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ESMC > SEC Filings for ESMC > Form 10-Q on 14-Nov-2011All Recent SEC Filings

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Form 10-Q for ESCALON MEDICAL CORP


14-Nov-2011

Quarterly Report


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

Forward Looking Statements

Certain statements contained in, or incorporated by reference in, this report 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 FDA, acquisitions, the development of joint venture opportunities, intellectual property and patent protection and infringement, 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, increased legal, accounting and Sarbanes-Oxley compliance costs, defending the Company in litigation matters and the Company's cost saving initiatives. 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 list of such factors contained in its periodic report on Form 10-K for the year ended June 30, 2011 and this Form 10-Q quarterly report to be an exhaustive statement of all risks, uncertainties or potentially inaccurate assumptions.


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Executive Overview - Three-Month Period Ended September 30, 2011

The following highlights are discussed in further detail within this report. The reader is encouraged to read this report in its entirety to gain a more complete understanding of factors impacting the Company's performance and financial condition.

Product revenue from continuing operations decreased approximately $453,000 or 6.1% during the three-month period ended September 30, 2011 as compared to the same period of last fiscal year. The decrease is related to sales decreases in the Company's ECD segment of approximately 7.7% and in the Sonomed-Escalon segment of 2.7%.

Other revenue from continuing operations decreased approximately $7,000 or 100 % during the three-month period ended September 30, 2011 as compared to the same period of last fiscal year. This was attributable to decreased Bio-Rad royalties received in the ECD segment.

Cost of goods sold as a percentage of product revenue from continuing operations decreased to approximately 56.6% of product revenues during the three-month period ended September 30, 2011 as compared to approximately 58.4% of product revenue for the same period of last fiscal year.

Total operating expenses decreased approximately 5.4% during the three-month period ended September 30, 2011 as compared to the same period of prior fiscal year. This was due to decreased marketing, general and administrative expenses of 5.6% and a decrease of 3.5% in research and development expenses related to the reduced research and development projects in favor of outsourcing in the ECD segment.

Company Overview

The following discussion should be read in conjunction with interim condensed consolidated financial statements and the notes thereto, which are set forth in Item 1 of this report.

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 and hematology. 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.

Critical Accounting Policies

The preparation of financial statements requires management to make estimates and assumptions that impact amounts reported therein. The most significant of those involve the application of FASB-issued authoritative guidance concerning Revenue Recognition, Goodwill and Other Intangible Assets, discussed further in the notes to consolidated financial statements included in the Form 10-K for the year ended June 30, 2011. 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, warranty liabilities 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.


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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 a right of return.

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

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

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

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

The Company 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, see footnote 4 to consolidated financial statements included in Form 10-K for the year ended June 30, 2011 for details on a goodwill impairment charge related to the carrying amount of EMI's goodwill. These intangible assets include goodwill, trademarks and trade names. Recoverability of these assets is measured by comparison of their carrying amounts to future discounted cash flows the assets are expected to generate. If identifiable intangibles are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds its fair market value. The Company does not amortize intangible assets with indefinite useful lives, rather such assets are required to be tested for impairment at least annually or sooner whenever events or changes in circumstances indicate that the assets may be impaired. The Company performs its intangible asset impairment tests on or about June 30, of each year. Any such impairment charge could be significant and could have a material adverse impact on the Company's financial statements if and when an impairment charge is recorded.

Income/(Loss) Per Share

The Company computes net income/(loss) per share under the provisions of FASB issued authoritative guidance.

Under the provisions of FASB issued authoritative guidance, 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 impact 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.


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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 tax 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 deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenue and expense. FASB issued authoritative guidance concerning accounting for income taxes also requires that the deferred tax assets be reduced by a valuation allowance, if based on the available evidence, it is more likely that not that all or some portion of the recorded deferred tax assets will not be realized in future periods.

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 September 30, 2011, the Company has recorded a valuation allowance against the Company's net operating losses for all of the deferred tax asset due to 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.

The Company has adopted FASB issued guidance related to accounting for uncertainty in income taxes, which provides a comprehensive model for the recognition, measurement, and disclosure in financial statements of uncertain income tax positions that a company has taken or expects to take on a tax return. Under the FASB guidance a company can recognize the benefit of an income tax position only if it is more likely than not (greater than 50%) that the tax position will be sustained upon tax examination, based solely on the technical merits of the tax position. Otherwise, no benefit can be recognized. The tax benefits recognized are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Additionally, companies are required to accrue interest and related penalties, if applicable, on all tax exposures for which reserves have been established consistent with jurisdictional tax laws. The Company has elected to recognize interest expense and penalties related to uncertain tax positions as a component of its provision for income taxes.

Stock-Based Compensation

Stock-based compensation expense for all stock-based compensation awards granted after July 1, 2006 is based on the grant-date fair value estimate in accordance with the provisions of the FASB issued guidance. The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award.

Valuations are based on highly subjective assumptions about the future, including stock price volatility and exercise patterns. The fair value of share-based payment awards was estimated using the Black-Scholes option pricing model. Expected volatilities are based on the historical volatility of the Company's stock. The Company uses historical data to estimate option exercise and employee terminations. The expected term of options granted represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.


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Three-Month Periods Ended September 30, 2011 and 2010

The following table shows consolidated product revenue from continuing
operations by business unit as well as identifying trends in business unit
product revenues for the three-month periods ended September 30, 2011 and 2010.
Table amounts are in thousands:



                                 For the Three Months Ended September 30,
                                2011                2010             % Change
         Product Revenue:

         ECD                $       4,613       $       4,998              -7.7 %
         Sonomed-Escalon            2,407               2,475              -2.7 %


         Total              $       7,020       $       7,473              -6.1 %

Consolidated product revenue decreased approximately $453,000, or 6.1%, to $7,020,000 during the three-month period ended September 30, 2011, as compared to the same period last fiscal year.

In the ECD business segment, product revenue decreased $385,000, or 7.7%, as compared to the same period last fiscal year. The decrease is related to a decrease in revenue at the Biocode facility due to the loss of a large customer during the period and a decline in international export business.

In the Sonomed-Escalon segment, product revenue decreased $68,000, or 2.7%, to $2,407,000 during the three-month period ended September 30, 2011, as compared to the same period last fiscal year. The decrease in revenue is attributed to decreased sales of $108,000 in Sonomed's ultrasound products offset by an increase of $6,000 in EMI's imaging systems and an increase in Trek's surgical and gas products of $34,000.

The following table presents consolidated other revenues by reportable business unit for the three-month periods ended September 30, 2011 and 2010. Table amounts are in thousands:

                                 For the Three Months Ended September 30,
                            2011            2010                 % Change
         Other Revenue:

         ECD               $     0         $     7                         -100 %
         Sonomed-Escalon         0               0                          0.0 %


         Total             $     0         $     7                       -100.0 %

Consolidated other revenue decreased by approximately $7,000, or 100%, to $0 during the three-month period ended September 30, 2011, as compared to the same period last fiscal year. This was attributable to decreased Bio-Rad royalties received in the ECD segment.


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The following table presents consolidated cost of goods sold by reportable business unit and as a percentage of related unit product revenues for the three-month periods ended September 30, 2011 and 2010. Table amounts are in thousands:

                                     For the Three Months Ended September 30,
                                  2011              %              2010         %
         Cost of Goods Sold:

         ECD                   $    2,752            59.7 %      $  2,991       59.8 %
         Sonomed-Escalon            1,224            50.9 %         1,371       55.4 %


         Total                 $    3,976            56.6 %      $  4,362       58.4 %

Consolidated cost of goods sold from continuing operations totaled approximately $3,976,000, or 56.6% of product revenue, for the three-month period ended September 30, 2011, as compared to $4,362,000, or 58.4% of product revenue, for the same period last fiscal year.

Cost of goods sold in the ECD segment totaled $2,752,000, or 59.7% of product revenue, for the three-month period ended September 30, 2011, as compared to $2,991,000, or 59.8% of product revenue, for the same period last fiscal year. Margins on Drew's instruments continue to range between 0% to 20% depending on the product. These lower margin sales are offset by the margins achieved on reagent sales which ranged from 50% to 70% during the periods ended September 30, 2011 and 2010.

Cost of goods sold in the Sonomed-Escalon business segment totaled $1,224,000, or 50.9% of product revenue, for the three-month period ended September 30, 2011, as compared to $1,371,000 or 55.4% of product revenue, for the same period last fiscal year. The decrease in cost of goods sold as percentage of product revenue is related to the decreased direct labor costs in Trek products and change of product mix with increased sales of high margin PacScan products and AXIS imaging software.

The following table presents consolidated marketing, general and administrative expenses from continuing operations as well as identifying trends in business unit marketing, general and administrative expenses for the three-month periods ended September 30, 2011 and 2010. Table amounts are in thousands:

                                                     For the Three Months Ended September 30,
                                                   2011                 2010              % Change
Marketing, General and Administrative:

ECD                                            $       1,986        $       2,192               -9.4 %
Sonomed-Escalon                                          684                  657                4.1 %
Escalon Medical Corp.                                    701                  722               -2.9 %


Total                                          $       3,371        $       3,571               -5.6 %

Consolidated marketing, general and administrative expenses decreased $200,000, or 5.6%, to $3,371,000 during the three-month period ended September 30, 2011, as compared to the same period last fiscal year.

Marketing, general and administrative expenses in the ECD business segment decreased $206,000, or 9.4%, to $1,986,000, as compared to the same period last fiscal year. During the last fiscal year it was decided that all manufacturing operations at our Dallas facility will be outsourced and the facility in Dallas will be closed on or about December 31, 2011. ECD has begun to realize the savings from this decision during the three-months ended September 30, 2011.

Marketing, general and administrative expenses in the Sonomed-Escalon business segment increased $27,000, or 4.1%, to $684,000, as compared to the same period last fiscal year. The increase is related to an increase in sales forces and advertising expenses of EMI, increased consulting and exhibition costs of Sonomed offset by bad-debts adjustment made during the three-month period ended September 30, 2011.

Marketing, general and administrative expenses in the Escalon Medical Corp business segment decreased $21,000, or 2.9%, to $701,000, as compared to the same period last fiscal year.


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The following table presents consolidated research and development expenses as well as identifying trends in business unit research and development expenses for the three-month periods ended September 30, 2011 and 2010. Table amounts are in thousands:

                                      For the Three Months Ended September 30,
                                     2011                2010             % Change
      Research and Development:

      ECD                         $       162         $       189             -14.3 %
      Sonomed-Escalon                     220                 207               6.3 %

      Total                       $       382         $       396              -3.5 %

Consolidated research and development expenses decreased $14,000, or 3.5%, to $382,000 during the three-month period ended September 30, 2011, as compared to the same period last fiscal year. Research and development expenses were primarily expenses associated with the planned introduction of new and or enhanced products in the ECD and Sonomed-Escalon business units.

Research and development expenses in the ECD business segment decreased $27,000, or 14.3%, to $162,000, as compared to the same period last fiscal year. The decrease is due to the cost reduction implemented in prior years which significantly reduced the research and development headcount in favor of outsourcing substantially all future research and development projects on an as needed basis.

Research and development expenses in the Sonomed-Escalon business segment increased $13,000, or 6.3%, to $220,000, as compared to the same period last fiscal year. The increase is related to the increased headcounts in research and development of imaging products partially offset by decreased consulting expense for ultrasound products.

The Company recognized a gain of $1,000 and loss of $23,000 related to its investment in OTM during the three-month periods ended September 30, 2011 and 2010, respectively. OTM began operations during the three-month period ended September 30, 2004. (See Note 6 of the notes to the condensed consolidated financial statements.)

There was no interest income for the three-month periods ended September 30, 2011 and 2010.

Interest expense was $82,000 for each of the three-month periods ended September 30, 2011 and 2010.


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Liquidity and Capital Resources

Changes in overall liquidity and capital resources from continuing operations
during the three-month period ended September 30, 2011 are reflected in the
following table (in thousands):



                                               September 30,        June 30,
                                                   2011               2011

       Current Ratio:

       Current assets                         $        12,219      $   13,262
       Less: Current liabilities                        5,267           5,573

       Working capital                        $         6,952      $    7,689


       Current ratio                               2.3 to 1          2.4 to 1


       Debt to Total Capital Ratio:

       Notes payable and current maturities   $           402      $      278
       Long-term debt                                   4,161           4,506

       Total debt                                       4,563           4,784

       Total equity                                     5,522           6,190

       Total capital                          $        10,085      $   10,974


       Total debt to total capital                       45.2 %          43.6 %

Working Capital Position

Working capital decreased approximately $737,000 as of September 30, 2011, and the current ratio decreased to 2.3 to 1 compared to 2.4 to 1 when compared to June 30, 2011.

Cash Provided by/Used in Operating Activities

During the three-month periods ended September 30, 2011 and 2010, the Company generated cash inflows and outflows from operating activities of $41,000 and $833,000, respectively. The net increase in cash provided by operating activities of approximately $874,000 for the three-month period ended September 30, 2011, as compared to the same period in the prior fiscal year is due primarily to the following factors:

For the three-month period ended September 30, 2011, the Company had a net loss of $790,000 and experienced net cash in flows from a decrease in accounts receivable of $1,169,000, and non-cash expenditures on depreciation and amortization and compensation expense related to stock options of approximately $223,000 and $24,000, respectively. These cash in-flows were partially offset by a decrease in accounts payable, accrued expenses and other liabilities of $433,000 and an increase in current and long-term assets and inventory of $60,000 and $91,000, respectively.

In the prior fiscal period ended September 30, 2010, the Company had a net loss of $649,000, and experienced net cash in flows from an increase in accounts payable, accrued expenses and other liabilities of $640,000, and non-cash expenditures on depreciation and amortization and compensation expense related to stock options of approximately $240,000 and $39,000, respectively. These cash in-flows were partially offset by increases in accounts receivable and inventory, which increased by $356,000 and $762,000, respectively, and income from discontinued operations of $304,000.

Cash Flows Used in Investing and Financing Activities

Cash flows used in investing activities of $7,000 is related to purchase of fixed assets during the three-month period ended September 30, 2011.


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Cash flows used in investing activities of $88,000 is related to investment in . . .

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