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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, 2005.

[ ] Transitional report pursuant to Section 13 or 15(d) of the securities
Exchange Act of 1934 for the transitional period from ________ to ________.

Commission File Number 0-20127

----------------------------

ESCALON MEDICAL CORP.
(Exact name of Registrant as specified in its charter)



PENNSYLVANIA 33-0272839
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)


565 EAST SWEDESFORD ROAD, SUITE 200
WAYNE, PA 19087
(Address of principal executive
offices, including zip code)

(610) 688-6830
(Registrant's telephone number, including area code)

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 5, 2005, 5,940,255 shares of common stock were outstanding.

ESCALON MEDICAL CORP.
FORM 10-Q QUARTERLY REPORT

TABLE OF CONTENTS



Part I. Financial Information

Item 1. Condensed Consolidated Financial Statements 2

Condensed Consolidated Balance Sheet as of March 31, 2005
(Unaudited) and June 30, 2004 2

Condensed Consolidated Statement of Operations for the three and
nine-month periods ended March 31, 2005 and 2004 (Unaudited) 3

Condensed Consolidated Statement of Cash Flows for nine-month
periods ended March 31, 2005 and 2004 (Unaudited) 4

Condensed Consolidated Statement of Shareholders' Equity for
the three and nine-month periods ended March 31, 2005 and 2004
(Unaudited) 5

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 19

Item 3. Quantitative and Qualitative Disclosures about Market Risk 37

Item 4. Controls and Procedures 38

Part II. Other Information

Item 1. Legal Proceedings 38

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 39

Item 6. Exhibits 40



1

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET



March 31, June 30,
2005 2004
---- ----
ASSETS (Unaudited)

Current assets:
Cash and cash equivalents $ 2,514,793 $ 12,601,971
Available for sale securities 4,227,436 --
Accounts receivable, net 4,507,190 2,492,689
Inventory, net 5,794,950 1,781,592
Note receivable 150,000 150,000
Other current assets 1,083,496 539,508
------------ ------------
Total current assets 18,277,865 17,565,760
------------ ------------
Furniture and equipment, net 1,015,445 409,187
Goodwill 20,015,265 10,591,795
Trademarks and trade names, net 616,906 616,906
Patents, net 578,481 172,078
Other assets 294,260 101,389
------------ ------------
Total assets $ 40,798,222 $ 29,457,115
============ ============


LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Line of credit $ - $ 250,000
Current portion of long-term debt 227,809 1,621,687
Accounts payable 2,098,491 499,242
Accrued expenses 2,753,334 1,229,498
------------ ------------
Total current liabilities 5,079,634 3,600,427
Long-term debt, net of current portion 461,608 2,396,019
------------ ------------
Total liabilities 5,541,242 5,996,446
Shareholders' equity:
Preferred stock, $0.001 par value; 2,000,000 shares authorized; no shares issued -- --
Common stock, $0.001 par value; 35,000,000 shares authorized; 5,940,020 and
5,017,122 shares issued and outstanding at March 31, 2005 and June 30, 2004,
respectively 5,940 5,018
Common stock warrants 1,601,346 1,601,346
Additional paid-in capital 63,658,130 56,438,903
Accumulated deficit (34,152,189) (34,584,598)
Accumulated other comprehensive income 4,143,753 --
------------ ------------
Total shareholders' equity 35,256,980 23,460,669
------------ ------------
Total liabilities and shareholders' equity $ 40,798,222 $ 29,457,115
============ ============


See notes to condensed consolidated financial statements


2

ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)



Three Months Ended Nine Months Ended
March 31, March 31,
2005 2004 2005 2004
---- ---- ---- ----

Product revenue $ 6,246,836 $ 3,019,536 $ 16,648,739 $ 9,004,696

Other revenue 982,241 593,242 2,233,987 1,777,649
------------ ------------ ------------ ------------
Revenues, net 7,229,077 3,612,778 18,882,726 10,782,345
------------ ------------ ------------ ------------

Costs and expenses:

Cost of goods sold 2,998,745 1,364,600 9,019,701 3,827,059

Research and development 463,808 167,123 1,257,132 600,245

Marketing, general and administrative 2,938,673 1,254,516 8,050,678 3,789,801
------------ ------------ ------------ ------------
Total costs and expenses 6,401,226 2,786,239 18,327,511 8,217,105
------------ ------------ ------------ ------------

Income from operations 827,851 826,539 555,215 2,565,240
------------ ------------ ------------ ------------

Other income and expenses:

Equity in Ocular Telehealth Management, LLC (13,632) -- (49,942) --

Interest income 9,166 9,356 53,607 10,317

Interest expense (15,915) (93,794) (42,534) (320,233)
------------ ------------ ------------ ------------
Total other income and expenses (20,381) (84,438) (38,869) (309,916)
------------ ------------ ------------ ------------

Income before income taxes 807,470 742,101 516,346 2,255,324

Income taxes 63,912 2,927 83,938 72,033
------------ ------------ ------------ ------------

Net income $ 743,558 $ 739,174 $ 432,408 $ 2,183,291
============ ============ ============ ============

Basic net income per share $ 0.125 $ 0.192 $ 0.075 $ 0.619
============ ============ ============ ============

Diluted net income per share $ 0.119 $ 0.172 $ 0.069 $ 0.564
============ ============ ============ ============

Weighted average shares - basic 5,932,920 3,839,937 5,787,753 3,524,603
============ ============ ============ ============

Weighted average shares - diluted 6,251,847 4,286,761 6,238,515 3,869,901
============ ============ ============ ============


See notes to condensed consolidated financial statements


3

ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)



Nine Months Ended
March 31,
2005 2004
---- ----

CASH FLOWS FROM OPERATING ACTIVITIES:


Net income $ 432,409 $ 2,183,291
Adjustments to reconcile net (loss)/income to net cash (used in)/
provided by operating activities:
Depreciation and amortization 287,176 186,745
Abandonment of leasehold improvements 11,057 --
Loss of Ocular Telehealth Management, LLC 49,942 --
Change in operating assets and liabilities:
Accounts receivable, net (750,816) 338,917
Inventory, net (1,377,461) (83,145)
Other current and long-term assets (340,351) 79,525
Accounts payable, accrued and other liabilities (826,531) 58,379
------------ ------------
Net cash (used in)/provided by operating activities (2,484,838) 2,763,712
------------ ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Drew, net of cash 151,996 --
Acquisition costs related to Drew (1,088,234)
Investment in Ocular Telehealth Management, LLC (256,000) --
Purchase of fixed assets (98,990) (41,647)
------------ ------------
Net cash used in investing activities (1,291,228) (41,647)
------------ ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Line of credit borrowing -- 153,981
Line of credit repayment (1,907,948) (878,981)
Principal payments on term loans (4,374,481) (1,199,675)
Issuance of common stock, private placement -- 9,834,485
Issuance of common stock, stock options 29,782 1,986,113
------------ ------------
Net cash used in financing activities (6,252,647) 9,895,923
------------ ------------
Effect of exchange rate changes on cash & cash equivalents (58,465) --
Net (decrease)/increase in cash and cash equivalents (10,087,178) 12,617,988
Cash and cash equivalents, beginning of period 12,601,971 298,390
------------ ------------
Cash and cash equivalents, end of period $ 2,514,793 $ 12,916,378
============ ============

SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:

Interest paid $ 234,781 $ 251,309
============ ============

Income taxes $ 394,469 $ --
============ ============

Accounts receivable $ 1,263,685 $ --
============ ============

Inventory $ 2,635,897 $ --
============ ============

Other current assets $ 178,261 $ --
============ ============

Furniture and equipment $ 736,179 $ --
============ ============

Patents $ 461,779 $ --
============ ============

Other long-term assets $ 7,406 $ --
============ ============

Line of credit $ 1,643,473 $ --
============ ============

Current liabilities $ 3,650,335 $ --
============ ============

Shares reserved for future issuance included in accrued liabilities $ 240,084 $ --
============ ============

Long-term debt $ 1,046,192 $ --
============ ============

Issuance of common stock $ 7,190,355 $ --
============ ============

Increase in unrealized appreciation on available for sale securities $ 4,227,436 $ --
============ ============


See notes to condensed consolidated financial statements


4

ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED MARCH 31, 2005
(UNAUDITED)



Accumulated
Common Stock Common Additional Other Total
------------ Stock Paid-in Accumulated Comprehensive Shareholders'
Shares Amount Warrants Capital Deficit Loss Equity
--------- ---------------------------------------------------------------------------------------




Balance at June 30, 2004 5,017,122 $ 5,018 $ 1,601,346 $ 56,438,903 $(34,584,598) $ -- $ 23,460,669


Acquisition of Drew 876,543 876 -- 7,189,478 -- -- 7,190,354
Exercise of common stock

purchase warrants 32,855 33 -- (33) -- -- --

Exercise of stock options 13,500 13 -- 29,782 -- -- 29,795

Increase in investment --
based on a readily available
market value becoming
available -- -- -- -- -- 3,282,955 3,282,955

Unrealized gains on securities -- -- -- -- -- 944,481 944,481

Foreign currency translation -- -- -- -- -- (83,683) (83,683)

Net income -- -- -- -- 432,409 -- 432,409
--------- --------------------------------------------------------------------------------------

Balance at March 31, 2005 5,940,020 $ 5,940 $ 1,601,346 $ 63,658,130 $(34,152,189) $ 4,143,753 $ 35,256,980
========= ======================================================================================


See notes to condensed consolidated financial statements


5

ESCALON MEDICAL CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements
include the accounts of Escalon Medical Corp. and its subsidiaries, collectively
referred to as "Escalon" or the "Company." Escalon's subsidiaries include
Sonomed, Inc. ("Sonomed"), Sonomed EMS, Srl ("Sonomed EMS"), Escalon Vascular
Access, Inc. ("Vascular"), Escalon Medical Europe GmbH, Escalon Digital Vision,
Inc. ("EMI"), Escalon Pharmaceutical, Inc. ("Pharmaceutical"), Escalon Medical
Holdings, Inc. and Drew Scientific Group, Plc ("Drew"). All intercompany
accounts and transactions have been eliminated. Additionally, the Company's
investment in Ocular Telehealth Management, LLC ("OTM") is accounted for under
the equity method.

The Company operates in the healthcare market, specializing in the
development, manufacture and marketing of (1) ophthalmic medical devices and
pharmaceuticals; (2) instrumentation and consumables for use in human and
veterinary hematology; (3) instrumentation and consumables for the diagnosing
and monitoring of diabetes; and (4) vascular access devices.

The accompanying condensed consolidated financial statements are unaudited
and are presented pursuant to the rules and regulations of the Securities and
Exchange Commission (the "SEC"). Accordingly, these consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto contained in the Company's 2004 Annual Report on
Form 10-K under the Securities Exchange Act of 1934 (the "Exchange Act"). In the
opinion of management, the accompanying consolidated financial statements
reflect all adjustments (which are of a normal recurring nature) necessary for a
fair presentation of the financial position, results of operations and cash
flows for the interim periods presented. The results of operations are not
necessarily indicative of the results that may be expected for the full year.

2. ACQUISITION OF DREW SCIENTIFIC GROUP, PLC

On July 23, 2004, Escalon acquired approximately 67% of the outstanding
ordinary shares of Drew Scientific Group, Plc ("Drew"), a United Kingdom
company, pursuant to the Company's exchange offer for all of the outstanding
ordinary shares of Drew. As of March 31, 2005, Escalon owns approximately 98% of
the ordinary shares of Drew. In the near future, Escalon expects to compel Drew
shareholders to exchange all of the remaining outstanding Drew shares pursuant
to procedures under United Kingdom laws and regulations. The results of Drew's
operations have been included in the consolidated financial statements since
July 23, 2004.

Drew is a diagnostics company specializing in the design, manufacture and
distribution of analytical systems for laboratory testing worldwide. Drew is
focused on providing instrumentation and consumables for diagnosis and
monitoring of medical disorders in the areas of diabetes and hematology. In
addition, Drew supplies diagnostic systems that perform blood component tests.
Escalon has been operating Drew as an additional business segment since July 23,
2004.

The aggregate purchase price of Drew was $8,366,677, net of acquired cash
of $151,996, consisting of direct acquisition costs of $1,088,234, primarily for
investment banking, legal and accounting fees that were directly related to the
acquisition of Drew, and 900,000 shares of Escalon common stock valued at
$7,430,439. The value of the 900,000 shares issued was based on the market price
on the date of acquisition. The remaining shares to be exchanged are recorded as
a liability.


6

The following table summarizes the preliminary purchase price allocation of
estimated fair values of assets acquired and liabilities assumed as of the date
of acquisition of Drew on July 23, 2004. Escalon is in the process of obtaining
additional data, identifying and valuing intangible assets acquired, obtaining
third party appraisals of tangible and intangible assets, and valuing certain
pre-acquisition legal contingencies. Therefore, the allocation of the purchase
price is subject to future refinement, which is expected to be completed no
later than June 30, 2005.



Current assets $ 4,077,843
Furniture and equipment 736,179
Patents 461,779
Other long-term assets 7,406
Goodwill 9,423,470
-----------

Total assets acquired $14,706,677
-----------

Line of credit $ 1,643,473
Current liabilities 3,650,335
Long-term debt 1,046,192
-----------

Total liabilities assumed $ 6,340,000
-----------

Net assets acquired $ 8,366,677
===========


The following pro forma results of operations information has been prepared
to give effect to the purchase of Drew as if such transaction had occurred at
the beginning of the period being presented. The information presented is not
necessarily indicative of results of future operations of the combined
companies.



Three Months Ended Nine Months Ended
March 31, March 31,
2005 2004 2005 2004
---- ---- ---- ----

Revenues $ 7,229,077 $ 7,418,558 $18,882,726 $22,199,685
Cost of goods sold 2,998,745 3,764,836 9,019,701 11,027,768
----------- ----------- ----------- -----------
Gross profit 4,230,332 3,653,722 9,863,025 11,171,917

Operating expenses 3,402,481 2,944,816 9,307,810 8,959,577
Other expense 20,381 596,056 38,869 1,844,770
----------- ----------- ----------- -----------
Net income before taxes 807,470 112,850 516,346 367,570

Provision for income taxes 63,912 (16,534) 83,938 13,649
----------- ----------- ----------- -----------
Net income $ 743,558 $ 129,384 $ 432,408 $ 353,921
=========== =========== =========== ===========

Basic net income per share $ 0.125 $ 0.034 $ 0.075 $ 0.100
=========== =========== =========== ===========
Diluted net income per share $ 0.119 $ 0.030 $ 0.069 $ 0.092
=========== =========== =========== ===========

Weighted average shares - basic 5,932,920 3,839,937 5,787,753 3,524,603
=========== =========== =========== ===========
Weighted average shares - diluted 6,251,847 4,286,761 6,238,515 3,861,901
=========== =========== =========== ===========



7

3. STOCK-BASED COMPENSATION

The Company reports stock-based compensation through the disclosure-only
requirements of the statement of Financial Accounting Standards No. 123 ("SFAS
123"), "Accounting for Stock-Based Compensation," as amended by Statement of
Financial Accounting Standards No. 148 ("SFAS 148"), "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment to FASB No. 123."
Compensation expense for options is measured using the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"). Under APB 25, because the exercise price
of the Company's employee stock options is generally equal to the market price
of the Company's underlying stock on the date of grant, no compensation expense
is recognized.

SFAS 123 establishes an alternative method of expense recognition for
stock-based compensation awards based on fair values. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS 123.



Three Months Ended Nine Months Ended
March 31, March 31,
2005 2004 2005 2004
---- ---- ---- ----

Net Income, as reported $ 743,558 $ 739,174 $ 432,409 $ 2,183,291
Deduct: Total stock-based employee compensation
expense determined under fair value based method

for all awards, net of related tax effects (75,442) (48,440) (435,802) (359,097)
---------- ---------- ----------- -------------
Pro forma net income $ 668,116 $ 690,734 $ (3,393) $ 1,824,194
========== ========== =========== =============
Earnings (loss) per share:

Basic - as reported $ 0.125 $ 0.192 $ 0.075 $ 0.619
========== ========== =========== =============
Basic - pro forma $ 0.113 $ 0.180 $ (0.001) $ 0.518
========== ========== =========== =============
Diluted - as reported $ 0.119 $ 0.172 $ 0.069 $ 0.564
========== ========== =========== =============
Diluted - pro forma $ 0.107 $ 0.161 $ (0.001) $ 0.471
========== ========== =========== =============


The Company has followed the guidelines of SFAS 123 to establish the
valuation of its stock options. The fair value of these equity awards was
estimated at the date of grant using the Black-Scholes option pricing method.
For the purposes of pro forma disclosures, the estimated fair value of the
equity awards is amortized to expense over the options' vesting period. For the
purposes of applying SFAS 123, the estimated per share value of the options
granted during the nine-month period ended March 31, 2005 was between $4.92 and
$5.06. The fair value was estimated using the following assumptions: dividend
yield of 0.0%, volatility of 0.78%; risk-free interest rate of 3.30%; and
expected life of 10 years. The volatility assumption is based on volatility seen
in the Company's stock over the last five years. This assumption was made
according to the guidance of SFAS 123. There is no reason to believe that future
volatility will compare with the historic volatility.


8

4. EARNINGS PER SHARE

The Company follows Financial Accounting Standards Board Statement No. 128,
"Earnings Per Share," in presenting basic and diluted earnings per share. The
following table sets forth the computation of basic and diluted earnings per
share:



Three Months Nine Months
Ended March 31, Ended March 31,
2005 2004 2005 2004
---- ---- ---- ----

Numerator:
Numerator for basic and diluted earnings per share:
Net income $ 743,558 $ 739,174 $ 432,409 $2,183,291
---------- ---------- ---------- ----------
Denominator:
Denominator for basic earnings per
share - weighted average shares 5,932,920 3,839,937 5,787,753 3,524,603
Effect of dilutive securities:
Stock options and warrants 295,470 446,824 427,305 345,298

Shares reserved for future exchange 23,457 -- 23,457 --
---------- ---------- ---------- ----------
Denominator for diluted earnings
earnings per share - weighted average and
assumed conversion 6,251,847 4,286,761 6,238,515 3,869,901
---------- ---------- ---------- ----------
Basic earnings per share $ 0.125 $ 0.192 $ 0.075 $ 0.619
========== ========== ========== ==========
Diluted earnings per share $ 0.119 $ 0.172 $ 0.069 $ 0.564
========== ========== ========== ==========


5. INVENTORY

Inventory, stated at lower of cost (determined on a first-in, first-out
basis) or market, consisted of the following:



March 31, June 30,
2005 2004
---- ----

Raw materials $ 4,015,486 $ 1,132,331

Work in process 526,362 287,276
Finished goods 1,617,905 367,110
----------- -----------
6,159,753 1,786,717
Valuation allowance (364,803) (5,125)
----------- -----------
Total inventory $ 5,794,950 $ 1,781,592
=========== ===========


6. NOTE RECEIVABLE

Escalon entered into an agreement with an individual who was involved in
the development of a drug delivery system. The Company holds a note receivable
from the individual in the amount of $150,000 that is due in May 2005.


9

7. INTANGIBLE ASSETS

ACQUIRED LICENSE AND DISTRIBUTION RIGHTS

In connection with the Company's acquisition of assets of Escalon
Ophthalmics, Inc. ("EOI") in February 1996, a portion of the purchase price was
allocated to certain license and distribution agreements. This cost allocation
was based on an evaluation by management, and such costs were amortized over an
eight-year period using the straight-line method.

Accumulated amortization of license and distribution rights was $180,182
and $180,182 at March 31, 2005 and June 30, 2004, respectively. Amortization
expense for the three-month periods ended March 31, 2005 and 2004 was $-0- and
$1,877, respectively. Amortization expense for the nine-month periods ended
March 31, 2005 and 2004 was $-0- and $13,138, 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 $211,754 and $122,139 at March 31, 2005 and June 30, 2004,
respectively. Amortization expense for the three-month periods ended March 31,
2005 and 2004 was $26,478 and $2,683, respectively. Amortization expense for the
nine-month periods ended March 31, 2005 and 2004 was $89,615 and $8,051,
respectively.

The aggregate amortization expense for each of the next five years for
acquired license and distribution rights and patents is as follows:



Year
ending
June 30,
--------

2005 $ 94,008
2006 94,008
2007 88,125
2008 41,332
2009 30,532
--------
Total $348,005
========



10

GOODWILL, TRADEMARKS AND TRADE NAMES

Goodwill, trademarks and trade names represent intangible assets obtained
from the EOI, Endologix, Inc. ("Endologix"), Sonomed and Drew acquisitions.
Goodwill represents the excess of purchase price over the fair market value of
net assets acquired.

The following table presents unamortized intangible assets by business unit
as of March 31, 2005:



Adjusted
Gross Gross
Carrying Carrying Accumulated Net Carrying
GOODWILL Amount Impairment Amount Amortization Value
------ ---------- ------ ------------ -----

Sonomed $10,547,488 $-- $10,547,488 $(1,021,938) $ 9,525,550

Drew 9,423,470 -- 9,423,470 -- 9,423,470

Vascular 1,149,813 -- 1,149,813 (208,595) 941,218

Medical/Trek 272,786 -- 272,786 (147,759) 125,027
----------- --- ----------- ----------- -----------

Total $21,393,557 $-- $21,393,557 $(1,378,292) $20,015,265
=========== === =========== =========== ===========




Adjusted
Gross Gross
UNAMORTIZED INTANGIBLE Carrying Carrying Accumulated Net Carrying
ASSETS Amount Impairment Amount Amortization Value
------ ---------- ------ ------------ -----

Sonomed $665,000 $ -- $665,000 $(63,194) $601,806

Sonomed EMS 15,100 -- 15,100 -- 15,100
-------- ---- -------- -------- --------

Total $680,100 $ -- $680,100 $(63,194) $616,906
======== ==== ======== ======== ========


The following table presents unamortized intangible assets by business unit
as of June 30, 2004:



Adjusted
Gross Gross
Carrying Carrying Accumulated Net Carrying
GOODWILL Amount Impairment Amount Amortization Value
------ ---------- ------ ------------ -----


Sonomed $10,547,488 $ -- $10,547,488 $(1,021,938) $ 9,525,550

Vascular 1,149,813 -- 1,149,813 (208,595) 941,218

Medical/Trek 272,786 -- 272,786 (147,759) 125,027
----------- ---- ----------- ----------- -----------

Total $11,970,087 $ -- $11,970,087 $(1,378,292) $10,591,795
=========== ==== =========== =========== ===========




Adjusted
Gross Gross
UNAMORTIZED INTANGIBLE Carrying Carrying Accumulated Net Carrying
ASSETS Amount Impairment Amount Amortization Value
------ ---------- ------ ------------ -----


Sonomed $665,000 $-- $665,000 $(63,194) $601,806

Sonomed EMS 15,100 -- 15,100 -- 15,100
-------- --- -------- -------- --------

Total $680,100 $-- $680,100 $(63,194) $616,906
======== === ======== ======== ========



11

The following table presents amortized intangible assets by business unit
as of March 31, 2005:



Adjusted
AMORTIZED INTANGIBLE Gross Gross
ASSETS Carrying Carrying Accumulated Net Carrying
PATENTS Amount Impairment Amount Amortization Value
------ ---------- ------ ------------ -----

Drew $ 496,018 $ -- $ 496,018 $ (81,567) $ 414,451

Vascular (pending issuance) 36,916 -- 36,916 -- 36,916

Medical/Trek 257,301 -- 257,301 (130,187) 127,114

Sonomed EMS -- -- -- -- --
--------- ---- --------- --------- ---------
Total $ 790,235 $ -- $ 790,235 $(211,754) $ 578,481
========= ==== ========= ========= =========


The following table presents amortized intangible assets by business unit
as of June 30, 2004:



Adjusted
AMORTIZED INTANGIBLE Gross Gross
ASSETS Carrying Carrying Accumulated Net Carrying
PATENTS Amount Impairment Amount Amortization Value
------ ---------- ------ ------------ -----

Vascular (pending issuance) $ 36,916 $ -- $ 36,916 $ -- $ 36,916

Medical/Trek 257,301 -- 257,301 (122,139) 135,162

Sonomed EMS -- -- -- -- --
--------- ---- --------- --------- ---------
Total $ 294,217 $ -- $ 294,217 $(122,139) $ 172,078
========= ==== ========= ========= =========


8. ACCRUED EXPENSES

The following table presents accrued expenses as of March 31, 2005 and June
30, 2004:



March 31, June 30,
2005 2004
---- ----
(unaudited)

Accrued compensation $ 910,064 $ 908,568

Acquisition expense accruals 793,218 --

Severance accruals 251,202 --

Shares reserved for future exchange 240,084 --
Other accruals 558,767 320,930
---------- ----------

Total $2,753,334 $1,229,498
========== ==========


Accrued compensation as of March 31, 2005 primarily relates to payroll,
bonus and vacation accruals and payroll tax liabilities.

Acquisition expense accruals as of March 31, 2005 primarily relate to
professional fees (attorneys, accountants and other consultants) accruals
related directly to the acquisition of Drew.

Severance accruals as of March 31, 2005 relate to certain former directors
and officers of Drew who management had the intent to terminate as of the
consummation date of the transaction.

Shares reserved for future exchange as of March 31, 2005 relate to the
remaining 23,457 shares that Escalon expects to issue to Drew shareholders who
are compelled to exchange their Drew shares pursuant to procedures under United
Kingdom Laws and regulations. This liability has been valued using the market
price of Escalon on September 22, 2004, the date Escalon could begin to compel
Drew shareholders to tender all remaining shares. This liability will be reduced
as the shareholders exchange the remaining Drew shares.


12

In addition to normal accruals, other accruals as of March 31, 2005 relate
to the remaining lease payments on a facility that had been vacated prior to the
Drew acquisition, accruals for litigation existing prior to the acquisition,
franchise and ad valorem tax accruals, royalty accruals and other sundry
operating expenses and accruals.

9. LINE OF CREDIT AND LONG-TERM DEBT

The Company has two long-term debt facilities through its Drew subsidiary:
the Texas Mezzanine Fund and Symbiotics, Inc. The Texas Mezzanine Fund term debt
is payable in monthly installments of $14,200, which includes interest at a
fixed rate of 8.00%. The note is due in April 2008 and is secured by certain
assets of Drew. The outstanding balance as of March 31, 2005 was $439,413. The
Symbiotics, Inc. term debt, which originated from the acquisition of a product
line from Symbiotics, Inc., is payable in monthly installments of $8,333 with
interest at a fixed rate of 5.00%. The outstanding balance as of March 31, 2005
was $250,004

The schedule below presents principal amortization for the next five years
under each of the Company's loan agreements as of March 31, 2005:



Twelve Months
Ending Texas
March 31, Mezzanine Symbiotics Total
--------- --------- ---------- -----

2005 $127,813 $ 99,996 $227,809
2006 150,606 99,996 250,602
2007 160,994 50,012 211,006

2008 -- -- --

2009 -- -- --
-------- -------- ----------
Total $439,413 $250,004 689,417
======== ========
Current portion of long-term debt 227,809
----------
Long-term portion $ 461,608
==========


10. OTHER REVENUE

Other revenue includes quarterly payments received from:

(1) Bausch & Lomb in connection with the sale of the Silicone Oil product
line;

(2) Royalty payments received from IntraLase Corp. ("IntraLase") relating
to the licensing of the Company's intellectual laser technology; and

(3) Royalty payments received from Bio-Rad Laboratories, Inc. ("Bio-Rad").

For the three-month periods ended March 31, 2005 and 2004, Silicone Oil
revenue totaled $364,000 and $447,000, respectively, IntraLase royalties totaled
$567,000 and $147,000, respectively, and the Bio-Rad royalty was $51,000 for the
three month period ended March 31, 2005. For the nine-month periods ended March
31, 2005 and 2004, Silicone Oil revenue totaled $1,119,000 and $1,481,000,
respectively, IntraLase royalties totaled $970,000 and $297,000, respectively,
and the Bio-Rad royalty was $144,000 for the nine-month period ended March 31,
2005. Accounts receivable as of March 31, 2005 and June 30, 2004 related to
other revenue was $364,002 and $459,727, respectively.


13

BAUSCH & LOMB SILICONE OIL

The Company's 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
through the termination date (August 2005) according to the following schedule:

From 8/13/00 to 8/12/01 100%
From 8/13/01 to 8/12/02 82%
From 8/13/02 to 8/12/03 72%
From 8/13/03 to 8/12/04 64%
From 8/13/04 to 8/12/05 45%

INTRALASE: LICENSING OF LASER TECHNOLOGY

The material terms of the license of the Company's laser patents to
IntraLase, which expires in 2013, provide that the Company will receive a 2.5%
royalty on product sales that are based on the licensed laser patents, subject
to deductions for third party royalties otherwise due and payable to the
Company, and a 1.5% royalty on product sales that are not based on the licensed
laser patents. The Company receives a minimum annual license fee of $15,000 per
year during the remaining term of the license. The minimum annual license fee is
offset against the royalty payments. In addition, the Company owns 252,535
common shares of IntraLase issued pursuant to the license agreement. See also
Note 11 of the Notes to the Condensed Consolidated Financial Statements for a
description of the Company's legal proceedings with Intralase.

The material termination provisions of the license of the laser technology
are as follows:


- Termination by the Company if Intralase defaults in the payment of any
royalty;

- Termination by the Company if Intralase makes any false report;

- Termination by the Company if Intralase defaults in the making of any
required report;

- Termination by either party due to the commission of any material
breach of any covenant or promise by the other party under the license
agreement; or

- Termination of the license by IntraLase after 90 days notice (if
IntraLase were to terminate, it would not be permitted to utilize the
licensed technology necessary to manufacture its current products).

See Note 11 of the Notes to the Condensed Consolidated Financial Statements
for a description of the Company's legal proceedings with IntraLase.

BIO-RAD ROYALTY

The royalty received from Bio-Rad relates to a certain non-exclusive Eighth
Amendment to an OEM Agreement ("OEM Agreement") between the Company's Drew
subsidiary and Bio-Rad, dated July 19, 1994. Bio-Rad pays a royalty based on
sales of certain of Drew's products in certain geographic regions.

The material terms of the OEM agreement, which expires May 15, 2005,
provide as follows:

- Drew receives a royalty of 19.5 cents per test;

- The royalty payments are due 30 days after the end of the month;

- Royalty payments will be made depending on the volume of tests
provided by Bio-Rad. If less than 3,750 tests per month are provided
by Bio-Rad, Bio-Rad will calculate the number of tests used on a
quarterly basis in arrears and pay Drew within 45 days of the end of
the quarter. If more than 3,750 tests per month are provided by
Bio-Rad, Bio-Rad will pay an estimated monthly


14

royalty and within 45 days of the end of the quarter will make final
settlement upon the actual number of tests.

11. COMMITMENTS AND CONTINGENCIES

COMMITMENTS

The Company leases its manufacturing, research and corporate office
facilities and certain equipment under non-cancelable operating lease
arrangements. The Company has also entered into an agreement whereby the Company
is obligated to purchase a contracted minimum amount of product from the other
party to the agreement. The future amounts to be paid under these arrangements
as of March 31, 2005 are as follows:



Twelve Months Ending Lease Purchase
March 31, Obligations Commitments Total
--------- ----------- ------------ -----

2005 $ 790,783 $ 350,000 $1,140,783

2006 722,533 -- 722,533

2007 403,457 -- 403,457

2008 271,083 -- 271,083

2009 272,438 -- 272,438

Thereafter 446,548 -- 446,548
------------------------------------------
Total $2,906,842 $ 350,000 $3,256,842
==========================================



Rent expense charged to operations during the three-month periods ended
March 31, 2005 and 2004 was $231,608 and $99,879, respectively. Rent expense
charged to operations during the nine-month periods ended March 31, 2005 and
2004 was $640,190 and $283,783, respectively.

CONTINGENCIES

ROYALTY AGREEMENT: CLINICAL DIAGNOSTIC SOLUTIONS

Drew and Clinical Diagnostic Solutions, Inc. ("CDS") entered into a Private
Label/Manufacturing Agreement dated April 1, 2002 for the right to sell
formulations or products of CDS including reagents, controls and calibrators
("CDS products") on a private label basis. The agreement term is 15 years and
automatically renews year-to-year thereafter. Drew is obligated to pay CDS a
royalty of 7.5% on all sales of CDS products produced from Drew's United Kingdom
facility.

LEGAL PROCEEDINGS: INTRALASE

On June 10, 2004, Escalon provided notice to IntraLase of the Company's
intention to terminate the license agreement with IntraLase due to IntraLase's
failure to pay certain royalties that the Company believes are due under the
License Agreement. On June 21, 2004, IntraLase sought a preliminary injunction
and a temporary restraining order with the United States District Court for the
Central District of California, Southern District against Escalon to prevent the
termination of the license agreement with IntraLase. The parties subsequently
agreed to stipulate to the temporary restraining order to prevent a termination
of the license agreement and, on July 6, 2004, as mutually agreed by IntraLase
and Escalon, the same district court entered a stipulation and order to remove
from the trial list the hearing on the preliminary injunction. On May 5, 2005
the United States District Court for the Central District of California,
Southern District entered judgment in the litigation between IntraLase Corp.
(Nasdaq: ILSE) and Escalon Medical wherein IntraLase asked the court to validate
its interpretation of certain terms of a licensing agreement relating to the
amount of royalties owed to Escalon Medical. Under the Licensing Agreement,
Escalon Medical granted IntraLase the exclusive right to use Escalon Medical's
patented and non-patented technology in exchange for, among other things,
royalty payments based on a percentage of net sales.

The Court did not agree with IntraLase's interpretation of certain terms
and declared that, under the terms of the License Agreement, IntraLase must pay
Escalon Medical royalties on revenue from maintenance contracts and one-year
warranties. Further, the Court rejected IntraLase's argument that it is entitled
to deduct the value of non-patented components of its ophthalmic products, which
it sells as an integrated unit, from the royalties due Escalon Medical.
Non-patented components of the products include computer monitors, joysticks,
keyboards, universal power supplies, microscope assemblies, installation kits
and syringes. In addition, the Court rejected IntraLase's assertion that account
receivables are not "consideration received" under the License Agreement and
expressly ruled that IntraLase must pay Escalon Medical royalties on IntraLase's
account receivables." The Court agreed with IntraLase, however, holding that
IntraLase is not required to pay royalties on research grants. The Court also
held that IntraLase must give Escalon Medical an accounting of third-party
royalties.

Further, the Court agreed with Escalon Medical in finding that royalties
are "monies" and default in the payment of royalties must be remedied within 15
days of written notice of the default. The Court rejected IntraLase's position
concerning the effective date of the Amended and Restated License Agreement
holding that the effective date of such Agreement was dated October 17, 2000.

In October 1997, Escalon Medical licensed its intellectual laser properties
to IntraLase in exchange for an equity interest in IntraLase as well as
royalties on future product sales. The shares of common stock were restricted
for sale until April 4, 2005 and, according to a Fourth Amended Registration
Right Agreement between Escalon Medical and IntraLase, are now able to be sold.

On May 16, 2005, Escalon Medical filed a complaint against IntraLase in the
Court of Chancery of the State of Delaware for breach of contract and breach of
fiduciary duty arising out of IntraLase's bad faith conduct under, and multiple
breaches of, a license agreement for laser technology. Escalon Medical seeks
declaratory relief, specified damages, and specific performance of its rights
under the license agreement, including its express right under the agreement to
have independent certified accountants audit the books and records of IntraLase
to verify and compute payments due Escalon Medical.

Escalon Medical is record holder of the common stock of IntraLase. On April
22, 2005 Escalon Medical made a formal written demand to inspect certain of
IntraLase's books and records pursuant to Section 220 of the Delaware General
Corporation Law ("DGCL"). IntraLase rejected Escalon Medical's demand.

Escalon is cognizant of the escalating legal expenses and costs associated
with the IntraLase matter. Escalon, however, is taking all necessary actions to
protect its rights and interests under the license agreement. Escalon expects
expenses associated with this litigation to adversely impact earnings in the
near term. Escalon believes that IntraLase has sufficient funds to support such
payments based on its filings with the Securities and Exchange Commission and
filings in connection with this litigation.



15

LEGAL PROCEEDINGS: DREW

Escalon is aware of two lawsuits involving Drew. One was settled during the
second quarter of fiscal 2005. The first lawsuit (not settled) involves the
principal shareholders of an entity previously acquired by Drew for the
collection of unpaid expenses. A counterclaim was filed by Drew for breach of
intellectual property rights and for breach of principal shareholders' covenants
not to compete. This action was filed in the state courts of Connecticut. The
second lawsuit was filed in the state court of Minnesota, but transferred to the
Federal District Court of Minnesota. This action was brought by a distributor
against an entity previously acquired by Drew claiming a breach of a marketing
and distribution agreement. The parties have reached a settlement of this
matter. The distributor has agreed to settle this matter for the sum of $140,000
in exchange for a full, final and complete release of all claims. The settlement
permits Escalon's subsidiary, CDC Acquisition Corp. to retain its claims, which
include indemnification, against a principal shareholder of an entity previously
acquired by CDC Acquisition Corp. Such principal shareholder is also involved in
the previously mentioned Connecticut action. The Company does not believe that
these matters have had or are likely to have a material adverse impact on the
Company's business, financial condition or future results of operations.

OTHER LEGAL PROCEEDINGS

Escalon, from time to time is involved in various legal proceedings and
disputes that arise in the normal course of business. These matters have
included intellectual property disputes, contract disputes, employment disputes
and other matters. The Company does not believe that the resolution of any of
these matters has had or is likely to have a material adverse effect on the
Company's business, financial condition or results of operations.

12. SEGMENTAL INFORMATION

During the three- and nine-month periods ended March 31, 2005 and 2004, the
Company operations were classified into four principal reportable segments that
provide different products or services. This represents a change from fiscal
2004. The Company acquired Drew on July 23, 2004, and subsequently, Drew has
been added as an additional business segment. During the first quarter of fiscal
2005, management also changed the structure of its internal organization that
caused Medical/Trek and EMI to be reported as one reportable segment. The
corresponding interim period has been restated to present comparative
information.

Separate management of each segment is required because each business unit
is subject to different marketing, production and technology strategies.


16

SEGMENTAL STATEMENTS OF OPERATIONS (IN THOUSANDS) - THREE MONTHS ENDED MARCH 31,




Drew Sonomed Vascular Medical/Trek/EMI Total
2005 2004 2005 2004 2005 2004 2005 2004 2005 2004
---------------- ------------------ ----------------- ------------------ -------------------

Product revenue $ 3,007 $ -- $ 1,977 $ 1,978 $ 830 $ 728 $ 433 $ 314 $ 6,247 $ 3,020

Other revenue 51 -- -- -- -- -- 931 593 982 593
---------------- ------------------ ----------------- ------------------ -------------------
Total revenue 3,058 -- 1,977 1,978 830 728 1,364 907 7,229 3,613
---------------- ------------------ ----------------- ------------------ -------------------
Costs and expenses:

Cost of goods sold 1,700 -- 662 811 379 362 258 192 2,999 1,365

Operating expenses 1,538 -- 747 757 451 367 665 297 3,401 1,421
---------------- ------------------ ----------------- ------------------ -------------------
Total costs and expenses 3,238 -- 1,409 1,568 830 729 923 489 6,400 2,786
---------------- ------------------ ----------------- ------------------ -------------------

(Loss)/income from operations (180) -- 568 410 -- (1) 441 418 829 827
Other income and
expenses:

Equity in OTM -- -- -- -- -- -- (14) -- (14) --

Interest income -- -- -- -- -- -- 9 9 9 9

Interest expense (16) -- -- (91) -- (3) -- -- (16) (94)
---------------- ------------------ ----------------- ------------------ -------------------
Total other income and
expenses (16) -- -- (91) -- (3) (5) 9 (21) (85)
---------------- ------------------ ----------------- ------------------ -------------------

(Loss)/income before taxes (196) -- 568 319 -- (4) 436 427 808 742

Income taxes -- -- -- -- -- (1) 64 4 64 3
---------------- ------------------ ----------------- ------------------ -------------------
Net (loss)/income $ (196) $ -- $ 568 $ 319 $ -- $ (3) $ 372 $ 423 $ 744 $ 739
================ ================== ================= ================== ===================
Depreciation and
amortization $ -- $ -- $ 6 $ 6 $ 11 $ 11 $ 24 $ 41 $ 41 $ 58
Assets $ 8,975 $ -- 13,499 $ 12,169 $ 2,172 $ 2,107 $ 16,084 $ 14,783 $ 40,730 $ 29,059
Expenditures for
long-lived assets $ 18 $ -- $ -- $ 5 $ 4 $ -- $ -- $ -- $ 22 $ 5


SEGMENTAL STATEMENTS OF OPERATIONS (IN THOUSANDS) - NINE MONTHS ENDED MARCH 31,



Drew Sonomed Vascular Medical/Trek/EMI Total
2005 2004 2005 2004 2005 2004 2005 2004 2005 2004
-------------- ------------------- ------------------ ------------------- ------------------

Product revenue $ 7,775 $ -- $ 5,494 $ 5,648 $ 2,246 $ 2,191 $ 1,135 $ 1,166 $ 16,650 $ 9,005

Other revenue 144 -- -- -- -- -- 2,090 1,778 2,234 1,778
-------------- ------------------- ------------------ ------------------- ------------------
Total revenue 7,919 -- 5,494 5,648 2,246 2,191 3,225 2,944 18,884 10,783
-------------- ------------------- ------------------ ------------------- ------------------
Costs and expenses:

Cost of goods sold 4,867 -- 2,360 2,191 1,069 942 725 694 9,021 3,827

Operating expenses 3,929 -- 2,148 2,251 1,212 1,239 2,020 901 9,309 4,391
-------------- ------------------- ------------------ ------------------- ------------------
Total costs and expenses 8,796 -- 4,508 4,442 2,281 2,181 2,745 1,595 18,330 8,218
-------------- ------------------- ------------------ ------------------- ------------------
(Loss)/income from operations (877) -- 986 1,206 (35) 10 480 1,349 554 2,565
Other income and
expenses:

Equity in OTM -- -- -- -- -- -- (50) -- (50) --

Interest income 4 -- -- -- -- -- 50 10 54 10

Interest expense (70) -- -- (310) (1) (10) 29 -- (42) (320)
-------------- ------------------- ------------------ ------------------- ------------------
Total other income and
expenses (66) -- -- (310) (1) (10) 29 10 (38) (310)
-------------- ------------------- ------------------ ------------------- ------------------
(Loss)/income before taxes (943) -- 986 896 (36) -- 509 1,359 516 2,255

Income taxes -- -- -- -- -- -- 84 72 84 72
-------------- ------------------- ------------------ ------------------- ------------------
Net (loss)/income $ (943) $ -- $ 986 $ 896 $ (36) $ -- $ 425 $ 1,287 $ 432 $ 2,183
============== =================== ================== =================== ==================
Depreciation and
amortization $ -- $ -- $ 19 $ 18 $ 34 $ 33 $ 80 $ 136 $ 133 $ 187
Assets $ 8,975 $ -- $13,499 $ 12,169 $ 2,172 $ 2,107 $ 16,084 $ 14,783 $ 40,730 $ 29,059
Expenditures for
long-lived assets $ 26 $ -- $ 23 $ 5 $ 11 $ -- $ 39 $ 37 $ 99 $ 42



17

13. SHAREHOLDERS' EQUITY

WARRANTS TO PURCHASE COMMON STOCK

In connection with debt issued by a former lender to Escalon in November
2001, the Company issued the lender warrants to purchase 60,000 shares of the
Company's common stock at $3.66 per share. The lender exercised the warrants on
December 13, 2004, in a cashless exercise receiving 32,855 shares of the
Company's common stock in satisfaction of the warrants.

In connection with the private placement of the Company's common stock in
March 2004, the Company issued to several accredited investors warrants to
purchase 120,000 shares of the Company's common stock at $15.60 per share. The
warrants are currently exercisable and expire in March 2009.

EXCHANGE OFFER FOR DREW SCIENTIFIC GROUP, PLC

During the nine-month period ended March 31, 2005, the Company issued
876,543 shares of its common stock pursuant to its exchange offer for all of the
outstanding shares of Drew, and had acquired approximately 97% of the
outstanding shares as of that date. In the near future, Escalon expects to
compel Drew shareholders to exchange all of the remaining outstanding shares
pursuant to procedures under United Kingdom laws and regulations. A total of
23,457 shares are reserved for future issuance in connection with this final
exchange.

14. RELATED-PARTY TRANSACTIONS

Escalon and a member of the Company's Board of Directors are founding and
equal members of Ocular Telehealth Management, LLC ("OTM"). OTM is a diagnostic
telemedicine company providing remote examination, diagnosis and management of
disorders affecting the human eye. OTM's initial solution focuses on the
diagnosis of diabetic retinopathy by creating access and providing annual
dilated retinal examinations for the diabetic population. OTM was founded to
harness the latest advances in telecommunications, software and digital imaging
in order to create greater access and a more successful disease management for
populations that are susceptible to ocular disease. Through March 31, 2005,
Escalon had invested $235,000 in OTM and has committed to invest an additional
$21,000. As of March 31, 2005, Escalon owned 50% of OTM. The members of OTM have
agreed to review the operations of OTM after 24 months, at which time the
members each have the right to sell their membership interest back to OTM at
fair market value. The Company will provide administrative support functions to
OTM. Through March 31, 2005, OTM had revenue of $2,235 and incurred expenses of
$102,119 This investment is accounted for under the equity method of accounting
and is included in other assets.

Commencing July 2004, a relative of a senior executive officer of Escalon
began providing legal services to the Company in connection with various legal
proceedings. Expenditures related to this individual during the three and
nine-month periods ended March 31, 2005 were $39,673 and $62,735, respectively.

15. INTRALASE INITIAL PUBLIC OFFERING

In October 1997, Escalon licensed its intellectual laser properties to
IntraLase in exchange for an equity interest of 252,535 shares of common stock
(as adjusted for splits), as well as royalties on future product sales. On
October 7, 2004, IntraLase announced the initial public offering of shares of
its common stock at a price of $13.00 per share. The shares of common stock were
restricted for a period of less than one year and were permitted to be sold
after April 6, 2005 pursuant to a certain Fourth Amended Registration Rights
Agreement between the Company and IntraLase. The Company has historically
accounted for these shares at a $0 basis because a readily determinable market
value was not available. As of March 31, 2005, the shares have been classified
as available-for sale and have a market value of $4,227,436.


18

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

EXECUTIVE OVERVIEW - NINE-MONTH PERIOD ENDED MARCH 31, 2005

The following highlights are discussed in further detail within this
Form 10-Q. The reader is encouraged to read this Form 10-Q in its entirety to
gain a more complete understanding of factors impacting Company performance and
financial condition.

- On July 23, 2004, Escalon acquired 67% of the outstanding ordinary
shares of Drew pursuant to the Company's exchange offer for all of the
outstanding ordinary shares of Drew, and since that date has acquired
98% of the Drew shares. In the near future, Escalon expects to compel
Drew shareholders to exchange all of the remaining outstanding Drew
shares pursuant to procedures under United Kingdom laws and
regulations. Drew's revenue during the period from July 24, 2004
through March 31, 2005 was $7,919,000 and Drew's operations resulted
in a net loss of $943,000. Prior to the acquisition, Drew's ability to
obtain raw materials and components was severely restricted due to
prolonged liquidity constraints. These constraints were pervasive
throughout all of Drew's locations and affected all aspects of Drew's
operations. Escalon's operational priorities with respect to Drew have
been to stabilize and increase Drew's revenue base and to infuse Drew
with working capital in the areas of manufacturing, sales and
marketing and product development in an effort to remove the
pre-acquisition liquidity constraints.

- In connection with the acquisition of Drew, the Company issued 876,543
shares of its common stock during the nine-month period ended March
31, 2005. As of March 31, 2005, 23,457 shares of the Company's common
stock remain reserved for future exchange for Drew shares.

- During the nine-month period ended March 31, 2005, the Company paid
off all of its term debt that existed prior to the acquisition as well
as the outstanding line of credit that existed prior to the
acquisition. During the nine-month period ended March 31, 2005, the
Company also paid off and terminated the outstanding line of credit
Drew maintained with a domestic financial institution as well as the
overdraft line of credit Drew maintained with a United Kingdom
financial institution. During the nine-month period ended March 31,
2005, the Company paid off debt totaling $6,282,000.

- When Drew is excluded, product revenue decreased 1.44% during the
nine-month period ended March 31, 2005 as compared to the same period
last fiscal year. The decrease is primarily related to the Sonomed
business unit, which decreased 2.73% during the period. The decrease
in the Sonomed business unit was primarily caused by a decrease in
demand for the Company's pachymeter product.

- Other revenue increased 25.65% during the nine-month period ended
March 31, 2005 as compared to the same period last fiscal year. The
increase primarily relates to an increase in royalty payments received
from Intralase. During the nine-month period ended March 31, 2005,
5.93% of the Company's revenue was received from Bausch & Lomb in
connection with the Silicone Oil product line. The contract for this
revenue expires in August 2005.

- When Drew is excluded, cost of goods sold as a percentage of product
revenue increased to 46.90% during the nine-month period ended March
31, 2005, as compared to 42.50% of product revenue for the same period
last fiscal year. Cost of goods sold as a percentage of product
revenue increased in each of the Company's business units that existed
prior to the Drew acquisition, each being driven by different factors.
In Sonomed, the increase was primarily related to an increase in
international sales, where the Company generally experiences lower
price per unit on its products. In Vascular, the increase was
primarily related to increases in overtime and temporary labor. In
Medical/Trek/EMI, the increase was primarily related to product mix.


19

- When Drew is excluded, operating expenses increased 22.51% during the
nine-month period ended March 31, 2005 as compared to the same period
last fiscal year. During the nine-month period ended March 31, 2005,
the Company incurred an unusually high amount of legal and accounting
fees primarily related to the Company's first quarterly filing with
the Securities and Exchange Commission, Intralase litigation costs and
increased auditor's fees in proportion to the increase in the
Company's size due to the acquisition of Drew. While the Company
expects these expenses to impact earnings in the near term, it does
not believe that all of these expenses will continue in the future at
such unusually high levels.

- Interest expense decreased during the nine-month period ended March
31, 2005 as compared to the same period last fiscal year. The Company
paid off several of its debt facilities to several entities in advance
of their maturity dates. Additionally, the Company reversed accrued
loan commitment fees as a result of satisfaction of the debt and
release by the lender of those fees. The fees were originally accrued
based on contractual terms.

CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS

Certain statements contained in, or incorporated by reference in, this
Quarterly Report on Form 10-Q are forward-looking statements made pursuant to
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995, which provide current expectations or forecasts of future events. Such
statements can be identified by the use of terminology such as "anticipate,"
"believe," "could," "estimate," "expect," "forecast," "intend," "may," "plan,"
"possible," "project," "should," "will," and similar words or expressions. The
Company's forward-looking statements include certain information relating to
general business strategy, growth strategies, financial results, liquidity,
product development, the introduction of new products, the potential markets and
uses for the Company's products, the Company's regulatory filings with the
United States Food and Drug Administration (the "FDA"), acquisitions, the
development of joint venture opportunities, the loss of revenue due to the
expiration on termination of certain agreements, the effect of competition on
the structure of the markets in which the Company competes and defending the
Company in litigation matters. The reader must carefully consider
forward-looking statements and understand that such statements involve a variety
of risks and uncertainties, known and unknown, and may be affected by
assumptions that fail to materialize as anticipated. Consequently, no
forward-looking statement can be guaranteed, and actual results may vary
materially. It is not possible to foresee or identify all factors affecting the
Company's forward-looking statements, and the reader therefore should not
consider the following list of such factors to be an exhaustive statement of all
risks, uncertainties or potentially inaccurate assumptions.

The Company cautions the reader to consider carefully these factors as
well as the specific factors discussed with each specific forward-looking
statement in this quarterly report and in the Company's other filings with the
SEC. In some cases, these factors have impacted, and in the future (together
with other unknown factors) could impact the Company's ability to implement the
Company's business strategy and may cause actual results to differ materially
from those contemplated by such forward-looking statements. No assurance can be
made that any expectation, estimate or projection contained in a forward-looking
statement can be achieved.

The Company also cautions the reader that forward-looking statements
speak only as of the date made. The Company undertakes no obligation to update
any forward-looking statement, but investors are advised to consult any further
disclosures by the Company on this subject in the Company's filings with the
SEC, especially on Forms 10-K, 10-Q an 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. Although it is not possible to create a
comprehensive list of all factors that may cause actual results to differ from
the Company's forward-looking statements, the most important factors include,
without limitation, the following:


20

ANY ACQUISITIONS, STRATEGIC ALLIANCES, JOINT VENTURES AND DIVESTITURES
THAT THE COMPANY EFFECTS COULD RESULT IN FINANCIAL RESULTS THAT DIFFER
FROM MARKET EXPECTATIONS.

In the normal course of business, the Company engages in discussions
with third parties regarding possible acquisitions, strategic alliances, joint
ventures and divestitures. As a result of any such transactions, the Company's
financial results may differ from the investment community's expectations in a
given quarter. In addition, acquisitions and alliances may require the Company
to integrate a different company culture, management team, business
infrastructure, accounting systems and financial reporting systems, although
there is no assurance that any such acquisitions or alliances will occur. The
Company may have difficulty developing, manufacturing and marketing the products
of a newly acquired company in a way that enhances the performance of the
Company's combined businesses or product lines to realize the value from
expected synergies. Depending on the size and complexity of an acquisition, the
Company's successful integration of the entity depends on a variety of factors
including the retention of key employees and the management of facilities and
employees in separate geographical areas. These efforts require varying levels
of management resources, which may divert the Company's attention from other
business operations. The Company acquired Drew during the first quarter of
fiscal 2005. Drew does not have a history of producing positive operating cash
flows and, as a result, at the time of acquisition, was operating under
financial constraints and was under-capitalized and is expected to negatively
impact the Company's financial results in the short-term. If the Company does
not realize the expected benefits or synergies of such transactions, the
Company's consolidated financial position, results of operations and stock price
could be negatively impacted. Also, the Company's results may be adversely
impacted because of acquisition-related costs, amortization costs for certain
intangible assets and impairment losses related to goodwill in connection with
such transactions.

COSTS ASSOCIATED WITH INTRALASE LITIGATION MAY ADVERSELY IMPACT
EARNINGS IN THE NEAR TERM.

Escalon is cognizant of the escalating legal expenses and costs
associated with the IntraLase matter. Escalon, however, is taking all necessary
actions to protect its rights and interests under the License Agreement. Escalon
expects expenses associated with this litigation to adversely impact earnings in
the near term. Escalon believes that IntraLase has sufficient funds to support
such payments based upon its filings with the Securities and Exchange Commission
and filings in connection with this litigation.

THE COMPANY'S RESULTS FLUCTUATE FROM QUARTER TO QUARTER.

The Company has experienced quarterly fluctuations in operating
results and anticipates continued fluctuations in the future. A number of
factors contribute to these fluctuations:

- Acquisitions, such as Drew, and subsequent integration of the acquired
company, although there is no assurance that such acquisitions will
occur;

- The timing and expense of new product introductions by the Company or
its competitors, although there is no assurance that any new products
will be successfully developed or gain market acceptance;

- The cancellation or delays in the purchase of the Company's products;

- Fluctuations in customer demand for the Company's products;

- Fluctuations in royalty income;

- The gain or loss of significant customers;

- Changes in the mix of products sold by the Company;

- Competitive pressures on prices at which the Company can sell its
products; and

- Announcements of new strategic relationships by the Company or its
competitors.


21

The Company sets its 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 impact on the
Company's results of operations and cash flows. Also, the Company's quarterly
results could fluctuate due to general market conditions in the healthcare
industry or global economy generally, or market volatility unrelated to the
Company's business and operating results.

FAILURE OF THE MARKET TO ACCEPT THE COMPANY'S PRODUCTS COULD ADVERSELY
IMPACT THE COMPANY'S BUSINESS AND FINANCIAL CONDITION.

The Company's business and financial condition will depend in part
upon the market acceptance of the Company's products. The Company cannot assure
that the Company's products will achieve market acceptance. Market acceptance
depends on a number of factors including:

- The price of the products;

- The receipt of regulatory approvals for multiple indications;

- The establishment and demonstration of the clinical safety and
efficacy of the Company's products; and

- The advantages of the Company's products over those marketed by the
Company's competitors.

Any failure to achieve significant market acceptance of the Company's
products will have a material adverse impact on the Company's business.

THE COMPANY WILL NO LONGER RECEIVE REVENUE FROM THE SALE OF SILICONE
OIL BY BAUSCH & LOMB AFTER AUGUST 12, 2005.

The Company received 5.93% and 13.74% of its net revenue during the
nine-month periods ended March 31, 2005 and 2004, respectively, from Bausch &
Lomb's sales of Silicone Oil. The Company is entitled to receive this revenue
from Bausch & Lomb, in varying amounts, through August 12, 2005. The Company's
agreement with Bausch & Lomb, which commenced on August 13, 2000, is structured
so that the Company receives consideration from Bausch & Lomb based on its
adjusted gross profit from its sales of Silicone Oil on a quarterly basis. The
consideration is subject to a factor, which declines according to the following
schedule:



From 8/13/00 to 8/12/01 100%
From 8/13/01 to 8/12/02 82%
From 8/13/02 to 8/12/03 72%
From 8/13/03 to 8/12/04 64%
From 8/13/04 to 8/13/05 45%


The revenue associated with the sale of Silicone Oil by Bausch & Lomb
has no associated expense and consequently provides a gross margin of 100%. Any
significant reduction in this revenue can have a significant negative impact on
gross margin. The Company will not receive revenue related to the Silicone Oil
royalty after August 12, 2005.

THE COMPANY'S PRODUCTS ARE SUBJECT TO STRINGENT ONGOING REGULATION BY
THE FDA AND SIMILAR HEALTH CARE REGULATORY 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 care regulatory authorities in foreign
countries extensively regulate the Company's activity. The Company must obtain
either 510(K) clearances or pre-market approvals and new drug application
approvals prior to marketing a product in the United States. Foreign regulation
also requires that 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.


22


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, FDA revocation would impair the
Company's ability to generate funds from operations.

The FDA and comparable agencies in state and local jurisdictions and in
foreign countries impose substantial requirements upon the manufacturing and
marketing of pharmaceutical and medical device equipment and related
disposables, including the obligation to adhere to the FDA's Good Manufacturing
Practice regulations. Compliance with these regulations requires time-consuming
detailed validation of manufacturing and quality control processes, FDA periodic
inspections and other procedures. If the FDA finds any deficiencies in the
validation processes, for example, the FDA may impose restrictions on marketing
the specific products until such deficiencies are corrected.

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 that the Company will be able to obtain regulatory clearances for
other products in the United States or foreign markets.

The process for obtaining regulatory clearances and approvals underlying
clinical studies for any new products or devices and for multiple indications
for existing products is lengthy and will require substantial commitments of
Escalon's financial resources and Escalon's management's time and effort. Any
delay in obtaining clearances or approvals or any changes in existing regulatory
requirements would materially adversely impact the Company's business.

Escalon's failure to comply with the applicable regulations would subject
the Company to fines, delays or suspensions of approvals or clearances, seizures
or recalls of products, operating restrictions, injunctions or civil or criminal
penalties, which would adversely impact the Company's business, financial
condition and results of operations.

THE SUCCESS OF COMPETITIVE PRODUCTS COULD HAVE AN ADVERSE IMPACT ON THE
COMPANY'S BUSINESS.

The Company faces intense competition in the medical device and
pharmaceutical markets, which are characterized by rapidly changing technology,
short product life cycles, cyclical oversupply and rapid price erosion. Many of
the Company's competitors have substantially greater financial, technical,
marketing, distribution and other resources. The Company's strategy is to
compete primarily on the basis of technological innovation, reliability, quality
and price of the Company's products. Without timely introductions of new
products and enhancements, the Company's products will become technologically
obsolete over time, in which case the Company's revenues and operating results
would suffer. The success of the Company's new product offerings will depend on
several factors, including the Company's ability to:

- Properly identify customer needs;

- Innovate and develop new technologies, services and applications;

- Establish adequate product distribution coverage;

- Obtain and maintain required regulatory approvals from the FDA and
other regulatory agencies;

- Protect the Company's intellectual property;

- Successfully commercialize new technologies in a timely manner;

- Manufacture and deliver the Company's products in sufficient volumes
on time;

- Differentiate the Company's offerings from the offerings of the
Company's competitors;

- Price the Company's products competitively;


23

- Anticipate competitors' announcements of new products, services or
technological innovations; and

- Anticipate general market and economic conditions.


The Company cannot ensure that the Company will be able to compete
effectively in the competitive environments in which the Company operates.

THE COMPANY'S PRODUCTS EMPLOY PROPRIETARY TECHNOLOGY, AND THIS TECHNOLOGY
MAY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF THIRD PARTIES.

The Company holds several United States and foreign patents for the
Company's products. Other parties, however, hold patents relating to similar
products and technologies. If patents held by others were adjudged valid and
interpreted broadly in an adversarial proceeding, the court or agency could deem
them to cover one or more aspects of the Company's products or procedures. Any
claims for patent infringements or claims by the Company for patent enforcement
would consume time, result in costly litigation, divert technical and management
personnel or require the Company to develop non-infringing technology or enter
into royalty or licensing agreements. The Company cannot be certain that the
Company will not be subject to one or more claims for patent infringement, that
the Company would prevail in any such action or that the Company's patents will
afford protection against competitors with similar technology.

If a court determines that any of the Company's products infringes,
directly or indirectly, on a patent in a particular market, the court may enjoin
the Company from making, using or selling the product. Furthermore, the Company
may be required to pay damages or obtain a royalty-bearing license, if
available, on acceptable terms.

LACK OF AVAILABILITY OF KEY SYSTEM COMPONENTS COULD RESULT IN DELAYS,
INCREASED COSTS OR COSTLY REDESIGN OF THE COMPANY'S PRODUCTS.

Although some of the parts and components used to manufacture the
Company's products are available from multiple sources, the Company currently
purchases most of the Company's components from single sources in an effort to
obtain volume discounts. Lack of availability of any of these parts and
components could result in production delays, increased costs, or costly
redesign of the Company's products. Any loss of availability of an essential
component could result in a material adverse change to Escalon's business,
financial condition and results of operations. Some of the Company's suppliers
are subject to the FDA's Good Manufacturing Practice regulations. Failure of
these suppliers to comply with these regulations could result in the delay or
limitation of the supply of parts or components to the Company, which would
adversely impact the Company's financial condition and results of operations.

THE COMPANY'S ABILITY TO MARKET OR SELL THE COMPANY'S PRODUCTS MAY BE
ADVERSELY IMPACTED BY LIMITATIONS ON REIMBURSEMENTS BY GOVERNMENT
PROGRAMS, PRIVATE INSURANCE PLANS AND OTHER THIRD PARTY PAYORS.

The Company's customers bill various third party payors, including
government programs and private insurance plans, for the health care services
provided to their patients. Third party payors may reimburse the customer,
usually at a fixed rate based on the procedure performed, or may deny
reimbursement if they determine that the use of the Company's products was
elective, unnecessary, inappropriate, not cost-effective, experimental or used
for a non-approved indication. Third party payors may deny reimbursement
notwithstanding FDA approval or clearance of a product and may challenge the
prices charged for the medical products and services. The Company's ability to
sell the Company's products on a profitable basis may be adversely impacted by
denials of reimbursement or limitations on reimbursement, compared with
reimbursement available for competitive products and procedures. New legislation
that further reduces reimbursements under the capital cost pass-through system
utilized in connection with the Medicare program could also adversely impact the
marketing of the Company's products.


24

FUTURE LEGISLATION OR CHANGES IN GOVERNMENT PROGRAMS MAY ADVERSELY IMPACT
THE MARKET FOR THE COMPANY'S PRODUCTS.

In the past several years, the federal government and Congress have made
proposals to change aspects of the delivery and financing of health care
services. The Company cannot predict what form any future legislation may take
or its impact on the Company's business. Legislation that sets price limits and
utilization controls adversely impact the rate of growth of the markets in which
the Company participates. If any future health care legislation were to
adversely impact those markets, the Company's product marketing could also
suffer, which would adversely impact the Company's business.

THE COMPANY MAY BECOME INVOLVED IN PRODUCT LIABILITY LITIGATION, WHICH MAY
SUBJECT THE COMPANY TO LIABILITY AND DIVERT MANAGEMENT ATTENTION.

The testing and marketing of the Company's products entails an inherent
risk of product liability, resulting in claims based upon injuries or alleged
injuries or a failure to diagnose associated with a product defect. Some of
these injuries may not become evident for a number of years. Although the
Company is not currently involved in any product liability litigation, the
Company may be party to litigation in the future as a result of an alleged
claim. Litigation, regardless of the merits of the claim or outcome, could
consume a great deal of the Company's time and attention away from the Company's
core businesses. The Company maintains limited product liability insurance
coverage of $1,000,000 per occurrence and $2,000,000 in the aggregate, with
umbrella policy coverage of $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 that product liability insurance coverage will continue to be available
to the Company in the future on reasonable terms or at all.

THE COMPANY'S INTERNATIONAL OPERATIONS COULD BE ADVERSELY IMPACTED BY
CHANGES IN LAWS OR POLICIES OF FOREIGN GOVERNMENTAL AGENCIES AND SOCIAL
AND ECONOMIC CONDITIONS IN THE COUNTRIES IN WHICH THE COMPANY OPERATES.

The Company derives a portion of its revenue from sales outside the United
States. Changes in the laws or policies of governmental agencies, as well as
social and economic conditions, in the countries in which the Company operates
could impact the Company's business in these countries and the Company's results
of operations. Also, economic factors, including inflation and fluctuations in
interest rates and foreign currency exchange rates, and competitive factors such
as price competition, business combinations of competitors or a decline in
industry sales from continued economic weakness, both in the United States and
other countries in which the Company conducts business, could adversely impact
the Company's results of operations.

THE COMPANY IS DEPENDENT ON ITS MANAGEMENT AND KEY PERSONNEL TO SUCCEED.

The Company's principal executive officers and technical personnel have
extensive experience with the Company's products, the Company's research and
development efforts, the development of marketing and sales programs and the
necessary support services to be provided to the Company's customers. Also, the
Company competes with other companies, universities, research entities and other
organizations to attract and retain qualified personnel. The loss of the
services of any of the Company's executive officers or other technical
personnel, or the Company's failure to attract and retain other skilled and
experienced personnel, could have a material adverse impact on the Company's
ability to maintain or expand businesses.

THE MARKET PRICE OF THE COMPANY'S STOCK HAS HISTORICALLY BEEN VOLATILE,
AND THE COMPANY HAS NOT PAID CASH DIVIDENDS.

The volatility of the Company's common stock imposes a greater risk of
capital losses on shareholders as compared to less volatile stocks. In addition,
such volatility makes it difficult to ascribe a stable valuation to a
shareholder's holdings of the Company's common stock. The following factors have
and may continue to have a significant impact on the market price of the
Company's common stock:


25

- Any acquisitions, strategic alliances, joint ventures and
divestitures that the Company effects;

- Announcements of technological innovations;

- Changes in marketing, product pricing and sales strategies or new
products by the Company's competitors;

- Changes in domestic or foreign governmental regulations or
regulatory requirements; and

- Developments or disputes relating to patent or proprietary rights
and public concern as to the safety and efficacy of the procedures
for which the Company's products are used.

Moreover, the possibility exists that the stock market, and in particular
the securities of technology companies such as Escalon, could experience extreme
price and volume fluctuations unrelated to operating performance.

The Company has not paid cash dividends on its common stock and does not
anticipate paying cash dividends in the foreseeable future.

THE IMPACT OF TERRORISM OR ACTS OF WAR COULD HAVE A MATERIAL ADVERSE
IMPACT ON THE COMPANY'S BUSINESS.

Terrorist acts or acts of war, whether in the United States or abroad,
could cause damage or disruption to the Company's operations, its suppliers,
channels to market or customers, or could cause costs to increase, or create
political or economic instability, any of which could have a material adverse
impact on the Company's business.

THE COMPANY'S CHARTER DOCUMENTS AND PENNSYLVANIA LAW MAY INHIBIT A
TAKEOVER.

Certain provisions of Pennsylvania law and the Company's Bylaws could
delay or impede the removal of incumbent directors and could make it more
difficult for a third party to acquire, or discourage a third party from
attempting to acquire, control of the Company. These provisions could limit the
share price that certain investors might be willing to pay in the future for
shares of the Company's common stock. The Company's Board of Directors is
divided into three classes, with directors in each class elected for three-year
terms. The Bylaws impose various procedural and other requirements that could
make it more difficult for shareholders to effect certain corporate actions. The
Company's Board of Directors may issue shares of preferred stock without
shareholder approval on such terms and conditions, and having such rights,
privileges and preferences, as the Board may determine. The rights of the
holders of common stock will be subject to, and may be adversely impacted by,
the rights of the holders of any preferred stock that may be issued in the
future. The Company has no current plans to issue any shares of preferred stock.

COMPANY OVERVIEW

The following discussion should be read in conjunction with interim
condensed consolidated financial statements and the notes thereto, which are set
forth elsewhere in this Quarterly Report on Form 10-Q.

The Company operates in the healthcare market specializing in the
development, manufacture, marketing and distribution of medical devices and
pharmaceuticals in the areas of ophthalmology, diabetes, hematology and vascular
access. The Company and its products are subject to regulation and inspection by
the FDA. The FDA requires extensive testing of new products prior to sale and
has jurisdiction over the safety, efficacy and manufacture of products, as well
as product labeling and marketing. The Company's Internet address is
WWW.escalonmed.com.

In February 1996, the Company acquired substantially all of the assets and
certain liabilities of EOI, a developer and distributor of ophthalmic surgical
products. Prior to this acquisition, the Company devoted substantially all of
its resources to the research and development of ultrafast laser systems
designed for the treatment of ophthalmic disorders. As a result of the EOI
acquisition, Escalon changed its market focus and is no longer developing laser
technology. In October 1997, the Company licensed its intellectual


26

laser property to IntraLase, in return for an equity interest and future
royalties on sales of products. IntraLase undertook responsibility for funding
and developing the laser technology through to commercialization. IntraLase
began selling products related to the laser technology during fiscal 2002 and
announced its initial public offering of its common stock in October 2004. See
Note 10 to Condensed Consolidated Financial Statements for further information.
The Company is in dispute with IntraLase over royalty payments owed to the
Company. See Part II, Item 1, " Legal Proceedings," and Note 11 of the Notes to
Condensed Consolidated Financial Statements for further information.

To further diversify its product portfolio, in January 1999, the Company's
Vascular subsidiary acquired the vascular access product line from Endologix,
formerly Radiance Medical Systems, Inc. Vascular's products use Doppler
technology to aid medical personnel in locating arteries and veins in difficult
circumstances. Currently, this product line is concentrated in the cardiac
catheterization market. In January 2000, the Company purchased Sonomed, a
privately held manufacturer of ophthalmic ultrasound diagnostic equipment.

On July 23, 2004, Escalon acquired 67% of the outstanding ordinary shares
of Drew, a United Kingdom company, pursuant to the Company's exchange offer for
all of the outstanding ordinary shares of Drew, and since that date has acquired
98% of the Drew shares. During the remainder of fiscal 2005, Escalon expects to
compel Drew shareholders to tender all of the remaining outstanding Drew shares
pursuant to procedures under United Kingdom laws and regulations. Drew is a
diagnostics company specializing in the design, manufacture and distribution of
analytical systems for laboratory testing worldwide. Drew is focused on
providing instrumentation and consumables for the diagnosis and monitoring of
medical disorders in the areas of diabetes and hematology. In addition, Drew
supplies diagnostic systems that perform blood component tests.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements requires management to make
estimates and assumptions that impact amounts reported therein. The most
significant of those involve the application for SFAS 142, discussed further in
Note 7 of the Notes to the Condensed Consolidated Financial Statements included
in this Quarterly Report on Form 10-Q. The financial statements are prepared in
conformity with accounting principles generally accepted in the United States of
America, and, as such, include amounts based on informed estimates and judgments
of management. For example, estimates are used in determining valuation
allowances for deferred income taxes, uncollectible receivables, obsolete
inventory, sales returns and rebates and purchased intangible assets. Actual
results achieved in the future could differ from current estimates. The Company
used what it believes are reasonable assumptions and, where applicable,
established valuation techniques in making its estimates.

REVENUE RECOGNITION

The Company recognizes revenue from the sale of its products at the time
of shipment, when title and risk of loss transfer. The Company provides products
to its distributors at agreed wholesale prices and to the balance of its
customers at set retail prices. Distributors can receive discounts for accepting
high volume shipments. The discounts are reflected immediately in the net
invoice price, which is the basis for revenue recognition. No further material
discounts are given.

The Company's considerations for recognizing revenue upon shipment of
product to a distributor are based on the following:

- Persuasive evidence that an arrangement (purchase order and sales
invoice) exists between a willing buyer (distributor) and the
Company that outlines the terms of the sale (company information,
quantity of goods, purchase price and payment terms). The buyer
(distributor) does not have an immediate right of return.

- Shipping terms are ex-factory shipping point. At this point the
buyer (distributor) takes title to the goods and is responsible for
all risks and rewards of ownership, including insuring the goods as
necessary.


27

- The Company's price to the buyer (distributor) is fixed and
determinable as specifically outlined on the sales invoice. The
sales arrangement does not have customer cancellation or termination
clauses.

- The buyer (distributor) places a purchase order with the Company;
the terms of the sale are cash, COD or credit. Customer credit is
determined based on the Company's policies and procedures related to
the buyer's (distributor's) creditworthiness. Based on this
determination, the Company believes that collectibility is
reasonably assured.

The Company assesses collectibility based on creditworthiness of the
customer and past transaction history. The Company performs ongoing credit
evaluations of its customers and does not require collateral from its customers.
For many of the Company's international customers, the Company requires an
irrevocable letter of credit to be issued by the customer before the purchase
order is accepted.

VALUATION OF INTANGIBLE ASSETS

Escalon annually evaluates for impairment its intangible assets and
goodwill in accordance with SFAS 142, "Goodwill and Other Intangible Assets," or
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable. These intangible assets include goodwill, trademarks and
trade names. Factors the Company considers important that could trigger an
impairment review include significant under-performance relative to historical
or projected future operating results or significant negative industry or
economic trends. If these criteria indicate that the value of the intangible
asset may be impaired, an evaluation of the recoverability of the net carrying
value of the asset is made. If this evaluation indicates that the intangible
asset is not recoverable, the net carrying value of the related intangible asset
will be reduced to fair value. Any such impairment charge could be significant
and could have a material adverse impact on the Company's financial statements
if an when an impairment charge is recorded. No impairment losses were recorded
for goodwill, trademarks and trade names during any of the periods presented
based on these evaluations.

INCOME/(LOSS) PER SHARE

The Company computes net income/(loss) per share under the provisions of
SFAS No. 128, Earnings per Share (SFAS 128), and Staff Accounting Bulletin, No.
98 (SAB 98).

Under the provisions of SFAS 128 and SAB 98, basic and diluted net
income/(loss) per share is computed by dividing the net income/(loss) for the
period by the weighted average number of shares of common stock outstanding
during the period. The calculation of diluted net income/(loss) per share
excludes potential common shares if the effect is anti-dilutive. Basic earnings
per share are computed by dividing net income/(loss) by the weighted average
number of shares of common stock outstanding during the period. Diluted earnings
per share are determined in the same manner as basic earnings per share, except
that the number of shares is increased by assuming exercise of dilutive stock
options and warrants using the treasury stock method.

TAXES

Estimates of taxable income of the various legal entities and
jurisdictions are used in the tax rate calculation. Management uses judgment in
estimating what the Company's income will be for the year. Since judgment is
involved, there is a risk that the tax rate may significantly increase or
decrease in any period.

In determining income (loss) for financial statement purposes, management
must make certain estimates and judgments. These estimates and judgments occur
in the calculation of certain tax liabilities and in the determination of the
recoverability of certain of the deferred tax assets, which arise from temporary
differences between the tax and financial statement recognition of revenue and
expense. SFAS 109 also requires that the deferred tax assets be reduced by a
valuation allowance, if based on the available evidence, it is more likely than
not that all or some portion of the recorded deferred tax assets will not be
realized in future periods.


28

In evaluating the Company's ability to recover the Company's deferred tax
assets, management considers all available positive and negative evidence
including the Company's past operating results, the existence of cumulative
losses and near-term forecasts of future taxable income that is consistent with
the plans and estimates management is using to manage the underlying businesses.

Through March 31, 2005, the Company has recorded a full valuation
allowance against the Company's net operating losses due to the uncertainty of
their realization as a result of the Company's earnings history, the number of
years the Company's net operating losses and tax credits can be carried forward,
the existence of taxable temporary differences and near-term earnings
expectations. The amount of the valuation allowance could decrease if facts and
circumstances change that materially increase taxable income prior to the
expiration of the loss carryforwards. Any reduction would reduce (increase) the
income tax expense (benefit) in the period such determination is made by the
Company.

THREE- AND NINE-MONTH PERIODS ENDED MARCH 31, 2005 AND 2004

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, 2005 and 2004.



Three-Month Periods Ended March 31, Nine-Month Periods Ended March 31,
------------------------------------------ ------------------------------------------
2005 2004 % Change 2005 2004 % Change
------- ------- -------- ------- ------- --------

Product revenue:
Drew $ 3,007 $ -- 100.00% $ 7,775 $ -- 100.00%
Sonomed 1,977 1,978 -0.05% 5,494 5,648 -2.73%
Vascular 830 728 14.01% 2,246 2,191 2.51%
Medical/Trek/EMI 433 314 37.90% 1,135 1,166 -2.66%
------- ------- ------ ------- ------- ------
$ 6,247 $ 3,020 106.85% $16,650 $ 9,005 84.90%
======= ======= ====== ======= ======= ======


Product revenue increased $3,227,000, or 106.85%, to $6,247,000 during the
three-month period ended March 31, 2005 as compared to the same period last
fiscal year. The increase is primarily attributed to the acquisition of Drew on
July 23, 2004. If Drew is excluded, product revenue increased $220,000, or
7.28%, to $3,240,000. In the Sonomed business unit, product revenue decreased
$1,000, or 0.05% during the three-month period ended March 31, 2005 as compared
to the same period last fiscal year. The decrease in Sonomed product revenue was
primarily caused by a decrease in demand for the Company's pachymeter product.
Unit sales of the pachymeter decreased by 68.67% as compared to the same period
last fiscal year. The domestic market for pachymeters had previously expanded
due to enhanced techniques in glaucoma screening performed by optometrists.
Historically, the typical optometrist had not been a user of the pachymeter.
Domestic demand for the pachymeter returned to historic levels during the fourth
quarter of fiscal 2004 due to market saturation and increased price competition
within the marketplace. Sales of Sonomed's new EZ-Scan product line have offset
the aforementioned declines. In the Vascular business unit, revenue increased
$102,000, or 14.01%, to $830,000 during the three-month period ended March 31,
2005 as compared to the same period last fiscal year. The increase in Vascular
product revenue was primarily caused by an increase in direct sales to end users
by the Company's domestic sales team and, to a lesser extent, increases in the
European market. These increases were partially offset by decreases in revenue
from the Company's distributor network. The Company has terminated its
relationship with several of its distributors during the current fiscal year. In
the Medical/Trek/EMI business unit, product revenue increased $119,000, or
37.90%, to $433,000 during the three-month period ended March 31, 2005 as
compared to the same period last fiscal year. The increase in Medical/Trek/EMI
product revenue is primarily attributed to an $82,000 increase in OEM revenue
from Bausch & Lomb.

Product revenue increased $7,645,000, or 84.90%, to $16,650,000 during the
nine-month period ended March 31, 2005 as compared to the same period last
fiscal year. The increase is attributed to the


29

acquisition of Drew on July 23, 2004. If Drew is excluded, product revenue
decreased $130,000, or 1.44%, to $8,875,000. In the Sonomed business unit,
product revenue decreased $154,000, or 2.73%, to $5,494,000 during the
nine-month period ended March 31, 2005 as compared to the same period last
fiscal year. The decrease in Sonomed product revenue was primarily caused by a
decrease in demand for the Company's pachymeter product. Unit sales of the
pachymeter decreased by 72.14% as compared to the same period last fiscal year.
The domestic market for pachymeters had previously expanded due to enhanced
techniques in glaucoma screening performed by optometrists. Historically, the
typical optometrist had not been a user of the pachymeter. Domestic demand for
the pachymeter returned to historic levels during the fourth quarter of fiscal
2004 due to market saturation and increased price competition within the
marketplace. Sales of Sonomed's new EZ-Scan product line have partially offset
the aforementioned declines. In the Vascular business unit, product revenue
increased $55,000, or 2.51%, to $2,246,000 during the nine-month period ended
March 31, 2005 as compared to the same period last fiscal year. The increase in
Vascular product revenue was primarily caused by an increase in direct sales to
end users by the Company's domestic sales team and, to a lesser extent,
increases in the European market. These increases were partially offset by
decreases in revenue from the Company's distributor network. The Company has
terminated its relationship with several of its distributors during the current
fiscal year. In the Medical/Trek/EMI business unit, product revenue decreased
$31,000, or 2.66%, to $1,135,000 during the nine-month period ended March 31,
2005 as compared to the same period last fiscal year. Sales of the Company's CFA
digital imaging system and related consumables decreased $96,000 due to
increased price competition. This decrease was partially offset by an $81,000
increase in OEM revenue from Bausch & Lomb.

Other revenue increased $389,000, or 65.60%, to $982,000 during the
three-month period ended March 31, 2005 as compared to the same period last
fiscal year. The increase is primarily attributed to a $420,000 increase in
royalty payments received from Intralase related to the licensing of the
Company's intellectual laser technology. Intralase royalties increased partially
due to a court order amending Intralase's method of calculating its royalty
payments to the Company. The Company received $51,000 from Bio-Rad related to an
OEM agreement between Bio-Rad and Drew. This agreement terminates as of May 15,
2005. These increases were partially offset by an $83,000 decrease in royalties
received from Bausch & Lomb in connection with their sales of Silicone Oil. The
Company's contract with Bausch & Lomb calls for annual step-downs in the
calculation of Silicone Oil revenue to be received by the Company from 64% from
August 13, 2003 to August 12, 2004 to 45% from August 13, 2004 to August 12,
2005. The Company's contract with Bausch & Lomb will end in August 2005. For the
three-month period ended March 31, 2005, the step-down under the Company's
contract with Bausch & Lomb caused a $154,000 decrease in Silicone Oil revenue.
The $71,000 offset was due to market demand for the product. The Company does
not have knowledge as to what factors have affected Bausch & Lomb's sales of
Silicone Oil. See Note 10 of the Notes to Condensed Consolidated Financial
Statements for a description of the step-down provisions under the contract with
Bausch & Lomb.

Other revenue increased $456,000, or 25.65%, to $2,234,000 during the
nine-month period ended March 31, 2005 as compared to the same period last
fiscal year. The increase is primarily attributed to a $674,000 increase in
royalty payments received from Intralase related to the licensing of the
Company's intellectual laser technology. Intralase royalties increased partially
due to a court order amending Intralase's method of calculating its royalty
payments to the Company. The Company received $144,000 from Bio-Rad related to
an OEM agreement between Bio-Rad and Drew. This agreement terminates as of May
15, 2005. These increases were partially offset by a $362,000 decrease in
royalties received from Bausch & Lomb in connection with their sales of Silicone
Oil. The Company's contract with Bausch & Lomb will end in August 2005. For the
nine-month period ended March 31, 2005, the step-down under the Company's
contract with Bausch & Lomb caused a $473,000 decrease in Silicone Oil revenue.
The $111,000 offset was due to market demand for the product. The Company does
not have knowledge as to what factors have affected Bausch & Lomb's sales of
Silicone Oil. See Note 10 of the Notes to Condensed Consolidated Financial
Statements for a description of the step-down provisions under the contract with
Bausch & Lomb.


30

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, 2005 and 2004.



Three-Month Periods Ended March 31, Nine-Month Periods Ended March 31,
-------------------------------------------------- -------------------------------------------------
Cost of goods sold: 2005 2004 2005 2004
----------------------- ----------------------- ---------------------- ----------------------
Dollars % Dollars % Dollars % Dollars %
------- ----- ------- ----- ------- ----- ------- -----
(in (in (in (in
thousands) thousands) thousands) thousands)


Drew $1,700 56.53% $ -- 0.00% $4,867 62.60% $ -- 0.00%
Sonomed 662 33.49% 811 41.00% 2,360 42.96% 2,191 38.79%
Vascular 379 45.66% 362 49.73% 1,069 47.60% 942 42.99%
Medical/Trek/EMI 258 59.58% 192 61.15% 725 63.88% 694 59.52%
------ ----- ------ ----- ------ ----- ------ -----
$2,999 48.01% $1,365 45.20% $9,021 54.18% $3,827 42.50%
====== ===== ====== ===== ====== ===== ====== =====


Cost of goods sold totaled $2,999,000, or 48.01% of product revenue, for
the three-month period ended March 31, 2005 as compared to $1,365,000, or 45.20%
of product revenue, for the same period last fiscal year. The increase in cost
of goods sold is primarily attributed to the acquisition of Drew on July 23,
2004. If Drew is excluded, cost of goods sold decreased $66,000, to $1,299,000
or 40.09% of product revenue during the three-month period ended March 31, 2005
as compared to $1,365,000 or 45.20% of product revenue for the same period last
fiscal year. Cost of goods sold in the Sonomed business unit totaled $662,000 or
33.49% of product revenue for the three-month period ended March 31, 2005 as
compared to $811,000, or 41.00% of product revenue for the same period last
fiscal year. The primary factor affecting the decrease in cost off goods sold as
a percentage of product revenue was product mix, most notably the decease in
pachymeter sales and offsetting increase in EZ-Scans. The Company generally
experiences lower margins on pachymeters as compared to EZ-Scans. Cost of goods
sold in the Vascular business unit totaled $379,000, or 45.66% of product
revenue, for the three-month period ended March 31, 2005 as compared to
$362,000, or 49.73% of product revenue for the same period last fiscal year. The
primary factor affecting the decrease in cost of goods sold as a percentage of
product revenue was the increase in direct sales to end users and corresponding
decrease in sales through the Company's distributor network where the Company
generally experiences lower price per unit on its products. Cost of goods sold
in the Medical/Trek/EMI business unit totaled $258,000, or 59.58% of product
revenue, during the three-month period ended March 31, 2005 as compared to
$192,000, or 61.15% of product revenue, during the same period last fiscal year.
Fluctuations in Medical/Trek/EMI cost of goods sold primarily emanates from
product mix, which was primarily controlled by market demand. See the executive
overview for further information regarding the operating results of Drew.

Cost of goods sold totaled $9,021,000, or 54.18% of product revenue, for
the nine-month period ended March 31, 2005 as compared to $3,827,000, or 42.50%
of product revenue for the same period last fiscal year. The increase in cost of
goods sold is primarily attributed to the acquisition of Drew on July 23, 2004.
If Drew is excluded, cost of goods sold increased $327,000, to $4,154,000 or
46.90% of product revenue during the nine-month period ended March 31, 2005 as
compared to $3,827,000 or 42.50% of product revenue for the same period last
fiscal year. Cost of goods sold in the Sonomed business unit totaled $2,360,000
or 42.96% of product revenue for the nine-month period ended March 31, 2005 as
compared to $2,191,000, or 38.79% of product revenue for the same period last
fiscal year. The primary factor affecting the increase in cost of goods sold as
a percentage of product revenue was an increase in international sales, where
the Company generally experiences lower price per unit on its products. Cost of
goods sold in the Vascular business unit totaled $1,069,000, or 47.605 of
product revenue, for the nine-month period ended March 31, 2005 as compared to
$942,000, or 42.99% of product revenue for the same period last fiscal year. The
Company experienced increases in overtime and temporary labor during the
nine-month period ended March 31, 2005 as compared to the same period last
fiscal year. Cost of goods sold in the Medical/Trek/EMI business unit totaled
$725,000, or 63.88% of product revenue, during the nine-month period ended March
31, 2005 as compared to $694,000, or 59.52% of product revenue for the same
period last fiscal year. Fluctuations in Medical/Trek/EMI cost of goods sold
primarily emanates from product mix, which was primarily controlled by market
demand. See the executive overview for further information regarding the
operating results of Drew.


31

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, 2005 and 2004.



Three-Month Periods Ended March 31, Nine-Month Periods Ended March 31,
---------------------------------------- -----------------------------------------
2004 2003 % Change 2004 2003 % Change
------ ------ -------- ------ ------ --------
(in (in (in (in
Marketing,general and thousands) thousands) thousands) thousands)
administrative
expenses:

Drew $1,187 $ -- 100.00% $3,129 $ -- 100.00%
Sonomed 408 285 43.16% 1,085 851 27.50%
Vascular 350 328 6.71% 1,045 982 6.42%
Medical/Trek/EMI 994 641 55.07% 2,791 1,957 42.62%
------ ------ ------ ------ ------ ------
$2,939 $1,254 134.37% $8,050 $3,790 112.40%
====== ====== ====== ====== ====== ======


Marketing, general and administrative expenses increased $1,685,000, or
134.37%, to $2,939,000 during the three-month period ended March 31, 2005 as
compared to the same period last fiscal year. The increase in marketing, general
and administrative expenses was primarily attributed to incremental expenses due
to the acquisition of Drew on July 23, 2004. If Drew is excluded, marketing,
general and administrative expenses increased $498,000, or 39.71%, to
$1,752,000. Marketing, general and administrative expenses in the Sonomed
business unit increased $123,000, or 43.18%, to $408,000 as compared to the same
period last fiscal year. Salaries and other personnel-related expenses increased
$29,000 as a result of increased headcount. Rent expense increased $23,000 due
to the relocation of Sonomed's facility and the corresponding new lease. Sales
meeting expenses, commissions, advertising and consulting increased by a
combined $63,000. Marketing, general and administrative expenses in the Vascular
business unit increased $22,000, or 6.71%, to $350,000 as compared to the same
period last fiscal year. Salaries and other personnel-related expenses increased
$22,000 primarily as a result of increased headcount. Marketing, general and
administrative expenses in the Medical/Trek/EMI business unit increased
$353,000, or 55.07%, to $994,000 as compared to the same period last fiscal
year. Legal and accounting fees increased $184,000. Legal fees increased due to
litigation costs with Intralase, which the Company expects will continue to
impact earnings in the near term. See Note 11 of the Notes to Condensed
Consolidated Financial Statements for a description of Legal Proceedings.
Accounting fees increased due to increased auditor's fees in proportion to the
increase in the Company's size due to the acquisition of Drew on July 23, 2004.
Insurance expense increased $52,000 due to the expiration Drew's insurance
policy and subsequent renewal under Escalon's policy. See the Executive Overview
for further information regarding the operations of Drew.

Marketing, general and administrative expenses increased $4,260,000, or
112.40%, to $8,050,000 during the nine-month period ended March 31, 2005 as
compared to the same period last fiscal year. The increase in marketing, general
and administrative expenses was primarily attributed to incremental expenses due
to the acquisition of Drew on July 23, 2004. If Drew is excluded, marketing,
general and administrative expenses increased $1,131,000, or 29.84%, to
$4,921,000. Marketing, general and administrative expenses in the Sonomed
business unit increased $234,000, or 27.50%, to $1,085,000 as compared to the
same period last fiscal year. Salaries and other personnel-related expenses
increased $89,000 and travel-related expenses increased $38,000 primarily as a
result of increased headcount. Sonomed incurred increased expenses of $43,000
related to moving its facility and increased rent. Advertising expense increased
$34,000. Marketing, general and administrative expenses in the Vascular business
unit increased $63,000, or 6.42%, to $1,045,000 as compared to the same period
last fiscal year. Salaries and other personnel-related expenses increased
$61,000 due to increased headcount. Consulting expense increased $36,000 related
to marketing expenses in the European market. Sales meeting and samples expense
increased by a combined $48,000. Bad debts increased $30,000 as a result of the
termination of distributors. 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
$117,000 decrease in royalty expense. Marketing, general and administrative
expenses in the Medical/Trek/EMI business unit increased $834,000, or 42.62%, to
$2,791,000 as compared to the


32

same period last fiscal year. Legal and accounting fees increased $434,000.
Legal fees increased due to litigation costs with Intralase, which the Company
expects will continue to impact earnings in the near term. See Note 11 of the
Notes to Condensed Consolidated Financial Statements for a description of Legal
Proceedings. Accounting fees increased due to the Company's first quarterly
filing with the Securities and Exchange Commission subsequent to the Drew
acquisition as well as increased auditor's fees in proportion to the increase in
the Company's size due to the acquisition of Drew on July 23, 2004.
Personnel-related expenses increased $141,000 primarily due to increased
headcount. Investor relations increased $99,000. Insurance expense increased
$58,000 due to the expiration Drew's insurance policy and subsequent renewal
under Escalon's policy. See the Executive Overview for further information
regarding the operations of Drew.

Research and development expenses increased $297,000, or 177.84%, to
$464,000 during the three-month period ended March 31, 2005 as compared to the
same period last fiscal year. The increase in research and development expenses
was attributed to incremental expenses due to the acquisition of Drew on July
23, 2004. If Drew is excluded, research and development expenses decreased
$57,000, or 34.13% as compared to the same period last fiscal year.

Research and development expenses increased $657,000, or 109.50%, to
$1,257,000 during the nine-month period ended March 31, 2005 as compared to the
same period last fiscal year. The increase in research and development expenses
was attributed to incremental expenses due to the acquisition of Drew on July
23, 2004. If Drew is excluded, research and development expenses decreased
$143,000, or 23.83% as compared to the same period last fiscal year.

Escalon recognized a loss of $14,000 and $50,000 related to its investment
in OTM during the three and nine-month periods ended March 31, 2005,
respectively. The share of OTM's loss recognized by the Company is in direct
proportion to the Company's ownership equity in OTM. OTM began operations during
the three-month period ended September 30, 2004. See related Party transactions
for further information regarding OTM.

Interest income was $9,000 and $9,000 for the three-month periods ended
March 31, 2005 and 2004, respectively, and was $54,000 and $10,000 for the
nine-month periods ended March 31, 2005 and 2004, respectively. The increase
relates to higher average cash balances in the current fiscal year.

Interest expense was $16,000 and $94,000 for the three-month periods ended
March 31, 2005 and 2004, respectively, and was $43,000 and $320,000 for the
nine-month periods ended March 31, 2005 and 2004, respectively. The decrease
relates to lower average debt balances in the current fiscal year.


33

LIQUIDITY AND CAPITAL RESOURCES

Changes in overall liquidity and capital resources from continuing
operations during the nine-month period ended March 31, 2005 are reflected in
the following table:



March 31, June 30,
(Dollars are in thousands) 2005 2004
------- -------

Current assets $18,278 $17,566
Less: Current liabilities 5,080 3,600
------- -------
Working capital $13,198 $13,966
Current ratio 3.6 to 1 4.9 to 1

- -----------------------------------------------------------------------
Notes payable and current maturities $ 228 $ 1,872
Long-term debt 462 2,396
------- -------
Total debt $ 690 $ 4,268
Total equity 35,257 23,461
------- -------
Total capital $35,947 $27,729
Total debt to total capital 1.92% 15.39%


WORKING CAPITAL POSITION

Working capital decreased $768,000 as of March 31, 2005 and the current
ratio decreased to 3.6 to 1 from 4.9 to 1 when compared to June 30, 2004. The
decrease in working capital was caused primarily by the pay-off of all of the
Company's pre-acquisition debt as well as substantially all of the debt acquired
from Drew. The Company paid off $6,282,000 during the nine-month period ended
March 31, 2005. The primary offset to this decrease in working capital was the
$4,227,000 increase in available for sale securities, which relates to the
Company's ownership of common stock in Intralase.

CASH USED IN OPERATING ACTIVITIES

Cash flows from operating activities decreased by $5,249,000 for the
nine-month period ended March 31, 2005 as compared to the same period last
fiscal year. Apart from year-over-year decreased net profitability of
$1,750,000, the Company also put an additional $3,239,000 into working capital.
These funds have primarily been used for planned inventory increases at Drew and
increases at Sonomed, increases in Drew accounts receivable and decreases in
Drew accounts payable.

CASH FLOWS USED IN INVESTING AND FINANCING ACTIVITIES

Cash flows used in investing activities relate primarily to acquisition
costs related to Drew, the Company's investment in OTM and the purchase of fixed
assets. Any necessary capital expenditures have generally been funded out of
cash from operations, and the Company is not aware of any factors that would
cause historical capital expenditure levels to not be indicative of capital
expenditures in the future and, accordingly, does not believe that the Company
will have to commit material resources to capital investment for the foreseeable
future.

Cash flows used in financing activities were $6,253,000 during the
nine-month period ended March 31, 2005. The Company paid off all of the
Company's pre-acquisition debt as well as substantially all of the debt acquired
from Drew. The Company paid off debt of $6,282,000 during the nine-month period
ended March 31, 2005. See "Debt History" for more information regarding
repayment of the Company's debt facilities.


34

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 principle payments, extend the term of the
repayments and to alter the covenants of the original bank agreement. On
September 30, 2004, the Company paid off and terminated both the remaining term
debt and the outstanding balance on the line of credit. In November 2001, the
Company issued 60,000 warrants to purchase the Company's common stock at $3.66
per share in connection with this debt. The warrants were exercised in December
2004.

On January 21, 1999, the Company's Vascular subsidiary and Endologix
entered into an Assets Sale and Purchase Agreement. Pursuant to this agreement,
the Company acquired for cash the assets of Endologix's vascular access business
in exchange 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 close
of the sale, with a guaranteed minimum of $300,000 per year. On February 1,
2001, the parties amended the agreement to eliminate any future royalty payments
to Endologix. Pursuant to this amendment, the Company paid $17,558 in cash to
Endologix, delivered a short-term note in the amount of $64,884 that was
satisfied in January 2002, delivered a note in the amount of $717,558 payable in
eleven quarterly installments that commenced on April 15, 2002, and issued
50,000 shares of its common stock to Endologix. On September 30, 2004, the
Company paid off the balance of the term debt.

During the three-month period ended December 31, 2004, the Company paid
off and terminated an overdraft line of credit with a United Kingdom financial
institution. The amount available on the line of credit was $689,720. The line
was secured by certain of Drew's current and former directors. During the
three-month period ended December 31, 2004, the Company also paid off and
terminated a line of credit with a domestic financial institution. The amount
available on the line of credit was $2,000,000.

The Company has long-term debt facilities through the Texas Mezzanine Fund
and through Symbiotics, Inc. The Texas Mezzanine Fund term debt is payable in
monthly installments of $14,200, which includes interest at a fixed rate of
8.00%. The note is due in April 2008 and is secured by certain assets of Drew.
The outstanding balance as of March 31, 2005 was $439,413. The Symbiotics, Inc.
term debt, which originated from the acquisition of a product line from
Symbiotics, Inc., is payable in monthly installments of $8,333 with interest at
a fixed rate of 5.00%. The outstanding balance as of March 31, 2005 was
$250,004.


35

BALANCE SHEET

The components of the balance sheet of the Company were increased as of
July 23, 2004 by the acquisition of Drew as follows:



Cash $ 151,996
Accounts receivable 1,263,685
Inventory 2,635,897
Other current assets 178,261
Furniture and equipment 736,179
Goodwill 9,423,470
Patents 461,779
Other long-term assets 7,406
Line of credit 1,643,473
Current liabilities 3,940,100
Liability for shares reserved
for future exchange 597,019
Long-term debt 756,427
Exchange of common stock 6,833,420


These amounts represent an $801,000 net difference from the amounts
reported in the Company's Form 10-Q for the quarter ended September 30, 2004,
which has been recorded as an increase in goodwill. Escalon is in the process of
obtaining additional data, identifying and valuing intangible assets acquired,
obtaining third-party appraisals of tangible and intangible assets, and valuing
certain pre-acquisition legal contingencies. Therefore, the allocation of the
purchase price is subject to future refinement, which is expected to be
completed no later than June 30, 2005.

OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS

Escalon was not a party to any off-balance sheet arrangements as of and
for the nine-month periods ended March 31, 2005 and 2004.

The following table presents the Company's contractual obligations as of
March 31, 2005:



Less than 3-5 More than
Total 1 Year 1-3 Years Years 5 Years
---------- ---------- ---------- ---------- ----------

Long-term debt $ 689,417 $ 227,809 $ 461,608 $ -- $ --
Operating lease agreements 2,906,842 790,783 1,125,990 543,521 446,548
Purchase obligations 350,000 350,000 -- -- --
---------- ---------- ---------- ---------- ----------
$3,946,259 $1,368,592 $1,587,598 $ 543,521 $ 446,548
========== ========== ========== ========== ==========


FORWARD-LOOKING STATEMENT ABOUT SIGNIFICANT ITEMS LIKELY TO IMPACT LIQUIDITY

On July 23, 2004, the Company acquired approximately 67% of the
outstanding ordinary shares of Drew, pursuant to the Company's exchange offer
for all of the outstanding ordinary shares of Drew. As of March 31, 2005, the
Company has acquired approximately 98% of the outstanding ordinary shares of
Drew. In the near future, the Company expects to compel Drew shareholders to
exchange all of the remaining outstanding Drew shares pursuant to procedures
under United Kingdom laws and regulations. Drew does not have a history of
producing positive operating cash flows and, as a result, at the time of
acquisition, was operating under financial constraints and was
under-capitalized. As Drew is integrated into the Company, management will be
working to reverse the situation, while at the same time seeking to strengthen
Drew's market position. As of March 31, 2005, as Drew is not yet wholly owned,
Escalon loaned $5,452,000 to Drew. The funds have been primarily used to procure
components to build up


36

inventory to support the manufacturing process as well as to pay off accounts
payable and debt of Drew. Escalon anticipates that further working capital will
likely be required by Drew.

In October 1997, the Company licensed its intellectual laser properties to
IntraLase in exchange for an equity interest on 252,535 shares of common stock
(as adjusted after splits), as well as royalties on future product sales. On
October 7, 2004, IntraLase announced the initial public offering of shares of
its common stock at a price of $13.00 per share. The Intralase shares have been
classified as available-for-sale securities. Upon the sale of any of these
shares, the Company's net proceeds will be the market price of the shares,
multiplied by the number of shares sold, less any broker commissions. As of May
2, 2005, IntraLase's common stock closed at $16.01 per share on the Nasdaq
National Market. At that price, Escalon's shares of IntraLase were valued at
$4,043,085. The Company cannot assure that it will be able to liquidate its
shares of IntraLase at the current market price. See Note 11 of the Notes to the
Condensed Consolidated Financial Statements for a description of the IntraLase
Litigation.

Escalon realized 5.93% and 13.74%, of its net revenue during the
nine-month periods ended March 31, 2005 and 2004, respectively, from Bausch &
Lomb's sale of Silicone Oil. Silicone Oil revenue is based on sale of the
product by Bausch & Lomb multiplied by a contractual factor that declines on an
annual basis due to a contractual step-down provision. While the Company does
not expect total Silicone Oil revenue to decline rapidly during the remainder of
the contract, any such decrease would have an impact on the Company's financial
position, results of operations and cash flows and the Company's stock price
could be negatively impacted. The Company is entitled to receive this revenue
from Bausch & Lomb, in varying amounts, until August 12, 2005, when all revenues
will cease. See Note 10 of the Notes to the Condensed Consolidated Financial
Statements for a description of the step-down provisions under the contract with
Bausch & Lomb.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE RISK

The table below provides information about the Company's financial instruments,
consisting primarily of fixed interest rate debt obligations. For debt
obligations, the table represents principal cash flows and related interest
rates by expected maturity dates. Interest rates as of March 31, 2005 were fixed
at 8.00% on the Texas Mezzanine Fund term debt, and were fixed at 5.00% on the
Symbiotics, Inc. term debt. See Note 9 of the Notes to the Condensed
Consolidated Financial Statements for further information regarding the
Company's debt obligations.



2004 2005 2006 Thereafter Total
-------- -------- ----------- ---------- --------

Texas Mezzanine Fund Note $127,813 $150,606 $ 160,994 $ -- $439,413
Interest rate 8.00% 8.00% 8.00% --
Symbiotics, Inc. Note 99,996 99,996 50,012 -- 250,004
Interest rate 5.00% 5.00% 5.00% --
-------- -------- ----------- -------- --------
$227,809 $250,602 $ 211,006 $ -- $689,417
======== ======== =========== ======== ========


EXCHANGE RATE RISK

During the three-month periods ended March 31, 2005 and 2004,
approximately 36.05% and 19.93%, respectively, of Escalon consolidated net
revenue was derived from international sales. During the nine-month periods
ended March 31, 2005 and 2004, approximately, 35.87% and 17.11%, respectively,
of Escalon consolidated net revenue was derived from international sales. Prior
to the acquisition of Drew, the price of all product sold overseas was
denominated in United States Dollars and consequently the Company incurred no
exchange rate risk on revenue. However, a portion of Drew's product revenue is
denominated in United Kingdom Pounds. During the three-month period ended March
31, 2005, Drew recorded $819,955 of revenue denominated in United Kingdom Pounds
and during the period from July 24,


37

2004 through March 31, 2005, Drew recorded $2,544,223 of revenue denominated in
United Kingdom Pounds.

Drew incurs a portion of its expenses denominated in United Kingdom
Pounds. During the three-month period ended March 31, 2005, Drew incurred
$1,017,230 of expense denominated in United Kingdom Pounds and during the period
from July 24, 2004 through March 31, 2005, Drew incurred $2,990,046 of expense
denominated in United Kingdom Pounds. The Company's Sonomed business unit incurs
a portion of its marketing expenses in the European market, the majority of
which are transacted in Euros. For the three-month periods ended March 31, 2005
and 2004, these expenses totaled $33,517 and $23,046, respectively, and during
the nine-month periods ended March 31, 2005 and 2004, these expenses totaled
$117,123 and $99,282, 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. For the three-month
periods ended March 31, 2005 and 2004, these expenses totaled $38,670 and
$41,280, respectively, and during the nine-month periods ended March 31, 2005
and 2004, these expenses totaled $123,756 and $50,177, respectively.

The Company may begin to experience fluctuations, beneficial or adverse,
in the valuation of currencies in which the Company transacts its business,
namely the United States Dollar, the United Kingdom Pound and the Euro.

ITEM 4. CONTROLS AND PROCEDURES

(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

The Company's management, with the participation of the Company's Chief
Executive Officer and Senior Vice President of Finance, has evaluated the
effectiveness of the Company's disclosure controls and procedures (as such term
is defined in Rule 13a-15(e) and 15(d)-15(e) under the 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
recording, on a timely basis, information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act.

(B) INTERNAL CONTROLS OVER FINANCIAL REPORTING

There have not been any changes in the Company's internal control over
financial reporting (as such term is defined in Rule 13a-15(f) under the
Exchange Act) during the third fiscal quarter ended March 31, 2005 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

On June 10, 2004, Escalon provided notice to IntraLase of the Company's
intention to terminate the license agreement with IntraLase due to IntraLase's
failure to pay certain royalties that the Company believes are due under the
License Agreement. On June 21, 2004, IntraLase sought a preliminary injunction
and a temporary restraining order with the United States District Court for the
Central District of California, Southern District against Escalon to prevent the
termination of the license agreement with IntraLase. The parties subsequently
agreed to stipulate to the temporary restraining order to prevent a termination
of the license agreement and, on July 6, 2004, as mutually agreed by IntraLase
and Escalon, the


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same district court entered a stipulation and order to remove from the trial
list the hearing on the preliminary injunction. On May 5, 2005 the United States
District Court for the Central District of California, Southern District entered
judgment in the litigation between IntraLase Corp. (Nasdaq: ILSE) and Escalon
Medical wherein IntraLase asked the court to validate its interpretation of
certain terms of a licensing agreement relating to the amount of royalties owed
to Escalon Medical. Under the Licensing Agreement, Escalon Medical granted
IntraLase the exclusive right to use Escalon Medical's patented and non-patented
technology in exchange for, among other things, royalty payments based on a
percentage of net sales.

The Court did not agree with IntraLase's interpretation of certain terms
and declared that, under the terms of the License Agreement, IntraLase must pay
Escalon Medical royalties on revenue from maintenance contracts and one-year
warranties. Further, the Court rejected IntraLase's argument that it is entitled
to deduct the value of non-patented components of its ophthalmic products, which
it sells as an integrated unit, from the royalties due Escalon Medical.
Non-patented components of the products include computer monitors, joysticks,
keyboards, universal power supplies, microscope assemblies, installation kits
and syringes. In addition, the Court rejected IntraLase's assertion that account
receivables are not "consideration received" under the License Agreement and
expressly ruled that IntraLase must pay Escalon Medical royalties on IntraLase's
account receivables." The Court agreed with IntraLase, however, holding that
IntraLase is not required to pay royalties on research grants. The Court also
held that IntraLase must give Escalon Medical an accounting of third-party
royalties.

Further, the Court agreed with Escalon Medical in finding that royalties
are "monies" and default in the payment of royalties must be remedied within 15
days of written notice of the default. The Court rejected IntraLase's position
concerning the effective date of the Amended and Restated License Agreement
holding that the effective date of such Agreement was dated October 17, 2000.

In October 1997, Escalon Medical licensed its intellectual laser
properties to IntraLase in exchange for an equity interest in IntraLase as well
as royalties on future product sales. The shares of common stock were restricted
for sale until April 4, 2005 and, according to a Fourth Amended Registration
Right Agreement between Escalon Medical and IntraLase, are now able to be sold.

On May 16, 2005, Escalon Medical filed a complaint against IntraLase in
the Court of Chancery of the State of Delaware for breach of contract and breach
of fiduciary duty arising out of IntraLase's bad faith conduct under, and
multiple breaches of, a license agreement for laser technology. Escalon Medical
seeks declaratory relief, specified damages, and specific performance of its
rights under the license agreement, including its express right under the
agreement to have independent certified accountants audit the books and records
of IntraLase to verify and compute payments due Escalon Medical.

Escalon Medical is record holder of the common stock of IntraLase. On
April 22, 2005 Escalon Medical made a formal written demand to inspect certain
of IntraLase's books and records pursuant to Section 220 of the Delaware General
Corporation Law ("DGCL"). IntraLase rejected Escalon Medical's demand.

Escalon is cognizant of the escalating legal expenses and costs associated
with the IntraLase matter. Escalon, however, is taking all necessary actions to
protect its rights and interests under the license agreement. Escalon expects
expenses associated with this litigation to adversely impact earnings in the
near term. Escalon believes that IntraLase has sufficient funds to support such
payments based on its filings with the Securities and Exchange Commission and
filings in connection with this litigation.

Escalon is aware of two lawsuits involving Drew. One was settled during
the second quarter of fiscal 2005. The first lawsuit (not settled) involves the
principal shareholders of an entity previously acquired by Drew for the
collection of unpaid expenses. A counterclaim was filed by Drew for breach of
intellectual property rights and for breach of principal shareholders' covenants
not to compete. This action was filed in the state courts of Connecticut. The
second lawsuit was filed in the state court of Minnesota, but transferred to the
Federal District Court of Minnesota. This action was brought by a distributor
against an entity previously acquired by Drew claiming a breach of a marketing
and distribution agreement. The parties have reached a settlement of this
matter. The distributor has agreed to settle this matter for the sum of $140,000
in exchange for a full, final and complete release of all claims. The settlement
permits Escalon's subsidiary, CDC Acquisition Corp. to retain its claims, which
include indemnification, against a principal shareholder of an entity previously
acquired by CDC Acquisition Corp. Such principal shareholder is also involved in
the previously mentioned Connecticut action. The Company does not believe that
these matters have had or are likely to have a material adverse impact on the
Company's business, financial condition or future results of operations.

Escalon, from time to time is involved in various legal proceedings and
disputes that arise in the normal course of business. These matters have
included intellectual property disputes, contract disputes, employment disputes
and other matters. The Company does not believe that the resolution of any of
these matters has had or is likely to have a material adverse effect on the
Company's business, financial condition or results of operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On July 23, 2004, Escalon acquired approximately 67% of the outstanding
ordinary shares of Drew, a United Kingdom company, pursuant to the Company's
exchange offer for all of the outstanding ordinary shares of Drew, and since
that date has acquired 98% of the Drew shares. In the near future, Escalon
expects to compel Drew shareholders to exchange all of the remaining outstanding
Drew shares pursuant to procedures under United Kingdom laws and regulations.
During the nine-month period ended March 31, 2005, the Company issued 876,543
shares of its common stock and reserved 23,457 shares for future issuance
pursuant to the exchange offer.

The issuances of shares of Escalon common stock in the exchange offer for
the acquisition of Drew were made in accordance with Rule 802 under the
Securities Act of 1933, as an exchange offer for a class of securities of a
foreign private issuer in which the conditions regarding the limitation on
United States ownership of Drew, the equal treatment of any United States
holders and Form CB filings were satisfied.

The Company did not effect any repurchases of its common stock during the
quarter ended March 31, 2005.


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ITEM 6. EXHIBITS

31.1 Certificate of Chief Executive Officer under Rule 13a-14(a).

31.2 Certificate of Senior Vice President - Finance under Rule 13a-14(a).

32.1 Certificate of Chief Executive Officer under Section 1350 of Title
18 of the United States Code.

32.2 Certificate of Senior Vice President - Finance under Section 1350
of Title 18 of the United States Code.


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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

ESCALON MEDICAL CORP.
(Registrant)

Date: May 16, 2005 By: /s/ Richard J. DePiano
-----------------------
Richard J. DePiano
Chairman and Chief
Executive Officer

Date: May 16, 2005 By: /s/ Harry M. Rimmer
--------------------
Harry M. Rimmer
Senior Vice President - Finance


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