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, 2005
[ ] 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
--------------------------------------------------------------------------------
(Address of principal executive offices)
Registrant's Telephone Number (516) 997-4600
Number of Shares Outstanding of Common Stock,
$.001 Par Value, at April 14, 2005 58,552,688
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 an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
--- --
Page 1
Vasomedical, Inc. and Subsidiaries
INDEX
PART I - FINANCIAL INFORMATION
Page
----
Item 1 - Financial Statements (unaudited)
Consolidated Condensed Balance Sheets as of
February 28, 2005 and May 31, 2004 3
Consolidated Condensed Statements of Earnings for the
Nine and Three Months Ended February 28, 2005 and February 29, 2004 4
Consolidated Condensed Statement of Changes in Stockholders'
Equity for the Period from June 1, 2004 to February 28, 2005 5
Consolidated Condensed Statements of Cash Flows for the
Nine Months Ended February 28, 2005 and February 29, 2004 6
Notes to Consolidated Condensed Financial Statements 7
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 3 Qualitative and Quantitative Disclosures About Market Risk 29
Item 4 Controls and Procedures 29
PART II - OTHER INFORMATION 30
Page 2
ITEM 1 - FINANCIAL STATEMENTS
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED CONDENSED BALANCE SHEETS
February 28, May 31,
2005 2004
----------------- -----------------
ASSETS (unaudited)
CURRENT ASSETS
Cash and cash equivalents $1,228,727 $6,365,049
Certificates of deposit and treasury bills 2,764,154 1,180,540
Accounts receivable, net of an allowance for doubtful accounts of
$520,914 at February 28, 2005 and $699,203 at May 31, 2004 1,589,381 5,521,853
Inventories 3,613,082 2,373,748
Other current assets 436,636 272,513
----------------- -----------------
Total current assets 9,631,980 15,713,703
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,559,660 at
February 28, 2005 and $ 2,378,576 at May 31, 2004 2,265,307 2,430,521
DEFERRED INCOME TAXES 14,582,000 14,582,000
OTHER ASSETS 318,597 297,391
----------------- -----------------
$26,797,884 $33,023,615
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $2,307,044 $3,122,184
Current maturities of long-term debt and notes payable 145,164 136,478
Sales tax payable 228,761 353,360
Deferred revenues 1,646,918 1,734,925
Accrued warranty and customer support expenses 105,583 161,917
Accrued professional fees 114,817 91,486
Accrued commissions 105,998 341,483
----------------- -----------------
Total current liabilities 4,654,285 5,941,833
LONG-TERM DEBT 985,089 1,092,837
ACCRUED WARRANTY COSTS 17,250 83,000
DEFERRED REVENUES 876,677 1,111,526
OTHER LIABILITIES 100,750 200,250
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; 1,000,000 shares authorized; none
issued and outstanding -- --
Common stock, $.001 par value; 110,000,000 shares authorized;
58,552,688 and 58,419,356 shares at February 28, 2005 and May 31,
2004, respectively, issued and outstanding 58,552 58,419
Additional paid-in capital 51,450,639 51,320,106
Accumulated deficit (31,345,358) (26,784,356)
----------------- -----------------
Total stockholders' equity 20,163,833 24,594,169
----------------- -----------------
$26,797,884 $33,023,615
================= =================
The accompanying notes are an integral part of these condensed statements.
Page 3
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS
(unaudited)
Nine Months Ended Three Months Ended
------------------------------ --------------------------------
February 28, February 29, February 28, February 29,
2005 2004 2005 2004
------------ ------------- --------------- -------------
Revenues
Equipment sales $8,629,026 $14,147,248 $2,131,567 $5,185,388
Equipment rentals and services 2,618,393 2,132,323 832,761 764,522
------------ ------------- --------------- -------------
11,247,419 16,279,571 2,964,328 5,949,910
Cost of sales and services
Cost of sales, equipment 3,034,836 4,616,671 831,936 1,628,210
Cost of equipment rentals and services 965,413 948,427 332,646 304,965
------------ ------------- --------------- -------------
4,000,249 5,565,098 1,164,582 1,933,175
------------ ------------- --------------- -------------
Gross Profit 7,247,170 10,714,473 1,799,746 4,016,735
Expenses
Selling, general and administrative 9,088,858 9,217,836 2,947,978 3,083,407
Research and development 2,521,321 2,996,970 863,476 1,043,595
Provision for doubtful accounts 135,156 1,147,011 2,200 161,500
Interest expense and financing costs 84,971 101,335 25,931 35,089
Interest and other income, net (51,795) (115,102) (20,968) (6,815)
------------ ------------- --------------- -------------
11,778,511 13,348,050 3,818,617 4,316,776
------------ ------------- --------------- -------------
LOSS BEFORE INCOME TAXES (4,531,341) (2,633,577) (2,018,871) (300,041)
Income tax expense, net (29,661) (30,000) (7,978) (10,000)
------------ ------------- --------------- -------------
NET LOSS $(4,561,002) $(2,663,577) $(2,026,849) $(310,041)
============ ============= =============== =============
Net loss per common share
- basic $(0.08) $(0.05) $(0.03) $(0.01)
============ ============= =============== =============
- diluted $(0.08) $(0.05) $(0.03) $(0.01)
============ ============= =============== =============
Weighted average common shares outstanding
- basic 58,545,850 57,847,004 58,552,688 57,886,701
============ ============= =============== =============
- diluted 58,545,850 57,847,004 58,552,688 57,886,701
============ ============= =============== =============
The accompanying notes are an integral part of these condensed statements.
Page 4
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED CONDENSED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(unaudited)
Additional Total
Paid-in Accumulated Stockholders'
Shares Amount Capital Deficit Equity
------------ ---------- -------------- --------------- ---------------
Balance at June 1, 2004 58,419,356 $58,419 $51,320,106 $(26,784,356) $24,594,169
Exercise of stock options 133,332 133 130,533 130,666
Net loss (4,561,002) (4,561,002)
------------ ---------- -------------- --------------- ---------------
Balance at February 28, 2005 58,552,688 $58,552 $51,450,639 $(31,345,358) $20,163,833
============ ========== ============== =============== ===============
The accompanying notes are an integral part of this condensed statement.
Page 5
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
Nine months ended
--------------------------------------
February 28, February 29,
2005 2004
----------------- -----------------
Cash flows from operating activities
Net loss $(4,561,002) $(2,663,577)
----------------- -----------------
Adjustments to reconcile net loss to net cash (used in) provided by
operating activities
Depreciation and amortization 433,177 595,685
Provision for doubtful accounts 178,289 674,175
Allowance for inventory write-off 71,908 90,516
Changes in operating assets and liabilities
Accounts receivable 3,754,183 2,606,696
Financing receivables, net -- 258,608
Inventories (1,372,541) 1,012,606
Other current assets (164,123) (203,176)
Other assets (50,530) (52,877)
Accounts payable, accrued expenses and other current
liabilities (1,296,234) 114,388
Other liabilities (400,099) (132,346)
----------------- -----------------
1,154,030 4,964,275
----------------- -----------------
Net cash (used in) provided by operating activities (3,406,972) 2,300,698
----------------- -----------------
Cash flows from investing activities
Purchase of property and equipment (177,340) (137,721)
Purchase of certificates of deposit and treasury bills (1,583,614) --
----------------- -----------------
Net cash used in investing activities (1,760,954) (137,721)
----------------- -----------------
Cash flows from financing activities
Proceeds from notes -- 67,149
Payments on notes (99,062) (92,453)
Proceeds from exercise of options and warrants 130,666 383,084
----------------- -----------------
Net cash provided by financing activities 31,604 357,780
----------------- -----------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
(5,136,322) 2,520,757
Cash and cash equivalents - beginning of period 6,365,049 5,222,847
----------------- -----------------
Cash and cash equivalents - end of period $1,228,727 $7,743,604
================= =================
Non-cash investing and financing activities were as follows:
Inventories transferred to (from) property and equipment, attributable
to operating leases, net $61,299 $(328,869)
The accompanying notes are an integral part of these condensed statements.
Page 6
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2005
NOTE A - BASIS OF PRESENTATION
The consolidated condensed balance sheet as of February 28, 2005, and the
related consolidated condensed statements of earnings for the nine and
three-month periods ended February 28, 2005 and February 29, 2004, changes in
stockholders' equity for the nine-month period ended February 28, 2005, and cash
flows for the nine- month periods ended February 28, 2005 and February 29, 2004,
have been prepared by Vasomedical, Inc. and Subsidiaries (the "Company") without
audit. In the opinion of management, all adjustments (which include only normal,
recurring accrual adjustments) necessary to present fairly the financial
position and results of operations as of February 28, 2005, 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, 2004. Results of operations for the periods ended February 28, 2005 and
February 29, 2004 are not necessarily indicative of the operating results
expected or reported for the full year.
We believe that our cash flow from operations together with our current
cash reserves will be sufficient to fund our business plan and projected capital
requirements through at least July 2005. Although we have incurred significant
losses during the last three fiscal years, we believe that the Company is
positioned for long-term growth. Our long-term growth is largely dependent upon
the successful commercialization of EECP(R) therapy into the congestive heart
failure ("CHF") indication which depends in part on results from the Prospective
Evaluation of EECP in Congestive Heart Failure ("PEECH(TM)") clinical trial
being sufficient to promote adoption of the therapy in CHF. As more fully
discussed in Note K "SUBSEQUENT EVENT", PEECH results were disclosed on March 8,
2005. Our long-term ability to achieve profitable operations is further
dependent on successfully completing additional debt or equity financing to
provide marketing funds necessary to launch EECP therapy in the congestive heart
failure market and to bridge the period between completion of the PEECH clinical
trial and a congestive heart failure national reimbursement coverage decision by
the Centers for Medicare and Medicaid Services (CMS). While we are currently
seeking to raise such capital through public or private equity or debt
financings, there is no assurance we will be successful in these efforts. Future
capital funding, if available, may result in dilution to current shareholders.
Reclassifications
Certain reclassifications have been made to the prior years' amounts to conform
with the current year's presentation.
NOTE B IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued
FASB Statement No. 153 ("SFAS No. 153"), "Exchanges of Non-monetary Assets an
amendment of APB Opinion No. 29". SFAS No. 153 amends Opinion 29 to eliminate
the exception for non-monetary exchanges of similar productive assets and
replaces it with a general exception for exchanges of non-monetary assets that
do not have commercial substance. A non- monetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. SFAS No. 153 is effective for fiscal
periods after June 15, 2005. The Company does not expect the adoption of SFAS
No. 153 to have a material impact on the Company's consolidated financial
statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123(R) ("SFAS No. 123(R)"), "Accounting for Stock-Based
Compensation". SFAS No. 123(R) establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. This Statement focuses primarily on accounting for transactions in
which an entity obtains employee services in share-based payment transactions.
SFAS No. 123(R) requires that the fair value of such equity instruments be
recognized as expense in the historical financial statements as services are
performed. Prior to SFAS No. 123(R), only certain pro-forma disclosures of fair
value were required. SFAS No. 123(R) shall be effective for the Company as of
the beginning of the first interim reporting period that begins after June 15,
2005. The adoption of this new accounting pronouncement is expected to have a
Page 7
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2005
material impact on the financial statements of the Company commencing with the
quarter ending November 30, 2005.
In November 2004, the FASB issued Statement of Financial Accounting
Standards No. 151 ("SFAS No. 151"), Inventory Costs, an amendment of ARB No. 43,
Chapter 4. The amendments made by SFAS No. 151 will improve financial reporting
by clarifying that abnormal amounts of idle facility expense, freight, handling
costs, and wasted materials (spoilage) should be recognized as current-period
charges and by requiring the allocation of fixed production overheads to
inventory based on the normal capacity of the production facilities. SFAS No.
151 is effective for inventory costs incurred during fiscal years beginning
after June 15, 2005. Earlier application is permitted for inventory costs
incurred during fiscal years beginning after November 24, 2004. The Company is
currently evaluating the impact of adoption of SFAS No. 151 on its financial
position and results of operations.
In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104,
"Revenue Recognition" (SAB No. 104), which codifies, revises and rescinds
certain sections of SAB No. 101, "Revenue Recognition in Financial Statements",
in order to make this interpretive guidance consistent with current
authoritative accounting and auditing guidance and SEC rules and regulations.
The changes noted in SAB No. 104 did not have a material effect on the Company's
financial position or results of operations.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150 ("SFAS No. 150"), "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." This statement establishes
standards for how an issuer classifies and measures in its statement of
financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. This Statement shall be effective for financial instruments entered
into or modified after May 31, 2003, and otherwise shall be effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 has not had a material impact on the Company's
financial position and results of operations.
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 ("SFAS No. 149"), "Amendment of Statement No. 133 on Derivative
Instruments and Hedging Activities," which amends and clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003, except for the provisions that were cleared by the
FASB in prior pronouncements. The adoption of SFAS No. 149 has not had a
material impact on the Company's financial position and results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation
of Variable Interest Entities" ("FIN 46"), as interpreted by FIN 46R. In
general, a variable interest entity is a corporation, partnership, trust, or any
other legal structure used for business purposes that either (a) does not have
equity investors with voting rights or (b) has equity investors that do not
provide sufficient financial resources for the entity to support its activities.
A variable interest entity often holds financial assets, including loans or
receivables, real estate or other property. A variable interest entity may be
essentially passive or it may engage in activities on behalf of another company.
Until now, a company generally has included another entity in its consolidated
financial statements only if it controlled the entity through voting interests.
FIN 46 changes that by requiring a variable interest entity to be consolidated
by a company if that company is subject to a majority of the risk of loss from
the variable interest entity's activities or entitled to receive a majority of
the entity's residual returns or both. FIN 46's consolidation requirements apply
immediately to variable interest entities created or acquired after January 31,
2003. The consolidation requirements apply to older entities in the first
interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The Company
adopted FIN 46 effective January 31, 2003. The adoption of FIN 46 did not have a
material impact on the Company's financial position or results of operations.
In November 2002, the Emerging Issues Task Force, ("EITF") reached a
consensus opinion on, "Revenue Arrangements with Multiple Deliverables", "(EITF
00-21)". That consensus provides that revenue arrangements with multiple
deliverables should be divided into separate units of accounting if certain
criteria are met. The consideration of the arrangement should be allocated to
the separate units of accounting based on their relative fair values, with
different provisions if the fair value is contingent on delivery of specified
items or performance conditions. Applicable revenue criteria should be
considered separately for each separate unit of accounting. EITF 00-21 is
effective for revenue arrangements entered into in fiscal periods beginning
Page 8
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2005
after June 15, 2003. Effective September 1, 2003, the Company prospectively
adopted the provisions of EITF 00-21.
NOTE C STOCK-BASED COMPENSATION
The Company has five stock-based employee 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.
On October 28, 2004 the shareholders approved the 2004 Stock Option/Stock
Issuance Plan and authorized the issuance of 2,500,000 shares.
During the nine-month period ended February 28, 2005, the Board of
Directors granted non-qualified stock options under the 1997 Stock Option Plan,
the 1999 Stock Option Plan and the 2004 Stock Option/Stock Issuance Plan to 9
directors, 4 officers, and 37 employees to purchase an aggregate of 2,428,000
shares of common stock, at exercise prices ranging from $0.95 to $1.19 per
share, which represented the fair market value of the underlying common stock at
the time of the respective grants. These options vest immediately, or over
three-year and four-year periods, and expire five years and ten years from the
date of grant.
During the nine-month period ended February 28, 2005, options to purchase
133,332 shares of common stock were exercised at an exercise price of $0.98 per
share, aggregating $130,666 of proceeds to the Company. During the nine-month
period ended February 28, 2005, options to purchase 474,166 shares of common
stock at an exercise price of $0.91 - $3.96 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 29, February 28, February 29,
2005 2004 2005 2004
--------------- --------------- -------------- ---------------
Net loss, as reported $(4,561,002) $(2,663,577) $(2,026,849) $(310,041)
Deduct: Total stock-based
employee compensation expense
determined under fair (888,075) (1,080,817) (234,549) (402,237)
value-based method for all
awards
--------------- --------------- -------------- ---------------
Pro forma net loss $(5,449,077) $(3,744,394) $(2,261,398) $(712,278)
=============== =============== ============== ===============
Loss per share:
Basic - as reported $(0.08) $(0.05) $(0.03) $(0.01)
=============== =============== ============== ===============
Diluted - as reported $(0.08) $(0.05) $(0.03) $(0.01)
=============== =============== ============== ===============
Basic - pro forma $(0.09) $(0.06) $(0.04) $(0.01)
=============== =============== ============== ===============
Diluted - pro forma $(0.09) $(0.06) $(0.04) $(0.01)
=============== =============== ============== ===============
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
Page 9
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2005
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
the following weighted- average assumptions for the nine months ended February
28, 2005:
Expected life (years) 5
Expected volatility 82%
Risk-free interest rate 4.4%
Expected dividend yield 0.0%
NOTE D - EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per share is based on the weighted average number of
common shares outstanding without consideration of potential common shares.
Diluted earnings (loss) per share is based on the weighted 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. For the nine-month and
three-month periods ended February 28, 2005 options and warrants to purchase
6,832,253 of common stock were excluded from the computation of diluted earnings
per share because the effect of their inclusion would be antidilutive.
Similarly, for the nine-month and three-month periods ended February 29, 2004,
options and warrants to purchase 6,745,086 were excluded from the computation of
diluted earnings per share due to their antidilutive effect.
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 29, February 28, February 29,
2005 2004 2005 2004
------------- ------------- ------------- -------------
Numerator:
Basic and diluted net loss $(4,561,002) $(2,663,577) $(2,026,849) $(310,041)
Denominator:
Basic - weighted average common shares 58,545,850 57,847,004 58,552,688 57,886,701
Stock options -- -- -- --
Warrants -- -- -- --
------------- ------------- ------------- -------------
Diluted - weighted average common shares 58,545,850 57,847,004 58,552,688 57,886,701
============= ============= ============= =============
Basic and diluted loss per common share $(0.08) $(0.05) $(0.03) $(0.01)
============= ============= ============= =============
NOTE E - INVENTORIES
Inventories consist of the following:
February 28, May 31,
2005 2004
----------------- -----------------
Raw materials $1,133,485 $928,269
Work in process 1,291,609 455,731
Finished goods 1,187,988 989,748
----------------- -----------------
$3,613,082 $2,373,748
================= =================
Page 10
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2005
At February 28, 2005 and May 31, 2004, the Company has recorded reserves
for obsolete inventory of $472,000 and $399,000, respectively.
NOTE F - LONG-TERM DEBT
The following table sets forth the computation of long-term debt:
February 28, May 31,
2005 2004
----------------- -----------------
Facility loans (a) $983,257 $1,022,933
Term loans (b) 146,996 206,382
----------------- -----------------
1,130,253 1,229,315
Less current portion (145,164) (136,478)
----------------- -----------------
$985,089 $1,092,837
================= =================
(a) The Company purchased its headquarters and warehouse facility and
secured notes of $641,667 and $500,000, respectively, under two programs
sponsored by New York State. These notes, which bear interest at 7.8% and 6%,
respectively, are payable in monthly installments consisting of principal and
interest payments over fifteen- year terms, expiring in September 2016 and
January 2017, respectively, and are secured by the building.
(b) In fiscal years 2003 and 2004, the Company financed the cost and
implementation of a management information system and secured several notes,
aggregating approximately $305,219. The notes, which bear interest at rates
ranging from 7.5% through 12.5%, are payable in monthly installments consisting
of principal and interest payments over four-year terms, expiring at various
times between August and October 2006.
NOTE G - DEFERRED REVENUES
The Company records revenue on extended service contracts ratably over the
term of the related warranty contracts. Effective September 1, 2003, the Company
prospectively adopted the provisions of EITF 00-21. Upon adoption of the
provisions of EITF 00-21, the Company began to defer revenue related to EECP
system sales for the fair value of in-service and training to the period when
the services are rendered and for warranty obligations ratably over the service
period, which is generally one year. The changes in the Company's deferred
revenues are as follows:
Nine Months Ended Three Months Ended
------------------------------ ------------------------------
February 28, February 29, February 28, February 29,
2005 2004 2005 2004
------------- ------------- ------------- -------------
Deferred Revenue at the beginning of the period $2,846,451 $1,709,551 $2,773,618 $2,284,166
ADDITIONS
Deferred extended service contracts 1,473,022 1,392,588 428,658 446,650
Deferred in-service and training 147,500 215,000 30,000 117,500
Deferred warranty obligations 630,000 650,000 132,500 357,500
RECOGNIZED AS REVENUE
Deferred extended service contracts (1,395,461) (1,066,682) (512,015) (399,109)
Deferred in-service and training (230,000) (157,500) (60,000) (102,500)
Deferred warranty obligations (947,917) (183,333) (269,166) (144,583)
------------- ------------- ------------- -------------
Deferred revenue at end of period 2,523,595 2,559,624 2,523,595 2,559,624
Less: current portion (1,646,918) (1,601,037) (1,646,918) (1,601,037)
------------- ------------- ------------- -------------
Long-term deferred revenue at end of period $876,677 $958,587 $876,677 $958,587
============= ============= ============= =============
NOTE H - WARRANTY COSTS
Equipment sold is generally covered by a warranty period of one year.
Effective September 1, 2003, the Company adopted the provisions of EITF 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables" on a
Page 11
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2005
prospective basis. Under EITF 00-21, for certain arrangements, a portion of the
overall system price attributable to the first year warranty service is deferred
and recognized as revenue over the service period. As such, the Company no
longer accrues estimated warranty costs upon delivery but rather recognizes
warranty and related service costs as incurred. Prior to September 1, 2003, the
Company accrued a warranty reserve for estimated costs to provide warranty
services when the equipment sale is recognized. The factors affecting the
Company's 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 serviced
during the warranty period or when the warranty period elapses. A review of
warranty obligations is performed regularly to determine the adequacy of the
reserve. Based on the outcome of this review, revisions to the estimated
warranty liability are recorded as appropriate.
The changes in the Company's product warranty liability are as follows:
Nine Months Ended Three Months Ended
------------------------------- ------------------------------
February 28, February 29, February 28, February 29,
2005 2004 2005 2004
------------- ------------- ------------- -------------
Warranty liability at the beginning of the $244,917 $788,000 $154,583 $501,000
period
Expense for new warranties issued - 164,000 - -
Warranty amortization (122,084) (602,000) (31,750) (151,000)
------------- ------------- ------------- -------------
Warranty liability at end of period 122,833 350,000 122,833 350,000
Less: Current portion (105,583) (241,000) (105,583) (241,000)
------------- ------------- ------------- -------------
Long-term warranty liability at end of period $17,250 $109,000 $17,250 $109,000
============= ============= ============= =============
NOTE I - INCOME TAXES
During the nine-months ended February 28, 2005 and February 29, 2004, we
recorded a provision for state income taxes of $29,661 and $30,000,
respectively.
As of February 28, 2005, the Company had recorded deferred tax assets of
$14,582,000 net of a $3,444,520 valuation allowance related to the anticipated
recovery of tax loss carryforwards. The amount of the deferred tax assets
considered realizable could be reduced in the future if estimates of future
taxable income during the carryforward period are lower than projected. Ultimate
realization of the deferred tax assets is dependent upon material improvements
over present levels of consolidated pre-tax losses in order for us to generate
sufficient taxable income prior to the expiration of the tax loss carryforwards.
Management believes that the Company is positioned for long-term growth despite
the financial results achieved through February 28, 2005, and that based upon
the weight of available evidence, that it is "more likely than not" that the net
deferred tax assets will be realized. The "more likely than not" standard is
subjective, and is based upon management's estimate of a greater than 50%
probability that its long range business plan can be realized.
Ultimate realization of any or all of the deferred tax assets is not
assured, due to significant uncertainties and material assumptions associated
with estimates of future taxable income during the carryforward period. The
Company's estimates are largely dependent upon achieving considerable growth in
revenue and profits resulting from the successful commercialization of EECP
therapy into the congestive heart failure indication, which Management believes
will enable the Company to reverse the current trend of increasing losses and
generate pre-tax income in excess of over $42 million over the next seven years
in order to fully utilize all of the deferred tax assets. Such future estimates
of future taxable income are based on the beliefs of the Company's management,
as well as assumptions made by and information currently available to the
Company's management. Certain critical assumptions associated with the Company's
estimates include:
-- that the results from the PEECH clinical trial, as disclosed in Note K
"SUBSEQUENT EVENT", as well as other cllinical evidence are
sufficiently positive for the PEECH clinical trial to be published in
a peer review journal and enable the EECP therapy to obtain approval
for a national Medicare reimbursement coverage policy plus other
third-party payer reimbursement policies specific to the congestive
heart failure indication;
Page 12
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2005
-- that the reimbursement coverage will be both broad enough in terms of
coverage language and at an amount adequate to enable successful
commercialization of EECP therapy into the congestive heart failure
indication and enable the Company to achieve material growth in
revenue and profits;
-- that the EECP therapy will be accepted by the medical community as an
adjunctive therapy for the treatment of patients suffering from
congestive heart failure; and
-- that we will be able to secure additional financing to provide
sufficient funds to market EECP therapy in the congestive heart
failure indication.
Additional uncertainties that could cause actual results to differ
materially are the following:
-- the effect of the dramatic changes taking place in the healthcare
environment;
-- the impact of competitive procedures and products and their pricing;
-- other medical insurance reimbursement policies;
-- there can be no assurance that we will be able to raise additional
capital necessary to implement our business plan;
-- unexpected manufacturing problems;
-- unforeseen difficulties and delays in the conduct of clinical trials,
peer review publications and other product development programs;
-- the actions of regulatory authorities and third-party payers in the
United States and overseas;
-- uncertainties about the acceptance of a novel therapeutic modality by
the medical community;
-- the recent history of declining revenues and profits; and
-- the risk factors reported from time to time in the Company's SEC
reports.
Factors considered by Management in making its assumptions and included in
the long-term business plan are the following:
-- FDA clearance to market EECP therapy in congestive heart failure;
-- independent market research indicates that the patient population
potentially eligible for EECP therapy in congestive heart failure
market is larger than the current refractory angina patient population
and when the two patient populations are combined the total market
opportunity for EECP therapy will be more than double;
-- many physician practices have told Management that they do not have a
sufficient number of patients to economically justify adoption of the
procedure with the current reimbursement coverage for refractory
angina. The increased market size resulting from the addition of CHF
patients should improve the economic model for the physician practice;
-- positive clinical evidence from the PEECH clinical trial that was
recently concluded as disclosed in Note K "SUBSEQUENT EVENT", plus
other smaller clinical trials and the IEPR patient registry that
demonstrates the clinical effectiveness of EECP therapy in the
treatment of congestive heart failure to medical providers, payers and
regulators.
-- the PEECH clinical trial was completed this fiscal year as planned and
the summary results of the trial were disclosed in March 2005;
-- the Company intends to have the results of the PEECH trial published
in a peer review journal, which is an important step necessary to
support an application to CMS to expand reimbursement coverage of EECP
therapy to include CHF patients;
-- the Company sustained a period of profitability in fiscal years 2000,
2001 and 2002 with profits before income taxes of $1,290,916,
$5,237,242 and $4,240,106, respectively; and
-- management continues to believe that the Company will be able to raise
sufficient funds to enable it to execute its business plan.
Page 13
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 28, 2005
While Management believes that they will be able to execute the Company's
business plan over the longer term and the Company will be able to utilize its
tax loss carryforwards, the exact timing of its return to profitability is
uncertain, subject to significant management judgments and estimates and
dependent on a variety of external factors including: market conditions at that
time, the reception of the EECP therapy by the medical professionals and payers
and the timing of a Medicare reimbursement decision. It is possible that
significant tax loss carryforwards from fiscal years 2005, 2006 and 2007 may
expire before the Company is able to use them. As a result of these
uncertainties, beginning in fiscal 2004, the Company began to provide a
valuation reserve for all additional tax loss carryforwards that were generated
by current operating losses. Management reviews this policy on a quarterly basis
and believes that the above valuation reserve is appropriate under the current
circumstances.
The amount of the deferred tax assets considered realizable could be
reduced in the future if estimates of future taxable income during the
carryforward period are reduced or if the accounting standards are changed to
reflect a more stringent standard for evaluation of deferred tax assets.
The recorded deferred tax asset includes an increase to the valuation
allowance of $1,536,520 during the nine-months ended February 28, 2005.
NOTE J - COMMITMENTS AND CONTINGENCIES
Employment Agreements
The approximate aggregate minimum compensation obligation under active
employment agreements at February 28, 2005 are summarized as follows:
Twelve month period ended February 28, Amount
------------------------------------------------------ --------------
2006 $78,125
NOTE K - SUBSEQUENT EVENT
On March 8, 2005, results of the Prospective Evaluation of EECP(R) in
Congestive Heart Failure ("PEECH") trial were presented by Dr. Arthur M.
Feldman, MD, PhD, Principal Investigator, in a Late Breaking Clinical Trials
session of the American College of Cardiology ("ACC") Annual Scientific Session.
Simultaneously, the Company announced the positive results of the trial to the
public in a Press Release. The PEECH trial evaluated the efficacy of EECP
therapy for the treatment of congestive heart failure ("CHF").
In designing the PEECH trial, success was demonstrated if the difference
between EECP therapy combined with optimal medical therapy compared to optimal
medical therapy alone achieved a p-value less than 0.025 in at least one of two
pre-defined co-primary endpoints:
1. percentage of subjects with greater than or equal to 60 seconds
improvement in exercise duration from baseline to six months, or
2. percentage of subjects with at least 1.25 ml/min/kg increase in peak
oxygen consumption from baseline to six months.
Additional secondary endpoints were changes in exercise duration and peak
oxygen consumption, changes in New York Heart Association ("NYHA") functional
classification, changes in quality of life, adverse experiences and pre-defined
clinical outcomes.
The study demonstrated that there were improvements in exercise duration
for subjects with NYHA Class II and III symptoms of CHF who were given EECP
therapy as an adjunctive therapy. Among those treated with EECP 35.4% achieved
an exercise duration increase equal to or more than 60 seconds, compared with
only 25.3% in the control group (p = 0.016). Peak oxygen consumption was not
significantly different between the two groups at six months.
In addition, consistent with the improvement in exercise duration, symptom
status, assessed by the NYHA functional class, improved 31% in the EECP group
compared to 16% in the control group (p = 0.01) and overall quality of life, as
reported on the Minnesota Living with Heart Failure scale, also improved
significantly. Furthermore, in exercise duration after six months the average
was an increase in 25 seconds for the subjects who underwent EECP therapy,
compared with a 10 second decline for patients without the EECP therapy (p =
0.01). Peak oxygen consumption was not significantly different between the two
groups at six months. Additionally, EECP therapy was deemed safe and well
tolerated in this group of patients. The study concluded that the results
suggest EECP provides adjunctive therapy in patients with NYHA Class II-III
heart failure receiving optimal pharmacological therapy.
Page 14
Vasomedical, Inc. and Subsidiaries
ITEM 2 - 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" and "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;
unexpected manufacturing or supplier problems; unforeseen difficulties and
delays in the conduct of clinical trials and other product development programs;
the actions of regulatory authorities and third-party payers in the United
States and overseas; uncertainties about the acceptance of a novel therapeutic
modality by the medical community; and the risk factors reported from time to
time in 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. (the "Company"), 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
currently indicated for use in cases of stable or unstable angina (i.e., chest
pain), cardiogenic shock, acute myocardial infarction (i.e., heart attack) and
congestive heart failure ("CHF"). EECP therapy is currently marketed for chronic
stable angina. We are also actively engaged in research to determine the
potential benefits of EECP therapy in the management of CHF. EECP is a
non-invasive, outpatient therapy for the treatment of diseases of the
cardiovascular system. The therapy serves to increase circulation in areas of
the heart with less than adequate blood supply and may restore systemic vascular
function. We provide hospitals, clinics and private practices with EECP
equipment, treatment guidance, and a staff training and maintenance program
designed to provide improved patient outcomes. EECP is a registered trademark
for Vasomedical's enhanced external counterpulsation systems.
Medicare and numerous other commercial third-party payers currently
reimburse for EECP therapy in the treatment of refractory angina. The Medicare
reimbursement rate in the continental United States for a full course of 35
one-hour treatments ranges from $3,955 to $7,216. Although Medicare has not
modified its national coverage policy for EECP therapy to specifically include
CHF patients, we believe, based upon data published from the International EECP
Patient Registry ("IEPR"), that there exists a significant subset of patients
with CHF that also have disabling angina that qualify for Medicare reimbursement
under its present coverage policy. However reimbursement for CHF as a primary
indication is not covered under national coverage policy.
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, 2004 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
Page 15
Vasomedical, Inc. and Subsidiaries
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - CONTINUED
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 direct 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 our multiple-element arrangements are generally
comprised of the following elements that would qualify as separate units of
accounting: system sales, in-service support consisting of equipment set-up and
training provided at the customers facilities and warranty service for system
sales generally covered by a warranty period of one year. 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 EECP system sales;
i) when delivery and acceptance occurs based on delivery and acceptance
documentation received from independent shipping companies or customers,
ii) for in-service and training following documented completion of the
training, and
iii) for warranty service ratably over the service period, which is
generally one year. In-service and training generally occurs within three weeks
of shipment and our return policy states that no returns will be accepted after
in-service and training has been completed.
We recognized deferred revenues of $230,000 and $60,000 related to
in-service training and $947,917 and $269,166 related to warranty service during
the nine-month and three-month periods ended February 28, 2005, respectively. In
addition, following the adoption of the provisions of EITF 00-21 beginning
September 1, 2003 we began to defer revenue that had previously been recorded at
the time of sale. Previously, in accordance with Staff Accounting Bulletin No.
101, "Revenue Recognition in Financial Statements," we accrued costs associated
with these arrangements as warranty expense in the period the system was
delivered and accepted. During the nine-month and three-month periods ended
February 28, 2005, we deferred $147,500 and $30,000 related to in-service
training and $630,000 and $132,500 related to warranty service, respectively.
The amount related to in-service training is recognized as revenue at the time
the in-service training is completed and the amount related to warranty service
is recognized as service revenue ratably over the related service period, which
is generally one year. Costs associated with the provision of in-service
training and warranty service, including salaries, benefits, travel, spare parts
and equipment, are recognized in cost of sales as incurred.
We also recognize revenue generated from servicing EECP systems that are no
longer covered by a warranty agreement, or by providing sites with additional
training, in the period that these services are provided. Revenue related to
future commitments under separately priced extended warranty agreements on the
EECP system are deferred and recognized ratably over the service period,
generally ranging from one year to four years. Deferred revenues recognized
related to extended warranty agreements that have been invoiced to customers
prior to the performance of these services, were $1,395,461 and $1,066,682 for
the nine-month periods ended February 28, 2005 and February 29, 2004,
respectively, and $512,015 and $399,109 for the three-month periods ended
February 28, 2005 and February 29, 2004, respectively. Costs associated with the
provision of service and maintenance, including salaries, benefits, travel,
spare parts and equipment, are recognized in cost of sales as incurred. Amounts
billed in excess of revenue recognized are included as deferred revenue in the
consolidated balance sheets.
Page 16
Vasomedical, Inc. and Subsidiaries
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - CONTINUED
We have also entered into lease agreements for our EECP systems, generally
for terms of one year or less, that are classified as operating leases. Revenues
from operating leases are generally recognized, in accordance with the terms of
the lease agreements, on a straight-line basis over the life of the respective
leases. For certain operating leases in which payment terms are determined on a
"fee-per-use" basis, revenues are recognized as incurred (i.e., as actual usage
occurs). The cost of the EECP system utilized under operating leases is recorded
as a component of property and equipment and is amortized to cost of sales over
the estimated useful life of the equipment, not to exceed five years. There were
no significant minimum rental commitments on these operating leases at February
28, 2005.
Accounts Receivable, net
Our accounts receivable, net 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 our allowance for doubtful accounts based on our 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. We also look at the credit quality
of its customer base as well as changes in our credit policies. We continuously
monitor collections and payments from its customers. While credit losses have
historically been within expectations and the provisions established, we cannot
guarantee that we will continue to experience the same credit loss rates that we
have in the past.
Inventories, net
We value inventory at the lower of cost or estimated market, cost being
determined on a first-in, first-out basis. We often place EECP systems at
various field locations for demonstration, training, evaluation, and other
similar purposes at no charge. The cost of these EECP systems is transferred to
property and equipment and is amortized over the next two to five years. We
record the cost of refurbished components of EECP systems and critical
components at cost plus the cost of refurbishment. We regularly review inventory
quantities on hand, particularly raw materials and components, and record a
provision for excess and obsolete inventory based primarily on existing and
anticipated design and engineering changes to our products as well as forecasts
of future product demand.
Deferred Revenues
We record revenue on extended service contracts ratably over the term of
the related warranty contracts. Effective September 1, 2003, we prospectively
adopted the provisions of EITF 00-21. Upon adoption of the provisions of EITF
00-21 effective September 1, 2003, we began to defer revenue related to EECP
system sales for the fair value of in-service and training to the period when
the services are rendered and for warranty obligations ratably over the service
period, which is generally one year.
Warranty Costs
Equipment sold is generally covered by a warranty period of one year.
Effective September 1, 2003, we adopted the provisions of EITF 00-21 on a
prospective basis. Under EITF 00-21, for certain arrangements, a portion of the
overall system price attributable to the first year warranty service is deferred
and recognized as revenue over the service period. As such, we no longer accrue
warranty costs upon delivery but rather recognize warranty and related service
costs as incurred. Prior to September 1, 2003, we accrued a warranty reserve for
estimated costs to provide warranty services when the equipment sale was
recognized. 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.
Page 17
Vasomedical, Inc. and Subsidiaries
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - CONTINUED
Income Taxes
Deferred income taxes are recognized for temporary differences between
financial statement and income tax bases of assets and liabilities and loss
carryforwards for which income tax benefits are expected to be realized in
future years. A valuation allowance is established, when necessary, to reduce
deferred tax assets to the amount expected to be realized. In estimating future
tax consequences, we generally consider all expected future events other than an
enactment of changes in the tax laws or rates. The deferred tax asset is
continually evaluated for realizability. To the extent our judgment regarding
the realization of the deferred tax assets change, an adjustment to the
allowance is recorded, with an offsetting increase or decrease, as appropriate,
in income tax expense. Such adjustments are recorded in the period in which our
estimate as to the realizability of the asset changed that it is "more likely
than not" that all of the deferred tax assets will be realized. The "more likely
than not" standard is subjective, and is based upon our estimate of a greater
than 50% probability that our long range business plan can be realized.
Deferred tax liabilities and assets are classified as current or
non-current based on the classification of the related asset or liability for
financial reporting. A deferred tax liability or asset that is not related to an
asset or liability for financial reporting, including deferred tax assets
related to carryforwards, are classified according to the expected reversal date
of the temporary difference. The deferred tax asset we recorded relates
primarily to the realization of net operating loss carryforwards, of which the
allocation of the current portion, if any, reflects the expected utilization of
such net operating losses in next twelve months. Such allocation is based our
internal financial forecast and may be subject to revision based upon actual
results.
Stock Compensation
We have five stock-based employee compensation plans. We account for
stock-based compensation using the intrinsic value method in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations ("APB No. 25") and have adopted the
disclosure provisions of Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure, an
amendment of FASB Statement No. 123." Under APB No. 25, when the exercise price
of our employee stock options equals the market price of the underlying stock on
the date of grant, no compensation expense is recognized. Accordingly, no
compensation expense has been recognized in the consolidated financial
statements in connection with employee stock option grants.
Pro forma compensation expense may not be indicative of future disclosures
because it does not take into effect pro forma compensation expense related to
grants before 1995. For purposes of estimating the fair value of each option on
the date of grant, we 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 our 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
our 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 December 2004, the Financial Accounting Standards Board (FASB) issued
FASB Statement No. 153 ("SFAS No. 153"), "Exchanges of Non-monetary Assets an
amendment of APB Opinion No. 29". SFAS No. 153 amends Opinion 29 to eliminate
the exception for non-monetary exchanges of similar productive assets and
replaces it with a general exception for exchanges of non-monetary assets that
do not have commercial substance. A non- monetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. SFAS No. 153 is effective for fiscal
periods after June 15, 2005. The Company does not expect the adoption of SFAS
No. 153 to have a material impact on the Company's consolidated financial
statements.
Page 18
Vasomedical, Inc. and Subsidiaries
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - CONTINUED
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123(R) ("SFAS No. 123(R)"), "Accounting for Stock-Based
Compensation". SFAS No. 123(R) establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. This Statement focuses primarily on accounting for transactions in
which an entity obtains employee services in share-based payment transactions.
SFAS No. 123(R) requires that the fair value of such equity instruments be
recognized as expense in the historical financial statements as services are
performed. Prior to SFAS No. 123(R), only certain pro-forma disclosures of fair
value were required. SFAS No. 123(R) shall be effective for the Company as of
the beginning of the first interim reporting period that begins after June 15,
2005. The adoption of this new accounting pronouncement is expected to have a
material impact on the financial statements of the Company commencing with the
quarter ending November 30, 2005.
In November 2004, the FASB issued Statement of Financial Accounting
Standards No. 151 ("SFAS No. 151"), Inventory Costs, an amendment of ARB No. 43,
Chapter 4. The amendments made by SFAS No. 151 will improve financial reporting
by clarifying that abnormal amounts of idle facility expense, freight, handling
costs, and wasted materials (spoilage) should be recognized as current-period
charges and by requiring the allocation of fixed production overheads to
inventory based on the normal capacity of the production facilities. SFAS No.
151 is effective for inventory costs incurred during fiscal years beginning
after June 15, 2005. Earlier application is permitted for inventory costs
incurred during fiscal years beginning after November 24, 2004. The Company is
currently evaluating the impact of adoption of SFAS No. 151 on its financial
position and results of operations.
In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104,
"Revenue Recognition" (SAB No. 104), which codifies, revises and rescinds
certain sections of SAB No. 101, "Revenue Recognition in Financial Statements",
in order to make this interpretive guidance consistent with current
authoritative accounting and auditing guidance and SEC rules and regulations.
The changes noted in SAB No. 104 did not have a material effect on our financial
position or results of operations.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150 ("SFAS No. 150"), "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." This statement establishes
standards for how an issuer classifies and measures in its statement of
financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. This Statement shall be effective for financial instruments entered
into or modified after May 31, 2003, and otherwise shall be effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 has not had a material impact on our financial position
and results of operations.
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 ("SFAS No. 149"), "Amendment of Statement 133 on Derivative Instruments
and Hedging Activities," which amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities under SFAS No. 133. SFAS
No. 149 is effective for contracts entered into or modified after June 30, 2003,
except for the provisions that were cleared by the FASB in prior pronouncements.
The adoption of SFAS No. 149 has not had a material impact on our financial
position and results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation
of Variable Interest Entities" ("FIN 46"), as interpreted by FIN 46R. In
general, a variable interest entity is a corporation, partnership, trust, or any
other legal structure used for business purposes that either (a) does not have
equity investors with voting rights or (b) has equity investors that do not
provide sufficient financial resources for the entity to support its activities.
A variable interest entity often holds financial assets, including loans or
receivables, real estate or other property. A variable interest entity may be
essentially passive or it may engage in activities on behalf of another company.
Until now, a company generally has included another entity in its consolidated
financial statements only if it controlled the entity through voting interests.
FIN 46 changes that by requiring a variable interest entity to be consolidated
by a company if that company is subject to a majority of the risk of loss from
the variable interest entity's activities or entitled to receive a majority of
the entity's residual returns or both. FIN 46's consolidation requirements apply
immediately to variable interest entities created or acquired after January 31,
2003. The consolidation requirements apply to older entities in the first
interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. We adopted FIN
46 effective January 31, 2003. The adoption of FIN 46 did not have a material
impact on our financial position or results of operations.
Page 19
Vasomedical, Inc. and Subsidiaries
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - CONTINUED
In November 2002, the Emerging Issues Task Force, ("EITF") reached a
consensus opinion on, "Revenue Arrangements with Multiple Deliverables", "(EITF
00-21)". That consensus provides that revenue arrangements with multiple
deliverables should be divided into separate units of accounting if certain
criteria are met. The consideration of the arrangement should be allocated to
the separate units of accounting based on their relative fair values, with
different provisions if the fair value is contingent on delivery of specified
items or performance conditions. Applicable revenue criteria should be
considered separately for each separate unit of accounting. EITF 00-21 is
effective for revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. Effective September 1, 2003, we prospectively adopted the
provisions of EITF 00-21.
Results of Operations
Three Months Ended February 28, 2005 and February 29, 2004
Net revenues from sales, leases and service of our external
counterpulsation systems ("EECP" systems) for the three-month periods ended
February 28, 2005 and February 29, 2004, were $2,964,328 and $5,949,910,
respectively, which represented a decline of $2,985,582 or 50%. We reported a
net loss of $2,026,849 compared to a net loss of $310,041 for the three-month
periods ended February 28, 2005 and February 29, 2004, respectively. Our net
loss per common share was $0.03 for the three-month period ended February 28,
2005 compared to a net loss of $0.01 for the three-month period February 29,
2004.
Revenues
Revenues from equipment sales declined approximately 59% to $2,131,567 for
the three-month period ended February 28, 2005 as compared to $5,185,388 for the
same period for the prior year. The decline in equipment sales is due primarily
to a 63% decline in domestic units shipped and a 10% decline in the average
sales prices of new EECP systems sold in the domestic market.
We believe the decline in domestic units shipped reflects weakened demand
in the refractory angina market as existing capacity is more fully utilized,
coupled with increased competition from surgical procedures, mainly the use of
drug-eluting stents. We anticipate that demand for EECP systems will remain soft
until an expansion of the current Centers for Medicare and Medicaid Services
("CMS") national reimbursement policy for use of EECP therapy to treat
congestive heart failure patients is obtained. In addition, average domestic
selling prices continue to decline reflecting the impact in the market of lower
priced competitive products. We continue to believe that our EECP systems
currently sell at a significant price premium to competitive products reflecting
the clinical efficacy and superior quality of the EECP system plus the many
value added services offered by us. However, we anticipate that this current
trend of declining prices will continue in the immediate future as our
competition attempts to capture greater market share through pricing discounts.
Lastly, we continue to reorganize certain territory responsibilities in our
sales department due to recently vacant and/or unproductive territories, and
recently completed the restructuring of a major independent distributor
territory to direct sales.
Our revenue from the sale of EECP systems to international distributors in
the third quarter of fiscal 2005 decreased approximately 49% to $145,000
compared to $286,500 in same period of the prior year reflecting decreased
volume.
The above decline in revenue from equipment sales was partially offset by a
9% increase in revenue from equipment rental and services for the three month
period ended February 28, 2005, from the same three-month period in the prior
year. Revenue from equipment rental and services represented 28% of total
revenue in the third quarter of fiscal 2005 compared to 13% in the third quarter
of fiscal 2004. The increase in both absolute amounts and percentage of total
revenue resulted primarily from an increase of $126,960, or approximately 20%,
in service related revenue from $640,690 to $767,650 for the three-month periods
ended February 29, 2004 and February 28, 2005, respectively. The higher service
revenue reflects an increase in service, spare parts and consumables as a result
of the continued growth of the installed base of EECP systems plus greater
marketing focus on the sale of extended service contracts. Rental revenue
decreased approximately 53% from $107,915 for the three-month period ended
February 29, 2004 to $50,379 for the three-month period ended February 28, 2005,
reflecting the deferral of $37,098 in rental revenue due to use of the
installment method of revenue recognition for one customer.
Page 20
Vasomedical, Inc. and Subsidiaries
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - CONTINUED
Gross Profit
Gross profit declined to $1,799,746 or 61% of revenues for the three-month
period ended February 28, 2005, compared to $4,016,735 or 68% of revenues for
the three-month period ended February 29, 2004. Gross profit margin as a
percentage of revenue for the three-month period ended February 28, 2005
decreased due to the lower margins from the sales of EECP systems due to
reduction in average selling prices, a lower mix of used systems and higher
production costs and reflecting reduced production quantities. Many of our used
EECP systems carried reduced book values since they were partially amortized and
as a result generated above average gross profit margins. We have limited
quantities of the lower cost systems and do not anticipate a significant volume
of used equipment will be sold in the future. Rental and service related margins
declined slightly due to the deferral of rental revenue due to collectibility
risks associated with our largest rental customer. The decline in gross profit
when compared to the prior year in absolute dollars is a direct result of the
lower revenue.
Gross profits are dependent on a number of factors, particularly the mix of
EECP models sold and their respective average selling prices, the mix of EECP
units sold, rented or placed during the period, the ongoing costs of servicing
such units, and certain fixed period costs, including facilities, payroll and
insurance. Gross profit margins are generally less on non-domestic business due
to the use of distributors resulting in lower selling prices.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses for the three-months
ended February 28, 2005 and February 29, 2004 were $2,947,978 or 99% of revenues
and $3,083,407 or 52% of revenues, respectively reflecting a decrease of
$135,429 or approximately 4%. The decrease in SG&A expenditures in the third
quarter of fiscal 2005 compared to fiscal 2004 resulted primarily from lower
sales commissions of $307,893 associated with decreased sales revenue and lower
administrative consulting of $76,425. Partially offsetting the above were
increases in marketing consulting and trade show related costs $ $93,678 and
$175,889, respectively.
Research and Development
Research and development ("R&D") expenses of $863,476 or 29% of revenues
for the three months ended February 28, 2005, decreased by $180,119 or 17%, from
the prior three months ended February 29, 2004, of $1,043,595 or 18% of
revenues. The decrease reflects lower spending related to the Prospective
Evaluation of EECP in Congestive Heart Failure ("PEECH(TM)") clinical trial and
lower new product development costs. The patient treatment phase of the PEECH
study was completed in March 2004; as a result, we have incurred lower levels of
spending related to subject study activity and study management aspects of the
trial. As described more fully below, we disclosed the initial results of the
PEECH trial in March 2005 and expect to submit an application to the Centers for
Medicare and Medicaid Services ("CMS") for a coverage decision leading to
reimbursement for use of EECP therapy in treatment of CHF. Based on the above
timetable we anticipate a coverage decision by CMS in early 2006.
On March 8, 2005, results of the PEECH trial were presented by Dr. Arthur
M. Feldman, MD, PhD, Principal Investigator, in a Late Breaking Clinical Trials
session of the American College of Cardiology ("ACC") Annual Scientific Session.
Simultaneously, the Company announced the positive results of the trial to the
public in a Press Release. The PEECH trial evaluated the efficacy of EECP
therapy for the treatment of congestive heart failure ("CHF").
In designing the PEECH trial, success was demonstrated if the difference
between EECP therapy combined with optimal medical therapy compared to optimal
medical therapy alone achieved a p-value less than 0.025 in at least one of two
pre-defined co-primary endpoints:
1. percentage of subjects with greater than or equal to 60 seconds
improvement in exercise duration from baseline to six months, or
2. percentage of subjects with at least 1.25 ml/min/kg increase in peak
oxygen consumption from baseline to six months.
Page 21
Vasomedical, Inc. and Subsidiaries
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - CONTINUED
Additional secondary endpoints were changes in exercise duration and peak
oxygen consumption, changes in New York Heart Association ("NYHA") functional
classification, changes in quality of life, adverse experiences and pre-defined
clinical outcomes.
The study demonstrated that there were improvements in exercise duration
for subjects with NYHA Class II and III symptoms of CHF who were given EECP
therapy as an adjunctive therapy. Among those treated with EECP 35.4% achieved
an exercise duration increase equal to or more than 60 seconds, compared with
only 25.3% in the control group (p = 0.016). Peak oxygen consumption was not
significantly different between the two groups at six months.
In addition, consistent with the improvement in exercise duration, symptom
status, assessed by the NYHA functional class, improved 31% in the EECP group
compared to 16% in the control group (p = 0.01) and overall quality of life, as
reported on the Minnesota Living with Heart Failure scale, also improved
significantly. Furthermore, in exercise duration after six months the average
was an increase in 25 seconds for the subjects who underwent EECP therapy,
compared with a 10 second decline for patients without the EECP therapy (p =
0.01). Peak oxygen consumption was not significantly different between the two
groups at six months. Additionally, EECP therapy was deemed safe and well
tolerated in this group of patients. The study concluded that the results
suggest EECP provides adjunctive therapy in patients with NYHA Class II-III
heart failure receiving optimal pharmacological therapy.
Provision for Doubtful Accounts
We collected funds from previously reserved accounts, which largely offset
new reserve requirements. As a result, we incurred a charge to our provision for
doubtful accounts during the three-month period ended February 28, 2005 of
$2,200, as compared to $161,500 during the three-month period ended February 29,
2004.
Interest Expense and Financing Costs
Interest expense and financing costs decreased to $25,931 in the
three-month period ended February 28, 2005, from $35,089 for the same period in
the prior year. Interest expense reflects interest on loans secured to refinance
the November 2000 purchase of our headquarters and warehouse facility, as well
as on loans secured to finance the cost and implementation of a new management
information system.
Interest and Other Income, Net
Interest and other income for the third quarters of fiscal years 2005 and
2004, was $20,968 and $6,815, respectively. The increase in interest and other
income from the prior period is attributable to higher yields on invested
balances, which offset the effect of lower average cash balances in the current
quarter.
Income Tax Expense, Net
During the three-months ended February 28, 2005 and February 29, 2004, we
recorded a provision for state income taxes of $7,978 and $10,000, respectively.
As of February 28, 2005, we had recorded deferred tax assets of $14,582,000
net of a $3,444,520 valuation allowance related to the anticipated recovery of
tax loss carryforwards. The amount of the deferred tax assets considered
realizable could be reduced in the future if estimates of future taxable income
during the carryforward period are lower than projected. Ultimate realization of
the deferred tax assets is dependent upon material improvements over present
levels of consolidated pre-tax losses in order for us to generate sufficient
taxable income prior to the expiration of the tax loss carryforwards. We believe
that the Company is positioned for long-term growth despite the financial
results achieved during fiscal years 2005, 2004 and 2003, and that based upon
the weight of available evidence, that it is "more likely than not" that net
deferred tax assets will be realized. The "more likely than not" standard is
subjective, and is based upon management's estimate of a greater than 50%
probability that its long range business plan can be realized.
Ultimate realization of any or all of the deferred tax assets is not
assured, due to significant uncertainties and material assumptions associated
with estimates of future taxable income during the carryforward period. Our
estimates are largely dependent upon achieving considerable growth in revenue
Page 22
Vasomedical, Inc. and Subsidiaries
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - CONTINUED
and profits resulting from the successful commercialization of EECP therapy into
the congestive heart failure indication, which we believe to enable us to
reverse the current trend of increasing losses and generate pre tax income in
excess of $42 million over the next seven years in order to fully utilize all of
the deferred tax assets. Such future estimates of future taxable income are
based on our beliefs, as well as assumptions made by and information currently
available to us. Certain critical assumptions associated with our estimates
include:
-- that the results from the PEECH clinical trial, as disclosed in the
above "Research and Development" section, as well as other clinical
evidence are sufficiently positive for the PEECH clinical trial to be
published in a peer review journal and enable the EECP therapy to
obtain approval for a national Medicare reimbursement coverage policy
plus other third-party payer reimbursement policies specific to the
congestive heart failure indication;
-- that the reimbursement coverage will be both broad enough in terms of
coverage language and at an amount adequate to enable successful
commercialization of EECP therapy into the congestive heart failure
indication and enable us to achieve material growth in revenue and
profits;
-- that the EECP therapy will be accepted by the medical community as an
adjunctive therapy for the treatment of patients suffering form
congestive heart failure; and
-- that we will be able to secure additional financing to provide
sufficient funds to market EECP therapy in the congestive heart
failure indication.
Additional uncertainties that could cause actual results to differ
materially are the following:
-- the effect of the dramatic changes taking place in the healthcare
environment;
-- the impact of competitive procedures and products and their pricing;
-- other medical insurance reimbursement policies;
-- there can be no assurance that we will be able to raise additional
capital necessary to implement our business plan;
-- unexpected manufacturing problems;
-- unforeseen difficulties and delays in the conduct of clinical trials,
peer review publications and other product development programs;
-- the actions of regulatory authorities and third-party payers in the
United States and overseas;
-- uncertainties about the acceptance of a novel therapeutic modality by
the medical community;
-- our recent financial history of declining revenues and losses; and
-- the risk factors reported from time to time in our SEC reports.
Factors considered by us in making our assumptions and included in our
long-term business plan are the following:
-- we currently have FDA clearance to market EECP therapy in congestive
heart failure;
-- independent market research indicates that the patient population
potentially eligible for EECP therapy in congestive heart failure
market is larger than the current refractory angina patient population
and when the two patient populations are combined the total market
opportunity for EECP therapy will be more than double;
-- many physician practices have told us that they do not have a
sufficient number of patients to economically justify adoption of the
procedure with the current reimbursement coverage for refractory
angina. The increased market size resulting from the addition of CHF
patents should improve the economic model for the physician practice;
-- we have positive clinical evidence from the PEECH clinical trial that
was recently concluded as disclosed in the above "Research and
Development" section, plus other smaller clinical trials and the IEPR
patient registry that demonstrates the clinical effectiveness of EECP
therapy in the treatment of congestive heart failure to medical
providers, payers and regulators;
-- we completed the PEECH clinical trial this fiscal year as planned and
disclosed the summary results of the trial in March 2005;
Page 23
Vasomedical, Inc. and Subsidiaries
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - CONTINUED
-- we intend to have the results of the PEECH trial published in a peer
review journal, which is an important step necessary to support an
application to CMS to expand reimbursement coverage of EECP therapy to
include CHF patients;
-- we sustained a period of profitability in fiscal years 2000, 2001 and
2002 with profits before income taxes of $1,290,916, $5,237,242 and
$4,240,106, respectively; and
-- we continue to believe that we will be able to raise sufficient funds
to enable us to execute our business plan.
While we believe that we will be able to execute our business plan over the
longer term and we will be able to utilize our tax loss carryforwards, the exact
timing of our return to profitability is uncertain, subject to significant
management judgments and estimates and dependent on a variety of external
factors including: market conditions at that time, the reception of the EECP
therapy by the medical professionals and payers and the timing of a Medicare
reimbursement decision. It is possible that significant tax loss carryforwards
from fiscal years 2005, 2006 and 2007 may expire before we are able to use them.
As a result of these uncertainties, beginning in fiscal 2004, we began to
provide a valuation reserve for all additional tax loss carryforwards that were
generated by current operating losses. We review this policy on a quarterly
basis and believe that the above valuation reserve is appropriate under the
current circumstances.
The amount of the deferred tax assets considered realizable could be
reduced in the future if estimates of future taxable income during the
carryforward period are reduced or if the accounting standards are changed to
reflect a more stringent standard for evaluation of deferred tax assets.
The recorded deferred tax asset includes an increase to the valuation
allowance during the three months ended February 28, 2005 of $682,351.
Nine Months Ended February 28, 2005 and February 29, 2004
Net revenues from sales, leases and service of our external
counterpulsation systems ("EECP" systems) for the nine-month periods ended
February 28, 2005 and February 29, 2004, were $11,247,419 and $16,279,571,
respectively, which represented a decline of $5,032,152 or 31%. We reported a
net loss of $4,561,002 compared to $2,663,577 for the nine-month periods ended
February 28, 2005 and February 29, 2004, respectively. Our net loss per common
share was $0.08 for the nine-month period ended February 28, 2005, compared to a
net loss of $0.05 for the nine-month period February 29, 2004.
Revenues
Revenues from equipment sales declined approximately 39% to $8,629,026 for
the nine-month period ended February 28, 2005 as compared to $14,147,248 for the
same period for the prior year. The decline in equipment sales is due primarily
to a 34% decline in domestic units shipped, a 13% decline in the average sales
prices of new EECP systems sold in the domestic market, and an unfavorable
product mix reflecting a higher portion of used versus new equipment sales. Used
systems earned a lower average selling price compared to new systems, and
experienced a 29% decrease in average selling price when compared to used
systems sold in the domestic market in the first three quarters of fiscal 2004.
We believe the decline in domestic units shipped reflects weakened demand
in the refractory angina market as existing capacity is more fully utilized,
coupled with increased competition from surgical procedures, mainly the use of
drug-eluting stents. We anticipate that demand for EECP systems will remain soft
until an expansion of the current CMS national reimbursement policy for use of
EECP therapy to treat congestive heart failure patients is obtained. In
addition, average domestic selling prices continue to decline reflecting the
impact in the market of lower priced competitive products. We continue to
believe that our EECP systems currently sell at a significant price premium to
competitive products reflecting the clinical efficacy and superior quality of
the EECP system plus the many value added services offered by us. However, we
anticipate that this current trend of declining prices will continue in the
immediate future as our competition attempts to capture greater market share
through pricing discounts. In addition, we sold an unusually high percentage of
used equipment, which reflected the availability of used EECP systems that had
been recovered from a former customer, as well as EECP systems that had been
used to treat patients in the PEECH clinical trial but were no longer required
Page 24
Vasomedical, Inc. and Subsidiaries
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - CONTINUED
since the treatment portion of the trial has been completed. These used systems
were sold at average sales prices significantly below our new systems. Lastly,
we continue to reorganize certain territory responsibilities in our sales
department due to recently vacant and/or unproductive territories, and recently
completed the restructuring of a major independent distributor territory to
direct sales.
Our revenue from the sale of EECP systems to international distributors for
the nine-month period ended February 28, 2005 decreased approximately 4% to
$607,995 compared to $636,600 in same period of the prior year reflecting
decreased volume of new systems, partially offset by improved average selling
prices.
The above decline in revenue from equipment sales was partially offset by a
23% increase in revenue from equipment rental and services for the nine month
period ended February 28, 2005, from the same nine-month period in the prior
year. Revenue from equipment rental and services represented 23% of total
revenue in the first three quarters of fiscal 2005 compared to 13% in the first
three quarters of fiscal 2004. The increase in both absolute amounts and
percentage of total revenue resulted primarily from an increase of approximately
35% in service related revenue. The higher service revenue reflects an increase
in service, spare parts and consumables as a result of the continued growth of
the installed base of EECP systems plus greater marketing focus on the sale of
extended service contracts. Rental revenue declined approximately 26% following
the termination of several short-term rental agreements partially offsetting the
above.
Gross Profit
Gross profit declined to $7,247,170 or 64% of revenues for the nine-month
period ended February 28, 2005, compared to $10,714,473 or 66% of revenues for
the nine-month period ended February 29, 2004. Gross profit margin as a
percentage of revenue for the nine-month period ended February 28, 2005,
declined compared to the same period of the prior fiscal year due to reduced
margins from EECP equipment sales reflecting the negative impact resulting from
the reduction in average selling prices. The gross profit for rentals and
services improved both in absolute amount and as a percentage of revenue
reflecting increased service resulting from accessory and service contract
revenue increases exceeding associated cost increases. The decline in gross
profit when compared to the prior year in absolute dollars is a direct result of
the lower revenue.
Gross profits are dependent on a number of factors, particularly the mix of
EECP models sold and their respective average selling prices, the mix of EECP
units sold, rented or placed during the period, the ongoing costs of servicing
such units, and certain fixed period costs, including facilities, payroll and
insurance. Gross profit margins are generally less on non-domestic business due
to the use of distributors resulting in lower selling prices. Consequently, the
gross profit realized during the current period may not be indicative of future
margins.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses for the nine-months
ended February 28, 2005 and February 29, 2004 were $9,088,858 or 81% of revenues
and $9,217,836 or 57% of revenues, respectively reflecting a decrease of
$128,978 or 1%. The decrease in SG&A expenditures in the first three quarters of
fiscal 2005 compared to fiscal 2004 resulted primarily from a $445,151 decrease
in administrative consulting and severance fees, $93,637 lower promotional
allowances, and $67,098 lower advertising costs, partially offset by $256,670
higher market research fees and $245,272 higher trade show costs.
Research and Development
Research and development ("R&D") expenses of $2,521,321 or 22% of revenues
for the nine months ended February 28, 2005, decreased by $475,649 or 16%, from
the prior nine months ended February 29, 2004, of $2,996,970 or 18% of revenues.
The decrease reflects lower spending related to the PEECH clinical trial,
partially offset by increased expenditures for developing the new Lumenair(TM)
EECP(R) Therapy System.
Page 25
Vasomedical, Inc. and Subsidiaries
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - CONTINUED
Provision for Doubtful Accounts
During the nine-month period ended February 28, 2005, we charged $135,156
to our provision for doubtful accounts as compared to $1,147,011 during the
nine-month period ended February 29, 2004. The decrease was due primarily to a
$680,000 provision made in the prior fiscal period associated with the write-off
of all funds due from a major customer that ceased operations in December 2003.
Interest Expense and Financing Costs
Interest expense and financing costs decreased to $84,971 in the nine-month
period ended February 28, 2005, from $101,335 for the same period in the prior
year. Interest expense reflects interest on loans secured to refinance the
November 2000 purchase of our headquarters and warehouse facility, as well as on
loans secured to finance the cost and implementation of a new management
information system.
Interest and Other Income, Net
Interest and other income for the first three quarters of 2005 and 2004,
was $51,795 and $115,102, respectively. The decrease in interest and other
income from the prior period is the direct result of the absence of interest
income related to certain equipment sold under sales-type leases incurred in
fiscal 2004 and lower miscellaneous customer payments, partially offset by
higher interest income due to improved yields.
Income Tax Expense, Net
During the nine-months ended February 28, 2005 and February 29, 2004, we
recorded a provision for state income taxes of $29,661 and $30,000,
respectively.
As of February 28, 2005, we had recorded deferred tax assets of $14,582,000
net of a $3,444,520 valuation allowance related to the anticipated recovery of
tax loss carryforwards. The amount of the deferred tax assets considered
realizable could be reduced in the future if estimates of future taxable income
during the carryforward period are reduced. Ultimate realization of the deferred
tax assets is dependent upon our generating sufficient taxable income prior to
the expiration of the tax loss carryforwards. We believe that the Company is
positioned for long-term growth despite the financial results achieved during
fiscal years 2005, 2004 and 2003, and that based upon the weight of available
evidence, that it is "more likely than not" that net deferred tax assets will be
realized. The "more likely than not" standard is subjective, and is based upon
management's estimate of a greater than 50% probability that its long range
business plan can be realized.
Ultimate realization of any or all of the deferred tax assets is not
assured, due to significant uncertainties associated with estimates of future
taxable income during the carryforward period. Our estimates are largely
dependent upon achieving considerable growth resulting from the successful
commercialization of EECP therapy into the congestive heart failure indication.
Such future estimates of future taxable income are based on our beliefs, as well
as assumptions made by and information currently available to us. (See "Income
Tax Expense, Net" in the "Three Months Ended February 28, 2005 and February 29,
2004" section of this "Management's Discussion and Analysis of Financial
Condition and Results of Operation").
The recorded deferred tax asset and increase to the valuation allowance
during the nine months ended February 28, 2005 was $1,536,520.
Liquidity and Capital Resources
We believe that our cash flow from operations together with our current
cash reserves will be sufficient to fund our business plan and projected capital
requirements through at least July 2005. Although we have incurred significant
losses during the last three fiscal years, we believe that the Company is
positioned for long-term growth. Our long-term growth is largely dependent upon
the successful commercialization of EECP therapy into the congestive heart
failure indication, which depends in part upon the acceptance of the results of
the PEECH clinical trial by the medical community as being sufficient to promote
the adoption of the therapy in CHF. Our long-term ability to achieve profitable
operations is further dependent on successfully completing additional debt or
equity financing to provide marketing funds necessary to launch EECP therapy in
the congestive heart failure market and to bridge the period between completion
of the PEECH clinical trial and a congestive heart failure national
reimbursement coverage decision by CMS. While we are currently seeking to raise
such capital through public or private equity or debt financings, there is no
Page 26
Vasomedical, Inc. and Subsidiaries
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - CONTINUED
assurance we will be successful in these efforts. Future capital funding, if
available, may result in dilution to current shareholders.
We have financed our operations in fiscal 2005 and 2004 primarily from
working capital and operating results. At February 28, 2005, we had a cash and
cash equivalents balance of $1,228,727 and working capital of $4,977,695 as
compared to a cash and cash equivalents balance of $6,365,049 and working
capital of $9,771,870 at May 31, 2004. Our cash balances decreased $5,136,322 in
the nine-month period compared to May 31, 2004, primarily due to $3,406,972 used
in operating activities and $1,760,954 used in investing activities.
The decrease in cash provided by our operating activities during the first
three quarters of fiscal year 2005 resulted primarily from the net loss of
$4,561,002 less adjustments to reconcile net loss to net cash used in operating
activities of $1,154,030. Changes in our operating assets and liabilities
provided cash of $470,656. The changes in the asset components primarily reflect
an increase in inventory of $1,372,541 plus higher other current assets of
$164,123, primarily prepaid insurance premiums offset by a $3,754,183 reduction
in accounts receivable due to the decreased revenue. The changes in our
operating liability components reflect a reduction in accounts payable and
accrued liabilities of $1,296,234 and other liabilities totaling $400,099.
Non-cash adjustments for depreciation, amortization, allowance for doubtful
accounts and allowance for inventory write-offs of $683,374 partially offset the
above.
Net accounts receivable were 14% of revenues for the nine-month period
ended February 28, 2005, compared to 34% at the end of the nine-month period
ended February 29, 2004, and accounts receivable turnover improved to 5.4 times
as of February 28, 2005, as compared to 3.6 times as of February 29, 2004.
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.
If in our judgment the degree of collectibility is uncertain at the time of
shipment, we use the installment sales method and record revenue based on cash
receipt. During the first three quarters of fiscal 2005 and 2004, approximately
2% and 3%, respectively, of revenues were generated from sales in which initial
payment terms were greater than 90 days, we offered no sales- type leases and 6%
and 0% of revenues reflect cash receipts from installment sales. 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 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 used net cash of $1,760,954 during the nine-month
period ended February 28, 2005. The principal use of cash was for the purchase
of short-term certificates of deposit and treasury bills totaling $1,583,614 to
improve the yield on our unused cash balances. All of our certificates of
deposit have original maturities of greater than three months and mature in less
than twelve months. Additionally, we used $177,340 in cash primarily for the
purchase of equipment to be used in the manufacture of our EECP systems.
Our financing activities provided net cash of $31,604 during the nine-month
period ended February 28, 2005, reflecting $130,666 received from the exercise
of stock options less payments on our outstanding notes and loans totaling
$99,062.
We cancelled our line of credit in August 2004 and do not currently have an
available line of credit.
Page 27
Vasomedical, Inc. and Subsidiaries
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - CONTINUED
The following table presents our expected cash requirements for contractual
obligations outstanding as of February 28, 2005.
Due as of Due as of
Due as of 2/28/07 and 2/28/09 and Due
Total 2/28/06 2/29/08 2/28/10 Thereafter
--------------------------------------------------------------------------------------------------------------------
Long-Term Debt $1,130,253 $145,164 $182,968 $143,622 $658,499
Operating Leases 99,835 74,918 24,917 -- --
Litigation Settlement 233,750 133,000 100,750 -- --
Employment Agreements 78,125 78,125 -- -- --
--------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------
Total Contractual Cash $1,541,963 $431,207 $308,635 $143,622 $658,499
Obligations
====================================================================================================================
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 28
Vasomedical, Inc. and Subsidiaries
ITEM 3 - QUALITATIVE AND QUANTITATIVE 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 its cash and cash equivalent balances and the line of credit
agreement. The majority of our investments are in short-term instruments and
subject to fluctuations in US interest rates. Due to the nature of our
short-term investments, we believe that there is no material risk exposure.
ITEM 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, 2005, 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, 2005 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 29
Vasomedical, Inc. and Subisidiaries
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS:
None.
ITEM 2 - UNREGISTERED SALES OF EQUITY 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 AND REPORTS ON FORM 8-K:
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.
Reports on Form 8-K
The Registrant filed a Report on Form 8-K dated January 13, 2005 to report
an event under Items 2.02 and 9.01.
The Registrant filed a Report on Form 8-K dated January 26, 2005 to report
an event under Item 8.01.
Page 30
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 14, 2005