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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM 10-K
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 2004.
[ ] Transitional report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transitional 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 (I.R.S. employer
incorporation or organization) identification number)
575 EAST SWEDESFORD ROAD, SUITE 100, WAYNE, PA 19087
(Address of principal executive offices, including zip code)
(610) 688-6830
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $0.001 PER SHARE
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 shorter period that the Registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the last 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
At December 31, 2003, the aggregate market value of the shares of Common Stock
held by the Registrant's nonaffiliates was approximately $22,835,416 (based upon
the last sales price of Common Stock on the Nasdaq SmallCap Market on such
date).
At September 20, 2004, 5,915,008 shares of Common Stock were outstanding.
Documents incorporated by reference
Registrant's proxy statement to be filed in connection with its 2004 Annual
Meeting of Shareholders incorporated by reference in Part III, Items 10, 11, 12,
13 and 14.
ESCALON MEDICAL CORP.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 30, 2004
TABLE OF CONTENTS
Page
Part I
Item 1. Business 2
Item 2. Properties 15
Item 3. Legal Proceedings 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities 17
Item 6. Selected Financial Data 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 31
Item 8. Financial Statements and Supplementary Data 32
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 32
Item 9A. Controls and Procedures 32
Item 9B. Other Information 32
Part III.
Item 10. Directors and Executive Officers of the Registrant 32
Item 11. Executive Compensation 32
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 33
Item 13. Certain Relationships and Related Transactions 33
Item 14. Principal Accountants Fees and Services 33
Part IV.
Item 15. Exhibits and Financial Statement Schedules 33
1
PART I
ITEM 1. BUSINESS
COMPANY OVERVIEW
Escalon Medical Corp. ("Escalon" or the "Company") was incorporated
in California in 1987 as Intelligent Surgical Lasers, Inc. The Company's present
name was adopted in August 1996. Escalon reincorporated in Delaware in November
1999, and then reincorporated in Pennsylvania in November 2001. Within this
document, the "Company" collectively shall mean Escalon and its wholly owned
subsidiaries: Sonomed, Inc. ("Sonomed"), Sonomed EMS, Srl. ("Sonomed EMS"),
Escalon Vascular Access, Inc. ("Vascular"), Escalon Digital Vision, Inc. ("EMI")
and Escalon Pharmaceutical, Inc. ("Pharmaceutical"). The Company operates in the
healthcare market, specializing in the development, manufacture, marketing and
distribution of ophthalmic medical devices, pharmaceuticals and vascular access
devices. The Company and its products are subject to regulation and inspection
by the United States Food and Drug Administration ("FDA"). The FDA requires
extensive testing of new products prior to sale and has jurisdiction over the
safety, efficacy and manufacturing 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 ultrafast laser systems designed for the treatment of ophthalmic
disorders. As a result of the EOI acquisition, Escalon changed its market focus
and is no longer developing laser technology. In October 1997, the Company
licensed its intellectual laser property to Intralase Corp. ("IntraLase"), in
return for an equity interest and future royalties on sales of products relating
to the laser technology. IntraLase undertook the responsibility for funding and
developing the laser technology through to commercialization. IntraLase began
selling products related to the laser technology during fiscal 2002. The Company
is in dispute with Intralase over royalty payments owed to the Company. See Item
3 - Litigation, for further information.
To further diversify its product portfolio, in January 1999, the
Company's Vascular subsidiary acquired the vascular access product line from
Endologix, Inc. ("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. In April 2000, EMI formed a joint venture, Escalon Medical
Imaging, LLC with Megavision, Inc. ("Megavision"), a privately held company, to
develop and market a camera back for ophthalmic photography. The Company
terminated its joint venture with Megavision and commenced operations within its
EMI business unit on January 1, 2002.
As of July 23, 2004, Escalon acquired approximately 67% of the
outstanding ordinary shares of Drew Scientific Group PLC ("Drew"), a United
Kingdom company, pursuant to the Company's exchange offer for all of the
outstanding ordinary shares of Drew, and since that date has acquired
approximately 92% of the Drew shares. Escalon expects to acquire the remaining
outstanding Drew shares pursuant to procedures under United Kingdom laws and
regulations within the next fiscal year.
Drew is a diagnostics company specializing in the design,
manufacture and distribution of analytical systems for laboratory testing
worldwide. Drew is focused on providing instrumentation and consumables for the
diagnosis and monitoring of medical disorders in the areas of diabetes,
cardiovascular diseases and hematology. In addition, Drew supplies other
diagnostic systems, which perform blood component tests. Escalon expects to
operate Drew as wholly owned separate business segment.
2
SONOMED BUSINESS
Sonomed develops, manufactures and markets Ultrasound systems for
diagnostic or biometric applications in ophthalmology. The systems are of three
types: A-Scans, B-Scans and pachymeters.
A-SCANS
The A-Scan provides information about the internal structure of the
eye by sending a beam of ultrasound along a fixed axis through the eye and
displaying the various echoes reflected from the surfaces intersected by the
beam. The principal echoes occur at the cornea, both surfaces of the lens and
the retina. The system displays the position and magnitudes of the echoes on an
electronic display. The A-Scan also includes software for measuring distances
within the eye. This information is primarily used to calculate lens power for
implants.
B-SCANS
The B-Scan is primarily a diagnostic tool, which supplies
information to physicians where the media within the eye are cloudy or opaque.
Whereas physicians normally use light, which cannot pass through such media, the
ultrasound beam is capable of passing through the opacity and displaying an
image of the internal structures of the eye. Unlike the A-Scan, the B-Scan
transducer is not in a fixed position; it swings through a 60 degree sector to
provide a two dimensional image of the eye.
PACHYMETERS
The pachymeter uses the same principles as the A-Scan, but the
system is tailored to measure the thickness of the cornea. With the advent of
refractive surgery (where the cornea is actually cut and reshaped) this
measurement has become critical. Surgeons must know the precise thickness of the
cornea so as to set the blade to make a cut of approximately 20% of the
thickness of the cornea.
VASCULAR BUSINESS
Vascular develops, manufactures and markets vascular access
products. These products are Doppler-guided vascular access assemblies used to
locate desired vessels for access. Primary specialty groups that use the device
are cardiac catheterization labs and interventional radiology. The Company's
vascular products include the PD Access(TM) and SmartNeedle(TM) lines of
monitors, Doppler-guided bare needles and Doppler-guided infusion needles.
PD ACCESS(TM) AND SMARTNEEDLE(TM) MONITORS, NEEDLES AND CATHETER
PRODUCTS
These patented devices detect blood flow using Doppler ultrasound
technology and differentiate between a venous and arterial vessel. The devices
utilize a miniature Doppler ultrasound probe that is positioned within the lumen
of a vascular access needle. When a Doppler-guided needle pierces the skin of a
patient, the probe and monitor can determine if the user is approaching an
artery or vein, guiding them to a successful access.
MEDICAL/TREK BUSINESS
Medical/Trek develops, manufactures and distributes ophthalmic
surgical products under the Escalon Medical Corp. and/or Trek Medical Products
names. Vitreoretinal ophthalmic surgeons primarily utilize the products. The
following is a summary of the business's key product lines:
ADATOSIL(R) 5000 SILICONE OIL ("SILICONE OIL")
Silicone Oil is a specialty product used in worst-case detached
retina surgery as a mechanical aid in the reattachment procedure. The Company
distributed Silicone Oil until August 13, 1999, at which time the license and
distribution rights for the product were sold to Bausch & Lomb Surgical, Inc.
The license
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and distribution rights were sold for $2.1 million and additional cash
consideration based on future sales to be received through August 2005 (See Note
10 of the Notes to Consolidated Financial Statements for additional details).
ISPAN INTRAOCULAR GASES
The Company distributes two intraocular gas products, C(3)F(8) and
SF(6), which are used by vitreoretinal surgeons as a temporary tamponade in
detached retina surgery. Under a non-exclusive distribution agreement with Scott
Medical Products ("Scott"), Escalon distributes packages of Scott gases in
canisters containing 25 grams or less of gas. Along with the intraocular gases,
the Company manufactures and distributes a patented disposable universal gas
kit, which delivers the gas from the canister to the patient.
VISCOUS FLUID TRANSFER SYSTEMS
Escalon markets viscous fluid transfer systems and related
disposable syringe products, which aid surgeons in the process of injecting and
extracting Silicone Oil. Adjustable pressures and vacuums provided by the
equipment allow surgeons to manipulate the flow of Silicone Oil during surgery.
FIBER OPTIC LIGHT SOURCES
Light source and fiber optic products are widely used by
vitreoretinal surgeons during surgery. The Company offers surgeons a complete
line of light sources along with a variety of fiber optic probes and illuminated
tissue manipulators.
EMI BUSINESS
EMI markets a CFA (Color/Fluorescein Angiography) digital imaging
system, designed specifically for ophthalmology. This diagnostic tool, ideal for
use in detecting retinal problems in diabetic and elderly patients, provides a
high-resolution image, far superior to conventional film in image quality,
processing and capture. The instant image display provides users with the
necessary clinical information so laser treatment can be performed while the
patient is still in the office.
CFA CAMERA BACK
The images furnished by the CFA camera system provide a very high
level of detail. The camera back is being marketed to medical institutions,
educational institutions and ophthalmologists for the use in connection with the
diagnosis of retinal disorders.
PHARMACEUTICAL BUSINESS
The Company obtained the license and distribution rights for
Povidone-Iodine 2.5% solution from Harbor-UCLA Medical Center. Povidone-Iodine
2.5% solution is a broad-spectrum anti-microbial intended to prevent ophthalmia
neonatorum in newborns. The product required further development before
achieving FDA approval. Having exhausted all partnering possibilities, during
fiscal 2003 the Company decided that further expenditures on this project were
not in the shareholders' best interest and the project was abandoned. The
decision resulted in the Company's taking a charge of $196,000, which included
the write-off of the remaining net book value of the license and distribution
rights subject to normal amortization.
DREW BUSINESS
Drew is a diagnostics company specializing in the design,
manufacture and distribution of analytical systems for laboratory testing
worldwide. Drew is focused on providing instrumentation and consumables for the
diagnosis and monitoring of medical disorders in the areas of diabetes,
cardiovascular
4
diseases and hematology. In addition, Drew supplies other diagnostic systems,
which perform blood component tests.
DIABETIC TESTING
The DS5 instrument, dispenser and associated reagent kit measure
long term glucose control in diabetic patients. The system's small size and ease
of use make it ideal for main laboratory, clinic or satellite laboratory
settings. The Hb-Gold instrument and associated reagent kit provides for the in
vitro measurement of certain genetic diseases of the blood. In the United
States, this instrument is available for research only.
HEMATOLOGY
Drew offers a broad array of equipment for use in the field of human
and veterinary hematology. Drew's Excell and HC product lines are for use in the
field of human hematology, whereas the Hemavet product line is for use in the
veterinary field.
RESEARCH AND DEVELOPMENT
Escalon conducts medical device and vascular access product
development at its New Berlin, Wisconsin facility located near Milwaukee. The
development of ultrasound ophthalmic equipment is performed at the Company's
Lake Success, New York facility located on Long Island. The Company sponsored
research and development expenditures for the fiscal years ended June 30, 2004,
2003 and 2002 were $776,496, $780,333 and $554,760, respectively.
MANUFACTURING AND DISTRIBUTION
Escalon leases 13,500 square feet of space in New Berlin, Wisconsin,
near Milwaukee, for its surgical products and vascular access operations. The
facility is currently used for engineering, product design and development,
manufacturing and product assembly. The Company subcontracts component
manufacture, assembly and sterilization to various vendors. The New Berlin
manufacturing facility includes a class 10,000 clean room. A class 10,000 clean
room is a controlled environment for producing devices while avoiding any
significant contaminants. The cleanliness provided by the clean room exceeds the
requirements of the FDA. All of the Company's ophthalmic surgical products and
vascular access products are distributed from its Wisconsin facility. The
Company designs, develops and services its ultrasound ophthalmic products at its
facility in Lake Success, New York. The Company relocated its New York
operations to a new 11,000 facility in September 2004. The Company pursued and
achieved ISO9001 certification at both of its manufacturing facilities for all
medical and ultrasound devices produced. ISO9001 requires an implemented quality
system that applies to product design. These certifications can be obtained only
after a complete audit of a company's quality system by an independent outside
auditor. These certifications require that these facilities undergo periodic
reexamination. European Community ("CE") certification has been obtained for
disposable delivery systems, fiber optic light probes, vascular access products
and certain ultrasound models. The manufacture, testing and marketing of each of
the Company's products entails the risk of product liability. Product liability
insurance is carried by Escalon to cover primary risk. Additionally, Drew leases
an aggregate of 69,000 square feet of space at its facilities in the United
Kingdom, Connecticut and Texas. These sites are currently used for engineering,
product design and development, manufacturing and product assembly.
GOVERNMENTAL REGULATIONS
Escalon's products are subject to stringent ongoing regulation by
the FDA and similar health authorities, and if the FDA's approvals or clearances
of the Company's products are restricted or revoked the Company could face
delays that would impair the Company's ability to generate funds from
operations.
5
The FDA and similar health authorities in foreign countries
extensively regulate Escalon's activity. The Company must obtain either 510(K)
clearances or pre-market approvals and new drug application approvals prior to
marketing a product in the United States. Foreign regulation also requires that
Escalon obtain other approvals from foreign government agencies prior to the
sale of products in those countries. Also, Escalon may be required to obtain FDA
clearance or approval before exporting a product or device that has not received
FDA marketing clearance or approval.
Escalon has received the necessary FDA clearances and approvals for
all products that the Company currently markets. Any restrictions on or
revocation of the FDA approvals and clearances that the Company has obtained,
however, would prevent the continued marketing of the impacted products and
other devices. The restrictions or revocations could result from the discovery
of previously unknown problems with the product. Consequently, the FDA
revocation would impair the Company's ability to generate funds from operations.
The FDA and comparable agencies in state and local jurisdictions and
in foreign countries impose substantial requirements upon the manufacturing and
marketing of pharmaceutical and medical device equipment and related
disposables, including the obligation to adhere the FDA's Good Manufacturing
Practice regulations. Compliance with these regulations requires time-consuming
detailed validation of manufacturing and quality control processes, FDA periodic
inspections and other procedures. If the FDA finds any deficiencies in the
validation processes, for example, the FDA may impose restrictions on marketing
the specific products until such deficiencies are corrected.
Escalon has received CE approval on several of the Company's
products that allows the Company to sell the products in the countries
comprising the European community. In addition to the CE mark, however, some
foreign countries may require separate individual foreign regulatory clearances.
Escalon cannot assure you that the Company will be able to obtain regulatory
clearances for other products in the United States or foreign markets.
The process for obtaining regulatory clearances and approvals and
underlying clinical studies for any new products or devices and for multiple
indications for existing products is lengthy and requires substantial
commitments of our financial resources and our management's time and effort. Any
delay in obtaining clearances or approvals or any changes in existing regulatory
requirements would materially adversely affect the Company's business.
Escalon's failure to comply with the applicable regulations would
subject the Company to fines, delays or suspensions of approvals or clearances,
seizures or recalls of products, operating restrictions, injunctions or civil or
criminal penalties, which would adversely affect the Company's business,
financial condition and results of operations.
MARKETING AND SALES
The Medical/Trek business unit sells its ophthalmic devices and
instruments products directly to end users through internal sales and marketing
employees located at the Company's Wisconsin facility. Sales are primarily to
teaching institutions, key hospitals and eye surgery centers focusing primarily
on physicians and operating room personnel performing vitreoretinal surgery.
Vascular business unit products are marketed domestically through internal sales
and marketing employees located in Pennsylvania, Illinois, California and at its
Wisconsin facility, as well as through five independent distributors and sales
representatives located in Florida, Missouri, Ohio, Washington and Germany
managed by the Company's sales team. The Sonomed product line is sold through
internal sales employees located at the Company's New York facility, as well as
an independent sales representative in Europe, to a large network of
distributors and directly to medical institutions both domestically and abroad.
The EMI product line is sold through independent sales representatives. The Drew
business unit sells its products through internal sales and marketing employees
as well as through a large network of distributors.
6
SERVICE AND SUPPORT
Escalon maintains a full-service program for all products sold.
Limited warranties are given on all products against defects and performance.
Product repairs are made at the Wisconsin facility for surgical devices and
vascular access products and EMI devices. Sonomed's products are serviced at the
New York facility. Drew's products are serviced at its Connecticut facility.
THIRD PARTY REIMBURSEMENT
It is expected that physicians and hospitals will purchase the
Company's ophthalmic products and that they in turn will bill various third
party payers for health care services provided to their patients. These payers
include Medicare, Medicaid and private insurers. Government agencies generally
reimburse health care providers at a fixed rate based on the procedure
performed. Third party payers may deny reimbursement if they determine that a
procedure performed using any one of the Company's products was unnecessary,
inappropriate, not cost-effective, experimental or used for a non-approved
indication.
PATENTS, TRADEMARKS AND LICENSES
The pharmaceutical and medical device communities place considerable
importance on obtaining patent and trade secret protection for new technologies,
products and processes for the purpose of strengthening the Company's position
in the market place and protecting the Company's economic interests. The
Company's policy is to protect its technology by aggressively obtaining patent
protection for all of its developments and products, both in the United States
and in selected countries outside the United States. It is the Company's policy
to file for patent protection in those foreign countries in which the Company
believes such protection is necessary to protect its economic interests.
Twenty-one United States issued patents, and nineteen patents issued abroad
cover the Company's surgical products and pharmaceutical technology. With
respect to the Company's ultrafast laser technology (licensed to Intralase
Corp.), sixteen patents have been issued in the United States and eleven
overseas. Vascular access products are covered by eighteen patents, which
provide protection in the United States, Europe, Japan and other countries
overseas. The Company intends to vigorously defend its patents if the need
arises. Drew has approximately sixty patents related to its technology.
While in the aggregate the Company's patents are of material
importance to its business taken as a whole, the patents, trademarks and license
that are the most critical to the Company's ability to generate revenues are as
follows:
- The Escalon trademark is due for renewal on January 19, 2013, and
the Company intends to renew the trademark. The Sonomed trademark is
due for renewal on April 16, 2006 and the Company intends to renew
the trademark.
- In the Vascular business unit, the Company has two patents that are
of material importance. The first patent is the apparatus for the
cannulation of blood vessels. This patent will expire on February
23, 2011. The second patent is also an apparatus for the cannulation
of blood vessels. This patent will expire on January 11, 2009.
- The Company licensed its ultrafast laser systems to Intralase Corp.
The material patents will expire between 2008 and 2014. Under the
terms of the ultrafast laser systems license, in exchange for the
use of the Company's licensed laser patents, Escalon will receive a
2.5% royalty on future product sales that are based on the licensed
laser patents, subject to deductions for royalties payable to third
parties up to a maximum of 50% of royalties otherwise due and
payable to the Company and a 1.5% royalty on product sales that are
not based on the licensed laser patents. The Company receives a
minimum annual license fee of $15,000 per year during the term of
the license that is offset against the royalty payments. The license
was dated October 23, 1997, and was amended and restated in October
2000 and expires upon the latest to occur of the following events:
1. the last to expire of the licensed patents;
2. ten years from the effective date of the amended and
restated agreement; or
7
3. the fifth anniversary date of the date of the first
commercial sale.
The material termination provisions of the license are as follows:
1. the default in payment of any royalty;
2. the default in the making of any required report;
3. making of any false report;
4. the commission of any material breach of any covenant or
promise under the license agreement; or
5. the termination of the license by the licensee at any
time after 90 days notice. If the licensee were to
terminate it would not be permitted to utilize the
licensed technology necessary to manufacture its current
products.
The duration of the Company's patents, trademarks and licenses vary
through 2020. See Item 3 - Litigation, for further information regarding the
licensing of Escalon intellectual property to Intralase.
COMPETITION
There are numerous direct and indirect competitors of the Company in
the United States and abroad. These companies include ophthalmic-oriented
companies that market a broad portfolio of products including prescription
ophthalmic pharmaceuticals, ophthalmic devices, consumer products (such as
contact lens cleaning solution) and other eye care products; large integrated
pharmaceutical companies that market a limited number of ophthalmic
pharmaceuticals in addition to many other pharmaceuticals; and smaller specialty
pharmaceutical and biotechnology companies that are engaged in the development
and commercialization of prescription ophthalmic pharmaceuticals and products
and, to some extent, drug delivery systems. The Company's competitors for
medical devices and ophthalmic pharmaceuticals include, but are not limited to,
Bausch & Lomb, Inc., Alcon Laboratories, Inc., Paradigm Medical, Inc., Quantel,
Inc. and Accutome, Inc.
Several large companies dominate the ophthalmic market, with the
balance of the industry being highly fragmented. The Company believes that these
large companies capture approximately 85% of the overall ophthalmic market. The
balance of the market is comprised of smaller companies ranging from start-up
entities to established market players. The ophthalmic market in general is
intensely competitive, with each company eager to expand its market share. The
Company's strategy is to compete primarily on the basis of technological
innovation to which it has proprietary rights. The Company believes, therefore,
that its success will depend in large part on protecting its intellectual
property through patents and other governmental regulations. The Company
recognizes that there are other innovative companies that may develop
competitive strategies.
Sonomed designs and manufactures ophthalmic ultrasound products:
A-Scans, pachymeters and B-Scans. The A-Scans and pachymeters furnish internal
measurements of the eye and B-Scans provide an image of the rear of the eye. The
principal competitors are Alcon Laboratories, Quantel, Inc. and Accutome, Inc.
Management believes that the Company is in a market leadership position. Sonomed
has had a leading presence in the industry for over thirty years. Management
believes that this has helped the Company build a reputation as a long-standing
operation that provides a quality product, which has enabled the Company to
establish effective distribution coverage within the United States market. The
Company seeks to preserve its position in the market through continued product
enhancement. Various competitors offering similar products at a lower price
could threaten Sonomed's market position. The development of laser technologies
for ophthalmic biometrics and imaging may also diminish the Company's market
position. This equipment can be used instead of ultrasound equipment in most,
but not all, patients. Such equipment, however, is more expensive.
The Medical/Trek business sells a broad range of ophthalmic surgical
products. The more significant products are ISPAN(R) gases and delivery systems.
Medical/Trek also manufactures various ophthalmic surgical products for major
ophthalmic companies to be sold under their name. To remain
8
competitive, the Company needs to maintain a low cost operation. There are
numerous other companies that can provide this manufacturing service.
There are a variety of other devices that directly compete with
Sonomed's ultrasound products and the camera back marketed by EMI.
The vascular access product line is comprised of disposable devices,
and currently it has no direct competition. However, a significantly higher
priced non-disposable device that facilitates vascular access is currently being
marketed. Vascular produces the only device that can be accommodated within a
standard needle for assisting medical practitioners in gaining access to a
vessel in the human vascular system. There are no similar devices in the market
that enable medical practitioners in gaining access using their normal
procedures. The only similar product utilizes a separate ultrasound monitor, but
no disposables are utilized. When using the competing device, medical
practitioners need to look at the monitor while advancing the needle into the
patient. The perceived disadvantage of the Company's vascular product is that
its retail price is substantially greater than the cost of a traditional needle.
HUMAN RESOURCES
As of June 30, 2004, the Company employed 63 full-time employees and
one part-time employee. Thirty-four of the Company's employees are employed in
manufacturing, 15 are employed in general and administrative positions, 10 are
employed in sales and marketing and five are employed in research and
development. Escalon's employees are not covered by a collective bargaining
agreement, and the Company considers its relationship with its employees to be
good. As of July 23, 2004, Drew employed approximately 90 employees.
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
Certain statements contained in, or incorporated by reference in,
this Annual Report on Form 10-K, 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," "protect," "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,
the development of joint venture opportunities, the effect of competition on the
structure of the markets in which the Company competes and defending the Company
in litigation matters. One must carefully consider forward-looking statements
and 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 one therefore should not consider the
following list of such factors to be an exhaustive statement of all risks,
uncertainties or potentially inaccurate assumptions. The Company undertakes no
obligation to update any forward-looking statement. Although it is not possible
to create a comprehensive list of all factors that may cause actual results to
differ from our forward-looking statements, the most important factors include,
without limitation, the following:
THE COMPANY'S PRODUCTS ARE SUBJECT TO STRINGENT ONGOING REGULATION
BY THE FDA AND SIMILAR HEALTH AUTHORITIES, AND IF THE FDA'S
APPROVALS OR CLEARANCES OF THE COMPANY'S PRODUCTS ARE RESTRICTED OR
REVOKED THE COMPANY COULD FACE DELAYS THAT WOULD IMPAIR THE
COMPANY'S ABILITY TO GENERATE FUNDS FROM OPERATIONS.
The FDA and similar health authorities in foreign countries
extensively regulate Escalon's activity. The Company must obtain either 510(K)
clearances or pre-market approvals and new drug application approvals prior to
marketing a product in the United States. Foreign regulation also requires that
Escalon obtain other approvals from foreign government agencies prior to the
sale of products in those
9
countries. Also, Escalon may be required to obtain FDA approval before exporting
a product or device that has not received FDA marketing clearance or approval.
Escalon has received the necessary FDA approvals for all products
that the Company currently markets. Any restrictions on or revocation of the FDA
approvals and clearances that the Company has obtained, however, would prevent
the continued marketing of the impacted products and other devices. The
restrictions or revocations could result from the discovery of previously
unknown problems with the product. Consequently, the FDA revocation would impair
the Company's ability to generate funds from operations.
The FDA and comparable agencies in state and local jurisdictions and
in foreign countries impose substantial requirements upon the manufacturing and
marketing of pharmaceutical and medical device equipment and related
disposables, including the obligation to adhere the FDA's Good Manufacturing
Practice regulations. Compliance with these regulations requires time-consuming
detailed validation of manufacturing and quality control processes, FDA periodic
inspections and other procedures. If the FDA finds any deficiencies in the
validation processes, for example, the FDA may impose restrictions on marketing
the specific products until such deficiencies are corrected.
Escalon has received CE approval on several of the Company's
products that allows the Company to sell the products in the countries
comprising the European community. In addition to the CE mark, however, some
foreign countries may require separate individual foreign regulatory clearances.
Escalon cannot assure you that the Company will be able to obtain regulatory
clearances for other products in the United States or foreign markets.
The process for obtaining regulatory clearances and approvals and
underlying clinical studies for any new products or devices and for multiple
indications for existing products is lengthy and will require substantial
commitments of Escalon's financial resources and Escalon's management's time and
effort. Any delay in obtaining clearances or approvals or any changes in
existing regulatory requirements would materially adversely affect the Company's
business.
Escalon's failure to comply with the applicable regulations would
subject the Company to fines, delays or suspensions of approvals or clearances,
seizures or recalls of products, operating restrictions, injunctions or civil or
criminal penalties, which would adversely affect the Company's business,
financial condition and results of operations.
FAILURE OF THE MARKET TO ACCEPT THE COMPANY'S PRODUCTS COULD
ADVERSELY IMPACT THE COMPANY'S BUSINESS AND FINANCIAL CONDITION.
The Company's business and financial condition will depend upon the
market acceptance of the Company's products. The Company cannot assure that the
Company's products will achieve market acceptance. Market acceptance depends
upon a number of factors:
- the price of the products;
- the receipt of regulatory approvals for multiple indications;
- the establishment and demonstration of the clinical safety and
efficacy of the Company's products; and
- the advantages of the Company's products over those marketed by the
Company's competitors.
Any failure to achieve significant market acceptance of the
Company's products will have a material adverse effect on the Company's
business.
10
THE SUCCESS OF COMPETITIVE PRODUCTS COULD HAVE AN ADVERSE EFFECT ON
THE COMPANY'S BUSINESS.
The Company faces intense competition in the medical device and
pharmaceutical markets, which are characterized by rapidly changing technology,
short product life cycles, cyclical oversupply and rapid price erosion. Many of
the Company's competitors have substantially greater financial, technical,
marketing, distribution and other resources. The Company's strategy is to
compete primarily on the basis of technological innovation, reliability, quality
and price of the Company's products. Without timely introductions of new
products and enhancements, the Company's products will become technologically
obsolete over time, in which case the Company's revenues and operating results
would suffer. The success of the Company's new product offerings will depend on
several factors, including the Company's ability to:
- properly identify customer needs;
- innovate and develop new technologies, services and applications;
- establish adequate product distribution coverage;
- obtain and maintain required regulatory approvals from the FDA and
other regulatory agencies;
- protect the Company's intellectual property;
- successfully commercialize new technologies in a timely manner;
- manufacture and deliver the Company's products in sufficient volumes
on time;
- differentiate the Company's offerings from the offerings of the
Company's competitors;
- price the Company's products competitively;
- anticipate competitors' announcements of new products, services or
technological innovations; and
- general market and economic conditions.
The Company cannot assure that the Company will be able to compete
effectively in this competitive environment.
THE COMPANY'S PRODUCTS EMPLOY PROPRIETARY TECHNOLOGY, AND THIS
TECHNOLOGY MAY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF THIRD PARTIES.
The Company holds several United States and foreign patents for the
Company's products. Other parties, however, hold patents relating to similar
products and technologies. The Company believes that the Company is not
infringing on any patents held by others. However, if patents held by others
were adjudged valid and interpreted broadly in an adversarial proceeding, the
court or agency could deem them to cover one or more aspects of the Company's
products or procedures. Any claims for patent infringements or claims by the
Company for patent enforcement would consume time, result in costly litigation,
divert technical and management personnel or require the Company to develop
non-infringing technology or enter into royalty or licensing agreements. The
Company cannot be certain that the Company will not be subject to one or more
claims for patent infringement, that the Company would prevail in any such
action or that the Company's patents will afford protection against competitors
with similar technology.
11
If a court determines that any of the Company's products, including
the Company's products used for the cannulation of blood vessels used in the
Company's vascular business segment, infringes, directly or indirectly, on a
patent in a particular market, the court may enjoin the Company from making,
using or selling the product. Furthermore, the Company may be required to pay
damages or obtain a royalty-bearing license, if available, on acceptable terms.
THE COMPANY WILL NO LONGER RECEIVE REVENUE FROM THE SALE OF SILICONE
OIL BY BAUSCH & LOMB SUBSEQUENT TO AUGUST 13, 2005.
The Company realized 13.18% and 13.90% of its net revenue during the
fiscal years ended June 30, 2004 and 2003, respectively, from Bausch & Lomb's
sales of Silicone Oil. The Company is entitled to receive this revenue from
Bausch & Lomb, in varying amounts, through August 2005. The agreement with
Bausch & Lomb, which commenced on August 13, 2000, is structured so that the
Company receives consideration from Bausch & Lomb based on its adjusted gross
profit from its sales of Silicone Oil on a quarterly basis. The consideration is
subject to a factor, which steps down according to the following schedule:
From 8/13/00 to 8/12/01 100%
From 8/13/01 to 8/12/02 82%
From 8/13/02 to 8/12/03 72%
From 8/13/03 to 8/13/04 64%
From 8/13/04 to 8/12/05 45%
The revenue associated with the sale of Silicone Oil by Bausch &
Lomb has no associated expenses and consequently provides a gross margin of
100%. Any significant reduction in this revenue can have a significant negative
impact on gross margin. Any significant decrease in Silicone Oil revenue
received by the Company would have an impact on the Company's financial
position, results of operations and cash flows and the Company's stock price
could be negatively impacted.
LACK OF AVAILABILITY OF KEY SYSTEM COMPONENTS COULD RESULT IN
DELAYS, INCREASED COSTS OR COSTLY REDESIGN OF THE COMPANY'S PRODUCTS.
Although some of the parts and components used to manufacture the
Company's products are available from multiple sources, the Company currently
purchases most of the Company's components from single sources in an effort to
obtain volume discounts. Lack of availability of any of these parts and
components could result in production delays, increased costs, or costly
redesign of the Company's products. Any loss of availability of an essential
component could result in a material adverse change to our business, financial
condition and results of operations. Some of the Company's suppliers are also
subject to the FDA's Good Manufacturing Practice regulations. Failure of these
suppliers to comply with these regulations could result in the delay or
limitation of the supply of parts or components to the Company, which would
adversely affect the Company's financial condition and results of operations.
THE COMPANY'S ABILITY TO MARKET AND SELL THE COMPANY'S PRODUCTS MAY
BE ADVERSELY AFFECTED BY LIMITATIONS ON REIMBURSEMENTS BY GOVERNMENT PROGRAMS,
PRIVATE INSURANCE PLANS AND OTHER THIRD PARTY PAYORS.
The Company's customers bill various third party payors, including
government programs and private insurance plans, for the health care services
provided to their patients. Third party payors may reimburse the customer,
usually at a fixed rate based on the procedure performed, or may deny
reimbursement if they determine that the use of the Company's products was
elective, unnecessary, inappropriate, not cost-effective, experimental or used
for a non-approved indication. Third party payors may deny reimbursement
notwithstanding FDA approval or clearance of a product and may challenge the
prices charged for the medical products and services. The Company's ability to
sell the Company's products on a profitable basis may be adversely impacted by
denials of reimbursement or limitations on reimbursement, compared with
reimbursement available for competitive products and procedures. New legislation
that further reduces reimbursements under the capital cost pass-through system
utilized in
12
connection with the Medicare program could also adversely affect the marketing
of the Company's products.
FUTURE LEGISLATION OR CHANGES IN GOVERNMENT PROGRAMS MAY ADVERSELY
AFFECT THE MARKET FOR THE COMPANY'S PRODUCTS.
In the past several years, the federal government and Congress have
made proposals to change aspects of the delivery and financing of health care
services. The Company cannot predict what form any future legislation may take
or its effect on the Company's business. Legislation that sets price limits and
utilization controls may adversely affect the rate growth of ophthalmic and
vascular access product markets. If any future health care legislation were to
adversely impact those markets, the Company's product marketing could also
suffer, which would adversely impact the Company's business.
THE COMPANY MAY BECOME INVOLVED IN PRODUCT LIABILITY LITIGATION,
WHICH MAY SUBJECT THE COMPANY TO LIABILITY AND DIVERT MANAGEMENT ATTENTION.
The testing and marketing of the Company's products for applications
in ophthalmology and vascular access, our pharmaceutical products and vascular
access products entail an inherent risk of product liability, resulting in
claims based upon injuries or alleged injuries associated with a defect in the
product's performance. Some of these injuries may not become evident for a
number of years. Although the Company is not currently involved in any product
liability litigation, the Company may be a party to litigation in the future as
a result of an alleged claim. Litigation, regardless of the merits of the claim
or outcome, could consume a great deal of the Company's time and money and would
divert management time and attention away from the Company's core business. The
Company maintains limited product liability insurance coverage of $1,000,000 per
occurrence and $2,000,000 in the aggregate, with umbrella policy coverage of up
to $5,000,000 in excess of such amounts. A successful product liability claim in
excess of any insurance coverage may adversely impact the Company's financial
condition and results of operations. The Company cannot assure you that product
liability insurance coverage will continue to be available to the Company in the
future on reasonable terms or at all.
THE COMPANY'S INTERNATIONAL OPERATIONS COULD BE ADVERSELY IMPACTED
BY CHANGES IN LAWS OR POLICIES OF FOREIGN GOVERNMENTAL AGENCIES AND SOCIAL AND
ECONOMIC CONDITIONS IN THE COUNTRIES IN WHICH THE COMPANY OPERATES.
The Company derives a portion of its revenues from sales outside the
United States. Changes in the laws or policies of governmental agencies, as well
as social and economic conditions, in the countries in which the Company
operates could affect the Company's business in these countries and the
Company's results of operations. Also, economic factors, including inflation and
fluctuations in interest rates and foreign currency exchange rates, and
competitive factors, such as price competition, business combinations of
competitors or a decline in industry sales from continued economic weakness,
both in the United States and other countries in which the Company conducts
business, could adversely affect the Company's results of operations.
THE COMPANY IS DEPENDENT ON ITS MANAGEMENT AND KEY PERSONNEL TO
SUCCEED.
The Company's principal executive officers and technical personnel
have extensive experience with the Company's products, the Company's research
and development efforts, the development of marketing and sales programs and the
necessary support services to be provided to the Company's customers. Also, the
Company competes with other companies, universities, research entities and other
organizations to attract and retain qualified personnel. The loss of the
services of any of the Company's executive officers or other technical
personnel, or the Company's failure to attract and retain other skilled and
experienced personnel, could have a material adverse effect on the Company's
ability to manufacture, sell and market the Company's products and the Company's
ability to maintain or expand its business.
13
ANY ACQUISITIONS, STRATEGIC ALLIANCES, JOINT VENTURES AND
DIVESTITURES THAT THE COMPANY EFFECTS COULD RESULT IN FINANCIAL RESULTS THAT
DIFFER FROM MARKET EXPECTATIONS.
In the normal course of business, the Company engages in discussions
with third parties regarding possible acquisitions (such as Drew), strategic
alliances, joint ventures and divestitures. As a result of any such
transactions, the Company's financial results may differ from the investment
community's expectations in a given quarter. In addition, acquisitions and
alliances may require the Company to integrate a different Company culture,
management team and business infrastructure. The Company may have difficulty
developing, manufacturing and marketing the products of a newly acquired company
in a way that enhances the performance of the Company's combined businesses or
product lines to realize the value from expected synergies. Depending on the
size and complexity of an acquisition, the Company's successful integration of
the entity depends on a variety of factors including the retention of key
employees and the management of facilities and employees in separate
geographical areas. These efforts require varying levels of management
resources, which may divert the Company's attention from other business
operations. The Company recently acquired 94% of Drew. Drew does not have a
history of producing positive operating cash flows and, as a result, at the time
of acquisition, was operating under financial constraints and was
under-capitalized and is expected to negatively impact the Company's financial
results in the short term. If the Company does not realize the expected benefits
or synergies of such transactions, the Company's consolidated financial
position, results of operations and stock price could be negatively impacted.
THE MARKET PRICE OF THE COMPANY'S STOCK HAS HISTORICALLY BEEN
VOLATILE, AND THE COMPANY HAS NOT PAID CASH DIVIDENDS.
The volatility of the Company's Common Stock imposes a greater risk
of capital losses on shareholders as compared to less volatile stocks. In
addition, such volatility makes it difficult to ascribe a stable valuation to a
shareholder's holdings of the Company's Common Stock. The following factors have
and may continue to have a significant impact on the market price of the
Company's Common Stock:
- announcements of technological innovations;
- changes in marketing, product pricing and sales strategies or new
products by the Company's competitors;
- any acquisitions, strategic alliances, joint ventures and
divestitures that the Company effects;
- changes in domestic or foreign governmental regulations or
regulatory requirements; and
- developments or disputes relating to patent or proprietary rights
and public concern as to the safety and efficacy of the procedures
for which the Company's products are used.
Moreover, the possibility exists that the stock market, and in particular
the securities of technology companies such as the Company, could experience
extreme price and volume fluctuations unrelated to operating performance. The
Company has not paid any cash dividends on its Common Stock and does not
anticipate paying any cash dividends in the foreseeable future.
THE COMPANY'S RESULTS FLUCTUATE FROM QUARTER TO QUARTER.
The Company has experienced quarterly fluctuations in operating
results and anticipates continued fluctuations in the future. A number of
factors contribute to these fluctuations:
- changes in the mix of products sold;
- the timing and expense of new product introductions by the Company
or its competitors;
- fluctuations in royalty income;
- announcements of new strategic relationships by the Company or its
competitors;
14
- the cancellation or delays in the purchase of the Company's
products;
- the gain or loss of significant customers;
- fluctuations in customer demand for the Company's products; and
- competitive pressures on prices at which the Company can sell its
products.
The Company sets its spending levels in advance of each quarter
based, in part, on the Company's expectations of product orders and shipments
during that quarter. A shortfall in revenue, therefore, in any particular
quarter as compared to the Company's plan could have a material adverse effect
on the Company's results of operations and cash flows. Also, the Company's
quarterly results could fluctuate due to general conditions in the healthcare
industry or global economy generally, or market volatility unrelated to the
Company's business and operating results.
THE IMPACT OF TERRORISM OR ACTS OF WAR COULD HAVE A MATERIAL ADVERSE
EFFECT ON THE COMPANY'S BUSINESS.
Terrorist acts or acts of war, whether in the United States or
abroad, could cause damage or disruption to the Company's operations, its
suppliers, channels to market or customers, or could cause costs to increase, or
create political or economic instability, any of which could have a material
adverse effect on the Company's business.
THE COMPANY'S CHARTER DOCUMENTS AND PENNSYLVANIA LAW MAY INHIBIT A
TAKEOVER.
Certain provisions of Pennsylvania law and our Bylaws could delay or
impede the removal of incumbent directors and could make it more difficult for a
third party to acquire, or could discourage a third party from attempting to
acquire, control of the Company. These provisions could limit the price that
certain investors might be willing to pay in the future for shares of the
Company's Common Stock. The Company's Board of Directors is divided into three
classes, with directors in each class elected for three-year terms. The bylaws
impose various procedural and other requirements that could make it more
difficult for shareholders to effect certain corporate actions. The Company's
Board of Directors may issue shares of preferred stock without shareholder
approval on such terms and conditions, and having such rights, privileges and
preferences, as the Board may determine. The rights of the holders of Common
Stock will be subject to, and may be adversely affected by, the rights of the
holders of any preferred stock that may be issued in the future. The Company has
no current plans to issue any shares of preferred stock.
ITEM 2. PROPERTIES
The Company currently leases an aggregate of approximately 24,300
square feet of space for its (i) corporate offices in Wayne, Pennsylvania, (ii)
manufacturing/warehouse facility in New Berlin, Wisconsin and (iii)
manufacturing facility in Lake Success, New York. The corporate offices in
Pennsylvania cover approximately 3,700 square feet. The Wisconsin lease,
covering approximately 13,500 square feet of space expires in April 2007. The
New York facility lease, covering approximately 7,100 square feet, expires
during fiscal 2005. The Company has signed a lease to a 10,900 square foot
facility, also in Lake Success, to which the New York operations will relocate
upon termination of the expiring facility lease. Annual rent under all of the
Company's lease arrangements was $386,276 for the year ended June 30, 2004.
Drew currently leases and aggregate of 69,000 square feet of space
for its (i) administrative office and manufacturing facility in
Barrow-on-Furness, United Kingdom, (ii) manufacturing facility in Dallas, Texas
and (iii) manufacturing facility in Oxford, Connecticut. The facility in the
United Kingdom covers approximately 23,000 square feet and consists of three
buildings whose leases expire in August and December 2005 and September 2006.
The facility in Texas covering approximately 34,000 square feet; and its lease
expires in March 2007. The Connecticut facility consists of two separate areas
within the same building. The leases cover approximately 12,000 square feet and
expire in January 2007 and 2008.
15
Annual rent under all of Drew's lease arrangements was approximately $390,000
for the year ended March 31, 2004.
ITEM 3. LEGAL PROCEEDINGS
On June 10, 2004, Escalon provided notice to Intralase of the
Company's intention to terminate the license agreement with Intralase due to
deficiencies in the payment of certain royalties that the Company believes are
due under the license agreement. On June 21, 2004, Intralase sought a
preliminary injunction and a temporary restraining order with the United States
District Court for the Central District of California, Southern District against
Escalon to prevent the termination of the license agreement with Intralase. The
parties subsequently agreed to stipulate to the temporary restraining order to
prevent a termination of the license agreement and, on July 6, 2004, as mutually
agreed by Intralase and Escalon, the same district court entered a stipulation
and order to delay the requested hearing on the preliminary injunction until
November 1, 2004. The Company does not believe that the resolution of these
matters has had or is likely to have a material adverse effect on the Company's
business, financial condition or future results of operations.
Escalon is aware of two lawsuits involving Drew. The first lawsuit
involves the principal shareholders of an entity previously acquired by Drew for
the collection of unpaid expenses. A counterclaim was filed for breach of
intellectual property rights and for breach of the principal shareholders'
covenants not to compete. This action was filed in the state courts of
Connecticut. The second lawsuit was filed in the state court of Minnesota, but
transferred to the Federal District Court of Minnesota. This action was brought
by a distributor against an entity previously acquired by Drew claiming a breach
of a marketing and distribution agreement. The district court granted in part
and denied in part both defendants' Motion for Summary Judgment and Motion to
Dismiss. Both parties have appealed the decision. The Company does not believe
that the resolution of these matters has had or is likely to have a material
adverse effect on the Company's business, financial condition or future results
of operations.
Furthermore, Escalon, 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 effect on the Company's business, financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Escalon's Common Stock trades on the Nasdaq SmallCap Market under
the symbol "ESMC." The Company's Common Stock has traded on the Nasdaq SmallCap
Market since June 7, 2000. The Common Stock previously traded on the Nasdaq
National Market. The table below sets forth, for the periods indicated, the high
and low sales prices as quoted on the Nasdaq Stock Market.
High Low
--------- ---------
Fiscal year ended June 30, 2004
Quarter ended September 30, 2003 $ 6.60 $ 3.00
Quarter ended December 31, 2003 $ 8.10 $ 5.47
Quarter ended March 31, 2004 $ 23.85 $ 6.33
Quarter ended June 30, 2004 $ 27.49 $ 8.83
Fiscal year ended June 30, 2003
Quarter ended September 30, 2002 $ 2.15 $ 1.35
Quarter ended December 31, 2002 $ 2.06 $ 1.52
Quarter ended March 31, 2003 $ 2.26 $ 0.85
Quarter ended June 30, 2003 $ 4.00 $ 1.82
As of September 14, 2004, there were 6,551 holders of record of the
Company's Common Stock. On September 14, 2004, the closing price of Escalon's
Common Stock as reported by the Nasdaq SmallCap Stock Market was $13.71 per
share.
Escalon has never declared or paid a cash dividend on its Common
Stock and presently intends to retain any future earnings to finance future
growth and working capital needs. In addition, the Company is party to loan
agreements that prohibit Escalon's payment of dividends.
17
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from the
consolidated financial statements of the Company. The data should be read in
conjunction with "Managements Discussion and Analysis of Financial Condition and
Results of Operations" included herein in Item 7 and the financial statements
and related notes thereto included herein in Item 8.
FOR THE YEARS ENDED JUNE 30,
----------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA: 2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Product revenue, net $ 12,348 $ 11,191 $ 10,293 $ 9,626 $ 6,670
Other revenue 2,373 2,175 1,781 2,254 -
-------- -------- -------- -------- --------
Total revenue 14,721 13,366 12,074 11,880 6,670
Costs and expenses:
Cost of goods sold 5,476 4,896 4,640 4,297 2,874
Research and development 776 780 555 492 984
Marketing, general and administrative 5,206 5,034 5,097 5,430 4,661
Writedown of goodwill, license and
distribution rights and patents - 196 - - 418
-------- -------- -------- -------- --------
Total costs and expenses 11,458 10,906 10,292 10,219 8,937
-------- -------- -------- -------- --------
Income/(loss) from operations 3,263 2,460 1,782 1,661 (2,267)
-------- -------- -------- -------- --------
Loss from termination of joint venture - - (23) - -
Sale of Silicone Oil product line - - - - 1,864
Equity in gain/(loss) of unconsolidated
joint venture - - 8 (19) (33)
Interest income 59 3 2 2 149
Interest expense (407) (638) (791) (1,052) (576)
-------- -------- -------- -------- --------
Income/(loss) before taxes 2,915 1,825 978 592 (863)
Income taxes 173 112 - - -
-------- -------- -------- -------- --------
Net income/(loss) $ 2,742 $ 1,713 $ 978 $ 592 $ (863)
======== ======== ======== ======== ========
Basic net income/(loss) per share $ 0.70 $ 0.51 $ 0.29 $ 0.18 $ (0.27)
======== ======== ======== ======== ========
Diluted net income/(loss) per share $ 0.64 $ 0.48 $ 0.29 $ 0.18 $ (0.27)
======== ======== ======== ======== ========
Weighted average shares - basic
used in per share computation 3,897 3,365 3,346 3,292 3,242
======== ======== ======== ======== ========
Weighted average shares - diluted
used in per share computation 4,304 3,573 3,360 3,308 3,242
======== ======== ======== ======== ========
AT JUNE 30,
----------------------------------------------------------------------
BALANCE SHEET DATA: 2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Cash and cash equivalents $ 12,602 $ 298 $ 221 $ 81 $ 177
Working capital/(deficit) 13,966 889 (240) (3,004) (3,211)
Total assets 29,457 16,890 16,912 17,798 16,845
Long-term debt, net of
current portion 2,396 4,080 5,191 4,502 4,900
Total liabilities 5,996 7,951 9,719 11,691 11,430
Accumulated deficit (34,585) (37,326) (39,039) (40,018) (40,610)
Total shareholders' equity 23,461 8,939 7,193 6,107 5,415
- -----------------------------
Note: No cash dividends were paid in any of the periods presented.
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read together with
the consolidated financial statements and notes thereto and other financial
information contained elsewhere in this Form 10-K and the discussion under
"Cautionary Factors that May Affect Future Results" included in Part I of this
Form 10-K.
Escalon operates primarily in four reportable business segments:
Sonomed, Vascular, Medical/Trek and EMI. Sonomed develops, manufactures and
markets ultrasound systems used for diagnostic or biometric applications in
ophthalmology. Vascular develops, manufactures and markets vascular access
products. Medical/Trek develops, manufactures and distributes ophthalmic
surgical products under the Escalon Medical Corp. and/or Trek Medical Products
names. EMI manufactures and markets a digital camera system for ophthalmic
fundus photography. For a more complete description of these businesses and
their products, see Item 1 - Business.
EXECUTIVE OVERVIEW - FISCAL YEARS ENDED JUNE 30, 2004 AND 2003
The following highlights are discussed in further detail within this
Form 10-K. The reader is encouraged to read this Form 10-K in its entirety to
gain a more complete understanding of factors affecting Company performance and
financial condition.
- The Company completed a $10,400,000 million private placement of
Common Stock and Common Stock purchase warrants on March 17, 2004.
The net proceeds to the Company of $9.8 million have enabled the
Company to strengthen its balance sheet and provide additional
working capital for general corporate purposes.
- Product revenue, up 10.34% from last year, benefited from increased
domestic demand for the Company's pachymeter product as well as
increased market penetration in Europe.
- Other revenue, up 9.12% from last year, was received primarily from
Bausch & Lomb in connection with the Silicone Oil product line. The
contract for this revenue expires in August 2005.
- Operating expenses increased by 2.89% driven primarily by the
Company's continuing efforts to strengthen its sales channels
domestically and overseas offset by reductions of certain
administrative costs.
- Interest expense decreased 36.31% primarily due to reduced debt
levels.
SUBSEQUENT EVENT
On July 23, 2004, the Company announced that holders of
approximately 67% of the outstanding ordinary shares of Drew accepted the
Company's exchange offer for the outstanding shares of Drew. As of September 22,
2004, Escalon had issued 897,886 common shares to Drew shareholders pursuant to
the exchange offer for approximately 94% of the outstanding ordinary shares of
Drew. Drew, based in the United Kingdom, with additional manufacturing
operations in Dallas, Texas and Oxford, Connecticut specializes in the design,
manufacture, sale and distribution of analytical systems for laboratory testing
worldwide. Drew provides instrumentation and consumables for the diagnosis and
monitoring of medical disorders in the areas of diabetes, cardiovascular
diseases and hematology, as well as veterinary hematology and blood chemistry.
19
RESULTS OF OPERATIONS
FISCAL YEAR ENDED JUNE 30, 2004 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2003
The following table presents consolidated product revenues by
business segment as well as identifying trends in business segment product
revenues for the fiscal years ended June 30, 2004 and 2003.
Fiscal Years ended June 30,
-----------------------------------
2004 2003 % Change
--------- --------- --------
(in thousands)
Product revenue:
Sonomed $ 7,596 $ 6,495 16.95%
Vascular 3,055 2,761 10.65%
Medical/Trek 1,448 1,502 -3.60%
EMI 249 433 -42.49%
--------- --------- -------
$ 12,348 $ 11,191 10.34%
========= ========= =======
Product revenue increased $1,157,000, or 10.34%, to $12,348,000 in
fiscal 2004 as compared to $11,191,000 in fiscal 2003. Product revenue in the
Sonomed business unit increased $1,101,000, or 16.95%, to $7,596,000. The
increase is attributed to a $336,000 increase in the domestic market, a $324,000
increase in the Middle East, a $297,000 increase in Europe and a $261,000
increase in Latin America offset by a $93,000 decrease in Asia and the Pacific
Rim. The increase in the domestic market primarily relates to increased demand
for the Company's pachymeter product. The domestic market for pachymeters
expanded due to enhanced techniques in glaucoma screening performed by
optometrists. Historically, the typical optometrist has not been a user of the
pachymeter. Domestic demand for the pachymeter returned to historic levels in
the fourth quarter of fiscal 2004. The increases in the Middle East and Europe
are the result of additional sales and marketing resources and management
attention to developing these markets whereas the increase in Latin America is a
result of recovering economies in South American countries. Product revenue in
the Vascular business unit increased $294,000, or 10.65%, to $3,055,000. The
increase primarily relates to increased usage in the domestic marketplace.
Product revenue in the Medical/Trek business unit decreased $54,000, or 3.60%,
to $1,448,000. The decrease primarily relates to decreased market demand for
Medical/Trek's products. Product revenue in the EMI business unit decreased
$184,000, or 42.49%, to $249,000.
Other revenue, which is included in the Medical/Trek business unit,
increased $198,000, or 9.10%, to $2,373,000 in fiscal 2004 as compared to
$2,175,000 in fiscal 2003. The increase relates to both a $116,000 increase in
royalty payments received from Intralase related to the licensing of the
Company's intellectual laser technology and a $83,000 increase in revenue
received from Bausch & Lomb in connection with its sales of Silicone Oil. The
Company's contract with Bausch & Lomb calls for annual step-downs in the
calculation of Silicone Oil revenue to be received by the Company. The
step-downs occur during the first quarter of each fiscal year through the
remainder of the contract, which ends in August 2005. For the fiscal year ended
June 30, 2004, the step-down caused a $250,000 decrease in Silicone Oil revenue
that the Company would have otherwise received had the step-down not occurred.
The offsetting $333,000 increase in Silicone Oil revenue is due to market demand
for the product. The Company does not have any further knowledge as to what
factors have affected Bausch & Lomb's sales of Silicone Oil. See the Notes to
Consolidated Financial Statements for a description of the step-down provisions
under the contract with Bausch & Lomb.
20
The following table presents consolidated cost of goods sold by
reportable business segment and as a percentage of related segment product
revenue for the fiscal years ended June 30, 2004 and 2003.
Fiscal Years Ended June 30,
---------------------------------
2004 2003
--------------- ---------------
Dollars % Dollars %
Cost of goods
sold:
Sonomed $3,076 40.49% $2,524 38.86%
Vascular 1,381 45.20% 1,195 43.28%
Medical/Trek 911 62.91% 961 63.98%
EMI 108 43.37% 216 49.88%
------ ----- ------ -----
$5,476 44.35% $4,896 43.75%
====== ===== ====== =====
Cost of goods totaled $5,476,000, or 44.35%, of product revenue for
the fiscal year ended June 30, 2004 as compared to $4,896,000, or 43.75%, of
product revenue for the fiscal year ended June 30, 2004. Cost of goods sold in
the Sonomed business unit was $3,076,000, or 40.49% of product revenue for the
fiscal year ended June 30, 2004 as compared to $2,524,000, or 38.86%, of product
revenue for the fiscal year ended June 30, 2003. The slight increase in cost of
goods sold as a percentage of product revenue was primarily caused by an
increase in international sales. Sonomed generally sells its products to
international customers at lower price levels. Cost of goods sold in the
Vascular business unit was $1,381,000, or 45.20%, or product revenue for the
fiscal year ended June 30, 2004 as compared to $1,195,000, or 43.28%, of product
revenue for the fiscal year ended June 30, 2003. The Company began manufacturing
its Doppler-Guided Peripheral I.V. product in the latter part of fiscal 2004.
This product has higher manufacturing costs than the remainder of the Vascular
product line. Cost of goods sold in the Medical/Trek business unit totaled
$911,000, or 62.91%, of product revenue for the fiscal year ended June 30, 2004
as compared to $961,000, or 63.98% of product revenue for the fiscal year ended
June 30, 2003. Fluctuations in Medical/Trek cost of goods sold results from
product mix changes, which were primarily controlled by market demand. Cost of
goods sold in the EMI business unit was $108,000, or 43.37%, of product revenue
for the fiscal year ended June 30, 2004 as compared to $216,000, or 49.88% of
product revenue for the same period last fiscal year.
The following table presents consolidated marketing, general and
administrative expenses as well as identifying trends in business segment
marketing, general and administrative expenses for the fiscal years ended June
30, 2004 and 2003.
Fiscal Years Ended June 30,
2004 2003 % Change
------ ------ --------
Marketing, general and
administrative expenses:
Sonomed $1,196 $1,281 -6.64%
Vascular 1,353 1,205 12.28%
Medical/Trek 2,427 2,294 5.80%
EMI 230 254 -9.45%
------ ------ -----
$5,206 $5,034 3.42%
====== ====== =====
Marketing, general and administrative expenses increased $172,000,
or 3.42%, for the fiscal year ended June 30, 2004 as compared to the fiscal year
ended June 30, 2003. In the Sonomed business unit, marketing, general and
administrative expenses decreased $85,000, or 6.64%, to $1,196,000. Salaries and
other personnel-related expenses decreased $134,000, primarily the result of
head count changes. Commission expense decreased $35,000 as a result of changes
in the commission structure with an international distributor. Offsetting these
decreases was an $84,000 increase in consulting expense, which increased as a
result of the Company's marketing efforts in the international markets. In the
Vascular
21
business unit, marketing, general and administrative expenses increased
$148,000, or 12.28%, to $1,353,000. Salaries and other personnel-related
expenses increased $155,000, primarily the result of increases in headcount.
Consulting expenses increased $55,000 as a result of marketing efforts in the
international markets. Sales and marketing travel-related expenses also
increased $68,000. The Company agreed to pay royalties for a five-year period
following the acquisition of the vascular access division of Endologix. That
five-year period ended in December 2003. This resulted in a $122,000 decrease in
royalty expense. In the Medical/Trek business unit, marketing, general and
administrative expenses increased $133,000, or 5.80%, to $2,427,000. Accrued
compensation increased $108,000. Payroll taxes increased $86,000 primarily due
to the exercise of employee stock options. Depreciation and amortization expense
decreased $32,000 primarily due to the abandonment of the Company's license and
distribution rights to Povidone Iodine 2.5% in March 2003 and consulting expense
decreased $14,000 as the Company incurred expenses in fiscal 2003 related to the
Company's search for alternate debt financing. In the EMI business unit,
marketing, general and administrative expenses decreased $24,000, or 9.45%, to
$230,000.
Research and development expenses decreased $4,000, or 0.51%, to
$776,000 for the fiscal year ended June 30, 2004 as compared to the fiscal year
ended June 30, 2003. Increases in consulting expenses incurred in connection
with product development were offset by reduced headcount.
Several years ago, the Company began seeking a corporate partner to
fund commercialization of the Povidone Iodine 2.5% product line. The Company
obtained the license and distribution rights to the product from Harbor UCLA
Medical Center. Having exhausted all partnering possibilities, during fiscal
2003, management decided that further expenditures on this project were not in
the shareholders' best interest, and the project was abandoned. This decision
resulted in the Company taking a charge of $195,000, which included the
write-off of remaining net book value of the license and distribution rights
subsequent to normal amortization.
Interest income was $59,000 and $3,000 for the fiscal years ended
June 30, 2004 and 2003, respectively. The increase relates to increased average
cash balances in the current fiscal year.
Interest expense was $407,000 and $638,000 for the fiscal years
ended June 30, 2004 and 2003, respectively. The decrease relates to reduced
total debt levels and lower interest rates.
Income tax expense was $173,000 and $112,000 for the fiscal years
ended June 30, 2004 and 2003, respectively. The Company began incurring income
tax expense in fiscal 2003 due to the exhausting of certain state net operating
loss carryforwards.
FISCAL YEAR ENDED JUNE 30, 2003 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2002
The following table presents consolidated product revenues by
business segment as well as identifying trends in business segment product
revenues for the fiscal years ended June 30, 2003 and 2002.
Fiscal Years ended June 30,
-------------------------------
2003 2002 % Change
------- ------- --------
(in thousands)
Product revenue:
Sonomed $ 6,495 $ 6,071 6.98%
Vascular 2,761 2,634 4.82%
Medical/Trek 1,502 1,321 13.70%
EMI 433 267 62.17%
------- ------- -----
$11,191 $10,293 8.72%
======= ======= =====
Product revenue increased $898,000, or 8.72%, to $11,191,000 in
fiscal 2003 as compared to $10,293,000 in fiscal 2002. Product revenue in the
Sonomed business unit increased $424,000, or 6.98%, to $6,495,000. The increase
is attributed to $476,000 increase in the domestic market as well as a $101,000
increase in Asia and the Pacific Rim. The surge in the domestic market primarily
relates to increased
22
demand for the Company's pachymeter product. The usage of pachymeters began to
include glaucoma screening, opening a new market for the product. The increase
in Asia and the Pacific Rim relate primarily to the Company's successful
strategy of increased penetration of those geographic areas. Conversely, Sonomed
experienced a $77,000 decrease in revenue in Latin America as well as a $60,000
decrease in the Middle East. Management believes that the weak economy in Latin
America and the turmoil in the Middle East led to these decreases. Product
revenue in the Vascular business unit increased $127,000, or 4.82% in fiscal
2003, to $2,761,000. The increase related primarily to increased usage in the
marketplace. During fiscal 2001, the Company identified certain underperforming
distributors within its Vascular business unit and terminated its relationship
with them. Subsequent to terminating these distributors, the Company began
direct selling in the territories once covered by the distributors. Management
believes that revenue in the territories once covered by the distributors
remained stable or increased in fiscal 2002, as revenue in the Vascular business
unit increase 24.42% for the fiscal year ended June 30, 2002 as compared to the
fiscal year ended June 30, 2001. During the fiscal year ended June 30, 2003,
revenue continued to build upon this increased base. Product revenue in the
Medical/Trek business unit increased $181,000, or 13.70%, to $1,502,000. OEM
revenue from Bausch & Lomb increased $229,000. Product revenue in the EMI
business unit increased $166,000. The Company terminated its joint venture and
commenced operations within the EMI business unit on January 1, 2002, and
therefore, during the first six months of fiscal 2002, these revenues were
recognized within the joint venture.
Other revenue, which is included in the Medical/Trek business unit,
increased $394,000, or 22.12%, to $2,175,000 for the fiscal year ended June 30,
2003 as compared to $1,781,000 for the fiscal year ended June 30, 2002. The
increase primarily related to a $289,000 increase in royalty payments received
from Intralase related to the licensing of Escalon's intellectual laser
technology. Escalon licensed the technology to Intralase in October 1997. These
royalty payments commenced during the fourth quarter of fiscal 2002 when
Intralase began selling products related to Escalon's intellectual laser
property. The remaining $105,000 increase in other revenue during fiscal 2003
related to revenue earned from Bausch & Lomb in connection with Silicone Oil.
The Company's contract with Bausch & Lomb calls for annual step-downs in the
calculation of Silicone Oil revenue to be received by Escalon. These step-downs
occur during the first quarter of each fiscal year through the remainder of the
contract. For the fiscal year ended June 30, 2003, the step-down caused a
$259,000 decrease in Silicone Oil revenue that Escalon would have otherwise
received had the step-down not occurred. The offsetting $364,000 increase in
Silicone Oil revenue is due to increase in the market demand for the product.
Escalon does not have any knowledge as to what factors have affected Bausch &
Lomb's sales of Silicone Oil. See Note 10 of the Notes to Consolidated Financial
Statements for a description of the step-down provisions under the contract with
Bausch & Lomb.
The following table presents consolidated cost of goods sold by
reportable business segment and as a percentage of related segment product
revenue for the fiscal years ended June 30, 2003 and 2002.
Fiscal Years Ended June 30,
-------------------------------------
2003 2002
---------------- -------------------
Dollars % Dollars %
Cost of goods
sold:
Sonomed $2,524 38.86% $2,704 44.54%
Vascular 1,195 43.28% 988 37.51%
Medical/Trek 961 63.98% 838 63.44%
EMI 216 49.88% 110 41.20%
------ ----- ------ -----
$4,896 43.75% $4,640 45.08%
====== ===== ====== =====
Cost of goods sold totaled $4,896,000, or 43.75% of product revenue
during fiscal 2003, as compared to $4,640,000, or 45.08% of product revenue.
Cost of goods sold in the Sonomed business unit totaled $2,524,000, or 38.86% of
net revenue, for the fiscal year ended June 30, 2003 as compared to $2,704,000,
or 44.54% of product revenue, for the fiscal year ended June 30, 2002. Sonomed
experienced a significant shift in product mix with the increase in demand for
the pachymeter product, which has higher
23
margins than much of the remainder of the Sonomed product line. Cost of goods
sold in the Vascular business unit totaled $1,195,000, or 43.28% of product
revenue, for the fiscal year ended June 30, 2003, as compared to $988,000, or
37.51% of product revenue, for the fiscal year ended June 30, 2002. Vascular's
margins were adversely affected by several factors including product mix, having
experienced an increase in sales of over-the-needle catheter ("ONC") product
line, which has lower margins than the remainder of the Vascular product line
due to smaller-scale production; lower price per unit, having experienced an
increase in sales to distributors to whom the Company discounts its products;
and quality issues that led to the Company writing off $52,000 of inventory in
the fourth quarter of fiscal 2003. Cost of goods sold in the Medical/Trek
business unit totaled $961,000, or 26.14% of net revenue, for the fiscal year
ended June 30, 2003, as compared to $838,000, or 27.01% of net revenue, for the
fiscal year ended June 30, 2002. When other revenue is excluded (no costs are
associated with these revenue streams), cost of goods sold, as a percentage of
product revenue, was 63.98% and 63.44% for the fiscal years ended June 30, 2003
and 2002, respectively. Fluctuations in Medical/Trek cost of goods sold resulted
from product mix changes, which were primarily controlled by market demand. Cost
of goods sold in the EMI business unit was $216,000, or 49.88% of net revenue,
for the fiscal year ended June 30, 2003, as compared to $110,000, or 41.20% of
net revenue, for the fiscal year ended June 30, 2002. During the first six
months of fiscal 2002, these expenses were incurred within the joint venture.
The following table presents consolidated marketing, general and
administrative expenses as well as identifying trends in business segment
marketing, general and administrative expenses for the fiscal years ended June
30, 2003 and 2002.
Fiscal Years Ended June 30,
2003 2002 % Change
------ ------ --------
Marketing, general and
administrative expenses:
Sonomed $1,281 $1,441 -11.10%
Vascular 1,205 999 20.62%
Medical/Trek 2,294 2,528 -9.26%
EMI 254 129 96.90%
------ ------ ------
$5,034 $5,097 -1.24%
====== ====== ======
Marketing, general and administrative expenses decreased $63,000, or
1.24%, for the fiscal year ended June 30, 2003, as compared to the fiscal year
ended June 30, 2002. In the Sonomed business unit, marketing, general and
administrative expenses decreased $160,000, or 11.10%. Salaries and other
personnel-related expenses decreased $201,000, primarily as a result of reduced
headcount. Bad debts decreased $55,000, primarily due to the Company reserving
for specific international accounts in the fiscal year ended June 30, 2002,
which did not reoccur in the fiscal year ended June 30, 2003. Offsetting these
decreases were an increase in consulting expense of $60,000, which increased as
a result of the Company's efforts in the international markets and an increase
in commissions of $35,000. In the Vascular business unit, marketing, general and
administrative expenses increased $206,000, or 20.62%, for the fiscal year ended
June 30, 2003, as compared to the fiscal year ended June 30, 2002. Salaries and
other personnel-related expenses increased $89,000, primarily as a result of
increases in headcount. Travel and sales meeting expenses increased by a
combined $36,000, and samples expense increased by $21,000. Also contributing to
the increase, the Company began allocating from the Medical/Trek business unit
certain overhead expenses related to the Wisconsin facility to the Vascular
business unit during fiscal 2003. In the Medical/Trek business unit, marketing,
general and administrative expenses decreased $234,000, or 9.26%, for the fiscal
year ended June 30, 2003 as compared to the fiscal year ended June 30, 2002.
Legal and accounting fees decrease $110,000. Legal fees were unusually high
during the fiscal year ended June 30, 2002 due to required filings with the SEC
related to the reincorporation into Pennsylvania and the issuance of Escalon
Common Stock shares to Endologix, Inc. Salaries and other personnel-related
expenses decreased $16,000, primarily the result of reduced headcount. Also
contributing to the decrease, the Company began allocating from the Medical/Trek
business unit certain overhead expenses related to the Wisconsin facility to the
Vascular business unit during fiscal 2003. Offsetting these decreases was a
24
$77,000 increase in insurance expense. The increase primarily relates to premium
increases being instituted by the insurance industry in general as well as to an
audit of prior year premiums in which the insurance company discovered that they
undercharged premiums by $22,000. The undercharge was corrected in the first
quarter of fiscal 2003. In the EMI business unit, marketing, general and
administrative expenses increased $125,000. The Company terminated its joint
venture and commenced operations within its EMI business unit on January 1,
2002, and therefore, during the six months of the fiscal 2002, these expenses
were incurred within the joint venture.
Research and development expenses increased $225,000, or 40.54%, for
the fiscal year ended June 30, 2003 as compared to fiscal 2002. The increase
primarily relates to consulting expenses incurred in connection with product
development. The Company redesigns its products every few years, as technology
changes, to remain competitive in the market place.
Several years ago, Escalon began seeking a corporate partner to fund
commercialization of the Povidone Iodine 2.5% product line. The Company obtained
the license and distribution rights to the product from Harbor-UCLA Medical
Center. Having exhausted all partnering possibilities, the Company decided that
further expenditures on this project were not in the shareholders' best
interest, and the project was abandoned. This decision resulted in the Company
taking an expense of $196,000 during the fiscal year ended June 30, 2003, which
included the write-off of the remaining net book value of the license and
distribution rights.
On December 18, 2000, the Company announced that it received 510(K)
clearance to begin marketing its high-end digital camera system for
ophthalmologists known as the CFA Digital Imaging System. As a result of the
approval, the Company began marketing the system through its joint venture with
Megavision. Escalon terminated its joint venture with Megavision and commenced
operations within the Company's EMI business unit on January 1, 2002. Escalon
recognized a gain of $8,000 related to the operations of the joint venture and a
$23,000 loss related to the termination of the joint venture during the fiscal
year ended June 30, 2002.
Interest income remained relatively unchanged for the fiscal year
ended June 30, 2003 as compared to the fiscal year ended June 30, 2002, $3,000
and $2,000, respectively.
Interest expense decreased $153,000, to $638,000, for the fiscal
year ended June 30, 2003 as compared to the same period in fiscal 2002 primarily
due to reduced total debt levels and lower interest rates.
There is no provision for federal income taxes for the periods
presented as a result of utilization of net operating loss carryforwards and
related changes in the deferred tax valuation allowances. Income taxes of
$112,000 were incurred during the fiscal year ended June 30, 2003 due to
Wisconsin state net operating losses being exhausted.
25
LIQUIDITY AND CAPITAL RESOURCES
In recent years, Escalon's principal source of liquidity generally
has been net cash provided by operating activities. The Company, however,
completed a private placement of its Common Stock during the fiscal year ended
June 30, 2004 that significantly affected the Company's liquidity. Additionally,
stock options were exercised during the fiscal year ended June 30, 2004
providing the Company with additional cash. Changes in Escalon's overall
liquidity and capital resources from continuing operations during fiscal 2004
are reflected in the following table:
June 30, June 30,
(Dollars are in thousands) 2004 2003
-------- --------
Current Assets $ 17,566 $ 4,759
Less: Current Liabilities 3,600 3,870
--------- ---------
Working Capital $ 13,966 $ 889
Current Ratio 4.9 to 1 1.2 to 1
Notes Payable and Current Maturities $ 1,872 $ 2,485
Long-Term Debt 2,396 4,080
--------- ---------
Total Debt $ 4,268 $ 6,565
Total Equity 23,461 8,939
--------- ---------
Total Capital $ 27,729 $ 15,504
Total Debt to Total Capital 15.39% 42.34%
WORKING CAPITAL POSITION
Working capital increased $13,077,000 as of June 30, 2004 and the
current ratio increased to 4.9 to 1 when compared with June 30, 2003. Current
assets increased by $12,807,000 primarily due to the issuance of Common Stock
totaling $11,780,000.
Current liabilities decreased by $270,000 as a result of several
offsetting factors that included the following:
- A $725,000 decrease in the Escalon's outstanding line of credit as
the Company used cash from operations to pay down its debt.
- A $201,000 increase in accrued compensation (incentive, payroll and
vacation).
- A $112,000 increase in current portion of long-term debt primarily
due to the step-up of principal payments due on the Company's term
debt.
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash provided by operating activities increased $992,000 to
$3,163,000, for the fiscal year ended June 30, 2004 as compared to the fiscal
year ended June 30, 2003. Apart from year-over-year increased net profitability
of $1,029,000, the following are the primary offsetting factors affecting the
increase in net cash provided by operating activities:
- The Company held overall inventory levels relatively constant as
compared to fiscal 2003 when the Company increased overall inventory
levels to be more quickly responsive to customer orders.
- Accounts receivable in the Sonomed and Vascular business unit
increased in proportion to increased volume in those business units
whereas in Medical/Trek and EMI, accounts receivable were lower than
fiscal 2003.
26
CASH FLOWS FROM INVESTING AND FINANCING ACTIVITIES
The Company had substantial expenditures related to the Drew
acquisition that are classified as other current assets until the transaction is
finalized. Otherwise, cash flows used in investing activities related solely to
the purchase of fixed assets for the fiscal year ended June 30, 2004 and 2003,
and remained largely unchanged. Any necessary capital expenditures have
generally been funded out of cash from operations, and the Company is not aware
of any factors that would cause historical capital expenditure levels not to be
indicative of capital expenditures in the future and, accordingly, does not
believe that it will have to commit material resources to capital investment for
the foreseeable future.
Cash flows from financing activities were $9,440,000 for the fiscal
year ended June 30,2004. Cash flows from financing activities primarily related
to proceeds from a private placement of Common Stock and Common Stock warrants
as well as proceeds from the issuance of Common Stock through the exercise of
stock options. On March 17, 2004, the Company completed a private placement of
Common Stock resulting in net proceeds of $9,788,000 and, during the fiscal year
ended June 30, 2004, issued Common Stock related to the exercise of stock
options resulting in proceeds to the Company of $1,992,000. This was offset by
repayments of the Company's term debt and line of credit. The Company paid down
its line of credit by $725,000 and paid down its term debt by $1,615,000. The
Company utilized cash from operations to pay down its term loan and line of
credit.
Cash flows used in financing activities were $2,017,000 during the
fiscal year ended June 30, 2003. During the fiscal year ended June 30, 2003,
cash flows used in financing activities primarily related to repayments of the
Company's term debt and line of credit. The Company paid down its term debt and
line of credit by $1,761,000 and $275,000, respectively. The reduction in
repayments of term debt relates to a reduction in required principal payments
that resulted from the Company's renegotiating its debt in February 2003.
Management believes that cash on hand, cash generated from
operations and cash available from the line of credit ($1,750,000 as of June 30,
2004) should be sufficient to satisfy the Company's (including Drew) working
capital, debt service, capital expenditures and research and development costs
for the foreseeable future.
FORWARD-LOOKING STATEMENT ABOUT SIGNIFICANT ITEMS LIKELY TO AFFECT LIQUIDITY
As of July 23, 2004, Escalon acquired 67.03% of the outstanding
ordinary shares of Drew, pursuant to the Company's exchange offer for all of the
outstanding ordinary shares of Drew; and since that date has acquired
approximately 94% of the Drew shares. Escalon expects to acquire the remaining
outstanding Drew shares pursuant to procedures under United Kingdom laws and
regulations. Drew does not have a history of producing positive operating cash
flows and, as a result, at the time of acquisition, was operating under
financial constraints and was under-capitalized and is expected to negatively
impact the Company's financial results in the short term. As of September 23,
2004, Escalon loaned $1,550,000 to Drew. The funds have been primarily used to
procure components to build up inventory to support the manufacturing process.
As Drew is integrated into the Company, management will be working to reverse
the situation, while at the same time strengthening Drew's market position.
Escalon realized 13.18% and 13.90% of its net revenue during the
fiscal years ended June 30, 2004 and 2003, respectively, from Bausch & Lomb's
sale of Silicone Oil. Silicone Oil revenue is based on sales of the product by
Bausch & Lomb multiplied by a contractual factor that reduces on an annual basis
due to a contractual step-down provision. While the Company does not expect
total Silicone Oil revenue to decline rapidly during the remainder of the
contract, any such decrease would have an impact on the Company's financial
position, results of operations and cash flows and the Company's stock price
could be negatively impacted. The Company is entitled to receive this revenue
from Bausch & Lomb, in varying amounts, through August 2005, when all revenues
will cease. See the Notes to Consolidated Financial Statements for a description
of the step-down provisions under the contract with Bausch & Lomb.
The Company issued 120,000 Common Stock purchase warrants in
connection with the private placement on March 17, 2004. The warrants are
exercisable 181 days from the placement date at $15.60
27
per share and expire five years from the placement date. If all 120,000 warrants
were to be exercised, it would provide gross proceeds to the Company of
$1,872,000. Escalon cannot assure, however, that the warrant exercise price will
be less than the market price of the Company's Common Stock when the warrants
are exercisable or that even if the exercise price is less than the market price
that any of the warrants will be exercised. See the notes to Consolidated
Financial Statements for a description of the private placement of the Company's
Common Stock and Common Stock purchase warrants.
Pursuant to the successful exchange offer for all of the outstanding
shares of Drew, Escalon is required to provide the historical financial
information of the acquired business required by Rule 3-05 of Regulation S-X.
Furthermore, pursuant to Item 7(a)(4) of Form 8-K, the required historical
financial information is also required to be filed as soon as practicable within
the time prescribed under such Item. To date, Escalon has experienced
difficulties in providing the required financial information due to
circumstances concerning the presentation of United Kingdom financial
statements. Therefore, in the event that Escalon does not file the financial
information required by Article 11 of Regulation S-X or Item 7(b)(2) of Form
8-K, Escalon will not be in compliance with the reporting requirements under the
Securities Exchange Act of 1934 rules. Consequently, Escalon's ability to raise
additional capital pursuant to registration statements may be limited. Escalon
intends to provide the required financial information. If, however, Escalon is
unable to timely report the required financial information due to the
aforementioned issues, Escalon intends to file such financial information as
soon as practicable.
DEBT HISTORY
On December 23, 2002, a lender acquired the Company's bank debt,
which consisted of term debt of $5,850,000 and $1,475,000 outstanding on a
$2,000,000 available line of credit. On February 13, 2003, the Company entered
into an Amended Agreement with the lender. The primary amendments of the Amended
Loan Agreement were to reduce the quarterly principal payments, extend the term
of the repayments and to alter the covenants of the original bank agreement.
As of June 30, 2004, the amount outstanding under the term loan and
line of credit were $3,896,019 and $250,000, respectively. At June 30, 2004, the
interest rates applicable to the term loan and line of credit were 5.75% and
5.50%, respectively. The lender's prime rate at June 30, 2004 was 4.00%. The
$3,896,000 term loan balance includes a $2,396,000 balloon payment that is due
on September 1, 2005. As of June 30, 2004, $1,750,000 was available on the line
of credit. The Company paid $100,000 in finance fees on January 14, 2000, when
this debt was originally incurred. The finance fees are being amortized over the
life of the loans using the effective interest method.
On January 21, 1999, the Company's Vascular subsidiary and Endologix
entered into an Assets Sale and Purchase Agreement. Pursuant to this agreement,
the Company acquired for cash the assets of Endologix's vascular access business
in exchange for cash and also agreed to pay royalties to Endologix based on
future sales of the vascular access business for a period of five years
following the closing of the sale, with a guaranteed minimum royalty of $300,000
per year. On February 1, 2001, the parties amended the agreement to eliminate
any future royalty payments to Endologix. Pursuant to the amendment, the Company
paid $17,558 in cash to Endologix, delivered a short-term note in the amount of
$64,884 that was satisfied in January 2002 and a note in the amount of $717,558,
payable in 11 quarterly installments that commenced on April 15, 2002 and issued
50,000 shares of the Company's Common Stock to Endologix.
As of June 30, 2004, the amount outstanding under the Endologix term
loan was $130,461 and the interest rate applicable to the loan was 5.00%.
28
ESCALON COMMON STOCK
The Company's Common Stock is currently listed on the Nasdaq
SmallCap Market. In order to continue to be listed on the Nasdaq SmallCap
Market, the following requirements must be met:
- Stockholders' equity of $2,500,000 or market value of listed
securities of $35,000,000 or net income from continuing operations
(in the latest fiscal year or two of the last three fiscal years) of
$500,000;
- 500,000 publicly held shares;
- $1,000,000 market value of publicly held shares;
- A minimum bid price of $1;
- 300 round lot shareholders;
- Two market makers; and
- Compliance with corporate governance standards.
As of June 30, 2004, Escalon complied with these requirements.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements requires management to make
estimates and assumptions that affect amounts reported therein. The most
significant of those involve the application of SFAS No. 142, discussed further
in the Notes to the Consolidated Financial Statements included in this Form
10-K. The financial statements are prepared in conformity with accounting
principles generally accepted in the United States of America, and, as such,
include amounts based on informed estimates and judgments of management. For
example, estimates are used in determining valuation allowances for
uncollectible receivables, obsolete inventory, sales returns and rebates,
deferred income taxes 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 or sales incentives 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 policy and procedures related to
the buyer's (distributor's) creditworthiness. Based on this
determination, the Company believes that collectibility is
reasonably assured.
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Escalon assesses collectibility based on credit worthiness 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 Escalon'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
Escalon annually evaluates for impairment its intangible assets and
goodwill in accordance with SFAS No. 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 ass