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ESMC > SEC Filings for ESMC > Form 10-Q on 14-Feb-2014All Recent SEC Filings

Show all filings for ESCALON MEDICAL CORP

Form 10-Q for ESCALON MEDICAL CORP


14-Feb-2014

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, discontinued operations, research and development, 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, dispositions, 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, compliance with Nasdaq continued listing qualifications, 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, 2013 and this Form 10-Q quarterly report to be an exhaustive statement of all risks, uncertainties or potentially inaccurate assumptions.

Executive Overview-Six-months Ended December 31, 2013 and 2012.

The following highlights are discussed in further detail within this Form 10-Q. The reader is encouraged to read this Form10-Q in its entirety to gain a more complete understanding of factors impacting Company performance and financial condition.

Consolidated product revenue from continuing operations increased approximately $299,000, or 5%, to $6,209,000 during the six-months ended December 31, 2013 as compared to same period of the last fiscal year. The increase in revenue is attributed to an increase of $293,000 in EMI's digital imaging cameras and AXIS image management systems and an increase of $75,000 in Trek products offset by a decrease of $69,000 in Sonomed's ultrasound products.

Consolidated cost of goods sold from continuing operations totaled approximately $3,067,000, or 49.4%, of product revenue from continuing operations for the six months ended December 31, 2013, as compared to $2,972,000, or 50.3%, of product revenue from continuing operations for the same period of the prior fiscal year. The decrease of 0.9% in cost of goods sold as a percentage of revenue is due mainly to the product mix sold during the current period.

Total operating expenses decreased approximately $231,000, or 6.8%, during the six months ended December 31, 2013 as compared to the same period of prior fiscal year. This was due to decreased marketing, general and administrative expenses of $401,000, or 13.9%, offset by an increase of $170,000 or 32.0%, in research and development expenses.

Net loss from continuing operations was approximately $44,000 for the six-months ended December 31, 2013. The Company is planning to increase its research and development expenditures in future quarters as it updates existing products and develops new products. Increases in research and development expenses along with potential fluctuations in sales as the Company updates its product offerings may have a negative impact on future earnings.

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 area of ophthalmology. 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.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. 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, 2013. 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 valuation of 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 upon 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.

The buyer (distributor) places a purchase order with the Company; the terms of the sale are cash in advance, cash on delivery 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, and as circumstances require, evaluates for impairment its intangible assets and goodwill in accordance with FASB guidance related to 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 tax will be for the year. Since judgment is involved, there is a risk that the tax rate may 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 than 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 December 31, 2013, the Company has recorded a valuation allowance against the Company's deferred tax assets arising from net operating losses 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 in the valuation allowance would result in an income tax 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, if any, 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. Results of Operations
Three-month and six-month periods Ended December 31, 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 three-month and six-month periods ended December 31, 2013 and 2012. Table amounts are in thousands:

                                  Three Months Ended December 31,           Six Months ended December 31,
                                   2013          2012      % Change         2013           2012       % Change
Product Revenue:
Sonomed-Escalon                $     3,078     $ 3,641      (15.5 )%   $      6,209     $  5,910         5.0 %
Total                          $     3,078     $ 3,641      (15.5 )%   $      6,209     $  5,910         5.0 %

Consolidated product revenue from continuing operations decreased approximately $563,000, or 15.5%, to $3,078,000 during the three months ended December 31, 2013 as compared to same period of the last fiscal year. The decrease in revenue is attributed to a decrease of $412,000 in Sonomed's ultrasound products, a decrease of $159,000 in EMI's digital imaging cameras and AXIS image management systems offset by an increase of $8,000 in Trek products.
Consolidated product revenue from continuing operations increased approximately $299,000, or 5%, to $6,209,000 during the six months ended December 31, 2013 as compared to same period of the last fiscal year. The increase in revenue is attributed to an increase of $293,000 in EMI's digital imaging cameras and AXIS image management systems and an increase of $75,000 in Trek products offset by a decrease of $69,000 in Sonomed's ultrasound 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 three months and six months ended December 31, 2013 and 2012. Table amounts are in thousands:

                                  Three Months Ended December 31,                    Six Months Ended December 31,
                                2013             %        2012        %           2013           %        2012         %
Cost of Goods Sold:
Sonomed-Escalon           $    1,510           49.1 %   $ 1,776     48.8 %   $   3,067         49.4 %   $ 2,972      50.3 %
Total                     $    1,510           49.1 %   $ 1,776     48.8 %   $   3,067         49.4 %   $ 2,972      50.3 %

Consolidated cost of goods sold from continuing operations totaled approximately $1,510,000, or 49.1%, of product revenue from continuing operations, for the three months ended December 31, 2013, as compared to $1,776,000, or 48.8%, of product revenue from continuing operations, for the same period of the prior fiscal year. The increase of 0.3% in cost of goods sold as a percentage of revenue is due mainly to the decreased margin in digital products.


Consolidated cost of goods sold from continuing operations totaled approximately $3,067,000, or 49.4%, of product revenue from continuing operations, for the six months ended December 31, 2013, as compared to $2,972,000, or 50.3%, of product revenue from continuing operations, for the same period of the prior fiscal year. The decrease of 0.9% in cost of goods sold as a percentage of revenue is due mainly to the increased margin in digital 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 three months and six months ended December 31, 2013 and 2012. Table amounts are in thousands:

                                    Three Months Ended December 31,       Six Months Ended December 31,
                                     2013          2012      % Change         2013         2012      % Change
Marketing, General and
Administrative:
Sonomed-Escalon                  $       711     $   790       (10.0 )%   $    1,442     $ 1,542        (6.5 )%
Corporate                                569         699       (18.6 )%        1,051       1,353       (22.2 )%
Total                            $     1,280     $ 1,489       (14.0 )%   $    2,493     $ 2,895       (13.9 )%

Consolidated marketing, general and administrative expenses from continuing operations decreased $209,000, or 14.0%, to $1,280,000 during the three-months ended December 31, 2013, as compared to the same period of the prior fiscal year.
Marketing, general and administrative expenses in the Sonomed-Escalon business segment decreased $79,000, or 10.0%, to $711,000 during the three-months ended December 31, 2013 as compared to the same period last fiscal year. The decrease is due to a decrease in payroll related to reduction in headcount, commission and travel expense.
Marketing, general and administrative expenses in the Corporate business segment decreased $130,000, or 18.6%, to $569,000 during the three-months ended December 31, 2013, as compared to the same period last fiscal year. The decrease is due to decreased expense in payroll related to the retirement of the CEO, stock option expense, SEC reporting fees, and insurance expense offset by an increase in meeting and exhibition expense.
Consolidated marketing, general and administrative expenses from continuing operations decreased $402,000, or 13.9%, to $2,493,000 during the six-months ended December 31, 2013, as compared to the same period of the prior fiscal year.
Marketing, general and administrative expenses in the Sonomed-Escalon business segment decreased $100,000, or 6.5%, to $1,442,000 during the six-months ended December 31, 2013 as compared to the same period last fiscal year. The decrease is due to a decrease in payroll related to a decrease in headcount, commission, advertising and travel expense.
Marketing, general and administrative expenses in the Corporate business segment decreased $302,000, or 22.2%, to $1,051,000 during the six-months ended December 31, 2013, as compared to the same period last fiscal year. The decrease is due to decreased expense in payroll related to the retirement of the CEO, stock option expense, SEC reporting fees, and insurance expense offset by an increase in meeting and exhibition expense and moving expenses.
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 three-months and six-months ended December 31, 2013 and 2012. Table amounts are in thousands:

                                      Three Months Ended December 31,          Six Months Ended December 31,
                                       2013          2012      % Change        2013         2012     % Change
Research and Development:
Sonomed Escalon                    $       377     $   266         41.7 %   $     700     $  530         32.1 %
Total                              $       377     $   266         41.7 %   $     700     $  530         32.1 %

Consolidated research and development expenses from continuing operations increased $111,000, or 41.7%, to $377,000 during the three-months ended December 31, 2013, as compared to the same period of the prior fiscal year. The increase is related to increased engineering staff and related expenses. Consolidated research and development expenses from continuing operations increased $170,000, or 32.1%, to $700,000 during the six-months ended December 31, 2013, as compared to the same period of 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. The increase is related to increased engineering staff and related expenses. The Company intends to increase research and development expenses throughout the remainder of the fiscal year as it continues to update and develop its product offering.
Discontinued Operations

For the three-months ended December 31, 2013 and 2012, the Company had a net loss and net income from discontinued operations of the BHH and ECD segments of $26,000 and $3,867,000, respectively. For the six-months ended December 31, 2013 and 2012, the Company had a net loss and net income from discontinued operations of the BHH and ECD segments of $51,000 and $4,058,000, respectively.

Other Income (expense)
The Company had other income of $7,000 and $17,000 during the three-months ended December 31, 2013 and 2012, respectively. Other income was $8,000 and $82,000 during the six-months ended December 31, 2013 and 2012, respectively. There was no interest expense for the three-months ended December 31, 2013 and 2012. Interest expense was $0 and $93,000 for the six-months ended December 31, 2013 and 2012, respectively. The decrease in interest expense during the six-month periods is due to the settlement of the BHH acquisition debt in October 2012 (see Note 6 of the notes to the December 31, 2013 condensed consolidated financial statements) and repayment of related party note payable. Liquidity and Capital Resources
The following table presents overall liquidity and capital resources as of December 31, 2013 and June 30, 2013. Table amounts are in thousands:

                                 December 31, 2013     June 30, 2013
Current Ratio:
Current assets                  $           6,707     $       6,523
Less: Current liabilities                   2,849             2,520
Working capital                 $           3,858     $       4,003
Current ratio                            2.4 to 1          2.6 to 1
Debt to Total Capital Ratio:
Note payable and long-term debt $               -     $           -
Total debt                                      -                 -
Total equity                                3,738             3,829
Total capital                   $           3,738     $       3,829
Total debt to total capital                     - %               - %

Working Capital Position
Working capital decreased $145,000 as of December 31, 2013, and the current ratio decreased to 2.4 to 1 from 2.6 to 1 when compared to June 30, 2013. Debt to Total Capital Ratio was 0% as of December 31, 2013 and June 30, 2013, as the Company had no long term debt as of these dates.

On October 3, 2012 the Company sold its Clinical Diagnostics Business to ERBA Diagnostics, Inc. The ECD segment consisted of Drew Scientific, Inc., and its wholly owned subsidiaries JAS and Drew Scientific Limited Co. The sales price was $6,500,000 in cash and the transaction generated a gain on sale of $2,717,000.

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 Biocode 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 has reduced the Company's debt related to Biocode to zero. The total gain from the extinguishment of debt and the gain on the sale of assets, offset by the cumulative translation adjustment related to Drew of $578,422 was $4,019,000 before tax.


The total gain brought the Company back into compliance with the minimum $2,500,000 stockholders' equity requirement for continued listing on the NASDAQ Capital Market as set forth in Listing Rule 5550(b).

The Company expects to have sufficient cash to fund its operations over the next 12 months.

Cash Used In or Provided By Operating Activities

During the six-month periods ended December 31, 2013 and 2012, the Company experienced cash outflows of $71,000, and $1,016,000 respectively. The net decrease in cash used in operating activities of approximately $945,000 for the six-month period ended December 31, 2013, as compared to the same period in the prior fiscal year is due primarily to the following factors:
For the six-month period ended December 31, 2013, the Company had a net loss of $95,000, which includes net loss from discontinued operations of $51,000, and experienced net cash in flows from a decrease in other current and long-term assets of $70,000, a decrease in accounts receivable of $38,000, an increase in accounts payable and accrued expenses of $330,000 and non-cash expenditures on depreciation and amortization and compensation expense related to stock options of approximately $5,000 and $4,000, respectively. These cash in-flows were offset by an increase in inventory and payment of post-retirement benefits of $382,000 and $41,000, respectively. . . .

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