ESCALON MEDICAL CORP - Quarter Report: 2009 December (Form 10-Q)

3. (Loss) Earnings per Share

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

		Three Months Ended December 31								Six Months Ended December 31,
		2009				2008				2009				2008
Numerator:
Numerator for basic and diluted earnings per share
Net (loss)		$	(1,052,547	)		$	(696,995	)		$	(1,710,047	)		$	(1,177,857	)
Denominator:
Denominator for basic earnings per share — weighted average shares			7,526,430				6,858,374				7,526,430				6,636,152
Effect of dilutive securities:
Stock options and warrants			0				0				0				0
Shares reserved for future exchange			0
Denominator for diluted earnings per share — weighted average and assumed conversion			7,526,430				6,858,374				7,526,430				6,636,152
Basic (loss) earnings per share		$	(0.14	)		$	(0.10	)		$	(0.23	)		$	(0.18	)
Diluted (loss) earnings per share		$	(0.14	)		$	(0.10	)		$	(0.23	)		$	(0.18	)

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

4. Legal Proceedings

     The Company, from time to time is involved in various legal proceedings and disputes that arise in the normal course of business. These matters have previously and could pertain to intellectual property disputes, commercial contract disputes, employment disputes, and other matters. The Company does not believe that the resolution of any of these matters has had or is likely to have a material adverse impact on the Company’s business, financial condition or results of operations.

5. Segmental Information

     During the three-month and six-month periods ended December 31, 2009 and 2008, the Company’s operations were classified into five principal reportable business segments that provide different products or services.

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

		Segment Statements of Operations (in thousands) - Three months ended December 31,
		Drew								Sonomed								Vascular								EMI								Medical/Trek								Total
		2009				2008				2009				2008				2009				2008				2009				2008				2009				2008				2009				2008
Revenues, net:
Product revenue		$	5,096			$	3,753			$	2,060			$	2,560			$	898			$	898			$	509			$	540			$	294			$	310			$	8,857			$	8,061
Other revenue			28				38				0				0				0				0				0				0				0				0				28				38
Total revenue, net			5,124				3,791				2,060				2,560				898				898				509				540				294				310				8,885				8,099
Costs and expenses:
Cost of goods sold			2727				2370				1103				1406				373				319				290				314				229				228				4723				4637
Research & Development			246				415				122				348				50				39				94				91				(4	)			0				508				893
Marketing, General & Admin			2692				1275				642				781				467				490				253				235				476				560				4531				3341
Total costs and expenses			5665				4060				1867				2535				890				848				637				640				701				788				9762				8871
(Loss) income from operations			(541	)			(269	)			193				25				8				50				(128	)			(100	)			(406	)			(478	)			(877	)			(772	)
Other (expense) and income:
Equity in OTM			0				0				0				0				0				0				0				0				(23	)			(13	)			(23	)			(13	)
Gain on sale of assets			0				92				0				0				0				0				0				0				0				0				0				92
Interest income			0				0				0				0				0				0				0				0				(1	)			3				(1	)			3
Interest expense			(151	)			(8	)			0				0				0				0				0				0				0				0				(151	)			(8	)
Total other (expense) and income			(151	)			84				0				0				0				0				0				0				(24	)			(10	)			(175	)			74
(Loss) and income before taxes			(692	)			(185	)			193				25				8				50				(128	)			(100	)			(430	)			(488	)			(1052	)			(698	)
Income taxes			0				0				0				0				0				0				0				0				0				0				0				0
Net (loss) income		$	(692	)			(185	)			193				25				8				50				(128	)			(100	)			(430	)			(488	)			(1052	)		$	(698	)

		Segment Statements of Operations (in thousands) - Six months ended December 31,
		Drew								Sonomed								Vascular								EMI								Medical/Trek/EHI								Total
		2009				2008				2009				2008				2009				2008				2009				2008				2009				2008				2009				2008
Revenues, net:
Product revenue		$	9,729			$	8,003			$	4,097			$	5,132			$	1,829			$	1,896			$	1,023			$	1,066			$	613			$	633			$	17,291			$	16,730
Other revenue			47				66				—				—				—				—				—				—				—				—				47				66
Total revenue, net			9,776				8,069				4,097				5,132				1,829				1,896				1,023				1,066				613				633				17,338				16,796
Costs and expenses:
Cost of goods sold			5,482				5,049				2,229				2,815				713				666				453				531				434				420				9,311				9,481
Research & Development			469				955				327				688				164				109				158				187				(4	)			—				1,114				1,939
Marketing, General & Admin			4,878				2,579				1,267				1,618				866				898				394				387				923				1,164				8,328				6,646
Total costs and expenses			10,829				8,583				3,823				5,121				1,743				1,673				1,005				1,105				1,354				1,584				18,753				18,066
(Loss) income from operations			(1,053	)			(514	)			274				11				86				223				18				(39	)			(741	)			(951	)			(1,415	)			(1,270	)
Other (expense) and income:
Equity in OTM			—				—				—				—				—				—				—				—				(39	)			(34	)			(39	)			(34	)
Gain on sale of assets			—				92				—				—				—				—				—								—				—				—				92
Interest income			—				—				—				—				—				—				—				—				(1	)			50				(1	)			50
Interest expense			(255	)			(17	)			—				—				—				—				—				—				—				—				(255	)			(17	)
Total other (expense) and income			(255	)			75				—				—				—				—				—				—				(40	)			16				(295	)			91
(Loss) and income before taxes			(1,308	)			(439	)			274				11				86				223				18				(39	)			(781	)			(935	)			(1,710	)			(1,179	)
Income taxes			—				—				—				—				—				—				—				—				—				—				—				—
Net (loss) income		$	(1,308	)			(439	)			274				11				86				223				18				(39	)			(781	)			(935	)			(1,710	)		$	(1,179	)

6. Related-Party Transactions

          The Company and a member of the Company’s Board of Directors are founding and equal members of Ocular Telehealth Management, LLC (“OTM”). OTM is a diagnostic telemedicine company providing remote examination, diagnosis and management of disorders affecting the human eye. OTM’s initial focus is on the diagnosis of diabetic retinopathy by creating access and providing annual dilated retinal examinations for the diabetic population. Through December 31, 2009, the Company has invested $424,200 in OTM, including $25,200 invested during the six-month period ended December 31, 2009. As of December 31, 2009, the Company owned 45% of OTM. The Company provides administrative support functions to OTM. For the three month periods ended December 31, 2009 and 2008 the Company recorded losses of $23,433 and $13,051, respectively. For the six-month periods ended December 31, 2009 and 2008 the Company recorded losses of $39,433 and $34,051, respectively.

7. Recently Issued Accounting Standards

          In October 2009, the Financial Accounting Standards Board (“FASB”) issued amended revenue recognition authoritative guidance for arrangements with multiple deliverables. The new authoritative guidance eliminates the residual method of revenue recognition and allows the use of management’s best estimate of selling price for individual elements of an arrangement when vendor specific objective evidence (“VSOE”), vendor objective evidence (“VOE”) or third-party evidence (“TPE”) is unavailable. This guidance is effective for all new or materially modified arrangements entered into on or after January 1, 2011, with earlier application permitted as of the beginning of any prior fiscal year. Full retrospective application of the new guidance is optional. The Company is currently assessing the impact that the implementation of this new guidance will have on the Company’s financial position and operations.

          In October 2009, the FASB issued authoritative guidance which amends the scope of existing software revenue recognition accounting. Tangible products containing software components and non-software components that function together to deliver the product’s essential functionality would be scoped out of the accounting guidance on software and accounted for based on other appropriate revenue recognition guidance. This guidance is effective for all new or materially modified arrangements entered into on or after January 1, 2011, with earlier application permitted as of the beginning of any prior fiscal year. Full retrospective application of the new guidance is optional. This guidance must be adopted in the same period that the Company adopts the amended accounting for arrangements with multiple deliverables described in the preceding paragraph. The Company is currently assessing the impact that the implementation of this new guidance will have on the Company’s financial position and operations.

          On July 1, 2009, the FASB issued the FASB Accounting Standards Codification (the “Codification”). The Codification became the single authoritative source of GAAP recognized by the FASB. The Codification superseded all previously-existing non-Securities and Exchange Commission accounting and reporting standards, and all other non-grandfathered non-Securities and Exchange Commission accounting literature not included in the Codification became nonauthoritative. The Codification was effective for interim and annual reporting periods ending after September 15, 2009. The Company adopted the Codification for the quarter ended September 30, 2009. The Company’s adoption of the Codification did not have any impact on the Company’s financial position and operations as this change is disclosure-only in nature.

          In June 2009, the FASB issued authoritative guidance which amends the consolidation guidance applicable to variable interest entities and requires enhanced disclosures intended to provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. This guidance will be effective beginning with the Company’s consolidated financial statements for the year ending December 31, 2010 and the quarterly periods thereof. The Company does not expect the impact of adoption to be material on its financial position and operations.

          In June 2009, the FASB issued authoritative guidance which eliminates the concept of a qualifying special-purpose entity, changes the requirements for derecognizing financial assets and requires enhanced disclosure to provide financial statement users with greater transparency about transfers of financial assets, including securitization transactions and an entity’s continuing involvement in and exposure to the risks related to the transfer of financial assets. This guidance will be effective beginning with the Company’s consolidated financial statements for the year ending June 30, 2011 and the quarterly periods thereof. The Company does not expect the impact of adoption to be material on its financial position and operations.

          In May 2009, the FASB issued amended authoritative guidance on subsequent event accounting which sets forth: (i) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and (iii) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. These guidelines were effective for interim and annual periods ending after June 15, 2009, and the Company adopted them in the quarter ended June 30, 2009. The Company has evaluated subsequent events through February 22, 2009, which is the date these financial statements were issued.

          In April 2009, the FASB issued authoritative guidance on determining fair value when the volume and level of activity for an asset or liability has significantly decreased, and in identifying transactions that are not orderly. Based on the guidance, if an entity determines that the level of activity for an asset or liability has significantly decreased and that a transaction is not orderly, further analysis of transactions or quoted prices is needed, and a significant adjustment to the transaction or quoted prices may be necessary to estimate fair value. The guidance was effective on a prospective basis for interim and annual periods ending after June 15, 2009. The adoption of this guidance did not have a material impact on the Company’s financial position and operations.

          In April 2009, the FASB issued authoritative guidance regarding interim disclosures about the fair value of financial instruments which were previously only disclosed on an annual basis. Entities are now required to disclose the fair value of financial instruments which are not recorded at fair value in the financial statements in both their interim and annual financial statements. The new requirements were effective for interim and annual periods ending after June 15, 2009 on a prospective basis. The Company adopted these requirements in the quarter ended June 30, 2009. The adoption of these requirements did not impact the Company’s financial position and operations, as the requirements relate only to additional disclosures.

          In April 2008, the FASB issued new authoritative guidance regarding the determination of the useful lives of intangible assets. In developing assumptions about renewal or extension options used to determine the useful life of an intangible asset, an entity needs to consider its own historical experience adjusted for entity-specific factors. In the absence of that experience, an entity shall consider the assumptions that market participants would use about renewal or extension options. The new requirements apply to intangible assets acquired after January 1, 2009. The adoption of these new rules did not have a material impact on the Company’s financial position and operations.

          In March 2008, the FASB issued new authoritative disclosure requirements regarding derivative instruments and hedging activities. Entities must now provide enhanced disclosures on an interim and annual basis regarding how and why the entity uses derivatives, how derivatives and related hedged items are accounted for, and how derivatives and related hedged items affect the entity’s financial position, financial results and cash flows. The Company adopted these new requirements on July 1, 2009. The adoption of these new requirements did not impact the Company’s financial position and operations.

          In December 2007, the FASB issued new authoritative guidance on noncontrolling interests in consolidated financial statements. This guidance requires that the noncontrolling interest in the equity of a subsidiary be accounted for and reported as equity, provides revised guidance on the treatment of net income and losses attributable to the noncontrolling interest and changes in ownership interests in a subsidiary and requires additional disclosures that identify and distinguish between the interests of the controlling and noncontrolling owners. The Company adopted this new guidance on July 1, 2009. The adoption of this guidance did not have a material impact on the Company’s financial position and operations.

8. Fair Value Measurements

          Effective July 1, 2008, the Company adopted authoritative guidance issued by the Financial Accounting Standards Board (the “FASB”) regarding fair value measurements. This accounting guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date and establishes a three-level fair value hierarchy for disclosure to show the extent and level of judgment used to estimate fair value measurements. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

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

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

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

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

          The Company determined that the fair value of the outstanding long term debt approximates their outstanding balances based on the remaining maturity of these instruments and other Level 3

measurements. The Company determined the estimated fair value amounts by using available market information and commonly accepted valuation methodologies. However, considerable judgment is required in interpreting market data as well as the risk of nonperformance related to the long term debt. The use of different assumptions and/or estimation methodologies may have a material effect on the estimate fair values.

9. Continuing Operations

          The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred recurring operating losses and negative cash flows from operating activities and the debt payments related to the Biocode acquisition are scheduled to commence within the next six months. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. If the Company is unsuccessful in its efforts to raise additional capital in the near term, the Company may be required to significantly reduce its research, development, and administrative activities, including further reduction of its employee base. The financial statements do not include any adjustments relating to the realization of the carrying value of assets or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern. Our continuance as a going concern is dependent on our future profitability and on the on-going support of our shareholders, affiliates and creditors. In order to mitigate the going concern issues, we are actively pursuing business partnerships, managing our continuing operations, and seeking capital funding on an ongoing basis via the issuance of securities and private placements.

     The Company is implementing an austerity plan to stem the recurring losses at Drew. If the Company is unable to achieve improvement in this area in the near term, it is not likely that our existing cash and cash flow from operations will be sufficient to fund activities throughout the next 12 months without curtailing certain business activities. The Company has based this estimate on assumptions that may prove to be incorrect, and the Company may use its available capital resources sooner or more slowly than the Company currently expects. The Company’s forecast of the period of time through which its financial resources will be adequate to support its operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed in “Risk Factors” in the June 30, 2009 Form 10K.

          If we do proceed with raising funds in the future, we may be required to raise those funds through public or private financings, strategic relationships or other arrangements. The sale of additional equity and debt securities may result in additional dilution to our stockholders. Additional financing may not be available in amounts or on terms acceptable to us or at all.

10. TECOM Agreement

     On June 25, 2009 BioCode entered into a License and Supply Agreement with TECOM Science Corporation (“TECOM”) for the sale of certain intellectual property and distribution rights in China from Biocode for the purpose of manufacturing the Xenia instrument and the purchasing of reagents for the Xenia for its own use and for sale to its customers in China for 750,000 Euros. TECOM has the exclusive right to manufacture the Xenia into a form for marketing and sale to end users under TECOM’S trademark and/or trade name within China. TECOM has the exclusive rights to constitute the Xenia reagents into a form for marketing and sale to end users under TECOM’s trademark and/or trade name within China. TECOM provided Biocode an exclusive right to the use of any improvements or modifications to the Xenia. The Agreement remains in effect for a period of twenty (20) years and is renewable for an additional ten (10) years. The payment terms pursuant to the Agreement are as follows:

	1.		The first payment of 200,000 Euros was received on October 5, 2009. After associated taxes Biocode received 170,000 Euros ($235,000) during the three-month period ended December 31, 2009 related to this agreement, which is included in product revenue on the condensed consolidated statement of operations.
	2.		The second payment of 200.000 Euros is due upon the successful production of the first 5 units of the Xenia with the training of the engineer from Biocode in China and at a maximum of 6 months after signature of Agreement.
	3.		The third payment of 200,000 Euros is due 15 months after signature of Agreement.
	4.		The final payment of 150,000 Euros is due 24 months after signature of Agreement.

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

          Certain statements contained in, or incorporated by reference in, this report are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, which provide current expectations or forecasts of future events. Such statements can be identified by the use of terminology such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “forecast,” “intend,” “may,” “plan,” “possible,” “project,” “should,” “will,” and similar words or expressions. The Company’s forward-looking statements include certain information relating to general business strategy, growth strategies, financial results, liquidity, product development, the introduction of new products, the potential markets and uses for the Company’s products, the Company’s regulatory filings with the FDA, acquisitions, the development of joint venture opportunities, intellectual property and patent protection and infringement, the loss of revenue due to the expiration on termination of certain agreements, the effect of competition on the structure of the markets in which the Company competes, increased legal, accounting and Sarbanes-Oxley compliance costs, defending the Company in litigation matters and the Company’s cost saving initiatives. The reader must carefully consider forward-looking statements and understand that

such statements involve a variety of risks and uncertainties, known and unknown, and may be affected by assumptions that fail to materialize as anticipated. Consequently, no forward-looking statement can be guaranteed, and actual results may vary materially. It is not possible to foresee or identify all factors affecting the Company’s forward-looking statements, and the reader therefore should not consider the list of such factors contained in its periodic report on Form 10-K for the year ended June 30, 2009 to be an exhaustive statement of all risks, uncertainties or potentially inaccurate assumptions. The Management’s Discussion and Analysis should be read in conjunction with the December 31, 2009 financial statements and the audited financial statements included in the June 30, 2009 Form 10K.

Executive Overview — Six-Month Period Ended December 31, 2009

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

	•		Product revenue increased approximately 3.4% during the six-month period ended December 31, 2009 as compared to the same period last fiscal year. The increase was related to increases in the Drew segment. Product revenue at Drew increased 21.6% during the six-month period ended December 31, 2009 due to the acquisition of Biocode at the end of December 2008 when compared to the same period last fiscal year. These increases were offset by weakened sales in the Company’s Sonomed, Vascular, EMI and Medical/Trek business segments. Sales at Sonomed, Vascular, EMI and Medical/Trek decreased approximately 20.2%, 3.5% 4.0% and 3.2% respectively during the six-month period ended December 31, 2009 compared to the same period last fiscal year.
	•		Other revenue decreased approximately $19,000 or 28.8% during the six-month period ended December 31, 2009 as compared to the same period last fiscal year. This was attributable to decreased Bio-Rad royalties received in the Drew business segment.
	•		Cost of goods sold as a percentage of product revenue decreased to approximately 53.9% during the six-month period ended December 31, 2009, as compared to approximately 56.7% for the same period last fiscal year. This decrease was primarily attributed to decrease in the cost of goods sold as a percentage of revenue in Drew segment related to the Biocode acquisition. Cost of goods sold as a percentage of revenue in the Drew segment decreased by 6.8% from 63.1% in the same period of last fiscal year to 56.3% due to the addition of higher margin sales related to Biocode.
	•		Operating expenses increased approximately 10.0% during the six-month period ended December 31, 2009 as compared to the same period in the prior fiscal year. The increase was due to the inclusion of marketing, general and administrative cost of Biocode, which was acquired by the company on December 31, 2008.

Company Overview

          The following discussion should be read in conjunction with interim condensed consolidated financial statements and the notes thereto, which are set forth in Item 1 this report.

          The Company operates in the healthcare market specializing in the development, manufacture, marketing and distribution of medical devices and pharmaceuticals in the areas of ophthalmology, diabetes, hematology and vascular access. The Company and its products are subject to regulation and inspection by the FDA. The FDA requires extensive testing of new products prior to sale and has jurisdiction over the safety, efficacy and manufacture of products, as well as product labeling and marketing. The Company’s Internet address is www.escalonmed.com.

          Critical Accounting Policies

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

          Revenue Recognition

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

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

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

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

          Valuation of Intangible Assets

          The Company annually evaluates for impairment its intangible assets and goodwill, or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. These intangible assets include goodwill, trademarks, trade names, patents, covenants not to compete, customer list and other intangible assets. Factors the Company considers important that could trigger an impairment review include significant under-performance relative to historical or projected future operating results or significant negative industry or economic trends. If these criteria indicate that the value of the intangible asset may be impaired, an evaluation of the recoverability of the net carrying value of the asset is made. If this evaluation indicates that the intangible asset is not recoverable, the net carrying value of the related intangible asset will be reduced to fair value. Any such impairment charge could be significant and could have a material adverse impact on the Company’s financial statements if and when an impairment charge is recorded.

          Loss Per Share

          Basic and diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net loss per share excludes potential common shares if the effect is anti-dilutive. Basic earnings per share are computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share are determined in the same manner as basic earnings per share, except that the number of shares is increased by assuming exercise of dilutive stock options and warrants using the treasury stock method.

          Income Taxes

          Estimates of taxable income of the various legal entities and jurisdictions are used in the tax rate calculation. Management uses judgment in estimating what the Company’s (loss) income will be for the year. Since judgment is involved, there is a risk that the tax rate may significantly increase or decrease in any period.

          The Company has adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), which provides a comprehensive model for the recognition, measurement, and disclosure in financial statements of uncertain income tax positions that a company has taken or expects to take on a tax return. Under FIN 48, a company can recognize the benefit of an income tax position only if it is more likely than not (greater than 50%) that the tax position will be sustained upon tax examination, based solely on the technical merits of the tax position. Otherwise, no benefit can be recognized. The tax benefits recognized are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. Additionally, companies are required to accrue interest and related penalties, if applicable, on all tax exposures for which reserves have been established consistent with jurisdictional tax laws. The Company has elected to recognize interest expense and penalties related to uncertain tax positions as a component of its provision for income taxes.

          In determining (loss)/income for financial statement purposes, management must make certain estimates and judgments. These estimates and judgments occur in the calculation of certain tax liabilities and in the determination of the recoverability of certain of the deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenue and expense. SFAS 109 also requires that the deferred tax assets be reduced by a valuation allowance, if based on the available evidence, it is more likely than not that all or some portion of the recorded deferred tax assets will not be realized in future periods.

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

          Through December 31, 2009, the Company has recorded a full valuation allowance against the Company’s deferred tax assets for the net operating losses due to the uncertainty of their realization as a result of the Company’s earnings history, the number of years the Company’s net operating losses and tax credits can be carried forward, the existence of taxable temporary differences and near-term earnings expectations. The amount of the valuation allowance could decrease if facts and circumstances change that materially increase taxable income prior to the expiration of the loss carry forwards. Any reduction would reduce (increase) the income tax expense (benefit) in the period such determination is made by the Company.

Three- and Six-Month Periods Ended December 31, 2009 and 2008

          The following table shows consolidated product revenue by business segment as well as identifying trends in business segment product revenues for the three- and six-month periods ended December 31, 2009 and 2008. Table amounts are in thousands:

		For the Three Months Ended December 31,												For the Six Months Ended December 31,
		2009				2008				% Change				2009				2008				% Change
Product Revenue:
Drew		$	5,096			$	3,753				35.8	%		$	9,729			$	8,003				21.6	%
Sonomed			2,060				2,560				-19.5	%			4,097				5,132				-20.2	%
Vascular			898				898				0.0	%			1,829				1,896				-3.5	%
EMI			509				540				-5.7	%			1,023				1,066				-4.0	%
Medical/Trek			294				310				-5.2	%			613				633				-3.2	%
Total		$	8,857			$	8,061				9.9	%		$	17,291			$	16,730				3.4	%

          Product revenue increased approximately $796,000, or 9.9%, to $8,857,000 for the three-month period ended December 31, 2009 as compared to the same period last fiscal year.

	•		In the Drew business segment, product revenue increased $1,343,000, or 35.8%, as compared to the same period last fiscal year. The increase in product revenue is related to the acquisition of Biocode in December 2008. Biocode generated $1,251,000 in revenue for the three month period ended December 31, 2009 which included $235,000 related to the TECOM agreement.
	•		Product revenue decreased $500,000, or 19.5%, at the Sonomed business segment for the three month period ended December 31, 2009 as compared to the same period last fiscal year. The decrease in product revenue was primarily caused by a significant contraction in the capital equipment marketplace related to the global economic recession and to the continued reliance on lower margin international sales.
	•		Product revenue remained at $898,000 in the Vascular business segment during the three-month period ended December 31, 2009, as compared to the same period last fiscal year.
	•		Product revenue decreased $31,000, or 5.7%, in the EMI business segment for the three month period ended December 31, 2009 when compared to the same period last year. The decrease in sales is related to the weakening of the capital equipment market related to the global economic recession, offset by increased custom system sales during the three month period ended December 31, 2009.
	•		In the Medical/Trek business segment, product revenue decreased $16,000, or 5.2%, to $294,000 during the three-month period ended December 31, 2009 as compared to the same period last fiscal year. The decrease in Medical/Trek product revenue is attributed to Medical/Trek’s aging product line of Ispan Intraocular gases and fiber optic light sources.

          Product revenue increased approximately $561,000, or 3.4%, to $17,291,000 during the six-month period ended December 31, 2009 as compared to the same period last fiscal year. The increase was related to increases in the Drew segment.

•

In the Drew business segment, product revenue increased $1,726,000, or 21.6%, for the six-month period ended December 31, 2009 as compared to the same period last fiscal year. The increase in

product revenue is related to the acquisition of Biocode on December 31, 2008. Biocode generated $2,587,000 in revenue for the six-month period ended December 31, 2009 which include $235,000 related to the TECOM agreement. This increase was offset by weak demand for Drew’s historical instrument and reagent offerings which decreased $838,000 for the six-month period ended December 31, 2009. In addition, reagent sales from JAS Diagnostics (“JAS”) decreased $23,000 for the period ended December 31, 2009.

	•		In the Sonomed business segment, product revenue decreased $1,035,000, or 20.2%, for the six-month period ended December 31, 2009 as compared to the same period last fiscal year. The decrease in product revenue was primarily caused by a significant contraction in the capital equipment marketplace related to the global economic recession and to the continued reliance on lower margin international sales.
	•		In the Vascular business segment, product revenue decreased $67,000, or 3.5%, to $1,829,000 during the six-month period ended December 31, 2009 as compared to the same period last fiscal year. The decrease in product revenue in the Vascular business segment was primarily related to weakened sales of disposable products and Vascular’s core needle business
	•		Product revenue decreased $43,000, or 4.0%, during the six-month period ended December 31, 2009 in the EMI business segment when compared to the same period last year. The decrease in sales is related to the weakening of the capital equipment market related to the global economic recession, offset by increased custom system sales during the three month period ended December 31, 2009.
	•		In the Medical/Trek business segment, product revenue decreased $20,000, or 3.2%, to $613,000 during the six-month period ended December 31, 2009 as compared to the same period last fiscal year. The decrease in Medical/Trek product revenue is attributed to Medical/Trek’s aging product line of Ispan Intraocular gases and fiber optic light sources.

          The following table shows consolidated other revenue by business segment as well as identifying trends in business segment other revenues for the three- and six-month periods ended December 31, 2009 and 2008. Table amounts are in thousands:

		For the Three Months Ended December 31,												For the Six Months Ended December 31,
		2009				2008				% Change				2009				2008				% Change
Other Revenue:
Drew		$	28			$	38				-26.3	%		$	47			$	66				-28.8	%
Total		$	28			$	38				-26.3	%		$	47			$	66				-28.8	%

          Other revenue decreased by approximately $10,000, or 26.3%, to $28,000 during the three-month period ended December 31, 2009 as compared to the same period last fiscal year. Other revenue decreased by approximately $19,000, or 28.8%, to $47,000 during the six-month period ended December 31, 2009 as compared to the same period last fiscal year. These decreases were attributable to decreased royalties from Bio-Rad related to an OEM agreement between Bio-Rad and Drew as a result of lower sales of Drew’s products in covered areas. While this agreement terminated as of May 15, 2006, the parties have continued to operate under the terms of the expired agreement pending negotiation of a potential extension and/or revision.

          The following table presents consolidated cost of goods sold by reportable business segment and as a percentage of related segment product revenues for the three- and six-month periods ended December 31, 2009 and 2008. Table amounts are in thousands:

		For the Three Months Ended December 31,																For the Six Months Ended December 31,
		2009				%				2008				%				2009				%				2008				%
Cost of Goods Sold:
Drew		$	2,727				53.5	%		$	2,370				63.2	%		$	5,482				56.4	%		$	5,049				63.1	%
Sonomed			1,103				53.5	%			1,406				54.9	%			2,229				54.4	%			2,815				54.9	%
Vascular			373				41.5	%			319				35.5	%			713				39.0	%			666				35.1	%
EMI			290				57.0	%			314				58.2	%			453				44.3	%			531				49.8	%
Medical/Trek			229				77.9	%			228				73.6	%			434				70.8	%			420				66.4	%
Total		$	4,722				53.3	%		$	4,637				57.5	%		$	9,311				53.9	%		$	9,481				56.7	%

          Cost of goods sold totaled approximately $4,722,000, or 53.3% of product revenue, for the three-month period ended December 31, 2009, as compared to $4,637,000 or 57.5%, of product revenue for the same period last fiscal year.

	•		Cost of goods sold in the Drew business segment totaled $2,727,000, or 53.5% of product revenue, for the three-month period ended December 31, 2009 as compared to $2,370,000, or 63.2% of product revenue, for the same period last fiscal year. Margins on Drew’s instruments continue to range between 10% and 20% depending on the product. These lower margin sales are offset by the margins achieved on increased reagent sales related to the Biocode acquisition which ranged from 50% to 75% during the three month period ended December 31, 2009 and 2008.
	•		Cost of goods sold in the Sonomed business segment totaled $1,103,000, or 53.5% of product revenue, for the three-month period ended December 31, 2009 as compared to $1,406,000, or 54.9% of product revenue, for the same period last fiscal year. Despite the drop off of capital equipment sales, margins remained relatively unchanged during the current period due to a similar mix of international and domestic sales during the three-month period ended December 31, 2009 and 2008. International sales typically have lower margins due to increased sales discounts to Sonomed’s international distributors.
	•		Cost of goods sold in the Vascular business segment totaled $373,000, or 41.5% of product revenue, for the three-month period ended December 31, 2009 as compared to $319,000, or 35.5% of product revenue, for the same period last fiscal year. The margins on Vascular’s core needle business remains near historical levels of approximately 60%. Overall margins could be lower depending on the amount of lower margin VascuView instruments sold in a given period. VascuView margins are approximately 50%.
	•		Cost of goods sold in the EMI business segment totaled $290,000, or 57.0% of product revenue, for the three-month period ended December 31, 2009 as compared to $314,000, or 58.2% of product revenue, during the same period last fiscal year. The decrease in cost of goods sold as a percentage of revenue is due to the product mix sold during the quarter.
	•		Cost of goods sold in the Medical/Trek business segment totaled $229,000, or 77.9% of product revenue, for the three-month period ended December 31, 2009 as compared to $228,000, or 73.6% of product revenue, for the same period last fiscal year. The reason for the increase in cost of goods sold as a percentage of revenue is a decline in sales to higher margin low volume purchasers. Medical/Trek anticipates that revenues will continue to decline as the product line continues to age.

          Cost of goods sold totaled approximately $9,311,000, or 53.9% of product revenue, for the six-month period ended December 31, 2009, as compared to $9,481,000, or 56.7% of product revenue, for the same period last fiscal year.

	•		Cost of goods sold in the Drew business segment totaled $5,482,000, or 56.4% of product revenue, for the six-month period ended December 31, 2009 as compared to $5,049,000, or 63.1% of product revenue, for the same period last fiscal year. Margins on Drew’s instruments continue to range between 10% and 20% depending on the product. These lower margin sales are offset by the margins achieved on increased reagent sales related to the Biocode Acquisition which ranged from 50% to 75% during the six-month periods ended December 31, 2009 and 2008.
	•		Cost of goods sold in the Sonomed business segment totaled $2,229,000, or 54.4% of product revenue, for the six-month period ended December 31, 2009 as compared to $2,815,000 or 54.9% of product revenue, for the same period last fiscal year. Despite the drop off of capital equipment sales, margins remained relatively unchanged during the current period due to a similar mix of international and domestic sales during the six-month period ended December 31, 2009 and 2008. International sales typically have lower margins due to increased sales discounts to Sonomed’s international distributors
	•		Cost of goods sold in the Vascular business segment totaled $713,000, or 39.0% of product revenue, for the six-month period ended December 31, 2009 as compared to $666,000, or 35.1% of product revenue, for the same period last fiscal year. The margins on Vascular’s core needle business remains near historical levels of approximately 60%. Overall margins could be lower depending on the amount of lower margin VascuView instruments sold in a given period. VascuView margins are approximately 50%.
	•		Cost of goods sold in the EMI business segment totaled $453,000, or 44.3%, of product revenue for the six-month period ended December 31, 2009 as compared to $531,000, or 49.8%, of product revenue, during the same period last fiscal year. The margin increase is related to the product mix shifting toward higher margin products enhanced or customized by software modifications.
	•		Cost of goods sold in the Medical/Trek business segment totaled $434,000, or 70.8% of product revenue, for the six-month period ended December 31, 2009 as compared to $420,000 or 66.4% of product revenue, during 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 three- and six-month periods ended December 31, 2009 and 2008. Table amounts are in thousands:

		For the Three Months Ended December 31,												For the Six Months Ended December 31,
		2009				2008				% Change				2009				2008				% Change
Marketing, General and Administrative:
Drew		$	2,692			$	1,275				111.1	%		$	4,878			$	2,579				89.1	%
Sonomed			642				781				-17.8	%			1,267				1,618				-21.7	%
Vascular			467				490				-4.7	%			866				898				-3.6	%
EMI			253				235				7.7	%			394				387				1.8	%
Medical/Trek			477				560				-14.8	%			923				1,164				-20.7	%
Total		$	4,531			$	3,341				35.6	%		$	8,328			$	6,646				25.3	%

          Marketing, general and administrative expenses increased $1,190,000, or 35.6%, to $4,531,000 during the three-month period ended December 31, 2009 as compared to the same period last fiscal year.

•

Marketing, general and administrative expenses in the Drew business segment increased $1,417,000, or 111.1%, to $2,692,000 for the three-month period ended December 31, 2009 as compared to the same period last fiscal year. The increase is primarily related to an additional $1,406,000 in expenses related to the operations of Biocode which was acquired in December 2008.

	•		Marketing, general and administrative expenses in the Sonomed business segment decreased $139,000, or 17.8%, to $642,000 for the three-month period ended December 31, 2009 as compared to the same period last fiscal year. The decrease was due to a reduction in trade shows, advertising, travel, commissions and a reduction in force made during the fourth quarter of fiscal year 2009.
	•		Marketing, general and administrative expenses in the Vascular business segment decreased $23,000, or 4.7%, to $467,000 for the three-month period ended December 31, 2009 as compared to the same period last fiscal year. The decrease is related to a reduction in force implemented during the fourth quarter of fiscal 2009.
	•		Marketing, general and administrative expenses in the EMI business segment increased $18,000, or 7.7%, to $253,000 for the three-month period ended December 31, 2009 as compared to the same period last fiscal year. The increase is related to increased marketing and travel during the period ended December 31, 2009 as compared to the same period last year.
	•		Marketing, general and administrative expenses in the Medical/Trek business segment decreased $83,000, or 15.0%, to $477,000 for the three-month period ended December 31, 2009 as compared to the same period last fiscal year. The decrease was related to decreased stock-based compensation costs, a decrease in headcount, and a 10% salary cut taken by senior management in the third quarter of fiscal year 2009.