UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the quarterly period ended February 29, 2004
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the transition period from _______________ to ______________
Commission File Number: 0-18105
VASOMEDICAL, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 11-2871434
- --------------------------------------------------------------------------------
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
180 Linden Ave., Westbury, New York 11590
- --------------------------------------------------------------------------------
(Address of principal executive offices)
Registrant's Telephone Number (516) 997-4600
Number of Shares Outstanding of Common Stock,
$.001 Par Value, at April 8, 2004 58,407,690
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
--- --
Page 1
Vasomedical, Inc. and Subsidiaries
INDEX
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements (unaudited) Page
----
Consolidated Condensed Balance Sheets as of
February 29, 2004 and May 31, 2003 3
Consolidated Condensed Statements of Earnings for the
Nine and Three Months Ended February 29, 2004 and
February 28, 2003 4
Consolidated Condensed Statement of Changes in Stockholders'
Equity for the Period from June 1, 2003 to
February 29, 2004 5
Consolidated Condensed Statements of Cash Flows for the
Nine Months Ended February 29, 2004 and
February 28, 2003 6
Notes to Consolidated Condensed Financial Statements 7
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 3 Qualitative and Quantitative Disclosures About Market Risk 29
Item 4 Procedures and Controls 29
PART II - OTHER INFORMATION 30
Page 2
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED CONDENSED BALANCE SHEETS
February 29, May 31,
2004 2003
----------------- -----------------
ASSETS (unaudited) (audited)
CURRENT ASSETS
Cash and cash equivalents $7,743,604 $5,222,847
Accounts receivable, net of an allowance for doubtful accounts of
$758,026 at February 29, 2004 and $768,629 at May 31, 2003 4,781,025 7,377,118
Inventories 2,665,314 3,439,567
Deferred income taxes -- 303,000
Financing receivables, net -- 264,090
Other current assets 471,407 268,231
----------------- -----------------
Total current assets 15,661,350 16,874,853
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,513,348 at
February 29, 2004 and $ 2,338,366 at May 31, 2003 2,471,085 3,233,158
FINANCING RECEIVABLES, net -- 679,296
DEFERRED INCOME TAXES 14,582,000 14,279,000
OTHER ASSETS 289,360 261,243
----------------- -----------------
$33,003,795 $35,327,550
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $2,791,755 $2,667,861
Current maturities of long-term debt and notes payable 133,617 108,462
Sales tax payable 330,943 461,704
Deferred revenues 1,601,037 789,118
Accrued warranty and customer support expenses 241,000 575,000
Accrued professional fees 90,926 207,793
Accrued commissions 347,026 586,823
----------------- -----------------
Total current liabilities 5,536,304 5,396,761
LONG-TERM DEBT 1,127,345 1,177,804
ACCRUED WARRANTY COSTS 109,000 213,000
DEFERRED REVENUES 958,587 920,433
OTHER LIABILITIES 233,750 300,250
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; 1,000,000 shares authorized; none
issued and outstanding -- --
Common stock, $.001 par value; 110,000,000 shares authorized;
58,157,690 and 57,822,023 shares at February 29, 2004 and May 31,
2003, respectively, issued and outstanding 58,158 57,822
Additional paid-in capital 51,006,064 50,623,316
Accumulated deficit (26,025,413) (23,361,836)
----------------- -----------------
Total stockholders' equity 25,038,809 27,319,302
----------------- -----------------
$33,003,795 $35,327,550
================= =================
The accompanying notes are an integral part of these condensed statements.
Page 3
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS
(unaudited)
Nine Months Ended Three Months Ended
------------------------------ ------------------------------
February February 28, February February 28,
29, 2004 2003 29, 2004 2003
------------- ------------- ------------- -------------
Revenues
Equipment sales $14,147,248 $16,995,678 $5,185,388 $6,581,338
Equipment rentals and services 2,132,323 1,340,344 764,522 571,246
------------- ------------- ------------- -------------
16,279,571 18,336,022 5,949,910 7,152,584
Cost of sales and services 5,565,098 6,733,743 1,933,175 2,769,854
------------- ------------- ------------- -------------
Gross Profit 10,714,473 11,602,279 4,016,735 4,382,730
Expenses
Selling, general and administrative 9,217,836 10,877,174 3,083,407 3,013,330
Research and development 2,996,970 3,520,928 1,043,595 1,003,302
Provision for doubtful accounts 1,147,011 3,541,627 161,500 280,919
Interest and financing costs 101,335 143,997 35,089 46,930
Interest and other income, net (115,102) (135,766) (6,815) (31,062)
------------- ------------- ------------- -------------
13,348,050 17,947,960 4,316,776 4,313,419
------------- ------------- ------------- -------------
EARNINGS (LOSS) BEFORE INCOME TAXES (2,633,577) (6,345,681) (300,041) 69,311
Income tax (expense) benefit, net (30,000) 1,540,442 (10,000) (43,480)
------------- ------------- ------------- -------------
NET EARNINGS (LOSS) ($2,663,577) ($4,805,239) $(310,041) $25,831
============= ============= ============= =============
Net earnings (loss) per common share
- basic ($0.05) ($0.08) ($0.01) $0.00
============= ============= ============= =============
- diluted ($0.05) ($0.08) ($0.01) $0.00
============= ============= ============= =============
Weighted average common shares outstanding
- basic 57,847,004 57,647,032 57,886,701 57,809,120
============= ============= ============= =============
- diluted 57,847,004 57,647,032 57,886,701 58,078,334
============= ============= ============= =============
The accompanying notes are an integral part of these condensed statements.
Page 4
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED CONDENSED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(unaudited)
Additional Total
Paid-in Accumulated Stockholders
Shares Amount Capital Deficit Equity
------------ ---------- -------------- --------------- --------------
Balance at June 1, 2003 57,822,023 $57,822 $50,623,316 ($23,361,836) $27,319,302
Exercise of stock options 335,667 336 382,748 383,084
Net loss (2,663,577) (2,663,577)
------------ ---------- -------------- --------------- --------------
Balance at February 29, 2004 58,157,690 $58,158 $51,006,064 ($26,025,413) $25,038,809
============ ========== ============== =============== ==============
The accompanying notes are an integral part of this condensed statement.
Page 5
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months ended
--------------------------------------
February 29, February 28,
2004 2003
----------------- -----------------
Cash flows from operating activities
Net loss ($2,663,577) ($4,805,239)
----------------- -----------------
Adjustments to reconcile net loss to net cash provided by operating
activities
Depreciation and amortization 595,685 879,375
Provision for doubtful accounts, net of write-offs 674,175 3,306,627
Allowance for inventory write-off 90,516 --
Deferred income taxes -- (1,619,420)
Stock options granted for services -- 50,681
Changes in operating assets and liabilities
Accounts receivable 2,606,696 2,932,790
Financing receivables, net 258,608 132,708
Inventories 1,012,606 709,978
Other current assets (203,176) 295,354
Other assets (52,877) (53,270)
Accounts payable, accrued expenses and other current
liabilities 114,388 (1,059,187)
Other liabilities (132,346) 380,650
----------------- -----------------
4,964,275 5,956,286
----------------- -----------------
Net cash provided by operating activities 2,300,698 1,151,047
----------------- -----------------
Cash flows from investing activities
Purchase of property and equipment (137,721) (223,625)
----------------- -----------------
Net cash used in investing activities (137,721) (223,625)
----------------- -----------------
Cash flows from financing activities
Proceeds from notes 67,149 126,960
Payments on notes (92,453) (48,270)
Proceeds from exercise of options and warrants 383,084 225,000
----------------- -----------------
Net cash provided by financing activities 357,780 303,690
----------------- -----------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,520,757 1,231,112
Cash and cash equivalents - beginning of period 5,222,847 2,967,627
----------------- -----------------
Cash and cash equivalents - end of period $7,743,604 $4,198,739
================= =================
Non-cash investing and financing activities were as follows:
Inventories transferred to (from) property and equipment, attributable
to operating leases - net ($328,869) $754,519
The accompanying notes are an integral part of these condensed statements.
Page 6
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 29, 2004
NOTE A - BASIS OF PRESENTATION
The consolidated condensed balance sheet as of February 29, 2004, and the
related consolidated condensed statements of earnings for the nine and
three-month periods ended February 29, 2004 and February 28, 2003, changes in
stockholders' equity for the nine-month period ended February 29, 2004, and cash
flows for the nine- month periods ended February 29, 2004 and February 28, 2003,
have been prepared by Vasomedical, Inc. and Subsidiaries (the "Company") without
audit. In the opinion of management, all adjustments (which include only normal,
recurring accrual adjustments) necessary to present fairly the financial
position and results of operations as of February 29, 2004, and for all periods
presented have been made.
Certain information and footnote disclosures, normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America, have been condensed or omitted. These
financial statements should be read in conjunction with the financial statements
and notes thereto included in the Annual Report on Form 10-K for the year ended
May 31, 2003. Results of operations for the periods ended February 29, 2004 and
February 28, 2003 are not necessarily indicative of the operating results
expected or reported for the full year.
NOTE B IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 ("SFAS No. 149"), "Amendment of Statement 133 on Derivative Instruments
and Hedging Activities," which amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities under SFAS No. 133. SFAS
No. 149 is effective for contracts entered into or modified after June 30, 2003,
except for the provisions that were cleared by the FASB in prior pronouncements.
The adoption of SFAS No. 149 has not had a material impact on the Company's
financial position and results of operations.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150 ("SFAS No. 150"), "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." This statement establishes
standards for how an issuer classifies and measures in its statement of
financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. This Statement shall be effective for financial instruments entered
into or modified after May 31, 2003, and otherwise shall be effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 has not had a material impact on the Company's
financial position and results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation
of Variable Interest Entities" ("FIN 46"), as interpreted by FIN 46R. In
general, a variable interest entity is a corporation, partnership, trust, or any
other legal structure used for business purposes that either (a) does not have
equity investors with voting rights or (b) has equity investors that do not
provide sufficient financial resources for the entity to support its activities.
A variable interest entity often holds financial assets, including loans or
receivables, real estate or other property. A variable interest entity may be
essentially passive or it may engage in activities on behalf of another company.
Until now, a company generally has included another entity in its consolidated
financial statements only if it controlled the entity through voting interests.
FIN 46 changes that by requiring a variable interest entity to be consolidated
by a company if that company is subject to a majority of the risk of loss from
the variable interest entity's activities or entitled to receive a majority of
the entity's residual returns or both. FIN 46's consolidation requirements apply
immediately to variable interest entities created or acquired after January 31,
2003. The consolidation requirements apply to older entities in the first
interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The Company
adopted FIN 46 effective January 31, 2003. The adoption of FIN 46 did not have a
material impact on the Company's financial position or results of operations.
In November 2002, the Emerging Issues Task Force, ("EITF") reached a
consensus opinion on, "Revenue Arrangements with Multiple Deliverables", "(EITF
00-21)". That consensus provides that revenue arrangements with multiple
deliverables should be divided into separate units of accounting if certain
criteria are met. The consideration of the arrangement should be allocated to
the separate units of accounting based on their relative fair values, with
Page 7
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 29, 2004
different provisions if the fair value is contingent on delivery of specified
items or performance conditions. Applicable revenue criteria should be
considered separately for each separate unit of accounting. EITF 00-21 is
effective for revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. Effective September 1, 2003, the Company prospectively
adopted the provisions of EITF 00-21. Upon adoption of the provisions of EITF
00-21, the Company deferred $57,500 and $15,000 of revenue related to the fair
value of installation and in-service training and $466,667 and $212,917 of
revenue related to the warranty service for EECP system sales recognized for the
nine-month and three-month periods ended February 29, 2004, respectively.
In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104,
"Revenue Recognition" (SAB No. 104), which codifies, revises and rescinds
certain sections of SAB No. 101, "Revenue Recognition in Financial Statements",
in order to make this interpretive guidance consistent with current
authoritative accounting and auditing guidance and SEC rules and regulations.
The changes noted in SAB No. 104 did not have a material effect on the Company's
financial position or results of operations.
NOTE C STOCK-BASED COMPENSATION
The Company has four stock-based employee compensation plans. The Company
accounts for stock-based compensation using the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related Interpretations ("APB No. 25") and has
adopted the disclosure provisions of Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an amendment of FASB Statement No. 123." Under APB No. 25, when the exercise
price of the Company's employee stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is recognized.
Accordingly, no compensation expense has been recognized in the consolidated
financial statements in connection with employee stock option grants.
During the nine-month period ended February 29, 2004, the Board of
Directors granted non-qualified stock options under the 1999 Stock Option Plan
(the "1999 Plan") to three employees and nine directors to purchase an aggregate
of 725,000 shares of common stock, at exercise prices ranging from $0.92 to
$1.31 per share (which represented the fair market value of the underlying
common stock at the time of the respective grants). These options vest over a
three-year period and expire ten years from the date of grant.
During the nine-month period ended February 29, 2004, options to purchase
335,667 shares of common stock were exercised at exercise prices ranging from
$0.88 to $1.22 per share, aggregating $383,084 of proceeds to the Company.
During the nine-month period ended February 29, 2004, options to purchase 35,000
shares of common stock at exercise prices ranging from $0.91 to $2.97 were
cancelled.
The following table illustrates the effect on net earnings (loss) and
earnings (loss) per share had the Company applied the fair value recognition
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation," to stock-based employee compensation.
Nine Months Ended Three Months Ended
------------------------------ ------------------------------
February 29, February 28, February 29, February 28,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Net earnings (loss), as reported ($2,663,577) ($4,805,239) $(310,041) $25,831
Deduct: Total stock-based employee
compensation expense determined under fair
value-based method for all awards (1,080,817) (671,516) (402,237) (237,597)
------------- ------------- ------------- -------------
Pro forma net loss ($3,744,394) ($5,476,755) ($712,278) ($211,766)
============= ============= ============= =============
Earnings (loss) per share:
Basic - as reported ($0.05) ($0.08) ($0.01) $0.00
============= ============= ============= =============
Diluted - as reported ($0.05) ($0.08) ($0.01) $0.00
============= ============= ============= =============
Basic - pro forma ($0.06) ($0.09) ($0.01) ($0.00)
============= ============= ============= =============
Diluted - pro forma ($0.06) ($0.09) ($0.01) ($0.00)
============= ============= ============= =============
Page 8
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 29, 2004
Pro forma compensation expense may not be indicative of future disclosures
because it does not take into effect pro forma compensation expense related to
grants before 1995. For purposes of estimating the fair value of each option on
the date of grant, the Company utilized the Black-Scholes option-pricing model.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
Equity instruments issued to non-employees in exchange for goods, fees and
services are accounted for under the fair value-based method of SFAS No. 123.
The fair value of the Company's stock-based awards was estimated assuming
no expected dividends and the following weighted-average assumptions for the
nine months ended February 29, 2004:
Expected life (years) 5
Expected volatility 89%
Risk-free interest rate 3.4%
Expected dividend yield 0.0%
NOTE D EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per share is based on the weighted average number of
common shares outstanding without consideration of potential common shares.
Diluted earnings (loss) per share is based on the weighted number of common and
potential common shares outstanding. The calculation takes into account the
shares that may be issued upon the exercise of stock options and warrants,
reduced by the shares that may be repurchased with the funds received from the
exercise, based on the average price during the period. Options and warrants to
purchase 6,545,086 and 4,708,000 shares of common stock were excluded from the
computation of diluted earnings per share for the three months ended February
29, 2004, and February 28, 2003, respectively, because the effect of their
inclusion would be antidilutive.
The following table sets forth the computation of basic and diluted
earnings (loss) per common share:
Nine Months Ended Three Months Ended
------------------------------ --------------------------------
February 29, February 28, February 29, February 28,
2004 2003 2004 2003
------------- ------------- ------------- ---------------
Numerator:
Basic and diluted net earnings (loss) ($2,663,577) ($4,805,239) $(310,041) $25,831
Denominator:
Basic - weighted average common shares 57,847,004 57,647,032 57,886,701 57,809,120
Stock options -- -- -- 26,721
Warrants -- -- -- 242,493
------------- ------------- ------------- ---------------
Diluted - weighted average common shares 57,847,004 57,647,032 57,886,701 58,078,334
============= ============= ============= ===============
Basic and diluted earnings (loss) per common
share ($0.05) ($0.08) ($0.01) $0.00
============= ============= ============= ===============
Page 9
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 29, 2004
NOTE E - INVENTORIES
Inventories consist of the following:
February 29, May 31,
2004 2003
------------ ---------
Raw materials $985,496 $1,374,241
Work in progress 648,418 634,890
Finished goods 1,031,400 1,430,436
---------------- ------------------
$2,665,314 $3,439,567
================ ==================
NOTE F FINANCING RECEIVABLES FROM MAJOR CUSTOMERS
In fiscal 2002, the Company sold its external counterpulsation systems
("EECP" units) to two major customers engaged in establishing independent
networks of EECP centers under sales-type leases aggregating revenues of
$4,187,009 in fiscal 2002. No additional equipment was sold to these customers
during fiscal 2003 or 2004.
In late August 2002, the largest customer became delinquent in its
scheduled monthly payments under its financing obligations to the Company. In
September 2002, the Company was notified by this customer of recent
circumstances that precluded their ability to remain current under their
financing obligations to the Company. Accordingly, management decided to
write-off, in full, all funds due from this customer as of August 31, 2002,
which aggregated approximately $3,000,000, including the present carrying amount
of the underlying equipment due to the uncertainty of the Company's ability to
repossess the equipment. During the second quarter of fiscal 2003, the customer
ceased operations and the Company was able to successfully recover all of the
units that it had sold under sales-type leases to the customer back into its
finished goods inventory and recorded a bad debt recovery of $479,000, which
represented the present carrying amount of the equipment. The Company redeployed
certain pieces of the equipment while other pieces were returned to the
Company's inventory for resale.
The second customer became delinquent in its scheduled monthly payments
during the fourth quarter of fiscal 2003. During the first and second quarters
of fiscal 2004 the customer attempted to remedy the situation and made payments
totaling $70,000. In December 2003, the customer ceased operations. Accordingly,
management decided to write-off all funds due from this customer as of November
30, 2003, less the anticipated recovery of equipment and the reduction of
related liabilities for sales tax. The write-off of approximately $680,000 is
included as a component of provision for doubtful accounts in the accompanying
Statement of Earnings for the nine-month period ended February 29, 2004. In the
third quarter of fiscal 2004, the Company recovered all of the EECP systems that
had been leased to this customer. Additionally, the Company is evaluating its
ability to seek additional recovery from the customer.
The Company is no longer offering sales-type leases.
NOTE G - LONG-TERM DEBT AND LINE OF CREDIT AGREEMENT
February 29, May 31,
2004 2003
-------------- ---------------
Revolving credit agreement (a) -- --
Term loans (b) (c) $1,260,962 $1,286,266
Less current portion (133,617) (108,462)
---------------- ------------------
$1,127,345 $1,177,804
================ ==================
(a) In February 2002, the Company renegotiated a secured revolving credit
line with its existing bank. The credit line provided 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,
Page 10
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 29, 2004
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 quarterly
covenants, including leverage ratio, liquidity, capital expenditures, minimum
net income, minimum interest coverage and minimum tangible net worth. In
addition, the line is secured by substantially all the tangible assets of the
Company. In October 2002, the credit line was further amended to provide for
borrowings up to $5,000,000 ($2,000,000, at any time that consolidated net
income for the immediately preceding three-month period is less than $1),
primarily based upon eligible accounts receivable, as defined therein, at the
Libor Rate plus 200 basis points or the published Prime Rate plus 50 basis
points. In April 2003, the agreement was further amended to allow for borrowings
absent compliance with the financial covenants as long as such eligible
borrowings are collateralized by cash. In April 2003, the Company repaid all
outstanding borrowings under the agreement instead of maintaining restricted
cash balances and there are currently no outstanding borrowings. At February 29,
2004, the Company did not meet the minimum interest coverage, tangible net worth
and minimum net earnings covenants and future compliance with each of these
covenants in the near term is not certain.
(b) The Company purchased its headquarters and warehouse facility and
secured notes of $641,667 and $500,000, respectively, under two programs
sponsored by New York State. These notes, which bear interest at 7.8% and 6%,
respectively, are payable in monthly installments consisting of principal and
interest payments over fifteen- year terms, expiring in September 2016 and
January 2017, respectively, and are secured by the building. At February 29,
2004, $1,035,705 was outstanding in connection with these notes.
(c) In fiscal 2003 and 2004, the Company financed the cost of
implementation of a management information system and secured several notes,
aggregating approximately $305,000. The notes, which bear interest at rates
ranging from 7.5% through 12.4%, are payable in monthly installments consisting
of principal and interest payments over four-year terms, expiring at various
times between August and October 2006. At February 29, 2004, $225,257 was
outstanding in connection with these notes.
NOTE H DEFERRED REVENUES
The Company records revenue on extended service contracts ratably over the
term of the related warranty contracts. Effective September 1, 2003, the Company
prospectively adopted the provisions of EITF 00-21. Upon adoption of the
provisions of EITF 00-21, the Company began to defer revenue related to EECP
system sales for the fair value of installation and in-service training to the
period when the services are rendered and for warranty obligations ratably over
the service period, which is generally one year.
The changes in the Company's deferred revenues are as follows:
Nine Months Ended Three Months Ended
------------------------------ ------------------------------
February 29, February 28, February 29, February 28,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Deferred Revenue at the beginning of the period $1,709,551 $991,204 $2,284,166 $1,445,529
ADDITIONS
Deferred extended service contracts 1,392,588 1,119,744 446,650 345,319
Deferred in-service training 215,000 -- 117,500 --
Deferred warranty obligations 650,000 -- 357,500 --
RECOGNIZED AS REVENUE
Deferred extended service contracts (1,066,682) (522,454) (399,109) (202,354)
Deferred in-service training (157,500) -- (102,500) --
Deferred warranty obligations (183,333) -- (144,583) --
------------- ------------- ------------- -------------
Deferred revenue at end of period 2,559,624 1,588,494 2,559,624 1,588,494
Less: current portion (1,601,037) (610,973) (1,601,037) (610,973)
------------- ------------- ------------- -------------
Long-term deferred revenue at end of period $958,587 $977,521 $958,587 $977,521
============= ============= ============= =============
Page 11
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 29, 2004
NOTE I WARRANTY COSTS
Equipment sold is generally covered by a warranty period of one year.
Effective September 1, 2003, the Company adopted the provisions of EITF 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables" on a
prospective basis. Under EITF 00-21, for certain arrangements, a portion of the
overall system price attributable to the first year warranty service is deferred
and recognized as revenue over the service period. As such, the Company no
longer accrues estimated warranty costs upon delivery but rather recognizes
warranty and related service costs as incurred. Prior to September 1, 2003, the
Company accrued a warranty reserve for estimated costs to provide warranty
services when the equipment sale is recognized. The factors affecting the
Company's warranty liability included the number of units sold and historical
and anticipated rates of claims and costs per claim. The warranty provision
resulting from transactions prior to September 1, 2003 will be reduced in future
periods for material and labor costs incurred as related product is serviced
during the warranty period or when the warranty period elapses. A review of
warranty obligations is performed regularly to determine the adequacy of the
reserve. Based on the outcome of this review, revisions to the estimated
warranty liability are recorded as appropriate. Warranty reserves related to
units sold under sales-type leases are recorded as executory costs, which serve
to reduce the amount of financing receivables reported in the consolidated
balance sheets.
The changes in the Company's product warranty liability are as follows:
Nine Months Ended Three Months Ended
------------------------------ ------------------------------
February 29, February 28, February 29, February 28,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Warranty liability at the beginning of the
period $788,000 $991,000 $501,000 $869,000
Expense for new warranties issued 164,000 540,000 -- 204,000
Warranty amortization (602,000) (689,000) (151,000) (231,000)
------------- ------------- ------------- -------------
Warranty liability at end of period $350,000 $842,000 $350,000 $842,000
============= ============= ============= =============
NOTE J - INCOME TAXES
During the nine-months ended February 29, 2004, the Company recorded a
provision for state income taxes of $30,000. This is in contrast to an income
tax benefit of $1,540,442 reported during the nine-months ended February 28,
2003.
As of February 29, 2004, the Company had recorded deferred tax assets of
$14,582,000 (net of a ($1,360,000) valuation allowance) related to the
anticipated recovery of tax loss carryforwards. The amount of the deferred tax
assets considered realizable could be reduced in the future if estimates of
future taxable income during the carryforward period are reduced. Ultimate
realization of the deferred tax assets is dependent upon the Company generating
sufficient taxable income prior to the expiration of the tax loss carryforwards.
In accordance with the Statement of Financial Accounting Standard No. 109
"Accounting for Income Taxes" ("SFAS 109"), management concluded at the end of
fiscal 2003, based upon the weight of available evidence at that time, that it
was more likely than not that all of the deferred tax assets would be realized.
It was management's belief that realization of the deferred tax asset was not
dependent on material improvements over the average of fiscal 2000 through
fiscal 2002 levels of pre-tax income, and that the Company is positioned for
long-term growth despite the results achieved in fiscal 2003, much of which was
unexpected and non-recurring. Management is currently evaluating the impact of
the average 34% reduction in Medicare reimbursement rates for EECP treatments in
2004 that was recently announced by The Centers for Medicare and Medicaid
Services ("CMS"), a Federal agency within the U.S. Department of Health and
Human Services responsible for the administration of the Medicare and Medicaid
programs, plus other factors currently influencing market conditions including
the impact of increased competition, declining sales prices and lower volume on
the Company's estimates of future taxable income. Due to the uncertainty
associated with estimates of future taxable income during the carryforward
period and the net value of the recorded deferred tax asset relative to the
Page 12
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 29, 2004
Company's historical taxable income, management has decided to provide a
valuation allowance for all potential deferred tax assets generated during
fiscal 2004. The recorded deferred tax asset and increase to the valuation
allowance during the nine-month period ended February 29, 2004 was $738,000.
The following factors are anticipated to positively impact the future of
the Company's business activities and initiatives:
A. A large and increasing worldwide patient population with
cardiovascular disease demanding new choices of therapy, leading to
increased reimbursement coverage in the United States and other
countries. The estimated US patient population for angina patients is
approximately 6.2 million and approximately 5 million patients for
heart failure.
B. Approval of Medicare coverage and other third-party payer policies
specific to the congestive heart failure indication. The results of
the Company's ongoing PEECH trial are likely a pre-requisite for
significant coverage policies. The Company anticipates that the
results from the PEECH trial will be favorable (based upon a published
feasibility study and other analyses). The results should be available
for submission to CMS in late 2004 and a coverage decision is
anticipated in mid 2005. The combination of favorable PEECH trial
results and Medicare reimbursement would likely be a significant
catalyst for significant Company growth.
C. Potential extension of Medicare coverage to include all classes of
angina (beyond the present Class III/IV indication for refractory
angina, for which the Company estimates the annual patient population
in the US alone is 150,000).
D. A cardiology community with a mandate to offer patients new disease
management solutions providing effective clinical and economic
outcomes. The Company has cultivated relationships with many of the
leading institutions and cardiologists (as evidenced in its roster of
PEECH study sites).
E. The accumulation of EECP clinical validation and removal of obstacles
to third-party insurance reimbursement. Numerous abstracts and
publications are presented each year at major scientific meetings
worldwide. The Company estimates that more than 300 third-party payers
reimburse for EECP therapy, many on a routine basis.
F. Expanded base of future FDA-cleared indications to more effectively
penetrate the hospital market, particularly with respect to heart
failure (for which FDA clearance was received in June 2002), acute
coronary syndromes (also cleared by FDA), diabetes management, and
peripheral and cerebrovascular diseases.
G. Initiatives planned to lower the cost of the Company's EECP systems,
thus improving margins or helping to preserve margins from further
price erosion.
H. The Company has a large, non-domestic market opportunity that it
intends to develop through a network of local independent
distributors. The Company has received the CE Mark (FDA-clearance
equivalent) and is ISO 13485 certified.
I. Continuing to prove more definitively the mechanism of action by which
EECP operates. Smaller scale clinical studies are aimed at convincing
those with lingering doubt about EECP's effectiveness that the therapy
is, indeed, safe and effective and serves to expand the market.
Studies have been presented and published in this area.
J. Increased hardware utility to allow for the use of EECP in an
increasing number of patient environments. The EECP TS4 system is
mobile, quieter and can be used more easily in the hospital
environment. Future system modifications could allow for emergency
room use.
The Company acknowledges that certain risk factors have the potential to
adversely affect the business opportunity that has been outlined. Initiatives
planned to mitigate the impact of such risks have been addressed. They include:
A. Dependence on outcome of PEECH trial and related reimbursement
coverage policies. Presently, the Company is engaged in the PEECH
trial, a pivotal study to evaluate the effectiveness of EECP therapy
for congestive heart failure patients. The Company anticipates that
the results of this study will be the catalyst for Medicare and other
third-party reimbursement coverage policies specific to heart failure.
Although the Company has received clearance from the FDA to market for
heart failure, the medical community, market acceptance and insurance
Page 13
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 29, 2004
coverage policies are highly influenced by scientifically proven
technologies. The Company had designed its PEECH protocol in
cooperation with the FDA and had reached a formal agreement with the
FDA that the key parameters of its investigational plan for this trial
were appropriate to determine the effectiveness of EECP as an adjunct
therapy for heart failure. The Company believes that its PEECH trial
is robust and will provide favorable results that should provide a
reasonable basis for market acceptance and insurance reimbursement.
B. Dependence on a single product platform. Current FDA labeling extends
beyond chronic stable angina and congestive heart failure to unstable
angina, myocardial infarction and cardiogenic shock (i.e., acute
coronary syndromes). The Company intends to pursue additional clinical
studies to validate the safety and effectiveness of EECP in acute
coronary syndromes over the next few years provided sufficient
financial resources are available.
C. Dependence on consistency of research findings about EECP efficacy and
increasing acceptance of EECP by the medical community. To that end,
the Company has sponsored the International EECP Patient Registry
(IEPR), maintained at the University of Pittsburgh. Results to date
(5,500 patients enrolled) have supported favorable results achieved in
the initial trials conducted at the State University of New York at
Stony Brook, as well the conclusions from the MUST-EECP multicenter,
controlled, randomized and double-blinded efficacy trial completed in
1997. Phase 2 of the registry, known as IEPR II, began enrollment of
2,500 patients in January 2002 and is capturing additional data from
angina patients that include, among other things, data related to
concomitant heart failure symptoms.
D. Technological obsolescence of EECP by newly developed process, device
or therapy. There is no assurance that such technology couldn't exist
in the future to make EECP obsolete. Several companies are evaluating
devices and drugs for heart failure but there is presently no
consensus treatment for those patients. Even in the event one or more
drugs are developed, it is unlikely that EECP would be replaced
completely as many ill patients suffer a myriad of conditions with
co-morbid disease states that would make them contraindicated for use.
The Company believes that the cardiovascular disease market is so
large and the disease so complex that numerous technologies can
aggressively and successfully compete in the marketplace.
E. Competition, through acquisition or development, from companies with
superior financial resources and marketing capabilities. The barriers
of entry for external counterpulsation therapy are relatively small
however; there are presently only two competitors with a marketed
external counterpulsation system. The Company believes that neither is
well capitalized or positioned within the medical community (neither
have done significant clinical trials). The Company estimates that it
has a 75% plus market share and does not foresee significant changes.
F. New or changed regulatory environment that creates unforeseen
obstacles, or costs, to continue to market and sell the EECP system.
None are known at this time. Such changes in this industry are
normally not swift and would allow, in the opinion of management,
sufficient time to modify its business plan or become compliant.
G. New or changed insurance reimbursement criteria that create, or
reinstate, obstacles to physician acceptance of EECP. With respect to
Medicare, CMS raised rates for EECP treatment by 35% in March 2003 and
then effective January 2004 lowered EECP treatment rates by 32% to
levels that are significantly below the pre-March 2003 rates. The
Company believes that the 2004 Medicare rates were dropped to a level
that may adversely effect the Company's future prospects and will be
evaluating the impact of the lower rates on its future prospects and
its ability to fully realize the deferred tax asset.
Ultimate realization of all deferred tax assets is not assured, due to the
uncertainty associated with estimates of future taxable income during the
carryforward period. Management is evaluating the amount of the deferred tax
asset in accordance with SFAS 109, to determine that based upon the weight of
available evidence, whether or not it is more likely than not that the deferred
tax asset will be realized. The amount of the deferred tax assets considered
realizable could be reduced in the future if estimates of future taxable income
during the carryforward period are reduced.
Page 14
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)
February 29, 2004
NOTE K - COMMITMENTS AND CONTINGENCIES
Litigation
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, tortuous 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
demanded on July 3, 2002 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.
Employment Agreements
In October 2002, the Company entered into an employment agreement with its
new President and Chief Operating Officer. The agreement, which expires in
October 2004, provides for certain settlement benefits, including a lump-sum
payment of twelve months of base salary in the event of a change of control, as
defined, or a termination payment in an amount equal to six months of base
salary in the event of termination without cause, as defined. Such agreement was
modified on June 30, 2003 reflecting this employee's promotion to President and
Chief Executive Officer, Gregory D. Cash. (See Note L)
In October 2003, the Company entered into an employment agreement with its
new Chief Financial Officer. The agreement, which expires in September 2005,
provides for certain settlement benefits, including a lump-sum payment of twelve
months of base salary in the event of a change of control, as defined, or a
termination payment in an amount equal to six months of base salary in the event
of termination without cause, as defined.
The approximate aggregate minimum compensation obligation under all active
employment agreements at February 29, 2004 are summarized as follows:
Twelve Months Ended Amount
------------------- ------
February 28, 2005 $454,167
February 28, 2006 78,493
--------
$532,660
========
Consulting Agreements
In September 2003, the Company and its then Chief Financial Officer entered
into a termination and consulting agreement. As a result of this termination,
the Company will pay to the former employee a severance payment of $140,000 in
equal monthly installments through September 2004. The Company recorded a charge
to operations during the three-month period ended November 30, 2003 to reflect
this obligation. Further, the consulting agreement provides for the continued
vesting of stock options that had been previously granted to the employee, which
would have otherwise vested during the term of the agreement. The terms of the
original option grants provided for vesting throughout the period that the
former employee was employed by or provided services to the Company. There were
no other modifications to any of his previously granted stock options.
NOTE L SUBSEQUENT EVENT
On March 23, 2004, Gregory D. Cash the Company's then President and Chief
Executive Officer resigned to pursue other business interests and all monetary
compensation under the employment agreement were terminated. Effective
immediately, the board of directors appointed Photios T. Paulson the Company's
former President and Chief Executive Officer and a director of the Company to
the interim position of President and Chief Executive Officer and initiated
plans to begin a search for a new President and Chief Executive Officer.
Page 15
Vasomedical, Inc. and Subsidiaries
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
Except for historical information contained in this report, the matters
discussed are forward-looking statements that involve risks and uncertainties.
When used in this report, words such as "anticipated", "believes", "could",
"estimates", "expects", "may", "plans", "potential" and "intends" and similar
expressions, as they relate to the Company or its management, identify
forward-looking statements. Such forward-looking statements are based on the
beliefs of the Company's management, as well as assumptions made by and
information currently available to the Company's management. Among the factors
that could cause actual results to differ materially are the following: the
effect of the dramatic changes taking place in the healthcare environment; the
impact of competitive procedures and products and their pricing; medical
insurance reimbursement policies; unexpected manufacturing problems in foreign
supplier facilities; unforeseen difficulties and delays in the conduct of
clinical trials and other product development programs; the actions of
regulatory authorities and third-party payers in the United States and overseas;
uncertainties about the acceptance of a novel therapeutic modality by the
medical community; and the risk factors reported from time to time in the
Company's SEC reports. The Company undertakes no obligation to update
forward-looking statements as a result of future events or developments.
General Overview
Vasomedical, Inc. (the "Company"), incorporated in Delaware in July 1987,
is primarily engaged in designing, manufacturing, marketing and supporting EECP
external counterpulsation systems based on the Company's proprietary technology
currently indicated for use in cases of angina (i.e., chest pain), cardiogenic
shock, acute myocardial infarction (i.e., heart attack) and 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 CHF. EECP is a non-invasive, outpatient therapy for the treatment of
diseases of the cardiovascular system. The therapy serves to increase
circulation in areas of the heart with less than adequate blood supply and may
restore systemic vascular function. 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
systems.
EECP therapy is currently reimbursed by Medicare and numerous other
commercial third-party payers for the treatment of refractory angina. The
Medicare reimbursement rate in the continental United States for a full course
of 35 one-hour treatments ranges from $3,960 to $6,926.Although Medicare has not
modified its national coverage policy for EECP therapy to specifically include
CHF patients, the Company believes, based upon data published from the
International EECP Patient Registry ("IEPR"), that there exists a significant
subset of patients with CHF that also have disabling angina that would qualify
for Medicare reimbursement under its present coverage policy.
Critical Accounting Policies
Financial Reporting Release No. 60, which was released by the Securities
and Exchange Commission, or SEC, in December 2001, requires all companies to
include a discussion of critical accounting policies or methods used in the
preparation of financial statements. Note A of the Notes to Consolidated
Financial Statements included in the Company's Annual Report on Form 10-K for
the year ended May 31, 2003 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. 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's critical
accounting policies are as follows:
Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement
exists, delivery has occurred or service has been rendered, the price is fixed
or determinable and collectibility is reasonably assured. In the United States,
the Company recognizes revenue from the sale of its EECP systems in the period
in which the Company delivers the system to the customer. Revenue from the sale
of its EECP systems to international markets is recognized upon shipment, during
the period in which the Company delivers the product to a common carrier, as
well as supplies, accessories and spare parts to both domestic and international
Page 16
Vasomedical, Inc. and Subsidiaries
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
customers. Returns are accepted prior the installation and in-service subject to
a 10% restocking charge or for normal warranty matters, and the Company is not
obligated for post-sale upgrades to these systems.
In most cases, revenue from direct EECP system sales is generated from
multiple-element arrangements that require judgment in the areas of customer
acceptance, collectibility, the separability of units of accounting, and the
fair value of individual elements. Effective September 1, 2003, the Company
adopted the provisions of Emerging Issues Task Force, or EITF, Issue No. 00-21,
"Revenue Arrangements with Multiple Deliverables", ("EITF 00-21"), on a
prospective basis. The principles and guidance outlined in EITF 00-21 provide a
framework to determine (a) how the arrangement consideration should be measured
(b) whether the arrangement should be divided into separate units of accounting,
and (c) how the arrangement consideration should be allocated among the separate
units of accounting. The Company determined that its multiple-element
arrangements are generally comprised of the following elements that would
qualify as separate units of accounting: system sales, in-service support
consisting of equipment set-up and training provided at the customers facilities
and warranty service for system sales generally covered by a warranty period of
one year. Each of these elements represent individual units of accounting as the
delivered item has value to a customer on a stand-alone basis, objective and
reliable evidence of fair value exists for undelivered items, and arrangements
normally do not contain a general right of return relative to the delivered
item. The Company determines fair value based on the price of the deliverable
when it is sold separately or based on third- party evidence. In accordance with
the guidance in EITF 00-21, the Company uses the residual method to allocate the
arrangement consideration when it does not have fair value of the EECP system
sale. Under the residual method, the amount of consideration allocated to the
delivered item equals the total arrangement consideration less the aggregate
fair value of the undelivered items. Assuming all other criteria for revenue
recognition have been met, the Company recognizes revenue for EECP system sales
when delivery and acceptance occurs, for installation and in- service training
when the services are rendered, and for warranty service ratably over the
service period, which is generally one year.
Upon adoption of the provisions of EITF 00-21 beginning September 1, 2003,
the Company deferred $57,500 and $15,000 of revenue related to the fair value of
installation and in-service training plus $466,667 and $212,917 of revenue
related to the warranty service for EECP system sales delivered during the
nine-month and three-month periods ended February 29, 2004, respectively. The
amount related to warranty service will be recognized as service revenue ratably
over the related service period, which is generally one year. Previously, in
accordance with Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements," the Company accrued costs associated with these
arrangements as warranty expense in the period the system was delivered and
accepted.
The Company also recognizes revenue generated from servicing EECP systems
that are no longer covered by a warranty agreement, or by providing sites with
additional training, in the period that these services are provided. Revenue
related to future commitments under separately priced extended warranty
agreements on the EECP system are deferred and recognized ratably over the
service period, generally ranging from one year to four years. Deferred revenues
related to extended warranty agreements that have been paid by customers prior
to the performance of extended warranty services were $2,035,457 as of February
29, 2004. Costs associated with the provision of service and maintenance,
including salaries, benefits, travel, spare parts and equipment, are recognized
in cost of sales as incurred.
Amounts billed in excess of revenue recognized are included as deferred
revenue in the condensed consolidated balance sheets.
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 generally recognized, in accordance
with the terms of the lease agreements, on a straight-line basis over the life
of the respective leases. For certain operating leases in which payment terms
are determined on a "fee-per-use" basis, revenues are recognized as incurred
(i.e., as actual usage occurs). The cost of the EECP system utilized under
operating leases is recorded as a component of property and equipment and is
amortized to cost of sales over the estimated useful life of the equipment, not
to exceed five years. There are no significant minimum rental commitments on
these operating leases at February 29, 2004.
The Company follows SFAS No. 13, "Accounting For Leases," for its sales of
EECP units under sales-type leases. 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, an allowance for bad debt and executory costs, which are
Page 17
Vasomedical, Inc. and Subsidiaries
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
primarily related to product warranties on each unit sold. Unearned interest
income is amortized to income in a manner that produces a constant rate of
return on the investment in the sales-type lease. The cost of the EECP unit
acquired by the customer is recorded as cost of sales in the same period that
the sale is recorded.
Accounts Receivable/Financing Receivables
The Company's accounts receivable trade are due from customers engaged in
the provision of medical services. Credit is extended based on evaluation of a
customer's financial condition and, generally, collateral is not required.
Accounts receivable are generally due 30 to 90 days from shipment and are stated
at amounts due from customers net of allowances for doubtful accounts, returns,
term discounts and other allowances. Accounts outstanding longer than the
contractual payment terms are considered past due. Estimates are used in
determining 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. In the first quarter of fiscal 2003 and the second quarter
of fiscal 2004, management decided to write-off financing receivables under
sales-type leases of approximately $2,558,000 and $680,000, respectively, as a
result of significant uncertainties with respect to these customers' ability to
meet their financial obligations.
Inventories
The Company values inventory at the lower of cost or estimated market, cost
being determined on a first-in, first-out basis. The Company often places EECP
systems at various field locations for demonstration, training, evaluation, and
other similar purposes at no charge. The cost of these EECP systems is
transferred to property and equipment and is amortized over the next two to five
years. The Company records the cost of refurbished components of EECP systems
and critical components at cost plus the cost of refurbishment. The Company
regularly reviews inventory quantities on hand, particularly raw materials and
components, and records a provision for excess and obsolete inventory based
primarily on existing and anticipated design and engineering changes to our
products as well as forecasts of future product demand.
Warranty Costs
Equipment sold is generally covered by a warranty period of one year.
Effective September 1, 2003, the Company adopted the provisions of EITF 00-21 on
a prospective basis. Under EITF 00-21, for certain arrangements, a portion of
the overall system price attributable to the first year warranty service is
deferred and recognized as revenue over the service period. As such, the Company
no longer accrues warranty costs upon delivery but rather recognizes warranty
and related service costs as incurred. Prior to September 1, 2003, the Company
accrued a warranty reserve for estimated costs to provide warranty services when
the equipment sale is recognized. The factors affecting the Company's warranty
liability included the number of units sold and historical and anticipated rates
of claims and costs per claim. The warranty provision resulting from
transactions prior to September 1, 2003 will be reduced in future periods for
material and labor costs incurred as related product is returned during the
warranty period or when the warranty period elapses. A review of warranty
obligations is performed regularly to determine the adequacy of the reserve.
Based on the outcome of this review, revisions to the estimated warranty
liability are recorded as appropriate. The Company records revenue on extended
warranties on a straight-line basis over the term of the related warranty
contracts. Service costs are expensed as incurred.
Deferred revenues related to extended warranties are $2,034,957 and
$1,588,494 at February 29, 2004, and February 28, 2003, respectively.
Page 18
Vasomedical, Inc. and Subsidiaries
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
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.
Deferred tax liabilities and assets shall be classified as current or
non-current based on the classification of the related asset or liability for
financial reporting. A deferred tax liability or asset that is not related to an
asset or liability for financial reporting, including deferred tax assets
related to carryforwards, shall be classified according to the expected reversal
date of the temporary difference. The deferred tax asset recorded by the Company
relates primarily to the realization of net operating loss carryforwards, of
which the allocation of the current portion reflects the expected utilization of
such net operating losses in fiscal 2004. Such allocation is based upon
management's internal financial forecast for fiscal 2004 and may be subject to
revision based upon actual results.
Stock Compensation
The Company has four stock-based employee compensation plans. The Company
accounts for stock-based compensation using the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related Interpretations ("APB No. 25") and has
adopted the disclosure provisions of Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an amendment of FASB Statement No. 123." under APB No. 25, when the exercise
price of the Company's employee stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is recognized.
Accordingly, no compensation expense has been recognized in the consolidated
financial statements in connection with employee stock option grants.
Pro forma compensation expense may not be indicative of future disclosures
because it does not take into effect pro forma compensation expense related to
grants before 1995. For purposes of estimating the fair value of each option on
the date of grant, the Company utilized the Black-Scholes option-pricing model.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
Equity instruments issued to non-employees in exchange for goods, fees and
services are accounted for under the fair value-based method of SFAS No. 123.
Recently Issued Accounting Standards
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 ("SFAS No. 149"), "Amendment of Statement 133 on Derivative Instruments
and Hedging Activities," which amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities under SFAS No. 133. SFAS
No. 149 is effective for contracts entered into or modified after June 30, 2003
except for the provisions that were cleared by the FASB in prior pronouncements.
The adoption of SFAS No. 149 has not had a material impact on the Company's
financial position and results of operations.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150 ("SFAS No. 150"), "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." This statement establishes
standards for how an issuer classifies and measures in its statement of
Page 19
Vasomedical, Inc. and Subsidiaries
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. This Statement shall be effective for financial instruments entered
into or modified after May 31, 2003, and otherwise shall be effective at the
beginning of the first interim period beginning after June 15, 2003. The Company
is currently evaluating the effect of the adoption of SFAS No. 150 on its
financial position and results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation
of Variable Interest Entities" ("FIN 46"), as interpreted by FIN 46R. In
general, a variable interest entity is a corporation, partnership, trust, or any
other legal structure used for business purposes that either (a) does not have
equity investors with voting rights or (b) has equity investors that do not
provide sufficient financial resources for the entity to support its activities.
A variable interest entity often holds financial assets, including loans or
receivables, real estate or other property. A variable interest entity may be
essentially passive or it may engage in activities on behalf of another company.
Until now, a company generally has included another entity in its consolidated
financial statements only if it controlled the entity through voting interests.
FIN 46 changes that by requiring a variable interest entity to be consolidated
by a company if that company is subject to a majority of the risk of loss from
the variable interest entity's activities or entitled to receive a majority of
the entity's residual returns or both. FIN 46's consolidation requirements apply
immediately to variable interest entities created or acquired after January 31,
2003. The consolidation requirements apply to older entities in the first
interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The Company
adopted FIN 46 effective January 31, 2003. The adoption of FIN 46 did not have a
material impact on the Company's financial position or results of operations.
In November 2002, the Emerging Issues Task Force, ("EITF") reached a
consensus opinion on, "Revenue Arrangements with Multiple Deliverables", "(EITF
00-21)". That consensus provides that revenue arrangements with multiple
deliverables should be divided into separate units of accounting if certain
criteria are met. The consideration of the arrangement should be allocated to
the separate units of accounting based on their relative fair values, with
different provisions if the fair value is contingent on delivery of specified
items or performance conditions. Applicable revenue criteria should be
considered separately for each separate unit of accounting. EITF 00-21 is
effective for revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. Effective September 1, 2003, the Company prospectively
adopted the provisions of EITF 00-21. After adoption of the provisions of EITF
00-21, the Company has deferred $57,500 of revenue related to the fair value of
installation and in-service training and $466,667 of revenue related to the
warranty service for EECP system sales recognized during the second and third
quarters of fiscal 2004.
In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104,
"Revenue Recognition" (SAB No. 104), which codifies, revises and rescinds
certain sections of SAB No. 101, "Revenue Recognition in Financial Statements",
in order to make this interpretive guidance consistent with current
authoritative accounting and auditing guidance and SEC rules and regulations.
The changes noted in SAB No. 104 did not have a material effect on the Company's
financial position or results of operations.
Results of Operations
Three Months Ended February 29, 2004 and February 28, 2003
- ----------------------------------------------------------
Net revenue from sales, leases and service of the Company's external
counterpulsation systems ("EECP" systems) for the three-month periods ended
February 29, 2004, and February 28, 2003, were $5,949,910 and $7,152,584,
respectively, which represented a decline of $1,202,674 or 17%. The Company's
loss before income taxes for the three-month period ended February 29, 2004, was
$300,041 as compared to income before income taxes of $69,311 for the
three-month period ended February 28, 2003. The Company reported a loss of
$310,041 for the three-month period ended February 29, 2004, as compared to net
income of $ 25,831 for the three-month period ended February 28, 2003.
Equipment sales declined approximately 21% to $5,185,388 for the
three-month period ended February 29, 2004 as compared to $6,581,338 for the
same period for the prior year. The decline in equipment sales is due primarily
to: a 10% decline in the total sales volume of EECP systems in the domestic
market; the impact of reduced selling prices for the sales of EECP systems in
the domestic market; an unfavorable product mix resulting from a higher portion
of used versus new equipment sales, which earn a lower average selling price
compared to new systems; plus adoption of the provisions of EITF 00-21.
Shipments of EECP systems in the third quarter of fiscal 2004 included an
Page 20
Vasomedical, Inc. and Subsidiaries
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
unusually high percentage of used equipment as the Company sold EECP systems
that had been used to treat patients in the Prospective Evaluation of EECP in
Congestive Heart Failure, ("PEECH") clinical trial but were no longer required
in the trial at some of the clinical sites since the treatment portion at those
sites had previously been completed. The Company believes that domestic sales of
EECP systems continue to be negatively impacted from the reduction by CMS of
approximately 34% in Medicare rates for the calendar year 2004 plus the impact
of increased competition, and a longer selling cycle. In addition, the Company
adopted EITF 00-21 during the second quarter of fiscal 2004. As a result, the
company deferred approximately $228,000, net of reversals from the previous
quarter, of revenue related to the fair value of installation, in-service
training and warranty service which will be recognized as revenue ratably over
the related service period, which is generally one year. Previously, the Company
accrued costs associated with these arrangements as warranty expense in the
period the system was delivered and accepted. The Company has recently rebuilt
its sales force and filled a number of US sales territory vacancies. The Company
estimates that a new sales representative needs between six and nine months from
date of hire to become fully effective. As of February 29, 2004, 11 of the
Company's 24 sales territories were filled with representatives who had been
with the Company for less than nine months. International sales of EECP systems
in the third quarter of fiscal 2004 increased approximately 147% to $312,000
compared to the same period of the prior year reflecting to increased volume.
The above decline in equipment sales was partially offset by a 34% increase
in revenue from equipment rental and services resulting from an increase of
approximately 88% in service related revenue. The higher service revenue
reflects an increase in service, spare parts and consumables as a result of the
continued growth of the installed base of EECP systems and greater marketing
focus on the sale of extended service contracts. Rental revenue declined
following the termination of several short-term rental agreements partially
offsetting the above.
The gross profit declined to $4,016,735 or 68% of revenues for the
three-month period ended February 29, 2004, compared to $4,382,730 or 61% of
revenues for the three-month period ended February 28, 2003. Gross profits are
dependent on a number of factors, particularly the mix of EECP models sold and
their respective average selling prices, the mix of EECP units sold, rented or
placed during the period, new or used during the period, the ongoing costs of
servicing such units, and certain fixed period costs, including facilities,
payroll and insurance. Gross profit margins are generally less on non-domestic
business due to the use of distributors, which results in lower selling prices.
Consequently, the gross profit realized during the current period may not be
indicative of future margins. The improvement in gross profit as a percentage of
sales for the quarter primarily reflects the impact from the sale of an
unusually high percentage of used equipment when compared to the same period of
the prior year. These systems reflected a lower than normal cost of sale since
they were partially amortized and as a result generated above average margins.
The Company has limited quantities of the lower cost systems and does not
anticipate a significant volume of used equipment will be sold in the future. In
addition, the Company began during the quarter to ship its newest model EECP
system, the TS4. The TS4 has a lower direct material cost when compared to the
previous model TS3 as a result of the Company's cost reduction program. Also,
the gross profit margin reflects lower spending for service parts, travel,
personnel and lower manufacturing overhead for the three-month period ended
February 29, 2004, compared to the same three-month period of the prior year.
Partially offsetting the above was the impact from lower average selling prices
for EECP systems.
Selling, general and administrative ("SG&A") expenses for the three-months
ended February 29, 2004, and February 28, 2003, were $3,083,407 or 52% of
revenues and $3,013,330 or 42% of revenues, respectively. The increase in SG&A
resulted primarily from increased personnel expenditures in sales and marketing
plus higher travel and advertising expenditures. Partially offsetting the above
were reduced expenditures for consulting services plus lower promotional
materials and events costs during the three-month period ended February 29,
2004, as compared to the same period for the prior year. The Company anticipates
increased sales and marketing expenditures in the immediate future compared to
the third quarter of fiscal 2004. Total administrative expenses were virtually
unchanged from the prior year period.
Research and development ("R&D") expenses of $1,043,595 or 18% of revenues
for the three months ended February 29, 2004, increased by $40,293 or 4%, from
the prior three months ended February 28, 2003, of $1,003,302 or 14% of
revenues. The increase reflects higher spending for consulting services and
product development, which were partially offset by lower spending for clinical
trials following the completion of several smaller clinical trials and reduced
spending related to the PEECH clinical trial. The Company expects to continue
its investments in product development and clinical trials through the remainder
Page 21
Vasomedical, Inc. and Subsidiaries
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
of fiscal 2004 and beyond to further validate and expand the clinical
applications of EECP, including, but not limited to, heart failure and acute
coronary syndromes. As of February 29, 2004, the PEECH trial was over 100%
enrolled. The PEECH trial will continue to consume the majority of R&D
expenditures allocated for clinical research projects, however the Company will
continue and/or initiate additional projects to further validate the use of the
Company's EECP System to support on- going efforts to expand reimbursement
coverage and to explore new clinical applications of the its technology.
During the three-month period ended February 29, 2004, the Company charged
$161,500 to its provision for doubtful accounts as compared to $280,919 during
the three-month period ended February 28, 2003.
Interest expense and financing costs decreased to $35,089 in the
three-month period ended February 29, 2004, from $46,930 for the same period in
the prior year due to repayment of the Company's revolving secured credit
facility in May 2003. Interest expense reflects interest on loans secured to
refinance the November 2000 purchase of the Company's headquarters and warehouse
facility, as well as on loans secured to finance the cost and implementation of
a new management information system.
Interest and other income for the three-month period February 29, 2004 and
ended February 28, 2003, were $6,815 and $31,062, respectively. The decrease in
interest income from the prior period is the direct result of the absence of
interest income related to certain equipment sold under sales-type leases
incurred in fiscal 2003, as well as declining interest rates this year over last
year earned on the average cash balances. Higher average cash balances invested
during the quarter compared to the prior period partially offset the above.
During the three-months ended February 29, 2004, the Company recorded a
provision for state income taxes of $10,000. This compares to a tax expense of
$43,480 reported during the three-months ended February 28, 2003. As of February
29, 2004, the Company had recorded deferred tax assets of $14,582,000 net of a
$1,360,000 valuation allowance related to the anticipated recovery of tax loss
carryforwards. The amount of the deferred tax assets considered realizable could
be reduced in the future if estimates of future taxable income during the
carryforward period are reduced. Ultimate realization of the deferred tax assets
is dependent upon the Company generating sufficient taxable income prior to the
expiration of the tax loss carryforwards. In accordance with the Statement of
Financial Accounting Standard No. 109 "Accounting for Income Taxes" ("SFAS
109"), management concluded at the end of fiscal 2003, based upon the weight of
available evidence at that time, that it was more likely than not that all of
the deferred tax assets would be realized. It was management's belief that
realization of the deferred tax asset was not dependent on material improvements
over the average of fiscal 2000 through fiscal 2002 levels of pre-tax income,
and that the Company is positioned for long-term growth despite the results
achieved in fiscal 2003, much of which was unexpected and non-recurring.
Management is currently evaluating the impact of the average 34% reduction in
Medicare reimbursement rates for EECP treatments that became effective in
January 2004 plus other factors currently influencing market conditions
including the impact of increased competition, declining sales prices and lower
volume on the Company's estimates of future taxable income. Due to the
uncertainty associated with estimates of future taxable income during the
carryforward period and the net value of the recorded deferred tax asset
relative to the Company's historical taxable income, management has decided to
provide a valuation allowance for all potential deferred tax assets generated
during fiscal 2004. The recorded deferred tax asset and decrease to the
valuation allowance during the third quarter for fiscal 2004 was $3,000.
Nine Months Ended February 29, 2004 and February 28, 2003
- ---------------------------------------------------------
The Company generated revenues from the sale, lease and service of its EECP
systems of $16,279,571 and $18,336,022 for the nine-month periods ended February
29, 2004, and February 28, 2003, respectively, reflecting a decrease of
$2,056,451 or 11%. The Company's loss before income taxes was $2,633,577 and
$6,345,681 for the nine-month periods ended February 29, 2004, and February 28,
2003, respectively. The Company reported a net loss of $2,663,577 and $4,805,239
for the nine-month periods ended February 29, 2004, and February 28, 2003,
respectively.
The decline in revenues is due primarily to lower sales of EECP systems in
the domestic market. Domestic equipment sales for the nine-month period ended
February 29, 2004, were down approximately 15% compared to the same nine-month
period in the prior year. The decline in domestic equipment sales is primarily
due to: a reduction in the average sales price for EECP systems of approximately
11%; a lower sales volume of EECP systems, which decreased by approximately 2%;
plus a higher proportion of used equipment versus new equipment sold during the
nine-month period ended February 29, 2004, which earn a lower average selling
price compared to new systems; plus adoption of the provisions of EITF 00-21.
The impact of lower prices resulting from lower priced competitive products
continues to have a negative impact on revenue when compared with prior periods.
Management believes that the EECP systems currently sell at a significant price
Page 22
Vasomedical, Inc. and Subsidiaries
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
premium to competitive products reflecting the clinical efficacy and superior
quality of the system plus the many value added services offered by the Company.
In addition, the Company adopted EITF 00-21 during the period. Following
adoption of the provisions of EITF 00-21, the Company deferred $57,500 of
revenue related to the fair value of installation and in-service training and
$466,667 of revenue related to the warranty service for EECP system sales
delivered during the second and third quarters of fiscal 2004. International
shipments of EECP systems declined approximately 26% to $676,000 due to a higher
sales rate in the previous year upon receipt of the CE Mark. The above was
partially offset by a 59% increase in revenue from equipment rental and services
reflecting primarily an increase of approximately 94% in service related
revenue. The higher service revenue reflects an increase in service, spare parts
and consumables as a result of the continued growth of the installed base of
EECP systems and greater marketing focus on the sale of extended service
contracts.
The gross profit declined to $10,714,473 or 66% of revenues for the
nine-month period ended February 29, 2004, compared to $11,602,279 or 63% of
revenues for the nine-month period ended February 28, 2003. The gross profit
margin as a percentage of revenue for the nine-month period ended February 29,
2004, improved compared to the same nine-month period of the prior fiscal year
despite the lower revenue and the impact from the reduction in average selling
prices. The improvement in gross profit as a percentage of sales reflects the
decline in expenditures for service related parts, travel and personnel for the
nine-month period ended February 29, 2004, when compared to same period of the
prior year. In addition, the gross profit margin benefited form the sale of an
unusually high percentage of used equipment when compared to the same nine-month
period of the prior year. These systems carried lower book values since they
were partially amortized and as a result generated above average margins. The
Company has limited quantities of the lower cost systems and does not anticipate
a significant volume of used equipment will be sold in the future.
Selling, general and administrative expenses for the nine months ended
February 29, 2004 and 2003 were $9,217,836 or 57% of revenues as compared to
$10,877,174 or 59% of revenues, respectively. The decrease of SG&A in both
absolute amount and as a percentage of sales resulted primarily from a one-time
$600,000 charge arising from the settlement of litigation in the prior year plus
a severance charge for approximately $300,000 in the prior year, as well as
lower selling and marketing expenditures primarily for outside services,
promotional spending for advertising and printing plus lower travel costs during
the nine-month period ended February 29, 2004, as compared to the same period
for the prior year. The above decreases were partially offset by higher
administrative expenses, which reflected increased personnel and insurance
expenses.
Research and development ("R&D") expenses of $2,996,970 or 18% of revenues
for the nine-month period ended February 29, 2004, decreased by $523,958, or
15%, from the prior nine-month period ended February 28, 2003, of $3,520,928 or
19% of revenues. The decrease is due primarily to reduced expenditures for
clinical consulting services related to several smaller clinical studies that
were completed plus lower product development costs.
During the nine-month period ended February 29, 2004, the Company charged
$1,147,011 to its provision for doubtful accounts as compared to $3,541,627
during the nine-month period ended February 28, 2003. In fiscal 2004, these
charges reflect management decision in the second quarter of fiscal 2004 to
record a $680,000 provision to the allowance for doubtful accounts, which
represents all funds due from a sales-type lease customer. The Company sold its
EECP systems to a major customer engaged in establishing independent networks of
EECP centers under a sales-type lease aggregating revenues of $1,271,888. No
additional equipment was sold to this customer during fiscal 2003 or 2004. This
customer became delinquent in its scheduled monthly payments during the fourth
quarter of fiscal 2003. During the first and second quarters of fiscal 2004 the
customer attempted to remedy the situation and made payments to the Company
totaling $70,000. In December 2003, the customer ceased operations. The Company
is evaluating its ability to seek additional recovery from the customer.
Additional provisions for all other accounts totals approximately $467,011. In
fiscal 2003, these charges primarily resulted from a approximately $2.5 million
for the capital lease and $500,000 for the notes receivable write-off of
receivables, with respect to another major customer, as well as specific
reserves against certain international accounts for which extended credit terms
were offered.
Interest expense and financing costs decreased to $101,335 in the
nine-month period ended February 29, 2004, from $143,997 for the same period in
the prior year due to repayment of the Company's revolving secured credit
facility in May 2003.
Page 23
Vasomedical, Inc. and Subsidiaries
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
Interest income and other income for the nine-month period ended February
29, 2004 and February 28 2003, was $115,102 and $135,766, respectively. The
decrease in interest income from the prior period is the direct result of the
absence of interest income related to certain equipment sold under sales-type
leases incurred in fiscal 2003, as well as declining interest rates this year
over last year earned on the average cash balances. Higher average cash balances
invested during the nine-month period ended February 29, 2004, compared to the
prior period partially offset the above.
During the nine-month period ended February 29, 2004, the Company recorded
a provision for state income taxes of $30,000. This is in contrast to an income
tax benefit of $1,540,442 reported during the nine-month period ended February
28, 2003. As of February 29, 2004, the Company had recorded deferred tax assets
of $14,582,000 net of a $1,360,000 valuation allowance related to the
anticipated recovery of tax loss carryforwards. The amount of the deferred tax
assets considered realizable could be reduced in the future if estimates of
future taxable income during the carryforward period are reduced. Ultimate
realization of the deferred tax assets is dependent upon the Company generating
sufficient taxable income prior to the expiration of the tax loss carryforwards.
In accordance with SFAS 109, management concluded at the end of fiscal 2003,
based upon the weight of available evidence at that time, that it was more
likely than not that all of the deferred tax assets would be realized. It was
management's belief that realization of the deferred tax asset was not dependent
on material improvements over the average of fiscal 2000 through fiscal 2002
levels of pre-tax income, and that the Company is positioned for long-term
growth despite the results achieved in fiscal 2003, much of which was unexpected
and non-recurring. Management is currently evaluating the impact of the average
34% reduction in Medicare reimbursement rates for EECP treatments in 2004 that
was recently announced by CMS plus other factors currently influencing market
conditions including the impact of increased competition, declining sales prices
and lower volume on the Company's estimates of future taxable income. Due to the
uncertainty associated with estimates of future taxable income during the
carryforward period and the net value of the recorded deferred tax asset
relative to the Company's historical taxable income, management has decided to
provide a valuation allowance for all potential deferred tax assets generated
during fiscal 2004. The recorded deferred tax asset and increase to the
valuation allowance during first nine months of fiscal 2004 was $738,000.
The following factors are anticipated to positively impact the future of
the Company's business activities and initiatives:
A. A large and increasing worldwide patient population with
cardiovascular disease demanding new choices of therapy, leading to
increased reimbursement coverage in the United States and other
countries. The estimated US patient population for angina patients is
approximately 6.2 million and approximately 5 million patients for
heart failure.
B. Approval of Medicare coverage and other third-party payer policies
specific to the congestive heart failure indication. The results of
the Company's ongoing PEECH trial are likely a pre-requisite for
significant coverage policies. The Company anticipates that the
results from the PEECH trial will be favorable (based upon a published
feasibility study and other analyses). The results should be available
for submission to CMS in late 2004 and a coverage decision is
anticipated in mid 2005. The combination of favorable PEECH trial
results and Medicare reimbursement would likely be a significant
catalyst for significant Company growth.
C. Potential extension of Medicare coverage to include all classes of
angina (beyond the present Class III/IV indication for refractory
angina, for which the Company estimates the annual patient population
in the US alone is 150,000.
D. A cardiology community with a mandate to offer patients new disease
management solutions providing effective clinical and economic
outcomes. The Company has cultivated relationships with many of the
leading institutions and cardiologists (as evidenced in its roster of
PEECH study sites).
E. The accumulation of EECP clinical validation and removal of obstacles
to third-party insurance reimbursement. Numerous abstracts and
publications are presented each year at major scientific meetings
worldwide. The Company estimates that more than 300 third-party payers
reimburse for EECP therapy, many on a routine basis.
F. Expanded base of future FDA-cleared indications to more effectively
penetrate the hospital market, particularly with respect to heart
failure (for which FDA clearance was received in June 2002), acute
Page 24
Vasomedical, Inc. and Subsidiaries
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
coronary syndromes (also cleared by FDA), diabetes management, and
peripheral and cerebrovascular diseases.
G. Initiatives planned to lower the cost of the Company's EECP systems,
thus improving margins or helping to preserve margins from further
price erosion.
H. The Company has a large, non-domestic market opportunity that it
intends to develop through a network of local independent
distributors. The Company has received the CE Mark (FDA-clearance
equivalent) and is ISO 13485 certified.
I. Continuing to prove more definitively the mechanism of action by which
EECP operates. These smaller scale clinical studies are aimed at
convincing those with lingering doubt about EECP's effectiveness that
the therapy is, indeed, safe and effective and serves to expand the
market. Studies have been presented and published in this area.
J. Increased hardware utility to allow for the use of EECP in an
increasing number of patient environments. The EECP TS4 system is
mobile, quieter and can be used more easily in the hospital
environment. Future system modifications could allow for emergency
room use.
The Company acknowledges that certain risk factors have the potential to
adversely affect the business opportunity that has been outlined. Initiatives
planned to mitigate the impact of such risks have been addressed. They include:
A. Dependence on outcome of PEECH trial and related reimbursement
coverage policies. Presently, the Company is engaged in the PEECH
trial, a pivotal study to evaluate the effectiveness of EECP therapy
for congestive heart failure patients. The Company anticipates that
the results of this study will be the catalyst for Medicare and other
third-party reimbursement coverage policies specific to heart failure.
Although the Company has received clearance from the FDA to market for
heart failure, the medical community, market acceptance and insurance
coverage policies are highly influenced by scientifically proven
technologies. The Company had designed its PEECH protocol in
cooperation with the FDA and had reached a formal agreement with the
FDA that the key parameters of its investigational plan for this trial
were appropriate to determine the effectiveness of EECP as an adjunct
therapy for heart failure. The Company believes that its PEECH trial
is robust and will provide favorable results that should provide a
reasonable basis for market acceptance and insurance reimbursement.
B. Dependence on a single product platform. Current FDA labeling extends
beyond chronic stable angina and congestive heart failure to unstable
angina, myocardial infarction and cardiogenic shock (i.e., acute
coronary syndromes). The Company intends to pursue additional clinical
studies to validate the safety and effectiveness of EECP in acute
coronary syndromes over the next few years provided sufficient
financial resources are available.
C. Dependence on consistency of research findings about EECP efficacy and
increasing acceptance of EECP by the medical community. To that end,
the Company has sponsored the International EECP Patient Registry
(IEPR), maintained at the University of Pittsburgh. Results to date
(5,500 patients enrolled) have supported favorable results achieved in
the initial trials conducted at the State University of New York at
Stony Brook, as well the conclusions from the MUST-EECP multicenter,
controlled, randomized and double-blinded efficacy trial completed in
1997. Phase 2 of the registry, known as IEPR II, began enrollment of
2,500 patients in January 2002 and is capturing additional data from
angina patients that include, among other things, data related to
concomitant heart failure symptoms.
D. Technological obsolescence of EECP by newly developed process, device
or therapy. There is no assurance that such technology couldn't exist
in the future to make EECP obsolete. Several companies are evaluating
devices and drugs for heart failure but there is presently no
consensus treatment for those patients. Even in the event one or more
drugs are developed, it is unlikely that EECP would be replaced
completely as many ill patients suffer a myriad of conditions with
co-morbid disease states that would make them contraindicated for use.
The Company believes that the cardiovascular disease market is so
large and the disease so complex that numerous technologies can
aggressively and successfully compete in the marketplace.
E. Competition, through acquisition or development, from companies with
superior financial resources and marketing capabilities. The barriers
of entry for external counterpulsation therapy are relatively small
however, there are presently only two competitors with a marketed
Page 25
Vasomedical, Inc. and Subsidiaries
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
external counterpulsation system. The Company believes that neither is
well capitalized or positioned within the medical community (neither
have done significant clinical trials). The Company estimates that it
has a 75% plus market share and does not foresee significant changes
in the immediate future.
F. New or changed regulatory environment that creates unforeseen
obstacles, or costs, to continue to market and sell the EECP system.
None are known at this time. Such changes in this industry are
normally not swift and would allow, in the opinion of management,
sufficient time to modify is business plan or become compliant.
G. New or changed insurance reimbursement criteria that create, or
reinstate, obstacles to physician acceptance of EECP. With respect to
Medicare, CMS raised rates for EECP treatment by 35% in March 2003 and
then effective January 2004 lowered EECP treatment rates by 32% to
levels that are significantly below the pre-March 2003 rates. The
Company believes that the 2004 Medicare rates were dropped to a level
that may adversely effect the Company's future prospects and will be
evaluating the impact of the lower rates on its future prospects and
its ability to fully realize the deferred tax asset.
Ultimate realization of all deferred tax assets is not assured, due to the
uncertainty associated with estimates of future taxable income during the
carryforward period. Management is evaluating the amount of the deferred tax
asset, in accordance with SFAS 109, to determine that based upon the weight of
available evidence, whether or not it is more likely than not that the deferred
tax asset will be realized. The amount of the deferred tax assets considered
realizable could be reduced in the future if estimates of future taxable income
during the carryforward period are reduced.
Liquidity and Capital Resources
The Company has financed its operations in fiscal 2004 and 2003 primarily
from working capital and operating results. At February 29, 2004, the Company
had a cash balance of $7,743,604 and working capital of $10,125,046 as compared
to a cash balance of $5,222,847 and working capital of $11,478,092 at May 31,
2003. The Company's cash balances increased $2,520,757 in the nine-month period
compared to May 31, 2003, primarily due to $2,300,698 cash provided by operating
activities.
The increase in cash provided by the Company's operating activities
resulted primarily from lower accounts receivable, which provided cash of
$2,606,696 for the nine-month period ended February 29, 2004. Net accounts
receivable were 80% of quarterly revenues for the three-month period ended
February 29, 2004, compared to 126% at the end of the three-month period ended
February 28, 2003, and accounts receivable turnover improved to 3.6 times as of
February 29, 2004, as compared to 3.2 times as of May 31, 2003. The Company's
management has tightened its sales credit policy, reduced extended payment terms
and provides routine oversight with respect to its accounts receivable credit
and collection efforts.
The Company's standard payment terms on its equipment sales are generally
net 30 to 90 days from shipment and do not contain "right of return" provisions.
The Company has historically offered a variety of extended payment terms,
including sales-type leases, in certain situations and to certain customers in
order to expand the market for its EECP products in the US and internationally.
Such extended payment terms were offered in lieu of price concessions, in
competitive situations, when opening new markets or geographies and for repeat
customers. Extended payment terms cover a variety of negotiated terms, including
payment in full - net 120, net 180 days or some fixed or variable monthly
payment amount for a six to twelve month period followed by a balloon payment,
if applicable. During the nine-month periods ended February 29, 2004, and
February 28, 2003, approximately 3% and 4% of revenues, respectively, were
generated from sales in which payment terms were greater than 90 days and no
sales-type leases were offered by the Company during either period. In general,
reserves are calculated on a formula basis considering factors such as the aging
of the receivables, time past due, and the customer's credit history and their
current financial status. In most instances where reserves are required, or
accounts are ultimately written-off, customers have been unable to successfully
implement their EECP program. As the Company is creating a new market for the
EECP therapy and recognizes the challenges that some customers may encounter, it
has opted, at times, on a customer-by-customer basis, to recover its equipment
instead of pursuing other legal remedies against these customers, which
necessitated the recording of a reserve or a write-off by the Company.
Other key factors causing the increase in cash provided by the Company's
operating activities included the reduction in inventories, which decreased by
$1,012,606 for the nine-month period ended February 29, 2004, reflecting efforts
Page 26
Vasomedical, Inc. and Subsidiaries
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
to improve procurement of its raw materials and management of finished goods
inventory levels, a reduction in financing receivables of $258,608, and an
increase in accounts payable, accrued expenses and other current liabilities of
$114,388. Additionally, non-cash adjustments for depreciation, amortization,
allowance for doubtful accounts and allowance for inventory write-offs to
reconcile the net loss of $2,663,577 to net cash provided by operating
activities total $1,360,376. Partially offsetting the above was an increase of
$203,176 in other current assets reflecting the prepayment of the Company's
annual insurance policies and an increase in other assets of $52,877 and a
decrease in other liabilities of $132,346.
Investing activities used net cash of $137,721 during the nine-month period
ended February 29, 2004. The principal use of cash was for the implementation of
the Company's new enterprise resource planning software.
Financing activities provided net cash of $357,780 during the nine-month
period ended February 29, 2004, reflecting $383,084 received form the exercise
of stock options plus new borrowings of $67,149 related to the Company's new ERP
system. Payments of principal on notes and loans were $92,453 partially
offsetting the above.
In fiscal 2002, the Company refinanced its long-term obligations on the
purchase of its headquarters and manufacturing facility. In October 2002, the
Company amended its existing credit facility to provide for borrowings up to
$5,000,000 ($2,000,000, at any time that consolidated net income for the
immediately preceding three-month period is less than $1), primarily based upon
eligible accounts receivable, as defined therein, at the Libor Rate plus 200
basis points or the published Prime Rate plus 50 basis points. Under the terms
of the agreement, which expires in February 2005, the Company is required to
meet certain quarterly covenants, including leverage ratio, liquidity, capital
expenditures, minimum net income, minimum interest coverage and minimum tangible
net worth. Although the Company was not in compliance with certain financial
covenants during each of its first three fiscal quarters of 2003, the bank
issued waivers to the Company for those periods. In April 2003, the agreement
was further amended to allow for borrowings absent compliance with the financial
covenants as long as cash collateralizes such eligible borrowings. In April
2003, the Company repaid all outstanding borrowings under the agreement instead
of maintaining restricted cash balances. At February 29, 2004, the Company did
not meet the minimum interest coverage, tangible net worth, leverage ratio and
minimum net earnings covenants and future compliance with each of these
covenants in the near term is not certain. Management believes, based upon its
cash balance at February 29, 2004 and its internal forecasts, that any
limitation on the Company's ability to borrow against this credit facility
through the remainder of fiscal 2004 and the first three quarters of fiscal 2005
would not have an adverse effect on the Company's operations.
Management believes that its working capital position at February 29, 2004,
the ongoing commercialization of the EECP system, and the effect of initiatives
undertaken to improve our cash position by managing operating expense levels and
by strengthening our sales and credit policies 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 February 29, 2004:
Due as of Due as of
Due as of 2/28/06 and 2/28/08 and Due
Total 2/28/05 2/28/07 2/29/09 Thereafter
- --------------------------------------------------------------------------------------------------------------------
Long-Term Debt $1,260,962 $133,617 $260,361 $116,153 $750,831
Operating Leases 135,609 63,434 72,175 -- --
Litigation Settlement 366,750 133,000 233,750 -- --
Severance obligations 70,000 70,000 -- -- --
Employment Agreements (a) 532,660 454,167 78,493 -- --
- --------------------------------------------------------------------------------------------------------------------
Total Contractual Cash $2,365,981 $854,218 $644,779 $116,153 $750,831
Obligations
====================================================================================================================
Page 27
Vasomedical, Inc. and Subsidiaries
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
(a) Includes $166,667 in contractual cash requirements under an employment
agreement as of February 29, 2004, with the Company's then President and Chief
Executive Officer, Mr. Gregory D. Cash. On March 23, 2004, Mr. Cash resigned
and, as a result, the Company was relieved of its obligation under this
agreement. The Company may incur a contractual cash requirement in the future
when a new President and Chief Executive Officer is hired.
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.
Page 28
Vasomedical, Inc. and Subsidiaries
ITEM 3 - 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 its cash and cash equivalent balances and
the line of credit agreement. The majority of our investments are in short-term
instruments and subject to fluctuations in US interest rates. Due to the nature
of our short-term investments, we believe that there is no material risk
exposure.
ITEM 4 - PROCEDURES AND CONTROLS
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures
pursuant to Exchange Act Rule 13a- 15. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective. There were no significant
changes in the Company's internal controls or in other factors that could
significantly affect these controls subsequent to the date of their evaluation.
Page 29
Vasomedical, Inc. and Subsidiaries
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS:
Previously reported.
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS:
None
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES:
None
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5 - OTHER INFORMATION:
None
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K:
Exhibits
10.1 Employment Agreement between the Company and Thomas W. Fry dated September
8, 2003.
31 Certifications pursuant to Rules 13a-14(a) as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32 Certifications pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
Reports on Form 8-K
None
Page 30
Vasomedical, Inc. and Subsidiaries
In accordance with to the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
VASOMEDICAL, INC.
By: /s/ Photios T. Paulson
Photios T. Paulson
Chief Executive Officer and Director (Principal Executive
Officer)
/s/ Thomas W. Fry
Thomas W. Fry
Chief Financial Officer (Principal Financial and Accounting
Officer)
Date: April 14, 2004
Page 31