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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 For the fiscal year ended May 31, 2006
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the transition period from _____ to _____
Commission File No. 0-18105
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VASOMEDICAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 11-2871434
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
180 Linden Avenue, Westbury, New York 11590
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (516) 997-4600
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [ X ]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [ X ]
Indicate by a check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. Large Accelerated Filer [ ]
Accelerated Filer [ ] Non-Accelerated Filer [ X ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ]
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant (based on the closing sale price of $0.42 as of
November 30, 2005, was approximately $23,831,000. Shares of common stock held by
each officer and director and by each person who owns 5% or more of the
outstanding common stock have been excluded in that such persons may be deemed
to be affiliates. The determination of affiliates status is not necessarily a
conclusive determination for other purposes.
At August 16, 2006, the number of shares outstanding of the issuer's common
stock was 65,198,592.
DOCUMENTS INCORPORATED BY REFERENCE
Part III - (Items 10, 11, 12, 13 and 14) Registrant's definitive proxy
statement to be filed pursuant to Regulation 14A of the Securities Exchange Act
of 1934.
[THIS PAGE LEFT INTENTIONALLY BLANK}
INDEX TO FORM 10-K
Page
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PART I
Item 1. Business..........................................................................................1
Item 1A. Risk Factors.....................................................................................16
Item 2. Properties.......................................................................................20
Item 3. Legal Proceedings................................................................................21
Item 4. Submission of Matters to a Vote of Security Holders..............................................21
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of
Equity Securities................................................................................22
Item 6. Selected Financial Data..........................................................................23
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............25
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.......................................37
Item 8. Financial Statements and Supplementary Data......................................................37
Item 9. Changes in and Disagreements with Accountants and Accounting and Financial Disclosure............37
Item 9A. Controls and Procedures..........................................................................38
PART III
Item 10. Directors and Executive Officers of the Registrant...............................................39
Item 11. Executive Compensation...........................................................................39
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ..39
Item 13. Certain Relationships and Related Transactions...................................................39
Item 14. Principal Accountant Fees and Services...........................................................39
PART IV
Item 15. Exhibits and Financial Statement Schedules.......................................................40
Signatures .................................................................................................42
EXHIBITS
Exhibit 23 Consents of Independent Registered Public Accounting Firms......................................E-1
Exhibit 31 Certifications Pursuant to Securities Exchange Act Rule 13A-14(A)/15D-14(A).....................E-2
Exhibit 32 Certification of Periodic Report................................................................E-4
- i -
PART I
ITEM 1 - BUSINESS
Except for historical information contained herein, the matters discussed
are forward looking statements that involve risks and uncertainties. When used
herein, words such as "anticipates", "believes", "estimates", "expects",
"feels", "plans", "projects" and "intends" and similar expressions, as they
relate to us, identify forward-looking statements In addition, any statements
that refer to our plans, expectations, strategies or other characterizations of
future events or circumstances are forward-looking statements. Such
forward-looking statements are based on our beliefs, as well as assumptions made
by and information currently available to us. Among the factors that could cause
actual results to differ materially are the following: the effect of the
dramatic changes taking place in the healthcare environment; the impact of
competitive procedures and products and their pricing; medical insurance
reimbursement policies; unexpected manufacturing problems; unforeseen
difficulties and delays in the conduct of clinical trials and other product
development programs; the actions of regulatory authorities and third-party
payers in the United States and overseas; uncertainties about the acceptance of
a novel therapeutic modality by the medical community; and the risk factors
reported from time to time in our SEC reports. We undertake no obligation to
update forward-looking statements as a result of future events or developments.
General Overview
Vasomedical, Inc. was incorporated in Delaware in July 1987. Unless the
context requires otherwise, all references to "we", "our", "us", "Company",
"registrant", "Vasomedical" or "management" refer to Vasomedical Inc. and its
subsidiaries. Since 1995, we have been primarily engaged in designing,
manufacturing, marketing and supporting EECP(R) enhanced external
counterpulsation systems based on our unique proprietary technology currently
indicated for use in cases of stable or unstable angina (i.e., chest pain),
congestive heart failure (CHF), acute myocardial infarction (i.e., heart attack,
(MI)) and cardiogenic shock. The EECP therapy system is a non-invasive,
outpatient therapy for the treatment of diseases of the cardiovascular system.
The therapy serves to increase circulation in areas of the heart with less than
adequate blood supply and helps to restore systemic vascular function. We
provide hospitals, clinics and physician private practices with EECP equipment,
treatment guidance, and a staff training and equipment maintenance program
designed to provide optimal patient outcomes. EECP is a registered trademark for
Vasomedical's enhanced external counterpulsation systems.
We have incurred declines in revenue and significant operating losses
during the last three fiscal years and our ability to continue operating as a
going concern is dependent upon achieving profitability or through additional
debt or equity financing. Achieving profitability is largely dependent on our
ability to reduce operating costs sufficiently as well as halting the current
trend of declining revenue. Our ability to maintain our current base of revenue
is largely dependent upon restructuring our sales and marketing efforts in the
angina market where reimbursement is currently available and operating in a more
efficient manner. If we are not able to reverse the trend of declining revenue
and sufficiently reduce operating costs to generate an adequate cash flow, or
raise additional capital, we will not be able to continue as a going concern.
In order to reduce the cash burn and bring our cost structure more into
alignment with current revenue, we initiated a company restructuring in January
2006, to reduce personnel and spending on marketing and development projects. We
anticipate that the restructuring will reduce manufacturing and operating cost
by approximately $3 million per year compared to prior levels. In addition, in
April 2006, the board of directors elected to defer meeting fees and certain
senior executives elected to defer approximately $0.4 million in annual salary
compensation. We believe that these steps to conserve cash will provide the
Company with the opportunity to rebuild sales to a profitable level and/or
explore strategic opportunities.
Based on the continuation of current revenue levels and the implementation
of our restructuring plan initiated in January 2006, we believe that we will be
able to fund our minimum projected capital requirements through at least the end
of the calendar year.
In the event that additional capital is required, we may seek to raise such
capital through public or private equity or debt financings or other means. We
may not be able to obtain additional financing on favorable terms or at all. If
we are unable to raise additional funds when we need them, we may be required to
further scale back our operations, research, marketing or sales efforts or
obtain funds through arrangements with collaborative partners or others that may
require us to license or relinquish rights to technologies or products. Future
capital funding, if available, may result in dilution to current shareholders,
and new investors could have rights superior to existing stockholders.
1
Market Overview
Cardiovascular disease (CVD) is the leading cause of death in the world and
is among the top three diseases in terms of healthcare spending in nearly every
country. CVD claimed approximately 2.4 million lives in the United States in
2003 and was responsible for 1 of every 2.7 deaths, according to The American
Heart Association (AHA) Heart and Stroke Statistical 2006 Update (2006 Update).
Approximately 71.3 million Americans suffer from some form of cardiovascular
disease. Among these, 12.0 million have coronary heart disease (CHD).
We have Food and Drug Administration (FDA) clearance to market our EECP
therapy for use in the treatment of stable and unstable angina, congestive heart
failure, acute myocardial infarction, and cardiogenic shock, however our current
marketing efforts are limited to the treatment of stable angina and congestive
heart failure indications. Within the stable angina and CHF indications,
Medicare and other third-party payers currently reimburse for stable angina
patients with moderate to severe symptoms who do not adequately respond or are
not amenable to medications and not candidates for invasive procedures. Ischemic
heart failure patients are also reimbursed under the same criteria provided they
have documented history of coronary artery disease (CAD) and they are being
treated for angina or angina equivalent symptoms as outlined in the American
College of Cardiology/American Heart Association 2002 Guideline Update for the
Management of Patients With Chronic Stable Angina.
We have actively engaged in research to establish the potential benefits of
EECP therapy in the management of CHF and sponsored a pivotal study to
demonstrate the efficacy of EECP therapy in the most prevalent types of heart
failure patients. This study, known as PEECH (Prospective Evaluation of EECP in
Congestive Heart Failure), provided additional clinical data in order to support
the use of EECP therapy in the treatment of CHF. The preliminary results of the
trial were presented at the American College of Cardiology scientific sessions
in March 2005, and we expect the results of the PEECH clinical trial to be
published in a peer-reviewed journal. In June 2005 we submitted an application
to the Centers for Medicare and Medicaid Services (CMS) for expanded coverage of
EECP therapy to include CHF as a primary indication, plus expanded coverage for
patients with milder angina. In March 2006, CMS issued a final decision not to
expand coverage and keep the existing coverage as stated prior to our
application. CMS has advised us that in order for them to fully consider the
results of the PEECH clinical study it must be published in a peer-reviewed
medical journal, therefore we intend to submit a revised application to CMS to
again consider expanding coverage for heart failure patients once the study is
published.
However, there can be no assurance that our revised application will be
accepted by CMS for review or that reimbursement coverage will be expanded even
if the application is accepted for review. If we are unable to obtain an
adequate national Medicare coverage policy for treatment procedures using EECP
therapy on patients with CHF, it would adversely affect our future business
prospects.
Angina
Angina pectoris is the medical term for a recurring pain or discomfort
in the chest due to coronary heart disease. Angina is a symptom of a condition
called myocardial ischemia, which occurs when the heart muscle or myocardium
doesn't receive as much blood, hence as much oxygen, as it needs. This usually
happens because one or more of the heart's arteries, the blood vessels that
supply blood to the heart muscle, is narrow or blocked. Insufficient blood
supply to meet the need of the organ to function is called ischemia.
The cardinal symptom of stable CAD is anginal chest pain or equivalent
symptoms, such as exertional dyspnea. Angina is uncomfortable pressure,
fullness, squeezing or pain usually occurring in the center of the chest under
the breastbone. The discomfort also may be felt in the neck, jaw, shoulder, back
or arm. Often the patient suffers not only from the discomfort of the symptom
itself but also from the accompanying limitations on activities and the
associated anxiety that the symptoms may produce. Uncertainty about prognosis
may be an additional source of anxiety. For some patients, the predominant
symptoms may be palpitations or syncope that is caused by arrhythmias or
fatigue, edema, or orthopnea caused by heart failure. Episodes of angina occur
when the heart's need for oxygen increases beyond the oxygen available from the
blood nourishing the heart. Physical exertion is the most common though not only
trigger for angina. For example, running to catch a bus could trigger an attack
of angina while walking might not. Angina may happen during exercise, periods of
emotional stress, exposure to extreme cold or heat, heavy meals, alcohol
consumption or cigarette smoking. Some people, such as those with a coronary
artery spasm, may have angina when they are resting.
There are approximately 6.4 million angina patients in the United States
and our EECP therapy currently competes with other technologies in the market
for approximately 130,000 new angina patients annually who do not adequately
respond to or are not amenable to medical and surgical therapy and have the
potential to meet the guidelines for reimbursement of EECP therapy. Most angina
patients are treated with medications, including beta blockers to slow and
2
protect the heart and vasodilators, which are often prescribed to increase blood
flow to the coronary arteries. When drugs fail or inadequately correct the
problem the patients are considered unresponsive to medical therapy. If the
patient is readily amenable, invasive revascularization procedures such as
angioplasty and coronary stent placement, as well as coronary artery bypass
grafting (CABG) are often employed.
In February 1999, the Centers for Medicare and Medicaid Services (CMS), the
federal agency that administers the Medicare program for more than 39 million
beneficiaries, issued a national coverage policy for the use of external
counterpulsation therapy in the treatment of angina. Medicare reimbursement
guidelines have a significant impact in determining the available market for
EECP therapy. We believe that over 65% of the patients that receive EECP therapy
are Medicare patients and many of the third-party payers follow Medicare
guidelines, which limits reimbursement for EECP therapy to patients who do not
adequately respond to or are not amenable to medical therapy and are not readily
amenable to surgical therapy. As a result, an important element of our strategy
is to grow the market for EECP therapy by expanding reimbursement coverage to
include a broader range of angina patients than the current coverage policy
provides and enabling EECP therapy to compete more with other therapies for
ischemic heart disease. Please see the heading "Reimbursement" in the "Item-1
Business" section of this Form 10-K for a more detailed discussion of
reimbursement issues.
Congestive Heart Failure
CHF is a condition in which the heart loses its full pumping capacity to
supply the metabolic needs of all other organs. The condition affects both sexes
and is most common in people over age 50. Symptoms include angina, shortness of
breath, weakness, fatigue, swelling of the abdomen, legs and ankles, rapid or
irregular heartbeat and low blood pressure. Causes range from chronic high blood
pressure, heart-valve disease, heart attack, coronary artery disease, heartbeat
irregularities, severe lung disease such as emphysema, congenital disease,
cardiomyopathy, hyperthyroidism, severe anemia and others.
CHF is treated with medication and, sometimes, surgery on heart valves or
the coronary arteries and, in certain severe cases, heart transplants. Left
ventricular assist devices (LVADs) and the use of cardiac resynchronization and
implantable defibrillators are useful in selected patients with heart failure.
Still, no consensus therapy currently exists for CHF and patients must currently
suffer their symptoms chronically and have a reduced life expectancy.
According to the 2006 Update, in 2003 approximately 2.4 million men and 2.6
million women in the US had CHF and about 550,000 new cases of the disease occur
each year. Deaths caused by the disease increased 20.5% from 1993 to 2003. The
prevalence of the disease is growing as a result of the aging of the population
and the improved survival rate of people after heart attacks. Because the
condition frequently entails visits to the emergency room and in-patient
treatment centers, two-thirds of all hospitalizations for people over age 65 are
due to CHF. The economic burden of congestive heart failure is enormous with an
estimated 2005 cost to the health care system in the United States of $29.6
billion. Congestive heart failure offers a good strategic fit with our current
angina business and offers an expanded market opportunity for EECP therapy.
Unmet clinical needs in CHF are greater than those for angina, as there are few
consensus therapies, invasive or otherwise, beyond medical management for the
condition. It is noteworthy that data collected from the International EECP
Patient Registry(TM) (IEPR) at the University of Pittsburgh Graduate School of
Public Health shows that approximately one-third of angina patients treated also
have a history of CHF and have demonstrated positive outcomes from EECP therapy.
The PEECH clinical trial provided additional clinical evidence to
demonstrate the potential benefits of EECP therapy in the management of CHF, and
we included a summary of the results of the PEECH trial in our application to
CMS to expand reimbursement coverage to include CHF. The application was
accepted by CMS on June 20, 2005, and CMS announced their final decision not to
expand coverage on March 20, 2006. Since the PEECH trial had not been published
in a peer-reviewed journal prior to CMS issuing a final decision, we intend to
resubmit a new application to CMS requesting additional coverage to include
heart failure patients once the PEECH manuscript is published. However, there
can be no assurance that the results of the PEECH trial or other clinical
evidence will be sufficient to support expansion of the Medicare national
coverage policy for EECP treatment.
The EECP Therapy Systems
The EECP therapy systems are advanced treatment systems utilizing
fundamental hemodynamic principles to augment coronary blood flow and at the
same time reduce the workload of the heart while improving the overall vascular
function. The treatment is completely noninvasive and is administered to
patients on an outpatient basis, usually in daily one-hour sessions, five days
per week over seven weeks for a total of 35 treatments. The procedure is well
tolerated and most patients begin to experience relief of chest pain due to
their coronary artery disease after 15 to 20 hours of therapy. As demonstrated
in our clinical studies, positive effects have been shown in most patients to
continue for years following a full course of therapy.
3
During EECP therapy, the patient lies on a contoured treatment table while
three sets of inflatable pressure cuffs, resembling oversized blood pressure
cuffs, are wrapped around the calves, and the lower and upper thighs, including
the buttocks. The system is synchronized to the individual patient's cardiac
cycle triggering the system to inflate the cuffs rapidly and sequentially -- via
computer-interpreted ECG signals -- starting from the calves and proceeding
upward to the buttocks during the relaxation phase of each heartbeat (diastole).
This has the effect of creating a strong retrograde counterpulse in the arterial
system, forcing freshly oxygenated blood towards the heart and coronary arteries
at a time when resistance to coronary blood flow is at its lowest level. The
counter pulse also simultaneously increases the volume of venous blood return to
the heart when the heart is filling up for ejection in the contracting phase.
Just prior to the next heartbeat when the heart begins to eject blood by
contracting (systole), all three cuffs simultaneously deflate, significantly
reducing the workload of the heart. This is achieved because the vascular beds
in the lower extremities are relatively empty when the cuffs are deflated,
significantly lowering the resistance, and provide vascular space to receive the
blood ejected by the heart, reducing the amount of work the heart must do to
pump oxygenated blood to the rest of the body. The inflation/deflation activity
is monitored constantly and coordinated by a computerized console that
interprets electrocardiogram signals from the patient's heart, monitors heart
rhythm and rate information, and actuates the inflation and deflation in
synchronization with the cardiac cycles. The end result of this sequential
"squeezing" of the legs is to create a pressure wave that significantly
increases peak diastolic pressure benefiting circulation to the heart muscle and
other organs, increases venous return so that the heart has more blood volume to
eject out, and increases cardiac output. The release of external pressure
produces reduction of systolic pressure, thereby reducing the workload of the
heart. This reduction of vascular resistance insures that the heart does not
have to work as hard to pump large amounts of blood through the body to help
supply its metabolic needs.
While the precise scientific means by which EECP therapy achieves its
long-term beneficial effects are only partially explained, there is evidence to
suggest that the EECP therapy triggers a neurohormonal response that induces the
production of growth and vasodilatation factors that promotes recruitment of new
arteries and dilates existing blood vessels. The recruitment of new arteries
known as "collateral blood vessels" bypass blocked or narrowed vessels and
increase blood flow to ischemic areas of the heart muscle that are receiving an
inadequate supply of blood. There is also evidence to support a mechanism
related to improved function of the endothelium (the inner lining of the blood
vessels), which regulates the luminal size of the arteries and controls the
dilation of the arteries to insure adequate blood flow to all organs, thus
reducing constriction of blood vessels that supply oxygenated blood to the
body's organs and tissues and as a result the required workload of the heart.
Clinical Studies
Early History
Early experiments with counterpulsation at Harvard in the 1950s
demonstrated that this technique markedly reduces the workload, and thus oxygen
consumption, of the left ventricle. This basic effect has been demonstrated over
the past forty years in both animal experiments and in patients. The clinical
benefits of external counterpulsation were not consistently achieved in early
studies because the equipment used then lacked some of the features found in the
current EECP systems, such as the computerized electrocardiographic signal for
triggering, and the use of pneumatic versus hydraulic actuating media that makes
sequential cuff inflation possible. As the technology improved, however, it
became apparent that both internal (i.e. intra-aortic balloon pumping) and
external forms of counterpulsation were capable of improving survival in
patients with cardiogenic shock following myocardial infarction. Later, in the
1980s, Dr. Zheng and colleagues in China reported on their extensive experience
in treating angina using the newly developed "enhanced" sequentially inflating
EECP device that incorporated three sets of cuffs including the buttocks cuff
instead of a single cuff used in the previous system. The Chinese investigators
were able to show that a 36-hour course of treatment with the EECP system
reduced the frequency and severity of anginal symptoms during normal daily
functions and also during exercise, and also that the improvements were
sustained for years after therapy.
These results prompted a group of investigators at the State University of
New York at Stony Brook (Stony Brook) to undertake a number of open label
studies with the EECP system between 1989 and 1996 to reproduce the Chinese
results, using both subjective and objective endpoints. These studies, though
open label and non-randomized, showed significant improvement in exercise
tolerance by patients as evidenced by exercise treadmill stress testing,
improvement in the perfusion of ischemic regions of the heart muscle by thallium
radionuclide imaging stress testing, and partial or complete resolution of
coronary perfusion defects. All of these results have been reported in medical
literature and support the assertion that EECP therapy is an effective and
durable treatment for patients suffering from chronic angina pectoris.
4
The MUST-EECP Study
In 1995, we began a randomized, controlled and double-blinded multicenter
clinical study (MUST-EECP) at seven leading university hospitals in the United
States to confirm the patient benefits observed in the open studies conducted at
Stony Brook and to provide definitive scientific evidence of EECP therapy's
effectiveness. MUST-EECP was completed in July 1997 and the results presented at
the annual meetings of the American Heart Association in November 1997 and the
American College of Cardiology in March 1998. The results of MUST-EECP were
published in the Journal of the American College of Cardiology (JACC), a major
peer-review medical journal, in June 1999.
This 139 patient study, which included a sham-EECP control group,
demonstrated that patients treated with EECP therapy were able to increase the
amount of time on exercise testing before they showed signs of cardiac ischemia
(i.e. ST-segment depression on their electrocardiogram) and experienced a
reduction in the frequency of their angina attacks compared to patients who did
not receive EECP therapy. In 1999, physician collaborators completed a
quality-of-life study with the EECP system in a subset of the same patients that
participated in MUST-EECP. Two highly regarded standardized means of measurement
were used to gauge changes in patients' outlook and ability to participate in
normal daily living during the treatment phase and for up to 12 months after
treatment. Results of this study, which have been presented at major scientific
meetings and published in the January 2002 Journal of Investigative Medicine,
show that after one-year of follow-up the group of patients receiving EECP
therapy enjoyed significantly improved aspects of health-related quality of life
compared to those who received a sham treatment.
The PEECH Study
As part of our program to expand the therapy's indications for use beyond
the treatment of angina, we applied for and received FDA approval in April 1998
to study, under an Investigational Device Exemption (IDE) protocol, the
application of EECP therapy in the treatment of CHF. A 32 patient feasibility
study was conducted simultaneously at the University of Pittsburgh, the
University of California San Francisco and the Grant/Riverside Methodist
Hospitals in Columbus, Ohio. The results of this study were presented at the
49th Scientific Sessions of the American College of Cardiology in March 2000 and
the Heart Failure Society of America's Annual Meeting in September 2000 and were
published in the July/August 2002 issue of Congestive Heart Failure. This study
indicated that EECP therapy could improve exercise capacity, increase functional
capacity was beneficial to left ventricular function in patients with New York
Heart Association (NYHA) Class II and III (i.e. mild to moderate) heart failure
and a reduced left ventricular ejection fraction (i.e. LVEF = 35% or less).
In summer 2000, an IDE supplement to proceed with a pivotal study to
demonstrate the efficacy of EECP therapy in the most prevalent types of heart
failure patients was approved. This study, known as PEECH (Prospective
Evaluation of EECP in Congestive Heart Failure), began patient enrollment in
March 2001. The PEECH clinical trial involved nearly thirty centers including:
the Cleveland Clinic, Mayo Clinic, Scripps Clinic, Thomas Jefferson University
Hospital, the University of North Carolina at Chapel Hill, the Minnesota Heart
Failure Consortium, Advocate Christ Hospital, Hull Infirmary (UK), the
University of California at San Diego Medical Center, the University of
Pittsburgh Medical Center, the Lindner Clinical Trial Center and the
Cardiovascular Research Institute. Vasomedical obtained 510(k) clearance for CHF
from FDA in June 2002, obviating the need to continue this trial for FDA
regulatory reasons. However, we decided to complete the clinical trial in order
to use the anticipated clinical outcomes to help establish the clinical
validation of EECP therapy as a treatment for CHF and to provide additional
scientific support for Medicare, Medicaid and other third-party payers to expand
reimbursement coverage of EECP therapy to include the CHF indication.
The protocol for the study required that patients have NYHA II or III
symptoms, have an LVEF of 35% or less, be able to undergo exercise testing and
complete patient examinations 1-week, 3-months and 6-months following treatment
that evaluated changes from baseline in exercise capacity, symptom status and
quality of life. Patients were randomized to receive either optimal (i.e.
guideline-recommended) medical therapy (OPT) or EECP therapy in addition to OPT.
Enrollment of patients into the PEECH trial was completed in February 2004, with
187 patients, and the six-month follow-up examinations were completed by the end
of December 2004.
On March 8, 2005, the preliminary PEECH clinical trial results were
presented by Arthur M. Feldman, MD, PhD, Principal Investigator, in a Late
Breaking Clinical Trials session of the American College of Cardiology ("ACC")
Annual Scientific Session. Simultaneously, the Company announced the positive
results of the trial to the public in a Press Release.
In designing the PEECH trial, success was demonstrated if the difference
between EECP therapy combined with optimal medical therapy compared to optimal
medical therapy alone achieved a p-value less than 0.025 in at least one of two
pre-defined co-primary endpoints:
5
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/kg/min increase in peak
oxygen consumption from baseline to six months.
Additional secondary endpoints were actual changes in exercise duration and
peak oxygen consumption, changes in New York Heart Association ("NYHA")
functional classification, changes in quality of life, adverse experiences and
pre-defined clinical outcomes.
The study was a positive clinical trial on the basis that a significantly
greater proportion of patients who underwent EECP therapy improved their
exercise duration by 60 seconds or more six months following completion of
therapy compared to those who received OPT alone (35.4% vs. 25.3%, p=0.016). The
proportion of patients achieving a 1.25 mL/kg/min improvement in peak oxygen
consumption was not significantly different between the two groups at six
months.
Consistent with the results on the primary endpoint of exercise duration,
statistically significant differences favoring the EECP-treated group were seen
in changes in average exercise duration, symptom status and quality of life
during follow-up. Average peak oxygen consumption showed a trend favoring the
EECP group at 1 week, but there were no differences detected at later follow-up.
Results in patients with heart failure of ischemic etiology were noted to be
clearly superior to those patients of idiopathic etiology though the benefit in
these later patients could not be ruled out statistically. Lastly, EECP therapy
was deemed safe and well tolerated in this group of patients, as patients in the
EECP-treated group did not suffer more adverse events than those in the control
group.
Moreover, results of a predefined subgroup analysis showed that patients 65
years of age or older not only had a significantly greater response rate
(co-primary endpoint) and average change in exercise duration favoring
EECP-treated patients, but the response rate (co-primary endpoint) and average
change in peak oxygen consumption were also significantly better out to
completion of the study at six months follow-up.
The results of the PEECH trial indicate that EECP therapy provides
beneficial adjunctive therapy in patients with NYHA Class II-III systolic heart
failure receiving optimal pharmacological therapy, especially in those 65 years
of age or older. There can be no assurance that the results of the PEECH
clinical trial will be sufficient to expand reimbursement coverage or the
adoption by the medical community of EECP therapy for use in the treatment of
congestive heart failure.
The International EECP Patient Registry (IEPR(TM))
The International EECP Patient Registry at the University of Pittsburgh
Graduate School of Public Health was established in January 1998 to track the
outcomes of angina patients who have undergone EECP therapy. More than one
hundred centers have participated in the registry and data from more than 5,000
patients from an initial cohort enrolled between 1998 and 2001 (IEPR-1) have
been tabulated and reported in several peer-reviewed publications.
The American Journal of Cardiology published a report in February of 2004
on the two-year outcomes after EECP therapy observed in 1,097 patients with
two-year follow-up enrolled in IEPR-1. The authors noted that 73% of patients in
this cohort had a decrease in their angina symptom status upon completion of
EECP therapy and that the average number of angina episodes for the group was
reduced from 10.6 to 2.8 per week. They characterized this improvement as a
"significant and dramatic reduction in CCSC" and stated that the adverse
clinical event rate was low. (CCSC, or Canadian Cardiovascular Society
Classification, is a rating scale used by physicians to assess the limitations
imposed on patients' lives by angina.) Patients also reported improvement in
health status, quality of life and satisfaction with life.
At two-years follow-up, 74.9% of patients reported their angina symptom
status (CCSC class) was improved compared to before EECP therapy, and the
accompanying improvements in angina frequency and quality of life measures were
largely sustained as well. Nine per cent of patients had died over the two-year
follow-up and 15% had undergone a revascularization procedure (angioplasty,
stenting or coronary bypass surgery).
The authors summarize the results by stating "Most patients experienced a
significant reduction in angina and improvement in quality of life after EECP
therapy, and this reduction was sustained in most patients at 2-year follow-up."
In a separate report that appeared in The American Journal of Cardiology in
2005, physician investigators participating in the IEPR(TM) reported on the
results of EECP therapy in patients with angina who also had severe left
ventricular dysfunction (LVD, a reduced pumping capacity of the heart).
Previously it was thought that such patients, and those with a diagnosis of
heart failure, would be put at risk if treated with EECP therapy, due to the
increase in venous return to the heart caused by compression of the leg veins by
enhanced external counterpulsation.
6
The 363 patients in this cohort had long-standing and extensive coronary
artery disease, had a high prevalence of cardiovascular disease risk factors,
were not amenable to invasive revascularization procedures, and suffered from
severe angina. Following completion of EECP treatment, 77% decreased their CCSC
angina class by at least one severity rating. The average number of angina
episodes per week was greatly reduced and many were able to discontinue the use
of nitroglycerin pills designed to relieve angina. As in the overall IEPR
population, measures of quality of life were significantly improved after
treatment.
The rate of major adverse clinical events, while somewhat more frequent in
this group of patients with significant comorbid disease, was characterized as
low over the course of EECP therapy. Exacerbation of heart failure was
significantly more frequent in patients who did not complete therapy compared to
those who did (16% vs. 0%) in patients with a previous history of heart failure.
At two-years of follow-up, 83% remained alive and 70% were free of death,
heart attack or invasive revascularization procedures (coronary artery bypass
surgery, angioplasty and/or stenting) during that period. The majority of
patients experienced sustained relief of their angina and improved quality of
life. Twenty per cent of the group underwent repeat EECP therapy during the
two-year follow-up, mostly due to failure to complete the original course of
therapy.
A second phase of enrollment into the registry (IEPR-2) enrolled
approximately 2,500 patients between 2002 and 2004 and these patients are
currently being followed to 2-year follow-up. IEPR-2 incorporates sub-studies
regarding treatment beyond 35 hours, possible predictors of response, effects on
certain aspects of peripheral vascular disease and sexual dysfunction in men.
Notably, the data set was modified in February 2003 to capture information on
changes in heart failure symptom status, occurrence of clinical events due to
heart failure and to include a heart failure-specific quality of life
questionnaire in IEPR-2 patients with concomitant heart failure.
Vasomedical considers the IEPR(TM) to be a vital source of information
about the effectiveness and safety of EECP(R) therapy in a real-world
environment for the medical community at large. To date, eighteen full-length
articles reporting data from the IEPR(TM) have been published in peer-review
medical journals and more than seventy-five abstracts have been presented at a
variety of major cardiovascular scientific conferences. For this reason, we
continue to provide an ongoing grant to fund the registry to publicize data that
assists clinicians in delivering optimal care to patients.
Registry data, while considered a valuable source of complementary clinical
data, is deemed by scientific cardiologists and others to be less convincing
than data from randomized, blinded, clinical trials and from certain other
well-controlled clinical study designs. There can be no assurance that the
Company will be able to obtain regulatory, reimbursement or other types of
approvals, or a favorable standing in medical professional practice guidelines,
based upon results observed in patients enrolled in registries.
Other studies and publications
A search on the term "external counterpulsation" of the PubMed database
available through the National Library of Medicine conducted on August 21, 2006,
identified one-hundred-ninety-eight (198) citations of articles published in the
medical scientific literature, including 28 review articles. The vast majority
of these publications have reported results in patients with chronic stable
angina and/or heart failure treated with EECP therapy, while others have
reported use of the device in other cardiovascular or non-cardiovascular
indications. The vast majority of these reports are generated using Vasomedical
EECP therapy systems and equipment. In summary, this body of literature contains
evidence from a variety of institutions and investigators demonstrating that
EECP therapy can provide benefit to appropriate patients in the following ways:
o Enhancement of coronary and peripheral circulation, myocardial
perfusion, ventricular function and hemodynamics,
o Improvement in endothelial function and vascular reactivity
o Elimination or reduction of cardiac ischemia,
o Elimination or reduction in symptoms and improved functional class in
angina and heart failure,
o Resolution of reversible ischemic defects found on quantitative
myocardial perfusion studies,
o Increased exercise duration and increased time to ischemic changes
during treadmill exercise in angina and increased exercise duration
and peak oxygen consumption in heart failure in properly selected
patients,
o Elimination or reduction in use of anti-angina medications,
o Improved quality of life in patients with angina and heart failure.
7
Strategic Initiatives
Our short- and long-term plans are to:
a) reduce the cash burn and bring our cost structure into alignment
with current revenue in the short term by:
i) reducing or eliminating spending on all but critical new
product development and clinical research projects,
ii) focusing on rebuilding our revenue base supporting our
direct sales effort and expanding our use of independent
sales representatives, and
iii) maintaining tight cost control on all areas of personnel
cost and spending.
b) pursue possible strategic investments and creative partnerships
with others who have distinctive competencies or delivery
capabilities for serving the cardiovascular and disease
management marketplace, as opportunities become available.
c) Increase market penetration in the domestic reimbursable user
base for EECP therapy by:
i) expanding reimbursement to include coverage for the
treatment of ischemic NYHA Class II and III CHF patients,
ii) marketing directly to third-party payers to increase
third-party reimbursement, and
iii) expanding reimbursement coverage in the angina market to
include patients with CCS Class II angina.
d) Increase the clinical and scientific understanding of EECP
therapy by:
i) completing the analysis of the PEECH clinical trial,
publishing the results in a major peer-reviewed medical
journal and resubmitting data to insurers, including
Medicare, for favorable coverage policies;
ii) continuing to support on a limited basis academic reference
centers in the United States and overseas in order to
accelerate the growth and prestige of EECP therapy and
e) Increase awareness of the benefits of the EECP therapy in the
medical community by:
i) developing campaigns to market the benefits of EECP therapy
directly to clinicians, third-party payers and patients;
ii) engaging in educational campaigns for providers and medical
directors of third-party insurers designed to highlight the
cost-effectiveness and quality-of-life advantages of EECP
therapy; and
iii) continuing the development of EECP therapy in certain
international markets, principally through the establishment
of a distribution network and the seeking of reimbursement
approvals.
f) Maintain development efforts to improve the EECP system and
expand its intellectual property estate by filing for additional
patents in the United States and other countries.
These listed strategic objectives are forward-looking statements. We
review, modify and change our strategic objectives from time to time based upon
changing business conditions. There can be no assurance that we will be able to
achieve our strategic objectives and even if these results are achieved risks
and uncertainties could cause actual results to differ materially from
anticipated results. To a large extent limited financial resources available
reduce our ability to achieve these strategic objectives. Please see the section
of this Form 10-K entitled "Risk Factors" for a description of certain risks
among others that may cause our actual results to vary from the forward-looking
statements.
Sales and Marketing
Domestic Operations
We sell EECP therapy systems to treatment providers such as hospitals,
clinics and physician private practices in the United States through a direct
and indirect sales force. Our sales force is a combination of employees and
independent sales representatives managed by a vice president of sales plus
in-house administrative support.
The efforts of our sales organization are further supported by a staff
of clinical educators who are responsible for the onsite training of physicians
and therapists as new centers are established. This clinical applications group
is also engaged in training and certification of new personnel at each site, as
well as for updating providers on new clinical developments relating to EECP
therapy.
Our marketing activities support physician education and physician outreach
programs, exhibition at national, international and regional medical
conferences, as well as sponsorship of seminars at professional association
meetings. These programs are designed to support our field sales organization
8
and increase awareness of EECP therapy in the medical community. Additional
marketing activities include creating awareness among third-party payers to the
benefits of EECP treatment for patients suffering from CHF as well as angina.
We employ service technicians responsible for the repair and maintenance of
EECP systems and, in some instances, on-site training of a customer's biomedical
engineering personnel. We provide a service arrangement (usually one year) that
includes: service by factory-trained service representatives, material and labor
costs, emergency and remedial visits, preventative maintenance, software
upgrades, technical phone support and preferred response times. We service our
customers after the service arrangement expires either under separately
purchased annual service contracts or on a fee-for-service basis.
International Operations
We distribute our product internationally through a network of independent
distributors. It has generally been our policy to appoint distributors exclusive
marketing rights to EECP therapy systems in their respective countries, in
exchange for their commitment to meet the duties and responsibilities required
of a distributor. Each distribution agreement contains a number of requirements
that must be met for the distributor to retain exclusivity, including minimum
performance standards. In most cases, distributors must assist us either to
obtain an FDA-equivalent marketing clearance, country registration or to
establish confirmatory clinical trials, conducted by local key opinion leaders
in cardiology, required to obtain Ministry of Health approval, certification or
reimbursement. Each distributor is responsible for registering the product and
obtaining any required regulatory or clinical approvals, supporting local
reimbursement efforts for EECP therapy and maintaining an infrastructure to
provide post-sales support.
To date, revenues from international operations have not been significant.
Revenues from non-domestic markets were 8%, 9% and 4% for the fiscal years ended
May 21, 2006, 2005, and 2004, respectively. Our international marketing
activities include, among other things, assisting in obtaining national or
third-party healthcare insurance reimbursement approval and participating in
medical conferences to create greater awareness and acceptance of EECP therapy
by clinicians.
International sales may be subject to certain risks, including
export/import licenses, tariffs, other trade regulations and local medical
regulations. Tariff and trade policies, domestic and foreign tax and economic
policies, exchange rate fluctuations and international monetary conditions have
not significantly affected our business to date. In addition, there can be no
assurance that we will be successful in maintaining our existing distribution
agreements or entering into any additional distribution agreements, or that our
international distributors will be successful in marketing EECP therapy.
Competition
Presently, we are aware of at least four direct competitors with an
external counterpulsation device on the market, namely Cardiomedics, Inc., ACS,
Scottcare and Living Data Technologies Corporation. In addition, other companies
have received FDA 510(k) clearance for external counterpulsation systems since
1998, although we have not seen these systems commercially in the marketplace.
While we believe that these competitors' involvement in the market is limited,
there can be no assurance that these companies will not become a significant
competitive factor or that other companies will not enter the external
counterpulsation market.
We view other companies engaged in the development of device-related,
biotechnology and pharmacological approaches to the management of cardiovascular
disease as potential competitors in the marketplace as well. These include such
common and well established medical devices and treatments as the intra-aortic
balloon pump (IABP), ventricular assist devices (VAD), coronary artery bypass
graft surgery (CABG), coronary angioplasty, mechanical circulatory support
(MCS), transmyocardial laser revascularization (TMR), cardiac recovery systems,
total artificial hearts, cardiac resynchronization devices, ranolazine and
nesiritide (Natrecor(R)); as well as newer technologies currently in
FDA-approved clinical trials such as spinal cord stimulation (SCS). There can be
no assurance that other companies will not develop new technologies or enter the
market intended for EECP therapy systems. Such other companies may have
substantially greater financial, manufacturing and marketing resources and
technological expertise than those possessed by us and may, therefore, succeed
in developing technologies or products that are more efficient than those
offered by Vasomedical and that would render our technology and existing
products obsolete or noncompetitive.
Government Regulations
We are subject to extensive regulation by numerous government regulatory
agencies, including the FDA and similar foreign agencies. Where applicable, we
are required to comply with laws, regulations and standards governing the
development, preclinical and clinical testing, manufacturing, quality testing,
labeling, promotion, import, export, and distribution of our medical devices.
9
Device Classification
FDA regulates medical devices, including the requirements for premarket
review, according to their classification. Class I devices are generally lower
risk products for which general regulatory controls are sufficient to provide
reasonable assurance of safety and effectiveness. Most Class I devices are
exempt from the requirement of 510(k) premarket notification clearance; however,
510(k) clearance is necessary prior to marketing a non-510(k) exempt Class I
device in the United States. Class II devices are devices for which general
regulatory controls are insufficient, but for which there is sufficient
information to establish special controls, such as guidance documents or
standards, to provide reasonable assurance of safety and effectiveness. A
premarket notification clearance is necessary prior to marketing a non-510(k)
exempt Class II device in the United States. Class III devices are devices for
which there is insufficient information demonstrating that general and special
controls will provide reasonable assurance of safety and effectiveness and which
are life-sustaining, life-supporting or implantable devices, are of substantial
importance in preventing impairment of human health, or pose a potential
unreasonable risk of illness or injury. The FDA generally must approve a
premarket approval or PMA application prior to marketing a Class III device in
the United States.
A medical device is considered by FDA to be a preamendments device, and
generally not subject to premarket review, if it was commercially distributed
before May 28, 1976, the date the Medical Device Amendments of 1976 became law.
A postamendments device is one that was first distributed commercially on or
after May 28, 1976. Postamendments device versions of preamendments Class III
devices are subject to the same requirements as those preamendments devices. FDA
may require a PMA for a preamendments Class III device only after it publishes a
regulation calling for such PMA submissions. Persons who market preamendments
devices must submit a PMA, and have it filed by FDA, by a date specified by FDA
in order to continue marketing the device. Prior to the effective date of a
regulation requiring a PMA, devices must have a cleared premarket notification
or 510(k) for marketing.
Certain external counterpulsation devices were commercially distributed
prior to May 28, 1976. Our external counterpulsation devices were marketed after
1976; however, they were found to be substantially equivalent to a preamendments
Class III device and therefore are subject to the same requirements as the
preamendments external counterpulsation devices.
Premarket Review
The 510(k) premarket notification process requires an applicant to give
notice to FDA of its intent to introduce its device into commerce. In its
premarket notification, the applicant must demonstrate that its new or modified
medical device is substantially equivalent to a legally marketed or predicate
device. Prior to beginning commercialization of the new or modified product it
must receive an order from the FDA classifying the device under section 510(k)
in the same classification as the predicate device, and as a result, the new
device will be cleared for marketing. Modifications to a previously cleared
medical device that do not significantly affect its safety and effectiveness or
constitute a major change in the intended use can be made without having to
submit a new 510(k). In February 1995, the Company received 510(k) clearance to
market the second-generation version of its EECP therapy system, the MC2, which
incorporated a number of technological improvements over the original system. In
addition, in December 2000, the Company received 510(k) clearance to market its
third generation system, the TS3. The FDA's clearance in these cases was for the
use of EECP therapy in the treatment of patients suffering from stable or
unstable angina pectoris, acute myocardial infarction and cardiogenic shock. In
June 2002, the FDA granted 510(k) market clearance for an upgraded TS3, which
incorporated the Company's patented CHF treatment and oxygen saturation
monitoring technologies, and provided for a new indication for the use of EECP
in CHF, which applied to all then-current models of the Company's EECP therapy
systems.
Modifications to a previously cleared medical device that do not
significantly affect its safety and effectiveness or constitute a major change
in the intended use can be made without having to submit a new 510(k). FDA
publishes guidance for medical device manufacturers on the types of changes that
meet the requirements for a new 510(k) prior to introduction of a device for
marketing distribution. Vasomedical followed FDA's guidance on when to submit a
new 510(k) for changes to a device and concluded that the changes incorporated
into its Model TS4 did not require a new 510(k) prior to its introduction to
market. Vasomedical subsequently obtained a 510(k) that applied to the Model TS4
and all of its models in March 2004, when it made changes to the labeling of all
of its EECP therapy systems. In November 2004, the Company introduced its Model
Lumenair, and again concluded that the changes did not require a new 510(k) at
that time. There can be no assurance that the FDA will agree with Vasomedical's
conclusions that a new 510(k) was unnecessary on these occasions or in other
similar instances, or that our products will not be subject to a regulation
requiring a PMA for preamendments Class III external counterpulsation devices.
10
If a device does not receive a clearance order because the FDA determines
that the device is not substantially equivalent to a predicate device and thus
the device automatically is considered a Class III device, the applicant may ask
the FDA to make a risk-based classification to place the device in Class I or
II. However, if a timely request for risk-based classification is not made, or
if the FDA determines that a Class III designation is appropriate, an approved
PMA will be required before the device may be marketed.
The more rigorous premarket review process is the PMA process. The FDA
approves a PMA if the applicant has provided sufficient valid scientific
evidence to prove that the device is safe and effective for its intended use(s).
Applications for premarket approval generally contain human clinical data. This
process is usually much more complex, time-consuming and expensive than the
510(k) process, and is uncertain. Both 510(k)s and PMAs now require the
submission of user fees in most circumstances.
There can be no assurance that all the necessary FDA clearances or
approvals, including approval of any PMA required by the promulgation of a
regulation, will be granted for our products, future-generation upgrades or
newly developed products, on a timely basis or at all. Failure to receive, or
delays in receipt of such clearances, could have a material adverse effect on
our financial condition and results of operations.
Clinical Trials
If human clinical trials of a device are required, whether to support a
510(k) or PMA application, the trials' sponsor, which is usually the
manufacturer of the device, first must obtain the approval of the appropriate
institutional review boards. If a trial is of a significant risk device, the
sponsor also must obtain an investigational device exemption or IDE from FDA
before the trial may begin. A significant risk device is a device that presents
a potential for serious risk to the subject and is an implant; is
life-sustaining or life-supporting; or is for a use of substantial importance in
diagnosing, curing, mitigating, or treating disease, or otherwise preventing
impairment of human health. For all clinical testing, the sponsor must obtain
informed consent from the patients participating in each trial. The results of
clinical testing that a sponsor undertakes may be insufficient to obtain
clearance or approval of the tested product.
Pervasive and Continuing FDA Regulation
We are also subject to other FDA regulations that apply prior to and after
a product is commercially released. These include Current Good Manufacturing
Practice (CGMP) requirements set forth in FDA's Quality System Regulation (QSR),
that require manufacturers to have a quality system for the design, manufacture,
packaging, labeling, storage, installation and servicing of medical devices
intended for commercial distribution in the United States. This regulation
covers various areas including management and organization, device design,
purchase and handling of components, production and process controls such as
those related to buildings and equipment, packaging and labeling control,
distribution, installation, complaint handling, corrective and preventive
action, servicing, and records. We are subject to periodic inspection by the FDA
for compliance with the CGMP requirements and Quality System Regulation.
The FDA also enforces post-marketing controls that include the requirement
to submit medical device reports to the agency when a manufacturer becomes aware
of information suggesting that any of its marketed products may have caused or
contributed to a death or serious injury, or any of its products has
malfunctioned and that a recurrence of the malfunction would likely cause or
contribute to a death or serious injury. The FDA relies on medical device
reports to identify product problems and utilizes these reports to determine,
among other things, whether it should exercise its enforcement powers. The FDA
also may require postmarket surveillance studies for specified devices.
We are subject to the Federal Food, Drug, and Cosmetic Act's, or FDCA's,
general controls, including establishment registration, device listing, and
labeling requirements. If we fail to comply with any requirements under the
FDCA, we, including our officers and employees, could be subject to, among other
things, fines, injunctions, civil penalties, and criminal prosecution. We also
could be subject to recalls or product corrections, total or partial suspension
of production, denial of premarket notification clearance or PMA approval, and
rescission or withdrawal of clearances and approvals. Our products could be
detained or seized, the FDA could order a recall, repair, replacement, or refund
of our devices, and the agency could require us to notify health professionals
and others that the devices present unreasonable risks of substantial harm to
the public health.
The advertising of our products is subject to regulation by the Federal
Trade Commission, or FTC. The FTC Act prohibits unfair or deceptive acts or
practices in or affecting commerce. Violations of the FTC Act, such as failure
to have substantiation for product claims, would subject us to a variety of
enforcement actions, including compulsory process, cease and desist orders and
injunctions, which can require, among other things, limits on advertising,
corrective advertising, consumer redress and restitution, as well as substantial
fines or other penalties.
11
Foreign Regulation
In most countries to which we seek to export the EECP system, we must first
obtain approval from the local medical device regulatory authority. The
regulatory review process varies from country to country and can be complex,
costly, uncertain, and time-consuming.
We are also subject to periodic audits by organizations authorized by
foreign countries to determine compliance with laws, regulations and standards
that apply to the commercialization of our products in those markets. Examples
include auditing by a European Union Notified Body organization (authorized by a
member state's Competent Authority) to determine conformity with the Medical
Device Directives (MDD) and by an organization authorized by the Canadian
government to determine conformity with the Canadian Medical Devices Regulations
(CMDR).
There can be no assurance that we will obtain desired foreign
authorizations to commercially distribute our products in those markets or that
we will comply with all laws, regulations and standards that pertain to our
products in those markets. Failure to receive or delays in receipt of such
authorizations or determinations of conformity could have a material adverse
effect on our financial condition and results of operations.
Patient Privacy
Federal and state laws protect the confidentiality of certain patient
health information, including patient records, and restrict the use and
disclosure of that protected information. The U.S. Department of Health and
Human Services (HHS) published patient privacy rules under the Health Insurance
Portability and Accountability Act of 1996 (HIPAA privacy rule) and the
regulation was finalized in October 2002. The HIPAA privacy rule governs the use
and disclosure of protected health information by "Covered Entities," which are
(1) health plans, (2) health care clearinghouses, and (3) health care providers
that transmit health information in electronic form in connection with certain
health care transactions such as benefit claims. Currently, the HIPAA privacy
rule affects us only indirectly in that patient data that we access, collect and
analyze may include protected health information. Additionally, we have signed
some Business Associate agreements with Covered Entities that contractually bind
us to protect protected health information, consistent with the HIPAA privacy
rule's requirements. We do not expect the costs and impact of the HIPAA privacy
rule to be material to our business.
Practice Guidelines
Medical professional societies periodically issue Practice Guidelines to
their members and make them available publicly. The American College of
Cardiology (ACC) and the American Heart Association (AHA) have jointly engaged
in developing practice guidelines since 1980 to critically evaluate the use of
diagnostic procedures and therapies in the management or prevention of
cardiovascular diseases. These guidelines are meant to "improve the
effectiveness of care, optimize patient outcomes and affect the overall cost of
care favorably by focusing resources on the most effective strategies".
Recommendations incorporated into the guidelines are based upon an assessment of
the strength of evidence for or against a treatment or procedure and estimates
of expected health outcomes stemming from a formal review of peer-reviewed
published literature. These guidelines may not be updated for some time.
The "ACC/AHA 2002 Guideline Update for the Management of Patients with
Chronic Stable Angina" was last issued in 2003. Comments on external
counterpulsation appear in a section entitled " Recommendations for Alternative
Therapies for Chronic Stable Angina in Patients Refractory to Medical Therapy
Who Are Not Candidates for Percutaneous Intervention or Surgical
Revascularization" and include a so-called Class IIb recommendation. ACC/AHA
guideline classifications I, II and III are used to "provide final
recommendations for both patient evaluation and therapy" and a Class IIb rating
is defined as "Usefulness/efficacy is less well established by
evidence/opinion".
The ACC/AHA 2005 Guidelines for the Diagnosis and Management of Chronic
Heart Failure in the Adult were issued in 2005. External counterpulsation is
listed as one of the devices under investigation in a section entitled "Drugs
and Interventions Under Active Investigation".
The 2006 Comprehensive Heart Failure Practice Guideline issued in February
2006 by the Heart Failure Society of America does not include any comments on
the use of external counterpulsation therapy for treating heart failure
patients.
In summary, while evaluations of the use of EECP therapy in patients with
chronic angina and heart failure continue to appear in several oral or poster
presentations at major scientific meetings and in peer-reviewed publications
each year, there continues to be skepticism in the cardiology community about
its broader use. Additional evidence regarding the efficacy of EECP therapy
continues to appear, however the evidence may not be sufficient to warrant a
modification of practice guidelines to a more favorable recommendation and
increased acceptance by the medical community.
12
Reimbursement
In addition to regulatory approvals for commercialization by government
agencies, reimbursement coverage and payment rates are factors in the sales of
our products and we depend in large part on the availability of reimbursement
programs. Medicare, Medicaid, as well as private health care insurance and
managed-care plans determine eligibility for coverage of a product or therapy
based on a number of factors, including the payer's determination that the
product is reasonable and necessary for the diagnosis or treatment of the
illness or injury for which it is administered according to the scope of
clinical evidence available, accepted standards of medical care in practice, the
product's cost effectiveness, whether the product is experimental or
investigational, impact on health outcomes and whether the product is not
otherwise excluded from coverage by law or regulation. The coverage process for
Medicare reimbursement is legislated by Congress and administered by the Centers
for Medicare and Medicaid Services (CMS), and is highly variable in the
commercial market. There may be significant delays in obtaining coverage for
newly-approved products, and coverage may be more limited than the purposes for
which the product is approved or cleared by FDA. Even when we obtain
authorization from the FDA or a foreign authority to begin commercial
distribution, there may be limited demand for the device until reimbursement
approval has been obtained from governmental and private third-party payers.
Moreover, eligibility for coverage does not imply that a product will be
reimbursed in all cases or at a rate that allows us to market our EECP systems
at a price that will enable us to make a profit or even cover our costs.
Reimbursement rates may vary according to the use of the product and the
clinical setting in which it is used, may be based on payments allowed for
lower-cost products that are already reimbursed, may be incorporated into
existing payments for other products or services, and may reflect budgetary
constraints and/or imperfections in Medicare or Medicaid data. Even if
successful, demand for products may be driven more by the scope of peer-reviewed
evidence and acceptance, endorsement by regulatory and clinical bodies, or
foreign country authorities than by the reimbursement rates available. Securing
coverage at adequate reimbursement rates from government and third party payers
can be a time consuming and costly process that could require us to provide
supporting scientific, clinical, and cost-effectiveness data for the use of our
products to each payer. Our inability to promptly obtain coverage and profitable
reimbursement rates from government-funded and private payers for our products
could have a material adverse effect on our financial condition and operating
results.
Our reimbursement strategies are currently focused in the following primary
areas: expanding Medicare coverage to include congestive heart failure and mild
angina, expanding coverage with other third-party payers, expanding Medicare
coverage for angina and obtaining coverage in selected international markets.
Current Medicare Coverage in Angina
In February 1999, the Centers for Medicare and Medicaid Services (CMS), the
federal agency that administers the Medicare program for more than 39 million
beneficiaries, issued a national coverage policy under HCPCS code G0166 for the
use of the EECP therapy system. Key excerpts from the coverage read as follows:
"Although ECP devices are cleared by the Food and Drug Administration (FDA)
for use in treating a variety of cardiac conditions, including stable or
unstable angina pectoris, acute myocardial infarction and cardiogenic
shock, the use of this device to treat cardiac conditions other than stable
angina pectoris is not covered, since only that use has developed
sufficient evidence to demonstrate its medical effectiveness."
"for patients who have been diagnosed with disabling angina (class III or
class IV, Canadian Cardiovascular Society Classification or equivalent
classification) who, in the opinion of a cardiologist or cardiothoracic
surgeon, are not readily amenable to surgical interventions such as balloon
angioplasty and cardiac bypass because:
1. their condition is inoperable, or at high risk of operative
complications or post-operative failure;
2. their coronary anatomy is not readily amenable to such
procedures; or
3. they have co-morbid states, which create excessive risk."
The 2006 national average payment rate per hourly session in the physician
office setting and the hospital outpatient facility is approximately $138 and
$104, respectively. Reimbursement rates vary throughout the country and range
from $113 to $231 per hourly session. Under the Medicare program, physician
reimbursement of the provision of EECP therapy is higher if the therapy is
performed in a physician office setting as compared to a hospital outpatient
facility in order to reflect higher costs associated with the physician office.
Since January 2000, the national average payment rate has varied considerably.
13
The initial national average payment rate for the physician office setting and
the hospital outpatient facility in 2000 was approximately $130 and $112,
respectively per hourly session. The average payment rate for the physician
office setting climbed to $208 per treatment session in 2003 before being
reduced approximately 37% in 2004 to $132 per treatment session. In 2005 the
physician rate increased approximately 5% and remained unchanged in 2006. The
average payment rate for the hospital outpatient facility declined steadily to
2005 before increasing approximately 2% in 2006.
In order to bill and receive payment from Medicare, an individual or entity
must be enrolled in the Medicare program for EECP therapy. The physician office
setting and the hospital outpatient facility are the only entities currently
authorized to receive reimbursement for the EECP therapy under the Medicare
program and reimbursement is not permitted to other individuals or entity types,
which include, but are not limited to, nurse practitioners, physical therapists,
ambulatory surgery centers, nursing homes, comprehensive outpatient
rehabilitation facilities, outpatient dialysis facilities, and independent
diagnostic testing facilities. For each of these provider types there is
statutory authorization and accompanying regulations that govern the terms and
conditions of Medicare program participation.
If there were any material change in the availability of Medicare coverage,
or if the reimbursement level for treatment procedures using the EECP therapy
system is determined to be inadequate, it would adversely affect our business,
financial condition and results of operations. Moreover, we are unable to
forecast what additional legislation or regulation, if any, relating to the
health care industry or Medicare coverage and payment level may be enacted in
the future, or what effect such legislation or regulation would have on us.
Application to Expand Medicare Coverage to include Class II Angina and Class
II/III CHF
On May 31, 2005, we submitted an application to CMS to expand the national
coverage policy for external counterpulsation treatment to patients with
Canadian Cardiovascular Class II stable angina and to patients with New York
Heart Association (NYHA) Class II and III stable heart failure symptoms with an
ejection fraction less than 35%. The application was accepted by CMS effective
June 20, 2005, and CMS announced their decision to maintain the existing
coverage as stated prior to the application and not to expand it to include
Class II Angina and Class II/III CHF on March 20, 2006.
The application was supported by clinical evidence from several of the more
than 50 peer-reviewed journal articles, as well as the results from the recently
concluded PEECH clinical trial in order to demonstrate that EECP therapy
provides relief of stable angina and congestive heart failure in selected
patients in the form of:
o improvement in symptoms
o improvement in functional capacity, i.e. ability to perform exertional
tasks
o improvement in quality of life and health status
One of the criteria established by CMS to provide coverage, is to assess
the effectiveness of the therapy by reviewing the scientific evidence published
in peer-review scientific journals. Since the PEECH trial has yet to be
published, CMS indicated it had to limit the weight of evidence provided from
the PEECH trial for congestive heart failure in making its final decision on
March 20, 2006. We intend to resubmit our application once the PEECH trial
manuscript does get published so that CMS can provide sufficient weight on the
evidence provided in the study.
Although the scientific evidence proving the safety, efficacy and cost
effectiveness of EECP treatment has continued to accumulate since the original
coverage policy was implemented, there can be no assurance that the existing
evidence is sufficient to support an expansion of EECP therapy and CMS may
require additional clinical and scientific evidence to support expanded
reimbursement coverage. We are unable to predict when or if CMS will approve an
expansion of reimbursement coverage for EECP therapy.
If we are unable to obtain an adequate national Medicare coverage policy
for treatment procedures using EECP therapy on patients with CHF, it will
adversely affect our future business prospects. Moreover, we are unable to
forecast what additional legislation or regulation, if any, relating to the
health care industry or Medicare coverage and payment level may be enacted in
the future, or what effect such legislation or regulation would have on us.
Expanding Coverage with Other Third-Party Payers
Some private insurance carriers continue to adjudicate EECP treatment
claims on a case-by-case basis. Since the establishment of reimbursement by the
federal government, however, an increasing number of these private carriers now
routinely pay for use of EECP therapy for the treatment of angina and have
issued positive coverage policies, which are generally similar to Medicare's
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coverage policy in scope. We estimate that over 300 private insurers are
reimbursing for EECP therapy for the treatment of angina today at favorable
payment levels and we expect that the number of private insurers and their
related health plans that provide for EECP therapy as a covered benefit will
continue to increase. In addition, we are aware of two third-party payers that
have begun limited coverage of EECP therapy for the treatment of CHF.
We intend to pursue a constructive dialogue with many private insurers for
the establishment of positive and expanded coverage policies for EECP treatment
that include CHF patients. If there were any material change in the availability
of third-party private insurers or the adequacy of the reimbursement level for
treatment procedures using the EECP therapy system it would adversely affect our
business, financial condition and results of operations. Moreover, we are unable
to forecast what additional legislation or regulation, if any, relating to the
health care industry or third-party private insurers coverage and payment levels
may be enacted in the future or what effect such legislation or regulation would
have on us.
Reimbursement in International Markets
The reimbursement environment for EECP therapy in international markets is
fragmented and coverage varies as a mix of available private and public
healthcare providers may not yet be aware of nor cover this therapy. Our
reimbursement strategy has been opportunistic and responsive to the selling
opportunities presented through our distribution partners. During this fiscal
year our efforts on behalf of EECP therapy in both the private and public
healthcare sectors of selected international markets have been initiated by our
distributors, in support of the therapy, in their designated territory.
Additionally, efforts have been initiated to obtain coverage in the public
sector in certain overseas markets; however, we do not anticipate an impact on
financial performance in the next fiscal year, given the long lead times from
submission to approval of international dossiers for each reimbursement
authority.
Patents and Trademarks
We own eleven US patents including eight utility and three design patents
that expire at various times between 2006 and 2021. In addition, more than 20
foreign patents have been issued that expire at various times from 2007 to 2022.
There are six major U.S. applications pending for approval, relating to aspects
of the Lumenair system, potential improvements, and new methods of treatment and
a notice of allowance in one of the applications has recently been granted. We
are pursuing these applications in other countries, including members of the
European Union. We are also planning to file other patent applications regarding
specific enhancements to the current EECP models, future generation products,
and methods of treatment. Moreover, trademarks have been registered for the
names "EECP" and "Natural Bypass".
We pursue a policy of seeking patent protection, both in the US and abroad,
for our proprietary technology. We believe that we have a solid patent
foundation in the field of external counterpulsation devices and that the number
of patents and applications demonstrates our technical leadership, dating back
to the mid-1980s. Our patent portfolio focuses on the areas of external
counterpulsation control and the overall design and arrangement of the external
counterpulsation apparatus, including the console, treatment bed, fluid
distribution, and inflatable cuffs. None of our current competitors have a
significant patent portfolio in the area of external counterpulsation devices.
There can be no assurance that our patents will not be violated or that any
issued patents will provide protection that has commercial significance. As with
any patented technology, litigation could be necessary to protect our patent
position. Such litigation can be costly and time-consuming, and there can be no
assurance that we will be successful. The loss or violation of our EECP patents
and trademarks could have a material adverse effect upon our business.
Employees
As of May 31, 2006, we employed 46 full-time and 2 part-time persons with
12 in direct sales, sales and clinical applications support, 18 in
manufacturing, quality control and technical service, 4 in marketing and
customer support, 5 in engineering, regulatory and clinical research and 9 in
administration. None of our employees are represented by a labor union. We
believe that our employee relations are good.
Manufacturing
We manufacture our EECP therapy systems in a single facility located in
Westbury, New York. Manufacturing operations are conducted under the Current
Good Manufacturing Practice (CGMP) requirements as set forth in the FDA Quality
System Regulation. These regulations subject us to inspections to verify
compliance and require us to maintain documentation and controls for the
manufacturing and quality activities. ISO 13485 is the international quality
standard for medical device manufacturers, based upon the ISO 9001 quality
15
standard with specific requirements consistent with the FDA Quality System
Regulation. While previously we were certified to comply with ISO 9001
requirements, we have applied and received ISO 13485 certification in February
2003. We are also certified to conform with the full quality assurance system
requirements of the EU Medical Device Directive and can apply the CE mark to
certain of our products. Lastly, we are certified to comply with the
requirements of the Canadian Medical Device Regulations (CMDR).
We believe our manufacturing facility, in addition to the other warehouse
facilities presently under lease, are adequate to meet the current and
immediately foreseeable future demand for the production of these systems.
ITEM 1A - RISK FACTORS
Investing in our common stock involves risk. You should carefully consider
the following information about these risks together with the other information
contained in this Report. If any of the following risks actually occur, our
business could be harmed. This could cause the price of our stock to decline,
and you may lose part or all of your investment.
Risks Related to Our Business
We may not be able to continue as a going concern.
As set forth in our independent auditors report for the fiscal year ended
May 31, 2006, we have suffered recurring losses from operations and have a net
capital deficiency that raises substantial doubt about our ability to continue
as a going concern. We currently anticipate that we will continue to sustain
operating losses. Our ability to continue operating, as a going concern is
dependent upon achieving profitability or through additional debt or equity
financing. Achieving profitability is largely dependent on our ability to reduce
operating costs sufficiently as well as halting the current trend of declining
revenue. Our ability to maintain our current base of revenue is largely
dependent upon restructuring our sales and marketing efforts in the angina
market where reimbursement is currently available and operating in a more
efficient manner. If we are not able to reverse the trend of declining revenue
and sufficiently reduce operating costs to generate an adequate cash flow, or
raise additional capital, we will not be able to continue as a going concern.
We are materially dependent on medical reimbursement for treatment
procedures using EECP therapy on patients with congestive heart failure in
order to achieve continued growth.
We are currently dependent on a single product platform which, based on
current medical reimbursement policies, provides coverage for a restricted class
of heart patients. On May 31, 2005, we submitted an application to CMS to expand
the national coverage policy for external counterpulsation treatment to patients
with Canadian Cardiovascular Class II stable angina and to patients with New
York Heart Association (NYHA) Class II and III stable heart failure symptoms
with an ejection fraction less than 35%. The application was accepted by CMS
effective June 20, 2005, and CMS announced their decision to maintain the
existing coverage as stated prior to the application and not to expand it to
include Class II Angina and Class II/III CHF on March 20, 2006. Since the PEECH
trial had not been published in a peer-reviewed journal prior to CMS issuing a
final decision, we intend to resubmit a new application to CMS requesting
additional coverage to include heart failure patients once the PEECH manuscript
is published; however, there can be no assurance that the results of the PEECH
trial or other clinical evidence will be sufficient to support expansion of the
Medicare national coverage policy for EECP treatment.
If we do not receive medical coverage for treatment procedures using EECP
therapy on patients with CHF, it will adversely affect our future business
prospects.
Material changes in the availability of Medicare, Medicaid or
third-party reimbursement at adequate price levels could adversely affect
our business.
Health care providers, such as hospitals and physician private practices,
that purchase or lease medical devices such as the EECP therapy system for use
on their patients generally rely on third-party payers, principally Medicare,
Medicaid and private health insurance plans, to reimburse all or part of the
costs and fees associated with the procedures performed with these devices. If
there were any material change in the availability of Medicare, Medicaid or
other third-party coverage or the adequacy of the reimbursement level for
treatment procedures using the EECP therapy system, it would adversely affect
our business, financial condition and results of operations. Moreover, we are
unable to forecast what additional legislation or regulation, if any, relating
to the health care industry or Medicare or Medicaid coverage and payment level
may be enacted in the future or what effect such legislation or regulation would
16
have on our business. Even if a device has FDA clearance, Medicare, Medicaid and
other third-party payers may deny reimbursement if they conclude that the device
is not "reasonable and necessary" according to their criteria. In addition,
reimbursement may not be at, or remain at, price levels adequate to allow
medical professionals and hospitals to realize an appropriate return on the
purchase of our products.
Increased acceptance by the medical community is important for
continued growth.
While many abstracts and publications are presented each year at major
scientific meetings worldwide with respect to EECP treatment efficacy, there is
continued skepticism concerning EECP therapy methodology. The American Heart
Association and the American College of Cardiology Practice Guidelines currently
list EECP as a therapy currently under investigation for treatment of heart
failure and have a classification rating of IIb as a treatment for patients who
are refractory to medical therapy and are not candidates for percutaneous
intervention or revascularization. A classification rating of IIb indicates the
usefulness/efficacy of EECP therapy is less well established by
evidence/opinion. The medical community utilizes these guidelines when
considering the various treatment options for their patients. Certain
cardiologists, in cases where the EECP therapy is a viable alternative, still
appear to prefer percutaneous coronary interventions (e.g. balloon angioplasty
and stenting) and cardiac bypass surgery for their patients. Additional evidence
regarding the efficacy of EECP therapy continues to evolve, however the evidence
may not be sufficient to warrant a modification of these guidelines to a more
favorable recommendation and increased acceptance by the medical community. We
are dependent on consistency of favorable research findings about EECP therapy
and increasing acceptance of EECP therapy as a safe, effective and cost
effective alternative to other available products by the medical community for
continued growth.
We face competition from other companies and technologies.
We compete with at least four other companies that are marketing external
counterpulsation devices. We do not know whether these companies or other
potential competitors who may be developing external counterpulsation devices,
may succeed in developing technologies or products that are more efficient than
those offered by us, and that would render our technology and existing products
obsolete or non-competitive. Potential new competitors may also have
substantially greater financial, manufacturing and marketing resources than
those possessed by us. In addition, other technologies or products may be
developed that have an entirely different approach or means of accomplishing the
intended purpose of our products. Accordingly, the life cycles of our products
are difficult to estimate. To compete successfully, we must keep pace with
technological advancements, respond to evolving consumer requirements and
achieve market acceptance.
We may not continue to receive necessary FDA clearances or approvals,
which could hinder our ability to market and sell our products.
If we modify our external counterpulsation devices and the modifications
significantly affect safety or effectiveness, or if we make a change to the
intended use, we will be required to submit a new premarket notification or
510(k) to FDA. We would be unable to market the modified device until FDA issues
a clearance for the 510(k).
Additionally, if FDA publishes a regulation requiring a premarket approval
application or PMA for external counterpulsation devices, we would then need to
submit a PMA, and have it filed by the agency, by the date specified by FDA in
its regulation. A PMA requires us to prove the safety and effectiveness of a
device to the FDA. The process of obtaining PMA approval is expensive,
time-consuming, and uncertain. If FDA were to require a PMA application, we may
be required to undertake a clinical study, which likely will be expensive and
require lengthy follow-up, to demonstrate the effectiveness of the device. If we
did obtain PMA approval, any change after approval affecting the safety or
effectiveness of the device will require approval of a PMA supplement.
If we offer new products that require 510(k) clearance or PMA approval, we
will not be able to commercially distribute those products until we receive such
clearance or approval. Regulatory agency approval or clearance for a product may
not be received or may entail limitations on the device's indications for use
that could limit the potential market for any such product. Delays in receipt
of, or failure to obtain or maintain, regulatory clearances and approvals, could
delay or prevent our ability to market or distribute our products. Such delays
could have a material adverse effect on our business.
17
If we are unable to comply with applicable governmental regulation, we
may not be able to continue our operations.
We also must comply with Current Good Manufacturing Practice (CGMP)
requirements as set forth in the Quality System Regulation (QSR) to receive FDA
approval to market new products and to continue to market current products. The
QSR imposes certain procedural and documentation requirements on us with respect
to manufacturing and quality assurance activities, including packaging, storage,
and record keeping. Our products and activities are subject to extensive,
ongoing regulation, including regulation of labeling and promotion activities
and adverse event reporting. Also, our FDA registered facilities are subject to
inspection by the FDA and other governmental authorities. Any failure to comply
with regulatory requirements could delay or prevent our ability to market or
distribute our products. Violation of FDA statutory or regulatory requirements
could result in enforcement actions, such as voluntary or mandatory recalls,
suspension or withdrawal of marketing clearances or approvals, seizures,
injunctions, fines, civil penalties, and criminal prosecutions, all of which
could have a material adverse effect on our business. Most states also have
similar postmarket regulatory and enforcement authority for devices.
We cannot predict the nature of any future laws, regulations,
interpretations, or applications, nor can we predict what effect additional
governmental regulations or administrative orders, when and if promulgated,
would have on our business in the future. We may be slow to adapt, or we may
never adapt to changes in existing requirements or adoption of new requirements
or policies. We may incur significant costs to comply with laws and regulations
in the future or compliance with laws or regulations may create an unsustainable
burden on our business.
We may not receive approvals by foreign regulators that are necessary
for international sales.
Sales of medical devices outside the United States are subject to foreign
regulatory requirements that vary from country to country. Premarket approval or
clearance in the United States does not ensure regulatory approval by other
jurisdictions. If we, or any international distributor, fail to obtain or
maintain required pre-market approvals or fail to comply with foreign
regulations, foreign regulatory authorities may require us to file revised
governmental notifications, cease commercial sales of our products in the
applicable countries or otherwise cure the problem. Such enforcement action by
regulatory authorities may be costly.
In order to sell our products within the European Union, we must comply
with the European Union's Medical Device Directive. The CE marking on our
products attests to this compliance. Future regulatory changes may limit our
ability to use the CE mark, and any new products we develop may not qualify for
the CE mark. If we lose this authorization or fail to obtain authorization on
future products, we will not be able to sell our products in the European Union.
We depend on management and other key personnel.
We are dependent on a limited number of key management and technical
personnel. The loss of one or more of our key employees may hurt our business if
we are unable to identify other individuals to provide us with similar services.
We do not maintain "key person" insurance on any of our employees. In addition,
our success depends upon our ability to attract and retain additional highly
qualified sales, management, manufacturing and research and development
personnel. We face competition in our recruiting activities and may not be able
to attract or retain qualified personnel.
We may not have adequate intellectual property protection.
Our patents and proprietary technology may not be able to prevent
competition by others. The validity and breadth of claims in medical technology
patents involve complex legal and factual questions. Future patent applications
may not be issued, the scope of any patent protection may not exclude
competitors, and our patents may not provide competitive advantages to us. Our
patents may be found to be invalid and other companies may claim rights in or
ownership of the patents and other proprietary rights held or licensed by us.
Also, our existing patents may not cover products that we develop in the future.
Moreover, when our patents expire, the inventions will enter the public domain.
There can be no assurance that our patents will not be violated or that any
issued patents will provide protection that has commercial significance.
Litigation may be necessary to protect our patent position. Such litigation may
be costly and time-consuming, and there can be no assurance that we will be
successful in such litigation.
18
The loss or violation of certain of our patents and trademarks could
have a material adverse effect upon our business.
Since patent applications in the United States are maintained in secrecy
until patents are issued, our patent applications may infringe patents that may
be issued to others. If our products were found to infringe patents held by
competitors, we may have to modify our products to avoid infringement, and it is
possible that our modified products would not be commercially successful.
We do not intend to pay dividends in the foreseeable future.
We do not intend to pay any cash dividends on our common stock in the
foreseeable future.
Risks Related to Our Industry
Technological change is difficult to predict and to manage.
We face the challenges that are typically faced by companies in the medical
device field. Our product line has required, and any future products will
require, substantial development efforts and compliance with governmental
clearance or approval requirements. We may encounter unforeseen technological or
scientific problems that force abandonment or substantial change in the
development of a specific product or process.
We are subject to product liability claims and product recalls that
may not be covered by insurance.
The nature of our business exposes us to risks of product liability claims
and product recalls. Medical devices as complex as ours frequently experience
errors or failures, especially when first introduced or when new versions are
released.
We currently maintain product liability insurance at $7,000,000 per
occurrence and $7,000,000 in the aggregate. Our product liability insurance may
not be adequate. In the future, insurance coverage may not be available on
commercially reasonable terms, or at all. In addition, product liability claims
or product recalls could damage our reputation even if we have adequate
insurance coverage.
We do not know the effects of healthcare reform proposals.
The healthcare industry is undergoing fundamental changes resulting from
political, economic and regulatory influences. In the United States,
comprehensive programs have been suggested seeking to increase access to
healthcare for the uninsured, control the escalation of healthcare expenditures
within the economy and use healthcare reimbursement policies to balance the
federal budget.
We expect that the United States Congress and state legislatures will
continue to review and assess various healthcare reform proposals, and public
debate of these issues will likely continue. There have been, and we expect that
there will continue to be, a number of federal and state proposals to constrain
expenditures for medical products and services, which may affect payments for
products such as ours. We cannot predict which, if any of such reform proposals
will be adopted and when they might be effective, or the effect these proposals
may have on our business. Other countries also are considering health reform.
Significant changes in healthcare systems could have a substantial impact on the
manner in which we conduct our business and could require us to revise our
strategies.
Risks Related to Stock Exchange and SEC Regulation
We were de-listed from Nasdaq and may be subject to regulations that
could reduce our ability to raise funds.
By letter dated May 2, 2005, we received written notification from Nasdaq
that the bid price of our common stock for the last 30 consecutive business days
had closed below the minimum $1.00 per share required for continued inclusion
under Marketplace Rule 4310(c) (4) (the Rule). In accordance with Marketplace
Rule 4310 (c) (d), we were provided an initial period of 180 calendar days to
regain compliance plus an automatic extension for additional period of 180
calendar days since we met the Nasdaq Capital Markets initial listing criteria
19
except for the bid price requirement. During this period our common stock did
not rise above the $1.00 per share minimum and on May 26, 2006, our common stock
was delisted and our stock is currently traded on the Over-the-Counter Bulletin
Board.
As a result of our de-listing from the Nasdaq Capital Market due to low
stock price, we may become subject to special rules, called "penny stock" rules
that impose additional sales practice requirements on broker-dealers who sell
our common stock. Penny stocks generally are equity securities that are not
registered on certain national securities exchanges or quoted by Nasdaq and have
a price per share of less than $5.00. The rules require, among other things, the
delivery, prior to the transaction, of a disclosure schedule required by the
Securities and Exchange Commission relating to the market for penny stocks. The
broker-dealer also must disclose the commissions payable both to the
broker-dealer and the registered representative and current quotations for the
securities, and monthly statements must be sent disclosing recent price
information.
In the event that our common stock becomes characterized as a penny stock,
our market liquidity could be severely affected. The regulations relating to
penny stocks could limit the ability of broker-dealers to sell our common stock
and thus the ability of purchasers of our common stock to sell their common
stock in the secondary market.
Additionally, Nasdaq's delisting of our common stock could have an adverse
effect on our ability to raise additional equity capital.
We are subject to stock exchange and SEC regulation.
Recent Sarbanes-Oxley legislation and stock exchange regulations have
increased disclosure control, financial reporting, corporate governance and
internal control requirements that will increase the administrative costs of
documenting and auditing internal processes, gathering data, and reporting
information. Our inability to comply with the requirements would significantly
impact our market valuation.
Our common stock is subject to price volatility.
The market price of our common stock historically has been and may continue
to be highly volatile. Our stock price could be subject to wide fluctuations in
response to various factors beyond our control, including:
o medical reimbursement
o quarterly variations in operating results;
o announcements of technological innovations, new products or pricing by
our competitors;
o the rate of adoption by physicians of our technology and products in
targeted markets;
o the timing of patent and regulatory approvals;
o the timing and extent of technological advancements;
o results of clinical studies;
o the sales of our common stock by affiliates or other shareholders with
large holdings; and
o general market conditions.
Our future operating results may fall below the expectations of securities
industry analysts or investors. Any such shortfall could result in a significant
decline in the market price of our common stock. In addition, the stock market
has experienced significant price and volume fluctuations that have affected the
market price of the stock of many medical device companies and that often have
been unrelated to the operating performance of such companies. These broad
market fluctuations may directly influence the market price of our common stock.
Additional Information
We are subject to the reporting requirements under the Securities Exchange
Act of 1934 and are required to file reports and information with the Securities
and Exchange Commission (SEC), including reports on the following forms: annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and amendments to those reports files or furnished pursuant to Section
13(a) or 15(d) of the Securities Act of 1934.
ITEM 2 - PROPERTIES
We own our 18,000 square foot headquarters and manufacturing facility at
180 Linden Avenue, Westbury, New York 11590. We currently lease approximately
3,500 square feet of additional warehouse space under an operating lease with a
20
non-affiliated landlord that expires in September 2006, which we do not intend
to renew. We believe that our current facility is adequate to meet our current
needs and should continue to be adequate for the immediately foreseeable future.
ITEM 3 - LEGAL PROCEEDINGS
There were no material legal proceedings under applicable rules.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of the fiscal year.
21
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock currently trades on the Over-the-Counter Bulletin Board
under the symbol VASO.OB. On May 26, 2006, our common stock ceased trading on
the Nasdaq Capital Market tier of the Nasdaq Stock Market and began trading on
the NASD Pink Sheets. Effective June 20, 2006, our common stock began trading on
the Over the Counter Bulletin Board (OTCBB). The number of record holders of
common stock as of August 1, 2006, was approximately 1,100, which does not
include approximately 27,600 beneficial owners of shares held in the name of
brokers or other nominees. The table below sets forth the range of high and low
trade prices of the common stock for the fiscal periods specified.
Fiscal 2006 Fiscal 2005
High Low High Low
First Quarter $0.88 $0.53 $1.27 $0.83
Second Quarter $0.65 $0.38 $1.25 $0.90
Third Quarter $0.53 $0.16 $1.52 $0.90
Fourth Quarter $0.35 $0.10 $1.98 $0.57
The last bid price of the Company's common stock on August 14, 2006, was
$0.10 per share.
De-listing from the Nasdaq Capital Market
By letter dated May 2, 2005, we received written notification from Nasdaq
that the bid price of our common stock for the last 30 consecutive business days
had closed below the minimum $1.00 per share required for continued inclusion
under Marketplace Rule 4310(c) (4) (the Rule). In accordance with Marketplace
Rule 4310 (c) (d), we were provided an initial period of 180 calendar days to
regain compliance plus an automatic extension for additional period of 180
calendar days since we met the Nasdaq Capital Markets initial listing criteria
except for the bid price requirement. During this period our common stock did
not rise above the $1.00 per share minimum and on May 26, 2006, our common stock
was delisted and our stock is currently traded over-the-counter.
As a result of our de-listing from the Nasdaq Capital Market due to low
stock price, we may become subject to special rules, called penny stock rules
that impose additional sales practice requirements on broker-dealers who sell
our common stock. The rules require, among other things, the delivery, prior to
the transaction, of a disclosure schedule required by the Securities and
Exchange Commission relating to the market for penny stocks. The broker-dealer
also must disclose the commissions payable both to the broker-dealer and the
registered representative and current quotations for the securities, and monthly
statements must be sent disclosing recent price information.
The regulations relating to penny stocks could limit the ability of
broker-dealers to sell our common stock and thus the ability of purchasers of
our common stock to sell their common stock in the secondary market.
Additionally, Nasdaq's delisting of our common stock could have an adverse
effect our ability to raise additional equity capital..
Dividend Policy
We have never paid any cash dividends on our common stock. While we do not
intend to pay cash dividends in the foreseeable future, payment of cash
dividends, if any, will be dependent upon our earnings and financial position,
investment opportunities and such other factors as the Board of Directors deems
pertinent. Stock dividends, if any, also will be dependent on such factors as
the Board of Directors deems pertinent.
Sale of Convertible Preferred Securities.
On July 19, 2005, we entered into a Securities Purchase Agreement that
provided us with gross proceeds of $2.5 million through a private placement of
preferred stock with M.A.G. Capital, LLC through its designated funds, Monarch
Pointe Fund Ltd., Mercator Momentum Fund III, LP, and Mercator Momentum Fund, LP
(the "Investors"). The agreement provided for a private placement of 25,000
shares of our Series D Preferred Stock at $100 per share plus warrants. As of
February 7, 2006, all of the preferred shares had been converted into common
shares and there are no preferred shares currently outstanding.
22
ITEM 6 -
SELECTED FINANCIAL DATA
The following table summarizes selected financial data for each of the five
years ended May 31 as derived from our audited consolidated financial
statements. These data should be read in conjunction with our consolidated
financial statements, related notes and other financial information.
Fiscal Year Ended May 31,
2006 2005 2004 2003 2002
Statements of Earnings
Revenues $10,942,997 $15,095,778 $22,207,037 $24,823,619 $34,830,471
Cost of sales and services 4,774,329 5,504,535 7,590,103 9,251,221 10,538,731
-------------- -------------- --------------- -------------- ---------------
Gross profit 6,168,668 9,591,243 14,616,934 15,572,398 24,291,740
Selling, general & administrative expenses 7,865,533 12,006,774 12,910,997 13,714,913 13,686,958
Research and development expenses 1,805,667 3,064,683 3,748,389 4,544,822 5,112,258
Provision for doubtful accounts 110,317 11,084 1,296,759 3,728,484 1,304,000
Interest and financing costs 81,662 105,232 132,062 186,574 98,140
Interest and other income, net (75,508) (74,153) (99,393) (176,724) (249,722)
-------------- -------------- --------------- -------------- ---------------
9,787,671 15,113,620 17,988,814 21,998,069 19,951,634
-------------- -------------- --------------- -------------- ---------------
Earnings (loss) before income taxes (3,619,003) (5,522,377) (3,371,880) (6,425,671) 4,340,106
Income tax (expense) benefit, net (7,082,138) (39,661) (50,640) 1,634,688 (1,554,000)
-------------- -------------- --------------- -------------- ---------------
Net earnings (loss) (10,701,141) (5,562,038) (3,422,520) (4,790,983) 2,786,106
Preferred stock dividend (877,870) -- -- -- --
-------------- -------------- --------------- -------------- ---------------
Net loss attributable to common shareholders $(11,579,011) $(5,562,038) $(3,422,520) $(4,790,983) $2,786,106
============== ============== =============== ============== ===============
Net earnings (loss) per common share
- basic $(0.19) $(0.10) $(0.06) $(0.08) $0.05
============== ============== =============== ============== ===============
- diluted $(0.19) $(0.10) $(0.06) $(0.08) $0.05
============== ============== =============== ============== ===============
Weighted average common shares
outstanding - basic 61,351,323 58,547,574 57,981,963 57,647,032 57,251,035
============== ============== =============== ============== ===============
- diluted 61,351,323 58,547,574 57,981,963 57,647,032 59,468,092
============== ============== =============== ============== ===============
Balance Sheet Data
Cash, cash equivalents, and certificates of
deposit $2,385,778 $2,747,967 $7,545,589 $5,222,847 $2,967,627
Working capital $2,867,288 $3,932,769 $9,771,870 $11,478,092 $17,225,434
Total assets $7,912,040 $25,361,470 $33,023,615 $35,327,550 $41,418,258
Long-term debt $853,189 $947,597 $1,092,837 $1,177,804 $1,072,716
Stockholders' equity (1) $3,166,156 $19,162,797 $24,594,169 $27,319,302 $31,602,604
-------------------
(1) No cash dividends on common stock were declared during any of the above periods.
23
Summary of quarterly financial data (unaudited)
The following is a summary of the Company's unaudited quarterly operating
results for the years ended May 31, 2006 and 2005.
Three months ended
------------------------------------------------------------------------------------------------
(in 000s except
earnings (loss) per May 31, Feb. 28, Nov. 30, Aug. 31, May 31, Feb. 28, Nov. 30, Aug. 31,
share data) 2006 2006 2005 2005 2005 2005 2004 2004
--------------------- ----------- ----------- ------------ ------------ ----------- ----------- ----------- ----------
Revenues $1,885 $2,842 $2,680 $3,536 $3,848 $2,964 $3,462 $4,821
Gross profit $859 $1,614 $1,582 $2,113 $2,344 $1,800 $2,288 $3,160
Net loss
attributable to
common
shareholders $(504) $(695) $(8,682) $(1,698) $(1,001) $(2,027) $(1,610) $(924)
Loss per
share - basic $(0.01) $(0.01) $(0.15) $(0.03) $(0.02) $(0.03) $(0.03) $(0.02)
- diluted $(0.01) $(0.01) $(0.15) $(0.03) $(0.02) $(0.03) $(0.03) $(0.02)
Weighted average
common shares
outstanding -
- basic 65,173 62,162 59,421 58,616 58,553 58,553 58,553 58,532
- diluted 65,173 62,162 59,421 58,616 58,553 58,553 58,553 58,532
24
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains descriptions of our expectations regarding future
trends affecting our business. These forward looking statements and other
forward-looking statements made elsewhere in this document are made under the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Please read the section titled "Risk Factors" in "Item One - Business" to review
certain conditions, among others, which we believe could cause results to differ
materially from those contemplated by the forward-looking statements.
Forward-looking statements are identified by words such as "anticipates",
"believes", "could", "estimates", "expects", "feels", "intends", "may", "plans",
"potential", and "projects" and similar expressions. In addition, any statements
that refer to our plans, business plan, expectations, strategies or other
characterizations of future events or circumstances are forward-looking
statements. Such forward-looking statements are based on our beliefs, as well as
assumptions made by and information currently available to us. Among the factors
that could cause actual results to differ materially are the following: the
effect of business and economic conditions, the effect of the dramatic changes
taking place in the healthcare environment; the impact of medical insurance
reimbursement policies including the continued inability to obtain Medicare
reimbursement for heart failure patients; competitive procedures and products
and their pricing; unexpected manufacturing problems; unforeseen difficulties
and delays in the conduct of clinical trials and other product development
programs; the actions of regulatory authorities and third-party payers in the
United States and overseas; uncertainties about the acceptance of a novel
therapeutic modality by the medical community; and the risk factors reported
from time to time in our SEC reports, including the ability of the Company to
continue as a going concern. We undertake no obligation to update
forward-looking statements as a result of future events or developments.
The following discussion should be read in conjunction with financial
statements and notes thereto included in this Annual Report on Form 10-K.
Overview
Vasomedical, Inc. incorporated in Delaware in July 1987 is primarily
engaged in designing, manufacturing, marketing and supporting EECP(R) external
counterpulsation systems based on our proprietary technology. EECP therapy is a
non-invasive, outpatient therapy for the treatment of diseases of the
cardiovascular system. The therapy serves to increase circulation in areas of
the heart with less than adequate blood supply and has been shown to improve
systemic vascular function. We provide hospitals and physician private practices
with EECP therapy systems, treatment guidance, and a staff training and
equipment maintenance programs designed to provide optimal patient outcomes.
EECP is a registered trademark for Vasomedical's enhanced external
counterpulsation systems.
We have Food and Drug Administration (FDA) clearance to market our EECP
therapy for use in the treatment of stable and unstable angina, congestive heart
failure (CHF), acute myocardial infarction, and cardiogenic shock, however our
current marketing efforts are limited to the treatment of stable angina and
congestive heart failure indications. Within the stable angina indications,
Medicare and other third-party payers currently reimburse for stable angina
patients with moderate to severe symptoms who remain symptomatic on medications
and not candidates for invasive procedures. Some CHF patients are also
reimbursed under the same criteria, provided their primary symptoms are angina.
We sponsored a pivotal study to demonstrate the efficacy of EECP therapy in
the most prevalent types of heart failure patients. This study, known as PEECH
(Prospective Evaluation of EECP in Congestive Heart Failure), was intended to
provide additional clinical data in order to support our application for
expanded Medicare national coverage policy for the use of EECP therapy in the
treatment of CHF. The preliminary results of the trial were presented at the
American College of Cardiology scientific sessions in March 2005, and we expect
the results of the PEECH clinical trial to be published in a peer-reviewed
journal within the next few months. On June 20, 2005, the Centers for Medicare
and Medicaid Services (CMS) accepted our application for expanded coverage of
EECP therapy to include CHF as a primary indication, as well as additional
patients with angina. However, on March 20, 2006, CMS issued a final decision to
maintain the existing coverage with no changes for expansion of external
counterpulsation therapy. The fact that the results of the PEECH trial have not
been published to date factored into CMS' decision, however, it is not clear
whether CMS will decide otherwise once the results are published.
We have incurred declines in revenue and have sustained significant
operating losses during the last three fiscal years and currently anticipate
that we will continue to sustain operating losses. Our ability to continue
operating as a going concern is dependent upon achieving profitability or
through additional debt or equity financing. We currently anticipate that we
will continue to sustain operating losses. Achieving profitability is largely
dependent on our ability to reduce operating costs sufficiently as well as
halting the current trend of declining revenue. Our ability to maintain our
25
current base of revenue is largely dependent upon restructuring our sales and
marketing efforts in the angina market where reimbursement is currently
available and operating in a more efficient manner. If we are not able to
reverse the trend of declining revenue and sufficiently reduce operating costs
to generate an adequate cash flow, or raise additional capital, we will not be
able to continue as a going concern.
In January 2006 in order to reduce the cash burn and bring our cost
structure more into alignment with current revenue, we initiated a company
restructuring, to reduce personnel and spending on marketing and development
projects. We anticipate that the restructuring will reduce manufacturing and
operating cost by approximately $3 million per year compared to prior levels. In
addition, in April 2006, the board of directors elected to defer meeting fees
and certain senior executives elected to defer approximately $0.4 million in
annual salary compensation. We believe that these steps to conserve cash will
provide the Company with the opportunity to rebuild sales to a profitable level
and/or explore strategic opportunities.
Based on the continuation of current revenue levels and the implementation
of our restructuring plan initiated in January 2006, we believe that we will be
able to fund our minimum projected capital requirements through at least the end
of the calendar year.
In the event that additional capital is required, we may seek to raise such
capital through public or private equity or debt financings or other means. We
may not be able to obtain additional financing on favorable terms or at all. If
we are unable to raise additional funds when we need them, we may be required to
further scale back our operations, research, marketing or sales efforts or
obtain funds through arrangements with collaborative partners or others that may
require us to license or relinquish rights to technologies or products. Future
capital funding, if available, may result in dilution to current shareholders,
and new investors could have rights superior to existing stockholders.
Results of Operations
Fiscal Years Ended May 31, 2006 and 2005
Net revenue from sales, leases and service of our EECP systems for the
fiscal year ended May 31, 2006 and 2005, was $10,942,997 and $15,095,778,
respectively, which represented a decline of $4,152,781 or 28%. We reported a
net loss attributable to common shareholders of $11,579,011 compared to
$5,562,038 for the fiscal year ended May 31, 2006 and 2005, respectively. Our
net loss per common share was $0.19 for the fiscal year ended May 31, 2006,
compared to a net loss of $0.10 per share for the fiscal year ended May 31,
2005. The increase in net loss is primarily due to the establishment of a
$7,093,000 valuation reserve in the fiscal year 2006 second-quarter for the
then-remaining carrying value of the deferred tax asset.
The gross profit declined to $6,168,668 or 56% of revenues for the fiscal
year ended May 31, 2006, compared to $9,591,243 or 64% of revenues for the
fiscal year ended May 31, 2005. The decline in gross profit primarily reflects
the reduced sales volume, however the loss from operations was reduced in the
fiscal year ended May 31, 2006 to $3,612,849 compared to the loss from
operations in fiscal year 2005 of $5,491,298. Total operating expenses in the
fiscal year ended May 31, 2006 and 2005 were $9,781,517 and $15,082,541,
respectively reflecting a decline of $5,301,024 due primarily to two major cost
savings measures initiated in May 2005 and January 2006.
Revenues
Revenue from equipment sales declined approximately 41% to $6,820,980 for
the twelve-month period ended May 31, 2006 as compared to $11,516,883 for the
same period for the prior year. The decline in equipment sales is due primarily
to a 41% decline in the number of EECP system shipments in both the domestic and
international markets. The lower equipment sales volume was partially offset by
a 1% improvement in average sales prices. A favorable mix of new equipment
versus used equipment was the primary cause of the increase in average sales
prices as new EECP system shipments increased to 79% of total system shipments
in fiscal 2006 compared to 68% in fiscal 2005.
Revenue from shipments of EECP systems in the domestic market declined
approximately 41%. We believe the decline in domestic units shipped reflects an
over capacity of EECP systems due to weakened demand for EECP therapy in the
angina market, coupled with increased competition from surgical procedures,
mainly the use of drug-eluting stents coupled with an unstable reimbursement
environment due to our inability to expand reimbursement coverage to include the
heart failure indication as well as the decline in average reimbursement rates
in recent years. Additionally, limited financial resources resulted in reduced
sales coverage, product promotions and marketing support. Although average
domestic selling prices for new and used systems improved compared to fiscal
2005, the average selling prices for new systems shipments in fiscal 2006
declined approximately 6% compared to fiscal 2005. We anticipate that the
prevailing trend of declining prices will continue in the immediate future as
our competition attempts to capture greater market share through pricing
discounts.
26
Our revenue from the sale of EECP systems and related products to
international distributors in the fiscal year ended May 31, 2006, decreased
approximately 39% to $808,000 compared to $1,316,000 in the same period of the
prior year, as a result of the lower system volume and lower selling prices.
The above decline in revenue from equipment sales was partially offset by a
15% increase in revenue from equipment rental and services for the fiscal year
ended May 31, 2006, compared to the same twelve-month period in the prior year.
Revenue from equipment rental and services represented 38% of total revenue in
fiscal 2006 compared to 24% in fiscal 2005. The increase in both absolute
amounts and percentage of total revenue resulted primarily from an increase of
approximately 37% in service related revenue. The higher service revenue
reflects an increase in service labor and spare parts, plus greater marketing
focus on the sale of extended service contracts as the installed base of EECP
therapy systems continues to grow. Rental revenue declined approximately 58%,
partially offsetting the above. The decline was primarily due to a multi-system
customer defaulting on its rental payments during fiscal 2005; consequently, we
shifted to a cash basis for revenue recognition for this customer and our
equipment was eventually returned.
Gross Profit
The gross profit declined to $6,168,668 or 56% of revenues for the fiscal
year ended May 31, 2006, compared to $9,591,243 or 64% of revenues for the
fiscal year ended May 31, 2005. Gross profit margin as a percentage of revenue
in fiscal year 2006 decreased compared to the same period of the prior fiscal
year despite the improvement in average selling prices, mainly due higher
overhead absorption costs associated with reduced production volumes in the last
four fiscal quarters. In addition, adoption of SFAS No. 151 lowered the amount
of fixed overhead costs absorbed into inventory in fiscal 2006 by $256,000 or 2%
of revenue. Partially offsetting the decline was an improvement in the gross
profit margins associated with accessory revenues, reflecting higher average
selling prices. The decline in gross profit when compared to the prior year in
absolute dollars is a direct result of the lower sales volume.
Gross profits are dependent on a number of factors, particularly the mix of
EECP models sold and their respective average selling prices, the mix of EECP
therapy systems 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 twelve-months
ended May 31, 2006 and 2005, were $7,865,533 or 72% of revenues and $12,006,774
or 80% of revenues, respectively reflecting an decrease of $4,141,241 or
approximately 35%. The decrease in SG&A expenditures in fiscal 2006 compared to
fiscal 2005 resulted primarily from decreased expenditures in direct selling
activities and clinical applications support of $1,487,420 and $420,775,
respectively, reflecting fewer personnel and associated travel plus lower sales
commission due the reduced sales volume. Marketing expenses declined $1,569,356,
due to reduced personnel plus lower market research, product promotion and trade
show costs. Administrative expenses declined $659,327 primarily reflecting lower
accounting costs.
Research and Development
Research and development ("R&D") expenses totaled $1,805,667 or 17% of
revenues for the fiscal year ended May 31, 2006, a decrease of $1,259,016 or
41%, from the fiscal year ended May 31, 2005, of $3,064,683 or 20% of revenues.
The decrease is primarily attributable to fewer engineering personnel and lower
new product development costs following the completion of the fourth generation
EECP therapy system, the Lumenair, plus reduced spending for clinical research
and regulatory affairs following completion of the PEECH clinical trial in
fiscal year 2005.
Provision for Doubtful Accounts
During the fiscal year ended May 31, 2006, we increased the provision for
doubtful accounts by $110,317 or 1% of revenue as compared to an increase of
$11,094 during the fiscal year ended May 31, 2005. Collection of doubtful
accounts from the previous fiscal year reduced the net provision for doubtful
accounts expense in fiscal 2005.
27
Interest Expense and Financing Costs
Interest expense and financing costs decreased to $81,662 in the fiscal
year ended May 31, 2006, from $105,232 for the fiscal year 2005 due to a
declining principal balance. Interest expense primarily reflects interest on
loans secured to refinance the November 2000 purchase of the Company's
headquarters, manufacturing and warehouse facility, as well as on loans secured
to finance the cost and implementation of a new management information system.
Interest and Other Income, Net
Interest and other income for the fiscal year ended May 31, 2006 and 2005,
were $75,508 and $74,153, respectively. Lower average cash, cash equivalents,
and certificates of deposit balances were invested during fiscal 2006 as
compared to the prior year. This was offset by increases in interest rates.
Income Tax Expense, Net
During the fiscal year ended May 31, 2006 and 2005, we recorded income tax
expense of $7,082,138 and $39,661, respectively. The fiscal 2006 tax expense
consists mainly of $7,093,000 in additional valuation allowance provided for the
deferred tax asset in the second fiscal quarter. The income tax expense for
fiscal 2006 does not include $7,489,000 added to the deferred tax valuation
allowance in the second quarter of fiscal 2006 for tax benefits associated with
prior years' exercises of stock options and warrants, which was charged directly
to additional paid-in capital.
As of May 31, 2005, we had recorded deferred tax assets of $14,582,000 net
of a $3,774,000 valuation allowance related to the anticipated recovery of tax
loss carryforwards. On December 20, 2005, Centers for Medicare and Medicaid
Services (CMS) issued a Proposed Decision Memorandum (PDM) for External
Counterpulsation in response to Vasomedical's application to expand
reimbursement coverage to include Canadian Cardiovascular Society (CCSC) Class
II angina and New York Heart Association (NYHA) Class II/III congestive heart
failure (CHF). The PDM stated that the evidence was not adequate to conclude
that external counterpulsation therapy is reasonable and necessary to expand
reimbursement coverage to CCSC Class II angina and NYHA Class II/III CHF and
that current coverage for CCSC class III/IV refractory angina would remain in
effect. Consequently, at the end of the second fiscal quarter of fiscal 2006, we
concluded that, based upon the weight of available evidence, it was no longer
"more likely than not" that the net deferred tax asset of $14,582,000 would be
realized, and added $14,582,000 to the valuation allowance to bring the net
deferred tax asset carrying value to zero. On March 20, 2006, CMS issued its
final decision, which upheld the PDM.
As of May 31, 2006, the recorded deferred tax asset was $19,559,458, which
was offset by a valuation allowance of the same amount.
Fiscal Years Ended May 31, 2005 and 2004
We generated revenues from the sale, lease and service of our EECP therapy
systems of $15,095,778 and $22,207,037 for the years ended May 31, 2005 and
2004, respectively, reflecting a decrease of $7,111,259 or 32%. Our loss was
$5,562,038 or $0.10 per share and $3,422,520 or $0.06 per share for the years
ended May 31, 2005 and 2004, respectively.
Revenues
Revenues from equipment sales declined approximately 40% to $11,516,883 for
the year ended May 31, 2005, as compared to $19,302,593 for the prior year. The
decline in equipment sales is due primarily to a 41% decline in domestic units
shipped, a 5% decline in the average sales prices of new EECP systems sold in
the domestic market, and an unfavorable product mix reflecting a higher portion
of used versus new equipment shipments. Used systems had lower average selling
price compared to new systems, and experienced a 29% decrease in average selling
price when compared to used systems sold in the domestic market in fiscal 2004.
Our revenue from the sale of EECP systems to international distributors for
the year ended May 31, 2005, increased approximately 64% to $1,315,985 compared
to $801,600 in the prior year reflecting increased volume of new systems and
improved average selling prices.
The above decline in revenue from domestic equipment sales was
partially offset by a 23% increase in revenue from equipment rental and services
for year ended May 31, 2005, as compared to the prior year. Revenue from
equipment rental and services represented 24% of total revenue in fiscal 2005
compared to 13% in fiscal 2004. The increase in both absolute amounts and
percentage of total revenue resulted primarily from an increase of approximately
30% in service related revenue. The higher service revenue reflects an increase
28
in service, spare parts and consumables as a result of the continued growth of
the installed base of EECP systems plus greater marketing focus on the sale of
extended service contracts. Rental revenue declined approximately 15% following
the termination of several short-term rental agreements partially offsetting the
above.
Reimbursement continues to play a critical role in the adoption of EECP
therapy. Medicare dropped the payment rates 34% from $208 per hour to $137 per
hour for physicians at the beginning of calendar year 2004. The current
reimbursement rate is now set at the rates near when the product first received
Medicare coverage in 2000, which makes it more difficult for a private physician
practice to financially justify an investment to provide EECP therapy. It is
difficult for us to determine the exact impact this decline has had on the
market for EECP therapy. Additionally, the impact from the drop in reimbursement
has been partially offset by the decline in average selling prices, and we
believe that EECP therapy continues to offer an attractive addition to the
physician private practice, plus the company has continued to support its
customers in gaining positive reimbursement coverage from other third-party
payers during the past year. EECP therapy is now covered by the majority of
private insurers for treating angina patients, including many of the leading
Blue Cross Blue Shield plans, who typically are the most difficult payers to
adopt coverage for new technologies.
Gross Profit
Gross profit declined to $9,591,243 or 64% of revenues for the year ended
May 31, 2005, compared to $14,616,934 or 66% of revenues for the year ended May
31, 2004. Gross profit margin as a percentage of revenue for the year ended May
31, 2005, declined compared to the same period of the prior fiscal year
reflecting reduced margins from EECP equipment sales due to the negative impact
resulting from the reduction in average selling prices. The gross profit for
rentals and services improved both in absolute amount and as a percentage of
revenue reflecting increased service resulting from accessory and service
contract revenue increases exceeding associated cost increases. The decline in
gross profit when compared to the prior year in absolute dollars is a direct
result of the lower revenue.
Gross profits are dependent on a number of factors, particularly the mix of
EECP models sold and their respective average selling prices, the mix of EECP
units sold, rented or placed during the period, the ongoing costs of servicing
such units, and certain fixed period costs, including facilities, payroll and
insurance. Gross profit margins are generally less on non-domestic business due
to the use of distributors resulting in lower selling prices. Consequently, the
gross profit realized during the current period may not be indicative of future
margins.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses for the years ended
May 31, 2005 and May 31, 2004 were $12,006,774 or 80% of revenues and
$12,910,997 or 58% of revenues, respectively, reflecting a decrease of $904,223
or 7%. The decrease in SG&A expenditures in fiscal 2005 compared to fiscal 2004
resulted primarily from a $590,192 decrease in administrative consulting and
severance fees, $103,637 lower promotional allowances, and $118,002 lower
advertising costs, partially offset by $150,910 higher market research fees and
$142,193 higher trade show costs. On May 5, 2005, the Company announced an
initiative to improve alignment of operations to pursue the CHF market. This
initiative, which included a workforce reduction plus tighter expense control,
is expected to provide a clear focus on CHF investment and to reduce total
expenses by approximately $3,000,000 in fiscal 2006.
Research and Development
Research and development ("R&D") expenses of $3,064,683 or 20% of revenues
for the year ended May 31, 2005, decreased by $683,706 or 18%, from the year
ended May 31, 2004, of $3,748,389 or 17% of revenues. The decrease reflects
lower spending related to the PEECH clinical trial following completion of the
clinical treatment portion of the trial in fiscal year 2004, partially offset by
increased expenditures for developing the new Lumenair(TM) EECP(R) Therapy
System, which was launched in November 2004.
Provision for Doubtful Accounts
During the year ended May 31, 2005, we charged $11,084 to our provision for
doubtful accounts as compared to $1,296,759 during the year ended May 31, 2004.
The decrease was due primarily to a $680,000 provision made in the prior fiscal
period associated with the write-off of all funds due from a major customer that
ceased operations in December 2003.
29
Interest Expense and Financing Costs
Interest expense and financing costs decreased to $105,232 in the year
ended May 31, 2005, from $132,062 for the prior year reflecting a reduction in
outstanding debt. Interest expense reflects interest on loans secured to
refinance the November 2000 purchase of our headquarters and warehouse facility,
as well as on loans secured to finance the cost and implementation of a new
management information system.
Interest and Other Income, Net
Interest and other income for the fiscal years of 2005 and 2004, was
$74,153 and $99,393, respectively. The decrease in interest and other income
from the prior year is the direct result of the absence of interest income
related to certain equipment sold under sales-type leases incurred in fiscal
2004 and lower miscellaneous customer payments, partially offset by higher
interest income due to improved yields.
Income Tax Expense, Net
During the fiscal year ended May 31, 2005 and 2004, we recorded a provision
for state income taxes of $39,661 and 50,640, respectively. As of May 31, 2005,
we had recorded deferred tax assets of $14,582,000 net of a $3,774,000 valuation
allowance related to the anticipated recovery of tax loss carryforwards. The
recorded deferred tax asset and increase to the valuation allowance during the
year ended May 31, 2005, was $1,866,000.
Liquidity and Capital Resources
Cash and Cash Flow
We have financed our operations in fiscal 2006, 2005 and 2004 primarily
from working capital and in fiscal 2006 from the issuance of preferred stock. At
May 31, 2006, we had cash, cash equivalents, and certificates of deposit balance
of $2,385,778 and working capital of $2,867,288 as compared to cash and cash
equivalents of $2,747,967 and working capital of $3,932,769 at May 31, 2005. Our
cash, cash equivalents, and certificates of deposit balances decreased $362,189
in fiscal year 2006. Our net loss of $10,701,141 was partially offset by an
adjustment to reconcile the net loss to net cash and changes in working capital
accounts of $8,425,268 plus cash provided by financing activities of $1,913,684.
The adjustments to reconcile net loss to net cash used in operating
activities consisted mainly of $8,008,002 in non-cash adjustments to reconcile
the not loss to net used in operating activities, primarily $7,093,000 for
deferred income taxes, as well as an aggregate of $915,002 in depreciation and
amortization, allowances for doubtful accounts, inventory reserves plus common
stock and stock options issued for services. In addition, changes in our
operating assets and liabilities produced net cash of $942,057. The changes in
the accounts balances primarily reflect a decrease in accounts receivable of
$938,403, lower inventory of $699,371 and lower other assets of $115,853, which
were partially offset by a decrease in accounts payable and accrued liabilities
of $1,070,978 and a decrease in other liabilities of $236,501. Net accounts
receivable were 46% of revenues for the three-month period ended May 31, 2006,
as compared to 50% for the three-month period ended May 31, 2005, and accounts
receivable turnover improved to 7.9 times as of May 31, 2006, as compared to 4.1
times as of May 31, 2005.
Standard payment terms on our domestic equipment sales are generally net 30
to 90 days from shipment and do not contain "right of return" provisions. We
have historically offered a variety of extended payment terms, including
sales-type leases, in certain situations and to certain customers in order to
expand the market for our EECP products in the US and internationally. Such
extended payment terms were offered in lieu of price concessions, in competitive
situations, when opening new markets or geographies and for repeat customers.
Extended payment terms cover a variety of negotiated terms, including payment in
full - net 120, net 180 days or some fixed or variable monthly payment amount
for a six to twelve month period followed by a balloon payment, if applicable.
During the first three quarters of fiscal 2006 and 2005, approximately 0% and
3%, respectively, of revenues were generated from sales in which initial payment
terms were greater than 90 days and we offered no sales-type leases during
either period. In general, reserves are calculated on a formula basis
considering factors such as the aging of the receivables, time past due, and the
customer's credit history and their current financial status. In most instances
where reserves are required, or accounts are ultimately written-off, customers
have been unable to successfully implement their EECP program. As we are
creating a new market for the EECP therapy and recognizing the challenges that
some customers may encounter, we have opted, at times, on a customer-by-customer
basis, to recover our equipment instead of pursuing other legal remedies, which
has resulted in our recording of a reserve or a write-off.
30
Investing activities provided net cash of $1,758,443 during the fiscal year
ended May 31, 2006. Cash was provided by the sale of short-term certificates of
deposit. All of our certificates of deposit had original maturities of greater
than three months and mature in less than twelve months.
Our financing activities provided net cash of $1,913,684 during the fiscal
year ended May 31, 2006, reflecting $2,150,117 in net proceeds received from the
issuance of preferred stock and $302,052 in proceeds for the issuance of a short
note payable, less payments on our outstanding notes and loans totaling
$447,393, and preferred stock dividend payments totaling $91,623.
We do not have an available line of credit.
Sale of Convertible Preferred Stock and Warrants
On July 19, 2005, we entered into a Securities Purchase Agreement that
provided us with gross proceeds of $2.5 million through a private placement of
preferred stock with M.A.G. Capital, LLC through its designated funds, Monarch
Pointe Fund Ltd., Mercator Momentum Fund III, LP, and Mercator Momentum Fund, LP
(the "Investors"). The agreement provided for a private placement of 25,000
shares of Vasomedical's Series D Preferred Stock at $100 per share. The
preferred stock was convertible into shares of Vasomedical's common stock at 85
percent of the volume weighted average price per share for the five trading days
preceding any conversion, but not at more than $0.6606 or less than $0.40 per
share. After registration in August 2005 the shares of common stock could be
acquired through conversion of the preferred shares. The Investors also acquired
warrants for the purchase of 1,892,219 shares of common stock. The warrants may
be exercised at a price of $0.69 per share for a term of five years, ending July
18, 2010.
By the placement of the preferred stock described above, we became
obligated to pay a cash dividend monthly on the outstanding shares of preferred
stock. The dividend rate was the higher of (i) the prime rate as reported by the
Wall Street Journal on the first day of the month, plus three percent or, (ii)
8.5% times $100 per share, but in no event greater than 10% annually.
During the period beginning on September 14, 2005, and ending February 7,
2006, all the preferred stock issued under this financing were converted into a
total of 6,112,209 shares of common stock and the are no remaining shares of
preferred stock outstanding.
These securities were offered and sold to the Investors in a private
placement transaction made in reliance upon exemptions from registration
pursuant to Section 4(2) of the Securities Act of 1933. The Investors are
accredited investors as defined in Rule 501 of Regulation D promulgated under
the Securities Act of 1933. Vasomedical intends to apply the funds for working
capital.
Liquidity
We have incurred declines in revenue and have sustained significant
operating losses during the last three fiscal years and currently anticipate
that we will continue to sustain operating losses. Our ability to continue
operating, as a going concern is dependent upon achieving profitability or
through additional debt or equity financing. Achieving profitability is largely
dependent on our ability to reduce operating costs sufficiently as well as
halting the current trend of declining revenue. Our ability to maintain our
current base of revenue is largely dependent upon restructuring our sales and
marketing efforts in the angina market where reimbursement is currently
available and operating in a more efficient manner. If we are not able to
reverse the trend of declining revenue and sufficiently reduce operating costs
to generate an adequate cash flow, or raise additional capital, we will not be
able to continue as a going concern. In this regard, our independent auditors
report for fiscal 2006 states that there is substantial doubt about our ability
to continue as a going concern.
In January 2006, in order to reduce the cash burn and bring our cost
structure more into alignment with current revenue, we initiated a company
restructuring, to reduce personnel and spending on marketing and development
projects. We anticipate that the restructuring will reduce manufacturing and
operating cost by approximately $3 million per year compared to prior levels. In
addition, in April 2006, the board of directors elected to defer meeting fees
and certain senior executives elected to defer approximately $0.4 million in
annual salary compensation. We believe that these steps to conserve cash will
provide the Company with the opportunity to rebuild sales to a profitable level
and/or explore strategic opportunities.
Based on the continuation of current revenue levels and the implementation
of our restructuring plan initiated in January 2006, we believe that we will be
able to fund our minimum projected capital requirements through at least the end
of the calendar year.
In the event that additional capital is required, we may seek to raise such
capital through public or private equity or debt financings or other means. We
may not be able to obtain additional financing on favorable terms or at all. If
we are unable to raise additional funds when we need them, we may be required to
31
further scale back our operations, research, marketing or sales efforts or
obtain funds through arrangements with collaborative partners or others that may
require us to license or relinquish rights to technologies or products. Future
capital funding, if available, may result in dilution to current shareholders,
and new investors could have rights superior to existing stockholders.
Off-Balance Sheet Arrangements
As part of our on-going business, we do not participate in transactions
that generate relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance or
special purpose entities (`SPES"), which would have been established for the
purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes. As of May 31, 2006, we are not involved in any
unconsolidated SPES.
Contractual Obligations
The following table presents our expected cash requirements for contractual
obligations outstanding as of May 31, 2006:
Due as of Due as of
Due as of 5/31/08 and 5/31/10 and Due
Total 5/31/07 5/31/09 5/31/11 Thereafter
--------------------------------------------------------------------------------------------------------------------
Long-Term Debt $950,498 $97,309 $136,195 $ 156,739 $560,255
Operating Leases 14,238 14,238 -- -- --
Employment Agreements -- -- -- -- --
--------------------------------------------------------------------------------------------------------------------
Total Contractual Cash
Obligations $964,736 $111,547 $136,195 $156,739 $560,255
====================================================================================================================
In April 2006, the Company approved a program to defer compensation of
certain senior executives of the company and incentives to them for these
deferrals. The Company agreed to repay monies deferred from zero to six months
at 1.5 times the amount deferred; for deferrals of six months to twelve months,
the repaid amount shall be two times the amount deferred; and for deferrals in
excess of twelve months, the amount shall be 2.5 times the amount deferred. In
addition, payment of board of directors meeting fees were deferred until a later
date.
Effects of Inflation
We believe that inflation and changing prices over the past three years
have not had a significant impact on our revenue or on our results of
operations.
Critical Accounting Policies
Financial Reporting Release No. 60, which was released by the Securities
and Exchange Commission, or SEC, in December 2001, requires all companies to
include a discussion of critical accounting policies or methods used in the
preparation of financial statements. Note B of the Notes to Consolidated
Financial Statements included in our Annual Report on Form 10-K for the year
ended May 31, 2006, includes a summary of our significant accounting policies
and methods used in the preparation of our financial statements. In preparing
these financial statements, we have made our best estimates and judgments of
certain amounts included in the financial statements, giving due consideration
to materiality. The application of these accounting policies involves the
exercise of judgment and use of assumptions as to future uncertainties and, as a
result, actual results could differ from these estimates. Our critical
accounting policies are as follows:
Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists,
delivery has occurred or service has been rendered, the price is fixed or
determinable and collectibility is reasonably assured. In the United States, we
recognize revenue from the sale of our EECP systems in the period in which we
deliver the system to the customer. Revenue from the sale of our EECP systems to
international markets is recognized upon shipment, during the period in which we
deliver the product to a common carrier, as are supplies, accessories and spare
parts delivered to both domestic and international customers. Returns are
accepted prior to the in-service and training subject to a 10% restocking charge
or for normal warranty matters, and we are not obligated for post-sale upgrades
to these systems. In addition, we use the installment method to record revenue
32
based on cash receipts in situations where the account receivable is collected
over an extended period of time and in our judgment the degree of collectibility
is uncertain.
In most cases, revenue from domestic EECP system sales is generated from
multiple-element arrangements that require judgment in the areas of customer
acceptance, collectibility, the separability of units of accounting, and the
fair value of individual elements. Effective September 1, 2003, we adopted the
provisions of Emerging Issues Task Force, or EITF, Issue No. 00-21, "Revenue
Arrangements with Multiple Deliverables", ("EITF 00-21"), on a prospective
basis. The principles and guidance outlined in EITF 00-21 provide a framework to
determine (a) how the arrangement consideration should be measured (b) whether
the arrangement should be divided into separate units of accounting, and (c) how
the arrangement consideration should be allocated among the separate units of
accounting. We determined that the domestic sale of our EECP systems includes a
combination of three elements that qualify as separate units of accounting:
i. EECP equipment sale,
ii. provision of in-service and training support consisting of equipment
set-up and training provided at the customer's facilities, and
iii. a service arrangement (usually one year), consisting of: service by
factory-trained service representatives, material and labor costs,
emergency and remedial service visits, preventative maintenance,
software upgrades, technical phone support and preferred response
times.
Each of these elements represent individual units of accounting as the
delivered item has value to a customer on a stand-alone basis, objective and
reliable evidence of fair value exists for undelivered items, and arrangements
normally do not contain a general right of return relative to the delivered
item. We determine fair value based on the price of the deliverable when it is
sold separately or based on third-party evidence. In accordance with the
guidance in EITF 00-21, we use the residual method to allocate the arrangement
consideration when it does not have fair value of the EECP system sale. Under
the residual method, the amount of consideration allocated to the delivered item
equals the total arrangement consideration less the aggregate fair value of the
undelivered items. Assuming all other criteria for revenue recognition have been
met, we recognize revenue for:
i. EECP equipment sales, when delivery and acceptance occurs based on
delivery and acceptance documentation received from independent
shipping companies or customers,
ii. in-service and training, following documented completion of the
training, and
iii. the service arrangement, ratably over the service period, which is
generally one year.
In-service and training generally occurs within three weeks of shipment and
our return policy states that no returns will be accepted after in-service and
training has been completed. The amount related to in-service and training is
recognized as equipment revenue at the time the in-service and training is
completed and the amount related to service arrangements is recognized ratably
over the related service period, which is generally one year. Costs associated
with the provision of in-service and training and the service arrangement,
including salaries, benefits, travel, spare parts and equipment, are recognized
in cost of equipment sales as incurred.
We also recognize revenue generated from servicing EECP systems that are no
longer covered by the service arrangement, or by providing sites with additional
training, in the period that these services are provided. Revenue related to
future commitments under separately priced extended service agreements on our
EECP system are deferred and recognized ratably over the service period,
generally ranging from one year to four years. Costs associated with the
provision of service and maintenance, including salaries, benefits, travel,
spare parts and equipment, are recognized in cost of sales as incurred. Amounts
billed in excess of revenue recognized are included as deferred revenue in the
consolidated balance sheets.
Revenues from the sale of EECP systems through our international
distributor network are generally covered by a one-year warranty period. We do
not offer a service arrangement to international customers; consequently, for
these customers we accrue a warranty reserve for estimated costs to provide
warranty services when the equipment sale is recognized.
We have also entered into lease agreements for our EECP systems, generally
for terms of one year or less, that are classified as operating leases. Revenues
from operating leases are generally recognized, in accordance with the terms of
the lease agreements, on a straight-line basis over the life of the respective
leases. For certain operating leases in which payment terms are determined on a
"fee-per-use" basis, revenues are recognized as incurred (i.e., as actual usage
occurs). The cost of the EECP system utilized under operating leases is recorded
as a component of property and equipment and is amortized to cost of equipment
rentals and services over the estimated useful life of the equipment, not to
exceed five years. There were no significant minimum rental commitments on these
operating leases at May 31, 2006.
33
Accounts Receivable/Financing Receivables
Our accounts receivable - trade are due from customers engaged in the
provision of medical services. Credit is extended based on evaluation of a
customer's financial condition and, generally, collateral is not required.
Accounts receivable are generally due 30 to 90 days from shipment and are stated
at amounts due from customers net of allowances for doubtful accounts, returns,
term discounts and other allowances. Accounts outstanding longer than the
contractual payment terms are considered past due. Estimates are used in
determining the allowance for doubtful accounts based on the Company's
historical collections experience, current trends, credit policy and a
percentage of our accounts receivable by aging category. In determining these
percentages, we look at historical write-offs of our receivables. We also look
at the credit quality of our customer base as well as changes in our credit
policies. We continuously monitor collections and payments from our 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 has in the past.
In addition, we periodically review and assess the net realizability of our
receivables arising from sales-type leases. If this review results in a lower
estimate of the net realizable value of the receivable, an allowance for the
unrealized amount is established in the period in which the estimate is changed.
In the second quarter of fiscal 2004, we decided to write-off financing
receivables under sales-type leases of approximately $680,000, respectively, as
a result of significant uncertainties with respect to this customer's ability to
meet its financial obligations.
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. Inventory on hand that exceeds two years requirements
based on forecasted demand is considered excess.
Effective June 1, 2005, we adopted the provisions of Statement of Financial
Accounting Standards No. 151, "Inventory Costs", on a prospective basis. The
statement clarifies that abnormal amounts of idle facility expense, freight,
handling costs, and wasted materials (spoilage) should be recognized as
current-period charges and requires the allocation of fixed production overheads
to inventory based on the normal capacity of the production facilities. As a
result of adopting SFAS No. 151, we absorbed approximately $256,000 less in
fixed production overheads into inventory during fiscal year 2006.
Deferred Revenues
We record revenue on extended service contracts ratably over the term of
the related contracts. In addition, we defer revenue related to EECP system
sales for the fair value of installation and in-service training to the period
when the services are rendered and for service arrangements ratably over the
service period, which is generally one year.
Warranty Costs
Equipment sold in domestic markets is generally covered by a warranty and
service arrangement period of one year. For certain arrangements, a portion of
the overall system price attributable to the first year service arrangement is
deferred and recognized as revenue over the service period. As such, we don't
accrue warranty costs upon delivery but rather recognize warranty and related
service costs as incurred.
Equipment sold to international customers through our distributor network
is generally covered by a one-year warranty period. We do not offer a service
arrangement to international customers; consequently, for these customers we
accrue a warranty reserve for estimated costs to provide warranty services when
the equipment sale is recognized.
The factors affecting our warranty liability included the number of units
sold and historical and anticipated rates of claims and costs per claim. The
warranty provision resulting from transactions prior to September 1, 2003, will
be reduced in future periods for material and labor costs incurred as related
product is returned during the warranty period or when the warranty period
elapses.
Net Loss per Common Share
Basic loss per share is based on the weighted average number of common
shares outstanding without consideration of potential common stock. Diluted loss
per share is based on the weighted number of common and potential dilutive
34
common shares outstanding. The calculation takes into account the shares that
may be issued upon the exercise of stock options and warrants, reduced by the
shares that may be repurchased with the funds received from the exercise, based
on the average price during the period
Income Taxes
Deferred income taxes are recognized for temporary differences between
financial statement and income tax bases of assets and liabilities and loss
carryforwards for which income tax benefits are expected to be realized in
future years. A valuation allowance is established, when necessary, to reduce
deferred tax assets to the amount expected to be realized. In estimating future
tax consequences, we generally consider all expected future events other than an
enactment of changes in the tax laws or rates. The deferred tax asset is
continually evaluated for realizability. To the extent our judgment regarding
the realization of the deferred tax assets changes, an adjustment to the
allowance is recorded, with an offsetting increase or decrease, as appropriate,
in income tax expense. Such adjustments are recorded in the period in which our
estimate as to the realizability of the asset changed that it is "more likely
than not" that all of the deferred tax assets will be realized. The "more likely
than not" standard is subjective, and is based upon our estimate of a greater
than 50% probability that our long range business plan can be realized.
Deferred tax liabilities and assets are classified as current or
non-current based on the classification of the related asset or liability for
financial reporting. A deferred tax liability or asset that is not related to an
asset or liability for financial reporting, including deferred tax assets
related to carryforwards, are classified according to the expected reversal date
of the temporary difference. The deferred tax asset we previously recorded
relates primarily to the realization of net operating loss carryforwards, of
which the allocation of the current portion, if any, reflected the expected
utilization of such net operating losses in the following twelve months. Such
allocation was based on our internal financial forecast and may be subject to
revision based upon actual results.
Stock-based Employee Compensation
We have five stock-based employee and director compensation plans. We
account for stock-based compensation using the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related Interpretations ("APB No. 25") and have
adopted the disclosure provisions of Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an amendment of FASB Statement No. 123." Under APB No. 25, when the exercise
price of our employee stock options equals the market price of the underlying
stock on the date of grant, no compensation expense is recognized. Accordingly,
no compensation expense has been recognized in the consolidated financial
statements in connection with employee stock option grants. For purposes of
estimating the fair value of each option on the date of grant, the Company
utilized the Black-Scholes option-pricing model. The Black-Scholes option
valuation model was developed for use in estimating the fair value of traded
options, which have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of highly subjective
assumptions including the expected stock price volatility. Because the Company's
employee stock options have characteristics significantly different from those
of traded options and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options.
Equity instruments issued to non-employees in exchange for goods, fees and
services are accounted for under the fair value-based method of SFAS No. 123.
Recently Issued Accounting Pronouncements Not Yet Effective
In December 2004, the FASB issued Statement of Financial Standards No. 123
(revised 2004), Share-Based Payment ("SFAS No. 123 (R)"), which is a revision of
SFAS No. 123. SFAS No. 123 (R) supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash
Flows. Generally, the approach to accounting for share-based payments in SFAS
No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS
No. 123(R) requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the financial statements based on
their fair values. Pro forma disclosure of the fair value of share-based
payments is no longer an alternative to financial statement recognition. SFAS
No. 123(R) is effective for small public business issuers at the beginning of
the first fiscal year beginning after December 15, 2005, and therefore effective
for the Company with the fiscal quarter ending August 31, 2006.
In May 2006, the compensation committee of the board of directors
accelerated the vesting provision of all outstanding stock options and warrants
so that they were fully vested at May 31, 2006, as a result the Company expects
the adoption of SFAS No. 123(R) to not to have an immediate material effect on
35
its financial statements, however as new on a stock options are issued the
Company does anticipate the adoption of SFAS No 123(R) will have a material
effect on its quarterly and annual financial statements, in the form of
additional compensation expense. It is not possible to precisely determine the
expense impact of adoption since a portion of the ultimate expense that is
recorded will likely relate to awards that have not yet been granted. The
expense associated with these future awards can only be determined based on
factors such as the price for the Company's common stock, volatility of the
Company's stock price and risk free interest rates as measured at the grant
date. However, the pro forma disclosures related to SFAS No. 123 included in the
Company's historic financial statements are relevant data points for gauging the
potential level of expense that might be recorded in future periods.
Statement of Financial Accounting Standards No. 152, "Accounting for Real
Estate Time-Sharing Transactions", an amendment of FASB Statements no 66 and 67
(SFAS 152) was issued in December 2004 and becomes effective for financial
statements for fiscal years beginning after June 15, 2005. The Company does not
expect that SFAS 152 will have an effect on future financial statements.
In December 2004, the 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 May 2005, the FASB issued Statement of Financial Accounting Standards
No. 154 ("SFAS No. 154"), "Accounting Changes and Error Corrections." SFAS No.
154 replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3,
Reporting Accounting Changes in Interim Financial Statements, and changes the
requirements for the accounting for and reporting of a change in accounting
principle. The Statement applies to all voluntary changes in accounting
principle. It also applies to changes required by an accounting pronouncement in
the unusual instance that the pronouncement does not include specific transition
provisions. When a pronouncement includes specific transition provisions, those
provisions should be followed. SFAS No. 154 is effective for accounting changes
and corrections of errors made in fiscal years beginning after December 15,
2005.
Statement of Financial Accounting Standards No. 155, Accounting for Certain
Hybrid Financial Instruments--an amendment of FASB Statements No. 133 and 140,
was issued in February 2006 and is effective for all financial instruments
acquired or issued after the beginning of an entity's first fiscal year that
begins after September 15, 2006. Certain parts of this Statement may be applied
prior to the adoption of this Statement. Earlier adoption is permitted as of the
beginning of an entity's fiscal year, provided the entity has not yet issued
financial statements, including financial statements for any interim period for
that fiscal year. Provisions of this Statement may be applied to instruments
that an entity holds at the date of adoption on an instrument-by-instrument
basis. The Company does not expect that SFAS 155 will have any significant
effect on future financial statements.
Statement of Financial Accounting Standards No. 156, Accounting for
Servicing of Financial Assets--an amendment of FASB Statement No. 140, pertains
to the servicing of financial assets and was issued in March 2006 and should be
adopted as of the beginning of its first fiscal year that begins after September
15, 2006. Earlier adoption is permitted as of the beginning of an entity's
fiscal year, provided the entity has not yet issued financial statements,
including interim financial statements, for any period of that fiscal year. The
Company does not expect that SFAS 156 will have any significant effect on future
financial statements.
In March 2005, FASB Interpretation No. 47, Accounting for Conditional Asset
Retirement Obligations--an interpretation of FASB Statement No. 143 (FIN 47).
FIN 47 is effective no later than the end of fiscal years ending after December
15, 2005 (December 31, 2005, for calendar-year enterprises). Retrospective
application for interim financial information is permitted but is not required.
Early adoption of this Interpretation is encouraged. The Company does not expect
that FIN 47 will have any significant effect on future financial statements.
In December 2004, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants (AcSEC) issued Statement of
Position 04-2, Accounting for Real Estate Time-Sharing Transactions (SOP 04-2).
SOP 04-2 is effective for financial statements issued for fiscal years beginning
after June 15, 2005, with earlier application encouraged. The Company does not
expect that SOP 04-2 will have any effect on future financial statements.
In September 2005, AcSEC issued Statement of Position 05-1: Accounting by
Insurance Enterprises for Deferred Acquisition Costs in Connection with
Modifications or Exchanges of Insurance Contracts (SOP 05-1). SOP 05-1 is
effective for fiscal years beginning after December 15, 2006, with earlier
adoption encouraged. The Company does not expect that SOP 05-1 will have any
effect on future financial statements.
36
FASB Staff Position (FSP) FAS 13-1--Accounting for Rental Costs Incurred
during a Construction Period, was issued on October 6, 2005, and becomes
effective for the for new transactions or arrangements entered into after the
beginning of the first fiscal quarter following the date that the final FSP is
posted by the FASB. The Company does not expect that FSP 13-1 will have any
significant effect on future financial statements.
On June 29, 2005, the FASB ratified the consensus reached for Emerging
Issues Task Force (EITF) Issue No. 05-5, Accounting for Early Retirement or
Postemployment Programs with Specific Features (Such As Terms Specified in
Altersteilzeit Early Retirement Arrangements). The consensus in this Issue
should be applied to fiscal years beginning after December 15, 2005, and
reported as a change in accounting estimate effected by a change in accounting
principle as described in paragraph 19 of FASB Statement 154. The Company does
not expect that EITF 05-5 will have any significant effect on future financial
statements.
On September 28, 2005, the FASB ratified the consensus reached for EITF
Issue No. 05-7, Accounting for Modifications to Conversion Options Embedded in
Debt Instruments and Related Issues. The provisions of this Issue should be
applied to future modifications of debt instruments beginning in the first
interim or annual reporting period beginning after December 15, 2005. The
Company expects that the application of EITF 05-7 could have an effect on
interest and debt valuations in future financial statements. It is not possible
to determine the impact, if any, from the application since the Company does not
presently have any convertible debt.
On September 28, 2005, the FASB ratified the consensus reached for EITF
Issue No. 05-8, Income Tax Consequences of Issuing Convertible Debt with a
Beneficial Conversion Feature. The provisions of this Issue should be applied
beginning in the first interim or annual reporting period beginning after
December 15, 2005. The Company expects that the application of EITF 05-8 could
have an effect on he income tax expense reported in future financial statements.
It is not possible to determine the impact, if any, from the application since
the Company does not presently have any convertible debt.
On July 13, 2006, the FASB issued Interpretation No. 48 for Uncertainty in
Income Taxes and interpretation of FASB Statement 109. Interpretation 48
clarifies the accounting for uncertainty in income taxes recognized in a
company's financial statements in accordance with Statement No. 109 and
prescribes a recognition threshold and measurement attribute for financial
statements disclosure of tax position taken or expected to be taken on a tax
return. Additionally, Interpretation No. 48 provides guidance on depreciation,
classification, interest and penalties accounting in interim periods, disclosure
and transition. Interpretation No. 48 is effective for fiscal years beginning
after December 15, 2006, with early adoption permitted. The Company is currently
evaluating whether the adoption of Interpretation No. 48 will have a material
effect on our consolidated financial position, results of operations and cash
flows.
In July 2006, the FASB issued Staff Position ("FSB") on FAS 13, FSP FAS
13-2, Accounting for a Change or Projected Change in the Timing of Cash Flows
Relating to Income Taxes Generated by a Leveraged Lease transaction. FSP FAS
13-2 addresses how a change or projected change in the timing of cash flows
relating to income taxes generated by a leveraged lease transaction affects the
accounting by a lessor for that lease and amends FAS 13 Accounting for Leases.
FSP FAS 13-2 is effective for fiscal years beginning December 15, 2006, with
earlier application permitted. The Company does not expect that FSP FAS 13-2
will have any significant effect on future financial statements.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain financial market risks, including changes in
interest rates. All of the Company's revenue, expenses and capital spending are
transacted in US dollars. Our exposure to market risk for changes in interest
rates relates primarily to our cash and cash equivalent balances, investments in
sales-type leases and the line of credit agreement. The majority of our
investments are in short-term instruments and subject to fluctuations in US
interest rates. Due to the nature of our short-term investments, we believe that
there is no material risk exposure.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements listed in the accompanying Index to
Consolidated Financial Statements are filed as part of this report.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
37
ITEM 9A - CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-15. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that as of the end of the period covered by this
report our disclosure controls and procedures are effective to ensure that
information required to be disclosed in our reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms, and are also effective to ensure
that information required to be disclosed in our reports filed or submitted
under the Exchange Act is accumulated and communicated to the Company's
management, including the principal executive and principal financial officers,
to allow timely decisions regarding required disclosure. During the fourth
fiscal quarter, there has been no change in our internal control over financial
reporting that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
ITEM 9B - OTHER INFORMATION.
None
38
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item will be included in our definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with our 2006 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this Item is intended to be included in our
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection with our 2006 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by this Item is intended to be included in our
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection with our 2006 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is intended to be included in our
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection with our 2006 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is intended to be included in our
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection with our 2006 Annual Meeting of Stockholders, and is
incorporated herein by reference.
39
PART IV
ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements and Financial Statement Schedules
----------------------------------------------------------
(1) See Index to Consolidated Financial Statements on page F-1 at
beginning of attached financial statements.
(2) The following Consolidated Financial Statement Schedule is included in
Part IV of this report:
Schedule II - Valuation and Qualifying Accounts All other schedules
are omitted because they are not applicable, or not required, or because
the required information is included in the Consolidated Financial
Statements or notes thereto.
(b) Exhibits
--------
(3) (a) Restated Certificate of Incorporation (2)
(b) By-Laws (1)
(4) (a) Specimen Certificate for Common Stock (1)
(b) Certificate of Designation of the Preferred Stock, Series A (3)
(c) Certificate of Designation of the Preferred Stock, Series B (7)
(d) Form of Rights Agreement dated as of March 9, 1995, between
Registrant and American Stock Transfer & Trust Company (5)
(e) Certificate of Designation of the Preferred Stock, Series C (8)
(f) Certificate of Designation of the Preferred Stock, Series D (18)
(g) Form of Stock Purchase Warrant (18)
(10) (a) 1995 Stock Option Plan (6)
(b) Outside Director Stock Option Plan (6)
(c) Employment Agreement dated February 1, 1995, as amended March 12,
1998, and October 10, 2001, between Registrant and John C.K. Hui
(4) (9) (13)
(d) 1997 Stock Option Plan, as amended (10)
(e) 1999 Stock Option Plan, as amended (11)
(f) Credit Agreement dated February 21, 2002, between Vasomedical,
Inc. and Fleet National Bank (12)
(g) Agreement dated October 1, 2002, between the Registrant and Peter
F. Cohn (14)
(h) Amendment and Waiver to Credit Agreement dated October 18, 2002,
between the Vasomedical, Inc. and Fleet National Bank (14)
(i) Amendment No. 2 and Waiver to Credit Agreement dated April 10,
2003, between the Registrant and Fleet National Bank (15)
(j) Employment Agreement dated September 8, 2003, between Registrant
and Thomas W. Fry (17)
(k) Subscription Agreement dated July 19, 2005, between Vasomedical,
Inc. and M.A.G. Capital LLC, Monarch Pointe Fund Ltd., Mercator
Momentum Fund III, LP and Mercator Momentum Fund, LP (the
"Investors") (18)
(l) Registration Rights Agreement, dated July 19, 2005, between
Vasomedical, Inc. and the Investors (18)
(m) Form of Employment Agreement dated June 22, 2006 between
Registrant and Thomas Glover.
(21) Subsidiaries of the Registrant
Percentage
Name State of Incorporation Owned by Company
---- ---------------------- ----------------
Viromedics, Inc. Delaware 61%
180 Linden Avenue Corp. New York 100%
(23.1) Consent of Miller Ellin & Company, LLP
(23.2) Consent of Grant Thornton LLP
(31) Certification Reports pursuant to Securities Exchange Act Rule
13a - 14
(32) Certification Reports pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
--------------------------
(1) Incorporated by reference to Registration Statement on Form S-18, No.
33-24095.
(2) Incorporated by reference to Registration Statement on Form S-1, No.
33-46377 (effective 7/12/94).
(3) Incorporated by reference to Report on Form 8-K dated November 14,
1994.
(4) Incorporated by reference to Report on Form 8-K dated January 24,
1995.
(5) Incorporated by reference to Registration Statement on Form 8-A dated
May 12, 1995.
40
(6) Incorporated by reference to Notice of Annual Meeting of Stockholders
dated December 5, 1995.
(7) Incorporated by reference to Report on Form 8-K dated June 25, 1997.
(8) Incorporated by reference to Report on Form 8-K dated April 30, 1998.
(9) Incorporated by reference to Report on Form 10-K for the fiscal year
ended May 31, 1998.
(10) Incorporated by reference to Report on Form 10-K for the fiscal year
ended May 31, 1999
(11) Incorporated by reference to Report on Form 10-K for the fiscal year
ended May 31, 2000.
(12) Incorporated by reference to Report on Form 10-Q for the quarterly
period ended February 28, 2002.
(13) Incorporated by reference to Report on Form 10-K for the fiscal year
ended May 31, 2002.
(14) Incorporated by reference to Report on Form 10-Q for the quarterly
period ended November 30, 2002.
(15) Incorporated by reference to Report on Form 10-Q for the quarterly
period ended February 28, 2003.
(16) Incorporated by reference to Report on Form 10-Q for the quarterly
period ended February 29, 2004.
(17) Incorporated by reference to Report on Form 8-K dated July 19, 2005.
41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, we have duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized on the 28th day of August, 2006.
VASOMEDICAL, INC.
By: /s/ Thomas Glover
-----------------------------------------------
Thomas Glover
President, Chief Executive Officer and Director
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on August 24, 2006, by the following persons in the
capacities indicated:
/s/ Thomas Glover President, Chief Executive Officer and Director
Thomas Glover (Principal Executive Officer)
/s/ Abraham E. Cohen Chairman of the Board
Abraham E. Cohen
/s/ Thomas W. Fry Chief Financial Officer (Principal Financial and
Thomas W. Fry Accounting Officer)
/s/ John C.K. Hui Senior Vice President, Chief Technology Officer and
John C.K. Hui Director
/s/ Photios T. Paulson Director
Photios T. Paulson
/s/ Kenneth W. Rind Director
Kenneth W. Rind
/s/ Martin Zeiger Director
Martin Zeiger
42
Vasomedical, Inc. and Subsidiaries
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Reports of Independent Registered Public Accounting Firms F-1 to F-2
Financial Statements
Consolidated Balance Sheets as of May 31, 2006 and 2005 F-3
Consolidated Statements of Operations for the
years ended May 31, 2006, 2005 and 2004 F-4
Consolidated Statement of Changes in Stockholders'
Equity for the years ended May 31, 2006, 2005 and 2004 F-5
Consolidated Statements of Cash Flows for the
years ended May 31, 2006, 2005 and 2004 F-6 to F-7
Notes to Consolidated Financial Statements F-8 to F-27
Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts S-1
i
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Vasomedical, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of Vasomedical, Inc.
and Subsidiaries (the "Company") as of May 31, 2006, and the related
consolidated statement of operations, stockholders' equity and cash flow for the
period ended May 31, 2006. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit. The Financial Statements of
Vasomedical, Inc. and Subsidiaries as of May 31, 2005 and 2004, were audited by
other auditors whose report dated July 29, 2005, expressed an unqualified
opinion.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Vasomedical, Inc. and Subsidiaries as of May 31, 2006 and the consolidated
results of their operations and their consolidated cash flow for the year ended
May 31, 2006 in conformity with accounting principles generally accepted in the
United States of America.
Our audit was conducted for the purpose of forming an opinion on the basic
financial statements taken as a whole. The financial statement schedule,
Schedule II, Valuation and Qualifying Accounts, is presented for the purposes of
additional analysis and is not a required part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, is fairly
stated in all material respects in relation to the basic financial statements
taken as a whole.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note A to the
financial statements, the Company has suffered recurring losses from operations
and a net capital deficiency that raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note A. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ Miller Ellin & Company, LLP
MILLER ELLIN & COMPANY, LLP
New York, New York
August 5, 2006
F - 1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Vasomedical, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of Vasomedical,
Inc. and Subsidiaries (the "Company") as of May 31, 2005, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the two years in the period ended May 31, 2005. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform an audit of its internal
control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Vasomedical, Inc. and Subsidiaries as of May 31, 2005, and the consolidated
results of their operations and their consolidated cash flows for each of the
two years in the period ended May 31, 2005 in conformity with accounting
principles generally accepted in the United States of America.
As described in Note A to the consolidated financial statements, the
Company adopted the provisions of the Emerging Issues Task Force, Issue No.
00-21, "Revenue Arrangements with Multiple Deliverables", on September 1, 2003.
Our audit was conducted for the purpose of forming an opinion on the basic
financial statements taken as a whole. The financial statement schedule,
Schedule II, Valuation and Qualifying Accounts, is presented for the purposes of
additional analysis and is not a required part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, is fairly
stated in all material respects in relation to the basic financial statements
taken as a whole.
/s/ GRANT THORNTON LLP
Melville, New York
July 29, 2005
F - 2
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
May 31,
2006 2005
----------------- -----------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $2,385,778 $989,524
Certificates of deposit -- 1,758,443
Accounts receivable, net of an allowance for doubtful accounts of
$410,691 and $394,692 at May 31, 2006 and 2005, respectively 843,282 1,892,002
Inventories, net 2,699,673 3,360,272
Other current assets 108,049 223,902
----------------- -----------------
Total current assets 6,036,782 8,224,143
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,613,180
and $2,626,983 at May 31, 2006 and 2005, respectively 1,569,588 2,234,153
DEFERRED INCOME TAXES -- 14,582,000
OTHER ASSETS 305,670 321,174
----------------- -----------------
$7,912,040 $25,361,470
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $938,095 $1,569,131
Current maturities of long-term debt and notes payable 97,309 148,212
Sales tax payable 172,646 216,753
Deferred revenue 1,600,887 1,667,080
Accrued director fees and executive compensation 175,000 --
Accrued warranty and customer support expenses 30,500 110,583
Accrued professional fees 61,875 401,511
Accrued commissions 93,182 178,104
----------------- -----------------
Total current liabilities 3,169,494 4,291,374
LONG-TERM DEBT 853,189 947,597
ACCRUED WARRANTY COSTS 1,500 7,750
DEFERRED REVENUE 721,701 884,452
OTHER LONG-TERM LIABILITIES -- 67,500
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;
65,198,592 and 58,552,688 shares at May 31, 2006 and 2005,
respectively, issued and outstanding 65,198 58,552
Additional paid-in capital 46,148,493 51,450,639
Accumulated deficit (43,047,535) (32,346,394)
----------------- -----------------
Total stockholders' equity 3,166,156 19,162,797
----------------- -----------------
$7,912,040 $25,361,470
================= =================
The accompanying notes are an integral part of these financial statements.
F - 3
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended May 31,
-------------------------------------------------
2006 2005 2004
-------------- ------------- -------------
Revenues
Equipment sales $6,820,980 $11,516,883 $19,302,593
Equipment rentals and services 4,122,017 3,578,895 2,904,444
-------------- ------------- -------------
Total revenues 10,942,997 15,095,778 22,207,037
Cost of Sales and Services
Cost of sales, equipment 3,374,194 4,223,523 6,309,119
Cost of equipment rentals and services 1,400,135 1,281,012 1,280,984
-------------- ------------- -------------
Total cost of sales and services 4,774,329 5,504,535 7,590,103
-------------- ------------- -------------
Gross profit 6,168,668 9,591,243 14,616,934
Operating Expenses
Selling, general and administrative 7,865,533 12,006,774 12,910,997
Research and development 1,805,667 3,064,683 3,748,389
Provision for doubtful accounts 110,317 11,084 1,296,759
-------------- ------------- -------------
Total operating expenses 9,781,517 15,082,541 17,956,145
-------------- ------------- -------------
LOSS FROM OPERATIONS (3,612,849) (5,491,298) (3,339,211)
Other Income (Expenses)
Interest and financing costs (81,662) (105,232) (132,062)
Interest and other income, net 75,508 74,153 99,393
-------------- ------------- -------------
Total other income (expenses) (6,154) (31,079) (32,669)
-------------- ------------- -------------
LOSS BEFORE INCOME TAXES (3,619,003) (5,522,377) (3,371,880)
Income tax expense, net (7,082,138) (39,661) (50,640)
-------------- ------------- -------------
NET LOSS (10,701,141) (5,562,038) (3,422,520)
Preferred stock dividend (877,870) -- --
-------------- ------------- -------------
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS $(11,579,011) $(5,562,038) $(3,422,520)
============== ============= =============
Net loss per common share
- basic $(0.19) $(0.10) $(0.06)
============== ============= =============
- diluted $(0.19) $(0.10) $(0.06)
============== ============= =============
Weighted average common shares outstanding
- basic 61,351,323 58,547,574 57,981,963
============== ============= =============
- diluted 61,351,323 58,547,574 57,981,963
============== ============= =============
The accompanying notes are an integral part of these financial statements.
F - 4
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Additional Total
Preferred Stock Common Stock Paid-in- Accumulated Stockholders'
Share Amount Shares Amount Capital Deficit Equity
---------- --------------- ----------- -------------- ------------ ------------- ------------
Balance at May 31, 2003 -- -- 57,822,023 $57,822 $50,623,316 $(23,361,836) $27,319,302
Exercise of options and warrants 597,333 597 696,790 697,387
Net loss (3,422,520) (3,422,520)
---------- --------------- ----------- -------------- ------------ ------------- ------------
Balance at May 31, 2004 -- -- 58,419,356 58,419 51,320,106 (26,784,356) 24,594,169
Exercise of options and warrants 133,332 133 130,533 130,666
Net loss (5,562,038) (5,562,038)
---------- --------------- ----------- -------------- ------------ ------------- ------------
Balance at May 31, 2005 -- -- 58,552,688 $58,552 51,450,639 (32,346,394) 19,162,797
Issuance of Series D convertible
preferred stock, net of costs 25,000 $250 1,613,209 1,613,459
Warrants issued in connection
with the issuance of Series D
convertible preferred stock
issued 411,158 411,158
Beneficial conversion feature
embedded in Series D convertible
preferred stock 786,247 786,247
Dividends of Series D convertible
preferred stock (877,870) (877,870)
Issuance of common stock in
connection with the conversion
of Series D convertible
preferred stock (25,000) (250) 6,112,209 6,112 (5,862) --
Issuance of common stock in
payment of outside director
fees 225,000 225 101,025 101,250
Issuance of common stock in
payment of a consulting fee 308,695 309 150,691 151,000
Issuance of stock options in
payment of a consulting fee 8,256 8,256
Reserve for tax benefit of
stock options and warrants
exercised in prior years (7,489,000) (7,489,000)
Net loss (10,701,141) (10,701,141)
---------- --------------- ----------- -------------- ------------ ------------- ------------
Balance at May 31, 2006 -- -- 65,198,592 $65,198 $46,148,493 $(43,047,535) $3,166,156
========== =============== =========== ============== ============ ============= ============
The accompanying notes are an integral part of this financial statement.
F - 5
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended May 31,
-------------------------------------------------
2006 2005 2004
-------------- ------------- -------------
Cash flows from operating activities
Net loss $(10,701,141) $(5,562,038) $(3,422,520)
-------------- ------------- -------------
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities
Depreciation and amortization 518,176 578,530 749,111
Provision for doubtful accounts, net of write-offs 110,317 11,084 616,759
Reserve for excess and obsolete inventory 152,004 166,672 119,000
Deferred income taxes 7,093,000 -- --
Common stock issued for services 126,250 -- --
Stock options granted for services 8,256 -- --
Changes in operating assets and liabilities
Accounts receivable 938,403 3,618,767 1,923,284
Financing receivables, net -- -- 258,608
Inventories 699,371 (1,295,294) 1,187,761
Other current assets 115,853 48,611 (4,282)
Other assets (28,883) (63,649) (69,610)
Accounts payable, accrued expenses and other
current liabilities (1,070,978) (1,662,193) 517,056
Other liabilities (236,501) (435,074) (38,907)
-------------- ------------- -------------
8,425,268 967,454 5,258,780
-------------- ------------- -------------
Net cash provided by (used in) operating activities (2,275,873) (4,594,584) 1,836,260
-------------- ------------- -------------
Cash flows provided by (used in) investing activities
Purchase of certificates of deposit and treasury -- (3,747,903) (1,180,540)
bills
Redemptions of certificates and deposit and 1,758,443 3,170,000 --
treasury bills
Purchase of property and equipment -- (200,198) (153,954)
-------------- ------------- -------------
Net cash provided by (used in) investing activities 1,758,443 (778,101) (1,334,494)
-------------- ------------- -------------
Cash flows provided by (used in) financing activities
Payments on long term debt and notes payable (447,363) (133,506) (124,100)
Payments on preferred stock dividends (91,623) -- --
Payments on preferred stock issue costs (349,382) -- --
Proceeds from notes payable 302,052 -- 67,149
Proceeds from exercise of options and warrants -- 130,666 697,387
Proceeds from sale of convertible preferred stock 2,500,000 -- --
-------------- ------------- -------------
Net cash provided by (used in) financing activities 1,913,684 (2,840) 640,436
-------------- ------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 1,396,254 (5,375,525) 1,142,202
-------------- ------------- -------------
Cash and cash equivalents - beginning of year 989,524 6,365,049 5,222,847
-------------- ------------- -------------
Cash and cash equivalents - end of year $2,385,778 $ 989,524 $6,365,049
============== ============= =============
The accompanying notes are an integral part of these financial statements.
F - 6
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
Year ended May 31,
-------------------------------------------------
2006 2005 2004
-------------- ------------- -------------
NON-CASH INVESTING AND FINANCING ACTIVITIES WERE AS FOLLOWS:
Inventories transferred from property and equipment,
attributable to operating leases - net $190,776 $142,098 $240,942
Issue of note for purchase of insurance policy $302,052 -- --
Preferred stock dividends $786,247 -- --
Preferred issue costs $227,087 -- --
SUPPLEMENT DISCLOSURES:
Interest paid $81,662 $105,232 $105,194
Income taxes paid $22,923 $19,888 $24,213
The accompanying notes are an integral part of these financial statements.
F - 7
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
NOTE A - ORGANIZATION AND PLAN OF OPERATIONS
The Company was incorporated in Delaware in July 1987. During fiscal 1996,
the Company commenced the commercialization of its EECP external
counterpulsation system ("EECP"), a microprocessor-based medical device for the
noninvasive, outpatient treatment of patients with cardiovascular disease. EECP
is marketed worldwide to hospitals and physician private practices. To date, the
Company's revenues have been generated primarily from customers in the United
States.
The Company has incurred large declines in revenue and significant
operating losses during the last three fiscal years and its ability to continue
operating as a going concern is dependent upon achieving profitability or
through additional debt or equity financing. Achieving profitability is largely
dependent on sufficiently reducing operating costs and halting the current trend
of declining revenue. The Company's ability to halt the declines in revenue and
restore its revenue base of revenue is largely dependent upon restructuring its
sales and marketing efforts in the refractory angina market and operating in a
more efficient manner. If the Company is not able to restore its revenue base
and sufficiently reduce operating costs to generate an adequate cash inflow, or
raise additional capital, it will not be able to continue as a going concern.
In order to reduce the Company's cash usage and bring its cost structure
more into alignment with current revenue, the Company initiated a restructuring
in January 2006, to reduce personnel and spending on marketing and development
projects. Additional cost reductions are continuing. In addition, in April 2006,
the outside directors of the Company elected to defer payment of board of
director meeting fees and senior officers elected to defer approximately $0.4
million in annual salary compensation. However, revenue has continued to decline
and the Company has not achieved its goal of profitability.
Management believes that cash flow from operations together with current
cash reserves will be sufficient to fund minimum projected capital requirements
through at least the end of the calendar year.
In the event that additional capital is required, the Company may seek to
raise such capital through public or private equity or debt financings or by
other means. The Company may not be able to obtain additional financing on
favorable terms or at all. If the Company is unable to raise additional funds
when needed, it may need to further scale back operations, research, marketing
or sales efforts or obtain funds through arrangements with collaborative
partners or others that may require the Company to license or relinquish rights
to technologies or products. Future capital funding, if available, may result in
dilution to current shareholders, and new investors could have rights superior
to existing stockholders.
The accompanying financial statements do not include any adjustments that
might be necessary if the Company is unable to continue as a going concern.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies consistently applied in
the preparation of the consolidated financial statements follows:
Reclassifications
Certain reclassifications have been made to prior years' amounts to conform
with the current year's presentation.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company,
its wholly-owned subsidiary and its inactive majority-owned subsidiary.
Significant intercompany accounts and transactions have been eliminated.
Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists,
delivery has occurred or service has been rendered, the price is fixed or
determinable and collectibility is reasonably assured. In the United States, we
recognize revenue from the sale of our EECP systems in the period in which we
deliver the system to the customer. Revenue from the sale of our EECP systems to
international markets is recognized upon shipment, during the period in which we
deliver the product to a common carrier, as are supplies, accessories and spare
parts delivered to both domestic and international customers. Returns are
accepted prior to the in-service and training subject to a 10% restocking charge
or for normal warranty matters, and we are not obligated for post-sale upgrades
to these systems. In addition, we use the installment method to record revenue
F - 8
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
based on cash receipts in situations where the account receivable is collected
over an extended period of time and in our judgment the degree of collectibility
is uncertain.
In most cases, revenue from domestic EECP system sales is generated from
multiple-element arrangements that require judgment in the areas of customer
acceptance, collectibility, the separability of units of accounting, and the
fair value of individual elements. Effective September 1, 2003, we adopted the
provisions of Emerging Issues Task Force, or EITF, Issue No. 00-21, "Revenue
Arrangements with Multiple Deliverables", ("EITF 00-21"), on a prospective
basis. The principles and guidance outlined in EITF 00-21 provide a framework to
determine (a) how the arrangement consideration should be measured (b) whether
the arrangement should be divided into separate units of accounting, and (c) how
the arrangement consideration should be allocated among the separate units of
accounting. We determined that the domestic sale of our EECP systems includes a
combination of three elements that qualify as separate units of accounting:
i. EECP equipment sale,
ii. provision of in-service and training support consisting of equipment
set-up and training provided at the customer's facilities, and
iii. a service arrangement (usually one year), consisting of: service by
factory-trained service representatives, material and labor costs,
emergency and remedial service visits, preventative maintenance,
software upgrades, technical phone support and preferred response
times.
Each of these elements represent individual units of accounting as the
delivered item has value to a customer on a stand-alone basis, objective and
reliable evidence of fair value exists for undelivered items, and arrangements
normally do not contain a general right of return relative to the delivered
item. We determine fair value based on the price of the deliverable when it is
sold separately or based on third-party evidence. In accordance with the
guidance in EITF 00-21, we use the residual method to allocate the arrangement
consideration when it does not have fair value of the EECP system sale. Under
the residual method, the amount of consideration allocated to the delivered item
equals the total arrangement consideration less the aggregate fair value of the
undelivered items. Assuming all other criteria for revenue recognition have been
met, we recognize revenue for:
i. EECP equipment sales, when delivery and acceptance occurs based on
delivery and acceptance documentation received from independent
shipping companies or customers,
ii. in-service and training, following documented completion of the
training, and
iii. the service arrangement, ratably over the service period, which is
generally one year.
In-service and training generally occurs within three weeks of shipment and
our return policy states that no returns will be accepted after in-service and
training has been completed. The amount related to in-service and training is
recognized as equipment revenue at the time the in-service and training is
completed and the amount related to service arrangements is recognized ratably
over the related service period, which is generally one year. Costs associated
with the provision of in-service and training and the service arrangement,
including salaries, benefits, travel, spare parts and equipment, are recognized
in cost of equipment sales as incurred.
We also recognize revenue generated from servicing EECP systems that are no
longer covered by the service arrangement, or by providing sites with additional
training, in the period that these services are provided. Revenue related to
future commitments under separately priced extended service agreements on our
EECP system are deferred and recognized ratably over the service period,
generally ranging from one year to four years. Costs associated with the
provision of service and maintenance, including salaries, benefits, travel,
spare parts and equipment, are recognized in cost of sales as incurred. Amounts
billed in excess of revenue recognized are included as deferred revenue in the
consolidated balance sheets.
Revenues from the sale of EECP systems through our international
distributor network are generally covered by a one-year warranty period. We do
not offer a service arrangement to international customers; consequently, for
these customers we accrue a warranty reserve for estimated costs to provide
warranty services when the equipment sale is recognized.
We have also entered into lease agreements for our EECP systems, generally
for terms of one year or less, that are classified as operating leases. Revenues
from operating leases are generally recognized, in accordance with the terms of
the lease agreements, on a straight-line basis over the life of the respective
leases. For certain operating leases in which payment terms are determined on a
F - 9
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
coverage policy in scope. We estimate that over 300 private insurers are
reimbursing for EECP therapy for the treatment of angina today at favorable
payment levels and we expect that the number of private insurers and their
related health plans that provide for EECP therapy as a covered benefit will
continue to increase. In addition, we are aware of two third-party payers that
have begun limited coverage of EECP therapy for the treatment of CHF.
Accounts Receivable/Financing Receivables
Our accounts receivable - trade are due from customers engaged in providing
medical services. Credit is extended based on evaluation of a customer's
financial condition and, generally, collateral is not required. Accounts
receivable are generally due 30 to 90 days from shipment and are stated at
amounts due from customers net of allowances for doubtful accounts, returns,
term discounts and other allowances. Accounts outstanding longer than the
contractual payment terms are considered past due. Estimates are used in
determining the allowance for doubtful accounts based on the Company's
historical collections experience, current trends, credit policy and a
percentage of our accounts receivable by aging category. In determining these
percentages, we look at historical write-offs of our receivables. We also look
at the credit quality of our customer base as well as changes in our credit
policies. We continuously monitor collections and payments from our 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 has in the past.
The changes in the Company's allowance for doubtful accounts are as
follows:
Year Ended May 31,
-----------------------------------------------------------
2006 2005 2004
------------------- --------------- ----------------
Beginning balance $394,692 $699,203 $768,629
Provision for losses on accounts 110,317
receivable 11,084 616,759
Direct write-offs, net of recoveries (94,318) (315,595) (686,185)
------------------- --------------- ----------------
Ending balance $410,691 $394,692 $699,203
=================== =============== ================
In addition, we periodically review and assess the net realizability of our
receivables arising from sales-type leases. If this review results in a lower
estimate of the net realizable value of the receivable, an allowance for the
unrealized amount is established in the period in which the estimate is changed.
In the second quarter of fiscal 2004, we decided to write-off financing
receivables under sales-type leases of approximately $680,000, respectively, as
a result of significant uncertainties with respect to this customer's ability to
meet its financial obligations. (See Note E).
The changes in our allowance for financing receivables, which primarily
relates to balloon payments due at lease end, are as follows:
Year Ended May 31,
-----------------------------------------------------
2006 2005 2004
--------------- --------------- ---------------
Beginning balance $-- $-- $244,994
Provision for losses on financing
receivables -- -- 680,000
Direct write-offs -- -- (924,994)
--------------- --------------- ---------------
Ending balance $-- $-- $--
=============== =============== ===============
Concentrations of Credit Risk
We market the EECP system principally to hospitals and physician private
practices. We perform credit evaluations of its customers' financial condition
and, as a consequence, believe that our receivable credit risk exposure is
limited. Receivables are generally due 30 to 90 days from shipment. For the
years ended May 31, 2006 and 2005 and 2004, no customer accounted for 10% or
more of revenues. For the year ended May 31, 2006, no customer accounted for 10%
or more of accounts receivable. As of May 31, 2005, one customer accounted for
13% of accounts receivable.
F - 10
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
Our revenues were derived from the following geographic areas:
Year Ended May 31,
------------------------------------------------------
2006 2005 2004
--------------- --------------- ---------------
Domestic (United States) $10,079,789 $13,673,293 $21,339,267
Non-domestic (foreign) 863,208 1,422,485 867,770
--------------- --------------- ---------------
$10,942,997 $15,095,778 $22,207,037
=============== =============== ===============
Cash and Cash Equivalents
Cash and cash equivalents represent cash and short-term, highly liquid
investments in certificates of deposit, treasury bills, money market funds, and
investment grade commercial paper issued by major corporations and financial
institutions that generally have maturities of three months or less. Realized
and unrealized gains and losses and declines in value, if any, are charged to
earnings. Dividend and interest income are recognized when earned. The cost of
securities sold is calculated using the specific identification method. (See
Note C)
Certificates of Deposit
Included in this caption are all certificates of deposit that have original
maturities of greater than three months. Realized and unrealized gains and
losses and declines in value, if any, are included in earnings. Dividend and
interest income are recognized when earned. The cost of securities sold is
calculated using the specific identification method. (See Note C)
Inventories, net
We value inventory at the lower of cost or estimated market, cost being
determined on a first-in, first-out basis. We often place EECP systems at
various field locations for demonstration, training, evaluation, and other
similar purposes at no charge. The cost of these EECP systems is transferred to
property and equipment and is amortized over the next two to five years. 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. Inventory on hand that exceeds two years requirements
based on forecasted demand is considered excess.
Effective June 1, 2005, we adopted the provisions of Statement of Financial
Accounting Standards No. 151, "Inventory Costs", on a prospective basis. The
statement clarifies that abnormal amounts of idle facility expense, freight,
handling costs, and wasted materials (spoilage) should be recognized as
current-period charges and requires the allocation of fixed production overheads
to inventory based on the normal capacity of the production facilities. As a
result of adopting SFAS No. 151, approximately $256,000 in fixed production
overheads was not absorbed into inventory at May 31, 2006. (See Note D)
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and
amortization. Major improvements are capitalized and minor replacements,
maintenance and repairs are charged to expense as incurred. Upon retirement or
disposal of assets, the cost and related accumulated depreciation are removed
from the consolidated balance sheets. Depreciation is provided over the
estimated useful lives of the assets, which range from two to thirty-nine years,
on a straight-line basis. Accelerated methods of depreciation are used for tax
purposes. We amortize leasehold improvements over the useful life of the related
leasehold improvement or the life of the related lease, whichever is less. (See
Note F)
Deferred Revenues
We record revenue on extended service contracts ratably over the term of
the related contracts. In addition, we defer revenue related to EECP system
sales for the fair value of installation and in-service training to the period
when the services are rendered and for service arrangements ratably over the
service period, which is generally one year. (See Note G)
F - 11
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
Warranty Costs
Equipment sold in domestic markets is generally covered by a warranty and
service arrangement period of one year. For certain arrangements, a portion of
the overall system price attributable to the first year service arrangement is
deferred and recognized as revenue over the service period. As such, we don't
accrue warranty costs upon delivery but rather recognize warranty and related
service costs as incurred.
Equipment sold to international customers through our distributor network
is generally covered by a one-year warranty period. We do not offer a service
arrangement to international customers; consequently, for these customers we
accrue a warranty reserve for estimated costs to provide warranty services when
the equipment sale is recognized.
The factors affecting our warranty liability included the number of units
sold and historical and anticipated rates of claims and costs per claim. The
warranty provision resulting from transactions prior to September 1, 2003, will
be reduced in future periods for material and labor costs incurred as related
product is returned during the warranty period or when the warranty period
elapses. (See Note H)
Research and Development
Research and development costs are expensed as incurred. Included in
research and development costs is amortization expense related to the cost of
EECP systems under loan for clinical trials.
Income Taxes
Deferred income taxes are recognized for temporary differences between
financial statement and income tax bases of assets and liabilities and loss
carryforwards for which income tax benefits are expected to be realized in
future years. A valuation allowance is established, when necessary, to reduce
deferred tax assets to the amount expected to be realized. In estimating future
tax consequences, we generally consider all expected future events other than an
enactment of changes in the tax laws or rates. The deferred tax asset is
continually evaluated for realizability. To the extent our judgment regarding
the realization of the deferred tax assets changes, an adjustment to the
allowance is recorded, with an offsetting increase or decrease, as appropriate,
in income tax expense. Such adjustments are recorded in the period in which our
estimate as to the realizability of the asset changed that it is "more likely
than not" that all of the deferred tax assets will be realized. The "more likely
than not" standard is subjective, and is based upon our estimate of a greater
than 50% probability that our long range business plan can be realized.
Deferred tax liabilities and assets are classified as current or
non-current based on the classification of the related asset or liability for
financial reporting. A deferred tax liability or asset that is not related to an
asset or liability for financial reporting, including deferred tax assets
related to carryforwards, are classified according to the expected reversal date
of the temporary difference. The deferred tax asset we previously recorded
relates primarily to the realization of net operating loss carryforwards, of
which the allocation of the current portion, if any, reflected the expected
utilization of such net operating losses in the following twelve months. Such
allocation was based on our internal financial forecast and may be subject to
revision based upon actual results. (See Note L)
Shipping and Handling Costs
All shipping and handling expenses are incurred as a component of cost of
sales. Amounts billed to customers related to shipping and handling costs are
included as a component of sales.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, accounts receivable and
accounts payable approximate fair value due to the short-term maturities of the
instruments. The carrying amount of the financing receivables approximates fair
value as the interest rates implicit in the leases approximate current market
interest rates for similar financial instruments. The carrying amounts of notes
payable approximates their fair value as the interest rates of these instruments
approximate the interest rates available on instruments with similar terms and
maturities.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Significant estimates and
assumptions relate to estimates of collectibility of accounts receivable and
F - 12
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
financing receivables, the realizability of deferred tax assets, and the
adequacy of inventory and warranty reserves. Actual results could differ from
those estimates.
Net Loss Per Common Share
Basic loss per share are based on the weighted average number of common
shares outstanding without consideration of potential common stock. Diluted loss
per share are based on the weighted number of common and potential dilutive
common shares outstanding. The calculation takes into account the shares that
may be issued upon the exercise of stock options and warrants, reduced by the
shares that may be repurchased with the funds received from the exercise, based
on the average price during the period
Stock-Based Employee Compensation
We have five stock-based employee and director compensation plans. We
account for stock-based compensation using the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related Interpretations ("APB No. 25") and have
adopted the disclosure provisions of Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an amendment of FASB Statement No. 123." Under APB No. 25, when the exercise
price of our employee stock options equals the market price of the underlying
stock on the date of grant, no compensation expense is recognized. Accordingly,
no compensation expense has been recognized in the consolidated financial
statements in connection with employee stock option grants.
The following table illustrates the effect on net income and earnings per
share had we applied the fair value recognition provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," to stock-based employee compensation.
Year Ended May 31,
-----------------------------------------------------
2006 2005 2004
--------------- --------------- ---------------
Net loss attributable to common shareholders,
as reported $(11,579,011) $(5,562,038) $(3,422,520)
Deduct: Total stock-based employee compensation
expense determined under fair value-based
method for all awards (2,173,828) (1,097,783) (1,080,817)
--------------- --------------- ---------------
Pro forma net loss $(13,752,839) $(6,659,821) $(4,503,337)
=============== =============== ===============
Loss per share:
Basic and diluted - as reported $(0.19) $(0.10) $(0.06)
Basic and diluted - pro forma $(0.22) $(0.11) $(0.08)
For purposes of estimating the fair value of each option on the date of
grant, the Company utilized the Black-Scholes option-pricing model. The
Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
F - 13
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
The fair value of the Company's stock-based awards was estimated assuming
no expected dividends and the following weighted-average assumptions:
Year Ended May 31,
-----------------------------------------------------
2006 2005 2004
--------------- --------------- --------------
Expected life (years) 5 5 5
Expected volatility 83% 81% 89%
Risk-free interest rate 4.5% 4.4% 3.4%
Expected dividend yield 0.0% 0.0% 0.0%
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 Pronouncements Not Yet Effective
In December 2004, the FASB issued Statement of Financial Standards No. 123
(revised 2004), Share-Based Payment ("SFAS No. 123 (R)"), which is a revision of
SFAS No. 123. SFAS No. 123 (R) supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash
Flows. Generally, the approach to accounting for share-based payments in SFAS
No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS
No. 123(R) requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the financial statements based on
their fair values. Pro forma disclosure of the fair value of share-based
payments is no longer an alternative to financial statement recognition. SFAS
No. 123(R) is effective for small public business issuers at the beginning of
the first fiscal year beginning after December 15, 2005, and therefore effective
for the Company with the fiscal quarter ending August 31, 2006.
In May 2006, the compensation committee of the board of directors
accelerated the vesting provision of all outstanding stock options and warrants
so that they were fully vested at May 31, 2006, as a result the Company expects
the adoption of SFAS No. 123(R) to not to have an immediate material effect on
its financial statements, however as new on a stock options are issued the
Company does anticipate the adoption of SFAS No 123(R) will have a material
effect on its quarterly and annual financial statements, in the form of
additional compensation expense. It is not possible to precisely determine the
expense impact of adoption since a portion of the ultimate expense that is
recorded will likely relate to awards that have not yet been granted. The
expense associated with these future awards can only be determined based on
factors such as the price for the Company's common stock, volatility of the
Company's stock price and risk free interest rates as measured at the grant
date. However, the pro forma disclosures related to SFAS No. 123 included in the
Company's historic financial statements are relevant data points for gauging the
potential level of expense that might be recorded in future periods.
Statement of Financial Accounting Standards No. 152, "Accounting for Real
Estate Time-Sharing Transactions", an amendment of FASB Statements no 66 and 67
(SFAS 152) was issued in December 2004 and becomes effective for financial
statements for fiscal years beginning after June 15, 2005. The Company does not
expect that SFAS 152 will have an effect on future financial statements.
In December 2004, the 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 May 2005, the FASB issued Statement of Financial Accounting Standards
No. 154 ("SFAS No. 154"), "Accounting Changes and Error Corrections." SFAS No.
154 replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3,
Reporting Accounting Changes in Interim Financial Statements, and changes the
requirements for the accounting for and reporting of a change in accounting
principle. The Statement applies to all voluntary changes in accounting
principle. It also applies to changes required by an accounting pronouncement in
the unusual instance that the pronouncement does not include specific transition
F - 14
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
provisions. When a pronouncement includes specific transition provisions, those
provisions should be followed. SFAS No. 154 is effective for accounting changes
and corrections of errors made in fiscal years beginning after December 15,
2005.
Statement of Financial Accounting Standards No. 155, Accounting for Certain
Hybrid Financial Instruments--an amendment of FASB Statements No. 133 and 140,
was issued in February 2006 and is effective for all financial instruments
acquired or issued after the beginning of an entity's first fiscal year that
begins after September 15, 2006. Certain parts of this Statement may be applied
prior to the adoption of this Statement. Earlier adoption is permitted as of the
beginning of an entity's fiscal year, provided the entity has not yet issued
financial statements, including financial statements for any interim period for
that fiscal year. Provisions of this Statement may be applied to instruments
that an entity holds at the date of adoption on an instrument-by-instrument
basis. The Company does not expect that SFAS 155 will have any significant
effect on future financial statements.
Statement of Financial Accounting Standards No. 156, Accounting for
Servicing of Financial Assets--an amendment of FASB Statement No. 140, pertains
to the servicing of financial assets and was issued in March 2006 and should be
adopted as of the beginning of its first fiscal year that begins after September
15, 2006. Earlier adoption is permitted as of the beginning of an entity's
fiscal year, provided the entity has not yet issued financial statements,
including interim financial statements, for any period of that fiscal year. The
Company does not expect that SFAS 156 will have any significant effect on future
financial statements.
In March 2005, FASB Interpretation No. 47, Accounting for Conditional Asset
Retirement Obligations--an interpretation of FASB Statement No. 143 (FIN 47).
FIN 47 is effective no later than the end of fiscal years ending after December
15, 2005 (December 31, 2005, for calendar-year enterprises). Retrospective
application for interim financial information is permitted but is not required.
Early adoption of this Interpretation is encouraged. The Company does not expect
that FIN 47 will have any significant effect on future financial statements.
In December 2004, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants (AcSEC) issued Statement of
Position 04-2, Accounting for Real Estate Time-Sharing Transactions (SOP 04-2).
SOP 04-2 is effective for financial statements issued for fiscal years beginning
after June 15, 2005, with earlier application encouraged. The Company does not
expect that SOP 04-2 will have any effect on future financial statements.
In September 2005, AcSEC issued Statement of Position 05-1: Accounting by
Insurance Enterprises for Deferred Acquisition Costs in Connection with
Modifications or Exchanges of Insurance Contracts (SOP 05-1). SOP 05-1 is
effective for fiscal years beginning after December 15, 2006, with earlier
adoption encouraged. The Company does not expect that SOP 05-1 will have any
effect on future financial statements.
FASB Staff Position (FSP) FAS 13-1--Accounting for Rental Costs Incurred
during a Construction Period, was issued on October 6, 2005, and becomes
effective for the for new transactions or arrangements entered into after the
beginning of the first fiscal quarter following the date that the final FSP is
posted by the FASB. The Company does not expect that FSP 13-1 will have any
significant effect on future financial statements.
On June 29, 2005, the FASB ratified the consensus reached for Emerging
Issues Task Force (EITF) Issue No. 05-5, Accounting for Early Retirement or
Postemployment Programs with Specific Features (Such As Terms Specified in
Altersteilzeit Early Retirement Arrangements). The consensus in this Issue
should be applied to fiscal years beginning after December 15, 2005, and
reported as a change in accounting estimate effected by a change in accounting
principle as described in paragraph 19 of FASB Statement 154. The Company does
not expect that EITF 05-5 will have any significant effect on future financial
statements.
On September 28, 2005, the FASB ratified the consensus reached for EITF
Issue No. 05-7, Accounting for Modifications to Conversion Options Embedded in
Debt Instruments and Related Issues. The provisions of this Issue should be
applied to future modifications of debt instruments beginning in the first
interim or annual reporting period beginning after December 15, 2005. The
Company expects that the application of EITF 05-7 could have an effect on
interest and debt valuations in future financial statements. It is not possible
to determine the impact, if any, from the application since the Company does not
presently have any convertible debt.
F - 15
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
On September 28, 2005, the FASB ratified the consensus reached for EITF
Issue No. 05-8, Income Tax Consequences of Issuing Convertible Debt with a
Beneficial Conversion Feature. The provisions of this Issue should be applied
beginning in the first interim or annual reporting period beginning after
December 15, 2005. The Company expects that the application of EITF 05-8 could
have an effect on he income tax expense reported in future financial statements.
It is not possible to determine the impact, if any, from the application since
the Company does not presently have any convertible debt.
On July 13, 2006, the FASB issued Interpretation No. 48 for Uncertainty in
Income Taxes and interpretation of FASB Statement 109. Interpretation 48
clarifies the accounting for uncertainty in income taxes recognized in a
company's financial statements in accordance with Statement No. 109 and
prescribes a recognition threshold and measurement attribute for financial
statements disclosure of tax position taken or expected to be taken on a tax
return. Additionally, Interpretation No. 48 provides guidance on depreciation,
classification, interest and penalties accounting in interim periods, disclosure
and transition. Interpretation No. 48 is effective for fiscal years beginning
after December 15, 2006, with early adoption permitted. The Company is currently
evaluating whether the adoption of Interpretation No. 48 will have a material
effect on our consolidated financial position, results of operations and cash
flows.
In July 2006, the FASB issued Staff Position ("FSB") on FAS 13, FSP FAS
13-2, Accounting for a Change or Projected Change in the Timing of Cash Flows
Relating to Income Taxes Generated by a Leveraged Lease transaction. FSP FAS
13-2 addresses how a change or projected change in the timing of cash flows
relating to income taxes generated by a leveraged lease transaction affects the
accounting by a lessor for that lease and amends FAS 13 Accounting for Leases.
FSP FAS 13-2 is effective for fiscal years beginning December 15, 2006, with
earlier application permitted. The Company does not expect that FSP FAS 13-2
will have any significant effect on future financial statements.
NOTE C -LOSS PER COMMON SHARE
The following table sets forth the computation of basic and diluted loss
per share:
Year Ended May 31,
-----------------------------------------------------
2006 2005 2004
--------------- --------------- --------------
Numerator:
Net loss $(11,579,011) $(5,562,038) $(3,422,520)
Denominator:
Basic - weighted average shares 61,351,323 58,547,574 57,981,963
Stock options -- -- --
Warrants -- -- --
--------------- --------------- --------------
Diluted - weighted average shares 61,351,323 58,547,574 57,981,963
=============== =============== ==============
Loss per share - basic $(0.19) $(0.10) $(0.06)
=============== =============== ==============
- diluted $(0.19) $(0.10) $(0.06)
=============== =============== ==============
Options and warrants to purchase 10,466,613, 6,745,544 and 5,161,751 shares
of common stock were excluded from the computation of diluted earnings per share
for the years ended May 31, 2006, 2005 and 2004, respectively, because the
effect of their inclusion would be antidilutive.
NOTE D - CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of the following:
May 31,
----------------------------------
2006 2005
--------------- ---------------
Cash accounts $2,383,312 $987,314
Money market funds 2,466 2,210
--------------- ---------------
$2,385,778 $989,524
=============== ===============
F - 16
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
NOTE E - INVENTORIES, NET
Inventories, net consist of the following:
May 31,
----------------------------------
2006 2005
--------------- ---------------
Raw materials $863,952 $ 960,101
Work in process 1,243,986 1,194,688
Finished goods 591,735 1,205,483
--------------- ---------------
$2,699,673 $3,360,272
=============== ===============
At May 31, 2006 and 2005, the Company has recorded reserves for excess and
obsolete inventory of $677,166 and $566,149, respectively.
NOTE F - PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
May 31,
-----------------------------------
2006 2005
--------------- ----------------
Land $ 200,000 $ 200,000
Building and improvements 1,383,976 1,383,976
Office, laboratory and other equipment 1,444,850 1,445,168
EECP systems under operating leases or under loan
for clinical trials 874,071 1,552,121
Furniture and fixtures 162,068 162,068
Leasehold improvements 117,803 117,803
--------------- ----------------
4,182,768 4,861,136
--------------- ----------------
Less: accumulated depreciation and amortization (2,613,180) (2,626,983)
--------------- ----------------
$1,569,588 $2,234,153
=============== ================
NOTE G - DEFERRED REVENUE
The changes in the Company's deferred revenues are as follows:
Year Ended May 31,
-----------------------------------------------------
2006 2005 2004
--------------- --------------- ---------------
Deferred revenue at beginning of year $2,551,532 $2,846,451 $1,709,551
Additions
Deferred extended service contracts 2,269,801 2,073,090 1,871,439
Deferred in-service and training 130,000 187,500 340,000
Deferred service arrangement obligations 425,000 765,001 1,040,000
Recognized as revenue
Deferred extended service contracts (2,383,121) (1,900,925) (1,485,372)
Deferred in-service and training (140,000) (262,500) (247,500)
Deferred service arrangement obligations (530,624) (1,157,085) (381,667)
--------------- --------------- ---------------
Deferred revenue at end of year 2,322,588 2,551,532 2,846,451
Less: current portion (1,600,887) (1,667,080) (1,734,925)
--------------- --------------- ---------------
Long-term deferred revenue at end of year $721,701 $884,452 $1,111,526
=============== =============== ===============
F - 17
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
NOTE H - WARRANTY LIABILITY
The changes in the Company's product warranty liability are as follows:
Year Ended May 31,
-------------------------------------------------------
2006 2005 2004
--------------- --------------- ----------------
Warranty liability at the beginning of the year $118,333 $244,917 $788,000
Expense for new warranties issued 33,000 27,000 164,000
Warranty claims (119,333) (153,584) (707,083)
--------------- --------------- ----------------
Warranty liability at the end of the year 32,000 118,333 244,917
Less: current portion (30,500) (110,583) (161,917)
--------------- --------------- ----------------
Long-term warranty liability at the end of
the year $1,500 $7,750 $83,000
=============== =============== ================
NOTE I - LONG-TERM DEBT AND LINE OF CREDIT AGREEMENT
The following table sets forth the computation of long-term debt:
May 31,
------------------------------------
2006 2005
---------------- ----------------
Facility loans (a) $914,528 $969,566
Term loans (b) 35,970 126,243
---------------- ----------------
950,498 1,095,809
Less: current portion (97,309) (148,212)
---------------- ----------------
$853,189 $947,597
================ ================
(a) The Company purchased its headquarters and warehouse facility with
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.
Maturities of long-term debt are as follows at May 31, 2006:
Fiscal Year Amount
------------------- --------------
2007 $97,309
2008 65,769
2009 70,426
2010 75,629
2011 81,110
Thereafter 560,255
--------------
$950,498
==============
NOTE J - SERIES D PREFERRED STOCK AND WARRANTS
On July 19, 2005, we entered into a Securities Purchase Agreement that
provided us with gross proceeds of $2.5 million through a private placement of
preferred stock with M.A.G. Capital, LLC through its designated funds, Monarch
Pointe Fund Ltd., Mercator Momentum Fund III, LP, and Mercator Momentum Fund, LP
(the "Investors"). The agreement provided for a private placement of 25,000
shares of Vasomedical's Series D Preferred Stock at $100 per share. The
preferred stock was convertible into shares of Vasomedical's common stock at 85
F - 18
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
percent of the volume weighted average price per share for the five trading days
preceding any conversion, but not at more than $0.6606 or less than $0.40 per
share. The Investors also acquired warrants for the purchase of 1,892,219 shares
of common stock. The warrants may be exercised at a price of $0.69 per share for
a term of five years, ending July 19, 2010. As of February 28, 2006, all of the
Series D Preferred Stock had been converted into 6,112,209 shares of common
stock.
Under the terms of a Registration Rights Agreement with the Investors,
Vasomedical filed a Form S-3 registration statement with the Securities and
Exchange Commission (SEC) on August 22, 2005, for 10,787,871 shares of common
stock representing up to 8,533,333 shares issuable in connection with conversion
of our Series D Convertible Preferred Stock and up to 2,254,538 shares issuable
upon the exercise of our common stock purchase warrants. The SEC declared the
registration statement effective on September 1, 2005. The total number of
shares registered was based on a conversion price of $0.30 per share, which
would only have affect in the event of default by Vasomedical of its obligation
to holders of the Series D Convertible Preferred Stock.
These securities were offered and sold to the Investors in a private
placement transaction made in reliance upon exemptions from registration
pursuant to Section 4(2) of the Securities Act of 1933. The Investors are
accredited investors as defined in Rule 501 of Regulation D promulgated under
the Securities Act of 1933. Vasomedical applied the funds to working capital.
Warrants and Beneficial Conversion Feature
The Company applied Emerging Issues Task Force Issue No. 98-5 "Accounting
for Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios"(EITF No. 98-5) and Emerging Issues Task Force
(EITF 00-27) Application of Issue No. 98-5 to Certain Convertible Instruments in
accounting for the preferred stock issuance. EITF No. 98-5 provides that
detachable warrants issued with convertible securities are valued separately,
and that the beneficial conversion feature of the convertible security be
measured and recognized over the minimum period over which the shareholders can
realize the return.
The Task Force reached a consensus that convertible preferred securities
with a non-detachable conversion feature that is in-the-money at the commitment
date represents an embedded beneficial conversion feature that should be
recognized as a dividend and recorded to additional paid-in capital. That amount
should be calculated at the commitment date as the difference between the
allocated portion of the gross proceeds to the convertible preferred stock and
the fair value of the common stock or other securities into which the security
is convertible, multiplied by the number of shares into which the security is
convertible (intrinsic value method).
The beneficial conversion feature is treated analogous to a dividend and is
recognizable immediately over the minimum period during which the preferred
shareholders can realize that return. The imputed dividend will increase the
Company's loss for the purpose of computing the loss-per-share applicable to
common shareholders. The beneficial conversion feature is calculated at its
intrinsic value at the commitment date (that is, the difference between the
total gross proceeds allocated to the preferred stock as compared to the total
market value of the common stock into which the Preferred Stock is convertible
on the commitment date). The computed value of the beneficial conversion feature
is treated as a deemed dividend immediately with a corresponding increase to
paid-in capital. No additional amount will be recognized at the conversion date
in recognition of an increase in the fair value of the stock conversion.
In circumstances in which convertible securities are issued with detachable
warrants, the Task Force noted that in order to determine the amount to be
allocated to the beneficial conversion feature, the issuer must first allocate
the proceeds between the convertible instrument and the detachable warrants
using the relative fair value method of APB Opinion Number 14.
F - 19
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
The investors and consultants acquired detachable warrants for the purchase
of 1,892,219 and 362,319 shares of common stock, respectively, which were valued
at $345,071 and $66,087, respectively. The warrants may be exercised at a price
of $0.69 per share for a term of five years, ending July 18, 2010. For purposes
of estimating the intrinsic fair value of each warrant as of July 19, 2005, we
utilized the Black-Scholes option-pricing model. We estimated the fair value of
the warrants assuming no expected dividends and the following weighted-average
assumptions:
Expected life (years) 2.5
Expected volatility 66%
Risk-free interest rate 4.16%
Expected dividend yield 0.0%
We next determined the intrinsic fair value of the convertible preferred
stock as of July 19, 2005, to be $2,941,176 based on the number of common shares
that could be acquired as of the date of closing times $0.63, the closing price
of the common stock on the date preceding the close of the transaction. In
applying EITF No. 98-5, we then allocated the gross proceeds of $2,500,000
between the warrants and preferred stock based on intrinsic value of each
instrument. As a result, we allocated $2,154,929 of gross proceeds to the
convertible preferred stock and $345,071 to the detachable warrants. The
beneficial conversion feature of $786,247 was then determined by subtracting the
allocated proceeds of convertible preferred stock from the intrinsic fair value
of convertible preferred stock. The beneficial conversion feature was
immediately recognized as a preferred stock dividend, as the preferred stock can
be converted immediately.
Dividends
By the placement of the convertible preferred stock described above, we
became obligated to pay a cash dividend monthly on the outstanding shares of
convertible preferred stock. The dividend rate is the higher of (i) the prime
rate as reported by the Wall Street Journal on the first day of the month, plus
three percent or, (ii) 8.5% times $100 per share, but in no event greater than
10% annually. For the fiscal year ended May 31, 2006, cash dividends of $91,623
were paid. Preferred stock dividends for the fiscal 2006 are summarized as
follows:
Amount
------
Cash dividends paid $91,623
Beneficial conversion feature 786,247
--------------
$877,870
==============
Common stock
The Company issued 200,000 shares of common stock in lieu of cash for
$126,000 in consultant services associated with the issuance of the Series D
Convertible Preferred Stock. These issue costs were treated as a reduction in
the paid-in capital associated with the preferred stock issuance.
NOTE K - STOCKHOLDERS' EQUITY AND WARRANTS
No warrants were exercised or cancelled in fiscal 2004 and 2005. On July
19, 2005, we granted warrants for the purchase of 2,254,538 shares of common
stock to investors and consultants associated with the issuance of Series D
Preferred Stock, (See Note J). The warrants may be exercised at a price of $0.69
per share for a term of five years, ending July 19, 2010. The remaining 200,000
warrants expire in October 2006.
Warrant activity for the years ended May 31, 2004, 2005 and 2006 is
summarized as follows:
Employees Consultants Total Price Range
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2004 -- 200,000 200,000 $0.91
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2005 -- 200,000 200,000 $0.91
----------------- ------------------- ------------------------ ----------------
Warrants granted 2,254,538 2,254,538 $0.69
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2006 -- 2,454,538 2,454,538 $0.71
================= =================== ======================== ================
Number of shares exercisable -- 2,454,538 2,454,538 $0.71
================= =================== ======================== ================
F - 20
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
NOTE L - OPTION PLANS
1995 Stock Option Plan
In May 1995, the Company's stockholders approved the 1995 Stock Option Plan
for officers and employees of the Company, for which the Company reserved an
aggregate of 1,500,000 shares of common stock. In December 1997, the Company's
Board of Directors terminated the 1995 Stock Option Plan with respect to new
option grants.
In fiscal 2006, options to purchase 155,000 shares of common stock at an
exercise price of $3.44 under the 1995 Stock Option Plan were retired or
cancelled
Outside Director Stock Option Plan
In May 1995, the Company's stockholders approved an Outside Director Stock
Option Plan (the "OD Plan") for non-employee directors of the Company, for which
the Company reserved an aggregate of 300,000 shares of common stock. In December
1997, the Company's Board of Directors terminated the OD Plan with respect to
new option grants.
In fiscal 2005, options to purchase 38,709 shares of common stock at an
exercise price of $0.78 under the OD Plan were retired unexercised.
In fiscal 2006, options to purchase 155,000 shares of common stock at an
exercise price of $2.21 under the OD Plan were retired unexercised.
1997 Stock Option Plan
In December 1997, the Company's stockholders approved the 1997 Stock Option
Plan (the "1997 Plan") for officers, directors, employees and consultants of the
Company, for which the Company has reserved an aggregate of 1,800,000 shares of
common stock. The 1997 Plan provides that a committee of the Board of Directors
of the Company will administer it and that the committee will have full
authority to determine the identity of the recipients of the options and the
number of shares subject to each option. Options granted under the 1997 Plan may
be either incentive stock options or non-qualified stock options. The option
price shall be 100% of the fair market value of the common stock on the date of
the grant (or in the case of incentive stock options granted to any individual
principal stockholder who owns stock possessing more than 10% of the total
combined voting power of all voting stock of the Company, 110% of such fair
market value). The term of any option may be fixed by the committee but in no
event shall exceed ten years from the date of grant. Options are exercisable
upon payment in full of the exercise price, either in cash or in common stock
valued at fair market value on the date of exercise of the option. The term for
which options may be granted under the 1997 Plan expires August 6, 2007.
In January 1999, the Company's Board of Directors increased the number of
shares authorized for issuance under the 1997 Plan by 1,000,000 shares to
2,800,000 shares.
In May 2006, the Board of Directors accelerated the vesting period for all
unvested options to May 31, 2006.
In fiscal 2004, options to purchase 75,667 shares of common stock under the
1997 Plan were exercised at an exercise price of $0.88 per share, aggregating
$66,209 of proceeds to the Company and options to purchase 350,000 shares of
common stock under the 1997 Plan at an exercise price of $0.88 were retired or
cancelled.
In fiscal 2005, the Company's Board of Directors granted non-qualified
stock options under the 1997 Plan to an officer to purchase an aggregate of
153,168 shares of common stock, at an exercise price of $1.09 per share, which
represented the fair market value of the underlying common stock at the time of
the respective grants. These options expire ten years from the date of grant. In
fiscal 2005, options to purchase 4,500 shares of common stock under the 1997
Plan at an exercise price of $0.88 were cancelled.
In fiscal 2006, options to purchase 4,500 shares of common stock under the
1997 Plan at exercise prices ranging from $0.88 to $1.91 were retired or
cancelled.
At May 31, 2006, there were 303,168 shares available for future grants
under the 1997 Plan.
1999 Stock Option Plan
In July 1999, the Company's Board of Directors approved the 1999 Stock
Option Plan (the "1999 Plan"), for which the Company reserved an aggregate of
2,000,000 shares of common stock. The 1999 Plan provides that a committee of the
Board of Directors of the Company will administer it and that the committee will
have full authority to determine the identity of the recipients of the options
and the number of shares subject to each option. Options granted under the 1999
F - 21
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
Plan may be either incentive stock options or non-qualified stock options. The
option price shall be 100% of the fair market value of the common stock on the
date of the grant (or in the case of incentive stock options granted to any
individual principal stockholder who owns stock possessing more than 10% of the
total combined voting power of all voting stock of the Company, 110% of such
fair market value). The term of any option may be fixed by the committee but in
no event shall exceed ten years from the date of grant. Options are exercisable
upon payment in full of the exercise price, either in cash or in common stock
valued at fair market value on the date of exercise of the option. The term for
which options may be granted under the 1999 Plan expires July 12, 2009. In July
2000, the Company's Board of Directors increased the number of shares authorized
for issuance under the 1999 Plan by 1,000,000 shares to 3,000,000 shares. In
December 2001, the Board of Directors of the Company increased the number of
shares authorized for issuance under the 1999 Plan by 2,000,000 shares to
5,000,000 shares.
In May 2006, the Board of Directors accelerated the vesting period for all
unvested options to May 31, 2006.
In fiscal 2004, the Board of Directors granted non-qualified stock options
under the 1999 Plan to directors and employees to purchase an aggregate of
725,000 shares of common stock, at exercise process ranging from $0.91 to $1.31
per shares (which represented the fair market value of the underlying common
stock at the time of the respective grants). In fiscal 2004, options to purchase
521,666 shares of common stock under the 1999 Plan were exercised at an exercise
price of $0.71 to $1.22 per share, aggregating $631,178 of proceeds to the
Company and options to purchase 956,669 shares of common stock under the 1999
Plan at an exercise price of $0.91 to $5.15 were retired or cancelled.
In fiscal 2005, the Company's Board of Directors granted non-qualified
stock options to directors, officers and employees to purchase an aggregate of
2,194,832 shares of common stock, at an exercise price of $0.95 to $1.70 per
share, which represented the fair market value of the underlying common stock at
the time of the respective grants. Some of these options vest immediately and
others vest or over three-year or four-year periods. Some of these options
expire in five years and others in ten years from the date of grant. In fiscal
2005, options to purchase 133,332 shares of common stock under the 1999 Plan
were exercised at an exercise price of $0.98 per share, aggregating $130,666 of
proceeds to the Company and options to purchase 662,666 shares of common stock
under the 1999 Plan at an exercise price of $0.91 to $4.69 were retired or
cancelled.
In fiscal 2006, the Company's Board of Directors granted non-qualified
stock options to purchase under the 1999 Plan to an Officers, directors and
employees to purchase an aggregate of 1,260,000 shares of common stock, at an
exercise price of $0.20 to $0.22 per share, which represented the fair market
value of the underlying common stock at the time of the respective grants. These
ten years from the date of grant. In fiscal 2006, options to purchase 1,173,250
shares of common stock under the 1999 Plan at an exercise price of $0.20 to
$4.69 were retired or cancelled.
At May 31, 2006, there were 23,253 shares available for future grants under
the 1999 Plan.
2004 Stock Option and Stock Issuance Plan
In October 2004, the Company's stockholders approved the 2004 Stock Option
and Stock Issuance Plan (the "2004 Plan"), for which the Company reserved an
aggregate of 2,500,000 shares of common stock. The 2004 Plan is divided into two
separate equity programs: (i) the Option Grant Program under which eligible
persons ("Optionees") may, at the discretion of the board of directors, be
granted options to purchase shares of common stock; and (ii) the Stock Issuance
Program under which eligible persons ("Participants") may, at the discretion of
the board or directors, be issued shares of common stock directly, either
through the immediate purchase of such shares or as a bonus for services
rendered to the Corporation.
Options granted under the 2004 Stock Plan shall be non-qualified or
incentive stock options and the exercise price is the fair market value of the
common stock on the date of grant except that for incentive stock options it
shall be 110% of the fair market value if the Optionee owns 10% or more of our
common stock. The term of any option may be fixed by the board of directors or
committee but in no event shall exceed ten years from the date of grant. Stock
options granted under the 2004 Plan may become exercisable in one or more
installments in the manner and at the time or times specified by the committee.
Options are exercisable upon payment in full of the exercise price, either in
cash or in common stock valued at fair market value on the date of exercise of
the option. The term for which options may be granted under the 2004 Plan
expires July 12, 2014.
Under the stock issuance program, the purchase price per share shall be
fixed by the board of directors or committee but cannot be less than the fair
market value of the common stock on the issuance date. Payment for the shares
may be made in cash or check payable to us, or for past services rendered to us
and all shares of common stock issued thereunder shall vest upon issuance unless
F - 22
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
otherwise directed by the committee. The number of shares issuable is also
subject to adjustments upon the occurrence of certain events, including stock
dividends, stock splits, mergers, consolidations, reorganizations,
recapitalizations, or other capital adjustments. The term for which shares may
be issued under the 2004 Plan expires July 12, 2014.
The 2004 Plan provides that a committee of the Board of Directors of the
Company will administer it and that the committee will have full authority to
determine and designate the individuals who are to be granted stock options or
qualify to purchase shares of common stock under the 2004 Stock Plan, the number
of shares to be subject to options or to be purchased and the nature and terms
of the options to be granted. The committee also has authority to interpret the
2004 Plan and to prescribe, amend and rescind the rules and regulations relating
to the 2004 Plan.
In May 2006, the Board of Directors accelerated the vesting period for all
unvested options to May 31, 2006.
In fiscal 2005, the Company's Board of Directors granted non-qualified
stock options under the 2004 Plan to directors to purchase an aggregate of
225,000 shares of common stock, at an exercise price of $0.95 per share, which
represented the fair market value of the underlying common stock at the time of
the respective grants. Some of these options vest immediately and others over a
four-year period, and expire ten years from the date of grant.
In fiscal 2006, the Company's Board of Directors granted an aggregate of
225,000 shares of common stock under the 2004 Plan directors of the Company
having a fair market value of $0.45 per share at the time of the respective
grants. In fiscal 2006, the Company's Board of Directors granted non-qualified
stock options under the 2004 Plan to Officers and employees to purchase an
aggregate of 2,118,045 shares of common stock, at exercise prices of $0.20 to
$0.58 per share, which represented the fair market value of the underlying
common stock at the time of the respective grants. These options expire ten
years from the date of grant. In fiscal 2006, options to purchase 266,496 shares
of common stock under the 2004 Plan at exercise prices of $0.45 to $0.58 were
retired or cancelled.
At May 31, 2006, there were 423,451 shares available for future grants
under the 2004 Plan.
Activity under all the plans for the years ended May 31, 2004, 2005 and
2006, is summarized as follows:
Outstanding Options
-------------------------------------------------------------
Shares Weighted
Available for Number of Shares Exercise Average
Grant Price per Share Exercise Price
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2003 1,438,668 5,990,753 $0.71 - $5.15 $2.13
Options granted (725,000) 725,000 $0.92 - $1.31 $1.06
Options exercised -- (597,333) $0.71 - $1.22 $1.17
Options canceled 1,306,669 (1,306,669) $0.88 - $5.15 $1.61
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2004 2,020,337 4,811,751 $0.71 - $5.15 $1.98
Options/shares authorized 2,500,000 (1) -- -- --
Options granted (2,573,000) 2,573,000 $0.951 - $1.70 $1.08
Options exercised -- (133,332) $0.98 $0.98
Options canceled 667,166 (705,875) $0.78 - $4.69 $2.03
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2005 2,614,503 6,545,544 $0.71 - $5.15 $1.86
Common shares granted (225,000) -- -- --
Options granted (3,378,045) 3,378,045 $0.20 - $0.58 $0.34
Options exercised -- -- --
Options canceled 1,738,414 (1,911,514) $0.20 - $5.15 $0.70
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2006 749,872 8,012,075 $0.20 - $5.15 $1.20
================= =================== ======================== ================
(1) May be issued under the Stock Issuance Program.
F - 23
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
The following table summarizes information about stock options outstanding
and exercisable at May 31, 2006
Options Outstanding Options Exercisable
--------------------------------------------------- --------------------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Outstanding at Contractual Exercise Price Exercisable at Exercise
Range of Exercise Prices May 31, 2006 Life (yrs.) May 31, 2006 Price
------------------ ---------------- --------------- ----------------- --------------
$0.20 - $0.58 2,971,549 9.6 $0.33 2,971,549 $0.33
$0.71 - $0.97 1,098,750 5.8 $0.90 1,098,750 $0.90
$1.00 - $1.49 2,129,167 7.3 $1.10 2,129,167 $1.10
$1.53 - $2.49 679,609 2.1 $1.87 679,609 $1.87
$2.66 - $5.15 1,133,000 3.6 $3.59 1,133,000 $3.59
------------------ ---------------- --------------- ----------------- --------------
8,012,075 7.0 $1.20 8,012,075 $1.20
================== ================ =============== ================= ==============
The weighted-average fair value of options granted during fiscal years
2006, 2005 and 2004 was $0.34, $1.08, and $1.06, respectively. At May 31, 2006,
there were approximately 33,584,075 remaining authorized shares of common stock
after reserves for all stock option plans and stock warrants.
NOTE M - INCOME TAXES
During the fiscal years ended May 31, 2006, 2005 and 2004, we recorded
income tax expense of $7,109,176, 39,661 and $50,640, respectively. The fiscal
2006 tax expense consists mainly of $7,093,000 in additional valuation allowance
provided for the deferred tax asset in the second fiscal quarter. The income tax
expense for fiscal 2006 does not include $7,489,000 added to the deferred tax
valuation allowance for tax benefits associated with prior years' exercises of
stock options and warrants, which was charged directly to additional paid-in
capital.
As of May 31, 2005, we had recorded deferred tax assets of $14,582,000 net
of a $3,774,000 valuation allowance related to the anticipated recovery of tax
loss carryforwards. No deferred tax assets have been recorded for state income
tax NOL's since it was determined that the amounts were not material and the
Company could not be sure that any benefit from the NOL's would be utilized.
On December 20, 2005, Centers for Medicare and Medicaid Services (CMS)
issued a Proposed Decision Memorandum (PDM) for External Counterpulsation in
response to Vasomedical's application to expand reimbursement coverage to
include Canadian Cardiovascular Society (CCSC) Class II angina and New York
Heart Association (NYHA) Class II/III congestive heart failure (CHF). The PDM
stated that the evidence was not adequate to conclude that external
counterpulsation therapy is reasonable and necessary to expand reimbursement
coverage to CCSC Class II angina and NYHA Class II/III CHF and that current
coverage for CCSC class III/IV refractory angina would remain in effect.
Consequently, at the end of the second fiscal quarter of fiscal 2006, we
concluded that, based upon the weight of available evidence, it was no longer
"more likely than not" that the net deferred tax asset of $14,582,000 would be
realized, and added $14,582,000 to the valuation allowance to bring the net
deferred tax asset carrying value to zero. On March 20, 2006, CMS issued its
final decision, which upheld the PDM.
As of May 31, 2006, the recorded deferred tax asset was $19,559,458,
reflecting an increase of $1,203,458 during fiscal 2006, which was offset by the
valuation allowance of the same amount.
F - 24
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
The Company's deferred tax assets are summarized as follows:
2006 2005 2004
--------------- --------------- ---------------
Net operating loss and other carryforwards $17,850,000 $16,489,000 $14,468,000
Accrued compensation 6,900 68,000 118,000
Bad debts 140,000 134,000 238,000
Other 1,562,558 1,665,000 1,666,000
--------------- --------------- ---------------
Total gross deferred tax assets 19,559,458 18,356,000 16,490,000
Valuation allowance (19,559,458) (3,774,000) (1,908,000)
--------------- --------------- ---------------
Net deferred tax assets -- $14,582,000 $14,582,000
=============== =============== ===============
F - 25
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
At May 31, 2006, the Company had net operating loss carryforwards for
Federal and state income tax purposes of approximately $52,108,005, expiring at
various dates from 2007 through 2026. In fiscal 2006 $336,198 of net operating
loss carryforwards expired. Expiration of net operating loss carryforwards are
as follows:
Fiscal Year Amount
------------------- --------------
2007 $517,934
2008 558,968
2009 470,994
2010 2,454,162
2011 5,449,051
Thereafter 42,656,286
--------------
$52,107,395
==============
Under current tax law, the utilization of tax attributes will be restricted
if an ownership change, as defined, were to occur. Section 382 of the Internal
Revenue Code provides, in general, that if an "ownership change" occurs with
respect to a corporation with net operating and other loss carryforwards, such
carryforwards will be available to offset taxable income in each taxable year
after the ownership change only up to the "Section 382 Limitation" for each year
(generally, the product of the fair market value of the corporation's stock at
the time of the ownership change, with certain adjustments, and a specified
long-term tax-exempt bond rate at such time). The Company's ability to use its
loss carryforwards would be limited in the event of an ownership change.
The following is a reconciliation of the effective income tax rate to the
federal statutory rate:
2006 2005 2004
% % %
----------------- ---------------- -----------------
Federal statutory rate (34.0) (34.0) (34.0)
State taxes, net 0.3 0.7 1.5
Permanent differences 0.6 0.6 0.8
Change in valuation allowance
relating to operations 229.0 34.3 38.1
Other (0.6) (0.9) (4.9)
----------------- ---------------- -----------------
(195.3) 0.7 1.5
================= ================ =================
NOTE N - COMMITMENTS AND CONTINGENCIES
Employment Agreements
In December 2005, the Company entered into an agreement with Thomas W. Fry,
Chief Financial Officer of the company, which entitled him to twelve months
salary in the event of his termination without cause.
In April 2006, the Company approved a program to defer compensation of
certain senior executives of the company and incentives to them for these
deferrals. The Company agreed to repay monies deferred from zero to six months
at 1.5 times the amount deferred; for deferrals of six months to twelve months,
the repaid amount shall be two times the amount deferred; and for deferrals in
excess of twelve months, the amount shall be 2.5 times the amount deferred. In
addition, payment of board of directors meeting fees were deferred until a later
date.
Leases
The Company leases additional warehouse space under a
noncancelable-operating lease, which one expires on September 30, 2006. Rent
expense was $94,000, $93,000 and $72,000 in fiscal 2006, 2005 and 2004,
respectively. The remaining minimum obligation under lease agreements is
$14,238.
F - 26
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005 and 2004
Litigation
The Company is currently, and has been in the past, a party to various
routine legal proceedings incident to the ordinary course of business. The
Company believes that the outcome of all such pending legal proceedings in the
aggregate is unlikely to have a material adverse effect on the business or
consolidated financial condition of the Company.
NOTE O - 401(K) PLAN
In April 1997, the Company adopted the Vasomedical, Inc. 401(k) Plan to
provide retirement benefits for its employees. As allowed under Section 401(k)
of the Internal Revenue Code, the plan provides tax-deferred salary deductions
for eligible employees. Employees are eligible to participate in the next
quarter enrollment period after employment. Participants may make voluntary
contributions to the plan up to 15% of their compensation. In fiscal year 2006,
2005 and 2004, the Company made discretionary contributions of approximately
$27,000, $38,000 and $36,000, respectively, to match a percentage of employee
contributions.
NOTE P - SUBSEQUENT EVENT
On June 22, 2006, the Company entered into an employment agreement with
Thomas Glover, President and Chief Executive of the Company. The agreement,
which expires in June 2008, provides for certain benefits including a payment of
twelve months of base salary in the event of a termination without cause, as
defined, payable in twelve equal monthly installments.
F - 27
Vasomedical, Inc. and Subsidiaries
Schedule II - Valuation and Qualifying Accounts
---------------------------------------- ---------------- -------------------------------- ---------------- ----------------
Column A Column B Column C Column D Column E
---------------------------------------- ---------------- -------------------------------- ---------------- ----------------
Additions
--------------------------------
(1) (2)
Balance at Charged to Charged to
beginning of costs and other accounts Balance at end
period expenses Deductions of period
---------------------------------------- ---------------- ---------------- --------------- ---------------- ----------------
Allowance for doubtful accounts
Year ended May 31, 2006 $394,692 $110,317 $-- $94,318 $410,691
Year ended May 31, 2005 $699,203 $11,084 $-- (a) $394,692
$315,595
Year ended May 31, 2004 $768,629 $616,759 $-- $686,185 $699,203
Valuation Allowance- Financing
Receivables
Year ended May 31, 2006 $-- $-- $-- $-- $--
Year ended May 31, 2005 $-- $-- $-- $-- $--
Year ended May 31, 2004 $244,994 $680,000 $-- (b) $--
$924,994
Reserve for excess and obsolete
inventory
Year ended May 31, 2006 $566,149 $152,004 $-- $41,004 $677,149
Year ended May 31, 2005 $399,477 $166,672 $-- $-- $566,149
Year ended May 31, 2004 $280,477 $119,000 $-- $-- $399,477
Valuation Allowance - Deferred Tax
Asset
Year ended May 31, 2006 $3,774,000 $8,296,458 $7,489,000 $-- $19,569,458
Year ended May 31, 2005 $1,908,000 $1,866,000 $-- $-- $3,774,000
Year ended May 31, 2004 $622,000 $1,286,000 $-- $-- $1,908,000
Provision for warranty obligations
Year ended May 31, 2006 $118,333 $33,000 $-- (c) $119,333 $32,000
Year ended May 31, 2005 $244,917 $27,000 $-- (c) $118,333
$153,584
Year ended May 31, 2004 $788,000 $164,000 $-- (c) $707,083 $244,917
(a) accounts receivable written off, net $10,000 in recoveries in 2005.
(b) financing receivables written off
(c) warranty claims
S - 1