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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 SEPTEMBER 30,
2003.
OR
( ) Transitional report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the transitional period
from..........to..........
COMMISSION FILE NUMBER 0-20127
-------------------------------
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)
575 EAST SWEDESFORD ROAD, SUITE 100, WAYNE, PA 19087
(Address of principal executive offices, including zip code)
(610) 688-6830
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required 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 November 3, 2003, 3,365,359 shares of Common Stock were outstanding.
ESCALON MEDICAL CORP.
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
Page
----
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements 3
Condensed Consolidated Balance Sheets as of September 30, 2003
(unaudited) and June 30, 2003 3
Condensed Consolidated Statements of Operations for the three-month
periods ended September 30, 2003 and 2002 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the three-month
Periods ended September 30, 2003 and 2002 (unaudited) 5
Notes to Condensed Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
Item 4. Controls and Procedures 23
Part II. Other Information 24
Item 1. Legal Proceedings 24
Item 6. Exhibits and Reports on Form 8-K 24
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, June 30,
2003 2003
---- ----
(Unaudited) (Audited)
ASSETS
Current assets:
Cash and cash equivalents $ 64,220 $ 298,390
Accounts receivable, net 2,069,009 2,364,370
Inventory, net 1,858,195 1,785,480
Other current assets 317,051 310,420
------------ ------------
Total current assets 4,308,475 4,758,660
------------ ------------
Long-term note receivable 150,000 150,000
Furniture and equipment, net 486,813 516,686
Goodwill 10,591,795 10,591,795
Trademarks and trade names, net 616,906 616,906
License and distribution rights, net 7,507 13,138
Patents, net 180,128 182,811
Other assets 60,235 60,235
------------ ------------
Total assets $ 16,401,859 $ 16,890,231
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Line of credit $ 475,000 $ 975,000
Current portion of long-term debt 1,570,849 1,510,344
Accounts payable 513,039 454,711
Accrued compensation 385,638 708,231
Other current liabilities 229,501 222,036
------------ ------------
Total current liabilities 3,174,027 3,870,322
Long-term debt, net of current portion 3,665,228 4,080,461
------------ ------------
Total liabilities 6,839,255 7,950,783
Shareholders' equity:
Preferred stock, $0.001 par value; 2,000,000 shares authorized; no shares issued -- --
Common stock, $0.001 par value; 35,000,000 shares authorized; 3,365,359
shares issued and outstanding at September 30, 2003 and June 30, 2003,
respectively 3,365 3,365
Additional paid-in capital 46,262,411 46,262,411
Accumulated deficit (36,703,172) (37,326,328)
------------ ------------
Total shareholders' equity 9,562,604 8,939,448
------------ ------------
Total liabilities and shareholders' equity $ 16,401,859 $ 16,890,231
============ ============
See notes to condensed consolidated financial statements
3
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
September 30,
2003 2002
---- ----
Product revenue $ 2,841,127 $ 2,513,518
Other revenue 570,515 494,822
----------- -----------
Revenues, net 3,411,642 3,008,340
----------- -----------
Costs and expenses:
Cost of goods sold 1,212,799 1,078,919
Research and development 207,130 190,318
Marketing, general and administrative 1,214,196 1,288,128
----------- -----------
Total costs and expenses 2,634,125 2,557,365
----------- -----------
Income from operations 777,517 450,975
----------- -----------
Other income and expenses:
Interest income 679 650
Interest expense (118,559) (192,466)
----------- -----------
Total other income and expenses (117,880) (191,816)
----------- -----------
Income before income taxes $ 659,637 $ 259,159
Income taxes 36,481 --
----------- -----------
Net income $ 623,156 $ 259,159
=========== ===========
Basic net income per share $ 0.185 $ 0.077
=========== ===========
Diluted net income per share $ 0.154 $ 0.076
=========== ===========
Weighted average shares - basic 3,365,359 3,345,851
=========== ===========
Weighted average shares - diluted 4,049,298 3,403,863
=========== ===========
See notes to condensed consolidated financial statements `
4
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Three-Month Periods Ended
September 30,
2003 2002
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 623,156 259,159
Adjustments to reconcile net income to net cash
provided by in operating activities:
Depreciation and amortization 64,377 87,899
Disposal of furniture and equipment -- 927
Change in operating assets and liabilities:
Accounts receivable, net 295,361 (18,421)
Inventory, net (72,715) (135,656)
Other current and long-term assets (6,630) 65,751
Accounts payable, accrued and other liabilities (256,801) 67,938
--------- ---------
Net cash provided by operating activities 646,748 327,597
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of fixed assets (15,685) (18,348)
--------- ---------
Net cash used in investing activities (15,685) (18,348)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Line of credit borrowing -- 325,000
Line of credit repayment (500,000) (175,000)
Principal payments on term loans (365,233) (515,233)
Issuance of common stock -- --
Payments of financing fees -- --
--------- ---------
Net cash used in financing activities (865,233) (365,233)
--------- ---------
Net decrease in cash and cash equivalents (234,170) (55,984)
Cash and cash equivalents, beginning 298,390 220,826
--------- ---------
Cash and cash equivalents, ending $ 64,220 $ 164,842
========= =========
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Interest paid $ 130,670 $ 142,249
========= =========
Income taxes $ 92,000 $ --
========= =========
See notes to condensed consolidated financial statements
5
ESCALON MEDICAL CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Escalon Medical Corp. and its subsidiaries Sonomed, Inc. ("Sonomed"), Escalon
Vascular Access, Inc. ("Vascular"), Escalon Digital Vision, Inc. ("EMI"),
Sonomed EMS, Srl ("Sonomed EMS") and Escalon Pharmaceutical, Inc.
("Pharmaceutical") (jointly referred to as "Escalon" or the "Company") have been
prepared in accordance with the rules and regulations of the United States
Securities and Exchange Commission (the "SEC").
Certain information and footnote disclosures normally included in
financial statements presented in accordance with accounting principles
generally accepted in the United States of America have been condensed or
omitted pursuant to such rules and regulations. In the opinion of management,
the financial statements reflect all adjustments, consisting of only normal
recurring adjustments, necessary for a fair presentation of financial position,
results of operations and cash flows for the interim periods presented.
Operating results are not indicative of the results that may be expected for the
fiscal year ending June 30, 2004.
For more complete financial information, the accompanying condensed
financial statements should be read in conjunction with the audited consolidated
financial statements for the year ended June 30, 2003 included in the Company's
annual report on Form 10-K.
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, Sonomed, Vascular, EMI, Sonomed EMS and
Pharmaceutical. All intercompany accounts and transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the date of the financial statements and reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS
For the purposes of reporting cash flows, the Company considers all cash
accounts that are not subject to withdrawal restrictions or penalties, and
highly liquid investments with original maturities of 90 days or less to be cash
and cash equivalents.
REVENUE RECOGNITION
The Company recognizes revenue from the sales 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 achieve 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 or sales incentives are given.
6
The Company's considerations for recognizing revenue upon shipment of
products to a distributor are based on the following:
- Persuasive evidence of 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, as the
Company must first consent in writing and is not required to do so.
- 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.
- A 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
a buyer's (distributor's) creditworthiness. Based on this
determination, the Company believes that collectibility is
reasonably assured.
Provision has been made for estimated sales returns based on historical
experience.
With respect to additional consideration related to the sale of the
Company's Silicone Oil product line by Bausch & Lomb and the licensing of the
Company's intellectual laser property, revenue is recognized upon notification
from the licensees of amounts earned or upon receipt of royalty payment.
SHIPPING AND HANDLING COSTS
Shipping and handling revenues are included in product revenue and the
related costs are included in cost of goods sold.
INVENTORIES
Raw materials/work in process and finished goods are recorded at lower of
cost (first-in, first-out) or market.
ACCOUNTS RECEIVABLE
Accounts receivable are recorded at net realizable value. The Company
performs ongoing credit evaluations of customers' financial condition and does
not require collateral for accounts receivable arising in the normal course of
business. The Company maintains allowances for potential credit losses based on
the Company's historical losses and upon periodic review of individual balances.
Accounts are written off when they are determined to be uncollectible based on
management's assessment of individual accounts. Credit losses, when realized,
have been within the range of management's expectations. Allowance for doubtful
accounts was $260,504 and $261,351 at September 30, 2003 and June 30, 2003,
respectively.
FURNITURE AND EQUIPMENT
Furniture and equipment is recorded at cost. Depreciation is computed
using the straight-line method over the economic useful life of the related
assets, which are estimated to be over three to ten years. Depreciation for the
three-month periods ended September 30, 2003 and 2002 was $45,558 and $46,003,
respectively.
LONG-LIVED ASSETS
Management assesses the recoverability of long-lived assets whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable from its future
7
undiscounted cash flows. If it is determined that impairment has occurred, an
impairment loss is recognized for the amount by which the carrying amount of the
asset exceeds its estimated fair value.
INTANGIBLE ASSETS
The Company follows Statement of Financial Accounting Standards No. 142
("SFAS 142"), "Goodwill and Other Intangible Assets," which discontinues the
amortization of goodwill and identifiable intangible assets that have indefinite
lives. In accordance with SFAS 142, these assets are tested for impairment on an
annual basis.
STOCK-BASED COMPENSATION
Effective December 31, 2002, the Company adopted the disclosure provisions
of Statement of Financial Accounting Standards No. 148 ("SFAS 148"), "Accounting
for Stock-Based Compensation - Transition and Disclosure." Since the Company
does not plan to adopt the fair value method of accounting of Statement of
Financial Accounting Standards No. 123 ("SFAS 123"), the Company does not expect
any impact on its consolidated results of operations or financial condition in
fiscal 2004. At September 30, 2003, the Company had five stock-based employee
compensation plans. The Company accounts for these plans under the intrinsic
value recognition and measurement principles of APB Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations. The following table
illustrates the effect on net income and earnings per share if the Company
applied the fair value recognition provisions of SFAS 123 to stock-based
employee compensation. SFAS 123 requires pro forma information regarding net
income and earnings per share as if the Company has accounted for its employee
stock options granted after December 31, 1994 under the fair value method of
SFAS 123. The fair value of these equity awards was estimated at the date of
grant using the Black-Scholes option pricing method with the following weighted
average assumptions for the three-month periods ended September 30, 2003 and
2002: dividend yield of 0.0%; volatility of between .06 and .16; risk free
interest rate of 4.0%; and expected lives of 10 years. 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 No.
123, the estimated per share value of options granted during the three-month
periods ended September 30, 2003 and 2002 was $0 and $145,110, respectively.
Three-Month Periods Ended
September 30,
2003 2002
---------- ------------
Net Income, as reported $ 623,156 $ 259,159
Deduct: Total stock-based
employee compensation
expense determined under
fair value based method for
all awards, net of related
tax effects -- (188,883)
---------- ------------
Pro forma net income $ 623,156 $ 70,276
========== ============
Earnings per share:
Basic - as reported $ 0.185 $ 0.077
========== ============
Basic - pro forma $ 0.185 $ 0.021
========== ============
Diluted - as reported $ 0.154 $ 0.076
========== ============
Diluted - pro forma $ 0.154 $ 0.021
========== ============
RESEARCH AND DEVELOPMENT
All research and development costs are charged to operations as incurred.
8
ADVERTISING COSTS
Advertising costs are charged to operations as incurred. Advertising
expense for the three-month periods ended September 30, 2003 and 2002 was $2,236
and $7,170, respectively.
NET INCOME 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-Month Periods
Ended September 30,
2003 2002
---------- ----------
Numerator:
Numerator for basic and diluted earnings per share:
Net income $ 623,156 $ 259,159
---------- ----------
Denominator:
Denominator for basic earnings per
share - weighted average shares 3,365,359 3,345,851
Effect of dilutive securities:
Employee stock options 683,939 58,012
---------- ----------
Denominator for diluted earnings
earnings per share - weighted average and
assumed conversion 4,049,298 3,403,863
---------- ----------
Basic earnings per share $ 0.185 $ 0.077
========== ==========
Diluted earnings per share $ 0.154 $ 0.076
========== ==========
INCOME TAXES
The Company accounts for income taxes using the asset and liability
method. Under this method, deferred tax assets and liabilities are recognized
based on the difference between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates in effect in the
years when those temporary differences are expected to reverse. The effect on
deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date.
9
3. INVENTORIES
Inventories, stated at the lower of cost (determined on a first-in,
first-out basis) or market, consisted of the following:
September 30, June 30,
2003 2003
----------- -----------
Raw materials/Work in process $ 1,377,466 $ 1,374,184
Finished goods 538,717 475,316
----------- -----------
1,916,183 1,849,500
Valuation allowance (57,988) (64,020)
----------- -----------
Total inventory $ 1,858,195 $ 1,785,480
=========== ===========
4. 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 cost 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 $172,675
and $167,044 at September 30, 2003 and June 30, 2003, respectively. Amortization
expense for the three-month periods ended September 30, 2003 and 2002 was $5,631
and $10,756, 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 $114,089 and $111,406 at September 30, 2003 and June 30, 2003,
respectively. Amortization expense for the three-month periods ended September
30, 2003 and 2002 was $2,683 and $2,683, respectively.
The aggregate amortization expense for each of the next five years for
acquired license and distribution rights and patents are as follows:
Year ending
June 30,
--------
2004 $23,871
2005 10,733
2006 10,733
2007 10,733
2008 10,733
-------
$66,803
=======
10
GOODWILL, TRADEMARKS AND TRADE NAMES
Goodwill, trademarks and trade names represent intangible assets
obtained from EOI, Endologix, Inc. ("Endologix") and Sonomed acquisitions.
Goodwill represents the excess of purchase price over the fair market value of
net assets acquired.
In accordance with SFAS No. 142, effective July 1, 2001, Escalon
discontinued the amortization of goodwill and identifiable intangible assets
that have indefinite lives. Intangible assets that have finite lives will
continue to be amortized over their useful lives. Management evaluated the
carrying value of goodwill and its identifiable intangible assets that have
indefinite lives during each of the fiscal years subsequent to July 1, 2001.
Management concluded that the carrying value of goodwill and identifiable
intangible assets did not exceed their fair values and therefore were not
impaired. Management made this conclusion after evaluating the discounted cash
flow of the business units. In accordance with SFAS No. 142, these intangible
assets will continue to be assessed on an annual basis.
The following table presents intangible assets by business segment as
of September 30, 2003:
Adjusted
Gross Gross Net
Carrying Carrying Accumulated 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
Sonomed EMS -- -- -- -- $ --
----------- ------- ----------- ----------- -----------
Balance as of September 30, 2003 $11,970,087 $ -- $11,970,087 $(1,378,292) $10,591,795
=========== ======= =========== =========== ===========
Adjusted
Gross Gross Net
Carrying Carrying Accumulated Carrying
AMORTIZED INTANGIBLE ASSETS Amount Impairment Amount Amortization Value
-------- ---------- -------- ------------ --------
Sonomed $ -- $ -- $ -- $ -- $ --
Vascular (pending issuance) 36,915 -- 36,915 -- $ 36,915
Medical/Trek 257,302 -- 257,302 (114,089) $ 143,213
Sonomed EMS -- -- -- -- $ --
--------- ------- --------- --------- ---------
Balance as of September 30, 2003 $ 294,217 $ -- $ 294,217 $(114,089) $ 180,128
========= ======= ========= ========= =========
Adjusted
Gross Gross Net
Carrying Carrying Accumulated Carrying
AMORTIZED INTANGIBLE ASSETS Amount Impairment Amount Amortization Value
-------- ---------- -------- ------------ --------
Sonomed $ -- $ -- $ -- $ -- $ --
Vascular -- -- -- -- $ --
Medical/Trek 180,182 -- 180,182 (172,675) $ 7,507
Sonomed EMS -- -- -- -- $ --
--------- ------- --------- --------- ---------
Balance as of September 30, 2003 $ 180,182 $ -- $ 180,182 $(172,675) $ 7,507
========= ======= ========= ========= =========
11
Adjusted
Gross Gross Net
Carrying Carrying Accumulated Carrying
UNAMORTIZED INTANGIBLE ASSETS Amount Impairment Amount Amortization Value
-------- ---------- -------- ------------ --------
Sonomed $665,000 $ -- $665,000 $(63,194) $601,806
Vascular -- -- -- -- $ --
Medical/Trek -- -- -- -- $ --
Sonomed EMS 15,100 -- 15,100 -- $ 15,100
-------- ------- -------- -------- --------
Balance as of September 30, 2003 $680,100 $ -- $680,100 $(63,194) $616,906
======== ======= ======== ======== ========
4. LONG-TERM RECEIVABLE
Escalon entered into a loan agreement with an individual who was involved
in the development of the Company's Ocufit SR(R) drug delivery system. The note
is for $150,000 and is due May 2005.
5. LINE OF CREDIT AND LONG-TERM DEBT
On December 23, 2002, a privately held financial group acquired the
Company's bank debt, which consisted of term debt of $5,850,000 and $1,475,000
outstanding on the $2,000,000 available line of credit. On February 13, 2003,
the Company entered into an Amended Agreement with the privately held financial
group. The primary amendments of the Amended Loan Agreement were to reduce
quarterly principal payments and extend the term of the repayments, and to alter
the covenants of the original bank agreement. Historically, the Company failed
to meet the EBITDA to current maturities ratio covenant required under its loan
agreements. The new loan agreement was amended to reduce the principal payments,
significantly reducing current maturities, and also amended this required ratio
from 1.05 to 1 to 1.00 to 1. Additionally, the calculation of this ratio has
been amended such that only bank debt is used in the calculation. All
subordinated debt is specifically excluded from the calculation.
As of September 30, 2003, the amounts outstanding under the term loan and
the line of credit were $4,950,000 and $475,000, respectively. At September 30,
2003, the interest rates applicable to the term loan and line of credit were
5.75% (prime plus 1.75%) and 5.50% (prime plus 1.50%), respectively. The
privately held financial group's prime rate at September 30, 2003 was 4.00%. The
$4,950,000 term loan balance includes a $2,450,000 balloon payment that is due
on September 1, 2005. The Company paid $100,000 in finance fees in on January
14, 2000, when this debt was originally incurred. The finance fees are being
amortized over the life of the loans using the effective interest method.
On January 21, 1999, the Company's Vascular subsidiary and Endologix
entered into an Assets Sale and Purchase Agreement. Pursuant to this agreement,
Escalon acquired for cash the assets of Endologix's vascular access business,
and also agreed to pay royalties based on future sales of the products of the
vascular access business for a period of five years following the close of the
sale, with a guaranteed minimum royalty of $300,000 per year. On February 1,
2001, the parties amended the agreement to provide an adjustment in the term of
payment of the royalties. Pursuant to the amendment, Escalon paid $17,558 in
cash to Endologix, delivered a short-term note in the amount of $64,884 that was
satisfied in January 2002, and an additional note in the amount of $717,558,
payable in eleven quarterly installments that commenced April 15, 2002, and
Escalon issued 50,000 shares of its Common Stock to Endologix.
As of September 30, 2003, the amount outstanding under the Endologix term
loan was $326,160. At September 30, 2003, the interest rate applicable to the
Endologix term loan was 5.00%.
12
The schedule below presents principal amortization for the next five
years under each of the Company's loan agreements as of September 30, 2003.
Twelve-month period Private Group Endologix Deferred
ending September 30, Term Loan Term Loan Finance Fees Total
-------------------- --------- --------- ------------ -----
2004 $ 1,350,000 $ 261,000 $ (40,000) $ 1,571,000
2005 3,600,000 65,000 -- 3,665,000
2006 -- -- -- --
2007 -- -- -- --
2008 -- -- -- --
----------- ----------- ----------- -----------
$ 4,950,000 $ 326,000 $ (40,000) $ 5,236,000
=========== =========== =========== ===========
6. SALE OF SILICONE OIL PRODUCT LINE, LICENSING OF LASER TECHNOLOGY AND OTHER
REVENUE
SILICONE OIL
In the first quarter of fiscal 2000, Escalon received $2,117,000 from the
sale of its license and distribution rights for the Silicone Oil product line.
This sale resulted in a $1,864,000 gain after writing off the remaining net book
value of license and distribution rights associated with that product line. The
Company will also continue to receive additional consideration based on future
sales of Silicone Oil through August 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 Bausch & Lomb's sales of Silicone Oil on a quarterly basis. The consideration
is subject to a factor, which steps down 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%
LICENSED TECHNOLOGY
The material terms of the license of the laser technology are that in
exchange for licensing the Company's laser patents, which expire in 2014, it
will receive a 2.5% royalty on future product sales that are based on the
licensed laser patents, subject to deductions for royalties payable to third
parties up to a maximum of 50% of royalties otherwise due and payable to the
Company and 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.
The license was dated October 23, 1997 and was amended and restated in
October 2000 and expires upon the latest of the following events:
1. the last to expire of the laser patents;
2. ten years from the effective date of the amended and restated
agreement; or
3. the fifth anniversary date of the first commercial sale.
The material termination provisions of the license of the laser technology
are as follows:
1. the default in payment of any royalty;
13
2. the default in the making of any required report;
3. making of any false report;
4. the commission of any material breach of any covenant or promise
under the license agreement; or
5. the termination of the license by the licensee after 90 days notice
(if the licensee were to terminate, the licensee would not be
permitted to utilize the licensed technology necessary to
manufacture its current products).
OTHER REVENUE
Other revenue includes quarterly payments received from Bausch & Lomb
in connection with the sale of the Silicone Oil product line as well as royalty
payment received from a privately held entity related to the licensing of the
Company's intellectual laser technology. For the three-month periods ended
September 30, 2003 and 2002, Silicone Oil revenue totaled $509,000 and $443,000,
respectively, and laser technology revenues totaled $62,000 and $51,000,
respectively. Accounts receivable related to other revenue was $508,000 and
$443,000, respectively.
7. SEGMENTAL INFORMATION
During the three-month periods ended September 30, 2003 and 2002,
Escalon's operations were classified into four principal reportable segments
that provide different product or services. Separate management of each segment
is required because each business unit is subject to different marketing,
production and technology strategies.
SEGMENTAL STATEMENTS OF OPERATIONS (IN THOUSANDS) -
THREE-MONTH PERIODS ENDED SEPTEMBER 30,
Sonomed Vascular Medical/Trek EMI Total
2003 2002 2003 2002 2003 2002 2003 2002 2003 2002
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Product revenue $ 1,705 $ 1,389 $ 734 $ 666 $ 357 $ 345 $ 45 $ 113 $ 2,841 $ 2,513
Other revenue -- -- -- -- 571 495 -- -- 571 495
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total revenue 1,705 1,389 734 666 928 840 45 113 3,412 3,008
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Costs and expenses:
Cost of goods sold 681 579 296 240 208 217 28 43 1,213 1,079
Operating expenses 712 626 434 417 206 354 70 82 1,422 1,479
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total costs and expenses 1,393 1,205 730 657 414 571 98 125 2,635 2,558
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Income from operations 312 184 4 9 514 269 (53) (12) 777 450
Other income and
expenses:
Interest income -- -- -- -- 1 1 -- -- 1 1
Interest expense (115) (184) (4) (9) -- -- -- -- (119) (193)
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total other income and
expenses (115) (184) (4) (9) 1 1 -- -- (118) (192)
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Income before taxes 197 -- -- -- 515 270 (53) (12) 659 258
Income taxes -- -- -- -- 36 -- -- -- 36 --
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) $ 197 $ -- $ -- $ -- $ 479 $ 270 $ (53) $ (12) $ 623 $ 258
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Depreciation and
amortization $ 6 $ 5 $ 11 $ 10 $ 42 $ 67 $ 6 $ 6 $ 65 $ 88
Assets $ 12,001 $ 12,198 $ 2,200 $ 2,256 $ 1,944 $ 2,071 $ 257 $ 365 $ 16,402 $ 16,890
Expenditures for
long-lived assets $ -- $ -- $ -- $ -- $ 16 $ 18 $ -- $ -- $ 16 $ 18
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
Certain statements contained in this Form 10-Q Report and other written
and oral statements made from time to time by the Company do not relate strictly
to historical or current facts. As such, they are considered "forward-looking
statements" 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," "protect," "should," "will" and
similar words or expressions. The Company's forward-looking statements include
certain information relating to general business strategy, growth strategies,
financial results, liquidity, product development, the introduction of new
products, the potential markets and uses for the Company's products, the
Company's regulatory filings with the FDA, the development of joint venture
opportunities, the effect of competition on the structure of the markets in
which the Company competes and defending itself in litigation matters. One must
carefully consider forward-looking statements and understand that such
statements involve a variety of risks and uncertainties, known and unknown, and
may be affected by assumptions that fail to materialize as anticipated.
Consequently, no forward-looking statement can be guaranteed, and actual results
may vary materially. It is not possible to foresee or identify all factors
affecting the Company's forward-looking statements, and you therefore should not
consider any list of such factors to be an exhaustive statement of all risks,
uncertainties or potentially inaccurate assumptions. The Company undertakes no
obligation to update any forward-looking statement. Although it is not possible
to create a comprehensive list of all factors that may cause actual results to
differ from the Company's forward-looking statements, the most important factors
include, without limitation, the following:
- FUTURE CAPITAL NEEDS AND THE UNCERTAINTY OF ADDITIONAL FUNDING
Escalon's liquidity is affected by many factors, some of which are
based on the normal ongoing operations of the Company's businesses and some of
which arise from fluctuations related to global markets and economies. The
Company's current term loan with the privately held financial group provides for
quarterly principal payments, which increase every twelve months, including a
$2,450,000 final balloon payment, which is due on September 1, 2005. The Company
believes that cash on hand plus cash available from the Company's line of credit
will be sufficient to satisfy its working capital, capital expenditures and
research and development until the balloon payment is due. The Company may be
required to secure additional debt or equity financing in order to satisfy the
balloon payment, and the Company cannot assure that such financing will be
available when required on acceptable terms.
- CONCENTRATION OF REVENUES
Escalon realized 14.91% and 14.74% of its net revenue during the
three-month periods ended September 30, 2003 and 2002, respectively, from Bausch
& Lomb's sale of Silicone Oil. Any significant 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, through fiscal
2005. See the Notes to Condensed Consolidated Financial Statements for further
information regarding the Silicone Oil revenue from Bausch & Lomb.
- ECONOMIC AND REGULATORY CONDITIONS AND THE COMPETITIVE NATURE
OF THE INDUSTRIES IN WHICH THE COMPANY COMPETES
It is difficult to ascertain if the current economic climate has
affected the Company's results. Management believes that any effect has been
limited to the Company's Sonomed business unit. Should it become necessary due
to economic climate, the Company cannot assure you that it will be able to
reduce expenditures quickly enough to maintain profitability and service the
Company's current debt. In addition, there is a risk that cost-cutting
initiatives will impair the Company's ability to effectively develop and market
products and remain competitive in the industries in which the Company competes.
These
15
measures could have long-term effects on Escalon's business by decreasing
or slowing improvements in the Company's products, making it more difficult to
respond to customers, limiting the Company's ability to increase production
quickly and limiting the Company's ability to hire and retain key personnel.
These circumstances could cause the Company's earnings to be lower than they
otherwise might be.
The Company could be affected by trends toward managed care,
health-care cost containment, and other changes in government and private sector
initiatives, in the United States and other countries in which the Company does
business, that are placing increased emphasis on the delivery of more
cost-effective medical therapies. Changes in governmental laws, regulations, and
accounting standards and the enforcement thereof and agency or government
actions or investigations involving the industry in general or the Company in
particular may be adverse to the Company.
- INTERNATIONAL BUSINESS ACTIVITY
The Company derives a portion of its revenues from sales outside the
United States. Changes in the laws or policies of governmental and
quasi-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. In addition, 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 affect the Company's results of
operations.
- THE ABILITY OF THE COMPANY TO SUCCESSFULLY DEVELOP AND MARKET
NEW PRODUCTS
Escalon generally sells its products in industries that are
characterized by rapid technological changes, frequent new product introductions
and changing industry standards. Without timely introduction of new products and
enhancements, Escalon's products will become technologically obsolete over time,
in which case the Company's revenue and operating results would suffer. The
success of Escalon's new product offerings will depend on several factors,
including the Company's ability to: (i) properly identify customer needs; (ii)
innovate and develop new technologies, services and applications; (iii)
successfully commercialize new technologies in a timely manner; (iv) manufacture
and deliver its products in sufficient volumes on time; (v) differentiate the
Company's offerings from its competitors' offerings; (vi) price the Company's
products competitively, and (vii) anticipate competitors' announcements of new
products, services or technological innovations.
- DEPENDENCE ON KEY PERSONNEL
Escalon's future success depends partly on the continued service of the
Company's key research, engineering, sales, marketing, manufacturing, executive
and administrative personnel. If Escalon fails to retain and hire a sufficient
number of these personnel, the Company will not be able to maintain or expand
its business.
- THE COMPANY'S ACQUISITIONS, STRATEGIC ALLIANCES, JOINT
VENTURES, AND DIVESTITURES MAY RESULT IN FINANCIAL RESULTS
THAT ARE DIFFERENT THAN EXPECTED
In the normal course of business, Escalon engages in discussions with
third parties relating to possible acquisitions, strategic alliances, joint
ventures and divestitures. As a result of such transactions, the Company's
financial results may differ from the investment community's expectations in a
given quarter. In addition, acquisitions and alliances may require Escalon to
integrate a different company culture, management team and business
infrastructure. We 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,
Escalon's successful integration of the entity depends on a variety of factors
including: (i) the retention of key employees, and (ii) the management of
facilities and employees in separate geographical areas. All of these efforts
require varying levels of management
16
resources, which may divert the Company's attention from other business
operations. If Escalon does not realize the expected benefits or synergies of
such transactions, the Company's consolidated financial position, results of
operations and stock price could be negatively impacted.
- THE OUTCOME OF LITIGATION MATTERS AND UNCERTAIN PROTECTION OF
PATENTED AND PROPRIETARY INFORMATION
Increased public interest in recent years in product liability claims
in the medical device industry could affect the Company should it become
directly involved in such lawsuits. Recent events have made the investing public
particularly sensitive to listed companies' reporting practices and accounting
policies in general. Additionally, the Company may find it necessary to enforce
its legal rights with respect to patented and proprietary information. The
outcome of any of these matters and the financial impact they may have on the
Company cannot be foreseen.
- VOLATILITY OF STOCK PRICE AND THE ABILITY OF THE COMPANY TO
MAINTAIN ITS LISTING ON THE NASDAQ SMALLCAP MARKET
The public stock markets have experienced significant volatility in
stock prices in recent years, which could cause the Company's stock price to
experience severe price changes that are unrelated or disproportionate to the
operating performance of the Company. The trading price of the Company's Common
Stock could be subject to wide fluctuations in response to, among other factors,
quarter-to-quarter variations in operating results, announcements of
technological innovations or new products by the Company or its competitors,
announcements of new strategic relationships by the Company or its competitors,
general conditions in the healthcare industry or the global economy generally,
or market volatility unrelated to the Company's business and operating results.
The Company's Common Stock is currently listed on the Nasdaq SmallCap
Market. In order to continue to be listed on the Nasdaq SmallCap Market, certain
listing requirements must be met and maintained. If Escalon's securities were
delisted, investors could find it more difficult to trade in the Company's
securities, or to obtain accurate quotations as to the market value of the
Company's securities.
COMPANY OVERVIEW
The following discussion should be read in conjunction with interim
condensed consolidated financial statements and the notes thereto, which are set
forth elsewhere in this report on Form 10-Q.
Escalon Medical Corp. was incorporated in California in 1987 as
Intelligent Surgical Lasers, Inc. Escalon's present name was adopted in August
1996. The Company reincorporated in Delaware in November 1999, and then
reincorporated in Pennsylvania in November 2001. Escalon operates in the
healthcare market, specializing in the development, manufacture, marketing and
distribution of ophthalmic medical devices, pharmaceuticals and vascular access
devices. The Company and its products are subject to regulation and inspection
by the United States Food and Drug Administration (the "FDA"). The FDA requires
extensive testing of new products prior to sale and has jurisdiction over the
safety, efficacy and manufacturing of products, as well as labeling and
marketing.
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
properties to a privately held company, in return for an equity interest and
future royalties on sales of products relating to the laser technology. The
privately held company undertook responsibility for funding and developing the
laser technology through to commercialization. The privately held company began
selling products related to the laser technology during fiscal 2002.
17
To further diversify its product portfolio, in January 1999, the
Company's Vascular subsidiary acquired the vascular access product line from
Endologix. 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. In April 2000, EMI formed a joint venture,
Escalon Medical Imaging, LLC with Megavision, Inc. ("Megavision"), a privately
held company, to develop and market a digital camera back for ophthalmic
photography. The Company terminated its joint venture with Megavision and
commenced operations within its EMI business unit on January 1, 2002.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements requires management to make
estimates and assumptions that affect amounts reported therein. The most
significant of those involve the application of SFAS No. 142, discussed further
in the Notes to the Condensed Consolidated Financial Statements included in this
Form 10-Q. The financial statements are prepared in conformity with generally
accepted accounting principles, and, as such, include amounts based on informed
estimates and judgments of management. For example, estimates are used in
determining valuation allowances for uncollectible receivables, obsolete
inventory, sales returns and rebates, deferred income taxes and purchased
intangible assets. Actual results achieved in the future could differ from
current estimates. The Company used what it believes are reasonable assumptions
and, where applicable, established valuation techniques in making its estimates.
REVENUE RECOGNITION
Escalon's standard arrangement for the Company's domestic and
international customers includes a signed purchase order or contract and no
right of return of delivered products without consent of the Company. Revenue
from sales of product is recognized when:
- The Company enters into a legally binding arrangement with a
buyer;
- The Company delivers the products;
- Buyer payment is deemed fixed and determinable and free of
contingencies or significant uncertainties; and
- Collection is probable
Escalon assesses collectibility based on the credit worthiness of the
buyer 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 periodically evaluates its intangible assets and goodwill in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," for
indications of impairment whenever events or changes in circumstances indicate
that the carrying value may not be recoverable. These intangible assets include
goodwill, trademarks and trade names. Factors the Company considers important
that could trigger an impairment review include significant under-performance
relative to historical or projected future operating results or significant
negative industry or economic trends. If these criteria indicate that the value
of the intangible asset may be impaired, an evaluation of the recoverability of
the net carrying value of the asset is made. If this evaluation indicates that
the intangible asset is not recoverable, the net carrying value of the related
intangible asset will be reduced to fair value. Any such impairment charge could
be significant and could have a material adverse effect on the Company's
reported financial statements if and when an impairment charge is recorded.
18
DEFERRED TAXES
The deferred tax valuation allowance is based on the Company's
assessment of the realizability of the Company's deferred tax assets on an
ongoing basis and may be adjusted from time to time as necessary. In determining
the valuation allowance, the Company has considered future taxable income and
the feasibility of tax planning initiatives and strategies. Should the Company
determine that it is more likely than not that it will realize certain of the
Company's deferred tax assets in the future, an adjustment would be required to
reduce the existing valuation allowance and increase income. On the contrary, if
the Company determines that it would not be able to realize the Company's
recorded deferred tax asset, an adjustment to increase our valuation allowance
would be charged to the results of operations in the period such conclusion was
made. Such charge could have an adverse effect on the Company's provision for
income taxes included in the Company's results of operations.
THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2003 AND 2002
The following table presents consolidated product revenues by business
segment as well as identifying trends in business segment product revenues for
the three-month periods ended September 30, 2003 and 2002.
Three-Month Periods Ended
September 30,
-----------------------------------
2003 2002 %Change
------ ------- --------
Product revenue:
Sonomed $1,705 $ 1,389 22.75%
Vascular 734 666 10.21%
Medical/Trek 357 346 3.18%
EMI 45 113 -60.18%
------ ------- ------
$2,841 $ 2,514 13.01%
====== ======= ======
Product revenue increased $328,000, or 13.05%, to $2,841,000 for the
three-month period ended September 30, 2003 as compared to $2,513,000 for the
same period in the prior fiscal year. Product revenue in the Sonomed business
unit increased $316,000, or 22.75%, to $1,705,000. The increase is attributed to
a $345,000 increase in the domestic market as well as a $66,000 increase in
Europe offset by a $93,000 decrease in Asia and the Pacific Rim. The increase in
the domestic market primarily relates to increased demand for the Company's
pachymeter product. The domestic market for pachymeters has expanded due to
enhanced techniques in glaucoma screening performed by optometrists.
Historically, the typical optometrist has not been a user of the pachymeter. The
increase in Europe is a result of the additional sales resources devoted to the
region. Product revenue in the Vascular business unit increased $68,000, or
10.21%, to $734,000. The increase relates primarily to increased usage within
the marketplace. Product revenue in the Medical/Trek business unit increased
$11,000, or 3.18%, to $357,000. OEM revenue from Bausch & Lomb increased
$17,000. Product revenue in the EMI business unit decreased $68,000, or 60.18%,
to $45,000.
Other revenue, which is included in the Medical/Trek business unit,
increased $76,000, or 15.35%, to $571,000 for the three-month period ended
September 30, 2003 as compared to $495,000 for the same period in the prior
fiscal year. The increase primarily relates to a $66,000 increase in the
revenue earned from Bausch & Lomb in connection with Silicone Oil. The
Company's contract with Bausch & Lomb calls for annual step-downs in the
calculation of Silicone Oil revenues to be received by the Company. These
step-downs occur during the first quarter of each fiscal year through the
remainder of the contract. For the three-month period ended September 30, 2003,
the step-down caused a $63,000 decrease in Silicone Oil revenue that Escalon
would have otherwise received had the step-down not occurred. The offsetting
$128,000 increase in Silicone Oil revenue is due to an increase in the market
demand for the product. Escalon does not have knowledge as to what factors have
affected Bausch & Lomb's sale 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 remaining $10,000
increase in other
19
revenue relates to royalty payments received from a privately held
entity related to the licensing of Escalon's intellectual laser technology.
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-month periods ended September 30, 2003 and 2002.
Three-Month Periods Ended September 30,
--------------------------------------------------------
2003 2002
-------------------------- ------------------------
Cost of
goods sold: Dollars % Dollars %
- ----------- -------------- ------ -------------- ------
(in thousands) (in thousands)
Sonomed $ 681 39.94% $ 579 41.68%
Vascular 296 40.33% 240 36.04%
Medical/Trek 208 58.26% 217 62.90%
EMI 28 62.22% 43 38.05%
------ ----- ------ -----
$1,213 42.70% $1,079 42.94%
====== ===== ====== =====
Cost of goods sold totaled $1,213,000, or 35.55% of net revenue, for
the three-month period ended September 30, 2003 as compared to $1,079,000, or
35.86% of net revenue, for the same period last fiscal year. Cost of goods sold
in the Sonomed business unit totaled $681,000, or 39.94% of product revenue, for
the three-month period ended September 30, 2003 as compared to $579,000, or
41.68% of product revenue for the three-month period ended September 30, 2002.
Sonomed experienced a significant shift in product mix with the increase in
sales of the pachymeter product, which has higher margins
than much of the remainder of the Sonomed product line. Cost of goods sold in
the Vascular business unit totaled $296,000, or 40.33% of product revenue, for
the three-month period ended September 30, 2003 as compared to $240,000, or
36.04% of product revenue for the three-month period ended September 30, 2002.
Vascular's margins were adversely affected by increased cost of materials as
well as lower sales price per unit on several of its products. Cost of goods
sold in the Medical/Trek business unit totaled $208,000, or 58.26% of product
revenue, for the three-month period ended September 30, 2003 as compared to
$217,000, or 62.90% of product revenue for the three-month period ended
September 30, 2002. Medical/Trek's margins increased due to two factors: a
significant shift in product mix toward product with higher margins and higher
price-per-unit on the Company's main product. When other revenue is included,
cost of goods sold in the Medical/Trek business unit was 22.41% of net revenue
for the three-month period ended September 30, 2003 as compared to 25.83% of net
revenue for the three-month period ended September 30, 2002. There are no costs
associated with other revenue. Cost of goods sold in the EMI business unit
totaled $28,000, or 62.22% of product revenue, for the three-month period ended
September 30, 2003 as compared to $43,000, or 38.5% of product revenue for the
three-month period ended September 30, 2002.
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-month periods ended
September 30, 2003 and 2002.
Three-Month Periods Ended September 30,
---------------------------------------
2003 2002 % Change
-------- ------ --------
Marketing, general and
administrative expenses:
Sonomed $ 259 $ 353 -26.63%
Vascular 314 282 11.35%
Medical/Trek 571 571 0.00%
EMI 70 82 -14.63%
------ ------ ------
$1,214 $1,288 -5.75%
====== ====== ======
20
Marketing, general and administrative expenses decreased $73,000, or
5.75%, for the three-month period ended September 30, 2003 as compared to the
same period last fiscal year. In the Sonomed business unit, marketing, general
and administrative expenses decreased $94,000, or 26.63%, to $259,000. Salaries
and other personnel-related expenses decreased $115,000, primarily the result of
reduced headcount. Offsetting these decreases was an increase in consulting
expense of $27,000, which increased as a result of the Company's efforts in the
international markets. In the Vascular business unit, marketing, general and
administrative expenses increased $32,000, or 11.35%, to $314,000 as compared to
the same period last fiscal year. Salaries and other personnel-related expenses
increased $25,000, primarily the result of increases in headcount.
Travel-related expenses increased by $13,000. In the Medical/Trek business unit,
marketing, general and administrative expenses remained unchanged at $571,000.
Salaries and other personnel-related expenses increased $37,000 primarily due to
a $48,000 increase in accrued bonuses, which were offset by decreased headcount.
Legal and accounting expenses increased $31,000 in part due to additional
required filings with the SEC. Insurance expense decreased $24,000. The decrease
primarily relates to an audit of premiums conducted in the first quarter of last
fiscal year by the Company's insurer, during which they discovered that they
undercharged premiums by $22,000. The undercharge was corrected in the first
quarter of fiscal 2003. Consulting expenses decreased by $10,000. In the EMI
business unit, marketing, general and administrative expenses decreased $12,000,
or 14.63%, to $70,000. Bad debts were $14,000 in the prior year period related
to the write-off of a specific account.
Research and development expenses increased $17,000, or 8.95%, to
$207,000 for the three-month period ended September 30, 2003 as compared to the
same period last fiscal year. The increase relates primarily to consulting
expenses incurred in connection with product development. The Company redesigns
its products every few years, as technology changes, to remain competitive in
the marketplace.
Interest income remained relatively unchanged for the three-month
period ended September 30, 2003 as compared to the same period last fiscal year,
$700 and $700, respectively.
Interest expense decreased $73,000 for the three-month period ended
September 30, 2003 as compared to the same period last fiscal year primarily due
to reduced total debt levels and lower interest rates.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2003, Escalon had cash and cash equivalents of $64,000
as compared to $298,000 at June 30, 2003, a decrease of $234,000. This resulted
primarily from increases of cash of $647,000 provided by operating activities
offset by $865,000 used to pay down the term loans and line of credit and
$16,000 used to purchase fixed assets.
Management believes that the current rate of cash generated from
operations, cash on hand and cash available from the line of credit should be
sufficient to satisfy the Company's working capital, debt service, capital
expenditures and research and development costs until the balloon payment under
its term loan is due on September 1, 2005. The Company may be required to secure
alternative debt or equity financing in order to satisfy the balloon payment,
and Escalon cannot assure that such financing will be available when required on
acceptable terms. Additionally, the Company relies on the Silicone Oil revenue
received from Bausch & Lomb, which is expected to continue in varying amounts
through fiscal 2005. While the Company does not expect this revenue to decline
rapidly in the immediate future, any such decrease would have a significant
impact on the Company's consolidated financial position, results of operations
and cash flows. Silicone Oil revenues are based on the sales of the product line
by Bausch & Lomb. Additionally, the Silicone Oil revenues reduce on an annual
basis due to a contractual step-down. See Note 10 of the Notes to Condensed
Consolidated Financial Statements for a description of the step-down provisions
under the contract with Bausch & Lomb.
DEBT HISTORY
On December 23, 2002, a privately held financial group acquired the
Company's bank debt, which consisted of term debt of $5,850,000 and $1,475,000
outstanding on the $2,000,000 available line of credit.
21
On February 13, 2003, the Company entered into an Amended Agreement with the
privately held financial group. The primary amendments of the Amended Loan
Agreement were to reduce quarterly principal payments and extend the term of the
repayments, and to alter the covenants of the original bank agreement.
Historically, the Company failed to meet the EBITDA to current maturities ratio
covenant required under its loan agreements. The new loan agreement was amended
to reduce the principal payments, significantly reducing current maturities, and
also amended this required ratio from 1.05 to 1 to 1.00 to 1. Additionally, the
calculation of this ratio has been amended such that only bank debt is used in
the calculation. All subordinated debt is specifically excluded from the
calculation.
As of September 30, 2003, the amounts outstanding under the term loan
and the line of credit were $4,950,000 and $475,000, respectively. At September
30, 2003, the interest rates applicable to the term loan and line of credit were
5.75% and 5.50%, respectively. The privately held financial group's prime rate
at September 30, 2003 was 4.00%. The $4,950,000 term loan balance includes a
$2,450,000 balloon payment that is due on September 1, 2005. The Company paid
$100,000 in finance fees in on January 14, 2000, when this debt was originally
incurred. The finance fees are being amortized over the life of the loans using
the effective interest method.
On January 21, 1999, the Company's Vascular subsidiary and Endologix
entered into an Assets Sale and Purchase Agreement. Pursuant to this agreement,
Escalon acquired for cash the assets of Endologix's vascular access business,
and also agreed to pay royalties based on future sales of the products of the
vascular access business for a period of five years following the close of the
sale, with a guaranteed minimum royalty of $300,000 per year. On February 1,
2001, the parties amended the agreement to provide an adjustment in the term of
payment of the royalties. Pursuant to the amendment, Escalon paid $17,558 in
cash to Endologix, delivered a short-term note in the amount of $64,884 that was
satisfied in January 2002, and an additional note in the amount of $717,558,
payable in eleven quarterly installments that commenced April 15, 2002, and
Escalon issued 50,000 shares of its Common Stock to Endologix.
As of September 30, 2003, the amount outstanding under the Endologix
term loan was $326,160. At September 30, 2003, the interest rate applicable to
the Endologix term loan was 5.00%.
ESCALON COMMON STOCK
The Company's Common Stock is currently listed on the Nasdaq SmallCap
Market. In order to continue to be listed on the Nasdaq SmallCap Market, the
following listing requirements must be met:
- - Stockholders' equity of $2,500,000 or market value of listed securities
of $35,000,000 or net income from continuing operations (in the latest
fiscal year or two of the last three fiscal years) of $500,000;
- - 500,000 publicly held shares;
- - $1,000,000 market value of publicly held shares;
- - A minimum bid price of $1;
- - 300 shareholders (round lot holders);
- - Two market makers; and
- - Compliance with corporate governance standards
As of September 30, 2003, Escalon complied with these requirements. If
the Company's securities were delisted, a shareholder would find it more
difficult to trade in the Company's securities, or obtain accurate quotations as
to the market value of the Company's securities.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The table below provides information about Escalon's financial
instruments, consisting primarily of debt obligations that are sensitive to
changes in interest rates. For debt obligations, the table represents principal
cash flows and related interest rates by expected maturity dates. Interest rates
are based on the prime rate at September 30, 2003 plus 1.75% on the term loan,
the prime rate plus 1.50% on the line of credit and prime plus 1.00% on the
Endologix note.
Long-term debt classified as current as of September 30,
----------------------------------------------------------------
2003 2004 2005 Thereafter Total
----------- ----------- ----- ---------- ----------
Term loan $1,350,000 $3,600,000 $-- $-- $4,950,000
Interest rate 5.75% 5.75%
Line of credit 475,000 -- -- -- 475,000
Interest rate 5.50%
Endologix note 260,932 65,228 -- -- 326,160
Interest rate 5.00% 5.00%
Deferred finance
fees (40,083) -- -- -- (40,083)
---------- ---------- --- --- ----------
Total $2,045,849 $3,665,228 $-- $-- $5,711,077
========== ========== === === ==========
EXCHANGE RATE RISK
During the three-month period ended September 30, 2003 and 2002,
approximately 15.80% and 20.48%, respectively, of Escalon's consolidated net
revenue was derived from international sales. The price of all product sold
overseas is denominated in United States Dollars and consequently the Company
incurs no exchange rate risk on revenue. The Company's Sonomed business unit
began incurring marketing consulting expenses in the European market during the
second quarter of fiscal 2003, the majority of which are transacted in Euros.
These expenses were $27,000 for the three-month period ended September 30, 2003.
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 15d-15(e) under the Exchange Act) 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 reporting, 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 Control Over Financial Reporting
There have not been any changes in the Company's internal
control over financial reporting (as such term is defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during
the Company's first fiscal quarter ended September 30, 2003
that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over
financial reporting.
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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
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
31.1 Certificate of Chief Executive Officer under Rule 13a-14(a)
31.2 Certificate of Senior Vice President - 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 - Finance under Section
1350 of Title 18 of the United States Code
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ESCALON MEDICAL CORP.
(Registrant)
Date: November 10, 2003 By: /s/ Richard J. DePiano
----------------- -----------------------
Richard J. DePiano
Chairman and Chief
Executive Officer
Date: November 10, 2003 By: /s/ Harry M. Rimmer
----------------- --------------------
Harry M. Rimmer
Senior Vice President - Finance
24