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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 MARCH 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)
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 May 14, 2004, 5,015,872 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
Condensed Consolidated Balance Sheets as of March 31, 2004 (Unaudited)
and June 30, 2003 3
Condensed Consolidated Statements of Operations for the three- and nine-
month periods ended March 31, 2004 and 2003 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the nine-month
periods ended March 31, 2004 and 2003 (Unaudited) 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk 33
Item 4. Controls and Procedures 33
Part II. Other Information
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 34
Item 5. Other Information 34
Item 6. Exhibits and Reports on Form 8-K 35
2
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, June 30,
2004 2003
------------ ------------
(Unaudited) (Audited)
ASSETS
Current assets:
Cash and cash equivalents $ 12,916,378 $ 298,390
Accounts receivable, net 2,025,453 2,364,370
Inventory, net 1,868,625 1,785,480
Other current assets 223,174 310,420
------------ ------------
Total current assets 17,033,630 4,758,660
------------ ------------
Long-term note receivable 150,000 150,000
Furniture and equipment, net 424,289 516,686
Goodwill 10,591,795 10,591,795
Trademarks and trade names, net 616,906 616,906
License and distribution rights, net - 13,138
Patents, net 174,760 182,811
Other assets 67,955 60,235
------------ ------------
Total assets $ 29,059,335 $ 16,890,231
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Line of credit $ 250,000 $ 975,000
Current portion of long-term debt 1,626,623 1,510,344
Accounts payable 430,404 454,711
Accrued compensation 693,281 708,231
Other current liabilities 319,671 222,036
------------ ------------
Total current liabilities 3,319,979 3,870,322
Long-term debt, net of current portion 2,796,019 4,080,461
------------ ------------
Total liabilities 6,115,998 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; 5,015,872 and
3,365,359 shares issued and outstanding at March 31, 2004 and June 30, 2003,
respectively 5,016 3,365
Common stock warrants 1,601,346 -
Additional paid-in capital 56,480,012 46,262,411
Accumulated deficit (35,143,037) (37,326,328)
------------ ------------
Total shareholders' equity 22,943,337 8,939,448
------------ ------------
Total liabilities and shareholders' equity $ 29,059,335 $ 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 Nine Months Ended
March 31, March 31,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Product revenue $ 3,019,536 $ 2,776,415 $ 9,004,696 $ 8,039,301
Other revenue 593,242 610,477 1,777,649 1,623,107
------------ ------------ ------------ ------------
Revenues, net 3,612,778 3,386,892 10,782,345 9,662,408
------------ ------------ ------------ ------------
Costs and expenses:
Cost of goods sold 1,364,600 1,178,377 3,827,059 3,536,340
Research and development 167,123 204,283 600,245 578,337
Marketing, general and administrative 1,254,516 1,220,007 3,789,801 3,786,148
Write-down of Povidone Iodine license and
distribution rights - 195,950 - 195,950
------------ ------------ ------------ ------------
Total costs and expenses 2,786,239 2,798,617 8,217,105 8,096,775
------------ ------------ ------------ ------------
Income from operations 826,539 588,275 2,565,240 1,565,633
------------ ------------ ------------ ------------
Other income and expenses:
Interest income 9,356 609 10,317 2,087
Interest expense (93,794) (133,750) (320,233) (505,757)
------------ ------------ ------------ ------------
Total other income and expenses (84,438) (133,141) (309,916) (503,670)
------------ ------------ ------------ ------------
Income before income taxes 742,101 455,134 2,255,324 1,061,963
Income taxes 2,927 - 72,033 -
------------ ------------ ------------ ------------
Net income $ 739,174 $ 455,134 $ 2,183,291 $ 1,061,963
============ ============ ============ ============
Basic net income per share $ 0.192 $ 0.136 $ 0.619 $ 0.316
============ ============ ============ ============
Diluted net income per share $ 0.172 $ 0.133 $ 0.564 $ 0.309
============ ============ ============ ============
Weighted average shares - basic 3,839,937 3,355,851 3,524,603 3,355,851
============ ============ ============ ============
Weighted average shares - diluted 4,286,761 3,420,474 3,869,901 3,441,180
============ ============ ============ ============
See notes to condensed consolidated financial statements
4
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
March 31,
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,183,291 1,061,963
Adjustments to reconcile net income to net cash
provided by in operating activities:
Depreciation and amortization 186,745 245,765
Write-down of license and distribution rights - 195,950
Disposal of furniture and equipment - 927
Change in operating assets and liabilities:
Accounts receivable, net 338,917 (249,991)
Inventory, net (83,145) (224,485)
Other current and long-term assets 79,525 227,608
Accounts payable, accrued and other liabilities 58,379 (10,621)
------------ ------------
Net cash provided by operating activities 2,763,712 1,247,116
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of fixed assets (41,647) (64,609)
------------ ------------
Net cash used in investing activities (41,647) (64,609)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Line of credit borrowing 153,981 650,000
Line of credit repayment (878,981) (525,000)
Principal payments on term loans (1,199,675) (1,395,699)
Issuance of common stock - private placement 9,834,485 -
Issuance of common stock - stock options 1,986,113 -
------------ ------------
Net cash provided by (used in) financing activities 9,895,923 (1,270,699)
------------ ------------
Net increase (decrease) in cash and cash equivalents 12,617,988 (88,192)
Cash and cash equivalents, beginning of period 298,390 220,826
------------ ------------
Cash and cash equivalents, end of period $ 12,916,378 $ 132,634
============ ============
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Interest paid $ 251,309 $ 500,127
============ ============
Issuance of Common Stock for EMS trade name $ - $ 15,100
============ ============
See notes to condensed consolidated financial statements
5
ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
FOR THE NINE MONTHS ENDED MARCH 31, 2004
(UNAUDITED)
Common Stock Common Additional Total
-------------------------- Stock Paid-in Accumulated Shareholders'
Shares Amount Warrants Capital Deficit Equity
--------- ------------ ------------ ------------ ------------ ------------
Balance at June 30, 2003 3,365,359 $ 3,365 - $ 46,262,411 $(37,326,328) $ 8,939,448
Private placement offering 800,000 800 1,601,346 8,232,339 - 9,834,485
Exercise of stock options 855,162 855 - 2,015,617 - 2,016,472
Treasury stock retirement (4,649) (4) - (30,355) - (30,359)
Net income - - - - 2,183,291 2,183,291
--------- ------------ ------------ ------------ ------------ ------------
Balance at March 31, 2004 5,015,872 $ 5,016 $ 1,601,346 $ 56,480,012 $(35,143,037) $ 22,943,337
========= ============ ============ ============ ============ ============
See notes to condensed consolidated financial statements
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, marketing and distribution of ophthalmic medical
devices, ophthalmic pharmaceuticals and vascular devices.
The accompanying unaudited condensed consolidated financial
statements include accounts 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") (collectively referred to as "Escalon"
or the "Company"). All significant intercompany balances and transactions have
been eliminated in consolidation.
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 condensed
consolidated financial statements should be read in conjunction with
consolidated financial statements and notes thereto contained in the Company's
2003 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 interim periods presented. The results
of operations are not necessarily indicative of the results that may be expected
for the full year.
6
2. SIGNIFICANT ACCOUNTING POLICIES
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 reported 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 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 or sales incentives are given.
The Company's considerations for recognizing revenue upon shipment
of products 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
reasonably assured.
Provision has been made for estimated sales returns based on
historical experience.
With respect to additional consideration related to the sale of
Silicone Oil by Bausch & Lomb and the licensing of the Company's intellectual
laser technology, revenue is recognized upon notification from the other parties
of amount earned or upon receipt of royalty payments.
SHIPPING AND HANDLING REVENUES AND COSTS
Shipping and handling revenues are included in product revenue and
the related costs are included in cost of goods sold.
7
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 $120,805 and $261,351 at March 31, 2004 and June 30, 2003,
respectively.
FURNITURE AND EQUIPMENT
Furniture and equipment is recorded at cost. Depreciation is
recorded 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 March 31, 2004 and 2003 was $43,255 and
$46,223, respectively. Depreciation for the nine-month periods ended March 31,
2004 and 2003 was $134,044 and $138,765, 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 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 assets 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
The Company reports stock-based compensation through the
disclosure-only requirements of 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 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.
8
Three-Month Period Ended Nine-Month Period Ended
March 31, March 31,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net Income, as reported $ 739,174 $ 455,134 $ 2,183,291 $ 1,061,963
Deduct: Total stock-based
employee compensation
expense determined under
fair value based method for
all awards, net of related
tax effects (48,440) (18,103) (359,097) (97,083)
------------ ------------ ------------ ------------
Pro forma net income $ 690,734 $ 437,031 $ 1,824,194 $ 964,880
============ ============ ============ ============
Earnings per share:
Basic - as reported $ 0.192 $ 0.136 $ 0.619 $ 0.316
============ ============ ============ ============
Basic - pro forma $ 0.180 $ 0.130 $ 0.518 $ 0.288
============ ============ ============ ============
Diluted - as reported $ 0.172 $ 0.133 $ 0.564 $ 0.309
============ ============ ============ ============
Diluted - pro forma $ 0.161 $ 0.128 $ 0.471 $ 0.280
============ ============ ============ ============
The Company has followed the guidelines of SFAS 123 to establish the
valuation of its stock options. The commonly accepted method of valuing these
options is the Black-Sholes option valuation model that requires assumptions for
the expected holding period and the expected volatility. The Company does not
have a reliable history of employee stock options being exercised and
consequently cannot estimate the expected holding period. For the sake of this
valuation, the expected holding period is assumed to be the life of the stock
option as defined in the stock option plan (10 years). The volatility assumption
is based on the 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. Because the Company's stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
the opinion of management, the existing models do not necessarily provide a
reliable single measure of the value of its options.
RESEARCH AND DEVELOPMENT
All research and development costs are charged to operations as
incurred.
ADVERTISING COSTS
Advertising costs are charged to operations as incurred. Advertising
expense for the three-month periods ended March 31, 2004 and 2003 was $1,926 and
$5,733, respectively. Advertising expense for the nine-month periods ended March
31, 2004 and 2003 was $16,686 and $19,197, respectively.
9
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 set forth the computation of basic and diluted
earnings per share:
Three-Month Periods Nine-Month Periods
Ended March 31, Ended December 31,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Numerator:
Numerator for basic and diluted earnings per share:
Net income $ 739,174 $ 455,134 $ 2,183,291 $ 1,061,963
------------ ------------ ------------ ------------
Denominator:
Denominator for basic earnings per
share - weighted average shares 3,839,937 3,355,851 3,524,603 3,355,851
Effect of dilutive securities:
Stock options and warrants 446,824 64,623 345,298 85,329
------------ ------------ ------------ ------------
Denominator for diluted earnings
earnings per share - weighted average and
assumed conversion 4,286,761 3,420,474 3,869,901 3,441,180
------------ ------------ ------------ ------------
Basic earnings per share $ 0.192 $ 0.136 $ 0.619 $ 0.316
============ ============ ============ ============
Diluted earnings per share $ 0.172 $ 0.133 $ 0.564 $ 0.309
============ ============ ============ ============
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, should a change occur, is recognized in
income in the period that include the enactment date.
3. INVENTORIES
Inventories, stated at lower of cost (determined on a first-in,
first-out basis) or market, consisted of the following:
March 31, June 30,
2004 2003
------------ ------------
Raw materials/Work in process $ 1,493,472 $ 1,374,184
Finished goods 439,048 475,316
------------ ------------
1,932,520 1,849,500
Valuation allowance (63,895) (64,020)
------------ ------------
Total inventory $ 1,868,625 $ 1,785,480
============ ============
10
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 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 $167,044 at March 31, 2004 and June 30, 2003, respectively.
Amortization expense for the three-month periods ended March 31, 2004 and 2003
was $1,877 and $10,756, respectively. Amortization expense for the nine-month
periods ended March 31, 2004 and 2003 was $13,138 and $32,269, 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 $119,455 and $111,406 at March 31, 2004 and June 30, 2003,
respectively. Amortization expense for the three-month periods ended March 31,
2004 and 2003 was $2,683 and $2,683, respectively. Amortization expense for the
nine-month periods ended March 31, 2004 and 2003 was $8,051 and $8,049,
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, 2004
-------------
2004 $ 23,871
2005 10,733
2006 10,733
2007 10,733
2008 10,733
--------
$ 66,803
========
GOODWILL, TRADEMARKS AND TRADE NAMES
Goodwill, trademarks and trade names represent intangible assets
obtained from the Escalon Ophthalmics, Inc. ("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 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 each of its business units. In accordance with SFAS 142, these
intangible assets will continue to be assessed on an annual basis.
11
The following table presents intangible assets by business unit as
of March 31, 2004:
Adjusted
Gross Gross Net
Carrying Carrying Accumulated Carrying
Amount Impairment Amount Amortization Value
------------ ------------ ------------ ------------ ------------
GOODWILL
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 March 31, 2004 $ 11,970,087 $ - $ 11,970,087 $ (1,378,292) $ 10,591,795
============ ============ ============ ============ ============
Adjusted
Gross Gross Net
Carrying Carrying Accumulated Carrying
Amount Impairment Amount Amortization Value
------------ ------------ ------------ ------------ ------------
PATENTS
Sonomed $ - $ - $ - $ - $ -
Vascular (pending issuance) 36,915 - 36,915 - $ 36,915
Medical/Trek 257,301 - 257,301 (119,456) $ 137,845
Sonomed EMS - - - - $ -
------------ ------------ ------------ ------------ ------------
Balance as of March 31, 2004 $ 294,216 $ - $ 294,216 $ (119,456) $ 174,760
============ ============ ============ ============ ============
Adjusted
Gross Gross Net
Carrying Carrying Accumulated Carrying
Amount Impairment Amount Amortization Value
------------ ------------ ------------ ------------ ------------
LICENSE AND DISTRIBUTION RIGHTS
Sonomed $ - $ - $ - $ - $ -
Vascular - - - - $ -
Medical/Trek 180,182 - 180,182 (180,182) $ -
Sonomed EMS - - - - $ -
------------ ------------ ------------ ------------ ------------
Balance as of March 31, 2004 $ 180,182 $ - $ 180,182 $ (180,182) $ -
============ ============ ============ ============ ============
Adjusted
Gross Gross Net
Carrying Carrying Accumulated Carrying
Amount Impairment Amount Amortization Value
------------ ------------ ------------ ------------ ------------
UNAMORTIZED INTANGIBLE ASSETS
Sonomed $ 665,000 $ - $ 665,000 $ (63,194) $ 601,806
Vascular - - - - $ -
Medical/Trek - - - - $ -
Sonomed EMS 15,100 - 15,100 - $ 15,100
------------ ------------ ------------ ------------ ------------
Balance as of March 31, 2004 $ 680,100 $ - $ 680,100 $ (63,194) $ 616,906
============ ============ ============ ============ ============
5. LONG-TERM RECEIVABLE
Escalon entered into an agreement with an individual who was
involved in the development of the Company's Ocufit SR(R) drug delivery system.
The Company holds a note receivable from the individual in the amount of
$150,000 that is due in May 2005.
12
6. LINE OF CREDIT AND LONG-TERM DEBT
On December 23, 2002, a privately held fund (the "lender") acquired
the Company's bank debt, which consisted of outstanding 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 Loan 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 loan agreement.
As of March 31, 2004, the amounts outstanding under the term loan
and the line of credit were $4,246,019 and $250,000, respectively. At March 31,
2004, 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
lender's prime rate at March 31, 2004 was 4.00%. The $4,246,019 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 January 2000 to the prior lender,
when this date was originally incurred. The finance fees are recorded as a
reduction of long-term debt and 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,
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 the 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, a note in the amount of $717,558
payable in 11 quarterly installments that commenced on April 15, 2002, and the
Company issued 50,000 shares of its Common Stock to Endologix.
As of March 31, 2004, the amount outstanding under the Endologix
term loan was $195,694. At March 31, 2004, the interest rate applicable to the
Endologix term loan was 5.00%.
The schedule below presents principal amortization for the next five
years under each of the Company's loan agreements as of March 31, 2004.
Twelve-month period Private Group Endologix Deferred
ending March 31, Term Loan Term Loan Finance Fees Total
- ------------------- ------------- --------- ------------ -----------
2004 $ 1,450,000 $ 196,000 $ (19,000) $ 1,627,000
2005 2,796,000 - - 2,796,000
2006 - - - -
2007 - - - -
2008 - - - -
------------- --------- ------------ -----------
$ 4,246,000 $ 196,000 $ (19,000) $ 4,423,000
============= ========= ============ ===========
7. SALE OF SILICONE OIL PRODUCT LINE, LICENSING OF LASER TECHNOLOGY AND
OTHER REVENUE
SALE OF SILICONE OIL
In the first quarter of fiscal 2000, Escalon received $2,117,000
from the sale to Bausch & Lomb 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 continue to receive additional
consideration based on future sales of Silicone Oil through August 2005.
13
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 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 8/13/05 45%
LICENSING OF LASER TECHNOLOGY
The material terms of the license of the Company's laser patents,
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 royalties payable to third parties up to a maximum of 50% of
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.
The license was dated October 23, 1997, was amended and restated in
October 2000 and expires on 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;
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 Company has the right to terminate if the licensee
defaults in the payment of any royalty;
2. the Company has the right to terminate if the licensee
defaults in the making of any required report;
3. the Company has the right to terminate if the licensee makes
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 payments received from a privately held entity relating to the licensing
of the Company's intellectual laser technology. For the three-month periods
ended March 31, 2004 and 2003, Silicone Oil revenue totaled $447,000 and
$455,000, respectively, and laser technology revenue totaled $147,000 and
$156,000, respectively. For the nine-month periods ended March 31, 2004 and
2003, Silicone Oil revenue totaled $1,481,000 and $1,348,000, respectively, and
laser technology revenue totaled $297,000 and $275,000, respectively. Accounts
receivable at March 31, 2004 and June 30, 2003 related to other revenue was
$447,000 and $443,000, respectively.
14
8. SEGMENTAL INFORMATION
During the nine-month periods ended March 31, 2004 and 2003, the
Company's operations were classified into four principal reportable segments
that provide different products 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
MARCH 31,
Sonomed Vascular Medical/Trek EMI Total
2004 2003 2004 2003 2004 2003 2004 2003 2004 2003
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Product revenue $ 1,978 $ 1,621 $ 728 $ 689 $ 308 $ 406 $ 6 $ 60 $ 3,020 $ 2,776
Other revenue - - - - 593 610 - - 593 610
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total revenue 1,978 1,621 728 689 901 1,016 6 60 3,613 3,386
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Costs and expenses:
Cost of goods sold 811 516 362 340 190 277 2 45 1,365 1,178
Operating expenses 757 930 367 343 260 300 37 47 1,421 1,620
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total costs and expenses 1,568 1,446 729 683 450 577 39 92 2,786 2,798
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Income from operations 410 175 (1) 6 451 439 (33) (32) 827 588
Other income/expenses
Interest income - - - - 9 1 - - 9 1
Interest expense (91) (128) (3) (6) - - - - (94) (134)
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total other income and
expenses (91) (128) (3) (6) 9 1 - - (85) (133)
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Income before taxes 319 47 (4) - 460 440 (33) (32) 742 455
Income taxes - - (1) - 4 - - - 3 -
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) $ 319 $ 47 $ (3) $ - $ 456 $ 440 $ (33) $ (32) $ 739 $ 455
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Depreciation/Amortization $ 6 $ 4 $ 11 $ 11 $ 38 $ 48 $ 3 $ 6 $ 58 $ 69
Assets $ 12,169 $ 12,198 $ 2,107 $ 2,256 $ 14,613 $ 2,071 $ 170 $ 365 $ 29,059 $ 16,890
Expenditures for
long-lived assets $ 5 $ 34 $ - $ 6 $ - $ - $ - $ - $ 5 $ 40
15
SEGMENTAL STATEMENTS OF OPERATIONS (IN THOUSANDS) - NINE-MONTH PERIODS ENDED
MARCH 31,
Sonomed Vascular Medical/Trek EMI Total
2004 2003 2004 2003 2004 2003 2004 2003 2004 2003
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Product revenue $ 5,648 $ 4,640 $ 2,191 $ 2,031 $ 985 $ 1,056 $ 181 $ 312 $ 9,005 $ 8,039
Other revenue - - - - 1,778 1,623 - - 1,778 1,623
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total revenue 5,648 4,640 2,191 2,031 2,763 2,679 181 312 10,783 9,662
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Costs and expenses:
Cost of goods sold 2,191 1,822 942 873 611 689 83 153 3,827 3,537
Operating expenses 2,251 2,288 1,239 1,136 721 944 180 191 4,391 4,559
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total costs and expenses 4,442 4,110 2,181 2,009 1,332 1,633 263 344 8,218 8,096
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Income from operations 1,206 530 10 22 1,431 1,046 (82) (32) 2,565 1,566
Other income/expenses:
Interest income - - - - 10 2 - - 10 2
Interest expense (310) (484) (10) (22) - - - - (320) (506)
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total other income and
expenses (310) (484) (10) (22) 10 2 - - (310) (504)
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Income before taxes 896 46 - - 1,441 1,048 (82) (32) 2,255 1,062
Income taxes - - - - 72 - - - 72 -
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) $ 896 $ 46 $ - $ - $ 1,369 $ 1,048 $ (82) $ (32) $ 2,183 $ 1,062
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Depreciation/Amortization $ 18 $ 13 $ 33 $ 31 $ 122 $ 183 $ 14 $ 18 $ 187 $ 245
Assets $ 12,169 $ 12,198 $ 2,107 $ 2,256 $ 14,613 $ 2,071 $ 170 $ 365 $ 29,059 $ 16,890
Expenditures for
long-lived assets $ 5 $ 34 $ - $ 6 $ 37 $ 24 $ - $ - $ 42 $ 64
9. SALE OF COMMON STOCK AND WARRANTS
On March 17, 2004, The Company completed a $10,400,000 private
placement of Common Stock and Common Stock purchase warrants to accredited and
institutional investors. The Company sold 800,000 shares of Common Stock at
$13.00 per share. The investors also received warrants to purchase an additional
120,000 shares of Common Stock at an exercise price of $15.60 per share. The
warrants cannot be exercised for 181 days from the private placement date and
expire on September 13, 2009, if not exercised. The securities were sold
pursuant to the exemptions from registration of Rule 506 of Regulation D and
Section 4(2) under the Securities Act of 1933. The Company has subsequently
filed a registration statement with the Securities and Exchange Commission, to
register all of the Common Stock and of the Common Stock purchasable upon
exercise of the warrants, which was declared effective on April 20, 2004.
The net proceeds to the Company from the offering, after costs
associated with the offering, of $9,834,485, have been allocated among the
Common Stock and warrants based on their relative fair values. The Company used
the Black-Scholes pricing model to determine the fair value of the warrants at
$1,601,346.
10. SUBSEQUENT EVENT - EXCHANGE OFFER TO ACQUIRED THE SHARES OF DREW
SCIENTIFIC GROUP PLC
On May 14, 2004, Escalon issued a press release announcing the
Company's exchange offer for the shares of Drew Scientific Group PLC ("Drew"),
headquartered in the United Kingdom. The exchange offer valued each Drew share
at 0.06 pounds sterling (approximately $0.11). Based on the closing price of
$21.00 per share of Escalon Common Stock and the foreign currency exchange rate
on May 12, 2004, Escalon offered 0.0051 shares of Escalon Common Stock in
exchange for each ordinary share of Drew that is validly tendered. If all of the
outstanding shares of Drew Scientific are exchanged, Escalon would issue
approximately 454,010 shares of Escalon Common Stock in the exchange offer.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
This Quarterly Report on Form 10-Q, including the information
incorporated by reference herein and the exhibits hereto may include
"forward-looking" statements. Forward-looking statements broadly involve the
Company's current expectations for future results. The Company's forward-looking
statements generally relate to growth strategies, financial results, product
development, regulatory approvals, competitive strengths, the scope of the
Company's intellectual property rights and sales efforts. Words such as
"anticipates," "believes," "could," "estimates," "expects," "forecasts,"
"intends," "may," "plan," "possible," "project," "should," "will" and similar
expressions generally identify the Company's forward-looking statements. Any
statement that is not historical fact, including estimates, projections, future
trends and the outcome of events that have not yet occurred, are forward-looking
statements. The Company's ability to actually achieve results consistent with
the Company's current expectations depends significantly on certain factors that
may cause actual future results to differ materially from the Company's current
expectations. Some of these factors include:
THE COMPANY'S PRODUCTS ARE SUBJECT TO STRINGENT ONGOING REGULATION
BY THE FOOD AND DRUG ADMINISTRATION, KNOWN AS 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 the Company's activities. 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 the Company obtain other approvals from foreign government
agencies prior to the sale of products in those countries. Also, the Company may
be required to obtain FDA approval before exporting a product or device that has
not received FDA marketing clearance or approval.
The Company 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, the 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 affected products until such deficiencies are corrected.
The Company 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.
The Company cannot assure you 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 and
underlying clinical studies for any new products or devices and for multiple
indications for existing products is lengthy and will require substantial
commitments of the Company's financial resources and our management's time and
effort. Any delay in obtaining clearances or approvals or any changes in
existing regulatory requirements would materially adversely affect the Company's
business.
17
A failure to comply with 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 affect adversely the Company's business, financial
condition and results of operations.
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 you that
the Company's products will achieve market acceptance. Market acceptance depends
upon a number of factors:
- 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.
Any failure to achieve significant market acceptance of the
Company's products will have a material adverse effect on the Company's
business.
THE SUCCESS OF COMPETITIVE PRODUCTS COULD HAVE AND ADVERSE EFFECT 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;
- establishing 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 Company's
competitors' offerings;
- price the Company's products competitively;
- anticipate competitors' announcements of new products, services or
18
technological innovations; and
- general market and economic conditions.
The Company cannot assure you that the Company will be able to
compete effectively in this competitive environment.
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. The Company believes that the Company is not
infringing on any patents held by others. However, 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 infringement 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 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, a patent in a particular market, the court may enjoin
the Company from making, using and selling the product. Furthermore, the Company
may be required to pay damages or obtain a royalty-bearing license, if
available, on acceptable terms.
A SIGNIFICANT DECREASE IN THE SALE OF SILICONE OIL BY BAUSCH & LOMB
WOULD HAVE A NEGATIVE IMPACT ON THE COMPANY'S FINANCIAL POSITION, RESULTS OF
OPERATIONS AND CASH FLOWS.
The Company realized 13.73% and 13.95% of the Company's net revenue
during the nine-month periods ended March 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 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 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%
The revenue associated with sale of Silicone Oil by Bausch & Lomb
has no associated expenses and consequently provides a gross margin of 100%. Any
significant reduction in this revenue can have a significant negative impact on
gross margin. Any significant decrease in Silicone Oil revenue received by the
Company 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.
LACK OF AVAILABILITY OF KEY SYSTEM COMPONENTS COULD RESULT IN
DELAYS, INCREASE COSTS OR COSTLY REDESIGN OF PRODUCT.
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
19
products. Any loss of availability of an essential component could result in a
material adverse change to the Company's business, financial condition and
results of operations. Some of the Company's suppliers are also 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, which would adversely affect the
Company's financial condition and results of operations.
THE COMPANY'S ABILITY TO MARKET AND SELL THE COMPANY'S PRODUCTS MAY
BE ADVERSELY AFFECTED 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 affect the
marketing of the Company's products.
FUTURE LEGISLATION OR CHANGES IN GOVERNMENT PROGRAMS MAY ADVERSELY
AFFECT 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 effect on the Company's business. Legislation that sets price limits and
utilization controls may adversely affect the rate of growth of ophthalmic and
vascular access product markets. If any future health care legislation were to
adversely impact those markets, the Company's product marketing could also
suffer, which could 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 for applications
in ophthalmology and vascular access, the Company's pharmaceutical products and
vascular access products entail an inherent risk of product liability, resulting
in claims based upon injuries or alleged injuries associated with a defect in
the product's performance. 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 a 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 Company's time and money and would
divert management time and attention away from the Company's core business. 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 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 SALES 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 the Company's revenues from sales
outside the United States. Changes in the laws or policies of governmental
agencies, as well as social and economic conditions, in the
20
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 affect the Company's results of
operations.
THE COMPANY IS DEPENDENT ON THE COMPANY'S 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 effect on the Company's
ability to manufacture, sell and market the Company's products and the Company's
ability to maintain or expand the Company's business.
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 and business
infrastructure. 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. If the Company does not realize the
expected benefits or synergies of such transactions, the Company's consolidated
financial position, results of operations and stock price could be negatively
impacted.
THE 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:
- announcements of technological innovations;
- changes in marketing, product pricing and sales strategies or new
products by the Company's competitors;
- any acquisitions, strategic alliances, joint ventures and
divestitures that the Company effects;
- 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.
21
Moreover, the possibility exists that the stock market, and in
particular the securities of medical device companies, could experience extreme
price and volume fluctuations unrelated to operating performance. The Company
has not paid any cash dividends on the Company's common stock and does not
anticipate paying any cash dividends in the foreseeable future.
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:
- changes in the mix of products sold;
- the timing and expense of new product introductions by the Company
or the Company's competitors;
- fluctuations in royalty income;
- announcements of new strategic relationships by the Company or the
Company's competitors;
- the cancellation or delays in the purchase of the Company's
products;
- the gain or loss of significant customers;
- fluctuations in customer demand for the Company's products; and
- competitive pressures on prices at which the Company can sell the
Company's products.
The Company sets spending levels in advance of each quarter based,
in part, on the Company's expectations of product 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 conditions in the healthcare industry or
global economy generally, or market volatility unrelated to the Company's
business and operating results.
THE IMPACT OF TERRORISM OR ACTS OF WAR COULD HAVE A MATERIAL ADVERSE
EFFECT ON THE COMPANYS' BUSINESS.
Terrorist acts or acts of war, whether in the United States or
abroad, could cause damage or disruption to the Company's operations, our
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 effect 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 could discourage a third party from
attempting to acquire, control of the Company. These provisions could limit the
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.
22
The reader must carefully consider forward-looking statements and
understand that such Statements involve a variety of risks and uncertainties,
known and unknown, and may be affected by inaccurate assumptions. It is not
possible to foresee or identify all factors that may affect the Company's
forward-looking statements, and the reader should not consider any list of such
factors to be an exhaustive list of all risks, uncertainties or potentially
inaccurate assumptions affecting such forward-looking statements.
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 affected,
and in the future (together with other unknown factors) could affect 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 Litigation 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.
EXECUTIVE OVERVIEW - NINE-MONTH PERIODS ENDED MARCH 31, 2004 AND 2003
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 affecting Company performance and
financial condition.
- The Company completed a $10.4 million private placement of Common
Stock and Common Stock purchase warrants on March 17, 2004. The net
proceeds to the Company of approximately $9.8 million will enable
the Company to strengthen its balance sheet and provide additional
working capital for general corporate purposes.
- Product revenue, up 12.01% from last year, is benefiting from
increased domestic demand for the Company's pachymeter product as
well as increased market penetration in Europe.
- Other revenue, up 9.52% from last year, was received primarily from
Bausch & Lomb in connection with the Silicone Oil product line. The
contract for this revenue expires in August 2005.
- Cost of goods sold as a percentage of revenue decreased to 35.49%
from 36.60% primarily due to product mix, an increase in other
revenue that has no associated costs and increased productivity.
- Operating expenses increased by less than 1% as the Company
continued to benefit from the reduction of certain administrative
costs while, at the same time, investing in product development and
strengthening of the Company's sales channels domestically and
overseas.
- Interest expense decreased by 36.68% primarily due to reduced debt
levels.
23
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. The Company's present name was adopted in
August 1996. The Company reincorporated in Delaware in 1999, and then
reincorporated in Pennsylvania in November 2001. The Company operates in the
healthcare market, specializing in the development, manufacture, marketing and
distribution of ophthalmic medical devices, pharmaceuticals and vascular access
devices. The 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 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, the Company changed its market focus and is no longer developing
laser technology. In October 1997, the Company licensed its intellectual laser
technology to a privately held company, in return for an equity interest and
future royalties on sales of products relating to the laser technology. The
privately held company undertook responsibility for funding and developing the
laser technology through to commercialization. The privately held company began
selling products related to the laser technology during fiscal 2002.
To further diversify its product portfolio, in January 1999, the
Company's Vascular subsidiary acquired the vascular access product line from
Endologix. 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 a privately held company, to develop and
market a digital camera back for ophthalmic photography. The Company terminated
its joint venture and commenced direct operations within its EMI business unit
on January 1, 2002.
On May 14, 2004, Escalon issued a press release announcing the
Company's exchange offer of the Company's Common Stock for the shares of Drew
Scientific Group PLC, headquartered in the United Kingdom. Drew is a
diagnostics company specializing in the design, manufacture, sale and
distribution of analytical systems for laboratory testing world-wide. Drew
provides instrumentation and consumables for the diagnosis and monitoring of
medical disorders in the rapidly growing areas of diabetes, cardiovascular
diseases and hematology, as well as veterinary hematology and blood chemistry.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements requires management to make
estimates and assumptions that affect the amount 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
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.
24
REVENUE RECOGNITION
The Company'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 the 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.
The Company assesses collectibility based on the creditworthiness 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 the Company's international customers, the Company requires
prepayment or an irrevocable letter of credit to be issued by the customer
before the purchase order is accepted.
VALUATION OF INTANGIBLE ASSETS
The Company periodically evaluates its intangible assets and
goodwill in accordance with SFAS 142, "Goodwill and Other Intangible Assets,"
for indications of impairment whenever events or changes in circumstances
indicate that the carrying amount 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
underperformance relative to historical or projected future operating results or
significant negative industry or economic trends. If these criteria indicate
that the value of the intangibles 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.
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 its 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.
25
THREE AND NINE-MONTH PERIODS ENDED MARCH 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 nine-month periods ended March 31, 2004 and 2003.
Three-Month Periods Nine-Month Periods
Ended March 31, Ended March 31,
------------------------------------------------------------------------------------------
2004 2003 % Change 2004 2003 % Change
------------ ------------ -------- ------------ ------------ --------
Product revenue:
Sonomed $ 1,978 $ 1,621 22.02% $ 5,648 $ 4,640 21.72%
Vascular 728 690 5.51% 2,191 2,031 7.88%
Medical/Trek 308 406 -24.14% 985 1,056 -6.72%
EMI 6 59 -89.83% 181 312 -41.99%
------------ ------------ ------ ------------ ------------ ------
$ 3,020 $ 2,776 8.79% $ 9,005 $ 8,039 12.02%
============ ============ ====== ============ ============ ======
Product revenues increased $244,000, or 8.79%, to $3,020,000 for the
three-month period ended March 31, 2004 as compared to $2,776,000 for the same
period in the prior fiscal year. Product revenue in the Sonomed business unit
increased $357,000, or 22.02%, to $1,978,000. The increase is attributed to a
$132,000 increase in the Middle East, a $117,000 increase in Europe and a
$72,000 increase in Latin America. The increases in the Middle East and Europe
are the result of additional sales and marketing resources and management
attention to developing these markets. The increase in Latin America is the
result of recovering economies in South American countries. Product revenue in
the Vascular business unit increased $38,000, or 5.51%, to $728,000. The
increase relates primarily to increased market coverage in Europe as a result of
the engagement of a marketing consultant in December 2003. Product revenue in
the Medical/Trek business unit decreased $98,000, or 24.14%, to $308,000. The
decrease primarily relates to decreased OEM shipments to Bausch & Lomb of
$50,000. Product revenue in the EMI business unit decreased $53,000, or 89.83%,
to $6,000. EMI did not ship any of its CFA systems during the three-month period
ended March 31, 2004.
Product revenues increased $966,000, or 12.02%, to $9,005,000 for
the nine-month period ended March 31, 2004 as compared to $8,039,000 for the
same period in the prior fiscal year. Product revenue in the Sonomed business
unit increased $1,008,000, or 21.72%, to $5,648,000. The increase is attributed
to a $525,000 increase in the domestic market, a $290,000 increase in Europe, a
$210,000 increase in the Middle East and a $133,000 increase in Latin America
offset by a $126,000 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
increases in Europe and the Middle East are the result of additional sales and
marketing resources and management attention to developing these markets,
whereas the increase in Latin America is a result of recovering economies in
South American countries. Product revenue in the Vascular business unit
increased $160,000, or 7.88%, to $2,191,000. The increase relates primarily to
increased usage in the domestic marketplace. Product revenue in the Medical/Trek
business unit decreased $71,000, or 6.72%, to $985,000. The decrease primarily
relates to decreased market demand for Medical/Trek's products. Product revenue
in the EMI business unit decreased $131,000, or 41.99%, to $181,000.
Other revenue, which is included in the Medical/Trek business unit,
decreased $17,000, or 2.79%, to $593,000 for the three-month period ended March
31, 2004 as compared to $610,000 from the same period in the prior fiscal year.
Royalty payments from a privately held entity related to the licensing of the
Company's intellectual laser technology decreased $9,000 and the revenue
received from Bausch & Lomb in connection with their sales of Silicone Oil
decreased $8,000. 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. These step-downs occur during the first quarter of each fiscal year
through the remainder of the contract, which ends in August 2005. For the
three-month period ended March 31, 2004, the step-down
26
caused a $56,000 decrease in Silicone Oil revenue that the Company would have
otherwise received had the step-down not occurred. The offsetting $48,000
increase in Silicone Oil revenue is due to increased 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.
Other revenue, which is included in the Medical/Trek business unit,
increased $155,000, or 9.55%, to $1,778,000 for the nine-month period ended
March 31, 2004 as compared to $1,623,000 for the same period in the prior fiscal
year. The increase primarily relates to a $133,000 increase in revenue received
from Bausch & Lomb in connection with its 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. These step-downs occur
during the first quarter of each fiscal year through the remainder of the
contract, which ends in August 2005. For the nine-month period ended March 31,
2004, the step-down caused a $185,000 decrease in Silicone Oil revenue that the
Company would have otherwise received had the step-down not occurred. The
offsetting $317,000 increase in Silicone Oil revenue is due to increased 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 remaining
$22,000 increase in other revenue relates to royalty payments from a privately
held entity related to the licensing of the Company'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 and nine-month periods ended March 31, 2004 and 2003.
Three-Month Periods Nine-Month Periods
Ended March 31, Ended March 31,
------------------------------------------------------------------------------------------
2004 2003 2004 2003
-------------------- -------------------- -------------------- --------------------
Dollars % Dollars % Dollars % Dollars %
Cost of goods sold:
Sonomed $ 813 41.10% $ 517 31.89% $ 2,191 38.79% $ 1,822 39.27%
Vascular 362 49.73% 339 49.13% 942 42.99% 873 42.98%
Medical/Trek 188 61.04% 277 68.23% 611 62.03% 689 65.25%
EMI 2 33.33% 45 76.27% 83 45.86% 153 49.04%
-------- ----- -------- ----- -------- ----- -------- -----
$ 1,365 45.20% $ 1,178 42.44% $ 3,827 42.50% $ 3,537 44.00%
======== ===== ======== ===== ======== ===== ======== =====
Cost of goods sold totaled $1,365,000, or 45.20%, of product
revenue, for the three-month period ended March 31, 2004 as compared to
$1,178,000, or 42.44% of product revenue, for the same period last fiscal year.
Cost of goods sold in the Sonomed business unit totaled $813,000, or 41.10% of
product revenue, for the three-month period ended March 31, 2004 as compared to
$517,000, or 31.89% of product revenue for the same period last fiscal year. The
increase in cost of goods sold as a percentage of product revenues is a result
of a decrease in price per unit of several of Sonomed's products primarily as a
result of increased international sales. Sonomed generally experiences lower
price per unit on products sold internationally. Cost of goods sold in the
Vascular business unit totaled $362,000, or 49.73% of product revenue as
compared to $339,000, or 49.13% of product revenue for the same period last
fiscal year. Cost of goods sold in the Medical/Trek business unit totaled
$188,000, or 61.04%, as compared to $277,000, or 68.23% of product revenue for
the same period last fiscal year. Fluctuations in Medical/Trek cost of goods
sold emanates from product mix, which was primarily controlled by market demand.
Cost of goods sold in the EMI business unit was $2,000, or 33.33%, of product
revenue as compared to $45,000, or 76.27% of product revenue for the same period
last fiscal year.
Cost of goods sold totaled $3,827,000, or 42.50%, of product revenue
for the nine-month period ended March 31, 2004 as compared to $3,537,000, or
44.00%, of product revenue for the same period last fiscal year. Cost of goods
sold in the Sonomed business unit was $2,191,000, or 38.79%, of product
27
revenue as compared to $1,822,000, or 39.27%, of product revenue for the same
period last fiscal year. Cost of goods in the Vascular business unit was
$942,000, or 42.99% of product revenue as compared to $873,000, or 42.98% of
product revenue for the same period last fiscal year. Cost of goods sold in the
Medical/Trek business unit totaled $611,000, or 62.03%, as compared to $689,000,
or 65.25% of product revenue for the same period last fiscal year. Fluctuations
in Medical/Trek cost of goods sold emanates from product mix, which was
primarily controlled by market demand. Cost of goods sold in the EMI business
unit was $83,000, or 45.86%, of product revenue as compared to $153,000, or
49.04% of product revenue for the same period last fiscal year.
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 nine-month
periods ended March 31, 2004 and 2003.
Three-Month Periods Nine-Month Periods
Ended March 31, Ended March 31,
----------------------------------------------------------------------------------------
2004 2003 % Change 2004 2003 % Change
------------ ------------ -------- ------------ ------------ --------
Marketing, general and
administrative expenses:
Sonomed $ 285 $ 265 7.55% $ 851 $ 999 -14.81%
Vascular 328 289 13.49% 982 858 14.45%
Medical/Trek 604 619 -2.42% 1,777 1,738 2.24%
EMI 37 47 -21.28% 180 191 -5.76%
------------ ------------ ------ ------------ ------------ ------
$ 1,254 $ 1,220 2.79% $ 3,790 $ 3,786 0.11%
============ ============ ====== ============ ============ ======
Marketing, general and administrative expenses increased $34,000, or
2.79%, for the three-month period ended March 31, 2004, as compared to the same
period last fiscal year. In the Sonomed business unit, marketing, general and
administrative expenses increased $20,000, or 7.55%, to $285,000. Salaries and
other personnel-related expenses increased $23,000, primarily the result of
increased headcount. In the Vascular business unit, marketing, general and
administrative expenses increased $39,000, or 13.49%, to $328,000. Salaries and
other personnel-related expenses increased $40,000, primarily the result of
increases in headcount. Consulting expenses increased $26,000 as a result of
marketing efforts in the international markets. Sales and marketing
travel-related expenses also increased $28,000. 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 $59,000 decrease in royalty expense. In the Medical/Trek business
unit, marketing, general and administrative expenses decreased $15,000, or
2.42%, to $604,000. Corporate franchise taxes, which had been over-accrued, and
were corrected during the three-month period ended March 31, 2004 decreased
$89,000, whereas, accrued compensation increased $105,000. Additionally, legal
expenses and consulting expense decreased $23,000 and $12,000, respectively. In
the EMI business unit, marketing, general and administrative expenses decreased
$10,000, or 21.28%, to $37,000.
Marketing, general and administrative expenses increased $4,000, or
0.11%, for the nine-month period ended March 31, 2004 as compared to the same
period last fiscal year. In the Sonomed business unit, marketing, general and
administrative expenses decreased $148,000, or 14.81%, to $851,000. Salaries and
other personnel-related expenses decreased $189,000, primarily the result of
headcount changes. Commission expense decreased $33,000 as a result of changes
in the commission structure with an international distributor. Offsetting these
decreases was an $80,000 increase in consulting expense, which increased as a
result of the Company's marketing efforts in the international markets. In the
Vascular business unit, marketing, general and administrative expenses increased
$124,000, or 14.45%, to $982,000. Salaries and other personnel-related expenses
increased $106,000, primarily the result of increases in headcount. Consulting
expenses increased $38,000 as a result of marketing efforts in the international
markets. Sales and marketing travel-related expenses also increased $56,000. 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 $65,000 decrease in royalty expense.
In
28
the Medical/Trek business unit, marketing, general and administrative expenses
increased $39,000, or 2.24%, to $1,777,000. Accrued compensation increased
$183,000. Depreciation and amortization expense decreased $26,000 primarily due
to the abandonment of the Company's license and distribution rights to Povidone
Iodine 2.5% in March 2003. Consulting expense decreased $24,000 as the Company
incurred expenses in the year ago period that related to the Company's search
for alternate debt financing. Corporate franchise taxes, legal expenses and
temporary labor decreased $15,000, $15,000 and $11,000, respectively. In the EMI
business unit, marketing, general and administrative expenses decreased $11,000,
or 5.76%, to $180,000.
Research and development expenses decreased $37,000, or 18.14%, to
$167,000, for the three- month period ended March 31, 2004 as compared to the
same period last fiscal year, whereas research and development expenses
increased $22,000, or 3.81%, to $600,000, for the nine-month period ended March
31, 2004 as compared to the same period last fiscal year. The decrease in the
three-month period ended March 31, 2004 was primarily caused by reduced
headcount. The increase in the nine-month period ended March 31, 2004 relates
primarily to consulting expenses incurred in connection with product
development. The Company redesigns its products as technology changes to remain
competitive in the marketplace.
Several years ago, the Company began seeking a corporate partner to
fund commercialization of the Povidone Iodine 2.5% product line. The Company
obtained the license and distribution rights to the product from Harbor UCLA
Medical Center. Having exhausted all partnering possibilities, during the
three-month period ended March 31, 2003, it was decided that further
expenditures on this project were not in the shareholders' best interest, and
the project was abandoned. This decision resulted in the Company taking a charge
of $195,000, which included the write-off of the remaining net book value of the
license and distribution rights subsequent to normal amortization.
Interest income increased $9,000 and $8,000 for the three and
nine-month periods ended March 31, 2004, respectively, as compared to the same
periods last fiscal year due to increased average cash balances.
Interest expense decreased $40,000 and $186,000 for the three and
nine-month periods ended March 31, 2004, respectively, as compared to the same
periods last fiscal year due to reduced total debt levels and lower interest
rates.
29
LIQUIDITY AND CAPITAL RESOURCES
In recent years, the Company's principal source of liquidity
generally has been net cash provided by operating activities. The Company,
however, completed a private placement of its Common Stock during the
three-month period ended March 31, 2004, that significantly affected the
Company's liquidity. Additionally, a significant number of stock options were
exercised during the three-month period ended March 31, 2004 providing the
Company with additional cash. Changes in the Company's overall liquidity and
capital resources from continuing operations during fiscal 2004 are reflected in
the following table:
March 31, June 30,
(Dollars are in thousands) 2004 2003
------------ -------------
Current Assets $ 17,034 $ 4,759
Less: Current Liabilities 3,320 3,870
------------ ------------
Working Capital $ 13,714 $ 889
Current Ratio 5.1:1 1.2:1
- ----------------------------------------------------------------------------------
Notes Payable and Current Maturities $ 1,877 $ 2,485
Long-Term Debt 2,796 4,080
------------ ------------
Total Debt $ 4,673 $ 6,565
Total Equity 22,943 8,939
------------ ------------
Total Capital $ 27,616 $ 15,504
Total Debt to Total Capital 16.92% 42.34%
WORKING CAPITAL POSITION
Working capital increased $12,825,000 as of March 31, 2004 and the
current ratio increased to 5.1:1 when compared with June 30, 2003. Current
assets increased by $12,275,000 primarily due to the issuance of common stock
totaling $11,821,000.
Current liabilities decreased by $550,000 as a result of several
offsetting changes that included the following:
- A $725,000 decrease in the Company's outstanding line of credit as
the Company used cash from operations to pay down its debt.
- A $116,000 increase in current portion of long-term debt primarily
due to the step-up of principal payments due on the Company's term
debt.
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash provided by operating activities increased $1,517,000 to
$2,764,000, for the nine-month period ended March 31, 2004, when compared to the
same period last fiscal year. Apart from year-over-year increased net
profitability of $1,121,000, the following are the primary offsetting factors
affecting the increase in net cash provided by operating activities:
- The Company collected a substantial amount of aged receivables in
its EMI business unit during the first quarter of fiscal 2004 which
significantly reduced accounts receivable in that business unit.
Revenue in the Company's Medical/Trek business unit during the third
quarter of fiscal 2004 was lower than revenue during the fourth
quarter of fiscal 2003, which had the effect of significantly
reducing accounts receivable in that business unit.
30
- The Company wrote-down license and distribution rights in fiscal
2003. The absence of this write-down of license and distribution
rights in fiscal 2004 had the effect of decreasing year-over-year
net cash provided by operations.
CASH FLOWS FROM INVESTING AND FINANCING ACTIVITIES
Cash flows used in investing activities related solely to the
purchase of fixed assets for the nine-month periods ended March 31, 2004 and
2003, and remained largely unchanged. 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 it will have to commit material resources to capital investment for
the foreseeable future.
Cash flows from financing activities were $9,896,000 for the
nine-month period ended March 31, 2004. Cash flows from financing activities
primarily related to proceeds from a private placement of common stock and
common stock warrants as well as proceeds from the issuance of common stock
through the exercise of stock options. This was offset by repayments of the
Company's term debt and line of credit. On March 17, 2004, the Company completed
a private placement of Common stock resulting in net proceeds of $9,834,000 and,
during the nine-month period ended March 31, 2004, issued common stock related
to the exercise of stock options resulting in proceeds to the Company of
$1,986,000. The Company paid down its line of credit by $725,000 and paid down
its term debt by $1,200,000. The Company utilized cash from operations to pay
down its term loan and line of credit.
Cash flows used in financing activities financing activities were
$1,271,000 during the nine-month period ended March 31, 2003. During the
nine-month period ended March 31, 2003, cash flows used in financing activities
primarily related to repayments of the Company's term debt offset by borrowings
from the line of credit. The Company paid down its term debt by $1,396,000 and
drew $125,000, net, from the line of credit. The reduction in repayments of term
debt relates to a reduction in required principal payments that resulted from
the Company's renegotiating its debt in February 2003. The Company utilized cash
from operations to pay down its term debt.
Management believes that cash on hand, cash generated from
operations 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 for the foreseeable future.
FORWARD-LOOKING STATEMENT ABOUT SIGNIFICANT ITEMS LIKELY TO AFFECT
LIQUIDITY
The Company realized 13.74% and 13.95% of its net revenue during the
nine-month periods ended March 31, 2004 and 2003, respectively, from Bausch &
Lomb's sale of Silicone Oil. Silicone Oil revenues are based on sales of the
product line by Bausch & Lomb multiplied by a contractual factor that reduces 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, through August 2005. 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 181 days from the placement date at $15.60 per share. If all 120,000
shares were to be exercised, it would provide gross proceeds to the Company of
$1,872,000. The Company cannot assure, however, that the warrant exercise price
will be less than the market price of the Company's Common Stock when the
warrants are exercisable or that even if the exercise price is less than the
market price that any of the warrants will be exercised. See the Notes to
Condensed Consolidated Financial Statements for a description of the private
placement of the Company's Common Stock and Common Stock purchase warrants.
31
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.
As of March 31, 2004, the amounts outstanding under the term loan
and the line of credit were $4,246,019 and $250,000, respectively. At March 31,
2004, the interest rates applicable to the term loan and the line of credit were
5.75% and 5.50%, respectively. The lender's prime rate at March 31, 2004 was
4.00%. The $4,596,019 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 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,
the Company acquired for cash the assets of Endologix's vascular access
business, and also agreed to pay royalties based on future sales of the products
of the vascular access business for a period of five years following the close
of the sale, with a guaranteed minimum royalty of $300,000 per year. On February
1, 2001, the parties amended the agreement to provide an adjustment in the terms
of payment of the royalties. Pursuant to the 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, an additional note in the amount of $717,558,
payable in eleven quarterly installments that commenced April 15, 2002 and the
Company issued 50,000 shares of its Common Stock to Endologix.
As of March 31, 2004, the amount outstanding under the Endologix
term loan was $196,000. At March 31, 2004, 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 round lot shareholders
- Two market makers; and
- Compliance with corporate governance standards.
As of March 31, 2004, the Company complied with these requirements.
32
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 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 March 31, 2004 plus 1.75% on the term loan, the prime rate
plus 1.50% on the line of credit and the prime rate plus 1.00% on the Endologix
note. See the Notes to Condensed Consolidated Financial Statements for further
information regarding the Company's debt obligations.
Long-term debt classified as current as of March 31,
-------------------------------------------------------------------------------------
2004 2005 2006 Thereafter Total
------------ ------------ -------------- -------------- ------------
Term loan $ 1,450,000 $ 2,796,000 $ - $ - $ 4,246,000
Interest rate 5.75% 5.75%
Line of credit 250,000 - - - 250,000
Interest rate 5.50%
Endologix note 196,000 - - - 196,000
Interest rate 5.00%
Deferred finance fees (19,000) - - - (19,000)
------------ ------------ -------------- -------------- ------------
Total $ 1,877,000 $ 2,796,000 $ - $ - $ 4,673,000
============ ============ ============== ============== ============
EXCHANGE RATE RISK
During the three and nine-month periods ended March 31, 2004 and
2003, approximately 19.93% and 17.11%, respectively, of the Company'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 expenses in the European market during
the second quarter of fiscal 2003, the majority of which are transacted in
Euros. These expenses were $23,000 and $72,000 for the three- and nine-month
periods ended March 31, 2004, respectively, and were $41,000 and $59,000 for the
three- and nine-month periods ended March 31, 2003, respectively. The Company's
Vascular business unit began incurring marketing expenses in the European market
during the second quarter of fiscal 2004, the majority of which are transacted
in Euros. These expenses were $41,000 and $50,000 for the three- and nine-month
periods ended March 31, 2004.
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 the 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 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
33
Act) during the Company's third fiscal quarter ended March 31, 2004
that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial
reporting.
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 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES.
On March 17, 2004, the Company completed a $10,400,000 private
placement of Common Stock and Common Stock purchase warrants to a limited number
of accredited and institutional investors. The Company sold 800,000 shares of
Common Stock at $13.00 per share. The investors also received warrants to
purchase an additional 120,000 shares of Common Stock at an exercise price of
$15.60 per share. The warrants cannot be exercised for 181 days from the private
placement date and expire on September 13, 2009, if not exercised. The Company
received net proceeds from the offering, after costs associated with the
offering, of $9,834,485.
The securities were offered and sold pursuant to the exemptions from
registration of Rule 506 of Regulation D and Section 4(2) under the Securities
Act of 1933. The Company subsequently filed a registration statement with the
Securities and Exchange Commission, to register all of the Common Stock and
Common Stock purchasable upon the exercise of the warrants, which registration
statement was declared effective on April 20, 2004.
The Company did not effect any repurchases of its Common Stock
during the quarter ended March 31, 2004.
ITEM 5. OTHER INFORMATION
On May 14, 2004, Escalon issued a press release announcing the
Company's exchange offer for the shares of Drew Scientific Group PLC ("Drew"),
headquartered in the United Kingdom. The exchange offer valued each Drew share
at 0.06 pounds sterling (approximately $0.11). Based on the closing price of
$21.00 per share of Escalon Common Stock and the foreign currency exchange rate
on May 12, 2004, Escalon offered 0.0051 shares of Escalon Common Stock in
exchange for each ordinary share of Drew that is validly tendered. If all of the
outstanding shares of Drew Scientific are exchanged, Escalon would issue
approximately 454,010 shares of Escalon Common Stock in the exchange offer.
34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit No. Exhibit
(a) Exhibits
10.30 Securities Purchase Agreement dated as of March 16,
2004 (the "Securities Purchase Agreement") between
the Company and the Purchasers signatory thereto.
(Incorporated by reference to Form S-3 filed with the
Securities and Exchange Commission on April 8, 2004.)
10.31 Registration Rights Agreement dated as of March 16,
2004 between the Company and the Purchasers signatory
thereto. (Incorporated by reference to Form S-3 filed
with the Securities and Exchange Commission on April
8, 2004.)
10.32 Form of Warrant to Purchase Common Stock issued to
each Purchaser under the Securities Purchase
Agreement. (Incorporated by reference to Form S-3
filed with the Securities and Exchange Commission on
April 8, 2004.)
10.33 Manufacturing Supply and Distribution Agreement
between Sonomed, Inc. and Ophthalmic Technologies,
Inc. dated as of March 11, 2004.*
31.1 Certificate of Chief Executive Officer under Rule
13a-14(a).*
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.*
* Filed herewith
(b) Reports on Form 8-K
Form 8-K filed with the Securities and Exchange Commission on March
18, 2004, reporting information regarding the Company's completed
private placement under Item 5.
Form 8-K filed with the Securities and Exchange Commission on April
8, 2004, reporting information regarding its intention to make an
exchange offer for all of the outstanding shares of Drew Scientific
Group PLC under Item 5.
Form 8-K filed with the Securities and Exchange Commission on April
21, 2004, reporting additional information regarding its intention
to make an exchange offer for all of the outstanding shares of Drew
Scientific Group PLC under Item 5.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ESCALON MEDICAL CORP.
(Registrant)
Date: May 17, 2004 By: /s/ Richard J.DePiano
-----------------------------
Richard J. DePiano
Chairman and Chief
Executive Officer
Date: May 17, 2004 By: /s/ Harry M. Rimmer
-----------------------------
Harry M. Rimmer
Senior Vice President of Finance
35