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, 2002
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File No. 0-18105
VASOMEDICAL, INC.
(Name of registrant as specified in its charter)
Delaware 11-2871434
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
180 Linden Avenue, Westbury, New York 11590
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (516) 997-4600
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of Class)
Indicate by a check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by a check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of August 12, 2002, based on the average price on that date,
was $116,980,000. At August 12, 2002, the number of shares outstanding of the
issuer's common stock was 57,559,120.
DOCUMENTS INCORPORATED BY REFERENCE
Certain exhibits are incorporated herein by reference as set forth in
Item 13(a)3, Index to Exhibits, in Part IV.
PART I
ITEM ONE - 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 "anticipate", "believe", "estimate", "expect" and "intend"
and similar expressions, as they relate to the Company or its management,
identify forward- looking statements. Such forward-looking statements are based
on the beliefs of the Company's management, as well as assumptions made by and
information currently available to the Company's management. Among the factors
that could cause actual results to differ materially are the following: the
effect of business and economic conditions; the impact of competitive products
and pricing; capacity and supply constraints or difficulties; product
development, commercialization or technological difficulties; the regulatory and
trade environment; and the risk factors reported from time to time in the
Company's SEC reports. The Company undertakes no obligation to update
forward-looking statements as a result of future events or developments.
General Overview
Vasomedical, Inc. (the Company), incorporated in Delaware in July 1987, is
primarily engaged in designing, manufacturing, marketing and supporting EECP
external counterpulsation systems based on the Company's proprietary technology
currently indicated for use in cases of angina, cardiogenic shock, acute
myocardial infarction and, most recently, congestive heart failure (CHF). The
Company is also actively engaged in research to determine the potential benefits
of EECP therapy in the setting of acute coronary syndromes, as well as in the
management of other major vascular disease states, including congestive heart
failure and diabetes. EECP is a non-invasive, outpatient therapy for the
treatment of diseases of the cardiovascular system. The therapy serves to
increase circulation in areas of the heart with less than adequate blood supply
and may restore systemic vascular function. The Company provides hospitals,
clinics and private practices with EECP equipment, treatment guidance, and a
staff training and maintenance program designed to provide optimal patient
outcomes. EECP is a registered trademark for Vasomedical's enhanced external
counterpulsation system.
EECP is currently reimbursed by Medicare and numerous private payers for
the treatment of refractory angina The reimbursement rate for a full course of
35 one-hour treatments ranges from $5,500 to $7,000. Although Medicare has not
modified its national coverage policy for EECP therapy to specifically include
CHF patients, the Company believes that there exists a significant subset of
patients with CHF that also have disabling angina that would qualify for
Medicare reimbursement under its present definition.
The EECP Enhanced External Counterpulsation System
General Discussion
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 950,000 lives in the United States in 1999
and was responsible for 1 of every 2.5 deaths. The American Heart Association
(AHA) reports in its 2002 Heart and Stroke Statistical Update that, if high
blood pressure is included, approximately 62 million Americans suffer from some
form of cardiovascular disease. Among these, 12.7 million have coronary artery
disease, 6.4 million of whom suffer from angina pectoris, a painful and often
debilitating complication caused by obstruction of the arteries that supply
blood to the myocardium or heart muscle, with an additional 350,000 new cases
seen annually. Medications, including vasodilators, are often prescribed to
increase blood flow to the coronary arteries. When drugs fail or cease to
correct the problem, invasive revascularization procedures such as angioplasty
and coronary stent placement, as well as coronary artery bypass grafting (CABG)
are employed. Despite the success of these procedures in lowering the death rate
from cardiovascular disease and allowing many to live longer lives, restenosis
or reocclusion of the affected vessels remains a problem. Restenosis rates
currently reported in the literature for angioplasty and stenting range from 18%
- - 30%. Half of all vein grafts in coronary artery bypass procedures exhibit
localized or diffuse narrowings within approximately ten years.
CHF is a complication of many serious diseases in which the heart loses its
full pumping capacity, causing blood to back up into other organs, especially
the lungs and liver. The condition affects both sexes and is most common in
people over age 50. Symptoms include shortness of breath, fatigue, swelling of
the abdomen, legs and ankles, rapid or irregular heartbeat, low blood pressure
1
and enlargement of the liver. Causes range from high blood pressure, heart-valve
disease, heart attack, coronary artery disease, heartbeat irregularities, severe
lung disease such as emphysema, congenital heart disease, cardiomyopathy,
hyperthyroidism and severe anemia.
CHF is treated with medication and, sometimes, surgery on heart valves or
the coronary arteries and, in certain severe cases, heart transplants. Left
ventricular assist devices (LVADs) and the use of cardiac resynchronization and
implantable defibrillators continue to advance. Still, no consensus therapy
currently exists for CHF and patients must currently suffer their symptoms
chronically and have a reduced life expectancy.
According to 2002 AHA data, 2.4 million men and 2.4 million women in the US
have the condition. About 550,000 new cases of the disease occur each year.
Deaths caused by the disease increased 145% from 1979 to 1999. The prevalence of
the disease is growing rapidly as a result of the aging of the population and
the improved survival rate of people after heart attacks. Also, because the
condition frequently entails visits to the emergency room and in-patient
treatment, two-thirds of all hospitalizations for people over age 65 are due to
CHF. In addition to careful outpatient care and monitoring, the economic burden
of heart failure is enormous. A discussion of this subject in Clinical
Cardiology (March 2000) estimated that heart failure management costs in 1999,
for the US alone, were $56 billion. Worldwide, 22 million people have CHF and
there are over 1 million new cases of CHF each year. Clearly, a treatment that
can reduce the incidence of heart failure and alleviate some of this burden
would be quickly adopted.
Given the pressing need to identify new and effective methods to treat CHF,
the Company has been actively focusing clinical development resources on CHF.
Heart failure offers a good strategic fit with the Company's current angina
business and offers an equal or better market opportunity. Additionally, since
CHF at times must be treated in acute-care settings, EECP can gain valuable
exposure and entre into the hospital market through this initiative. There are
more than 30,000 acute care facilities in the industrialized world, according to
a recent Datek-Ohmeda study, a huge market opportunity that cannot be addressed
with a therapy viewed as efficacious only with angina. Unmet clinical needs in
CHF are greater than those for angina, as there are no consensus therapies,
invasive or otherwise, beyond medical management for the condition. It is
noteworthy that the International EECP Patient Registry (IEPR) currently shows
that one-third of patients treated also have a history of CHF and have
demonstrated positive outcomes from EECP therapy.
The System
The EECP therapy systems, models MC2 and TS3 (collectively, the system(s)),
are advanced treatment systems utilizing fundamental hemodynamic principles to
relieve angina pectoris. Treatment is administered to patients on an outpatient
basis in daily one-hour sessions, 5 days per week over seven weeks for a total
of 35 treatments.
During EECP therapy, the patient lies on a bed while wearing three sets of
inflatable pressure cuffs, resembling oversized blood pressure cuffs, on the
calves, the upper and lower thighs and buttocks. The cuffs inflate sequentially
- -- via computer-interpreted ECG signals -- starting from the calves and
proceeding upward during the resting phase of each heartbeat (diastole). When
the heart pumps (systole), all three cuffs instantaneously deflate. This
sequential "squeezing" of the legs creates a pressure wave that forces blood
from the legs to the heart. To coordinate the inflation and deflation of the
cuffs with the beating heart, the heart rate and rhythm are monitored
constantly. Precise timing means that each wave of blood is delivered to the
heart when it will do the most good. This surge of circulation insures that the
heart does not have to work as hard to pump large amounts of blood through the
body, and that more blood is forced into the coronary arteries which supply
energy to the heart muscle or myocardium.
While the precise mechanism of action remains unknown, there is strong
hypothetical evidence to suggest that EECP triggers a neurohormonal response
that induces the production of growth factors and dilates existing blood
vessels, thus fostering the recruitment of collateral blood vessels. These tiny
collateral vessels, it is theorized, then bypass current blockages and feed
blood to areas of the heart that are receiving an inadequate supply.
Circulation improvement is further induced or reinforced by the fact that a
course of EECP treatment represents sustained and moderately vigorous exercise,
even though passive in nature, that is much more than the often sedentary
patient has been able to attempt previously.
Patients usually begin to experience symptomatic relief of angina after 15
or 20 hours of a 35-hour treatment regimen. Positive effects are sustained
between treatments and usually persist years after completion of a full course
of therapy. Data reported in the April 2000 issue of Clinical Cardiology showed
a five-year survival rate for those who respond to EECP therapy of 88%, a rate
similar to those seen in contemporary surgical bypass and angioplasty trials,
despite the fact that many of the patients who underwent EECP therapy had
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already failed previous attempts at revascularization. In addition, data
collected by the International EECP Patient Registry at the University of
Pittsburgh Graduate School of Public Health points to sustained lowering of
anginal severity and frequency of attacks at six, twelve and twenty-four months
post-treatment.
In February 1995, the Company received 510(k) clearance to market the
second-generation version of its EECP therapy system, the MC2, which
incorporated a number of technological improvements over the original system. In
addition, in December 2000, the Company received 510(k) clearance to market its
third generation system, the TS3. The FDA's clearance in these cases was for the
use of EECP therapy in the treatment of patients suffering from stable or
unstable angina pectoris, acute myocardial infarction and cardiogenic shock. In
June 2002, the FDA granted 510(k) market clearance for an upgraded TS3, which
incorporated the Company's patent-pending CHF treatment and oxygen saturation
monitoring technologies, and provided for a new indication for the use of EECP
in CHF, which applied to all present models of the Company's EECP systems.
Clinical Studies
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 gating, 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 a third cuff for the buttocks. Not only did a
course of treatment with EECP reduce the frequency and severity of anginal
symptoms during normal daily functions and also during exercise, but 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 studies with
EECP between 1989 and 1996 to reproduce the Chinese results, using both
subjective and objective endpoints. These studies, though open and
non-randomized, showed statistical improvement in exercise tolerance by patients
as evidenced by thallium-stress testing and partial or complete resolution of
coronary perfusion defects as evidenced by radionuclide imaging studies. All of
these results have been reported in the literature and support the assertion
that EECP therapy is an effective and durable treatment for patients suffering
from chronic angina pectoris.
In 1995, the Company began a large randomized, controlled and
double-blinded multicenter clinical study (MUST-EECP) at four 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. Initial participating sites included
the University of California San Francisco, Columbia University College of
Physicians & Surgeons at the Columbia-Presbyterian Medical Center in New York,
Beth Israel Deaconess Hospital, a teaching affiliate of Harvard Medical School,
and the Yale University School of Medicine. These institutions were later joined
by Loyola University, the University of Pittsburgh and Grant/Riverside Methodist
Hospitals. 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 placebo control group, showed that
EECP therapy was a safe and effective treatment option for patients suffering
from angina pectoris, including those on maximal medication and for whom
invasive revascularization procedures were no longer an option. The results of
the MUST-EECP study confirmed the clinical benefits described in earlier open
trials, namely a decline in anginal frequency, an increase in the ability to
exercise and a decrease in exercise-induced signs of myocardial ischemia. Data
collected by the IEPR at the University of Pittsburgh Graduate School of Public
Health closely mirror the results seen in the MUST-EECP trial.
In fiscal 1999, the Company completed a quality-of-life study with EECP in
the same institutions and with the same patients that participated in MUST-EECP.
Two highly regarded standardized means of measurement were used to gauge changes
in patients outlook and ability to participate in normal daily living during the
treatment phase and for up to 12 months after treatment. Results of this study,
which have been presented at major scientific meetings and published in the
January 2002 Journal of Investigative Medicine, show that the group of patients
receiving EECP enjoyed significantly improved aspects of health-related quality
of life compared to those who received a sham treatment.
3
As part of its program to expand the therapy's indications for use beyond
the treatment of angina, the Company applied for and received FDA approval in
April 1998 to study, under an Investigational Device Exemption (IDE) protocol,
the application of EECP in the treatment of congestive heart failure (CHF). A
32-patient feasibility study was conducted simultaneously at the University of
Pittsburgh, the University of California San Francisco and the Grant/Riverside
Methodist Hospitals in Columbus, Ohio. The results of this study were presented
at the 49th Scientific Sessions of the American College of Cardiology in March
2000 and the Heart Failure Society of America's Annual Meeting in September 2000
and were published in the July/August 2002 issue of Congestive Heart Failure.
This study concluded that EECP therapy was beneficial to left ventricular
function in heart failure patients and may be a useful adjunct to current
medical therapy.
In summer 2000, an IDE supplement to proceed with a pivotal study to
demonstrate the efficacy of EECP therapy in most 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 and results
are expected to be released no earlier than the end of calendar 2003. The PEECH
trial, which presently involves more than twenty centers and was designed to
enroll 180 patients, will evaluate improvements in exercise capacity and quality
of life, as well as the reduction in the need for certain medications that CHF
patients are typically prescribed. Centers participating in the PEECH trial
include, among others, the Cleveland Clinic, Mayo Clinic, Scripps Clinic, Temple
University, Texas Heart Institute, the University of California at San Diego
Medical Center, the University of California at Los Angeles Medical Center,
University Hospital at the UMDNJ/New Jersey Medical School, the University of
Pittsburgh Medical Center and the Cardiovascular Research Institute.
The IEPR at the University of Pittsburgh Graduate School of Public Health
was established in January 1998 to track the outcomes of patients who have
undergone EECP therapy. As of this publication, more than one hundred centers
participate in the registry and data from 5,000 patient records has been
entered. Phase 2 of the IEPR, planned for an additional 2,500 patients, began
enrollment in January 2002 and incorporates sub-studies that are examining
treatment beyond 35 hours of treatment, where needed, the presence of protein in
the urine of type 2 diabetic patients as a predictor of response to EECP, the
effects on peripheral vascular disease, and the effects of sexual function in
men. The IEPR is a vital source of information about the effectiveness of EECP
in a real-world environment for the medical community at large. For this reason,
the Company will continue to provide an ongoing grant to fund the Registry to
publicize data that may assist clinicians in delivering optimal care to
patients. Recently released data from the IEPR show that patients continue to
receive dramatic benefit at six, twelve and twenty-four months following the
completion of their course of EECP therapy.
Over the last several years, the Company's clinical bibliography has
expanded to include numerous abstracts presented a major medical conferences, as
well as publications in major peer-review journals. Notable among these studies
were several discussing the neurohumoral effects of EECP therapy including
increases in the levels of nitric oxide, a potent vasodilator and decreases in
levels of endothelin a vasoconstrictor as well as the release of certain growth
factors.
The Company's Plans
The Company's short- and long-term plans are to:
(a) Launch EECP in the CHF market through the initiation of campaigns to
market the benefits of EECP therapy directly to clinicians, third-party payors
and patients.
(b) Enlarge the market opportunity, short and long-term, by (i) advancing
the progress of marketplace acceptance of EECP as a viable treatment modality
for CHF (principally the chronic patient with NYHA Class III and IV) and as a
common treatment for the early and mid-stage (Canadian Class I and II) angina
populations, (ii) increasing the reimbursed patient base for the existing angina
and CHF indications, (iii) continue to drive the clinical validation process for
acceptance of EECP as a primary or complimentary therapy for congestive heart
failure, diabetes disease management, peripheral vascular and cerebrovascular
conditions and (iv) renew the exposure of EECP as an already approved therapy
for acute coronary conditions, such as myocardial infarction and cardiogenic
shock.
(c) Continue the development of EECP in international markets, principally
through the establishment of a distribution network, and appoint distributors in
South America and Japan.
(d) Continue to establish and support academic reference centers in the
United States and overseas in order to accelerate the growth and prestige of
EECP therapy and to increase the number and diversity of clinical and
mode-of-action studies, as well as the number of presentations, publications,
speakers and advocates.
4
(e) Continue product 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.
(f) Engage 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 in order to broaden coverage policies
and process claims more rapidly for EECP services.
(g) Complete the PEECH clinical trial and publish the results in a major
peer-review medical journal.
(h) Invest in creative partnerships with others who have distinctive
competencies or delivery capabilities for serving the cardiovascular and disease
management marketplace.
(i) Continue to provide an ongoing grant to fund the International EECP
Patient Registry at the University of Pittsburgh Graduate School of Public
Health to publicize key information relating to patient outcomes.
(j) Secure the CE mark for the Company's TS3 system.
Glossary of Terms
Acute Myocardial Infarction - heart attack
Angina Pectoris - literally "chest pain"
Cardiogenic shock - severe reduction in blood pressure owing to weak
pumping action of the heart
Collateral circulation - the use (recruitment) of small supplemental,
usually unused channels through which blood can be made to flow when normal
blood supply is impeded because of obstructions in coronary arteries
Congestive Heart Failure or CHF-A condition in which the heart is unable to
pump blood efficiently enough to meet the body's demands. The circulatory
systems of CHF patients become congested when the heart fails to empty its
chambers sufficiently, leading to an accumulation in the chest and lower limbs
Coronary Artery Bypass Graft or CABG - a surgical transplant of a vein to
connect the aorta with an obstructed coronary artery
Coronary arteries - those that supply blood to the heart muscle
Diastole - rest period during which the heart chambers fill with blood and
the heart muscle receives most of its supply of oxygen and other nutrients
Enhanced External Counterpulsation or EECP - "Enhanced" describes the
Company's proprietary system which increases the level of diastolic augmentation
by 40-50% over that of earlier devices
Ischemia - lack of blood supply
Occlusion - blockage of blood vessels
Percutaneous Transluminal Coronary Angioplasty or PTCA - insertion of a
wire into a coronary artery to which a balloon or other instrument is attached
for the purpose of widening a narrowed vessel
Stenosis - the narrowing of a blood vessel's diameter
Systole - contracting period during which the heart is pumping blood to the
rest of the body
Thallium - an imaging medium used to detect areas of ischemia within the
heart muscle
Sales and Marketing
Domestic Operations
The Company sells its EECP systems to treatment providers in the United
States through a direct sales force that is supported by an in-house service
organization. The Company's sales force is comprised of more than twenty sales
representatives, including management. In July 2002, the Company entered into a
strategic alliance with Palo Verde Technologies Inc. (PVT) as a means of
dramatically expanding the Company's sales coverage beyond its direct sales
force. PVT is a national cardiovascular independent agent network with over 85
independent sales representatives in pacemaker and cardiovascular product sales.
PVT expects 30 - 50 independent representatives to be specially trained in
selling the Company's EECP system by the end of fiscal 2003.
The efforts of the Company's sales organization are further supported by a
field-based staff of clinical educators who are responsible for the on-site
training and certification of physicians and therapists as new centers are
established. Training generally takes three days. These centers are closely
monitored and their charts reviewed for several weeks following the initial
training of the center's clinicians to ensure treatment guidelines are being
appropriately followed. This clinical applications group is also responsible for
training and certification of new personnel at each site, as well as for
updating providers on new clinical developments relating to EECP therapy.
5
The expanded sales force has allowed the Company to focus more intently on
sales to National Accounts. The Company plans to continue developing its
relationships with such major U.S. hospital groups as Tenet Healthcare, Kaiser
Permanente, Health South, Columbia HCA and with other cardiac care operations
that have plans for nationwide expansion. To date, the Company has entered into
agreements with three group purchasing organizations: Amerinet, Magnet and
MedAxiom.
Vasomedical's continuing transformation to a more commercial, market-driven
company will be reflected in its marketing activities planned for 2003 to
heighten awareness among clinicians, patients and third-party payers. Such
activities are expected to include journal advertising, publication of
EECP-related newsletters, support of physician education and physician outreach
programs, exhibition at national, international and regional medical
conferences, as well as sponsorship of seminars at professional association
meetings. All of these programs are designed to support the Company's field
sales organization. Additional Company marketing activities include supporting
direct-to-patient marketing campaigns to individuals suffering from angina and
other heart failure related symptoms as well as creating awareness among
third-party payers to the benefits of EECP for patients suffering from heart
failure.
The Company employs service technicians responsible for the installation of
EECP systems and, in many instances, on-site training of a customer's biomedical
engineering personnel. The Company provides a one-year product warranty that
includes parts and labor. The Company offers extended service to its customers
under annual service contracts or on a fee-for-service basis.
International Operations
One of the Company's key objectives has been to appoint distributors in
exchange for exclusive marketing rights to EECP in their respective countries.
The Company currently has distribution agreements for Canada, the Middle East
(Israel, Saudi Arabia, Egypt, Jordan, United Arab Emirates), India, Pakistan,
Greece, the United Kingdom, Italy and the Far East (Malaysia, Singapore,
Thailand). 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 either obtain an
FDA-equivalent marketing clearance or establish confirmation clinical
evaluations conducted by local opinion leaders in cardiology. Each distributor
is responsible for obtaining any required approvals and maintaining an
infrastructure to provide post-sales support, including clinical training and
product maintenance services. In July 2000, the Company received its medical
device license to market its EECP system in Canada. However, there can be no
assurance that all of the Company's distributors will be successful in obtaining
proper approvals for the EECP system in their respective countries or that these
distributors will be successful in their marketing efforts. The Company plans to
enter into additional distribution agreements to enhance its international
distribution base. There can be no assurance that the Company will be successful
in entering into any additional distribution agreements.
To date, revenues from international operations have not been significant
(fiscal 2002 revenues approximated 8%) but are expected to increase in future
years. Toward that end, in June 2001, the Company hired a Director of Sales and
Marketing for Europe. Marketing activities planned include, among other things,
increasing our participation 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 the Company's
business to date.
Competition
Presently, Vasomedical is aware of at least two competitors with an
external counterpulsation device on the market, namely Cardiomedics, Inc. and
Nicore, Inc. While the Company believes that these competitors' involvement in
the market is limited, there can be no assurance that these companies will not
become a significant competitive factor. The Company believes it competes
favorably in value with these companies, as EECP is the only external
counterpulsation system that is clinically proven in controlled clinical trials,
the only system to be covered by an independent patient registry and the only
system to have secured a CE mark. Vasomedical views other companies engaged in
the development of device-related and biotechnology approaches to the management
of cardiovascular disease as potential competitors in the marketplace as well.
There can be no assurance that other companies will not enter the market
intended for EECP systems. Such other companies may have substantially greater
financial, manufacturing and marketing resources and technological expertise
6
than those possessed by the Company and may, therefore, succeed in developing
technologies or products that are more efficient than those offered by the
Company and that would render the Company's technology and existing products
obsolete or noncompetitive.
Government Regulations
The EECP system is subject to extensive regulation by the FDA. Pursuant to
the Federal Food, Drug and Cosmetic Act, as amended, the FDA regulates and must
approve the clinical testing, manufacture, labeling, distribution and promotion
of medical devices in the US.
If a medical device manufacturer can establish that a newly developed
device is "substantially equivalent" to a device that was legally marketed prior
to May 28, 1976, the date on which the Medical Device Amendments Act of 1976 was
enacted, the manufacturer may seek marketing clearance from the FDA to market
the device by filing a 510(k) premarket notification. The 510(k) premarket
notification must be supported by appropriate data establishing the claim of
substantial equivalence to the satisfaction of the FDA. Pursuant to recent
amendments to the law, the FDA can now require clinical data or other evidence
of safety and effectiveness. The FDA may have authority to deny marketing
clearance if the device is not shown to be safe and effective even if the device
is "substantially equivalent" to a device marketed prior to May 28, 1976. The
Company's EECP system can be marketed in the United States based on the FDA's
determination of substantial equivalence. There can be no assurance that the
Company's EECP system will not be reclassified in the future by the FDA and
subject to additional regulatory requirements.
If substantial equivalence cannot be established or if the FDA determines
that more extensive efficacy and safety data are in order, the FDA will require
the manufacturer to submit a premarket application (PMA) for full review and
approval. Management does not believe that the EECP system will ultimately
require PMA approval for continued commercialization under its present labeling;
however, the Company so designed the protocol for MUST-EECP as to be able to
generate some of the data needed in the event that a PMA is required at some
future date. The Company received notice in June 2000 that its EECP system, when
used to treat congestive heart failure patients, would be classified by FDA as a
Class III PMA device. However, the FDA reversed that determination and the
Company understands from discussions with the FDA that one reason for the change
in the regulatory status of EECP for the treatment of congestive heart failure
was the result of the agency's reassessment of the system's safety profile. As
such, the Company filed a 510(k) premarket notification and in June 2002, FDA
granted market clearance to all three of the models of the EECP system for a new
indication for use in the treatment of congestive heart failure.
In most countries to which the Company seeks to export the EECP system, it
must first obtain documentation from the local medical device regulatory
authority stating that the marketing of the device is not in violation of that
country's medical device laws. The regulatory review process varies from country
to country. Presently, the Company is in the process of obtaining regulatory
approval of the EECP system in non-domestic markets.
There can be no assurance that all the necessary FDA clearances, including
approval of any PMA required, and non-domestic approvals will be granted for
EECP, its future-generation upgrades or newly developed products, on a timely
basis or at all. Delays in receipt of or failure to receive such clearances
could have a material adverse effect on the Company's financial condition and
results of operations.
In June 1998, the Company's EECP System Model MC2 was awarded the CE Mark,
which satisfies the regulatory provisions for marketing in all 15 countries of
the European Union. The CE Mark was awarded by DGM of Denmark, an official
notified regulatory body, under the European Council Directive concerning
medical devices. The CE Mark, in combination with the ISO 9001 certification
awarded by Underwriter's Laboratories (UL) in February 1998, places the Company
in full compliance with requirements for the marketing of this EECP system in
the countries of the European Union. The ISO 9001 Certificate covers the
Company's design and manufacturing operation for the EECP system and recognizes
that the Company has established and operates a world-class quality system. In
addition, in July 2000, the Company received its license for Level II devices
from the Canadian Health authority. In July 2001, the Company received the UL
classified mark, an electrical certification, for its new TS3 system and intends
to pursue the CE Mark for the TS3 in fiscal 2003.
Compliance with current Good Manufacturing Practices (GMP) regulations is
necessary to receive FDA approval to market new products and to continue to
market current products. The Company's manufacturing (including its contract
manufacturer), quality control and quality assurance procedures and
documentation are currently in compliance, and are subject to periodic
inspection and evaluation by the FDA.
7
Third-Party Reimbursements
Health care providers, such as hospitals and physicians, that purchase or
lease medical devices, such as the EECP 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. Even if a device
has FDA approval, Medicare and other third-party payers may deny reimbursement
if they conclude that the device is not cost-effective, is experimental or is
used for an unapproved indication.
In February 1999, the Centers for Medicare and Medicaid Services (CMS)
(formerly known as the Health Care Financing Administration (HCFA)), the federal
agency that administers the Medicare program for more than 39 million
beneficiaries, issued a national coverage policy for the use of the EECP system
for patients with disabling angina pectoris who, in the opinion of a
cardiologist or cardiothoracic surgeon, are not readily amenable to surgical
interventions, such as balloon angioplasty and cardiac bypass. In July 1999, CMS
communicated payment instructions for the EECP therapy to its contractors around
the country, stipulating coverage for services provided on or after July 1,
1999. In January 2000, a national Medicare payment level was established.
Beginning August 1, 2000, Medicare coverage was extended to include EECP
treatment received on an outpatient basis at hospitals and outpatient clinics
under the new APC (Ambulatory Payment Classification) system. The national
average payment rate approximates $150 per hourly session. Effective January 1,
2001, CMS approved an 11% increase in the reimbursement rate for EECP therapy
which raised the average Medicare payment from $130 to $144 per hourly session.
Effective January 1, 2002, CMS approved an additional increase of 7%, raising
the average Medicare payment to $153 per hourly session, or $5,355 for a full
course of therapy.
Some private insurance carriers continue to adjudicate EECP 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 for the treatment of angina and have issued
positive coverage policies. The Company estimates that over 300 private insurers
are reimbursing for EECP today at favorable payment levels and the Company
expects 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 June 2002, the Company announced that all three of its models of the
EECP system had been granted a 510(k) market clearance from the FDA for a new
indication for the treatment of congestive heart failure. Congestive heart
failure is the single most expensive disease state in the nation. Although CMS
has not modified its national coverage policy for EECP therapy to specifically
include CHF patients, the Company believes that there exists a significant
subset of patients with CHF that also have disabling angina that would qualify
for Medicare reimbursement under its present definition. The Company intends to
apply to CMS for a national coverage policy for EECP specific to CHF when it has
completed and analyzed the results of the ongoing PEECH trial, a randomized,
controlled clinical study on the use of EECP in CHF patients. The Company
expects the enrollment in PEECH to be completed in Spring 2003 and results
announced no earlier than the end of calendar 2003.
The Company intends to vigorously pursue a constructive dialogue with many
private insurers for the establishment of positive coverage policies for EECP
that include CHF patients. The Company believes that its discussions with these
third-party payers will, as a minimum, continue to define circumstances that
justify reimbursement on a case-by-case basis and create a pathway for rapid
review of patient data and determination of medical necessity.
If there is any material change in the availability of third-party coverage
or the inadequacy of the reimbursement level for treatment procedures using the
EECP system, it would adversely affect the Company's business, financial
condition and results of operations. Moreover, the Company is 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 the Company.
Patents and Trademarks
The Company owns three US patents that issued in June 1988, September 1996
and December 1999 which expire in 2005, 2013 and 2013, respectively. In
addition, foreign patents have issued which expire in 2013, and others are
pending. In fiscal 2002, the Company filed three patent applications in the US
regarding aspects of the TS3 system, potential improvements, and new methods of
8
treatment. The Company is planning to pursue these applications in other
countries, including members of the European Union. The Company is also planning
to file other patent applications regarding specific enhancements to the current
EECP models, future generation products, and methods of treatment. Moreover,
trademarks have been registered for the names "EECP" and "Natural Bypass", as
well as for its widely-recognized man-like figure representing the application
of EECP therapy.
The Company pursues a policy of seeking patent protection, both in the US
and abroad, for its proprietary technology. There can be no assurance that the
Company's patents will not be violated or that any issued patents will provide
protection that has commercial significance. Litigation may be necessary to
protect the Company's patent position. Such litigation may be costly and
time-consuming, and there can be no assurance that the Company will be
successful in such litigation. The loss or violation of the Company's EECP
patents and trademarks could have a material adverse effect upon the Company's
business.
Employees
As of August 1, 2002, the Company employed 110 full-time persons and 3
part-time persons with 27 in direct sales and sales support, 11 in clinical
applications, 45 in manufacturing, quality control and technical service, 8 in
marketing and customer support, 12 in engineering, regulatory and clinical
research and 10 in administration. None of the Company's employees are
represented by a labor union. The Company believes that its employee relations
are satisfactory.
Manufacturing
The Company manufactures its EECP Model TS3 at its plant in Westbury, NY
and believes its 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. The
Company's EECP Model MC2 system was manufactured for the Company by VAMED
Medical Instrument Company Ltd. ("VAMED"), a Chinese company, pursuant to a
certain 1993 manufacturing agreement. Early in 2002, Foshan Life Sciences Co.
Ltd. ("FLSC"), a Chinese joint venture comprised of a Florida company and VAMED,
assumed the operational activities for manufacturing the EECP Model MC2 systems
and accessories for the Company pursuant to separate purchase orders issued by
the Company. The Company believes that FLSC will be able to meet the Company's
future need for this system.
ITEM TWO - PROPERTIES
The Company owns its 18,000 square foot headquarters and manufacturing
facility at 180 Linden Avenue, Westbury, New York 11590. The Company leases
approximately 9,500 square feet of additional warehouse space under three
noncancelable operating leases with non-affiliated landlords, two of which
expire in October 2002 and one in September 2006, at an annual cost of
approximately $100,000. Management believes that the Company can renegotiate its
leases that will expire in October 2002 or lease other available space under
reasonable terms and that these combined facilities are adequate to meet its
current needs and should continue to be adequate for the immediately foreseeable
future.
ITEM THREE - LEGAL PROCEEDINGS
In February 1999, an action was commenced in the Massachusetts Superior
Court, Essex County, against the Company. The action sought damages in the sum
of $1,000,000 based upon an alleged breach of a sales contract. In January 2002,
this matter was dismissed by the court.
In June 2001, an action was commenced in the New York Supreme Court, Nassau
County, against the Company by the former holder of a warrant to purchase
100,000 shares of the Company's stock seeking undefined damages based upon a
claim that the Company breached an agreement to register the common shares
underlying the warrant at the "earliest practicable date" after due demand by
the warrant holder had been made. The Company believes that it fulfilled its
obligations under the warrant to the plaintiff in a timely fashion and that the
complaint is without merit. Accordingly, the Company is defending the action
vigorously. Although discovery has been completed, the Company is yet unable to
establish the likelihood of an unfavorable outcome or the existence or amount of
any potential loss.
In or about late June 2002, the Company was notified by a letter from the
domestic counsel for Foshan Life Sciences Co. Ltd. ("FLSC"), a joint venture
comprised of a Florida company and Vamed Medical Instrument Company Limited
9
("Vamed"), a Chinese company with whom the Company had an agreement to
manufacture the Company's EECP Model MC2 system, that FLSC was initiating an
arbitration proceeding before the Hong Kong International Arbitration Council
("HKIAC") to recover compensatory and punitive damages in excess of $1,000,000
and injunctive relief based upon claims of breach of the manufacturing
agreement, tortious interference and misappropriation of confidential
information and trade secrets. Although possessing several substantive defenses
to these claims, the Company initially has challenged the HKIAC's right to hear
and determine the dispute on the ground that FLSC is neither a legitimate nor
recognized party to the manufacturing agreement which provides for such
arbitration and, therefore, is not entitled to enforce the same. The Company
also has demanded that FLSC deposit with the HKIAC security to cover the
Company's costs of arbitration. To date, FLSC has neither responded to the
Company's demand for security nor apparently filed a formal statement of claim
with the HKIAC.
ITEM FOUR - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year.
PART II
ITEM FIVE - MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY
HOLDER MATTERS
The Company's Common Stock trades on the Nasdaq SmallCap Market tier of The
Nasdaq Stock MarketSM under the symbol VASO. The approximate number of record
holders of Common Stock as of August 6, 2002 was 1,000, which does not include
approximately 34,250 beneficial owners of shares held in the name of brokers or
other nominees. The table below sets forth the range of high and low trade
prices of the Common Stock as reported by the Nasdaq SmallCap Market tier of The
Nasdaq Stock MarketSM for the fiscal periods specified.
Fiscal 2002 Fiscal 2001
High Low High Low
---- --- ---- ---
First Quarter $4.32 $3.51 $5.50 $3.56
Second Quarter $3.75 $2.26 $5.50 $2.53
Third Quarter $4.02 $2.65 $5.63 $2.00
Fourth Quarter $3.30 $1.65 $5.00 $2.94
The last bid price of the Company's Common Stock on August 12, 2002 was
$2.19 per share. The Company has never paid any cash dividends on its Common
Stock. While the Company does not intend to pay cash dividends in the
foreseeable future, payment of cash dividends, if any, will be dependent upon
the earnings and financial position of the Company, 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.
10
ITEM SIX - SELECTED FINANCIAL DATA
The following table summarizes selected financial data for each of the five
years ended May 31, 2002 as derived from the Company's audited consolidated
financial statements. These data should be read in conjunction with the
consolidated financial statements of the Company, related notes and other
financial information.
Year ended May 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Statements of Earnings
Revenues $34,830,471 $27,508,338 $13,673,632 $6,024,263 $5,225,064
Cost of sales and services 10,538,731 7,910,359 3,277,700 2,035,578 1,654,979
------------------------------------------------------------------
Gross profit 24,291,740 19,597,979 10,395,932 3,988,685 3,570,085
Selling, general & administrative expenses 13,686,958 11,634,965 7,383,567 6,207,924 5,941,675
Research and development expenses 5,112,258 2,554,470 1,413,464 706,934 1,595,970
Provision for doubtful accounts 1,304,000 325,000 400,000
Interest and financing costs 98,140 48,294 7,302 11,880 4,057
Interest and other income, net (249,722) (201,992) (99,317) (115,064) (169,422)
------------------------------------------------------------------
19,951,634 14,360,737 9,105,016 6,811,674 7,372,280
------------------------------------------------------------------
Earnings (loss) before income taxes 4,340,106 5,237,242 1,290,916 (2,822,989) (3,802,195)
Income tax (expense) benefit, net (1,554,000) 6,457,108 400,000 - -
------------------------------------------------------------------
Net earnings (loss) 2,786,106 11,694,350 1,690,916 (2,822,989) (3,802,195)
Deemed dividend on preferred stock - - - (864,000) (1,132,000)
Preferred stock dividend requirement - - (94,122) (205,163) (96,717)
------------------------------------------------------------------
Earnings (loss) applicable to
common stockholders $2,786,106 $11,694,350 $1,596,794 $(3,892,152) $(5,030,912)
==================================================================
Net earnings (loss) per common share
- basic $.05 $.21 $.03 $(.08) $(.11)
==================================================================
- diluted $.05 $.20 $.03 $(.08) $(.11)
==================================================================
Weighted average common shares
outstanding - basic 57,251,035 56,571,402 52,580,623 49,371,574 47,873,711
==================================================================
- diluted 59,468,092 59,927,199 57,141,949 49,371,574 47,873,711
==================================================================
Balance Sheet
Working capital $17,225,434 $16,214,655 $ 7,380,236 $2,174,774 $5,046,202
Total assets $41,418,258 $36,518,974 $10,588,962 $5,198,172 $7,345,246
Long-term debt $ 1,072,716 $ 1,108,593 $ - $ - $ -
Stockholders' equity (1) $31,602,604 $28,508,729 $ 7,943,770 $ 3,153,533 $ 5,752,993
- -------------------
(1) No cash dividends were declared during any of the above periods.
11
ITEM SEVEN - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Results of Operations
Fiscal Years Ended May 31, 2002 and 2001
The Company generated revenues from the sale and lease of EECP systems of
$34,830,000 and $27,508,000 for fiscal 2002 and fiscal 2001, respectively,
representing a 27% increase. The Company generated earnings before income taxes
of $4,340,000 and $5,237,000 for fiscal 2002 and fiscal 2001, respectively. The
Company reported net earnings of $2,786,000 and $11,694,000 for fiscal 2002 and
fiscal 2001, respectively, after recognition of an income tax provision
(benefit) of $1,554,000 and $(6,457,000), respectively.
The number of cardiology practices and hospitals interested in becoming
providers of EECP therapy has increased following the announcement by the
Centers for Medicare and Medicaid Services (CMS) (formerly the Health Care
Financing Administration (HCFA)) in February 1999 of its decision to extend
Medicare coverage nationally to the Company's noninvasive, outpatient treatment
for coronary artery disease. CMS is the federal agency that administers the
Medicare program for approximately 39 million beneficiaries. In addition, the
results of the Company's multicenter, prospective, randomized, blinded,
controlled clinical study of EECP (MUST-EECP) were published in the June 1999
issue of the Journal of the American College of Cardiology. Interest in EECP
therapy has also been spurred by the announcement of the results of six-month,
twelve-month and twenty-four month post-treatment outcomes reported by the
International EECP Patient Registry, as well as numerous other studies reported
and presented at major scientific meetings, including the American Heart
Association (AHA) and the American College of Cardiology (ACC) annual meetings.
Effective January 1, 2002, CMS approved an additional increase of 7%,
raising the average Medicare payment to $153 per hourly session, or $5,355 for a
full course of therapy. These events led to an increased demand for EECP therapy
and EECP equipment and, consequently, to revenue growth overall. Pursuant to
contractual arrangements with two customers, the Company has sold equipment
under sales-type leases. In fiscal 2002, revenues of $4,187,000 were reported
from equipment sold under sales-type leases. In fiscal 2002, the Company shipped
263 systems (a 23% increase over the prior year) under various domestic and
non-domestic commercial arrangements, including direct sales, rental and
"fee-per-use" placements, sales-type leases and sales to foreign distributors.
Revenues from non-domestic business were $2,725,000, accounting for nearly 8% of
total revenues compared to $1,441,000, or 5%, in fiscal 2001.
The Company continues to be optimistic about its future. In June 2002, the
Company announced that all three of its models of the EECP system had been
granted a 510(k) market clearance from the Food and Drug Administration (FDA)
for a new indication for the treatment of congestive heart failure. Congestive
heart failure afflicts more than 5 million people in the United States alone,
with more than 550,000 new patients diagnosed every year. It is the single most
expensive disease state in the nation, accounting for more than $40 billion in
direct and indirect medical costs.
Gross profit margins for fiscal 2002 and 2001 were 70% and 71%,
respectively. Gross profits are dependent on a number of factors, particularly
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 margins are furthermore affected by the
location of the Company's customers (including non-domestic business or
distributorship arrangements which, for discounted equipment purchase prices,
co-invest in establishing a market for EECP equipment) and the amount and nature
of training and other initial costs required to place the EECP system in service
for customer use. Consequently, the gross profit realized during the current
period may not be indicative of future margins. The decrease in gross profit
margin for fiscal 2002 compared to 2001 was primarily attributable to a change
in the product mix now favoring the new, but more costly, Model TS3 system
manufactured in Westbury, NY. Management believes that the increased production
costs of TS3 will be offset in the future by manufacturing efficiencies and
engineering initiatives toward further product cost reduction. In addition,
gross profit margin was further affected by the change in sales mix, inclusive
of an 89% increase in revenues from non-domestic business in fiscal 2002 which,
as described above, is less profitable than the Company's domestic business.
Selling, general and administrative (SG&A) expenses for fiscal 2002 and
2001 were $13,687,000 (39% of revenues) and $11,635,000 (42% of revenues),
respectively. The Company has been effectively leveraging its SG&A expenses as a
percentage of sales, decreasing by 3%. The increases in SG&A expenses, on an
12
absolute basis, from the comparable prior fiscal year resulted primarily from
increases in personnel in sales and marketing functions, increases in selling
and marketing expenses (including commissions) related to increased revenues, as
well as increases in insurance and other administrative expenses.
In fiscal 2002, the Company charged $1,304,000 to its provision for
doubtful accounts, substantially increasing reserves primarily as a result of
extended credit terms offered to certain domestic and international customers,
as well as a valuation reserve in connection with long-term financing
receivables generated by equipment sold under sales-type leases.
Research and development (R&D) expenses of $5,112,000 (15% of revenues) for
fiscal 2002 increased by $2,558,000, or 100%, from the prior fiscal year of
$2,554,000 (9% of revenues). The increase relates primarily to expenses incurred
for the PEECH clinical trial in heart failure (which received FDA approval in
July 2000 and began treating patients in March 2001), the initiation of other
clinical studies and initiatives, as well as continued product design and
development costs (including an increase in engineering and other personnel).
The Company's newly developed EECP system, Model TS3, received FDA 510(k)
clearance to market in December 2000 and was commercially available for sale in
the fourth quarter of fiscal 2001. The Company intends to invest approximately
12%-14% of revenues in product development and clinical trials in fiscal 2003 to
further expand the clinical applications of EECP, including, but not limited to,
heart failure, diabetes disease management and acute coronary syndromes.
In fiscal 2002, the Company recorded a provision for income taxes of
$1,554,000, inclusive of $39,000 in current tax expense principally resulting
from state taxes. This is in contrast to a deferred tax benefit reported in
fiscal 2001 of $6,457,000 resulting principally from a change in the deferred
tax valuation allowance.
The increase in interest income in fiscal 2002 is the direct result of
interest income reported on equipment sold under sales-type leases, offset by
the decrease in the average cash balances invested during the year, as well as
declining interest rates this year over last year.
The increase in interest expense over the prior fiscal year is primarily
due to interest payments on loans secured for the purchase of the Company's
headquarters and operating facility in November 2000, as well as working capital
borrowings under the Company's revolving secured credit facility.
Fiscal Years Ended May 31, 2001 and 2000
The Company generated revenues from the sale and lease of EECP systems of
$27,508,000 and $13,674,000 for fiscal 2001 and fiscal 2000, respectively,
representing a 101% increase. The Company generated earnings before income taxes
of $5,237,000 and $1,291,000 for fiscal 2001 and fiscal 2000, respectively. The
Company generated earnings of $11,694,000 and $1,597,000 for fiscal 2001 and
fiscal 2000, respectively (after recognition of a deferred income tax benefit of
$6.6 million for fiscal 2001 and after deducting $94,000 in preferred stock
dividend requirements related to its June 1997 financing for fiscal 2000).
Revenue growth in the prior fiscal period (fiscal 2000) was initially
hindered because local Medicare contractors established inappropriate payment
levels that did not take into account the full value of the resources health
care providers must deploy to deliver EECP therapy. Consequently, in November
1999, CMS created a specific code for external counterpulsation therapy and
established a nationally applicable allowable charge, which became effective on
January 1, 2000. The allowable charge under the new code was based upon a
preliminary determination of Relative Value Units (RVUs) assigned by CMS to the
resources needed for the administration of the therapy. Certain patients may
require additional services, such as evaluation and management, which may be
billed separately. This resulted in a standard charge of $4,550 for a full
course of therapy, which typically involves 35 one-hour outpatient sessions. The
assigned code now allows EECP providers to bill Medicare electronically,
substantially reducing the process for receiving reimbursement. Moreover, in
light of these new payment instructions, local Medicare contractors no longer
have the responsibility of establishing reimbursement rates. Beginning August 1,
2000, Medicare coverage was extended to include EECP treatment received on an
outpatient basis at hospitals and outpatient clinics under the new APC
(Ambulatory Payment Classification) system. The national average payment rate
approximated $150 per session. Effective January 1, 2001, CMS approved an 11%
increase in the reimbursement rate for EECP therapy which raised the average
Medicare payment from $130 to $144 per hourly session, or $5,040 for a full
course of therapy. These events led to an increased demand for EECP therapy and
EECP equipment and, consequently, to revenue growth overall, as well as an
increase in the number of systems placed under fee-per-use arrangements with
certain providers.
In fiscal 2001, the Company shipped 168% more systems over the prior year
under various domestic and non-domestic commercial arrangements, including
direct sales, rental and "fee-per-use" placements and sales to foreign
distributors. Revenues from non-domestic business were $1,441,000, accounting
for 5% of total revenues compared to $155,000 or 1%, in 2000.
13
Gross profit
margins for fiscal 2001 and 2000 were 71% and 76%, respectively. Gross profits
are dependent on a number of factors, particularly the mix of EECP units sold
and rented during the period, the mix of EECP models sold, the ongoing costs of
servicing such units, and certain fixed period costs, including facilities,
payroll and insurance. Gross margins are furthermore affected by the location of
the Company's customers (including non-domestic business or distributorship
arrangements which, for discounted equipment purchase prices, co-invest in
establishing a market for EECP equipment) and the amount and nature of training
and other initial costs required to place the EECP system in service for
customer use. Consequently, the gross profit realized during the current period
may not be indicative of future margins. The decrease in gross profit for fiscal
2001 was partially attributable to the increased manufacturing costs of its
Model TS3 system manufactured in Westbury, NY. Management believes that these
increased costs will be offset in the future by manufacturing efficiencies and
the Company is continually engaged in a product cost reduction program.
Selling, general and administrative (SG&A) expenses for fiscal 2001 and
2000 were $11,635,000 and $7,384,000, respectively. The increase in SG&A
expenses of $4,251,000 from the comparable prior fiscal year resulted primarily
from increases in personnel in sales, marketing and administrative functions,
increases in selling and marketing expenses, including commissions, related to
increased revenues, as well as increases in insurance and other administrative
expenses.
Research and development (R&D) expenses of $2,554,0000, or 9% of revenues,
in fiscal 2001 increased by $1,141,000 from the comparable prior year expenses
of $1,413,000, or 10% of revenues. The increase relates primarily to continued
product design and development costs (including an increase in engineering and
other personnel), as well as the initiation of the pivotal study in heart
failure (which received FDA approval in July 2000 and began treating patients in
March 2001). The Company's newly developed EECP system, Model TS3, received FDA
510(k) clearance to market in December 2000 and was commercially available for
sale in the fourth quarter of fiscal 2001. The Company intends to invest in
product development and clinical trials in future periods to further expand the
clinical applications of EECP, including, but not limited to, heart failure and
diabetes disease management.
In fiscal 2001, the Company recorded a benefit for income taxes of
$6,457,000, inclusive of $140,000 in current tax expense principally resulting
from the federal alternative minimum tax and a deferred tax benefit of
$6,597,000 resulting principally from the change in the valuation allowance. The
fiscal 2001 deferred tax benefit does not include the tax benefit associated
with the current and prior years' exercises of stock options and warrants,
aggregating $7,209,000, which was credited directly to additional paid-in
capital in fiscal 2001.
In fiscal 2000, management had established a valuation allowance for a
portion of the deferred tax assets based on uncertainties with respect to the
Company's ability to generate future taxable income. At May 31, 2000, the
valuation allowance primarily related to net operating losses and a $6,165,000
tax benefit from the exercise of stock options and warrants included in the net
operating loss carryforward.
As of May 31, 2001, management determined that no valuation allowance was
required based upon its financial performance, which was positively affected by
the availability of Medicare coverage and reimbursement and the increasing
acceptance by the medical community of the Company's cost-effective and
noninvasive therapy system. In addition, the Company's assessment of the
cardiovascular disease marketplace, which includes favorable patient
demographics and unmet clinical needs, provides a substantial economic
opportunity and anticipated future earnings stream with respect to current and
prospective clinical applications for its products. Ultimate realization of the
deferred tax assets is dependent upon the Company generating sufficient taxable
income prior to the expiration of the loss carryforwards. Although realization
is not assured, management believes it is more likely than not that the net
deferred tax assets will be realized. The amount of the deferred tax assets
considered realizable, however, could be reduced in the future if estimates of
future taxable income during the carryforward period are reduced.
Liquidity and Capital Resources
The Company has financed its fiscal 2002 and 2001 operations primarily from
working capital and operating results. At May 31, 2002, the Company had a cash
balance of $2,968,000 and working capital of $17,225,000, compared to a cash
balance of $3,785,000 and working capital of $16,215,000 at May 31, 2001. The
Company's operating activities (used) provided cash of $(2,317,000) and $679,000
for fiscal 2002 and fiscal 2001, respectively. Net cash used in operations
during fiscal 2002 consisted primarily of increases in accounts receivable,
financing receivables and inventories, offset by increases in accounts payable,
14
accrued expenses and other liabilities. The increase in financing receivables
resulted from sales of equipment under sales-type leases, the first such
commercial contracts entered into by the Company in fiscal 2002. Cash receipts
under sales-type leases are expected over terms ranging between three and six
years. The increase in inventories resulted from an increase in finished goods
of the Company's Model TS3 system, which began commercial shipments in the
fourth quarter of fiscal 2001. The increase in accounts receivable resulted
primarily from extended credit terms offered to customers, particularly
non-domestic customers, in the current year. The Company's management provides
routine oversight with respect to its accounts receivable credit and collection
efforts, as well as the procurement of its raw materials and management of
finished goods inventory levels. Cash used in operations during fiscal year
2002, particularly as they relate to financing receivables, are not necessarily
indicative of the results expected in future years.
Investing activities used net cash of $820,000 and $1,578,000 during fiscal
2002 and fiscal 2001, respectively. In fiscal 2002, the principal use of cash
was a $500,000 loan made by the Company, through the issuance of notes to a
customer engaged in the establishment of a national network of EECP centers. In
fiscal 2001, the principal use of cash was for the purchase of property and
equipment, notably the purchase of the Company's headquarters and operating
facility.
Financing activities provided cash of $2,319,000 and $1,627,000 during
fiscal 2002 and fiscal 2001, respectively. In September 2001, the Company
refinanced a $641,667 outstanding short-term note payable (which arose in
connection with the November 2000 purchase of the Company's headquarters and
operating facility) with the New York Business Development Corporation. This
transaction released $641,667 of cash previously restricted as collateral under
the original note. The cash restricted as collateral on the second outstanding
note for $500,000 was released in January 2002 upon its refinancing. The balance
of the financing activities during fiscal 2002 and 2001 consisted primarily from
the sale of common stock and receipt of cash proceeds upon the exercise of
Company common stock warrants by officers, directors, employees and consultants.
In February 2002, the Company increased its existing credit facility to provide
for borrowings up to $15,000,000, based upon eligible accounts receivable and
raw materials inventory, as defined therein, at the Libor Rate plus 150 basis
points. At May 31, 2002, approximately $3,600,000 of the line was available of
which there were outstanding borrowings of $1,000,000.
Management believes that its working capital position at May 31, 2002, the
availability of its credit facility, and the ongoing commercialization of the
EECP system will make it possible for the Company to support its operating
expenses and to implement its business plans for at least the next twelve
months.
The following table presents the Company's expected cash requirements for
contractual obligations outstanding as of May 31, 2002:
Total Due in FY 2003 Due in FY 2004 - 2005 Due in FY 2006 - 2007 Due Thereafter
------------------------------------------------------------------------------------------------------
Line-of Credit (1) $1,000,000 $1,000,000
Long-Term Debt 1,119,161 46,445 $103,151 $118,551 $851,014
Operating Leases 226,000 87,000 90,000 49,000 -
Employment Agreements 520,000 270,000 150,000 100,000 -
Purchase Obligations 324,000 324,000 - - -
------------------------------------------------------------------------------------------------------
Total Contractual
Cash Obligations $3,189,161 $1,727,445 $343,151 $267,551 $851,014
======================================================================================================
(1) The Company maintains a revolving credit agreement which provides for
borrowings of up to $15,000,000, based upon eligible accounts receivable, as
defined therein. Approximately $3,600,000 is available under the revolving
credit agreement, of which $1,000,000 is outstanding at May 31, 2002. The
revolving credit agreement expires in February 2005.
Effects of Inflation
The Company believes 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.
Qualitative and Quantitative Disclosures About Market Risk
The Company is 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. The Company's 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.
15
Critical Accounting Policies
Financial Reporting Release No. 60, which was released by the Securities
and Exchange Commission, or SEC, in December 2001, requires all companies to
include a discussion of critical accounting policies or methods used in the
preparation of financial statements. Note A of the Notes to Consolidated
Financial Statements includes a summary of the Company's significant accounting
policies and methods used in the preparation of our financial statements. In
preparing these financial statements, the Company has made its 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. The Company does not believe there is a great likelihood that
materially different amounts would be reported under different conditions or
using different assumptions. The Company's critical accounting policies are as
follows:
Revenue Recognition
The Company recognizes revenue from the sale of its EECP system in the
period in which the Company fulfills its obligations under the sale agreement,
including delivery and customer acceptance. The Company has also entered into
lease agreements for its EECP system, generally for terms of one year or less,
that are classified as operating leases. Revenues from operating leases are
recognized on a straight-line basis over the life of the respective leases.
Revenues from the sale of extended warranties on the EECP system are recognized
on a straight-line basis over the life of the extended warranty, ranging from
one year to four years. Deferred revenues relate to extended warranty fees that
have been paid by customers prior to the performance of extended warranty
services.
The Company follows SFAS No. 13, "Accounting For Leases," for its sales of
EECP units under sales type-leases with two customers. In accordance with SFAS
No. 13, the Company records the sale and financing receivable at the amount of
the minimum lease payment, less unearned interest income, which is computed at
the interest rate implicit in the lease, and executory costs. The cost of the
EECP unit acquired by the customer is recorded as cost of sales in the same
period.
Accounts Receivable/Financing Receivables
Estimates are used in determining our allowance for doubtful accounts based
on our historical collections experience, current trends, credit policy and a
percentage of our accounts receivable by aging category. In determining these
percentages, we look at historical write-offs of our receivables. The Company
also looks at the credit quality of its customer base as well as changes in its
credit policies. The Company continuously monitors collections and payments from
its customers. While credit losses have historically been within expectations
and the provisions established, the Company cannot guarantee that it will
continue to experience the same credit loss rates that it has in the past.
In addition, the Company periodically reviews and assesses the net
realizability of its receivables arising from sales-type leases. If this review
results in a lower estimate of the net realizable value of the receivable, an
allowance for the unrealized amount is established in the period in which the
estimate is changed.
Inventories
The Company values inventory at the lower of cost or estimated market, cost
being determined on a first-in, first-out basis. The Company regularly reviews
inventory quantities on hand, particularly raw materials and components, and
records a provision for excess and obsolete inventory based primarily on
existing and anticipated design and engineering changes to our products as well
as forecasts of future product demand.
Warranty Costs
Equipment sold is generally covered by a warranty period of one year. The
Company accrues a warranty reserve for estimated costs to provide warranty
services. The estimate of costs to service our warranty obligations is based on
historical experience and an expectation of future conditions. While these
warranty costs have historically been within the Company's expectations and the
provisions established, to the extent the Company experiences increased warranty
claim activity or increased costs associated with servicing those claims, the
warranty accrual will increase, and the Company would experience decreased gross
profit.
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
16
deferred tax assets to the amount expected to be realized. In estimating future
tax consequences, the Company generally considers 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 management's
judgment regarding the realization of the deferred tax assets change, an
adjustment to the allowance is recorded, with an offsetting increase or
decrease, as appropriate, in income tax expense. Such adjustments are recorded
in the period in which management's estimate as to the realizability of the
asset changed.
Stock Compensation
The Company measures stock-based awards using the intrinsic value method.
As described in Note I, pro forma disclosure of the effect on net earnings and
net earnings per common share has been computed as if the fair value-based
method had been applied in measuring compensation expense.
Recently Issued Accounting Standards
In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No.
144"). SFAS No. 144 supersedes SFAS No. 121 "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and Accounting
Principles Board Opinion No. 30, "Reporting Results of Operations - Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions." This statement retains the
fundamental provisions of SFAS No. 121 for recognition and measurement of
impairment, but amends the accounting and reporting standards for segments of a
business to be disposed of. The new rules are effective for the Company on June
1, 2002. The Company is currently evaluating the impact of the adoption of SFAS
No. 144, which the Company expects will not be material.
ITEM EIGHT - FINANCIAL STATEMENTS
The consolidated financial statements listed in the accompanying Index to
Consolidated Financial Statements are filed as part of this report.
ITEM NINE - DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
17
PART III
ITEM TEN - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item will be included in the Company's
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection with the Company's 2002 Annual Meeting of Stockholders,
and is incorporated herein by reference.
ITEM ELEVEN - EXECUTIVE COMPENSATION
The information required by this Item will be included in the Company's
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection with the Company's 2002 Annual Meeting of Stockholders,
and is incorporated herein by reference.
ITEM TWELVE - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required by this Item will be included in the Company's
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection with the Company's 2002 Annual Meeting of Stockholders,
and is incorporated herein by reference.
ITEM THIRTEEN - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be included in the Company's
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection with the Company's 2002 Annual Meeting of Stockholders,
and is incorporated herein by reference.
ITEM FOURTEEN-EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(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 (15)
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) Form 8-K Reports
None
18
(c) 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 (8)
(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 (9)
(f) Stock Purchase Agreement dated April 30, 1998 between Registrant
and JNC Opportunity Fund, Ltd. (9)
(g) Registration Rights Agreement dated April 30, 1998 between
Registrant and JNC Opportunity Fund, Ltd. (9)
(h) Form of Warrant dated April 30, 1998 (9)
(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) (15)
(d) 1997 Stock Option Plan, as amended (10)
(e) Employment Agreement dated January 6, 2000, and amended
November 2000, between Registrant and
D. Michael Deignan (11) (13)
(f) 1999 Stock Option Plan, as amended (12)
(g) Credit Agreement dated February 21, 2002 between
Vasomedical, Inc. and Fleet National Bank (14)
(h) Loan Modification Agreement dated March 4, 2002 by
and among Vasomedical, Inc., HeartGen Centers, Inc., RLA
1993 Trust and Richard Abrahams (14)
(i) Loan Modification Agreement dated March 4, 2002 by and among
Vasomedical, Inc., HeartGen Centers, Inc., RLA 1993 Trust
and Richard Abrahams (14)
(j) Subordinated Security Agreement dated March 4, 2002 between
Vasomedical, Inc. and HeartGen Centers, Inc. (14)
(k) Warrant Agreement dated March 4, 2002 issued to Vasomedical, Inc.
by HeartGen Centers, Inc.(14)
(l) Center Financing Note dated March 5, 2002 issued by
HeartGen Centers, Inc. to Vasomedical, Inc. (14)
(m) Center Financing Note dated March 20, 2002 issued by HeartGen
Centers, Inc. to Vasomedical, Inc. (14)
(22) Subsidiaries of the Registrant
Percentage
Name State of Incorporation Owned by Company
---- ----------------------- ----------------
Viromedics, Inc. Delaware 61%
180 Linden Avenue Corp. New York 100%
(23) Consent of Grant Thornton LLP (15)
(99) Certification of Periodic Report (15)
- ------------------
(1) Incorporated by reference to Registration Statement on Form
S-18, No. 33-24095.
(2) Incorporated by reference to Registration Statement on Form S-1,
No. 33-46377 (effective 7/12/94).
(3) Incorporated by reference to Report on Form 8-K dated November
14, 1994.
(4) Incorporated by reference to Report on Form 8-K dated January 24, 1995.
(5) Incorporated by reference to Registration Statement on Form 8-A
dated May 12, 1995.
(6) Incorporated by reference to Notice of Annual Meeting of
Stockholders dated December 5, 1995.
(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-Q for the quarterly
period ended February 29, 2000.
(12) Incorporated by reference to Report on Form 10-K for the fiscal
year ended May 31, 2000.
(13) Incorporated by reference to Report on Form 10-Q for the quarterly
period ended November 30, 2000.
(14) Incorporated by reference to Report on Form 10-Q for the quarterly
period ended February 28, 2002.
(15) Filed herewith.
19
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized on the fifteenth day of August,
2002.
VASOMEDICAL, INC.
By: /s/ D. Michael Deignan
-----------------------------------
D. Michael Deignan
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 15, 2002 by the following persons in the
capacities indicated:
/s/ Alexander G. Bearn Director
- ----------------------------
Alexander G. Bearn
/s/ David S. Blumenthal Director
- ----------------------------
David S. Blumenthal
/s/ Abraham E. Cohen Chairman of the Board
- ----------------------------
Abraham E. Cohen
President, Chief Executive
/s/ D. Michael Deignan Officer and Director
- ---------------------------- (Principal Executive Officer)
D. Michael Deignan
Chief Financial Officer
/s/ Joseph A. Giacalone (Principal Financial and
- ---------------------------- Accounting Officer)
Joseph A. Giacalone
/s/ John C.K. Hui Senior Vice President, Chief
- ---------------------------- Technology Officer and Director
John C.K. Hui
/s/ Photios T. Paulson Director
- ----------------------------
Photios T. Paulson
/s/ Kenneth W. Rind Director
- ----------------------------
Kenneth W. Rind
/s/ E. Donald Shapiro Director
- ----------------------------
E. Donald Shapiro
/s/ Anthony Viscusi Director
- ----------------------------
Anthony Viscusi
/s/ Forrest R. Whittaker Director
- ----------------------------
Forrest R. Whittaker
/s/ Martin Zeiger Director
- ----------------------------
Martin Zeiger
Vasomedical, Inc. and Subsidiaries
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Certified Public Accountants F-2
Financial Statements
Consolidated Balance Sheets as of May 31, 2002 and 2001 F-3
Consolidated Statements of Earnings for the
years ended May 31, 2002, 2001 and 2000 F-4
Consolidated Statement of Changes in Stockholders'
Equity for the years ended May 31, 2002, 2001 and 2000 F-5
Consolidated Statements of Cash Flows for the
years ended May 31, 2002, 2001 and 2000 F-6
Notes to Consolidated Financial Statements F-7 - F-18
REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS
Stockholders and Board of Directors of
Vasomedical, Inc.
We have audited the accompanying consolidated balance sheets of Vasomedical,
Inc. and Subsidiaries (the "Company") as of May 31, 2002 and 2001, and the
related consolidated statements of earnings, changes in stockholders' equity and
cash flows for each of the three fiscal years in the period ended May 31, 2002.
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 auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes 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 the
Company as of May 31, 2002 and 2001, and the consolidated results of their
operations and their consolidated cash flows for each of the three fiscal years
in the period ended May 31, 2002, in conformity with accounting principles
generally accepted in the United States of America.
We have also audited Schedule II - Valuation and Qualifying Accounts for each of
the three fiscal years in the period ended May 31, 2002. In our opinion, this
schedule presents fairly, in all material respects, the information required to
be set forth therein.
/s/ Grant Thornton LLP
GRANT THORNTON LLP
Melville, New York
July 26, 2002
F-2
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
May 31,
2002 2001
---- ----
ASSETS
CURRENT ASSETS
Cash and cash equivalents $2,967,627 $3,785,456
Restricted cash - 1,141,667
Accounts receivable, net of an allowance
for doubtful accounts of $1,099,687 and
$545,000 at May 31, 2002 and 2001,
respectively 12,682,725 9,731,749
Inventories 4,902,121 4,367,943
Deferred income taxes 3,033,000 2,908,000
Financing receivables, net 633,786 -
Other current assets 627,243 443,887
----------- -----------
Total current assets 24,846,502 22,378,702
PROPERTY AND EQUIPMENT, net 3,252,030 2,606,037
CAPITALIZED COST IN EXCESS OF FAIR
VALUE OF NET ASSETS ACQUIRED, net of
accumulated amortization
of $1,349,613 at May 31, 2001 - 142,085
FINANCING RECEIVABLES, net 2,941,587 -
NOTES RECEIVABLE 512,329 -
DEFERRED INCOME TAXES 9,658,000 11,298,000
OTHER ASSETS 207,810 94,150
----------- -----------
$41,418,258 $36,518,974
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $3,645,846 $4,041,243
Current maturities of long-term debt and
notes payable 1,046,445 33,074
Sales tax payable 732,362 532,548
Deferred revenues 272,000 -
Accrued warranty and customer support expenses 588,334 567,000
Accrued professional fees 362,083 320,854
Accrued commissions 973,998 669,328
----------- -----------
Total current liabilities 7,621,068 6,164,047
LONG-TERM DEBT 1,072,716 1,108,593
ACCRUED WARRANTY COSTS 402,666 488,000
DEFERRED REVENUES 719,204 243,151
OTHER LONG-TERM LIABILITIES - 6,454
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; 57,309,120
and 57,195,453 shares at May 31, 2002 and
2001, respectively, issued and outstanding 57,309 57,195
Additional paid-in capital 50,116,148 49,808,493
Accumulated deficit (18,570,853) (21,356,959)
----------- -----------
31,602,604 28,508,729
----------- -----------
$41,418,258 $36,518,974
=========== ===========
The accompanying notes are an integral part of these statements.
F-3
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF EARNINGS
Year ended May 31,
------------------------------------------
2002 2001 2000
---- ---- ----
Revenues
Equipment sales $29,304,349 $26,912,373 $13,120,144
Equipment rentals and services 1,339,113 595,965 553,488
Equipment sold under sales-type leases 4,187,009 - -
----------- ----------- -----------
34,830,471 27,508,338 13,673,632
Cost of sales and services 10,538,731 7,910,359 3,277,700
----------- ----------- -----------
Gross profit 24,291,740 19,597,979 10,395,932
Expenses
Selling, general and administrative 13,686,958 11,634,965 7,383,567
Research and development 5,112,258 2,554,470 1,413,464
Provision for doubtful accounts 1,304,000 325,000 400,000
Interest and financing costs 98,140 48,294 7,302
Interest and other income, net (249,722) (201,992) (99,317)
----------- ----------- -----------
19,951,634 14,360,737 9,105,016
----------- ----------- -----------
EARNINGS BEFORE INCOME TAXES 4,340,106 5,237,242 1,290,916
Income tax (expense) benefit, net (1,554,000) 6,457,108 400,000
----------- ----------- -----------
NET EARNINGS 2,786,106 11,694,350 1,690,916
Preferred stock dividend requirement - - (94,122)
----------- ----------- -----------
EARNINGS APPLICABLE TO
COMMON STOCKHOLDERS $2,786,106 $11,694,350 $1,596,794
=========== =========== ===========
Net earnings per common share
- basic $.05 $.21 $.03
==== ==== ====
- diluted $.05 $.20 $.03
==== ==== ====
Weighted average common shares
outstanding - basic 57,251,035 56,571,402 52,580,623
=========== =========== ===========
- diluted 59,468,092 59,927,199 57,141,949
=========== =========== ===========
The accompanying notes are an integral part of these statements.
F-4
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Additional Total
Preferred stock Common stock paid-in Accumulated stockholders'
Shares Amount Shares Amount capital deficit equity
------ ------ ------ ------ ---------- ------------ -------------
Balance at June 1, 1999 175,000 $1,750 50,402,687 $50,403 $37,749,483 $(34,648,103) $3,153,533
Conversion of preferred stock (175,000) (1,750) 3,095,612 3,096 (1,346) - -
Exercise of options and warrants 2,169,831 2,169 2,816,542 2,818,711
Preferred stock dividend requirement (94,122) (94,122)
Common stock issued in lieu of
preferred stock dividends 253,200 253 287,479 287,732
Stock options granted for services 87,000 87,000
Net earnings 1,690,916 1,690,916
---------- ------- ---------- -------- ----------- ----------- ----------
Balance at May 31, 2000 - - 55,921,330 55,921 40,939,158 (33,051,309) 7,943,770
Exercise of options and warrants 1,274,123 1,274 1,625,335 1,626,609
Stock options granted for services 35,000 35,000
Tax benefit of stock options and
warrants exercised in the current
and prior years 7,209,000 7,209,000
Net earnings 11,694,350 11,694,350
---------- ------- ---------- -------- ----------- ----------- ----------
Balance at May 31, 2001 - - 57,195,453 57,195 49,808,493 (21,356,959) 28,508,729
Exercise of options and warrants 113,667 114 199,529 199,643
Stock options granted for services 50,126 50,126
Tax benefit of stock options and
warrants exercised in the
current year 58,000 58,000
Net earnings 2,786,106 2,786,106
---------- ------- ---------- -------- ----------- ------------ -----------
Balance at May 31, 2002 - - 57,309,120 $57,309 $50,116,148 $(18,570,853) $31,602,604
========== ======= =========== ======== =========== ============ ===========
The accompanying notes are an integral part of this statement.
F-5
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended May 31,
------------------------------------------
2002 2001 2000
---- ---- ----
Cash flows from operating activities
Net earnings $2,786,106 $11,694,350 $1,690,916
------------ ------------ ------------
Adjustments to reconcile net earnings
to net cash provided by (used in) operating
activities
Depreciation and amortization 962,167 587,541 483,627
Provision for doubtful accounts, net of write-offs 904,687 145,000 400,000
Reserve for inventory obsolescence 30,000 150,000 -
Deferred income taxes 1,573,000 (6,597,000) (400,000)
Stock options granted for services 50,126 35,000 87,000
Changes in operating assets and liabilities
Accounts receivable (3,855,663) (5,043,939) (3,647,378)
Financing receivables, net (3,575,373) - -
Inventories (1,694,198) (4,460,572) (281,337)
Other current assets (183,356) 35,380 (301,555)
Other assets (142,062) (90,251) 15,077
Accounts payable, accrued expenses and other
current liabilities 443,649 3,833,781 630,164
Other liabilities 384,265 389,605 164,000
------------ ------------ ------------
(5,102,758) (11,015,455) (2,850,402)
------------ ------------ ------------
Net cash provided by (used in) operating activities (2,316,652) 678,895 (1,159,486)
------------ ------------ ------------
Cash flows from investing activities
Issuance of notes (500,000) - -
Purchase of property and equipment (319,981) (1,578,415) (279,033)
------------ ------------ ------------
Net cash used in investing activities (819,981) (1,578,415) (279,033)
------------ ------------ ------------
Cash flows from financing activities
Proceeds from notes 2,141,667 1,141,667 -
Payments on notes (1,164,173) - -
Restricted cash 1,141,667 (1,141,667) -
Proceeds from exercise of options and warrants 199,643 1,626,609 2,818,711
------------ ------------ ------------
Net cash provided by financing activities 2,318,804 1,626,609 2,818,711
------------ ------------ ------------
NET INCREASE (DECREASE) IN
CASH AND CASH EQUIVALENTS (817,829) 727,089 1,380,192
Cash and cash equivalents - beginning of year 3,785,456 3,058,367 1,678,175
------------ ------------ ------------
Cash and cash equivalents - end of year $2,967,627 $3,785,456 $3,058,367
============ ============ ============
Non-cash investing and financing activities
were as follows:
Issuance of common stock in lieu of preferred
dividends $94,122
Inventories transferred to property and equipment
attributable to operating leases, net $1,130,020 $849,613 $31,554
Supplemental disclosures:
Interest paid $98,139 $48,294 $7,302
Income taxes paid $304,263 $10,749 $9,224
The accompanying notes are an integral part of these statements.
F-6
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2002, 2001 and 2000
NOTE A - BUSINESS ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company was incorporated in Delaware in July 1987. During fiscal 1996,
the Company commenced the commercialization of its EECP enhanced 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, clinics and other cardiac health care
providers. To date, a significant portion of the Company's revenues have been
generated from customers in the United States.
A summary of the significant accounting policies consistently applied in
the preparation of the consolidated financial statements follows:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company,
its wholly-owned subsidiary and its majority-owned subsidiary. Significant
intercompany accounts and transactions have been eliminated.
Inventories
Inventories are stated at the lower of cost or market; cost is determined
using the first-in, first-out method.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation is provided over the estimated useful lives of the
assets, which range from three to thirty-nine years, on a straight-line basis.
Accelerated methods of depreciation are used for tax purposes. Leasehold
improvements are amortized over the useful life of the related leasehold
improvement or the life of the related lease, whichever is less.
Capitalized Cost in Excess of Fair Value of Net Assets Acquired
The capitalized cost in excess of the fair value of the net assets acquired
("goodwill") was being amortized on a straight-line basis over a period of seven
years. The goodwill was fully amortized at May 31, 2002 and written off.
Revenue Recognition
The Company recognizes revenue from the sale of its EECP system in the
period in which the Company fulfills its obligations under the sale agreement,
including delivery and customer acceptance. The Company has also entered into
lease agreements for its EECP system, generally for terms of one year or less,
that are classified as operating leases. Revenues from operating leases are
recognized on a straight-line basis over the life of the respective leases.
Revenues from the sale of extended warranties on the EECP system are recognized
on a straight-line basis over the life of the extended warranty, ranging from
one year to four years. Deferred revenues relate to extended warranty fees that
have been paid by customers prior to the performance of extended warranty
services.
The Company follows SFAS No. 13, "Accounting For Leases," for its sales of
EECP units under sales type-leases with two customers. In accordance with SFAS
No. 13, the Company records the sale and financing receivable at the amount of
the minimum lease payment, less unearned interest income, which is computed at
the interest rate implicit in the lease, and executory costs. The cost of the
EECP unit acquired by the customer is recorded as cost of sales in the same
period.
In addition, the Company periodically reviews and assesses the net
realizability of its receivables arising from sales-type leases. If this review
results in a lower estimate of the net realizable value of the receivable, an
allowance for the unrealized amount is established in the period in which the
estimate is changed.
F-7
Concentrations of Credit Risk
The Company markets the EECP system principally to cardiologists,
hospitals, clinics and other health care providers. The Company performs credit
evaluations of its customers' financial condition and, as a consequence,
believes that its receivable credit risk exposure is limited. Receivables are
generally due within 60-90 days. (See Note E.)
Warranty Costs
The Company provides for a warranty period on its EECP system. The Company
accounts for estimated warranty costs at the time the related revenue is earned.
As the Company's experience with respect to the commercial use of the EECP
system is limited, revisions to the Company's warranty cost estimates may be
necessary in the future.
Research and Development
Research and development costs are expensed as incurred.
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, the Company generally considers 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 management's
judgment regarding the realization of the deferred tax assets change, an
adjustment to the allowance is recorded, with an offsetting increase or
decrease, as appropriate, in income tax expense. Such adjustments are recorded
in the period in which management's estimate as to the realizability of the
asset changed.
Shipping and Handling Costs
The Company includes all shipping and handling expenses incurred as a
component of cost 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 fair value of the financing receivables approximate fair value
as they are discounted using the interest rates implicit in the lease. The
carrying amounts of notes payable and notes receivable approximate their fair
values 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. These estimates and assumptions
relate to estimates of collectibility of accounts receivable, the realizability
of deferred tax assets, and the adequacy of inventory and warranty reserves.
Actual results could differ from those estimates.
Net Earnings Per Common Share
Basic earnings per common share are computed by dividing net earnings
available to common stockholders by the weighted average number of shares
outstanding during the period. Diluted earnings per common share reflect the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock.
Stock Compensation
The Company measures stock-based awards using the intrinsic value method.
As described in Note H, pro forma disclosure of the effect on net earnings and
net earnings per common share has been computed as if the fair value-based
method had been applied in measuring compensation expense.
F-8
Statements of Cash Flows
The Company considers highly liquid temporary cash investments with an
original maturity of three months or less to be cash equivalents. Cash
equivalents consist principally of money market funds. The market value of the
cash equivalents approximates cost.
Impact of New Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No.
144"). SFAS No. 144 supersedes SFAS No. 121 "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and Accounting
Principles Board Opinion No. 30, "Reporting Results of Operations - Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions." This statement retains the
fundamental provisions of SFAS No. 121 for recognition and measurement of
impairment, but amends the accounting and reporting standards for segments of a
business to be disposed of. The new rules are effective for the Company on June
1, 2002. The Company is currently evaluating the impact of the adoption of SFAS
No. 144, which the Company expects will not be material.
NOTE B - INVENTORIES
May 31,
2002 2001
---- ----
Inventories consist of the following:
Raw materials $2,661,303 $3,364,276
Work in progress 547,818 497,667
Finished goods 1,693,000 506,000
---------- ----------
$4,902,121 $4,367,943
========== ==========
NOTE C - FINANCING RECEIVABLES
In fiscal 2002, the Company entered into sales-type lease agreements for
certain EECP units with two customers. The following table shows the future
minimum rentals receivable under sales-type leases and future minimum lease
payments and obligations under capital leases in effect for the twelve months
ended May 31:
2003 $960,990
2004 859,560
2005 1,683,329
2006 628,680
2007 774,086
Thereafter 1,121,850
----------
Total minimum lease payments 6,028,495
Less estimated executory costs (493,684)
----------
Net minimum lease payments 5,534,811
Less interest (1,240,559)
----------
Present value of minimum lease payments 4,294,252
Less valuation allowance (718,879)
----------
Net financing receivables 3,575,373
Less current portion (633,786)
----------
Long-term portion $2,941,587
==========
The annual minimum lease payments are subject to adjustment based on usage
of the leased units in accordance with the provisions of the lease agreements.
F-9
NOTE D - PROPERTY AND EQUIPMENT
May 31,
2002 2001
---- ----
Property and equipment is summarized as follows:
Land $200,000 $200,000
Building and improvements 1,366,855 1,252,423
Office, laboratory and other equipment 794,801 617,875
EECP units under operating leases or
under loan for clinical trials 2,174,000 1,176,500
Furniture and fixtures 148,164 124,764
Leasehold improvements 117,803 112,578
---------- ----------
4,801,623 3,484,140
Less accumulated depreciation and amortization (1,549,593) (878,103)
---------- ----------
$3,252,030 $2,606,037
========== ==========
NOTE E - NOTES RECEIVABLE
In March 2002, the Company provided a $500,000 unsecured loan to a customer
engaged in establishing a national network of EECP centers. This financing was
part of an aggregate $3.2 million credit facility, subject to certain
conditions, executed by the customer with the Company and an unaffiliated lender
in January 2002, under which the Company has no further financing obligation.
The customer issued two notes to the Company of $250,000 each in connection with
two EECP centers that bear interest at 18% per annum and mature in September
2005. Payments of principal and interest under these notes will commence in
April 2003 in varying amounts determined by a formula based upon cash generated,
as defined in the loan agreement. In connection with this financing, the
customer issued to the Company a warrant to purchase 52,620 of its common shares
at $2.20 per share expiring in January 2007. The warrant contains a repurchase
option for a 30-day period beginning December 1, 2006 (assuming no earlier
liquidity event has taken place, as defined) that allows the Company, at its
option, to require the customer to redeem the warrant for $249,945. The warrant
value is collateralized by a subordinated security interest in the customer's
accounts receivable.
Under a multiyear sales contract, the Company sold to this customer
equipment (EECP units) under sales-type leases aggregating revenues of
$3,160,792 in fiscal 2002. At May 31, 2002, financing receivables of
approximately $2,563,000 from these sales-type lease transactions with this
customer are outstanding (Note C). In fulfilling the requirements of the
multi-year sales contract, the Company's concentration of credit risk with this
customer may increase significantly.
NOTE F - LONG-TERM DEBT AND LINE OF CREDIT AGREEMENT
May 31,
2002 2001
---- ----
Revolving credit agreement (a) $1,000,000 -
Term loans (b) 1,119,161 $1,141,667
---------- ----------
2,119,161 1,141,667
Less current portion (1,046,445) (33,074)
---------- ----------
$1,072,716 $1,108,593
========== ==========
(a) In February 2002, the Company renegotiated a secured revolving credit
line with its existing bank. The credit line provides for borrowings up to
$15,000,000, based upon eligible accounts receivable, as defined therein, at the
Libor Rate plus 150 basis points (3.4% at May 31, 2002). At May 31, 2002,
approximately $3,600,000 of the line was available of which there were
outstanding borrowings of $1,000,000. Under the terms of the agreement, which
expires in February 2005, the Company is required to meet certain covenants,
including, among others, maintenance of minimum tangible net worth. In addition,
the line is secured by substantially all the tangible assets of the Company.
(b) In November 2000, the Company purchased its headquarters and warehouse
facility and secured two notes payable from a financial institution for $641,667
and $500,000, respectively, which bore interest at the Libor Rate plus 150 basis
points and were payable in monthly installments of interest payments only.
Concurrent with the building purchase, the Company had received long-term
financing commitments under two programs sponsored by New York State. In
September 2001, the Company refinanced $641,667 of the notes under the first New
York State sponsored program at a fixed interest rate of 7.8% over a
fifteen-year term. In January 2002, the second note for $500,000 was refinanced
under the other program with a fixed interest rate of 6% over a fifteen-year
term. These notes are payable in monthly installments consisting of principal
and interest payments and are secured by the building.
F-10
Maturities of long-term debt are as follows at May 31, 2002:
2003 $46,445
2004 49,784
2005 53,367
2006 57,212
2007 61,339
Thereafter 851,014
----------
$1,119,161
==========
NOTE G - STOCKHOLDERS' EQUITY AND WARRANTS
In fiscal 2000, all 175,000 shares outstanding of the 5% Series C
Cumulative Convertible Preferred Stock issued in April 1998 were converted into
3,095,612 shares of common stock. In addition, warrants to purchase 1,435,000
shares of common stock were exercised (net of 101,910 shares offered in payment
in lieu of cash), aggregating $1,272,000 in proceeds to the Company.
In fiscal 2001, warrants to purchase 776,212 shares of common stock were
exercised, aggregating $1,143,000 in proceeds to the Company.
In fiscal 2002, warrants to purchase 15,000 shares of common stock were
exercised, aggregating $31,200 in proceeds to the Company. Subsequent to May 31,
2002, warrants to purchase 250,000 shares of common stock were exercised,
aggregating $112,500 in proceeds to the Company.
Warrants expire at varying dates between April 2003 and October 2006.
Warrant activity for the years ended May 31, 2000, 2001 and 2002 is summarized
as follows:
Non-employee
Directors Employees Consultants Total Price Range
------------ --------- ----------- ----- -----------
Balance at June 1, 1999 400,000 1,275,000 1,378,712 3,053,712 $.38 - $2.18
Exercised (400,000) (525,000) (510,000) (1,435,000) $.38 - $2.18
---------- ---------- ---------- ---------- ------------
Balance at May 31, 2000 - 750,000 868,712 1,618,712 $.45 - $2.08
Exercised (250,000) (526,212) (776,212) $.45 - $2.08
---------- ---------- ---------- ---------- ------------
Balance at May 31, 2001 - 500,000 342,500 842,500 $.45 - $2.08
Exercised (15,000) (15,000) $2.08
---------- ---------- ---------- ---------- ------------
Balance at May 31, 2002 - 500,000 327,500 827,500 $.45 - $2.08
========== ========== ========== ========== ============
Number of shares exercisable - 500,000 327,500 827,500 $.45 - $2.08
========== ========== ========== ========== ============
The following table summarizes information about warrants outstanding and
exercisable at May 31, 2002:
Warrants Outstanding and Exercisable
-------------------------------------------------
Weighted
Number Average
Outstanding and Remaining Weighted
Exercisable at Contractual Average
May 31, 2002 Life (yrs.) Exercise Price
Range of Exercise Prices
- ----------------------------- ------------------ ---------------- --------------
$.45 500,000 1.1 $.45
$.91 200,000 4.4 $.91
$2.08 127,500 0.9 $2.08
----------------- ---------------- --------------
827,500 1.9 $.81
================= ================ ==============
NOTE H - 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.
F-11
Outside Director Stock Option Plan
In May 1995, the Company's stockholders approved an Outside Director Stock
Option Plan for non-employee directors of the Company, for which the Company
reserved an aggregate of 300,000 shares of common stock. In December 1997, the
Company's Board of Directors terminated the Outside Director Stock Option Plan.
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 it will be administered by a committee
of the Board of Directors of the Company 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 addition, the Board of Directors granted stock options
under the 1997 Plan to a consultant to purchase 150,000 shares of common stock
at an exercise price of $.875 per share (which represented the fair market value
of the underlying common stock at the time of grant). The stock options granted
to the consultant were contingent upon meeting certain performance criteria. The
stock options were fair-valued at $87,000 for which the Company recorded a
charge to operations in fiscal 2000, commensurate with the satisfaction of the
performance criteria defined therein.
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 it will be
administered by a committee of the Board of Directors of the Company and that
the committee will have full authority to determine the identity of the
recipients of the options and the number of shares subject to each option.
Options granted under the 1999 Plan may be either incentive stock options or
non-qualified stock options. The option price shall be 100% of the fair market
value of the common stock on the date of the grant (or in the case of incentive
stock options granted to any individual principal stockholder who owns stock
possessing more than 10% of the total combined voting power of all voting stock
of the Company, 110% of such fair market value). The term of any option may be
fixed by the committee but in no event shall exceed ten years from the date of
grant. Options are exercisable upon payment in full of the exercise price,
either in cash or in common stock valued at fair market value on the date of
exercise of the option. The term for which options may be granted under the 1999
Plan expires July 12, 2009. In July 2000, the Company's Board of Directors
increased the number of shares authorized for issuance under the 1999 Plan by
1,000,000 shares to 3,000,000 shares. In December 2001, the Board of Directors
of the Company increased the number of shares authorized for issuance under the
1999 Plan by 2,000,000 shares to 5,000,000 shares.
In January 2001, the Board of Directors granted stock options under the
1999 Plan to a consultant to purchase 25,000 shares of common stock at an
exercise price of $3.81 per share (which represented the fair market value of
the underlying common stock at the time of the respective grant). The Company
charged $60,000 to operations over the one-year period in which services were
rendered. In December 2001, the Board of Directors granted stock options under
the 1999 Plan to a consultant to purchase 25,000 shares of common stock at an
exercise price of $2.95 per share (which represented the fair market value of
the underlying common stock at the time of the respective grant). These stock
options were fair-valued at $50,250 which the Company will charge to operations
over the one-year period in which services are rendered. During fiscal 2002 and
2001, the Company charged $50,126 and $35,000, respectively, to operations for
these grants.
In fiscal 2002, the Board of Directors granted stock options under the 1999
Plan to directors and employees to purchase an aggregate of 1,059,100 shares of
common stock, at exercise prices ranging from $1.78 to $4.02 per share (which
represented the fair market value of the underlying common stock at the time of
the respective grants).
F-12
Activity under all the plans for the years ended May 31, 2000, 2001 and
2002 is summarized as follows:
Outstanding Options
-----------------------------------------------------------
Shares Available Exercise Weighted Average
for Grant Number of Shares Price per Share Exercise Price
---------------------- ----------------- ---------------------- ------------------
Balance at June 1, 1999 40,500 3,855,143 $.75 - $3.44 $1.70
Shares authorized 2,000,000
Options granted (1,270,000) 1,270,000 $1.22 - $5.15 $1.95
Options exercised - (836,741) $.75 - $3.44 $1.85
Options canceled 134,668 (144,668) $.88 - $1.91 $1.47
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2000 905,168 4,143,734 $.75 - $5.15 $1.76
Shares authorized 1,000,000
Options granted (798,000) 798,000 $2.66 - $5.00 $4.00
Options exercised - (497,911) $.75 - $3.44 $.97
Options canceled 111,000 (111,000) $.75 - $3.47 $1.90
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2001 1,218,168 4,332,823 $.78 - $5.15 $2.26
Shares authorized 2,000,000
Options granted (1,084,100) 1,084,100 $1.78 - $4.02 $3.61
Options exercised - (98,667) $.88 - $2.44 $1.71
Options canceled 125,333 (125,333) $.88 - $5.00 $3.90
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2002 2,259,401 5,192,923 $.78 - $5.15 $2.51
================= =================== ======================== ================
F-13
The following table summarizes information about stock options outstanding
and exercisable at May 31, 2002:
Options Outstanding Options Exercisable
------------------------------------------------- --------------------------------
Weighted
Average
Number Remaining Weighted Number Weighted
Outstanding at Contractual Average Exercisable at Average
May 31, 2002 Life (yrs.) Exercise Price May 31, 2002 Exercise
Range of Exercise Prices Price
- ----------------------------- ------------------ ---------------- --------------- ----------------- --------------
$.75 - $.88 979,779 4.6 $.87 980,779 $.87
$1.22 - $1.78 968,250 7.5 $1.37 484,918 $1.41
$1.91 - $2.78 842,727 6.1 $2.01 762,461 $1.94
$2.89 - $4.28 2,144,667 7.6 $3.69 836,000 $3.60
$4.59 - $5.15 257,500 7.7 $4.82 132,500 $4.92
------------------ ---------------- --------------- ----------------- --------------
5,192,923 6.8 $2.51 3,196,658 $2.09
================== ================ =============== ================= ==============
As permitted under Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS No. 123"), the Company has
elected to follow APB Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25") in accounting for stock-based awards. Pursuant to APB 25, the Company
generally recognizes no compensation expense with respect to such awards. Pro
forma information regarding net income and earnings per share is required for
awards granted as if the Company had accounted for its stock-based awards under
the fair value method of SFAS No. 123. The fair value of the Company's
stock-based awards was estimated using the Black-Scholes option valuation model.
The fair value of the Company's stock-based awards was estimated assuming no
expected dividends and the following weighted-average assumptions:
Fiscal year ended May 31, 2002 2001 2000
- ------------------------- ---- ---- ----
Expected life (years) 5 5 5
Expected volatility 86% 80% 80%
Risk-free interest rate 3.9% 5.2% 6.0%
The following are the pro forma net earnings and net earnings per share
basic and diluted amounts for fiscal 2002, 2001 and 2000, as if compensation
expense for stock-based awards had been determined based on their estimated fair
value at the date of grant:
2002 2001 2000
---- ---- ----
Pro forma net earnings $1,642,986 $10,382,690 $576,435
Pro forma net earnings per share
- basic $.03 $.18 $.01
- diluted $.03 $.17 $.01
The weighted-average fair value of options granted during fiscal 2002, 2001
and 2000 was $2.50, $2.73 and $2.75, respectively. At May 31, 2002, there were
approximately 11,617,000 remaining authorized shares of common stock after
reserves for all stock option plans, stock warrants and shareholders' rights.
NOTE I - EARNINGS PER COMMON SHARE
Basic earnings per share are based on the weighted average number of common
shares outstanding without consideration of potential common stock. Diluted
earnings per share are based on the weighted number of common and potential
common shares outstanding. The calculation takes into account the shares that
may be issued upon the exercise of stock options and warrants, reduced by the
shares that may be repurchased with the funds received from the exercise, based
on the average price during the period. Options and warrants to purchase
2,432,000 and 893,000 shares of common stock were excluded from the computation
of diluted earnings per share as of May 31, 2002 and 2001, respectively, because
the effect of their inclusion would be antidilutive.
F-14
The following table sets forth the computation of basic and diluted
earnings per share:
For the fiscal year ended May 31,
2002 2001 2000
---- ---- ----
Numerator:
Basic earnings $2,786,106 $11,694,350 $1,690,916
Preferred stock dividends - - (94,122)
---------- ----------- ----------
Diluted earnings $2,786,106 $11,694,350 $1,596,794
========== =========== ==========
Denominator:
Basic - weighted average shares 57,251,035 56,571,402 52,580,623
Stock options 1,624,744 2,270,094 1,389,607
Warrants 592,313 1,085,703 1,428,678
Convertible preferred stock - - 1,743,041
---------- ----------- ----------
Diluted - weighted average shares 59,468,092 59,927,199 57,141,949
========== =========== ==========
Earnings per share - basic $.05 $.21 $0.03
==== ==== =====
- diluted $.05 $.20 $0.03
==== ==== =====
NOTE J - INCOME TAXES
In fiscal 2002, the Company recorded an expense for income taxes of
$1,554,000, inclusive of $39,000 in current tax expense and a deferred tax
expense of $1,515,000. In fiscal 2001, the Company recorded a benefit for income
taxes of $6,457,108, inclusive of $139,892 in current tax expense principally
resulting from the federal alternative minimum tax and a deferred tax benefit of
$6,597,000 resulting principally from the change in the valuation allowance. In
fiscal 2000, the Company recorded a $400,000 benefit for income taxes resulting
principally from a change in the deferred tax valuation allowance.
The Company's deferred tax assets are summarized as follows:
May 31,
-----------------------------------------------
2002 2001 2000
---- ---- ----
Deferred tax assets
Net operating loss and other carryforwards $11,344,000 $13,422,000 $14,627,000
Accrued compensation - - 12,500
Bad debts 493,000 178,000 187,000
Other 854,000 606,000 238,500
----------- ----------- ------------
Total gross deferred tax assets 12,691,000 14,206,000 15,065,000
Valuation allowance - - (14,665,000)
----------- ----------- ------------
Net deferred tax assets $12,691,000 $14,206,000 $ 400,000
=========== =========== ============
The fiscal 2002 tax expense does not include the tax benefit associated
with the current exercises of stock options and warrants, aggregating $58,000,
which was credited directly to additional paid-in capital in the current year.
The fiscal 2001 deferred tax benefit does not include the tax benefit
associated with the current and prior years' exercises of stock options and
warrants, aggregating $7,209,000, which was credited directly to additional
paid-in capital in such year.
In fiscal 2000, management had established a valuation allowance for a
significant portion of the deferred tax assets based on uncertainties with
respect to the Company's ability to generate future taxable income. At May 31,
2000, the valuation allowance primarily related to net operating losses and a
$6,165,000 tax benefit from the exercise of stock options and warrants included
in the net operating loss carryforward.
F-15
As of May 31, 2001, management determined that no valuation allowance was
required based upon its financial performance, which was positively affected by
the availability of Medicare coverage and reimbursement and the increasing
acceptance by the medical community of the Company's cost-effective and
noninvasive therapy system. In addition, the Company's assessment of the
cardiovascular disease marketplace, which includes favorable patient
demographics and unmet clinical needs, provides a substantial economic
opportunity and anticipated future earnings stream with respect to current and
prospective clinical applications for its products. Ultimate realization of the
deferred tax assets is dependent upon the Company generating sufficient taxable
income prior to the expiration of the loss carryforwards. Although realization
is not assured, management believes it is more likely than not that the net
deferred tax assets will be realized. The amount of the deferred tax assets
considered realizable, however, could be reduced in the future if estimates of
future taxable income during the carryforward period are reduced.
At May 31, 2002, the Company had net operating loss carryforwards for
Federal income tax purposes of approximately $33,366,000, expiring at various
dates from 2005 through 2020.
The following is a reconciliation of the effective income tax rate to the
federal statutory rate:
2002 2001 2000
Amount % Amount % Amount %
-------------- ---------- -------------- ---------- --------------- ----------
Federal statutory rate $1,475,000 34.0 $1,781,000 34.0 $387,911 34.0
State taxes, net 56,000 1.3 65,000 1.2 83,451 7.3
Permanent differences 23,000 .5 67,300 1.3 89,756 7.8
Utilization of net operating loss - (1,781,000) (34.0) (561,118) (49.1)
Change in valuation allowance
relating to operations - (6,719,000) (128.3) (400,000) (35.0)
Other - 129,592 2.5 -
-------------- ---------- -------------- ---------- --------------- ----------
$1,554,000 35.8 $(6,457,108) (123.3) $(400,000) (35.0)
============== ========== ============== ========== =============== ==========
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.
NOTE K - COMMITMENTS AND CONTINGENCIES
Employment Agreements
The Company maintains employment agreements with certain executive
officers, expiring at various dates through January 2005. One of the employment
agreements contains a provision that provides for automatic one-year extensions
through November 2005 provided no non-renewal notice is given. All such
employment agreements provide, among other things, that in the event there is a
change in the control of the Company, as defined therein, or in any person
directly or indirectly controlling the Company, as also defined therein, the
employee has the option, exercisable within six months of becoming aware of such
event, to terminate the employment agreement. Upon such termination, the
employee has the right to receive, as a lump-sum payment, certain compensation
remaining to be paid for the balance of the term of the agreement.
The approximate aggregate minimum compensation obligation under active
employment agreements at May 31, 2002 are summarized as follows:
Fiscal Year Amount
----------- ------
2003 $270,000
2004 150,000
2005 100,000
--------
$520,000
========
F-16
Leases
The Company leases additional warehouse space under three noncancelable
operating leases, two of which expire on October 31, 2002 and one on September
30, 2006. Rent expense was $85,000, $69,000 and $130,000 in fiscal 2002, 2001
and 2000, respectively.
Approximate aggregate minimum annual obligations under these lease
agreements and other equipment leasing agreements at May 31, 2002 are summarized
as follows:
Fiscal Year Amount
----------- ------
2003 $87,000
2004 48,000
2005 42,000
2006 37,000
2007 12,000
--------
$226,000
========
Litigation
In February 1999, an action was commenced in the Massachusetts Superior
Court, Essex County, against the Company. The action sought damages in the sum
of $1,000,000 based upon an alleged breach of a sales contract. In January 2002,
this matter was dismissed by the court.
F-17
In June 2001, an action was commenced in the New York Supreme Court, Nassau
County, against the Company by the former holder of a warrant to purchase
100,000 shares of the Company's stock seeking undefined damages based upon a
claim that the Company breached an agreement to register the common shares
underlying the warrant at the "earliest practicable date" after due demand by
the warrant holder had been made. The Company believes that it fulfilled its
obligations under the warrant to the plaintiff in a timely fashion and that the
complaint is without merit. Accordingly, the Company is defending the action
vigorously. Although discovery has been completed, the Company is yet unable to
establish the likelihood of an unfavorable outcome or the existence or amount of
any potential loss.
In or about late June 2002, the Company was notified by a letter from the
domestic counsel for Foshan Life Sciences Co. Ltd. ("FLSC"), a joint venture
comprised of a Florida company and Vamed Medical Instrument Company Limited
("Vamed"), a Chinese company with whom the Company had an agreement to
manufacture the Company's EECP Model MC2 system, that FLSC was initiating an
arbitration proceeding before the Hong Kong International Arbitration Council
("HKIAC") to recover compensatory and punitive damages in excess of $1,000,000
and injunctive relief based upon claims of breach of the manufacturing
agreement, tortious interference and misappropriation of confidential
information and trade secrets. Although possessing several substantive defenses
to these claims, the Company initially has challenged the HKIAC's right to hear
and determine the dispute on the ground that FLSC is neither a legitimate nor
recognized party to the manufacturing agreement which provides for such
arbitration and, therefore, is not entitled to enforce the same. The Company
also has demanded that FLSC deposit with the HKIAC security to cover the
Company's costs of arbitration. To date, FLSC has neither responded to the
Company's demand for security nor apparently filed a formal statement of claim
with the HKIAC.
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 2002, the
Company made contributions of approximately $20,000 to match a percentage of
employee contributions. No Company contributions were made for the fiscal years
ended May 31, 2001 and 2000.
Purchase Commitments
At May 31, 2002, the Company had outstanding purchase commitments of
$324,000 with Foshan Life Sciences Co. Ltd. ("FLSC"), a Chinese company that has
assumed the operational activities of Vamed, another Chinese company, for the
manufacture of its EECP Model MC2 system. The Company believes that FLSC will be
able to meet the Company's future need for this system.
NOTE L - 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, 2002 and 2001.
Three months ended
-----------------------------------------------------------------------------------------------------
(in 000s except
earnings per share May 31, Feb. 28, Nov. 30, Aug. 31, May 31, Feb. 28, Nov. 30, Aug. 31,
data) 2002 2002 2001 2001 2001 2001 2000 2000
- -------------------- ------------- ------------ ------------- ------------ ----------- ----------- ----------- -----------
Revenues $8,641 $8,019 $8,544 $9,626 $8,741 $7,068 $6,454 $5,245
Gross Profit $6,083 $5,382 $5,980 $6,847 $6,115 $4,836 $4,765 $3,882
Net Earnings $440 $98 $1,005 $1,243 $6,814 $1,785 $1,695 $1,400
Earnings per
share - basic $.01 $.00 $.02 $.02 $.12 $.03 $.03 $.02
- diluted $.01 $.00 $.02 $.02 $.11 $.03 $.03 $.02
Weighted average
common shares
outstanding -
- basic 57,309 57,281 57,207 57,198 57,068 56,711 56,383 56,129
- diluted 59,256 59,469 59,364 59,776 60,299 59,891 59,852 59,694
F-18
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 Balance at
beginning of costs and other end of period
period expenses accounts Deductions
- -----------------------------------------------------------------------------------------------------------------
Allowance for doubtful accounts (a)
Year ended May 31, 2002 $545,000 $954,000 $399,313 (a) $1,099,687
Year ended May 31, 2001 $400,000 $325,000 $180,000 (a) $545,000
Year ended May 31, 2000 $- $400,000 $400,000
Valuation Allowance- Financing
Receivables
Year ended May 31, 2002 $- $718,879 $718,879
Reserve for obsolete inventory
Year ended May 31, 2002 $150,000 $ 30,000 $180,000
Year ended May 31, 2001 $- $150,000 $150,000
Valuation Allowance Deferred Tax
Asset
Year ended May 31, 2002 $- $-
Year ended May 31, 2001 $14,665,000 $14,665,000 $-
Year ended May 31, 2000 $12,252,000 $2,413,000 $14,665,000
Provision for warranty obligations
Year ended May 31, 2002 $1,055,000 $780,000 $844,000 $991,000
Year ended May 31, 2001 $387,000 $1,250,000 $582,000 $1,055,000
Year ended May 31, 2000 $496,000 $316,000 $425,000 $387,000
(a) accounts receivable written off
S-1