UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the quarterly period ended February 28, 2006
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the transition period from _______________ to ______________
Commission File Number: 0-18105
VASOMEDICAL, INC.
--------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 11-2871434
--------------------------------------------------------------------------------
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
180 Linden Ave., Westbury, New York 11590
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(Address of principal executive offices)
Registrant's Telephone Number (516) 997-4600
Number of Shares Outstanding of Common Stock,
$.001 Par Value, at April 13, 2006 65,089,897
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the 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 check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Page 1
Vasomedical, Inc. and Subsidiaries
INDEX
Page
----
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements (unaudited)
Consolidated Condensed Balance Sheets as of
February 28, 2006 and May 31, 2005 3
Consolidated Condensed Statements of Operations for the
Nine and Three Months Ended February 28, 2006 and 2005 4
Consolidated Condensed Statement of Changes in Stockholders'
Equity for the Period from June 1, 2005 to February 28, 2006 5
Consolidated Condensed Statements of Cash Flows for the
Nine Months Ended February 28, 2006 and 2005 6
Notes to Consolidated Condensed Financial Statements 7
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 27
Item 4 - Controls and Procedures 27
PART II - OTHER INFORMATION 28
Page 2
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED CONDENSED BALANCE SHEETS
February 28, May 31,
2006 2005
----------------- ------------------
ASSETS (unaudited) (Derived from
audited
financial
statements)
CURRENT ASSETS
Cash and cash equivalents $733,423 $989,524
Certificates of deposit 998,287 1,758,443
Accounts receivable, net of an allowance for doubtful accounts of
$477,623 at February 28, 2006, and $394,692 at May 31, 2005 2,571,241 1,892,002
Inventories, net 2,851,402 3,360,272
Other current assets 281,982 223,902
----------------- ------------------
Total current assets 7,436,335 8,224,143
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,549,006 at
February 28, 2006, and $2,626,983 at May 31, 2005 1,664,538 2,234,153
DEFERRED INCOME TAXES -- 14,582,000
OTHER ASSETS 308,191 321,174
----------------- ------------------
$9,409,064 $25,361,470
================= ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $1,281,668 $1,569,131
Current maturities of long-term debt and notes payable 150,658 148,212
Sales tax payable 225,637 216,753
Deferred revenue 1,629,143 1,667,080
Accrued warranty and customer support expenses 42,750 110,583
Accrued professional fees 497,661 401,511
Accrued commissions 257,255 178,104
----------------- ------------------
Total current liabilities 4,084,772 4,291,374
LONG-TERM DEBT 868,204 947,597
ACCRUED WARRANTY COSTS 2,250 7,750
DEFERRED REVENUE 816,741 884,452
OTHER LIABILITIES -- 67,500
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; 1,000,000 shares authorized; none
issued and outstanding at February 28, 2006 and May 31, 2005 -- --
Common stock, $.001 par value; 110,000,000 shares authorized;
65,089,897 and 58,552,688 shares at February 28, 2006, and May
31, 2005, respectively, issued and outstanding 65,089 58,552
Additional paid-in capital 46,115,346 51,450,639
Accumulated deficit (42,543,338) (32,346,394)
----------------- ------------------
Total stockholders' equity 3,637,097 19,162,797
----------------- ------------------
$9,409,064 $25,361,470
================= ==================
The accompanying notes are an integral part of these condensed financial
statements.
Page 3
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(unaudited)
Nine Months Ended Three Months Ended
February 28, February 28,
--------------------------------- --------------------------------
2006 2005 2006 2005
--------------- -------------- -------------- -------------
Revenues
Equipment sales $5,998,943 $8,629,026 $1,807,625 $2,131,567
Equipment rentals and services 3,059,433 2,618,393 1,034,196 832,761
--------------- -------------- -------------- -------------
Total revenues 9,058,376 11,247,419 2,841,821 2,964,328
Cost of Sales and Services
Cost of sales, equipment 2,755,419 3,034,836 898,014 831,936
Cost of equipment rentals and services 993,613 965,413 330,005 332,646
--------------- -------------- -------------- -------------
Total cost of sales and services 3,749,032 4,000,249 1,228,019 1,164,582
--------------- -------------- -------------- -------------
Gross Profit 5,309,344 7,247,170 1,613,802 1,799,746
Operating Expenses
Selling, general and administrative 6,769,946 9,088,858 1,852,173 2,947,978
Research and development 1,528,699 2,521,321 412,997 863,476
Provision for doubtful accounts 89,559 135,156 18,984 2,200
--------------- -------------- -------------- -------------
Total operating expenses 8,388,204 11,745,335 2,284,154 3,813,654
--------------- -------------- -------------- -------------
LOSS FROM OPERATIONS (3,078,860) (4,498,165) (670,352) (2,013,908)
Other Income (Expense)
Interest and financing costs (64,299) (84,971) (19,346) (25,931)
Interest and other income, net 59,041 51,795 18,251 20,968
--------------- -------------- -------------- -------------
Total other income (expense) (5,258) (33,176) (1,095) (4,963)
--------------- -------------- -------------- -------------
LOSS BEFORE INCOME TAXES (3,084,118) (4,531,341) (671,447) (2,018,871)
Income tax expense, net (7,112,826) (29,661) -- (7,978)
--------------- -------------- -------------- -------------
NET LOSS (10,196,944) (4,561,002) (671,447) (2,026,849)
Preferred Stock Dividend (877,870) -- (23,334) --
--------------- -------------- -------------- -------------
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS
$(11,074,814) $(4,561,002) $(694,781) $(2,026,849)
=============== ============== ============== =============
Net loss per common share
- basic $(0.18) $(0.08) $(0.01) $(0.03)
=============== ============== ============== =============
- diluted $(0.18) $(0.08) $(0.01) $(0.03)
=============== ============== ============== =============
Weighted average common shares
outstanding
- basic 60,063,566 58,545,850 62,162,119 58,552,688
=============== ============== ============== =============
- diluted 60,063,566 58,545,850 62,162,119 58,552,688
=============== ============== ============== =============
The accompanying notes are an integral part of these condensed financial
statements.
Page 4
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED CONDENSED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(unaudited)
Additional Total
Preferred Stock Common Stock Paid-in Accumulated Stockholders'
Shares Amount Shares Amount Capital Deficit Equity
------------- -------------- --------------- ------------ ---------------- ------------------ ---------------
Balance at June 1, 2005 -- -- 58,552,688 $58,552 $51,450,639 $(32,346,394) $19,162,797
Issuance of Series
D convertible
preferred stock,
net of costs 25,000 $250 1,613,209 1,613,459
Warrants issued in
connection with
the issuance of
Series D conver-
tible preferred
stock 411,158 411,158
Beneficial con-
version feature
embedded in Series
D convertible
preferred stock
issued 786,247 786,247
Dividends on Series
D convertible
preferred stock (877,870) (877,870)
Issuance of common
stock in connection
with the issuance
of Series D conver-
tible preferred stock 200,000 200 125,800 126,000
Issuance of common
stock in connection
with the conversion
of Series D con-
vertible preferred
stock (25,000) (250) 6,112,209 6,112 (5,862) --
Issuance of common
stock in payment
of outside director
fees 225,000 225 101,025 101,250
Reserve for tax
benefit of stock
options and warrants
exercised in prior
years (7,489,000) (7,489,000)
Net loss (10,196,944) (10,196,944)
------------- -------------- --------------- ------------ ---------------- ------------------ --------------
Balance at February
28, 2006 -- $-- 65,089,897 $65,089 $46,115,346 $(42,543,338) $3,637,097
============= ============== =============== ============ ================ ================== ==============
The accompanying notes are an integral part of this condensed financial
statement.
Page 5
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months
Ended February 28,
-------------------------------------
2006 2005
----------------- ----------------
Cash flows from operating activities
Net loss $(10,196,944) $(4,561,002)
----------------- ----------------
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization 413,038 433,177
Provision for doubtful accounts 89,559 135,156
Reserve for excess and obsolete inventory (11,509) 71,908
Deferred income taxes 7,093,000 --
Common stock issued for services 101,250 --
Changes in operating assets and liabilities
Accounts receivable (768,798) 3,797,316
Inventories 709,765 (1,372,541)
Other current assets 243,972 (164,123)
Other assets (19,826) (50,530)
Accounts payable, accrued expenses and other current liabilities (244,048) (1,296,234)
Other liabilities (140,711) (400,099)
----------------- ----------------
7,465,692 1,154,030
----------------- ----------------
Net cash used in operating activities (2,731,252) (3,406,972)
----------------- ----------------
Cash flows provided by (used in) investing activities
Purchase of property and equipment -- (177,340)
Purchase of certificates of deposit and treasury bills -- (1,583,614)
Redemptions of certificates of deposit 760,156 --
----------------- ----------------
Net cash provided by (used in) investing activities 760,156 (1,760,954)
----------------- ----------------
Cash flows provided by financing activities
Payments on long term debt and notes payable (378,999) (99,062)
Payments of preferred stock dividends (91,623) --
Payments of preferred stock issue costs (314,383) --
Proceeds from exercise of options and warrants -- 130,666
Proceeds from sale of convertible preferred stock 2,500,000 --
----------------- ----------------
Net cash provided by financing activities 1,714,995 31,604
----------------- ----------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (256,101) (5,136,322)
Cash and cash equivalents - beginning of period 989,524 6,365,049
----------------- ----------------
Cash and cash equivalents - end of period $733,423 $1,228,727
================= ================
Non-cash investing and financing activities were as follows:
Inventories transferred to (from) property and equipment, attributable to
operating leases, net $(189,386) $61,299
Issue of note for purchase of insurance policy $302,052 --
Preferred stock dividends $786,247 --
Preferred stock issue costs $227,087 --
Supplemental Disclosures
Interest paid $64,299 $84,971
Income taxes paid $22,923 $36,572
The accompanying notes are an integral part of these condensed financial
statements.
Page 6
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2006
NOTE A - BASIS OF PRESENTATION
The consolidated condensed balance sheet as of February 28, 2006, and the
related consolidated condensed statements of operations for the nine and
three-month periods ended February 28, 2006 and 2005, changes in stockholders'
equity for the nine-month period ended February 28, 2006, and cash flows for the
nine- month periods ended February 28, 2006 and 2005, have been prepared by
Vasomedical, Inc. and Subsidiaries (the "Company") without audit. In the opinion
of management, all adjustments (which include normal, recurring accrual
adjustments) necessary to present fairly the financial position and results of
operations as of February 28, 2006, and for all periods presented have been
made.
Certain information and footnote disclosures, normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America, have been condensed or omitted. These
financial statements should be read in conjunction with the financial statements
and notes thereto included in the Annual Report on Form 10-K for the year ended
May 31, 2005. Results of operations for the periods ended February 28, 2006 and
2005, are not necessarily indicative of the operating results expected or
reported for the full year.
We have incurred declines in revenue and significant operating losses
during the last three fiscal years and our ability to continue operating as a
going concern is dependent upon achieving profitability in the refractory angina
market or through additional debt or equity financing. Achieving profitability
is largely dependent on our ability to reduce operating costs sufficiently as
well as halting the current trend of declining revenue. Our ability to maintain
our current base of revenue is largely dependent upon restructuring our sales
and marketing efforts in the angina market and operating in a more efficient
manner. If we are not able to maintain our existing base of revenue and
sufficiently reduce operating costs to generate an adequate cash flow, or raise
additional capital, we will not be able to continue as a going concern.
In order to reduce the Company's cash burn and bring its cost structure
more into alignment with current revenue, we initiated a company restructuring
in January 2006, to reduce personnel and spending on marketing and development
projects. We anticipate that the restructuring will reduce manufacturing and
operating cost by approximately $3 million per year compared to prior levels. In
addition, in April 2006, certain senior executives elected to defer
approximately $0.4 million in annual salary compensation. We believe that these
steps to conserve cash will provide the Company with the opportunity to rebuild
sales to a profitable level and/or explore strategic opportunities.
Based on the continuation of current revenue levels and the implementation
of our restructuring plan initiated in January 2006, we believe that we will be
able to fund our minimum projected capital requirements through at least the end
of the calendar year.
In the event that additional capital is required, we may seek to raise such
capital through public or private equity or debt financings or other means. We
may not be able to obtain additional financing on favorable terms or at all. If
we are unable to raise additional funds when we need them, we may be required to
further scale back our operations, research, marketing or sales efforts or
obtain funds through arrangements with collaborative partners or others that may
require us to license or relinquish rights to technologies or products. Future
capital funding, if available, may result in dilution to current shareholders,
and new investors could have rights superior to existing stockholders.
The accompanying financial statements do not include any adjustments that
might be necessary if the Company is unable to continue as a going concern.
Reclassifications
Certain reclassifications have been made to the prior year's amounts to conform
with the current year's presentation.
NOTE B - 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
Page 7
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2006
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 adopted SFAS No. 153 effective for
fiscal periods beginning September 1, 2005. The adoption of SFAS No. 153 did not
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 next fiscal year 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 August 31, 2006.
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
adopted SFAS No. 151 effective for fiscal periods beginning June 1, 2005. We
determined that our production facilities are currently operating below normal
capacity and as a result we applied production overhead rates based on normal
production capacity which resulted in a reduction of the amount of overhead
allocated to inventory for the nine-month and three-month periods ended February
28, 2006 of $290,000 and $149,000, respectively. Had the Company adopted the
provisions of SFAS No. 151 beginning in fiscal 2005, there would have been no
change in overhead allocation as the Company was operating within its normal
production capacity at that time.
NOTE C - STOCK-BASED COMPENSATION
The Company has five stock-based employee and director compensation plans.
The Company accounts 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 has 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 the Company's 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.
During the nine-month period ended February 28, 2006, the Board of
Directors granted non-qualified stock options under the 1999 Stock Option Plan
to eight employees to purchase 560,000 shares of common stock, at an exercise
price of $0.20 per share, and granted non-qualified stock options under the 2004
Stock Option/Stock Issuance Plan to three officers, and 49 employees to purchase
an aggregate of 1,418,045 shares of common stock, at an exercise price of $0.20
to $0.58 per share, which represented the fair market value of the underlying
Page 8
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2006
common stock at the time of the respective grants. These options vest over one
to three year periods, and expire ten years from the date of grant.
During the nine-month period ended February 28, 2006, options to purchase
895,611 shares of common stock at an exercise price of $0.57 - $5.15 were
cancelled.
The following table illustrates the effect on net loss and loss 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.
Nine Months Ended Three Months Ended
February 28, February 28,
-------------------------------------- ----------------------------------
2006 2005 2006 2005
----------------- ----------------- -------------- ---------------
Net loss attributable to common $(11,074,814) $(4,561,002) $(694,781) $(2,026,846)
stockholders, as reported
Deduct: Total stock-based
employee compensation expense
determined under fair (618,715) (888,075) (184,973) (234,549)
value-based method for all
awards
----------------- ----------------- -------------- ---------------
Pro forma net loss $(11,693,529) $(5,449,077) $(879,754) $(2,261,398)
================= ================= ============== ===============
Loss per share:
Basic and diluted - as reported $(0.18) $(0.08) $(0.01) $(0.03)
================= ================= ============== ===============
Basic and diluted - pro forma $(0.19) $(0.08) $(0.01) $(0.03)
================= ================= ============== ===============
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.
The fair value of the Company's stock-based awards was estimated assuming
no expected dividends and the following weighted-average assumptions for the
nine months ended February 28, 2006:
Expected life (years) 5
Expected volatility 74%
Risk-free interest rate 4.21%
Expected dividend yield 0.0%
NOTE D - LOSS PER COMMON SHARE
Basic loss per share is based on the weighted average number of common
shares outstanding without consideration of potential common shares. Diluted
loss per share is based on the weighted average number of common and potential
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, plus conversion of convertible preferred
stock into common shares based upon the most advantageous conversion rate during
the period, unless the effect on results of operations is antidilutive.
Page 9
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2006
The following table sets forth the computation of basic and diluted
earnings (loss) per common share:
Nine Months Ended Three Months Ended
February 28, February 28,
---------------------------------- -------------------------------
2006 2005 2006 2005
--------------- --------------- -------------- -------------
Numerator:
Net loss $(10,196,944) $(4,561,002) $(671,447) $(2,026,849)
Deemed dividend related to beneficial
conversion feature on Series D preferred
stock (786,247) -- -- --
Series D preferred stock dividends (91,623) -- (23,334) --
--------------- --------------- -------------- -------------
Net loss attributable to common
stockholders - basic and diluted $(11,074,814) $(4,561,002) $(694,781) $(2,026,849)
=============== =============== ============== =============
Denominator:
Basic - weighted average common shares 60,063,566 58,545,850 62,162,119 58,552,688
Stock options -- -- -- --
Warrants -- -- -- --
--------------- --------------- -------------- -------------
Diluted - weighted average common shares 60,063,566 58,545,850 62,162,119 58,552,688
=============== =============== ============== =============
Basic and diluted loss per common share $(0.18) $(0.08) $(0.01) $(0.03)
=============== =============== ============== =============
Options and warrants to purchase common stock, in accordance with the
following table, were excluded from the computation of diluted loss per share
because the effect of their inclusion would be antidilutive.
Nine Months and Three Months
Ended February 28,
---------------------------------------
2006 2005
----------------- -----------------
Options to purchase common stock 7,627,978 6,632,253
Warrants to purchase common stock 2,454,538 200,000
----------------- -----------------
10,082,516 6,832,253
================= =================
NOTE E - INVENTORIES, NET
Inventories, net consist of the following:
February 28, May 31,
2006 2005
----------------- -----------------
Raw materials $890,661 $960,101
Work in process 1,355,442 1,194,688
Finished goods 605,299 1,205,483
----------------- -----------------
$2,851,402 $3,360,272
================= =================
At February 28, 2006 and May 31, 2005, the Company has recorded reserves
for excess and obsolete inventory of $554,640 and $566,149, respectively.
NOTE F - PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
Page 10
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2006
February 28, May 31,
2006 2005
---------------- ---------------
Land $ 200,000 $ 200,000
Building and improvements 1,383,976 1,383,976
Office, laboratory and other equipment 1,444,850 1,445,168
EECP systems under operating leases or under loan
for clinical trials or evaluations 904,847 1,552,121
Furniture and fixtures 162,068 162,068
Leasehold improvements 117,803 117,803
---------------- ---------------
4,213,544 4,861,136
---------------- ---------------
Less: accumulated depreciation and amortization (2,549,006) (2,626,983)
---------------- ---------------
$1,664,538 $2,234,153
================ ===============
NOTE G - NOTES PAYABLE
The Company financed the purchase of Director's and Officer's Liability
Insurance through the issuance of a note with a principal value of $302,052. The
note, which bears interest at 5.85%, is payable in ten monthly installments
consisting of principal and interest, and expires in March 2006. The balance
outstanding at February 28, 2006, of $30,871 is presented on the consolidated
condensed balance sheet in current maturities of long-term debt and notes
payable.
NOTE H - LONG-TERM DEBT
The following table sets forth the computation of long-term debt:
February 28, May 31,
2006 2005
----------------- --------------
Facility loans (a) $927,033 $969,566
Term loans (b) 60,958 126,243
----------------- --------------
987,991 1,095,809
Less: current portion (119,787) (148,212)
----------------- --------------
$868,204 $947,597
================= ==============
(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.
NOTE I - DEFERRED REVENUES
The Company records revenue on extended service contracts ratably over the
term of the related warranty contracts. In addition, the Company defers revenue
related to domestic EECP system sales for the fair value of in- service and
training to the period when the services are rendered and for service
arrangements ratably over the service period, which is generally one year.
Page 11
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2006
The changes in the Company's deferred revenues are as follows:
Nine Months Ended Three Months Ended
February 28, February 28,
------------------------------ ------------------------------
2006 2005 2006 2005
------------- ------------- ------------- -------------
Deferred Revenue at the beginning of the period $2,551,532 $2,846,451 $2,561,030 $2,773,618
ADDITIONS
Deferred extended service contracts 1,713,937 1,473,022 536,622 428,658
Deferred in-service and training 115,000 147,500 30,000 30,000
Deferred service arrangements 355,000 630,000 90,000 132,500
RECOGNIZED AS REVENUE
Deferred extended service contracts (1,770,002) (1,395,461) (626,143) (512,015)
Deferred in-service and training (107,500) (230,000) (22,500) (60,000)
Deferred service arrangements (412,083) (947,917) (123,125) (269,166)
------------- ------------- ------------- -------------
Deferred revenue at end of period 2,445,884 2,523,595 2,445,884 2,523,595
Less: current portion (1,629,143) (1,646,918) (1,629,143) (1,646,918)
------------- ------------- ------------- -------------
Long-term deferred revenue at end of period $816,741 $876,677 $816,741 $876,677
============= ============= ============= =============
NOTE J - WARRANTY COSTS
Equipment sold is generally covered by a warranty and service arrangement
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 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. We do not offer a service
arrangement to international customers; consequently, 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.
The changes in the Company's product warranty liability are as follows:
Nine Months Ended Three Months Ended
February 28, February 28,
------------------------------- ------------------------------
2006 2005 2006 2005
------------- ------------- ------------- -------------
Warranty liability at the beginning of the $118,333 $244,917 $65,000 $154,583
period
Expense for new warranties issued 24,000 -- 9,000 --
Warranty amortization (97,333) (122,084) (29,000) (31,750)
------------- ------------- ------------- -------------
Warranty liability at end of period 45,000 122,833 45,000 122,833
Less: current portion (42,750) (105,583) (42,750) (105,583)
------------- ------------- ------------- -------------
Long-term warranty liability at end of period $2,250 $17,250 $2,250 $17,250
============= ============= ============= =============
Page 12
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2006
NOTE K - INCOME TAXES
During the nine months ended February 28, 2006 and 2005, we recorded income
tax expense of $7,112,826 and $29,661, respectively. The fiscal 2006 tax expense
consists mainly of $7,093,000 in additional valuation allowance provided for the
deferred tax asset in the second fiscal quarter. The income tax expense for the
first nine months of fiscal 2006 does not include $7,489,000 added to the
deferred tax valuation allowance for tax benefits associated with prior years'
exercises of stock options and warrants, which was charged directly to
additional paid-in capital.
As of August 31, 2005, we had recorded deferred tax assets of $14,582,000
net of a $4,674,000 valuation allowance related to the anticipated recovery of
tax loss carryforwards. On December 20, 2005, Centers for Medicare and Medicaid
Services (CMS) issued a Proposed Decision Memorandum (PDM) for External
Counterpulsation in response to Vasomedical's application to expand
reimbursement coverage to include Canadian Cardiovascular Society (CCSC) Class
II angina and New York Heart Association (NYHA) Class II/III congestive heart
failure (CHF). The PDM stated that the evidence was not adequate to conclude
that external counterpulsation therapy is reasonable and necessary to expand
reimbursement coverage to CCSC Class II angina and NYHA Class II/III CHF and
that current coverage for CCSC class III/IV refractory angina would remain in
effect. Consequently, at the end of the second fiscal quarter, we concluded
that, based upon the weight of available evidence, it was no longer "more likely
than not" that the net deferred tax asset of $14,582,000 would be realized, and
added $14,582,000 to the valuation allowance to bring the net deferred tax asset
carrying value to zero. On March 20, 2006, CMS issued its final decision, which
upheld the PDM.
As of February 28, 2006, the recorded deferred tax asset remained at zero,
consisting of a gross tax asset and offsetting valuation allowance of
$19,394,000, reflecting an increase of $1,038,000 during the first nine months
of fiscal 2006.
NOTE L - SERIES D CONVERTIBLE PREFERRED STOCK AND WARRANTS
On July 19, 2005, we entered into a Securities Purchase Agreement that
provided 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"). The agreement provided for a private placement of 25,000
shares of Vasomedical's Series D Preferred Stock at $100 per share. The
preferred stock was 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. 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. As of February 28, 2006, all of the
Series D Preferred Stock had been converted into 6,112,209 shares of common
stock.
Under the terms of a Registration Rights Agreement with the Investors,
Vasomedical filed a Form S-3 registration statement with the Securities and
Exchange Commission (SEC) on August 22, 2005, for 10,787,871 shares of common
stock representing up to 8,533,333 shares issuable in connection with conversion
of our Series D Convertible Preferred Stock and up to 2,254,538 shares issuable
upon the exercise of our common stock purchase warrants. The registration
statement was declared effective by the SEC on September 1, 2005. The total
number of shares registered was based on a conversion price of $0.30 per share,
which would only have affect in the event of default by Vasomedical of its
obligation to holders of the Series D Convertible Preferred Stock.
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 applied the funds to working capital.
Warrants and Beneficial Conversion Feature
The Company applied Emerging Issues Task Force Issue No. 98-5 "Accounting
for Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios"(EITF No. 98-5) and Emerging Issues Task Force
(EITF 00-27) Application of Issue No. 98-5 to Certain Convertible Instruments in
accounting for the preferred stock issuance. EITF No. 98-5 provides that
detachable warrants issued with convertible securities are valued separately,
Page 13
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2006
and that the beneficial conversion feature of the convertible security be
measured and recognized over the minimum period over which the shareholders can
realize the return.
The Task Force reached a consensus that convertible preferred securities
with a non-detachable conversion feature that is in-the-money at the commitment
date represents an embedded beneficial conversion feature that should be
recognized as a dividend and recorded to additional paid-in capital. That amount
should be calculated at the commitment date as the difference between the
allocated portion of the gross proceeds to the convertible preferred stock and
the fair value of the common stock or other securities into which the security
is convertible, multiplied by the number of shares into which the security is
convertible (intrinsic value method).
The beneficial conversion feature is treated analogous to a dividend and is
recognizable immediately over the minimum period during which the preferred
shareholders can realize that return. The imputed dividend will increase the
Company's loss for the purpose of computing the loss-per-share. The beneficial
conversion feature is calculated at its intrinsic value at the commitment date
(that is, the difference between the total gross proceeds allocated to the
preferred stock as compared to the total market value of the common stock into
which the Preferred Stock is convertible on the commitment date). The computed
value of the beneficial conversion feature is treated as a deemed dividend
immediately with a corresponding increase to paid-in capital. No additional
amount will be recognized at the conversion date in recognition of an increase
in the fair value of the stock conversion.
In circumstances in which convertible securities are issued with detachable
warrants, the Task Force noted that in order to determine the amount to be
allocated to the beneficial conversion feature, the issuer must first allocate
the proceeds between the convertible instrument and the detachable warrants
using the relative fair value method of APB Opinion Number 14.
The investors and consultants acquired detachable warrants for the purchase
of 1,892,219 and 362,319 shares of common stock, respectively, which were valued
at $345,071 and $66,087, respectively. The warrants may be exercised at a price
of $0.69 per share for a term of five years, ending July 18, 2010. For purposes
of estimating the intrinsic fair value of each warrant as of July 19, 2005, we
utilized the Black-Scholes option-pricing model. We estimated the fair value of
the warrants assuming no expected dividends and the following weighted- average
assumptions:
Expected life (years) 2.5
Expected volatility 66%
Risk-free interest rate 4.16%
Expected dividend yield 0.0%
We next determined the intrinsic fair value of the convertible preferred
stock as of July 19, 2005, to be $2,941,176 based on the number of common shares
that could be acquired as of the date of closing times $0.63, the closing price
of the common stock on the date preceding the close of the transaction. In
applying EITF No. 98- 5, we then allocated the gross proceeds of $2,500,000
between the warrants and preferred stock based on intrinsic value of each
instrument. As a result, we allocated $2,154,929 of gross proceeds to the
convertible preferred stock and $345,071 to the detachable warrants. The
beneficial conversion feature of $786,247 was then determined by subtracting the
allocated proceeds of convertible preferred stock from the intrinsic fair value
of convertible preferred stock. The beneficial conversion feature was
immediately recognized as a preferred stock dividend, as the preferred stock can
be converted immediately.
Page 14
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2006
Dividends
By the placement of the convertible preferred stock described above, we
became obligated to pay a cash dividend monthly on the outstanding shares of
convertible 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. For the nine-month period ended February 28, 2006, cash dividends
of $91,623 were paid. Preferred stock dividends for the nine months ended
February 28, 2006, are summarized as follows:
Amount
------
Cash dividends paid $91,623
Beneficial conversion feature 786,247
-------
$877,870
========
Common stock
The Company issued 200,000 shares of common stock in lieu of cash for
$126,000 in consultant services associated with the issuance of the Series D
Convertible Preferred Stock. These issue costs were treated as a reduction in
the paid-in capital associated with the preferred stock issuance.
NOTE M - COMMITMENTS AND CONTINGENCIES
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.
NOTE N - SUBSEQUENT EVENT
We 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), was 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 within the next few months.
On June 20, 2005, the Centers for Medicare and Medicaid Services (CMS)
accepted our application for expanded coverage of EECP therapy to include CHF as
a primary indication, as well as additional patients with angina. However, on
March 20, 2006, CMS issued a final decision to keep the existing coverage with
no changes for expansion of External Counterpulsation therapy. It is not
possible to predict the impact of the CMS' final decision on current operations.
Page 15
Vasomedical, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Except for historical information contained in this report, the matters
discussed are forward-looking statements that involve risks and uncertainties.
When used in this report, words such as "anticipated", "believes", "could",
"estimates", "expects", "may", "plans", "potential", "intends" and similar
expressions, as they relate to the Company or its management, identify
forward-looking statements. Such forward-looking statements are based on the
beliefs of the Company's management, as well as assumptions made by and
information currently available to the Company's management. Among the factors
that could cause actual results to differ materially are the following: the
effect of business and economic conditions; 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,
including the continued inability to obtain Medicare reimbursement for
congestive heart failure patents; unexpected manufacturing or supplier problems;
the ability to attract and retain qualified executives and employees; 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 the Company's SEC reports. The Company undertakes
no obligation to update forward-looking statements as a result of future events
or developments.
General 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 has been shown to improve
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 (CHF), 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 indication,
Medicare and other third-party payers currently reimburse for stable angina
patients with moderate to severe symptoms who remain symptomatic on medications
and are not candidates for invasive procedures. Some CHF patients are also
reimbursed under the same criteria, provided their primary symptoms are angina.
We 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), was 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 within the next few months. On June 20, 2005, the Centers for Medicare
and Medicaid Services (CMS) accepted our application for expanded coverage of
EECP therapy to include CHF as a primary indication, as well as additional
patients with angina. However, on March 20, 2006, CMS issued a final decision to
maintain the existing coverage with no changes for expansion of external
counterpulsation therapy. The fact that the results of the PEECH trial have not
been published to date factored into CMS' decision. However, it is not clear
whether CMS will decide otherwise once the results are published.
We have incurred declines in revenue and significant operating losses
during the last three fiscal years and our ability to continue operating as a
going concern is dependent upon achieving profitability in the refractory angina
market or through additional debt or equity financing. Achieving profitability
is largely dependent on our ability to reduce operating costs sufficiently as
well as halting the current trend of declining revenue. Our ability to maintain
our current base of revenue is largely dependent upon restructuring our sales
and marketing efforts in the angina market and operating in a more efficient
manner. If we are not able to maintain our existing base of revenue and
sufficiently reduce operating costs to generate an adequate cash flow, or raise
additional capital, we will not be able to continue as a going concern.
Page 16
Vasomedical, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
In order to reduce the Company's cash burn and bring its cost structure
more into alignment with current revenue, we initiated a company restructuring
in January 2006, to reduce personnel and spending on marketing and development
projects. We anticipate that the restructuring will reduce manufacturing and
operating cost by approximately $3 million per year compared to prior levels. In
addition, in April 2006, certain senior executives elected to defer
approximately $0.4 million in annual salary compensation. We believe that these
steps to conserve cash will provide the Company with the opportunity to rebuild
sales to a profitable level and/or explore strategic opportunities.
Based on the continuation of current revenue levels and the implementation
of our restructuring plan initiated in January 2006, we believe that we will be
able to fund our minimum projected capital requirements through at least the end
of the calendar year.
In the event that additional capital is required, we may seek to raise such
capital through public or private equity or debt financings or other means. We
may not be able to obtain additional financing on favorable terms or at all. If
we are unable to raise additional funds when we need them, we may be required to
further scale back our operations, research, marketing or sales efforts or
obtain funds through arrangements with collaborative partners or others that may
require us to license or relinquish rights to technologies or products. Future
capital funding, if available, may result in dilution to current shareholders,
and new investors could have rights superior to existing stockholders.
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,
ii. provision of in-service and training support consisting of equipment
set-up and training provided at the customer's facilities, and
Page 17
Vasomedical, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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. The amount related to in-service and training is
recognized as equipment revenue at the time the in-service and training is
completed and the amount related to service arrangements is recognized 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 equipment 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. 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. We do
not offer a service arrangement to international customers; consequently, 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 equipment
rentals and services 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 February 28, 2006.
Accounts Receivable, net
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
Page 18
Vasomedical, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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.
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.
Effective June 1, 2005, we adopted the provisions of Statement of Financial
Accounting Standards No. 151, "Inventory Costs", on a prospective basis. The
statement clarifies that abnormal amounts of idle facility expense, freight,
handling costs, and wasted materials (spoilage) should be recognized as
current-period charges and requires the allocation of fixed production overheads
to inventory based on the normal capacity of the production facilities. As a
result of adopting SFAS No. 151, we absorbed approximately $290,000 less in
fixed production overheads into inventory.
Deferred Revenues
We record revenue on extended service contracts ratably over the term of
the related contracts. In addition, we defer revenue related to EECP system
sales for the fair value of installation and in-service training to the period
when the services are rendered and for service arrangements ratably over the
service period, which is generally one year.
Warranty Costs
Equipment sold in domestic markets is generally covered by a warranty and
service arrangement period of one year. 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 don't
accrue warranty costs upon delivery but rather recognize warranty and related
service costs as incurred.
Equipment sold to international customers through our distributor network
is generally covered by a one year warranty period. We do not offer a service
arrangement to international customers; consequently, 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 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.
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
Page 19
Vasomedical, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
the realization of the deferred tax assets changes, 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 previously recorded
relates primarily to the realization of net operating loss carryforwards, of
which the allocation of the current portion, if any, reflected the expected
utilization of such net operating losses in the following twelve months. Such
allocation was based on our internal financial forecast and may be subject to
revision based upon actual results.
Stock-based Employee Compensation
We have five stock-based employee and director 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.
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
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 adopted SFAS No. 153 effective for
fiscal periods beginning September 1, 2005. The adoption of SFAS No. 153 did not
have a material impact on the Company's consolidated financial statements.
Page 20
Vasomedical, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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 August 31, 2006.
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 has
adopted SFAS No. 151 effective June 1, 2005.
Results of Operations
Three Months Ended February 28, 2006 and 2005
Net revenue from sales, leases and service of our EECP systems for the
three-month periods ended February 28, 2006 and 2005, was $2,841,821 and
$2,964,328, respectively, which represented a decline of $122,507 or 4%. We
reported a net loss of $671,447 compared to $2,026,849 for the three-month
periods ended February 28, 2006 and 2005, respectively. Our net loss per common
share was $0.01 for the three-month period ended February 28, 2006 compared to a
net loss of $0.03 per share for the three-month period ended February 28, 2005.
Revenues
Revenue from equipment sales declined approximately 15% to $1,807,625 for
the three-month period ended February 28, 2006 as compared to $2,131,567 for the
same period for the prior year. The decline in equipment sales is due primarily
to a 10% decline in average sales prices. A higher mix of sales to international
distributors was the primary cause of the decrease in average sales prices and
increased international shipments offset the decline in domestic systems
shipped.
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. Although average domestic selling prices were essentially
flat compared to the third quarter of fiscal 2005, we anticipate that a
prevailing trend of declining prices will continue in the immediate future as
our competition attempts to capture greater market share through pricing
discounts. Our revenue from the sale of EECP systems to international
distributors in the third quarter of fiscal 2006 increased approximately 103% to
$295,000 compared to $145,000 in the same period of the prior year as a result
of increased sales volume.
The above decline in revenue from equipment sales was partially offset by a
24% increase in revenue from equipment rental and services for the three-month
period ended February 28, 2006, from the same three-month period in the prior
year. Revenue from equipment rental and services represented 36% of total
revenue in the third quarter of fiscal 2006 compared to 28% in the third quarter
of fiscal 2005. The increase in both absolute amounts and percentage of total
revenue resulted primarily from an increase of approximately 27% in service
related revenue. The higher service revenue reflects an increase in service and
spare parts, plus greater marketing focus on the sale of extended service
contracts. Rental revenue declined approximately 43% due to fewer rental units
in service, partially offsetting the above.
Page 21
Vasomedical, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Gross Profit
The gross profit declined to $1,613,802 or 57% of revenues for the
three-month period ended February 28, 2006, compared to $1,799,746 or 61% of
revenues for the three-month period ended February 28, 2005. Gross profit margin
as a percentage of revenue for the three-month period ended February 28, 2006,
decreased compared to the same period of the prior fiscal year due to the
decline in average selling prices and the adoption of SFAS No. 151, which
lowered the amount of fixed overhead costs absorbed into inventory in the third
quarter of fiscal 2006 by $149,000. Partially offsetting the decline was an
improvement in the gross profit margins associated with accessory revenues,
reflecting higher average selling prices. The decline in gross profit when
compared to the prior year in absolute dollars is a direct result of the lower
margin percentage as volume was essentially flat.
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 three months
ended February 28, 2006 and 2005, were $1,852,173 or 65% of revenues and
$2,947,978 or 99% of revenues, respectively reflecting a decrease of $1,095,805
or approximately 37%. The decrease in SG&A expenditures in the third quarter of
fiscal 2006 compared to fiscal 2005 resulted primarily from decreased sales and
marketing expenditures reflecting fewer sales and marketing personnel and
reduced travel, plus lower consulting, trade show, and accounting costs.
Research and Development
Research and development ("R&D") expenses of $412,997 or 14% of revenues
for the three months ended February 28, 2006, decreased by $450,479 or 52%, from
the three months ended February 28 2005, of $863,476 or 29% of revenues. The
decrease is primarily attributable to fewer R&D personnel and lower new product
development and clinical research spending.
Provision for Doubtful Accounts
During the three-month periods ended February 28, 2006 and 2005, we charged
$18,984 and $2,200, respectively, to our provision for doubtful accounts. In the
prior fiscal year period, we collected funds from previously reserved accounts,
which largely offset new reserve requirements.
Interest Expense and Financing Costs
Interest expense and financing costs decreased to $19,346 in the
three-month period ended February 28, 2006, from $25,931 for the same period in
the prior year. Interest expense primarily reflects interest on loans secured to
refinance the November 2000 purchase of the Company's 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 third fiscal quarters of 2006 and 2005,
was $18,251 and $20,968, respectively. The decrease in interest income from the
prior period resulted from lower cash, cash equivalents, and certificates of
deposit balances, partially offset by higher average interest rates on invested
balances.
Income Tax Expense, Net
During the three months ended February 28, 2006 and 2005, we recorded
income tax expense of $0 and $7,978, respectively. An increase of $223,000 was
made to the gross deferred tax asset and related valuation allowance during the
third quarter of fiscal 2006.
Page 22
Vasomedical, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Nine Months Ended February 28, 2006 and 2005
Net revenue from sales, leases and service of our EECP systems for the
nine-month periods ended February 28, 2006 and 2005, was $9,058,376 and
$11,247,419, respectively, which represented a decline of $2,189,043 or 19%. We
reported a net loss of $10,196,944 compared to $4,561,002 for the nine-month
periods ended February 28, 2006 and 2005, respectively. Our net loss per common
share was $0.18 for the nine-month period ended February 28, 2006 compared to a
net loss of $0.08 per share for the nine-month period February 28, 2005. The
increase in net loss is primarily due to the establishment of a $7,093,000
valuation reserve in the fiscal 2006 second quarter for the then-remaining
carrying value of the deferred tax asset.
Revenues
Revenue from equipment sales declined approximately 30% to $5,998,943 for
the nine-month period ended February 28, 2006 as compared to $8,629,026 for the
same period for the prior year. The decline in equipment sales is due primarily
to a 32% decline in the number of EECP system shipments, partially offset by a
5% improvement in average sales prices. A higher mix of both newer model
equipment and new equipment versus used equipment was the primary cause of the
increase in average sales prices.
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. Although average domestic selling prices improved compared
to the first nine months of fiscal 2005, we anticipate that a prevailing trend
of declining prices will continue in the immediate future as our competition
attempts to capture greater market share through pricing discounts. We sold an
unusually high percentage of used equipment in the first nine months of fiscal
2005, which reduced the average selling price in that period. The average price
of new systems sales declined approximately 2% in the first nine months of
fiscal 2006 compared to the same period in the prior year. Our revenue from the
sale of EECP systems to international distributors in the first nine months of
fiscal 2006 increased approximately 13% to $690,000 compared to $607,995 in the
same period of the prior year, as a result of increased volume.
The above decline in revenue from equipment sales was partially offset by a
17% increase in revenue from equipment rental and services for the nine-month
period ended February 28, 2006, from the same nine-month period in the prior
year. Revenue from equipment rental and services represented 34% of total
revenue in the first nine months of fiscal 2006 compared to 23% in the same
period of fiscal 2005. The increase in both absolute amounts and percentage of
total revenue resulted primarily from an increase of approximately 28% in
service related revenue. The higher service revenue reflects an increase in
service, spare parts and accessories, plus greater marketing focus on the sale
of extended service contracts. Rental revenue declined approximately 52%,
partially offsetting the above. The decline was primarily due to a multi-system
customer defaulting on its rental payments during fiscal 2005; consequently, we
shifted to a cash basis for revenue recognition for this customer and our
equipment was eventually returned.
Gross Profit
The gross profit declined to $5,309,344 or 59% of revenues for the
nine-month period ended February 28, 2006, compared to $7,247,170 or 64% of
revenues for the nine-month period ended February 28, 2005. Gross profit margin
as a percentage of revenue for the nine-month period ended February 28, 2006,
decreased compared to the same period of the prior fiscal year despite the
improvement in average selling prices, mainly due to an unfavorable sales mix of
lower cost used equipment, and the higher production units costs associated with
reduced production volumes in the last four fiscal quarters. In addition,
adoption of SFAS No. 151 lowered the amount of fixed overhead costs absorbed
into inventory in the first nine months of fiscal 2006 by $290,000. Partially
offsetting the decline was an improvement in the gross profit margins associated
with accessory revenues, reflecting higher average selling prices. The decline
in gross profit when compared to the prior year in absolute dollars is a direct
result of the lower sales volume.
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.
Page 23
Vasomedical, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses for the nine-months
ended February 28, 2006 and 2005, were $6,769,946 or 75% of revenues and
$9,088,858 or 81% of revenues, respectively reflecting an decrease of $2,318,912
or approximately 26%. The decrease in SG&A expenditures in the first nine months
of fiscal 2006 compared to fiscal 2005 resulted primarily from decreased sales
and marketing expenditures reflecting fewer sales and marketing personnel and
reduced travel, plus lower market research, advertising, trade show, and
accounting costs.
Research and Development
Research and development ("R&D") expenses of $1,528,699 or 17% of revenues
for the nine months ended February 28, 2006, decreased by $992,622 or 39%, from
the nine months ended February 28, 2005, of $2,521,321 or 22% of revenues. The
decrease is primarily attributable to fewer R&D personnel and lower new product
development and clinical research spending.
Provision for Doubtful Accounts
During the nine-month period ended February 28, 2006, we charged $89,559 to
our provision for doubtful accounts, as compared to $135,156 during the
nine-month period ended February 28, 2005. The decrease was mainly due to
reduced sales.
Interest Expense and Financing Costs
Interest expense and financing costs decreased to $64,299 in the nine-month
period ended February 28, 2006, from $84,971 for the same period in the prior
year. Interest expense primarily reflects interest on loans secured to refinance
the November 2000 purchase of the Company's 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 first nine months of fiscal 2006 and
fiscal 2005, were $59,041 and $51,795, respectively. The increase in interest
income from the prior period is the direct result of $15,405 in increased
unrealized gain on investments. Lower average cash, cash equivalents, and
certificates of deposit balances invested during the first nine months of fiscal
2006 compared to the prior period partially offset the above.
Income Tax Expense, Net
During the nine months ended February 28, 2006 and 2005, we recorded income
tax expense of $7,112,826 and $29,661, respectively. The fiscal 2006 tax expense
consists mainly of $7,093,000 in additional valuation allowance provided for the
deferred tax asset in the second fiscal quarter. The income tax expense for the
first nine months of fiscal 2006 does not include $7,489,000 added to the
deferred tax valuation allowance for tax benefits associated with prior years'
exercises of stock options and warrants, which was charged directly to
additional paid-in capital.
As of August 31, 2005, we had recorded deferred tax assets of $14,582,000
net of a $4,674,000 valuation allowance related to the anticipated recovery of
tax loss carryforwards. On December 20, 2005, Centers for Medicare and Medicaid
Services (CMS) issued a Proposed Decision Memorandum (PDM) for External
Counterpulsation in response to Vasomedical's application to expand
reimbursement coverage to include Canadian Cardiovascular Society (CCSC) Class
II angina and New York Heart Association (NYHA) Class II/III congestive heart
failure (CHF). The PDM stated that the evidence was not adequate to conclude
that external counterpulsation therapy is reasonable and necessary to expand
reimbursement coverage to CCSC Class II angina and NYHA Class II/III CHF and
that current coverage for CCSC class III/IV refractory angina would remain in
effect. Consequently, at the end of the second fiscal quarter, we concluded
that, based upon the weight of available evidence, it was no longer "more likely
than not" that the net deferred tax asset of $14,582,000 would be realized, and
added $14,582,000 to the valuation allowance to bring the net deferred tax asset
carrying value to zero. On March 20, 2006, CMS issued its final decision, which
upheld the PDM.
Page 24
Vasomedical, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
An increase of $1,038,000 was made to the gross deferred tax asset and
related valuation allowance during the nine months ended February 28, 2006.
Liquidity and Capital Resources
Cash and cash flow
We have financed our operations in fiscal 2006 and fiscal 2005 from working
capital and in fiscal 2006 from the issuance of preferred stock. At February 28,
2006, we had cash, cash equivalents, and certificates of deposit balances of
$1,731,710 and working capital of $3,351,563 as compared to cash, cash
equivalents, and certificates of deposit balances of $2,747,967 and working
capital of $3,932,769 at May 31, 2005. Our cash, cash equivalents, and
certificates of deposit balances decreased $1,016,257 for the first nine months
of fiscal year 2006 primarily due to cash used in operating activities of
$2,731,252, and cash used in other financing activities of $470,622, partially
offset by $2,185,617 in net proceeds from the issuance of preferred stock, which
was subsequently converted to common stock.
The increase in cash used in our operating activities during the first nine
months of fiscal year 2006 resulted primarily from the net loss of $10,196,944
offset by adjustments to reconcile net loss to net cash used in operating
activities of $7,465,692. The adjustments to reconcile net loss to net cash used
in operating activities consisted mainly of $7,685,338 in non-cash adjustments,
primarily $7,093,000 for deferred income taxes, as well as an aggregate of
$592,338 in depreciation and amortization, allowances for doubtful accounts and
inventory write-offs, and common stock issued for services. In addition, changes
in our operating assets and liabilities used net cash of $219,646. The changes
in the asset components primarily reflect an increase in accounts receivable of
$768,798, offset by lower inventory of $709,765. The changes in our operating
liability components reflect a decrease in accounts payable and accrued
liabilities of $244,048 and a decrease in other liabilities of $140,711. Net
accounts receivable were 28% of revenues for the nine-month period ended
February 28, 2006, compared to 14% at the end of the nine-month period ended
February 28, 2005, and accounts receivable turnover increased to 6.2 times as of
February 28, 2006, as compared to 5.4 times as of February 28, 2005.
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 lieu of price concessions, in competitive
situations, when opening new markets or geographies and 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 first three quarters of fiscal 2006 and 2005, approximately 0% and
2%, respectively, of revenues were generated from sales in which initial 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.
Investing activities provided net cash of $760,156 during the nine-month
period ended February 28, 2006. Cash was provided by the sale of short-term
certificates of deposit. All of our certificates of deposit have original
maturities of greater than three months and mature in less than twelve months.
Our financing activities provided net cash of $1,714,995 during the
nine-month period ended February 28, 2006, reflecting $2,185,617 in net proceeds
received from the issuance of preferred stock, less payments on our outstanding
notes and loans totaling $378,999, and preferred stock dividend payments
totaling $91,623. On July 19, 2005, we entered into a Securities Purchase
Agreement that provided 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 agreement provided for a private placement of 25,000
shares of Vasomedical's Series D Preferred Stock at $100 per share.
We do not have an available line of credit.
Page 25
Vasomedical, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Liquidity
We have incurred declines in revenue and significant operating losses
during the last three fiscal years and our ability to continue operating as a
going concern is dependent upon achieving profitability in the refractory angina
market or through additional debt or equity financing. Achieving profitability
is largely dependent on our ability to reduce operating costs sufficiently as
well as halting the current trend of declining revenue. Our ability to maintain
our current base of revenue is largely dependent upon restructuring our sales
and marketing efforts in the angina market and operating in a more efficient
manner. If we are not able to maintain our existing base of revenue and
sufficiently reduce operating costs to generate an adequate cash flow, or raise
additional capital, we will not be able to continue as a going concern.
In order to reduce the Company's cash burn and bring its cost structure
more into alignment with current revenue, we initiated a company restructuring
in January 2006, to reduce personnel and spending on marketing and development
projects. We anticipate that the restructuring will reduce manufacturing and
operating cost by approximately $3 million per year compared to prior levels. In
addition, in April 2006, certain senior executives elected to defer
approximately $0.4 million in annual salary compensation. We believe that these
steps to conserve cash will provide the Company with the opportunity to rebuild
sales to a profitable level and/or explore strategic opportunities.
Based on the continuation of current revenue levels and the implementation
of our restructuring plan initiated in January 2006, we believe that we will be
able to fund our minimum projected capital requirements through at least the end
of the calendar year.
In the event that additional capital is required, we may seek to raise such
capital through public or private equity or debt financings or other means. We
may not be able to obtain additional financing on favorable terms or at all. If
we are unable to raise additional funds when we need them, we may be required to
further scale back our operations, research, marketing or sales efforts or
obtain funds through arrangements with collaborative partners or others that may
require us to license or relinquish rights to technologies or products. Future
capital funding, if available, may result in dilution to current shareholders,
and new investors could have rights superior to existing stockholders.
Contractual Obligations
The following table presents the Company's expected cash requirements for
contractual obligations outstanding as of February 28, 2006.
Due as of Due as of
Due as of 2/29/08 and 2/28/10 and Due
Total 2/28/07 2/28/09 2/28/11 Thereafter
--------------------------------------------------------------------------------------------------------------------
Long-Term Debt $987,991 $119,787 $133,838 $154,022 $580,344
Notes Payable 30,871 30,871 -- -- --
Operating Leases 24,917 24,917 -- -- --
Litigation Settlement 100,750 100,750 -- -- --
--------------------------------------------------------------------------------------------------------------------
Total Contractual Cash
Obligations $1,144,529 $ 276,325 $133,838 $154,022 $580,344
====================================================================================================================
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.
Page 26
Vasomedical, Inc. and Subsidiaries
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain financial market risks, including changes in
interest rates. All of our 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. 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 4 - CONTROLS AND PROCEDURES
We 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 our
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 February 28, 2006, our disclosure controls and procedures
are effective to provide reasonable assurances that such disclosure controls and
procedures satisfy their objectives and that the information required to be
disclosed by us in the reports we file under the Exchange Act is recorded,
processed, summarized and reported within the required time periods. There were
no changes during the fiscal quarter ended February 28, 2006 in our internal
controls or in other factors that could have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
Page 27
Vasomedical, Inc. and Subsidiaries
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS:
None.
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS:
None
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES:
None
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5 - OTHER INFORMATION:
None
ITEM 6 - EXHIBITS
Exhibits
31 Certifications pursuant to Rules 13a-14(a) as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32 Certifications pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes- Oxley Act of 2002.
Page 28
Vasomedical, Inc. and Subsidiaries
In accordance with to the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
VASOMEDICAL, INC.
By: /s/ Thomas Glover
--------------------------------------------
Thomas Glover
Chief Executive Officer and Director (Principal
Executive Officer)
/s/ Thomas W. Fry
--------------------------------------------
Thomas W. Fry
Chief Financial Officer (Principal Financial and
Accounting Officer)
Date: April 13, 2006