UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended May 31, 2004
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____ to _____
Commission File No. 0-18105
---------------------------
VASOMEDICAL, INC.
(Name of registrant as specified in its charter)
Delaware 11-2871434
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
180 Linden Avenue, Westbury, New York 11590
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (516) 997-4600
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of Class)
Indicate by a check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by a check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
[ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ ] No [X ]
The aggregate market value of the voting and non-voting common stock held by
non-affiliates of the registrant (based on the closing sale price of $1.06 as of
November 30, 2003 was approximately $ 57,931,000. Shares of common stock held by
each officer and director and by each person who owns 5% of more of the
outstanding common stock have been excluded in that such persons may be deemed
to be affiliates. The determination of affiliates status is not necessarily a
conclusive determination for other purposes.
At August 10, 2004, the number of shares outstanding of the issuer's common
stock was 58,552,688.
DOCUMENTS INCORPORATED BY REFERENCE
Part III (Items 10, 11, 12 and 13) Registrant's definitive proxy statement
to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934.
INDEX TO FORM 10-K
Page
PART I
Item 1. Business 1
Risk Factors 13
Item 2. Properties 18
Item 3. Legal Proceedings 18
Item 4. Submission of Matters to a Vote of Security Holders 18
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters, and Issuer Purchases of Equity Securities 19
Item 6. Selected Financial Data 20
Item 7. Management's Discussion and Analysis of Financial Condition
and results of Operation 21
Item 7A.Quantitative and Qualitative Disclosures about Market Risk 31
Item 8. Financial Statements and Supplementary Data 32
Item 9. Changes in and Disagreements with Accountants and Accounting
and Financial Disclosure 32
Item 9A.Controls and Procedures 32
PART III
Item 10.Directors and Executive Officers of the Registrant 33
Item 11.Executive Compensation 33
Item 12.Security Ownership of Certain Beneficial Owners and Management 33
Item 13.Certain Relationships and Related Transactions 33
Item 14.Principal Accountant Fees and Services 33
PART IV
Item 15.Exhibits, Financial Statement Schedules, and Reports on Form 8-K 33
Signatures 35
-i-
PART I
ITEM 1 - BUSINESS
Except for historical information contained herein, the matters discussed
are forward looking statements that involve risks and uncertainties. When used
herein, words such as "anticipates", "believes", "estimates", "expects",
"feels", "plans", "projects" and "intends" and similar expressions, as they
relate to us, identify forward-looking statements.In addition, any statements
that refer to our plans, expectations, strategies or other characterizations of
future events or circumstances are forward-looking statements. Such
forward-looking statements are based on our beliefs, as well as assumptions made
by and information currently available to us. Among the factors that could cause
actual results to differ materially are the following: the effect of the
dramatic changes taking place in the healthcare environment; the impact of
competitive procedures and products and their pricing; medical insurance
reimbursement policies; unexpected manufacturing problems; unforeseen
difficulties and delays in the conduct of clinical trials and other product
development programs; the actions of regulatory authorities and third-party
payers in the United States and overseas; uncertainties about the acceptance of
a novel therapeutic modality by the medical community; and the risk factors
reported from time to time in our SEC reports. We undertake no obligation to
update forward-looking statements as a result of future events or developments.
General Overview
Vasomedical, Inc. was incorporated in Delaware in July 1987. Unless the
context requires otherwise, all references to "we", "our", "us", "Company",
"registrant" or "Vasomedical" refer to Vasomedical Inc. and its subsidiaries.
Since 1995, we have been primarily engaged in designing, manufacturing,
marketing and supporting EECP external counterpulsation systems based on our
proprietary technology currently indicated for use in cases of stable or
unstable angina (i.e., chest pain), cardiogenic shock, acute myocardial
infarction (i.e., heart attack, (MI)) and congestive heart failure (CHF). The
EECP system is a non-invasive, outpatient therapy for the treatment of diseases
of the cardiovascular system. The therapy serves to increase circulation in
areas of the heart with less than adequate blood supply and may restore systemic
vascular function. We provide hospitals and physician 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.
Market Overview
Cardiovascular disease (CVD) is the leading cause of death in the world and
is among the top three diseases in terms of healthcare spending in nearly every
country. CVD claimed approximately 931,000 lives in the United States in 2001
and was responsible for 1 of every 2.6 deaths, according to The American Heart
Association (AHA) Heart and Stroke Statistical 2004 Update (2004 Update). If
high blood pressure is included, approximately 64 million Americans suffer from
some form of cardiovascular disease. Among these, 13.2 million have coronary
artery disease (CAD).
We have Food and Drug Administration (FDA) clearance to market the EECP
therapy for use in the treatment of angina pectoris (angina), cardiogenic shock,
acute myocardial infarction and CHF, however our current marketing efforts are
limited to the treatment of refractory angina, where reimbursement for the EECP
treatment is available. Medicare and numerous other commercial third-party
payers currently provide reimbursement for the treatment of refractory angina
using the EECP therapy.
We are also actively engaged in research to establish the potential
benefits of EECP therapy in the management of CHF and are sponsoring a pivotal
study to demonstrate the efficacy of EECP therapy in most types of heart failure
patients. This study, known as PEECH (Prospective Evaluation of EECP in
Congestive Heart Failure), is intended to provide additional clinical data in
order to support a Medicare national coverage policy for the use of the EECP
therapy in the treatment of CHF. We expect to be able to release the results of
the PEECH trial by early 2005.
Angina
Angina pectoris is the medical term for a recurring pain or discomfort in
the chest due to coronary heart disease (CHD). Angina is a symptom of a
condition called myocardial ischemia, which occurs when the heart muscle or
1
myocardium doesn't receive as much blood, hence as much oxygen, as it needs.
This usually happens because one or more of the hearts arteries, the blood
vessels that supply blood to the heart muscle, is narrow or blocked.
Insufficient blood supply is called ischemia.
Typical angina is uncomfortable pressure, fullness, squeezing or pain
usually occurring in the center of the chest under the breastbone. The
discomfort also may be felt in the neck, jaw, shoulder, back or arm. Episodes of
angina occur when the heart's need for oxygen increases beyond the oxygen
available from the blood nourishing the heart. Physical exertion is the most
common trigger for angina. For example running to catch a bus could trigger an
attack of angina while walking might not. Angina may happen during exercise,
periods of emotional stress, exposure to extreme cold or heat, heavy meals,
alcohol consumption or cigarette smoking. Some people, such as those with a
coronary artery spasm, may have angina when they are resting.
There are approximately 6.5 million angina patients in the United States
and the EECP therapy currently competes with other technologies in the market
for approximately 150,000 angina patients annually who are considered refractory
to medical and/or surgical therapy and have the potential to meet the Medicare
guidelines for reimbursement of the EECP therapy. Most angina patients are
treated with medications, including vasodilators, which are often prescribed to
increase blood flow to the coronary arteries. When drugs fail or cease to
correct the problem they are considered refractory to medical therapy. Invasive
revascularization procedures such as angioplasty and coronary stent placement,
as well as coronary artery bypass grafting (CABG) are often employed in both
refractory and non-refractory angina patients.
In February 1999, the Centers for Medicare and Medicaid Services (CMS), the
federal agency that administers the Medicare program for more than 39 million
beneficiaries, issued a national coverage policy for the use of the EECP system.
Medicare reimbursement guidelines have a significant impact in determining the
available market for EECP therapy. We believe that over 65% of the patients that
receive EECP therapy are Medicare patients and many of the third-party payers
follow Medicare guidelines, which limits reimbursement for the EECP therapy to
patients who are refractory to medical and/or surgical therapy. As a result, an
important element of our strategy is to grow the market for EECP therapy by
expanding reimbursement coverage to include a broader range of angina patients
than the current coverage policy provides and enabling the EECP therapy to
compete more with other technologies. Please see the heading "Reimbursement" in
the "Item-1 Business of this Form 10-K" section for a more detailed discussion
of reimbursement issues.
Congestive Heart Failure
CHF is a complication of many serious diseases in which the heart loses its
full pumping capacity, causing blood to back up into other organs, especially
the lungs and liver. The condition affects both sexes and is most common in
people over age 50. Symptoms include shortness of breath, fatigue, swelling of
the abdomen, legs and ankles, rapid or irregular heartbeat, low blood pressure
and enlargement of the liver. Causes range from high blood pressure, heart-valve
disease, heart attack, coronary artery disease, heartbeat irregularities, severe
lung disease such as emphysema, congenital heart disease, cardiomyopathy,
hyperthyroidism and severe anemia.
CHF is treated with medication and, sometimes, surgery on heart valves or
the coronary arteries and, in certain severe cases, heart transplants. Left
ventricular assist devices (LVADs) and the use of cardiac resynchronization and
implantable defibrillators continue to advance. Still, no consensus therapy
currently exists for CHF and patients must currently suffer their symptoms
chronically and have a reduced life expectancy.
According to the 2004 Update, in 2001 approximately 2.5 million men and 2.5
million women in the US had CHF and about 550,000 new cases of the disease occur
each year. Deaths caused by the disease increased 155% from 1979 to 2001. The
prevalence of the disease is growing rapidly as a result of the aging of the
population and the improved survival rate of people after heart attacks. At age
forty the lifetime risk of developing CHF for both men and women was 1 in 5.
Also, because the condition frequently entails visits to the emergency room and
in-patient treatment centers, two-thirds of all hospitalizations for people over
age 65 are due to CHF. In addition to careful outpatient care and monitoring,
the economic burden of congestive heart failure is enormous with an estimated
2004 cost to the health care system in the United States of $28.8 billion. In
1999, $3.6 billion (an average of $5,456 per discharge) was paid to Medicare
beneficiaries for CHF.
Given the pressing need to identify new and effective methods to treat CHF,
we have been actively focusing clinical development resources on CHF. Congestive
heart failure offers a good strategic fit with our current angina business and
offers a new market opportunity for EECP therapy. Unmet clinical needs in CHF
are greater than those for angina, as there are few consensus therapies,
invasive or otherwise, beyond medical management for the condition. It is
noteworthy that data collected from the International EECP Patient RegistryTM
2
(IEPR) at the University of Pittsburgh Graduate School of Public Health
currently shows that approximately one- third of patients treated also have a
history of CHF and have demonstrated positive outcomes from EECP therapy.
The PEECH trial is intended to provide additional clinical evidence to
demonstrate the potential benefits of the EECP therapy in the management of CHF
and we plan to submit the results of the PEECH trial to Centers for Medicare and
Medicaid Services (CMS) to support the adoption of a Medicare national coverage
policy. We expect to be able to submit the results of the PEECH trial to CMS and
release the results of the PEECH trial to the public by early 2005. We
anticipate a coverage decision in late 2005 or early 2006; however, there can be
no assurance that the results of the PEECH trial will be sufficient to support
expansion of the Medicare national coverage policy for the EECP treatment.
The EECP Therapy Systems
The EECP therapy systems marketed by us are advanced treatment systems
utilizing fundamental hemodynamic principles to augment coronary blood flow and
at the same time reduce the workload of the heart while improving the overall
vascular function. The treatment is completely noninvasive and is administered
to patients on an outpatient basis usually in daily one-hour sessions, 5 days
per week over seven weeks for a total of 35 treatments. The procedure is well
tolerated and most patients begin to experience relief of chest pain due to
their coronary artery disease after 15 to 20 hours of therapy. Positive effects
have been shown in most patients to continue for years following a full course
of therapy.
During EECP therapy, the patient lies on a bed while wearing three sets of
inflatable pressure cuffs, resembling oversized blood pressure cuffs, on the
calves, the lower and upper thighs, including the buttocks. The cuffs inflate
rapidly and sequentially -- via computer-interpreted ECG signals -- starting
from the calves and proceeding upward to the buttocks during the resting phase
of each heartbeat (diastole). This has the effect of creating a strong
retrograde counter pulse in the arterial system, forcing freshly oxygenated
blood towards the heart and coronary arteries, while simultaneously increasing
the volume of venous blood return to the heart under increased pressure. Just
prior to the next heartbeat when the heart begins to eject blood by contracting
(systole), all three cuffs simultaneously deflate, significantly reducing the
workload of the heart. This is achieved because the vascular beds in the lower
extremities are relatively empty when the cuffs are deflated, significantly
lowering the resistance to blood ejected by the heart, reducing the amount of
work the heart must do to pump oxygenated blood to the rest of the body. The
inflation/deflation activity is monitored constantly and coordinated by a
computerized console that interprets electrocardiogram signals from the
patient's heart, monitors heart rhythm and rate information, and actuates the
inflation and deflation cycles. The end result of this sequential "squeezing" of
the legs is to create a pressure wave that significantly increases peak
diastolic pressure, benefiting circulation to the heart muscle and other organs,
while also reducing systolic pressure, to the general benefit of the vascular
system. This surge of circulation insures that the heart does not have to work
as hard to pump large amounts of blood through the body, and that more blood is
forced into the coronary arteries which supply energy to the heart muscle or
myocardium.
While the precise mechanism of action remains unknown, there is evidence to
suggest that the EECP therapy triggers a neurohormonal response that induces the
production of growth factors and dilates existing blood vessels. This in turn
fosters the recruitment of collateral blood vessels, which bypass blocked or
narrowed vessels and increase blood flow to restore ischemic areas of the heart
muscle that are receiving an inadequate supply of blood. The myocardium itself
may also develop new vasculature. There is also evidence to support a mechanism
related to improved function of the endothelium (the inner lining of the blood
vessels), reducing constriction of blood vessels that supply oxygenated blood to
the body's organs and tissues and the required workload of the heart.
Clinical Studies
Early History
Early experiments with counterpulsation at Harvard in the 1950s
demonstrated that this technique markedly reduces the workload, and thus oxygen
consumption, of the left ventricle. This basic effect has been demonstrated over
the past forty years in both animal experiments and in patients. The clinical
benefits of external counterpulsation were not consistently achieved in early
studies because the equipment used then lacked some of the features found in the
current EECP systems, such as the computerized electrocardiographic gating, that
makes sequential cuff inflation possible. As the technology improved, however,
it became apparent that both internal (i.e. intra-aortic balloon pumping) and
external forms of counterpulsation were capable of improving survival in
patients with cardiogenic shock following myocardial infarction. Later, in the
1980s, Dr. Zheng and colleagues in China reported on their extensive experience
in treating angina using the newly developed "enhanced" sequentially inflating
3
EECP device that incorporated a third cuff for the buttocks. Not only did a
course of treatment with the EECP system reduce the frequency and severity of
anginal symptoms during normal daily functions and also during exercise, but
also the improvements were sustained for years after therapy.
These results prompted a group of investigators at the State University of
New York at Stony Brook (Stony Brook) to undertake a number of open studies with
the EECP system between 1989 and 1996 to reproduce the Chinese results, using
both subjective and objective endpoints. These studies, though open and non-
randomized, showed statistical improvement in exercise tolerance by patients as
evidenced by thallium-stress testing and partial or complete resolution of
coronary perfusion defects as evidenced by radionuclide imaging studies. All of
these results have been reported in the medical literature and support the
assertion that EECP therapy is an effective and durable treatment for patients
suffering from chronic angina pectoris.
The MUST-EECP Study
In 1995, we began a large randomized, controlled and double-blinded
multicenter clinical study (MUST- EECP) at four leading university hospitals in
the United States to confirm the patient benefits observed in the open studies
conducted at Stony Brook and to provide definitive scientific evidence of EECP
therapy's effectiveness. MUST-EECP was completed in July 1997 and the results
presented at the annual meetings of the American Heart Association in November
1997 and the American College of Cardiology in March 1998. The results of MUST-
EECP were published in the Journal of the American College of Cardiology (JACC),
a major peer-review medical journal, in June 1999.
This 139 patient study, which included a sham-EECP control group, showed
that EECP therapy was a safe and effective treatment option for patients
suffering from angina pectoris, including those on maximal medication and for
whom invasive revascularization procedures were no longer an option. The results
of the MUST-EECP study confirmed the clinical benefits described in earlier open
trials, namely a decline in anginal frequency, an increase in the ability to
exercise and a decrease in exercise-induced signs of myocardial ischemia. Data
collected by the IEPR closely mirror the results seen in the MUST-EECP trial.
In fiscal 1999, we completed a quality-of-life study with the EECP system
in the same institutions and with the same patients that participated in
MUST-EECP. Two highly regarded standardized means of measurement were used to
gauge changes in patients' outlook and ability to participate in normal daily
living during the treatment phase and for up to 12 months after treatment.
Results of this study, which have been presented at major scientific meetings
and published in the January 2002 Journal of Investigative Medicine, show that
the group of patients receiving EECP therapy enjoyed significantly improved
aspects of health-related quality of life compared to those who received a sham
treatment.
The PEECH Study
As part of its program to expand the therapy's indications for use beyond
the treatment of angina, we applied for and received FDA approval in April 1998
to study, under an Investigational Device Exemption (IDE) protocol, the
application of EECP therapy in the treatment of CHF. A 32-patient feasibility
study was conducted simultaneously at the University of Pittsburgh, the
University of California San Francisco and the Grant/Riverside Methodist
Hospitals in Columbus, Ohio. The results of this study were presented at the
49th Scientific Sessions of the American College of Cardiology in March 2000 and
the Heart Failure Society of America's Annual Meeting in September 2000 and were
published in the July/August 2002 issue of Congestive Heart Failure. This study
concluded that EECP therapy increased functional capacity of the patients, was
beneficial to left ventricular function and portends to be a useful adjunct to
current medical therapy in heart failure patients.
In summer 2000, an IDE supplement to proceed with a pivotal study to
demonstrate the efficacy of EECP therapy in most types of heart failure patients
was approved. This study, known as PEECH (Prospective Evaluation of EECP in
Congestive Heart Failure), began patient enrollment in March 2001. The PEECH
trial involves nearly thirty centers including: the Cleveland Clinic, Mayo
Clinic, Scripps Clinic, Thomas Jefferson University Hospital, the University of
North Carolina at Chapel Hill, the Minnesota Heart Failure Consortium, Advocate
Christ Hospital, Hull Infirmary (UK), the University of California at San Diego
Medical Center, the University of Pittsburgh Medical Center and the
Cardiovascular Research Institute. The 510(k) clearance for CHF granted in June
2002 obviated the need to continue this trial for FDA regulatory reasons.
However, we intend to complete the clinical trial and use the anticipated
positive clinical outcomes to establish the clinical validation of EECP therapy
as a treatment for CHF and to obtain Medicare and other third-party
reimbursement for this indication.
The PEECH trial enrollment was completed in February 2004 with 187
patients, The protocol for the study requires patient examinations six months
following treatment and will evaluate improvements in exercise capacity and
4
quality of life, as well as the reduction in the need for certain medications
that CHF patients are typically prescribed. We anticipate that the six-month
follow-up examinations will be completed by the end of October 2004. We expect
to be able to release the results of the PEECH trial in March 2005 and, provided
results of the trial are positive, submit a request to CMS to provide
reimbursement for use of the EECP therapy in treatment of CHF in early 2005.
Based on the above timetable we anticipate a coverage decision by CMS in late
2005 or early 2006.
We are blinded to the results of the PEECH trial until after the study is
completed and there can be no assurance that the results of the PEECH trial will
be sufficient to demonstrate the efficacy of the EECP therapy in the treatment
of congestive heart failure or that the results will provide sufficient evidence
to expand insurance coverage or the adoption of the EECP therapy for use in the
treatment of congestive heart failure by the medical community.
The IEPR Registry
The International EECP Patient Registry at the University of Pittsburgh
Graduate School of Public Health was established in January 1998 to track the
outcomes of patients who have undergone EECP therapy. More than one hundred
centers have participated in the registry and data from 5,000 patient records
has been entered. Phase 2 of the IEPR, planned for an additional 2,500 patients,
began enrollment in January 2002 and incorporates sub-studies that are examining
treatment beyond 35 hours of treatment, where needed, the presence of protein in
the urine of type 2 diabetic patients as a predictor of response to EECP
therapy, the effects on peripheral vascular disease, and the effects of sexual
function in men. The IEPR is a vital source of information about the
effectiveness of EECP therapy in a real-world environment for the medical
community at large. For this reason, we will continue to provide an ongoing
grant to fund the registry to publicize data that assists clinicians in
delivering optimal care to patients. Data from the IEPR show that patients
continue to receive dramatic benefit at six, twelve, twenty-four and thirty-six
months following completion of their course of EECP therapy. Data on 1,097
patients in the IEPR reported early in 2004 showed 92% of patients remained
alive (including 41% free of cardiac events during that period) and sustained
reduction in anginal status and nitrate medication use at 2 years following EECP
therapy.
The following tables illustrate the results:
Pre-EECP Post EECP At 1 year At 2 years At 3 years
(N=5,019) (N=3,982) (N=2,374) (N=1,022) (N=238)
% % % % %
No Angina -- 20.7 29.1 33.3 34.9
Class I 3.5 26.2 21.2 20.7 19.3
Class II 14.7 36.4 29.4 26.7 24.8
Class III 58.4 14.0 16.2 15.0 16.0
Class IV 23.4 2.6 4.1 4.3 5.0
prn Nitro Use 68.8 31.5 43.4 40.8 44.4
Angina Improvement Post
Patient Demographics Medical History EECP
Mean age 66.8 years Duration of CAD 10.8 years > 1 CCSC 82.3%
Age > 65 59.7% Prior PCI/CABG 85.8% > 2 CCSC 45.4%
Male gender 75.5% Prior MI 67.6%
CHF 31.7%
Diabetes 41.3%
N = number of patients reporting at these points
CCSA = Canadian Cardiovascular Society Classification
Other studies and publications
Over the last several years, our clinical bibliography has expanded to
include over 50 publications in peer- review journals, as well as other
publications and abstracts presented at major medical conferences. Notable among
these studies are several discussing the neurohumoral effects of EECP therapy
including increases in the levels of nitric oxide, a potent vasodilator and
decreases in levels of endothelin a vasoconstrictor as well as the release of
certain growth factors.
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Strategic Initiatives
Our short- and long-term plans are to:
a) Increase the domestic reimbursable user base for the EECP therapy by:
i) obtaining reimbursement for the treatment of CHF,
ii) marketing directly to third-party payers to increase third-party
reimbursement, and
iii) reducing reimbursement limitations in the refractory angina
market.
b) Increase the clinical and scientific understanding of the EECP therapy
by:
i) completing the PEECH clinical trial, publishing the results in a
major peer-review medical journal and submitting data to
insurers, including Medicare, for favorable coverage policies;
ii) continuing to establish and support academic reference centers in
the United States and overseas in order to accelerate the growth
and prestige of EECP therapy and to increase the number and
diversity of clinical and mode-of-action studies, as well as the
number of presentations, publications, speakers and advocates;
and
iii) providing an ongoing grant to fund the International EECP Patient
Registry at the University of Pittsburgh Graduate School of
Public Health to publicize key information relating to patient
outcomes.
c) Increase awareness of the benefits of the EECP therapy in the medical
community by:
i) developing campaigns to market the benefits of EECP therapy
directly to clinicians, third-party payers and patients;
ii) engaging in educational campaigns for providers and medical
directors of third-party insurers designed to highlight the
cost-effectiveness and quality-of-life advantages of EECP
therapy; and
iii) continuing the development of the EECP therapy in certain
international markets, principally through the establishment of a
distribution network.
d) Maintain development efforts to improve the EECP system and expand its
intellectual property estate by filing for additional patents in the
United States and other countries.
e) Pursue possible strategic investments and creative partnerships with
others who have distinctive competencies or delivery capabilities for
serving the cardiovascular and disease management marketplace, as
opportunities become available.
These strategic objectives above are forward-looking statements. We review,
modify and change our strategic objectives from time to time based upon changing
business conditions. There can be no assurance that we will be able to achieve
our strategic objectives and even if these results are achieved risks and
uncertainties could cause actual results to differ materially from anticipated
results. Please see the section of this Form 10-K entitled "Risk Factors" for a
description of certain risks among others that may cause our actual results to
vary from the forward-looking statements.
Sales and Marketing
Domestic Operations
We sell EECP systems to treatment providers in the United States through a
direct sales force directly to hospitals and physician private practices. Our
sales force is currently comprised of over twenty sales representatives, as well
as one independent sales organization and is supported by a management team
consisting of a vice president of domestic sales, three regional sales managers
plus in-house administrative support.
The efforts of our sales organization are further supported by a
field-based staff of seven clinical educators who are responsible for the onsite
training of physicians and therapists as new centers are established. Training
generally takes approximately two and a half days. This clinical applications
group is also engaged in training and certification of new personnel at each
site, as well as for updating providers on new clinical developments relating to
EECP therapy.
Our marketing activities include medical journal advertising, direct mail
promotions aimed at the cardiology medical community, publication of
EECP-related newsletters to EECP therapy centers and participants in the IEPR
study, support of physician education and physician outreach programs,
exhibition at national, international and regional medical conferences, as well
as sponsorship of seminars at professional association meetings. These programs
are designed to support our field sales organization and increase awareness of
the EECP therapy in the medical community. Additional marketing activities
6
include creating awareness among third-party payers to the benefits of the EECP
treatment for patients suffering from CHF as well as angina.
We employ six field service technicians responsible for the repair and
maintenance of EECP systems and, in some instances, on-site training of a
customer's biomedical engineering personnel as required. We provide a one-year
product warranty that includes parts and labor and we offer post-warranty
service to our customers under annual service contracts or on a fee-for-service
basis.
International Operations
We distribute our product internationally through a network of independent
distributors. It has generally been our policy to appoint distributors in
exchange for exclusive marketing rights to EECP systems in their respective
countries. Each distribution agreement contains a number of requirements that
must be met for the distributor to retain exclusivity, including minimum
performance standards. In most cases, distributors must assist us either to
obtain an FDA-equivalent marketing clearance or to establish confirmation
clinical evaluations conducted by local opinion leaders in cardiology. Each
distributor is responsible for obtaining any required regulatory approvals,
supporting local reimbursement efforts for the EECP therapy and maintaining an
infrastructure to provide post-sales support, including clinical training and
product maintenance services.
To date, revenues from international operations have not been significant
(fiscal 2004 revenues were less than 4% of total revenues) but we anticipate
international revenues to increase in future years. Our international marketing
activities include, among other things, assisting in obtaining national or
third-party healthcare insurance reimbursement approval and participating in
medical conferences to create greater awareness and acceptance of EECP therapy
by clinicians.
International sales may be subject to certain risks, including
export/import licenses, tariffs, other trade regulations and local medical
regulations. Tariff and trade policies, domestic and foreign tax and economic
policies, exchange rate fluctuations and international monetary conditions have
not significantly affected our business to date. In addition, there can be no
assurance that we will be successful in maintaining our existing distribution
agreements or entering into any additional distribution agreements that our
international distributors will be successful in marketing the EECP therapy.
Competition
Presently, we are aware of at least two competitors with an external
counterpulsation device on the market, namely Cardiomedics, Inc. and Nicore,
Inc. In addition, at least eight other companies have received FDA 510K
clearance for external counterpulsation systems, although we have not seen these
systems commercially in the marketplace. While we believe that these
competitors' involvement in the market is limited, there can be no assurance
that these companies will not become a significant competitive factor or that
other companies will not enter the external counterpulsation market.
We view other companies engaged in the development of device-related,
biotechnology and pharmacological approaches to the management of cardiovascular
disease as potential competitors in the marketplace as well. These include such
common and well established medical devices such as the intra-aortic balloon
pump (IANP), ventricular assist devices (VAD), coronary artery bypass graft
(CABG), coronary angioplasty, mechanical circulatory support (MCS),
transmyocardial laser revascularization (TMR), cardiac recovery systems, total
artificial hearts; as well as newer technologies currently in FDA clinical
trials such as spinal cord stimulation (SCS) and partial fatty acid oxidation
(pFOX inhibitor). We are unaware of any other biotech or pharmaceutical
technologies that may impact our ability to market and distribute EECP systems
in the near term.
There can be no assurance that other companies will not develop new
technologies or enter the market intended for EECP systems. Such other companies
may have substantially greater financial, manufacturing and marketing resources
and technological expertise than those possessed by us and may, therefore,
succeed in developing technologies or products that are more efficient than
those offered by Vasomedical and that would render our technology and existing
products obsolete or noncompetitive.
Government Regulations
We are subject to extensive regulation by numerous government regulatory
agencies, including the FDA and similar foreign agencies. Where applicable, we
are required to comply with laws, regulations and standards governing the
development, preclinical and clinical testing, manufacturing, labeling,
promotion, import, export, and distribution of our medical devices.
7
Device Classification.
FDA regulates medical devices, including the requirements for premarket
review, according to their classification. Class I devices are generally lower
risk products for which general regulatory controls are sufficient to provide
reasonable assurance of safety and effectiveness. Most Class I devices are
exempt from the requirement of 510(k) premarket notification clearance; however,
510(k) clearance is necessary prior to marketing a non-510(k) exempt Class I
device in the United States. Class II devices are devices for which general
regulatory controls are insufficient, but for which there is sufficient
information to establish special controls, such as guidance documents or
standards, to provide reasonable assurance of safety and effectiveness. A
premarket notification clearance is necessary prior to marketing a non-510(k)
exempt Class II device in the United States. Class III devices are devices for
which there is insufficient information demonstrating that general and special
controls will provide reasonable assurance of safety and effectiveness and which
are life-sustaining, life-supporting or implantable devices, are of substantial
importance in preventing impairment of human health, or pose a potential
unreasonable risk of illness or injury. The FDA generally must approve a
premarket approval or PMA application prior to marketing a Class III device in
the United States.
A medical device is considered by FDA to be a preamendments device, and
generally not subject to premarket review, if it was commercially distributed
before May 28, 1976, the date the Medical Device Amendments of 1976 became law.
A postamendments device is one that was first distributed commercially on or
after May 28, 1976. Postamendments device versions of preamendments Class III
devices are subject to the same requirements as those preamendments devices. FDA
may require a PMA for a preamendments Class III device only after it publishes a
regulation calling for such PMA submissions. Persons who market preamendments
devices must submit a PMA, and have it filed by FDA, by a date specified by FDA
in order to continue marketing the device. Prior to the effective date of a
regulation requiring a PMA, devices must have a cleared premarket notification
or 510(k) for marketing.
Certain external counterpulsation devices were commercially distributed
prior to May 28, 1976. Our external counterpulsation devices were marketed after
1976; however, they were found to be substantially equivalent to a preamendments
Class III device and therefore are subject to the same requirements as the
preamendments external counterpulsation devices. In February 1995, the Company
received 510(k) clearance to market the second-generation version of its EECP
therapy system, the MC2, which incorporated a number of technological
improvements over the original system. In addition, in December 2000, the
Company received 510(k) clearance to market its third generation system, the
TS3. The FDA's clearance in these cases was for the use of EECP therapy in the
treatment of patients suffering from stable or unstable angina pectoris, acute
myocardial infarction and cardiogenic shock. In June 2002, the FDA granted
510(k) market clearance for an upgraded TS3, which incorporated the Company's
patent-pending CHF treatment and oxygen saturation monitoring technologies, and
provided for a new indication for the use of EECP in CHF, which applied to all
present models of the Company's EECP systems. In March 2004, the Company
obtained 510(k) market clearance for revisions to the labeling of all its
products, including the new Model TS4, which eliminated certain
contrainindications and changed other precautions. There can be no assurance
that our products will not be subject to a regulation requiring a PMA for
preamendments Class III external counterpulsation devices.
Premarket Review.
The 510(k) premarket notification process requires an applicant to give 90
days notice to FDA of its intent to introduce its device into commerce. In its
premarket notification, the applicant must demonstrate that its new or modified
medical device is substantially equivalent to a legally marketed or predicate
device. Prior to beginning commercialization of the new or modified product we
must receive an order from the FDA classifying the device under section 510(k)
in the same classification as the predicate device, and as a result, the new
device will be cleared for marketing. Modifications to a previously cleared
medical device that do not significant affect its safety and effectiveness or
constitute a major change in the intended use can be made without having to
submit a new 510(k). If a device does not receive a clearance order because the
FDA determines that the device is not substantially equivalent to a predicate
device and thus the device automatically is considered a Class III device, the
applicant may ask the FDA to make a risk-based classification to place the
device in Class I or II. However, if a timely request for risk-based
classification is not made, or if the FDA determines that a Class III
designation is appropriate, an approved PMA will be required before the device
may be marketed.
The more rigorous premarket review process is the PMA process. The FDA
approves a PMA if the applicant has provided sufficient valid scientific
evidence to prove that the device is safe and effective for its intended use(s).
Applications for premarket approval generally contain human clinical data. This
8
process is usually much more complex, time-consuming and expensive than the
510(k) process, and is uncertain. Both 510(k)s and PMAs now require the
submission of user fees in most circumstances.
There can be no assurance that all the necessary FDA clearances or
approvals, including approval of any PMA required by the promulgation of a
regulation, will be granted for our products, future-generation upgrades or
newly developed products, on a timely basis or at all. Failure to receive or
delays in receipt of such clearances could have a material adverse effect on our
financial condition and results of operations.
Clinical Trials.
If human clinical trials of a device are required, whether to support a
510(k) or PMA application, the trials' sponsor, which is usually the
manufacturer of the device, first must obtain the approval of the appropriate
institutional review boards. If a trial is of a significant risk device, the
sponsor also must obtain an investigational device exemption or IDE before the
trial may begin. A significant risk device is a device that presents a potential
for serious risk to the subject and is an implant; is life-sustaining or
life-supporting; or is for a use of substantial importance in diagnosing,
curing, mitigating, or treating disease, or otherwise preventing impairment of
human health. For all clinical testing, the sponsor must obtain informed consent
from the patients participating in each trial. The results of clinical testing
that a sponsor undertakes may be insufficient to obtain clearance or approval of
the tested product.
Pervasive and Continuing FDA Regulation.
We are also subject to other FDA regulations that apply prior to and after
a product is commercially released. These include current Good Manufacturing
Practices or GMP requirements set forth in FDA's Quality System Regulation or
QSR that require manufacturers to have a quality system for the design and
production of medical devices intended for commercial distribution in the United
States. This regulation covers various areas including management and
organization, device design, purchase and handling of components, production and
process controls such as those related to buildings and equipment, packaging and
labeling control, distribution, installation, complaint handling, corrective and
preventive action, servicing, and records. We are subject to periodic inspection
by the FDA for compliance with the current good manufacturing practice
requirements and Quality System Regulation.
The FDA also enforces post-marketing controls that include the requirement
to submit medical device reports to the agency when a manufacturer becomes aware
of information suggesting that any of its marketed products may have caused or
contributed to a death or serious injury, or any of its products has
malfunctioned and that a recurrence of the malfunction would likely cause or
contribute to a death or serious injury. The FDA relies on medical device
reports to identify product problems and utilizes these reports to determine,
among other things, whether it should exercise its enforcement powers. The FDA
also may require postmarket surveillance studies for specified devices.
We are subject to the Federal Food, Drug, and Cosmetic Act's or FDCA's
general controls, including establishment registration, device listing, and
labeling requirements. If we fail to comply with any requirements under the
FDCA, we, including our officers and employees, could be subject to, among other
things, fines, injunctions, civil penalties, and criminal prosecution. We also
could be subject to recalls or product corrections, total or partial suspension
of production, denial of premarket notification clearance or PMA approval, and
rescission or withdrawal of clearances and approvals. Our products could be
detained or seized, the FDA could order a recall, repair, replacement, or refund
of our devices, and the agency could require us to notify health professionals
and others that the devices present unreasonable risks of substantial harm to
the public health.
The advertising of our products is subject to regulation by the Federal
Trade Commission or FTC. The FTC Act prohibits unfair or deceptive acts or
practices in or affecting commerce. Violations of the FTC Act, such as failure
to have substantiation for product claims, would subject us to a variety of
enforcement actions, including compulsory process, cease and desist orders and
injunctions, which can require, among other things, limits on advertising,
corrective advertising, consumer redress and restitution, as well as substantial
fines or other penalties.
Foreign Regulation.
In most countries to which we seek to export the EECP system, it must first
obtain approval from the local medical device regulatory authority. The
regulatory review process varies from country to country and can be complex,
costly, uncertain, and time-consuming.
We are also subject to periodic audits by organizations authorized by
foreign countries to determine compliance with laws, regulations and standards
that apply to the commercialization of its products in those markets. Examples
include auditing by a European Union Notified Body organization (authorized by a
9
member state's Competent Authority) to determine conformity with the Medical
Device Directives (MDD) and by an organization authorized by the Canadian
government to determine conformity with the Canadian Medical Devices Conformity
Assessment System (CMDCAS).
There can be no assurance that we will obtain desired foreign
authorizations to commercially distribute its products in those markets or that
we will comply with all laws, regulations and standards that pertain to its
products in those markets. Failure to receive or delays in receipt of such
authorizations or determinations of conformity could have a material adverse
effect on our financial condition and results of operations.
Patient Privacy.
Federal and state laws protect the confidentiality of certain patient
health information, including patient records, and restrict the use and
disclosure of that protected information. The U.S. Department of Health and
Human Services (HHS) published patient privacy rules under the Health Insurance
Portability and Accountability Act of 1996 (HIPAA privacy rule) and the
regulation was finalized in October 2002. The HIPAA privacy rule governs the use
and disclosure of protected health information by "Covered Entities," which are
(1) health plans, (2) health care clearinghouses, and (3) health care providers
that transmit health information in electronic form in connection with certain
health care transactions such as benefit claims. Currently, the HIPAA privacy
rule affects us only indirectly in that patient data that we access, collect and
analyze may include protected health information. Additionally, we have signed
some Business Associate agreements with Covered Entities that contractually bind
us to protect protected health information, consistent with the HIPAA privacy
rule's requirements. We do not expect the costs and impacts of the HIPAA privacy
rule to be material to our business.
Reimbursement
Sales of our products depend in part on the availability of reimbursement
by government programs such as Medicare, Medicaid, private health care insurance
and managed-care plans. Whether a product receives coverage depends upon a
number of factors, including the payer's determination that the product is
reasonable and necessary for the diagnosis or treatment of the illness or injury
for which it is administered according to accepted standards of medical
practice, the product's cost effectiveness, whether the product is experimental
or investigational, and whether the product is not otherwise excluded from
coverage by law or regulation. There may be significant delays in obtaining
coverage for newly-approved products, and coverage may be more limited than the
purposes for which the product is approved or cleared by FDA. Even when we
obtain authorization from the FDA or foreign authority to begin commercial
distribution, there may be limited demand for the device until reimbursement
approval has been obtained from governmental and private third-party payers.
Moreover, eligibility for coverage does not imply that a product will be
reimbursed in all cases or at a rate that allows us to make a profit or even
cover our costs. Reimbursement rates may vary according to the use of the
product and the clinical setting in which it is used, may be based on payments
allowed for lower-cost products that are already reimbursed, may be incorporated
into existing payments for other products or services, and may reflect budgetary
constraints and/or imperfections in Medicare or Medicaid data. Even if
successful, securing coverage at adequate reimbursement rates from government
and third party payers can be a time consuming and costly process that could
require us to provide supporting scientific, clinical, and cost-effectiveness
data for the use of our products to each payer. Our inability to promptly obtain
coverage and profitable reimbursement rates from government-funded and private
payers for our products could have a material adverse effect on our financial
condition and operating results.
Our reimbursement strategies are currently focused in the following primary
areas: obtaining Medicare coverage for congestive heart failure, expanding
coverage with other third-party payers, reducing the limitations in Medicare
coverage for angina and obtaining coverage in selected international markets.
Current Medicare Coverage in Angina
In February 1999, the Centers for Medicare and Medicaid Services (CMS), the
federal agency that administers the Medicare program for more than 39 million
beneficiaries, issued a national coverage policy under HCPCS code G1066 for the
use of the EECP therapy system. Key excerpts from the coverage read as follows:
"Although ECP devices are cleared by the Food and Drug Administration (FDA)
for use in treating a variety of cardiac conditions, including stable or
unstable angina pectoris, acute myocardial infarction and cardiogenic
shock, the use of this device to treat cardiac conditions other than stable
10
angina pectoris is not covered, since only that use has developed
sufficient evidence to demonstrate its medical effectiveness."
"for patients who have been diagnosed with disabling angina (class III or
class IV, Canadian Cardiovascular Society Classification or equivalent
classification) who, in the opinion of a cardiologist or cardiothoracic
surgeon, are not readily amenable to surgical interventions such as balloon
angioplasty and cardiac bypass because:
1. their condition is inoperable, or at high risk of operative
complications or post- operative failure;
2. their coronary anatomy is not readily amenable to such
procedures; or
3. they have co-morbid states, which create excessive risk."
Additionally, a physician must be present in the office suite and
immediately available to provide assistance and directions throughout the time
that personnel are performing the procedure.
The 2004 national average payment rate per hourly session in the physician
office setting and the hospital outpatient facility is approximately $137 and
$113, respectively. Under the Medicare program, physician reimbursement of the
provision of the EECP therapy is higher if the therapy is performed in a
physician office setting as compared to a hospital outpatient facility in order
to reflect higher cost associated with the physician office. Since January 2000,
the national average payment rate has varied considerably. The initial national
average payment rate for the physician office setting and the hospital
outpatient facility in 2000 was approximately $130 and $112, respectively per
hourly session. The average payment rate for the physician office setting
climbed steadily to $208 per treatment session in 2003 before being reduced
approximately 34% to the 2004 rate, while the average payment rate for the
hospital outpatient facility declined steadily to the 2004 rate.
In order to bill and receive payment from Medicare, an individual or entity
must be enrolled in the Medicare program for EECP therapy. The physician office
setting and the hospital outpatient facility are the only entities currently
authorized to receive reimbursement for the EECP therapy under the Medicare
program and reimbursement is not permitted to other individuals or entities
types, which include, but are not limited to, nurse practitioners, physical
therapists, ambulatory surgery centers nursing homes, comprehensive outpatient
rehabilitation facilities, out patient dialysis facilities, and independent
diagnostic testing facilities. For each of these provider types there is
statutory authorization and accompanying regulations that govern the terms and
conditions of Medicare program participation.
If there were any material change in the availability of Medicare coverage
or the reimbursement level for treatment procedures using the EECP system is
determined to be inadequate, it would adversely affect our business, financial
condition and results of operations. Moreover, we are unable to forecast what
additional legislation or regulation, if any, relating to the health care
industry or Medicare coverage and payment level may be enacted in the future or
what effect such legislation or regulation would have on us.
Reducing the Limitations in Medicare Coverage for Angina
We have initiated discussions with CMS to broaden the national coverage
policy for the EECP treatment to include all classes of stable angina and
eliminate the language from current policy that limits coverage to those
patients who are not readily amenable to surgical interventions, such as balloon
angioplasty and cardiac bypass. Although the scientific evidence proving the
safety, efficacy and cost effectiveness of the EECP treatment has continued to
accumulate since the original coverage policy was implemented, additional
clinical and scientific evidence may be required by CMS to support expanded
coverage and we are unable to predict when or if we will be able to reduce the
current limitations for Medicare coverage in angina. We do not anticipate any
changes to the coverage language in fiscal 2005.
Obtaining Medicare Coverage for Congestive Heart Failure
In June 2002, we announced that all three of our models of the EECP system
had been granted a 510(k) market clearance from the FDA for a new indication for
the treatment of congestive heart failure. We intend to apply to CMS for a
national coverage policy for EECP therapy specific to CHF when we have completed
and analyzed the results of the ongoing PEECH trial, a randomized, controlled
clinical study on the use of EECP in CHF patients.
We expect to be able to submit the results of the PEECH trial to CMS and
release the results of the trial by early 2005. We anticipate a coverage
decision in late 2005 or early 2006; however, there can be no assurance that the
11
results of the PEECH trial will be sufficient to support expansion of the
Medicare national coverage policy for the EECP treatment. If we were unable to
obtain an adequate national Medicare coverage policy for treatment procedures
using the EECP system in CHF, it would adversely affect our future business
prospects. Moreover, we are unable to forecast what additional legislation or
regulation, if any, relating to the health care industry or Medicare coverage
and payment level may be enacted in the future or what effect such legislation
or regulation would have us.
Expanding Coverage with Other Third-Party Payers
Some private insurance carriers continue to adjudicate EECP treatment
claims on a case-by-case basis. Since the establishment of reimbursement by the
federal government, however, an increasing number of these private carriers now
routinely pay for use of EECP therapy for the treatment of angina and have
issued positive coverage policies, which are generally similar to Medicare's
coverage policy in scope. We estimate that over 300 private insurers are
reimbursing for the EECP therapy for the treatment of angina today at favorable
payment levels and we expect that the number of private insurers and their
related health plans that provide for EECP therapy as a covered benefit will
continue to increase. In addition, we are aware of two third-party payers that
have begun limited coverage of the EECP therapy for the treatment of CHF.
We intend to pursue a constructive dialogue with many private insurers for
the establishment of positive and expanded coverage policies for EECP treatments
that include CHF patients. If there were any material change in the availability
of third-party private insurers or the adequacy of the reimbursement level for
treatment procedures using the EECP system it would adversely affect our
business, financial condition and results of operations. Moreover, we are unable
to forecast what additional legislation or regulation, if any, relating to the
health care industry or third-party private insurers coverage and payment levels
may be enacted in the future or what effect such legislation or regulation would
have on us.
Reimbursement in International Markets
The reimbursement environment for EECP therapy in international markets is
fragmented and coverage varies as a mix of available private and public
healthcare providers may not yet be aware of nor cover this therapy. Our
reimbursement strategy has been opportunistic and responsive to the selling
opportunities presented through our distribution partners. During this fiscal
year our efforts on behalf of EECP therapy in both the private and public
healthcare sectors of selected international markets have been initiated by our
distributors, in support of the therapy, in their designated territory. The
results in fiscal 2004 included limited coverage for EECP therapy by major
private health insurance companies in England, Spain, Saudi Arabia, India and
Venezuela. Additionally, efforts have been initiated to obtain coverage in the
public sector, in Canada, England, Ireland, Israel, Italy, Malaysia, Thailand
and Sweden; however, we do not anticipate an impact on financial performance in
the next fiscal year, given the long lead times from submission to approval of
international dossiers for each reimbursement authority.
Patents and Trademarks
We own seven US patents that expire at various times between 2006 and 2021.
In addition, more than 20 foreign patents have been issued that expire at
various times from 2007 to 2022. There are four major U.S. applications pending
for approval, relating to aspects of the TS3 system, potential improvements, and
new methods of treatment. We are pursuing these applications in other countries,
including members of the European Union. We are also planning to file other
patent applications regarding specific enhancements to the current EECP models,
future generation products, and methods of treatment. Moreover, trademarks have
been registered for the names "EECP" and "Natural Bypass", as well as for its
widely-recognized man-like figure representing the application of EECP therapy.
We pursue a policy of seeking patent protection, both in the US and abroad,
for our proprietary technology. There can be no assurance that our patents will
not be violated or that any issued patents will provide protection that has
commercial significance. As with any patented technology, litigation could be
necessary to protect our patent position. Such litigation can be costly and
time-consuming, and there can be no assurance that we will be successful. The
loss or violation of our EECP patents and trademarks could have a material
adverse effect upon our business.
12
Employees
As of August 1, 2004, we employed 94 full-time and 2 part-time persons with
27 in direct sales and sales support, 7 in clinical applications, 29 in
manufacturing, quality control and technical service, 7 in marketing and
customer support, 14 in engineering, regulatory and clinical research and 12 in
administration. None of our employees are represented by a labor union. We
believe that our employee relations are good.
In March 2004 the then current Chief Executive Officer (CEO) of the Company
resigned from the Company and Photios T. Paulson, who served as CEO of the
Company from October 2002 to June 2003, accepted the position as acting CEO. The
Company has engaged a search firm to retain a new CEO. The search is currently
ongoing.
Manufacturing
We manufacture our EECP therapy systems in a single facility located in
Westbury, New York. Manufacturing operations are conducted under the FDA Quality
System Regulations. These regulations subject us to inspections to verify
compliance and require us to maintain documentation and controls for the
manufacturing and quality activities. ISO 13485 is the international quality
standard for medical device manufacturers, based upon the ISO 9001 quality
standard with specific requirements consistent with the FDA Quality System
Regulation. We received ISO 13485 certification in February 2003.
We believe our manufacturing facility, in addition to the other warehouse
facilities presently under lease, are adequate to meet the current and
immediately foreseeable future demand for the production of these systems.
RISK FACTORS
Investing in our common stock involves risk. You should carefully consider
the following information about these risks together with the other information
contained in this Report. If any of the following risks actually occur, our
business could be harmed. This could cause the price of our stock to decline,
and you may lose part or all of your investment.
Risks Related to Our Business
Material changes in the availability of Medicare, Medicaid or
third-party reimbursement at adequate price levels could adversely affect
our business.
Health care providers, such as hospitals and physician private practices,
that purchase or lease medical devices such as the EECP system for use on their
patients generally rely on third-party payers, principally Medicare, Medicaid
and private health insurance plans, to reimburse all or part of the costs and
fees associated with the procedures performed with these devices. If there were
any material change in the availability of Medicare, Medicaid or other
third-party coverage or the adequacy of the reimbursement level for treatment
procedures using the EECP system, it would adversely affect our business,
financial condition and results of operations. Moreover, we are unable to
forecast what additional legislation or regulation, if any, relating to the
health care industry or Medicare or Medicaid coverage and payment level may be
enacted in the future or what effect such legislation or regulation would have
on our business. Even if a device has FDA clearance, Medicare, Medicaid and
other third-party payers may deny reimbursement if they conclude that the device
is not cost- effective, is experimental or is used for an unapproved indication.
In addition, reimbursement may not be at or remain at price levels adequate to
allow medical professionals to realize an appropriate return on the purchase of
our products.
We may not continue to receive necessary FDA clearances or approvals,
which could hinder our ability to market and sell our products.
If we modify our external counterpulsation devices and the modifications
significantly affect safety or effectiveness, or if we make a change to the
intended use, we will be required to submit a new premarket notification or
510(k) to FDA. We would be unable to market the modified device until FDA issues
a clearance for the 510(k).
Additionally, if FDA publishes a regulation requiring a premarket approval
application or PMA for external counterpulsation devices, we would then need to
submit a PMA, and have it filed by the agency, by the date specified by FDA in
its regulation. A PMA requires us to prove the safety and effectiveness of a
13
device to the FDA. The process of obtaining PMA approval is expensive,
time-consuming, and uncertain. If FDA were to require a PMA application, we
likely would be required to undertake a clinical study, which likely will be
expensive and require lengthy follow-up, to demonstrate the effectiveness of the
device. If we did obtain PMA approval, any change after approval affecting the
safety or effectiveness of the device will require approval of a PMA supplement.
If we offer new products that require 510(k) clearance or PMA approval, we
will not be able to commercially distribute those products until we receive such
clearance or approval. Regulatory agency approval or clearance for a product may
not be received or may entail limitations on the device's indications for use
that could limit the potential market for any such product. Delays in receipt
of, or failure to obtain or maintain, regulatory clearances and approvals, could
delay or prevent our ability to market or distribute our products. Such delays
could have a material adverse effect on our business.
If we are unable to comply with applicable governmental regulation, we
may not be able to continue our operations.
We also must comply with current Good Manufacturing Practices (GMP)
requirements as set forth in the Quality System Regulation or QSR to receive FDA
approval to market new products and to continue to market current products. The
QSR imposes certain procedural and documentation requirements on us with respect
to manufacturing and quality assurance activities, including packaging, storage,
and recordkeeping. Our products and activities are subject to extensive, ongoing
regulation, including regulation of labeling and promotion activities and
adverse event reporting. Also, our FDA registered facilities are subject to
inspection by the FDA and other governmental authorities. Any failure to comply
with regulatory requirements could delay or prevent our ability to market or
distribute our products. Violation of FDA statutory or regulatory requirements
could result in enforcement actions, such as voluntary or mandatory recalls,
suspension or withdrawal of marketing clearances or approvals, seizures,
injunctions, fines, civil penalties, and criminal prosecutions, all of which
could have a material adverse effect on our business. Most states also have
similar postmarket regulatory and enforcement authority for devices.
We cannot predict the nature of any future laws, regulations,
interpretations, or applications, nor can we predict what effect additional
governmental regulations or administrative orders, when and if promulgated,
would have on our business in the future. We may be slow to adapt, or we may
never adapt to changes in existing requirements or adoption of new requirements
or policies. We may incur significant costs to comply with laws and regulations
in the future or compliance with laws or regulations may create an unsustainable
burden on our business.
We may be dependent on the outcome of certain clinical trials to
obtain broader reimbursement coverage and to achieve substantial future
growth.
We are currently dependent on a single product platform which, based on
current medical reimbursement policies, provides coverage for a restricted class
of heart patients. While we have been engaged in discussions with the Centers
for Medicare and Medicaid Services to expand the class of heart patients for
medical coverage, we are uncertain as to the outcome of these meetings. We also
have been engaged in certain clinical trials for the purpose of expanding this
coverage, most notable being our PEECH trial. We expect that the PEECH trial,
which has been evaluating the effectiveness of EECP therapy for congestive heart
failure patients, will be concluded at the end of 2004 and it is anticipated
that the results will be available in early 2005. Favorable results from the
PEECH trial, whose protocol has been designed in cooperation with the FDA, could
substantially expand the number of patients available for medical reimbursement.
Successful clinical trials are important for substantial future revenue growth.
Increased acceptance by the medical community is important for
continued growth.
While many abstracts and publications are presented each year at major
scientific meetings worldwide with respect to EECP treatment efficacy, there is
continued skepticism concerning EECP therapy methodology. Certain cardiologists,
in cases where the EECP therapy is a viable alternative, still appear to prefer
percutaneous coronary interventions (e.g. balloon angioplasty and stenting) and
cardiac bypass surgery for their patients. We are dependent on consistency of
favorable research findings about the EECP therapy and increasing acceptance of
the EECP therapy as a safe, effective and cost effective alternative to other
available products by the medical community for continued growth.
14
We face competition from other companies and technologies.
We compete with at least two other companies that are marketing external
counterpulsation devices. We do not know whether these companies or other
potential competitors who may be developing external counterpulsation devices,
may succeed in developing technologies or products that are more efficient than
those offered by us, and that would render our technology and existing products
obsolete or non-competitive. Potential new competitors may also have
substantially greater financial manufacturing and marketing resources than those
possessed by us. In addition, other technologies or products may be developed
that have an entirely different approach or means of accomplishing the intended
purpose of our products. Accordingly, the life cycles of our products are
difficult to estimate. To compete successfully, we must keep pace with
technological advancements, respond to evolving consumer requirements and
achieve market acceptance.
We may not receive approvals by foreign regulators that are necessary
for international sales.
Sales of medical devices outside the United States are subject to foreign
regulatory requirements that vary from country to country. Premarket approval or
clearance in the United States does not ensure regulatory approval by other
jurisdictions. If we, or any international distributor, fail to obtain or
maintain required pre-market approvals or fail to comply with foreign
regulations, foreign regulatory authorities may require us to file revised
governmental notifications, cease commercial sales of our products in the
applicable countries or otherwise cure the problem. Such enforcement action by
regulatory authorities may be costly.
In order to sell our products within the European Union, we must comply
with the European Union's Medical Device Directive. The CE marking on our
products attests to this compliance. Future regulatory changes may limit our
ability to use the CE mark, and any new products we develop may not qualify for
the CE mark. If we lose this authorization or fail to obtain authorization on
future products, we will not be able to sell our products in the European Union.
We may not be able to manage growth.
If our short and long-term plans are successful, including our clinical
trials, we will experience a period of growth that could place a significant
strain upon our managerial, financial and operational resources. Our
infrastructure, procedures, controls and information systems may not be adequate
to support our operations and to achieve the rapid execution necessary to
successfully market our products. Our future operating results will also depend
on our ability to successfully upgrade our information systems, expand our
direct sales force and our internal sales, marketing and support staff. If we
are unable to manage future expansion effectively, our business, results of
operations and financial condition will suffer, our senior management will be
less effective, and our revenues and product development efforts may decrease.
We depend on management and other key personnel.
We are dependent on a limited number of key management and technical
personnel. The loss of one or more of our key employees may hurt our business if
we are unable to identify other individuals to provide us with similar services.
We do not maintain "key person" insurance on any of our employees. In addition,
our success depends upon our ability to attract and retain additional highly
qualified sales, management, manufacturing and research and development
personnel. We face competition in our recruiting activities and may not be able
to attract or retain qualified personnel.
We may not have adequate intellectual property protection.
Our patents and proprietary technology may not be able to prevent
competition by others. The validity and breadth of claims in medical technology
patents involve complex legal and factual questions. Future patent applications
may not be issued, the scope of any patent protection may not exclude
competitors, and our patents may not provide competitive advantages to us. Our
patents may be found to be invalid and other companies may claim rights in or
ownership of the patents and other proprietary rights held or licensed by us.
Also, our existing patents may not cover products that we develop in the future.
Moreover, when our patents expire, the inventions will enter the public domain.
There can be no assurance that our patents will not be violated or that any
issued patents will provide protection that has commercial significance.
Litigation may be necessary to protect our patent position. Such litigation may
be costly and time-consuming, and there can be no assurance that we will be
successful in such litigation.
15
The loss or violation of certain of our patents and trademarks could
have a material adverse effect upon our business.
Since patent applications in the United States are maintained in secrecy
until patents are issued, our patent applications may infringe patents that may
be issued to others. If our products were found to infringe patents held by
competitors, we may have to modify our products to avoid infringement, and it is
possible that our modified products would not be commercially successful.
We do not intend to pay dividends in the foreseeable future.
We do not intend to pay any cash dividends on our common stock in the
foreseeable future.
Risks Related to Our Industry
Technological change is difficult to predict and to manage.
We face the challenges that are typically faced by companies in the medical
device field. Our product line has required, and any future products will
require, substantial development efforts and compliance with governmental
clearance or approval requirements. We may encounter unforeseen technological or
scientific problems that force abandonment or substantial change in the
development of a specific product or process.
We are subject to product liability claims and product recalls that
may not be covered by insurance.
The nature of our business exposes us to risks of product liability claims
and product recalls. Medical devices as complex as ours frequently experience
errors or failures, especially when first introduced or when new versions are
released.
We currently maintain product liability insurance at $2,000,000 per
occurrence and $5,000,000 in the aggregate. Our product liability insurance may
not be adequate. In the future, insurance coverage may not be available on
commercially reasonable terms, or at all. In addition, product liability claims
or product recalls could damage our reputation even if we have adequate
insurance coverage.
We do not know the effects of healthcare reform proposals.
The healthcare industry is undergoing fundamental changes resulting from
political economic and regulatory influences. In the United States,
comprehensive programs have been suggested seeking to increase access to
healthcare for the uninsured, control the escalation of healthcare expenditures
within the economy and use healthcare reimbursement policies to balance the
federal budget.
We expect that the United States Congress and state legislatures will
continue to review and assess various healthcare reform proposals, and public
debate of these issues will likely continue. There have been, and we expect that
there will continue to be, a number of federal and state proposals to constrain
expenditures for medical products and services, which may affect payments for
products such as ours. We cannot predict which, if any of such reform proposals
will be adopted and when they might be effective, or the effect these proposals
may have on our business. Other countries also are considering health reform.
Significant changes in healthcare systems could have a substantial impact on the
manner in which we conduct our business and could require us to revise our
strategies.
Risks Related to Stock Exchange and SEC Regulation
We are subject to stock exchange and SEC regulation.
Recent Sarbanes-Oxley legislation and stock exchange regulations have
increased disclosure control, financial reporting, corporate governance and
internal control requirements that will increase the administrative costs of
documenting and auditing internal processes, gathering data, and reporting
information. Our inability to comply with the requirements would significantly
impact our market valuation.
16
Our common stock is subject to price volatility.
The market price of our common stock has been and is likely to continue to
be highly volatile. Our stock price could be subject to wide fluctuations in
response to various factors beyond our control, including:
-- quarterly variations in operating results;
-- announcements of technological innovations, new products or pricing by
our competitors;
-- the rate of adoption by physicians of our technology and products in
targeted markets;
-- the timing of patent and regulatory approvals;
-- the timing and extent of technological advancements;
-- results of clinical studies;
-- the sales of our common stock by affiliates or other shareholders with
large holdings; and
-- general market conditions.
Our future operating results may fall below the expectations of securities
industry analysts or investors. Any such shortfall could result in a significant
decline in the market price of our common stock. In addition, the stock market
has experienced significant price and volume fluctuations that have affected the
market price of the stock of many medical device companies and that often have
been unrelated to the operating performance of such companies. These broad
market fluctuations may directly influence the market price of our common stock.
A low stock price could result in our being de-listed from the Nasdaq
and subject us to regulations that could reduce our ability to raise funds.
If our stock price, which currently is below $1.00 per share remains below
$1.00 per share for an extended period of time, or if we fail to maintain other
Nasdaq criteria, Nasdaq may de-list our common stock from the Nasdaq SmallCap
Market. In such an event, our shares could only be traded on over-the-counter
bulletin board system. This method of trading could significantly impair our
ability to raise new capital.
In the event that our common stock was de-listed from the Nasdaq SmallCap
Market due to low stock price, we may become subject to special rules, called
penny stock rules that impose additional sales practice requirements on
broker-dealers who sell our common stock. The rules require, among other things,
the delivery, prior to the transaction, of a disclosure schedule required by the
Securities and Exchange Commission relating to the market for penny stocks. The
broker-dealer also must disclose the commissions payable both to the broker-
dealer and the registered representative and current quotations for the
securities, and monthly statements must be sent disclosing recent price
information.
In the event that our common stock becomes characterized as a penny stock,
our market liquidity could be severely affected. The regulations relating to
penny stocks could limit the ability of broker-dealers to sell our common stock
and thus the ability of purchasers of our common stock to sell their common
stock in the secondary market.
Recent corporate scandals involving alleged accounting irregularities
have resulted in unavailability of, or significantly higher premiums for,
director and officer liability insurance.
As a result of recent well-publicized corporate business failures alleged
to have involved improper acts by executives and accounting irregularities,
director and officer liability insurance has become more difficult to obtain and
the premiums for such insurance have increased significantly. If we are unable
to obtain director and officer liability insurance at rates that are reasonable
or at all, we may not be able to retain our current officers and directors or
attract qualified directors and officers in the future.
Additional Information
We are subject to the reporting requirements under the Securities Exchange
Act of 1934 and are required to file reports and information with the Securities
and Exchange Commission (SEC), including reports on the following forms: annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and amendments to those reports files or furnished pursuant to Section
13(a) or 15(d) of the Securities Act of 1934.
17
ITEM 2 - PROPERTIES
We own our 18,000 square foot headquarters and manufacturing facility at
180 Linden Avenue, Westbury, New York 11590. We lease approximately 7,100 square
feet of additional warehouse space under two operating leases with
non-affiliated landlords, of which one expires in October 2004 and the other in
September 2006, plus additional parking locations in the area at an annual cost
of approximately $92,000. We believe that we can renegotiate the lease that will
expire in October 2004 or lease other available space under reasonable terms and
that these combined facilities are adequate to meet our current needs and should
continue to be adequate for the immediately foreseeable future.
ITEM 3 - LEGAL PROCEEDINGS
There were no material legal proceedings under applicable rules.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of the fiscal year.
18
PART II
ITEM 5 - MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our Common Stock trades on the Nasdaq SmallCap Market tier of The Nasdaq
Stock MarketSM under the symbol VASO. The number of record holders of Common
Stock as of August 1, 2004 was approximately 1,100, which does not include
approximately 27,600 beneficial owners of shares held in the name of brokers or
other nominees. The table below sets forth the range of high and low trade
prices of the Common Stock as reported by the Nasdaq SmallCap Market tier of The
Nasdaq Stock MarketSM for the fiscal periods specified.
Fiscal 2004 Fiscal 2003
High Low High Low
First Quarter $1.55 $0.84 $3.00 $1.25
Second Quarter $1.59 $0.86 $1.85 $0.52
Third Quarter $2.34 $1.00 $1.20 $0.70
Fourth Quarter $1.94 $1.10 $1.60 $0.63
The last bid price of the Company's Common Stock on August 10, 2004, was
$0.88 per share.
Dividend Policy
We have never paid any cash dividends on our Common Stock. While we do not
intend to pay cash dividends in the foreseeable future, payment of cash
dividends, if any, will be dependent upon our earnings and financial position,
investment opportunities and such other factors as the Board of Directors deems
pertinent. Stock dividends, if any, also will be dependent on such factors as
the Board of Directors deems pertinent.
19
ITEM 6 - SELECTED FINANCIAL DATA
The following table summarizes selected financial data for each of the five
years ended May 31 as derived from our audited consolidated financial
statements. These data should be read in conjunction with our consolidated
financial statements, related notes and other financial information.
Fiscal Year Ended May 31,
2004 2003 2002 2001 2000
Statements of Earnings
Revenues $22,207,037 $24,823,619 $34,830,471 $27,508,338 $13,673,632
Cost of sales and services 7,590,103 9,251,221 10,538,731 7,910,359 3,277,700
-------------- -------------- --------------- -------------- ---------------
Gross profit 14,616,934 15,572,398 24,291,740 19,597,979 10,395,932
Selling, general & administrative expenses 12,910,997 13,714,913 13,686,958 11,634,965 7,383,567
Research and development expenses 3,748,389 4,544,822 5,112,258 2,554,470 1,413,464
Provision for doubtful accounts 1,296,759 3,728,484 1,304,000 325,000 400,000
Interest and financing costs 132,062 186,574 98,140 48,294 7,302
Interest and other income, net (99,393) (176,724) (249,722) (201,992) (99,317)
-------------- -------------- --------------- -------------- ---------------
17,988,814 21,998,069 19,951,634 14,360,737 9,105,016
-------------- -------------- --------------- -------------- ---------------
Earnings (loss) before income taxes (3,371,880) (6,425,671) 4,340,106 5,237,242 1,290,916
Income tax (expense) benefit, net (50,640) 1,634,688 (1,554,000) 6,457,108 400,000
-------------- -------------- --------------- -------------- ---------------
Net earnings (loss) (3,422,520) (4,790,983) 2,786,106 11,694,350 1,690,916
Preferred stock dividend requirement -- -- -- -- (94,122)
-------------- -------------- --------------- -------------- ---------------
Net earnings (loss) applicable to
common stockholders $(3,422,520) $(4,790,983) $2,786,106 $11,694,350 $1,596,794
============== ============== =============== ============== ===============
Net earnings (loss) per common share
- basic $(0.06) $(0.08) $0.05 $0.21 $0.03
============== ============== =============== ============== ===============
- diluted $(0.06) $(0.08) $0.05 $0.20 $0.03
============== ============== =============== ============== ===============
Weighted average common shares
outstanding - basic 57,981,963 57,647,032 57,251,035 56,571,402 52,580,623
============== ============== =============== ============== ===============
- diluted 57,981,963 57,647,032 59,468,092 59,927,199 57,141,949
============== ============== =============== ============== ===============
Balance Sheet Data
Cash, cash equivalents and certificates
of deposit $7,545,589 $5,222,847 $2,967,627 $3,785,456 $3,058,367
Working capital $9,771,870 $11,478,092 $17,225,434 $16,214,655 $7,380,236
Total assets $33,023,615 $35,327,550 $41,418,258 $36,518,974 $10,588,962
Long-term debt $1,092,837 $1,177,804 $1,072,716 $1,108,593 $--
Stockholders' equity (1) $24,594,169 $27,319,302 $31,602,604 $28,508,729 $7,943,770
___________________
(1) No cash dividends on common stock were declared during any of the above periods.
20
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains descriptions of our expectations regarding future
trends affecting our business. These forward looking statements and other
forward-looking statements made elsewhere in this document are made under the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Please read the section titled "Risk Factors" in" Item One Business" to review
certain conditions, among others, which we believe could cause results to differ
materially from those contemplated by the forward-looking statements.
Forward-looking statements are identified by words such as "anticipates",
"believes", "estimates", "expects", "feels", "plans", "projects" and "intends"
and similar expressions. In addition, any statements that refer to our plans,
expectations, strategies or other characterizations of future events or
circumstances are forward-looking statements. Such forward-looking statements
are based on our beliefs, as well as assumptions made by and information
currently available to us. Among the factors that could cause actual results to
differ materially are the following: the effect of the dramatic changes taking
place in the healthcare environment; the impact of competitive procedures and
products and their pricing; medical insurance reimbursement policies; unexpected
manufacturing problems; unforeseen difficulties and delays in the conduct of
clinical trials and other product development programs; the actions of
regulatory authorities and third-party payers in the United States and overseas;
uncertainties about the acceptance of a novel therapeutic modality by the
medical community; and the risk factors reported from time to time in our SEC
reports. We undertake no obligation to update forward- looking statements as a
result of future events or developments.
The following discussion should be read in conjunction with financial
statements and notes thereto included in this Annual Report on Form 10-K.
Overview
Vasomedical, Inc. incorporated in Delaware in July 1987 is primarily
engaged in designing, manufacturing, marketing and supporting EECP external
counterpulsation systems based on our proprietary technology. EECP therapy is a
non-invasive, outpatient therapy for the treatment of diseases of the
cardiovascular system. The therapy serves to increase circulation in areas of
the heart with less than adequate blood supply and may restore systemic vascular
function. We provide hospitals and physician 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.
We have Food and Drug Administration (FDA) approval to market the EECP
therapy for use in the treatment of angina pectoris (i.e., chest pain),
cardiogenic shock, acute myocardial infarction (i.e., heart attack, (MI)) and
congestive heart failure (CHF), however our current marketing efforts are
limited to the treatment of refractory angina, where reimbursement for the EECP
treatment is available. Medicare and numerous other commercial third-party
payers currently provide reimbursement for the treatment of refractory angina
using the EECP therapy.
We are also actively engaged in research to establish the potential
benefits of EECP therapy in the management of CHF and are sponsoring a pivotal
study to demonstrate the efficacy of EECP therapy in most types of heart failure
patients. This study, known as PEECH (Prospective Evaluation of EECP in
Congestive Heart Failure), is intended to provide additional clinical data in
order to support a Medicare national coverage policy for the use of the EECP
therapy in the treatment of CHF. We expect to be able to release the results of
the PEECH trial by early 2005.
Results of Operations
Fiscal Years Ended May 31, 2004 and 2003
Summary
We generated revenues from the sale, lease and service of our EECP systems
of $22,207,037 and $24,823,619 for the years ended May 31, 2004 and 2003,
respectively, reflecting a decrease of $2,616,582 or 11%. Our loss before income
taxes was $3,371,880 and $6,425,671 for the years ended May 31, 2004 and 2003,
respectively. We reported a net loss of $3,422,520 and $4,790,983 for the years
ended May 31, 2004 and 2003, respectively.
21
Revenues
The decline in revenues in fiscal year 2004 compared to fiscal year 2003 is
due primarily to lower revenue from the sale of EECP systems in the domestic
market. Domestic equipment revenue for fiscal 2004 declined approximately 15%
compared to prior year due to: a reduction in the average sales price for EECP
systems of approximately 12%; a higher proportion of used equipment compared to
new equipment sold during fiscal year 2004 compared to 2003, plus adoption of
the provisions of EITF 00-21. Average domestic selling prices have been
declining for several years reflecting the impact in the market of lower priced
competitive products. We believe that the EECP systems currently sell at a
significant price premium to competitive products reflecting the clinical
efficacy and superior quality of the EECP system plus the many value added
services offered by us, however we anticipate that this current trend of
declining prices will continue in the immediate future as our competition
attempts to capture greater market share through pricing discounts. Revenue in
fiscal year 2004 reflects a 115% increase in the sale of used equipment to the
domestic market. This increase in used equipment sales reflects primarily an
increase in used equipment available for sale following the completion of the
PEECH trial and the repossession of EECP systems from previous sales-type lease
customers. We sell used equipment as available to help lessen the impact of
price sensitive situations. In September 2003, we adopted "Revenue Arrangements
with Multiple Deliverables", ("EITF 00-21"). During the nine months following
adoption of the provisions of EITF 00- 21, as a result of the adoption of the
new policy, we deferred $92,500 of revenue related to the fair value of
installation and in-service training and $658,333 of revenue related to the
warranty service for EECP system sales, which would have previously been
recognized as revenue during the period. International shipments of EECP systems
declined approximately 24% to $850,333 due to a higher sales rate in the
previous year following receipt of the CE Mark. This was partially offset by a
47% increase in revenue from equipment rental and services reflecting 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. Rental revenue
declined approximately 27% during the period reflecting fewer outstanding rental
agreements and lower average rental prices.
Reimbursement continues to play a critical role in the adoption of the EECP
therapy. Medicare dropped the payment rates 34% from $208 per hour to $137 per
hour for physicians at the beginning of calendar year 2004. The current
reimbursement rate is now set at the rates near when the product first received
Medicare coverage in 2000, which makes it more difficult for a private physician
practice to financially justify an investment to provide the EECP therapy. It is
difficult for us to determine the exact impact this decline has had on the
market for the EECP therapy. Additionally, the impact from the drop in
reimbursement has been partially offset by the decline in average selling prices
and we believe that the EECP therapy continues to offer an attractive addition
to the physician private practice, plus the company has continued to support its
customers in gaining positive reimbursement coverage from other third-party
payers during the past year. EECP therapy is now covered by the majority of
private insurers for treating angina patients, including many of the leading
Blue Cross Blue Shield plans, who typically are the most difficult payers to
adopt coverage for new technologies.
Gross Profit
Gross profit was $14,616,934 or 66% of revenues for the year ended May 31,
2004, compared to $15,572,398 or 63% of revenues for the year ended May 31,
2003. Gross profit margin as a percentage of revenue for the twelve-month period
ended May 31, 2004, improved compared to the same year 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
year ended May 31, 2004, when compared to same period of the prior year. In
addition, the gross profit margin benefited from the sale of an unusually high
percentage of used equipment when compared to the prior year. These systems
carried lower book values since they were partially amortized and as a result
generated above average margins. We have limited quantities of the lower cost
systems and do not anticipate a significant volume of used equipment will be
sold in the future. The decline in gross profit when compared to the prior year
in absolute dollars is a direct result of the lower sales volume.
Gross profits are dependent on a number of factors, particularly the mix of
EECP models sold and their respective average selling prices, the mix of EECP
units sold, rented or placed during the period, the ongoing costs of servicing
22
such units, and certain fixed period costs, including facilities, payroll and
insurance. Gross profit margins are generally less on non-domestic business due
to the use of distributors resulting in lower selling prices. Consequently, the
gross profit realized during the current period may not be indicative of future
margins.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses for the year ended
May 31, 2004 and 2003 were $12,910,997 or 58% of revenues as compared to
$13,714,913 or 55% of revenues, respectively. The decrease of SG&A 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 marketing expenditures, primarily for
outside services and promotional spending for print and electronic media during
fiscal year 2004, as compared to fiscal year 2003. The above decreases were
partially offset by higher administrative and selling expenses, which reflected
increased insurance costs and continued investment in our direct sales force,
consisting of additional personnel and higher incentive and travel costs.
Research and Development
Research and development ("R&D") expenses of $3,748,389 or 17% of revenues
for fiscal year 2004, decreased by $796,433, or 18%, from fiscal year 2003
expenses of $4,544,822, or 18% of revenues. The decrease is due primarily to
reduced clinical study expenditures related to the completion of several smaller
clinical studies and, at several sites, the patient treatment phase of the PEECH
study. This decrease was partially offset by increased product development costs
related to new EECP system models and improvements.
We expect to continue our investments in product development and clinical
trials in fiscal 2005 and beyond to further validate and expand the clinical
applications of the EECP therapy.
Provision for Doubtful Accounts
During the year ended May 31, 2004, we charged $1,296,759 to our provision
for doubtful accounts as compared to $3,728,484 during the year ended May 31,
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. We sold our EECP systems to a major customer engaged in establishing
independent networks of EECP treatment 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 us totaling $70,000. In December 2003, the
customer ceased operations. Additional provisions for all other accounts totals
approximately $616,759. In fiscal 2003, these charges primarily resulted from
approximately a $3.0 million write-off of receivables with respect to another
major customer, comprised of $2.5 million for the capital lease and $500,000 in
notes receivable, as well as specific reserves against certain international
accounts for which extended credit terms were offered. We no longer offer
sales-type leases.
Interest Expense and Financing Costs
Interest expense and financing costs decreased to $132,062 in the year
ended May 31, 2004, from $186,574 for the same period in the prior year due to
repayment of our revolving secured credit facility in May 2003, which resulted
in lower average outstanding borrowings during the fiscal year.
Interest and Other Income, Net
Interest income and other income for the years ended May 31, 2004, and May
31 2003, was $99,393 and $176,724, respectively. The decrease in interest income
from the prior year is the direct result of the absence of interest income
related to certain equipment sold under sales-type leases incurred in fiscal
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 year
ended May 31, 2004, compared to the prior period partially offset the above.
Income Tax (Expense) Benefit, Net
During the fiscal year ended May 31, 2004, we recorded a provision for
state income taxes of $50,640. This is in contrast to an income tax benefit of
$1,634,688 reported during the fiscal year ended May 31, 2003.
As of May 31, 2004, we had recorded deferred tax assets of $14,582,000 net
of a $1,908,000 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
23
is dependent upon our generating sufficient taxable income prior to the
expiration of the tax loss carryforwards. We believe that the Company is
positioned for long-term growth despite the financial results achieved during
fiscal years 2004 and 2003, and that based upon the weight of available
evidence, that it is "more likely than not" that net deferred tax assets will be
realized. The "more likely than not" standard is subjective, and is based upon
management's estimate of a greater than 50% probability that its long range
business plan can be realized.
Ultimate realization of any or all of the deferred tax assets is not
assured, due to significant uncertainties associated with estimates of future
taxable income during the carryforward period. Our estimates are largely
dependent upon achieving considerable growth resulting from the successful
commercialization of the EECP therapy into the congestive heart failure
indication. Such future estimates of future taxable income are based on our
beliefs, as well as assumptions made by and information currently available to
us. Certain critical assumptions associated with our estimates include:
-- that the results from the PEECH clinical trial will be sufficiently
positive to enable the EECP therapy to obtain approval for a national
Medicare reimbursement coverage policy plus other third-party payer
reimbursement policies specific to the congestive heart failure
indication;
-- that the reimbursement coverage will be both broad enough in terms of
coverage language and at an amount adequate to enable successful
commercialization of the EECP therapy into the congestive heart
failure indication.
Additional 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;
-- other medical insurance reimbursement policies;
-- unexpected manufacturing problems;
-- unforeseen difficulties and delays in the conduct of clinical trials
and other product development programs;
-- the actions of regulatory authorities and third-party payers in the
United States and overseas;
-- uncertainties about the acceptance of a novel therapeutic modality by
the medical community;
-- and the risk factors reported from time to time in our SEC reports.
The amount of the deferred tax assets considered realizable could be
reduced in the future if estimates of future taxable income during the
carryforward period are reduced or if the accounting standards are changed to
reflect a more stringent standard for evaluation of deferred tax assets.
The recorded deferred tax asset and increase to the valuation allowance
during the fiscal year ended May 31, 2004 was $1,286,000.
Fiscal Years Ended May 31, 2003 and 2002
Summary
We generated revenues from the sale, lease and service of EECP systems of
$24,824,000 and $34,830,000 for fiscal 2003 and fiscal 2002, respectively,
representing a 29% decrease. We generated earnings (loss) before income taxes of
$(6,426,000) and $4,340,000 for fiscal 2003 and fiscal 2002, respectively. We
reported net earnings (loss) of $(4,791,000) and $2,786,000 for fiscal 2003 and
fiscal 2002, respectively, after recognition of an income tax provision
(benefit) of $(1,635,000) and $1,554,000, respectively.
Revenue
The decrease in revenues in fiscal 2003 as compared to fiscal 2002 is a
result of the following:
-- Revenues in fiscal 2002 were favorably impacted by $4,187,000
resulting from the shipment of EECP systems under sales-type leases
and there was no equipment sold under sales-type leases in fiscal
2003.
-- Revenues in fiscal 2003 were affected by several factors including, an
increase in the duration of the selling cycle of our EECP systems and
reduced average unit selling prices. Factors that have caused a longer
selling cycle for EECP systems include, among other things, (a) a
change in the mix of prospective customers toward larger medical
practices and hospitals which have longer decision-making processes;
(b) inconsistent or inadequate reimbursement coverage policies among
certain third-party insurers; and (c) general economic conditions.
Factors that have contributed to reduced average selling prices
include increased competition and general economic conditions. Fiscal
24
2003 revenues from equipment sales were adversely impacted by
reductions in average selling prices aggregating approximately
$5,100,000.
-- Revenues from non-domestic business were $1,122,000, accounting for
nearly 5% of total revenues compared to $2,725,000, or 8%, in fiscal
2002.
Our revenue growth over the previous fiscal year periods through 2002
resulted primarily from the increase in cardiology practices and hospitals who
became providers of EECP therapy following the announcement by the Centers for
Medicare and Medicaid Services (CMS) in February 1999 of its decision to extend
Medicare coverage nationally to the Company's noninvasive, outpatient treatment
for coronary artery disease. CMS is the federal agency that administers the
Medicare program for approximately 39 million beneficiaries. In addition, the
results of our multicenter, prospective, randomized, blinded, controlled
clinical study of EECP (MUST-EECP) were published in the June 1999 issue of the
Journal of the American College of Cardiology. Interest in EECP therapy was also
spurred by the announcement of the results of six-month, twelve-month and
twenty-four month post-treatment outcomes reported by the International EECP
Patient Registry, as well as numerous other studies reported and presented at
major scientific meetings, including the American Heart Association (AHA) and
the American College of Cardiology (ACC) annual meetings.
Gross Profit
Gross profit margins for fiscal 2003 and fiscal 2002 and were 63% and 70%,
respectively. The decrease in overall gross profit for fiscal 2003 compared to
2002 primarily resulted from increases in unit costs, due to lower production
levels, as well as overall reductions in the average selling price of EECP
systems.
Selling, General and Administrative
Selling, general and administrative (SG&A) expenses for fiscal 2003 and
fiscal 2002 were $13,715,000 (55% of revenues) and $13,687,000 (39% of
revenues), respectively. The increase in the percentage of SG&A expenses as a
percentage of sales was primarily due to the significant decrease in revenues
from the prior comparable periods, as discussed above. The increase in SG&A
expenses, on an absolute basis, from the comparable prior fiscal periods
resulted primarily from a $600,000 accrual arising from the settlement of
litigation in the first quarter, non-recurring charges of $420,000 for employee
severance arrangements and executive recruiting fees in the second quarter,
partially offset by overall decreases in sales related expenses due to decreased
revenues.
Research and Development
Research and development (R&D) expenses of $4,545,000 (18% of revenues) for
fiscal 2003 decreased by $567,000, or 11%, from fiscal 2002 R&D expenses of
$5,112,000 (15% of revenues). R&D expenses are primarily impacted by the PEECH
clinical trial in heart failure and other clinical initiatives (including the
International EECP Patient Registry), as well as continued product design and
development costs.
Provision for Doubtful Accounts
During fiscal 2003, we charged $3,728,000 (net of bad debt recoveries of
$494,000) to our provision for doubtful accounts as compared to $1,304,000 in
fiscal 2002. These charges primarily resulted from the write-off of receivables
from a major customer during the first quarter of fiscal 2003 of approximately
$3,000,000 due to significant uncertainties related to this customer's ability
to satisfy its financial obligations to the Company (see Note E of the
accompanying Consolidated Financial Statements), as well as specific reserves
against certain domestic and international accounts that defaulted on their
payment obligations. During the second quarter of fiscal 2003, we were able to
successfully recover all of the units that we had sold under sales-type leases
to the aforementioned major customer back into our finished goods inventory and
recorded a bad debt recovery of $479,408, which represented the carrying amount
of the equipment at that time.
Interest Expense and Financing Costs
The increase in interest expense over the prior periods is primarily due to
interest on working capital borrowings and related charges under our revolving
secured credit facility, as well as loans secured to refinance the November 2000
purchase of our headquarters and warehouse facility.
25
Interest and Other Income, Net
The decrease in interest income from the prior fiscal period is the direct
result of a decrease in interest income related to certain equipment sold under
sales-type leases to a major customer reported in fiscal 2002 and during the
first quarter of fiscal 2003, as well as declining interest rates this year over
last year, offset by the increase in the average cash balances invested during
the current year.
Income Tax (Expense) Benefit, Net
In fiscal 2003, we recorded a net benefit for income taxes of $1,635,000,
inclusive of a $622,000 valuation allowance on deferred tax assets.
Liquidity and Capital Resources
Cash and Cash Flow
We have financed our operations in fiscal 2004 and 2003 primarily from
operations and working capital. At May 31, 2004, we had a cash, cash
equivalents, and certificates of deposit balance of $7,545,589 and working
capital of $9,771,870 as compared to a cash balance of $5,222,847 and working
capital of $11,478,092 at May 31, 2003. Our cash, cash equivalents, and
certificates of deposit balances increased $2,332,742 in fiscal year 2004
primarily due to $1,836,260 in cash provided by operating activities.
The increase in cash provided by our operating activities resulted
primarily from lower accounts receivable, which provided cash of $1,923,284 for
the fiscal year ended May 31, 2004. Net accounts receivable were 93% of
quarterly revenues for the three-month period ended May 31, 2004, compared to
114% at the end of the three-month period ended May 31, 2003, and net accounts
receivable turnover improved to 3.4 times as of May 31, 2004, as compared to 2.5
times as of May 31, 2003. We have tightened our sales credit policy, reduced
extended payment terms and provide routine oversight with respect to our
accounts receivable credit and collection efforts.
Standard payment terms on our domestic equipment sales are generally net 30
to 90 days from shipment and do not contain "right of return" provisions. We
have historically offered a variety of extended payment terms, including
sales-type leases, in certain situations and to certain customers in order to
expand the market for our EECP products in the US and internationally. Such
extended payment terms were offered in lieu of price concessions, in competitive
situations, when opening new markets or geographies and for repeat customers.
Extended payment terms cover a variety of negotiated terms, including payment in
full - net 120, net 180 days or some fixed or variable monthly payment amount
for a six to twelve month period followed by a balloon payment, if applicable.
During the fiscal years ended May 31, 2004 and 2003, approximately 1% and 5% of
revenues, respectively, were generated from sales in which payment terms were
greater than 90 days and we offered no sales- type leases during either period.
In general, reserves are calculated on a formula basis considering factors such
as the aging of the receivables, time past due, and the customer's credit
history and their current financial status. In most instances where reserves are
required, or accounts are ultimately written-off, customers have been unable to
successfully implement their EECP program. As we are creating a new market for
the EECP therapy and recognizing the challenges that some customers may
encounter, we have opted, at times, on a customer-by- customer basis, to recover
our equipment instead of pursuing other legal remedies, which has resulted in
our recording of a reserve or a write-off.
Other key factors causing the increase in cash from the prior year provided
by our operating activities included the reduction in inventories, which
decreased by $1,065,819 for the fiscal year ended May 31, 2004, reflecting
efforts to improve our procurement of raw materials and management of finished
goods inventory levels and an increase in accounts payable, accrued expenses and
other current liabilities of $517,056. Additionally, non- cash adjustments for
depreciation, amortization, allowance for doubtful accounts and allowance for
inventory write-offs to reconcile the net loss of $3,422,520 to net cash
provided by operating activities total $1,484,870.
Investing activities used net cash of $1,334,494 during the fiscal year
ended May 31, 2004, reflecting investment associated with the purchase of
short-term certificates of deposit of $1,180,540 and the purchase of property
and equipment, primarily the implementation of our new enterprise resource
planning software (ERP), of $153,954.
Financing activities provided net cash of $640,436 during the fiscal year
ended May 31, 2004, reflecting $697,387 received form the exercise of stock
options plus new borrowings of $67,149 related to our new ERP system. Payments
of principal on notes and loans were $124,100 partially offsetting the above.
We cancelled our line of credit in August 2004 and do not currently have an
available line of credit.
26
We believe that our cash flow from operations together with our current
cash reserves will be sufficient to fund our business plan and projected capital
requirements through at least May 31, 2005; however, despite our improved cash
balances, we have incurred significant losses during the last two fiscal years
and our long-term ability to maintain current operations is dependent upon
achieving profitable operations or through additional debt or equity financing.
In the event that additional capital is required, we may seek to raise such
capital through public or private equity or debt financings. Future capital
funding, if available, may result in dilution to current shareholders.
Off-Balance Sheet Arrangements
As part of our on-going business, we do not participate in transactions
that generate relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance or
special purpose entities ('SPEs"), which would have been established for the
purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes. As of May 31, 2004, we are not involved in any
unconsolidated SPE.
Contractual Obligations
The following table presents our expected cash requirements for contractual
obligations outstanding as of May 31, 2004:
Due as of Due as of
Due as of 5/31/06 and 5/31/08 and Due
Total 5/31/05 5/31/07 5/31/09 Thereafter
- --------------------------------------------------------------------------------------------------------------------
Long-Term Debt $1,229,315 $136,478 $241,890 $136,293 $714,654
Operating Leases 138,873 76,446 62,427 -- --
Litigation Settlement 333,500 133,250 200,250 -- --
Severance obligations 35,000 35,000 -- -- --
Employment Agreements 290,685 250,000 40,685 -- --
- --------------------------------------------------------------------------------------------------------------------
Total Contractual Cash $2,027,373 $631,174 $545,252 $136,293 $714,654
Obligations
====================================================================================================================
Effects of Inflation
We believe that inflation and changing prices over the past three years
have not had a significant impact on our revenue or on our results of
operations.
27
Critical Accounting Policies
Financial Reporting Release No. 60, which was released by the Securities
and Exchange Commission, or SEC, in December 2001, requires all companies to
include a discussion of critical accounting policies or methods used in the
preparation of financial statements. Note A of the Notes to Consolidated
Financial Statements included in our Annual Report on Form 10-K for the year
ended May 31, 2004 includes a summary of our significant accounting policies and
methods used in the preparation of our financial statements. In preparing these
financial statements, we have made our best estimates and judgments of certain
amounts included in the financial statements, giving due consideration to
materiality. The application of these accounting policies involves the exercise
of judgment and use of assumptions as to future uncertainties and, as a result,
actual results could differ from these estimates. Our critical accounting
policies are as follows:
Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists,
delivery has occurred or service has been rendered, the price is fixed or
determinable and collectibility is reasonably assured. In the United States, we
recognize revenue from the sale of our EECP systems in the period in which we
deliver the system to the customer. Revenue from the sale of our EECP systems to
international markets is recognized upon shipment, during the period in which we
deliver the product to a common carrier, as are supplies, accessories and spare
parts delivered to both domestic and international customers. Returns are
accepted prior to the installation and in-service training subject to a 10%
restocking charge or for normal warranty matters, and we are not obligated for
post-sale upgrades to these systems.
In most cases, revenue from direct EECP system sales is generated from
multiple-element arrangements that require judgment in the areas of customer
acceptance, collectibility, the separability of units of accounting, and the
fair value of individual elements. Effective September 1, 2003, we adopted the
provisions of Emerging Issues Task Force, or EITF, Issue No. 00-21, "Revenue
Arrangements with Multiple Deliverables", ("EITF 00-21"), on a prospective
basis. The principles and guidance outlined in EITF 00-21 provide a framework to
determine (a) how the arrangement consideration should be measured (b) whether
the arrangement should be divided into separate units of accounting, and (c) how
the arrangement consideration should be allocated among the separate units of
accounting. We determined that our multiple-element arrangements are generally
comprised of the following elements that would qualify as separate units of
accounting: system sales, in-service support consisting of equipment set-up and
training provided at the customers facilities and warranty service for system
sales generally covered by a warranty period of one year. Each of these elements
represent individual units of accounting as the delivered item has value to a
customer on a stand-alone basis, objective and reliable evidence of fair value
exists for undelivered items, and arrangements normally do not contain a general
right of return relative to the delivered item. We determine fair value based on
the price of the deliverable when it is sold separately or based on third- party
evidence. In accordance with the guidance in EITF 00-21, we use the residual
method to allocate the arrangement consideration when it does not have fair
value of the EECP system sale. Under the residual method, the amount of
consideration allocated to the delivered item equals the total arrangement
consideration less the aggregate fair value of the undelivered items. Assuming
all other criteria for revenue recognition have been met, we recognize revenue
for EECP system sales 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,
we deferred $92,500 of revenue, net of amortization during the period, related
to the fair value of installation and in-service training plus $658,333 of
revenue, net of amortization during the period, related to the warranty service
for EECP system sales delivered during the nine-month period ended May 31, 2004.
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," we accrued costs associated with these
arrangements as warranty expense in the period the system was delivered and
accepted.
We also recognize revenue generated from servicing EECP systems that are no
longer covered by a warranty agreement, or by providing sites with additional
training, in the period that these services are provided. Revenue related to
future commitments under separately priced extended warranty agreements on the
EECP system are deferred and recognized ratably over the service period,
generally ranging from one year to four years. Deferred revenues related to
extended warranty agreements that have been invoiced to customers prior to the
performance of these services were $2,095,618 and $1,709,551 as of May 31, 2004
and 2003, respectively. Costs associated with the provision of service and
28
maintenance, including salaries, benefits, travel, spare parts and equipment,
are recognized in cost of sales as incurred. Amounts billed in excess of revenue
recognized are included as deferred revenue in the consolidated balance sheets.
We have also entered into lease agreements for our EECP systems, generally
for terms of one year or less, that are classified as operating leases. Revenues
from operating leases are generally recognized, in accordance with the terms of
the lease agreements, on a straight-line basis over the life of the respective
leases. For certain operating leases in which payment terms are determined on a
"fee-per-use" basis, revenues are recognized as incurred (i.e., as actual usage
occurs). The cost of the EECP system utilized under operating leases is recorded
as a component of property and equipment and is amortized to cost of sales over
the estimated useful life of the equipment, not to exceed five years. There were
no significant minimum rental commitments on these operating leases at May 31,
2004.
We follow SFAS No. 13, "Accounting For Leases," for sales of EECP systems
under sales-type leases. In accordance with SFAS No. 13, we record 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 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 system acquired by the customer is
recorded as cost of sales in the same period that the sale is recorded. At the
present time, the Company is no longer offering sales-type leases.
Accounts Receivable/Financing Receivables
Our accounts receivable-trade are due from customers engaged in the
provision of medical services. Credit is extended based on evaluation of a
customer's financial condition and, generally, collateral is not required.
Accounts receivable are generally due 30 to 90 days from shipment and are stated
at amounts due from customers net of allowances for doubtful accounts, returns,
term discounts and other allowances. Accounts outstanding longer than the
contractual payment terms are considered past due. Estimates are used in
determining our allowance for doubtful accounts based on our historical
collections experience, current trends, credit policy and a percentage of our
accounts receivable by aging category. In determining these percentages, we look
at historical write-offs of our receivables. We also look at the credit quality
of its customer base as well as changes in our credit policies. We continuously
monitor collections and payments from its customers. While credit losses have
historically been within expectations and the provisions established, we cannot
guarantee that we will continue to experience the same credit loss rates that we
have in the past.
In addition, we periodically review and assess the net realizability of our
receivables arising from sales- type leases. If this review results in a lower
estimate of the net realizable value of the receivable, an allowance for the
unrealized amount is established in the period in which the estimate is changed.
In the first quarter of fiscal 2003 and the second quarter of fiscal 2004, we
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, Net
We value inventory at the lower of cost or estimated market, cost being
determined on a first-in, first-out basis. We often place EECP systems at
various field locations for demonstration, training, evaluation, and other
similar purposes at no charge. The cost of these EECP systems is transferred to
property and equipment and is amortized over the next two to five years. We
record the cost of refurbished components of EECP systems and critical
components at cost plus the cost of refurbishment. We regularly review inventory
quantities on hand, particularly raw materials and components, and record a
provision for excess and obsolete inventory based primarily on existing and
anticipated design and engineering changes to our products as well as forecasts
of future product demand.
Deferred Revenues
We record revenue on extended service contracts ratably over the term of
the related warranty contracts. Effective September 1, 2003, we prospectively
adopted the provisions of EITF 00-21. Upon adoption of the provisions of EITF
00-21we 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.
29
Warranty Costs
Equipment sold is generally covered by a warranty period of one year.
Effective September 1, 2003, we adopted the provisions of EITF 00-21 on a
prospective basis. Under EITF 00-21, for certain arrangements, a portion of the
overall system price attributable to the first year warranty service is deferred
and recognized as revenue over the service period. As such, we no longer accrue
warranty costs upon delivery but rather recognize warranty and related service
costs as incurred. Prior to September 1, 2003, we accrued a warranty reserve for
estimated costs to provide warranty services when the equipment sale was
recognized. The factors affecting our warranty liability included the number of
units sold and historical and anticipated rates of claims and costs per claim.
The warranty provision resulting from transactions prior to September 1, 2003
will be reduced in future periods for material and labor costs incurred as
related product is returned during the warranty period or when the warranty
period elapses.
Income Taxes
Deferred income taxes are recognized for temporary differences between
financial statement and income tax bases of assets and liabilities and loss
carryforwards for which income tax benefits are expected to be realized in
future years. A valuation allowance is established, when necessary, to reduce
deferred tax assets to the amount expected to be realized. In estimating future
tax consequences, we generally consider all expected future events other than an
enactment of changes in the tax laws or rates. The deferred tax asset is
continually evaluated for realizability. To the extent our judgment regarding
the realization of the deferred tax assets change, an adjustment to the
allowance is recorded, with an offsetting increase or decrease, as appropriate,
in income tax expense. Such adjustments are recorded in the period in which our
estimate as to the realizability of the asset changed that it is "more likely
than not" that all of the deferred tax assets will be realized. The "more likely
than not" standard is subjective, and is based upon our estimate of a greater
than 50% probability that our long range business plan can be realized.
Deferred tax liabilities and assets are classified as current or
non-current based on the classification of the related asset or liability for
financial reporting. A deferred tax liability or asset that is not related to an
asset or liability for financial reporting, including deferred tax assets
related to carryforwards, are classified according to the expected reversal date
of the temporary difference. The deferred tax asset we recorded relates
primarily to the realization of net operating loss carryforwards, of which the
allocation of the current portion, if any, reflects the expected utilization of
such net operating losses in next twelve months. Such allocation is based our
internal financial forecast and may be subject to revision based upon actual
results.
Stock Compensation
We have four stock-based employee compensation plans. We account for
stock-based compensation using the intrinsic value method in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations ("APB No. 25") and have adopted the
disclosure provisions of Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure, an
amendment of FASB Statement No. 123." Under APB No. 25, when the exercise price
of our employee stock options equals the market price of the underlying stock on
the date of grant, no compensation expense is recognized. Accordingly, no
compensation expense has been recognized in the consolidated financial
statements in connection with employee stock option grants.
Pro forma compensation expense may not be indicative of future disclosures
because it does not take into effect pro forma compensation expense related to
grants before 1995. For purposes of estimating the fair value of each option on
the date of grant, we utilized the Black-Scholes option-pricing model.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because our employee stock options have characteristics
significantly different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
our opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
Equity instruments issued to non-employees in exchange for goods, fees and
services are accounted for under the fair value-based method of SFAS No. 123.
30
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 our 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 our financial position
and results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation
of Variable Interest Entities" ("FIN 46"), as interpreted by FIN 46R. In
general, a variable interest entity is a corporation, partnership, trust, or any
other legal structure used for business purposes that either (a) does not have
equity investors with voting rights or (b) has equity investors that do not
provide sufficient financial resources for the entity to support its activities.
A variable interest entity often holds financial assets, including loans or
receivables, real estate or other property. A variable interest entity may be
essentially passive or it may engage in activities on behalf of another company.
Until now, a company generally has included another entity in its consolidated
financial statements only if it controlled the entity through voting interests.
FIN 46 changes that by requiring a variable interest entity to be consolidated
by a company if that company is subject to a majority of the risk of loss from
the variable interest entity's activities or entitled to receive a majority of
the entity's residual returns or both. FIN 46's consolidation requirements apply
immediately to variable interest entities created or acquired after January 31,
2003. The consolidation requirements apply to older entities in the first
interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. We adopted FIN
46 effective January 31, 2003. The adoption of FIN 46 did not have a material
impact on our financial position or results of operations.
In November 2002, the Emerging Issues Task Force, ("EITF") reached a
consensus opinion on, "Revenue Arrangements with Multiple Deliverables", "(EITF
00-21)". That consensus provides that revenue arrangements with multiple
deliverables should be divided into separate units of accounting if certain
criteria are met. The consideration of the arrangement should be allocated to
the separate units of accounting based on their relative fair values, with
different provisions if the fair value is contingent on delivery of specified
items or performance conditions. Applicable revenue criteria should be
considered separately for each separate unit of accounting. EITF 00-21 is
effective for revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. Effective September 1, 2003, we prospectively adopted the
provisions of EITF 00-21. Upon adoption of the provisions of EITF 00-21, we
deferred net of amortization $92,500 of revenue related to the fair value of
installation and in- service training and $658,333 of revenue related to the
warranty service for EECP system sales recognized for the nine-month period
ended May 31, 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 our financial
position or results of operations.
ITEM 7A - QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain financial market risks, including changes in
interest rates. All of the Company's revenue, expenses and capital spending are
transacted in US dollars. Our exposure to market risk for changes in interest
rates relates primarily to our cash and cash equivalent balances, investments in
sales-type leases and the line of credit agreement. The majority of our
investments are in short-term instruments and subject to fluctuations in US
31
interest rates. Due to the nature of our short-term investments, we believe that
there is no material risk exposure.
ITEM 8 - FINANCIAL STATEMENTS
The consolidated financial statements listed in the accompanying Index to
Consolidated Financial Statements are filed as part of this report.
ITEM 9 - DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A - CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-15. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective. There were no significant changes in our internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.
32
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item will be included in our definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with our 2004 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this Item will be included in our definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with our 2004 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be included in our definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with our 2004 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be included in our definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with our 2004 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item will be included in our definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with our 2004 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements and Financial Statement Schedules
------------------------------------------------------
(1) See Index to Consolidated Financial Statements on page F-1 at
beginning of attached financial statements.
(2) The following Consolidated Financial Statement Schedule is included in
Part IV of this report:
Schedule II Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable, or
not required, or because the required information is included in the
Consolidated Financial Statements or notes thereto.
(b) Form 8-K Reports
----------------
None
(c) Exhibits
--------
(3) (a) Restated Certificate of Incorporation (2)
(b) By-Laws (1)
(4) (a) Specimen Certificate for Common Stock (1)
(b) Certificate of Designation of the Preferred Stock, Series A (3)
(c) Certificate of Designation of the Preferred Stock, Series B (7)
(d) Form of Rights Agreement dated as of March 9, 1995, between
Registrant and American Stock Transfer & Trust Company (5)
(e) Certificate of Designation of the Preferred Stock, Series C (8)
(10) (a) 1995 Stock Option Plan (6)
(b) Outside Director Stock Option Plan (6)
(c) Employment Agreement dated February 1, 1995, as amended March 12,
1998, and October 10, 2001, between Registrant and John C.K. Hui
(4) (9) (13)
(d) 1997 Stock Option Plan, as amended (10)
(e) 1999 Stock Option Plan, as amended (11)
(f) Credit Agreement dated February 21, 2002, between Vasomedical,
Inc. and Fleet National Bank (12)
(g) Agreement dated October 1, 2002, between the Registrant and Peter
F. Cohn (14)
(h) Termination and Settlement Agreement dated October 21, 2002,
between the Registrant and D. Michael Deignan (14)
(i) Employment Agreement dated October 28, 2002, and amended June 30,
2003, between the Registrant and Photios T. Paulson (14) (16)
33
(j) Amendment and Waiver to Credit Agreement dated October 18, 2002,
between the Vasomedical, Inc. and Fleet National Bank (14)
(k) Amendment No. 2 and Waiver to Credit Agreement dated April 10,
2003, between the Registrant and Fleet National Bank (15)
(l) Employment Agreement dated September 8, 2003, between Registrant
and Thomas W. Fry (17)
(22) Subsidiaries of the Registrant
Percentage
Name State of Incorporation Owned by Company
----- ---------------------- ----------------
Viromedics, Inc. Delaware 61%
180 Linden Avenue Corp. New York 100%
(23) Consent of Grant Thornton LLP
(31) Certification Reports pursuant to Securities Exchange Act Rule 13a -
14
(32) Certification Reports pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
__________________________
(1) Incorporated by reference to Registration Statement on Form S-18, No.
33-24095.
(2) Incorporated by reference to Registration Statement on Form S-1, No.
33-46377 (effective 7/12/94).
(3) Incorporated by reference to Report on Form 8-K dated November 14, 1994.
(4) Incorporated by reference to Report on Form 8-K dated January 24, 1995.
(5) Incorporated by reference to Registration Statement on Form 8-A dated May
12, 1995.
(6) Incorporated by reference to Notice of Annual Meeting of Stockholders dated
December 5, 1995.
(7) Incorporated by reference to Report on Form 8-K dated June 25, 1997.
(8) Incorporated by reference to Report on Form 8-K dated April 30, 1998.
(9) Incorporated by reference to Report on Form 10-K for the fiscal year ended
May 31, 1998.
(10) Incorporated by reference to Report on Form 10-K for the fiscal year ended
May 31, 1999
(11) Incorporated by reference to Report on Form 10-K for the fiscal year ended
May 31, 2000.
(12) Incorporated by reference to Report on Form 10-Q for the quarterly period
ended February 28, 2002.
(13) Incorporated by reference to Report on Form 10-K for the fiscal year ended
May 31, 2002.
(14) Incorporated by reference to Report on Form 10-Q for the quarterly period
ended November 30, 2002.
(15) Incorporated by reference to Report on Form 10-Q for the quarterly period
ended February 28, 2003.
(16) Incorporated by reference to Report on Form 8-K dated June 30, 2003.
(17) Incorporated by reference to Report on Form 10-Q for the quarterly period
ended February 29, 2004.
34
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, we have duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized on the 16 day of August, 2004.
VASOMEDICAL, INC.
By: /s/ Photios T. Paulson
-----------------------------------
Photios T. Paulson
President, Chief Executive Officer
and Director
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on August 16, 2004, by the following persons in the
capacities indicated:
/s/ Alexander G. Bearn Director
Alexander G. Bearn
/s/ David S. Blumenthal Director
David S. Blumenthal
/s/ Photios T. Paulson President, Chief Executive Officer
Photios T. Paulson and Director Principal Executive Officer)
/s/ Abraham E. Cohen Chairman of the Board
Abraham E. Cohen
/s/ Thomas W. Fry Chief Financial Officer
Thomas W. Fry (Principal Financial and Accounting Officer)
/s/ John C.K. Hui Senior Vice President,
John C.K. Hui Chief Technology Officer and Director
/s/ Kenneth W. Rind Director
Kenneth W. Rind
/s/ E. Donald Shapiro Director
E. Donald Shapiro
/s/ Anthony Viscusi Director
Anthony Viscusi
/s/ Forrest R. Whittaker Director
Forrest R. Whittaker
/s/ Martin Zeiger Director
Martin Zeiger
35
Vasomedical, Inc. and Subsidiaries
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Registered Public Accounting Firm F-2
Financial Statements
Consolidated Balance Sheets as of May 31, 2004 and 2003 F-3
Consolidated Statements of Earnings for the
years ended May 31, 2004, 2003 and 2002 F-4
Consolidated Statement of Changes in Stockholders'
Equity for the years ended May 31, 2004, 2003 and 2002 F-5
Consolidated Statements of Cash Flows for the
years ended May 31, 2004, 2003 and 2002 F-6
Notes to Consolidated Financial Statements F-7 - F-21
Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts S-1
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors
Vasomedical, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Vasomedical,
Inc. and Subsidiaries (the "Company") as of May 31, 2004 and 2003, and the
related consolidated statements of earnings, changes in stockholders' equity and
cash flows for each of the three fiscal years in the period ended May 31, 2004.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with the standards of the Public
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Vasomedical, Inc. and Subsidiaries as of May 31, 2004 and 2003, and the
consolidated results of their operations and their consolidated cash flows for
each of the three fiscal years in the period ended May 31, 2004, in conformity
with accounting principles generally accepted in the United States of America.
We have also audited Schedule II - Valuation and Qualifying Accounts for each of
the three fiscal years in the period ended May 31, 2004. In our opinion, this
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
/S/ Grant Thornton, LLP
GRANT THORNTON LLP
Melville, New York
July 23, 2004
F-2
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
May 31,
2004 2003
----------------- -----------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $6,365,049 $5,222,847
Certificates of deposit 1,180,540 --
Accounts receivable, net of an allowance for doubtful accounts of
$699,203 and $768,629 at May 31, 2004 and 2003, respectively 5,521,853 7,377,118
Inventories, net 2,373,748 3,439,567
Deferred income taxes -- 303,000
Financing receivables, net -- 264,090
Other current assets 272,513 268,231
----------------- -----------------
Total current assets 15,713,703 16,874,853
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,378,576
and $ 2,338,366 at May 31, 2004 and 2003, respectively 2,430,521 3,233,158
FINANCING RECEIVABLES, net -- 679,296
DEFERRED INCOME TAXES 14,582,000 14,279,000
OTHER ASSETS 297,391 261,243
----------------- -----------------
$33,023,615 $35,327,550
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $3,122,184 $2,667,861
Current maturities of long-term debt and notes payable 136,478 108,462
Sales tax payable 353,360 461,704
Deferred revenues 1,734,925 789,118
Accrued warranty and customer support expenses 161,917 575,000
Accrued professional fees 91,486 207,793
Accrued commissions 341,483 586,823
----------------- -----------------
Total current liabilities 5,941,833 5,396,761
LONG-TERM DEBT 1,092,837 1,177,804
ACCRUED WARRANTY COSTS 83,000 213,000
DEFERRED REVENUES 1,111,526 920,433
OTHER LIABILITIES 200,250 300,250
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;
58,419,356 and 57,822,023 shares at May 31, 2004 and 2003,
respectively, issued and outstanding 58,419 57,822
Additional paid-in capital 51,320,106 50,623,316
Accumulated deficit (26,784,356) (23,361,836)
----------------- -----------------
Total stockholders' equity 24,594,169 27,319,302
----------------- -----------------
$33,023,615 $35,327,550
================= =================
The accompanying notes are an integral part of these statements.
F-3
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF EARNINGS
Fiscal Year Ended May 31,
-------------------------------------------------
2004 2003 2002
-------------- ------------- -------------
Revenues
Equipment sales $19,302,593 $22,850,391 $29,304,349
Equipment rentals and services 2,904,444 1,973,228 1,339,113
Equipment sold under sales-type leases -- -- 4,187,009
-------------- ------------- -------------
22,207,037 24,823,619 34,830,471
Cost of sales and services 7,590,103 9,251,221 10,538,731
-------------- ------------- -------------
Gross profit 14,616,934 15,572,398 24,291,740
Expenses
Selling, general and administrative 12,910,997 13,714,913 13,686,958
Research and development 3,748,389 4,544,822 5,112,258
Provision for doubtful accounts 1,296,759 3,728,484 1,304,000
Interest and financing costs 132,062 186,574 98,140
Interest and other income, net (99,393) (176,724) (249,722)
-------------- ------------- -------------
17,988,814 21,998,069 19,951,634
-------------- ------------- -------------
EARNINGS (LOSS) BEFORE INCOME TAXES (3,371,880) (6,425,671) 4,340,106
Income tax (expense) benefit, net (50,640) 1,634,688 (1,554,000)
-------------- ------------- -------------
NET EARNINGS (LOSS) $(3,422,520) $(4,790,983) $2,786,106
============== ============= =============
Net earnings (loss) per common share
- basic $(0.06) $(0.08) $0.05
============== ============= =============
- diluted $(0.06) $(0.08) $0.05
============== ============= =============
Weighted average common shares outstanding
- basic 57,981,963 57,647,032 57,251,035
============== ============= =============
- diluted 57,981,963 57,647,032 59,468,092
============== ============= =============
The accompanying notes are an integral part of these statements
F-4
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Total
Common Stock Additional Accumulated Stockholders'
Shares Amount Paid-in-Capital Deficit Equity
------------------------------ --------------- --------------- --------------
Balance at June 1, 2001 57,195,453 $57,195 $49,808,493 $(21,356,959) $28,508,729
Exercise of options and warrants 113,667 114 199,529 199,643
Stock options granted for services 50,126 50,126
Tax benefit of stock options and warrants 58,000 58,000
Net earnings 2,786,106 2,786,106
--------------- -------------- --------------- --------------- --------------
Balance at May 31, 2002 57,309,120 57,309 50,116,148 (18,570,853) 31,602,604
Exercise of options and warrants 512,903 513 234,487 235,000
Stock options granted for services 50,681 50,681
Tax benefit of stock options and warrants 222,000 222,000
Net loss (4,790,983) (4,790,983)
--------------- -------------- --------------- --------------- --------------
Balance at May 31, 2003 57,822,023 57,822 50,623,316 (23,361,836) 27,319,302
Exercise of options and warrants 597,333 597 696,790 697,387
Net loss (3,422,520) (3,422,520)
--------------- -------------- --------------- --------------- --------------
Balance at May 31, 2004 58,419,356 $58,419 $51,320,106 $(26,784,356) $24,594,169
=============== =============== =============== =============== ==============
The accompanying notes are an integral part of these statements.
F-5
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended May 31,
2004 2003 2002
-------------- ------------- -------------
Cash flows from operating activities
Net earning (loss) $(3,422,520) $(4,790,983) $2,786,106
-------------- ------------- -------------
Adjustments to reconcile net earnings (loss) to net
cash provided by (used in) operating activities
Depreciation and amortization 749,111 1,132,996 962,167
Provision for doubtful accounts, net of write-offs 616,759 2,209,101 904,687
Reserve for inventory obsolescence 119,000 100,000 30,000
Deferred income taxes -- (1,669,000) 1,573,000
Stock options granted for services -- 50,681 50,126
Changes in operating assets and liabilities
Accounts receivable 1,923,284 5,643,288 (3,855,663)
Financing receivables, net 258,608 118,126 (3,575,373)
Inventories 1,187,761 1,079,976 (1,694,198)
Other current assets (4,282) 359,012 (183,356)
Other assets (69,610) (79,082) (142,062)
Accounts payable, accrued expenses and other
current liabilities 517,056 (1,286,324) 443,649
Other liabilities (38,907) 311,813 384,265
-------------- ------------- -------------
5,258,780 7,970,587 (5,102,758)
-------------- ------------- -------------
Net cash provided by (used in) operating activities 1,836,260 3,179,604 (2,316,652)
-------------- ------------- -------------
Cash flows (used in) investing activities
Purchase of certificates of deposit, net (1,180,540) -- --
Issuance of notes -- -- (500,000)
Purchase of property and equipment (153,954) (326,489) (319,981)
-------------- ------------- -------------
Net cash (used in) investing activities (1,334,494) (326,489) (819,981)
-------------- ------------- -------------
Cash flows provided by (used in) financing activities
Proceeds from notes payable 67,149 238,071 2,141,667
Payments on notes payable (124,100) (1,070,966) (1,164,173)
Restricted cash -- -- 1,141,667
Proceeds from exercise of options and warrants 697,387 235,000 199,643
-------------- ------------- -------------
Net cash provided by (used in) financing activities 640,436 (597,895) 2,318,804
-------------- ------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH
-------------- ------------- -------------
EQUIVALENTS 1,142,202 2,255,220 (817,829)
-------------- ------------- -------------
Cash and cash equivalents - beginning of period 5,222,847 2,967,627 3,785,456
-------------- ------------- -------------
Cash and cash equivalents - end of period $6,365,049 $5,222,847 $2,967,627
============== ============= =============
Non-cash investing and financing activities were as follows:
Inventories transferred to (from) property and
equipment, attributable to operating leases - net $(240,942) $761,986 $1,130,020
Supplement disclosures:
Interest paid $105,194 $186,574 $98,139
Income taxes paid $24,213 $87,963 $304,263
The accompanying notes are an integral part of these statements.
F-6
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2004, 2003 and 2002
NOTE A - BUSINESS ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company was incorporated in Delaware in July 1987. During fiscal 1996,
the Company commenced the commercialization of its EECP external
counterpulsation system ("EECP"), a microprocessor-based medical device for the
noninvasive, outpatient treatment of patients with cardiovascular disease. EECP
is marketed worldwide to hospitals and physician private practices. To date, net
Company's revenues have been generated from customers in the United States.
A summary of the significant accounting policies consistently applied in
the preparation of the consolidated financial statements follows:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company,
its wholly-owned subsidiary and its inactive majority-owned subsidiary.
Significant intercompany accounts and transactions have been eliminated.
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 are
supplies, accessories and spare parts delivered to both domestic and
international customers. Returns are accepted prior to the installation and
in-service training 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 $92,500 of revenue, net of amortization during the period,
related to the fair value of installation and in-service training plus $658,333
of revenue, net of amortization during the period, related to the warranty
service for EECP system sales delivered during the nine-month period ended May
31, 2004. 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.
F-7
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 invoiced to customers
prior to the performance of extended warranty services were $2,095,618 and
$1,709,551 as of May 31, 2004 and 2003, respectively. Costs associated with the
provision of service and maintenance, including salaries, benefits, travel,
spare parts and equipment, are recognized in cost of sales as incurred. Amounts
billed in excess of revenue recognized are included as deferred revenue in the
consolidated balance sheets.
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 were no significant minimum rental commitments on
these operating leases at May 31, 2004.
The Company follows SFAS No. 13, "Accounting For Leases," for its sales of
EECP systems 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 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 system
acquired by the customer is recorded as cost of sales in the same period that
the sale is recorded. The Company is no longer offering sales-type leases.
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 the allowance for doubtful accounts based on the Company's
historical collections experience, current trends, credit policy and a
percentage of our accounts receivable by aging category. In determining these
percentages, we look at historical write-offs of our receivables. The Company
also looks at the credit quality of its customer base as well as changes in its
credit policies. The Company continuously monitors collections and payments from
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.
The changes in the Company's allowance for doubtful accounts are as
follows:
Fiscal Years Ended May 31,
-----------------------------------------------------
2004 2003 2002
--------------- --------------- ---------------
Beginning balance $768,629 $1,099,687 $545,000
Provision for losses on accounts
receivable 616,759 1,227,324 954,000
Direct write-offs (686,185) (1,543,382) (399,313)
Recoveries -- (15,000) --
--------------- --------------- ---------------
Ending balance $699,203 $768,629 $1,099,687
=============== =============== ===============
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. (See Note E).
F-8
The changes in the Company's allowance for financing receivables, which
primarily relates to balloon payments due at lease end, are as follows:
Fiscal Year Ended May 31,
-----------------------------------------------------
2004 2003 2002
--------------- --------------- ---------------
Beginning balance $244,994 $718,879 $ --
Provision for losses on financing
receivables 680,000 -- 718,879
Direct write-offs (924,994) (473,885) --
--------------- --------------- ---------------
Ending balance $ -- $244,994 $718,879
=============== =============== ===============
Concentrations of Credit Risk
The Company markets the EECP system principally to hospitals and physician
private practices. The Company performs credit evaluations of its customers'
financial condition and, as a consequence, believes that its receivable credit
risk exposure is limited. Receivables are generally due 30 to 90 days from
shipment. For the years ended May 31, 2004, 2003 and 2002, no customer accounted
for 10% or more of revenues. For the years ended May 31, 2004, 2003 and 2002, no
customer accounted for 10% or more of accounts receivable. At May 31, 2003 and
2002, financing receivables were due from one and two customers, respectively.
(See Note E).
The Company's revenues were derived from the following geographic areas:
Fiscal Years Ended May 31,
------------------------------------------------------
2004 2003 2002
--------------- --------------- ---------------
Domestic (United States) $21,339,267 $23,701,619 $32,105,471
Non-domestic 867,770 1,122,000 2,725,000
--------------- --------------- ---------------
$22,207,037 $24,823,619 $34,830,471
=============== =============== ===============
Cash and Cash Equivalents
Cash and cash equivalents represent cash and short-term, highly liquid
investments in certificates of deposit, treasury bills, money market funds, and
investment grade commercial paper issued by major corporations and financial
institutions that generally have maturities of three months or less. Realized
and unrealized gains and losses and declines in value, if any, are charged to
earnings. Dividend and interest income are recognized when earned. The cost of
securities sold is calculated using the specific identification method. (See
Note C)
Certificates of Deposit
Included in this caption are all certificates of deposit that have original
maturities of greater than three months. Realized and unrealized gains and
losses and declines in value, if any, are charged to earnings. Dividend and
interest income are recognized when earned. The cost of securities sold is
calculated using the specific identification method.
Inventories, net
The Company values inventory at the lower of cost or estimated market, cost
being determined on a first-in, first- out basis. The Company often places EECP
systems at various field locations for demonstration, training, evaluation, and
other similar purposes at no charge. The cost of these EECP systems is
transferred to property and equipment and is amortized over the next two to five
years. The Company records the cost of refurbished components of EECP systems
and critical components at cost plus the cost of refurbishment. The Company
regularly reviews inventory quantities on hand, particularly raw materials and
components, and records a provision for excess and obsolete inventory based
primarily on existing and anticipated design and engineering changes to our
products as well as forecasts of future product demand.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation is provided over the estimated useful lives of the
assets, which range from two to thirty-nine years, on a straight-line basis.
Accelerated methods of depreciation are used for tax purposes. Leasehold
improvements are amortized over the useful life of the related leasehold
improvement or the life of the related lease, whichever is less.
Deferred Revenues
The Company records revenue on extended service contracts ratably over the
F-9
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.
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 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.
Research and Development
Research and development costs are expensed as incurred. Included in
research and development costs is amortization expense related to the cost of
EECP systems under loan for clinical trials.
Income Taxes
Deferred income taxes are recognized for temporary differences between
financial statement and income tax bases of assets and liabilities and loss
carryforwards for which income tax benefits are expected to be realized in
future years. A valuation allowance is established, when necessary, to reduce
deferred tax assets to the amount expected to be realized. In estimating future
tax consequences, 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 that it is "more likely than not" that all of the deferred tax
assets will be realized. The "more likely than not" standard is subjective, and
is based upon management's estimate of a greater than 50% probability that its
long range business plan can be realized.
Deferred tax liabilities and assets are classified as current or
non-current based on the classification of the related asset or liability for
financial reporting. A deferred tax liability or asset that is not related to an
asset or liability for financial reporting, including deferred tax assets
related to carryforwards, 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, if any, reflects the expected
utilization of such net operating losses in the next twelve months. Such
allocation is based upon management's internal financial forecast and may be
subject to revision based upon actual results.
Shipping and Handling Costs
The Company includes all shipping and handling expenses incurred as a
component of cost of sales. Amounts billed to customers related to shipping and
handling costs are included as a component of sales.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, accounts receivable and
accounts payable approximate fair value due to the short-term maturities of the
instruments. The carrying amount of the financing receivables approximates fair
value as the interest rates implicit in the leases approximate current market
interest rates for similar financial instruments. The carrying amounts of notes
payable approximates their fair value as the interest rates of these instruments
approximate the interest rates available on instruments with similar terms and
maturities.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Significant estimates and
assumptions relate to estimates of collectibility of accounts receivable and
financing receivables, the realizability of deferred tax assets, and the
adequacy of inventory and warranty reserves. Actual results could differ from
those estimates.
F-10
Net Earnings (Loss) Per Common Share
Basic earnings (loss) per share are based on the weighted average number of
common shares outstanding without consideration of potential common stock.
Diluted earnings (loss) per share are based on the weighted number of common and
potential common shares outstanding. The calculation takes into account the
shares that may be issued upon the exercise of stock options and warrants,
reduced by the shares that may be repurchased with the funds received from the
exercise, based on the average price during the period.
Stock-Based Employee Compensation
The Company has four stock-based employee compensation plans, which are
described in Note K. 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.
The following table illustrates the effect on net income and earnings 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.
Fiscal Year Ended May 31,
-----------------------------------------------------
2004 2003 2002
--------------- --------------- ---------------
Net earnings (loss), as reported $(3,422,520) $(4,790,983) $2,786,106
Deduct: Total stock-based employee compensation
expense determined under fair value-based
method for all awards (1,080,817) (917,281) (1,143,120)
--------------- --------------- ---------------
Pro forma net earnings (loss) $(4,503,337) $(5,708,264) $1,642,986
=============== =============== ===============
Earnings (loss) per share:
Basic and diluted - as reported $(0.06) $(0.08) $0.05
Basic and diluted - pro forma $(0.08) $(0.10) $0.03
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. The fair value
of the Company's stock-based awards was estimated assuming no expected dividends
and the following weighted-average assumptions are as follows:
Fiscal Years Ended May 31,
-----------------------------------------------------
2004 2003 2002
--------------- --------------- --------------
Expected life (years) 5 5 5
Expected volatility 89% 89% 86%
Risk-free interest rate 3.4% 3.0% 3.9%
Expected dividend yield 0.0% 0.0% 0.0%
Equity instruments issued to non-employees in exchange for goods, fees and
services are accounted for under the fair value-based method of SFAS No. 123.
F-11
Impact of New Accounting Pronouncements
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 ("SFAS No. 149"), "Amendment of Statement No. 133 on Derivative
Instruments and Hedging Activities," which amends and clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003, except for the provisions that were cleared by the
FASB in prior pronouncements. The adoption of SFAS No. 149 has not had a
material impact on the Company's financial position and results of operations.
In 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
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 $92,500 net of amortization, of revenue related to
the fair value of installation and in-service training and $658,333 net of
amortization of revenue related to the warranty service for EECP system sales
recognized for the nine- month period ended May 31, 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.
F-12
NOTE B - EARNINGS (LOSS) PER COMMON SHARE
The following table sets forth the computation of basic and diluted
earnings (loss) per share:
Fiscal Year Ended May 31,
-----------------------------------------------------
2004 2003 2002
--------------- --------------- --------------
Numerator:
Net earnings (loss) $(3,422,520) $(4,790,983) $2,786,106
Denominator:
Basic - weighted average shares 57,981,963 57,647,032 57,251,035
Stock options -- -- 1,624,744
Warrants -- -- 592,313
--------------- --------------- --------------
Diluted - weighted average shares 57,981,963 57,647,032 59,468,092
=============== =============== ==============
Earnings (loss) per share - basic $(0.06) $(0.08) $0.05
=============== =============== ==============
- diluted $(0.06) $(0.08) $0.05
=============== =============== ==============
Options and warrants to purchase 5,161,751, 6,190,753 and 2,432,167 shares
of common stock were excluded from the computation of diluted earnings per share
for the years ended May 31, 2004, 2003 and 2002, respectively, because the
effect of their inclusion would be antidilutive.
NOTE C - CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of the following:
May 31,
----------------------------------
2004 2003
--------------- ---------------
Cash accounts $2,522,570 961,922
Money market funds 3,842,479 4,260,925
--------------- ---------------
$6,365,049 $5,222,847
=============== ===============
NOTE D - INVENTORIES, NET
Inventories, net consist of the following:
May 31,
----------------------------------
2004 2003
--------------- ---------------
Raw materials $928,269 $1,374,241
Work in progress 455,731 634,890
Finished goods 989,748 1,430,436
--------------- ---------------
$2,373,748 $3,439,567
=============== ===============
At May 31, 2004 and 2003, the Company has recorded reserves for obsolete
inventory of $399,000 and $280,000, respectively.
NOTE E - FINANCING RECEIVABLES FROM MAJOR CUSTOMERS
In fiscal year 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 year 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
F-13
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 year 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 carrying amount at that time of the equipment. 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 the provision for doubtful accounts in the accompanying
Statement of Earnings for the year ended May 31, 2004. In the third quarter of
fiscal 2004, the Company recovered all of the EECP systems that had been leased
to this customer. The Company is no longer offering sales-type leases.
NOTE F - PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
May 31,
-----------------------------------
2004 2003
--------------- ----------------
Land $200,000 $200,000
Building and improvements 1,382,270 1,376,106
Office, laboratory and other equipment 1,246,089 1,111,827
EECP systems under operating leases or under loan
for clinical trials 1,700,867 2,617,624
Furniture and fixtures 162,068 148,164
Leasehold improvements 117,803 117,803
--------------- ----------------
4,809,097 5,571,524
--------------- ----------------
Less: accumulated depreciation and amortization (2,378,576) (2,338,366)
--------------- ----------------
$2,430,521 $3,233,158
=============== ================
NOTE G - DEFERRED REVENUE
The changes in the Company's deferred revenues are as follows:
Fiscal Year Ended May 31,
-----------------------------------------------------
2004 2003 2002
--------------- --------------- ---------------
Deferred Revenue at the beginning of the year
$1,709,551 $991,204 $243,151
ADDITIONS
Deferred extended service contracts 1,871,439 1,478,933 1,156,244
Deferred in-service training 340,000 -- --
Deferred warranty obligations 1,040,000 -- --
RECOGNIZED AS REVENUE
Deferred extended service contracts (1,485,372) (760,586) (408,191)
Deferred in-service training (247,500) -- --
Deferred warranty obligations (381,667) -- --
--------------- --------------- ---------------
Deferred revenue at end of the year 2,846,451 1,709,551 991,204
Less: current portion (1,734,925) (789,118) (272,000)
--------------- --------------- ---------------
Long-term deferred revenue at end of the year $1,111,526 $920,433 $719,204
=============== =============== ===============
F-14
NOTE H - WARRANTY LIABILITY
The changes in the Company's product warranty liability are as follows:
Fiscal Year Ended May 31,
-------------------------------------------------------
2004 2003 2002
--------------- --------------- ----------------
Beginning balance $788,000 $991,000 $1,055,000
Expense for new warranties issued 164,000 724,000 780,000
Warranty claims (707,083) (927,000) (844,000)
--------------- --------------- ----------------
Ending balance $244,917 $788,000 $991,000
=============== =============== ================
NOTE I - LONG-TERM DEBT AND LINE OF CREDIT AGREEMENT
The following table sets forth the computation of long-term debt:
May 31,
-----------------------------------
2004 2003
---------------- ---------------
Facility loans (a) $1,022,933 $1,072,717
Term loans (b) 206,382 213,549
---------------- ---------------
1,229,315 1,286,266
Less: current portion (136,478) (108,462)
---------------- ---------------
$1,092,837 $1,177,804
================ ===============
(a) The Company purchased its headquarters and warehouse facility and
secured notes of $641,667 and $500,000, respectively, under two programs
sponsored by New York State. These notes, which bear interest at 7.8% and 6%,
respectively, are payable in monthly installments consisting of principal and
interest payments over fifteen-year terms, expiring in September 2016 and
January 2017, respectively, and are secured by the building.
(b) In fiscal years 2003 and 2004, the Company financed the cost and
implementation of a management information system and secured several notes,
aggregating approximately $305,219. The notes, which bear interest at rates
ranging from 7.5% through 12.5%, are payable in monthly installments consisting
of principal and interest payments over four-year terms, expiring at various
times between August and October 2006. Maturities of long-term debt are as
follows at May 31, 2004:
Fiscal Year Amount
------------------- --------------
2005 $136,478
2006 148,212
2007 93,678
2008 65,769
2009 70,524
Thereafter 714,654
--------------
$1,229,315
==============
At May 31, 2004 and 2003, the Company maintained a secured revolving credit
line with a bank. The credit line provided 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. The agreement allowed 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. At May 31, 2004 and 2003, the Company did not meet the
minimum net income, interest coverage, leverage ratio and tangible net worth
covenants and future compliance with each of these covenants in the near term is
not certain. The agreement, which was due to expire in February 2005, was
cancelled by the Company in August 2004.
F-15
NOTE J - STOCKHOLDERS' EQUITY AND WARRANTS
In fiscal 2002, warrants to purchase 15,000 shares of common stock were
exercised, aggregating $31,200 in proceeds to the Company. In fiscal 2003,
warrants to purchase 500,000 shares of common stock were exercised, aggregating
$225,000 in proceeds to the Company. No warrants were exercised or cancelled in
fiscal 2004.
All outstanding warrants expire in October 2006. Warrant activity for the
years ended May 31, 2002, 2003 and 2004 is summarized as follows:
Employees Consultants Total Price Range
----------------- ------------------- ------------------------ ----------------
Balance at June 1, 2001 500,000 342,500 842,500 $0.45 - $2.08
Exercised -- (15,000) (15,000) $2.08
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2002 500,000 327,500 827,500 $0.45 - $2.08
Exercised (500,000) -- (500,000) $0.45
Cancelled -- (127,500) (127,500) $2.08
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2003 -- 200,000 200,000 $0.91
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2004 -- 200,000 200,000 $0.91
================= =================== ======================== ================
Number of shares exercisable -- 200,000 200,000 $0.91
================= =================== ======================== ================
NOTE K - OPTION PLANS
1995 Stock Option Plan
In May 1995, the Company's stockholders approved the 1995 Stock Option Plan
for officers and employees of the Company, for which the Company reserved an
aggregate of 1,500,000 shares of common stock. In December 1997, the Company's
Board of Directors terminated the 1995 Stock Option Plan with respect to new
option grants.
Outside Director Stock Option Plan
In May 1995, the Company's stockholders approved an Outside Director Stock
Option Plan for non-employee directors of the Company, for which the Company
reserved an aggregate of 300,000 shares of common stock. In December 1997, the
Company's Board of Directors terminated the Outside Director Stock Option Plan
with respect to new option grants.
1997 Stock Option Plan
In December 1997, the Company's stockholders approved the 1997 Stock Option
Plan (the "1997 Plan") for officers, directors, employees and consultants of the
Company, for which the Company has reserved an aggregate of 1,800,000 shares of
common stock. The 1997 Plan provides that a committee of the Board of Directors
of the Company will administer it and that the committee will have full
authority to determine the identity of the recipients of the options and the
number of shares subject to each option. Options granted under the 1997 Plan may
be either incentive stock options or non-qualified stock options. The option
price shall be 100% of the fair market value of the common stock on the date of
the grant (or in the case of incentive stock options granted to any individual
principal stockholder who owns stock possessing more than 10% of the total
combined voting power of all voting stock of the Company, 110% of such fair
market value). The term of any option may be fixed by the committee but in no
event shall exceed ten years from the date of grant. Options are exercisable
upon payment in full of the exercise price, either in cash or in common stock
valued at fair market value on the date of exercise of the option. The term for
which options may be granted under the 1997 Plan expires August 6, 2007.
In January 1999, the Company's Board of Directors increased the number of
shares authorized for issuance under the 1997 Plan by 1,000,000 shares to
2,800,000 shares. At May 31, 2004, there were 153,168 shares available for
future grants under the 1997 Plan.
1999 Stock Option Plan
In July 1999, the Company's Board of Directors approved the 1999 Stock
Option Plan (the "1999 Plan"), for which the Company reserved an aggregate of
2,000,000 shares of common stock. The 1999 Plan provides that a committee of the
Board of Directors of the Company will administer it and that the committee will
have full authority to determine the identity of the recipients of the options
F-16
and the number of shares subject to each option. Options granted under the 1999
Plan may be either incentive stock options or non-qualified stock options. The
option price shall be 100% of the fair market value of the common stock on the
date of the grant (or in the case of incentive stock options granted to any
individual principal stockholder who owns stock possessing more than 10% of the
total combined voting power of all voting stock of the Company, 110% of such
fair market value). The term of any option may be fixed by the committee but in
no event shall exceed ten years from the date of grant. Options are exercisable
upon payment in full of the exercise price, either in cash or in common stock
valued at fair market value on the date of exercise of the option. The term for
which options may be granted under the 1999 Plan expires July 12, 2009. In July
2000, the Company's Board of Directors increased the number of shares authorized
for issuance under the 1999 Plan by 1,000,000 shares to 3,000,000 shares. In
December 2001, the Board of Directors of the Company increased the number of
shares authorized for issuance under the 1999 Plan by 2,000,000 shares to
5,000,000 shares.
In January 2001, the Board of Directors granted stock options under the
1999 Plan to a consultant to purchase 25,000 shares of common stock at an
exercise price of $3.81 per share (which represented the fair market value of
the underlying common stock at the time of the respective grant). The Company
charged $60,000 to operations over the one-year period in which services were
rendered. In December 2001, the Board of Directors granted stock options under
the 1999 Plan to a consultant to purchase 25,000 shares of common stock at an
exercise price of $2.95 per share (which represented the fair market value of
the underlying common stock at the time of the respective grant). These stock
options were fair-valued at $50,250, which the Company charged to operations
over the one-year period in which services were rendered. During fiscal 2003 and
2002, the Company charged $25,000 and $50,000, respectively, to operations for
these grants.
In fiscal 2003, the Board of Directors granted stock options under the 1999
Plan to directors and employees to purchase an aggregate of 1,175,000 shares of
common stock, at exercise prices ranging from $0.71 to $1.67 per share (which
represented the fair market value of the underlying common stock at the time of
the respective grants). In fiscal 2004, the Board of Directors granted stock
options under the 1999 Plan to directors and employees to purchase an aggregate
of 725,000 shares of common stock, at exercise process ranging from $0.91 to
$1.31 per shares (which represented the fair market value of the underlying
common stock at the time of the respective grants). At May 31, 2004, there were
1,517,169 shares available for future grants under the 1999 Plan.
Activity under all the plans for the years ended May 31, 2002, 2003 and
2004, is summarized as follows:
Outstanding Options
------------------- ------------------------ ----------------
Shares Weighted
Available for Number of Exercise Average
Grant Shares Price per Share Exercise Price
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2001 1,218,168 4,332,823 $0.78 - $5.15 $2.26
Shares authorized 2,000,000
Options granted (1,084,100) 1,084,100 $1.78 - $4.02 $3.61
Options exercised -- (98,667) $0.88 - $2.44 $1.71
Options canceled 125,333 (125,333) $0.88 - $5.00 $3.90
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2002 2,259,401 5,192,923 $0.78 - $5.15 $2.51
Options granted (1,175,000) 1,175,000 $0.71 - $1.67 $0.95
Options exercised -- (12,903) $0.78 $0.78
Options canceled 354,267 (364,267) $0.88 - $5.15 $3.77
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2003 1,438,668 5,990,753 $0.71 - $5.15 $2.13
Options granted (725,000) 725,000 $0.92 - $1.31 $1.06
Options exercised -- (597,333) $0.71 - $1.22 $1.17
Options canceled 956,669 (956,669) $0.91 - $2.97 $1.88
----------------- ------------------- ------------------------ ----------------
Balance at May 31, 2004 1,670,337 5,161,751 $0.71 - $5.15 $2.10
================= =================== ======================== ================
F-17
The following table summarizes information about stock options outstanding
and exercisable at May 31, 2004
Options Outstanding Options Exercisable
--------------------------------------------------- --------------------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Outstanding at Contractual Exercise Price Exercisable at Exercise
Range of Exercise Prices May 31, 2004 Life (yrs.) May 31, 2004 Price
- ----------------------------- ------------------ ---------------- --------------- ----------------- --------------
$0.71 - $1.04 2,227,874 6.4 $0.95 1,327,874 $0.88
$1.22 - $1.78 263,250 5.0 $1.68 263,250 $1.68
$1.91 - $2.78 805,127 4.0 $1.97 800,127 $1.97
$2.89 - $4.28 1,697,500 5.3 $3.60 1,471,997 $3.61
$4.59 - $5.15 168,000 6.1 $4.69 168,000 $4.69
------------------ ---------------- --------------- ----------------- --------------
5,161,751 5.6 $2.14 4,031,248 $2.30
================== ================ =============== ================= ==============
The weighted-average fair value of options granted during fiscal years
2004, 2003 and 2002 was $1.06, $0.95 and $2.50, respectively. At May 31, 2004,
there were approximately 11,823,000 remaining authorized shares of common stock
after reserves for all stock option plans, stock warrants and shareholders'
rights.
NOTE L- INCOME TAXES
During the fiscal year ended May 31, 2004, the Company recorded a provision
for state income taxes of $50,640. In fiscal 2003, the Company recorded a
benefit for income taxes of $1,634,688, inclusive of $256,312 in current tax
expense and a deferred benefit of $1,891,000. In fiscal 2002, the Company
recorded an expense for income taxes of $1,554,000, inclusive of $39,000 in
current tax expense and a deferred tax expense of $1,515,000.
As of May 31, 2004, the Company had recorded deferred tax assets of
$14,582,000 (net of a $1,908,000 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. Management
believes that the Company is positioned for long-term growth despite the
financial results achieved during fiscal years 2004 and 2003, and that based
upon the weight of available evidence, that it is "more likely than not" that
the net deferred tax assets will be realized. The "more likely than not"
standard is subjective, and is based upon management's estimate of a greater
than 50% probability that its long range business plan can be realized.
Ultimate realization of any or all of the deferred tax assets is not
assured, due to significant uncertainties associated with estimates of future
taxable income during the carryforward period. The Company's estimates are
largely dependent upon achieving considerable growth resulting from the
successful commercialization of the EECP therapy into the congestive heart
failure indication. Such future estimates of future taxable income are based on
the beliefs of the Company's management, as well as assumptions made by and
information currently available to the Company's management. Certain critical
assumptions associated with the Company's estimates include:
- -- that the results from the PEECH clinical trial will be sufficiently
positive to enable the EECP therapy to obtain approval for a national
Medicare reimbursement coverage policy plus other third-party payer
reimbursement policies specific to the congestive heart failure indication;
- -- that the reimbursement coverage will be both broad enough in terms of
coverage language and at an amount adequate to enable successful
commercialization of the EECP therapy into the congestive heart failure
indication.
Additional 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;
- -- other medical insurance reimbursement policies;
- -- unexpected manufacturing problems;
- -- unforeseen difficulties and delays in the conduct of clinical trials and
other product development programs;
- -- the actions of regulatory authorities and third-party payers in the United
States and overseas;
F-18
- -- 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 amount of the deferred tax assets considered realizable could be
reduced in the future if estimates of future taxable income during the
carryforward period are reduced or if the accounting standards are changed to
reflect a more stringent standard for evaluation of deferred tax assets.
The recorded deferred tax asset includes an increase to the valuation
allowance of $1,286,000 during fiscal year ended May 31, 2004.
The Company's deferred tax assets are summarized as follows:
2004 2003 2002
--------------- --------------- ---------------
Net operating loss and other carryforwards $14,468,000 $13,368,000 $11,344,000
Accrued compensation 118,000 153,000 --
Bad debts 238,000 244,000 493,000
Other 1,666,000 1,439,000 854,000
--------------- --------------- ---------------
Total gross deferred tax assets 16,490,000 15,204,000 12,691,000
Valuation allowance (1,908,000) (622,000) --
--------------- --------------- ---------------
Net deferred tax assets $14,582,000 $14,582,000 $12,691,000
=============== =============== ===============
The deferred tax benefit for fiscal years May 31, 2004, 2003 and 2002 does
not include the tax benefit associated with the current exercises of stock
options and warrants, aggregating $0, $222,000, and $58,000, respectively, which
was credited directly to additional paid-in capital.
At May 31, 2004, the Company had net operating loss carryforwards for
Federal and state income tax purposes of approximately $42,612,000, expiring at
various dates from 2006 through 2022. Expiration of net operating loss
carryforwards are as follows:
Fiscal Year Amount
------------------- --------------
2005 $96,516
2006 336,198
2007 517,934
2008 558,968
2009 470,994
Thereafter 40,630,952
--------------
$42,611,562
==============
Under current tax law, the utilization of tax attributes will be restricted
if an ownership change, as defined, were to occur. Section 382 of the Internal
Revenue Code provides, in general, that if an "ownership change" occurs with
respect to a corporation with net operating and other loss carryforwards, such
carryforwards will be available to offset taxable income in each taxable year
after the ownership change only up to the "Section 382 Limitation" for each year
(generally, the product of the fair market value of the corporation's stock at
the time of the ownership change, with certain adjustments, and a specified
long-term tax-exempt bond rate at such time). The Company's ability to use its
loss carryforwards would be limited in the event of an ownership change.
The following is a reconciliation of the effective income tax rate to the
federal statutory rate:
2004 2003 2002
Amount % Amount % Amount %
--------------- -------- -------------- --------- --------------- --------
Federal statutory rate $(1,146,439) (34.0) $(2,185,000) (34.0) $1,475,000 34.0
State taxes, net 50,640 1.5 34,000 .5 56,000 1.3
Permanent differences 23,839 0.8 33,320 .5 23,000 .5
Utilization of net operating loss -- -- -- -- -- --
Change in valuation allowance
relating to operations 1,286,000 (38.1) 622,000 9.7 -- --
Other (163,400) (4.9) (139,008) (2.1) -- --
--------------- -------- -------------- --------- --------------- --------
$50,640 1.5 $(1,634,688) (25.4) $1,554,000 35.8
=============== ======== ============== ========= =============== ========
F-19
NOTE M - COMMITMENTS AND CONTINGENCIES
Employment Agreements
In October 2002, the Company entered into an employment agreement with its
new President and Chief Operating Officer, Gregory D. Cash. The agreement, which
expired in October 2004, provided 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. In March 2004 this employee resigned to
pursue other business interests and all monetary compensation under the
employment agreement was terminated.
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 active
employment agreements at May 31, 2004 are summarized as follows:
Fiscal Year Amount
------------------- --------------
2005 $250,000
2006 40,685
--------------
$290,685
==============
Leases
The Company leases additional warehouse space under two noncancelable
operating leases, of which one expires on October 31, 2004 and the other on
September 30, 2006. Rent expense was $72,000, $99,000 and $85,000 in fiscal
2004, 2003 and 2002, respectively.
Approximate aggregate minimum annual obligations under these lease
agreements and other equipment leasing agreements at May 31, 2004 are summarized
as follows:
Fiscal Year Amount
------------------- --------------
2005 $76,446
2006 48,189
2007 14,238
--------------
$138,873
==============
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.
Litigation
In June 2001, an action was commenced in the New York Supreme Court, Nassau
County, against the Company by the former holder of a warrant to purchase
100,000 shares of the Company's stock seeking undefined damages based upon a
claim that the Company breached an agreement to register the common shares
underlying the warrant at the "earliest practicable date" after due demand by
the warrant holder had been made. In October 2002, the Company settled this
matter for $600,000 through the execution of an agreement that enables the
Company to satisfy this obligation over a four-year period ($200,000 in fiscal
F-20
2003, $66,500 in fiscal 2004, $133,000 each in fiscal years 2005 and 2006 and
$66,500 in fiscal 2007). Accordingly, the Company recorded a $600,000 charge to
operations in fiscal 2003. In December 2002, the Company paid $200,000 to the
warrant holder pursuant to the terms of the settlement agreement.
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.
401(k) Plan
In April 1997, the Company adopted the Vasomedical, Inc. 401(k) Plan to
provide retirement benefits for its employees. As allowed under Section 401(k)
of the Internal Revenue Code, the plan provides tax-deferred salary deductions
for eligible employees. Employees are eligible to participate in the next
quarter enrollment period after employment. Participants may make voluntary
contributions to the plan up to 15% of their compensation. In fiscal year 2004,
2003 and 2002, the Company made discretionary contributions of approximately $
35,535, $35,000 and $20,000, respectively, to match a percentage of employee
contributions.
NOTE N - SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the Company's unaudited quarterly operating
results for the years ended May 31, 2004 and 2003.
Three months ended
--------------------------------------------------------------------------------------------------
(in 000s except May 31, Feb. 29, Nov. 30, Aug. 31, May 31, Feb. 28, Nov. 30, Aug. 31,
Earnings (loss) per 2004 2004 2003 2003 2003 2003 2002 2002
share data) (a) (c) (b)
- ----------------------- ----------- ----------- ------------- ------------ ----------- ----------- ----------- -----------
Revenues $5,927 $5,950 $4,903 $5,427 $6,488 $7,153 $6,644 $4,539
Gross Profit $3,903 $4,017 $3,210 $3,488 $3,970 $4,383 $4,640 $2,580
Net Earnings (Loss) $(759) $(310) $(2,087) $(267) $14 $26 $(597) $(4,234)
Earnings (loss) per
share - basic $(0.01) $(0.01) $(0.04) $(0.00) $0.00 $0.00 $(0.01) $(0.07)
- diluted $(0.01) $(0.01) $(0.04) $(0.00) $0.00 $0.00 $(0.01) $(0.07)
Weighted average
common shares
outstanding -
- basic 58,384 57,887 57,828 57,827 57,817 57,809 57,658 57,478
- diluted 58,384 57,887 57,828 57,827 58,453 58,078 57,658 57,478
(a) Net Loss for the second quarter of fiscal 2004 was adversely affected by
the write-off of approximately $680 related to significant uncertainties
related to the ability of a major customer to satisfy its financial
obligations to the Company, (see Note E).
(b) Net Loss for the first quarter of fiscal 2003 was adversely affected by the
write-off of approximately $3,000 related to significant uncertainties
related to the ability of a major customer to satisfy its financial
obligations to the Company, (see Note E).
(c) Net Loss for the second quarter of fiscal 2003 was adversely affected by
the settlement of litigation of $600 and approximately $300 in severance
obligations, principally to the Company's former Chief Executive Officer,
(see Note M).
F-21
Vasomedical, Inc. and Subsidiaries
Schedule II - Valuation and Qualifying Accounts
- ------------------------------------------- --------------- ---------------------------- ------------------ -----------------
Column A Column B Column C Column D Column E
- ------------------------------------------- --------------- ---------------------------- ------------------ -----------------
Additions
----------------------------
(1) (2)
Balance at Charged to Charged to
beginning of costs and other Balance at end
period expenses accounts Deductions of period
- ------------------------------------------- --------------- --------------- ------------ ------------------ -----------------
Allowance for doubtful accounts
Year ended May 31, 2004 $768,629 $616,759 $-- $686,185 $699,203
Year ended May 31, 2003 $1,099,687 $1,227,324 $-- (a) $1,558,382 $768,629
Year ended May 31, 2002 $545,000 $954,000 $-- $399,313 $1,099,687
Valuation Allowance- Financing Receivables
Year ended May 31, 2004 $244,994 $680,000 $-- $924,994 $--
Year ended May 31, 2003 $718,879 $-- $473,885 $244,994
Year ended May 31, 2002 $-- $718,879 $-- $-- $718,879
Reserve for obsolete inventory
Year ended May 31, 2004 $280,000 $119,000 $-- $-- $399,000
Year ended May 31, 2003 $180,000 $100,000 $-- $-- $280,000
Year ended May 31, 2002 $150,000 $30,000 $-- $-- $180,000
Valuation Allowance - Deferred Tax Asset
Year ended May 31, 2004 $622,000 $1,286,000 $-- $-- $1,908,000
Year ended May 31, 2003 $-- $622,000 $-- $-- $622,000
Year ended May 31, 2002 $-- $-- $-- $-- $--
Provision for warranty obligations
Year ended May 31, 2004 $788,000 $164,000 $-- $707,083 $244,917
Year ended May 31, 2003 $991,000 $724,000 $-- $927,000 $788,000
Year ended May 31, 2002 $1,055,000 $780,000 $-- $844,000 $991,000
(a) accounts receivable written off, net of $15,000 in recoveries in fiscal 2003
S-1