Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-Q

 

 

Mark One

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED March 31, 2012

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION 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

incorporation or organization)

 

(IRS Employer

Identification No.)

435 Devon Park Drive, Building 100

Wayne, PA 19087

  19087
(Address of principal executive offices)   (Zip code)

(610) 688-6830

(Registrant’s telephone number, including area code)

N/A

Former name, former address and former fiscal year, if changed since last report

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 7,526,430 shares of common stock, $0.001 par value, outstanding as of May 14, 2012.

 

 

 


Table of Contents

Escalon Medical Corp.

Form 10-Q Quarterly Report

Table of Contents

 

Part I.

  Financial Statements   
 

Item 1.

 

Condensed Consolidated Financial Statements (Unaudited)

  
   

Condensed Consolidated Balance Sheets as of March 31, 2012 and June 30, 2011 (Unaudited)

     3   
   

Condensed Consolidated Statements of Operations for the three- and nine- month periods ended March 31, 2012 and 2011 (Unaudited)

     4   
   

Condensed Consolidated Statements of Cash Flows for the nine-month periods ended March 31, 2012 and 2011 (Unaudited)

     5   
   

Condensed Consolidated Statement of Shareholders’ Equity for the nine-month period ended March 31, 2012 (Unaudited)

     6   
   

Condensed Consolidated Statements of Comprehensive (Loss) for the three- and nine-month periods ended March 31, 2012 and 2011 (Unaudited)

     7   
   

Notes to Condensed Consolidated Financial Statements

     8   
 

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      18   
 

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      29   
 

Item 4.

  Controls and Procedures      29   

Part II.

  Other Information      29   
 

Item 1.

  Legal Proceedings      29   
 

Item 1A.

  Risk Factors      29   
 

Item 5.

  Other Information      30   
 

Item 6.

  Exhibits      30   

 

2


Table of Contents

Part I. Financial Statements

Item 1. Condensed Consolidated Financial Statements

ESCALON MEDICAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

     March  31,
2012
    June  30,
2011
 
      

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 562,880      $ 1,684,746   

Accounts receivable, net

     3,452,402        3,802,316   

Inventory, net

     4,463,485        5,184,272   

Other current assets

     173,694        248,642   

Assets of discontinued operations

     0        2,342,137   
  

 

 

   

 

 

 

Total current assets

     8,652,461        13,262,113   
  

 

 

   

 

 

 

Property and equipment, net

     373,737        540,919   

Goodwill

     218,208        218,208   

Trademarks and trade names

     694,006        694,006   

Patents, net

     30,277        52,931   

Covenant not to compete and customer lists, net

     600,391        808,640   

Non-current assets of discontinued operations

     0        1,699,527   
  

 

 

   

 

 

 

Total assets

   $ 10,569,080      $ 17,276,344   
  

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Current liabilities:

    

Current portion of long-term debt

   $ 4,149,516      $ 278,278   

Related party note payable

     300,000        0   

Accounts payable

     1,819,125        1,746,951   

Accrued expenses

     1,712,712        1,897,441   

Liabilities of discontinued operations

     0        1,671,422   
  

 

 

   

 

 

 

Total current liabilities

     7,981,353        5,594,092   
  

 

 

   

 

 

 

Long-term debt, net of current portion

     0        4,506,018   

Accrued post-retirement benefits

     986,102        986,102   
  

 

 

   

 

 

 

Total long-term liabilities

     986,102        5,492,120   
  

 

 

   

 

 

 

Total liabilities

     8,967,455        11,086,212   
  

 

 

   

 

 

 

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; 7,526,430 issued and outstanding at March 31, 2012 and June 30, 2011

     7,526        7,526   

Common stock warrants

     132,114        1,733,460   

Additional paid-in capital

     69,353,173        67,694,959   

Accumulated deficit

     (67,368,449     (62,404,014

Accumulated other comprehensive loss

     (522,739     (841,799
  

 

 

   

 

 

 

Total shareholders’ equity

     1,601,625        6,190,132   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 10,569,080      $ 17,276,344   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements

 

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Table of Contents

ESCALON MEDICAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

     Three Months Ended
March 31,
    Nine Months Ended
March 31,
 
     2012     2011     2012     2011  

Net revenues:

        

Product revenue

   $ 6,065,931      $ 6,399,159      $ 18,365,885      $ 19,075,536   

Other revenue

     0        0        0        6,933   
  

 

 

   

 

 

   

 

 

   

 

 

 

Revenues, net

     6,065,931        6,399,159        18,365,885        19,082,469   
  

 

 

   

 

 

   

 

 

   

 

 

 

Costs and expenses:

        

Cost of goods sold

     3,593,302        4,068,483        11,446,127        12,335,468   

Marketing, general and administrative

     2,621,482        2,715,690        7,669,231        8,157,077   

Research and development

     413,874        395,656        1,116,414        1,198,273   

Goodwill impairment

     0        905,810        0        905,810   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

     6,628,658        8,085,639        20,231,772        22,596,628   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (562,727     (1,686,480     (1,865,887     (3,514,159
  

 

 

   

 

 

   

 

 

   

 

 

 

Other (expense) and income:

        

Equity in Ocular Telehealth Management, LLC

     (532     (37,600     612        (71,745

Loss on disposal of assets

     0        0        (86,885     0   

Interest income

     17        83        119        194   

Interest expense

     (76,544     (84,186     (247,094     (244,064
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other (expense) income

     (77,059     (121,703     (333,248     (315,615
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations before taxes

     (639,786     (1,808,183     (2,199,135     (3,829,774

Provision for income taxes

     0        0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss from continuing operations

     (639,786     (1,808,183     (2,199,135     (3,829,774

Net income (loss) from discontinued operations

     0        (113,302     (2,765,300     210,525   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (639,786   ($ 1,921,485   ($ 4,964,435   ($ 3,619,249
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share

        

Basic:

        

Continuing operations

   $ (0.09   $ (0.24   $ (0.29   $ (0.51

Discontinued operations

     0.00        (0.02     (0.37     0.03   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ (0.09   $ (0.26   $ (0.66   $ (0.48
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

        

Continuing operations

   $ (0.09   $ (0.24   $ (0.29   $ (0.51

Discontinued operations

     0.00        (0.02     (0.37     0.03   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ (0.09   $ (0.26   $ (0.66   $ (0.48
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares - basic

     7,526,430        7,526,430        7,526,430        7,526,430   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares - diluted

     7,526,430        7,526,430        7,526,430        7,526,430   
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements

 

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Table of Contents

ESCALON MEDICAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     For the Nine Months
Ended March 31,
 
     2012     2011  

Cash Flows from Operating Activities:

    

Net loss

   $ (4,964,435   $ (3,619,249

Adjustments to reconcile net loss to cash provided by operating activities of continuing operations:

    

Income (loss) from discontinued operations

     2,765,300        (210,525

Depreciation and amortization

     458,921        486,631   

Goodwill impairment

     0        905,810   

Compensation expense related to stock options

     56,868        87,156   

(Income) Loss from Ocular Telehealth Management, LLC

     (612     71,745   

Change in operating assets and liabilities:

    

Accounts receivable, net

     349,914        622,300   

Inventory, net

     720,787        (447,958

Other current and long-term assets

     74,948        251,858   

Accounts payable and accrued expenses

     (112,555     (57,333
  

 

 

   

 

 

 

Net cash used in operating activities from continuing operations

     (650,864     (1,909,565

Net cash used in (provided by) operating activities from discontinued operations

     (566,953     1,024,365   
  

 

 

   

 

 

 

Net cash used in operating activities

     (1,217,817     (885,200
  

 

 

   

 

 

 

Cash Flows from Investing Activities:

    

Investment in Ocular Telehealth Management, LLC

     0        (45,000

Purchase of fixed assets

     (66,723     (96,805
  

 

 

   

 

 

 

Net cash (used in) investing activities

     (66,723     (141,805
  

 

 

   

 

 

 

Cash Flows from Financing Activities:

    

Principal payments on long-term debt

     (155,795     (50,538

Proceeds from related party note payable

     300,000        0   
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     144,205        (50,538
  

 

 

   

 

 

 

Effect of exchange rate changes on cash & cash equivalents

     18,469        205,122   

Net decrease in cash and cash equivalents

     (1,121,866     (872,421

Cash and cash equivalents, beginning of period

     1,684,746        3,008,485   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 562,880      $ 2,136,064   
  

 

 

   

 

 

 

Supplemental Schedule of Cash Flow Information:

    

Interest paid

   $ 170,550      $ 168,694   

Income taxes paid

   $ —        $ 45,000   

See notes to condensed consolidated financial statements

 

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Table of Contents

ESCALON MEDICAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED MARCH 31, 2012

(Unaudited)

 

    Common Stock    

Common

Stock

   

Additional

Paid-in

    Accumulated    

Accumulated
Other

Comprehensive

   

Total

Shareholders’

 
    Shares     Amount     Warrants     Capital     Deficit     (Loss)     Equity  

BALANCE AT JUNE 30, 2011

    7,526,430      $ 7,526      $ 1,733,460      $ 67,694,959      $ (62,404,014   $ (841,799   $ 6,190,132   

Comprehensive Income:

             

Net loss

    0        0        0        0        (4,964,435     0        (4,964,435

Foreign currency translation

    0        0        0        0        0        319,060        319,060   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income

    0        0        0        0        (4,964,435     319,060        (4,645,375

Expired stock warrants

    0        0        (1,601,346     1,601,346        0        0        0   

Compensation expense

    0        0        0        56,868        0        0        56,868   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT MARCH 31, 2012

    7,526,430      $ 7,526      $ 132,114      $ 69,353,173      $ (67,368,449   $ (522,739   $ 1,601,625   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements

 

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Table of Contents

ESCALON MEDICAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)

(Unaudited)

 

     Three Months Ended
March 31,
    Nine Months Ended
March 31,
 
     2012     2011     2012     2011  

Net loss

   $ (639,786   $ (1,921,485   $ (4,964,435   $ (3,619,249

Foreign currency translation

     (206,446     (59,716     319,060        (3,269
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive (loss)

   $ (846,232   $ (1,981,201   $ (4,645,375   $ (3,622,518
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements

 

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Table of Contents

Escalon Medical Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1. Basis of Presentation

Escalon Medical Corp. (“Escalon” or the “Company” ) is a Pennsylvania corporation initially incorporated in California in 1987, and reincorporated in Pennsylvania in November 2001. Within this document, the “Company” collectively shall mean Escalon and its wholly owned subsidiaries: Sonomed, Inc. (“Sonomed”), Trek, Inc. (“Trek”), Escalon Vascular Access, Inc. (“Vascular”), Escalon Medical Europe GmbH (“EME”), Escalon Digital Vision, Inc. (“EMI”), Escalon Pharmaceutical, Inc. (“Pharmaceutical”), Escalon Holdings, Inc. (“EHI”), Escalon IP Holdings, Inc., Escalon Vascular IP Holdings, Inc., Sonomed IP Holdings, Inc., Drew Scientific, Inc., (“Drew”) and its subsidiaries. All intercompany accounts and transactions have been eliminated.

On January 12, 2012 BH Holdings, S.A.S. (“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. Since BHH is no longer controlled by Drew it was deconsolidated in the December 31, 2011 consolidated financial statements and prior period amounts are presented as discontinued operations (see footnote 10 to the Notes to Condensed Consolidated Financial Statements for additional information).

The Company sold certain assets of the Vascular business for $5,750,000 on April 30, 2010 to Vascular Solutions, Inc. (see footnote 10 to the Notes to Condensed Consolidated Financial Statements for additional information).

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 United States Food and Drug Administration (the “FDA”). The FDA and other governmental authorities require extensive testing of new products prior to sale and have jurisdiction over the safety, efficacy and manufacture of products, as well as product labeling and marketing.

Management reviews financial information allocates resources and manages the business as three segments, Escalon Clinical Diagnostics (“ECD”), Sonomed-Escalon and Escalon Medical Corp (“Corporate”). The ECD segment consists of Drew Scientific, Inc., and its wholly owned subsidiary JAS Diagnostics, Inc. (“JAS”). ECD develops and sells clinical diagnostic instruments, reagents and chemistries. The Sonomed-Escalon segment consists of Sonomed, Inc., EMI and Trek, all of which are engaged in the development and sale of ophthalmic medical devices. The Escalon Medical Corp. segment includes the administrative corporate operations of the consolidated group. The Company began including redesignated reporting segments beginning with Form 10-K for the year ended June 30, 2011, and prior period segment information has been reclassified to conform with the current period presentation.

 

2. Stock-Based Compensation

Valuations are based upon 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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Table of Contents

The Company has historically granted options under the Company’s option plans with an option exercise price equal to the closing market value of the stock on the date of the grant and with vesting, primarily for Company employees, either in equal annual amounts over a two- to five-year period or immediately, and, primarily for non-employee directors, immediately.

As of March 31, 2012 and 2011 total unrecognized compensation cost related to non-vested share-based compensation arrangements granted to employees under the 2004 Equity Incentive Plan was $71,241 and $152,008 respectively. The remaining cost is expected to be recognized over a weighted average period of 1.42 years. For the three-month periods ended March 31, 2012 and 2011, $16,485 and $23,898 was recorded as compensation expense, respectively. For the nine-month periods ended March 31, 2012 and 2011, $56,868 and $87,156 was recorded as compensation expense, respectively.

The Company did not receive any cash from share option exercises under stock-based payment plans for the three month and nine-month periods ended March 31, 2012 and 2011. The Company did not realize any tax effect, which would be a reduction in its tax rate, on options due to the full valuation allowances established on its deferred tax assets.

The Company measures compensation expense for non-employee stock-based compensation based on the fair value of the options issued, as this is more reliable than the fair value of the services received. Fair value is measured as the value of the Company’s common stock on the date that the commitment for performance by the counterparty has been reached or the counterparty’s performance is complete. The fair value of the equity instrument is charged directly to compensation expense and additional paid-in capital. There was no non-employee compensation expense for the three-month and nine-month periods ended March 31, 2012 and 2011.

 

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Table of Contents
3. (Loss) earnings per Share

The following table sets forth the computation of basic and diluted net loss per share:

 

     Three Months Ended
March 31,
    Nine Months Ended
March 31,
 
     2012     2011     2012     2011  

Numerator:

        

Numerator for basic and diluted earnings per share

        

Net loss from continuing operations

   $ (639,786   $ (1,808,183   $ (2,199,135   $ (3,829,774

Net (loss) income from discontinued operations

     0        (113,302     (2,765,300     210,525   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (639,786   $ (1,921,485   $ (4,964,435   $ (3,619,249
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Denominator for basic earnings per share - weighted average shares

     7,526,430        7,526,430        7,526,430        7,526,430   

Effect of dilutive securities:

        

Stock options and warrants

     0        0        0        0   

Shares reserved for future exchange

     0        0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator for diluted earnings per share - weighted average and assumed conversion

     7,526,430        7,526,430        7,526,430        7,526,430   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share

        

Basic:

        

Continuing operations

   $ (0.09   $ (0.24   $ (0.29   $ (0.51

Discontinued operations

     0.00        (0.02     (0.37     0.03   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ (0.09   $ (0.26   $ (0.66   $ (0.48
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

        

Continuing operations

   $ (0.09   $ (0.24   $ (0.29   $ (0.51

Discontinued operations

     0.00        (0.02     (0.37     0.03   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ (0.09   $ (0.26   $ (0.66   $ (0.48
  

 

 

   

 

 

   

 

 

   

 

 

 

The impact of dilutive securities was omitted from the earnings per share calculation in all periods presented as they would reduce the loss per share and thus were anti-dilutive.

 

4. Legal Proceedings

The Company, from time to time is involved in various legal proceedings and disputes that arise in the normal course of business. These matters have previously and could pertain to intellectual property disputes, commercial 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 impact on the Company’s business, financial condition or results of operations. (See footnote 10 for details on BHH court proceedings related to the insolvency declaration).

 

5. Segmental Information

During the three-month and nine-month periods ended March 31, 2012 and 2011, the Company’s operations were classified into three principal reportable business units that provide different products or services.

Management reviews financial information, allocates resources, and manages the business as three segments: ECD, Sonomed-Escalon and Escalon Medical Corp. (“Corporate”). The ECD segment consists of Drew

 

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Table of Contents

Scientific, Inc., and its wholly owned subsidiary JAS. ECD develops and sells clinical diagnostic instruments, reagents and chemistries. The Sonomed-Escalon segment consists of Sonomed, Inc., EMI and Trek, all of which are engaged in the development and sale of Ophthalmic medical devices. The Corporate segment includes the administrative corporate operations of the consolidated group. The Company began to include redesignated reporting segments beginning with Form 10-K for the year ended June 30, 2011, and prior period segment information has been reclassified to conform with the current period presentation.

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

 

     Segment Statements of Operations (in thousands) -
Three months ended March 31,
             
     ECD     Sonomed-Escalon     Corporate     Total  
     2012     2011     2012      2011     2012     2011     2012     2011  

Revenues, net:

                 

Product revenue

   $ 2,968      $ 3,395      $ 3,098       $ 3,004      $ 0      $ 0      $ 6,066      $ 6,399   

Other revenue

     0        0        0         0        0        0        0        0   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue, net

     2,968        3,395        3,098         3,004        0        0        6,066        6,399   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Costs and expenses:

                 

Cost of goods sold

     2,094        2,562        1,499         1,508        0        0        3,593        4,070   

Research & Development

     114        172        300         223        0        0        414        395   

Marketing, General & Admin

     1,349        1,769        1,147         822        126        124        2,622        2,715   

Goodwill impairment

     0        0        0         906        0        0        0        906   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

     3,557        4,503        2,946         3,459        126        124        6,629        8,086   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income from operations

     (589     (1,108     152         (455     (126     (124     (563     (1,687
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other (expense) and income:

                 

Equity in OTM

     0        0        0         0        0        (38     0        (38

Interest income

     0        0        0         0        0        1        0        1   

Interest expense

     (1     (84     0         0        (75     0        (76     (84
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other (expense) income

     (1     (84     0         0        (75     (37     (76     (121
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)income before taxes

     (590     (1,192     152         (455     (201     (161     (639     (1,808

Income taxes

     0        0        0         0        0        0        0        0   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income from continuing operations

   $ (590   $ (1,192   $ 152       $ (455   $ (201   $ (161   $ (639   $ (1,808
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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     Segment Statements of Operations (in thousands) -
Nine-months ended March 31,
             
     ECD     Sonomed-Escalon     Corporate     Total  
     2012     2011     2012      2011     2012     2011     2012     2011  

Revenues, net:

                 

Product revenue

   $ 9,675      $ 10,423      $ 8,691       $ 8,653      $ 0      $ 0      $ 18,366      $ 19,076   

Other revenue

     0        7        0         0        0        0        0        7   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue, net

     9,675        10,430        8,691         8,653        0        0        18,366        19,083   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Costs and expenses:

                 

Cost of goods sold

     7,261        7,735        4,185         4,601        0        0        11,446        12,336   

Research & Development

     386        544        730         654        0        0        1,116        1,198   

Marketing, General & Admin

     4,198        5,284        3,109         2,517        363        356        7,669        8,157   

Goodwill impairment

     0        0        0         906        0        0        0        906   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

     11,845        13,563        8,024         8,678        363        356        20,232        22,597   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income from operations

     (2,170     (3,133     667         (25     (363     (356     (1,866     (3,514
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other (expense) income:

                 

Equity in OTM

     0        0        0         0        1        (72     1        (72

Loss on Disposal of Assets

     (87     0        0         0        0        0        (87     0   

Interest income

     0        0        0         0        0        0        0        0   

Interest expense

     (164     (244     0         0        (83     0        (247     (244
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other (expense) income

     (251     (244     0         0        (82     (72     (333     (316
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income before taxes

     (2,421     (3,377     667         (25     (444     (428     (2,199     (3,830
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income taxes

     0        0        0         0        0        0        0        0   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income from continuing Operations

   $ (2,421   $ (3,377   $ 667       $ (25   $ (444   $ (428   $ (2,199   $ (3,830
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Company operates in the healthcare market, specializing in the development, manufacture and marketing of (1) ophthalmic medical devices and pharmaceuticals; (2) in-vitro diagnostic (“IVD”) instrumentation and consumables for use in human and veterinary hematology. On April 30, 2010, the Company sold its Vascular business. The business segments reported above are the segments for which separate financial information is available and for which operating results are evaluated regularly by executive management in deciding how to allocate resources and assessing performance. The accounting policies of the business segments are the same as those described in the summary of significant accounting policies in Form 10-K for the year ended June 30, 2011. For the purposes of this illustration, corporate expenses, which consist primarily of executive management and administrative support functions, are allocated across the business segments based upon a methodology that has been established by the Company, which includes a number of factors and estimates and that has been consistently applied across the business segments. These expenses are otherwise included in the corporate segment.

During the three- and nine-month periods ended March 31, 2012 and 2011, ECD derived its revenue from the sale of instrumentation and consumables for blood cell counting and blood analysis in the areas of diabetes, cardiovascular diseases and human and veterinary hematology. Sonomed-Escalon derived its revenue from the sale of A-Scans, B-Scans, pachymeters, digital imaging products, ISPAN™ gas products and various disposable ophthalmic surgical products.

 

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6. Related Party Transaction

The Company 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 focus is on the diagnosis of diabetic retinopathy by creating access and providing annual dilated retinal examinations for the diabetic population. Through March 31, 2012, the Company has invested $444,000 in OTM. As of March 31, 2012, the Company owned 45% of OTM. The Company provides administrative support functions to OTM. For the three-month periods ended March 31, 2012 and 2011 the Company recorded losses of $532 and $37,600, respectively. For the nine-month periods ended March 31, 2012 and 2011 the Company recorded a gain of $612 and a loss of $71,745, respectively.

At March 31, 2012 OTM had total assets, liabilities and equity of $1,000, $80,000 and ($79,000), respectively.

During the nine-month period ended March 31, 2012, Richard J. DePiano, Sr., the Company’s CEO participated in an accounts receivable factoring program that was implemented by the Company. Under the program, Mr. DePiano advanced the Company $300,000 which represented 100% of an amount due from various Drew customers. The receivables were not eligible to be sold to the Company’s usual factoring agent. Interest on the transaction is 1.25% per month, which is equal to the best price offered by the Company’s usual factoring agent. The transaction excluded fees typically charged by the factoring agent and provided much needed liquidity to the Company.

 

7. Recently Issued Accounting Standards

In January 2010, FASB issued ASU No. 2010-06, Improving Disclosures about Fair Value Measurements. This update provides amendments to Subtopic 820-10 that requires new disclosure to include transfers in and out of Levels 1 and 2 and activity in Level 3 fair value measurements. Further, this update clarifies existing disclosures on level of disaggregation and disclosures about inputs and valuation techniques. A reporting entity should provide fair value measurement disclosures for each class of assets and liabilities and should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3. The new disclosures and clarifications of existing disclosures became effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements

In April 2010, the FASB issued ASU 2010-13, “Compensation—Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades,” or ASU 2010-13. ASU 2010-13 provides amendments to Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The Company does not expect the adoption of ASU 2010-13 to have a significant impact on its consolidated financial statements.

In May 2011, the FASB issued ASU No. 2011-04 which provides a consistent definition of fair value in GAAP and International Financial Reporting Standards and ensures that their respective fair value measurement and disclosure requirements are the same (except for minor differences in wording and style). The amendments change certain fair value measurement principles and enhance the disclosure requirements particularly for level 3 fair value measurements. The standard will become effective for the Company during interim and annual periods beginning after December 15, 2011 and should be applied prospectively. The Company does not believe that the implementation of this standard will have a material impact on its financial position, results of operation and cash flows.

 

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In June 2011, the FASB issued ASU No. 2011-05 which requires an entity to present all non-owner changes in stockholders’ equity either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. This standard will become effective for the Company in fiscal years, and interim periods within those years, beginning after December 15, 2011 and should be applied retrospectively. The Company does not believe that the implementation of this standard will have a material impact on its financial position, results of operation and cash flows.

In September 2011, the FASB issued ASU No. 2011-08, Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment, which simplifies how an entity tests goodwill for impairment. Under that option, an entity no longer would be required to calculate the fair value of a reporting unit unless the entity determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments will be effective for the company for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 and should be applied prospectively. The Company does not believe that the implementation of this standard will have a material impact on its financial position, results of operation and cash flows.

 

8. Fair Value Measurements

On July 1, 2008, the Company adopted the FASB-issued authoritative guidance for the fair value of financial assets and liabilities. This standard defines fair value and establishes a hierarchy for reporting the reliability of input measurements used to assess fair value for all assets and liabilities. The FASB issued authoritative guidance defines fair value as the selling price that would be received for an asset, or paid to transfer a liability, in the principal or most advantageous market on the measurement date. The hierarchy established prioritizes fair value measurements based on the types of inputs used in the valuation technique. The inputs are categorized into the following levels:

Level 1 - Observable inputs such as quoted prices in active markets for identical assets or liabilities.

Level 2 - Directly or indirectly observable inputs for quoted and other than quoted prices for identical or similar assets and liabilities in active or non-active markets.

Level 3 - Unobservable inputs not corroborated by market data, therefore requiring the entity to use the best available information available in the circumstances, including the entity’s own data.

Certain financial instruments are carried at cost on the condensed consolidated balance sheets, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, related party note payable and other liabilities.

The Company determined that the fair value of the outstanding debt approximates the outstanding balances based on the remaining maturity of the note for the Biocode debt and other Level 3 measurements. By “other level 3 measurements” we are referring to “unobservable inputs not corroborated by market data, therefore requiring the entity to use the best available information available in the circumstances, including the entity’s own data”. We included this reference because in determining the estimated fair value of our debt we first attempted to use a “commonly accepted valuation methodology” of applying rates currently available to the Company for debt with similar terms and remaining maturities. The long-term debt currently on our balance sheet is related to the acquisition of certain assets of Biocode Hycell on December 31, 2008. The acquisition was 100% financed by the seller. Management concluded that given the financial state of the Company and the overall state of the credit markets there is no financial institution that would make available funds to us for the 100% financing of a foreign entity with similar terms and remaining maturities, or in fact, on any terms. We then considered whether there was any “level 3” considerations, as defined above, which might aid us in determining the fair market value of this unique form of debt. We determined that there was not and came to the conclusion that given the weakened state of our Company and overall market conditions there was no other source of financing available to us, from any source on any terms, other than the willing seller of the Biocode assets. Therefore, we concluded that the fair market value of the debt remains equal to its book value.

 

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9. Continuing Operations

The accompanying consolidated financial statements have been prepared on the going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred recurring operating losses, no longer have the benefit of cash inflows from Vascular and on May 11, 2012 the BHH debtholder informed the Company that it intends to declare the BHH debt, which is guaranteed by Escalon, into default, as such, the entire debt of $4,149,516 is recorded as a current liability (see footnote 10 for further information on the Biocode acquisition debt). These conditions raise substantial doubt about the Company’s ability to continue as a going concern. If the Company is unsuccessful in its efforts to raise additional capital in the near term, the Company may be required to significantly reduce its research, development, and administrative activities, including further reduction of its employee base or consider the sale of certain assets. The financial statements do not include any adjustments relating to the realization of the carrying value of assets or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern. Our continuance as a going concern is dependent on our future profitability and on the on-going support of our shareholders, affiliates and creditors. In order to mitigate the going concern issues, the Company is actively pursuing business partnerships, managing our continuing operations, and seeking capital funding on an ongoing basis via the issuance of securities and private placements, although the Company may not succeed in these mitigation efforts.

The filing of the insolvency declaration at BHH will have a material effect on results of operations in subsequent periods. BHH’s product line revenues from operations were $4,763,056, $5,254,574 and $2,647,877 in fiscal 2011, 2010 and 2009, respectively. Losses from operations, net of taxes, were ($1,232,904), ($635,952) and ($1,068,040) in 2011, 2010 and 2009, respectively.

As part of ongoing austerity measures that have been implemented over the past two years at Drew, management decided in June 2011 to outsource the manufacturing of Drew’s instruments and cease all manufacturing out of its Dallas facility. Research and development activities performed in Dallas will also be eliminated and will be outsourced on an as needed basis. Management continues to work with outsource partners to perfect the manufacturing of Drew’s instruments and anticipates that the Dallas facility will cease manufacturing activities on or about June 30, 2012.

If the Company is unable to achieve continued improvement in this area in the near term, it is not likely that its existing cash and cash flow from operations will be sufficient to fund activities throughout the next four to six months without curtailing certain business activities. 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” of the Company’s Form 10-K for the year ended June 30, 2011.

If the Company seeks to raise 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 without 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 the Company or at all.

 

10. Discontinued Operations

BH Holdings, S.A.S

On January 12, 2012 BHH 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. Since Drew no longer has a controlling financial interest in BHH it was deconsolidated in the December 31, 2011 financial statements and prior period amounts are presented as discontinued operations.

 

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The Company incurred a loss of $2,216,000 related to the deconsolidation of BHH. The disconsolidated loss was calculated by measuring the difference between:

a. The aggregate of:

(1) The fair value of any consideration received, (there was no consideration received);

(2) The fair value of any retained noncontrolling investment in the former subsidiary at the date the subsidiary is deconsolidated; and

(3) The carrying amount of any noncontrolling interest in the former subsidiary (including any accumulated other comprehensive income attributable to the noncontrolling interest) at the date the subsidiary is deconsolidated (there was no noncontrolling interest in the former subsidiary).

b. The carrying amount of the former subsidiary’s assets and liabilities.

The following table summarizes the results of discontinued operations of BHH for the three-month and nine-month periods ended March 31, 2012 and 2011 (in thousands):

 

0000000000 0000000000
    For the Three Months Ended
March 31,
 
    2012     2011  

Total revenue, net

  $ 0      $ 1,102   
 

 

 

   

 

 

 

Costs and expenses:

   

Cost of goods sold

    0        181   

Research & Development

    0        0   

Marketing, General & Admin

    0        1,034   
 

 

 

   

 

 

 

Total costs and expenses

    0        1,215   
 

 

 

   

 

 

 

Loss from discontinued operations

    0        (113
 

 

 

   

 

 

 

Loss before income taxes

    0        (113

Income taxes

    0        0   
 

 

 

   

 

 

 

Net loss from discontinued operations

  $ 0      $ (113
 

 

 

   

 

 

 

 

0000000000 0000000000
    For the Nine Months Ended
March 31,
 
    2012     2011  

Total revenue, net

  $ 1,970      $   3,499   
 

 

 

   

 

 

 

Costs and expenses:

   

Cost of goods sold

    574        521   

Research & Development

    0        0   

Marketing, General & Admin

    1,945        2,938   
 

 

 

   

 

 

 

Total costs and expenses

    2,519        3,459   
 

 

 

   

 

 

 

Income (loss) from discontinued operations

    (549     40   

Other income and expenses:

   

Loss on liquidation of net assets from discontinued operations

    (2,216     0   
 

 

 

   

 

 

 

Income (loss) before income taxes

    (2,765     40   
 

 

 

   

 

 

 

Income taxes

    0        0   
 

 

 

   

 

 

 

Net (loss) income from discontinued operations

  $ (2,765   $ 40   
 

 

 

   

 

 

 

 

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Assets and liabilities of discontinued operations included in the consolidated balance sheets are summarized as follows at March 31, 2012 and June 30, 2011, (in thousands):

 

     March 31,
2012
     June 30,
2011
 

Assets

     

Cash

   $ 0       $ 230   

Accounts receivable

     0         965   

Inventory

     0         1,076   

Other Current Assets

     0         70   

Fixed assets

     0         110   

Covenant not to compete and customer list, net

     0         1,481   

Other Assets

     0         109   
  

 

 

    

 

 

 

Total Assets

     0         4,041   
  

 

 

    

 

 

 

Liabilities

     

Accounts Payable

     0         370   

Accrued expenses

     0         1,147   

Other Current Liabilities

     0         155   
  

 

 

    

 

 

 

Total Liabilities

     0         1,672   
  

 

 

    

 

 

 

Net assets of discontinued operations

   $ 0       $ (2,369
  

 

 

    

 

 

 

Discontinued operation of Vascular

In an effort to enhance stockholder value, improve working capital and enable the Company to focus on its core in-vitro diagnostics and ophthalmology manufacturing businesses, on April 30, 2010 the Company divested certain Vascular Access assets held by its Vascular Access subsidiaries to Vascular Solutions, Inc. The total sales price was $5,750,000, consisting of cash of $5,000,000 at closing and $750,000 payable in cash upon the successful completion of the transfer of the manufacturing to Vascular Solutions, Inc. plus a one-time earn-out payment in an amount equal to 25% of the net sales of the VascuView TAP products sold by Vascular Solutions, Inc. between July 1, 2010 and June 30, 2011. The manufacturing transfer was completed on August 31, 2010. During this four-month transition, the Company continued to manufacture product in its Wisconsin facility under a supply agreement concurrently entered into with Vascular Solutions, Inc. The supply agreement ended on August 30, 2010, and the Company has had no significant continuing involvement in the operations of Vascular. Vascular Access generated approximately $565,000 in gross profit from May 1, 2010 through August 31, 2010 related to the supply agreement.

There was no activity from discontinued operations for the three-month periods ended March 31, 2012 and 2011 related to Vascular Access.

The following table summarizes the results of discontinued operations of Vascular Access for the nine-month periods ended March 31, 2012 and 2011 (in thousands):

 

     For the Nine Months Ended
March 31,
 
     2012      2011  

Total revenue, net

   $ 0       $ 638   
  

 

 

    

 

 

 

Costs and expenses:

     

Cost of goods sold

     0         283   

Research & Development

     0         29   

Marketing, General & Admin

     0         155   
  

 

 

    

 

 

 

Total costs and expenses

     0         467   
  

 

 

    

 

 

 

Income from discontinued operations

   $ 0       $ 171   
  

 

 

    

 

 

 

 

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There are no assets and liabilities of discontinued operations included in the consolidated balance sheets at March 31, 2012 and June 30, 2011 related to Vascular Access.

 

11. Expiration of commons stock warrant

Common stock warrants in the amount of $1,601,346 have expired and were released to additional paid-in capital.

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, 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, 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, 2011 and this Form 10-Q quarterly report to be an exhaustive statement of all risks, uncertainties or potentially inaccurate assumptions.

Executive Overview – Nine-Month Period Ended March 31, 2012

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 Company performance and financial condition.

 

   

Product revenue decreased approximately 3.7% during the nine-month period ended March 31, 2012, as compared to the same period last fiscal year. The decrease was related to a decrease in ECD business segment of 7.2% during the nine-month period ended March 31, 2012 compared to the same period last fiscal year.

 

   

There is no other revenue during the nine-month period ended March 31, 2012 as compared to $7,000 for the same period last fiscal year.

 

   

Cost of goods sold as a percentage of product revenue decreased to 62.3% during the nine-month period ended March 31, 2012, as compared to approximately 64.7% for the same period last fiscal year mainly due to change of product mix favoring higher-margin products and the continuing process of outsourcing manufacturing and closing the Dallas facility.

 

   

Marketing, general and administrative expenses decreased approximately 6.0% during the nine-month period ended March 31, 2012, as compared to the same period in the prior fiscal year. The decrease was primarily due to a decrease in administrative expense in the ECD business related to the planned closure of the Dallas facility.

 

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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 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.

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.

 

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Valuation of Intangible Assets

The Company annually evaluates for impairment its intangible assets and goodwill in accordance with FASB ASC 350, “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 the Company’s 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.

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 March 31, 2012, 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

 

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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.

Three- and Nine-Month Periods Ended March 31, 2012 and 2011

The following table shows consolidated product revenue from continuing operations by business segment as well as identifying trends in business segment product revenues for the three- and nine-month periods ended March 31, 2012 and 2011. Table amounts are in thousands:

 

     For the Three Months Ended
March 31,
    For the Nine Months Ended
March 31,
 
     2012      2011      % Change     2012      2011      % Change  

Product Revenue:

                

ECD

   $ 2,968       $ 3,395         -12.6   $ 9,675       $ 10,423         -7.2

Sonomed-Escalon

     3,098         3,004         3.1     8,691         8,653         0.4
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 6,066       $ 6,399         -5.2   $ 18,366       $ 19,076         -3.7
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

   

Product revenue decreased approximately $333,000, or 5.2%, to $6,066,000 for the three-month period ended March 31, 2012, as compared to the same period last fiscal year.

In the ECD business segment, product revenue decreased $427,000, during the three-month period ended March 31, 2012, or 12.6% to $2,968,000, as compared to the same period last fiscal year. The decrease is related to a decline in sales of instruments and reagents related to decreased availability of instruments due to the decision to outsource the manufacturing of instruments and an increase in the chemistry reagents backlog.

 

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Drew received and sold 32 units from its outsource partner and anticipates receiving approximately 30 units per quarter for the remainder of the year. Drew is investigating outsource partners for its Drew 2280 hematology analyzer, as well as, pursuing alternative hematology instruments from other manufacturers. Drew continues to manufacture its Hemavet analyzer at is Dallas facility and expects to begin outsourcing its manufacture by the end of the current fiscal year.

In the Sonomed-Escalon business segment, product revenue increased $94,000, or 3.1% to $3,098,000 during the three-month period ended March 31, 2012, as compared to the same period last fiscal year. The increase in product revenue was primarily caused by increased sales of Digital imaging systems.

 

   

Product revenue decreased approximately $710,000, or 3.7%, to $18,366,000 during the nine-month period ended March 31, 2012, as compared to the same period last fiscal year.

In the ECD business segment, product revenue decreased $748,000, or 7.2% to $9,675,000, as compared to the same period last fiscal year. The decrease is related to a decline in sales of diabetes instruments and reagents related to decreased availability of instruments due to the decision to outsource the manufacturing of instruments and an increase in the chemistry reagents backlog.

During the three months ended March 31, 2012, Drew’s outsource partner began to supply DS5 diabetes instruments for sale. Drew received and sold 32 units from its outsource partner and anticipates receiving approximately 30 units per quarter for the remainder of the year. Drew is investigating outsource partners for its Drew 2280 hematology analyzer, as well as, pursuing alternative hematology instruments from other manufacturers. Drew continues to manufacture its Hemavet analyzer at is Dallas facility and expects to begin outsourcing its manufacture by the end of the current fiscal year.

In the Sonomed-Escalon business segment, product revenue increased $38,000, or 0.4% to $8,691,000 during the nine-month period ended March 31, 2012, as compared to the same period last fiscal year. The increase in product revenue was primarily caused by increased sales of Digital imaging systems.

The following table shows consolidated other revenue by business segment as well as identifying trends in business segment other revenues for the three- and nine-month periods ended March 31, 2012 and 2011. Table amounts are in thousands:

 

     For the Three Months Ended
March 31,
    For the Nine Months Ended
March 31,
 
     2012      2011      % Change     2012      2011      % Change  

Other Revenue:

                

ECD

   $ 0       $ 0         0.0   $ 0       $ 7         -100.0

Sonomed-Escalon

     0         0         0.0     0         0         0.0
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 0       $ 0         0.0   $ 0       $ 7         -100.0
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

There was no other revenue during the three-month periods ended March 31, 2012 and 2011.

There was no other revenue during the nine-month period ended March 31, 2012 as compared to $7,000 during the same period last fiscal year.

 

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The following table presents consolidated cost of goods sold from continuing operations by reportable business segment and as a percentage of related segment product revenues for the three- and nine-month periods ended March 31, 2012 and 2011. Table amounts are in thousands:

 

     For the Three Months Ended
March 31,
    For the Nine Months Ended
March 31,
 
     2012      %     2011      %     2012      %     2011      %  

Cost of Goods Sold:

                    

ECD

   $ 2,094         70.6   $ 2,562         75.5   $ 7,261         75.1   $ 7,735         74.2

Sonomed-Escalon

     1,499         48.4     1,508         50.2     4,185         48.2     4,601         53.2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 3,593         59.2   $ 4,070         63.6   $ 11,446         62.3   $ 12,336         64.7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

   

Cost of goods sold totaled approximately $3,593,000, or 59.2% of product revenue, for the three-month period ended March 31, 2012, as compared to $4,070,000 or 63.6%, of product revenue for the same period last fiscal year.

Cost of goods sold in the ECD business segment totaled $2,094,000, or 70.6% of product revenue, for the three-month period ended March 31, 2012, as compared to $2,562,000, or 75.5% of product revenue, for the same period last fiscal year. The decrease in cost of goods sold as a percentage of product revenue is related to the continuing process of outsourcing manufacturing and closing the Dallas facility. Drew anticipates outsourcing the remaining manufacturing activities at it Dallas facility by June 30, 2012.

Cost of goods sold in the Sonomed-Escalon business segment totaled $1,499,000, or 48.4% of product revenue, for the three-month period ended March 31, 2012, as compared to $1,508,000, or 50.2% of product revenue, for the same period last fiscal year. The decrease in Sonomed’s cost of goods sold as a percentage of revenue was primarily related to the reduced labor costs and change of product mix in favor of higher margin Axis image management systems.

 

   

Cost of goods sold totaled approximately $11,446,000, or 62.3% of product revenue, for the nine-month period ended March 31, 2012, as compared to $12,336,000, or 64.7% of product revenue, for the same period last fiscal year.

Cost of goods sold in the ECD business segment totaled $7,261,000, or 75.1% of product revenue, for the nine-month period ended March 31, 2012 as compared to $7,735,000, or 74.2% of product revenue, for the same period last fiscal year. The increase of approximately 1% is related to a write-off of slow moving inventory during the second quarter of the current fiscal year offset by decreased costs related to the continuing process of outsourcing manufacturing and closing the Dallas facility.

Cost of goods sold in the Sonomed-Escalon business segment totaled $4,185,000, or 48.2% of product revenue, for the nine-month period ended March 31, 2012 as compared to $4,601,000 or 53.2% of product revenue, for the same period last fiscal year. The decrease in Sonomed’s cost of goods sold as a percentage of revenue was primarily related to the reduced labor costs and change of product mix in favor of higher margin domestic Axis and VuMax sales.

 

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The following table presents consolidated marketing, general and administrative expenses from continuing operations as well as identifying trends in business segment marketing, general and administrative expenses for the three- and nine-month periods ended March 31, 2012 and 2011. Table amounts are in thousands:

 

     For the Three Months Ended
March 31,
    For the Nine Months Ended
March 31,
 
     2012      2011      % Change     2012      2011      % Change  

Marketing, General and Administrative:

  

          

ECD

   $ 1,065       $ 1,286         -17.2   $ 3,187       $ 3,844         -17.1

Sonomed-Escalon

     781         674         15.9     2,286         2,093         9.2

Corporate

     775         756         2.5     2,196         2,220         -1.1
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 2,621       $ 2,716         -3.5   $ 7,669       $ 8,157         -6.0
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

   

Marketing, general and administrative expenses decreased $95,000, or 3.5% to $2,621,000 during the three-month period ended March 31, 2012, as compared to the same period last fiscal year.

Marketing, general and administrative expenses in the ECD business segment decreased $221,000, or 17.2%, to $1,065,000 for the three-month period ended March 31, 2012, as compared to the same period last fiscal year. The decrease is related to a reduction in force and other administrative expenses related to the planned closure of the Dallas facility.

Marketing, general and administrative expenses in the Sonomed-Escalon business segment increased $107,000, or 15.9%, to $781,000 for the three-month period ended March 31, 2012, as compared to the same period last fiscal year. The increase is due to increased headcount in sales and marketing, exhibition expenses and advertising expenses.

Marketing, general and administrative expenses in the Corporate business segment increased $19,000, or 2.5%, to $775,000 for the three-month period ended March 31, 2012, as compared to the same period last fiscal year. The increase is related to increased printing and legal expense.

 

   

Marketing, general and administrative expenses decreased $488,000 or 6.0% to $7,669,000 for the nine-month period ended March 31, 2012, as compared to the same period last fiscal year.

Marketing, general and administrative expenses in the ECD business segment decreased $657,000, or 17.1%, to $3,187,000 for the nine-month period ended March 31, 2012, as compared to the same period last fiscal year. The decrease is related to a reduction in force and other administrative expenses related to the planned closure of the Dallas facility.

Marketing, general and administrative expenses in the Sonomed-Escalon business segment increased $193,000, or 9.2%, to $2,286,000 for the nine-month period ended March 31, 2012, as compared to the same period last fiscal year. The increase headcount in sales and marketing, exhibitions expense and advertising expenses partially offset by reduction in commission, royalties and consulting expense.

Marketing, general and administrative expenses in the Corporate business segment decreased $24,000, or 1.1%, to $2,196,000 for the nine-month period ended March 31, 2012, as compared to the same period last fiscal year. The decrease is due to a decrease in accounting, investor relations, director stock option compensation expense and depreciation expense.

 

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The following table presents consolidated research and development expenses from continuing operations as well as identifying trends in business segment research and development expenses for the three- and nine-month periods ended March 31, 2012 and 2011. Table amounts are in thousands:

 

     For the Three Months Ended
March 31,
    For the Nine Months Ended
March 31,
 
     2012      2011      % Change     2012      2011      % Change  

Research and Development:

  

             

ECD

   $ 114       $ 172         -33.7   $ 386       $ 544         -29.0

Sonomed-Escalon

     300         223         34.5     730         654         11.6
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 414       $ 395         4.8   $ 1,116       $ 1,198         -6.8
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

   

Research and development expenses increased $19,000, or 4.8%, to $414,000 during the three-month period ended March 31, 2012, as compared to the same period last fiscal year.

Research and development expenses in the ECD business segment decreased $58,000, or 33.7% to $114,000 during the three-month period ended March 31, 2012, as compared to the same period last fiscal year. The decrease is due to the cost model implemented in June 2009, 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 $77,000, or 34.5%, to $300,000 during the three-month period ended March 31, 2012, as compared to the same period last fiscal year. The increase is related to the increased headcount in research and development of digital imaging products.

 

   

Research and development expenses decreased $82,000, or 6.8%, to $1,116,000 during the nine-month period ended March 31, 2012, as compared to the same period last fiscal year.

Research and development expenses in the ECD business segment decreased $158,000, or 29.0%, to $386,000 during the nine-month period ended March 31, 2012, as compared to the same period last fiscal year. The decrease is due to the cost model implemented in June 2009, 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 $76,000, or 11.6%, to $730,000 during the nine-month period ended March 31, 2012, as compared to the same period last fiscal year. The increase is related to increased headcount in research and development of digital imaging products.

The Company recognized a loss of $1,000 and $38,000 related to its investment in OTM during the three-month periods ended March 31, 2012 and 2011, respectively, and recognized a gain of $1,000 and a loss of $72,000 for the nine-month periods ended March 31, 2012 and 2011, respectively.

There was no material interest income for the three-month and nine-month periods ended March 31, 2012 and 2011.

Interest expense was $77,000 and $84,000 for the three-month periods ended March 31, 2012 and 2011, respectively, and $247,000 and $244,000 for the nine-month periods ended March 31, 2012 and 2011, respectively

 

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Liquidity and Capital Resources

Changes in overall liquidity and capital resources as of March 31, 2012 and June 30, 2011 are reflected in the following table (in thousands):

 

     March 31,
2012
    June 30,
2011
 

Current Ratio:

    

Current assets

   $ 8,652,461      $ 13,262,113   

Less: Current liabilities

     7,981,353        5,594,092   
  

 

 

   

 

 

 

Working capital

   $ 671,108      $ 7,668,021   
  

 

 

   

 

 

 

Current ratio

     1.1 to 1        2.4 to 1   
  

 

 

   

 

 

 

Debt to Total Capital Ratio:

    

Notes payable and current maturities

   $ 4,449,516      $ 278,278   

Long-term debt

     0        4,506,018   
  

 

 

   

 

 

 

Total debt

     4,449,516        4,784,296   

Total equity

     1,601,625        6,190,132   
  

 

 

   

 

 

 

Total capital

   $ 6,051,141      $ 10,974,428   
  

 

 

   

 

 

 

Total debt to total capital

     73.5     43.6
  

 

 

   

 

 

 

Working Capital Position

Working capital decreased approximately $6,997,000 as of March 31, 2012, and the current ratio decreased to 1.1 to 1 when compared to June 30, 2011. The decrease in working capital is mainly related to the loss from continuing operations of $2,199,000, loss from discontinued operations of $2,765,300, and the increase in the current position of long term debt of $3,840,500 related to the pending default on the BHH debt.

Cash Used in Operating Activities

During the nine-month periods ended March 31, 2012 and 2011, the Company used approximately $1,218,000 and $885,000 of cash for operating activities. The net increase in cash used in operating activities of approximately $333,000 for the nine-month period ended March 31, 2012 as compared to the same period in the prior fiscal year is due primarily to the following factors:

The Company had a net loss from continuing operations of $2,199,000, a loss from discontinued operations of $2,765,000 and experienced cash inflows from non-cash expenditures of depreciation and amortization, compensation expense related to stock operations of $459,000, and $57,000, respectively; and a decrease in accounts receivable, inventory and other current and long-term assets of $350,000, $721,000 and $75,000, respectively. These net cash in-flows were partially offset by a decrease in accounts payable, accrued expenses and other liabilities of $113,000.

In the prior fiscal period the cash used in operating activities of $885,000 was related to the net loss from continuing operations of $3,830,000, a decrease in accounts payable, accrued expenses and other liabilities of approximately $57,000 and an increase in inventory of approximately $448,000. These cash out-flows were partially offset by income from discontinued operations of $211,000, non-cash expenditures of depreciation and amortization, goodwill impairment and compensation expense related to stock option of $487,000, $906,000 and $87,000, respectively; and also a decrease in accounts receivable of $622,000.

 

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Cash Flows (Used in) Investing Activities

Cash flows used in investing activities of $67,000 during the nine-month period ended March 31, 2012 were all related to fixed asset purchases. During the same period of the prior fiscal year cash flow used in investing activities was $142,000. The net cash flows used in investing activities from the prior fiscal period were related to an additional investment in Ocular Telehealth Management of $45,000 and fixed assets purchases of $97,000.

Cash Flows provided by/ (used in) in Financing Activities

Cash flows provided by the financing activities were approximately $144,000 during the nine-month period ended March 31, 2012 attributed to proceeds from a related-party note payable of $300,000 and offset by outflows for principal payments of long-term debt of $156,000. Cash flows used in financing activities for the same period last fiscal year were approximately $51,000 related to principal payments of long-term debt.

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 BHH. The seller-provided financing is collateralized by certain assets of Biocode and guaranteed by Escalon. 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 rate remained unchanged and interest will accrue 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 has agreed to pay the balance of the outstanding amount in euros in full in one payment.

On January 12, 2012 BH Holdings, S.A.S. (“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. On April 2, 2012 the Commercial Court appointed a liquidator. Because BHH is no longer controlled by Drew, it was deconsolidated in the December 31, 2011 financial statements and prior period amounts are presented as discontinued operations (see footnote 10 to the Notes to Condensed Consolidated Financial Statements for additional information). This debt was guaranteed by Escalon and as a result of the insolvency declaration the debt was transferred to the Company. Since the liquidation was ordered, the Company was negotiating with the debt holder to reach a mutually agreeable resolution to the outstanding debt. On May 11, 2012, the debt holder informed Escalon that it intended to declare the debt in default under the terms of the agreement, as such; the entire debt of $4,149,516 is recorded as a current liability. The Company will not be able to pay the debt in its current form from existing resources. The Company will need to explore all potential options including raising additional funds or selling certain assets in order to pay the debt; there is no guarantee that the Company will be able to successfully achieve these options.

Continuing Operations

The accompanying consolidated financial statements have been prepared on the going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred recurring operating losses, no longer have the benefit of cash inflows from Vascular, and on May 11, 2012, the BHH debtholder informed the Company that it intends to declare the BHH debt, which is guaranteed by Escalon, into default, as such, the entire debt of $4,149,516 is recorded as a current liability. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. If the Company is unsuccessful in its efforts to raise additional capital in the near term, the Company may be required to significantly reduce its research, development, and administrative activities, including further reduction of its employee base or consider the sale of certain assets. The financial statements do not include any adjustments relating to the realization of the carrying value of assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company’s continuance as a going concern is dependent on the Company’s future profitability and on the on-going support of the Company’s shareholders, affiliates and creditors. In order to mitigate the going concern issues, the Company is actively pursuing business partnerships, managing our continuing operations, and seeking capital funding on an ongoing basis via the issuance of securities and private placements although the Company may not succeed in these mitigation efforts.

 

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The filing of the insolvency declaration at BHH will have a material effect on results of operations in subsequent periods. BHH’s product line revenues from operations were $4,763,056, $5,254,574 and $2,647,877 in fiscal 2011, 2010 and 2009, respectively. Losses from operations, net of taxes, were ($1,232,904), ($635,952) and ($1,068,040) in 2011, 2010 and 2009, respectively.

As part of ongoing austerity measures that have been implemented over the past two years at Drew, management decided in June 2011 to outsource the manufacturing of Drew’s instruments and cease all manufacturing out of its Dallas facility. Research and development activities performed in Dallas will also be eliminated and will be outsourced on an as needed basis. Management continues to work with outsource partners to perfect the manufacturing of Drew’s instruments and anticipates that the Dallas facility will cease manufacturing activities on or about June 30, 2012.

If the Company is unable to achieve continued improvement in this area in the near term, it is not likely that our existing cash and cash flow from operations will be sufficient to fund activities throughout the next 4 to 6 months without curtailing certain business activities. 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” of the Company’s Form 10-K for the year ended June 30, 2011.

If the Company seeks to raise 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 without 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 the Company or at all.

Off-Balance Sheet Arrangements and Contractual Obligations

The Company was not a party to any off-balance sheet arrangements during the three and nine-month periods ended March 31, 2012 and 2011.

The following table presents the Company’s contractual obligations as of March 31, 2012 (excluding interest):

 

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

Long-term debt

   $ 4,149,516       $ 4,149,516       $ 0       $ 0       $ 0   

Operating lease agreements

     2,722,952         773,204         1,072,124         735,611         142,013   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 6,872,468       $ 4,922,720       $ 1,072,124       $ 735,611       $ 142,013   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

The table below provides information about the Company’s financial instruments consisting of fixed interest rate debt obligations. For debt obligations, the table represents principal cash flows and related interest rates by expected maturity dates.

 

           Due during the year ending March 31,                       
     Interest Rate     2012      2013      2014      2015      2016      Total  

Note Payable -Drew

     7   $ 4,149,516       $           0       $           0       $           0       $           0       $ 4,149,516   

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 Principal Financial and Accounting Officer, have established disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the officers who certify the Company’s financial reports and to other members of senior management and the Board of Directors.

Based on their evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2012, the Chief Executive Officer and Principal Financial and Accounting Officer of the Company have concluded that such disclosure controls and procedures are effective to ensure that the information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Principal Financial and Accounting Officer, to allow timely decisions regarding required disclosure.

 

(B) Internal Control 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, 2012 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II. Other Information

Item 1. Legal Proceedings

See note 4 of the notes to the condensed consolidated financial statements for further information regarding the Company’s legal proceedings (see footnote 10 for details on the court proceedings related to the insolvency declaration at BHH).

Item 1A. Risk Factors

The holder of debt incurred by the Company in connection with its acquisition of BHH intends to declare the entire amount in default.

On May 11, 2012, the holder of debt incurred by the Company in connection with its acquisition of BHH informed the Company that it intends 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 has recorded the entire debt of $4,149,516 as a current liability. The Company will not be able to pay the debt in its current form from existing resources. The Company will need to explore all potential options including raising additional funds or selling certain assets in order to pay the debt; there is no guarantee that the Company will be able to successfully achieve these options. The Company’s ability to continue as a going concern is dependent upon reaching a reasonable resolution with the debt holder or the ability to access funds to satisfy the debt obligation, as well as the other factors set forth under “Management’s Discussion and Analysis—Debt History; – Continuing Operations” of this Form 10-Q Report.

 

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Item 5. Other Information

The holder of debt incurred by the Company in connection with its acquisition of BHH intends to declare the debt is in default.

On May 11, 2012, the holder of debt incurred by the Company in connection with its acquisition of BHH informed the Company that it intends 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 has recorded the entire debt of $4,149,516 as a current liability. The Company will not be able to pay the debt in its current form from existing resources. The Company will need to raise additional funds or sell certain assets in order to pay the debt; there is no guarantee that the Company will be able to successfully achieve either option.

Notice of Delisting or Failure to Satisfy a Continued Listing Rule or Standard; Transfer of Listing.

On February 15, 2012, the Company received a letter from the Listing Qualifications Staff of the NASDAQ Stock Market (the “Staff”) notifying the Company that it did not comply 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). As of December 31, 2011, the Company reported stockholders’ equity of $2,307,284. The Company submitted a plan to regain compliance within the 45 calendar days from February 15, 2012 as required by NASDAQ rules. The Staff accepted the Company’s plan to regain compliance and granted the Company until August 13, 2012 to successfully implement it.

Item 6. Exhibits

 

31.1    Certificate of Chief Executive Officer under Rule 13a-14(a).
31.2    Certificate of Principal Financial and Accounting Officer 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 Principal Financial and Accounting Officer under Section 1350 of Title 18 of the United States Code.

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 15, 2012   By:  

/s/ Richard J. DePiano

    Richard J. DePiano
    Chairman and Chief Executive Officer
Date: May 15, 2012   By:  

/s/ Robert O’Connor

    Robert O’Connor
   

Chief Financial Officer

 

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