-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, OOqcPNq63AFh6e7uq1UhqrHbmHyaEPIWxYksMxZUeV7ONZBz8R0eSCJgxtbgbyGU nOSFi3NTr56JLCKeydVS1A== 0000893220-05-001217.txt : 20050516 0000893220-05-001217.hdr.sgml : 20050516 20050516161131 ACCESSION NUMBER: 0000893220-05-001217 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20050331 FILED AS OF DATE: 20050516 DATE AS OF CHANGE: 20050516 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ESCALON MEDICAL CORP CENTRAL INDEX KEY: 0000862668 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 330272839 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-20127 FILM NUMBER: 05834540 BUSINESS ADDRESS: STREET 1: 351 EAST CONESTOGA ROAD STREET 2: PLZ LEVEL CITY: WAYNE STATE: PA ZIP: 19087 BUSINESS PHONE: 6106886830 MAIL ADDRESS: STREET 1: 351 EAST CONESTOGA ROAD CITY: WAYNE STATE: PA ZIP: 19087 FORMER COMPANY: FORMER CONFORMED NAME: INTELLIGENT SURGICAL LASERS INC DATE OF NAME CHANGE: 19930328 10-Q 1 w09181e10vq.txt FORM 10-Q FOR ESCALON MEDICAL CORP. 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 38 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. 39 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. 40 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 41 EX-31.1 2 w09181exv31w1.txt CERTIFICATE OF CHIEF EXECUTIVE OFFICER UNDER RULE 13A-14(A) EXHIBIT 31.1 CERTIFICATION I, Richard J. DePiano, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Escalon Medical Corp. for the quarter ended March 31, 2005. 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which the statements were made, not misleading with respect to the periods covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report. 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the Audit Committee of the registrant's Board of Directors (or persons performing the equivalent function): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: May 16, 2005 /s/ Richard J. DePiano ----------------------- Richard J. DePiano Chairman and Chief Executive Officer (Principal Executive Officer) 42 EX-31.2 3 w09181exv31w2.txt CERTIFICATE OF SENIOR VICE PRESIDENT-FINANCE UNDER RULE 13A-14(A) EXHIBIT 31.2 CERTIFICATION I, Harry M. Rimmer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Escalon Medical Corp. for the quarter ended March 31, 2005. 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which the statements were made, not misleading with respect to the periods covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report. 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the Audit Committee of the registrant's Board of Directors (or persons performing the equivalent function): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: May 16, 2005 /s/ Harry M. Rimmer -------------------- Harry M. Rimmer Senior Vice President - Finance (Principal Financial Officer) 43 EX-32.1 4 w09181exv32w1.txt CERTIFICATE OF CHIEF EXECUTIVE OFFICER UNDER SECTION 1350 EXHIBIT 32.1 STATEMENT OF CHAIRMAN AND CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 1350 OF TITLE 18 OF THE UNITED STATES CODE Pursuant to Section 1350 of Title 18 of the United States Code, I, Richard J. DePiano, the Chairman and Chief Executive Officer of Escalon Medical Corp. (the "Registrant"), hereby certify that, to the best of my knowledge: 1. The Company's Form 10-Q Quarterly Report for the period ended March 31, 2005 fully complies with the requirements of Section 13(a) of the Exchange Act; and 2. The information contained in this report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Date: May 16, 2005 /s/ Richard J. DePiano ----------------------- Richard J. DePiano Chairman and Chief Executive Officer A signed copy of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Registrant and will be furnished to the Securities Exchange Commission or its staff upon request. 44 EX-32.2 5 w09181exv32w2.txt CERTIFICATE OF SENIOR VICE PRESIDENT-FINANCE UNDER SECTION 1350 EXHIBIT 32.2 STATEMENT OF SENIOR VICE PRESIDENT - FINANCE PURSUANT TO SECTION 1350 OF TITLE 18 OF THE UNITED STATES CODE Pursuant to Section 1350 of Title 18 of the United States Code, I, Harry M. Rimmer, the Senior Vice President - Finance of Escalon Medical Corp. (the "Registrant"), hereby certify that, to the best of my knowledge: 3. The Company's Form 10-Q Quarterly Report for the period ended March 31, 2005 fully complies with the requirements of Section 13(a) of the Exchange Act; and 4. The information contained in this quarterly report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Date: May 16, 2005 /s/ Harry M. Rimmer -------------------- Harry M. Rimmer Senior Vice President - Finance A signed copy of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Registrant and will be furnished to the Securities Exchange Commission or its staff upon request. 45 -----END PRIVACY-ENHANCED MESSAGE-----