ESCALON MEDICAL CORP - Quarter Report: 2011 March (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

Mark One

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

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

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		(IRS Employer
incorporation or organization)		Identification No.)
435 Devon Park Drive, Building 100
Wayne, PA 19087		19087
(Address of principal executive offices)		(Zip code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). o Yes o No

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

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

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

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 7,526,430 shares of common stock, $0.001 par value, outstanding as of May 13, 2011.

 

 

Escalon Medical Corp.
Form 10-Q Quarterly Report

Table of Contents

Part I. Financial Statements
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of March 31, 2011 and June 30, 2010 (Unaudited)			3
Condensed Consolidated Statements of Operations for the three- and nine-month periods ended March 31, 2011 and 2010 (Unaudited)			4
Condensed Consolidated Statements of Cash Flows for the nine-month periods ended March 31, 2011 and 2010 (Unaudited)			5
Condensed Consolidated Statement of Shareholders’ Equity for the nine-month periods ended March 31, 2011 (Unaudited)			6
Condensed Consolidated Statements of Comprehensive (Loss) for the three- and nine-month periods ended March 31, 2011 and 2010 (Unaudited)			7
Notes to Condensed Consolidated Financial Statements			8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			18
Item 3. Quantative and Qualitative Disclosures about Market Risk			31
Item 4. Controls and Procedures			32
Part II. Other Information
Item 1. Legal Proceedings			33
Item 1A. Risk Factors			33
Item 6. Exhibits			33

Part I. Financial Statements

Item 1.		Condensed Consolidated Financial Statements

ESCALON MEDICAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

		March 31,				June 30,
		2011				2010
ASSETS
Current assets:
Cash and cash equivalents		$	2,363,532			$	3,342,422
Accounts receivable, net			4,664,138				4,481,249
Inventory, net			7,693,300				6,978,714
Other current assets			192,523				521,341
Assets of discontinued operations			—				1,424,183
Total current assets			14,913,493				16,747,909
Furniture and equipment, net			644,783				672,490
Goodwill			218,208				1,124,018
Trademarks and trade names			694,006				694,006
Patents, net			1,196,867				1,284,109
Covenant not to compete, customer list, net			1,280,278				1,480,264
Other assets			84,015				4,140
Total assets		$	19,031,650			$	22,006,936
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt		$	251,953			$	1,254,492
Accounts payable			1,945,406				1,537,860
Accrued expenses			2,770,706				2,499,878
Liabilities of discontinued operations			—				705,635
Total current liabilities			4,968,065				5,997,865
Long-term debt, net of current portion			4,506,122				2,916,246
Accrued post-retirement benefits			1,027,821				1,027,821
Total long-term liabilities			5,533,943				3,944,067
Total liabilities			10,502,008				9,941,932
Shareholders equity:
Preferred stock, $0.001 par value; 2,000,000 shares authorized; no shares issued
Common stock, $0.001 par value; 35,000,000 shares authorized; 7,526,430 issued and outstanding at March 31, 2011 and June 30, 2010			7,526				7,526
Common stock warrants			1,733,460				1,733,460
Additional paid-in capital			67,671,061				67,583,905
Accumulated deficit			(60,265,615	)			(56,646,366	)
Accumulated other comprehensive loss			(616,790	)			(613,521	)
Total shareholders’ equity			8,529,642				12,065,004
Total liabilities and shareholders’ equity		$	19,031,650			$	22,006,936

See notes to condensed consolidated financial statements

ESCALON MEDICAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

		Three Months Ended March 31,								Nine Months Ended March 31,
		2011				2010				2011				2010
Net revenues:
Product revenue		$	7,501,075			$	7,624,372			$	22,574,761			$	23,086,612
Other revenue			—				243,805				6,933				534,444
Revenues, net			7,501,075				7,868,177				22,581,694				23,621,056
Costs and expenses:
Cost of goods sold			4,248,996				4,507,847				12,856,765				13,106,736
Marketing, general and administrative			3,750,395				3,376,063				11,095,170				11,231,658
Research and development			395,656				446,359				1,198,273				1,396,283
Goodwill impairment			905,810				0				905,810				0
Total costs and expenses			9,300,857				8,330,269				26,056,018				25,734,677
(Loss) from operations			(1,799,782	)			(462,092	)			(3,474,324	)			(2,113,621	)
Other (expense) and income:
Equity in Ocular Telehealth Management, LLC			(37,600	)			(20,963	)			(71,745	)			(60,396	)
Interest income			83				16				194				213
Interest expense			(84,186	)			(59,193	)			(244,064	)			(314,645	)
Total other expense			(121,703	)			(80,140	)			(315,615	)			(374,828	)
Net loss from continuing operations before taxes			(1,921,485	)			(542,232	)			(3,789,939	)			(2,488,449	)
Provision for income taxes			—				—				—				—
Net loss from continuing operations			(1,921,485	)			(542,232	)			(3,789,939	)			(2,488,449	)
Net income from discontinued operations			—				232,874				170,690				469,044
Net (loss)			(1,921,485	)			(309,358	)			(3,619,249	)			(2,019,405	)
Net income (loss) per share
Basic:
Continuing operations		$	(0.26	)		$	(0.07	)		$	(0.50	)		$	(0.33	)
Discontinued operations			—				0.03				0.02				0.06
		$	(0.26	)		$	(0.04	)		$	(0.48	)		$	(0.27	)
Diluted:
Continuing operations		$	(0.26	)		$	(0.07	)		$	(0.50	)		$	(0.33	)
Discontinued operations			—				0.03				0.02				0.06
		$	(0.26	)		$	(0.04	)		$	(0.48	)		$	(0.27	)
Weighted average shares - basic			7,526,430				7,526,430				7,526,430				7,526,430
Weighted average shares - diluted			7,526,430				7,526,430				7,526,430				7,526,430

See notes to condensed consolidated financial statements

ESCALON MEDICAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

For the Nine Months Ended March 31,		2011				2010
Cash Flows from Operating Activities:
Net (loss)		$	(3,619,249	)		$	(2,019,405	)
Adjustments to reconcile net loss to cash provided by operating activities of continuing operations:
Income from discontinued operations			(170,690	)			(469,044	)
Depreciation and amortization			668,391				550,421
Goodwill impairment			905,810				0
Compensation expense related to stock options			87,156				100,909
Loss of Ocular Telehealth Management, LLC			71,745				60,396
Change in operating assets and liabilities:
Accounts receivable, net			(182,889	)			(1,428,827	)
Inventory, net			(714,586	)			1,361,879
Other current and long-term assets			248,942				88,919
Accounts payable, accrued expenses and other liabilities			678,375				524,769
Net cash (used in) operating activities from continuing operations			(2,026,995	)			(1,229,983	)
Net cash provided by operating activities from discontinued operations			861,341				589,439
Net cash (used in)/provided by operating activities			(1,165,654	)			(640,544	)
Cash Flows from Investing Activities:							—
Investment in Ocular Telehealth Management, LLC			(45,000	)			(33,400	)
Purchase of fixed assets			(114,128	)			(75,128	)
Net cash (used in) investing activities from continuing operations			(159,128	)			(108,528	)
Net cash (used in) investing activities from discontinued operations			0				(59,709	)
Net cash (used in) investing activities			(159,128	)			(168,237	)
Cash Flows from Financing Activities:
Principal payments on long-term debt			(50,538	)			(132,956	)
Related party note payable			0				157,332
Net cash (used in) provided by financing activities			(50,538	)			24,376
Effect of exchange rate changes on cash & cash equivalents			396,430				(61,709	)
Net decrease in cash and cash equivalents			(978,890	)			(846,114	)
Cash and cash equivalents, beginning of period			3,342,422				1,810,045
Cash and cash equivalents, end of period		$	2,363,532			$	963,931
Supplemental Schedule of Cash Flow Information:
Interest paid		$	168,694			$	5,102
Income taxes paid		$	45,000			$	0

See notes to condensed consolidated financial statements

ESCALON MEDICAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED MARCH 31, 2011
(Unaudited)

																						Accumulated
										Common				Additional								Other				Total
		Common Stock								Stock				Paid-in				Accumulated				Comprehensive				Shareholders’
		Shares				Amount				Warrants				Capital				Deficit				(Loss)				Equity
BALANCE AT JUNE 30, 2010			7,526,430			$	7,526			$	1,733,460			$	67,583,905			$	(56,646,366	)		$	(613,521	)		$	12,065,004
Comprehensive Loss:
Net loss			—				—				—				—				(3,619,249	)			—				(3,619,249	)
Foreign currency translation			—				—				—				—				—				(3,269	)			(3,269	)
Total comprehensive loss																			(3,619,249	)			(3,269	)			(3,622,518	)
Compensation expense			—				—				—				87,156				—				—				87,156
BALANCE AT MARCH 31, 2011			7,526,430			$	7,526			$	1,733,460			$	67,671,061			$	(60,265,615	)		$	(616,790	)		$	8,529,642

See notes to condensed consolidated financial statements

ESCALON MEDICAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)
(Unaudited)

		Three Months Ended March 31,								Nine Months Ended March 31,
		2011				2010				2011				2010
Net (loss)		$	(1,921,485	)		$	(309,358	)		$	(3,619,249	)		$	(2,019,405	)
Foreign currency translation			168,562				(20,016	)			(3,269	)			(11,768	)
Comprehensive (loss)		$	(1,752,922	)		$	(329,374	)		$	(3,622,518	)		$	(2,031,173	)

See notes to condensed consolidated financial statements

Escalon Medical Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(Unaudited)

1. Basis of Presentation

          Escalon Medical Corp. (“Escalon” or the “Company”) is a Pennsylvania corporation initially incorporated in California in 1987 and reincorporated in Pennsylvania in November 2001. Within this document, the “Company” collectively shall mean Escalon and its wholly owned subsidiaries: Sonomed, Inc. (“Sonomed”), Escalon Vascular Access, Inc. (“Vascular”), Escalon Medical Europe GmbH (“EME”), Escalon Digital Vision, Inc. (“EMI”), Escalon Pharmaceutical, Inc. (“Pharmaceutical”), Escalon Holdings, Inc. (“EHI”), Escalon IP Holdings, Inc., Escalon Vascular IP Holdings, Inc., Sonomed IP Holdings, Inc., Drew Scientific Holdings, Inc. and Drew Scientific Group, Plc (“Drew”) its subsidiaries and the assets acquired from Biocode Hycell (“Biocode”). All inter-company accounts and transactions have been eliminated. The Company sold certain assets of the Vascular business for $5,750,000 on April 30, 2010 to Vascular Solutions, Inc. (see footnote 10 to the Notes to Condensed Consolidated Financial Statements for additional information).

          The Company operates in the healthcare market specializing in the development, manufacture, marketing and distribution of medical devices and pharmaceuticals in the areas of ophthalmology, diabetes, hematology and vascular access. The Company and its products are subject to regulation and inspection by the United States Food and Drug Administration (the “FDA”). The FDA and other governmental authorities require extensive testing of new products prior to sale and have jurisdiction over the safety, efficacy and manufacture of products, as well as product labeling and marketing. The Company’s Internet address is www.escalonmed.com.

2. Stock-Based Compensation

          Valuations are based upon highly subjective assumptions about the future, including stock price volatility and exercise patterns. The fair value of share-based payment awards was estimated using the Black-Scholes option pricing model. Expected volatilities are based on the historical volatility of the Company’s stock. The Company uses historical data to estimate option exercise and employee terminations. The expected term of options granted represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

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

          As of March 31, 2011 and 2010 total unrecognized compensation cost related to non-vested share-based compensation arrangements granted to employees under the 2004 Equity Incentive Plan was $152,008 and $246,618, respectively. The remaining cost is expected to be recognized over a weighted average period of 1.93 years. For the three-month periods ended March 31, 2011 and 2010, $23,898 and $30,468 was recorded as compensation expense, respectively. For the nine-month periods ended March 31, 2011 and 2010, $87,156 and $100,909 was recorded as compensation expense, respectively.

          The Company did not receive any cash from share option exercises under stock-based payment plans for the three months and nine month period ended March 31, 2011 and 2010. The Company did not realize any tax effect, which would be a reduction in its tax rate, on options due to the full valuation allowances established on its deferred tax assets.

          The Company measures compensation expense for non-employee stock-based compensation based on the fair value of the options issued, as this is more reliable than the fair value of the services received. Fair value is measured as the value of the Company’s common stock on the date that the

commitment for performance by the counterparty has been reached or the counterparty’s performance is complete. The fair value of the equity instrument is charged directly to compensation expense and additional paid-in capital. There was no non-employee compensation expense for the three-month and nine-month periods ended March 31, 2011 and 2010.

3. (Loss) earnings per Share

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

		Three Months Ended March 31,								Nine Months Ended March 31,
		2011				2010				2011				2010
Numerator:
Numerator for basic and diluted earnings per share
Net loss from continuing operations		$	(1,921,485	)		$	(542,232	)		$	(3,789,939	)		$	(2,488,449	)
Net income from discontinued operations			—				232,874				170,690				469,044
Net (loss)		$	(1,921,485	)		$	(309,358	)		$	(3,619,249	)		$	(2,019,405	)
Denominator:
Denominator for basic earnings per share — weighted average shares			7,526,430				7,526,430				7,526,430				7,526,430
Effect of dilutive securities:
Stock options and warrants			—				—				—				—
Denominator for diluted earnings per share — weighted average and assumed conversion			7,526,430				7,526,430				7,526,430				7,526,430
Net income (loss) per share
Basic:
Continuing operations		$	(0.26	)		$	(0.07	)		$	(0.50	)		$	(0.33	)
Discontinued operations			—				0.03				0.02				0.06
		$	(0.26	)		$	(0.04	)		$	(0.48	)		$	(0.27	)
Diluted:
Continuing operations		$	(0.26	)		$	(0.07	)		$	(0.50	)		$	(0.33	)
Discontinued operations			—				0.03				0.02				0.06
		$	(0.26	)		$	(0.04	)		$	(0.48	)		$	(0.27	)

          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 nine-month periods ended March 31, 2011 and 2010, the Company’s continuing operations were classified into four principal reportable business segments that provide different products or services, not including the Company’s Vascular business, which the Company sold on April 30, 2010.

          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 March 31,

		Drew								Sonomed								EMI								Medical/Trek								Total
		2011				2010				2011				2010				2011				2010				2011				2010				2011				2010
Revenues, net:
Product revenue		$	4,497			$	4,891			$	2,226			$	1,942			$	410			$	431			$	368			$	360			$	7,501			$	7,624
Other revenue			—				243				—				—				—				—				—				—				0				244
Total revenue, net			4,497				5,134				2,226				1,942				410				431				368				360				7,501				7,868
Costs and expenses:
Cost of goods sold			2,742				3,160				1,120				989				150				162				237				197				4,249				4,508
Research & Development			172				254				96				101				125				87				2				5				395				446
Marketing, General & Admin			2,804				2,231				632				529				177				145				138				471				3,750				3,376
Goodwill Impairment			—				—				—				—				906				—				—				—				906
Total costs and expenses			5,718				5,645				1,848				1,619				1,358				394				377				673				9,300				8,330
(Loss) income from operations			(1,221	)			(511	)			378				323				(948	)			37				(9	)			(313	)			(1,799	)			(462	)
Other (expense) and income:
Equity in OTM			—				—				—				—				—				—				(38	)			(21	)			(38	)			(21	)
Interest income			—				—				—				—				—				—				1				—				1				—
Interest expense			(85	)			(59	)			—				—				—				—				—				—				(85	)			(59	)
Total other (expense) and income			(85	)			(59	)			—				—				—				—				(37	)			(21	)			(122	)			(80	)
(Loss) and income before taxes			(1,306	)			(570	)			378				323				(948	)			37				(45	)			(334	)			(1,921	)			(542	)
Income taxes			—				—				—				—				—				—				—				—				—				—
Net (loss) income		$	(1,306	)		$	(570	)		$	378			$	323			$	(948	)		$	37			$	(45	)		$	(334	)		$	(1,921	)		$	(542	)

Segment Statements of Operations (in thousands) — Nine months ended March 31,

		Drew								Sonomed								EMI								Medical/Trek/EHI								Total
		2011				2010				2011				2010				2011				2010				2011				2010				2011				2010
Revenues, net:
Product revenue		$	13,922			$	14,620			$	6,569			$	6,039			$	1,106			$	1,454			$	978			$	973			$	22,575			$	23,086
Other revenue			7.00				534				—				—				—				—				—				—				7				534
Total revenue, net			13,929				15,154				6,569				6,039				1,106				1,454				978				973				22,582				23,620
Costs and expenses:
Cost of goods sold			8,256				8,642				3,512				3,218				421				615				668				631				12,857				13,106
Research & Development			544				723				334				428				318				245				2				1				1,198				1,397
Marketing, General & Admin			8,222				7,353				1,936				1,796				542				539				396				1,544				11,095				11,232
Goodwill Impairment			—				—				—				—				906				—				—				—				906				—
Total costs and expenses			17,022				16,718				5,782				5,442				1,281				1,399				1,066				2,176				26,056				25,735
(Loss) income from operations			(3,093	)			(1,564	)			787				597				(175	)			55				(88	)			(1,203	)			(3,474	)			(2,115	)
Other (expense) and income:
Equity in OTM			—				—				—				—				—				—				(72	)			(60	)			(72	)			(60	)
Interest income			—				—				—				—				—				—				—				0				—				—
Interest expense			(244	)			(314	)			—				—				—				—				—				—				(244	)			(314	)
Total other (expense) and income			(244	)			(314	)			0				0				0				0				(72	)			(60	)			(316	)			(374	)
(Loss) and income before taxes			(3,337	)			(1,878	)			787				597				(175	)			55				(159	)			(1,263	)			(3,790	)			(2,489	)
Income taxes			—				—				—				—				—				—				—				—				—				—
Net (loss) income		$	(3,337	)		$	(1,878	)		$	787			$	597			$	(175	)		$	55			$	(159	)		$	(1,263	)		$	(3,790	)		$	(2,489	)

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

6. Related Party Transaction

          The Company and a member of the Company’s Board of Directors are founding and equal members of Ocular Telehealth Management, LLC (“OTM”). OTM is a diagnostic telemedicine company providing remote examination, diagnosis and management of disorders affecting the human eye. OTM’s initial focus is on the diagnosis of diabetic retinopathy by creating access and providing annual dilated retinal examinations for the diabetic population. Through March 31, 2011 and 2010, the Company has invested $444,000 and $432,000, respectively in OTM, including $45,000 and $33,400 invested during the nine-month period ended March 31, 2011 and 2010, respectively. As of March 31, 2011, the Company owned 45% of OTM. The Company provides administrative support functions to OTM. For the three-month periods ended March 31, 2011 and 2010 the Company recorded losses of $37,600 and $20,963, respectively. For the nine-month periods ended March 31, 2011 and 2010 the Company recorded losses of $71,745 and $60,396, respectively.

7. Recently Issued Accounting Standards

          In October 2009, the FASB issued an amendment to the accounting for multiple-deliverable revenue arrangements. This amendment provides guidance on determining whether multiple deliverables exist, how the arrangements should be separated and how the consideration paid should be allocated. As a result of this amendment, entities may be able to separate multiple-deliverable arrangements in more circumstances than under previous accounting guidance. This guidance amends the requirement to establish the fair value of undelivered products and services based on objective evidence and instead provides for separate revenue recognition based upon management’s best estimate of the selling price for an undelivered item when there is no other means to determine the fair value of that undelivered item. The previous guidance previously required that the fair value of the undelivered item reflect the price of the item either sold in a separate transaction between unrelated third parties or the price charged for each item when the item is sold separately by the vendor. If the fair value of all of the elements in the arrangement was not determinable, then revenue was deferred until all of the items were delivered or fair value was determined. This amendment became be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The Company adopted this standard and the standard did not have material effect on the Company’s consolidated financial statements.

          In December 2009, FASB issued ASU No. 2009-17, Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. This Accounting Standards Update amends the FASB Accounting Standards Codification for the issuance of FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R). The amendments in this Accounting Standards Update replace the quantitative-based risks and rewards calculation for determining which reporting entity, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which reporting entity has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. An approach that is expected to be primarily qualitative will be more effective for identifying which reporting entity has a controlling financial interest in a variable interest entity. The amendments in this Update also require additional disclosures about a reporting entity’s involvement in variable interest entities, which will enhance the information provided to users of financial statements. The Company adopted this standard and the standard did not have material effect on the Company’s consolidated financial statements.

          In January 2010, FASB issued ASU No. 2010-01, Accounting for Distributions to Shareholders with Components of Stock and Cash. The amendments in this Update clarify that the stock portion of a distribution to shareholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance that is reflected in EPS prospectively and is not a stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings Per Share). The amendments in this update became effective for interim and annual periods ending on or after December 15, 2009, and should be applied on a retrospective basis. The Company adopted this standard and the standard did not have material effect on the Company’s consolidated financial statements.

          In January 2010, FASB issued ASU No. 2010-02 regarding accounting and reporting for decreases in ownership of a subsidiary. Under this guidance, an entity is required to deconsolidate a subsidiary when the entity ceases to have a controlling financial interest in the subsidiary. Upon deconsolidation of a subsidiary, an entity recognizes a gain or loss on the transaction and measures any retained investment in the subsidiary at fair value. In contrast, an entity is required to account for a decrease in its ownership interest of a subsidiary that does not result in a change of control of the subsidiary as an equity

transaction. This ASU clarifies the scope of the decrease in ownership provisions, and expands the disclosures about the deconsolidation of a subsidiary or de-recognition of a group of assets. This ASU is effective beginning in the first interim or annual reporting period ending on or after December 31, 2009. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

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

          In February 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements,” or ASU 2010-09. ASU 2010-09 primarily rescinds the requirement that, for listed companies, financial statements clearly disclose the date through which subsequent events have been evaluated. Subsequent events must still be evaluated through the date of financial statements issuance; however, the disclosure requirement has been removed to avoid conflicts with other SEC guidelines. ASU 2010-09 was effective immediately upon issuance and was adopted in February 2010.

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

          In March 2010, the FASB reached a consensus to issue an amendment to the accounting for revenue arrangements under which a vendor satisfies its performance obligations to a customer over a period of time, when the deliverable or unit of accounting is not within the scope of other authoritative literature and when the arrangement consideration is contingent upon the achievement of a milestone. The amendment defines a milestone and clarifies whether an entity may recognize consideration earned from the achievement of a milestone in the period in which the milestone is achieved. This amendment is effective for fiscal years beginning on or after June 15, 2010, with early adoption permitted. The amendment may be applied retrospectively to all arrangements or prospectively for milestones achieved after the effective date. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements

          In July 2010, the FASB issued FASB ASC “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” This standard amends existing guidance by requiring more robust and disaggregated disclosures by an entity about the credit quality of its financing receivables and its allowance for credit losses. These disclosures will provide financial statement users with additional information about the nature of credit risks inherent in the Company’s financing receivables, how the Company analyzes and assesses credit risk in determining its allowance for credit losses, and the reasons for any changes the Company may make in its allowance for credit losses. This update is generally effective for interim and annual reporting periods ending on or after December 15, 2010, which for us is the 2011 second quarter; however, certain aspects of the update pertaining to activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010, which for us is the 2011 third quarter. The Company adopted this standard and the standard did not have a material effect on the Company’s consolidated financial statements.

8. Fair Value Measurements

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

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

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

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

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

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

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, negative cash flows from operating activities, will no longer have the benefit of cash inflows from Vascular and the debt payments related to the Biocode acquisition commenced on June 30, 2010 (see footnote 12 for more information on the debt). These conditions raise substantial doubt about the Company’s ability to continue as a going concern. If the Company is unsuccessful in its efforts to raise additional capital in the near term, the Company may be required to significantly reduce its research, development, and administrative activities, including further reduction of its employee base. The financial statements do not include any adjustments relating to the realization of the carrying value of assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company’s continuance as a going concern is dependent on the Company’s future profitability and on the on-going support of the Company’s shareholders, affiliates and creditors. In order to mitigate the going concern issues, the Company is actively pursuing business partnerships, managing its continuing operations, and seeking capital funding on an ongoing basis via the issuance of securities and private placements although the Company may not succeed in these mitigation efforts.

          Drew continues to implement its plan to curtail its continuing losses. The first part of the plan consists of relocating where certain Drew products are manufactured. Drew has successfully transferred the manufacturing of its Gold Reagent kits to its UK facility from its facility in France, which has eliminated a significant backlog in Gold kit orders. Additionally, Drew is sharing manufacturing techniques and know-how among each of its divisions in an effort to ensure multiple sources for Drew’s products which will enhance its flexibility in fulfilling future orders. The first stage of the plan is nearly complete The second stage is to explore the possibility of reducing additional costs from the Company’s manufacturing process.

          If the Company is unable to achieve improvement in this area in the near term, it is not likely that the Company’s existing cash and cash flow from operations will be sufficient to fund activities throughout the next 8 to 12 months without curtailing certain business activities. The Company’s forecast of the period of time through which its financial resources will be adequate to support its operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed in “Risk Factors” of the Company’s Form 10-K for the year ended June 30, 2010.

          If the Company seeks to raise funds in the future, the Company may be required to raise those funds through public or private financings, strategic relationships or other arrangements at prices and other terms that may not be as favorable as they would without such qualification. The sale of additional equity and debt securities may result in additional dilution to the Company’s shareholders. Additional financing may not be available in amounts or on terms acceptable to the Company or at all.

     10. Discontinued Operations

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

Access generated approximately $565,000 in gross profit from May 1, 2010 through August 31, 2010 related to the supply agreement.

          The following table summarizes the results of discontinued operations for the three-month and nine-month periods ended March 31, 2011 and 2010 (in thousands):

		For the Three Months Ended March 31,
		2011				2010
Total revenue, net		$	—			$	1,059
Costs and expenses:
Cost of goods sold			—				406
Research & Development			—				63
Marketing, General & Admin			—				357
Total costs and expenses			—				826
Income from discontinued operations		$	—			$	233

		For the Nine Months Ended March 31,
		2011				2010
Total revenue, net		$	638			$	2,888
Costs and expenses:
Cost of goods sold			283				1119
Research & Development			29				227
Marketing, General & Admin			155				1073
Total costs and expenses			467				2419
Income from discontinued operations		$	171			$	469

          Assets and liabilities of discontinued operations included in the consolidated balance sheets are summarized as follows at March 31, 2011 and June 30, 2010 (in thousands):

		March 31, 2011				June 30, 2010
Assets
Accounts receivable, trade		$	—			$	325
Inventory			—				342
Other assets			—				7
Receivable from sale of Vascular Assets			—				750
Total Assets			—				1,424
Liabilities
Payable related to sale of Vascular Assets			—				500
Accrued expenses and other liabilities			—				206
Total Liabilities			—				706
Net Assets of Discontinued Operations		$	—			$	718

     11. Goodwill Impairment EMI

          During the period ended March 31, 2011 management became concerned about EMI’s performance year to date as compared to the Company’s projected budget. The projected budget included sales related to EMI’s new image management system, Axis, as well as traditional legacy digital imaging systems. A significant portion of the Axis product target market represents institutions requiring large-scale, multi-instrument solutions, which has resulted in a much longer sales cycle than the Company had originally envisioned. While the feedback from initial and potential customers of the Axis product has been positive, converting this interest into sales has not materialized to date at the levels the Company had originally projected.

          EMI has also encountered unexpected lagging demand for its legacy digital imaging systems primarily due to institutions allocating a disproportionate level of their capital budgets toward purchasing Optical Coherence Tomography (“OCT”) devices. It was anticipated that the emerging OCT technology would erode legacy digital imaging product sales due to competition for budgetary resources; however, the level has been greater than originally expected and not reflected in the Company’s original projection. OCT and digital imaging technologies are complementary and it is not known whether or for how long the lower available capital budgets for digital imaging will continue. These events negatively affected the evaluation of the future operating results and cash flows of EMI.

          The Company typically tests goodwill for possible impairment on an annual basis at June 30, and at any other time events occur or circumstances indicate that the carrying amount of goodwill may be impaired. Management determined that the events discussed above warranted performing an interim test of goodwill for possible impairment during the quarter ended March 31, 2011.

          The first step of the FASB ASC 350 impairment analysis consists of a comparison of the fair value of the reporting segment with its carrying amount, including the goodwill. The fair value was determined based on the income approach, which estimates the fair value based on the future discounted cash flows. Under the income approach, the Company assumed, with respect to EMI, a forecasted cash flow period of five years, long-term annual growth rates of 3% and a discount rate of 19%.

          Based on the interim income approach analysis that was performed for EMI it was determined that the carrying amount of the goodwill was in excess of its respective fair value. As such, the Company was required to perform the second step analysis in order to determine the amount of the goodwill impairment. The second step analysis consisted of comparing the implied fair value of the goodwill with the carrying amount of the goodwill, with an impairment charge resulting from any excess of the carrying value of the

goodwill over the implied fair value of the goodwill. Based on the second step analysis, the Company concluded that all $905,810 of the goodwill recorded at EMI was impaired. As a result, the Company recorded a non-cash goodwill impairment charge to continuing operations totaling $905,810 during the three- and nine-month periods ended March 31, 2011.

          The determination as to whether a write-down of goodwill is necessary involves significant judgment based on short-term and long-term projections of the Company. The assumptions supporting the estimated future cash flows of the reporting segment, including profit margins, long-term forecasts, discount rates and terminal growth rates, reflect the Company’s best estimates.

12. Subsequent Event

          On April 29, 2011 the Company amended its seller financed debt related to the acquisition of certain assets of Biocode in 2008. Under the terms of the debt refinancing, the Company has agreed to pay the balance of the seller provided financing of $3,375,000 Euros by the sum per month in euros having an exchange value of $50,000 United States Dollars, including interest, as of the date of payment. Interest will remain unchanged and will accrue on the outstanding amount of the purchase price at an interest rate of 7% per year on the basis of the actual days elapsed and a 365 day year. The first payment on the under the amended agreement is due May 31, 2011. Upon the sixtieth month after this Amendment, the Company has agreed to pay the balance of the outstanding amount in euros in full in one payment. The refinancing reduced the current portion of the Company’s long-term debt from approximately $2,600,000 to $252,000. The effect of this amendment is reflected in the Company’s March 31, 2011 balance sheet.

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, 2010 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 March 31, 2011 financial statements and the audited financial statements included in the June 30, 2010 Form 10-K.

Executive Overview — Nine-Month Period Ended March 31, 2011

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

     •   Product revenue decreased approximately 2.0% during the nine-month period ended March 31, 2011, as compared to the same period last fiscal year. The decrease was primarily related to decreases in

the Drew and EMI business segments of 4.8%, and 23.9%, respectively. These decreases were partially offset by product revenue increases at Sonomed and Medical/Trek of 8.8% and .5%, respectively, during the nine-month period ended March 31, 2011 compared to the same period last fiscal year.

     •   Other revenue decreased approximately $527,000 or 98.7% during the nine-month period ended March 31, 2011, as compared to the same period last fiscal year. These decreases were attributable to decreased royalties from the TECOM agreement and the Bio-Rad OEM agreement in the Drew business segment.

     •   Cost of goods sold as a percentage of product revenue remained approximately unchanged at 57.0% during the nine-month period ended March 31, 2011, as compared to the same period last fiscal year. Gross margins in the Drew and Sonomed business segment remained relatively unchanged at 40.7% and 46.5%, respectively. Gross margin in the EMI business segment increased by 4.2% due to the sales of higher margin products. Gross margin in Medical/Trek decreased by 3.4%, however, due to the continued aging of its products.

     •   Marketing, general and administrative expenses decreased approximately 1.2% during the nine-month period ended March 31, 2011, as compared to the same period in the prior fiscal year. The decrease was primarily due to decreased expenses in the Drew business segment as a result of the austerity plan offset by an increase in consulting, legal, office rent and payroll expense in Medical/Trek, Sonomed and EMI business segments.

Company Overview

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

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

Critical Accounting Policies

          The preparation of financial statements requires management to make estimates and assumptions that impact amounts reported therein. The most significant of those involve the application of FASB-issued authoritative guidance concerning Revenue Recognition, Goodwill and Other Intangible Assets, discussed further in the notes to consolidated financial statements included in the Form 10-K for the year ended June 30, 2010. The financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, and, as such, include amounts based on informed estimates and judgments of management. For example, estimates are used in determining valuation allowances for deferred income taxes, uncollectible receivables, obsolete inventory, sales returns and rebates, warranty liabilities and purchased intangible assets. Actual results achieved in the future could differ from current estimates. The Company used what it believes are reasonable assumptions and, where applicable, established valuation techniques in making its estimates.

     Revenue Recognition

          The Company recognizes revenue from the sale of its products at the time of shipment, when title and risk of loss transfer. The Company provides products to its distributors at agreed wholesale prices and to the balance of its customers at set retail prices. Distributors can receive discounts for accepting high

volume shipments. The discounts are reflected immediately in the net invoice price, which is the basis for revenue recognition. No further material discounts are given.

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

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

     Long Lived Assets Including Goodwill

          As discussed in footnote 11 to the March 31, 2011 condensed consolidated financial information, the Company tests goodwill for possible impairment on an annual basis as of June 30 and at any other time events occur or circumstances indicate that the carrying amount of goodwill may be impaired. In assessing the recoverability of goodwill and other long-lived assets, the Company makes assumptions regarding, among other things, estimated future cash flows, including current and projected levels of income/loss, success of research and development projects, discount rates and terminal growth rates, business trends, prospects and market conditions, to determine the fair value of the respective assets. If these or other estimates or their related assumptions change in the future, impairment charges may be required to be recorded for these assets not previously recorded. See footnote 11 the March 31, 2011 condensed consolidated financial information for discussion of goodwill impairment at the Company’s EMI reporting unit.

     Income/Loss Per Share

          The Company computes net income/(loss) per share under the provisions of FASB issued authoritative guidance.

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

     Income Taxes

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

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

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

          Through March 31, 2011, the Company has recorded a valuation allowance against the Company’s net operating losses for substantially all of the deferred tax asset due to uncertainty of their realization as a result of the Company’s earnings history, the number of years the Company’s net operating losses and tax credits can be carried forward, the existence of taxable temporary differences and near-term earnings expectations. The amount of the valuation allowance could decrease if facts and circumstances change that materially increase taxable income prior to the expiration of the loss carryforwards. Any reduction would reduce (increase) the income tax expense (benefit) in the period such determination is made by the Company.

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

     Stock-Based Compensation

          Stock-based compensation expense for all stock-based compensation awards granted after July 1, 2006 is based on the grant-date fair value estimate in accordance with the provisions of the FASB issued guidance. The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award.

          Valuations are based on highly subjective assumptions about the future, including stock price volatility and exercise patterns. The fair value of share-based payment awards was estimated using the Black-Scholes option pricing model. Expected volatilities are based on the historical volatility of the Company’s stock. The Company uses historical data to estimate option exercise and employee terminations. The expected term of options granted represents the period of time that options granted are

expected to be outstanding. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

Three- and Nine-Month Periods Ended March 31, 2011 and 2010

          The following table shows consolidated product revenue from continuing operations by business segment as well as identifying trends in business segment product revenues for the three- and nine-month periods ended March 31, 2011 and 2010. Table amounts are in thousands:

		For the Three Months Ended March 31,												For the Nine Months Ended March 31,
		2011				2010				% Change				2011				2010				% Change
Product Revenue:
Drew		$	4,497			$	4,891				-8.1	%		$	13,922			$	14,620				-4.8	%
Sonomed			2,226				1,942				14.6	%			6,569				6,039				8.8	%
EMI			410				431				-4.9	%			1,106				1,454				-23.9	%
Medical/Trek			368				360				2.2	%			978				973				0.5	%
Total		$	7,501			$	7,624				-1.6	%		$	22,575			$	23,086				-2.2	%

     •   Product revenue decreased approximately $123,000, or 1.6%, to $7,501,000 for the three-month period ended March 31, 2011, as compared to the same period last fiscal year.

          In the Drew business segment, product revenue decreased $394,000, during the three-month period ended March 31, 2011, or 8.1% to $4,497,000, as compared to the same period last fiscal year. The decrease is related to a decrease in revenue at the Biocode facility compared to the same period last year. In addition, there was a decrease in PDQ instrument sales during the current period as Drew discontinued its manufacturing agreement for this aging instrument and a decrease in DREW3 instruments during the three-month period ended March 31, 2011 as compared to the same period last year.

          Product revenue increased $284,000, or 14.6% to $2,226,000, during the three-month period ended March 31, 2011, at the Sonomed business segment, as compared to the same period last fiscal year. The increase in product revenue is due to an increase sales to Sonomed’s European distributors, an overall improvement in the capital equipment market and a fulfillment of backlogged orders.

          Product revenue decreased $21,000, during the three-month period ended March 31, 2011, or 4.9%, in the EMI business segment as compared to the same period last year. The reduction in revenue is related to a general decline during the three-month period ended March 31, 2011, in the purchase of capital equipment by Digital’s customers related to the acceptance of a competitive new low cost OCT technology in the market place.

          In the Medical/Trek business segment, product revenue increased $8,000, or 2.2%, to $368,000 during the three-month period ended March 31, 2011, as compared to the same period last fiscal year.

     •   Product revenue decreased approximately $511,000, or 2.2%, to $22,575,000 during the nine-month period ended March 31, 2011, as compared to the same period last fiscal year.

          In the Drew business segment, product revenue decreased $698,000, or 4.8% to $13,922,000, as compared to the same period last fiscal year. The decrease is related to a decrease in revenue at the Biocode facility as compared to the same period last year. In addition, there was a decrease in PDQ instrument sales during the current period as Drew discontinued its manufacturing agreement for this aging

instrument and a decrease in DREW3 and DS2280 instruments during the nine-month period ended March 31, 2011 as compared to the same period last year.

          In the Sonomed business segment, product revenue increased $530,000, during the nine-month period ended March 31, 2011, or 8.8% to $6,569,000, as compared to the same period last fiscal year. The increase in product revenue was primarily caused by an increase in product revenue at Sonomed’s European distributors.

          Product revenue decreased $348,000, or 23.9% to $1,106,000, during the nine-month period ended March 31, 2011 in the EMI business segment as compared to the same period last year. The reduction is related to a general decline in the purchase of capital equipment by Digital’s customers related to the acceptance of competitive new low cost OCT technology in the market place.

          In the Medical/Trek business segment, product revenue increased $5,000 or 0.5%, to $978,000 during the nine-month period ended March 31, 2011, as compared to the same period last fiscal year.

          The following table shows consolidated other revenue by business segment as well as identifying trends in business segment other revenues for the three- and nine-month periods ended March 31, 2011 and 2010. Table amounts are in thousands:

		For the Three Months Ended March 31,												For the Nine Months Ended March 31,
		2011				2010				% Change				2011				2010				% Change
Other Revenue:
Drew		$	0			$	243				-100.0	%		$	7			$	534				-98.7	%
Total		$	0			$	243				-100.0	%		$	7			$	534				-98.7	%

          Other revenue decreased by approximately $527,000, or 98.7%, to $7 during the nine-month period ended March 31, 2011 as compared to the same period last fiscal year. Other revenue decreased by approximately $243,000, or 100%, to $0 during the three-month period ended March 31, 2011 as compared to the same period last fiscal year. The decrease is related to revenue earned from the TECOM agreement in the prior periods.

          The following table presents consolidated cost of goods sold from continuing operations by reportable business segment and as a percentage of related segment product revenues for the three- and nine-month periods ended March 31, 2011 and 2010. Table amounts are in thousands:

		For the Three Months Ended March 31,																For the Nine Months Ended March 31,
		2011				%				2010				%				2011				%				2010				%
Cost of Goods Sold:
Drew		$	2,742				61.0	%		$	3,160				64.6	%		$	8,256				59.3	%		$	8,642				59.1	%
Sonomed			1,120				50.3	%			989				50.9	%			3,512				53.5	%			3,218				53.3	%
EMI			150				36.6	%			162				37.6	%			421				38.1	%			615				42.3	%
Medical/Trek			237				64.4	%			197				54.7	%			668				68.3	%			631				64.9	%
Total		$	4,249				56.7	%		$	4,508				59.1	%		$	12,857				57.0	%		$	13,106				56.8	%

     •   Cost of goods sold totaled approximately $4,249,000, or 56.7% of product revenue, for the three-month period ended March 31, 2011, as compared to $4,508,000 or 59.1%, of product revenue for the same period last fiscal year.

          Cost of goods sold in the Drew business segment totaled $2,742,000, or 61.0% of product revenue, for the three-month period ended March 31, 2011, as compared to $3,160,000, or 64.6% of product revenue, for the same period last fiscal year. Margins on Drew’s instruments continue to range between 0% and 20% depending on the product. These lower margin sales are offset by the margins achieved on reagent sales which typically range from 50% to 75%. The decrease in cost of goods sold as a percent of product revenue is related to the relative sales mix of these product groups during the nine-month period ended March 31, 2011, as compared to the same period last year.

          Cost of goods sold in the Sonomed business segment totaled $1,120,000, or 50.3% of product revenue, for the three-month period ended March 31, 2011, as compared to $989,000, or 50.9% of product revenue, for the same period last fiscal year. The decrease in Sonomed’s cost of goods sold as a percentage of revenue was primarily caused by an increase in higher margin sales of Sonomed’s newer PacScan Plus.

          Cost of goods sold in the EMI business segment totaled $150,000, or 36.6% of product revenue, for the three-month period ended March 31, 2011, as compared to $162,000, or 37.6% 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 an increase in sales of Digital’s new high margin product during the three-month period ended March 31, 2011.

          Cost of goods sold in the Medical/Trek business segment totaled $237,000, or 64.4% of product revenue, for the three-month period ended March 31, 2011 as compared to $197,000, or 54.7% of product revenue, for the same period last fiscal year. The increase in cost of goods sold as percentage of revenue is due to the continued aging of its products. The Company does not intend to invest any funds to develop or upgrade any new or existing Medical/Trek products.

     •   Cost of goods sold totaled approximately $12,857,000, or 57.0% of product revenue, for the nine-month period ended March 31, 2011, as compared to $13,106,000, or 56.8% of product revenue, for the same period last fiscal year.

          Cost of goods sold in the Drew business segment totaled $8,256,000, or 59.3% of product revenue, for the nine-month period ended March 31, 2011 as compared to $8,642,000, or 59.1% of product revenue, for the same period last fiscal year. Margins on Drew’s instruments continue to range between 0% and 20% depending on the product. These lower margin sales are offset by the margins achieved on reagent sales which typically range from 50% to 75%. The increase in cost of goods sold as a percent of product revenue is related to the relative mix of these product groups during the three-month period ended March 31, 2010 as compared to the same period last year.

          Cost of goods sold in the Sonomed business segment totaled $3,512,000, or 53.5% of product revenue, for the nine-month period ended March 31, 2011 as compared to $3,218,000 or 53.3% of product revenue, for the same period last fiscal year.

          Cost of goods sold in the EMI business segment totaled $421,000, or 38.1%, of product revenue for the nine-month period ended March 31, 2011 as compared to $615,000, or 42.3%, 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 an increase in sales of EMI’s new high margin product during the nine-month period ended March 31, 2011.

          Cost of goods sold in the Medical/Trek business segment totaled $668,000, or 68.3% of product revenue, for the nine-month period ended March 31, 2011 as compared to $631,000 or 64.9% of product revenue, during the same period last fiscal year. The increase in cost of goods sold as percentage of revenue is due to the continued aging of its products. The Company does not intend to invest any funds to develop or upgrade any new or existing Medical/Trek products.

          The following table presents consolidated marketing, general and administrative expenses from continuing operations as well as identifying trends in business segment marketing, general and administrative expenses for the three- and nine-month periods ended March 31, 2011 and 2010. Table amounts are in thousands:

		For the Three Months Ended March 31,												For the Nine Months Ended March 31,
		2011				2010				% Change				2011				2010				% Change
Marketing, General and Administrative:
Drew		$	2,309			$	2,231				3.5	%		$	6,782			$	7,353				-7.8	%
Sonomed			453				387				17.1	%			1,431				1,307				9.5	%
EMI			144				113				27.4	%			457				420				8.8	%
Medical/Trek			844				645				30.9	%			2,425				2,152				12.7	%
Total		$	3,750			$	3,376				11.1	%		$	11,095			$	11,232				-1.2	%