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ESMC > SEC Filings for ESMC > Form 10-K on 20-Sep-2013All Recent SEC Filings

Show all filings for ESCALON MEDICAL CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-K for ESCALON MEDICAL CORP


20-Sep-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read together with the consolidated financial statements and notes thereto and other financial information contained elsewhere in this Form 10-K and the discussion under "Risk Factors" included in Item IA of this Form 10-K.
The Company's continuing operations is primarily in two business segments:
Sonomed-Escalon and Escalon Medical Corp. On October 3, 2012 the Company sold its ECD business to ERBA Diagnostics, Inc. The ECD segment consisted of Drew Scientific, Inc., and its wholly owned subsidiaries JAS and Drew Scientific Limited Co. ECD was a diagnostics company specializing in the design, manufacture and distribution of instruments for blood cell counting and blood analysis. ECD was focused on providing instrumentation and consumables for the physician office and veterinary office laboratories. ECD also supplied the reagent and other consumable materials needed to operate the instruments. ECD added to its reagent business with the May 29, 2008 purchase of JAS and on December 31, 2008 BHH acquired certain assets of BioCode. BHH was deconsolidated beginning in the December 31, 2011 quarterly consolidated financial statements after Drew lost control of BHH (see footnote 10 of the Company's June 30, 2013 annual consolidated financial statements for additional information). The sales price was $6,500,000 in cash. The sale of this business will have a material effect on earnings in subsequent periods. ECD prior period amounts are presented as discontinued operations (see footnote 10 to the Notes to Condensed Consolidated


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Financial Statements for additional information).
On October 18, 2012, the Company and its debt holder reached an agreement whereby the Company paid the balance of the seller-provided financing plus accrued interest related to the purchase of certain assets of BHH of $4,367,604 with a one-time payment of $2,487,480 resulting in a gain on extinguishment of debt of $1,880,124 which was included in discontinued operations. The repayment of the debt has reduced the Company's debt related to Biocode to zero.

Sonomed-Escalon segment consists of the operations of Sonomed, EMI, and Trek. Sonomed develops, manufactures and markets ultrasound systems used for diagnosis or biometric applications in ophthalmology. Trek develops, manufactures and distributes ophthalmic surgical products under the Trek Medical Products names. EMI manufactures and markets digital camera systems for ophthalmic fundus photography and image management systems.

The Escalon Medical Corp. business segment includes the administrative corporate operations of the consolidated group.

For a more complete description of these businesses and their products, see Item 1-Business.
Executive Overview-Fiscal Years Ended June 30, 2013 and 2012 The following highlights are discussed in further detail within this Form 10-K. The reader is encouraged to read this Form 10-K in its entirety to gain a more complete understanding of factors impacting Company performance and financial condition.

Product revenue from continuing operations increased approximately $35,000 or 0.3% during the fiscal year ended June 30, 2013 as compared to the prior fiscal year. The increase in revenue is attributed to the increased sales in Sonomed's ultrasound products in domestic market offset by decreased sales of Trek's products.

Cost of goods sold as a percentage of product revenue from continuing operations increased to approximately 51.4% of product revenues during the fiscal year ended June 30, 2013, as compared to approximately 50.3% of product revenue for the prior fiscal year. The increase of 1.1% in cost of goods sold as a percentage of revenue is due mainly to the product mix sold during the current period with reduced margin in ultrasound products.

Operating expenses decreased approximately 2.8% during the fiscal year ended June 30, 2013, as compared to the prior fiscal year. This was due to decreased marketing, general and administrative expenses of 5.0% and offset by an increase of 10.0% in research and development.

The gain from the extinguishment of debt of $1,880,124, the gain on the sale of assets of ECD of $2,712,163, and net income from discontinued operations related to ECD of $110,383 offset by the cumulative translation adjustment ("CTA") related to Drew of $578,422, the net loss from discontinued operations related to BHH of $186,750, the net loss from operations of $1,233,029 and taxes of $80,000 resulted in net income after taxes of $2,624,469 for the year ended June 30, 2013.

Results of Operations
Fiscal Years Ended June 30, 2013 and 2012 The following table shows consolidated product revenue by business segment, as well as identifying trends in business segment product revenues for the fiscal years ended June 30, 2013 and 2012. Table amounts are in thousands:

                         Fiscal Years Ended June 30,
                         2013             2012      % Change
Product Revenue:
Sonomed-Escalon  $     11,497           $ 11,462       0.3 %
Total            $     11,497           $ 11,462       0.3 %

Consolidated product revenue from continuing operations increased approximately $35,000 or 0.3%, to $11,497,000 during the year ended June 30, 2013 as compared to the last fiscal year. The increase in revenue is attributed to the increased sales in Sonomed's ultrasound products in the domestic market offset by decreased sales of Trek's products.

The following table presents consolidated cost of goods sold by reportable business segment and as a percentage of related segment product revenues for the fiscal years ended June 30, 2013 and 2012. Table amounts are in thousands:


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                          Fiscal Years Ended June 30,
                       2013        %        2012       %
Cost of Goods Sold:
Sonomed-Escalon     $   5,905    51.4 %   $ 5,760    50.3 %
Total               $   5,905    51.4 %   $ 5,760    50.3 %

Consolidated cost of goods sold from continuing operations totaled approximately $5,905,000, or 51.4%, of product revenue from continuing operations, for the fiscal year ended June 30, 2013, as compared to $5,760,000, or 50.3%, of product revenue from continuing operations, for the prior fiscal year. The increase of 1.1% in cost of goods sold as a percentage of revenue is due mainly to the product mix sold during the current period with reduced margin in ultrasound products.
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 fiscal years ended June 30, 2013 and 2012. Table amounts are in thousands:

                                              Fiscal Years Ended June 30,
                                             2013            2012     % Change
Marketing, General and Administrative:
Sonomed-Escalon                        $    3,083          $ 3,066        0.6  %
Escalon Medical                             2,635            2,950      (10.7 )%
Total                                  $    5,718          $ 6,016       (5.0 )%

Consolidated marketing, general and administrative expenses from continuing operations decreased $298,000, or 5%, to $5,718,000 during the fiscal year ended June 30, 2013, as compared to the prior fiscal year.
Marketing, general and administrative expenses in the Sonomed-Escalon business segment increased $17,000, or 0.6%, to $3,083,000, as compared to the same period last fiscal year. The increase is due to an increase in related sales and marketing expenses offset by decreased consulting fees.
Marketing, general and administrative expenses in the corporate segment decreased $315,000, or 10.7% to $2,635,000, as compared to the same period last fiscal year. The decrease is due to reduced payroll, legal and travel expense and depreciation.
The following table presents consolidated research and development expenses from continuing operations by reportable business segment and as a percentage of related segment product revenues for the fiscal years ended June 30, 2013 and 2012.
Table amounts are in thousands:

                                  Fiscal Years Ended June 30,
                                  2013             2012     % Change
Research and Development:
Sonomed Escalon           $     1,105            $ 1,005        10.0 %
Total                     $     1,105            $ 1,005        10.0 %

Consolidated research and development expenses from continuing operations increased $100,000, or 10.0% of product revenue, to $1,105,000 during the fiscal year ended June 30, 2013, as compared to the prior fiscal year. Research and development expenses were primarily expenses associated with the planned introduction of new or enhanced products in the Sonomed-Escalon business unit during the next 12 to 18 months.
Discontinued Operations

For the years ended June 30, 2013 and 2012 the Company had net income from discontinued operations of $3,857,000 and net loss from discontinued operation of $4,294,000, respectively. The current year amount for income is mainly due to a gain from the sale of Drew of $2,712,000, the gain related to the debt settlement of $1,880,000 offset by the cumulative translation adjustment related to Drew of $579,000. The prior year amount for loss from discontinued operations includes a loss


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from discontinued operations of Drew and BHH of $915,000 and $549,000 respectively, and a loss from abandonment of assets of $2,738,000.

Other Income (Expense)
The Company recognized a gain of $14,000 and a loss of approximately $7,000 related to its investment in Ocular Telehealth Management ("OTM") during the fiscal years ended June 30, 2013 and 2012, respectively. OTM began operations during the three-month period ended September 30, 2004. (See note 12 of the notes to the June 30, 2013 consolidated financial statements.) Interest expense was $79,000 and $339,000 for the fiscal years ended June 30, 2013 and 2012, respectively. The decrease is related to the settlement of debt after the sale of Drew on October 3, 2013.

Liquidity and Capital Resources
The following table presents overall liquidity and capital resources as of June 30, 2013 and 2012. Table amounts are in thousands:

                                                             June 30,
                                                        2013           2012
Current Ratio:
Current assets                                      $    6,523     $    7,881
Less: Current liabilities                                2,520          8,063
Working capital                                     $    4,003     $     (182 )
Current ratio                                         2.6 to 1       1.0 to 1
Debt to Total Capital Ratio:
Notes payable and current portion of long-term debt $        -     $    4,450
Total debt                                                   -          4,450
Total equity                                             3,829            645
Total capital                                       $    3,829     $    5,095
Total debt to total capital                                  - %         87.3 %

Working Capital Position
Working capital increased $4,185,000 as of June 30, 2013, and the current ratio increased to 2.6 to 1 from 1.0 to 1 when compared to June 30, 2012. The increase in working capital was caused primarily by the fact that the Company received proceeds of $6,500,000 from the sale of Drew during fiscal year 2013. The Company also settled the short-term debt of $4,368,000 (including accrued interest) with a payment of $2,487,000 and payment of $300,000 for the related party note payable. Overall total current assets decreased $1,358,000 to $6,523,000 in 2013 from $7,881,000 in 2012. Total current liabilities, which consists of all the long term debt, current portion of post-retirement pension benefits, related party note payable, accounts payable, accrued expenses, and liabilities of discontinued operations, decreased $5,543,000 to $2,520,000 in 2013 from $8,063,000 in 2012.
Debt to Total Capital Ratio decreased to 0% in 2013 from 87.3% in 2012 as a result of the increase in total equity of $3,184,000 to $3,829,000 in 2013 from $645,000 in 2012 due mainly to the settlement of debt after the sale of Drew and increase in equity due to gain from the sale of Drew and related gain on the settlement of debt.

Cash Used In or Provided By Operating Activities During fiscal 2013, the Company used approximately $1,934,000 of cash for operating activities as compared to using approximately $794,000 for operating activities during the year ended June 30, 2012.

For the year period ended June 30, 2013, the Company had a net income of $2,624,000, which includes net income from discontinued operations of $3,857,000, an increase in accounts receivable of $382,000, an increase in inventory of $419,000, other income of $14,000, a increase in other current assets of $89,000 and decrease in accrued post retirement benefits of


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$17,000, and a decrease in accounts payable and accrued expenses of $152,000, partially offset by non cash items of depreciation and amortization of $14,000 and compensation expense related to stock options of $44,000.
For the year ended June 30, 2012, the Company had a net loss of $5,945,000, which includes a net loss from discontinued operations of $4,294,000, an increase in inventory of $307,000 and an increase in current and long-term assets of $55,000, partially offset by non cash items of depreciation and amortization of $23,000, compensation expense related to stock options of $73,000 and an increase in accrued post-retirement benefits of $56,000 and were also offset by a decrease in accounts receivable of $656,000 and an increase in accounts payable and accrued expenses of $418,000.
Cash flow from operations also included $314,000 and $93,000 provided by operating activities from discontinued operations for the years ended June 30, 2013 and 2012, respectively. These cash inflows will not recur in future periods.

Cash Flows Used In Investing and Financing Activities Cash flows provided by investing activities for 2013 were approximately $6,486,000 primarily related to the proceeds from the sale of Drew of $6,500,000, offset by purchase of fixed assets from continuing operations of $6,000 and the purchase of fixed assets from discontinued operations of $8,000. Cash flows used in investing activities for 2012 were approximately $79,000. This amount is made up of purchases of fixed assets of $13,000 from continuing operations and purchase of fixed assets of $66,000 from discontinued operations. 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 in the amount of $2,787,000 during 2013 relate to settlement of the debt related to the BHH purchase of $2,487,000 and repayment of a related party note payable of $300,000. Cash flows provided by financing activities for 2012 were approximately $144,000, related to the proceeds from a related party note payable of $300,000 offset by repayment of debt of $156,000.
The Company's forecast of the period of time through which its financial resources will be adequate to support its operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed in "Risk Factors".
If the Company raises funds in the future, the Company may be required to raise those funds through public or private financings, strategic relationships or other arrangements at prices and other terms that may not be as favorable as they would be absent such qualification. The sale of additional equity and debt securities may result in additional dilution to the Company's shareholders. Additional financing may not be available in amounts or on terms acceptable to us or at all.
Debt History
On December 31, 2008, Drew acquired certain assets of Biocode for $5,900,000 (4,200,000 Euros) plus acquisition costs of approximately $300,000. The sales price was payable in cash of approximately $324,000 (approximately 231,000 Euros) and $5,865,000 in debt from Drew. The seller-provided financing was collateralized by certain assets of Biocode. Biocode assets were vertically integrated into the Company's clinical diagnostics business that includes Drew and JAS.
On April 29, 2011 the Company amended its seller financed debt in connection with the Biocode transaction. Under the terms of the debt refinancing, the Company agreed to pay the balance of the seller provided financing of 3,375,000 Euros by the sum per month in euros having an exchange value of $50,000 United States Dollars as of the date of payment. Interest remained unchanged and accrued on the outstanding amount of the purchase price at an interest rate of 7% per year on the basis of the actual days elapsed and a 365 day year. The first payment under the amended agreement was paid on May 31, 2011. Upon the 60th month after this Amendment, the Company agreed to pay the balance of the outstanding amount in euros in full in one payment. At the time of the refinancing, the current portion of our long-term debt was reduced from approximately $2,600,000 to $252,000.
On January 12, 2012 BHH a wholly owned subsidiary of Drew, initiated the filing of an insolvency declaration with the Tribunal de Commerce de Rennes, France ("Commercial Court"). The Commercial Court on January 18, 2012 opened the liquidation proceedings with continuation of BHH's activity for three months and named an administrator to manage BHH. Because BHH was no longer controlled by Drew it was deconsolidated in the December 31, 2011 quarterly consolidated financial statements and prior period amounts are presented as discontinued operations (see footnote 10 to the Notes to Consolidated Financial


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Statements for additional information). This debt was guaranteed by Escalon, and as a result of the insolvency declaration the debt was transferred to Escalon. On May 11, 2012, the holder of debt incurred by the Company in connection with its acquisition of BHH informed the Company that it intended to declare the entire amount in default, seek a judgment from a French Court and then enforce the Company's guarantee for payment. Consequently the Company recorded the entire debt of $4,149,516 as a current liability.
On October 18, 2012, the Company and its debt holder reached an agreement whereby the Company paid off the balance of the seller-provided financing of $4,367,604 with a one-time payment of $2,487,480 resulting in a gain on extinguishment of debt of $1,880,124. The repayment of the debt reduced the Company's debt related to Biocode to zero.

Common Stock
The Company's common stock is currently listed on the NASDAQ Capital Market. In order to continue to be listed on the NASDAQ Capital Market, the following requirements must be met:

Shareholders' equity of $2,500,000 or market value of listed securities of $35,000,000 or net income from continuing operations (in the latest fiscal year or two of the last three fiscal years) of $500,000;

500,000 publicly held shares;

$1,000,000 market value of publicly held shares;

A minimum bid price of $1;

300 round lot shareholders;

Two market makers; and

Compliance with corporate governance standards.

As of September 14, 2013 the Company is compliant with each of these requirements.
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 this Form 10-K. 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.
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.


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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 collectability is reasonably assured.

The Company assesses collectability 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 the provisions of FASB issued authoritative guidance for 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. 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. 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 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 June 30, 2013, the Company has recorded a valuation allowance against the Company's net operating losses for substantially 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 . . .

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