UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended May 31, 2005
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____ to _____
Commission File No. 0-18105
VASOMEDICAL, INC.
(Name of registrant as specified in its charter)
Delaware 11-2871434
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
180 Linden Avenue, Westbury, New York 11590
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (516) 997-4600
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of Class)
Indicate by a 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 [ ]
Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X ]
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant (based on the closing sale price of $0.94 as of
November 30, 2004 was approximately $ 52,074,000. Shares of common stock held by
each officer and director and by each person who owns 5% of more of the
outstanding common stock have been excluded in that such persons may be deemed
to be affiliates. The determination of affiliates status is not necessarily a
conclusive determination for other purposes.
At August 16, 2005, the number of shares outstanding of the issuer's common
stock was 58,752,688.
DOCUMENTS INCORPORATED BY REFERENCE
Part III - (Items 10, 11, 12, 13 and 14) Registrant's definitive proxy statement
to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934.
[THIS PAGE LEFT INTENTIONALLY BLANK}
INDEX TO FORM 10-K
Page
----
PART I
Item 1. Business 1
Risk Factors 15
Item 2. Properties 20
Item 3. Legal Proceedings 20
Item 4. Submission of Matters to a Vote of Security Holders 20
PART II
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters, and Issuer Purchases of Equity Securities 21
Item 6. Selected Financial Data 22
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 23
Item 7A.Quantitative and Qualitative Disclosures about Market Risk 35
Item 8. Financial Statements and Supplementary Data 35
Item 9. Changes in and Disagreements with Accountants and
Accounting and Financial Disclosure 35
Item 9A.Controls and Procedures 35
PART III
Item 10.Directors and Executive Officers of the Registrant 36
Item 11.Executive Compensation 36
Item 12.Security Ownership of Certain Beneficial Owners
and Management 36
Item 13.Certain Relationships and Related Transactions 36
Item 14.Principal Accountant Fees and Services 36
PART IV
Item 15.Exhibits and Financial Statement Schedules 37
Signatures 39
PART I
ITEM 1 - BUSINESS
Except for historical information contained herein, the matters discussed
are forward looking statements that involve risks and uncertainties. When used
herein, words such as "anticipates", "believes", "estimates", "expects",
"feels", "plans", "projects" and "intends" and similar expressions, as they
relate to us, identify forward-looking statements In addition, any statements
that refer to our plans, expectations, strategies or other characterizations of
future events or circumstances are forward-looking statements. Such
forward-looking statements are based on our beliefs, as well as assumptions made
by and information currently available to us. Among the factors that could cause
actual results to differ materially are the following: the effect of the
dramatic changes taking place in the healthcare environment; the impact of
competitive procedures and products and their pricing; medical insurance
reimbursement policies; unexpected manufacturing problems; unforeseen
difficulties and delays in the conduct of clinical trials and other product
development programs; the actions of regulatory authorities and third-party
payers in the United States and overseas; uncertainties about the acceptance of
a novel therapeutic modality by the medical community; and the risk factors
reported from time to time in our SEC reports. We undertake no obligation to
update forward-looking statements as a result of future events or developments.
General Overview
Vasomedical, Inc. was incorporated in Delaware in July 1987. Unless the
context requires otherwise, all references to "we", "our", "us", "Company",
"registrant", "Vasomedical" or "management" refer to Vasomedical Inc. and its
subsidiaries. Since 1995, we have been primarily engaged in designing,
manufacturing, marketing and supporting EECP(R) external counterpulsation
systems based on our unique proprietary technology currently indicated for use
in cases of stable or unstable angina (i.e., chest pain), congestive heart
failure (CHF), acute myocardial infarction (i.e., heart attack, (MI)) and
cardiogenic shock. The EECP therapy system is a non-invasive, outpatient therapy
for the treatment of diseases of the cardiovascular system. The therapy serves
to increase circulation in areas of the heart with less than adequate blood
supply and may restore systemic vascular function. We provide hospitals, clinics
and physician private practices with EECP equipment, treatment guidance, and a
staff training and equipment maintenance program designed to provide optimal
patient outcomes. EECP is a registered trademark for Vasomedical's enhanced
external counterpulsation systems.
Market Overview
Cardiovascular disease (CVD) is the leading cause of death in the world and
is among the top three diseases in terms of healthcare spending in nearly every
country. CVD claimed approximately 1.4 million lives in the United States in
2002 and was responsible for 1 of every 2.6 deaths, according to The American
Heart Association (AHA) Heart and Stroke Statistical 2005 Update (2005 Update).
Approximately 70.1 million Americans suffer from some form of cardiovascular
disease. Among these, 13.0 million have coronary heart disease (CHD).
We have Food and Drug Administration (FDA) clearance to market our EECP
therapy for use in the treatment of stable and unstable angina, congestive heart
failure, acute myocardial infarction, and cardiogenic shock, however our current
marketing efforts are limited to the treatment of stable angina and congestive
heart failure indications. Within the stable angina and CHF indications,
Medicare and other third-party payers currently reimburse for stable angina
patients with moderate to severe symptoms who are refractory to medications and
not candidates for invasive procedures. CHF patients are also reimbursed under
the same criteria, provided their primary symptoms are angina.
We are also actively engaged in research to establish the potential
benefits of EECP therapy in the management of CHF and recently sponsored a
pivotal study to demonstrate the efficacy of EECP therapy in the most prevalent
types of heart failure patients. This study, known as PEECH (Prospective
Evaluation of EECP in Congestive Heart Failure), provided additional clinical
data in order to support an application for the use of EECP therapy in the
treatment of CHF. The preliminary results of the trial were presented at the
American College of Cardiology scientific sessions in March 2005, and we expect
the results of the PEECH clinical trial to be published in a peer-reviewed
journal before the end of the calendar year. In June 2005, we submitted an
application to the Centers for Medicare and Medicaid Services (CMS) for expanded
coverage of EECP therapy to include CHF as a primary indication, plus expanded
coverage for patients with angina.
1
Angina
Angina pectoris is the medical term for a recurring pain or discomfort in
the chest due to coronary heart disease. Angina is a symptom of a condition
called myocardial ischemia, which occurs when the heart muscle or myocardium
doesn't receive as much blood, hence as much oxygen, as it needs. This usually
happens because one or more of the heart's arteries, the blood vessels that
supply blood to the heart muscle, is narrow or blocked. Insufficient blood
supply is called ischemia.
Typical angina is uncomfortable pressure, fullness, squeezing or pain
usually occurring in the center of the chest under the breastbone. The
discomfort also may be felt in the neck, jaw, shoulder, back or arm. Episodes of
angina occur when the heart's need for oxygen increases beyond the oxygen
available from the blood nourishing the heart. Physical exertion is the most
common trigger for angina. For example, running to catch a bus could trigger an
attack of angina while walking might not. Angina may happen during exercise,
periods of emotional stress, exposure to extreme cold or heat, heavy meals,
alcohol consumption or cigarette smoking. Some people, such as those with a
coronary artery spasm, may have angina when they are resting.
There are approximately 6.4 million angina patients in the United States
and our EECP therapy currently competes with other technologies in the market
for approximately 150,000 angina patients annually who are considered refractory
to medical and surgical therapy and have the potential to meet the guidelines
for reimbursement of EECP therapy. Most angina patients are treated with
medications, including vasodilators, which are often prescribed to increase
blood flow to the coronary arteries. When drugs fail or cease to correct the
problem the patients are considered refractory to medical therapy. Invasive
revascularization procedures such as angioplasty and coronary stent placement,
as well as coronary artery bypass grafting (CABG) are often employed in both
refractory and non-refractory angina patients.
In February 1999, the Centers for Medicare and Medicaid Services (CMS), the
federal agency that administers the Medicare program for more than 39 million
beneficiaries, issued a national coverage policy for the use of external
counterpulsation therapy in the treatment of refractory angina. Medicare
reimbursement guidelines have a significant impact in determining the available
market for EECP therapy. We believe that over 65% of the patients that receive
EECP therapy are Medicare patients and many of the third-party payers follow
Medicare guidelines, which limits reimbursement for EECP therapy to patients who
are refractory to medical and surgical therapy. As a result, an important
element of our strategy is to grow the market for EECP therapy by expanding
reimbursement coverage to include a broader range of angina patients than the
current coverage policy provides and enabling EECP therapy to compete more with
other therapies for ischemic heart disease. Please see the heading
"Reimbursement" in the "Item-1 Business" section of this Form 10-K for a more
detailed discussion of reimbursement issues.
Congestive Heart Failure
CHF is a condition in which the heart loses its full pumping capacity,
causing blood to back up into other organs, especially the lungs and liver. The
condition affects both sexes and is most common in people over age 50. Symptoms
include shortness of breath, weakness, fatigue, swelling of the abdomen, legs
and ankles, rapid or irregular heartbeat, low blood pressure and enlargement of
the liver. Causes range from chronic high blood pressure, heart-valve disease,
heart attack, coronary artery disease, heartbeat irregularities, severe lung
disease such as emphysema, congenital disease, cardiomyopathy, hyperthyroidism,
severe anemia and others.
CHF is treated with medication and, sometimes, surgery on heart valves or
the coronary arteries and, in certain severe cases, heart transplants. Left
ventricular assist devices (LVADs) and the use of cardiac resynchronization and
implantable defibrillators continue to advance. Still, no consensus therapy
currently exists for CHF and patients must currently suffer their symptoms
chronically and have a reduced life expectancy.
According to the 2005 Update, in 2002 approximately 2.4 million men and 2.5
million women in the US had CHF and about 550,000 new cases of the disease occur
each year. Deaths caused by the disease increased 35.3% from 1992 to 2002. The
prevalence of the disease is growing as a result of the aging of the population
and the improved survival rate of people after heart attacks. Because the
condition frequently entails visits to the emergency room and in- patient
treatment centers, two-thirds of all hospitalizations for people over age 65 are
due to CHF. In addition to careful outpatient care and monitoring, the economic
burden of congestive heart failure is enormous with an estimated 2005 cost to
the health care system in the United States of $27.9 billion. In 1999, $3.6
billion (an average of $5,456 per discharge) was paid to Medicare providers for
CHF.
Given the pressing need to identify new and effective methods to treat CHF,
we have been actively focusing our clinical development resources on CHF.
Congestive heart failure offers a good strategic fit with our current angina
business and offers an expanded market opportunity for EECP therapy. Unmet
2
clinical needs in CHF are greater than those for angina, as there are few
consensus therapies, invasive or otherwise, beyond medical management for the
condition. It is noteworthy that data collected from the International EECP
Patient Registry(TM)(IEPR) at the University of Pittsburgh Graduate School of
Public Health currently shows that approximately one-third of angina patients
treated also have a history of CHF and have demonstrated positive outcomes from
EECP therapy.
The PEECH trial provided additional clinical evidence to demonstrate the
potential benefits of EECP therapy in the management of CHF, and we have
included a summary of the results of the PEECH trial in our application to CMS
to expand reimbursement coverage to include CHF. The application was accepted by
CMS effective June 20, 2005, and CMS announced their proposed decision memo due
date is December 20, 2005, with an expected National Coverage Analysis (NCA)
completion date of March 20, 2006; however, there can be no assurance that the
results of the PEECH trial or other clinical evidence will be sufficient to
support expansion of the Medicare national coverage policy for EECP treatment.
The EECP Therapy Systems
The EECP therapy systems are advanced treatment systems utilizing
fundamental hemodynamic principles to augment coronary blood flow and at the
same time reduce the workload of the heart while improving the overall vascular
function. The treatment is completely noninvasive and is administered to
patients on an outpatient basis usually in daily one-hour sessions, 5 days per
week over seven weeks for a total of 35 treatments. The procedure is well
tolerated and most patients begin to experience relief of chest pain due to
their coronary artery disease after 15 to 20 hours of therapy. Positive effects
have been shown in most patients to continue for years following a full course
of therapy.
During EECP therapy, the patient lies on a contoured treatment table while
three sets of inflatable pressure cuffs, resembling oversized blood pressure
cuffs, are wrapped around the calves, and the lower and upper thighs, including
the buttocks. The system is synchronized to the individual patient's cardiac
cycle causing the cuffs to inflate rapidly and sequentially -- via
computer-interpreted ECG signals -- starting from the calves and proceeding
upward to the buttocks during the relaxation phase of each heartbeat (diastole).
This has the effect of creating a strong retrograde counter pulse in the
arterial system, forcing freshly oxygenated blood towards the heart and coronary
arteries at a time when resistance to coronary blood flow is at its lowest
level. The counter pulse also simultaneously increases the volume of venous
blood return to the heart under increased pressure. Just prior to the next
heartbeat when the heart begins to eject blood by contracting (systole), all
three cuffs simultaneously deflate, significantly reducing the workload of the
heart. This is achieved because the vascular beds in the lower extremities are
relatively empty when the cuffs are deflated, significantly lowering the
resistance, and provide vascular space to receive the blood ejected by the
heart, reducing the amount of work the heart must do to pump oxygenated blood to
the rest of the body. The inflation/deflation activity is monitored constantly
and coordinated by a computerized console that interprets electrocardiogram
signals from the patient's heart, monitors heart rhythm and rate information,
and actuates the inflation and deflation in synchronization with the cardiac
cycles. The end result of this sequential "squeezing" of the legs is to create a
pressure wave that significantly increases peak diastolic pressure, benefiting
circulation to the heart muscle and other organs, increases venous return so
that the heart has more blood volume to eject out, and increases cardiac output.
The release of external pressure produces reduction of systolic pressure, to the
general benefit of the vascular system. This reduction of vascular resistance
insures that the heart does not have to work as hard to pump large amounts of
blood through the body, and that more blood is forced into the coronary arteries
which supply energy to the heart muscle or myocardium.
While the precise means by which EECP therapy achieves its beneficial
effects remains unknown, there is evidence to suggest that the EECP therapy
triggers a neurohormonal response that induces the production of growth factors
and dilates existing blood vessels. This in turn fosters the recruitment of
collateral blood vessels, which bypass blocked or narrowed vessels and increase
blood flow to restore ischemic areas of the heart muscle that are receiving an
inadequate supply of blood. The myocardium itself may also develop new
vasculature. There is also evidence to support a mechanism related to improved
function of the endothelium (the inner lining of the blood vessels), reducing
constriction of blood vessels that supply oxygenated blood to the body's organs
and tissues and the required workload of the heart.
Clinical Studies
Early History
Early experiments with counterpulsation at Harvard in the 1950s
demonstrated that this technique markedly reduces the workload, and thus oxygen
consumption, of the left ventricle. This basic effect has been demonstrated over
3
the past forty years in both animal experiments and in patients. The clinical
benefits of external counterpulsation were not consistently achieved in early
studies because the equipment used then lacked some of the features found in the
current EECP systems, such as the computerized electrocardiographic signal for
triggering, and the use of pneumatic versus hydraulic actuating media that makes
sequential cuff inflation possible. As the technology improved, however, it
became apparent that both internal (i.e. intra-aortic balloon pumping) and
external forms of counterpulsation were capable of improving survival in
patients with cardiogenic shock following myocardial infarction. Later, in the
1980s, Dr. Zheng and colleagues in China reported on their extensive experience
in treating angina using the newly developed "enhanced" sequentially inflating
EECP device that incorporated three sets of cuffs including the buttocks cuff
instead of a single cuff used in the previous system. The Chinese investigators
were able to show that a 36 hour course of treatment with the EECP system
reduced the frequency and severity of anginal symptoms during normal daily
functions and also during exercise, and also that the improvements were
sustained for years after therapy.
These results prompted a group of investigators at the State University of
New York at Stony Brook (Stony Brook) to undertake a number of open label
studies with the EECP system between 1989 and 1996 to reproduce the Chinese
results, using both subjective and objective endpoints. These studies, though
open label and non-randomized, showed statistical improvement in exercise
tolerance by patients as evidenced by exercise treadmill stress testing,
improvement in the perfusion of ischemic regions of the heart muscle by thallium
radionuclide imaging stress testing, and partial or complete resolution of
coronary perfusion defects. All of these results have been reported in the
medical literature and support the assertion that EECP therapy is an effective
and durable treatment for patients suffering from chronic angina pectoris.
The MUST-EECP Study
In 1995, we began a randomized, controlled and double-blinded multicenter
clinical study (MUST-EECP) at seven leading university hospitals in the United
States to confirm the patient benefits observed in the open studies conducted at
Stony Brook and to provide definitive scientific evidence of EECP therapy's
effectiveness. MUST-EECP was completed in July 1997 and the results presented at
the annual meetings of the American Heart Association in November 1997 and the
American College of Cardiology in March 1998. The results of MUST-EECP were
published in the Journal of the American College of Cardiology (JACC), a major
peer-review medical journal, in June 1999.
This 139 patient study, which included a sham-EECP control group, showed
that EECP therapy was a safe and effective treatment option for patients
suffering from angina pectoris, including those on maximal medication and for
whom invasive revascularization procedures were no longer an option. The results
of the MUST-EECP study confirmed the clinical benefits described in earlier open
trials, namely a decline in anginal frequency and a decrease in exercise-
induced signs of myocardial ischemia between EECP and sham-EECP treated groups,
and also showed a post-therapy increase in exercise duration in the EECP group.
Data regarding symptom relief collected by the IEPR closely mirror the results
seen in the MUST-EECP trial.
In fiscal 1999, we completed a quality-of-life study with the EECP system
in the same institutions and with a subset of the same patients that
participated in MUST-EECP. Two highly regarded standardized means of measurement
were used to gauge changes in patients' outlook and ability to participate in
normal daily living during the treatment phase and for up to 12 months after
treatment. Results of this study, which have been presented at major scientific
meetings and published in the January 2002 Journal of Investigative Medicine,
show that the group of patients receiving EECP therapy enjoyed significantly
improved aspects of health-related quality of life compared to those who
received a sham treatment.
The PEECH Study
As part of our program to expand the therapy's indications for use beyond
the treatment of angina, we applied for and received FDA approval in April 1998
to study, under an Investigational Device Exemption (IDE) protocol, the
application of EECP therapy in the treatment of CHF. A 32 patient feasibility
study was conducted simultaneously at the University of Pittsburgh, the
University of California San Francisco and the Grant/Riverside Methodist
Hospitals in Columbus, Ohio. The results of this study were presented at the
49th Scientific Sessions of the American College of Cardiology in March 2000 and
the Heart Failure Society of America's Annual Meeting in September 2000 and were
published in the July/August 2002 issue of Congestive Heart Failure. This study
concluded that EECP therapy increased functional capacity of the patients, was
beneficial to left ventricular function and portends to be a useful adjunct to
current medical therapy in heart failure patients.
In summer 2000, an IDE supplement to proceed with a pivotal study to
demonstrate the efficacy of EECP therapy in the most prevalent types of heart
failure patients was approved. This study, known as PEECH (Prospective
Evaluation of EECP in Congestive Heart Failure), began patient enrollment in
4
March 2001. The PEECH clinical trial involved nearly thirty centers including:
the Cleveland Clinic, Mayo Clinic, Scripps Clinic, Thomas Jefferson University
Hospital, the University of North Carolina at Chapel Hill, the Minnesota Heart
Failure Consortium, Advocate Christ Hospital, Hull Infirmary (UK), the
University of California at San Diego Medical Center, the University of
Pittsburgh Medical Center and the Cardiovascular Research Institute. Vasomedical
obtained 510(k) clearance for CHF from FDA in June 2002, obviating the need to
continue this trial for FDA regulatory reasons. However, we decided to complete
the clinical trial in order to use the anticipated clinical outcomes to help
establish the clinical validation of EECP therapy as a treatment for CHF and to
provide additional scientific support for Medicare, Medicaid and other
third-party payers to expand reimbursement coverage of EECP therapy to include
the CHF indication.
The PEECH clinical trial enrollment was completed in February 2004, with
187 patients. The protocol for the study required patient examinations six
months following treatment and evaluated changes in exercise capacity, symptom
status and quality of life. The six-month follow-up examinations were completed
by the end of December 2004.
On March 8, 2005, the preliminary PEECH clinical trial results were
presented by Dr. Arthur M. Feldman, MD, PhD, Principal Investigator, in a Late
Breaking Clinical Trials session of the American College of Cardiology ("ACC")
Annual Scientific Session. Simultaneously, the Company announced the positive
results of the trial to the public in a Press Release.
In designing the PEECH trial, success was demonstrated if the difference
between EECP therapy combined with optimal medical therapy compared to optimal
medical therapy alone achieved a p-value less than 0.025 in at least one of two
pre-defined co-primary endpoints:
1. percentage of subjects with greater than or equal to 60 seconds
improvement in exercise duration from baseline to six months, or
2. percentage of subjects with at least 1.25 ml/min/kg increase in peak
oxygen consumption from baseline to six months.
Additional secondary endpoints were actual changes in exercise duration and
peak oxygen consumption, changes in New York Heart Association ("NYHA")
functional classification, changes in quality of life, adverse experiences and
pre-defined clinical outcomes.
The study demonstrated that there were improvements in exercise duration
for subjects with NYHA Class II and III symptoms of CHF who were given EECP
therapy as an adjunctive therapy. Among those treated with EECP 35.4% achieved
an exercise duration increase equal to or more than 60 seconds, compared with
only 25.3% in the control group (p = 0.016). Peak oxygen consumption was not
significantly different between the two groups at six months.
In addition, consistent with the improvement in exercise duration, symptom
status, assessed by the NYHA functional class, improved 31% in the EECP group
compared to 14% in the control group (p = 0.01) and overall quality of life, as
reported on the Minnesota Living with Heart Failure scale, also improved
significantly. Furthermore, the average increase in exercise duration at 6
months was an increase of 25 seconds for the subjects who underwent EECP
therapy, compared with a 10 second decline for patients without the EECP therapy
(p = 0.01). Although a trend favoring EECP therapy was present one week
following completion of therapy, peak oxygen consumption was not significantly
different between the two groups at six months. Additionally, EECP therapy was
deemed safe and well tolerated in this group of patients, as patients in the
EECP-treated group did not suffer more adverse events than those in the control
group. Also, while the size of the study was not sufficient to assess the effect
on mortality, no patients in the EECP-treated group died, while there were two
deaths in the control group. The study concluded that the results suggest that
EECP therapy provides beneficial adjunctive therapy in patients with NYHA Class
II-III heart failure receiving optimal pharmacological therapy. There can be no
assurance that the results of the PEECH clinical trial will be sufficient to
expand reimbursement coverage or the adoption by the medical community of EECP
therapy for use in the treatment of congestive heart failure.
The IEPR Registry
The International EECP Patient Registry(TM)at the University of Pittsburgh
Graduate School of Public Health was established in January 1998 to track the
outcomes of angina patients who have undergone EECP therapy. More than one
hundred centers have participated in the registry and data from 5,000 patients
5
has been entered. Phase 2 of the IEPR, planned for an additional 2,500 patients,
began enrollment in January 2002 and incorporates sub-studies regarding
treatment beyond 35 hours, possible predictors of response, effects on certain
aspects of peripheral vascular disease and sexual dysfunction in men. In
February 2003, data points were added to assess symptom status and clinical
events in patients with concomitant heart failure. The IEPR is a vital source of
information about the effectiveness of EECP therapy in a real-world environment
for the medical community at large. For this reason, we continue to provide an
ongoing grant to fund the registry to publicize data that assists clinicians in
delivering optimal care to patients. Data from the IEPR show that patients
continue to receive dramatic benefit at six, twelve, twenty-four and thirty-six
months following completion of their course of EECP therapy. Data on 1,097
patients in the IEPR reported early in 2004 showed 92% of patients remained
alive (including 41% free of cardiac events during that period) and sustained
reduction in anginal status and nitrate medication use at 2 years following EECP
therapy.
The following tables illustrate the results:
Pre-EECP Post EECP At 1 year At 2 years At 3 years
(N=5,019) (N=3,982) (N=2,374) (N=1,022) (N=238)
% % % % %
No Angina -- 20.7 29.1 33.3 34.9
Class I 3.5 26.2 21.2 20.7 19.3
Class II 14.7 36.4 29.4 26.7 24.8
Class III 58.4 14.0 16.2 15.0 16.0
Class IV 23.4 2.6 4.1 4.3 5.0
prn Nitro Use 68.8 31.5 43.4 40.8 44.4
Angina Improvement Post EECP
Patient Demographics Medical History
Mean age 66.8 years Duration of CAD 10.8 years > 1 CCSC 82.3%
Age > 65 59.7% Prior PCI/CABG 85.8% > 2 CCSC 45.4%
Male gender 75.5% Prior MI 67.6%
CHF 31.7%
Diabetes 41.3%
N = number of patients reporting at these points
CCSC = Canadian Cardiovascular Society Classification
Other studies and publications
A search on the term "external counterpulsation" of the PubMed database
available through the National Library of Medicine identified
one-hundred-thirty-five (135) citations of articles published in the medical
scientific literature since 1990, including 22 review articles. The vast
majority of these publications have reported results of patients with chronic
stable angina treated with EECP therapy, while others have reported use of the
device in other cardiovascular or non-cardiovascular indications. More recently,
articles on the use of EECP therapy in patients with chronic heart failure have
begun to appear.
In summary, this body of literature contains evidence from a variety of
institutions and investigators demonstrating that EECP therapy can provide
benefit to appropriate patients in the following ways:
-- Enhancement of coronary and peripheral circulation, myocardial
perfusion, ventricular function and hemodynamics,
-- Elimination or reduction of cardiac ischemia,
-- Elimination or reduction in symptoms and improved functional class in
angina and heart failure,
-- Resolution of reversible ischemic defects found on quantitative
myocardial perfusion studies,
-- Increased exercise duration and increased time to ischemic changes
during treadmill exercise in angina and increased exercise duration
and peak oxygen consumption in heart failure,
-- Elimination or reduction in use of anti-angina medications,
-- Improved quality of life parameters in angina and heart failure.
Moreover, several of the articles examine the potential mechanisms by which
EECP therapy causes its effects. In summary, they demonstrate that the therapy
can induce cardiac effects such as favorable changes in hemodynamics, levels of
circulating neurohormones, endothelial and vascular function, blood supply and
tissue perfusion, as well as peripheral effects in the form of "passive
exercise" and peripheral conditioning. They also introduce the possibility that
the effects of EECP therapy result from a multifactorial process.
6
Strategic Initiatives
Our short- and long-term plans are to:
a) Increase the domestic reimbursable user base for the EECP therapy by:
i) expanding reimbursement to include coverage for the treatment of
NYHA Class II and III CHF patients with an ejection fraction less
than 35% on optimal medical therapy,
ii) marketing directly to third-party payers to increase third-party
reimbursement, and
iii) expanding reimbursement coverage in the refractory angina market
to include patients with CCS Class II angina.
b) Increase the clinical and scientific understanding of the EECP therapy
by:
i) completing the analysis of the PEECH clinical trial, publishing
the results in a major peer-reviewed medical journal and
submitting data to insurers, including Medicare, for favorable
coverage policies;
ii) continuing to support on a limited basis academic reference
centers in the United States and overseas in order to accelerate
the growth and prestige of EECP therapy and
iii) providing an ongoing grant to fund the Phase II portion of the
International EECP Patient Registry at the University of
Pittsburgh Graduate School of Public Health to publicize key
information relating to patient outcomes.
c) Increase awareness of the benefits of the EECP therapy in the medical
community by:
i) developing campaigns to market the benefits of EECP therapy
directly to clinicians, third- party payers and patients;
ii) engaging in educational campaigns for providers and medical
directors of third-party insurers designed to highlight the
cost-effectiveness and quality-of-life advantages of EECP
therapy; and
iii) continuing the development of EECP therapy in certain
international markets, principally through the establishment of a
distribution network and the seeking of reimbursement approvals.
d) Maintain development efforts to improve the EECP system and expand its
intellectual property estate by filing for additional patents in the
United States and other countries.
e) Pursue possible strategic investments and creative partnerships with
others who have distinctive competencies or delivery capabilities for
serving the cardiovascular and disease management marketplace, as
opportunities become available.
These listed strategic objectives are forward-looking statements. We
review, modify and change our strategic objectives from time to time based upon
changing business conditions. There can be no assurance that we will be able to
achieve our strategic objectives and even if these results are achieved risks
and uncertainties could cause actual results to differ materially from
anticipated results. Please see the section of this Form 10-K entitled "Risk
Factors" for a description of certain risks among others that may cause our
actual results to vary from the forward-looking statements.
Sales and Marketing
Domestic Operations
We sell EECP therapy systems to treatment providers in the United States
through a direct sales force directly to hospitals, clinics and physician
private practices. Our sales force is currently comprised of approximately
fifteen sales representatives and is supported by a management team consisting
of a vice president of sales, two regional sales managers plus in-house
administrative support.
The efforts of our sales organization are further supported by a
field-based staff of six clinical educators who are responsible for the onsite
training of physicians and therapists as new centers are established. This
clinical applications group is also engaged in training and certification of new
personnel at each site, as well as for updating providers on new clinical
developments relating to EECP therapy.
Our marketing activities support physician education and physician outreach
programs, exhibition at national, international and regional medical
conferences, as well as sponsorship of seminars at professional association
meetings. These programs are designed to support our field sales organization
and increase awareness of EECP therapy in the medical community. Additional
marketing activities include creating awareness among third-party payers to the
benefits of the EECP treatment for patients suffering from CHF as well as
angina.
7
We employ six field service technicians responsible for the repair and
maintenance of EECP systems and, in some instances, on-site training of a
customer's biomedical engineering personnel as required. We provide a service
arrangement (usually one year) that includes: service by factory-trained service
representatives, material and labor costs, emergency and remedial visits,
preventative maintenance, software upgrades, technical phone support and
preferred response times. We service our customers after the service arrangement
expires either under separately purchased annual service contracts or on a
fee-for-service basis.
International Operations
We distribute our product internationally through a network of independent
distributors. It has generally been our policy to appoint distributors exclusive
marketing rights to EECP therapy systems in their respective countries, in
exchange for their commitment to meet the duties and responsibilities required
of a distributor. Each distribution agreement contains a number of requirements
that must be met for the distributor to retain exclusivity, including minimum
performance standards. In most cases, distributors must assist us either to
obtain an FDA-equivalent marketing clearance, country registration or to
establish confirmation clinical trials, conducted by local key opinion leaders
in cardiology, required to obtain Ministry of Health approval or certification.
Each distributor is responsible for registering the product and obtaining any
required regulatory or clinical approvals, supporting local reimbursement
efforts for EECP therapy and maintaining an infrastructure to provide post-sales
support, including clinical training and product maintenance services.
To date, revenues from international operations have not been significant
(fiscal 2004 revenues were less than 5% of total revenues) however, in fiscal
year 2005 international sales revenue exceeded 9% and we anticipate revenues
from international operations to increase in future years. Our international
marketing activities include, among other things, assisting in obtaining
national or third-party healthcare insurance reimbursement approval and
participating in medical conferences to create greater awareness and acceptance
of EECP therapy by clinicians.
International sales may be subject to certain risks, including
export/import licenses, tariffs, other trade regulations and local medical
regulations. Tariff and trade policies, domestic and foreign tax and economic
policies, exchange rate fluctuations and international monetary conditions have
not significantly affected our business to date. In addition, there can be no
assurance that we will be successful in maintaining our existing distribution
agreements or entering into any additional distribution agreements, or that our
international distributors will be successful in marketing EECP therapy.
Competition
Presently, we are aware of at least three direct competitors with an
external counterpulsation device on the market, namely Cardiomedics, Inc.,
Nicore, Inc. and Living Data Technologies. In addition, at least six other
companies have received FDA 510(k) clearance for external counterpulsation
systems since 1998, although we have not seen these systems commercially in the
marketplace. While we believe that these competitors' involvement in the market
is limited, there can be no assurance that these companies will not become a
significant competitive factor or that other companies will not enter the
external counterpulsation market.
We view other companies engaged in the development of device-related,
biotechnology and pharmacological approaches to the management of cardiovascular
disease as potential competitors in the marketplace as well. These include such
common and well established medical devices and treatments as the intra-aortic
balloon pump (IABP), ventricular assist devices (VAD), coronary artery bypass
graft surgery (CABG), coronary angioplasty, mechanical circulatory support
(MCS), transmyocardial laser revascularization (TMR), cardiac recovery systems,
total artificial hearts, cardiac resynchronization devices, and nesiritide
(Natrecor(R)); as well as newer technologies currently in FDA-approved clinical
trials such as spinal cord stimulation (SCS). We are unaware of any other
biotech or pharmaceutical technologies that may impact our ability to market and
distribute EECP therapy systems in the near term.
There can be no assurance that other companies will not develop new
technologies or enter the market intended for EECP therapy systems. Such other
companies may have substantially greater financial, manufacturing and marketing
resources and technological expertise than those possessed by us and may,
therefore, succeed in developing technologies or products that are more
efficient than those offered by Vasomedical and that would render our technology
and existing products obsolete or noncompetitive.
Government Regulations
We are subject to extensive regulation by numerous government regulatory
agencies, including the FDA and similar foreign agencies. Where applicable, we
are required to comply with laws, regulations and standards governing the
development, preclinical and clinical testing, manufacturing, quality testing,
labeling, promotion, import, export, and distribution of our medical devices.
8
Device Classification
FDA regulates medical devices, including the requirements for premarket
review, according to their classification. Class I devices are generally lower
risk products for which general regulatory controls are sufficient to provide
reasonable assurance of safety and effectiveness. Most Class I devices are
exempt from the requirement of 510(k) premarket notification clearance; however,
510(k) clearance is necessary prior to marketing a non-510(k) exempt Class I
device in the United States. Class II devices are devices for which general
regulatory controls are insufficient, but for which there is sufficient
information to establish special controls, such as guidance documents or
standards, to provide reasonable assurance of safety and effectiveness. A
premarket notification clearance is necessary prior to marketing a non-510(k)
exempt Class II device in the United States. Class III devices are devices for
which there is insufficient information demonstrating that general and special
controls will provide reasonable assurance of safety and effectiveness and which
are life-sustaining, life-supporting or implantable devices, are of substantial
importance in preventing impairment of human health, or pose a potential
unreasonable risk of illness or injury. The FDA generally must approve a
premarket approval or PMA application prior to marketing a Class III device in
the United States.
A medical device is considered by FDA to be a preamendments device, and
generally not subject to premarket review, if it was commercially distributed
before May 28, 1976, the date the Medical Device Amendments of 1976 became law.
A postamendments device is one that was first distributed commercially on or
after May 28, 1976. Postamendments device versions of preamendments Class III
devices are subject to the same requirements as those preamendments devices. FDA
may require a PMA for a preamendments Class III device only after it publishes a
regulation calling for such PMA submissions. Persons who market preamendments
devices must submit a PMA, and have it filed by FDA, by a date specified by FDA
in order to continue marketing the device. Prior to the effective date of a
regulation requiring a PMA, devices must have a cleared premarket notification
or 510(k) for marketing.
Certain external counterpulsation devices were commercially distributed
prior to May 28, 1976. Our external counterpulsation devices were marketed after
1976; however, they were found to be substantially equivalent to a preamendments
Class III device and therefore are subject to the same requirements as the
preamendments external counterpulsation devices. In February 1995, the Company
received 510(k) clearance to market the second-generation version of its EECP
therapy system, the MC2, which incorporated a number of technological
improvements over the original system. In addition, in December 2000, the
Company received 510(k) clearance to market its third generation system, the
TS3. The FDA's clearance in these cases was for the use of EECP therapy in the
treatment of patients suffering from stable or unstable angina pectoris, acute
myocardial infarction and cardiogenic shock. In June 2002, the FDA granted
510(k) market clearance for an upgraded TS3, which incorporated the Company's
patent-pending CHF treatment and oxygen saturation monitoring technologies, and
provided for a new indication for the use of EECP in CHF, which applied to all
then-current models of the Company's EECP therapy systems.
Modifications to a previously cleared medical device that do not
significantly affect its safety and effectiveness or constitute a major change
in the intended use can be made without having to submit a new 510(k). FDA
publishes guidance for medical device manufacturers on the types of changes that
meet the requirements for a new 510(k) prior to introduction of a device for
marketing distribution. Vasomedical followed FDA's guidance on when to submit a
new 510(k) for changes to a device and concluded that the changes incorporated
into its Model TS4 did not require a new 510(k) prior to its introduction to
market. Vasomedical subsequently obtained a 510(k) that applied to the Model TS4
and all of its models in March 2004, when it made changes to the labeling of all
of its EECP therapy systems. In November 2004, the Company introduced its Model
Lumenair, and again concluded that the changes did not require a new 510(k) at
that time. There can be no assurance that the FDA will agree with Vasomedical's
conclusions that a new 510(k) was unnecessary on these occasions or in other
similar instances, or that our products will not be subject to a regulation
requiring a PMA for preamendments Class III external counterpulsation devices.
Premarket Review
The 510(k) premarket notification process requires an applicant to give 90
days notice to FDA of its intent to introduce its device into commerce. In its
premarket notification, the applicant must demonstrate that its new or modified
medical device is substantially equivalent to a legally marketed or predicate
device. Prior to beginning commercialization of the new or modified product we
must receive an order from the FDA classifying the device under section 510(k)
9
in the same classification as the predicate device, and as a result, the new
device will be cleared for marketing. Modifications to a previously cleared
medical device that do not significantly affect its safety and effectiveness or
constitute a major change in the intended use can be made without having to
submit a new 510(k). If a device does not receive a clearance order because the
FDA determines that the device is not substantially equivalent to a predicate
device and thus the device automatically is considered a Class III device, the
applicant may ask the FDA to make a risk-based classification to place the
device in Class I or II. However, if a timely request for risk-based
classification is not made, or if the FDA determines that a Class III
designation is appropriate, an approved PMA will be required before the device
may be marketed.
The more rigorous premarket review process is the PMA process. The FDA
approves a PMA if the applicant has provided sufficient valid scientific
evidence to prove that the device is safe and effective for its intended use(s).
Applications for premarket approval generally contain human clinical data. This
process is usually much more complex, time-consuming and expensive than the
510(k) process, and is uncertain. Both 510(k)s and PMAs now require the
submission of user fees in most circumstances.
There can be no assurance that all the necessary FDA clearances or
approvals, including approval of any PMA required by the promulgation of a
regulation, will be granted for our products, future-generation upgrades or
newly developed products, on a timely basis or at all. Failure to receive, or
delays in receipt of such clearances, could have a material adverse effect on
our financial condition and results of operations.
Clinical Trials
If human clinical trials of a device are required, whether to support a
510(k) or PMA application, the trials' sponsor, which is usually the
manufacturer of the device, first must obtain the approval of the appropriate
institutional review boards. If a trial is of a significant risk device, the
sponsor also must obtain an investigational device exemption or IDE from FDA
before the trial may begin. A significant risk device is a device that presents
a potential for serious risk to the subject and is an implant; is
life-sustaining or life-supporting; or is for a use of substantial importance in
diagnosing, curing, mitigating, or treating disease, or otherwise preventing
impairment of human health. For all clinical testing, the sponsor must obtain
informed consent from the patients participating in each trial. The results of
clinical testing that a sponsor undertakes may be insufficient to obtain
clearance or approval of the tested product.
Pervasive and Continuing FDA Regulation
We are also subject to other FDA regulations that apply prior to and after
a product is commercially released. These include Current Good Manufacturing
Practice (CGMP) requirements set forth in FDA's Quality System Regulation (QSR),
that require manufacturers to have a quality system for the design, manufacture,
packaging, labeling, storage, installation and servicing of medical devices
intended for commercial distribution in the United States. This regulation
covers various areas including management and organization, device design,
purchase and handling of components, production and process controls such as
those related to buildings and equipment, packaging and labeling control,
distribution, installation, complaint handling, corrective and preventive
action, servicing, and records. We are subject to periodic inspection by the FDA
for compliance with the CGMP requirements and Quality System Regulation.
The FDA also enforces post-marketing controls that include the requirement
to submit medical device reports to the agency when a manufacturer becomes aware
of information suggesting that any of its marketed products may have caused or
contributed to a death or serious injury, or any of its products has
malfunctioned and that a recurrence of the malfunction would likely cause or
contribute to a death or serious injury. The FDA relies on medical device
reports to identify product problems and utilizes these reports to determine,
among other things, whether it should exercise its enforcement powers. The FDA
also may require postmarket surveillance studies for specified devices.
We are subject to the Federal Food, Drug, and Cosmetic Act's, or FDCA's,
general controls, including establishment registration, device listing, and
labeling requirements. If we fail to comply with any requirements under the
FDCA, we, including our officers and employees, could be subject to, among other
things, fines, injunctions, civil penalties, and criminal prosecution. We also
could be subject to recalls or product corrections, total or partial suspension
of production, denial of premarket notification clearance or PMA approval, and
rescission or withdrawal of clearances and approvals. Our products could be
detained or seized, the FDA could order a recall, repair, replacement, or refund
of our devices, and the agency could require us to notify health professionals
and others that the devices present unreasonable risks of substantial harm to
the public health.
The advertising of our products is subject to regulation by the Federal
Trade Commission, or FTC. The FTC Act prohibits unfair or deceptive acts or
practices in or affecting commerce. Violations of the FTC Act, such as failure
to have substantiation for product claims, would subject us to a variety of
enforcement actions, including compulsory process, cease and desist orders and
injunctions, which can require, among other things, limits on advertising,
corrective advertising, consumer redress and restitution, as well as substantial
fines or other penalties.
10
Foreign Regulation
In most countries to which we seek to export the EECP system, we must first
obtain approval from the local medical device regulatory authority. The
regulatory review process varies from country to country and can be complex,
costly, uncertain, and time-consuming.
We are also subject to periodic audits by organizations authorized by
foreign countries to determine compliance with laws, regulations and standards
that apply to the commercialization of our products in those markets. Examples
include auditing by a European Union Notified Body organization (authorized by a
member state's Competent Authority) to determine conformity with the Medical
Device Directives (MDD) and by an organization authorized by the Canadian
government to determine conformity with the Canadian Medical Devices Conformity
Assessment System (CMDCAS).
There can be no assurance that we will obtain desired foreign
authorizations to commercially distribute our products in those markets or that
we will comply with all laws, regulations and standards that pertain to our
products in those markets. Failure to receive or delays in receipt of such
authorizations or determinations of conformity could have a material adverse
effect on our financial condition and results of operations.
Patient Privacy
Federal and state laws protect the confidentiality of certain patient
health information, including patient records, and restrict the use and
disclosure of that protected information. The U.S. Department of Health and
Human Services (HHS) published patient privacy rules under the Health Insurance
Portability and Accountability Act of 1996 (HIPAA privacy rule) and the
regulation was finalized in October 2002. The HIPAA privacy rule governs the use
and disclosure of protected health information by "Covered Entities," which are
(1) health plans, (2) health care clearinghouses, and (3) health care providers
that transmit health information in electronic form in connection with certain
health care transactions such as benefit claims. Currently, the HIPAA privacy
rule affects us only indirectly in that patient data that we access, collect and
analyze may include protected health information. Additionally, we have signed
some Business Associate agreements with Covered Entities that contractually bind
us to protect protected health information, consistent with the HIPAA privacy
rule's requirements. We do not expect the costs and impact of the HIPAA privacy
rule to be material to our business.
Practice Guidelines
Medical professional societies periodically issue Practice Guidelines to
their members and make them available publicly. The American College of
Cardiology (ACC) and the American Heart Association (AHA) have jointly engaged
in developing practice guidelines since 1980 to critically evaluate the use of
diagnostic procedures and therapies in the management or prevention of
cardiovascular diseases. These guidelines are meant to "improve the
effectiveness of care, optimize patient outcomes and affect the overall cost of
care favorably by focusing resources on the most effective strategies".
Recommendations incorporated into the guidelines are based upon an assessment of
the strength of evidence for or against a treatment or procedure and estimates
of expected health outcomes stemming from a formal review of peer-reviewed
published literature.
The "ACC/AHA 2002 Guideline Update for the Management of Patients with
Chronic Stable Angina" were last issued in 2003. Comments on external
counterpulsation appear in a section entitled " Recommendations for Alternative
Therapies for Chronic Stable Angina in Patients Refractory to Medical Therapy
Who Are Not Candidates for Percutaneous Intervention or Surgical
Revascularization" and include a so-called Class IIb recommendation. ACC/AHA
guideline classifications I, II and III are used to "provide final
recommendations for both patient evaluation and therapy" and a Class IIb rating
is defined as "Usefulness/efficacy is less well established by
evidence/opinion". These guidelines are not expected to be updated for some
time.
The ACC/AHA Guidelines for the Evaluation and Management of Chronic Heart
Failure in the Adult were last issued in 2001. Comments on external
counterpulsation appear in a section entitled "Drugs and Interventions Under
Active Investigation" and include the statement "[u]ntil more data are
available, this approach cannot be recommended for the management of patients
with symptomatic left ventricular systolic dysfunction". A revised version of
these guidelines have been under development for some time and may be issued in
the relatively near future. However, we do not believe they will include a
substantive change in the recommendation regarding use of external
counterpulsation in chronic heart failure in adults because the results of the
PEECH trial have not yet appeared in a peer-reviewed publication. Other evidence
that has appeared in peer-reviewed publications since issuance of the current
11
guidelines includes results of a pilot study in heart failure and analyses of
patients with angina complicated by left ventricular dysfunction that were
enrolled in the International Patient Registry. However, such studies, while
valued in certain respects, are not considered as strong as the results of
randomized, controlled clinical trials in assessing the strength of evidence for
or against a particular procedure or therapy.
In summary, while evaluations of the use of EECP therapy in patients with
chronic angina and heart failure continue to appear in several oral or poster
presentations at major scientific meetings and in peer-reviewed publications
each year, there continues to be skepticism in the cardiology community about
its broader use. Additional evidence regarding the efficacy of EECP therapy
continues to appear, however the evidence may not be sufficient to warrant a
modification of practice guidelines to a more favorable recommendation and
increased acceptance by the medical community.
Reimbursement
In addition to regulatory approvals for commercialization by government
agencies, reimbursement coverage and payment rates are factors in the sales of
our products and we depend in part on the availability of reimbursement
programs. Medicare, Medicaid, as well as private health care insurance and
managed-care plans determine eligibility for coverage of a product or therapy
based on a number of factors, including the payer's determination that the
product is reasonable and necessary for the diagnosis or treatment of the
illness or injury for which it is administered according to the scope of
clinical evidence available, accepted standards of medical care in practice, the
product's cost effectiveness, whether the product is experimental or
investigational, impact on health outcomes and whether the product is not
otherwise excluded from coverage by law or regulation. The coverage process for
Medicare reimbursement is legislated by Congress and administrated by the
Centers for Medicare and Medicaid Services (CMS), and highly variable in the
commercial market. There may be significant delays in obtaining coverage for
newly-approved products, and coverage may be more limited than the purposes for
which the product is approved or cleared by FDA. Even when we obtain
authorization from the FDA or a foreign authority to begin commercial
distribution, there may be limited demand for the device until reimbursement
approval has been obtained from governmental and private third-party payers.
Moreover, eligibility for coverage does not imply that a product will be
reimbursed in all cases or at a rate that allows us to make a profit or even
cover our costs. Reimbursement rates may vary according to the use of the
product and the clinical setting in which it is used, may be based on payments
allowed for lower-cost products that are already reimbursed, may be incorporated
into existing payments for other products or services, and may reflect budgetary
constraints and/or imperfections in Medicare or Medicaid data. Even if
successful, demand for products may be driven more by the scope of peer-reviewed
evidence and acceptance, endorsement by regulatory and clinical bodies, or
foreign country authorities than by the reimbursement rates available. Securing
coverage at adequate reimbursement rates from government and third party payers
can be a time consuming and costly process that could require us to provide
supporting scientific, clinical, and cost-effectiveness data for the use of our
products to each payer. Our inability to promptly obtain coverage and profitable
reimbursement rates from government-funded and private payers for our products
could have a material adverse effect on our financial condition and operating
results.
Our reimbursement strategies are currently focused in the following primary
areas: obtaining Medicare coverage for congestive heart failure, expanding
coverage with other third-party payers, expanding Medicare coverage for angina
and obtaining coverage in selected international markets.
Current Medicare Coverage in Angina
In February 1999, the Centers for Medicare and Medicaid Services (CMS), the
federal agency that administers the Medicare program for more than 39 million
beneficiaries, issued a national coverage policy under HCPCS code G0166 for the
use of the EECP therapy system. Key excerpts from the coverage read as follows:
"Although ECP devices are cleared by the Food and Drug Administration (FDA)
for use in treating a variety of cardiac conditions, including stable or
unstable angina pectoris, acute myocardial infarction and cardiogenic
shock, the use of this device to treat cardiac conditions other than stable
angina pectoris is not covered, since only that use has developed
sufficient evidence to demonstrate its medical effectiveness."
"for patients who have been diagnosed with disabling angina (class III or
class IV, Canadian Cardiovascular Society Classification or equivalent
classification) who, in the opinion of a cardiologist or cardiothoracic
surgeon, are not readily amenable to surgical interventions such as balloon
angioplasty and cardiac bypass because:
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1. their condition is inoperable, or at high risk of operative
complications or post-operative failure;
2. their coronary anatomy is not readily amenable to such procedures; or
3. they have co-morbid states, which create excessive risk."
Additionally, a physician must be present in the office suite and
immediately available to provide assistance and directions throughout the time
that personnel are performing the procedure.
The 2005 national average payment rate per hourly session in the physician
office setting and the hospital outpatient facility is approximately $138 and
$102, respectively. Reimbursement rates vary throughout the country and range
from $113 to $231 per hourly session. Under the Medicare program, physician
reimbursement of the provision of EECP therapy is higher if the therapy is
performed in a physician office setting as compared to a hospital outpatient
facility in order to reflect higher costs associated with the physician office.
Since January 2000, the national average payment rate has varied considerably.
The initial national average payment rate for the physician office setting and
the hospital outpatient facility in 2000 was approximately $130 and $112,
respectively per hourly session. The average payment rate for the physician
office setting climbed to $208 per treatment session in 2003 before being
reduced approximately 34% to the 2004 rate, while the average payment rate for
the hospital outpatient facility declined steadily to the 2004 rate. Although
CMS proposed a further reduction in physician fees for the EECP therapy in 2005,
this was successfully negotiated to reflect an increase of 1.2% over the 2004
rate, reversing the declining trend.
In order to bill and receive payment from Medicare, an individual or entity
must be enrolled in the Medicare program for EECP therapy. The physician office
setting and the hospital outpatient facility are the only entities currently
authorized to receive reimbursement for the EECP therapy under the Medicare
program and reimbursement is not permitted to other individuals or entity types,
which include, but are not limited to, nurse practitioners, physical therapists,
ambulatory surgery centers, nursing homes, comprehensive outpatient
rehabilitation facilities, outpatient dialysis facilities, and independent
diagnostic testing facilities. For each of these provider types there is
statutory authorization and accompanying regulations that govern the terms and
conditions of Medicare program participation.
If there were any material change in the availability of Medicare coverage,
or if the reimbursement level for treatment procedures using the EECP therapy
system is determined to be inadequate, it would adversely affect our business,
financial condition and results of operations. Moreover, we are unable to
forecast what additional legislation or regulation, if any, relating to the
health care industry or Medicare coverage and payment level may be enacted in
the future, or what effect such legislation or regulation would have on us.
Application to Expand Medicare Coverage to include Class II Angina and Class
II/III CHF
On May 31, 2005, we submitted an application to CMS to expand the national
coverage policy for external counterpulsation treatment to patients with
Canadian Cardiovascular Class II stable angina and to patients with New York
Heart Association (NYHA) Class II and III stable heart failure symptoms with an
ejection fraction less than 35%. The application was accepted by CMS effective
June 20, 2005, and CMS announced their proposed decision memo due date is
December 20, 2005, with an expected National Coverage Analysis (NCA) completion
date of March 20, 2006.
The application was supported by clinical evidence from several of the more
than 50 peer-reviewed journal articles, as well as the recently concluded PEECH
clinical trial in order to demonstrate that EECP therapy provides relief of
stable angina and congestive heart failure in selected patients in the form of:
-- improvement in symptoms
-- improvement in functional capacity, i.e. ability to perform exertional
tasks
-- improvement in quality of life and health status
Although the scientific evidence proving the safety, efficacy and cost
effectiveness of EECP treatment has continued to accumulate since the original
coverage policy was implemented, there can be no assurance that the existing
evidence is sufficient to support an expansion of EECP therapy and CMS may
require additional clinical and scientific evidence to support expanded
reimbursement coverage. We are unable to predict when or if CMS will approve an
expansion of reimbursement coverage for EECP therapy.
If we are unable to obtain an adequate national Medicare coverage policy
for treatment procedures using EECP therapy on patients with CHF, it would
adversely affect our future business prospects. Moreover, we are unable to
forecast what additional legislation or regulation, if any, relating to the
health care industry or Medicare coverage and payment level may be enacted in
the future, or what effect such legislation or regulation would have on us.
13
Expanding Coverage with Other Third-Party Payers
Some private insurance carriers continue to adjudicate EECP treatment
claims on a case-by-case basis. Since the establishment of reimbursement by the
federal government, however, an increasing number of these private carriers now
routinely pay for use of EECP therapy for the treatment of angina and have
issued positive coverage policies, which are generally similar to Medicare's
coverage policy in scope. We estimate that over 300 private insurers are
reimbursing for EECP therapy for the treatment of angina today at favorable
payment levels and we expect that the number of private insurers and their
related health plans that provide for EECP therapy as a covered benefit will
continue to increase. In addition, we are aware of two third-party payers that
have begun limited coverage of EECP therapy for the treatment of CHF.
We intend to pursue a constructive dialogue with many private insurers for
the establishment of positive and expanded coverage policies for EECP treatment
that include CHF patients. If there were any material change in the availability
of third-party private insurers or the adequacy of the reimbursement level for
treatment procedures using the EECP therapy system it would adversely affect our
business, financial condition and results of operations. Moreover, we are unable
to forecast what additional legislation or regulation, if any, relating to the
health care industry or third-party private insurers coverage and payment levels
may be enacted in the future or what effect such legislation or regulation would
have on us.
Reimbursement in International Markets
The reimbursement environment for EECP therapy in international markets is
fragmented and coverage varies as a mix of available private and public
healthcare providers may not yet be aware of nor cover this therapy. Our
reimbursement strategy has been opportunistic and responsive to the selling
opportunities presented through our distribution partners. During this fiscal
year our efforts on behalf of EECP therapy in both the private and public
healthcare sectors of selected international markets have been initiated by our
distributors, in support of the therapy, in their designated territory.
Additionally, efforts have been initiated to obtain coverage in the public
sector in certain overseas markets; however, we do not anticipate an impact on
financial performance in the next fiscal year, given the long lead times from
submission to approval of international dossiers for each reimbursement
authority.
Patents and Trademarks
We own nine US patents including six utility and three design patents that
expire at various times between 2006 and 2021. In addition, more than 20 foreign
patents have been issued that expire at various times from 2007 to 2022. There
are eight major U.S. applications pending for approval, relating to aspects of
the TS3 system, potential improvements, and new methods of treatment and a
notice of allowance in one of the applications has recently been granted. We are
pursuing these applications in other countries, including members of the
European Union. We are also planning to file other patent applications regarding
specific enhancements to the current EECP models, future generation products,
and methods of treatment. Moreover, trademarks have been registered for the
names "EECP" and "Natural Bypass", as well as for its widely-recognized man-like
figure representing the application of EECP therapy.
We pursue a policy of seeking patent protection, both in the US and abroad,
for our proprietary technology. We believe that we have a solid patent
foundation in the field of external counterpulsation devices and that our
technical leadership is demonstrated by the number of patents and applications,
dating back to the mid-1980s. Our patent portfolio focuses on the areas of
external counterpulsation control and the overall design and arrangement of the
external counterpulsation apparatus, including the console, treatment bed, fluid
distribution, and inflatable cuffs. None of our current competitors have a
significant patent portfolio in the area of external counterpulsation devices
and we believe that none has more than one patent application pending.
There can be no assurance that our patents will not be violated or that any
issued patents will provide protection that has commercial significance. As with
any patented technology, litigation could be necessary to protect our patent
position. Such litigation can be costly and time-consuming, and there can be no
assurance that we will be successful. The loss or violation of our EECP patents
and trademarks could have a material adverse effect upon our business.
Employees
As of May 31, 2005, we employed 76 full-time and 2 part-time persons with
21 in direct sales and sales support, 6 in clinical applications, 25 in
manufacturing, quality control and technical service, 6 in marketing and
customer support, 9 in engineering, regulatory and clinical research and 11 in
administration. None of our employees are represented by a labor union. We
believe that our employee relations are good.
14
In March 2004, the then current Chief Executive Officer (CEO) of the
Company resigned from the Company, and Photios T. Paulson accepted the position
as acting CEO and served from March to October 2004 at which time Thomas Glover
was appointed President and Chief Executive Officer of the Company.
Manufacturing
We manufacture our EECP therapy systems in a single facility located in
Westbury, New York. Manufacturing operations are conducted under the Current
Good Manufacturing Practice (CGMP) requirements as set forth in the FDA Quality
System Regulation. These regulations subject us to inspections to verify
compliance and require us to maintain documentation and controls for the
manufacturing and quality activities. ISO 13485 is the international quality
standard for medical device manufacturers, based upon the ISO 9001 quality
standard with specific requirements consistent with the FDA Quality System
Regulation. While previously we were certified to comply with ISO 9001
requirements, we received ISO 13485 certification in February 2003. We are also
certified to conform with the full quality assurance system requirements of the
EU Medical Device Directive and can apply the CE mark to certain of our
products. Lastly, we are certified to comply with the requirements of the
Canadian Medical Device Conformity Assessment System (CMDCAS).
We believe our manufacturing facility, in addition to the other warehouse
facilities presently under lease, are adequate to meet the current and
immediately foreseeable future demand for the production of these systems.
RISK FACTORS
Investing in our common stock involves risk. You should carefully consider
the following information about these risks together with the other information
contained in this Report. If any of the following risks actually occur, our
business could be harmed. This could cause the price of our stock to decline,
and you may lose part or all of your investment.
Risks Related to Our Business
We are materially dependent on medical reimbursement for treatment procedures
using EECP therapy on patients with congestive heart failure in order to achieve
continued growth.
We are currently dependent on a single product platform which, based on
current medical reimbursement policies, provides coverage for a restricted class
of heart patients. While we have been engaged in discussions with the Centers
for Medicare and Medicaid Services to expand the class of heart patients for
medical coverage, we are uncertain as to the outcome of these meetings. We also
have been engaged in certain clinical trials for the purpose of expanding this
coverage, most notable being our PEECH clinical trial. Our business plan
projects that the results could substantially expand the number of patients
available for medical reimbursement. However Medicare, Medicaid and other
third-party payers may deny expansion of reimbursement coverage if they feel the
data from the PEECH clinical trial and other clinical studies is not sufficient
to support a positive coverage decision. On May 31, 2005 we submitted an
application to CMS to expand the national coverage policy for EECP treatment to
include, among other patients, patients with congestive heart failure (CHF). If
we do not receive medical coverage for treatment procedures using EECP therapy
on patients with CHF, it will adversely affect our future business prospects.
Material changes in the availability of Medicare, Medicaid or third-party
reimbursement at adequate price levels could adversely affect our business.
Health care providers, such as hospitals and physician private practices,
that purchase or lease medical devices such as the EECP therapy system for use
on their patients generally rely on third-party payers, principally Medicare,
Medicaid and private health insurance plans, to reimburse all or part of the
costs and fees associated with the procedures performed with these devices. If
there were any material change in the availability of Medicare, Medicaid or
other third- party coverage or the adequacy of the reimbursement level for
treatment procedures using the EECP therapy system, it would adversely affect
our business, financial condition and results of operations. Moreover, we are
15
unable to forecast what additional legislation or regulation, if any, relating
to the health care industry or Medicare or Medicaid coverage and payment level
may be enacted in the future or what effect such legislation or regulation would
have on our business. Even if a device has FDA clearance, Medicare, Medicaid and
other third-party payers may deny reimbursement if they conclude that the device
is not cost-effective, is experimental or is used for an unapproved indication.
In addition, reimbursement may not be at, or remain at, price levels adequate to
allow medical professionals and hospitals to realize an appropriate return on
the purchase of our products.
Increased acceptance by the medical community is important for continued growth.
While many abstracts and publications are presented each year at major
scientific meetings worldwide with respect to EECP treatment efficacy, there is
continued skepticism concerning EECP therapy methodology. The American Heart
Association and the American College of Cardiology Practice Guidelines currently
list EECP as a therapy currently under investigation for treatment of heart
failure and have a classification rating of IIb as a treatment for patients who
are refractory to medical therapy and are not candidates for percutaneous
intervention or revascularization. A classification rating of IIb indicates the
usefulness/efficacy of EECP therapy is less well established by
evidence/opinion. The medical community utilizes these guidelines when
considering the various treatment options for their patients. Certain
cardiologists, in cases where the EECP therapy is a viable alternative, still
appear to prefer percutaneous coronary interventions (e.g. balloon angioplasty
and stenting) and cardiac bypass surgery for their patients. Additional evidence
regarding the efficacy of EECP therapy continues to evolve, however the evidence
may not be sufficient to warrant a modification of these guidelines to a more
favorable recommendation and increased acceptance by the medical community. We
are dependent on consistency of favorable research findings about EECP therapy
and increasing acceptance of EECP therapy as a safe, effective and cost
effective alternative to other available products by the medical community for
continued growth.
We face competition from other companies and technologies.
We compete with at least three other companies that are marketing external
counterpulsation devices. We do not know whether these companies or other
potential competitors who may be developing external counterpulsation devices,
may succeed in developing technologies or products that are more efficient than
those offered by us, and that would render our technology and existing products
obsolete or non-competitive. Potential new competitors may also have
substantially greater financial manufacturing and marketing resources than those
possessed by us. In addition, other technologies or products may be developed
that have an entirely different approach or means of accomplishing the intended
purpose of our products. Accordingly, the life cycles of our products are
difficult to estimate. To compete successfully, we must keep pace with
technological advancements, respond to evolving consumer requirements and
achieve market acceptance.
We may not continue to receive necessary FDA clearances or approvals, which
could hinder our ability to market and sell our products.
If we modify our external counterpulsation devices and the modifications
significantly affect safety or effectiveness, or if we make a change to the
intended use, we will be required to submit a new premarket notification or
510(k) to FDA. We would be unable to market the modified device until FDA issues
a clearance for the 510(k).
Additionally, if FDA publishes a regulation requiring a premarket approval
application or PMA for external counterpulsation devices, we would then need to
submit a PMA, and have it filed by the agency, by the date specified by FDA in
its regulation. A PMA requires us to prove the safety and effectiveness of a
device to the FDA. The process of obtaining PMA approval is expensive,
time-consuming, and uncertain. If FDA were to require a PMA application, we may
be required to undertake a clinical study, which likely will be expensive and
require lengthy follow-up, to demonstrate the effectiveness of the device. If we
did obtain PMA approval, any change after approval affecting the safety or
effectiveness of the device will require approval of a PMA supplement.
If we offer new products that require 510(k) clearance or PMA approval, we
will not be able to commercially distribute those products until we receive such
clearance or approval. Regulatory agency approval or clearance for a product may
not be received or may entail limitations on the device's indications for use
that could limit the potential market for any such product. Delays in receipt
of, or failure to obtain or maintain, regulatory clearances and approvals, could
delay or prevent our ability to market or distribute our products. Such delays
could have a material adverse effect on our business.
If we are unable to comply with applicable governmental regulation, we may not
be able to continue our operations.
16
We also must comply with Current Good Manufacturing Practice (CGMP)
requirements as set forth in the Quality System Regulation (QSR) to receive FDA
approval to market new products and to continue to market current products. The
QSR imposes certain procedural and documentation requirements on us with respect
to manufacturing and quality assurance activities, including packaging, storage,
and recordkeeping. Our products and activities are subject to extensive, ongoing
regulation, including regulation of labeling and promotion activities and
adverse event reporting. Also, our FDA registered facilities are subject to
inspection by the FDA and other governmental authorities. Any failure to comply
with regulatory requirements could delay or prevent our ability to market or
distribute our products. Violation of FDA statutory or regulatory requirements
could result in enforcement actions, such as voluntary or mandatory recalls,
suspension or withdrawal of marketing clearances or approvals, seizures,
injunctions, fines, civil penalties, and criminal prosecutions, all of which
could have a material adverse effect on our business. Most states also have
similar postmarket regulatory and enforcement authority for devices.
We cannot predict the nature of any future laws, regulations,
interpretations, or applications, nor can we predict what effect additional
governmental regulations or administrative orders, when and if promulgated,
would have on our business in the future. We may be slow to adapt, or we may
never adapt to changes in existing requirements or adoption of new requirements
or policies. We may incur significant costs to comply with laws and regulations
in the future or compliance with laws or regulations may create an unsustainable
burden on our business.
We may not receive approvals by foreign regulators that are necessary for
international sales.
Sales of medical devices outside the United States are subject to foreign
regulatory requirements that vary from country to country. Premarket approval or
clearance in the United States does not ensure regulatory approval by other
jurisdictions. If we, or any international distributor, fail to obtain or
maintain required pre-market approvals or fail to comply with foreign
regulations, foreign regulatory authorities may require us to file revised
governmental notifications, cease commercial sales of our products in the
applicable countries or otherwise cure the problem. Such enforcement action by
regulatory authorities may be costly.
In order to sell our products within the European Union, we must comply
with the European Union's Medical Device Directive. The CE marking on our
products attests to this compliance. Future regulatory changes may limit our
ability to use the CE mark, and any new products we develop may not qualify for
the CE mark. If we lose this authorization or fail to obtain authorization on
future products, we will not be able to sell our products in the European Union.
We may not be able to manage growth.
If our short and long-term plans are successful, including our clinical
trials, we will experience a period of growth that could place a significant
strain upon our managerial, financial and operational resources. Our
infrastructure, procedures, controls and information systems may not be adequate
to support our operations and to achieve the rapid execution necessary to
successfully market our products. Our future operating results will also depend
on our ability to successfully upgrade our information systems, expand our
direct sales force and our internal sales, marketing and support staff. If we
are unable to manage future expansion effectively, our business, results of
operations and financial condition will suffer, our senior management will be
less effective, and our revenues and product development efforts may decrease.
We depend on management and other key personnel.
We are dependent on a limited number of key management and technical
personnel. The loss of one or more of our key employees may hurt our business if
we are unable to identify other individuals to provide us with similar services.
We do not maintain "key person" insurance on any of our employees. In addition,
our success depends upon our ability to attract and retain additional highly
qualified sales, management, manufacturing and research and development
personnel. We face competition in our recruiting activities and may not be able
to attract or retain qualified personnel.
We may not have adequate intellectual property protection.
Our patents and proprietary technology may not be able to prevent
competition by others. The validity and breadth of claims in medical technology
patents involve complex legal and factual questions. Future patent applications
17
may not be issued, the scope of any patent protection may not exclude
competitors, and our patents may not provide competitive advantages to us. Our
patents may be found to be invalid and other companies may claim rights in or
ownership of the patents and other proprietary rights held or licensed by us.
Also, our existing patents may not cover products that we develop in the future.
Moreover, when our patents expire, the inventions will enter the public domain.
There can be no assurance that our patents will not be violated or that any
issued patents will provide protection that has commercial significance.
Litigation may be necessary to protect our patent position. Such litigation may
be costly and time-consuming, and there can be no assurance that we will be
successful in such litigation.
The loss or violation of certain of our patents and trademarks could have a
material adverse effect upon our business.
Since patent applications in the United States are maintained in secrecy
until patents are issued, our patent applications may infringe patents that may
be issued to others. If our products were found to infringe patents held by
competitors, we may have to modify our products to avoid infringement, and it is
possible that our modified products would not be commercially successful.
We do not intend to pay dividends in the foreseeable future.
We do not intend to pay any cash dividends on our common stock in the
foreseeable future.
Risks Related to Our Industry
Technological change is difficult to predict and to manage.
We face the challenges that are typically faced by companies in the medical
device field. Our product line has required, and any future products will
require, substantial development efforts and compliance with governmental
clearance or approval requirements. We may encounter unforeseen technological or
scientific problems that force abandonment or substantial change in the
development of a specific product or process.
We are subject to product liability claims and product recalls that may not be
covered by insurance.
The nature of our business exposes us to risks of product liability claims
and product recalls. Medical devices as complex as ours frequently experience
errors or failures, especially when first introduced or when new versions are
released.
We currently maintain product liability insurance at $7,000,000 per
occurrence and $7,000,000 in the aggregate. Our product liability insurance may
not be adequate. In the future, insurance coverage may not be available on
commercially reasonable terms, or at all. In addition, product liability claims
or product recalls could damage our reputation even if we have adequate
insurance coverage.
We do not know the effects of healthcare reform proposals.
The healthcare industry is undergoing fundamental changes resulting from
political, economic and regulatory influences. In the United States,
comprehensive programs have been suggested seeking to increase access to
healthcare for the uninsured, control the escalation of healthcare expenditures
within the economy and use healthcare reimbursement policies to balance the
federal budget.
We expect that the United States Congress and state legislatures will
continue to review and assess various healthcare reform proposals, and public
debate of these issues will likely continue. There have been, and we expect that
there will continue to be, a number of federal and state proposals to constrain
expenditures for medical products and services, which may affect payments for
products such as ours. We cannot predict which, if any of such reform proposals
will be adopted and when they might be effective, or the effect these proposals
may have on our business. Other countries also are considering health reform.
Significant changes in healthcare systems could have a substantial impact on the
manner in which we conduct our business and could require us to revise our
strategies.
18
Risks Related to Stock Exchange and SEC Regulation
A continued stock price below $1 could result in our being de-listed from the
Nasdaq and subject us to regulations that could reduce our ability to raise
funds.
By letter dated May 2, 2005, the Company received written notification from
Nasdaq that the bid price of its common stock for the last 30 consecutive
business days had closed below the minimum $1.00 per share required for
continued inclusion under Marketplace Rule 4310(c) (4) (the Rule). In accordance
with Marketplace Rule 4310 (c) (d), the Company has been provided an initial
period of 180 calendar days of until October 31, 2005, to regain compliance. If
at any time before that date the bid price of the Company's common stock closes
at $1.00 per share or more for a minimum of 10 consecutive business days, the
Company will be provided written notification that it is in compliance with the
Rule.
Further, if the Company is not in compliance with the Rule by October 31,
2005, and the Company meets the Nasdaq SmallCap initial listing criteria except
for the bid price requirement, it will be granted an additional 180 calendar
days to April 29, 2006 to comply. In this regard, the Company currently meets
all of the initial listing criteria except for the bid price requirement.
Nasdaq's notification further provides that in the event the Company were
to receive written notification that its securities will be delisted, it
maintains its right to appeal such determination to a Listing Qualifications
Panel.
Ultimately, non-compliance could result in Nasdaq delisting the Company's
common stock. Such delisting could have an adverse effect on the liquidity of
the Company's common stock and could also impact the Company's ability to raise
additional equity capital, if necessary.
In the event that our common stock was de-listed from the Nasdaq SmallCap
Market due to low stock price, we may become subject to special rules, called
penny stock rules that impose additional sales practice requirements on
broker-dealers who sell our common stock. The rules require, among other things,
the delivery, prior to the transaction, of a disclosure schedule required by the
Securities and Exchange Commission relating to the market for penny stocks. The
broker-dealer also must disclose the commissions payable both to the
broker-dealer and the registered representative and current quotations for the
securities, and monthly statements must be sent disclosing recent price
information.
In the event that our common stock becomes characterized as a penny stock,
our market liquidity could be severely affected. The regulations relating to
penny stocks could limit the ability of broker-dealers to sell our common stock
and thus the ability of purchasers of our common stock to sell their common
stock in the secondary market.
We are subject to stock exchange and SEC regulation.
Recent Sarbanes-Oxley legislation and stock exchange regulations have
increased disclosure control, financial reporting, corporate governance and
internal control requirements that will increase the administrative costs of
documenting and auditing internal processes, gathering data, and reporting
information. Our inability to comply with the requirements would significantly
impact our market valuation.
Our common stock is subject to price volatility.
The market price of our common stock has been and is likely to continue to
be highly volatile. Our stock price could be subject to wide fluctuations in
response to various factors beyond our control, including:
-- quarterly variations in operating results;
-- announcements of technological innovations, new products or pricing by
our competitors;
-- the rate of adoption by physicians of our technology and products in
targeted markets;
-- the timing of patent and regulatory approvals;
-- medical reimbursement
-- the timing and extent of technological advancements;
-- results of clinical studies;
-- the sales of our common stock by affiliates or other shareholders with
large holdings; and
-- general market conditions.
Our future operating results may fall below the expectations of securities
industry analysts or investors. Any such shortfall could result in a significant
decline in the market price of our common stock. In addition, the stock market
has experienced significant price and volume fluctuations that have affected the
19
market price of the stock of many medical device companies and that often have
been unrelated to the operating performance of such companies. These broad
market fluctuations may directly influence the market price of our common stock.
Recent corporate scandals involving alleged accounting irregularities have
resulted in unavailability of, or significantly higher premiums for, director
and officer liability insurance.
As a result of recent well-publicized corporate business failures alleged
to have involved improper acts by executives and accounting irregularities,
director and officer liability insurance has become more difficult to obtain and
the premiums for such insurance have increased significantly. If we are unable
to obtain director and officer liability insurance at rates that are reasonable
or at all, we may not be able to retain our current officers and directors or
attract qualified directors and officers in the future.
Additional Information
We are subject to the reporting requirements under the Securities Exchange
Act of 1934 and are required to file reports and information with the Securities
and Exchange Commission (SEC), including reports on the following forms: annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and amendments to those reports files or furnished pursuant to Section
13(a) or 15(d) of the Securities Act of 1934.
ITEM 2 - PROPERTIES
We own our 18,000 square foot headquarters and manufacturing facility at
180 Linden Avenue, Westbury, New York 11590. We lease approximately 7,100 square
feet of additional warehouse space under two operating leases with
non-affiliated landlords, of which one expires in October 2005, and the other in
September 2006, plus additional parking locations in the area at an annual cost
of approximately $92,000. We believe that we can renegotiate the lease that will
expire in October 2005, or lease other available space under reasonable terms
and that these combined facilities are adequate to meet our current needs and
should continue to be adequate for the immediately foreseeable future.
ITEM 3 - LEGAL PROCEEDINGS
There were no material legal proceedings under applicable rules.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of the fiscal year.
20
PART II
ITEM 5 - MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY
HOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock trades on the Nasdaq SmallCap Market tier of The Nasdaq
Stock Market(SM) under the symbol VASO. The number of record holders of common
stock as of August 1, 2004, was approximately 1,100, which does not include
approximately 27,600 beneficial owners of shares held in the name of brokers or
other nominees. The table below sets forth the range of high and low trade
prices of the common stock as reported by the Nasdaq SmallCap Market tier of The
Nasdaq Stock Market(SM) for the fiscal periods specified.
Fiscal 2005 Fiscal 2004
High Low High Low
First Quarter $1.27 $0.83 $1.55 $0.84
Second Quarter $1.25 $0.90 $1.59 $0.86
Third Quarter $1.52 $0.90 $2.34 $1.00
Fourth Quarter $1.98 $0.57 $1.94 $1.10
The last bid price of the Company's common stock on August 1, 2005, was
$0.61 per share.
Notice of Failure to Satisfy a Continued Listing Rule
By letter dated May 2, 2005, the Company received written notification from
Nasdaq that the bid price of its common stock for the last 30 consecutive
business days had closed below the minimum $1.00 per share required for
continued inclusion under Marketplace Rule 4310(c) (4) (the Rule). In accordance
with Marketplace Rule 4310 (c) (d), the Company has been provided an initial
period of 180 calendar days of until October 31, 2005, to regain compliance. If
at any time before that date the bid price of the Company's common stock closes
at $1.00 per share or more for a minimum of 10 consecutive business days, the
Company will be provided written notification that it is in compliance with the
Rule.
Further, if the Company is not in compliance with the Rule by October 31,
2005, and the Company meets the Nasdaq SmallCap initial listing criteria except
for the bid price requirement, it will be granted an additional 180 calendar
days to April 29, 2006, to comply. In this regard, the Company currently meets
all of the initial listing criteria except for the bid price requirement.
Nasdaq's notification further provides that in the event the Company were
to receive written notification that its securities will be delisted, it
maintains its right to appeal such determination to a Listing Qualifications
Panel.
Ultimately, non-compliance could result in Nasdaq delisting the Company's
common stock. Such delisting could have an adverse effect on the liquidity of
the Company's common stock and could also impact the Company's ability to raise
additional equity capital, if necessary.
Dividend Policy
We have never paid any cash dividends on our common stock. While we do not
intend to pay cash dividends in the foreseeable future, payment of cash
dividends, if any, will be dependent upon our earnings and financial position,
investment opportunities and such other factors as the Board of Directors deems
pertinent. Stock dividends, if any, also will be dependent on such factors as
the Board of Directors deems pertinent.
Recent Sales of Unregistered Securities.
On July 19, 2005, we entered into a Securities Purchase Agreement that will
provide us with gross proceeds of $2.5 million through a private placement of
preferred stock with M.A.G. Capital, LLC through its designated funds, Monarch
Pointe Fund Ltd., Mercator Momentum Fund III, LP, and Mercator Momentum Fund, LP
(the "Investors"). We received $1.75 million or 70% of the gross proceeds on
July 19, 2005 and the balance of $750,000 is expected to be received upon the
filing of the registration statement (see below). The agreement provides for a
private placement of 25,000 shares of our Series D Preferred Stock at $100 per
share. By the placement of the preferred stock, we became obligated to pay a
cash dividend monthly on the outstanding shares of preferred stock. The dividend
rate is the higher of (i) the prime rate as reported by the Wall Street Journal
on the first day of the month, plus three percent or, (ii) 8.5% times $100 per
share, but in no event greater than 10% annually.
21
ITEM 6 - SELECTED FINANCIAL DATA
The following table summarizes selected financial data for each of the five
years ended May 31 as derived from our audited consolidated financial
statements. These data should be read in conjunction with our consolidated
financial statements, related notes and other financial information.
Fiscal Year Ended May 31,
2005 2004 2003 2002 2001
Statements of Earnings
Revenues $15,095,778 $22,207,037 $24,823,619 $34,830,471 $27,508,338
Cost of sales and services 5,504,535 7,590,103 9,251,221 10,538,731 7,910,359
-------------- -------------- --------------- -------------- ---------------
Gross profit 9,591,243 14,616,934 15,572,398 24,291,740 19,597,979
Selling, general & administrative expenses 12,006,774 12,910,997 13,714,913 13,686,958 11,634,965
Research and development expenses 3,064,683 3,748,389 4,544,822 5,112,258 2,554,470
Provision for doubtful accounts 11,084 1,296,759 3,728,484 1,304,000 325,000
Interest and financing costs 105,232 132,062 186,574 98,140 48,294
Interest and other income, net (74,153) (99,393) (176,724) (249,722) (201,992)
-------------- -------------- --------------- -------------- ---------------
15,113,620 17,988,814 21,998,069 19,951,634 14,360,737
-------------- -------------- --------------- -------------- ---------------
Earnings (loss) before income taxes (5,522,377) (3,371,880) (6,425,671) 4,340,106 5,237,242
Income tax (expense) benefit, net (39,661) (50,640) 1,634,688 (1,554,000) 6,457,108
-------------- -------------- --------------- -------------- ---------------
Net earnings (loss) $ (5,562,038) $(3,422,520) $(4,790,983) $2,786,106 $11,694,350
============== ============== =============== ============== ===============
Net earnings (loss) per common share
- basic $(0.10) $(0.06) $(0.08) $0.05 $0.21
============== ============== =============== ============== ===============
- diluted $(0.10) $(0.06) $(0.08) $0.05 $0.20
============== ============== =============== ============== ===============
Weighted average common shares
outstanding - basic 58,547,574 57,981,963 57,647,032 57,251,035 56,571,402
============== ============== =============== ============== ===============
- diluted 58,547,574 57,981,963 57,647,032 59,468,092 59,927,199
============== ============== =============== ============== ===============
Balance Sheet Data
Cash, cash equivalents, and certificates of
deposit $2,747,967 $7,545,589 $5,222,847 $2,967,627 $3,785,456
Working capital $3,932,769 $9,771,870 $11,478,092 $17,225,434 $16,214,655
Total assets $25,361,470 $33,023,615 $35,327,550 $41,418,258 $36,518,974
Long-term debt $947,597 $1,092,837 $1,177,804 $1,072,716 $1,108,593
Stockholders' equity (1) $19,162,797 $24,594,169 $27,319,302 $31,602,604 $28,508,729
___________________
(1) No cash dividends on common stock were declared during any of the above periods.
22
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains descriptions of our expectations regarding future
trends affecting our business. These forward looking statements and other
forward-looking statements made elsewhere in this document are made under the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Please read the section titled "Risk Factors" in "Item One - Business" to review
certain conditions, among others, which we believe could cause results to differ
materially from those contemplated by the forward-looking statements.
Forward-looking statements are identified by words such as "anticipates",
"believes", "could", "estimates", "expects", "feels", "intends", "may", "plans",
"potential", and "projects" and similar expressions. In addition, any statements
that refer to our plans, business plan, expectations, strategies or other
characterizations of future events or circumstances are forward-looking
statements. Such forward-looking statements are based on our beliefs, as well as
assumptions made by and information currently available to us. Among the factors
that could cause actual results to differ materially are the following: the
effect of the dramatic changes taking place in the healthcare environment; the
impact of medical insurance reimbursement policies; competitive procedures and
products and their pricing; unexpected manufacturing problems; unforeseen
difficulties and delays in the conduct of clinical trials and other product
development programs; the actions of regulatory authorities and third-party
payers in the United States and overseas; uncertainties about the acceptance of
a novel therapeutic modality by the medical community; and the risk factors
reported from time to time in our SEC reports. We undertake no obligation to
update forward-looking statements as a result of future events or developments.
The following discussion should be read in conjunction with financial
statements and notes thereto included in this Annual Report on Form 10-K.
Overview
Vasomedical, Inc. incorporated in Delaware in July 1987 is primarily
engaged in designing, manufacturing, marketing and supporting EECP(R) external
counterpulsation systems based on our proprietary technology. EECP therapy is a
non-invasive, outpatient therapy for the treatment of diseases of the
cardiovascular system. The therapy serves to increase circulation in areas of
the heart with less than adequate blood supply and may restore systemic vascular
function. We provide hospitals and physician private practices with EECP
equipment, treatment guidance, and a staff training and equipment maintenance
program designed to provide optimal patient outcomes. EECP is a registered
trademark for Vasomedical's enhanced external counterpulsation systems.
We have Food and Drug Administration (FDA) clearance to market our EECP
therapy for use in the treatment of stable and unstable angina, congestive heart
failure, acute myocardial infarction, and cardiogenic shock, however our current
marketing efforts are limited to the treatment of stable angina and congestive
heart failure indications. Within the stable angina and CHF indications,
Medicare and other third-party payers currently reimburse for stable angina
patients with moderate to severe symptoms who are refractory to medications and
not candidates for invasive procedures. CHF patients are also reimbursed under
the same criteria, provided their primary symptoms are angina.
We are also actively engaged in research to establish the potential
benefits of EECP therapy in the management of CHF and sponsored a pivotal study
to demonstrate the efficacy of EECP therapy in the most prevalent types of heart
failure patients. This study, known as PEECH (Prospective Evaluation of EECP in
Congestive Heart Failure), is intended to provide additional clinical data in
order to support our application for expanded Medicare national coverage policy
for the use of EECP therapy in the treatment of CHF. The preliminary results of
the trial were presented at the American College of Cardiology scientific
sessions in March 2005, and we expect the results of the PEECH clinical trial to
be published in a peer-reviewed journal before the end of the calendar year. On
May 31, 2005 we submitted an application to the Centers for Medicare and
Medicaid Services (CMS) for expanded coverage of EECP therapy to include CHF as
a primary indication, as well as additional patients with angina.
Results of Operations
Fiscal Years Ended May 31, 2005 and 2004
We generated revenues from the sale, lease and service of our EECP therapy
systems of $15,095,778 and $22,207,037 for the years ended May 31, 2005 and
2004, respectively, reflecting a decrease of $7,111,259 or 32%. Our loss was
$5,562,038 or $0.10 per share and $3,422,520 or $0.06 per share for the years
ended May 31, 2005 and 2004, respectively.
23
Revenues
Revenues from equipment sales declined approximately 40% to $11,516,883 for
the year ended May 31, 2005, as compared to $19,302,593 for the prior year. The
decline in equipment sales is due primarily to a 41% decline in domestic units
shipped, a 5% decline in the average sales prices of new EECP systems sold in
the domestic market, and an unfavorable product mix reflecting a higher portion
of used versus new equipment shipments. Used systems earned a lower average
selling price compared to new systems, and experienced a 29% decrease in average
selling price when compared to used systems sold in the domestic market in
fiscal 2004.
We believe the decline in domestic units shipped reflects weakened demand
in the refractory angina market as existing capacity is more fully utilized,
coupled with increased competition from surgical procedures, mainly the use of
drug-eluting stents. We anticipate that demand for EECP systems will remain soft
until a projected expansion of the current CMS national reimbursement policy for
use of EECP therapy to treat congestive heart failure patients is obtained. If
we are unable to obtain an adequate national Medicare coverage policy for
treatment procedures using the EECP therapy system in CHF, it would adversely
affect our business prospects. In addition, average domestic selling prices
continue to decline reflecting the impact in the market of lower priced
competitive products. We continue to believe that our EECP systems currently
sell at a significant price premium to competitive products reflecting the
clinical efficacy and superior quality of the EECP therapy system plus the many
value added services offered by us. However, we anticipate that this current
trend of declining prices will continue in the immediate future as our
competition attempts to capture greater market share through pricing discounts.
In addition, we sold an unusually high percentage of used equipment, which
reflected the availability of used EECP systems that had been recovered from a
former customer, as well as EECP systems that had been used to treat patients in
the PEECH clinical trial but were no longer required since the trial has been
completed. These used systems were sold at average sales prices significantly
below our new systems. We sell used equipment as available to help lessen the
impact of price sensitive situations. Lastly, we continue to reorganize certain
territory responsibilities in our sales department due to vacant and/or
unproductive territories, completed the restructuring of a major independent
distributor territory to direct sales, and reduced the number of sales
territories to 15 from 21.
Our revenue from the sale of EECP systems to international distributors for
the year ended May 31, 2005, increased approximately 64% to $1,315,985 compared
to $801,600 in the prior year reflecting increased volume of new systems and
improved average selling prices.
The above decline in revenue from domestic equipment sales was partially
offset by a 23% increase in revenue from equipment rental and services for year
ended May 31, 2005, as compared to the prior year. Revenue from equipment rental
and services represented 24% of total revenue in fiscal 2005 compared to 13% in
fiscal 2004. The increase in both absolute amounts and percentage of total
revenue resulted primarily from an increase of approximately 30% in service
related revenue. The higher service revenue reflects an increase in service,
spare parts and consumables as a result of the continued growth of the installed
base of EECP systems plus greater marketing focus on the sale of extended
service contracts. Rental revenue declined approximately 15% following the
termination of several short-term rental agreements partially offsetting the
above.
Reimbursement continues to play a critical role in the adoption of EECP
therapy. Medicare dropped the payment rates 34% from $208 per hour to $137 per
hour for physicians at the beginning of calendar year 2004. The current
reimbursement rate is now set at the rates near when the product first received
Medicare coverage in 2000, which makes it more difficult for a private physician
practice to financially justify an investment to provide EECP therapy. It is
difficult for us to determine the exact impact this decline has had on the
market for EECP therapy. Additionally, the impact from the drop in reimbursement
has been partially offset by the decline in average selling prices. We believe
that EECP therapy continues to offer an attractive addition to the physician
private practice, plus the company has continued to support its customers in
gaining positive reimbursement coverage from other third-party payers during the
past year. EECP therapy is now covered by the majority of private insurers for
treating angina patients, including many of the leading Blue Cross Blue Shield
plans, who typically are the most difficult payers to adopt coverage for new
technologies.
Gross Profit
Gross profit declined to $9,591,243 or 64% of revenues for the year ended
May 31, 2005, compared to $14,616,934 or 66% of revenues for the year ended May
31, 2004. Gross profit margin as a percentage of revenue for the year ended May
31, 2005, declined compared to the same period of the prior fiscal year
24
reflecting reduced margins from EECP equipment sales due to the negative impact
resulting from the reduction in average selling prices. The gross profit for
rentals and services improved both in absolute amount and as a percentage of
revenue reflecting increased service resulting from accessory and service
contract revenue increases exceeding associated cost increases. The decline in
gross profit when compared to the prior year in absolute dollars is a direct
result of the lower revenue.
Gross profits are dependent on a number of factors, particularly the mix of
EECP models sold and their respective average selling prices, the mix of EECP
units sold, rented or placed during the period, the ongoing costs of servicing
such units, and certain fixed period costs, including facilities, payroll and
insurance. Gross profit margins are generally less on non-domestic business due
to the use of distributors resulting in lower selling prices. Consequently, the
gross profit realized during the current period may not be indicative of future
margins.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses for the years ended
May 31, 2005 and May 31, 2004 were $12,006,774 or 80% of revenues and
$12,910,997 or 58% of revenues, respectively, reflecting a decrease of $904,223
or 7%. The decrease in SG&A expenditures in fiscal 2005 compared to fiscal 2004
resulted primarily from a $590,192 decrease in administrative consulting and
severance fees, $103,637 lower promotional allowances, and $118,002 lower
advertising costs, partially offset by $150,910 higher market research fees and
$142,193 higher trade show costs. On May 5, 2005, the Company announced an
initiative to improve alignment of operations to pursue the CHF market. This
initiative, which included a workforce reduction plus tighter expense control,
is expected to provide a clear focus on CHF investment and to reduce total
operating expenses and other costs by approximately $3,000,000 in fiscal 2006.
Research and Development
Research and development ("R&D") expenses of $3,064,683 or 20% of revenues
for the year ended May 31, 2005, decreased by $683,706 or 18%, from the year
ended May 31, 2004, of $3,748,389 or 17% of revenues. The decrease reflects
lower spending related to the PEECH clinical trial following completion of the
clinical treatment portion of the trial in fiscal year 2004, partially offset by
increased expenditures for developing the new Lumenair(TM) EECP(R) Therapy
System, which was launched in November 2004.
Provision for Doubtful Accounts
During the year ended May 31, 2005, we charged $11,084 to our provision for
doubtful accounts as compared to $1,296,759 during the year ended May 31, 2004.
The decrease was due primarily to a $680,000 provision made in the prior fiscal
period associated with the write-off of all funds due from a major customer that
ceased operations in December 2003.
Interest Expense and Financing Costs
Interest expense and financing costs decreased to $105,232 in the year
ended May 31, 2005, from $132,062 for the prior year reflecting a reduction in
outstanding debt. Interest expense reflects interest on loans secured to
refinance the November 2000 purchase of our headquarters and warehouse facility,
as well as on loans secured to finance the cost and implementation of a new
management information system.
Interest and Other Income, Net
Interest and other income for the fiscal years of 2005 and 2004, was
$74,153 and $99,393, respectively. The decrease in interest and other income
from the prior year is the direct result of the absence of interest income
related to certain equipment sold under sales-type leases incurred in fiscal
2004 and lower miscellaneous customer payments, partially offset by higher
interest income due to improved yields.
Income Tax Expense, Net
During the years ended May 31, 2005, and May 31, 2004, we recorded a
provision for state income taxes of $39,661 and $50,640, respectively.
As of May 31, 2005, we had recorded deferred tax assets of $14,582,000 net
of a $3,774,000 valuation allowance related to the anticipated recovery of tax
loss carryforwards. The amount of the deferred tax assets considered realizable
could be reduced in the future if estimates of future taxable income during the
carryforward period are reduced. Ultimate realization of the deferred tax assets
25
is dependent upon our generating sufficient taxable income prior to the
expiration of the tax loss carryforwards. We believe that the Company is
positioned for long-term growth despite the losses during fiscal years 2005,
2004 and 2003, and that based upon the weight of available evidence, that it is
"more likely than not" that net deferred tax assets will be realized. The "more
likely than not" standard is subjective, and is based upon management's estimate
of a greater than 50% probability that its long range business plan can be
realized.
Ultimate realization of any or all of the deferred tax assets is not
assured, due to significant uncertainties and material assumptions associated
with estimates of future taxable income during the carryforward period. Our
estimates are largely dependent upon achieving considerable growth in revenue
and profits resulting from the successful commercialization of EECP therapy into
the congestive heart failure indication, which we believe will enable us to
reverse the current trend of increasing losses and generate pre-tax income in
excess of $39 million over the next seven years in order to fully utilize all of
the deferred tax assets. Such estimates of future taxable income are based on
our beliefs, as well as assumptions made by and information currently available
to us. Certain critical assumptions associated with our estimates include:
-- that the results from the PEECH clinical trial, as disclosed in "Item
1 - Business" of this Form 10K, as well as other clinical evidence are
sufficiently positive for the PEECH clinical trial to be published in
a peer-reviewed journal and to enable EECP therapy to obtain approval
of a national Medicare reimbursement coverage policy plus other
third-party payer reimbursement policies inclusive of the congestive
heart failure indication;
-- that the reimbursement coverage will be both broad enough in terms of
coverage language and at an amount adequate to enable successful
commercialization of EECP therapy into the congestive heart failure
indication and enable us to achieve material growth in revenue and
profits;
-- that EECP therapy will be sufficiently accepted by the medical
community as an adjunctive therapy for the treatment of patients
suffering from congestive heart failure; and
-- that we will be able to secure additional financing to provide
sufficient funds to market EECP therapy in the congestive heart
failure indication.
Additional uncertainties that could cause actual results to differ
materially are the following:
-- the effect of the dramatic changes taking place in the healthcare
environment;
-- the impact of competitive procedures and products and their pricing;
-- other medical insurance reimbursement policies;
-- there can be no assurance that we will be able to raise additional
capital necessary to implement our business plan;
-- unexpected manufacturing problems;
-- unforeseen difficulties and delays in the conduct of clinical trials,
peer-reviewed publications and product development programs;
-- the actions of regulatory authorities and third-party payers in the
United States and overseas;
-- uncertainties about the acceptance of a novel therapeutic modality by
the medical community;
-- our recent financial history of declining revenues and losses; and
-- the risk factors reported from time to time in our SEC reports.
Factors considered by us in making our assumptions and included in our
long-term business plan are the following:
-- we currently have FDA clearance to market EECP therapy in congestive
heart failure;
-- independent market research indicates that the patient population
potentially eligible for EECP therapy in congestive heart failure
market is larger than the current refractory angina patient population
and when the two patient populations are combined the total market
opportunity for EECP therapy will be more than double;
-- many physician practices have told us that they do not have a
sufficient number of patients to economically justify adoption of the
procedure with the current reimbursement coverage for refractory
angina. The increased market size resulting from the addition of CHF
patients could improve the economic model for the physician practice;
-- we have positive clinical evidence from the PEECH clinical trial that
was recently concluded, plus other smaller clinical trials and the
IEPR patient registry that demonstrates the clinical effectiveness of
EECP therapy in the treatment of congestive heart failure to medical
providers, payers and regulators;
26
-- we completed the PEECH clinical trial this fiscal year as planned and
disclosed the summary results of the trial in March 2005;
-- we intend to have the results of the PEECH trial published in a
peer-reviewed journal, which is an important step necessary to support
an application to CMS to expand reimbursement coverage of EECP therapy
to include CHF patients;
-- we sustained a period of profitability in fiscal years 2000, 2001 and
2002 with profits before income taxes of $1,290,916, $5,237,242 and
$4,240,106, respectively; and
-- we continue to believe that we will be able to raise sufficient funds
to enable us to execute our business plan.
While we believe that we will be able to execute our business plan over the
longer term and we will be able to utilize our tax loss carryforwards, the exact
timing of our return to profitability is uncertain, subject to significant
management judgments and estimates and dependent on a variety of external
factors including: market conditions at that time, the reception of EECP therapy
by medical professionals and payers and the timing of a Medicare reimbursement
decision. It is possible that significant tax loss carryforwards from fiscal
years 2005, 2006 and 2007 may expire before we are able to use them. As a result
of these uncertainties, beginning in fiscal 2004, we began to provide a
valuation reserve for all additional tax loss carryforwards that were generated
by current operating losses. We review this policy on a quarterly basis and
believe that the above valuation reserve is appropriate under the current
circumstances.
The amount of the deferred tax assets considered realizable could be
reduced in the future if estimates of future taxable income during the
carryforward period are reduced.
The recorded deferred tax asset and increase to the valuation allowance
during the year ended May 31, 2005 and 2004, was $1,866,000 and $1,286,000,
respectively.
Fiscal Years Ended May 31, 2004 and 2003
Summary
We generated revenues from the sale, lease and service of our EECP systems
of $22,207,037 and $24,823,619 for the years ended May 31, 2004 and 2003,
respectively, reflecting a decrease of $2,616,582 or 11%. Our loss before income
taxes was $3,371,880 and $6,425,671 for the years ended May 31, 2004 and 2003,
respectively. We reported a net loss of $3,422,520 and $4,790,983 for the years
ended May 31, 2004 and 2003, respectively.
Revenues
The decline in revenues in fiscal year 2004 compared to fiscal year 2003 is
due primarily to lower revenue from the sale of EECP therapy systems in the
domestic market. Domestic equipment revenue for fiscal 2004 declined
approximately 15% compared to prior year due to: a reduction in the average
sales price for EECP therapy systems of approximately 12%; a higher proportion
of used equipment compared to new equipment sold during fiscal year 2004
compared to 2003, plus adoption of the provisions of EITF 00-21. Revenue in
fiscal year 2004 reflects a 115% increase in the sale of used equipment to the
domestic market. This increase in used equipment sales reflects primarily an
increase in used equipment available for sale following the completion of the
PEECH trial and the repossession of EECP systems from previous sales-type lease
customers. In September 2003, we adopted "Revenue Arrangements with Multiple
Deliverables", ("EITF 00-21"). During the nine months following adoption of the
provisions of EITF 00-21, as a result of the adoption of the new policy, we
deferred $92,500 of revenue related to the fair value of installation and
in-service training and $658,333 of revenue related to the warranty service for
EECP system sales, which would have previously been recognized as revenue during
the period. International shipments of EECP systems declined approximately 24%
to $850,333 due to a higher sales rate in the previous year following receipt of
the CE Mark. This was partially offset by a 47% increase in revenue from
equipment rental and services reflecting an increase of approximately 94% in
service related revenue. The higher service revenue reflects an increase in
service, spare parts and consumables as a result of the continued growth of the
installed base of EECP systems and greater marketing focus on the sale of
extended service contracts. Rental revenue declined approximately 27% during the
period reflecting fewer outstanding rental agreements and lower average rental
prices.
Gross Profit
Gross profit was $14,616,934 or 66% of revenues for the year ended May 31,
2004, compared to $15,572,398 or 63% of revenues for the year ended May 31,
2003. Gross profit margin as a percentage of revenue for the twelve-month period
27
ended May 31, 2004, improved compared to the same year of the prior fiscal year
despite the lower revenue and the impact from the reduction in average selling
prices. The improvement in gross profit as a percentage of sales reflects the
decline in expenditures for service related parts, travel and personnel for the
year ended May 31, 2004, when compared to same period of the prior year. In
addition, the gross profit margin benefited from the sale of an unusually high
percentage of used equipment when compared to the prior year. These systems
carried lower book values since they were partially amortized and as a result
generated above average margins. The decline in gross profit when compared to
the prior year in absolute dollars is a direct result of the lower sales volume.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses for the year ended
May 31, 2004 and 2003 were $12,910,997 or 58% of revenues as compared to
$13,714,913 or 55% of revenues, respectively. The decrease of SG&A resulted
primarily from a one-time $600,000 charge arising from the settlement of
litigation in the prior year plus a severance charge for approximately $300,000
in the prior year, as well as lower marketing expenditures, primarily for
outside services and promotional spending for print and electronic media during
fiscal year 2004, as compared to fiscal year 2003. The above decreases were
partially offset by higher administrative and selling expenses, which reflected
increased insurance costs and continued investment in our direct sales force,
consisting of additional personnel and higher incentive and travel costs.
Research and Development
Research and development ("R&D") expenses of $3,748,389 or 17% of revenues
for fiscal year 2004, decreased by $796,433, or 18%, from fiscal year 2003
expenses of $4,544,822, or 18% of revenues. The decrease is due primarily to
reduced clinical study expenditures related to the completion of several smaller
clinical studies and, at several sites, the patient treatment phase of the PEECH
study. This decrease was partially offset by increased product development costs
related to new EECP system models and improvements.
Provision for Doubtful Accounts
During the year ended May 31, 2004, we charged $1,296,759 to our provision
for doubtful accounts as compared to $3,728,484 during the year ended May 31,
2003. In fiscal 2004, these charges reflect management decision in the second
quarter of fiscal 2004 to record a $680,000 provision to the allowance for
doubtful accounts, which represents all funds due from a sales-type lease
customer. We sold our EECP systems to a major customer engaged in establishing
independent networks of EECP treatment centers under a sales-type lease
aggregating revenues of $1,271,888. No additional equipment was sold to this
customer during fiscal 2003 or 2004. This customer became delinquent in its
scheduled monthly payments during the fourth quarter of fiscal 2003. During the
first and second quarters of fiscal 2004 the customer attempted to remedy the
situation and made payments to us totaling $70,000. In December 2003, the
customer ceased operations. Additional provisions for all other accounts totals
approximately $616,759. In fiscal 2003, these charges primarily resulted from
approximately a $3.0 million write-off of receivables with respect to another
major customer, comprised of $2.5 million for the capital lease and $500,000 in
notes receivable, as well as specific reserves against certain international
accounts for which extended credit terms were offered.
Interest Expense and Financing Costs
Interest expense and financing costs decreased to $132,062 in the year
ended May 31, 2004, from $186,574 for the same period in the prior year due to
repayment of our revolving secured credit facility in May 2003, which resulted
in lower average outstanding borrowings during the fiscal year.
Interest and Other Income, Net
Interest income and other income for the years ended May 31, 2004, and May
31 2003, was $99,393 and $176,724, respectively. The decrease in interest income
from the prior year is the direct result of the absence of interest income
related to certain equipment sold under sales-type leases incurred in fiscal
2003, as well as declining interest rates this year over last year earned on the
average cash balances. Higher average cash balances invested during the year
ended May 31, 2004, compared to the prior period partially offset the above.
28
Income Tax (Expense) Benefit, Net
During the fiscal year ended May 31, 2004, we recorded a provision for
state income taxes of $50,640. This is in contrast to an income tax benefit of
$1,634,688 reported during the fiscal year ended May 31, 2003.
As of May 31, 2004, we had recorded deferred tax assets of $14,582,000 net
of a $1,908,000 valuation allowance related to the anticipated recovery of tax
loss carryforwards.
The recorded deferred tax asset and increase to the valuation allowance
during the fiscal year ended May 31, 2004 was $1,286,000.
Liquidity and Capital Resources
Cash and Cash Flow
We have financed our operations in fiscal 2005 and 2004 primarily from
operations and working capital. At May 31, 2005, we had a cash, cash
equivalents, and certificates of deposit balance of $2,747,967 and working
capital of $3,932,769 as compared to a cash balance of $7,545,589 and working
capital of $9,771,870 at May 31, 2004. Our cash, cash equivalents, and
certificates of deposit balances decreased $4,797,622 in fiscal year 2005
primarily due to the net loss of $5,562,038.
The decrease in cash used by our operating activities of $4,594,584
resulted primarily from the net loss of $5,562,038 plus increases in inventory
of $1,295,294, decreases in accounts payable and accrued liabilities of
$1,662,193 and decreases in other long term liabilities of $435,074. The above
was partially offset by reduced accounts receivable, which provided cash of
$3,618,767. Net accounts receivable were 50% of quarterly revenues for the
three- month period ended May 31, 2005, compared to 93% at the end of the
three-month period ended May 31, 2004, and net accounts receivable turnover
improved to 4.1 times as of May 31, 2005, as compared to 3.4 times as of May 31,
2004. We have tightened our sales credit policy, reduced extended payment terms
and provide routine oversight with respect to our accounts receivable credit and
collection efforts.
Standard payment terms on our domestic equipment sales are generally net 30
to 90 days from shipment and do not contain "right of return" provisions. We
have historically offered a variety of extended payment terms, including
sales-type leases, in certain situations and to certain customers in order to
expand the market for our EECP products in the US and internationally. Such
extended payment terms were offered in competitive situations, when opening new
markets or geographies or for repeat customers. Extended payment terms cover a
variety of negotiated terms, including payment in full - net 120, net 180 days
or some fixed or variable monthly payment amount for a six to twelve month
period followed by a balloon payment, if applicable. During the fiscal years
ended May 31, 2005 and 2004, approximately 3% and 1% of revenues, respectively,
were generated from sales in which payment terms were greater than 90 days and
we offered no sales-type leases during either period. In general, reserves are
calculated on a formula basis considering factors such as the aging of the
receivables, time past due, and the customer's credit history and their current
financial status. In most instances where reserves are required, or accounts are
ultimately written-off, customers have been unable to successfully implement
their EECP program. As we are creating a new market for the EECP therapy and
recognizing the challenges that some customers may encounter, we have opted, at
times, on a customer-by- customer basis, to recover our equipment instead of
pursuing other legal remedies, which has resulted in our recording of a reserve
or a write-off.
Non-cash adjustments for depreciation, amortization, allowance for doubtful
accounts and allowance for inventory write-offs to reconcile the net loss of
$5,562,038 to net cash provided by operating activities total $756,286.
Investing activities used net cash of $778,101 during the fiscal year ended
May 31, 2005, reflecting investment associated with the purchase of short-term
certificates of deposit and treasury bills of $ $3,747,903 offset by redemptions
of $3,170,000, and the purchase of property and equipment of $200,198.
Financing activities used net cash of $2,840 during the fiscal year ended
May 31, 2005, reflecting payments of principal on notes and loans of $133,506
partially offset by $130,666 received form the exercise of stock options.
We cancelled our line of credit in August 2004 and do not currently have an
available line of credit.
Sale of Convertible Preferred Stock and Warrants
On July 19, 2005, we entered into a Securities Purchase Agreement that will
provide us with gross proceeds of $2.5 million through a private placement of
preferred stock with M.A.G. Capital, LLC through its designated funds, Monarch
Pointe Fund Ltd., Mercator Momentum Fund III, LP, and Mercator Momentum Fund, LP
(the "Investors"). We received $1.75 million or 70% of the gross proceeds on
July 19, 2005 and the balance of $750,000 is expected to be received upon the
filing of the registration statement (see below). The agreement provides for a
29
private placement of 25,000 shares of Vasomedical's Series D Preferred Stock at
$100 per share. The preferred stock is convertible into shares of Vasomedical's
common stock at 85 percent of the volume weighted average price per share for
the five trading days preceding any conversion, but not at more than $0.6606 or
less than $0.40 per share. After registering the shares of common stock that
could be acquired through conversion of the preferred shares, Vasomedical may,
at its option, require the holders to convert all their preferred stock into
common shares if the market price for the common stock for the preceding 20
trading days has been $1.30 or more per share. Such a conversion by Vasomedical
is not allowed if it would make the stock held by the Investors through this
transaction and the conversion exceed 9.99% of the common stock outstanding. The
Investors also acquired warrants for the purchase of 1,892,219 shares of common
stock. The warrants may be exercised at a price of $0.6936 per share for a term
of five years, ending July 18, 2010. Under the terms of a Registration Rights
Agreement with the Investors, Vasomedical is to file a registration statement
with the Securities and Exchange Commission by September 2, 2005, for the shares
of common stock underlying the preferred stock and the warrants.
By the placement of the preferred stock described above, we became
obligated to pay a cash dividend monthly on the outstanding shares of preferred
stock. The dividend rate is the higher of (i) the prime rate as reported by the
Wall Street Journal on the first day of the month, plus three percent or, (ii)
8.5% times $100 per share, but in no event greater than 10% annually.
An event of default occurs if Vasomedical fails to timely pay the dividend,
fails to timely file a registration statement for the shares of common stock
underlying the preferred shares and the warrants, or has not obtained
effectiveness of the registration statement by December 1, 2005, among other
specified occurrences. Upon an event of default, the price at which the
preferred stock may be converted into common stock is reduced from 85 percent to
75 percent of the then current volume weighted average market price per share,
but not more than $0.6606 or less than $0.30 per share. In addition, the holders
of the preferred stock have the right to be paid first from the assets of
Vasomedical upon any dissolution or liquidation of the company. If the
registration statement is not timely filed or declared effective by the
Securities and Exchange Commission, Vasomedical is to pay the Investors $1,467
in cash for each day of delay.
These securities were offered and sold to the Investors in a private
placement transaction made in reliance upon exemptions from registration
pursuant to Section 4(2) of the Securities Act of 1933. The Investors are
accredited investors as defined in Rule 501 of Regulation D promulgated under
the Securities Act of 1933. Vasomedical intends to apply the funds for working
capital.
Liquidity
We believe that our cash flow from operations together with our current
cash reserves and the cash received for the sale of convertible preferred stock
and warrants on July 19, 2005, will be sufficient to fund our business plan and
projected capital requirements through at least May 31, 2006. However, we have
incurred significant losses during the last three fiscal years and our long-term
ability to maintain current operations is dependent upon achieving profitable
operations, which is largely dependent upon the successful commercialization of
EECP therapy into the congestive heart failure indication, and depends in part
upon the acceptance of the results of the PEECH clinical trial by the medical
community and expanded reimbursement coverage to include CHF as being sufficient
to promote the adoption of EECP therapy in CHF; or through additional debt or
equity financing. In the event that additional capital is required, we may seek
to raise such capital through public or private equity or debt financings.
Future capital funding, if available, may result in dilution to current
shareholders.
Off-Balance Sheet Arrangements
As part of our on-going business, we do not participate in transactions
that generate relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance or
special purpose entities ('SPEs"), which would have been established for the
purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes. As of May 31, 2005, we are not involved in any
unconsolidated SPE.
30
Contractual Obligations
The following table presents our expected cash requirements for contractual
obligations outstanding as of May 31, 2005:
Due as of Due as of
Due as of 5/31/07 and 5/31/09 and Due
Total 5/31/06 5/31/08 5/31/10 Thereafter
--------------------------------------------------------------------------------------------------------------------
Long-Term Debt $1,095,809 $148,212 $162,351 $146,153 $639,093
Operating Leases 76,567 62,329 14,238 -- --
Litigation Settlement 200,750 133,250 67,500 -- --
Employment Agreements 40,625 40,625 -- -- --
--------------------------------------------------------------------------------------------------------------------
Total Contractual Cash $1,413,751 $384,416 $244,089 $146,153 $639,093
Obligations
====================================================================================================================
By the placement of the convertible preferred stock on July 19, 2005, as
described in above, we became obligated to pay a dividend monthly on the
outstanding shares of preferred stock. The dividend rate is the higher of (i)
the prime rate as reported by the Wall Street Journal on the first day of the
month, plus three percent or, (ii) 8.5% times $100 per share, but in no event
greater than 10% annually. The dividend is payable in cash.
Effects of Inflation
We believe that inflation and changing prices over the past three years
have not had a significant impact on our revenue or on our results of
operations.
Critical Accounting Policies
Financial Reporting Release No. 60, which was released by the Securities
and Exchange Commission, or SEC, in December 2001, requires all companies to
include a discussion of critical accounting policies or methods used in the
preparation of financial statements. Note A of the Notes to Consolidated
Financial Statements included in our Annual Report on Form 10-K for the year
ended May 31, 2005, includes a summary of our significant accounting policies
and methods used in the preparation of our financial statements. In preparing
these financial statements, we have made our best estimates and judgments of
certain amounts included in the financial statements, giving due consideration
to materiality. The application of these accounting policies involves the
exercise of judgment and use of assumptions as to future uncertainties and, as a
result, actual results could differ from these estimates. Our critical
accounting policies are as follows:
Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists,
delivery has occurred or service has been rendered, the price is fixed or
determinable and collectibility is reasonably assured. In the United States, we
recognize revenue from the sale of our EECP systems in the period in which we
deliver the system to the customer. Revenue from the sale of our EECP systems to
international markets is recognized upon shipment, during the period in which we
deliver the product to a common carrier, as are supplies, accessories and spare
parts delivered to both domestic and international customers. Returns are
accepted prior to the in-service and training subject to a 10% restocking charge
or for normal warranty matters, and we are not obligated for post-sale upgrades
to these systems. In addition, we use the installment method to record revenue
based on cash receipts in situations where the account receivable is collected
over an extended period of time and in our judgment the degree of collectibility
is uncertain.
In most cases, revenue from domestic EECP system sales is generated from
multiple-element arrangements that require judgment in the areas of customer
acceptance, collectibility, the separability of units of accounting, and the
fair value of individual elements. Effective September 1, 2003, we adopted the
provisions of Emerging Issues Task Force, or EITF, Issue No. 00-21, "Revenue
Arrangements with Multiple Deliverables", ("EITF 00-21"), on a prospective
basis. The principles and guidance outlined in EITF 00-21 provide a framework to
determine (a) how the arrangement consideration should be measured (b) whether
the arrangement should be divided into separate units of accounting, and (c) how
the arrangement consideration should be allocated among the separate units of
accounting. We determined that the domestic sale of our EECP systems includes a
combination of three elements that qualify as separate units of accounting:
i. EECP equipment sale,
31
ii. provision of in-service and training support consisting of equipment
set-up and training provided at the customer's facilities, and
iii. a service arrangement (usually one year), consisting of: service by
factory-trained service representatives, material and labor costs,
emergency and remedial service visits, preventative maintenance,
software upgrades, technical phone support and preferred response
times.
Each of these elements represent individual units of accounting as the
delivered item has value to a customer on a stand-alone basis, objective and
reliable evidence of fair value exists for undelivered items, and arrangements
normally do not contain a general right of return relative to the delivered
item. We determine fair value based on the price of the deliverable when it is
sold separately or based on third-party evidence. In accordance with the
guidance in EITF 00-21, we use the residual method to allocate the arrangement
consideration when it does not have fair value of the EECP system sale. Under
the residual method, the amount of consideration allocated to the delivered item
equals the total arrangement consideration less the aggregate fair value of the
undelivered items. Assuming all other criteria for revenue recognition have been
met, we recognize revenue for:
i. EECP equipment sales, when delivery and acceptance occurs based on
delivery and acceptance documentation received from independent
shipping companies or customers,
ii. in-service and training, following documented completion of the
training, and
iii. the service arrangement, ratably over the service period, which is
generally one year.
In-service and training generally occurs within three weeks of shipment and
our return policy states that no returns will be accepted after in-service and
training has been completed.
We recognized deferred revenues of $262,500 and $247,500 related to
in-service and training and $1,157,085 and $381,667 related to service
arrangements during the year ended May 31, 2005, and May 31, 2004, respectively.
In addition, following the adoption of the provisions of EITF 00-21 beginning
September 1, 2003 we began to defer revenue that had previously been recorded at
the time of sale.
Previously, in accordance with Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements," we accrued costs associated with these
arrangements as warranty expense in the period the system was delivered and
accepted. During fiscal year 2005 and 2004, we deferred $187,500 and $340,000,
respectively, related to in-service and training and $765,001 and $1,040,000
related to service arrangements, respectively. The amount related to in-service
and training is recognized as revenue at the time the in-service and training is
completed and the amount related to service arrangements is recognized as
service revenue ratably over the related service period, which is generally one
year. Costs associated with the provision of in-service and training and the
service arrangement, including salaries, benefits, travel, spare parts and
equipment, are recognized in cost of sales as incurred.
We also recognize revenue generated from servicing EECP systems that are no
longer covered by the service arrangement, or by providing sites with additional
training, in the period that these services are provided. Revenue related to
future commitments under separately priced extended service agreements on our
EECP system are deferred and recognized ratably over the service period,
generally ranging from one year to four years. Deferred revenues recognized
related to extended service agreements that have been invoiced to customers
prior to the performance of these services, were $1,900,925 and $1,485,372 for
the fiscal years ended May 31, 2005, and May 31, 2004, respectively. Costs
associated with the provision of service and maintenance, including salaries,
benefits, travel, spare parts and equipment, are recognized in cost of sales as
incurred. Amounts billed in excess of revenue recognized are included as
deferred revenue in the consolidated balance sheets.
Revenues from the sale of EECP systems through our international
distributor network are generally covered by a one-year warranty period. For
these customers we accrue a warranty reserve for estimated costs to provide
warranty services when the equipment sale is recognized.
We have also entered into lease agreements for our EECP systems, generally
for terms of one year or less, that are classified as operating leases. Revenues
from operating leases are generally recognized, in accordance with the terms of
the lease agreements, on a straight-line basis over the life of the respective
leases. For certain operating leases in which payment terms are determined on a
"fee-per-use" basis, revenues are recognized as incurred (i.e., as actual usage
occurs). The cost of the EECP system utilized under operating leases is recorded
as a component of property and equipment and is amortized to cost of sales over
the estimated useful life of the equipment, not to exceed five years. There were
no significant minimum rental commitments on these operating leases at May 31,
2005.
Accounts Receivable/Financing Receivables
The Company's accounts receivable - trade are due from customers engaged in
the provision of medical services. Credit is extended based on evaluation of a
32
customer's financial condition and, generally, collateral is not required.
Accounts receivable are generally due 30 to 90 days from shipment and are stated
at amounts due from customers net of allowances for doubtful accounts, returns,
term discounts and other allowances. Accounts outstanding longer than the
contractual payment terms are considered past due. Estimates are used in
determining the allowance for doubtful accounts based on the Company's
historical collections experience, current trends, credit policy and a
percentage of our accounts receivable by aging category. In determining these
percentages, we look at historical write- offs of our receivables. The Company
also looks at the credit quality of its customer base as well as changes in its
credit policies. The Company continuously monitors collections and payments from
its customers. While credit losses have historically been within expectations
and the provisions established, the Company cannot guarantee that it will
continue to experience the same credit loss rates that it has in the past.
In addition, the Company periodically reviews and assesses the net
realizability of its receivables arising from sales-type leases. If this review
results in a lower estimate of the net realizable value of the receivable, an
allowance for the unrealized amount is established in the period in which the
estimate is changed. In the first quarter of fiscal 2003 and the second quarter
of fiscal 2004, management decided to write-off financing receivables under
sales-type leases of approximately $2,558,000 and $680,000, respectively, as a
result of significant uncertainties with respect to these customers' ability to
meet their financial obligations.
Inventories, net
The Company values inventory at the lower of cost or estimated market, cost
being determined on a first-in, first-out basis. The Company often places EECP
systems at various field locations for demonstration, training, evaluation, and
other similar purposes at no charge. The cost of these EECP systems is
transferred to property and equipment and is amortized over the next two to five
years. The Company records the cost of refurbished components of EECP systems
and critical components at cost plus the cost of refurbishment. The Company
regularly reviews inventory quantities on hand, particularly raw materials and
components, and records a provision for excess and obsolete inventory based
primarily on existing and anticipated design and engineering changes to our
products as well as forecasts of future product demand.
Deferred Revenues
We record revenue on extended service contracts ratably over the term of
the related warranty contracts. Effective September 1, 2003, we prospectively
adopted the provisions of EITF 00-21. Upon adoption of the provisions of EITF
00-21 effective September 1, 2003, we began to defer revenue related to EECP
domestic system sales for the fair value of in-service and training to the
period when the services are rendered and for service arrangement obligations
ratably over the service period, which is generally one year.
Warranty Costs
Equipment sold is generally covered by a warranty period of one year.
Effective September 1, 2003, we adopted the provisions of EITF 00-21 on a
prospective basis. Under EITF 00-21, for certain arrangements, a portion of the
overall system price attributable to the first year service arrangement is
deferred and recognized as revenue over the service period. As such, we no
longer accrue warranty costs upon delivery but rather recognize warranty and
related service costs as incurred. Prior to September 1, 2003, we accrued a
warranty reserve for estimated costs to provide warranty services when the
equipment sale was recognized.
Equipment sold to international customers through our distributor network
is generally covered by a one year warranty period. For these customers we
accrue a warranty reserve for estimated costs to provide warranty services when
the equipment sale is recognized.
The factors affecting our warranty liability included the number of units
sold and historical and anticipated rates of claims and costs per claim. The
warranty provision resulting from transactions prior to September 1, 2003, will
be reduced in future periods for material and labor costs incurred as related
product is returned during the warranty period or when the warranty period
elapses.
Net Loss per Common Share
Basic loss per share are based on the weighted average number of common
shares outstanding without consideration of potential common stock. Diluted loss
per share are based on the weighted number of common and potential dilutive
common shares outstanding. The calculation takes into account the shares that
may be issued upon the exercise of stock options and warrants, reduced by the
shares that may be repurchased with the funds received from the exercise, based
on the average price during the period.
33
Income Taxes
Deferred income taxes are recognized for temporary differences between
financial statement and income tax bases of assets and liabilities and loss
carryforwards for which income tax benefits are expected to be realized in
future years. A valuation allowance is established, when necessary, to reduce
deferred tax assets to the amount expected to be realized. In estimating future
tax consequences, we generally consider all expected future events other than an
enactment of changes in the tax laws or rates. The deferred tax asset is
continually evaluated for realizability. To the extent our judgment regarding
the realization of the deferred tax assets change, an adjustment to the
allowance is recorded, with an offsetting increase or decrease, as appropriate,
in income tax expense. Such adjustments are recorded in the period in which our
estimate as to the realizability of the asset changed that it is "more likely
than not" that all of the deferred tax assets will be realized. The "more likely
than not" standard is subjective, and is based upon our estimate of a greater
than 50% probability that our long range business plan can be realized.
Deferred tax liabilities and assets are classified as current or
non-current based on the classification of the related asset or liability for
financial reporting. A deferred tax liability or asset that is not related to an
asset or liability for financial reporting, including deferred tax assets
related to carryforwards, are classified according to the expected reversal date
of the temporary difference. The deferred tax asset we recorded relates
primarily to the realization of net operating loss carryforwards, of which the
allocation of the current portion, if any, reflects the expected utilization of
such net operating losses in next twelve months. Such allocation is based our
internal financial forecast and may be subject to revision based upon actual
results.
Stock-based Employee Compensation
We have five stock-based employee compensation plans. We account for
stock-based compensation using the intrinsic value method in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations ("APB No. 25") and have adopted the
disclosure provisions of Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure, an
amendment of FASB Statement No. 123." Under APB No. 25, when the exercise price
of our employee stock options equals the market price of the underlying stock on
the date of grant, no compensation expense is recognized. Accordingly, no
compensation expense has been recognized in the consolidated financial
statements in connection with employee stock option grants.
Pro forma compensation expense may not be indicative of future disclosures
because it does not take into effect pro forma compensation expense related to
grants before 1995. For purposes of estimating the fair value of each option on
the date of grant, the Company utilized the Black-Scholes option-pricing model.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options. Equity
instruments issued to non-employees in exchange for goods, fees and services are
accounted for under the fair value-based method of SFAS No. 123.
Recently Issued Accounting Standards
In May 2005, the FASB issued Statement of Financial Accounting Standards
No. 154 ("SFAS No. 154"), "Accounting Changes and Error Corrections." SFAS No.
154 replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3,
Reporting Accounting Changes in Interim Financial Statements, and changes the
requirements for the accounting for and reporting of a change in accounting
principle. The Statement applies to all voluntary changes in accounting
principle. It also applies to changes required by an accounting pronouncement in
the unusual instance that the pronouncement does not include specific transition
provisions. When a pronouncement includes specific transition provisions, those
provisions should be followed. SFAS No. 154 is effective for accounting changes
and corrections of errors made in fiscal years beginning after December 15,
2005.
In December 2004, the Financial Accounting Standards Board (FASB) issued
FASB Statement No. 153 ("SFAS No. 153"), "Exchanges of Non-monetary Assets - an
amendment of APB Opinion No. 29". SFAS No. 153 amends Opinion 29 to eliminate
the exception for non-monetary exchanges of similar productive assets and
replaces it with a general exception for exchanges of non-monetary assets that
do not have commercial substance. A non-monetary exchange has commercial
34
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. SFAS No. 153 is effective for fiscal
periods after June 15, 2005. The Company does not expect the adoption of SFAS
No. 153 to have a material impact on the Company's consolidated financial
statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123(R) ("SFAS No. 123(R)"), "Accounting for Stock-Based
Compensation". SFAS No. 123(R) establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. This Statement focuses primarily on accounting for transactions in
which an entity obtains employee services in share-based payment transactions.
SFAS No. 123(R) requires that the fair value of such equity instruments be
recognized as expense in the historical financial statements as services are
performed. Prior to SFAS No. 123(R), only certain pro-forma disclosures of fair
value were required. SFAS No. 123(R) shall be effective for the Company as of
the beginning of the first interim reporting period that begins after June 15,
2005. The adoption of this new accounting pronouncement is expected to have a
material impact on the financial statements of the Company commencing with the
quarter ending November 30, 2005.
In November 2004, the FASB issued Statement of Financial Accounting
Standards No. 151 ("SFAS No. 151"), Inventory Costs, an amendment of ARB No. 43,
Chapter 4. The amendments made by SFAS No. 151 will improve financial reporting
by clarifying that abnormal amounts of idle facility expense, freight, handling
costs, and wasted materials (spoilage) should be recognized as current-period
charges and by requiring the allocation of fixed production overheads to
inventory based on the normal capacity of the production facilities. SFAS No.
151 is effective for inventory costs incurred during fiscal years beginning
after June 15, 2005. Earlier application is permitted for inventory costs
incurred during fiscal years beginning after November 24, 2004. The Company is
currently evaluating the impact of adoption of SFAS No. 151 on its financial
position and results of operations.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain financial market risks, including changes in
interest rates. All of the Company's revenue, expenses and capital spending are
transacted in US dollars. Our exposure to market risk for changes in interest
rates relates primarily to our cash and cash equivalent balances, investments in
sales-type leases and the line of credit agreement. The majority of our
investments are in short-term instruments and subject to fluctuations in US
interest rates. Due to the nature of our short-term investments, we believe that
there is no material risk exposure.
ITEM 8 - FINANCIAL STATEMENTS
The consolidated financial statements listed in the accompanying Index to
Consolidated Financial Statements are filed as part of this report.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A - CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-15. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of May 31, 2005, our disclosure controls
and procedures are effective to ensure that information required to be disclosed
in our reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and are also effective to ensure that information required to be
disclosed in our reports filed or submitted under the Exchange Act is
accumulated and communicated to the Company's management, including the
principal executive and principal financial officers, to allow timely decisions
regarding required disclosure. During the fourth fiscal quarter, there has been
no change in our internal control over financial reporting that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
35
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item will be included in our definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with our 2005 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this Item will be included in our definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with our 2005 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be included in our definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with our 2005 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be included in our definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with our 2005 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item will be included in our definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with our 2005 Annual Meeting of Stockholders, and is incorporated
herein by reference.
36
PART IV
ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements and Financial Statement Schedules
(1) See Index to Consolidated Financial Statements on page i at beginning
of attached financial statements.
(2) The following Consolidated Financial Statement Schedule is included in
Part IV of this report:
Schedule II - Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable, or
not required, or because the required information is included in the
Consolidated Financial Statements or notes thereto.
(b) Exhibits
(3) (a) Restated Certificate of Incorporation (2)
(b) By-Laws (1)
(4) (a) Specimen Certificate for Common Stock (1)
(b) Certificate of Designation of the Preferred Stock, Series A (3)
(c) Certificate of Designation of the Preferred Stock, Series B (7)
(d) Form of Rights Agreement dated as of March 9, 1995, between
Registrant and American Stock Transfer & Trust Company (5)
(e) Certificate of Designation of the Preferred Stock, Series C (8)
(f) Certificate of Designation of the Preferred Stock, Series D (18)
(g) Form of Stock Purchase Warrant (18)
(10) (a) 1995 Stock Option Plan (6)
(b) Outside Director Stock Option Plan (6)
(c) Employment Agreement dated February 1, 1995, as amended March 12,
1998, and October 10, 2001, between Registrant and John C.K. Hui
(4) (9) (13)
(d) 1997 Stock Option Plan, as amended (10)
(e) 1999 Stock Option Plan, as amended (11)
(f) Credit Agreement dated February 21, 2002, between Vasomedical,
Inc. and Fleet National Bank (12)
(g) Agreement dated October 1, 2002, between the Registrant and Peter
F. Cohn (14)
(h) Termination and Settlement Agreement dated October 21, 2002,
between the Registrant and D. Michael Deignan (14)
(i) Employment Agreement dated October 28, 2002, and amended June 30,
2003, between the Registrant and Photios T. Paulson (14) (16)
(j) Amendment and Waiver to Credit Agreement dated October 18, 2002,
between the Vasomedical, Inc. and Fleet National Bank (14)
(k) Amendment No. 2 and Waiver to Credit Agreement dated April 10,
2003, between the Registrant and Fleet National Bank (15)
(l) Employment Agreement dated September 8, 2003, between Registrant
and Thomas W. Fry (17)
(m) Subscription Agreement dated July 19, 2005, between Vasomedical,
Inc. and M.A.G. Capital LLC, Monarch Pointe Fund Ltd., Mercator
Momentum Fund III, LP and Mercator Momentum Fund, LP (the
"Investors") (18)
(n) Registration Rights Agreement, dated July 19, 2005, between
Vasomedical, Inc. and the Investors (18)
(22) Subsidiaries of the Registrant
Percentage
Name State of Incorporation Owned by Company
---- ---------------------- ----------------
Viromedics, Inc. Delaware 61%
180 Linden Avenue Corp. New York 100%
(23) Consent of Grant Thornton LLP
(31) Certification Reports pursuant to Securities Exchange Act Rule
13A-14(A)/15D-14(A)
(32) Certification Reports pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
_________________
(1) Incorporated by reference to Registration Statement on Form S-18, No.
33-24095.
(2) Incorporated by reference to Registration Statement on Form S-1, No.
33-46377 (effective 7/12/94).
(3) Incorporated by reference to Report on Form 8-K dated November 14, 1994.
(4) Incorporated by reference to Report on Form 8-K dated January 24, 1995.
(5) Incorporated by reference to Registration Statement on Form 8-A dated May
12, 1995.
(6) Incorporated by reference to Notice of Annual Meeting of Stockholders dated
December 5, 1995.
37
(7) Incorporated by reference to Report on Form 8-K dated June 25, 1997.
(8) Incorporated by reference to Report on Form 8-K dated April 30, 1998.
(9) Incorporated by reference to Report on Form 10-K for the fiscal year ended
May 31, 1998.
(10) Incorporated by reference to Report on Form 10-K for the fiscal year ended
May 31, 1999
(11) Incorporated by reference to Report on Form 10-K for the fiscal year ended
May 31, 2000.
(12) Incorporated by reference to Report on Form 10-Q for the quarterly period
ended February 28, 2002.
(13) Incorporated by reference to Report on Form 10-K for the fiscal year ended
May 31, 2002.
(14) Incorporated by reference to Report on Form 10-Q for the quarterly period
ended November 30, 2002.
(15) Incorporated by reference to Report on Form 10-Q for the quarterly period
ended February 28, 2003.
(16) Incorporated by reference to Report on Form 8-K dated June 30, 2003.
(17) Incorporated by reference to Report on Form 10-Q for the quarterly period
ended February 29, 2004.
(18) Incorporated by reference to Report on Form 8-K dated July 19, 2005.
38
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, we have duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized on the 16 day of August, 2005.
VASOMEDICAL, INC.
By: /s/ Thomas Glover
Thomas Glover
President, Chief Executive Officer and Director
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on August 16, 2004, by the following persons in the
capacities indicated:
______________________ Director
Alexander G. Bearn
/s/ David S. Blumenthal Director
David S. Blumenthal
/s/ Thomas Glover President, Chief Executive Officer and Director
Thomas Glover (Principal Executive Officer)
/s/ Abraham E. Cohen Chairman of the Board
Abraham E. Cohen
/s/ Thomas W. Fry Chief Financial Officer (Principal Financial
Thomas W. Fry and Accounting Officer)
/s/ John C.K. Hui Senior Vice President, Chief Technology Officer
John C.K. Hui and Director
/s/ Photios T. Paulson Director
Photios T. Paulson
/s/ Kenneth W. Rind Director
Kenneth W. Rind
/s/ E. Donald Shapiro Director
E. Donald Shapiro
/s/ Anthony Viscusi Director
Anthony Viscusi
/s/ Forrest R. Whittaker Director
Forrest R. Whittaker
/s/ Martin Zeiger Director
Martin Zeiger
39
Vasomedical, Inc. and Subsidiaries
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
-----
Report of Independent Registered Public Accounting Firm F-1
Financial Statements
Consolidated Balance Sheets as of May 31, 2005 and 2004 F-2
Consolidated Statements of Operations for the
years ended May 31, 2005, 2004 and 2003 F-3
Consolidated Statement of Changes in Stockholders'
Equity for the years ended May 31, 2005, 2004 and 2003 F-4
Consolidated Statements of Cash Flows for the
years ended May 31, 2005, 2004 and 2003 F-5
Notes to Consolidated Financial Statements F-6 - F-26
Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts S-1
i
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Vasomedical, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of
Vasomedical, Inc. and Subsidiaries (the "Company") as of May 31, 2005 and 2004,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended May 31, 2005. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform an audit of its internal
control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Vasomedical, Inc. and Subsidiaries as of May 31, 2005 and 2004, and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the period ended May 31, 2005 in conformity with
accounting principles generally accepted in the United States of America.
As described in Note A to the consolidated financial statements, the
Company adopted the provisions of the Emerging Issues Task Force, Issue No.
00-21, "Revenue Arrangements with Multiple Deliverables", on September 1, 2003.
Our audit was conducted for the purpose of forming an opinion on the basic
financial statements taken as a whole. The financial statement schedule,
Schedule II, Valuation and Qualifying Accounts, is presented for the purposes of
additional analysis and is not a required part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, is fairly
stated in all material respects in relation to the basic financial statements
taken as a whole.
/s/ Grant Thornton LLP
GRANT THORNTON LLP
Melville, New York
July 29, 2005
F-1
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
May 31,
2005 2004
----------------- -----------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 989,524 $ 6,365,049
Certificates of deposit 1,758,443 1,180,540
Accounts receivable, net of an allowance for doubtful accounts of
$394,692 and $699,203 at May 31, 2005 and 2004, respectively 1,892,002 5,521,853
Inventories, net 3,360,272 2,373,748
Other current assets 223,902 272,513
----------------- -----------------
Total current assets 8,224,143 15,713,703
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,626,983
and $2,378,576 at May 31, 2005 and 2004, respectively 2,234,153 2,430,521
DEFERRED INCOME TAXES 14,582,000 14,582,000
OTHER ASSETS 321,174 297,391
----------------- -----------------
$25,361,470 $33,023,615
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 1,569,131 $ 2,972,184
Current maturities of long-term debt and notes payable 148,212 136,478
Sales tax payable 216,753 353,360
Deferred revenue 1,667,080 1,734,925
Accrued warranty and customer support expenses 110,583 161,917
Accrued professional fees 401,511 241,486
Accrued commissions 178,104 341,483
----------------- -----------------
Total current liabilities 4,291,374 5,941,833
LONG-TERM DEBT 947,597 1,092,837
ACCRUED WARRANTY COSTS 7,750 83,000
DEFERRED REVENUE 884,452 1,111,526
OTHER LIABILITIES 67,500 200,250
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; 1,000,000 shares authorized; none
issued and outstanding -- --
Common stock, $.001 par value; 110,000,000 shares authorized;
58,552,688 and 58,419,356 shares at May 31, 2005 and 2004,
respectively, issued and outstanding 58,552 58,419
Additional paid-in capital 51,450,639 51,320,106
Accumulated deficit (32,346,394) (26,784,356)
----------------- -----------------
Total stockholders' equity 19,162,797 24,594,169
----------------- -----------------
$25,361,470 $33,023,615
================= =================
The accompanying notes are an integral part of these financial statements.
F-2
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended May 31,
-------------------------------------------------
2005 2004 2003
-------------- ------------- -------------
Revenues
Equipment sales $11,516,883 $19,302,593 $22,850,391
Equipment rentals and services 3,578,895 2,904,444 1,973,228
-------------- ------------- -------------
15,095,778 22,207,037 24,823,619
Cost of Sales and Services
Cost of sales, equipment 4,223,523 6,309,119 8,050,389
Cost of equipment rentals and services 1,281,012 1,280,984 1,200,832
-------------- ------------- -------------
5,504,535 7,590,103 9,251,221
-------------- ------------- -------------
Gross profit 9,591,243 14,616,934 15,572,398
Expenses
Selling, general and administrative 12,006,774 12,910,997 13,714,913
Research and development 3,064,683 3,748,389 4,544,822
Provision for doubtful accounts 11,084 1,296,759 3,728,484
Interest and financing costs 105,232 132,062 186,574
Interest and other income, net (74,153) (99,393) (176,724)
-------------- ------------- -------------
15,113,620 17,988,814 21,998,069
-------------- ------------- -------------
LOSS BEFORE INCOME TAXES (5,522,377) (3,371,880) (6,425,671)
Income tax (expense) benefit, net (39,661) (50,640) 1,634,688
-------------- ------------- -------------
NET LOSS $(5,562,038) $(3,422,520) $(4,790,983)
============== ============= =============
Net loss per common share
- basic $(0.10) $(0.06) $(0.08)
============== ============= =============
- diluted $(0.10) $(0.06) $(0.08)
============== ============= =============
Weighted average common shares outstanding
- basic 58,547,574 57,981,963 57,647,032
============== ============= =============
- diluted 58,547,574 57,981,963 57,647,032
============== ============= =============
The accompanying notes are an integral part of these financial statements.
F-3
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Additional Total
Common Stock Paid-in- Accumulated Stockholders
Shares Amount Capital Deficit Equity
------------------------- --------------- --------------- ---------------
Balance at May 31, 2002 57,309,120 $57,309 $50,116,148 $(18,570,853) $31,602,604
Exercise of options and warrants 512,903 513 234,487 235,000
Stock options granted for services 50,681 50,681
Tax benefit of stock options and
warrants 222,000 222,000
Net loss (4,790,983) (4,790,983)
------------ ------------ ------------ ------------- ------------
Balance at May 31, 2003 57,822,023 57,822 50,623,316 (23,361,836) 27,319,302
Exercise of options and warrants 597,333 597 696,790 697,387
Net loss (3,422,520) (3,422,520)
------------ ------------ ------------ ------------- ------------
Balance at May 31, 2004 58,419,356 58,419 51,320,106 (26,784,356) 24,594,169
Exercise of options and warrants 133,332 133 130,533 130,666
Net loss (5,562,038) (5,562,038)
------------ ------------ ------------ ------------- ------------
Balance at May 31, 2005 58,552,688 $58,552 $51,450,639 $(32,346,394) $19,162,797
============ ============ ============ ============= ============
The accompanying notes are an integral part of this financial statement.
F-4
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended May 31,
-------------------------------------------------
2005 2004 2003
-------------- ------------- -------------
Cash flows from operating activities
Net loss $(5,562,038) $(3,422,520) $(4,790,983)
-------------- ------------- -------------
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities
Depreciation and amortization 578,530 749,111 1,132,996
Provision for doubtful accounts 11,084 616,759 2,209,101
Reserve for excess and obsolete inventory 166,672 119,000 100,000
Deferred income taxes -- -- (1,669,000)
Stock options granted for services -- -- 50,681
Changes in operating assets and liabilities
Accounts receivable 3,618,767 1,923,284 5,643,288
Financing receivables, net -- 258,608 118,126
Inventories (1,295,294) 1,187,761 1,079,976
Other current assets 48,611 (4,282) 359,012
Other assets (63,649) (69,610) (79,082)
Accounts payable, accrued expenses and other
current liabilities (1,662,193) 517,056 (1,286,324)
Other liabilities (435,074) (38,907) 311,813
-------------- ------------- -------------
967,454 5,258,780 7,970,587
-------------- ------------- -------------
Net cash provided by (used in) operating activities (4,594,584) 1,836,260 3,179,604
-------------- ------------- -------------
Cash flows (used in) investing activities
Purchase of certificates of deposit and treasury (3,747,903) (1,180,540) --
bills
Redemptions of certificates of deposit and 3,170,000 -- --
treasury bills
Purchase of property and equipment (200,198) (153,954) (326,489)
-------------- ------------- -------------
Net cash (used in) investing activities (778,101) (1,334,494) (326,489)
-------------- ------------- -------------
Cash flows provided by (used in) financing activities
Proceeds from notes payable -- 67,149 238,071
Payments on notes payable (133,506) (124,100) (1,070,966)
Proceeds from exercise of options and warrants 130,666 697,387 235,000
-------------- ------------- -------------
Net cash provided by (used in) financing activities (2,840) 640,436 (597,895)
-------------- ------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (5,375,525) 1,142,202 2,255,220
-------------- ------------- -------------
Cash and cash equivalents - beginning of year 6,365,049 5,222,847 2,967,627
-------------- ------------- -------------
Cash and cash equivalents - end of year $ 989,524 $6,365,049 $5,222,847
============== ============= =============
Non-cash investing and financing activities were as follows:
Inventories transferred to (from) property and
equipment, attributable to operating leases - net $(142,098) $(240,942) $761,986
Supplement disclosures:
Interest paid $105,232 $105,194 $186,574
Income taxes paid $19,888 $24,213 $87,963
The accompanying notes are an integral part of these financial statements.
F-5
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2005, 2004 and 2003
NOTE A - BUSINESS ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company was incorporated in Delaware in July 1987. During fiscal 1996,
the Company commenced the commercialization of its EECP external
counterpulsation system ("EECP"), a microprocessor-based medical device for the
noninvasive, outpatient treatment of patients with cardiovascular disease. EECP
is marketed worldwide to hospitals and physician private practices. To date, the
Company's revenues have been generated primarily from customers in the United
States.
We believe that our cash flow from operations together with our current
cash reserves and the cash received for the sale of convertible preferred stock
and warrants on July 19, 2005 (see Note O), will be sufficient to fund our
business plan and projected capital requirements through at least May 31, 2006.
However, we have incurred significant losses during the last three fiscal years
and our long-term ability to maintain current operations is dependent upon
achieving profitable operations, which is largely dependent upon the successful
commercialization of EECP therapy into the congestive heart failure indication,
and depends in part upon the acceptance of the results of the PEECH clinical
trial by the medical community and expanded reimbursement coverage to include
CHF as being sufficient to promote the adoption of EECP therapy in CHF; or
through additional debt or equity financing. In the event that additional
capital is required, we may seek to raise such capital through public or private
equity or debt financings. Future capital funding, if available, may result in
dilution to current shareholders.
A summary of the significant accounting policies consistently applied in
the preparation of the consolidated financial statements follows:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company,
its wholly-owned subsidiary and its inactive majority-owned subsidiary.
Significant intercompany accounts and transactions have been eliminated.
Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists,
delivery has occurred or service has been rendered, the price is fixed or
determinable and collectibility is reasonably assured. In the United States, we
recognize revenue from the sale of our EECP systems in the period in which we
deliver the system to the customer. Revenue from the sale of our EECP systems to
international markets is recognized upon shipment, during the period in which we
deliver the product to a common carrier, as are supplies, accessories and spare
parts delivered to both domestic and international customers. Returns are
accepted prior to the in-service and training subject to a 10% restocking charge
or for normal warranty matters, and we are not obligated for post-sale upgrades
to these systems. In addition, we use the installment method to record revenue
based on cash receipts in situations where the account receivable is collected
over an extended period of time and in our judgment the degree of collectibility
is uncertain.
In most cases, revenue from domestic EECP system sales in the United States
is generated from multiple-element arrangements that require judgment in the
areas of customer acceptance, collectibility, the separability of units of
accounting, and the fair value of individual elements. Effective September 1,
2003, we adopted the provisions of Emerging Issues Task Force, or EITF, Issue
No. 00-21, "Revenue Arrangements with Multiple Deliverables", ("EITF 00-21"), on
a prospective basis. The principles and guidance outlined in EITF 00-21 provide
a framework to determine (a) how the arrangement consideration should be
measured (b) whether the arrangement should be divided into separate units of
accounting, and (c) how the arrangement consideration should be allocated among
the separate units of accounting. We determined that the domestic sale of our
EECP systems includes a combination of three elements that qualify as separate
units of accounting:
i. EECP equipment sale,
ii. provision of in-service and training support consisting of equipment
set-up and training provided at the customer's facilities, and
F-6
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
iii. a service arrangement (usually one year) consisting of: service by
factory-trained service representatives, material and labor costs,
emergency and remedial service visits, preventative maintenance,
software upgrades, technical phone support and preferred response
times.
Each of these elements represent individual units of accounting as the
delivered item has value to a customer on a stand-alone basis, objective and
reliable evidence of fair value exists for undelivered items, and arrangements
normally do not contain a general right of return relative to the delivered
item. We determine fair value based on the price of the deliverable when it is
sold separately or based on third-party evidence. In accordance with the
guidance in EITF 00-21, we use the residual method to allocate the arrangement
consideration when it does not have fair value of the EECP system sale. Under
the residual method, the amount of consideration allocated to the delivered item
equals the total arrangement consideration less the aggregate fair value of the
undelivered items. Assuming all other criteria for revenue recognition have been
met, we recognize revenue for:
i. EECP equipment sales, when delivery and acceptance occurs based on
delivery and acceptance documentation received from independent
shipping companies or customers,
ii. in-service and training, following documented completion of the
training, and
iii. for the service arrangement ratably over the service period, which is
generally one year.
In-service and training generally occurs within three weeks of shipment and
our return policy states that no returns will be accepted after in-service and
training has been completed.
We recognized deferred revenues of $262,500 and $247,500 related to
in-service and training and $1,157,085 and $381,667 related to service
arrangements during the years ended May 31, 2005 and 2004, respectively. In
addition, following the adoption of the provisions of EITF 00-21 beginning
September 1, 2003, we began to defer revenue that had previously been recorded
at the time of sale.
Previously, in accordance with Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements," we accrued costs associated with these
arrangements as warranty expense in the period the system was delivered and
accepted. During the years ended May 31, 2005 and 2004, we deferred $187,500 and
$340,000 related to in- service and training and $765,001 and $1,040,000 related
to service arrangements, respectively. The amount related to in- service and
training is recognized as revenue at the time the in-service and training is
completed and the amount related to service arrangements is recognized as
service revenue ratably over the related service period, which is generally one
year. Costs associated with the provision of in-service and training and the
service arrangement, including salaries, benefits, travel, spare parts and
equipment, are recognized in cost of sales as incurred.
The following tables illustrate the effect on revenues, cost of sales and
services, net loss, and net loss per common share had the Company applied the
provisions of "Revenue Arrangements with Multiple Deliverables" (EITF 00-21) as
if the provisions had been adopted prior to fiscal 2003:
Year Ended May 31, 2003
-------------------------------------------------------------
As reported EITF adjustment Pro forma
------------------- ----------------- -----------------
Revenues $24,823,619 $(26,458) $24,797,161
Cost of sales and services 9,251,221 (16,333) 9,234,888
------------------- ----------------- -----------------
Gross profit 15,572,398 (10,125) 15,562,273
Operating expenses 21,998,069 -- 21,998,069
------------------- ----------------- -----------------
Loss before income taxes (6,425,671) (10,125) (6,435,796)
Income tax (expense) benefit, net 1,634,688 -- 1,634,688
------------------- ----------------- -----------------
Net loss $(4,790,983) $(10,125) $(4,801,108)
=================== ================= =================
Net loss per common share, basic and diluted $(0.08) $(0.08)
Weighted average common shares 57,647,032 57,647,032
F-7
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
Year Ended May 31, 2004
-------------------------------------------------------------
As reported EITF adjustment Pro forma
------------------- ----------------- -----------------
Revenues $22,207,037 $730,208 $22,937,245
Cost of sales and services 7,590,103 369,000 7,959,103
------------------- ----------------- -----------------
Gross profit 14,616,934 361,208 14,978,142
Operating expenses 17,988,814 -- 17,988,814
------------------- ----------------- -----------------
Loss before income taxes (3,371,880) 361,208 (3,010,672)
Income tax (expense) benefit, net (50,640) -- (50,640)
------------------- ----------------- -----------------
Net loss $(3,422,520) $361,208 $(3,061,312)
=================== ================= =================
Net loss per common share, basic and diluted $(0.06) $(0.05)
Weighted average common shares 57,981,963 57,981,963
Year Ended May 31, 2005
-------------------------------------------------------------
As reported EITF adjustment Pro forma
------------------- ----------------- -----------------
Revenues $15,095,778 $50,000 $15,145,778
Cost of sales and services 5,504,535 (26,667) 5,477,868
------------------- ----------------- -----------------
Gross profit 9,591,243 76,667 9,667,910
Operating expenses 15,113,620 -- 15,113,620
------------------- ----------------- -----------------
Loss before income taxes (5,522,377) 76,667 (5,445,710)
Income tax (expense) benefit, net (39,661) -- (39,661)
------------------- ----------------- -----------------
Net loss $(5,562,038) $76,667 $(5,485,371)
=================== ================= =================
Net loss per common share, basic and diluted $(0.10) $(0.10)
Weighted average common shares 58,547,574 58,547,574
Revenues from the sale of EECP systems through our international
distributor network are generally covered by a one-year warranty period. For
these customers we accrue a warranty reserve for estimated costs to provide
warranty services when the equipment sale is recognized.
We also recognize revenue generated from servicing EECP systems that are no
longer covered by the service arrangement, or by providing sites with additional
training, in the period that these services are provided. Revenue related to
future commitments under separately priced extended warranty agreements on the
EECP system are deferred and recognized ratably over the service period,
generally ranging from one year to four years. Deferred revenues recognized
related to extended warranty agreements that have been invoiced to customers
prior to the performance of these services, were $1,900,925 and $1,485,372 for
the years ended May 31, 2005 and 2004, respectively. Costs associated with the
provision of service and maintenance, including salaries, benefits, travel,
spare parts and equipment, are recognized in cost of sales as incurred. Amounts
billed in excess of revenue recognized are included as deferred revenue in the
consolidated balance sheets.
We have also entered into lease agreements for our EECP systems, generally
for terms of one year or less, that are classified as operating leases. Revenues
from operating leases are generally recognized, in accordance with the terms of
the lease agreements, on a straight-line basis over the life of the respective
leases. For certain operating leases in which payment terms are determined on a
"fee-per-use" basis, revenues are recognized as incurred (i.e., as actual usage
F-8
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
occurs). The cost of the EECP system utilized under operating leases is recorded
as a component of property and equipment and is amortized to cost of sales over
the estimated useful life of the equipment, not to exceed five years. There were
no significant minimum rental commitments on these operating leases at May 31,
2005.
Accounts Receivable/Financing Receivables
The Company's accounts receivable - trade are due from customers engaged in
the provision of medical services. Credit is extended based on evaluation of a
customer's financial condition and, generally, collateral is not required.
Accounts receivable are generally due 30 to 90 days from shipment and are stated
at amounts due from customers net of allowances for doubtful accounts, returns,
term discounts and other allowances. Accounts outstanding longer than the
contractual payment terms are considered past due. Estimates are used in
determining the allowance for doubtful accounts based on the Company's
historical collections experience, current trends, credit policy and a
percentage of our accounts receivable by aging category. In determining these
percentages, we look at historical write-offs of our receivables. The Company
also looks at the credit quality of its customer base as well as changes in its
credit policies. The Company continuously monitors collections and payments from
its customers. While credit losses have historically been within expectations
and the provisions established, the Company cannot guarantee that it will
continue to experience the same credit loss rates that it has in the past.
The changes in the Company's allowance for doubtful accounts are as
follows:
Year Ended May 31,
-----------------------------------------------------------
2005 2004 2003
------------------- --------------- ----------------
Beginning balance $699,203 $768,629 $1,099,687
Provision for losses on accounts
receivable 11,084 616,759 1,227,324
Direct write-offs, net of recoveries (315,595) (686,185) (1,558,382)
------------------- --------------- ----------------
Ending balance $394,692 $699,203 $768,629
=================== =============== ================
In addition, we periodically review and assess the net realizability of
receivables arising from sales-type leases. If this review results in a lower
estimate of the net realizable value of the receivable, an allowance for the
unrealized amount is established in the period in which the estimate is changed.
In the first quarter of fiscal 2003 and the second quarter of fiscal 2004, we
decided to write-off financing receivables under sales-type leases of
approximately $2,558,000 and $680,000, respectively, as a result of significant
uncertainties with respect to these customers' ability to meet their financial
obligations. (See Note E).
The changes in our allowance for financing receivables, which primarily
relates to balloon payments due at lease end, are as follows:
Year Ended May 31,
-----------------------------------------------------
2005 2004 2003
--------------- --------------- ---------------
Beginning balance $-- $244,994 $718,879
Provision for losses on financing
receivables -- 680,000 --
Direct write-offs -- (924,994) (473,885)
--------------- --------------- ---------------
Ending balance $-- $-- $244,994
=============== =============== ===============
Concentrations of Credit Risk
We market the EECP system principally to hospitals and physician private
practices. We perform credit evaluations of its customers' financial condition
and, as a consequence, believes that its receivable credit risk exposure is
limited. Receivables are generally due 30 to 90 days from shipment. For the
years ended May 31, 2005, 2004 and 2003, no customer accounted for 10% or more
of revenues. At May 31, 2005, one customer accounted for 13% of accounts
receivable. At May 31, 2004 and May 31, 2003, no customer accounted for greater
than 10% of accounts receivable.
F-9
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
Our revenues were derived from the following geographic areas:
Year Ended May 31,
------------------------------------------------------
2005 2004 2003
--------------- --------------- ---------------
Domestic (United States) $13,673,293 $21,339,267 $23,701,619
Non-domestic 1,422,485 867,770 1,122,000
--------------- --------------- ---------------
$15,095,778 $22,207,037 $24,823,619
=============== =============== ===============
Cash and Cash Equivalents
Cash and cash equivalents represent cash and short-term, highly liquid
investments in certificates of deposit, treasury bills, money market funds, and
investment grade commercial paper issued by major corporations and financial
institutions that generally have maturities of three months or less. Realized
and unrealized gains and losses and declines in value, if any, are charged to
earnings. Dividend and interest income are recognized when earned. The cost of
securities sold is calculated using the specific identification method. (See
Note C)
Certificates of Deposit
Included in this caption are all certificates of deposit that have original
maturities of greater than three months. Realized and unrealized gains and
losses and declines in value, if any, are charged to earnings. Dividend and
interest income are recognized when earned. The cost of securities sold is
calculated using the specific identification method. (See Note C)
Inventories, net
We value inventory at the lower of cost or estimated market, cost being
determined on a first-in, first-out basis. We often place EECP systems at
various field locations for demonstration, training, evaluation, and other
similar purposes at no charge. The cost of these EECP systems is transferred to
property and equipment and is amortized over the next two to five years. The
cost of refurbished components of EECP systems and critical components are
recorded at cost plus the cost of refurbishment. We regularly review inventory
quantities on hand, particularly raw materials and components, and records a
provision for excess and obsolete inventory based primarily on existing and
anticipated design and engineering changes to our products as well as forecasts
of future product demand. (See Note D)
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and
amortization. Major improvements are capitalized and minor replacements,
maintenance and repairs are charged to expense as incurred. Upon retirement or
disposal of assets, the cost and related accumulated depreciation are removed
from the consolidated balance sheets. Depreciation is provided over the
estimated useful lives of the assets, which range from two to thirty-nine years,
on a straight-line basis. Accelerated methods of depreciation are used for tax
purposes. We amortize leasehold improvements over the useful life of the related
leasehold improvement or the life of the related lease, whichever is less. (See
Note F)
Deferred Revenues
We record revenue on extended service contracts ratably over the term of
the related warranty contracts. Effective September 1, 2003, we prospectively
adopted the provisions of EITF 00-21. Upon adoption of the provisions of EITF
00-21 effective September 1, 2003, we began to defer revenue related to EECP
domestic system sales for the fair value of in- service and training to the
period when the services are rendered and for service arrangement obligations
ratably over the service period, which is generally one year. (See Note G)
Warranty Costs
Equipment sold is generally covered by a warranty period of one year.
Effective September 1, 2003, we adopted the provisions of EITF 00-21 on a
prospective basis for our shipments to customers in the United States. Under
F-10
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
EITF 00-21, for certain arrangements, a portion of the overall system price
attributable to the first year service arrangement is deferred and recognized as
revenue over the service period. As such, we no longer accrue warranty costs
upon delivery for these customers but rather recognize warranty and related
service costs as incurred. Prior to September 1, 2003, we accrued a warranty
reserve for estimated costs to provide warranty services when the equipment sale
was recognized.
Equipment sold to international customers through our distributor network
is generally covered by a one year warranty period. For these customers we
accrue a warranty reserve for estimated costs to provide warranty services when
the equipment sale is recognized.
The factors affecting our warranty liability included the number of units
sold and historical and anticipated rates of claims and costs per claim. The
warranty provision resulting from transactions prior to September 1, 2003, will
be reduced in future periods for material and labor costs incurred as related
product is returned during the warranty period or when the warranty period
elapses. (See Note H)
Research and Development
Research and development costs are expensed as incurred. Included in
research and development costs is amortization expense related to the cost of
EECP systems under loan for clinical trials.
Income Taxes
Deferred income taxes are recognized for temporary differences between
financial statement and income tax bases of assets and liabilities and loss
carryforwards for which income tax benefits are expected to be realized in
future years. A valuation allowance is established, when necessary, to reduce
deferred tax assets to the amount expected to be realized. In estimating future
tax consequences, we generally consider all expected future events other than an
enactment of changes in the tax laws or rates. The deferred tax asset is
continually evaluated for realizability. To the extent our judgment regarding
the realization of the deferred tax assets change, an adjustment to the
allowance is recorded, with an offsetting increase or decrease, as appropriate,
in income tax expense. Such adjustments are recorded in the period in which our
estimate as to the realizability of the asset changed that it is "more likely
than not" that all of the deferred tax assets will be realized. The "more likely
than not" standard is subjective, and is based upon our estimate of a greater
than 50% probability that our long range business plan can be realized.
Deferred tax liabilities and assets are classified as current or
non-current based on the classification of the related asset or liability for
financial reporting. A deferred tax liability or asset that is not related to an
asset or liability for financial reporting, including deferred tax assets
related to carryforwards, are classified according to the expected reversal date
of the temporary difference. The deferred tax asset we recorded relates
primarily to the realization of net operating loss carryforwards, of which the
allocation of the current portion, if any, reflects the expected utilization of
such net operating losses in next twelve months. Such allocation is based our
internal financial forecast and may be subject to revision based upon actual
results. (See Note L)
Shipping and Handling Costs
The Company includes all shipping and handling expenses incurred as a
component of cost of sales. Amounts billed to customers related to shipping and
handling costs are included as a component of sales.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, accounts receivable and
accounts payable approximate fair value due to the short-term maturities of the
instruments. The carrying amount of the financing receivables approximates fair
value as the interest rates implicit in the leases approximate current market
interest rates for similar financial instruments. The carrying amounts of notes
payable approximates their fair value as the interest rates of these instruments
approximate the interest rates available on instruments with similar terms and
maturities.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Significant estimates and
assumptions relate to estimates of collectibility of accounts receivable and
financing receivables, the realizability of deferred tax assets, and the
adequacy of inventory and warranty reserves. Actual results could differ from
those estimates.
F-11
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
Net Loss Per Common Share
Basic loss per share is based on the weighted average number of common
shares outstanding without consideration of potential common stock. Diluted loss
per share is based on the weighted number of common and potential dilutive
common shares outstanding. The calculation takes into account the shares that
may be issued upon the exercise of stock options and warrants, reduced by the
shares that may be repurchased with the funds received from the exercise, based
on the average price during the period.
Stock-Based Employee Compensation
We have five stock-based employee compensation plans. We account for
stock-based compensation using the intrinsic value method in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations ("APB No. 25") and have adopted the
disclosure provisions of Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure, an
amendment of FASB Statement No. 123." Under APB No. 25, when the exercise price
of our employee stock options equals the market price of the underlying stock on
the date of grant, no compensation expense is recognized. Accordingly, no
compensation expense has been recognized in the consolidated financial
statements in connection with employee stock option grants.
The following table illustrates the effect on net income and earnings per
share had the Company applied the fair value recognition provisions of Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," to stock-based employee compensation.
Year Ended May 31,
-----------------------------------------------------
2005 2004 2003
--------------- --------------- ---------------
Net loss, as reported $(5,562,038) $(3,422,520) $(4,790,983)
Deduct: Total stock-based employee compensation
expense determined under fair value-based
method for all awards (1,097,783) (1,080,817) (917,281)
--------------- --------------- ---------------
Pro forma net loss $(6,659,821) $(4,503,337) $(5,708,264)
=============== =============== ===============
Loss per share:
Basic and diluted - as reported $(0.10) $(0.06) $(0.08)
Basic and diluted - pro forma $(0.11) $(0.08) $(0.10)
For purposes of estimating the fair value of each option on the date of
grant, the Company utilized the Black- Scholes option-pricing model. The
Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options. The fair value of the
Company's stock-based awards was estimated assuming no expected dividends and
the following weighted-average assumptions:
Year Ended May 31,
-----------------------------------------------------
2005 2004 2003
--------------- --------------- --------------
Expected life (years) 5 5 5
Expected volatility 81% 89% 89%
Risk-free interest rate 4.4% 3.4% 3.0%
Expected dividend yield 0.0% 0.0% 0.0%
F-12
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
Equity instruments issued to non-employees in exchange for goods, fees and
services are accounted for under the fair value-based method of SFAS No. 123.
Impact of New Accounting Pronouncements
In May 2005, the FASB issued Statement of Financial Accounting Standards
No. 154 ("SFAS No. 154"), "Accounting Changes and Error Corrections." SFAS No.
154 replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3,
Reporting Accounting Changes in Interim Financial Statements, and changes the
requirements for the accounting for and reporting of a change in accounting
principle. The Statement applies to all voluntary changes in accounting
principle. It also applies to changes required by an accounting pronouncement in
the unusual instance that the pronouncement does not include specific transition
provisions. When a pronouncement includes specific transition provisions, those
provisions should be followed. SFAS No. 154 is effective for accounting changes
and corrections of errors made in fiscal years beginning after December 15,
2005.
In December 2004, the Financial Accounting Standards Board (FASB) issued
FASB Statement No. 153 ("SFAS No. 153"), "Exchanges of Non-monetary Assets - an
amendment of APB Opinion No. 29". SFAS No. 153 amends Opinion 29 to eliminate
the exception for non-monetary exchanges of similar productive assets and
replaces it with a general exception for exchanges of non-monetary assets that
do not have commercial substance. A non-monetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. SFAS No. 153 is effective for fiscal
periods after June 15, 2005. The Company does not expect the adoption of SFAS
No. 153 to have a material impact on the Company's consolidated financial
statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123(R) ("SFAS No. 123(R)"), "Accounting for Stock-Based
Compensation". SFAS No. 123(R) establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. This Statement focuses primarily on accounting for transactions in
which an entity obtains employee services in share-based payment transactions.
SFAS No. 123(R) requires that the fair value of such equity instruments be
recognized as expense in the historical financial statements as services are
performed. Prior to SFAS No. 123(R), only certain pro-forma disclosures of fair
value were required. SFAS No. 123(R) shall be effective for the Company as of
the beginning of the first interim reporting period that begins after June 15,
2005. The adoption of this new accounting pronouncement is expected to have a
material impact on the financial statements of the Company commencing with the
quarter ending November 30, 2005.
In November 2004, the FASB issued Statement of Financial Accounting
Standards No. 151 ("SFAS No. 151"), Inventory Costs, an amendment of ARB No. 43,
Chapter 4. The amendments made by SFAS No. 151 will improve financial reporting
by clarifying that abnormal amounts of idle facility expense, freight, handling
costs, and wasted materials (spoilage) should be recognized as current-period
charges and by requiring the allocation of fixed production overheads to
inventory based on the normal capacity of the production facilities. SFAS No.
151 is effective for inventory costs incurred during fiscal years beginning
after June 15, 2005. Earlier application is permitted for inventory costs
incurred during fiscal years beginning after November 24, 2004. The Company is
currently evaluating the impact of adoption of SFAS No. 151 on its financial
position and results of operations.
F-13
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
NOTE B - LOSS PER COMMON SHARE
The following table sets forth the computation of basic and diluted loss
per share:
Year Ended May 31,
-----------------------------------------------------
2005 2004 2003
--------------- --------------- --------------
Numerator:
Net loss $(5,562,038) $(3,422,520) $(4,790,983)
Denominator:
Basic - weighted average shares 58,547,574 57,981,963 57,647,032
Stock options -- -- --
Warrants -- -- --
--------------- --------------- --------------
Diluted - weighted average shares 58,547,574 57,981,963 57,647,032
=============== =============== ==============
Loss per share - basic $(0.10) $(0.06) $(0.08)
=============== =============== ==============
- diluted $(0.10) $(0.06) $(0.08)
=============== =============== ==============
Options and warrants to purchase 6,745,544, 5,161,751 and 6,190,753 shares
of common stock were excluded from the computation of diluted earnings per share
for the years ended May 31, 2005, 2004 and 2003, respectively, because the
effect of their inclusion would be antidilutive.
NOTE C - CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of the following:
May 31,
----------------------------------
2005 2004
--------------- ---------------
Cash accounts $987,314 $2,522,570
Money market funds 2,210 3,842,479
--------------- ---------------
$989,524 $6,365,049
=============== ===============
NOTE D - INVENTORIES, NET
Inventories, net consist of the following:
May 31,
----------------------------------
2005 2004
--------------- ---------------
Raw materials $ 960,101 $ 928,269
Work in process 1,194,688 455,731
Finished goods 1,205,483 989,748
--------------- ---------------
$ 3,360,272 $ 2,373,748
=============== ===============
At May 31, 2005 and 2004, the Company has recorded reserves for excess and
obsolete inventory of $566,149 and $399,477, respectively.
NOTE E - FINANCING RECEIVABLES FROM MAJOR CUSTOMERS
In fiscal year 2002, the Company sold its external counterpulsation systems
("EECP" units) to two major customers engaged in establishing independent
networks of EECP centers under sales-type leases aggregating revenues of
$4,187,009 in fiscal year 2002. No additional equipment was sold to these
customers during fiscal 2003 or 2004.
F-14
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
In late August 2002, the largest customer became delinquent in its
scheduled monthly payments under its financing obligations to the Company. In
September 2002, the Company was notified by this customer of recent
circumstances that precluded their ability to remain current under their
financing obligations to the Company. Accordingly, management decided to
write-off, in full, all funds due from this customer as of August 31, 2002,
which aggregated approximately $3,000,000, including the present carrying amount
of the underlying equipment due to the uncertainty of the Company's ability to
repossess the equipment. During the second quarter of fiscal year 2003, the
customer ceased operations and the Company was able to successfully recover all
of the units that it had sold under sales-type leases to the customer back into
its finished goods inventory and recorded a bad debt recovery of $479,000, which
represented the carrying amount at that time of the equipment. The second
customer became delinquent in its scheduled monthly payments during the fourth
quarter of fiscal 2003. During the first and second quarters of fiscal 2004 the
customer attempted to remedy the situation and made payments totaling $70,000.
In December 2003, the customer ceased operations. Accordingly, management
decided to write- off all funds due from this customer as of November 30, 2003,
less the anticipated recovery of equipment and the reduction of related
liabilities for sales tax. The write-off of approximately $680,000 is included
as a component of the provision for doubtful accounts in the accompanying
Statement of Operations for the year ended May 31, 2004. In the third quarter of
fiscal 2004, the Company recovered all of the EECP systems that had been leased
to this customer. The Company is no longer offering sales-type leases.
NOTE F - PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
May 31,
-----------------------------------
2005 2004
--------------- ----------------
Land $ 200,000 $ 200,000
Building and improvements 1,383,976 1,382,270
Office, laboratory and other equipment 1,445,168 1,246,089
EECP systems under operating leases or under loan
for clinical trials 1,552,121 1,700,867
Furniture and fixtures 162,068 162,068
Leasehold improvements 117,803 117,803
--------------- ----------------
4,861,136 4,809,097
--------------- ----------------
Less: accumulated depreciation and amortization (2,626,983) (2,378,576)
--------------- ----------------
$2,234,153 $2,430,521
=============== ================
F-15
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
NOTE G - DEFERRED REVENUE
The changes in the Company's deferred revenues are as follows:
Year Ended May 31,
-----------------------------------------------------
2005 2004 2003
--------------- --------------- ---------------
Deferred revenue at beginning of year $2,846,451 $1,709,551 $991,204
ADDITIONS
Deferred extended service contracts 2,073,090 1,871,439 1,478,933
Deferred in-service and training 187,500 340,000 --
Deferred service arrangement obligations 765,001 1,040,000 --
RECOGNIZED AS REVENUE
Deferred extended service contracts (1,900,925) (1,485,372) (760,586)
Deferred in-service and training (262,500) (247,500) --
Deferred service arrangement obligations (1,157,085) (381,667) --
--------------- --------------- ---------------
Deferred revenue at end of year 2,551,532 2,846,451 1,709,551
Less: current portion (1,667,080) (1,734,925) (789,118)
--------------- --------------- ---------------
Long-term deferred revenue at end of year $884,452 $1,111,526 $920,433
=============== =============== ===============
NOTE H - WARRANTY LIABILITY
The changes in the Company's product warranty liability are as follows:
Year Ended May 31,
-------------------------------------------------------
2005 2004 2003
--------------- --------------- ----------------
Beginning balance $244,917 $788,000 $991,000
Expense for new warranties issued 27,000 164,000 724,000
Warranty claims (153,584) (707,083) (927,000)
--------------- --------------- ----------------
Ending balance $118,333 $244,917 $788,000
=============== =============== ================
NOTE I - LONG-TERM DEBT AND LINE OF CREDIT AGREEMENT
The following table sets forth the computation of long-term debt:
May 31,
------------------------------------
2005 2004
---------------- ----------------
Facility loans (a) $969,566 $1,022,933
Term loans (b) 126,243 206,382
---------------- ----------------
1,095,809 1,229,315
Less: current portion (148,212) (136,478)
---------------- ----------------
$947,597 $1,092,837
================ ================
(a) The Company purchased its headquarters and warehouse facility and
secured notes of $641,667 and $500,000, respectively, under two programs
sponsored by New York State. These notes, which bear interest at 7.8% and 6%,
respectively, are payable in monthly installments consisting of principal and
interest payments over fifteen-year terms, expiring in September 2016 and
January 2017, respectively, and are secured by the building.
(b) In fiscal years 2003 and 2004, the Company financed the cost and
implementation of a management information system and secured several notes,
aggregating approximately $305,219. The notes, which bear interest at rates
ranging from 7.5% through 12.5%, are payable in monthly installments consisting
of principal and interest payments over four-year terms, expiring at various
times between August and October 2006.
F-16
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
Maturities of long-term debt are as follows at May 31, 2005:
Fiscal Year Amount
------------------- --------------
2006 148,212
2007 96,583
2008 65,769
2009 70,524
2010 75,629
Thereafter 639,093
--------------
$1,095,809
==============
NOTE J - STOCKHOLDERS' EQUITY AND WARRANTS
In fiscal 2003, warrants to purchase 500,000 shares of common stock were
exercised, aggregating $225,000 in proceeds to the Company. No warrants were
exercised or cancelled in fiscal 2004 and 2005.
All outstanding warrants expire in October 2006. Warrant activity for the
years ended May 31, 2003, 2004 and 2005 is summarized as follows:
Employees Consultants Total Price Range
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2002 500,000 327,500 827,500 $0.45 - $2.08
Exercised (500,000) -- (500,000) $0.45
Cancelled -- (127,500) (127,500) $2.08
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2003 -- 200,000 200,000 $0.91
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2004 -- 200,000 200,000 $0.91
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2005 -- 200,000 200,000 $0.91
================= =================== ======================== ================
Number of shares exercisable -- 200,000 200,000 $0.91
================= =================== ======================== ================
NOTE K - OPTION PLANS
1995 Stock Option Plan
In May 1995, the Company's stockholders approved the 1995 Stock Option Plan
for officers and employees of the Company, for which the Company reserved an
aggregate of 1,500,000 shares of common stock. In December 1997, the Company's
Board of Directors terminated the 1995 Stock Option Plan with respect to new
option grants.
Outside Director Stock Option Plan
In May 1995, the Company's stockholders approved an Outside Director Stock
Option Plan for non-employee directors of the Company, for which the Company
reserved an aggregate of 300,000 shares of common stock. In December 1997, the
Company's Board of Directors terminated the Outside Director Stock Option Plan
with respect to new option grants.
In fiscal 2005 options to purchase 38,709 shares of common stock at an
exercise price of $0.78 under the Outside Director Stock Option Plan were
retired unexercised.
1997 Stock Option Plan
In December 1997, the Company's stockholders approved the 1997 Stock Option
Plan (the "1997 Plan") for officers, directors, employees and consultants of the
Company, for which the Company has reserved an aggregate of 1,800,000 shares of
common stock. The 1997 Plan provides that a committee of the Board of Directors
of the Company will administer it and that the committee will have full
authority to determine the identity of the recipients of the options and the
number of shares subject to each option. Options granted under the 1997 Plan may
be either incentive stock options or non- qualified stock options. The option
price shall be 100% of the fair market value of the common stock on the date of
the grant (or in the case of incentive stock options granted to any individual
principal stockholder who owns stock possessing more than 10% of the total
F-17
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
combined voting power of all voting stock of the Company, 110% of such fair
market value). The term of any option may be fixed by the committee but in no
event shall exceed ten years from the date of grant. Options are exercisable
upon payment in full of the exercise price, either in cash or in common stock
valued at fair market value on the date of exercise of the option. The term for
which options may be granted under the 1997 Plan expires August 6, 2007.
In January 1999, the Company's Board of Directors increased the number of
shares authorized for issuance under the 1997 Plan by 1,000,000 shares to
2,800,000 shares.
In fiscal 2004, options to purchase 75,667 shares of common stock under the
1997 Plan were exercised at an exercise price of $0.88 per share, aggregating
$66,209 of proceeds to the Company and options to purchase 350,000 shares of
common stock under the 1997 Plan at an exercise price of $0.88 were retired or
cancelled..
In fiscal 2005, the Company's Board of Directors granted non-qualified
stock options to purchase under the 1997 Plan to an officer to purchase an
aggregate of 153,168 shares of common stock, at an exercise price of $1.09 per
share, which represented the fair market value of the underlying common stock at
the time of the respective grants. These options vest over four years and expire
ten years from the date of grant. In fiscal 2005, options to purchase 4,500
shares of common stock under the 1997 Plan at an exercise price of $0.88 were
cancelled.
At May 31, 2005, there were 4,500 shares available for future grants under
the 1997 Plan.
1999 Stock Option Plan
In July 1999, the Company's Board of Directors approved the 1999 Stock
Option Plan (the "1999 Plan"), for which the Company reserved an aggregate of
2,000,000 shares of common stock. The 1999 Plan provides that a committee of the
Board of Directors of the Company will administer it and that the committee will
have full authority to determine the identity of the recipients of the options
and the number of shares subject to each option. Options granted under the 1999
Plan may be either incentive stock options or non-qualified stock options. The
option price shall be 100% of the fair market value of the common stock on the
date of the grant (or in the case of incentive stock options granted to any
individual principal stockholder who owns stock possessing more than 10% of the
total combined voting power of all voting stock of the Company, 110% of such
fair market value). The term of any option may be fixed by the committee but in
no event shall exceed ten years from the date of grant. Options are exercisable
upon payment in full of the exercise price, either in cash or in common stock
valued at fair market value on the date of exercise of the option. The term for
which options may be granted under the 1999 Plan expires July 12, 2009. In July
2000, the Company's Board of Directors increased the number of shares authorized
for issuance under the 1999 Plan by 1,000,000 shares to 3,000,000 shares. In
December 2001, the Board of Directors of the Company increased the number of
shares authorized for issuance under the 1999 Plan by 2,000,000 shares to
5,000,000 shares.
In December 2001, the Board of Directors granted stock options under the
1999 Plan to a consultant to purchase 25,000 shares of common stock at an
exercise price of $2.95 per share (which represented the fair market value of
the underlying common stock at the time of the respective grant). These stock
options were fair-valued at $50,250, which the Company charged to operations
over the one-year period in which services were rendered. During fiscal 2003 and
2002, the Company charged $25,000 and $50,000, respectively, to operations for
these grants.
In fiscal 2003, the Board of Directors granted stock non-qualified options
under the 1999 Plan to directors and employees to purchase an aggregate of
1,175,000 shares of common stock, at exercise prices ranging from $0.71 to $1.67
per share (which represented the fair market value of the underlying common
stock at the time of the respective grants).
In fiscal 2004, the Board of Directors granted non-qualified stock options
under the 1999 Plan to directors and employees to purchase an aggregate of
725,000 shares of common stock, at exercise prices ranging from $0.91 to $1.31
per share (which represented the fair market value of the underlying common
stock at the time of the respective grants). In fiscal 2004, options to purchase
521,666 shares of common stock under the 1999 Plan were exercised at an exercise
price of $0.71 to $1.22 per share, aggregating $631,178 of proceeds to the
Company and options to purchase 956,669 shares of common stock under the 1999
Plan at an exercise price of $0.91 to $5.15 were retired or cancelled.
In fiscal 2005, the Company's Board of Directors granted non-qualified
stock options to purchase under the 1999 Plan to an officer to purchase an
aggregate of 2,194,832 shares of common stock, at an exercise price of $0.95 to
F-18
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
$1.70 per share, which represented the fair market value of the underlying
common stock at the time of the respective grants. These options vest
immediately, or over three-year and four-year periods, and expire five years and
ten years from the date of grant. In fiscal 2005, options to purchase 133,332
shares of common stock under the 1999 Plan were exercised at an exercise price
of $0.98 per share, aggregating $130,666 of proceeds to the Company and options
to purchase 662,666 shares of common stock under the 1999 Plan at an exercise
price of $0.91 to $4.69 were retired or cancelled.
At May 31, 2005, there were 335,003 shares available for future grants
under the 1999 Plan.
2004 Stock Option and Stock Issuance Plan
In October 2004, the Company's stockholders approved the 2004 Stock Option
and Stock Issuance Plan (the "2004 Plan"), for which the Company reserved an
aggregate of 2,500,000 shares of common stock. The 2004 Plan is divided into two
separate equity programs: (i) the Option Grant Program under which eligible
persons ("Optionees") may, at the discretion of the board of directors, be
granted options to purchase shares of common stock; and (ii) the Stock Issuance
Program under which eligible persons ("Participants") may, at the discretion of
the board or directors, be issued shares of common stock directly, either
through the immediate purchase of such shares or as a bonus for services
rendered to the Corporation.
Options granted under the 2004 Stock Plan shall be non-qualified or
incentive stock options and the exercise price is the fair market value of the
common stock on the date of grant except that for incentive stock options it
shall be 110% of the fair market value if the Optionee owns 10% or more of our
common stock. The term of any option may be fixed by the board of directors or
committee but in no event shall exceed ten years from the date of grant. Stock
options granted under the 2004 Plan may become exercisable in one or more
installments in the manner and at the time or times specified by the committee.
Options are exercisable upon payment in full of the exercise price, either in
cash or in common stock valued at fair market value on the date of exercise of
the option. The term for which options may be granted under the 2004 Plan
expires July 12, 2014.
Under the stock issuance program, the purchase price per share shall be
fixed by the board of directors or committee but cannot be less than the fair
market value of the common stock on the issuance date. Payment for the shares
may be made in cash or check payable to us, or for past services rendered to us
and all shares of common stock issued thereunder shall vest upon issuance unless
otherwise directed by the committee. The number of shares issuable is also
subject to adjustments upon the occurrence of certain events, including stock
dividends, stock splits, mergers, consolidations, reorganizations,
recapitalizations, or other capital adjustments. The term for which shares may
be issued under the 2004 Plan expires July 12, 2014.
The 2004 Plan provides that a committee of the Board of Directors of the
Company will administer it and that the committee will have full authority to
determine and designate the individuals who are to be granted stock options or
qualify to purchase shares of common stock under the 2004 Stock Plan, the number
of shares to be subject to options or to be purchased and the nature and terms
of the options to be granted. The committee also has authority to interpret the
2004 Plan and to prescribe, amend and rescind the rules and regulations relating
to the 2004 Plan.
In fiscal 2005, the Company's Board of Directors granted non-qualified
stock options to purchase under the 2004 Plan to directors to purchase an
aggregate of 225,000 shares of common stock, at an exercise price of $0.95 per
share, which represented the fair market value of the underlying common stock at
the time of the respective grants. These options vest immediately, or over a
four-year period, and expire ten years from the date of grant.
At May 31, 2005, there were 2,275,000 shares available for future grants
under the 2004 Plan.
F-19
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
Activity under all the plans for the years ended May 31, 2003, 2004 and
2005, is summarized as follows:
Outstanding Options
-------------------------------------------------------------
Shares Weighted
Available for Number of Shares Exercise Average
Grant Price per Share Exercise Price
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2002 2,259,401 5,192,923 $0.78 - $5.15 $2.51
Options granted (1,175,000) 1,175,000 $0.71 - $1.67 $0.95
Options exercised -- (12,903) $0.78 $0.78
Options canceled 354,267 (364,267) $0.88 - $5.15 $3.77
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2003 1,438,668 5,990,753 $0.71 - $5.15 $2.13
Options granted (725,000) 725,000 $0.92 - $1.31 $1.06
Options exercised -- (597,333) $0.71 - $1.22 $1.17
Options canceled 1,306,669 (1,306,669) $0.88 - $5.15 $1.61
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2004 2,020,337 4,811,751 $0.71 - $5.15 $1.98
Options/shares authorized 2,500,000 (1) -- -- --
Options granted (2,573,000) 2,573,000 $0.95 - $1.70 $1.08
Options exercised -- (133,332) $0.98 $0.98
Options canceled 667,166 (705,875) $0.78 - $4.69 $2.03
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2005 2,614,503 6,545,544 $0.71 - $5.15 $1.86
================= =================== ======================== ================
(1) May be issued under the Stock Issuance Program.
The following table summarizes information about stock options outstanding
and exercisable at May 31, 2005
Options Outstanding Options Exercisable
--------------------------------------------------- --------------------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Outstanding at Contractual Exercise Price Exercisable at Exercise
Range of Exercise Prices May 31, 2005 Life (yrs.) May 31, 2005 Price
------------------ ---------------- --------------- ----------------- --------------
$0.71 - $0.98 1,553,000 6.9 $0.91 951,334 $0.88
$1.00 - $1.48 2,350,000 8.3 $1.11 546,664 $1.08
$1.53 - $2.21 947,544 3.2 $1.85 940,877 $1.85
$2.66 - $3.44 801,000 3.4 $3.24 801,000 $3.24
$3.50 - $5.15 894,000 5.6 $4.03 894,000 $4.03
------------------ ---------------- --------------- ----------------- --------------
6,545,544 6.2 $1.83 4,133,875 $2.26
================== ================ =============== ================= ==============
The weighted-average fair value of options granted during fiscal years
2005, 2004 and 2003 was $1.08, $1.06, and $0.95, respectively. At May 31, 2005,
there were approximately 42,087,265 remaining authorized shares of common stock
after reserves for all stock option plans and stock warrants.
NOTE L - INCOME TAXES
During the fiscal years ended May 31, 2005 and 2004, the Company recorded a
provision for state income taxes of $39,661 and $50,640, respectively. In fiscal
2003, the Company recorded a benefit for income taxes of $1,634,688, inclusive
of $256,312 in current tax expense and a deferred benefit of $1,891,000.
As of May 31, 2005, the Company had recorded deferred tax assets of
$14,582,000 (net of a $3,774,000 valuation allowance) related to the anticipated
recovery of tax loss carryforwards. The amount of the deferred tax assets
considered realizable could be reduced in the future if estimates of future
taxable income during the carryforward period are reduced. Ultimate realization
of the deferred tax assets is dependent upon the Company generating sufficient
F-20
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
taxable income prior to the expiration of the tax loss carryforwards. Management
believes that the Company is positioned for long-term growth despite the losses
during fiscal years 2005 and 2004, and that based upon the weight of available
evidence, that it is "more likely than not" that the net deferred tax assets
will be realized. The "more likely than not" standard is subjective, and is
based upon management's estimate of a greater than 50% probability that its long
range business plan can be realized.
Ultimate realization of any or all of the deferred tax assets is not
assured, due to significant uncertainties and material assumptions associated
with estimates of future taxable income during the carryforward period. Our
estimates are largely dependent upon achieving considerable growth in revenue
and profits resulting from the successful commercialization of EECP therapy into
the congestive heart failure indication, which we believe to enable us to
reverse the current trend of increasing losses and generate pre-tax income in
excess of $39 million over the next seven years in order to fully utilize all of
the deferred tax assets. Such future estimates of future taxable income are
based on our beliefs, as well as assumptions made by and information currently
available to us. Certain critical assumptions associated with our estimates
include:
-- that the results from the PEECH clinical trial, as well as other
clinical evidence are sufficiently positive for the PEECH clinical
trial to be published in a peer review journal and enable the EECP
therapy to obtain approval for a national Medicare reimbursement
coverage policy plus other third-party payer reimbursement policies
specific to the congestive heart failure indication;
-- that the reimbursement coverage will be both broad enough in terms of
coverage language and at an amount adequate to enable successful
commercialization of EECP therapy into the congestive heart failure
indication and enable us to achieve material growth in revenue and
profits;
-- that the EECP therapy will be accepted by the medical community as an
adjunctive therapy for the treatment of patients suffering from
congestive heart failure; and
-- that we will be able to secure additional financing to provide
sufficient funds to market EECP therapy in the congestive heart
failure indication.
Additional uncertainties that could cause actual results to differ
materially are the following:
-- the effect of the dramatic changes taking place in the healthcare
environment;
-- the impact of competitive procedures and products and their pricing;
-- other medical insurance reimbursement policies;
-- there can be no assurance that we will be able to raise additional
capital necessary to implement our business plan;
-- unexpected manufacturing problems;
-- unforeseen difficulties and delays in the conduct of clinical trials,
peer review publications and other product development programs;
-- the actions of regulatory authorities and third-party payers in the
United States and overseas;
-- uncertainties about the acceptance of a novel therapeutic modality by
the medical community;
-- our recent financial history of declining revenues and losses; and
-- the risk factors reported from time to time in our SEC reports.
Factors considered by us in making our assumptions and included in our
long-term business plan are the following:
-- we currently have FDA clearance to market EECP therapy in congestive
heart failure;
-- independent market research indicates that the patient population
potentially eligible for EECP therapy in congestive heart failure
market is larger than the current refractory angina patient population
and when the two patient populations are combined the total market
opportunity for EECP therapy will be more than double;
-- many physician practices have told us that they do not have a
sufficient number of patients to economically justify adoption of the
procedure with the current reimbursement coverage for refractory
angina. The increased market size resulting from the addition of CHF
patients could improve the economic model for the physician practice;
-- we have positive clinical evidence from the PEECH clinical trial that
was recently concluded as disclosed in the above "Research and
Development" section, plus other smaller clinical trials and the IEPR
patient registry that demonstrates the clinical effectiveness of EECP
therapy in the treatment of congestive heart failure to medical
providers, payers and regulators;
F-21
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
-- we completed the PEECH clinical trial this fiscal year as planned and
disclosed the summary results of the trial in March 2005;
-- we intend to have the results of the PEECH trial published in a peer
review journal, which is an important step necessary to support an
application to CMS to expand reimbursement coverage of EECP therapy to
include CHF patients;
-- we sustained a period of profitability in fiscal years 2000, 2001 and
2002 with profits before income taxes of $1,290,916, $5,237,242 and
$4,240,106, respectively; and
-- we continue to believe that we will be able to raise sufficient funds
to enable us to execute our business plan.
While we believe that we will be able to execute our business plan over the
longer term and we will be able to utilize our tax loss carryforwards, the exact
timing of our return to profitability is uncertain, subject to significant
management judgments and estimates and dependent on a variety of external
factors including: market conditions at that time, the reception of the EECP
therapy by the medical professionals and payers and the timing of a Medicare
reimbursement decision. It is possible that significant tax loss carryforwards
from fiscal years 2005, 2006 and 2007 may expire before we are able to use them.
As a result of these uncertainties, beginning in fiscal 2004, we began to
provide a valuation reserve for all additional tax loss carryforwards that were
generated by current operating losses. We review this policy on a quarterly
basis and believe that the above valuation reserve is appropriate under the
current circumstances.
The amount of the deferred tax assets considered realizable could be
reduced in the future if estimates of future taxable income during the
carryforward period are reduced.
The recorded deferred tax asset includes an increase to the valuation
allowance of $1,866,000 during the fiscal year ended May 31, 2005.
The Company's deferred tax assets are summarized as follows:
2005 2004 2003
--------------- --------------- ---------------
Net operating loss and other carryforwards $16,489,000 $14,468,000 $13,368,000
Accrued compensation 68,000 118,000 153,000
Bad debts 134,000 238,000 244,000
Other 1,665,000 1,666,000 1,439,000
--------------- --------------- ---------------
Total gross deferred tax assets 18,356,000 16,490,000 15,204,000
Valuation allowance (3,774,000) (1,908,000) (622,000)
--------------- --------------- ---------------
Net deferred tax assets $14,582,000 $14,582,000 $14,582,000
=============== =============== ===============
The deferred tax benefit for fiscal years May 31, 2005, 2004 and 2003 does
not include the tax benefit associated with the current exercises of stock
options and warrants, aggregating $0, $0, and $222,000, respectively, which was
credited directly to additional paid-in capital.
F-22
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
At May 31, 2005, the Company had net operating loss carryforwards for
Federal and state income tax purposes of approximately $48,498,000, expiring at
various dates from 2006 through 2022. During fiscal 2005, $96,516 of net
operating loss carryforwards expired, and subsequent expiration of net operating
loss carryforwards are as follows:
Fiscal Year Amount
------------------- --------------
2006 336,198
2007 517,934
2008 558,968
2009 470,994
2010 2,454,162
Thereafter 44,159,560
--------------
$48,497,816
==============
Under current tax law, the utilization of tax attributes will be restricted
if an ownership change, as defined, were to occur. Section 382 of the Internal
Revenue Code provides, in general, that if an "ownership change" occurs with
respect to a corporation with net operating and other loss carryforwards, such
carryforwards will be available to offset taxable income in each taxable year
after the ownership change only up to the "Section 382 Limitation" for each year
(generally, the product of the fair market value of the corporation's stock at
the time of the ownership change, with certain adjustments, and a specified
long-term tax-exempt bond rate at such time). The Company's ability to use its
loss carryforwards would be limited in the event of an ownership change.
The following is a reconciliation of the effective income tax rate to the
federal statutory rate:
2005 2004 2003
Amount % Amount % Amount %
--------------- -------- -------------- --------- --------------- --------
Federal statutory rate $(1,850,626) (34.0) $(1,146,439) (34.0) $(2,185,000) (34.0)
State taxes, net 39,661 0.7 50,640 1.5 34,000 .5
Permanent differences 34,720 0.6 23,839 0.8 33,320 .5
Utilization of net operating loss -- -- -- -- -- --
Change in valuation allowance
relating to operations 1,866,000 34.3 1,286,000 38.1 622,000 9.7
Other (50,094) (0.9) (163,400) (4.9) (139,008) (2.1)
--------------- -------- -------------- --------- --------------- --------
$39,661 0.7 $50,640 1.5 $(1,634,688) (25.4)
=============== ======== ============== ========= =============== ========
NOTE M - COMMITMENTS AND CONTINGENCIES
Employment Agreements
In October 2003, the Company entered into an employment agreement with its
new Chief Financial Officer. The agreement, which expires in September 2005,
provides for certain settlement benefits, including a lump-sum payment of twelve
months of base salary in the event of a change of control, as defined, or a
termination payment in an amount equal to six months of base salary in the event
of termination without cause, as defined.
The approximate aggregate minimum compensation obligation under active
employment agreements at May 31, 2005, are summarized as follows:
Fiscal Year Amount
------------------- -----------------
2006 $40,625
=================
F-23
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
Leases
The Company leases additional warehouse space under two noncancelable
operating leases, of which one expires on October 31, 2005, and the other on
September 30, 2006. Rent expense was $93,000, $72,000 and $99,000 in fiscal
2005, 2004 and 2003, respectively.
Approximate aggregate minimum annual obligations under these lease
agreements and other equipment leasing agreements at May 31, 2005, are
summarized as follows:
Fiscal Year Amount
------------------- --------------
2006 62,329
2007 14,238
--------------
$76,567
==============
Litigation
The Company is currently, and has in the past been, a party to various
routine legal proceedings incident to the ordinary course of business. The
Company believes that the outcome of all such pending legal proceedings in the
aggregate is unlikely to have a material adverse effect on the business or
consolidated financial condition of the Company.
In June 2001, an action was commenced in the New York Supreme Court, Nassau
County, against the Company by the former holder of a warrant to purchase
100,000 shares of the Company's stock seeking undefined damages based upon a
claim that the Company breached an agreement to register the common shares
underlying the warrant at the "earliest practicable date" after due demand by
the warrant holder had been made. In October 2002, the Company settled this
matter for $600,000 through the execution of an agreement that enables the
Company to satisfy this obligation over a four-year period ($200,000 in fiscal
2003, $66,500 in fiscal 2004, $133,000 each in fiscal years 2005 and 2006 and
$66,500 in fiscal 2007). Accordingly, the Company recorded a $600,000 charge to
operations in fiscal 2003. In December 2002, the Company paid $200,000 to the
warrant holder pursuant to the terms of the settlement agreement.
401(k) Plan
In April 1997, the Company adopted the Vasomedical, Inc. 401(k) Plan to
provide retirement benefits for its employees. As allowed under Section 401(k)
of the Internal Revenue Code, the plan provides tax-deferred salary deductions
for eligible employees. Employees are eligible to participate in the next
quarter enrollment period after employment. Participants may make voluntary
contributions to the plan up to 15% of their compensation. In fiscal year 2005,
2004 and 2003, the Company made discretionary contributions of approximately
$38,000, $35,535 and $35,000, respectively, to match a percentage of employee
contributions.
F-24
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
NOTE N - SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the Company's unaudited quarterly operating
results for the years ended May 31, 2005 and 2004.
Three months ended
--------------------------------------------------------------------------------------------------
(in 000s except May 31, Feb. 28, Nov. 30, Aug. 31, May 31, Feb. 29, Nov. 30, Aug. 31,
Earnings (loss) per 2005 2005 2004 2004 2004 2004 2003 2003
share data) (a)
----------------------- ----------- ----------- ------------- ------------ ----------- ----------- ----------- -----------
Revenues $3,848 $2,964 $3,462 $4,821 $5,927 $5,950 $4,903 $5,427
Gross Profit $2,344 $1,800 $2,288 $3,160 $3,903 $4,017 $3,210 $3,488
Net Loss $(1,001) $(2,027) $(1,610) $(924) $(759) $(310) $(2,087) $(267)
Loss per
share - basic $(0.02) $(0.03) $(0.03) $(0.02) $(0.01) $(0.01) $(0.04) $(0.00)
- diluted $(0.02) $(0.03) $(0.03) $(0.02) $(0.01) $(0.01) $(0.04) $(0.00)
Weighted average
common shares
outstanding
- basic 58,553 58,553 58,553 58,532 58,384 57,887 57,828 57,827
- diluted 58,553 58,553 58,553 58,532 58,384 57,887 57,828 57,827
(a) Net loss for the second quarter of fiscal 2004 was adversely affected by
the write-off of approximately $680 related to significant uncertainties
related to the ability of a major customer to satisfy its financial
obligations to the Company, (see Note E).
NOTE O - SUBSEQUENT EVENT
On July 19, 2005, we entered into a Securities Purchase Agreement that will
provide us with gross proceeds of $2.5 million through a private placement of
preferred stock with M.A.G. Capital, LLC through its designated funds, Monarch
Pointe Fund Ltd., Mercator Momentum Fund III, LP, and Mercator Momentum Fund, LP
(the "Investors"). We received $1.75 million or 70% of the gross proceeds on
July 19, 2005 and the balance of $750,000 is expected to be received upon the
filing of the registration statement (see below). The agreement provides for a
private placement of 25,000 shares of Vasomedical's Series D Preferred Stock at
$100 per share. The preferred stock is convertible into shares of Vasomedical's
common stock at 85 percent of the volume weighted average price per share for
the five trading days preceding any conversion, but not at more than $0.6606 or
less than $0.40 per share. After registering the shares of common stock that
could be acquired through conversion of preferred shares, Vasomedical may, at
its option, require the holders to convert all their preferred stock into common
shares if the closing price for the common stock for the preceding 20 trading
days has been greater than $1.30 per share. The Investors also acquired warrants
for the purchase of 1,892,219 shares of common stock. The warrants may be
exercised at a price of $0.69 per share for a term of five years, ending July
19, 2010. Conversion of the preferred stock and exercise of the warrants are
subject to limitation such that the beneficial ownership of the Investors and
their affiliates shall not exceed 9.99% of the common stock outstanding. Under
the terms of a Registration Rights Agreement with the Investors, Vasomedical is
to file a registration statement with the Securities and Exchange Commission by
September 2, 2005, for the shares of common stock underlying the preferred stock
and warrants.
By the placement of the preferred stock described above, we became
obligated to pay a cash dividend monthly on the outstanding shares of preferred
stock. The dividend rate is the higher of (i) the prime rate as reported by the
Wall Street Journal on the first day of the month, plus three percent or, (ii)
8.5% times $100 per share, but in no event greater than 10% annually.
An event of default occurs if we fail to timely pay the dividend, fail to
timely file a registration statement for the shares of common stock underlying
the preferred shares and warrants, or have not obtained effectiveness of the
registration statement by December 1, 2005, among other specified occurrences.
Upon an event of default, the price at which the preferred stock may be
converted into common stock is reduced from 85 percent to 75 percent of the then
current volume weighted average market price per share, but not more than
$0.6606 or less than $0.40 per share (the "Floor Price"). In the event that our
quarterly gross revenues are less than $2,500,000, then the Floor Price shall
automatically reduce to $0.30. In addition, the holders of the preferred stock
have the right to be paid first from the assets of Vasomedical upon any
dissolution or liquidation of the company.
F-25
Vasomedical Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
May 31, 2005, 2004 and 2003
These securities were offered and sold to the Investors in a private
placement transaction made in reliance upon exemptions from registration
pursuant to Section 4(2) of the Securities Act of 1933. The Investors are
accredited investors as defined in Rule 501 of Regulation D promulgated under
the Securities Act of 1933. Vasomedical intends to apply the funds for working
capital.
F-26
Vasomedical, Inc. and Subsidiaries
Schedule II - Valuation and Qualifying Accounts
------------------------------------------- --------------- ---------------------------- ------------------ -----------------
Column A Column B Column C Column D Column E
------------------------------------------- --------------- ---------------------------- ------------------ -----------------
Additions
----------------------------
(1) (2)
Balance at Charged to Charged to
beginning of costs and other Balance at end
period expenses accounts Deductions of period
------------------------------------------- --------------- --------------- ------------ ------------------ -----------------
Allowance for doubtful accounts
Year ended May 31, 2005 $699,203 $11,084 $-- (a) $315,595 $394,692
Year ended May 31, 2004 $768,629 $616,759 $-- (a) $686,185 $699,203
Year ended May 31, 2003 $1,099,687 $1,227,324 $-- (a) $1,558,382 $768,629
Valuation Allowance- Financing Receivables
Year ended May 31, 2005 $-- $-- $-- $-- $--
Year ended May 31, 2004 $244,994 $680,000 $-- (b) $924,994 $--
Year ended May 31, 2003 $718,879 $-- (b) $473,885 $244,994
Reserve for excess and obsolete inventory
Year ended May 31, 2005 $399,477 $166,672 $-- $-- $566,149
Year ended May 31, 2004 $280,477 $119,000 $-- $-- $399,477
Year ended May 31, 2003 $180,477 $100,000 $-- $-- $280,477
Valuation Allowance - Deferred Tax Asset
Year ended May 31, 2005 $1,908,000 $1,866,000 $-- $-- $3,774,000
Year ended May 31, 2004 $622,000 $1,286,000 $-- $-- $1,908,000
Year ended May 31, 2003 $-- $622,000 $-- $-- $622,000
Provision for warranty obligations
Year ended May 31, 2005 $244,917 $27,000 $-- (c) $153,584 $118,333
Year ended May 31, 2004 $788,000 $164,000 $-- (c) $707,083 $244,917
Year ended May 31, 2003 $991,000 $724,000 $-- (c) $927,000 $788,000
(a) accounts receivable written off, net of $10,000, $0 and $15,000 in
recoveries in fiscal years 2005, 2004 and 2003, respectively.
(b) financing receivables written off
(c) warranty claims paid
S-1