
condensed consolidated financial statements and the notes thereto, which are set
forth elsewhere in this Quarterly Report on Form 10-Q.
The Company operates in the healthcare market specializing in the
development, manufacture, marketing and distribution of medical devices and
pharmaceuticals in the areas of ophthalmology, diabetes, hematology and vascular
access. The Company and its products are subject to regulation and inspection by
the FDA. The FDA requires extensive testing of new products prior to sale and
has jurisdiction over the safety, efficacy and manufacture of products, as well
as product labeling and marketing. The Company's Internet address is
www.escalonmed.com.
In February 1996, the Company acquired substantially all of the assets and
certain liabilities of EOI, a developer and distributor of ophthalmic surgical
products. Prior to this acquisition, the Company devoted substantially all of
its resources to the research and development of 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
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 in October 2004. See the Notes to Condensed Consolidated
Financial Statements for further information. The Company is in dispute with
IntraLase over royalty payments owed to the Company. See Part II, Item 1. Legal
Proceedings, for further information.
To further diversify its product portfolio, in January 1999, the Company's
Vascular subsidiary acquired the vascular access product line from Endologix,
formerly Radiance Medical Systems, Inc. Vascular's products use Doppler
technology to aid medical personnel in locating arteries and veins in difficult
circumstances. Currently, this product line is concentrated in the cardiac
catheterization market. In January 2000, the Company purchased Sonomed, a
privately held manufacturer of ophthalmic ultrasound diagnostic equipment.
On July 23, 2004, Escalon 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
26
Drew, and since that date has acquired 94% of the Drew shares. During the
remainder of fiscal 2005, Escalon expects to compel Drew shareholders to tender
all of the remaining outstanding Drew shares pursuant to procedures under United
Kingdom laws and regulations. Drew is a diagnostics company specializing in the
design, manufacture and distribution of analytical systems for laboratory
testing worldwide. Drew is focused on providing instrumentation and consumables
for the diagnosis and monitoring of medical disorders in the areas of diabetes
and hematology. In addition, Drew supplies diagnostic systems that perform blood
component tests.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements requires management to make
estimates and assumptions that impact amounts reported therein. The most
significant of those involve the application of SFAS 142, discussed further in
the Notes to the Condensed Consolidated Financial Statements included in this
Quarterly Report on Form 10-Q. The financial statements are prepared in
conformity with accounting principles generally accepted in the United States of
America, and, as such, include amounts based on informed estimates and judgments
of management. For example, estimates are used in determining valuation
allowances for deferred income taxes, uncollectible receivables, obsolete
inventory, sales returns and rebates and purchased intangible assets. Actual
results achieved in the future could differ from current estimates. The Company
used what it believes are reasonable assumptions and, where applicable,
established valuation techniques in making its estimates.
REVENUE RECOGNITION
The Company recognizes revenue from the sale of its products at the time
of shipment, when title and risk of loss transfer. The Company provides products
to its distributors at agreed wholesale prices and to the balance of its
customers at set retail prices. Distributors can receive discounts for accepting
high volume shipments. The discounts are reflected immediately in the net
invoice price, which is the basis for revenue recognition. No further material
discounts are given.
The Company's considerations for recognizing revenue upon shipment of
product to a distributor are based on the following:
- Persuasive evidence that an arrangement (purchase order and sales invoice)
exists between a willing buyer (distributor) and the Company that outlines
the terms of the sale (company information, quantity of goods, purchase
price and payment terms). The buyer (distributor) does not have an
immediate right of return.
- Shipping terms are ex-factory shipping point. At this point the buyer
(distributor) takes title to the goods and is responsible for all risks
and rewards of ownership, including insuring the goods as necessary.
- The Company's price to the buyer (distributor) is fixed and determinable
as specifically outlined on the sales invoice. The sales arrangement does
not have customer cancellation or termination clauses.
- The buyer (distributor) places a purchase order with the Company; the
terms of the sale are cash, COD or credit. Customer credit is determined
based on the Company's policies and procedures related to the buyer's
(distributor's) creditworthiness. Based on this determination, the Company
believes that collectibility is reasonable assured.
Escalon 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
Escalon'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
Escalon 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
27
indicate that the carrying value may not be recoverable. These intangible assets
include goodwill, trademarks and trade names. Factors the Company considers
important that could trigger an impairment review include significant
under-performance relative to historical or projected future operating results
or significant negative industry or economic trends. If these criteria indicate
that the value of the intangible asset may be impaired, an evaluation of the
recoverability of the net carrying value of the asset is made. If this
evaluation indicates that the intangible asset is not recoverable, the net
carrying value of the related intangible asset will be reduced to fair value.
Any such impairment charge could be significant and could have a material
adverse impact on the Company's financial statements if and when an impairment
charge is recorded. No impairment losses were recorded for goodwill, trademarks
and trade names during any of the periods presented based on these evaluations.
INCOME/(LOSS) PER SHARE
The Company computes net income/(loss) per share under the provisions of
SFAS No. 128, Earnings per Share (SFAS 128), and Staff Accounting Bulletin, No.
98 (SAB 98).
Under the provisions of SFAS 128 and SAB 98, basic and diluted net
income/(loss) per share is computed by dividing the net income/(loss) for the
period by the weighted average number of shares of common stock outstanding
during the period. The calculation of diluted net income/(loss) per share
excludes potential common shares if the effect is anti-dilutive. Basic earnings
per share are computed by dividing income/(loss) by the weighted average number
of shares of common stock outstanding during the period. Diluted earnings per
share are determined in the same manner as basic earnings per share, except that
the number of shares is increased assuming exercise of dilutive stock options
and warrants using the treasury stock method. As the Company had a net loss, the
impact of the assumed exercise of the stock options, warrants and shares
reserved for future exchange in the aggregate amount of 569,641 shares at
December 31, 2004 is anti-dilutive and as such, these amounts have been excluded
from the calculation of diluted earnings per share.
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 risk that the tax rate may significantly increase or decrease
in any period.
In determining income (loss) for financial statement purposes, management
must make certain estimates and judgments. These estimates and judgments occur
in the calculation of certain tax liabilities and in the determination of the
recoverability of certain of the deferred tax assets, which arise from temporary
differences between the tax and financial statement recognition of revenue and
expense. SFAS 109 also requires that the deferred tax assets be reduced by a
valuation allowance, if based on the weight of available evidence, it is more
likely than not that all or some portion of the recorded deferred tax assets
will not be realized in future periods.
In evaluating Escalon's ability to recover the Company's deferred tax
assets, management considers all available positive and negative evidence
including the Company's past operating results, the existence of cumulative
losses and near-term forecasts of future taxable income that is consistent with
the plans and estimates management is using to manage the underlying businesses.
Through December 31, 2004, Escalon 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 operating losses and tax credits can be carried forward, the
existence of taxable temporary differences and near-term earnings expectations.
The amount of the valuation allowance could decrease if facts and circumstances
change that materially increase taxable income prior to the expiration of the
loss carryforwards. Any reduction would reduce (increase) the income tax expense
(benefit) in the period such determination is made by the Company.
28
THREE AND SIX-MONTH PERIODS ENDED DECEMBER 31, 2004 AND 2003
The following table shows consolidated product revenue by business segment
as well as identifying trends in business segment product revenues for the three
and six-month periods ended December 31, 2004 and 2003.
Three-Month Periods Ended December 31, Six-Month Periods Ended December 31,
-------------------------------------- ------------------------------------
2004 2003 % Change 2004 2003 % Change
------ ------ -------- ------- ------ --------
Product revenue:
Drew $2,841 $ - 100.00% $ 4,754 $ - 100.00%
Sonomed 1,872 1,965 -4.73% 3,517 3,670 -4.17%
Vascular 721 729 -1.10% 1,416 1,463 -3.21%
Medical/Trek/EMI 309 450 -31.33% 702 852 -17.61%
------ ------ -------- ------- ------ --------
$5,743 $3,144 82.67% $10,389 $5,985 73.58%
====== ====== ======== ======= ====== ========
Product revenue increased $2,5 99,000, or 82.67%, to $5,743 ,000 du ring
the three-month period ended December 31, 2004 as compared to the same period
last fiscal year. The increase in revenue is attributed to the acquisition of
Drew on July 23, 2004. If Drew is excluded, product revenue decreased $242,000,
or 7.70%, to $2,902,000 during the three-month period ended December 31, 2004 as
compared to the same period last fiscal year. In the Sonomed business unit,
product revenue decreased $93,000, or 4.73%, to $1,872,000 during the
three-month period ended December 31, 2004 as compared to the same period last
fiscal year. The decrease in Sonomed product revenue was primarily caused by a
decrease in demand for the Company's pachymeter product. Unit sales of the
pachymeter decreased by 57.71% as compared to the same period last fiscal year.
The domestic market for pachymeters had previously expanded due to enhanced
techniques in glaucoma screening performed by optometrists. Historically, the
typical optometrist had not been a user of the pachymeter. Domestic demand for
the pachymeter returned to historic levels during the fourth quarter of fiscal
2004. Due to market saturation and increased price competition within the
marketplace. Sales of Sonomed's new EZ-Scan product line have partially offset
the aforementioned declines. In the Vascular business unit, revenue decreased
$8,000, or 1.10%, to $721,000 during the three-month period ended December 31,
2004 as compared to the same period last fiscal year. The decrease in product
revenues in the Vascular business unit was primarily the result of the Company
providing relief from contracted minimum purchase requirements to one of its
distributors and ultimately terminating the Company's relationship with the
distributor. The Company provided this relief to prevent the distributor from
becoming overstocked with the Company's product. The decrease in revenue was
largely offset by increases in both direct sales to end users by the Company's
domestic sales team as well as increases in the European market. In the
Medical/Trek/EMI business unit, revenue decreased $141,000, or 31.33%, to
$309,000 during the three-month period ended December 31, 2004 as compared to
the same period last fiscal year. Sales of the Company's CFA digital imaging
system and related consumables decreased $126,000. Due to increased price
competition.
Product revenue increased $4,404,000 or 73.58%, to $10,389,000 during the
six-month period ended December 31, 2004 as compared to the same period last
fiscal year. The increase in revenue is attributed to the acquisition of Drew on
July 23, 2004. If Drew is excluded, product revenue decreased $350,000, or
5.85%, to $5,635,000 during the six-month period ended December 31, 2004 as
compared to the same period last fiscal year. In the Sonomed business unit,
product revenue decreased $153,000, or 4.17%, to $3,517,000 during the six-month
period ended December 31, 2004 as compared to the same period last fiscal year.
The decrease in Sonomed product revenue was primarily caused by a decrease in
demand for the Company's pachymeter product. Unit sales of the pachymeter
decreased by 73.61% as compared to the same period last fiscal year. The
domestic market for pachymeters had previously expanded due to enhanced
techniques in glaucoma screening performed by optometrists. Historically, the
typical optometrist had not been a user of the pachymeter. Domestic demand for
the pachymeter returned to historic levels during the fourth quarter of fiscal
2004. Due to market saturation and increased price competition within the
marketplace. Sales of Sonomed's new EZ-Scan product line have partially offset
the aforementioned declines. In the Vascular business unit, revenue decreased
$47,000, or 3.21%, to $1,416,000 during the six-month period ended December 31,
2004 as compared to the same period last fiscal year. The decrease in product
revenues in the Vascular business unit was
29
primarily the result of the Company providing relief from contracted minimum
purchase requirements to several of its distributors and ultimately terminating
the Company's relationship with one of these distributors. The Company provided
this relief to prevent the distributors from becoming overstocked with the
Company's product. The decrease in revenue was largely offset by increases in
both direct sales to end users by the Company's domestic sales team as well as
increases in the European market. In the Medical/Trek/EMI business unit, revenue
decreased $150,000, or 17.61%, to $702,000 during the six-month period ended
December 31, 2004 as compared to the same period last fiscal year. Sales of the
Company's CFA digital imaging system and related consumables decreased
$131,000. Due to increased price competition.
Other revenue decreased $19,000, or 3.09%, to $595,000 during the
three-month period ended December 31, 2004 as compared to the same period last
fiscal year. The royalty received from Bausch & Lomb in connection with their
sales of Silicone Oil decreased $187,000. The Company's contract with Bausch &
Lomb calls for annual step-downs in the calculation of Silicone Oil revenue to
be received by the Company from 64% from August 13, 2003 to August 12, 2004 to
45% from August 13, 2004 to August 12, 2005. The contract will end in August
2005. For the three-month period ended December 31, 2004, the step-down caused a
$143,000 decrease in Silicone Oil revenue. The remaining $44,000 decrease in
Silicone Oil revenue was due to market demand for the product. The Company does
not have any further knowledge as to what factors have affected Bausch & Lomb's
sales of Silicone Oil. See the Notes to Condensed Consolidated Financial
Statements for a description of the step-down provisions under the contract with
Bausch & Lomb. Offsetting the decrease in Silicone Oil revenue was a $92,000
royalty received from Bio-Rad related to an OEM agreement between Bio-Rad and
Drew and a $76,000 increase in royalty payments received from Intralase related
to the licensing of the Company's intellectual laser technology.
Other revenue increased $67,000, or 5.66%, to $1,251,000 during the
six-month period ended December 31, 2004 as compared to the same period last
fiscal year. The increase is attributed to a $253,000 increase in royalty
payments received from Intralase related to the licensing of the Company's
intellectual laser technology as well as a $92,000 royalty received from Bio-Rad
related to an OEM agreement between Bio-Rad and Drew. Offsetting these increases
was a $278,000 decrease in the royalty received from Bausch & Lomb in connection
with their sales of Silicone Oil. The Company's contract with Bausch & Lomb
calls for annual step-downs in the calculation of Silicone Oil revenue to be
received by the Company from 64% from August 13, 2003 to August 12, 2004 to 45%
from August 13, 2004 to August 12, 2005. The contract will end in August 2005.
For the three-month period ended December 31, 2004, the step-down caused a
$319,000 decrease in Silicone Oil revenue. The offsetting $4,000 increase in
Silicone Oil revenue was due to market demand for the product. The Company does
not have any further knowledge as to what factors have affected Bausch & Lomb's
sales of Silicone Oil. See the Notes to Condensed Consolidated Financial
Statements for a description of the step-down provisions under the contract with
Bausch & Lomb.
The following table presents consolidated cost of goods sold by reportable
business segment and as a percentage of related segment product revenues for the
three and six-month periods ended December 31, 2004 and 2003.
Three-Month Periods Ended December 31, Six-Month Periods Ended December 31,
-------------------------------------------------------------------------------------------------
2004 2003 2004 2003
Cost of goods --------------------- --------------------- -------------------- --------------------
sold: Dollars % Dollars % Dollars % Dollars %
------------- ----- ------------- ----- ------------- ----- ------------- -----
(in thousands) (in thousands) (in thousands) (in thousands)
Drew $ 1,903 66.98% $ - 0.00% $ 3,158 66.43% $ - 0.00%
Sonomed 839 44.82% 700 35.62% 1,698 48.28% 1,378 37.55%
Vascular 370 51.32% 284 38.96% 690 48.73% 580 39.64%
Medical/Trek/EMI 225 72.82% 266 59.11% 467 66.52% 504 59.15%
------------- ----- ------------- ----- ------------- ----- ------------- -----
$ 3,337 58.11% $ 1,250 39.76% $ 6,013 57.88% $ 2,462 41.14%
============= ===== ============= ===== ============= ===== ============= =====
Cost of goods sold totaled $3,337,000, or 58.11% of product revenue, for
the three-month period ended December 31, 2004 as compared to $1,250,000, or
39.76% of product revenue, for the same period
30
last fiscal year. The increase in cost of goods sold is primarily attributed to
the acquisition of Drew on July 23, 2004. If Drew is excluded, cost of goods
sold increased $184,000, to $1,434,000 or 49.41% of product revenue during the
three-month period ended December 31, 2004 as compared to $1,250,000, or 39.76%
of product revenue for the same period last fiscal year. Cost of goods sold in
the Sonomed business unit totaled $839,000, or 44.82% of product revenue for the
three-month period ended December 31, 2004 as compared to $700,000, or 35.62% of
product revenue for the same period last fiscal year. The primary factors
affecting the increase in cost of goods sold as a percentage of product revenue
were product mix, most notably the decrease in pachymeter sales, in addition to
an increase in international sales, where the Company generally experiences
lower price per unit on its products. Cost of goods sold in the Vascular
business unit totaled $370,000, or 51.32% of product revenue, for the
three-month period ended December 31, 2004 as compared to $284,000, or 38.96% of
product revenue for the same period last fiscal year. The Company experienced
increases in overtime and temporary labor during the three-month period ended
December 31, 2004 as compared to the same period last fiscal year. Cost of goods
sold in the Medical/Trek/EMI business unit totaled $225,000, or 72.82% of
product revenue, during the three-month period ended December 31, 2004 as
compared to $266,000, or 59.11% of product revenue during the same period last
fiscal year. Fluctuations in Medical/Trek/EMI cost of goods sold primarily
emanates from product mix, which was primarily controlled by market demand.
Please see the executive overview for further information regarding the
operating results of Drew.
Cost of goods sold totaled $6,013,000, or 57.88% of product revenue, for
the six-month period ended December 31, 2004 as compared to $2,462,000, or
41.14% of product revenue, for the same period last fiscal year. The increase in
cost of goods sold is primarily attributed to the acquisition of Drew on July
23, 2004. If Drew is excluded, cost of goods sold increased $393,000, to
$2,855,000 or 50.67% of product revenue during the six-month period ended
December 31, 2004 as compared to $2,462,000, or 41.14% of product revenue for
the same period last fiscal year. Cost of goods sold in the Sonomed business
unit totaled $1,698,000, or 48.28% of product revenue for the six-month period
ended December 31, 2004 as compared to $1,378,000, or 37.55% of product revenue
for the same period last fiscal year. The primary factors affecting the increase
in cost of goods sold as a percentage of product revenue were product mix, most
notably the decrease in pachymeter sales, in addition to an increase in
international sales, where the Company generally experiences lower price per
unit on its products. Cost of goods sold in the Vascular business unit totaled
$690,000, or 48.73% of product revenue, for the six-month period ended December
31, 2004 as compared to $580,000, or 39.64% of product revenue for the same
period last fiscal year. The Company experienced increases in overtime and
temporary labor during the three-month period ended December 31, 2004 as
compared to the same period last fiscal year. Cost of goods sold in the
Medical/Trek/EMI business unit totaled $467,000, or 66.52% of product revenue,
during the six-month period ended December 31, 2004 as compared to $504,000, or
59.15% of product revenue during the same period last fiscal year. Fluctuations
in Medical/Trek/EMI cost of goods sold primarily emanates from product mix,
which was primarily controlled by market demand. Please see the executive
overview for further information regarding the operating results of Drew.
The following table presents consolidated marketing, general and
administrative expenses as well as identifying trends in business segment
marketing, general and administrative expenses for the three and six-month
periods ended December 31, 2004 and 2003.
Three-Month Periods Ended December 31, Six-Month Periods Ended December 31,
----------------------------------------------------------------------------
2004 2003 % Change 2004 2003 % Change
------- ------- -------- ------- ------- --------
Marketing,general and
administrative
expenses:
Drew $ 1,137 $ - 100.00% $ 1,936 $ - 100.00%
Sonomed 353 306 15.36% 677 564 20.04%
Vascular 356 340 4.71% 695 654 6.27%
Medical/Trek/EMI 1,071 676 58.43% 1,798 1,317 36.52%
------- ------- -------- ------- ------- --------
$ 2,917 $ 1,322 120.65% $ 5,106 $ 2,535 101.42%
======= ======= ======== ======= ======= ========
31
Marketing, general and administrative expenses increased $1,595,000, or
120.65%, to $2,917,000 during the three-month period ended December 31, 2004 as
compared to the same period last fiscal year. The increase in marketing, general
and administrative expenses was primarily attributed to incremental expenditures
due to the acquisition of Drew on July 23, 2004. If Drew is excluded, marketing,
general and administrative expenses increased $458,000, or 34.64%, to $1,780,000
during the three-month period ended December 31, 2004 as compared to the same
period last fiscal year. Marketing, general and administrative expenses in the
Sonomed business unit increased $47,000, or 15.36%, to $353,000 as compared to
the same period last fiscal year. Salaries and other personnel-related expenses
increased $33,000 as a result of increased headcount. Marketing, general and
administrative expenses in the Vascular business unit increased $16,000, or
4.71%, to $356,000 as compared to the same period last fiscal year.
Travel-related and sales meeting expenses increased $25,000, consulting expense
increased $18,000 related to marketing expenses in the European market and
salaries and other personnel-related expenses increased $17,000 as a result of
increased headcount. The Company agreed to pay royalties for a period of five
years following the acquisition of the Vascular access division of Endologix.
That five-year period ended in December 2003. This resulted in a $60,000
decrease in royalty expense. Marketing, general and administrative expenses in
the Medical/Trek/EMI business unit increased $395,000, or 58.43%, to $1,071,000
as compared to the same period last fiscal year. Legal and accounting fees
increased $242,000 primarily related to the Company's first quarterly filing
with the Securities and Exchange Commission subsequent to the Drew acquisition
as well litigation costs. Escalon expects expenses associated with the IntraLase
litigation to adversely impact earnings in the near term. See the Notes to
Condensed Consolidated Financial Statements for a description of Legal
Proceedings. Investor relations increased $84,000. Please see the executive
overview for further information regarding the operating results of Drew.
Marketing, general and administrative expenses increased $2,571,000, or
101.42%, to $5,106,000 during the six-month period ended December 31, 2004 as
compared to the same period last fiscal year. The increase in marketing, general
and administrative expenses was primarily attributed to incremental expenditures
due to the acquisition of Drew on July 23, 2004. If Drew is excluded, marketing,
general and administrative expenses increased $635,000, or 25.05%, to $3,170,000
during the six-month period ended December 31, 2004 as compared to the same
period last fiscal year. Marketing, general and administrative expenses in the
Sonomed business unit increased $113,000, or 20.04%, to $677,000 as compared to
the same period last fiscal year. Salaries and other personnel-related expenses
increased $60,000 as a result of increased headcount, advertising increased
$18,000 and the Company incurred $15,000 of expenses related to moving Sonomed's
manufacturing facility. Marketing, general and administrative expenses in the
Vascular business unit increased $41,000, or 6.27%, to $695,000 as compared to
the same period last fiscal year. Travel-related and sales meeting expenses
increased $44,000, consulting expense increased $42,000 related to marketing
expenses in the European market and salaries and other personnel-related
expenses increased $39,000 as a result of increased headcount. The Company
agreed to pay royalties for a period of five years following the acquisition of
the Vascular access division of Endologix. That five-year period ended in
December 2003. This resulted in a $120,000 decrease in royalty expense.
Marketing, general and administrative expenses in the Medical/Trek/EMI business
unit increased $481,000, or 36.52%, to $1,798,000 as compared to the same period
last fiscal year. Legal and accounting fees increased $251,000 primarily related
to the Company's first quarterly filing with the Securities and Exchange
Commission subsequent to the Drew acquisition as well as litigation costs.
Escalon expects expenses associated with the IntraLase litigation to adversely
impact earnings in the near term. See the Notes to Condensed Consolidated
Financial Statements for a description of Legal Proceedings. Salaries and other
personnel-related expenses increased $115,000 primarily due to increased
headcount. Investor relations increased $86,000. Please see the executive
overview for further information regarding the operating results of Drew.
Research and development expenses increased $249,000, or 110.18%, to
$475,000 during the three-month period ended December 31, 2004 as compared to
the same period last fiscal year. The increase in research and development
expenses was attributed to incremental expenditures due to the acquisition of
Drew on July 23, 2004. If Drew is excluded, research and development expenses
decreased $52,000, or 23.01% as compared to the same period last fiscal year.
Research and development expenses increased $358,000, or 82.79%, to
$791,000 during the six-month period ended December 31, 2004 as compared to the
same period last fiscal year. The increase in research and development expenses
was attributed to incremental expenditures due to the acquisition of
32
Drew on July 23, 2004. If Drew is excluded, research and development expenses
decreased $87,000, or 20.09% as compared to the same period last fiscal year.
Escalon recognized a loss of $7,000 and $36,000 related to its investment
in OTM during the three and six-month periods ended December 31, 2004,
respectively. The share of OTM's loss recognized by the Company is in direct
proportion to the Company's ownership equity in OTM. OTM began operations during
the three-month period ended September 30, 2004. See Related Party Transactions.
Interest income was $12,349 and $282 for the three-month periods ended
December 31, 2004, respectively, and was $44,441 and $961 for the six-month
periods ended December 31, 2004, respectively. The increase relates to increased
average cash balances in the current fiscal year.
Interest expense was $30,000 and $108,000 for the three-month periods
ended December 31, 2004, respectively, and was $27,000 and $226,000 for the
six-month periods ended December 31, 2004, respectively. The decrease relates to
lower average debt balances in the current fiscal year.
LIQUIDITY AND CAPITAL RESOURCES
Changes in Escalon's overall liquidity and capital resources from
continuing operations during the six-month period ended December 31, 2004 are
reflected in the following table:
December 31, June 30,
(Dollars are in thousands) 2004 2004
------------ ---------
Current assets $ 19,776 $ 17,566
Less: Current liabilities 5,952 3,600
------------ ---------
Working capital $ 13,824 $ 13,966
Current ratio 3.3 to 1 4.9 to 1
Notes payable and current maturities $ 236 $ 1,872
Long-term debt 522 2,396
------------ ---------
Total debt $ 758 $ 4,268
Total equity 35,889 23,461
------------ ---------
Total capital $ 36,647 $ 27,729
Total debt to total capital 2.07% 15.39%
WORKING CAPITAL POSITION
Working capital decreased $142,000 as of December 31, 2004 and the current
ratio decreased to 3.3 to 1 when compared to June 30, 2004. The decrease in
working capital was caused primarily by the pay-off of all of the Company's
pre-acquisition debt as well as substantially all of the debt acquired from
Drew. The Company paid off debt of $6,206,000 during the six-month period ended
December 31, 2004. The primary offset to this decrease in working capital was
the $5,930,000 increase in available for sale securities which relates to the
Company's ownership of common stock in Intralase.
CASH USED IN OPERATING ACTIVITIES
Cash flows from operating activities decreased by $3,199,000 for the
six-month period ended December 31, 2004 as compared to the same period last
fiscal year. Apart from year-over-year decreased net profitability of
$1,753,000, the Company also put an additional $1,542,000 into working capital
(related
33
to the purchase of inventory and other working related to Drew) during the
six-month period ended December 31, 2004 as compared to the same period last
fiscal year.
CASH FLOWS USED IN INVESTING AND FINANCING ACTIVITIES
Cash flows used in investing activities relate primarily to acquisition
costs related to Drew, the Company's investment in OTM and the purchase of fixed
assets. Any necessary capital expenditures have generally been funded out of
cash from operations, and the Company is not aware of any factors that would
cause historical capital expenditure levels not to be indicative of capital
expenditures in the future and, accordingly, does not believe that the Company
will have to commit material resources to capital investment for the foreseeable
future.
Cash flows used in financing activities were $6,176,000 during the
six-month period ended December 31, 2004. The Company paid off all of the
Company's pre-acquisition debt as well as substantially all of the Debt acquired
from Drew. The Company paid off debt of $6,206,000 during the six-month period
ended December 31, 2004.
DEBT HISTORY
On December 23, 2002, a lender acquired the Company's bank debt, which
consisted of term debt of $5,850,000 and $1,475,000 outstanding on a $2,000,000
available line of credit. On February 13, 2003, the Company entered into an
amended agreement with the lender. The primary amendments of the amended loan
agreement were to reduce quarterly principal payments, extend the term of the
repayments and to alter the covenants of the original bank agreement. On
September 30, 2004, the Company paid off and terminated both the remaining term
debt and the outstanding balance on the line of credit. In November 2001, the
Company issued the lender 60,000 warrants to purchase the Company's common stock
at $3.66 per share in connection with this debt. The warrants were exercised in
December 2004.
On January 21, 1999, the Company's Vascular subsidiary and Endologix
entered into an Assets Sale and Purchase Agreement. Pursuant to this agreement,
the Company acquired for cash the assets of Endologix's vascular access business
in exchange for cash and also agreed to pay royalties to Endologix based on
future sales of the vascular access business for a period of five years
following the closing of the sale, with a guaranteed minimum royalty of $300,000
per year. On February 1, 2001, the parties amended the agreement to eliminate
any future royalty payments to Endologix. Pursuant to this amendment, the
Company paid $17,558 in cash to Endologix, delivered a short-term note in the
amount of $64,884 that was satisfied in January 2002, delivered a note in the
amount of $717,558 payable in eleven quarterly installments that commenced on
April 15, 2002, and issued 50,000 shares of its common stock to Endologix. On
September 30, 2004, the Company paid off the balance of the term debt.
During the three-month period ended December 31, 2004, the Company paid
off and terminated an overdraft line of credit with a United Kingdom financial
institution. The amount available on the line of credit was $689,720. The line
was secured by certain of Drew's assets and was personally guaranteed by certain
of Drew's current and former directors. During the three-month period ended
December 31, 2004, the Company also paid off and terminated a line of credit
with a domestic financial institution. The amount available on the line of
credit was $2,000,000.
Drew has long-term debt facilities through the Texas Mezzanine Fund and
through Symbiotics, Inc. The Texas Mezzanine Fund term debt is payable in
monthly installments of $14,200, which includes interest at a fixed rate of
8.00%. The note is due in April 2008 and is secured by certain assets of Drew.
The outstanding balance as of December 31, 2004 is $483,630. The Symbiotics,
Inc. term debt, which originated from the acquisition of a product line from
Symbiotics, Inc., is payable in monthly installments of $8,333 with interest at
a fixed rate of 5.00%. The outstanding balance at December 31, 2004 is $275,003.
34
BALANCE SHEET
The components of the balance sheet of the Company were increased as of
July 23, 2004 by the acquisition of Drew as follows:
Cash $ 151,996
Accounts receivable 1,286,019
Inventory 2,635,897
Other current assets 178,261
Furniture and equipment 736,179
Goodwill 9,461,402
Patents 461,779
Other long-term assets 7,406
Line of credit 1,643,473
Current liabilities 4,068,461
Liability for shares reserved
for future exchange 597,019
Long-term debt 756,427
Exchange of common stock 6,833,420
These amounts represent an $839,000 net difference from the amounts
reported in the Company's Form 10-Q for the quarter ended September 30, 2004,
which has been recorded as an increase in goodwill. Escalon is in the process of
obtaining additional data, identifying and valuing intangible assets acquired,
obtaining third party appraisals of tangible and intangible assets, and valuing
certain pre-acquisition legal contingencies. Therefore, the allocation of the
purchase price is subject to future refinement, which is expected to be
completed no later than June 30, 2005.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
Escalon was not a party to any off-balance sheet arrangements as of and
for the six-month periods ended December 31, 2004 and 2003.
The following table presents the Company's contractual obligations as of
December 31, 2004:
Less than More than
Total 1 Year 1-3 Years 3-5 Years 5 Years
----------- ----------- ----------- ---------- ----------
Long-term debt $ 758,633 $ 236,164 $ 482,703 $ 39,766 $ -
Operating lease agreements 3,107,131 799,727 1,234,768 557,856 514,780
OTM commitment 63,000 63,000 - - -
Purchase obligations 560,000 560,000 - - -
----------- ----------- ----------- ---------- ----------
$ 4,488,764 $ 1,658,891 $ 1,717,471 $ 597,622 $ 514,780
=========== =========== =========== ========== ==========
FORWARD-LOOKING STATEMENT ABOUT SIGNIFICANT ITEMS LIKELY TO IMPACT LIQUIDITY
On July 23, 2004, Escalon 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. As of December 31, 2004, the Company had
acquired approximately 94% of the outstanding ordinary shares of Drew. During
the remainder of fiscal 2005, Escalon expects to compel Drew shareholders to
tender all of the remaining outstanding Drew shares pursuant to procedures under
United Kingdom laws and regulations. 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
35
seeking to strengthen Drew's market position. As of December 31, 2004, as Drew
is not yet wholly owned, Escalon loaned $4,153,000 to Drew. The funds have been
primarily used to procure components to build up inventory to support the
manufacturing process as well as to pay off accounts payable and debt of Drew.
Escalon anticipates that further working capital will likely be required by
Drew.
In October 1997, Escalon licensed its intellectual laser properties to
IntraLase in exchange for an equity interest of 252,535 shares of common stock
(as adjusted after splits), as well as royalties on future product sales. On
October 7, 2004, IntraLase announced the initial public offering of shares of
its common stock at a price of $13.00 per share. The shares of common stock are
restricted until April 4, 2005 pursuant to a certain Fourth Amended Registration
Rights Agreement between the Company and IntraLase. The shares have been
classified as available-for-sale-securities. The Company's net proceeds will be
the market price of the shares, multiplied by the number of shares sold, less
any broker commissions. As of February 4, 2005, Intralase's common stock closed
at $22.80 per share on the Nasdaq National Market. At that price, Escalon's
shares of IntraLase were valued at $5,757,798. The Company cannot assure that
will be able to liquidate its shares of IntraLase at the current market price.
Please see Notes to Consolidated Financial Statements for a description of the
Intralase Litigation.
Escalon realized 6.49% and 14.43%, of its net revenue during the six-month
period ended December 31, 2004 and 2003, respectively, from Bausch & Lomb's sale
of Silicone Oil. Silicone Oil revenue is based on sales of the product by Bausch
& Lomb multiplied by a contractual factor that declines on an annual basis due
to a contractual step-down provision. While the Company does not expect total
Silicone Oil revenue to decline rapidly during the remainder of the contract,
any such decrease would have an impact on the Company's financial position,
results of operations and cash flows and the Company's stock price could be
negatively impacted. The Company is entitled to receive this revenue from Bausch
& Lomb, in varying amounts, until August 12, 2005, when all revenues will cease.
See the Notes to Condensed Consolidated Financial Statements for a description
of the step-down provisions under the contract with Bausch & Lomb.
The Company issued 120,000 common stock purchase warrants in connection
with the private placement on March 17, 2004. The warrants are exercisable at
$15.60 per share and expire on March 17, 2009. If all 120,000 warrants were to
be exercised, it would provide gross proceeds to the Company of $1,872,000.
These warrants are not currently in the money and will not be exercised, and the
Company will not receive any proceeds as long as the exercise price is greater
than the market price. Escalon cannot assure that the warrant exercise price
will ever be less than the market price of the Company's common stock or that
even if the exercise price is less than the market price that any of the
warrants will be exercised.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The table below provides information about the Company's financial
instruments, consisting primarily of fixed interest rate debt obligations. For
debt obligations, the table represents principal cash flows and related interest
rates by expected maturity dates. Interest rates at December 31, 2004 are fixed
at 8.00% on the Texas Mezzanine Fund term debt, and are fixed at 5.00% on the
Symbiotics, Inc. term debt. See the Notes to Condensed Consolidated Financial
Statements for further information regarding the Company's debt obligations.
2004 2005 2006 Thereafter Total
--------- --------- --------- ---------- ----------
Texas Mezzanine Fund Note $ 136,168 $ 147,633 $ 160,063 $ 39,766 $ 483,630
Interest rate 8.00% 8.00% 8.00% 8.00%
Synbiotics, Inc. Note 99,996 99,996 75,011 - 275,003
Interest rate 5.00% 5.00% 5.00% -
--------- --------- --------- ---------- ----------
$ 236,164 $ 247,629 $ 235,074 $ 39,766 $ 758,633
========= ========= ========= ========== ==========
36
EXCHANGE RATE RISK
During the three-month periods ended December 31, 2004 and 2003,
approximately 35.44% and 17.39%, respectively, of Escalon consolidated net
revenue was derived from international sales. During the six-month periods ended
December 31, 2004 and 2003, approximately 35.72% and 17.39%, respectively, of
Escalon consolidated net revenue was derived from international sales. Prior to
the acquisition of Drew, the price of all product sold overseas was denominated
in United States Dollars and consequently the Company incurred no exchange rate
risk on revenue. However, a portion of Drew's product revenue is denominated in
United Kingdom Pounds. During the three-month period ended December 31, 2004,
Drew recorded $1,074,000 of revenue denominated in United Kingdom pounds and
during the period from July 24, 2004 through December 31, 2004, Drew recorded
$1,719,000 of revenue denominated in United Kingdom pounds.
Drew incurs a portion of its expenses denominated in United Kingdom
pounds. During the three-month period ended December 31, 2004, Drew incurred
$1,313,000 of expense denominated in United Kingdom pounds and during the period
from July 24, 2004 through December 31, 2004, Drew incurred $1,957,000 of
expense denominated in United Kingdom pounds. The Company's Sonomed business
unit incurs a portion of its marketing expenses in the European market, the
majority of which are transacted in Euros. For the three-month period ended
December 31, 2004 and 2003, these expenses totaled $43,000 and $50,000,
respectively, and during the six-month period ended December 31, 2004 and 2003,
these expenses totaled $84,000 and $76,000, respectively. The Company's Vascular
business unit began incurring marketing expense in the European market during
the second quarter of fiscal 2004, the majority of which are transacted in
Euros. For the three-month periods ended December 31, 2004 and 2003, these
expenses totaled $29,000 and $11,000, respectively, and during the six-month
periods ended December 31, 2004 and 2003, these expenses totaled $55,000 and
$13,000, respectively.
The Company may begin to experience fluctuations, beneficial or adverse,
in the valuation of currencies in which the Company transacts its business,
namely the United States Dollar, the United Kingdom Pound and the Euro.
ITEM 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 Senior Vice President of Finance, has evaluated the
effectiveness of the Company's disclosure controls and procedures (as such term
is defined in Rule 13a-15(e) and 15(d)-15(e) under the Securities Exchange Act
of 1934) as of the end of the period covered by this report. Based on such
evaluation, the Company's Chief Executive Officer and Senior Vice President of
Finance have concluded that, as of the end of such period, the Company's
disclosure controls and procedures are effective in recording, processing,
summarizing and recording, on a timely basis, information required to be
disclosed by the Company in the reports that it files or submits under the
Exchange Act.
(B) INTERNAL CONTROLS OVER FINANCIAL REPORTING
There have been changes in the Company's internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Securities and Exchange Act of 1934) during the Company's second fiscal quarter
ended December 31, 2004, that are reasonably likely to materially affect, the
Company's internal control over financial reporting. The Company's management
notes that there have not been any changes in the Company's internal control
over financial reporting in the Company's historical business; however, the
Company's recent acquisition of Drew did cause a change in the Company's
internal control as it relates to that business.
During the three-month period ended December 31, 2004, the Company
performed a detailed internal review of the financial accounting and reporting
function of the acquired Drew business. All accounts were reviewed and all
balance sheet accounts were reconciled in accordance with Company
37
financial procedures. Management ensured that all relevant personnel in the
newly acquired business were trained in the application of the Company's
financial policies and procedures. No significant deficiencies in financial
control were identified during the three-month period ended December 31, 2004.
The improvement of internal controls surrounding the acquired Drew business is a
continuing focus of Company management. The Company does not believe that the
cost of implementing any of these improvements will have a material effect on
the Company's financial condition or results of operations.
A control system, no matter how well-designed and operated, cannot provide
absolute assurance that the objectives of the control systems are met, and no
evaluation of internal controls can provide absolute assurance that all control
issues and instances of fraud, if any, within a company have been detected.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On June 10, 2004, Escalon provided notice to IntraLase of the Company's
intention to terminate the license agreement with IntraLase due to IntraLase's
failure to pay certain royalties that the Company believes are due under the
license agreement. On June 21, 2004, IntraLase sought a preliminary injunction
and a temporary restraining order with the United States District Court for the
Central District of California, Southern District against Escalon to prevent the
termination of the license agreement with IntraLase. The parties subsequently
agreed to stipulate to the temporary restraining order to prevent a termination
of the license agreement and, on July 6, 2004, as mutually agreed by IntraLase
and Escalon, the same district court entered a stipulation and order to remove
from the trial list the hearing on the preliminary injunction. The litigation
will continue in accordance with the court order. Escalon is cognizant of the
escalating legal expenses and cost associated with the Intralase matter.
Escalon, however, is taking all necessary actions to protect its rights and
interests under the license agreement. Escalon expects expenses associated with
this litigation to adversely impact earnings in the near term. If Escalon is
successful in the litigation, there is a cure feature written into the
stipulation to the temporary restraining order, which would enable IntraLase to
continue to pay royalties Escalon believes are done under the License Agreement.
Escalon believes that IntraLase has sufficient funds to support such payments
based upon its filings with the Securities and Exchange Commission and filings
in connection with this litigation. If IntraLase is successful in the
litigation, they would continue to pay royalties under their calculations.
Escalon is aware of three lawsuits involving Drew. Two were settled during
the quarter. The first lawsuit (not settled) involves the principal shareholders
of an entity previously acquired by Drew for the collection of unpaid expenses.
A counterclaim was filed by Drew for Breach of intellectual property rights and
for breach of the principal shareholders' covenants not to compete. This action
was filed in the state courts of Connecticut. The second lawsuit was filed in
the state court of Minnesota, but transferred to the Federal District Court of
Minnesota. This action was brought by a distributor against an entity previously
acquired by Drew claiming a breach of a marketing and distribution agreement.
The parties have reached a settlement of this matter. The distributor has agreed
to settle this matter for the sum of $140,000 in exchange or a full, final ands
complete release of all claims. The settlement permits Escalon's subsidiary, CDC
Acquisition Corp. to retain its claims, which include indemnification, against a
principal shareholder of an entity previously acquired by CDC Acquisition Corp.
Such principal shareholder is also involved in the previously mentioned
Connecticut action. The third action involved a suit instituted in California in
connection with a dispute from a customer claiming a refund for a product
purchase. The parties have reached a settlement of this matter. The distributor
has agreed to settle this matter for the sum of $8,000 in exchange for a full,
final and complete release of all claims and the return of the equipment. The
Company does not believe that these matters have had or are likely to have a
material adverse impact on the Company's business, financial condition or future
results of operations.
Escalon, 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 have had or are likely to have a material adverse impact on the
Company's business, financial condition or results of operations.
38
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On July 23, 2004, Escalon acquired approximately 67% of the outstanding
ordinary shares of Drew, a United Kingdom company, pursuant to the Company's
exchange offer for all of the outstanding ordinary shares of Drew, and since
that date has acquired substantially all of the Drew shares. During the
remainder of fiscal 2005, Escalon expects to compel Drew shareholders to tender
all of the remaining outstanding Drew shares pursuant to procedures under United
Kingdom laws and regulations. During the six-month period ended December 31,
2004, the Company has issued 841,686 shares of its common stock and reserved
58,314 shares for future issuance pursuant to the exchange offer.
The issuances of shares of Escalon common stock in the exchange offer for
the acquisition of Drew were made in accordance with Rule 802 under the
Securities Act of 1933, as an exchange offer for a class of securities of a
foreign private issuer in which the conditions regarding the limitation on
United States ownership of Drew, the equal treatment of any United States
holders and Form CB filings were satisfied.
In connection with debt issued by a former lender to Escalon in November
2001, the Company issued the lender warrants to purchase 60,000 shares of the
Company's common stock at $3.66 per share. The lender exercised the warrants on
December 13, 2004, in a cashless exercise receiving 32,855 shares of the
Company's common stock in satisfaction of the warrants. These shares were issued
and exempt from registration pursuant to Section 4(2) the Securities Act of
1933.
The Company did not effect any repurchases of its common stock during the
quarter ended December 31, 2004.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders was held on December 1, 2004. The
following matters were acted upon:
1. The following persons were elected as directors of the Company for
the next three years until their successors are elected and
qualified.
Nominees for Director For Withheld
- --------------------- --------- --------
Lisa A. Napolitano 4,646,512 69,956
Jeffrey F. O'Donnell (*) 4,752,571 67,996
* - subsequent to having been successfully elected to a new three-year term.,
Mr. O'Donnell resigned his position as director effective January 3, 2005 as
disclosed on Form 8-K filed with the Securities and Exchange Commission on
January 3, 2005.
2. The shareholders approved the adoption of the Escalon Medical Corp.
2004 Equity Incentive Plan providing an additional 550,000 shares of
common stock.
For Against Abstain Broker Non-Votes
- ------- ------- ------- ----------------
621,427 180,809 30,265 3,883,967
ITEM 5. OTHER INFORMATION
In October 1997, Escalon licensed its intellectual laser properties to
IntraLase in exchange for an equity interest of 252,535 shares of common stock
(as adjusted for splits), as well as royalties on future product sales. On
October 7, 2004, IntraLase announced the initial public offering of shares of
its common stock at a price of $13.00 per share. The shares of common stock are
restricted due to contractual restrictions until April 4, 2005. The shares have
been classified as available-for-sale securities. The Company has historically
accounted for these shares at $0 basis because a readily determinable market
value was not available. The Company cannot assume that it will be able to
liquidate its shares of IntraLase at the current market price.
ITEM 6. EXHIBITS
31.1 Certificate of Chief Executive Officer under Section 1350 of the 18
of the United states Code
31.2 Certificate of Senior Vice President of Finance 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 Senior Vice President of Finance under Section 1350
of Title 18 of the United States Code.
39
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ESCALON MEDICAL CORP.
(Registrant)
Date: February 14, 2005 By: /s/ Richard J.DePiano
-------------------------------
Richard J. DePiano
Chairman and Chief
Executive Officer
Date: February 14, 2005 By: /s/ Harry M. Rimmer
-------------------------------
Harry M. Rimmer
Senior Vice President of Finance
40
EXHIBIT 31.1
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 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 the statements were made, not misleading with respect to
the periods covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report.
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
Registrant and have:
a. Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
b. Evaluated the effectiveness of the Registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
c. Disclosed in this report any change in the Registrant's internal
control over financial reporting that occurred during the
Registrant's most recent fiscal quarter (the Registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the Registrant's internal control over financial
reporting; and
5. The Registrant's other certifying officer and I have disclosed,
based on our most recent evaluation of internal control over
financial reporting, 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 and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the Registrant's
ability to record, process, summarize and report financial
information; 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 over financial reporting.
Date: February 14, 2005 /s/ Richard J. DePiano
----------------------------
Richard J. DePiano
Chairman and Chief
Executive Officer
(Principal Executive Officer)
EXHIBIT 31.2
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 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 the statements were made, not misleading with respect to
the periods covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report.
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
Registrant and have:
a. Designed such disclosure controls and procedures, or
caused such disclosure controls and procedures to be
designed under our supervision, 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 report is being prepared;
b. Evaluated the effectiveness of the Registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure
controls and procedures, as of the end of the period
covered by this report based on such evaluation; and
c. Disclosed in this report any change in the Registrant's
internal control over financial reporting that occurred
during the Registrant's most recent fiscal quarter (the
Registrant's fourth fiscal quarter in the case of an
annual report) that has materially affected, or is
reasonably likely to materially affect, the Registrant's
internal control over financial reporting; and
5. The Registrant's other certifying officer and I have disclosed,
based on our most recent evaluation of internal control over
financial reporting, 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 and material weaknesses in
the design or operation of internal control over financial
reporting which are reasonably likely to adversely affect
the Registrant's ability to record, process, summarize and
report financial information; 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 over financial
reporting.
Date: February 14, 2005 /s/ Harry M. Rimmer
---------------------------------
Harry M. Rimmer
Senior Vice President of Finance
EXHIBIT 32.1
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
December 31, 2004 (the "Report") fully complies with the
requirements of Section 13(a) of the Securities Act of 1934; and
2. The information contained in this quarterly report fairly presents,
in all material respects, the financial condition and results of
operations of the Company.
Date: February 14, 2005 /s/ Richard J. DePiano
------------------------------------
Richard J. DePiano
Chairman and Chief Executive Officer
A signed copy of this written statement required by Section 906 of the
Sarbanes-Oxley Act of 2002 has been provided to Escalon Medical Corp. and will
be retained by Escalon Medical Corp. and furnished to the Securities and
Exchange Commission or its staff upon request.
EXHIBIT 32.2
STATEMENT OF SENIOR VICE PRESIDENT - FINANCE
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:
1. The Company's Form 10-Q Quarterly Report for the period ended
December 31, 2004 (the "Report") fully complies with the
requirements of Section 13(a) of the Securities Act of 1934; and
2. The information contained in this quarterly report fairly presents,
in all material respects, the financial condition and results of
operations of the Company.
Date: February 14, 2005 /s/ Harry M. Rimmer
-------------------------------
Harry M. Rimmer
Senior Vice President - Finance
A signed copy of this written statement required by Section 906 of the
Sarbanes-Oxley Act of 2002 has been provided to Escalon Medical Corp. and will
be retained by Escalon Medical Corp. and furnished to the Securities and
Exchange Commission or its staff upon request.