UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

Mark One

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

FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2007

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

FOR THE TRANSITION PERIOD FROM                      TO                     

 

Escalon Medical Corp.

Pennsylvania (State or other jurisdiction of incorporation or organization)		33-0272839 (I.R.S. Employer Identification No.)

565 East Swedesford Road, Suite 200 Wayne, PA (Address of principal executive offices)		19087 (Zip code)

     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 þ     No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

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

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 6,389,315 shares of common stock, $0.001 par value, outstanding as of February 8, 2008.

 

 

Escalon Medical Corp.
Form 10-Q Quarterly Report

Table of Contents

Part I.		Financial Statements
		Item 1.		Condensed Consolidated Financial Statements (unaudited)		2
				Condensed Consolidated Balance Sheets as of December 31, 2007
				(Unaudited) and June 30, 2007		2
				Condensed Consolidated Statements of Income for the three- and six-
				month periods ended December 31, 2007 and 2006 (Unaudited)		3
				Condensed Consolidated Statements of Cash Flows for the six-month
				periods ended December 31, 2007 and 2006 (Unaudited)		4
				Condensed Consolidated Statement of Shareholders’ Equity for the
				six-month periods ended December 31, 2007 and 2006 (Unaudited)		5
				Condensed Consolidated Statement of Other Comprehensive Income (Loss)
				for the six-month periods ended December 31, 2007 and 2006 (Unaudited)		6
		Item 2.		Management’s Discussion and Analysis of Financial Condition
				and Results of Operations		12
		Item 3.		Quantitive and Qualitative Disclosures about Market Risk		25
		Item 4.		Controls and Procedures		26
Part II.		Other Information
		Item 1.		Legal Proceedings		26
		Item 1A.		Risk Factors		26
		Item 4T.		Submission of Matters to a Vote of Security Holders		26
		Item 6.		Exhibits		27
Certificate of CEO under Rule 13a-14(a)
Certificate of Principal Fin. & Acc. Officer Rule 13a-14(a)
Certificate of CEO Section 1350 of Title 18
Cert. of Principal Fin & Acc Officer Section 1350 Title 18

Part I. Financial Statements

Item 1. Condensed Consolidated Financial Statements

ESCALON MEDICAL CORP. AND SUBSIDIARIES CONDENSED
CONSOLIDATED BALANCE SHEETS
(Unaudited)

		December 31,				June 30,
		2007				2007
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	7,527,023			$	8,879,462
Accounts receivable, net			4,636,152				4,653,073
Inventory, net			7,621,515				7,761,370
Other current assets			278,947				469,107
Total current assets			20,063,637				21,763,012
Furniture and equipment, net			946,202				873,191
Goodwill			21,072,260				21,072,260
Trademarks and trade names, net			620,106				620,106
Patents, net			183,544				216,228
Covenant not to compete and customer list, net			278,536				326,860
Other assets			127,839				145,556
Total assets		$	43,292,124			$	45,017,213
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt		$	54,552			$	150,200
Accounts payable			1,979,115				1,626,274
Accrued expenses			2,098,245				2,748,133
Total current liabilities			4,131,912				4,524,607
Accrued post-retirement benefits			1,087,000				1,087,000
Total liabilities			5,218,912				5,611,607
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 share authorized; 6,389,315 and 6,386,857 shares issued and outstanding at December 31, 2007 and June 30, 2007, respectively			6,390				6,387
Common stock warrants			1,601,346				1,601,346
Additional paid-in capital			66,225,396				66,045,050
Retained earnings			(29,675,961	)			(28,207,824	)
Accumulated other comprehensive (loss)			(83,959	)			(39,353	)
Total shareholders’ equity			38,073,212				39,405,606
Total liabilities and shareholders’ equity		$	43,292,124			$	45,017,213

ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

		Three Months								Six Months
		Ended December 31,								Ended December 31,
		2007				2006				2007				2006
Net revenues:
Product revenue		$	7,449,626			$	7,033,860			$	14,282,976				13,577,446
Other revenue			45,454				602,880				105,375				1,227,454
Revenues, net			7,495,080				7,636,740				14,388,351				14,804,900
Costs and expenses:
Cost of goods sold			3,951,607				3,878,214				7,874,193				7,508,594
Research and development			876,750				1,080,950				1,800,111				1,794,555
Marketing, general and administrative			3,372,353				3,144,611				6,312,261				6,700,511
Total costs and expenses			8,200,710				8,103,775				15,986,565				16,003,660
Loss from operations			(705,630	)			(467,035	)			(1,598,214	)			(1,198,760	)
Other (expense) and income:
Equity in Ocular Telehealth Management, LLC			(16,611	)			(12,155	)			(50,722	)			(30,698	)
Interest income			85,391				13,498				187,088				58,934
Interest expense			(2,496	)			(5,654	)			(6,289	)			(14,939	)
Total other income			66,284				(4,311	)			130,077				13,297
Net (loss) before taxes			(639,346	)			(471,346	)			(1,468,137	)			(1,185,463	)
Benefit from income taxes			—				(1,243	)			0				(1,243	)
Net (loss)		$	(639,346	)		$	(470,103	)		$	(1,468,137	)		$	(1,184,220	)
Basic net (loss) per share		$	(0.10	)		$	(0.07	)		$	(0.23	)		$	(0.19	)
Diluted net (loss) per share		$	(0.10	)		$	(0.07	)		$	(0.23	)		$	(0.19	)
Weighted average shares — basic			6,389,315				6,347,972				6,388,701				6,346,315
Weighted average shares — diluted			6,389,315				6,347,972				6,388,701				6,346,315

See notes to condensed consolidated financial statements

ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

		Six Months
		Ended December 31,
		2007				2006
Cash Flows from Operating Activities:
Net (loss)		$	(1,468,137	)		$	(1,184,220	)
Adjustments to reconcile net (loss) to net cash (used in) operating activities:
Depreciation and amortization			296,328				282,082
Compensation expense related to stock options			172,911				123,774
Loss on Ocular Telehealth Management, LLC			50,722				30,698
Change in operating assets and liabilities:
Accounts receivable, net			16,921				(644,752	)
Inventory, net			139,855				(1,149,054	)
Other current and long-term assets			62,320				152,349
Accounts payable, accrued and other liabilities			(297,047	)			700,201
Net cash (used in) operating activities			(1,026,127	)			(1,688,921	)
Cash Flows from Investing Activities:
Investment in Ocular Telehealth Management, LLC			(33,000	)			—
Purchase of fixed assets			(142,880	)			(61,329	)
Net cash (used in) investing activities			(175,880	)			(61,329	)
Cash Flows from Financing Activities:
Principal payments on term loans			(95,648	)			(108,457	)
Issuance of common stock — stock options			7,438				141,037
Net cash (used in)/provided by financing activities			(88,210	)			32,580
Effect of exchange rate changes on cash and cash equivalents			(62,222	)			(92,899	)
Net (decrease) in cash and cash equivalents			(1,352,439	)			(1,810,568	)
Cash and cash equivalents, beginning of period			8,879,462				3,379,710
Cash and cash equivalents, end of period		$	7,527,023			$	1,569,142
Supplemental Schedule of Cash Flow Information:
Interest paid		$	6,289			$	14,939
Income taxes paid		$	0			$	(98,412	)
Increase in unrealized appreciation on available for sale securities		$	0			$	8,910
Reclassification of other current assets to fixed assets		$	145,559			$	0

See notes to condensed consolidated financial statements

ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
FOR THE SIX MONTHS ENDED DECEMBER 31, 2007
(Unaudited)

																						Accumulated
										Common				Additional								Other				Total
		Common Stock								Stock				Paid-in				Accumulated				Comprehensive				Shareholders’
		Shares				Amount				Warrants				Capital				Deficit				Income (Loss)				Equity
Balance at June 30, 2007			6,386,857			$	6,387			$	1,601,346			$	66,045,050			$	(28,207,824	)		$	(39,353	)		$	39,405,606
Net (loss)							0				0				0				(1,468,137	)			0				(1,468,137	)
Exercise of stock options			2,458				3				0				7,435				0				0				7,438
Compensation expense							0				0				172,911				0				0				172,911
Foreign currency translation							0				0				0				0				(44,606	)			(44,606	)
Balance at September 30, 2007			6,389,315			$	6,390			$	1,601,346			$	66,225,396			$	(29,675,961	)		$	(83,959	)		$	38,073,212

See notes to condensed consolidated financial statements

ESCALON MEDICAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OTHER COMPREHENSIVE INCOME (LOSS)
(Unaudited)

		Three Months								Six Months
		Ended December 31,								Ended December 31,
		2007				2006				2007				2006
Net (loss)		$	(639,346	)		$	(470,103	)		$	(1,468,137	)		$	(1,184,220	)
Change in unrealized gains on available for sale securities			0				0				0				8,910
Foreign currency translation			(48,731	)			(21,398	)			(44,606	)		$	104,836
Comprehensive (loss)		$	(688,077	)		$	(491,501	)		$	(1,512,743	)		$	(1,070,474	)

See notes to condensed consolidated financial statements

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”), Escalon Vascular Access, Inc. (“Vascular”), Escalon Digital Vision, Inc. (“EMI”), Escalon Holdings, Inc. (“EHI”), Escalon IP Holdings, Inc., Escalon Vascular IP Holdings, Inc., Sonomed IP Holdings, Inc., Drew Scientific Holdings, Inc., and Drew Scientific Group, Plc (“Drew”) and its subsidiaries. All inter-company accounts and transactions have been eliminated.

          The Company operates in the healthcare market, specializing in the development, manufacture, marketing and distribution of medical devices in the areas of ophthalmology, diabetes, hematology and vascular access. The Company and its products are subject to regulation and inspection by the United States Food and Drug Administration (the “FDA”) and other regulatory authorities. 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 accompanying condensed consolidated financial statements are unaudited and are presented pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, these consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s 2007 Annual Report on Form 10-K under the Securities Exchange Act of 1934 (the “Exchange Act”). In the opinion of management, the accompanying consolidated financial statements reflect all adjustments (which are of a normal recurring nature) necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The results of operations are not necessarily indicative of the results that may be expected for the full year.

2. Stock-Based Compensation

          In December 2004, the FASB issued SFAS No.123R (“SFAS No.123R”) (revised 2004), “Share-Based Payments.” SFAS No. 123R is a revision of SFAS No. 123 and supersedes ABP Opinion No. 25, which requires the Company to expense share-based payments, including employee stock options. With limited exceptions, the amount of compensation costs will be measured based on the grant date fair value of the equity or liability instrument issued. Compensation cost will be recognized over the period that the optionee provides service in exchange for the award. Prior to fiscal 2007 the Company was a small business issuer as defined in Item 10 of Regulation S-B. As a result, the Company was required to adopt this standard in its fiscal year beginning July 1, 2006.

          As of December 31, 2007 and 2006 total unrecognized compensation cost related to non-vested share-based compensation arrangements under the 2004 Equity Incentive Plan was $292,215 and $152,920, respectively. The cost is expected to be recognized over a weighted average period of four years. For the six-month periods ended December 31, 2007 and 2006, $30,457 and $0 was recorded as compensation expense, respectively.

          Cash received from share option exercises under stock-based payment plans for the six months ended December 31, 2007 and 2006 was $7,438 and $42,625, respectively. 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 its non-employee stock-based compensation under the Financial Accounting Standards Board (FASB) Emerging Issues Task Force (EITF) Issue No. 96-18, “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Service.” The fair value of the option issued is used to measure the transaction, 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. For the three-month and six-month periods ended December 31, 2007 and 2006, $141,454 and $123,772 was recorded as compensation expense, respectively.

3. Earnings Per Share

          The Company follows Financial Accounting Standards Board Statement No. 128, “Earnings Per Share,” in presenting basic and diluted earnings per share. The following table sets forth the computation of basic and diluted earnings per share:

		Three Months								Six Months
		Ended December 31,								Ended December 31,
		2007				2006				2007				2006
Numerator:
Numerator for basic and diluted earnings per share
Net (loss)		$	(639,346	)		$	(470,103	)		$	(1,468,137	)		$	(1,184,220	)
Denominator:
Denominator for basic earnings per share — weighted average shares			6,389,315				6,347,972				6,388,701				6,346,315
Effect of dilutive securities:
Stock options and warrants			0				0				0				0
Denominator for diluted earnings per share — weighted average and assumed conversion			6,389,315				6,347,972				6,388,701				6,346,315
Basic (loss) earnings per share		$	(0.10	)		$	(0.07	)		$	(0.23	)		$	(0.19	)
Diluted (loss) earnings per share		$	(0.10	)		$	(0.07	)		$	(0.23	)		$	(0.19	)

          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 (anti-dilutive).

4. Legal Proceedings

Institute of Child Health

          Drew entered into a license agreement with the Institute of Child Health (“ICH”) on May 10, 1993 to use ICH’s intellectual property to manufacture, lease, sell, use and sublicense certain products and all related consumables used therein in the testing of blood and fluids. Under the license agreement Drew was obligated to pay royalties to ICH on the products and consumables. On January 23, 2006, the Company received a letter from ICH alleging that Drew had failed to remit certain monies due under the license agreement and has sought an accounting to determine such amount due.

          The parties agreed to settle this matter in October 2007 for a payment by the Company to ICH of $23,304.

Other 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 included intellectual property disputes, contract disputes, employment disputes, and other matters. The Company does not believe that the resolution of any of these matters has had or is likely to have a material adverse impact on the Company’s business, financial condition or results of operations.

5. Segmental Information

          During the three-month and six-month periods ended December 31, 2007 and 2006, the Company’s operations were classified into five principal reportable business units that provide different products or services.

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

		Segmental Statements of Operations (in thousands) - Three months ended December 31, 2007 and 2006
		Drew								Sonomed								Vascular								Medical/Trek/EHI								EMI								Total
		2007				2006				2007				2006				2007				2006				2007				2006				2007				2006				2007				2006
Revenues, net:
Product revenue		$	3,154			$	2,717			$	2,529			$	2,732			$	876			$	796			$	331			$	379			$	560			$	411			$	7,450			$	7,035
Other revenue		$	45			$	55			$	0			$	0			$	0			$	0			$	0			$	547			$	0			$	0			$	45			$	602
Total revenue, net			3,199				2,772				2,529				2,732				876				796				331				926				560				411			$	7,495			$	7,637
Costs and expenses:
Cost of goods sold		$	1,942			$	1,922			$	1,209			$	1,220			$	351			$	305			$	212			$	245			$	237			$	186			$	3,951			$	3,878
Research & Development			590				875				176				84				44				36				0				2				67				83			$	877			$	1,080
Marketing, General & Admin			1,283				1,277				895				762				425				412				629				582				140				113			$	3,372			$	3,146
Total costs and expenses			3,815				4,074				2,280				2,066				820				753				841				829				444				382				8,200			$	8,104
(Loss) income from operations			(616	)			(1,302	)			249				666				56				43				(510	)			97				116				29				(705	)		$	(467	)
Other (expense) income:
Equity in OTM		$	0			$	0			$	0			$	0			$	0			$	0			$	(17	)		$	(12	)		$	0			$	0			$	(17	)		$	(12	)
Interest income		$	0			$	0			$	0			$	0			$	0			$	0			$	85			$	14			$	0			$	0			$	85			$	14
Interest expense		$	(2	)		$	(6	)		$	0			$	0			$	0			$	0			$	0			$	0			$	0			$	0			$	(2	)		$	(6	)
Total other (expense) income			(2	)			(6	)			0				0				0				0				68				2				0				0				66			$	(4	)
(Loss) income before taxes			(618	)		$	(1,309	)		$	249			$	666			$	56			$	43			$	(440	)		$	101			$	116			$	29				(639	)		$	(470	)
Income taxes		$	0			$	0				0				0				0				0				0				(1	)											0			$	(1	)
Net (loss) income		$	(618	)		$	(1,309	)		$	249			$	666			$	56			$	43			$	(440	)		$	102			$	116			$	29			$	(639	)		$	(469	)
Depreciation and amortization		$	81			$	56			$	8			$	5			$	16			$	11			$	24			$	23			$	53			$	28			$	182			$	123
Assets		$	17,310			$	17,325			$	12,549			$	14,099			$	1,687			$	4,034			$	10,135			$	1,590			$	1,611			$	1,069			$	43,292			$	38,117
Expenditures for long-lived assets		$	10			$	35			$	0			$	0			$	51			$	0			$	27			$	0			$	0			$	0			$	89			$	35

		Segmental Statements of Operations (in thousands) — Six months ended December 31, 2007 and 2006
		Drew								Sonomed								Vascular								Medical/Trek/EHI								EMI								Total
		2007				2006				2007				2006				2007				2006				2007				2006				2007				2006				2007				2006
Revenues, net:
Product revenue		$	6,189			$	5,502			$	4,762			$	5,025			$	1,680			$	1,613			$	716			$	744			$	937			$	694			$	14,284			$	13,578
Other revenue			105				125				0				0				0				0				0				1,102				0				0				105				1,227
Total revenue, net			6,294				5,627				4,762				5,025				1,680				1,613				716				1,846				937				694				14,389				14,805
Costs and expenses:
Cost of goods sold			3,844				3,681				2,466				2,407				634				618				466				499				464				304				7,874				7,509
Research & Development			1,192				1,333				340				161				129				58				0				91				139				151				1,800				1,794
Marketing, General & Admin			2,287				2,660				1,707				1,569				833				942				1,188				1,337				297				193				6,312				6,701
Total costs and expenses			7,323				7,674				4,513				4,137				1,596				1,618				1,654				1,927				900				648				15,986				16,004
(Loss) income from operations			(1,029	)			(2,047	)			249				888				84				(5	)			(938	)			(81	)			37				46				(1,597	)			(1,199	)
Other (expense) and income:
Equity in OTM			0				0				0				0				0				0				(51	)			(31	)			0				0				(51	)			(31	)
Interest income			0				0				0				0				0				0				187				59				0				0				187				59
Interest expense			(6	)			(15	)			0				0				0				0				0				0				0				0				(6	)			(15	)
Total other (expense) income			(6	)			(15	)			0				0				0				0				136				28				0				0				130				13
(Loss) income before taxes			(1,035	)			(2,062	)			249				888				84				(5	)			(802	)			(53	)			37				46				(1,467	)			(1,186	)
Income taxes			0				0				0				0				0				0				0				(2	)			0				0				0				(2	)
Net (loss) income		$	(1,035	)		$	(2,062	)		$	249			$	888			$	84			$	(5	)		$	(802	)		$	(51	)		$	37			$	46			$	(1,467	)		$	(1,184	)
Depreciation and amortization		$	149			$	142			$	18			$	11			$	25			$	36			$	46			$	41			$	58			$	52			$	296			$	282
Assets		$	17,310			$	17,325			$	12,549			$	14,099			$	1,687			$	4,034			$	10,135			$	1,590			$	1,611			$	1,069			$	43,292			$	38,117
Expenditures for long-lived assets		$	63			$	59			$	0			$	0			$	52			$	0			$	27			$	2			$	0			$	0			$	143			$	61

6. Related-Party Transactions

          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 December 31, 2007, the Company has invested $321,000 in OTM, including $33,000 invested during the six-month period ended December 31, 2007. As of December 31, 2007, the Company owned 45% of OTM. The Company provides administrative support functions to OTM. From inception through December 31, 2007, OTM had revenue of approximately $28,100 and incurred expenses of approximately $465,000.

7. Recently Issued Accounting Standards

          In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in the tax return. The Company adopted the provisions of FIN 48 on July 1, 2007. As of the date of adoption, the 2003-2006 tax years remain subject to examination by major tax jurisdictions.

          As a result of the implementation of FIN 48, the Company recognized no material adjustments in the liability for unrecognized income tax benefits and, at the adoption date of July 1, 2007, the Company had no unrecognized tax benefits that would affect its effective tax rate if recognized. At December 31, 2007, the Company also had no unrecognized tax benefits. If uncertain tax positions had been recorded, the Company would have recognized interest and penalties related to uncertain tax positions in income tax expense. As of December 31, 2007, no accrued interest related to uncertain tax positions has been recorded.

          In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 establishes a framework for measuring fair value and expands the disclosures on fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of the adoption of SFAS No. 157 on its consolidated financial statements. However, the Company does not expect the effect to be significant.

          In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities including an amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159 permits a company to choose to measure many financial instruments and other items at fair value that are not currently required to be measured at fair value. The objective is to improve financial reporting by providing a company with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 will be effective for fiscal years that begin after November 15, 2007. The Company is currently evaluating the impact of the adoption of SFAS No. 159 on its consolidated financial statements. However, the Company does not expect the effect to be significant.

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

Forward Looking Statements

          Certain statements contained in, or incorporated by reference in, this report are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, which provide current expectations or forecasts of future events. Such statements can be identified by the use of terminology such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “forecast,” “intend,” “may,” “plan,” “possible,” “project,” “should,” “will,” and similar words or expressions. The Company’s forward-looking statements include certain information relating to general business strategy, growth strategies, financial results, liquidity, product development, the introduction of new products, the potential markets and uses for the Company’s products, the Company’s regulatory filings with the FDA, acquisitions, the development of joint venture opportunities, intellectual property and patent protection and infringement, the loss of revenue due to the expiration or termination of certain agreements, the effect of competition on the structure of the markets in which the Company competes and defending the Company in litigation matters. The reader must carefully consider forward-looking statements and understand that such statements involve a variety of risks and uncertainties, known and unknown, and may be affected by assumptions that fail to materialize as anticipated. Consequently, no forward-looking statement can be guaranteed, and actual results may vary materially. It is not possible to foresee or identify all factors affecting the Company’s forward-looking statements, and the reader therefore should not consider the list of such factors contained in this report and its annual report on Form 10-K for the year ended June 30, 2007 to be an exhaustive statement of all risks, uncertainties or potentially inaccurate assumptions.

Executive Overview — Six-Month Period Ended December 31, 2007

          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 increased approximately 6% during the six-month period ended December 31, 2007 as compared to the same period last fiscal year. The increase was primarily related to increases in the Drew and EMI business units. Product revenue at Drew and EMI increased 12% and 35%, respectively, during the six-month period ended December 31, 2007 when compared to the same period last fiscal year. These increases were offset by weakened sales in the Company’s Sonomed and Medical/Trek business units. Sales at Sonomed and Medical/Trek decreased approximately 5% and 4%, respectively, during the six-month period ended December 31, 2007 compared to the same period last fiscal year.
	•		Other revenue decreased approximately $1,122,000 or 91% during the six-month period ended December 31, 2007 as compared to the same period last fiscal year. The decrease was attributable

			to decreased royalties received from the IntraLase License Agreement as a result of the settlement agreement between the Company and IntraLase dated February 27, 2007. Under the settlement agreement, IntraLase made a lump-sum payment to the Company of $9,600,000 in exchange for which all pending litigation between the parties was dismissed, the parties exchanged general releases, the Company’s ownership of all patents and intellectual property formerly licensed to IntraLase from the Company was obtained by IntraLase, and the license agreement has terminated. In addition, the payment from IntraLase satisfied all outstanding past, current and future royalties owed or alleged to be owed by IntraLase to the Company.
	•		Cost of goods sold as a percentage of product revenue increased slightly to approximately 56% during the six-month period ended December 31, 2007, as compared to approximately 55% for the same period last fiscal year. Gross margins in the Drew business unit have historically been lower than those in the Company’s other business units. The aggregate cost of goods sold as a percentage of product revenue of the Sonomed, Vascular, Medical/Trek and EMI business units during the three-month period ended December 31, 2007 was approximately 49% in the current period as compared to 45% in the same period last fiscal year.
	•		Operating expenses decreased approximately 5% during the six-month period ended December 31, 2007 as compared to the same period in the prior fiscal year. The decrease was due to a significant decrease in legal fees related to the IntraLase litigation and to the Company’s realizing the effect of the cost reduction plan implemented in the prior fiscal year.

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, hematology and vascular access. The Company and its products are subject to regulation and inspection by the FDA. The FDA requires extensive testing of new products prior to sale and has jurisdiction over the safety, efficacy and manufacture of products, as well as product labeling and marketing. The Company’s Internet address is www.escalonmed.com.

          In February 1996, the Company acquired substantially all of the assets and certain liabilities of Escalon Ophthalmics, Inc. (“EOI”), a developer and distributor of ophthalmic surgical products. Prior to this acquisition, the Company devoted substantially all of its resources to the research and development of ultra fast laser systems designed for the treatment of ophthalmic disorders. As a result of the EOI acquisition, the Company changed its market focus and ceased developing laser technology. In October 1997, the Company licensed its intellectual laser property to IntraLase, in return for an equity interest and future royalties on sales of products. In February 2007, the Company and IntraLase terminated the license agreement pursuant to the settlement agreement discussed above.

          To further diversify its product portfolio, in January 1999, the Company’s Vascular subsidiary acquired the vascular access product line from Endologix, formerly Radiance Medical Systems, Inc. Vascular’s products use Doppler technology to aid medical personnel in locating arteries and veins in difficult circumstances. Currently, this product line is concentrated in the cardiac catheterization market. In January 2000, the Company purchased Sonomed, a privately held manufacturer of ophthalmic ultrasound diagnostic equipment.

          On July 23, 2004, the Company acquired 67% of the outstanding ordinary shares of Drew, a United Kingdom company, pursuant to the Company’s exchange offer for all of the outstanding ordinary shares of Drew, and acquired all of the Drew shares during fiscal 2005. Drew is a diagnostics company specializing in the design, manufacture and distribution of instruments for blood cell counting and blood analysis. Drew is focused on providing instrumentation and consumables for the physician office and

veterinary office laboratories. Drew also supplies the reagent and other consumable materials needed to operate the instruments.

          Critical Accounting Policies

          The preparation of financial statements requires management to make estimates and assumptions that impact amounts reported therein. The most significant of those involve the application for SFAS 142, discussed further in Note 2 of the notes to the condensed consolidated financial statements included in this report. The financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, and, as such, include amounts based on informed estimates and judgments of management. For example, estimates are used in determining valuation allowances for deferred income taxes, uncollectible receivables, obsolete inventory, sales returns and rebates and purchased intangible assets. Actual results achieved in the future could differ from current estimates. The Company used what it believes are reasonable assumptions and, where applicable, established valuation techniques in making its estimates.

          Revenue Recognition

          The Company recognizes revenue from the sale of its products at the time of shipment, when title and risk of loss transfer. The Company provides products to its distributors at agreed wholesale prices and to the balance of its customers at set retail prices. Distributors can receive discounts for accepting high volume shipments. The discounts are reflected immediately in the net invoice price, which is the basis for revenue recognition. No further material discounts are given.

          The Company’s considerations for recognizing revenue upon shipment of product to a distributor are based on the following:

	•		Persuasive evidence that an arrangement (purchase order and sales invoice) exists between a willing buyer (distributor) and the Company that outlines the terms of the sale (company information, quantity of goods, purchase price and payment terms). The buyer (distributor) does not have an immediate right of return.
	•		Shipping terms are ex-factory shipping point. At this point the buyer (distributor) takes title to the goods and is responsible for all risks and rewards of ownership, including insuring the goods as necessary.
	•		The Company’s price to the buyer (distributor) is fixed and determinable as specifically outlined on the sales invoice. The sales arrangement does not have customer cancellation or termination clauses.
	•		The buyer (distributor) places a purchase order with the Company; the terms of the sale are cash, COD or credit. Customer credit is determined based on the Company’s policies and procedures related to the buyer’s (distributor’s) creditworthiness. Based on this determination, the Company believes that collectibility is reasonably assured.

          The Company assesses collectibility based on creditworthiness of the customer and past transaction history. The Company performs ongoing credit evaluations of its customers and does not require collateral from its customers. For many of the Company’s international customers, the Company requires an irrevocable letter of credit to be issued by the customer before the purchase order is accepted.

          Valuation of Intangible Assets

          The Company annually evaluates for impairment its intangible assets and goodwill in accordance with SFAS 142, “Goodwill and Other Intangible Assets,” or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. These intangible assets include goodwill, trademarks and trade names. Factors the Company considers important that could trigger an impairment review include significant under-performance relative to historical or projected future operating results or significant negative industry or economic trends. If these criteria indicate that the value of the intangible asset may be impaired, an evaluation of the recoverability of the net carrying value of the asset is made. If

this evaluation indicates that the intangible asset is not recoverable, the net carrying value of the related intangible asset will be reduced to fair value. Any such impairment charge could be significant and could have a material adverse impact on the Company’s financial statements if and when an impairment charge is recorded. No impairment losses were recorded for goodwill, trademarks and trade names during any of the periods presented based on these evaluations.

          (Loss)/Income Per Share

          The Company computes net (loss)/income per share under the provisions of SFAS No. 128, Earnings per Share (SFAS 128), and Staff Accounting Bulletin, No. 98 (SAB 98).

          Under the provisions of SFAS 128 and SAB 98, basic and diluted net (loss)/income per share is computed by dividing the net (loss)/income for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net (loss)/income per share excludes potential common shares if the effect is anti-dilutive. Basic earnings per share are computed by dividing net (loss)/income 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 (loss)/income for financial statement purposes, management must make certain estimates and judgments. These estimates and judgments occur in the calculation of certain tax liabilities and in the determination of the recoverability of certain of the deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenue and expense. SFAS 109 also requires that the deferred tax assets be reduced by a valuation allowance, if based on the available evidence, it is more likely than not that all or some portion of the recorded deferred tax assets will not be realized in future periods.

          In evaluating the Company’s ability to recover the Company’s deferred tax assets, management considers all available positive and negative evidence including the Company’s past operating results, the existence of cumulative losses and near-term forecasts of future taxable income that is consistent with the plans and estimates management is using to manage the underlying businesses.

          Through December 31, 2007, the Company has recorded a full valuation allowance against the Company’s net operating losses due to the uncertainty of their realization as a result of the Company’s earnings history, the number of years the Company’s net operating losses and tax credits can be carried forward, the existence of taxable temporary differences and near-term earnings expectations. The amount of the valuation allowance could decrease if facts and circumstances change that materially increase taxable income prior to the expiration of the loss carry forwards. Any reduction would reduce (increase) the income tax expense (benefit) in the period such determination is made by the Company.

Three- and Six-Month Periods Ended December 31, 2007 and 2006

          The following table shows consolidated product revenue by business segment as well as identifying trends in business segment product revenues for the three- and six-month periods ended December 31, 2007 and 2006. Table amounts are in thousands:

		Three-Month Period Ended												Six-Month Period Ended
		December 31,												December 31,
		2007				2006				% Change				2007				2006				% Change
Product Revenue:
Drew		$	3,154			$	2,717				16	%			6,189				5,502				12	%
Sonomed			2,529				2,732				-7	%			4,762				5,025				-5	%
Vascular			876				796				10	%			1,680				1,613				4	%
Medical/Trek			331				379				-13	%			716				744				-4	%
EMI			560				411				36	%			937				694				35	%
Total		$	7,450			$	7,035				6	%			14,284				13,578				5	%

          Product revenue increased approximately 415,000, or 6%, to $7,450,000 for the three-month period ended December 31, 2007 as compared to the same period last fiscal year.

          In the Drew business unit, product revenue increased $437,000, or 16%, as compared to the same period last fiscal year. The increase is primarily due to the introduction of the new FDA approved Trilogy and D3 instruments, and increased reagent revenues generated from Drew’s United Kingdom facility. Drew anticipates that its new DS-360 instrument, currently under development, will be ready for sale in the fourth quarter of fiscal 2008.

          Product revenue decreased $203,000, or 7%, at the Sonomed business unit as compared to the same period last fiscal year. The decrease in product revenue was primarily caused by an increase in sales discounts during the period as a result of a large increase in sales to the more price sensitive international market combined with a decrease in overall domestic sales of the Company’s new Vumax II ultrasound systems.

          Product revenue increased $80,000, or 10%, to $876,000 in the Vascular business unit during the three-month period ended December 31, 2007, as compared to the same period last fiscal year. The increase in product revenue in the Vascular business unit was primarily caused by an increase in direct sales to end users by the Company’s domestic sales team, and by turning over the territory of a terminated domestic distributor to the domestic sales team.

          In the Medical/Trek business unit, product revenue decreased $48,000, or 13%, to $331,000 during the three-month period ended December 31, 2007 as compared to the same period last fiscal year. The decrease in Medical/Trek product revenue is primarily attributed to a decrease in the sale of Trek’s mature product line of Ispan Intraocular gases and fiber optic sources.

          Product revenue increased $149,000, or 36%, in the EMI business unit when compared to the same period last year. This is due to increased sales of digital imaging systems.

          Product revenue increased approximately $706,000, or 5%, to $14,284,000 during the six-month period ended December 31, 2007 as compared to the same period last fiscal year.

          In the Drew business unit, product revenue increased $687,000, or 12%, as compared to the same period last fiscal year. The increase in product revenue is attributable to the introduction of the new FDA approved Trilogy and D3 instruments, and increased reagent revenues generated from Drew’s United

Kingdom facility. Drew anticipates that its new DS-360 instrument, currently under development, will be ready for sale in the fourth quarter of fiscal 2008.

          In the Sonomed business unit, product revenue decreased $263,000, or 5%, as compared to the same period last fiscal year. The decrease in product revenue was primarily caused by an increase in sales discounts during the period as a result of a large increase in sales to the more price sensitive international market combined with a decrease in overall domestic sales of the Company’s new Vumax II ultrasound systems.

          In the Vascular business unit, product revenue increased $67,000, or 4%, to $1,680,000 during the six-month period ended December 31, 2007 as compared to the same period last fiscal year. The increase in product revenue in the Vascular business unit was primarily caused an increase in direct sales to end users by the Company’s domestic sales team, and by turning over the territory of a terminated domestic distributor to the domestic sales team.

          In the Medical/Trek business unit, product revenue decreased $28,000, or 4%, to $716,000 during the six-month period ended December 31, 2007 as compared to the same period last fiscal year. The decrease in Medical/Trek product revenue is primarily attributed to a decrease in the sale of Trek’s mature product line of Ispan Intraocular gases and fiber optic sources.

          Product revenue increased $243,000, or 35%, during the six-month period ended December 31, 2007 in the EMI business unit when compared to the same period last year. This is due to 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 six-month periods ended December 31, 2007 and 2006. Table amounts are in thousands:

		Three-Month Period Ended												Six-Month Period Ended
		December 31,												December 31,
		2007				2006				% Change				2007				2006				% Change
Other Revenue:
Drew		$	45			$	55				-18	%			105				125				-16	%
Sonomed			0				0				0	%			0				0				0	%
Vascular			0				0				0	%			0				0				0	%
Medical/Trek			0				547				-100	%			0				1,102				-100	%
EMI			0				0				0	%			0				0				0	%
Total		$	45			$	602				-93	%			105				1,227				-91	%

          Other revenue decreased by approximately $557,000, or 93%, to $45,000 during the three-month period ended December 31, 2007 as compared to the same period last fiscal year. Other revenue also decreased by approximately $1,122,000, or 8.2%, to $1,227,000 during the six-month period ended December 31, 2007 as compared to the same period last fiscal year. The decreases are attributable to decreased royalties received from the IntraLase License Agreement as a result of the settlement agreement between the Company and IntraLase dated February 27, 2007. Under the settlement agreement, IntraLase made a lump-sum payment to the Company of $9,600,000 in exchange for which all pending litigation between the parties was dismissed, the parties exchanged general releases, the Company’s ownership of all patents and intellectual property formerly licensed to IntraLase from the Company was obtained by IntraLase, and the license agreement has terminated. In addition, the payment from IntraLase satisfied all outstanding past, current and future royalties owed or alleged to be owed by IntraLase to the Company.

          The following table presents consolidated cost of goods sold by reportable business segment and as a percentage of related segment product revenues for the three- and six-month periods ended December 31, 2007 and 2006. Table amounts are in thousands:

		Three-Month Period																Six-Month Period
		Ended December 31,																Ended December 31,
		2007				%				2006				%				2007				%				2006				%
Cost of Goods Sold:
Drew		$	1,942				62	%		$	1,922				71	%			3,844				62	%			3,681				67	%
Sonomed			1,209				48	%			1,220				45	%			2,466				52	%			2,407				48	%
Vascular			351				40	%			305				38	%			634				38	%			618				38	%
Medical/Trek			212				64	%			245				65	%			466				65	%			499				67	%
EMI			237				42	%			186				45	%			464				50	%			304				44	%
Total		$	3,951				53	%		$	3,878				55	%			7,874				55	%			7,509				55	%