ESMC 10-Q Quarterly Report Dec. 31, 2013

ESMC 10-Q Quarter ended Dec. 31, 2013

ESCALON MEDICAL CORP

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10-Q 1 esmc_20131231-10q2014.htm 10-Q ESMC_2013.12.31-10Q 2014

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY PERIOD PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period ended December 31, 2013

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 incorporation or organization)		(I.R.S. Employer Identification No.)

100 Church Road, Suite 200, Ardmore, PA 19003

(Address of principal executive offices, including zip code)

(610) 688-6830

(Registrant’s telephone number, including area code)

N/A

Former name, former address and former fiscal year, if changed since last report

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 x 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). Yes x No o

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

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

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 February 13, 2014.

TABLE OF CONTENTS

		Page
	PART I Financial Information
Item I.	Condensed Consolidated Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets as of December 31, 2013 and June 30, 2013 (Unaudited)	2
	Condensed Consolidated Statements of Operations for the three-month and six-month periods ended December 31, 2013 and 2012 (Unaudited)	3
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the three-month and six-month periods ended December 31, 2013 and 2012 (Unaudited)	4
	Condensed Consolidated Statement of Shareholders' Equity for the six-month period ended December 31, 2013 (Unaudited)	5
	Condensed Consolidated Statements of Cash Flows for the six-month periods ended December 31, 2013 and 2012 (Unaudited)	6
	Notes to the Condensed Consolidated Financial Statements (Unaudited)	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	22
Item 4T.	Controls and Procedures	22

	PART II Other Information
Item 1.	Legal Proceedings	22
Item 1A.	Risk Factors	22
Item 6.	Exhibits	22

Item 1. Condensed Consolidated Financial Statements

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

	December 31, 2013			June 30, 2013
ASSETS
Current assets:
Cash and cash equivalents	$	2,565,156		$	2,654,701
Accounts receivable, net	1,687,557			1,725,841
Inventory, net	2,235,488			1,853,686
Other current assets	218,529			288,598
Total current assets	6,706,730			6,522,826
Property and equipment, net	27,939			12,594
Goodwill	125,027			125,027
Trademarks and trade names	605,006			605,006
Patents, net	5,600			6,712
Total assets	$	7,470,302		$	7,272,165
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,100,027		$	672,926
Accrued expenses	1,048,893			1,171,281
Current portion of accrued post-retirement benefits	101,891			101,891
Liabilities of discontinued operations	598,591			573,435
Total current liabilities	2,849,402			2,519,533
Accrued post-retirement benefits, net of current portion	882,968			923,706
Total long-term liability	882,968			923,706
Total liabilities	3,732,370			3,443,239
Shareholders equity:
Common stock, $0.001 par value; 35,000,000 shares authorized; 7,526,430 issued and outstanding	7,526			7,526
Common stock warrants	—			132,114
Additional paid-in capital	69,550,057			69,413,628
Accumulated deficit	(65,819,651		)	(65,724,342		)
Total shareholders’ equity	3,737,932			3,828,926
Total liabilities and shareholders’ equity	$	7,470,302		$	7,272,165

See notes to condensed consolidated financial statements

ESCALON MEDICAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

	Three Months Ended December 31,						Six-months ended December 31,
	2013			2012			2013			2012
Net revenues:
Product revenue	$	3,078,485		$	3,640,761		$	6,208,568		$	5,910,338
Revenues, net	3,078,485			3,640,761			6,208,568			5,910,338
Costs and expenses:
Cost of goods sold	1,510,322			1,776,054			3,066,536			2,972,452
Marketing, general and administrative	1,280,427			1,488,915			2,493,390			2,894,501
Research and development	377,042			266,169			700,232			530,367
Total costs and expenses	3,167,791			3,531,138			6,260,158			6,397,320
(Loss) income from operations	(89,306		)	109,623			(51,590		)	(486,982		)
Other income (expense)
Other income	6,535			16,842			7,603			81,623
Interest income	56			62			117			91
Interest expense	—			—			—			(92,596		)
Total other income (expense)	6,591			16,904			7,720			(10,882		)
Net (loss) income from continuing operations	(82,715		)	126,527			(43,870		)	(497,864		)
Net (loss) income from discontinued operations before tax	(25,834		)	3,946,858			(51,439		)	4,137,824
Income tax expense	—			(80,000		)	—			(80,000		)
Net (loss) income from discontinued operations, net of tax	(25,834		)	3,866,858			(51,439		)	4,057,824
Net (loss) income	$	(108,549	)	$	3,993,385		$	(95,309	)	$	3,559,960
Net (loss) income per share
Basic:
Continuing operations	$	(0.01	)	$	0.02		$	—		$	(0.07	)
Discontinued operations	—			0.51			(0.01		)	0.54
Net (loss) income	$	(0.01	)	$	0.53		$	(0.01	)	$	0.47
Diluted:
Continuing operations	$	(0.01	)	$	0.02		$	—		$	(0.07	)
Discontinued operations	—			0.51			(0.01		)	0.54
Net (loss) income	$	(0.01	)	$	0.53		$	(0.01	)	$	0.47
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 COMPREHENSIVE (LOSS ) INCOME (UNAUDITED)

	Three months ended December 31,						Six months ended December 31,
	2013			2012			2013			2012
Net (loss) income	$	(108,549	)	$	3,993,385		$	(95,309	)	$	3,559,960
Foreign currency translation	—			(971		)	—			(62,800		)
Add: Reclassification adjustment for foreign currency losses included in net income (loss)	—			578,422			—			578,422
Total comprehensive (loss) income	$	(108,549	)	$	4,570,836		$	(95,309	)	$	4,075,582

See notes to condensed consolidated financial statements

ESCALON MEDICAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY FOR THE SIX MONTHS ENDED DECEMBER 31, 2013 (UNAUDITED)

	Common Stock			Common Stock Warrants			Additional Paid-in Capital		Accumulated Deficit			Total Shareholders' Equity
	Shares	Amount
Balance at June 30, 2013	7,526,430	$	7,526	$	132,114		$	69,413,628	$	(65,724,342	)	$	3,828,926
Net loss	—	—		—			—		(95,309		)	(95,309		)
Expired warrants	—	—		(132,114		)	132,114		—			—
Compensation expense	—	—		—			4,315		—			4,315
Balance at December 31, 2013	7,526,430	$	7,526	$	—		$	69,550,057	$	(65,819,651	)	$	3,737,932

See notes to condensed consolidated financial statements

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

	For the six months ended December 31,
	2013			2012
Cash Flows from Operating Activities:
Net (loss) income	$	(95,309	)	$	3,559,960
Adjustments to reconcile net (loss) income to cash provided by (used in) operating activities of continuing operations:
Loss (income) from discontinued operations	51,439			(4,057,824		)
Depreciation and amortization	4,597			6,992
Compensation expense related to stock options	4,315			25,647
Other income	—			(81,623		)
Change in operating assets and liabilities:
Accounts receivable, net	38,284			(478,645		)
Inventory, net	(381,802		)	(278,092		)
Other current assets	70,069			25,764
Accounts payable and accrued expenses	304,712			173,081
Change in accrued post-retirement benefits	(40,738		)	—
Net cash (used in) operating activities from continuing operations	(44,433		)	(1,104,740		)
Net cash (used in) provided by operating activities from discontinued operations	(26,282		)	88,445
Net cash (used in) operating activities	(70,715		)	(1,016,295		)
Cash Flows from Investing Activities:
Purchase of fixed assets	(18,830		)	—
Net cash (used in) investing activities from continuing operations	(18,830		)	—
Proceeds from sale of Drew Scientific	—			6,500,000
Purchase of fixed assets, discontinued operations	—			(8,618		)
Net cash provided by investing activities from discontinued operations	—			6,491,382
Net cash (used in) provided by investing activities	(18,830		)	6,491,382
Cash Flows from Financing Activities:
Repayments of related party note payable	—			(300,000		)
Net cash (used in) financing activities from continuing operations	—			(300,000		)
Principal payments on long-term debt	—			(2,487,480		)
Net cash (used in) financing activities from discontinued operations	—			(2,487,480		)
Net cash (used in) financing activities	—			(2,787,480		)
Net (decrease) increase in cash and cash equivalents	(89,545		)	2,687,607
Cash and cash equivalents, beginning of period	2,654,701			890,623
Cash and cash equivalents, end of period	$	2,565,156		$	3,578,230
Supplemental Schedule of Cash Flow Information:

Interest paid	$	—		$	32,216
Income taxes paid	$	25,000		$	—

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”), Trek, Inc. (“Trek”), Escalon Medical Europe GmbH (“EME”), Escalon Digital Solutions, Inc. (“EMI”), Escalon Pharmaceutical, Inc. (“Pharmaceutical” inactive), Escalon Holdings, Inc. (“EHI”), Escalon IP Holdings, Inc., Sonomed IP Holdings, Inc., Drew Scientific Holdings, Inc. (discontinued), Drew Scientific Inc. (discontinued), and Drew Scientific Group, Plc (“Drew”) and its subsidiaries (discontinued). All intercompany accounts and transactions have been eliminated.

On October 3, 2012 the Company sold its Clinical Diagnostics Business to ERBA Diagnostics, Inc. The Escalon Clinical Diagnostics Business ("ECD") consisted of Drew Scientific, Inc., and its wholly owned subsidiaries JAS Diagnostics, Inc. ("JAS") and Drew Scientific Limited Co. The sales price was $6,500,000 in cash. The sale of this business will have a material effect on earnings in subsequent periods. ECD prior period amounts are presented as discontinued operations (see footnote 10 to the Notes to Condensed Consolidated Financial Statements for additional information).

On October 18, 2012, the Company and its debt holder reached an agreement whereby the Company paid the balance of the seller-provided financing plus accrued interest related to the purchase of certain assets of BH Holdings, S.A.S ("Biocode" or "BHH") of $4,367,604 with a one-time payment of $2,487,480 resulting in a gain on extinguishment of debt of $1,880,124 which was included in discontinued operations. The repayment of the debt has reduced the Company's debt related to Biocode to zero .

As a result of these transactions the Company realized total gains of $4,019,000 . The total gain brought the Company back into compliance with the minimum $2,500,000 stockholders' equity requirement for continued listing on the NASDAQ Capital Market as set forth in Listing Rule 5550(b).

The Company operates in the healthcare market, specializing in the development, manufacture, marketing, and distribution of medical devices and pharmaceuticals in the area of ophthalmology. The Company and its products are subject to regulation and inspection by the 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.

Management reviews financial information, allocates resources, and manages the business as two segments: Sonomed-Escalon and Escalon Medical Corp. (“Corporate”). The Sonomed-Escalon segment consists of Sonomed, Inc., EMI and Trek, all of which are engaged in the development and sale of Ophthalmic medical devices. The Escalon Medical Corp. segment includes the administrative corporate operations of the consolidated group.

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, primarily for non-employee directors, immediately.

As of December 31, 2013 and 2012 total unrecognized compensation cost related to non-vested share-based compensation arrangements granted to employees under the 2004 Equity Incentive Plan was $6,472 and $29,110 , respectively. The remaining cost is expected to be recognized over a weighted average period of 0.75 years . For the three-month periods ended December 31, 2013 and 2012, $2,158 and $9,162 was recorded as compensation expense, respectively. For the six-month periods ended December 31, 2013 and 2012, $4,315 and $25,647 was recorded as compensation expense, respectively.

The Company did not receive any cash from share option exercises under stock-based payment plans for the six-month periods ended December 31, 2013 and 2012. 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 six-month periods ended December 31, 2013 and 2012.

2013 Equity Plan

On December 28, 2013, the shareholders of the Company approved the Company's 2013 Equity Plan (2013 Equity Plan) at the Company's 2013 annual meeting of shareholders. The purpose of the 2013 Equity Plan is to provide a means by which certain employees and directors of, and others providing services to or having a relationship with, the Company and its subsidiaries may be given an opportunity to acquire shares of the Company’s common stock. There were not stock option grants made under the 2013 Equity Plan as of December 31, 2013.

Our 2013 Equity Plan will permit the granting of incentive stock options, nonqualified stock options, stock awards, stock units, stock appreciation rights ("SARs") and other equity-based awards (collectively, "grants"). The maximum number of shares of our common stock that we may issue under our Plan may not exceed 550,000 shares, all of which may be granted as incentive stock options under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). The number of shares of our common stock that will be subject to grants made under our 2013 Equity Plan will be increased annually on July 1 of each year commencing July 1, 2014, until the expiration of our 2013 Equity Plan by a number equal to the lesser of (i) 10,000 shares of our common stock, (ii) 4% of the shares of our capital stock outstanding on such date, calculated on a common-equivalent basis, or (iii) an amount determined by our board of directors. If a grant expires or terminates for any reason before it is fully vested or exercised, or if any grant is forfeited, we may again make the number of shares subject to that grant that the participant has not purchased or that has not vested subject to another grant under our Plan. We will make appropriate adjustments to outstanding grants and to the number or kind of shares subject to our 2013 Equity Plan in the event of a stock split, reverse stock split, stock dividend, share combination or reclassification and certain other types of corporate transactions, including a merger or a sale of all or substantially all of our assets. The maximum number of shares of our common stock that may be subject to grants made under our Plan to any individual in any calendar year may not exceed 550,000 shares.

3. Net (Loss) income earnings per Share

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



	Three Months Ended December 31,					Six Months Ended December 31,
	2013			2012		2013			2012

Numerator:
Numerator for basic and diluted earnings per share
(Loss) income from continuing operations	$	(82,715	)	$	126,527	$	(43,870	)	$	(497,864	)
(Loss) income from discontinued operations	(25,834		)	3,866,858		(51,439		)	4,057,824
Net (loss) income	$	(108,549	)	$	3,993,385	$	(95,309	)	$	3,559,960
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	—			—		—			—
Shares reserved for future exchange	—			—		—			—
Denominator for diluted earnings per share - weighted average and assumed conversion	7,526,430			7,526,430		7,526,430			7,526,430

Net (loss) income per share
Basic:
Continuing operations	$	(0.01	)	$	0.02	$	—		$	(0.07	)
Discontinued operations	—			0.51		(0.01		)	0.54
	$	(0.01	)	$	0.53	$	(0.01	)	$	0.47
Diluted:
Continuing operations	$	(0.01	)	$	0.02	$	—		$	(0.07	)
Discontinued operations	—			0.51		(0.01		)	0.54
	$	(0.01	)	$	0.53	$	(0.01	)	$	0.47

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 may in the future 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. Segment Reporting

During the six-month periods ended December 31, 2013 and 2012, the Company's continuing operations were classified into two principal reportable business units that provide different products or services.

Management reviews financial information, allocates resources, and manages the business as two segments: Sonomed-Escalon and Corporate. The Sonomed-Escalon segment consists of Sonomed, Inc., EMI and Trek, all of which are engaged in the development and sale of ophthalmic medical devices. The Corporate segment includes the administrative corporate operations of the consolidated group. The ECD segment which consisted of Drew Scientific, Inc., and its wholly owned subsidiary JAS, was reported under discontinued operations beginning with the Form 10-Q for three months ended September 30, 2012.

The table below sets forth the income/losses from continuing operations for the three-month periods ended December 31, 2013 and 2012 (in thousands).




	Sonomed-Escalon					Corporate						Total
	2013			2012		2013			2012			2013			2012
Revenues, net:
Product revenue	$	3,078		$	3,641	$	—		$	—		$	3,078		$	3,641
Total revenue, net	3,078			3,641		—			—			3,078			3,641
Costs and expenses:
Cost of goods sold	1,510			1,776		—			—			1,510			1,776
Marketing, general & administration	1,262			1,340		19			149			1,280			1,489
Research & development	377			266		—			—			377			266
Total costs and expenses	3,149			3,382		19			149			3,168			3,531
(Loss) income from operations	(71		)	259		(19		)	(149		)	(89		)	110
Other (expense) and income:
Other income (expense)	—			—		7			17			7			17
Total other income and (expense)	—			—		7			17			7			17
(Loss) income before taxes	(71		)	259		(12		)	(132		)	(83		)	127
Income taxes (benefits) from continuing operations	—			—		—			—			—			—
Net (loss) income from continuing operations	$	(71	)	$	259	$	(12	)	$	(132	)	$	(83	)	$	127

The table below sets forth the income/losses from continuing operations for the six-month periods ended December 31, 2013 and 2012 (in thousands).



	Sonomed-Escalon					Corporate						Total
	2013		2012			2013			2012			2013			2012
Revenues, net:
Product revenue	$	6,209	$	5,910		$	—		$	—		$	6,209		$	5,910
Total revenue, net	6,209		5,910			—			—			6,209			5,910
Costs and expenses:
Cost of goods sold	3,067		2,972			—			—			3,067			2,972
Marketing, general & admin	2,332		2,683			162			212			2,494			2,895
Research & development	700		530			—			—			700			530
Total costs and expenses	6,099		6,185			162			212			6,261			6,397
Income (loss) from operations	110		(275		)	(162		)	(212		)	(52		)	(487		)
Other (expense) and income:
Other income	—		—			8			82			8			82
Interest expense	—		—			—			(93		)	—			(93		)
Total other (expense) and income	—		—			8			(11		)	8			(11		)
Income (loss) before taxes	110		(275		)	(154		)	(223		)	(44		)	(498		)
Income taxes (benefits) from continuing operations	—		—			—			—			—			—
Net income (loss) from continuing operations	$	110	$	(275	)	$	(154	)	$	(223	)	$	(44	)	$	(498	)

The Company operates in the healthcare market, specializing in the development, manufacture and marketing of ophthalmic medical devices and pharmaceuticals. The business segments reported above are the segments for which separate financial information is available and for which operating results are evaluated regularly by executive 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 in the Company's Form 10-K for the year ended June 30, 2013 . 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 otherwise included in the corporate segment.

During the six-month periods ended December 31, 2013 and 2012, Sonomed-Escalon derived its revenue from the sale of A-Scans, B-Scans, UBM, pachymeters, Digital imaging products, ISPAN™ gas products and various disposable ophthalmic surgical products.

6. Related Party Transactions

During the six-month period ended December 31, 2012, Richard J. DePiano, Sr., the Company’s Chief Executive Officer, participated in an accounts receivable factoring program that was implemented by the Company. Under the program, Mr. DePiano advanced the Company $300,000 which represented 80% of an amount due from certain Drew customers. The receivables were not eligible to be sold to the Company’s usual factoring agent. Interest on the transaction was 1.25% per month, which was equal to the best price offered by the Company’s usual factoring agent. The transaction excluded fees typically charged by the factoring agent and provided much needed liquidity to the Company. Related party interest expense for the six-month periods ended December 31, 2013 and 2012 was $0 and $11,250 , respectively. The entire amount due of $332,216 including accrued interest of $32,216 , was paid in full on October 5, 2012; therefore there was no related party interest expense for the three month periods ended December 31, 2013 and 2012.

7. Recently Issued Accounting Standards

In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740), which clarifies the presentation requirements of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013 and should be applied prospectively. The adoption of this ASU is not expected to have a material impact to the Company’s consolidated financial statements.

In February 2013, FASB issued Accounting Standards Update 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income to improve the transparency of reporting these reclassifications. Other comprehensive income (loss) includes gains and losses that are initially excluded from net income for an accounting period. Those gains and losses are later reclassified out of accumulated other comprehensive income into net income. The amendments in this ASU do not change the current requirements for reporting net income or other comprehensive income in financial statements. All of the information that this ASU requires already is required to be disclosed elsewhere in the financial statements under U.S. GAAP. The new amendments will require an organization to (i) present the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income, but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period; and (ii) cross-reference to other disclosures currently required under U.S. GAAP for other reclassification items to be reclassified directly to net income in their entirety in the same reporting period. The amendments are effective for interim and annual reporting periods beginning after December 15, 2012. The adoption of this standard did not have a material impact to 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 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 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.

9. Continuing Operations

The accompanying condensed consolidated financial statements have been prepared on the going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.

Based on the following transactions, the Company expects that these transactions will provide the Company with sufficient cash to fund its operations over the next 12 months.

On October 3, 2012 the Company sold its Clinical Diagnostics Business to ERBA Diagnostics, Inc. The ECD consisted of Drew Scientific, Inc., and its wholly owned subsidiaries JAS and Drew Scientific Limited Co. The sales price was $6,500,000 in cash and the transaction generated a gain on sale of approximately $2,717,000 .

As a result of these transactions the Company realized total gains of $4,019,000 before tax during fiscal year 2013 including $578,422 of cumulative translation adjustment reversal related to the ECD segment. The total gain brought the Company back into compliance with the minimum $2,500,000 stockholders' equity requirement for continued listing on the NASDAQ Capital Market as set forth in Listing Rule 5550(b).

10. Discontinued Operations

BH Holdings, S.A.S

On January 12, 2012 BHH initiated the filing of an insolvency declaration with the Tribunal de Commerce de Rennes, France ("Commercial Court"). The Commercial Court on January 18, 2012 opened the liquidation proceedings with continuation of BHH's activity for three months and named an administrator to manage BHH. Since Drew no longer had a controlling financial interest in BHH it was deconsolidated in the December 31, 2011 quarterly condensed consolidated financial statements and prior period amounts were presented as discontinued operations.

The following tables summarize the results of discontinued operations of BHH for the three-month and six-month periods ended December 31, 2013 and 2012 (in thousands):




For the Three Months Ended December 31,	2013			2012
Revenue, net	$	—		$	—
Cost of goods sold	—			—
Marketing, general and administrative	25			—
Research & development	—			—
Total Costs and expenses	25			—
Loss from discontinued operations	$	(25	)	$	—





For the Six Months Ended December 31,	2013			2012
Revenue, net	$	—		$	—
Cost of goods sold	—			—
Marketing, general and administrative	50			—
Research & development	—			—
Total Costs and expenses	50			—

Loss from discontinued operations	(50		)	—
Loss on liquidation of net assets from discontinued operations	—			—
Net loss from discontinued operations	$	(50	)	$	—

Assets and liabilities of discontinued operations of BHH included in the condensed consolidated balance sheets are summarized as follows at December 31, 2013 and June 30, 2013 (in thousands):



	December 31,			June 30,
	2013			2013
Total assets	$	—		$	—
Liabilities
Accrued lease termination costs	543			493
Total liabilities	543			493
Net liabilities of discontinued operations	$	(543	)	$	(493	)

Discontinued operation of ECD

$6,500,000 in cash and gain on sale of assets was approximately $ 2,717,000 . The following table is in thousands:



	October 3, 2012
Sales Price	$	6,500
Broker's fee	(325		)
Net Proceeds	6,175
Net Assets Sold	(3,458		)
Gain on Sale of Assets	$	2,717

Net assets sold
Assets:
Cash and cash equivalents	$	4
Accounts receivable, net	1,661
Inventory, net	1,997
Other current assets	113
Furniture and equipment, net	287
Goodwill	93
Trademarks and trade names, net	89
Customer list, net	462
Total Assets	4,706

Liabilities:
Accounts payable	639
Accrued expenses	609
Total liabilities	1,248
Net assets sold	$	3,458

The following tables summarize the results of discontinued operations for the three-month and six-month periods ended December 31, 2013 and 2012 (in thousands):




For the three-month period ended December 31,	2013			2012
Revenue, net	$	—		$	—
Cost of goods sold	—			—
Marketing, general and administrative	1			72
Research & development	—			—
Total costs and expenses	1			72
Other expense	—			—
Net (loss) from discontinued operations	(1		)	(72		)
Gain from sale of assets and debt settlement net of tax (CTA included)	—			3,939
Net (loss) income from discontinued operations, net of tax	$	(1	)	$	3,867



For the six-month period ended December 31,	2013			2012
Revenue, net	$	—		$	3,637
Cost of goods sold				2,194
Marketing, general and administrative	2			1,248
Research & development	—			76
Total costs and expenses	2			3,518
Net (loss) income from discontinued operations	(2		)	119
Gain from sale of assets and debt settlement, net of tax (CTA included)	—			3,939
Net loss (income)	$	(2	)	$	4,058

Assets and liabilities of discontinued operations of ECD included in the condensed consolidated balance sheets are summarized as follows at December 31, 2013 and June 30, 2013 (in thousands):



	December 31,			June 30,
	2013			2013
Total Assets	$	—		$	—
Liabilities
Accrued expenses	55			80
Total liabilities	55			80
Net liabilities of discontinued operations	$	(55	)	$	(80	)

11. Composition of Certain Assets



(In thousands)	December 31,		June 30,
	2013		2013
Inventory, net:
Raw Material	$	1,019	$	742
Work-In-Process	321		414
Finished Goods	896		698
Total	$	2,236	$	1,854

12. Expired warrants

On November 20, 2008, the Company completed a $1,100,000 private placement of common stock and common stock purchase warrants to accredited investors. The Company sold 1,000,000 shares of common stock at $1.10 per share. The investors also received warrants to purchase an additional 150,000 shares of common stock at an exercise price of $1.21 per share, which expired in five years. The warrants have a fair value of $132,114 . The fair value of the warrants was estimated at the date of agreement using the Black-Scholes pricing method. The net proceeds to the Company from the offering, after fees and expenses of $1,029,000 have been allocated among common stock and warrants based on their relative fair values. As the result of the private placement, the Company had 7,526,430 shares of common stock outstanding, not including the shares issuable upon the exercise of the warrants. The warrants expired on November 20, 2013. As a result the fair value of the warrants were reclassed to additional paid-in capital for the six-month period ended December 31, 2013.

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, discontinued operations, research and development, product development, the introduction of new products, the potential markets and uses for the Company's products, the Company's regulatory filings with the FDA, acquisitions, dispositions, the development of joint venture opportunities, intellectual property and patent protection and infringement, the loss of revenue due to the expiration 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, compliance with Nasdaq continued listing qualifications, 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, 2013 and this Form 10-Q quarterly report to be an exhaustive statement of all risks, uncertainties or potentially inaccurate assumptions.

Executive Overview—Six-months Ended December 31, 2013 and 2012.

The following highlights are discussed in further detail within this Form 10-Q. The reader is encouraged to read this Form10-Q in its entirety to gain a more complete understanding of factors impacting Company performance and financial condition.

• Consolidated product revenue from continuing operations increased approximately $ 299,000 , or 5% , to $ 6,209,000 during the six-months ended December 31, 2013 as compared to same period of the last fiscal year. The increase in revenue is attributed to an increase of $293,000 in EMI’s digital imaging cameras and AXIS image management systems and an increase of $75,000 in Trek products offset by a decrease of $69,000 in Sonomed’s ultrasound products.

• Consolidated cost of goods sold from continuing operations totaled approximately $ 3,067,000 , or 49.4% , of product revenue from continuing operations for the six months ended December 31, 2013, as compared to $ 2,972,000 , or 50.3% , of product

revenue from continuing operations for the same period of the prior fiscal year. The decrease of 0.9% in cost of goods sold as a percentage of revenue is due mainly to the product mix sold during the current period.

• Total operating expenses decreased approximately $ 231,000 , or 6.8%, during the six months ended December 31, 2013 as compared to the same period of prior fiscal year. This was due to decreased marketing, general and administrative expenses of $401,000, or 13.9%, offset by an increase of $170,000 or 32.0%, in research and development expenses.

• Net loss from continuing operations was approximately $44,000 for the six-months ended December 31, 2013. The Company is planning to increase its research and development expenditures in future quarters as it updates existing products and develops new products. Increases in research and development expenses along with potential fluctuations in sales as the Company updates its product offerings may have a negative impact on future earnings.

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 of this report.

The Company operates in the healthcare market specializing in the development, manufacture, marketing and distribution of medical devices and pharmaceuticals in the area of ophthalmology. The Company and its products are subject to regulation and inspection by the FDA. The FDA requires extensive testing of new products prior to sale and has jurisdiction over the safety, efficacy and manufacture of products, as well as product labeling and marketing. The Company's Internet address is www.escalonmed.com .Sonomed-Escalon segment consists of the operations of Sonomed, EMI, and Trek. Sonomed develops, manufactures and markets ultrasound systems used for diagnosis or biometric applications in ophthalmology. Trek develops,

manufactures and distributes ophthalmic surgical products under the Trek Medical Products names. EMI manufactures and markets digital camera systems for ophthalmic fundus photography and image management systems.

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, 2013. 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 valuation of purchased intangible assets. Actual results achieved in the future could differ from current estimates. The Company used what it believes are reasonable assumptions and, where applicable, established valuation techniques in making its estimates.

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 upon 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 in advance, cash on delivery or credit. Customer credit is determined based on the Company's policies and procedures related to the buyer's (distributor's) creditworthiness. Based on this determination, the Company believes that collectibility is reasonably assured.

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

Valuation of Intangible Assets

The Company annually, and as circumstances require, evaluates for impairment its intangible assets and goodwill in accordance with FASB guidance related to goodwill and other intangible assets or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. These intangible assets include goodwill, trademarks and trade names. Recoverability of these assets is measured by comparison of their carrying amounts to future discounted cash flows the assets are expected to generate. If identifiable intangibles are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds its fair market value. The Company does not amortize intangible assets with indefinite useful lives, rather such assets are required to be tested for impairment at least annually or sooner whenever events or changes in circumstances indicate that the assets may be impaired. The Company performs its intangible asset impairment tests on or about June 30, of each year. 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.

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.

Taxes

Estimates of taxable income of the various legal entities and jurisdictions are used in the tax rate calculation. Management uses judgment in estimating what the Company's income tax will be for the year. Since judgment is involved, there is a risk that the tax rate may 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 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, 2013 , the Company has recorded a valuation allowance against the Company's deferred tax assets arising from net operating losses 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 in the valuation allowance would result in an income tax 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, if any, 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.

Results of Operations

Three-month and six-month periods Ended December 31, 2013 and 2012

The following table shows consolidated product revenue by business segment, as well as identifying trends in business segment product revenues for the three-month and six-month periods ended December 31, 2013 and 2012.

Table amounts are in thousands:



	Three Months Ended December 31,						Six Months ended December 31,
	2013		2012		% Change		2013		2012		% Change
Product Revenue:
Sonomed-Escalon	$	3,078	$	3,641	(15.5	)%	$	6,209	$	5,910	5.0	%
Total	$	3,078	$	3,641	(15.5	)%	$	6,209	$	5,910	5.0	%

Consolidated product revenue from continuing operations decreased approximately $ 563,000 , or 15.5% , to $3,078,000 during the three months ended December 31, 2013 as compared to same period of the last fiscal year. The decrease in revenue is attributed to a decrease of $412,000 in Sonomed’s ultrasound products, a decrease of $159,000 in EMI’s digital imaging cameras and AXIS image management systems offset by an increase of $8,000 in Trek products.

Consolidated product revenue from continuing operations increased approximately $ 299,000 , or 5% , to $ 6,209,000 during the six months ended December 31, 2013 as compared to same period of the last fiscal year. The increase in revenue is attributed to an increase of $293,000 in EMI’s digital imaging cameras and AXIS image management systems and an increase of $75,000 in Trek products offset by a decrease of $69,000 in Sonomed’s ultrasound products.

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 months and six months ended December 31, 2013 and 2012. Table amounts are in thousands:



	Three Months Ended December 31,								Six Months Ended December 31,
	2013		%		2012		%		2013		%		2012		%
Cost of Goods Sold:
Sonomed-Escalon	$	1,510	49.1	%	$	1,776	48.8	%	$	3,067	49.4	%	$	2,972	50.3	%
Total	$	1,510	49.1	%	$	1,776	48.8	%	$	3,067	49.4	%	$	2,972	50.3	%

Consolidated cost of goods sold from continuing operations totaled approximately $1,510,000, or 49.1%, of product revenue from continuing operations, for the three months ended December 31, 2013 , as compared to $1,776,000, or 48.8%, of product revenue from continuing operations, for the same period of the prior fiscal year. The increase of 0.3% in cost of goods sold as a percentage of revenue is due mainly to the decreased margin in digital products.

Consolidated cost of goods sold from continuing operations totaled approximately $ 3,067,000 , or 49.4% , of product revenue from continuing operations, for the six months ended December 31, 2013 , as compared to $ 2,972,000 , or 50.3% , of product revenue from continuing operations, for the same period of the prior fiscal year. The decrease of 0.9% in cost of goods sold as a percentage of revenue is due mainly to the increased margin in digital products.

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 months and six months ended December 31, 2013 and 2012. Table amounts are in thousands:



	Three Months Ended December 31,						Six Months Ended December 31,
	2013		2012		% Change		2013		2012		% Change
Marketing, General and Administrative:
Sonomed-Escalon	$	711	$	790	(10.0	)%	$	1,442	$	1,542	(6.5	)%
Corporate	569		699		(18.6	)%	1,051		1,353		(22.2	)%
Total	$	1,280	$	1,489	(14.0	)%	$	2,493	$	2,895	(13.9	)%

Consolidated marketing, general and administrative expenses from continuing operations decreased $209,000, or 14.0%, to $1,280,000 during the three-months ended December 31, 2013 , as compared to the same period of the prior fiscal year.

Marketing, general and administrative expenses in the Sonomed-Escalon business segment decreased $79,000, or 10.0%, to $711,000 during the three-months ended December 31, 2013 as compared to the same period last fiscal year. The decrease is due to a decrease in payroll related to reduction in headcount, commission and travel expense.

Marketing, general and administrative expenses in the Corporate business segment decreased $130,000, or 18.6%, to $569,000 during the three-months ended December 31, 2013 , as compared to the same period last fiscal year. The decrease is due to decreased expense in payroll related to the retirement of the CEO, stock option expense, SEC reporting fees, and insurance expense offset by an increase in meeting and exhibition expense.

Consolidated marketing, general and administrative expenses from continuing operations decreased $ 402,000 , or 13.9% , to $ 2,493,000 during the six-months ended December 31, 2013 , as compared to the same period of the prior fiscal year.

Marketing, general and administrative expenses in the Sonomed-Escalon business segment decreased $100,000, or 6.5%, to $ 1,442,000 during the six-months ended December 31, 2013 as compared to the same period last fiscal year. The decrease is due to a decrease in payroll related to a decrease in headcount, commission, advertising and travel expense.

Marketing, general and administrative expenses in the Corporate business segment decreased $302,000, or 22.2%, to $ 1,051,000 during the six-months ended December 31, 2013 , as compared to the same period last fiscal year. The decrease is due to decreased expense in payroll related to the retirement of the CEO, stock option expense, SEC reporting fees, and insurance expense offset by an increase in meeting and exhibition expense and moving expenses.

The following table presents consolidated research and development expenses from continuing operations by reportable business segment and as a percentage of related segment product revenues for the three-months and six-months ended December 31, 2013 and 2012. Table amounts are in thousands:



	Three Months Ended December 31,						Six Months Ended December 31,
	2013		2012		% Change		2013		2012		% Change
Research and Development:
Sonomed Escalon	$	377	$	266	41.7	%	$	700	$	530	32.1	%
Total	$	377	$	266	41.7	%	$	700	$	530	32.1	%

Consolidated research and development expenses from continuing operations increased $111,000, or 41.7%, to $377,000 during the three-months ended December 31, 2013 , as compared to the same period of the prior fiscal year. The increase is related to increased engineering staff and related expenses.

Consolidated research and development expenses from continuing operations increased $ 170,000 , or 32.1% , to $ 700,000 during the six-months ended December 31, 2013 , as compared to the same period of the prior fiscal year. Research and development expenses were primarily expenses associated with the planned introduction of new or enhanced products in the Sonomed-Escalon

business unit. The increase is related to increased engineering staff and related expenses. The Company intends to increase research and development expenses throughout the remainder of the fiscal year as it continues to update and develop its product offering.

Discontinued Operations

For the three-months ended December 31, 2013 and 2012, the Company had a net loss and net income from discontinued operations of the BHH and ECD segments of $26,000 and $3,867,000, respectively. For the six-months ended December 31, 2013 and 2012, the Company had a net loss and net income from discontinued operations of the BHH and ECD segments of $51,000 and $4,058,000 , respectively.

Other Income (expense)

The Company had other income of $7,000 and $17,000 during the three-months ended December 31, 2013 and 2012, respectively. Other income was $8,000 and $82,000 during the six-months ended December 31, 2013 and 2012, respectively.

There was no interest expense for the three-months ended December 31, 2013 and 2012. Interest expense was $0 and $93,000 for the six-months ended December 31, 2013 and 2012, respectively. The decrease in interest expense during the six-month periods is due to the settlement of the BHH acquisition debt in October 2012 (see Note 6 of the notes to the December 31, 2013 condensed consolidated financial statements) and repayment of related party note payable.

Liquidity and Capital Resources

The following table presents overall liquidity and capital resources as of December 31, 2013 and June 30, 2013. Table amounts are in thousands:



	December 31, 2013			June 30, 2013
Current Ratio:
Current assets	$	6,707		$	6,523
Less: Current liabilities	2,849			2,520
Working capital	$	3,858		$	4,003
Current ratio	2.4 to 1			2.6 to 1
Debt to Total Capital Ratio:
Note payable and long-term debt	$	—		$	—
Total debt	—			—
Total equity	3,738			3,829
Total capital	$	3,738		$	3,829
Total debt to total capital	—		%	—		%

Working Capital Position

Working capital decreased $ 145,000 as of December 31, 2013 , and the current ratio decreased to 2.4 to 1 from 2.6 to 1 when compared to June 30, 2013 .

Debt to Total Capital Ratio was 0% as of December 31, 2013 and June 30, 2013, as the Company had no long term debt as of these dates.

On October 3, 2012 the Company sold its Clinical Diagnostics Business to ERBA Diagnostics, Inc. The ECD segment consisted of Drew Scientific, Inc., and its wholly owned subsidiaries JAS and Drew Scientific Limited Co. The sales price was $6,500,000 in cash and the transaction generated a gain on sale of $2,717,000 .

On October 18, 2012, the Company and its debt holder reached an agreement whereby the Company paid the balance of the seller-provided financing plus accrued interest related to the purchase of certain assets of Biocode of $4,367,604 with a one-time payment of $2,487,480 resulting in a gain on extinguishment of debt of $1,880,124 . The repayment of the debt has reduced the Company's debt related to Biocode to zero . The total gain from the extinguishment of debt and the gain on the sale of assets, offset by the cumulative translation adjustment related to Drew of $578,422 was $4,019,000 before tax.

The total gain brought the Company back into compliance with the minimum $2,500,000 stockholders' equity requirement for continued listing on the NASDAQ Capital Market as set forth in Listing Rule 5550(b).

The Company expects to have sufficient cash to fund its operations over the next 12 months.

Cash Used In or Provided By Operating Activities

During the six-month periods ended December 31, 2013 and 2012, the Company experienced cash outflows of $71,000, and $1,016,000 respectively. The net decrease in cash used in operating activities of approximately $945,000 for the six-month period ended December 31, 2013 , as compared to the same period in the prior fiscal year is due primarily to the following factors:

For the six-month period ended December 31, 2013 , the Company had a net loss of $95,000, which includes net loss from discontinued operations of $51,000, and experienced net cash in flows from a decrease in other current and long-term assets of $70,000, a decrease in accounts receivable of $38,000, an increase in accounts payable and accrued expenses of $330,000 and non-cash expenditures on depreciation and amortization and compensation expense related to stock options of approximately $5,000 and $4,000, respectively. These cash in-flows were offset by an increase in inventory and payment of post-retirement benefits of $382,000 and $41,000, respectively.

For the six-month period ended December 31, 2012, the Company had a net income of $3,560,000, which includes net income from discontinued operations of $4,058,000, and experienced net cash in flows from a decrease in other current assets of $25,000, an increase in accounts payable and accrued expenses of $173,000 and non-cash expenditures on depreciation and amortization and compensation expense related to stock options of approximately $7,000 and $26,000, respectively. These cash in-flows were partially offset by an increase in inventory of $278,000, an increase in accounts receivable of $479,000, and other income of $82,000.

Cash flow from operations also included $51,000 used in operating activities from discontinued operations and $88,000 provided by operating activities from discontinued operations for the six months ended December 31, 2013 and 2012, respectively. These cash activities are not expected to recur in future periods.

Cash Flows Used In Investing and Financing Activities

Cash flows used in investing activities of $19,000 were due to the purchase of fixed assets during the six-month period ended December 31, 2013 . Cash flows from investing activities of $6,491,000 were due to the proceeds from sale of Drew's net assets of $6,500,000 and offset by purchase of fixed assets from discontinued operation of $9,000 during the six-month period ended December 31, 2012.

There were no cash flows used in (provided by) financing activities during the six-month period ended December 31, 2013 . Cash flows used in financing activities during the six-month period ended December 31, 2012 were related to the payment for related party note payable of $300,000 and payment for debt settlement of $2,487,000.

Continuing Operations

The accompanying condensed financial statements have been prepared on the going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.

Based on the following transactions, the Company expects that these transactions will provide the Company with sufficient cash to fund its operations over the next 12 months.

On October 18, 2012, the Company and its debt holder reached an agreement whereby the Company paid the balance of the seller-provided financing plus accrued interest related to the purchase of certain assets of Biocode of $4,367,604 with a one-time payment of $2,487,480 resulting in a gain on extinguishment of debt of $1,880,124 . The repayment of the debt has reduced the Company's debt related to Biocode to zero . The total gain from the extinguishment of debt and the gain on the sale of assets, offset by the cumulative translation adjustment related to Drew of $578,422 was $4,019,000 before tax.

Off-Balance Sheet Arrangements and Contractual Obligations

The Company was not a party to any off-balance sheet arrangements during the six-month periods ended December 31, 2013 and 2012.

The following table presents the Company's contractual obligations as of December 31, 2013 (excluding interest):



			Less than				3-5		More than
	Total		1 Year		1-3 Years		Years		5 Years

Operating lease agreements	$	1,315,075	$	410,549	$	699,818	$	204,708	$	—
Total	$	1,315,075	$	410,549	$	699,818	$	204,708	$	—

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

On October 18, 2012, the Company and its debt holder reached an agreement whereby the Company paid the balance of the seller-provided financing plus accrued interest related to the purchase of certain assets of Biocode of $4,367,604 with a one-time payment of $2,487,480 resulting in a gain on extinguishment of debt of $1,880,124 . The repayment of the debt has reduced the Company's debt related to Biocode to zero . In addition, the entire related party debt due of $332,216 including accrued interest of $32,216, was paid in full on October 5, 2012.

Item 4T. Controls and Procedures

(A) Evaluation of Disclosure Controls and Procedures

The Company's management, with the participation of the Company's Chief Executive Officer and Principal Financial and Accounting Officer, have established disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the officers who certify the Company's financial reports and to other members of senior management and the Board of Directors.

Based on their evaluation of the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2013 , the Chief Executive Officer and Principal Financial and Accounting Officer of the Company have concluded that such disclosure controls and procedures are effective to ensure that the information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to the Company's management, including its Chief Executive Officer and Principal Financial and Accounting Officer, to allow timely decisions regarding required disclosure.

(B) Internal Control over Financial Reporting

There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act), during the second fiscal quarter ended December 31, 2013 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

Item 1. Legal Proceedings

See footnote 4 of the notes to the condensed consolidated financial statements for further information regarding the Company's legal proceedings (see footnote 10. for details on the court proceedings related to the insolvency declaration at BHH).

Item 1A. Risk Factors

There are no material changes from the risks previously disclosed in the Company's Annual Report on Form 10-K for the year ended June 30, 2013.

Item 6. Exhibits

31.1 Certificate of Chief Executive Officer under Rule 13a-14(a).

31.2 Certificate of Principal Financial and Accounting Officer under Rule 13a-14(a).


32.1	Certificate of Chief Executive Officer under Section 1350 of Title 18 of the United States Code.


32.2	Certificate of Principal Financial and Accounting Officer under Section 1350 of Title 18 of the United States Code

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.




	Escalon Medical Corp.
	(Registrant)

Date: February 14, 2014	By:	/s/ Richard J. DePiano, Jr.
		Richard J. DePiano, Jr.
		Chief Executive Officer

Date: February 14, 2014	By:	/s/ Robert O’Connor
		Robert O’Connor
		Chief Financial Officer

TABLE OF CONTENTS

Item 1. Condensed Consolidated Financial Statements Item 2. Management's Discussion and Analysis Of Financial Condition and Results Of Item 3. Quantitative and Qualitative Disclosures About Market Risk Item 4T. Controls and Procedures Item 1. Legal Proceedings Item 1A. Risk Factors Item 6. Exhibits

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