Forward Looking Statements
Certain statements contained in, or incorporated by reference in, this report are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, which provide current expectations or forecasts of future events. Such statements can be identified by the use of terminology such as "anticipate," "believe," "could," "estimate," "expect," "forecast," "intend," "may," "plan," "possible," "project," "should," "will," and similar words or expressions. The Company's forward-looking statements include certain information relating to general business strategy, growth strategies, financial results, liquidity, the Company's ability to continue as a going concern, discontinued operations, research and development, product development, the introduction of new products, the potential markets and uses for the Company's products, the Company's ability to increase its sales campaign effectively, the Company's regulatory filings with the FDA, acquisitions, dispositions, the development of joint venture opportunities, intellectual property and patent protection and infringement, the loss of revenue due to the expiration or termination of certain agreements, the effect of competition on the structure of the markets in which the Company competes, increased legal, accounting and Sarbanes-Oxley compliance costs, defending the Company in litigation matters and the Company's cost saving initiatives. The reader must carefully consider forward-looking statements and understand that such statements involve a variety of risks and uncertainties, known and unknown, and may be affected by assumptions that fail to materialize as anticipated, including risks related to the COVID-19 pandemic and other risks described in the Company's Form 10-K for the fiscal year endedJune 30, 2020 . Consequently, no forward-looking statement can be guaranteed, and actual results may vary materially. It is not possible to foresee or identify all factors affecting the Company's forward-looking statements, and the reader therefore should not consider the list of such factors contained in its periodic report on Form 10-K for the year endedJune 30, 2020 and this Form 10-Q quarterly report to be an exhaustive statement of all risks, uncertainties or potentially inaccurate assumptions. Executive Overview-three-month periods endedSeptember 30, 2020 and 2019 The following highlights are discussed in further detail within this Form 10-Q. The reader is encouraged to read this Form 10-Q in its entirety to gain a more complete understanding of factors impacting Company performance and financial condition.
• Consolidated net revenue increased approximately
same period of the last fiscal year. The increase in net revenue is attributed to an increase in sales of Trek products of$224,000 . The increase is offset by a decrease of$14,000 in ophthalmic fundus photography system products, a decrease in revenue from service plans of$5,000 , and a decrease in sales in Sonomed's ultrasound products of$79,000 .
• Consolidated cost of goods sold totaled approximately
of total revenue or the three months ended
to
fiscal year. The decrease of 10.9% in cost of goods sold as a percentage of
total revenue is mainly due to changes in product sales mix and geographic
difference. The relative portion of ultrasound sales was about 12% less in
high-margin
the sales of higher margin products decreased in the quarter ended
quarter ended
• Consolidated marketing, general and administrative expenses decreased
2020, as compared to the same period of last fiscal year. The decrease in
marketing, general and administrate expenses is mainly due to decreased
payroll expense for the replacement of senior positions and commission
expense.
• Consolidated research and development expenses decreased
to
the same period of last fiscal year. Research and development expenses were
primarily expenses associated with the introduction of new or enhanced
products. The decrease in research and development expense is mainly due to
decreased payroll expense for the replacement of senior positions during
the three months endedSeptember 30, 2020 . 18
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Company Overview
The following discussion should be read in conjunction with the interim unaudited condensed consolidated financial statements and the notes thereto, which are set forth in Item 1 of this report.
The Company operates in the healthcare market specializing in the development, manufacture, marketing and distribution of medical devices and pharmaceuticals in the area of ophthalmology. The Company and its products are subject to regulation and inspection by the FDA. The FDA requires extensive testing of new products prior to sale and has jurisdiction over the safety, efficacy and manufacture of products, as well as product labeling and marketing. The Company's Internet address is www.escalonmed.com. Under the trade name of Sonomed-Escalon the Company develops, manufactures and markets ultrasound systems used for diagnosis or biometric applications in ophthalmology, develops, manufactures and distributes ophthalmic surgical products under the Trek Medical Products name, and manufactures and markets digital camera systems for ophthalmic fundus photography and image management systems. Critical Accounting Policies The preparation of unaudited condensed consolidated financial statements requires management to make estimates and assumptions that impact amounts reported therein. The most significant of those involve the application of FASB-issued authoritative guidance concerning revenue recognition, and intangible assets, discussed further in the notes to consolidated financial statements included in the Form 10-K for the year endedJune 30, 2020 . The unaudited condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted inthe United States of America ("US GAAP"), and, as such, include amounts based on informed estimates and judgments of management. For example, estimates are used in determining valuation allowances for deferred income taxes, uncollectible receivables, obsolete inventory, sales returns and rebates, warranty liabilities, right-of-use assets and related lease liabilities, and valuation of purchased intangible assets. Actual results achieved in the future could differ from current estimates. The Company used what it believes are reasonable assumptions and, where applicable, established valuation techniques in making its estimates. Accounts Receivable Accounts receivable are recorded at net realizable value. The Company performs ongoing credit evaluations of customers' financial condition and does not require collateral for accounts receivable arising in the normal course of business. The Company maintains allowances for potential credit losses based on the Company's historical trends, specific customer issues and current economic trends. Accounts are written off against the allowance when they are determined to be uncollectible based on management's assessment of individual accounts. The Company recorded an allowance for doubtful accounts of approximately$105,000 and$123,000 as ofSeptember 30, 2020 andJune 30, 2020 . Inventories Inventories include freight-in, materials, labor and overhead costs and are stated at the lower of cost (on a first-in, first-out basis) or net realizable value. The Company writes down its inventories as it becomes aware of any situation whereas the carrying amount exceeds the estimated realizable value based on assumptions about future demands and market conditions. Intangible Assets and Long-Lived Assets Intangible assets deemed to have indefinite lives (including trademark and trade names) are not amortized but, instead, are subject to an annual impairment assessment. Additionally, if events or conditions were to indicate the carrying value or a reporting unit may not be recoverable, the Company would evaluate the other intangible assets for impairment at that time. Long-lived assets including intangible assets deemed to have finite lives, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment indicators include, among other conditions, cash flow deficits, historic or anticipated declines in revenue or operating profit or material adverse changes in the business climate that indicate that the carrying amount of an asset may be impaired. When impairment indicators are present, the recoverability of the asset is measured by comparing the carrying value of the asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the projected undiscounted cash flows from the asset are less than the carrying value of the asset the asset is considered to be impaired. The impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. The Company tests indefinite-life intangible assets for possible impairment on an annual basis atJune 30 , and at any other time events occur or circumstances indicate that the carrying amount of intangible assets may be impaired. During the three months endedSeptember 30, 2020 and 2019, no impairments were recorded. 19
-------------------------------------------------------------------------------- Accrued Warranties The Company provides a limited one-year warranty against manufacturer's defects on its products sold to customers. The Company's standard warranties require the Company to repair or replace, at the Company's discretion, defective parts during such warranty period. The Company accrues for its product warranty liabilities based on estimates of costs to be incurred during the warranty period, based on historical repair information for warranty costs. PPP Loans The Company's policy is to account for the PPP loan (See Note 8) as debt. The Company will continue to record the loan as debt until either (1) the loan is partially or entirely forgiven and the Company has been legally released, at which point the amount forgiven will be recorded as income or (2) the Company pays off the loan. Revenue Recognition The Company recognizes revenue when its performance obligations with its customers have been satisfied. At contract inception, the Company determines if the contract is within the scope of Accounting Standards Codification ("ASC") Topic 606, Revenue from Contracts with Customers, and then evaluates the contract using the following five steps: (1) identify the contract with the customer; (2) identify the performance obligations; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The Company only recognizes revenue to the extent that it is probable that a significant revenue reversal will not occur in a future period. Income Taxes The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the unaudited condensed consolidated financial statements. Under this method, the Company determines deferred tax assets and liabilities on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. The Company recognizes deferred tax assets to the extent that it believes that these assets are more likely than not to be realized. In making such a determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If the Company determines that it would be able to realize its deferred tax assets in the future in excess of their net recorded amount, the Company would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes. As ofSeptember 30, 2020 andJune 30, 2020 , the Company has a fully recorded valuation allowance against its deferred tax assets. The Company records uncertain tax positions in accordance with ASC 740 on the basis of a two-step process in which (1) the Company determines whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, the Company recognizes the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. The Company recognizes interest and penalties related to unrecognized tax benefits on the income tax expense line in the accompanying unaudited condensed consolidated statements of operations. As ofSeptember 30, 2020 andJune 30, 2020 , no accrued interest or penalties were required to be included on the related tax liability line in the unaudited condensed consolidated balance sheets. Earnings (loss) Per Share Earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the year. All outstanding stock options are considered potential common stock. All outstanding convertible preferred stock are considered common stock at the beginning of the period or at the time of issuance, if later, pursuant to the if-converted method. The dilutive effect, if any, of stock options is calculated using the treasury stock method. As of September, 2020 and 2019, the average market prices for the three-month period then ended are less than the exercise price of all the outstanding stock options and, therefore, the inclusion of the stock options would be anti-dilutive. In addition, since the effect of common stock equivalents is anti-dilutive with respect to losses, the convertible preferred stock has also been excluded from the Company's computation of loss per common for the three-month period endedSeptember 30, 2020 . Therefore, basic and diluted loss per 20 -------------------------------------------------------------------------------- common share for the three-month period endedSeptember 30, 2020 are the same. For the three-month period endedSeptember 30, 2019 , the if-converted method was used for the convertible preferred stock to calculate the dilutive earnings per share. Results of Operations Three Months ended EndedSeptember 30, 2020 and 2019 The following table shows consolidated net revenue, as well as identifying trends in revenues for the three months endedSeptember 30, 2020 and 2019. Table amounts are in thousands: For the Three Months Ended September 30, 2020 2019 % Change Net Revenue: Products$ 2,184 $ 2,053 6.4 % Service plans $ 230$ 235 (2.1 )% Total$ 2,414 $ 2,288 5.5 % Consolidated net revenue increased approximately$126,000 or 5.5%, to$2,414,000 during the three months endedSeptember 30, 2020 as compared to the same period of last fiscal year. The increase in net revenue is attributed to a an increase in sales of Trek products of$224,000 . The increase is offset by a decrease of$14,000 in ophthalmic fundus photography system products, a decrease in revenue from service plans of$5,000 , and a decrease in sales in Sonomed's ultrasound products of$79,000 . The table amounts are in thousands: For the Three Months Ended September 30, 2020 2019 Domestic$ 1,542 63.9 %$ 1,467 64.1 % Foreign 872 36.1 % 821 35.9 % Total$ 2,414 100.0 %$ 2,288 100.0 % The following table presents consolidated cost of goods sold and as a percentage of revenues for the thee months endedSeptember 30, 2020 and 2019. Table amounts are in thousands: For the Three Months Ended September 30, 2020 % of revenue
2019 % of revenue Cost of Goods Sold: $ 1,504 62.3 % $ 1,177 51.4 % Total $ 1,504 62.3 % $ 1,177 51.4 % Consolidated cost of goods sold totaled approximately$1,504,000 , or 62.3%, of total revenue for the three months endedSeptember 30, 2020 , as compared to$1,177,000 , or 51.4%, of total revenue of the same period of last fiscal year. The decrease of 10.9% in cost of goods sold as a percentage of total revenue is mainly due to changes in product sales mix and geographic difference. The relative portion of ultrasound sales was about 12% less in high-marginNorth America and 9% more in lowest margin territories and also the sales of higher margin products decreased in the quarter endedSeptember 30, 2020 . Higher Digital customer service labor during the quarter endedSeptember 30, 2020 also contributed to the decreased margin. The following table presents consolidated marketing, general and administrative expenses for the three months endedSeptember 30, 2020 and 2019. Table amounts are in thousands: For the Three Months Ended September 30, 2020 2019 % Change Marketing, General and Administrative: $ 892 $ 999 (10.7 )% Total $ 892 $ 999 (10.7 )% 21
-------------------------------------------------------------------------------- Consolidated marketing, general and administrative expenses decreased$107,000 , or 10.7%, to$892,000 for the three months endedSeptember 30, 2020 , as compared to the same period of last fiscal year. The decrease in marketing, general and administrate expenses is mainly due to decreased payroll expense for the replacement of senior positions and commission expense. The following table presents consolidated research and development expenses for the three months ended endedSeptember 30, 2020 and 2019. Table amounts are in thousands: For the Three Months Ended September 30, 2020 2019 % Change Research and Development:$ 209 $ 246 (15.0 )% Total$ 209 $ 246 (15.0 )% Consolidated research and development expenses decreased$37,000 , or 15.0%, to$209,000 for the three months endedSeptember 30, 2020 , as compared to the same period of last fiscal year. Research and development expenses were primarily expenses associated with the introduction of new or enhanced products. The decrease in research and development expense is mainly due to decreased payroll expense for the replacement of senior positions during the three months endedSeptember 30, 2020 . Other income (expense) The Company did not have significant other income during the three months endedSeptember 30, 2020 . As ofJune 30, 2019 ,$792,000 was accrued forMr. DePiano's retirement benefits. The amount represent the approximate present value of the supplemental retirement benefits awarded using a discount rate of 4.5% as ofJune 30, 2019 .Richard DePiano Sr . passed away onOctober 3, 2019 . According to the agreement, the benefits terminate uponMr. DePiano Sr .'s death. Therefore, the Company recognized a gain with the termination of the retirement benefit obligation of$758,000 , which has been reported as other income for the three-month period endedSeptember 30, 2019 .
COVID-19 Disclosure
OnMarch 11, 2020 , theWorld Health Organization declared the outbreak of a coronavirus (COVID-19) a pandemic. This pandemic has had a significant impact on the global and domestic economy, and is likely to impact the operations of the company. The Company has been assessing the impact of the COVID-19 pandemic on the business, including the impact on the financial condition and results of operations, financial resources, changes in accounting judgment as well as the impact on the supply and demand, etc. The Company is considered an essential business and has been able to maintain operations during the lockdown. The Company applied for and received$500,000 inApril 2020 under the Payroll Protection Program (PPP loan) which will help reverse the negative impact in terms of the liquidity. The maturity date is two years from the date of the note. The interest rate is 1.00% per year. The Company remains in strong communications with the customers and there is no evidence showing that COVID-19 will greatly affect collection of accounts receivable as of date of this filing. The Company does not know the extent and duration of the impact of COVID-19 on its business due to the uncertainty about the spread of the virus.
Liquidity and Capital Resources
Our total cash on hand as ofSeptember 30, 2020 was approximately$1,366,000 excluding restricted cash of approximately$255,000 compared to approximately$826,000 of cash on hand and restricted cash of$255,000 as ofJune 30, 2020 . Approximately$48,000 was available under our line of credit as ofSeptember 30, 2020 . Because our operations have not historically generated sufficient revenues to enable profitability we will continue to monitor costs and expenses closely and may need to raise additional capital in order to fund operations. We expect to continue to fund operations from cash on hand and through capital raising sources if possible and available, which may be dilutive to existing stockholders, through revenues from the licensing of our products, or through strategic alliances. Additionally, we may seek to sell additional equity or debt securities through one or more discrete transactions, or enter into a strategic alliance arrangement, but can provide no assurances that any such financing or strategic alliance arrangement will be 22 --------------------------------------------------------------------------------
available on acceptable terms, or at all. Moreover, the incurrence of indebtedness in connection with a debt financing would result in increased fixed obligations and could contain covenants that would restrict our operations.
As ofSeptember 30, 2020 we had an accumulated deficit of approximately$69.0 million , incurred recurring losses from operations and negative cash flows from operating activities in prior years. These factors raise substantial doubt regarding our ability to continue as a going concern, and our ability to generate cash to meet our cash requirements for the following twelve months as of the date of this form 10-Q.
The following table presents overall liquidity and capital resources as of
September 30, June 30, 2020 2020 Current Ratio: Current assets$4,431 $4,333 Less: Current liabilities 3,191 2,865 Working capital$1,240 $1,468 Current ratio 1.39 to 1 1.51 to 1 Debt to Total Capital Ratio: Line of credit, note payable, lease liabilities, PPP loan and EIDL loan$1,976 $2,042 Total debt 1,976 2,042 Total equity 1,315 1,512 Total capital$3,291 $3,554 Total debt to total capital 60.0% 57.5% Working Capital Position Working capital decreased approximately$228,000 as ofSeptember 30, 2020 , and the current ratio decreased to 1.39 to 1 from 1.51 to 1 when compared toJune 30, 2020 . The decreased in working capital is due to an increase in current assets of$98,000 and an increase in current liabilities of$326,000 during the quarter endedSeptember 30, 2020 . Debt to total capital ratio was 60.0% and 57.5% as ofSeptember 30, 2020 andJune 30, 2020 , respectively. The increase in the debt to total capital ratio is due to the operating loss in the quarter endedSeptember 30, 2020 . Cash Flow Provided By Operating Activities During the three months endedSeptember 30, 2020 the Company provided approximately$541,000 of cash from operating activities as compared to providing cash of approximately$7,000 for operating activities during the three months endedSeptember 30, 2019 . For the three months endedSeptember 30, 2020 , the Company provided approximately$541,000 from operations. The cash provided by operations is mainly due to decreases in accounts receivable and inventory of approximately$467,000 , increase in accounts payable and accrued expenses of approximately$292,000 , offset by the Company's net loss of$197,000 . The remaining offsetting items for cash provided by operations is comprised of less significant items. The change in the mentioned working capital accounts are due to timing as well as the Company's focus on preserving cash due to uncertainty in the current economic climate. For the three months endedSeptember 30, 2019 , the Company had a net income of approximately$621,000 , which includes non cash post-retirement adjustment of$758,000 . Cash inflows were mainly due to a decrease in accounts receivable of$141,000 , an increase in accrued expenses of$33,000 , an increase in accounts payable of$25,000 , an increase in non cash lease expense of$82,000 , a decrease in liabilities of discontinued operations of$3,000 , and an increase in non-cash expenditure on depreciation and amortization of approximately$12,000 . The cash inflow is offset by a decrease in accrued post retirement benefits of$25,000 , a decrease in operating lease liability of$83,000 , an increase in inventory of$22,000 , an increase in other current assets of$5,000 and an increase in other assets of$11,000 . 23
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Cash Flows Used in Financing Activities
For the three months ended
OnJune 29, 2018 the Company entered a business loan agreement with TD bank receiving a line of credit evidenced by a promissory note of$250,000 . The interest is subject to change based on changes in an independent index which the Wall Street Journal Prime. The index rate at the date of the agreement is 5.000% per annum. Interest on the unpaid principal balance of the note will be calculated using a rate of 0.740 percentage points over the index, adjusted if necessary for any minimum and maximum rate limitations, resulting in an initial rate of 5.740% per annum based on a year of 360 days. The interest rate was 6.24% as ofSeptember 30, 2020 . The Company was required to put$250,000 in the TD bank savings account as collateral.
As of
COVID-19 Relief Loans and Liabilities
Payroll Protection Program ("PPP")
OnApril 27, 2020 , the Company entered into a PPP loan for$500,000 in connection with the CARES Act related to COVID-19.$304,664 of the PPP loan is classified as current. The promissory note has a fixed payment schedule, commencing seven months following the funding of the note and consisting of seventeen monthly payments of principal and interest, with the principal component of each payment based upon the level of amortization of principal over a two year period from the funding date. The PPP loan is unsecured. A final payment for the unpaid principal and accrued interest will be payable no later thanApril 26, 2022 . The note will bear interest at a rate of 1.00% per annum and is deferred for the first six months of the loan. Major portions of the loan and accrued interest may qualify for loan forgiveness based on the terms of the program. The Company is intended to apply for the loan forgiveness. No assurance is provided that the Company will in fact obtain forgiveness of the PPP loan in whole or in part.
Economic Injury Disaster Loan ("EIDL")
EIDL is designed to provide economic relief to businesses that are currently experiencing a temporary loss of revenue due to the Coronavirus (COVID-19) pandemic . EIDL proceeds can be used to cover a wide array of working capital and normal operating expenses, such as continuation to health care benefits, rent, utilities, and fixed debt payments. The Company received$150,000 EIDL loan. The annual interest rate is 3.75%, the payment term is 30 years and the monthly payment will be$731 . The EIDL loan is secured by the tangible and intangible personal property of the Company.
Employer Payroll Tax Withholdings
The CARES Act allows employers to defer the deposit and payment of the employer share ofSocial Security tax that would otherwise be due on or afterMarch 27, 2020 , and beforeJanuary 1, 2021 . The Company has deferred approximately$45,000 of the social security tax as ofSeptember 30, 2020 . 50% of the deferred employment taxes will not be due untilDecember 31, 2021 , with the remaining 50% not due untilDecember 31, 2022 .
Off-balance Sheet Arrangements and Contractual Obligations
The Company was not a party to any off-balance sheet arrangements during the
three-month periods ended
None
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