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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 For the fiscal year ended May 31, 2008
[ ] 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.
(Exact name of small business issuer 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)
Issuer'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)
Check whether the issuer is not required to file reports pursuant to Section 13
or Section 15(d) of the Act.
Yes [ ] No [ X ]
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 [ ]
Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B contained in this Form, and no disclosure will 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-KSB or any
amendment to this Form 10-KSB.
[ X ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [ X ]
State issuer's revenues for its most recent fiscal year. $5,182,768
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant based on the closing sale price of $0.07 as of
August 20, 2008, was approximately $3,943,747. Shares of common stock held by
each officer and director and by each person who owns 5% or more of the
outstanding common stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliates status is not necessarily a
conclusive determination for other purposes.
At August 20, 2008, the number of shares outstanding of the issuer's common
stock was 93,768,004.
DOCUMENTS INCORPORATED BY REFERENCE
Part III - (Items 9, 10, 11, 12 and 14) Registrant's definitive proxy
statement to be filed pursuant to Regulation 14A of the Securities Exchange Act
of 1934.
Transitional Small Business Disclosure Format (check one) Yes [ ] No [X].
{THIS PAGE LEFT INTENTIONALLY BLANK}
INDEX TO FORM 10-KSB
Page
PART I
Item 1. Description of Business...........................................................................1
Item 2. Description of Property..........................................................................24
Item 3. Legal Proceedings................................................................................25
Item 4. Submission of Matters to a Vote of Security Holders..............................................25
PART II
Item 5. Market for Registrant's Common Equity, and Related Stockholder Matters and Small Business
Issuer Purchases of Equity Securities............................................................26
Item 6. Management's Discussion and Analysis or Plan of Operation........................................26
Item 7. Financial Statements.............................................................................41
Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.............41
Item 8A. Controls and Procedures..........................................................................41
Item 8A.(T) Controls and Procedures..........................................................................42
Item 8B. Other Information................................................................................42
PART III
Item 9. Directors, Executive Officers, Promoters, Control Persons and Corporate
Governance; Compliance with Section 16(a) of the Exchange Act....................................43
Item 10. Executive Compensation...........................................................................43
Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ..43
Item 12. Certain Relationships and Related Transactions, and Director Independence........................43
Item 13. Exhibits.........................................................................................43
Item 14. Principal Accountant Fees and Services...........................................................44
Signatures .................................................................................................45
EXHIBITS
Exhibit 23 Consent of Independent Registered Public Accounting Firm........................................E-1
Exhibit 31 Certifications Pursuant to Securities Exchange Act Rule 13A-14(A)/15D-14(A).....................E-2
Exhibit 32 Certification of Periodic Report................................................................E-4
- i -
PART I
ITEM 1 - DESCRIPTION OF BUSINESS
Except for historical information contained in this report, the matters
discussed are forward-looking statements that involve risks and uncertainties.
When used in this report, words such as "anticipates", "believes", "could",
"estimates", "expects", "may", "plans", "potential" and "intends" and similar
expressions, as they relate to the Company or its management, identify
forward-looking statements. Such forward-looking statements are based on the
beliefs of the Company's management, as well as assumptions made by and
information currently available to the Company's management. Among the factors
that could cause actual results to differ materially are the following: the
effect of business and economic conditions; the effect of the dramatic changes
taking place in the healthcare environment; the impact of competitive procedures
and products and their pricing; medical insurance reimbursement policies;
unexpected manufacturing or supplier problems; unforeseen difficulties and
delays in the conduct of clinical trials and other product development programs;
the actions of regulatory authorities and third-party payers in the United
States and overseas; uncertainties about the acceptance of a novel therapeutic
modality by the medical community; and the risk factors reported from time to
time in the Company's SEC reports. The Company undertakes no obligation to
update forward-looking statements as a result of future events or developments.
General Overview
Vasomedical, Inc. was incorporated in Delaware in July 1987. Unless the
context requires otherwise, all references to "we", "our", "us", "Company",
"registrant", "Vasomedical" or "management" refer to Vasomedical, Inc. and its
subsidiaries. Since 1995, we have been primarily engaged in designing,
manufacturing, marketing and supporting EECP(R) enhanced external
counterpulsation systems based on our unique proprietary technology currently
indicated for use in cases of stable or unstable angina (i.e., chest pain),
congestive heart failure (CHF), acute myocardial infarction (i.e., heart attack,
(MI)) and cardiogenic shock. The EECP(R) therapy system is a non-invasive,
outpatient therapy for the treatment of diseases of the cardiovascular system.
The therapy serves to increase circulation in areas of the heart with less than
adequate blood supply and helps to restore systemic vascular function. The
therapy also increases blood flow and oxygen supply to the heart muscle and
other organs and decreases the heart's workload and reduces oxygen demand, while
also improving function of the endothelium, the lining of blood vessels
throughout the body, lessening resistance to blood flow. We provide hospitals,
clinics and physician private practices with EECP(R) equipment, treatment
guidance, and a staff training and equipment maintenance program designed to
provide optimal patient outcomes. EECP(R) is a registered trademark for
Vasomedical's enhanced external counterpulsation therapy and systems. For more
information, visit www.vasomedical.com.
We have Food and Drug Administration (FDA) clearance to market our EECP(R)
therapy for use in the treatment of stable and unstable angina, congestive heart
failure, acute myocardial infarction, and cardiogenic shock; however, our
current marketing efforts are limited to the treatment of chronic stable angina
and congestive heart failure. Medicare and other third-party payers currently
reimburse for the treatment of angina symptoms in patients with moderate to
severe symptoms who are refractory to medications and not candidates for
invasive procedures. Patients with co-morbidities of heart failure, diabetes,
peripheral vascular disease, etc. are also reimbursed under the same criteria,
provided the primary diagnosis and indication for treatment with EECP(R) therapy
is angina symptoms.
During the last two fiscal years ended May 31, 2008 and 2007 we incurred
large operating losses. We attempted to achieve profitability by reducing
operating costs and halting the trend of declining revenues, to reduce cash
usage by bringing our cost structure more into alignment with current revenue by
engaging in restructurings during January 2006, March 2007 and April 2007 to
substantially reduce personnel and spending on sales, marketing and development
projects. In addition, we were seeking to obtain a strategic alliance within the
sales and marketing areas and/or to raise additional capital through public or
private equity or debt financings.
During the first quarter of fiscal year 2008, the following events took
place which allowed us to raise additional capital through a private equity
financing and by the sale of our facility under a leaseback agreement.
1
o On June 21, 2007, we entered into a Securities Purchase Agreement with
Kerns Manufacturing Corp. (Kerns). Concurrently with our entry into
the Securities Purchase Agreement, we also entered into a Distribution
Agreement and a Supplier Agreement with Living Data Technology
Corporation, an affiliate of Kerns (Living Data).
We sold to Kerns, pursuant to the Securities Purchase Agreement,
21,428,572 shares of our common stock at $.07 per share for an
aggregate of $1,500,000, as well a five-year warrant to purchase
4,285,714 shares of our common stock at an initial exercise price of
$.08 per share (the Warrant). The agreement further provided for the
appointment to our Board of Directors of two representatives of Kerns.
In furtherance thereof, Mr. Jun Ma and Mr. Simon Srybnik, Chairman of
both Kerns and Living Data, have been appointed members of our Board
of Directors. Pursuant to the Distribution Agreement, we have become
the exclusive distributor in the United States of the AngioNew ECP
systems manufactured by Living Data. As additional consideration for
such agreement, we agreed to issue an additional 6,990,840 shares of
our common stock to Living Data. Pursuant to the Supplier Agreement,
Living Data now is the exclusive supplier to us of the ECP therapy
systems that we market under the registered trademark EECP(R). The
Distribution Agreement and the Supplier Agreement each have an initial
term extending through May 31, 2012.
Pursuant to a Registration Rights Agreement, we granted to Kerns and
Living Data, subject to certain restrictions, "piggyback registration
rights" covering the shares sold to Kerns, as well as the shares
issuable upon exercise of the Warrant and the shares issued to Living
Data.
o On August 15, 2007, we sold our facility under a five-year leaseback
agreement for $1.4 million. The net proceeds from the sale were
approximately $425,000 after payment in full of the two secured notes
on our facility, brokers fees, closing costs, and the opening of a
certificate of deposit in accordance with the provisions of the new
lease.
Market Overview
Cardiovascular disease (CVD) is the leading cause of death in the world and
is among the top three diseases in terms of healthcare spending in nearly every
country. CVD claimed approximately 2.4 million lives in the United States in
2003 and was responsible for 1 of every 2.7 deaths, according to The American
Heart Association (AHA) Heart and Stroke Statistical 2006 Update (2006 Update).
Approximately 71.3 million Americans suffer from some form of cardiovascular
disease. Among these, 12.0 million have coronary heart disease (CHD).
We have Food and Drug Administration (FDA) clearance to market our EECP(R)
therapy for use in the treatment of stable and unstable angina, congestive heart
failure, acute myocardial infarction, and cardiogenic shock; however, our
current marketing efforts are limited to the treatment of chronic stable angina
and congestive heart failure. Medicare and other third-party payers currently
reimburse for the treatment of angina symptoms in patients with moderate to
severe symptoms who are refractory to medications and not candidates for
invasive procedures. Patients with co-morbidities of heart failure, diabetes,
peripheral vascular disease, etc. are also reimbursed under the same criteria,
provided the primary diagnosis and indication for treatment with EECP(R) therapy
is angina symptoms.
We will continue to educate the marketplace that EECP(R) therapy is a
therapy for ischemic cardiovascular disease and that patients with a primary
diagnosis of heart failure, diabetes or peripheral vascular disease are also
eligible for reimbursement under the current coverage policy, provided the
primary indication for treatment with EECP(R) therapy is angina or angina
equivalent symptoms and the patient satisfies other listed criteria.
Additionally, we will continue to pursue expansion of coverage for EECP(R)
therapy with Medicare and other third-party payers as evidence of its clinical
utility develops.
2
Angina
Angina pectoris is the medical term for a recurring pain or discomfort in
the chest due to coronary artery disease (CAD). Angina is a symptom of a
condition called myocardial ischemia, which occurs when the heart muscle or
myocardium doesn't receive sufficient blood, hence as much oxygen, as it needs.
This usually happens because one or more of the heart's arteries, the blood
vessels that supply blood to the heart muscle, is narrow or blocked.
Insufficient blood supply to meet the need of the organ to function is called
ischemia.
The cardinal symptom of stable CAD is anginal chest pain or equivalent
symptoms, such as exertional dyspnea or fatigue. Angina is uncomfortable
pressure, fullness, squeezing or pain, usually occurring in the center of the
chest under the breastbone. The discomfort also may be felt in the neck, jaw,
shoulder, back or arm. Often the patient suffers not only from the discomfort of
the symptom itself but also from the accompanying limitations on activities and
the associated anxiety that the symptoms may produce. Uncertainty about
prognosis may be an additional source of anxiety. For some patients, the
predominant symptoms may be palpitations or syncope that is caused by
arrhythmias or fatigue, edema, or orthopnea caused by heart failure. Episodes of
angina occur when the heart's need for oxygen increases beyond the oxygen
available from the blood nourishing the heart. Physical exertion is the most
common trigger, but not the only one for angina. For example, running to catch a
bus could trigger an attack of angina while walking might not. Angina may happen
during exercise, periods of emotional stress, exposure to extreme cold or heat,
heavy meals, alcohol consumption or cigarette smoking. Some people, such as
those with a coronary artery spasm, may have angina when they are resting.
There are approximately 6.4 million angina patients in the United States
and our EECP(R) therapy currently competes with other technologies in the market
for approximately 100,000 to 150,000 new refractory angina patients annually who
do not adequately respond to or are not amenable to medical and surgical therapy
and have the potential to meet the guidelines for reimbursement of EECP(R)
therapy. Most angina patients are treated with medications, including beta
blockers to slow and protect the heart and vasodilators, which are often
prescribed to increase blood flow to the coronary arteries. When drugs fail or
inadequately correct the problem, the patients are considered unresponsive to
medical therapy. Most angina patients are readily amenable to invasive
revascularization procedures such as angioplasty and coronary stent placement,
as well as coronary artery bypass grafting (CABG). However, there are
approximately 130,000 angina patients each year whose angina can not be stopped
by medication and they are no longer readily amenable to palliative invasive
procedures.
In February 1999, the Centers for Medicare and Medicaid Services (CMS), the
federal agency that administers the Medicare program for more than 39 million
beneficiaries, issued a national coverage policy for the use of external
counterpulsation therapy in the treatment of angina. Medicare reimbursement
guidelines have a significant impact in determining the available market for
EECP(R) therapy. We believe that over 65% of the patients that receive EECP(R)
therapy are Medicare patients and many of the third-party payers follow Medicare
guidelines, which limit reimbursement for EECP(R) therapy to patients who do not
adequately respond to or are not amenable to medical therapy and are not readily
amenable to invasive therapy. As a result, an important element of our strategy
is to grow the market for EECP(R) therapy by expanding reimbursement coverage to
include a broader range of angina patients than the current coverage policy
provides and enable EECP(R) therapy to compete more with other therapies for
ischemic heart disease. Please see the heading "Reimbursement" in the "Item-1
Business" section of this Form 10-KSB for a more detailed discussion of
reimbursement issues.
Congestive Heart Failure
CHF is a condition in which the heart loses its full pumping capacity to
supply the metabolic needs of all other organs. The condition affects both sexes
and is most common in people over age 50. Symptoms include angina, shortness of
breath, weakness, fatigue, swelling of the abdomen, legs and ankles, rapid or
irregular heartbeat and low blood pressure. Causes range from chronic high blood
pressure, heart-valve disease, heart attack, coronary artery disease, heartbeat
irregularities, severe lung disease such as emphysema, congenital disease,
cardiomyopathy, hyperthyroidism, severe anemia and others.
CHF is treated with medication and, sometimes, surgery on heart valves or
the coronary arteries and, in certain severe cases, heart transplants. Left
ventricular assist devices (LVADs) and the use of cardiac resynchronization and
3
implantable defibrillators are useful in selected patients with heart failure.
Still, no consensus therapy currently exists for CHF and patients must currently
suffer their symptoms chronically and have a reduced life expectancy.
According to the 2006 Update, in 2003 approximately 2.4 million men and 2.6
million women in the United States had CHF and about 550,000 new cases of the
disease occur each year. Deaths caused by the disease increased 20.5% from 1993
to 2003. The prevalence of the disease is growing as a result of the aging of
the population and the improved survival rate of people after heart attacks.
Because the condition frequently entails visits to the emergency room and
in-patient treatment centers, two-thirds of all hospitalizations for people over
age 65 are due to CHF. The economic burden of congestive heart failure is
enormous with an estimated cost to the health care system in 2005 in the United
States of $29.6 billion. Congestive heart failure offers a good strategic fit
with our current angina business and offers an expanded market opportunity for
EECP(R) 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(R) Patient Registry(TM) (IEPR) at the University of
Pittsburgh Graduate School of Public Health shows that approximately one-third
of angina patients treated with EECP(R) also have a history of CHF and 70% to
80% have demonstrated positive outcomes from EECP(R) therapy.
We sponsored a pivotal, randomized clinical trial to demonstrate the
efficacy of EECP(R) therapy in the most prevalent types of heart failure
patients. This trial, known as PEECH(TM) (Prospective Evaluation of EECP(R) in
Congestive Heart Failure), was intended to provide additional evidence of the
safety and efficacy of EECP(R) therapy in the treatment of mild-to-moderate
heart failure and to support our application for expansion of the Medicare
national reimbursement coverage policy to include mild-to-moderate heart failure
as a primary indication. The PEECH(TM) trial was a positive clinical trial,
having met the statistical requirement of meeting at least one of its co-primary
endpoints, a significant difference in the proportion of patients satisfying a
prespecified threshold of improvement in exercise duration. The trial also
demonstrated significant improvements in favor of EECP(R) therapy on several
important secondary endpoints, including exercise duration and improvement in
symptom status and quality of life. Measures of change in peak oxygen
consumption were not statistically significant in the overall study population,
though a trend favoring EECP(R) therapy was present in early follow-up. Patients
in the trial who had an ischemic etiology (i.e. pre-existing coronary artery
disease), demonstrated a greater response to EECP(R) therapy than those who had
an idiopathic (non-ischemic) etiology.
The preliminary results of the PEECH(TM) trial were presented at the
American College of Cardiology scientific sessions in March 2005. On June 20,
2005, CMS accepted our application for expansion of reimbursement coverage of
EECP(R) therapy to include patients with New York Heart Association (NYHA) Class
II/III stable heart failure symptoms with an ejection fraction of less than or
equal to 35% (i.e. chronic, stable, mild-to-moderate systolic heart failure as a
primary indication), as well as patients with Canadian Cardiovascular Society
Classification (CCSC) II (i.e. chronic, stable mild angina).
On June 23, 2005, CMS also received a request from a competing manufacturer
of external counterpulsation therapy equipment to reconsider the reimbursement
coverage policy. They requested expansion of coverage to include 1) treatment of
congestive heart failure, to include NYHA Class II, III with a left ventricular
ejection fraction (LVEF) less than or equal to 40%, and acute heart failure; 2)
treatment of stable angina to include CCSC II angina; 3) treatment of acute
myocardial infarction; and 4) treatment of cardiogenic shock. On September 15,
2005, they amended their request to include NYHA Class IV heart failure.
On March 20, 2006, CMS issued their Decision Memorandum regarding this
reconsideration with the opinion "that the evidence is not adequate to conclude
that external counterpulsation therapy is reasonable and necessary for the
treatment of:
o CCSC II angina
o Heart Failure
o NYHA Class II/III stable heart failure symptoms with an ejection
fraction of less than or equal to 35%
o NYHA Class II/III stable heart failure symptoms with an ejection
fraction of less than or equal to 40%
o NYHA Class IV heart failure
o Acute heart failure
o Cardiogenic shock
4
o Acute myocardial infarction."
They commented in their decision memorandum that they were not able to
apply full weight to the evidence generated by the PEECH(TM) trial as it had not
yet been published in a peer-reviewed medical journal by the time they were
required to issue a final decision on this application. Moreover, they did not
opine on whether they would consider the results of the trial when published to
be sufficient evidence to conclude that external counterpulsation therapy is
reasonable and necessary for the treatment of NYHA Class II/III stable heart
failure symptoms with an ejection fraction of less than or equal to 35%. They
did, however, reiterate in the decision memorandum that "Current coverage as
described in Section 20.20 of the Medicare National Coverage Determination (NCD)
manual will remain in effect" for refractory angina patients.
On August 25, 2006 the results of the trial were initially published online
by the Journal of the American College of Cardiology (JACC) and in print in its
September 19, 2006 issue. JACC is the official journal of the American College
of Cardiology.
In the November-December issue of the journal Congestive Heart Failure, a
second report of results from the PEECH(TM) trial was published, focusing on the
results of a prespecified subgroup analysis in trial patients age 65 and over.
This analysis demonstrated a statistically positive response on both co-primary
endpoints of the trial in patients receiving EECP(R) therapy versus those who
did not, i.e. a significantly larger proportion of patients undergoing EECP(R)
therapy met or exceeded prespecified thresholds of improvement in exercise
duration and peak oxygen consumption. Moreover, the patients age 65 and older
who received EECP(R) therapy demonstrated the greatest differences in exercise
duration, peak oxygen consumption and functional class (symptom status) compared
with those who did not receive EECP(R) therapy.
These papers were submitted to CMS and we were advised to continue to
gather more clinical evidence for future submission.
We will continue to educate the marketplace that EECP(R) therapy is a
therapy for ischemic cardiovascular disease and that patients with a primary
diagnosis of heart failure, diabetes, peripheral vascular disease, etc. are also
eligible for reimbursement under the current coverage policy, provided the
primary indication for treatment with EECP(R) therapy is angina or angina
equivalent symptoms and the patient satisfies other listed criteria.
Additionally, we will continue to pursue expansion of coverage for EECP(R)
therapy with Medicare and other third-party payers as evidence of its clinical
utility develops.
The EECP(R) Therapy Systems
The EECP(R) therapy systems are noninvasive treatment systems utilizing
fundamental hemodynamic principles to augment coronary blood flow and, at the
same time, reduce the workload of the heart while improving the overall vascular
function. The treatment is completely noninvasive and is administered to
patients on an outpatient basis, usually in daily one-hour sessions, five days
per week over seven weeks for a total of 35 treatments. The procedure is well
tolerated and most patients begin to experience relief of chest pain due to
their coronary artery disease after 15 to 20 hours of therapy. As demonstrated
in our clinical studies, positive effects have been shown in most patients to
continue for years following a full course of therapy.
During EECP(R) therapy, the patient lies on a contoured treatment table
while three sets of inflatable pressure cuffs, resembling oversized blood
pressure cuffs, are wrapped around the calves, and the lower and upper thighs,
including the buttocks. The system is synchronized to the individual patient's
cardiac cycle triggering the system to inflate the cuffs rapidly and
sequentially -- via computer-interpreted ECG signals -- starting from the calves
and proceeding upward to the buttocks during the relaxation phase of each
heartbeat (diastole). This has the effect of creating a strong retrograde
arterial wave in the arterial system, forcing freshly oxygenated blood towards
the heart and coronary arteries at a time when resistance to coronary blood flow
is at its lowest level. The inflation of cuffs also simultaneously increases the
volume of venous blood that is returned to the heart when the heart is filling
up for ejection in the contracting phase. Just prior to the next heartbeat when
the heart begins to eject blood by contracting (systole), all three cuffs
5
simultaneously deflate, leaving an empty vascular space to receive blood
ejecting from the heart, thereby significantly reducing the workload of the
heart. This is achieved because the vascular beds in the lower extremities are
relatively empty when the cuffs are deflated, significantly lowering the
resistance, and provide vascular space to receive the blood ejected by the
heart, reducing the amount of work the heart must do to pump oxygenated blood to
the rest of the body. The inflation/deflation activity is monitored constantly
and coordinated by a computerized console that interprets electrocardiogram
signals from the patient's heart, monitors heart rhythm and rate information,
and actuates the inflation and deflation in synchronization with the cardiac
cycles. The end result of this sequential "squeezing" of the legs is to create a
pressure wave that significantly increases peak diastolic pressure benefiting
circulation to the heart muscle and other organs, increases venous return so
that the heart has more blood volume to eject out, and increases cardiac output.
The release of external pressure produces reduction of systolic pressure,
thereby reducing the workload of the heart. This reduction of vascular
resistance insures that the heart does not have to work as hard to pump large
amounts of blood through the body to help supply its metabolic needs.
While the precise scientific means by which EECP(R) therapy achieves its
long-term beneficial effects are only partially explained, there is evidence to
suggest that the EECP(R) therapy triggers a neurohormonal response that induces
the production of growth and vasodilatation factors that promotes recruitment of
new arteries and dilates existing blood vessels. The recruitment of new arteries
known as "collateral blood vessels" bypass blocked or narrowed vessels and
increase blood flow to ischemic areas of the heart muscle that are receiving an
inadequate supply of blood. There is also evidence to support a mechanism
related to improved function of the endothelium (the inner lining of the blood
vessels), which regulates the luminal size of the arteries and controls the
dilation of the arteries to insure adequate blood flow to all organs, thus
reducing constriction of blood vessels that supply oxygenated blood to the
body's organs and tissues and as a result the required workload of the heart.
Clinical Studies
Early History
Early experiments with counterpulsation at Harvard in the 1950s
demonstrated that this technique markedly reduces the workload, and thus oxygen
consumption, of the left ventricle. This basic effect has been demonstrated over
the past forty years in both animal experiments and in patients. The clinical
benefits of external counterpulsation were not consistently achieved in early
studies because the equipment used then lacked some of the features found in the
current EECP(R) systems, such as the computerized electrocardiographic signal
for triggering, and the use of pneumatic versus hydraulic actuating media that
makes sequential cuff inflation possible. As the technology improved, however,
it became apparent that both internal (i.e. intra-aortic balloon pumping) and
external forms of counterpulsation were capable of improving survival in
patients with cardiogenic shock following myocardial infarction. Later, in the
1980s, Dr. Zheng and colleagues in China reported on their extensive experience
in treating angina using the newly developed "enhanced" sequentially inflating
EECP(R) device that incorporated three sets of cuffs including the buttocks cuff
instead of a single cuff used in the previous system. The Chinese investigators
were able to show that a 36-hour course of treatment with the EECP(R) system
reduced the frequency and severity of anginal symptoms during normal daily
functions and also during exercise, and also that the improvements were
sustained for years after therapy.
These results prompted a group of investigators at the State University of
New York at Stony Brook (Stony Brook) to undertake a number of open label
studies with the EECP(R) system between 1989 and 1996 to reproduce the Chinese
results, using both subjective and objective endpoints. These studies, though
open label and non-randomized, showed significant improvement in exercise
tolerance by patients as evidenced by exercise treadmill stress testing,
improvement in the perfusion of ischemic regions of the heart muscle by thallium
radionuclide imaging stress testing, and partial or complete resolution of
coronary perfusion defects. All of these results have been reported in medical
literature and support the assertion that EECP(R) therapy is an effective and
durable treatment for patients suffering from chronic angina pectoris.
The MUST-EECP(R) Study
In 1995, we began a randomized, controlled and double-blinded multicenter
clinical study (MUST-EECP(R)) at seven leading university hospitals in the
United States to confirm the patient benefits observed in the open studies
conducted at Stony Brook and to provide definitive scientific evidence of
EECP(R) therapy's effectiveness. MUST-EECP(R) 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(R) were published in the Journal of the American College of
Cardiology (JACC), a major peer-review medical journal, in June 1999.
6
This 139 patient study, which included a sham-EECP(R) control group,
demonstrated that patients treated with EECP(R) therapy were able to increase
the amount of time on exercise testing before they showed signs of cardiac
ischemia (i.e. ST-segment depression on their electrocardiogram) and experienced
a reduction in the frequency of their angina attacks compared to patients who
did not receive EECP(R) therapy. In 1999, physician collaborators completed a
quality-of-life study with the EECP(R) system in a subset of the same patients
that participated in MUST-EECP(R). Two highly regarded standardized means of
measurement were used to gauge changes in patients' outlook and ability to
participate in normal daily living during the treatment phase and for up to 12
months after treatment. Results of this study, which have been presented at
major scientific meetings and published in the January 2002 Journal of
Investigative Medicine, show that after one-year of follow-up the group of
patients receiving EECP(R) therapy enjoyed significantly improved aspects of
health-related quality of life compared to those who received a sham treatment.
The PEECH(TM) Study
As part of our program to expand the therapy's indications for use beyond
the treatment of angina, we applied for and received FDA approval in April 1998
to study, under an Investigational Device Exemption (IDE) protocol, the
application of EECP(R) therapy in the treatment of CHF. A 32 patient feasibility
study was conducted simultaneously at the University of Pittsburgh, the
University of California San Francisco and the Grant/Riverside Methodist
Hospitals in Columbus, Ohio. The results of this study were presented at the
49th Scientific Sessions of the American College of Cardiology in March 2000 and
the Heart Failure Society of America's Annual Meeting in September 2000 and were
published in the July/August 2002 issue of Congestive Heart Failure. This study
indicated that EECP(R) therapy could improve exercise capacity, increase
functional capacity was beneficial to left ventricular function in patients with
NYHA Class II and III (i.e. mild to moderate) heart failure and a reduced left
ventricular ejection fraction (i.e. LVEF = 35% or less).
In summer 2000, an IDE supplement to proceed with a pivotal study to
demonstrate the efficacy of EECP(R) therapy in the most prevalent types of heart
failure patients was approved. This study, known as PEECH(TM), began patient
enrollment in March 2001. The PEECH(TM) clinical trial involved nearly thirty
centers including: the Cleveland Clinic, Mayo Clinic, Scripps Clinic, Thomas
Jefferson University Hospital, the University of North Carolina at Chapel Hill,
the Minnesota Heart Failure Consortium, Advocate Christ Hospital, Hull Infirmary
(UK), the University of California at San Diego Medical Center, the University
of Pittsburgh Medical Center, the Lindner Clinical Trial Center and the
Cardiovascular Research Institute. Vasomedical obtained 510(k) clearance for CHF
from FDA in June 2002, obviating the need to continue this trial for FDA
regulatory reasons. However, we decided to complete the clinical trial in order
to use the anticipated clinical outcomes to help establish the clinical
validation of EECP(R) therapy as a treatment for CHF and to provide additional
scientific support for Medicare, Medicaid and other third-party payers to expand
reimbursement coverage of EECP(R) therapy to include the CHF indication.
The protocol for the study required that patients have NYHA II or III
symptoms, have an LVEF of 35% or less, be able to undergo exercise testing and
complete patient examinations 1-week, 3-months and 6-months following treatment
that evaluated changes from baseline in exercise capacity, symptom status and
quality of life. Patients were randomized to receive either optimal (i.e.
guideline-recommended) pharmaceutical therapy (OPT) or EECP(R) therapy in
addition to OPT. Enrollment of patients into the PEECH(TM) trial was completed
in February 2004, with 187 patients, and the six-month follow-up examinations
were completed by the end of December 2004.
The preliminary results of the PEECH(TM) trial were presented at the
American College of Cardiology scientific sessions in March 2005. On June 20,
2005, CMS accepted our application for expansion of reimbursement coverage of
EECP(R) therapy to include patients with NYHA Class II/III stable heart failure
symptoms with an ejection fraction of less than or equal to 35%, (i.e., chronic,
stable, mild-to-moderate systolic heart failure as a primary indication), as
well as patients with CCSC II, (i.e., chronic, stable mild angina).
In designing the PEECH(TM) trial, success was demonstrated if the
difference between EECP(R) therapy combined with OPT compared to OPT alone
achieved a p-value less than 0.025 in at least one of two pre-defined co-primary
endpoints:
7
1. percentage of subjects with greater than or equal to 60 seconds
improvement in exercise duration from baseline to six months, or
2. percentage of subjects with at least 1.25 mL/kg/min increase in peak
oxygen consumption from baseline to six months.
Additional secondary endpoints were actual changes in exercise duration and
peak oxygen consumption, changes in NYHA functional classification, changes in
quality of life, adverse experiences and pre-defined clinical outcomes.
The study was a positive clinical trial on the basis that a significantly
greater proportion of patients who underwent EECP(R) therapy improved their
exercise duration by 60 seconds or more six months following completion of
therapy compared to those who received OPT alone (35.4% vs. 25.3%, p=0.016). The
proportion of patients achieving a 1.25 mL/kg/min improvement in peak oxygen
consumption was not significantly different between the two groups at six
months.
Consistent with the results on the primary endpoint of exercise duration,
statistically significant differences favoring the EECP(R)-treated group were
seen in changes in average exercise duration, symptom status and quality of life
during follow-up. Average peak oxygen consumption showed a trend favoring the
EECP(R) group at 1 week, but there were no differences detected at later
follow-up. Results in patients with heart failure of ischemic etiology were
noted to be clearly superior to those patients of idiopathic etiology though the
benefit in these later patients could not be ruled out statistically. Lastly,
EECP(R) therapy was deemed safe and well tolerated in this group of patients, as
patients in the EECP(R)-treated group did not suffer more adverse events than
those in the control group.
Moreover, results of a predefined subgroup analysis showed that patients 65
years of age or older not only had a significantly greater response rate
(co-primary endpoint) and average change in exercise duration favoring
EECP(R)-treated patients, but the response rate (co-primary endpoint) and
average change in peak oxygen consumption were also significantly better out to
completion of the study at six months follow-up.
The results of the PEECH(TM) trial indicate that EECP(R) therapy provides
beneficial adjunctive therapy in patients with NYHA Class II-III systolic heart
failure receiving optimal pharmacological therapy, especially in those 65 years
of age or older. There can be no assurance that the results of the PEECH(TM)
clinical trial will be sufficient to expand reimbursement coverage or the
adoption by the medical community of EECP(R) therapy for use in the treatment of
congestive heart failure.
The International EECP(R) Patient Registry (IEPR(TM))
The International EECP(R) Patient Registry at the University of Pittsburgh
Graduate School of Public Health was established in January 1998 to track the
outcomes of angina patients who have undergone EECP(R) therapy. More than one
hundred centers have participated in the registry and data from more than 5,000
patients from an initial cohort enrolled between 1998 and 2001 (IEPR-1) have
been tabulated and reported in several peer-reviewed publications.
The American Journal of Cardiology published a report in February of 2004
on the two-year outcomes after EECP(R) therapy observed in 1,097 patients with
two-year follow-up enrolled in IEPR-1. The authors noted that 73% of patients in
this cohort had a decrease in their angina symptom status upon completion of
EECP(R) therapy and that the average number of angina episodes for the group was
reduced from 10.6 to 2.8 per week. They characterized this improvement as a
"significant and dramatic reduction in CCSC" and stated that the adverse
clinical event rate was low. (CCSC is a rating scale used by physicians to
assess the limitations imposed on patients' lives by angina.) Patients also
reported improvement in health status, quality of life and satisfaction with
life.
At two-years follow-up, 74.9% of patients reported their angina symptom
status (CCSC class) was improved compared to before EECP(R) therapy, and the
accompanying improvements in angina frequency and quality of life measures were
largely sustained as well. Nine percent of patients had died over the two-year
follow-up and 15% had undergone a revascularization procedure (angioplasty,
stenting or coronary bypass surgery).
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The authors summarize the results by stating "Most patients experienced a
significant reduction in angina and improvement in quality of life after EECP(R)
therapy, and this reduction was sustained in most patients at 2-year follow-up."
In a separate report that appeared in The American Journal of Cardiology in
2005, physician investigators participating in the IEPR(TM) reported on the
results of EECP(R) therapy in patients with angina who also had severe left
ventricular dysfunction (LVD, a reduced pumping capacity of the heart).
Previously it was thought that such patients, and those with a diagnosis of
heart failure, would be put at risk if treated with EECP(R) therapy, due to the
increase in venous return to the heart caused by compression of the leg veins by
enhanced external counterpulsation.
The 363 patients in this cohort had long-standing and extensive coronary
artery disease, had a high prevalence of cardiovascular disease risk factors,
were not amenable to invasive revascularization procedures, and suffered from
severe angina. Following completion of EECP(R) treatment, 77% decreased their
CCSC angina class by at least one severity rating. The average number of angina
episodes per week was greatly reduced and many were able to discontinue the use
of nitroglycerin pills designed to relieve angina. As in the overall IEPR
population, measures of quality of life were significantly improved after
treatment.
The rate of major adverse clinical events, while somewhat more frequent in
this group of patients with significant comorbid disease, was characterized as
low over the course of EECP(R) therapy. Exacerbation of heart failure was
significantly more frequent in patients who did not complete therapy compared to
those who did (16% vs. 0%) in patients with a previous history of heart failure.
At two-years of follow-up, 83% remained alive and 70% were free of death,
heart attack or invasive revascularization procedures (coronary artery bypass
surgery, angioplasty and/or stenting) during that period. The majority of
patients experienced sustained relief of their angina and improved quality of
life. Twenty per cent of the group underwent repeat EECP(R) therapy during the
two-year follow-up, mostly due to failure to complete the original course of
therapy.
A second phase of enrollment into the registry (IEPR-2) enrolled
approximately 2,500 patients between 2002 and 2004 and these patients were
followed to 2-year follow-up. IEPR-2 incorporated sub-studies regarding
treatment beyond 35 hours, possible predictors of response, effects on certain
aspects of peripheral vascular disease and sexual dysfunction in men. Notably,
the data set was modified in February 2003 to capture information on changes in
heart failure symptom status, occurrence of clinical events due to heart failure
and to include a heart failure-specific quality of life questionnaire in IEPR-2
patients with concomitant heart failure.
Vasomedical considers the IEPR(TM) to be a vital source of information
about the effectiveness and safety of EECP(R) therapy in a real-world
environment for the medical community at large. To date, twenty full-length
articles reporting data from the IEPR(TM) have been published in peer-reviewed
medical journals and more than seventy-eight abstracts have been presented at a
variety of major cardiovascular scientific conferences. For this reason, we
continue to provide an ongoing grant to fund the analysis of the registry data
to be published in medical journals.
Registry data, while considered a valuable source of complementary clinical
data, is deemed by scientific cardiologists and others to be less convincing
than data from randomized, blinded, clinical trials and from certain other
well-controlled clinical study designs. There can be no assurance that the
Company will be able to obtain regulatory, reimbursement or other types of
approvals, or a favorable standing in medical professional practice guidelines,
based upon results observed in patients enrolled in registries.
Other studies and publications
A search on the term "external counterpulsation" of the PubMed database
available through the National Library of Medicine conducted on August 21, 2006,
identified one-hundred-ninety-eight (198) citations of articles published in the
medical scientific literature, including 28 review articles. Over 99% of these
publications have reported results in patients with chronic stable angina and/or
heart failure treated with EECP(R) therapy, while others have reported use of
the device in other cardiovascular or non-cardiovascular indications. The vast
majority of these reports are generated using Vasomedical EECP(R) therapy
systems and equipment. In summary, this body of literature contains evidence
9
from a variety of institutions and investigators demonstrating that EECP(R)
therapy can provide benefit to appropriate patients in the following ways:
o Enhancement of coronary and peripheral circulation, myocardial
perfusion, ventricular function and hemodynamics,
o Improvement in endothelial function and vascular reactivity
o Elimination or reduction of cardiac ischemia,
o Elimination or reduction in symptoms and improved functional class in
angina and heart failure,
o Resolution of reversible ischemic defects found on quantitative
myocardial perfusion studies,
o Increased exercise duration and increased time to ischemic changes
during treadmill exercise in angina and increased exercise duration
and peak oxygen consumption in heart failure in properly selected
patients,
o Elimination or reduction in use of anti-angina medications,
o Improved quality of life in patients with angina and heart failure.
Strategic Initiatives
Our short-and long-term plans are to:
a) Maintain our cost structure alignment with current revenues in the
short term by:
i) continuing to monitor, reduce, or eliminate spending on all but
critical new product development and clinical research projects,
ii) focusing on rebuilding our revenue base through supporting our
direct sales effort and expanding our use of independent sales
representatives, and
iii) maintaining tight cost control on all areas of personnel cost and
spending.
b) Pursue possible strategic investments and creative partnerships with
others who have distinctive competencies or delivery capabilities for
serving the cardiovascular and disease management marketplace, as
opportunities become available.
c) Increase market penetration in the domestic reimbursable user base for
EECP(R) therapy by:
i) expanding reimbursement to include coverage for the treatment of
ischemic NYHA Class II and III CHF patients,
ii) marketing directly to third-party payers to increase third-party
reimbursement, and
iii) expanding reimbursement coverage in the angina market to include
patients with CCS Class II angina.
d) Increase the clinical and scientific understanding of EECP(R) therapy
by:
i) resubmitting data to insurers, including Medicare, for favorable
coverage policies;
ii) continuing to support on a limited basis academic reference
centers in the United States and overseas in order to accelerate
the growth and prestige of EECP(R) therapy and
e) Increase awareness of the benefits of the EECP(R) therapy in the
medical community by:
i) developing campaigns to market the benefits of EECP(R) 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(R)
therapy; and
iii) continuing the development of EECP(R) therapy in certain
international markets, principally through the expansion of our
distribution network and obtaining of reimbursement approvals.
f) Maintain development efforts to improve the EECP(R) system and expand
its intellectual property estate by filing for additional patents in
the United States and other countries.
These listed strategic objectives are forward-looking statements. We
review, modify and change our strategic objectives from time to time based upon
changing business conditions. There can be no assurance that we will be able to
achieve our strategic objectives and even if these results are achieved risks
and uncertainties could cause actual results to differ materially from
anticipated results. To a large extent, limited financial resource availability
reduces our ability to achieve these strategic objectives. Please see the
section of this Form 10-KSB entitled "Risk Factors" for a description of certain
risks, among others that may cause our actual results to vary from the
forward-looking statements.
10
Sales and Marketing
Domestic Operations
We sell EECP(R) therapy systems to treatment providers such as hospitals,
clinics and physician private practices in the United States through a direct
and indirect sales force. Our sales force has consisted of a combination of
employees and independent sales representatives managed by a vice president of
sales plus in-house administrative support.
The efforts of our sales organization are further supported by clinical
educators who are responsible for the onsite training of physicians and
therapists as new centers are established. This clinical applications group is
also engaged in training and certification of new personnel at each site, as
well as for updating providers on new clinical developments relating to EECP(R)
therapy.
Our marketing activities support physician education and physician outreach
programs, exhibition at national, international and regional medical
conferences, as well as sponsorship of seminars at professional association
meetings. These programs are designed to support our field sales organization
and increase awareness of EECP(R) therapy in the medical community. Additional
marketing activities include creating awareness among third-party payers of the
benefits of EECP(R) treatment for patients suffering from CHF as well as angina.
We employ service technicians responsible for the repair and maintenance of
EECP(R) systems and, in some instances, on-site training of a customer's
biomedical engineering personnel. We provide a service arrangement (usually one
year) that includes: service by factory-trained service representatives,
material and labor costs, emergency and remedial visits, software upgrades,
technical phone support and preferred response times. We service our customers
after the service arrangement expires either under separately purchased annual
service contracts or on a fee-for-service basis.
International Operations
We distribute our product internationally through a network of independent
distributors. It has generally been our policy to appoint distributors with
exclusive marketing rights to EECP(R) therapy systems in their respective
countries, in exchange for their commitment to meet the duties and
responsibilities required of a distributor. Each distribution agreement contains
a number of requirements that must be met for the distributor to retain
exclusivity, including minimum performance standards. In most cases,
distributors must assist us either to obtain an FDA-equivalent marketing
clearance, country registration or to establish confirmatory clinical trials,
conducted by local key opinion leaders in cardiology, required to obtain
Ministry of Health approval, certification or reimbursement. Each distributor is
responsible for registering the product and obtaining any required regulatory or
clinical approvals, supporting local reimbursement efforts for EECP(R) therapy
and maintaining an infrastructure to provide post-sales support.
Revenues from international operations is 16% of total revenue for the
fiscal years ended May 31, 2008 and 2007. 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(R) therapy by
clinicians.
International sales may be subject to certain risks, including
export/import licenses, tariffs, other trade regulations and local medical
regulations. Tariff and trade policies, domestic and foreign tax and economic
policies, exchange rate fluctuations and international monetary conditions have
not significantly affected our business to date. In addition, there can be no
assurance that we will be successful in maintaining our existing distribution
agreements or entering into any additional distribution agreements, or that our
international distributors will be successful in marketing EECP(R) therapy.
11
Competition
Presently, we are aware of at least five direct competitors with an
external counterpulsation device on the market. In addition, other companies
have received FDA 510(k) clearance for external counterpulsation systems since
1998, although we have not seen these systems commercially in the marketplace.
While we believe that these competitors' involvement in the market is limited,
there can be no assurance that these companies will not become a significant
competitive factor or that other companies will not enter the external
counterpulsation market.
We view other companies engaged in the development of device-related,
biotechnology and pharmacological approaches to the management of cardiovascular
disease as potential competitors in the marketplace as well. These include such
common and well-established medical devices and treatments as the intra-aortic
balloon pump (IABP), ventricular assist devices (VAD), coronary artery bypass
graft surgery (CABG), coronary angioplasty, mechanical circulatory support
(MCS), transmyocardial laser revascularization (TMR), total artificial hearts,
cardiac resynchronization devices, ranolazine and nesiritide (Natrecor(R)); as
well as newer technologies currently in FDA-approved clinical trials such as
gene therapy and spinal cord stimulation (SCS). There can be no assurance that
other companies will not develop new technologies or enter the market intended
for EECP(R) therapy systems. Such other companies may have substantially greater
financial, manufacturing and marketing resources and technological expertise
than those possessed by us and may, therefore, succeed in developing
technologies or products that are more efficient than those offered by
Vasomedical and that would render our technology and existing products obsolete
or noncompetitive.
Government Regulations
We are subject to extensive regulation by numerous government regulatory
agencies, including the FDA and similar foreign agencies. Where applicable, we
are required to comply with laws, regulations and standards governing the
development, preclinical and clinical testing, manufacturing, quality testing,
labeling, promotion, import, export, and distribution of our medical devices.
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
12
1976; however, they were found to be substantially equivalent to a preamendments
Class III device and therefore are subject to the same requirements as the
preamendments external counterpulsation devices.
Premarket Review
The 510(k) premarket notification process requires an applicant to give
notice to FDA of its intent to introduce its device into commerce. In its
premarket notification, the applicant must demonstrate that its new or modified
medical device is substantially equivalent to a legally marketed or predicate
device marketed before May 28, 1976. Prior to beginning commercialization of the
new or modified product it must receive an order from the FDA classifying the
device under section 510(k) in the same classification as the predicate device,
and as a result, the new device will be cleared for marketing. Modifications to
a previously cleared medical device that do not significantly affect its safety
and effectiveness or constitute a major change in the intended use can be made
without having to submit a new 510(k). In February 1995, the Company received
510(k) clearance to market the second-generation version of its EECP(R) therapy
system, the MC2, which incorporated a number of technological improvements over
the predicate 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(R) therapy in the treatment of patients
suffering from stable or unstable angina pectoris, acute myocardial infarction
and cardiogenic shock. In June 2002, the FDA granted 510(k) market clearance for
an upgraded TS3, which incorporated the Company's patented CHF treatment and
oxygen saturation monitoring technologies, and provided for a new indication for
the use of EECP(R) in CHF, which applied to all then-current models of the
Company's EECP(R) therapy systems.
Modifications to a previously cleared medical device that do not
significantly affect its safety and effectiveness or constitute a major change
in the intended use can be made without having to submit a new 510(k). FDA
publishes guidance for medical device manufacturers on the types of changes that
meet the requirements for a new 510(k) prior to introduction of a device for
marketing distribution. Vasomedical followed FDA's guidance on when to submit a
new 510(k) for changes to a device and concluded that the changes incorporated
into its Model TS4 did not require a new 510(k) prior to its introduction to
market. Vasomedical subsequently obtained a 510(k) that applied to the Model TS4
and all of its models in March 2004, when it made changes to the labeling of all
of its EECP(R) therapy systems. In November 2004, the Company introduced its
Model Lumenair, and again concluded that the changes did not require a new
510(k) at that time. There can be no assurance that the FDA will agree with
Vasomedical's conclusions that a new 510(k) was unnecessary on these occasions
or in other similar instances, or that our products will not be subject to a
regulation requiring a PMA for preamendments Class III external counterpulsation
devices.
If a device does not receive a clearance order because the FDA determines
that the device is not substantially equivalent to a predicate device and thus
the device automatically is considered a Class III device, the applicant may ask
the FDA to make a risk-based classification to place the device in Class I or
II. However, if a timely request for risk-based classification is not made, or
if the FDA determines that a Class III designation is appropriate, an approved
PMA will be required before the device may be marketed.
The more rigorous premarket review process is the PMA process. The FDA
approves a PMA if the applicant has provided sufficient valid scientific
evidence to prove that the device is safe and effective for its intended use(s).
Applications for premarket approval generally contain human clinical data. This
process is usually much more complex, time-consuming and expensive than the
510(k) process, and is uncertain. Both 510(k)s and PMAs now require the
submission of user fees in most circumstances.
There can be no assurance that all the necessary FDA clearances or
approvals, including approval of any PMA required by the promulgation of a
regulation, will be granted for our products, future-generation upgrades or
newly developed products, on a timely basis or at all. Failure to receive, or
delays in receipt of such clearances, could have a material adverse effect on
our financial condition and results of operations.
Clinical Trials
If human clinical trials of a device are required, whether to support a
510(k) or PMA application, the trials' sponsor, which is usually the
manufacturer of the device, first must obtain the approval of the appropriate
institutional review boards. If a trial is of a significant risk device, the
sponsor also must obtain an investigational device exemption or IDE from FDA
before the trial may begin. A significant risk device is a device that presents
a potential for serious risk to the subject and is an implant; is
13
life-sustaining or life-supporting; or is for a use of substantial importance in
diagnosing, curing, mitigating, or treating disease, or otherwise preventing
impairment of human health. For all clinical testing, the sponsor must obtain
informed consent from the patients participating in each trial. The results of
clinical testing that a sponsor undertakes may be insufficient to obtain
clearance or approval of the tested product.
Pervasive and Continuing FDA Regulation
We are also subject to other FDA regulations that apply prior to and after
a product is commercially released. These include Current Good Manufacturing
Practice (CGMP) requirements set forth in FDA's Quality System Regulation (QSR),
that require manufacturers to have a quality system for the design, manufacture,
packaging, labeling, storage, installation and servicing of medical devices
intended for commercial distribution in the United States. This regulation
covers various areas including management and organization, device design,
purchase and handling of components, production and process controls such as
those related to buildings and equipment, packaging and labeling control,
distribution, installation, complaint handling, corrective and preventive
action, servicing, and records. We are subject to periodic inspection by the FDA
for compliance with the CGMP requirements and Quality System Regulation.
The FDA also enforces post-marketing controls that include the requirement
to submit medical device reports to the agency when a manufacturer becomes aware
of information suggesting that any of its marketed products may have caused or
contributed to a death or serious injury, or any of its products has
malfunctioned and that a recurrence of the malfunction would likely cause or
contribute to a death or serious injury. The FDA relies on medical device
reports to identify product problems and utilizes these reports to determine,
among other things, whether it should exercise its enforcement powers. The FDA
also may require postmarket surveillance studies for specified devices.
We are subject to the Federal Food, Drug, and Cosmetic Act's, or FDCA's,
general controls, including establishment registration, device listing, and
labeling requirements. If we fail to comply with any requirements under the
FDCA, we, including our officers and employees, could be subject to, among other
things, fines, injunctions, civil penalties, and criminal prosecution. We also
could be subject to recalls or product corrections, total or partial suspension
of production, denial of premarket notification clearance or PMA approval, and
rescission or withdrawal of clearances and approvals. Our products could be
detained or seized, the FDA could order a recall, repair, replacement, or refund
of our devices, and the agency could require us to notify health professionals
and others that the devices present unreasonable risks of substantial harm to
the public health.
The advertising of our products is subject to regulation by the Federal
Trade Commission, or FTC. The FTC Act prohibits unfair or deceptive acts or
practices in or affecting commerce. Violations of the FTC Act, such as failure
to have substantiation for product claims, would subject us to a variety of
enforcement actions, including compulsory process, cease and desist orders and
injunctions, which can require, among other things, limits on advertising,
corrective advertising, consumer redress and restitution, as well as substantial
fines or other penalties.
Foreign Regulation
In most countries to which we seek to export the EECP(R) system, we must
first obtain approval from the local medical device regulatory authority. The
regulatory review process varies from country to country and can be complex,
costly, uncertain, and time-consuming.
We are also subject to periodic audits by organizations authorized by
foreign countries to determine compliance with laws, regulations and standards
that apply to the commercialization of our products in those markets. Examples
include auditing by a European Union Notified Body organization (authorized by a
member state's Competent Authority) to determine conformity with the Medical
Device Directives (MDD) and by an organization authorized by the Canadian
government to determine conformity with the Canadian Medical Devices Regulations
(CMDR).
There can be no assurance that we will obtain desired foreign
authorizations to commercially distribute our products in those markets or that
we will comply with all laws, regulations and standards that pertain to our
14
products in those markets. Failure to receive or delays in receipt of such
authorizations or determinations of conformity could have a material adverse
effect on our financial condition and results of operations.
Patient Privacy
Federal and state laws protect the confidentiality of certain patient
health information, including patient records, and restrict the use and
disclosure of that protected information. The U.S. Department of Health and
Human Services (HHS) published patient privacy rules under the Health Insurance
Portability and Accountability Act of 1996 (HIPAA privacy rule) and the
regulation was finalized in October 2002. The HIPAA privacy rule governs the use
and disclosure of protected health information by "Covered Entities," which are
(1) health plans, (2) health care clearinghouses, and (3) health care providers
that transmit health information in electronic form in connection with certain
health care transactions such as benefit claims. Currently, the HIPAA privacy
rule affects us only indirectly in that patient data that we access, collect and
analyze may include protected health information. Additionally, we have signed
some Business Associate agreements with Covered Entities that contractually bind
us to protect protected health information, consistent with the HIPAA privacy
rule's requirements. We do not expect the costs and impact of the HIPAA privacy
rule to be material to our business.
Practice Guidelines
Medical professional societies periodically issue Practice Guidelines to
their members and make them available publicly. The American College of
Cardiology (ACC) and the American Heart Association (AHA) have jointly engaged
in developing practice guidelines since 1980 to critically evaluate the use of
diagnostic procedures and therapies in the management or prevention of
cardiovascular diseases. These guidelines are meant to "improve the
effectiveness of care, optimize patient outcomes and affect the overall cost of
care favorably by focusing resources on the most effective strategies".
Recommendations incorporated into the guidelines are based upon an assessment of
the strength of evidence for or against a treatment or procedure and estimates
of expected health outcomes stemming from a formal review of peer-reviewed
published literature. These guidelines may not be updated for some time.
The "ACC/AHA 2002 Guideline Update for the Management of Patients with
Chronic Stable Angina" was last issued in 2003. Comments on external
counterpulsation appear in a section entitled "Recommendations for Alternative
Therapies for Chronic Stable Angina in Patients Refractory to Medical Therapy
Who Are Not Candidates for Percutaneous Intervention or Surgical
Revascularization" and include a so-called Class IIb recommendation. ACC/AHA
guideline classifications I, II and III are used to "provide final
recommendations for both patient evaluation and therapy" and a Class IIb rating
is defined as "Usefulness/efficacy is less well established by
evidence/opinion".
The ACC/AHA 2005 Guidelines for the Diagnosis and Management of Chronic
Heart Failure in the Adult were issued in 2005. External counterpulsation is
listed as one of the devices under investigation in a section entitled "Drugs
and Interventions Under Active Investigation".
The 2006 Comprehensive Heart Failure Practice Guideline, issued in February
2006 by the Heart Failure Society of America, does not include any comments on
the use of external counterpulsation therapy for treating heart failure
patients.
In summary, while evaluations of the use of EECP(R) therapy in patients
with chronic angina and heart failure continue to appear in several oral or
poster presentations at major scientific meetings and in peer-reviewed
publications each year, there continues to be skepticism in the cardiology
community about its broader use. Additional evidence regarding the efficacy of
EECP(R) therapy continues to appear, however the evidence may not be sufficient
to warrant a modification of practice guidelines to a more favorable
recommendation and increased acceptance by the medical community.
Reimbursement
In addition to regulatory approvals for commercialization by government
agencies, reimbursement coverage and payment rates are factors in the sales of
our products and we depend in large part on the availability of reimbursement
15
programs. Medicare, Medicaid, as well as private health care insurance and
managed-care plans determine eligibility for coverage of a product or therapy
based on a number of factors, including the payer's determination that the
product is reasonable and necessary for the diagnosis or treatment of the
illness or injury for which it is administered according to the scope of
clinical evidence available, accepted standards of medical care in practice, the
product's cost effectiveness, whether the product is experimental or
investigational, impact on health outcomes and whether the product is not
otherwise excluded from coverage by law or regulation. The coverage process for
Medicare reimbursement is legislated by Congress and administered by the Centers
for Medicare and Medicaid Services (CMS), and is highly variable in the
commercial market. There may be significant delays in obtaining coverage for
newly-approved products, and coverage may be more limited than the purposes for
which the product is approved or cleared by FDA. Even when we obtain
authorization from the FDA or a foreign authority to begin commercial
distribution, there may be limited demand for the device until reimbursement
approval has been obtained from governmental and private third-party payers.
Moreover, eligibility for coverage does not imply that a product will be
reimbursed in all cases or at a rate that allows us to market our EECP(R)
systems at a price that will enable us to make a profit or even cover our costs.
Reimbursement rates may vary according to the use of the product and the
clinical setting in which it is used, may be based on payments allowed for
lower-cost products that are already reimbursed, may be incorporated into
existing payments for other products or services, and may reflect budgetary
constraints and/or imperfections in Medicare or Medicaid data. Even if
successful, demand for products may be driven more by the scope of peer-reviewed
evidence and acceptance, endorsement by regulatory and clinical bodies, or
foreign country authorities than by the reimbursement rates available. Securing
coverage at adequate reimbursement rates from government and third party payers
can be a time consuming and costly process that could require us to provide
supporting scientific, clinical, and cost-effectiveness data for the use of our
products to each payer. Our inability to promptly obtain coverage and profitable
reimbursement rates from government-funded and private payers for our products
could have a material adverse effect on our financial condition and operating
results.
Our reimbursement strategies are currently focused in the following primary
areas: expanding Medicare coverage to include congestive heart failure and mild
angina, expanding coverage with other third-party payers, expanding Medicare
coverage for angina and obtaining coverage in selected international markets.
Current Medicare Coverage in Angina
In February 1999, CMS, the federal agency that administers the Medicare
program for more than 39 million beneficiaries, issued a national coverage
policy under HCPCS code G0166 for the use of the EECP(R) therapy system. Key
excerpts from the coverage read as follows:
"Although ECP devices are cleared by the Food and Drug Administration
(FDA) for use in treating a variety of cardiac conditions, including
stable or unstable angina pectoris, acute myocardial infarction and
cardiogenic shock, the use of this device to treat cardiac conditions
other than stable angina pectoris is not covered, since only that use
has developed sufficient evidence to demonstrate its medical
effectiveness."
"for patients who have been diagnosed with disabling angina (class III
or class IV, Canadian Cardiovascular Society Classification or
equivalent classification) who, in the opinion of a cardiologist or
cardiothoracic surgeon, are not readily amenable to surgical
interventions such as balloon angioplasty and cardiac bypass because:
1. their condition is inoperable, or at high risk of operative
complications or post-operative failure;
2. their coronary anatomy is not readily amenable to such
procedures; or
3. they have co-morbid states, which create excessive risk."
The 2008 national average payment rate per hourly session in the physician
office setting and the hospital outpatient facility is approximately $156.16 and
$109.47, respectively. Reimbursement rates vary throughout the country and range
from $98 to $215 per hourly session. The 2007 national average payment rate per
hourly session in the physician office setting and the hospital outpatient
facility was approximately $147 and $107, respectively. Reimbursement rates
varied throughout the country and range from $98 to $215 per hourly session.
Under the Medicare program, physician reimbursement of the provision of EECP(R)
therapy is higher if the therapy is performed in a physician office setting as
compared to a hospital outpatient facility in order to reflect higher costs
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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 to $208 per treatment
session in 2003 before being reduced approximately 37% in 2004 to $132 per
treatment session. In 2005 the physician rate increased approximately 5% and
remained unchanged in 2006. The average payment rate for the hospital outpatient
facility declined steadily to 2005 before increasing approximately 2% in 2006.
In order to bill and receive payment from Medicare, an individual or entity
must be enrolled in the Medicare program for EECP(R) therapy. The physician
office setting and the hospital outpatient facility are the only entities
currently authorized to receive reimbursement for the EECP(R) therapy under the
Medicare program and reimbursement is not permitted to other individuals or
entity types, which include, but are not limited to, nurse practitioners,
physical therapists, ambulatory surgery centers, nursing homes, comprehensive
outpatient rehabilitation facilities, outpatient dialysis facilities, and
independent diagnostic testing facilities. For each of these provider types
there is statutory authorization and accompanying regulations that govern the
terms and conditions of Medicare program participation.
If there were any material change in the availability of Medicare coverage,
or if the reimbursement level for treatment procedures using the EECP(R) therapy
system is determined to be inadequate, it would adversely affect our business,
financial condition and results of operations. Moreover, we are unable to
forecast what additional legislation or regulation, if any, relating to the
health care industry or Medicare coverage and payment level may be enacted in
the future, or what effect such legislation or regulation would have on us.
Application to Expand Medicare Coverage to include Class II Angina and Class
II/III CHF
On May 31, 2005, we submitted an application to CMS to expand the national
coverage policy for external counterpulsation treatment to patients with
Canadian Cardiovascular Class II stable angina and to patients with NYHA Class
II and III stable heart failure symptoms with an ejection fraction less than
35%.
On June 20, 2005, CMS accepted our application for expansion of
reimbursement coverage of EECP(R) therapy to include patients with NYHA Class
II/III stable heart failure symptoms with an ejection fraction of less than or
equal to 35%, i.e. chronic, stable, mild-to-moderate systolic heart failure as a
primary indication, as well as patients with CCSC II, i.e. chronic, stable mild
angina.
On June 23, 2005, CMS also received a request from a competing manufacturer
of external counterpulsation therapy equipment, to reconsider the reimbursement
coverage policy. They requested expansion of coverage to include 1) treatment of
congestive heart failure, to include NYHA Class II, III with a left ventricular
ejection fraction (LVEF) less than or equal to 40%, and acute heart failure; 2)
treatment of stable angina to include CCSC II angina; 3) treatment of acute
myocardial infarction; 4) treatment of cardiogenic shock. On September 15, 2005,
they amended their request to include NYHA Class IV heart failure.
On March 20, 2006, CMS issued their Decision Memorandum regarding this
reconsideration with the opinion "that the evidence is not adequate to conclude
that external counterpulsation therapy is reasonable and necessary for the
treatment of:
o CCSC II angina
o Heart Failure
o NYHA Class II/III stable heart failure symptoms with an ejection
fraction of less than or equal to 35%
o NYHA Class II/III stable heart failure symptoms with an ejection
fraction of less than or equal to 40%
o NYHA Class IV heart failure
o Acute heart failure
o Cardiogenic shock
o Acute myocardial infarction."
They commented in their decision memorandum that they were not able to
apply full weight to the evidence generated by the PEECH(TM) trial, as it had
not yet been published in a peer-reviewed medical journal by the time they were
required to issue a final decision on this application. Moreover, they did not
17
opine on whether they would consider the results of the trial when published to
be sufficient evidence to conclude that external counterpulsation therapy is
reasonable and necessary for the treatment of NYHA Class II/III stable heart
failure symptoms with an ejection fraction of less than or equal to 35%. They
did, however, reiterate in the decision memorandum that "Current coverage as
described in Section 20.20 of the Medicare National Coverage Determination (NCD)
manual will remain in effect" for refractory angina patients.
On August 25, 2006, the results of the trial were initially published on
line by the Journal of the American College of Cardiology (JACC), and in print
in its September 19, 2006 issue. JACC is the official journal of the American
College of Cardiology.
In the November-December issue of the journal Congestive Heart Failure, a
second report of results from the PEECH(TM) trial was published, focusing on the
results of a prespecified subgroup analysis in trial patients age 65 and over.
This analysis demonstrated a statistically positive response on both co-primary
endpoints of the trial in patients receiving EECP(R) therapy versus those who
did not, i.e. a significantly larger proportion of patients undergoing EECP(R)
therapy met or exceeded prespecified thresholds of improvement in exercise
duration and peak oxygen consumption. Moreover, the patients age 65 and older
who received EECP(R) therapy demonstrated the greatest differences in exercise
duration, peak oxygen consumption and functional class (symptom status) compared
with those who did not receive EECP(R) therapy.
These papers were submitted to CMS and we were advised to continue to
gather more clinical evidence for future submission.
We will continue to educate the marketplace that EECP(R) therapy is a
therapy for ischemic cardiovascular disease and that patients with a primary
diagnosis of heart failure, diabetes, peripheral vascular disease, etc. are also
eligible for reimbursement under the current coverage policy, provided the
primary indication for treatment with EECP(R) therapy is angina or angina
equivalent symptoms and the patient satisfies other listed criteria.
Additionally, we will continue to pursue expansion of coverage for EECP(R)
therapy with Medicare and other third-party payers as evidence of its clinical
utility develops.
Expanding Coverage with Other Third-Party Payers
Some private insurance carriers continue to adjudicate EECP(R) 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(R) 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 EECP(R) 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(R) therapy as a covered benefit will
continue to increase. In addition, we are aware of two third-party payers that
have begun limited coverage of EECP(R) 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(R)
treatment that include CHF patients. If there were any material change in the
availability of third-party private insurers or the adequacy of the
reimbursement level for treatment procedures using the EECP(R) therapy system,
it would adversely affect our business, financial condition and results of
operations. Moreover, we are unable to forecast what additional legislation or
regulation, if any, relating to the health care industry or third-party private
insurers coverage and payment levels may be enacted in the future or what effect
such legislation or regulation would have on us.
Reimbursement in International Markets
The reimbursement environment for EECP(R) 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 coverage of this therapy. Our
reimbursement strategy has been opportunistic and responsive to the selling
opportunities presented through our distribution partners. During this fiscal
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year our efforts on behalf of EECP(R) therapy in both the private and public
healthcare sectors of selected international markets have been initiated by our
distributors, in support of the therapy, in their designated territory.
Additionally, efforts have been initiated to obtain coverage in the public
sector in certain overseas markets; however, we do not anticipate an impact on
financial performance in the next fiscal year, given the long lead times from
submission to approval of international dossiers for each reimbursement
authority.
Patents and Trademarks
We own eleven US patents including eight utility and three design patents
that expire at various times between 2008 and 2021. In addition, more than 20
foreign patents have been issued that expire at various times from 2008 to 2022.
We are also planning to file other patent applications regarding specific
enhancements to the current EECP(R) models, future generation products, and
methods of treatment in the future. Moreover, trademarks have been registered
for the names "EECP(R)" and "Natural Bypass".
We pursue a policy of seeking patent protection, both in the US and abroad,
for our proprietary technology. We believe that we have a solid patent
foundation in the field of external counterpulsation devices and that the number
of patents and applications demonstrates our technical leadership, dating back
to the mid-1980s. Our patent portfolio focuses on the areas of external
counterpulsation control and the overall design and arrangement of the external
counterpulsation apparatus, including the console, treatment bed, fluid
distribution, and inflatable cuffs. None of our current competitors have a
significant patent portfolio in the area of external counterpulsation devices.
There can be no assurance that our patents will not be violated or that any
issued patents will provide protection that has commercial significance. As with
any patented technology, litigation could be necessary to protect our patent
position. Such litigation can be costly and time-consuming, and there can be no
assurance that we will be successful. The loss or violation of our EECP(R)
patents and trademarks could have a material adverse effect upon our business.
Employees
As of May 31, 2008, we employed 24 full-time and 1 part-time persons with 4
in direct sales, sales and clinical applications support, 9 in manufacturing,
quality control and technical service, 3 in marketing and customer support, 2 in
engineering, regulatory and clinical research and 7 in administration. None of
our employees are represented by a labor union. We believe that our employee
relations are good.
Manufacturing
Under our Supplier Agreement with Living Data Technology Corporation dated
June 21, 2007, Living Data is our exclusive supplier for the ECP therapy systems
that we market under the registered trademark EECP(R). Living Data has
represented to us that it is in compliance in all material respects with all
applicable laws, rules and regulations, and has obtained all the necessary
licenses, permits, consents and approvals necessary for it to provide the
products and services specified under the Supplier Agreement.
Under the agreement with Living Data, we continue to manufacture products
from our existing inventory, as well as other products, at our leased facility
located in Westbury, New York.
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.
19
Financial Risks
We have incurred recurring losses over the past few years and may continue
to sustain losses, which could result in a further decline in the value of our
common stock.
During the last few fiscal years we incurred large operating losses. We
currently anticipate that we may continue to sustain operating losses. Our
ability to achieve profitability is largely dependent on our ability to reduce
operating costs sufficiently, as well as halting the current trend of declining
revenue. Our ability to maintain our current base of revenue and increase
revenue is largely dependent upon restructuring our sales and marketing efforts
in the angina market where reimbursement is currently available and operating in
a more efficient manner.
Risks Related to Our Business
We are materially dependent on medical reimbursement for treatment
procedures using EECP(R) therapy on patients with congestive heart failure in
order to achieve growth.
We are currently dependent on a single product platform which, based on
current medical reimbursement policies, provides coverage for a restricted class
of heart patients. On May 31, 2005, we submitted an application to CMS to expand
the national coverage policy for external counterpulsation treatment to patients
with Canadian Cardiovascular Class II stable angina and to patients with New
York Heart Association (NYHA) Class II and III stable heart failure symptoms
with an ejection fraction less than 35%. The application was accepted by CMS
effective June 20, 2005, and CMS announced their decision to maintain the
existing coverage as stated prior to the application and not to expand it to
include Class II Angina and Class II/III CHF on March 20, 2006. Results of the
PEECH(TM) trial have been published in the Journal of the American College of
Cardiology in September 2006, and the subgroup analysis of CHF patients age 65
and over has also been published in the November-December 2006 issue of the
Journal of Congestive Heart Failure. These two papers have been submitted to CMS
for reconsideration of our application. We had met with representatives from CMS
in February 2007 and presented our case. CMS has requested additional data from
us. We will continue our dialogue with CMS to obtain coverage for heart failure
patients. However, there is no assurance that the Company will have sufficient
resources to gather the necessary data to be sufficient to support expansion of
the Medicare National Coverage Policy for EECP(R) treatment for NYHA class II
and III heart failure patients.
If we do not receive medical coverage for treatment procedures using
EECP(R) therapy on patients with CHF, it will adversely affect our future
business prospects.
Material changes in the availability of Medicare, Medicaid or third-party
reimbursement at adequate price levels could adversely affect our business.
Health care providers, such as hospitals and physician private practices,
that purchase or lease medical devices such as the EECP(R) therapy system for
use on their patients generally rely on third-party payers, principally
Medicare, Medicaid and private health insurance plans, to reimburse all or part
of the costs and fees associated with the procedures performed with these
devices. If there were any material change in the availability of Medicare,
Medicaid or other third-party coverage or the adequacy of the reimbursement
level for treatment procedures using the EECP(R) therapy system, it would
adversely affect our business, financial condition and results of operations.
Moreover, we are unable to forecast what additional legislation or regulation,
if any, relating to the health care industry or Medicare or Medicaid coverage
and payment level may be enacted in the future or what effect such legislation
or regulation would have on our business. Even if a device has FDA clearance,
Medicare, Medicaid and other third-party payers may deny reimbursement if they
conclude that the device is not "reasonable and necessary" according to their
criteria. In addition, reimbursement may not be at, or remain at, price levels
adequate to allow medical professionals and hospitals to realize an appropriate
return on the purchase of our products.
Increased acceptance by the medical community is important for growth.
While many abstracts and publications are presented each year at major
scientific meetings worldwide with respect to EECP(R) treatment efficacy, there
is continued skepticism concerning EECP(R) therapy methodology. The American
Heart Association and the American College of Cardiology Practice Guidelines
20
currently list EECP(R) as a therapy currently under investigation for treatment
of heart failure and have a classification rating of IIb as a treatment for
patients who are refractory to medical therapy and are not candidates for
percutaneous intervention or revascularization. A classification rating of IIb
indicates the usefulness/efficacy of EECP(R) therapy is less well established by
evidence/opinion. The medical community utilizes these guidelines when
considering the various treatment options for their patients. Certain
cardiologists, in cases where the EECP(R) therapy is a viable alternative, still
appear to prefer percutaneous coronary interventions (e.g. balloon angioplasty
and stenting) and cardiac bypass surgery for their patients. Additional evidence
regarding the efficacy of EECP(R) therapy continues to evolve, however the
evidence may not be sufficient to warrant a modification of these guidelines to
a more favorable recommendation and increased acceptance by the medical
community. We are dependent on consistency of favorable research findings about
EECP(R) therapy and increasing acceptance of EECP(R) therapy as a safe,
effective and cost effective alternative to other available products by the
medical community for growth.
We face competition from other companies and technologies.
We compete with at least five 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.
As of June 2007, the Company entered into a distribution and supplier
agreement with Living Data Technology Corporation, a competitor as of May 31,
2007. This arrangement has subsequently reduced the competitors to at least four
other companies.
We may not continue to receive necessary FDA clearances or approvals, which
could hinder our ability to market and sell our products.
If we modify our external counterpulsation devices and the modifications
significantly affect safety or effectiveness, or if we make a change to the
intended use, we will be required to submit a new premarket notification or
510(k) to FDA. We would be unable to market the modified device until FDA issues
a clearance for the 510(k).
Additionally, if FDA publishes a regulation requiring a premarket approval
application or PMA for external counterpulsation devices, we would then need to
submit a PMA, and have it filed by the agency, by the date specified by FDA in
its regulation. A PMA requires us to prove the safety and effectiveness of a
device to the FDA. The process of obtaining PMA approval is expensive,
time-consuming, and uncertain. If FDA were to require a PMA application, we may
be required to undertake a clinical study, which likely will be expensive and
require lengthy follow-up, to demonstrate the effectiveness of the device. If we
did obtain PMA approval, any change after approval affecting the safety or
effectiveness of the device will require approval of a PMA supplement.
If we offer new products that require 510(k) clearance or PMA approval, we
will not be able to commercially distribute those products until we receive such
clearance or approval. Regulatory agency approval or clearance for a product may
not be received or may entail limitations on the device's indications for use
that could limit the potential market for any such product. Delays in receipt
of, or failure to obtain or maintain, regulatory clearances and approvals, could
delay or prevent our ability to market or distribute our products. Such delays
could have a material adverse effect on our business.
If we are unable to comply with applicable governmental regulation, we may
not be able to continue our operations.
We also must comply with Current Good Manufacturing Practice (CGMP)
requirements as set forth in the Quality System Regulation (QSR) to receive FDA
approval to market new products and to continue to market current products. The
21
QSR imposes certain procedural and documentation requirements on us with respect
to manufacturing and quality assurance activities, including packaging, storage,
and record keeping. Our products and activities are subject to extensive,
ongoing regulation, including regulation of labeling and promotion activities
and adverse event reporting. Also, our FDA registered facilities are subject to
inspection by the FDA and other governmental authorities. Any failure to comply
with regulatory requirements could delay or prevent our ability to market or
distribute our products. Violation of FDA statutory or regulatory requirements
could result in enforcement actions, such as voluntary or mandatory recalls,
suspension or withdrawal of marketing clearances or approvals, seizures,
injunctions, fines, civil penalties, and criminal prosecutions, all of which
could have a material adverse effect on our business. Most states also have
similar postmarket regulatory and enforcement authority for devices.
We cannot predict the nature of any future laws, regulations,
interpretations, or applications, nor can we predict what effect additional
governmental regulations or administrative orders, when and if promulgated,
would have on our business in the future. We may be slow to adapt, or we may
never adapt to changes in existing requirements or adoption of new requirements
or policies. We may incur significant costs to comply with laws and regulations
in the future or compliance with laws or regulations may create an unsustainable
burden on our business.
We may not receive approvals by foreign regulators that are necessary for
international sales.
Sales of medical devices outside the United States are subject to foreign
regulatory requirements that vary from country to country. Premarket approval or
clearance in the United States does not ensure regulatory approval by other
jurisdictions. If we, or any international distributor, fail to obtain or
maintain required pre-market approvals or fail to comply with foreign
regulations, foreign regulatory authorities may require us to file revised
governmental notifications, cease commercial sales of our products in the
applicable countries or otherwise cure the problem. Such enforcement action by
regulatory authorities may be costly.
In order to sell our products within the European Union, we must comply
with the European Union's Medical Device Directive. The CE marking on our
products attests to this compliance. Future regulatory changes may limit our
ability to use the CE mark, and any new products we develop may not qualify for
the CE mark. If we lose this authorization or fail to obtain authorization on
future products, we will not be able to sell our products in the European Union.
We depend on Living Data for the supply of our ECP therapy systems.
Under our Supplier Agreement with Living Data Technology Corporation dated
June 21, 2007, Living Data is our exclusive supplier for the ECP therapy systems
that we market under the registered trademark EECP(R). With certain exceptions,
including the use of existing inventory, we are required to purchase this
product from Living Data at specified prices. While we do not foresee any
difficulties in timely receiving products at competitive prices, this inability
would adversely affect our business.
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.
The loss or violation of certain of our patents and trademarks could have a
material adverse effect upon our business.
22
Since patent applications in the United States are maintained in secrecy
until such patent applications are issued, our current product development may
infringe patents that may be issued to others. If our products were found to
infringe patents held by competitors, we may have to modify our products to
avoid infringement, and it is possible that our modified products would not be
commercially successful.
We do not intend to pay dividends in the foreseeable future.
We do not intend to pay any cash dividends on our common stock in the
foreseeable future.
Risks Related to Our Industry
Technological change is difficult to predict and to manage.
We face the challenges that are typically faced by companies in the medical
device field. Our product line has required, and any future products will
require, substantial development efforts and compliance with governmental
clearance or approval requirements. We may encounter unforeseen technological or
scientific problems that force abandonment or substantial change in the
development of a specific product or process.
We are subject to product liability claims and product recalls that may not
be covered by insurance.
The nature of our business exposes us to risks of product liability claims
and product recalls. Medical devices as complex as ours frequently experience
errors or failures, especially when first introduced or when new versions are
released.
We currently maintain product liability insurance at $7,000,000 per
occurrence and $7,000,000 in the aggregate. Our product liability insurance may
not be adequate. In the future, insurance coverage may not be available on
commercially reasonable terms, or at all. In addition, product liability claims
or product recalls could damage our reputation even if we have adequate
insurance coverage.
We do not know the effects of healthcare reform proposals.
The healthcare industry is undergoing fundamental changes resulting from
political, economic and regulatory influences. In the United States,
comprehensive programs have been suggested seeking to increase access to
healthcare for the uninsured, control the escalation of healthcare expenditures
within the economy and use healthcare reimbursement policies to balance the
federal budget.
We expect that the United States Congress and state legislatures will
continue to review and assess various healthcare reform proposals, and public
debate of these issues will likely continue. There have been, and we expect that
there will continue to be, a number of federal and state proposals to constrain
expenditures for medical products and services, which may affect payments for
products such as ours. We cannot predict which, if any of such reform proposals
will be adopted and when they might be effective, or the effect these proposals
may have on our business. Other countries also are considering health reform.
Significant changes in healthcare systems could have a substantial impact on the
manner in which we conduct our business and could require us to revise our
strategies.
Risks Related to our Securities
The application of the "penny stock" rules could adversely affect the
market price of our common stock and increase your transaction costs to sell
those shares.
As long as the trading price of our common shares is below $5 per share,
the open-market trading of our common shares will be subject to the "penny
stock" rules. The "penny stock" rules impose additional sales practice
requirements on broker-dealers who sell securities to persons other than
established customers and accredited investors (generally those with assets in
excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together
with their spouse). For transactions covered by these rules, the broker-dealer
must make a special suitability determination for the purchase of securities and
have received the purchaser's written consent to the transaction before the
purchase. Additionally, for any transaction involving a penny stock, unless
23
exempt, the broker-dealer must deliver, before the transaction, a disclosure
schedule prescribed by the Securities and Exchange Commission relating to the
penny stock market. The broker-dealer also must disclose the commissions payable
to both the broker-dealer and the registered representative and current
quotations for the securities. Finally, monthly statements must be sent
disclosing recent price information on the limited market in penny stocks. These
additional burdens imposed on broker-dealers may restrict the ability or
decrease the willingness of broker-dealers to sell our common shares, and may
result in decreased liquidity for our common shares and increased transaction
costs for sales and purchases of our common shares as compared to other
securities.
Our common stock is subject to price volatility.
The market price of our common stock historically has been and may
continue to be highly volatile. Our stock price could be subject to wide
fluctuations in response to various factors beyond our control, including, but
not limited to:
o medical reimbursement;
o quarterly variations in operating results;
o announcements of technological innovations, new products or
pricing by our competitors;
o the rate of adoption by physicians of our technology and products
in targeted markets;
o the timing of patent and regulatory approvals;
o the timing and extent of technological advancements;
o results of clinical studies;
o the sales of our common stock by affiliates or other shareholders
with large holdings; and
o general market conditions.
Our future operating results may fall below the expectations of securities
industry analysts or investors. Any such shortfall could result in a significant
decline in the market price of our common stock. In addition, the stock market
has experienced significant price and volume fluctuations that have affected the
market price of the stock of many medical device companies and that often have
been unrelated to the operating performance of such companies. These broad
market fluctuations may directly influence the market price of our common stock.
Additional Information
We are subject to the reporting requirements under the Securities Exchange
Act of 1934 and are required to file reports and information with the Securities
and Exchange Commission (SEC), including reports on the following forms: annual
report on Form 10-KSB, quarterly reports on Form 10-QSB, current reports on Form
8-K, and amendments to those reports files or furnished pursuant to Section
13(a) or 15(d) of the Securities Act of 1934.
ITEM 2 - DESCRIPTION OF PROPERTY
We have historically owned our 18,000 square foot headquarters and
manufacturing facility at 180 Linden Avenue, Westbury, New York 11590.
Additionally, we leased approximately 3,500 square feet of additional warehouse
space under an operating lease with a non-affiliated landlord that expired in
September 2006, which we did not renew.
On August 15, 2007, we sold our facility under a five-year leaseback
agreement for $1.4 million. The net proceeds from the sale was approximately
$425,000, after payment in full of the two secured notes on our facility,
brokers fees, closing costs, and the opening of a certificate of deposit in
accordance with the provisions of the new lease. The annual rental expense for
the lease is approximately $138,600. We believe that our current facility is
adequate to meet our current needs and should continue to be adequate for the
immediately foreseeable future.
24
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.
25
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock currently trades on the Over-the-Counter Bulletin Board
under the symbol VASO.OB. On May 26, 2006, our common stock ceased trading on
the Nasdaq Capital Market tier of the Nasdaq Stock Market and began trading on
the NASD Pink Sheets. Effective June 20, 2006, our common stock began trading on
the Over-the- Counter Bulletin Board (OTCBB). The number of record holders of
common stock as of August 20, 2008, was approximately 1,043, which does not
include approximately 17,079 beneficial owners of shares held in the name of
brokers or other nominees. The table below sets forth the range of high and low
trade prices of the common stock for the fiscal periods specified.
Fiscal 2008 Fiscal 2007
----------- -----------
High Low High Low
First Quarter $0.19 $0.06 $0.17 $0.08
Second Quarter $0.13 $0.06 $0.15 $0.08
Third Quarter $0.10 $0.05 $0.12 $0.07
Fourth Quarter $0.09 $0.07 $0.09 $0.07
The last bid price of the Company's common stock on August 20, 2008, was
$0.08 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.
Entry Into A Material Definitive Agreement
On June 21, 2007, we entered into a Securities Purchase Agreement with
Kerns Manufacturing Corp. (Kerns). Concurrently with our entry into the
Securities Purchase Agreement, we also entered into a Distribution Agreement and
a Supplier Agreement with Living Data Technology Corporation, an affiliate of
Kerns (Living Data).
We sold to Kerns, pursuant to the Securities Purchase Agreement, 21,428,572
shares of our common stock at $.07 per share for a total purchase price of
$1,500,000, as well a five-year warrant to purchase 4,285,714 shares of our
common stock at an initial exercise price of $.08 per share (the Warrant). The
agreement further provided for the appointment to our Board of Directors of two
representatives from Kerns. In furtherance thereof, Mr. Jun Ma and Mr. Simon
Srybnik, Chairman of both Kerns and Living Data, have been appointed members of
our Board of Directors. Pursuant to the Distribution Agreement, we have become
the exclusive distributor in the United States of the AngioNew ECP systems
manufactured by Living Data. As additional consideration for such agreement, we
agreed to issue an additional 6,990,840 shares of our common stock to Living
Data. Pursuant to the Supplier Agreement, Living Data now is the exclusive
supplier to us of the ECP therapy systems that we market under the registered
trademark EECP(R). The Distribution Agreement and the Supplier Agreement each
have an initial term extending through May 31, 2012.
Pursuant to a Registration Rights Agreement, we granted to Kerns and Living
Data, subject to certain restrictions, "piggyback registration rights" covering
the shares sold to Kerns as well as the shares issuable upon exercise of the
Warrant and the shares issued to Living Data.
ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
This Management's Discussion and Analysis or Plan of Operations contains
descriptions of our expectations regarding future trends affecting our business.
26
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.
Except for historical information contained in this report, the matters
discussed are forward-looking statements that involve risks and uncertainties.
When used in this report, words such as "anticipates", "believes", "could",
"estimates", "expects", "may", "plans", "potential" and "intends" and similar
expressions, as they relate to the Company or its management, identify
forward-looking statements. Such forward-looking statements are based on the
beliefs of the Company's management, as well as assumptions made by and
information currently available to the Company's management. Among the factors
that could cause actual results to differ materially are the following: the
effect of business and economic conditions; the effect of the dramatic changes
taking place in the healthcare environment; the impact of competitive procedures
and products and their pricing; medical insurance reimbursement policies;
unexpected manufacturing or supplier problems; unforeseen difficulties and
delays in the conduct of clinical trials and other product development programs;
the actions of regulatory authorities and third-party payers in the United
States and overseas; uncertainties about the acceptance of a novel therapeutic
modality by the medical community; and the risk factors reported from time to
time in the Company's SEC reports. The Company undertakes no obligation to
update forward-looking statements as a result of future events or developments.
The following discussion should be read in conjunction with the financial
statements and notes thereto included in this Annual Report on Form 10-KSB.
Overview
Vasomedical, Inc. was incorporated in Delaware in July 1987. Unless the
context requires otherwise, all references to "we", "our", "us", "Company",
"registrant", "Vasomedical" or "management" refer to Vasomedical Inc. and its
subsidiaries. Since 1995, we have been primarily engaged in designing,
manufacturing, marketing and supporting EECP(R) enhanced external
counterpulsation systems based on our unique proprietary technology currently
indicated for use in cases of stable or unstable angina (i.e., chest pain),
congestive heart failure (CHF), acute myocardial infarction (i.e., heart attack,
(MI)) and cardiogenic shock. The EECP(R) therapy system is a non-invasive,
outpatient therapy for the treatment of diseases of the cardiovascular system.
The therapy serves to increase circulation in areas of the heart with less than
adequate blood supply and helps to restore systemic vascular function. The
therapy also increases blood flow and oxygen supply to the heart muscle and
other organs and decreases the heart's workload and need for oxygen, while also
improving function of the endothelium, the lining of blood vessels throughout
the body, lessening resistance to blood flow. We provide hospitals, clinics and
physician private practices with EECP(R) equipment, treatment guidance, and a
staff training and equipment maintenance program designed to provide optimal
patient outcomes. EECP(R) is a registered trademark for Vasomedical's enhanced
external counterpulsation systems. For more information, visit
www.vasomedical.com.
We have Food and Drug Administration (FDA) clearance to market our EECP(R)
therapy for use in the treatment of stable and unstable angina, congestive heart
failure, acute myocardial infarction, and cardiogenic shock, however, our
current marketing efforts are limited to the treatment of chronic stable angina
and congestive heart failure. Medicare and other third-party payers currently
reimburse for the treatment of angina symptoms in patients with moderate to
severe symptoms who are refractory to medications and not candidates for
invasive procedures, including patients with serious comorbidities, such as
heart failure, diabetes, peripheral vascular disease, etc. Patients with primary
diagnoses of heart failure, diabetes, peripheral vascular disease, etc. are also
reimbursed under the same criteria, provided the primary indication for
treatment with EECP(R) therapy is angina symptoms.
During the last two fiscal years ended May 31, 2008 and 2007 we incurred
large operating losses. We attempted to achieve profitability by reducing
operating costs and halting the trend of declining revenue, to reduce cash usage
through bringing our cost structure more into alignment with current revenue by
engaging in restructurings during January 2006, March 2007 and April 2007 to
substantially reduce personnel and spending on sales, marketing and development
projects. In addition, we were seeking to obtain a strategic alliance within the
sales and marketing areas and/or to raise additional capital through public or
private equity or debt financings.
27
During the first quarter of fiscal year 2008 the following events took
place which allowed us to raise additional capital through a private equity
financing and by the sale of our facility under a leaseback agreement.
o On June 21, 2007, we entered into a Securities Purchase Agreement with
Kerns Manufacturing Corp. (Kerns). Concurrently with our entry into the
Securities Purchase Agreement, we also entered into a Distribution
Agreement and a Supplier Agreement with Living Data Technology Corporation,
an affiliate of Kerns (Living Data).
We sold to Kerns, pursuant to the Securities Purchase Agreement, 21,428,572
shares of our common stock at $.07 per share for an aggregate of
$1,500,000, as well a five-year warrant to purchase 4,285,714 shares of our
common stock at an initial exercise price of $.08 per share (the Warrant).
The agreement further provided for the appointment to our Board of
Directors of two representatives of Kerns. In furtherance thereof, Mr. Jun
Ma and Mr. Simon Srybnik, Chairman of both Kerns and Living Data, have been
appointed members of our Board of Directors. Pursuant to the Distribution
Agreement, we have become the exclusive distributor in the United States of
the AngioNew ECP systems manufactured by Living Data. As additional
consideration for such agreement, we agreed to issue an additional
6,990,840 shares of our common stock to Living Data. Pursuant to the
Supplier Agreement, Living Data now is the exclusive supplier to us of the
ECP therapy systems that we market under the registered trademark EECP(R).
The Distribution Agreement and the Supplier Agreement each have an initial
term extending through May 31, 2012.
Pursuant to a Registration Rights Agreement, we granted to Kerns and Living
Data, subject to certain restrictions, "piggyback registration rights"
covering the shares sold to Kerns as well as the shares issuable upon
exercise of the Warrant and the shares issued to Living Data.
o On August 15, 2007, we sold our facility under a five-year leaseback
agreement for $1.4 million. The net proceeds from the sale were
approximately $425,000, after payment in full of the two secured notes on
our facility, brokers fees, closing costs, and the opening of a certificate
of deposit in accordance with the provisions of the new lease.
Results of Operations
Fiscal Years Ended May 31, 2008 and 2007
Net revenue from sales, leases and service of our EECP(R) systems for the
fiscal years ended May 31, 2008 and 2007, was $5,182,768 and $6,354,083,
respectively, which represented a decline of $1,171,315, or 18%. We reported a
net loss attributable to common stockholders of $676,965 and $1,571,066 for
fiscal 2008 and 2007, respectively. The decrease in the net loss was primarily
due to the significant decrease in our operating expenses from the comparative
prior period, offset slightly by the decrease in revenue. Our net loss per
diluted common share was $0.01 for the fiscal year ended May 31, 2008 compared
to a net loss of $0.02 per diluted common share for the fiscal year ended May
31, 2007.
Revenues
Revenue from equipment sales declined approximately 18% to $2,087,365 for
the fiscal year ended May 31, 2008 as compared to $2,561,064 for the prior year.
The decline in equipment sales is due primarily to a 33% decrease in average
sales prices, which is attributable to a large number of system upgrades or
trade-ups of older EECP models from existing customers. Although the average
sales price decreased domestically and internationally, generating lower revenue
per unit, the number of unit sales for new and used equipment increased by
approximately 53% within the domestic market while remaining constant for the
international market.
28
We believe the decline in the sales price per unit reflects weakened demand
in the refractory angina market as existing capacity is more fully utilized,
coupled with increased direct and indirect competition. We anticipate that
demand for EECP(R) systems will remain soft unless there is greater clinical
acceptance for the use of EECP(R) therapy in treating patients with angina or
angina equivalent symptoms who meet the current reimbursement guidelines or an
expansion of the current CMS national reimbursement policy to include some or
all Class II & III heart failure patients. Patients with angina or angina
equivalent symptoms eligible for reimbursement under current policies include
many with serious comorbidities, such as heart failure, diabetes, peripheral
vascular disease and/or others. Despite this, many cardiology clinicians appear
to be waiting for approval of reimbursement coverage for heart failure as a
primary indication before they will move forward with the treatment of ischemic
heart failure patients with angina equivalent symptoms. Reluctance to bill for
ischemic heart failure patients under the current coverage guidelines, and
failure to get or maintain adequate reimbursement coverage for angina and heart
failure would adversely affect our business prospects. We anticipate that a
prevailing trend of declining prices will continue in the immediate future as
our competition attempts to capture greater market share through pricing
discounts. The average price of new systems sales declined by 33% which was
mainly due to a large number of system upgrades or trade-ups of older EECP
models from existing customers, in fiscal 2008 compared to the prior year and
the average sales price of used systems declined 37% in fiscal 2008. We continue
to reorganize certain territory responsibilities in our sales department due to
vacant and/or unproductive territories.
Our revenue from the sale of EECP(R) systems and related products to
international distributors in fiscal 2008 decreased approximately 16% to
$836,000 compared to $991,000 in the prior year reflecting decreased sales
volume.
Our revenue from equipment rental and services decreased 18% to $3,095,403
in fiscal 2008 from $3,793,019 in fiscal year 2007. Revenue from equipment
rental and services represented 60% of total revenue in fiscal 2008 and fiscal
2007. The decrease in revenue generated from equipment rentals and services is
due to a decrease in the service business compared to the prior fiscal year. The
decline was also due to a decrease in the rental install base from the prior
fiscal year ended May 31, 2007.
Gross Profit
Gross profit declined to $2,352,398, or 45% of revenues for fiscal 2008
compared to $3,450,970 or 54% of revenues for fiscal 2007. The decrease of gross
profit margin as a percentage of revenue for fiscal 2008 compared to the prior
fiscal year was due mainly to the higher unabsorbed fixed production cost
associated with reduced production volume, and the effects of SFAS No. 151,
which decreased the amount of fixed costs absorbed into inventory in fiscal
2008. The decline in gross profit when compared to the prior year in absolute
dollars is principally due to the lower sales price per unit from fiscal 2007.
Gross profits are dependent on a number of factors, particularly the mix of
EECP(R) models sold domestically and internationally and their respective
average selling prices, the mix of EECP(R) units sold, rented or placed during
the period, the ongoing costs of servicing such units, and certain fixed period
costs, including facilities, payroll and insurance. Gross profit margins are
generally less on non-domestic business due to the use of distributors resulting
in lower selling prices. Consequently, the gross profit realized during the
current period may not be indicative of future margins.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses for fiscal 2008 and
2007 were $2,626,045, or 51% of revenues, and $4,051,993, or 64% of revenues,
respectively, reflecting a decrease of $1,425,525 or approximately 35%. The
decrease in SG&A expenditures in fiscal 2008 resulted primarily from decreased
direct expenditures of $576,729 due to reduced sales personnel and associated
travel plus lower sales commission due to reduced sales price, offset by minimal
increases in other sales related costs. Marketing expenses decreased $451,658
due to reduced expenditures in personnel and their associated costs in the
marketing and clinical application support areas, as well as associated travel,
plus lower market research, product promotion, advertising, and trade show
expenses. Administrative expenses decreased $397,138 as a result of decreased
expenditures in personnel and their associated costs, professional fees related
to accounting, legal and consulting services, reversal of bad debt reserves, and
insurance expenses offset slightly by increases in other administrative
expenses.
29
During fiscal 2008 the Company reversed $42,837 of its provision for
doubtful accounts compared to fiscal 2007 when the Company recorded a provision
for doubtful accounts of $423. The reversal of the provision is primarily a
result of the fiscal 2008 decrease in sales in addition to the continuous
efforts to ensure collection of accounts receivable.
Research and Development
Research and development ("R&D") expenses of $474,111 or 9% of revenues for
fiscal 2008 decreased by $459,205, or 49%, from $933,316, or 15% of revenues for
the fiscal 2007. The decrease is primarily attributable to fewer engineering and
clinical personnel and associated expenditures and reduced spending on clinical
trials, offset by a slight increase in new product spending.
Interest Expense and Financing Costs
Interest expense and financing costs decreased to $16,616 for fiscal 2008
from $69,767 for the prior year. Interest expense primarily reflects interest on
loans secured to refinance the November 2000 purchase of the Company's
headquarters and warehouse facility. The decrease is a direct result of the
sale-leaseback agreements for the Company's headquarters and warehouse facility
which occurred during the first quarter of fiscal 2008.
Interest and Other Income, Net
Interest and other income for fiscal 2008 and 2007 were $61,083 and
$53,648, respectively. Interest income primarily reflects interest earned on the
Company's cash balances. Other income has been derived primarily from the
liquidation of equipment and fixtures used in previously leased properties.
Gain on Sale of Assets
The Gain on Sale of Assets for fiscal 2008 of $44,371 resulted from the
Company's sale-leaseback of its facility.
Income Tax Expense, Net
During fiscal 2008 and 2007 we recorded a provision for income taxes of
$18,045 and $20,608, respectively.
As of May 31, 2008, the recorded deferred tax assets were $19,819,352,
reflecting an increase of $230,000 during the fiscal year ended May 31, 2008,
which was offset by a valuation allowance of the same amount.
Ultimate realization of any or all of the deferred tax assets is not
assured due to significant uncertainties and material assumptions associated
with estimates of future taxable income during the carryforward period. In
November 2005, we concluded that, based upon the weight of available evidence,
it was "more likely than not" that the net deferred tax asset would not be
realized and increased the valuation allowance to bring the net deferred tax
asset carrying value to zero.
Liquidity and Capital Resources
Cash and Cash Flow
We have financed our operations primarily from working capital and in
fiscal 2008 from a private equity financing and by the sale of our facility
under a leaseback agreement. At May 31, 2008, we had cash and cash equivalents
of $2,653,999 and working capital of $2,851,901 compared to cash and cash
equivalents of $850,288 and working capital of $1,320,347 at May 31, 2007.
30
Cash used in operating activities was $32,021 during fiscal 2008, which
consisted of a net cash loss after adjustments of $385,491 and cash provided by
operating assets and liabilities of $353,470. The changes in the accounts
balances primarily reflect lower inventory of $592,427 and increase in deferred
revenues - LT and other liabilities of $15,982,which were partially offset by a
decrease in accounts receivable of $27,031, a decrease in accounts payable,
accrued expenses, deferred revenues - ST, and other current liabilities of
$163,246 and lower other current assets of $24,172, as well as deferred
distributor costs of $40,490. Net accounts receivable were 14% of revenues for
the period ended May 31, 2008, as compared to 12% for the period ended May 31,
2007, and accounts receivable turnover decreased to 7.1 times as of May 31,
2008, as compared to 8.1 times as of May 31, 2007.
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(R) 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 fiscal 2008 and 2007, there were no revenues generated from sales in
which initial payment terms were greater than 90 days and we offered no
sales-type leases during either period. In general, reserves are calculated on a
formula basis considering factors such as the aging of the receivables, time
past due, and the customer's credit history and their current financial status.
In most instances where reserves are required, or accounts are ultimately
written-off, customers have been unable to successfully implement their EECP(R)
program. As we are creating a new market for the EECP(R) therapy and recognizing
the challenges that some customers may encounter, we have opted, at times, on a
customer-by-customer basis, to recover our equipment instead of pursuing other
legal remedies, which has resulted in our recording of a reserve or a write-off.
Investing activities provided net cash of $1,310,857 during the fiscal year
ended May 31, 2008,I which represented proceeds received from the building sale,
net of related costs.
Our financing activities provided net cash of $524,875 during the fiscal
year ended May 31, 2008, reflecting proceeds, net of related expenses, of
$1,375,890 from the Securities Purchase Agreement, which was offset by loan
repayments on the building of $851,015.
Liquidity
During the last two fiscal years ended May 31, 2008 and 2007, we incurred
large operating losses. The Company attempted to achieve profitability by
reducing operating costs and halting the trend of declining revenue, to reduce
cash usage by bringing its cost structure more into alignment with current
revenue by engaging in restructurings during January 2006, March 2007 and April
2007 to substantially reduce personnel and spending on sales, marketing and
development projects. In addition, the Company was seeking to obtain a strategic
alliance within the sales and marketing areas and/or to raise additional capital
through public or private equity or debt financings.
During the first quarter of fiscal year 2008 the following events took
place which allowed us to raise additional capital through a private equity
financing and by the sale of our facility under a leaseback agreement.
o On June 21, 2007, we entered into a Securities Purchase Agreement with
Kerns Manufacturing Corp. (Kerns). Concurrently with our entry into
the Securities Purchase Agreement, we also entered into a Distribution
Agreement and a Supplier Agreement with Living Data Technology
Corporation, an affiliate of Kerns (Living Data).
We sold to Kerns, pursuant to the Securities Purchase Agreement,
21,428,572 shares of our common stock at $.07, per share for a total
purchase price of $1,500,000, as well a five-year warrant to purchase
4,285,714 shares of our common stock at an initial exercise price of
$.08 per share (the Warrant) . The agreement further provided for the
appointment to our Board of Directors of two representatives from
Kerns. In furtherance thereof, Mr. Jun Ma and Mr. Simon Srybnik,
Chairman of both Kerns and Living Data, have been appointed members of
our Board of Directors. Pursuant to the Distribution Agreement, we
31
have become the exclusive distributor in the United States of the
AngioNew ECP systems manufactured by Living Data. As additional
consideration for such agreement, we agreed to issue an additional
6,990,840 shares of our common stock to Living Data. Pursuant to the
Supplier Agreement, Living Data now is the exclusive supplier to us of
the ECP therapy systems that we market under the registered trademark
EECP(R). The Distribution Agreement and the Supplier Agreement each
have an initial term extending through May 31, 2012.
Pursuant to a Registration Rights Agreement, we granted to Kerns and
Living Data, subject to certain restrictions, "piggyback registration
rights" covering the shares sold to Kerns as well as the shares
issuable upon exercise of the Warrant and the shares issued to Living
Data.
o On August 15, 2007, we sold our facility under a five-year leaseback
agreement for $1.4 million. The net proceeds from the sale were
approximately $425,000 after payment in full of the two secured notes
on our facility, brokers fees, closing costs, and the opening of a
certificate of deposit in accordance with the provisions of the new
lease.
Based on the above transactions, we believe that we have sufficient working
capital to continue our operations through at least May 31, 2009.
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, 2008, we are not involved in any
unconsolidated SPES.
Related Party Transactions
As previously described, on June 21, 2007, we entered into a Securities
Purchase Agreement with Kerns Manufacturing Corp. (Kerns). Concurrently with our
entry into the Securities Purchase Agreement, we also entered into a
Distribution Agreement and a Supplier Agreement with Living Data Technology
Corporation, an affiliate of Kerns (Living Data).
We sold to Kerns, pursuant to the Securities Purchase Agreement, 21,
428,572 shares of our common stock at $.07 per share, for an aggregate of
$1,500,000 as well a five-year warrant to purchase 4,285,714 shares of our
common stock at an initial exercise price of $.08 per share (the Warrant). The
agreement further provided for the appointment to our Board of Directors of two
representatives from Kerns. In furtherance thereof, Mr. Jun Ma and Mr. Simon
Srybnik, Chairman of both Kerns and Living Data, have been appointed members of
our Board of Directors. Pursuant to the Distribution Agreement, we have become
the exclusive distributor in the United States of the AngioNew ECP systems
manufactured by Living Data. As additional consideration for such agreement, we
agreed to issue an additional 6,990,840 shares of our common stock to Living
Data. Pursuant to the Supplier Agreement, Living Data now will be the exclusive
supplier to us of the ECP therapy systems that we market under the registered
trademark EECP(R). The Distribution Agreement and the Supplier Agreement each
have an initial term extending through May 31, 2012.
Pursuant to a Registration Rights Agreement, we granted to Kerns and Living
Data, subject to certain restrictions, "piggyback registration rights" covering
the shares sold to Kerns as well as the shares issuable upon exercise of the
Warrant and the shares issued to Living Data.
32
On July 10, 2007, the Board of Directors appointed Mr. Behnam Movaseghi,
Treasurer and Chief Financial Officer of Kerns Manufacturing Corporation, to our
Board of Directors.
As affiliates of Living Data and Kerns, Mr. Ma, Mr. Movaseghi and Mr.
Srybnik have each been directly involved in the transactions between Living Data
and Kerns, and the Company, with respect to the Securities Purchase Agreement,
the Distribution Agreement and the Supplier Agreement, as well as consulting
servicesto the Company with no compensation.
During fiscal 2008, the Company purchased ECP therapy systems under the
Supplier Agreement for $120,000 from Living Data, which was paid in full by the
Company as of June 2008. In addition, Living Data purchased $5,000 worth of ECP
therapy system components from the Company, which was paid in full by Living
Data as of June 2008.
During fiscal 2009 Living Data assigned to Vasomedical, Inc. all of its
rights and interests under its Distributorship Agreement with a corporation
organized and existing under the laws of the People's Republic of China, that
manufactures Ambulatory Blood Pressure Monitors, Ambulatory ECG Recorders and
Holter & ABPM Combiner Recorders, for $20,000 payable to Living Data based on
certain terms and conditions. Vasomedical Inc., also must pay to Living Data 5%
of the selling price or 5% of the cost of all goods sold (whichever is higher),
and 5% of the cost of all goods transferred but not sold under the Assignment
Agreement to Living Data based on sales of this equipment. The Company intends
to sell these systems in the United States and other countries subject to
obtaining regulatory clearance.
During fiscal 2009 Living Data assigned to Vasomedical, Inc. all of its
rights and interests under its Distributorship Agreement with a corporation
organized and existing under the laws of the People's Republic of China, that
manufactures Ultrasound Scanners, for $20,000 payable to Living Data based on
certain terms and conditions. Vasomedical Inc., also must pay to Living Data 5%
of the selling price or 5% of the cost of all goods sold (whichever is higher),
and 5% of the cost of all goods transferred but not sold under the Assignment
Agreement to Living Data based on sales of this equipment. The Company intends
to sell these systems in the United States and other countries subject to
obtaining regulatory clearance.
In July of 2008 Vasomedical, Inc. has agreed to purchase ECP therapy
systems under its Distributorship Agreement with Living Data for $360,000
payable over 18 months.
Further, Kerns is providing the Company, free of charge, part time use of
one of its Information Technology (IT) employees as well one of their IT
consultants to provide the Company with IT and database support services. In
addition, a clinical applications support specialist and a service engineer from
Living Data may be used by Vasomedical, Inc. to provide customers with clincial
training and technical service.
Effects of Inflation
We believe that inflation and changing prices over the past three years
have not had a significant impact on our revenue or on our results of
operations.
Critical Accounting Policies
Financial Reporting Release No. 60, which was released by the Securities
and Exchange Commission, or SEC, in December 2001, requires all companies to
include a discussion of critical accounting policies or methods used in the
preparation of financial statements. Note B of the Notes to Consolidated
Financial Statements included in our Annual Report on Form 10-KSB for the year
ended May 31, 2008, 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:
33
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,
we recognize revenue from the sale of our EECP(R) systems in the period in which
we deliver the system to the customer. Revenue from the sale of our EECP(R)
systems to international markets is recognized upon shipment of the product to a
common carrier, as are supplies, accessories and spare parts delivered to both
domestic and international customers. Returns are accepted prior to the
in-service and training subject to a 10% restocking charge or for normal
warranty matters, and we are not obligated for post-sale upgrades to these
systems. In addition, we use the installment method to record revenue based on
cash receipts in situations where the account receivable is collected over an
extended period of time and in our judgment the degree of collectibility is
uncertain.
In most cases, revenue from domestic EECP(R) 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. We follow the provisions of Emerging Issues
Task Force, or EITF, Issue No. 00-21, "Revenue Arrangements with Multiple
Deliverables" ("EITF 00-21"). The principles and guidance outlined in EITF 00-21
provide a framework to determine (a) how the arrangement consideration should be
measured (b) whether the arrangement should be divided into separate units of
accounting, and (c) how the arrangement consideration should be allocated among
the separate units of accounting. We determined that the domestic sale of our
EECP(R) systems includes a combination of three elements that qualify as
separate units of accounting:
i. EECP(R) equipment sale,
ii. provision of in-service and training support consisting of equipment
set-up and training provided at the customer's facilities, and
iii. a service arrangement (usually one year), consisting of: service by
factory-trained service representatives, material and labor costs,
emergency and remedial service visits, software upgrades, technical
phone support and preferred response times.
Each of these elements represent individual units of accounting as the
delivered item has value to a customer on a stand-alone basis, objective and
reliable evidence of fair value exists for undelivered items, and arrangements
normally do not contain a general right of return relative to the delivered
item. We determine fair value based on the price of the deliverable when it is
sold separately or based on third-party evidence. In accordance with the
guidance in EITF 00-21, we use the residual method to allocate the arrangement
consideration when it does not have fair value of the EECP(R) system sale. Under
the residual method, the amount of consideration allocated to the delivered item
equals the total arrangement consideration less the aggregate fair value of the
undelivered items. Assuming all other criteria for revenue recognition have been
met, we recognize revenue for:
i. EECP(R) equipment sales, when delivery and acceptance occurs based on
delivery and acceptance documentation received from independent
shipping companies or customers,
ii. in-service and training, following documented completion of the
training, and
iii. the service arrangement, ratably over the service period, which is
generally one year.
In-service and training generally occurs within a few weeks of shipment and
our return policy states that no returns will be accepted after in-service and
training has been completed. The amount related to in-service and training is
recognized as service revenue at the time the in-service and training is
completed and the amount related to service arrangements is recognized ratably
as service revenue over the related service period, which is generally one year.
Costs associated with the provision of in-service and training and the service
arrangement, including salaries, benefits, travel, spare parts and equipment,
are recognized in cost of equipment sales as incurred.
The Company also recognizes revenue generated from servicing EECP(R)
systems that are no longer covered by the service arrangement, or by providing
sites with additional training, in the period that these services are provided.
Revenue related to future commitments under separately priced extended service
agreements on our EECP(R) system are deferred and recognized ratably over the
service period, generally ranging from one year to four years. Costs associated
with the provision of service and maintenance, including salaries, benefits,
travel, spare parts and equipment, are recognized in cost of sales as incurred.
Amounts billed in excess of revenue recognized are included as deferred revenue
in the consolidated balance sheets.
34
Revenues from the sale of EECP(R) systems through our international
distributor network are generally covered by a one-year warranty period. For
these customers we accrue a warranty reserve for estimated costs to provide
warranty parts when the equipment sale is recognized.
The Company has also entered into lease agreements for our EECP(R) 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(R) 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, 2008.
Accounts Receivable, net
The Company's accounts receivable 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 that remain 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 its 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
our 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.
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(R) systems at various field locations for demonstration, training,
evaluation, and other similar purposes at no charge. The cost of these EECP(R)
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(R) 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 its products as well as forecasts of future product demand.
We have adopted the provisions of Statement of Financial Accounting
Standards No. 151, "Inventory Costs", on a prospective basis. The statement
clarifies that abnormal amounts of idle facility expense, freight, handling
costs, and wasted materials (spoilage) should be recognized as current-period
charges and requires the allocation of fixed production overheads to inventory
based on the normal capacity of the production facilities. As a result of
adopting SFAS No. 151, we absorbed approximately $158,000 less in fixed
production overhead into inventory during fiscal year 2008 as compared to fiscal
2007.
Deferred Revenues
The Company records revenue on extended service contracts ratably over the
term of the related contract period. In accordance with the provisions of EITF
00-21, we began to defer revenue related to EECP(R) 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. Under
the provisions of EITF 00-21, for certain arrangements, a portion of the overall
35
system price attributable to the first year service arrangement is deferred and
recognized as revenue over the service period. As such, we do not accrue
warranty costs upon delivery but we rather recognize warranty and related
service costs as incurred.
Equipment sold to international customers through our distributor network
is generally covered by a one-year warranty period. For these customers the
Company accrues a warranty reserve for estimated costs of providing a parts only
warranty when the equipment sale is recognized.
The factors affecting our warranty liability included the number of units
sold and historical and anticipated rates of claims and costs per claim.
Net Loss per Common Share
Basic loss per share is based on the weighted average number of common
shares outstanding without consideration of potential common stock. Diluted loss
per share is based on the weighted number of common and potential dilutive
common shares outstanding. The calculation takes into account the shares that
may be issued upon the exercise of stock options and warrants, reduced by the
shares that may be repurchased with the funds received from the exercise, based
on the average price during the period.
Income Taxes
Deferred income taxes are recognized for temporary differences between
financial statement and income tax bases of assets and liabilities and loss
carryforwards for which income tax benefits are expected to be realized in
future years. A valuation allowance is established, when necessary, to reduce
deferred tax assets to the amount expected to be realized. In estimating future
tax consequences, we generally consider all expected future events other than an
enactment of changes in the tax laws or rates. The deferred tax asset is
continually evaluated for realizability. To the extent our judgment regarding
the realization of the deferred tax assets changes, an adjustment to the
allowance is recorded, with an offsetting increase or decrease, as appropriate,
in income tax expense. Such adjustments are recorded in the period in which our
estimate as to the realizability of the asset changed that it is "more likely
than not" that all of the deferred tax assets will be realized. The "more likely
than not" standard is subjective, and is based upon our estimate of a greater
than 50% probability that the deferred tax asset will be realized.
Deferred tax assets and liabilities are classified as current or
non-current based on the classification of the related asset or liability for
financial reporting. A deferred tax asset or liability 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 the Company previously
recorded, and then reversed fully in fiscal 2006, related primarily to the
realization of net operating loss carryforwards, of which the allocation of the
current portion, if any, reflected the expected utilization of such net
operating losses for the following twelve months. Such allocation was based on
the Company's internal financial forecast and may be subject to revision based
upon actual results.
Stock-based Employee Compensation
In December 2004, the FASB issued Statement of Financial Standards No. 123
(revised 2004), Share-Based Payment ("SFAS No. 123 (R)"), which is a revision of
SFAS No. 123. SFAS No. 123 (R) supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash
Flows. Generally, the approach to accounting for share-based payments in SFAS
No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS
No. 123(R) requires all share-based payments to employees including grants of
employee stock options, to be recognized in the financial statements based on
their fair values. Pro forma disclosure of the fair value of share-based
payments is no longer an alternative to financial statement recognition. The
Company has five stock-based employee compensation plans.
Prior to second quarter of fiscal 2007, the Company accounted 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 adopted the
36
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 prior to
fiscal 2007.
In May 2006, the compensation committee of the board of directors
accelerated the vesting provision of all outstanding stock options and warrants
so that they were fully vested at May 31, 2006, and as a result the adoption of
SFAS No. 123(R) did not have an immediate material effect on the financial
statements. However, as new stock options are issued by the Company this may
have a material effect on its quarterly and annual financial statements, in the
form of additional compensation expense. It is not possible to precisely
determine the expense impact of adoption since a portion of the ultimate expense
that is recorded will likely relate to awards that have not yet been granted.
The expense associated with these future awards can only be determined based on
factors such as the price for the Company's common stock, volatility of the
Company's stock price and risk free interest rates as measured at the grant
date.
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 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 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
(R).
Recently Issued Accounting Pronouncements Not Yet Effective
Statements of Financial Accounting Standards (SFAS):
SFAS No. 141 (R), "Business Combinations" -- retains the fundamental
requirements in Statement 141 that the acquisition method of accounting (which
Statement 141 called the purchase method) be used for all business combinations
and for an acquirer to be identified for each business combination. This
Statement defines the acquirer as the entity that obtains control of one or more
businesses in the business combination and establishes the acquisition date as
the date that the acquirer achieves control.
o replaces Statement 141's cost-allocation process and requires an
acquirer to recognize the assets acquired, the liabilities assumed,
and any noncontrolling interest in the acquiree at the acquisition
date, measured at their fair values as of that date,
o requires the acquirer in a business combination achieved in stages
(sometimes referred to as a step acquisition) to recognize the
identifiable assets and liabilities, as well as the noncontrolling
interest in the acquiree, at the full amounts of their fair values,
o requires that an acquirer evaluate new information and measure a
liability at the higher of its acquisition-date fair value or the
amount that would be recognized if applying Statement 5, then
measuring an asset at the lower of its acquisition-date fair value or
the best estimate of its future settlement amount,
o requires the acquirer to recognize contingent consideration at the
acquisition date, measured at its fair value at that date,
SFAS No. 157, Fair Value Measurements. This Statement defines fair value,
establishes a framework for measuring fair value, and expands disclosures about
fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the Board having
previously concluded in those accounting pronouncements that fair value is the
relevant measurement attribute. Accordingly, this Statement does not require any
new fair value measurements. However, for some entities, the application of this
Statement will change current practice. This Statement is effective for
37
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. Earlier application is
encouraged, provided that the reporting entity has not yet issued financial
statements for that fiscal year, including financial statements for an interim
period within that fiscal year. The Company does not expect that SFAS No. 157
will have any significant effect on future financial statements.
SFAS No. 159, The Fair Value Option for Financial Assets and Financial
Liabilities - Including an Amendment to FASB Statement No. 115. This Statement
permits entities to choose to measure many financial instruments and certain
other items at fair value. The objective is to improve financial reporting by
providing entities with the opportunity to mitigate volatility in reported
earnings caused by measuring related assets and liabilities differently without
having to apply complex hedge accounting provisions. This Statement is expected
to expand the use of fair value measurement, which is consistent with the
Board's long-term measurement objectives for accounting for financial
instruments. This Statement is effective as of the beginning of an entity's
first fiscal year that begins after November 15, 2007, and interim periods
within those fiscal years. Early adoption is permitted as of the beginning of a
fiscal year that begins on or before November 15, 2007, provided the entity also
elects to apply the provisions of FASB Statement No. 157, Fair Value
Measurements. The Company does not expect that SFAS No. 159 will have any
significant effect on future financial statements.
Effective for fiscal years beginning after December 15, 2008
SFAS No. 160, "Noncontrolling Interests in Consolidated Financial
Statements" -- changes the way the consolidated income statement is presented.
It requires consolidated net income to be reported at amounts that include the
amounts attributable to both the parent and the noncontrolling interest. It also
requires disclosure, on the face of the consolidated statement of income, of the
amounts of consolidated net income attributable to the parent and to the
noncontrolling interest. Previously, net income attributable to the
noncontrolling interest generally was reported as an expense or other deduction
in arriving at consolidated net income. It also was often presented in
combination with other financial statement amounts. Effective for fiscal years
beginning after December 15, 2008.
SFAS No. 161, Disclosures about Derivative Instruments and Hedging
Activities - an Amendment of FASB Statement 133 -- enhances required disclosures
regarding derivatives and hedging activities, including enhanced disclosures
regarding how: (a) an entity uses derivative instruments; (b) derivative
instruments and related hedged items are accounted for under FASB Statement No.
133, Accounting for Derivative Instruments and Hedging Activities; and (c)
derivative instruments and related hedged items affect an entity's financial
position, financial performance, and cash flows. Specifically, Statement SFAS
No. 161 requires:
o Disclosure of the objectives for using derivative instruments be
disclosed in terms of underlying risk and accounting designation;
o Disclosure of the fair values of derivative instruments and their
gains and losses in a tabular format;
o Disclosure of information about credit-risk-related contingent
features; and
o Cross-reference from the derivative footnote to other footnotes in
which derivative-related information is disclosed.
Effective for fiscal years and interim periods beginning after November 15,
2008. Early application is encouraged. The Company does not expect that SFAS No.
161 will have any significant effect on future financial statements.
SFAS No. 163, "Accounting for Financial Guarantee Insurance Contracts" --
clarifies how SFAS No. 60, "Accounting and Reporting by Insurance Enterprises",
applies to financial guarantee insurance contracts issued by insurance
enterprises, including the recognition and measurement of premium revenue and
claim liabilities. It also requires expanded disclosures about financial
guarantee insurance contracts. SFAS No. 163 is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and all
interim periods within those fiscal years, except for disclosures about the
insurance enterprise's risk-management activities, which are effective the first
period beginning after May 23, 2008.
38
FASB Staff Positions (FSP):
FSP APB 14-1, "Accounting for Convertible Debt Instruments That May Be
Settled in Cash upon Conversion (Including Partial Cash Settlement)" --
clarifies that convertible debt instruments that may be settled in cash upon
conversion (including partial cash settlement) are not addressed by paragraph 12
of APB Opinion No. 14, Accounting for Convertible Debt and Debt Issued with
Stock Purchase Warrants. Additionally, this FSP specifies that issuers of such
instruments should separately account for the liability and equity components in
a manner that will reflect the entity's nonconvertible debt borrowing rate when
interest cost is recognized in subsequent periods. This FSP is effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years.
FSP FAS 140-3, "Accounting for Transfers of Financial Assets and Repurchase
Financing Transactions" -- amends FASB Statement 140 to state that a transferor
and transferee shall not separately account for a transfer of a financial asset
and a related repurchase financing unless (a) the two transactions have a valid
and distinct business or economic purpose for being entered into separately and
(b) the repurchase financing does not result in the initial transferor regaining
control over the financial asset. This FSP is effective for financial statements
issued for fiscal years beginning after November 15, 2008, and interim periods
within those fiscal years. Earlier application is not permitted.
FSP FAS 142-3, "Determination of the Useful Life of Intangible Assets" --
amends the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible asset
under FASB Statement No. 142, Goodwill and Other Intangible Assets. Paragraph
11(d) of Statement 142 precluded an entity from using its own assumptions about
renewal or extension of an arrangement where there is likely to be substantial
cost or material modifications. This FSP amends paragraph 11(d) of Statement 142
so that an entity will use its own assumptions about renewal or extension of an
arrangement, adjusted for the entity-specific factors in paragraph 11 of
Statement 142, even when there is likely to be substantial cost or material
modifications. Therefore, in determining the useful life of the asset for
amortization purposes, an entity shall consider the period of expected cash
flows used to measure the fair value of the recognized intangible asset,
adjusted for the entity-specific factors including, but are not limited to, the
entity's expected use of the asset and the entity's historical experience in
renewing or extending similar arrangements. This FSP shall be effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years. Early adoption is prohibited.
FSP FAS 157-1, "Application of FASB Statement No. 157 to FASB Statement No.
13 and Other Accounting Pronouncements That Address Fair Value Measurements for
Purposes of Lease Classification or Measurement under Statement 13" -- amends
SFAS No. 157, "Fair Value Measurements", to exclude SFAS No. 13, "Accounting for
Leases", and other accounting pronouncements that address fair value
measurements for purposes of lease classification or measurement under Statement
13. However, this scope exception does not apply to assets acquired and
liabilities assumed in a business combination that are required to be measured
at fair value under SFAS No. 141, "Business Combinations", or No. 141 (revised
2007), "Business Combinations", regardless of whether those assets and
liabilities are related to leases.
FSP FAS 157-2, "Effective Date of FASB Statement No. 157" -- delays the
effective date of SFAS No. 157, "Fair Value Measurements", for nonfinancial
assets and nonfinancial liabilities, except for items that are recognized or
disclosed at fair value in the financial statements on a recurring basis (at
least annually). The delay is intended to allow the Board and constituents
additional time to consider the effect of various implementation issues that
have arisen, or that may arise, from the application of SFAS No. 157. This FSP
defers the effective date of SFAS No. 157 to fiscal years beginning after
November 15, 2008, and interim periods within those fiscal years for items
within the scope of this FSP.
FSP FIN 46(R)-7, "Application of FASB Interpretation No. 46(R) to
Investment Companies" -- states that investments accounted for at fair value in
accordance with the specialized accounting guidance in the AICPA Audit and
Accounting Guide, Investment Companies, are not subject to consolidation
according to the requirements of FIN 46(R).
39
FSP SOP 94-3-1 and AAG HCO-1, " Omnibus Changes to Consolidation and Equity
Method Guidance for Not-for-Profit Organizations " -- makes several changes to
the guidance on consolidation and the equity method of accounting in AICPA
Statement of Position 94-3, "Reporting of Related Entities by Not-for-Profit
Organizations", and the AICPA Audit and Accounting Guide, "Health Care
Organizations." This FSP:
a. Eliminates the temporary control exception to consolidation that
currently exists for certain relationships between not-for-profit
organizations and makes two related changes:
(1) Amends the definition of majority voting interest in the board of
another entity in SOP 94-3 and the health care Guide
(2) (2) Conforms the categorization of sole corporate membership in
SOP 94-3 to that in the health care Guide
b. Confirms the continued applicability to not-for-profit organizations
of the consensus guidance on consolidation of special-purpose entity
(SPE) lessors in the following EITF Issues:
(1) No. 90-15, "Impact of Nonsubstantive Lessors, Residual Value
Guarantees, and Other Provisions in Leasing Transactions"
(2) No. 96-21, "Implementation Issues in Accounting for Leasing
Transactions involving Special-Purpose Entities"
(3) No. 97-1, "Implementation Issues in Accounting for Lease
Transactions, including Those involving Special-Purpose Entities"
c. Requires that not-for-profit organizations apply the guidance in:
AICPA Statement of Position 78-9, "Accounting for Investments in Real
Estate Ventures", on the equity method of accounting to their noncontrolling
interests in for-profit real estate partnerships, limited liability companies
(LLCs), and similar entities unless those investments are reported at fair
value, where permitted.
(1) FSP SOP 78-9-1, "Interaction of AICPA Statement of Position 78-9 and
EITF Issue No. 04-5", to help determine whether their interests in
for-profit partnerships, LLCs, and similar entities are controlling
interests or noncontrolling interests
(2) EITF Issue No. 03-16, "Accounting for Investments in Limited Liability
Companies," to determine whether an LLC should be viewed as similar to
a partnership, as opposed to a corporation, for purposes of
determining whether noncontrolling interests in an LLC or a similar
entity should be accounted for in accordance with SOP 78-9 and related
guidance.
FSP SOP 94-3-1 and AAG HCO-1 is effective for fiscal years beginning after
June 15, 2008, and to interim periods therein.
FSP SOP 07-1-1, -- indefinitely delays the effective date of AICPA
Statement of Position 07-1, "Clarification of the Scope of the Audit and
Accounting Guide Investment Companies and Accounting by Parent Companies and
Equity Method Investors for Investments in Investment Companies."
FSP EITF 03-6-1, -- "Determining Whether Instruments Granted in Share-Based
Payment Transactions Are Participating Securities." This FSP provides that
unvested share-based payment awards that contain nonforfeitable rights to
dividends or dividend equivalents (whether paid or unpaid) are participating
securities and shall be included in the computation of earnings per share
pursuant to the two-class method. The FSP is effective for financial statements
issued for fiscal years beginning after December 15, 2008, and interim periods
within those years. Upon adoption, a company is required to retrospectively
adjust its earnings per share data (including any amounts related to interim
periods, summaries of earnings and selected financial data) to conform with the
provisions in this FSP. Early application of this FSP is prohibited.
40
EITF Consensuses (EITF):
EITF Issue No. 07-1, "Accounting for Collaborative Arrangements " -- when
entities enter into arrangements to participate in a joint operating activity a
collaborative arrangement may provide that one participant has sole or primary
responsibility for certain activities or that two or more participants have
shared responsibility for certain activities. Participants should evaluate
whether an arrangement is a collaborative arrangement at the inception of the
arrangement based on the facts and circumstances present at that time. Revenue
generated and costs incurred by participants from transactions with parties
should be reported gross or net on the appropriate line item in each
participant's respective financial statements depending on the nature of the
participation. Disclosures should include information about the nature and
purpose of its collaborative arrangements, the entity's rights and obligations
under the collaborative arrangements, the accounting policy for collaborative
arrangements, and the income statement classification and amounts attributable
to transactions arising from the collaborative arrangement. Effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years.
EITF Issue No. 07-4, "Application of the Two-Class Method under FASB
Statement No. 128, Earnings per Share, to Master Limited Partnerships" --The
scope of this issue includes Master Limited Partnerships (MLPs) that are
required to make incentive distribution rights (IDR) payments, regardless of
whether the IDRs are embedded in the GP (General Partner) interest or are a
separate LP (Limited Partner) interest, and the MLPs account for these IDR
payments as equity distributions. The consensus is that when the IDR is embedded
in the GP interest, undistributed earnings should be allocated to the GP
(including the distribution rights of the embedded IDR) and LPs utilizing the
distribution formula for available cash specified in the partnership agreement.
The undistributed earnings should be allocated to the GP (with respect to the
distribution rights of an embedded IDR) based on the contractual participation
rights of the IDR to share in current period earnings. Therefore, if the
partnership agreement includes a "specified threshold," an MLP should not
allocate undistributed earnings to the GP (with respect to the distribution
rights of an embedded IDR) once the specified threshold has been met. The final
consensus requires that an entity: (a) apply the guidance in this issue in its
first fiscal year beginning after December 15, 2008, including interim periods
within those fiscal years, and (b) transition to the guidance in this issue by
retrospectively applying the guidance to all periods presented. Early
application is prohibited.
ITEM 7 - FINANCIAL STATEMENTS
The consolidated financial statements listed in the accompanying Index to
Consolidated Financial Statements are filed as part of this report.
ITEM 8 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 8A - CONTROLS AND PROCEDURES
Report on Disclosure Controls and Procedures
The Company's Chief Executive Officer ("CEO") and Chief Financial Officer
("CFO") with the participation of the Company's management ("Management") and
through the guidance of an independent internal control consulting firm
("Consultants") conducted an evaluation of the effectiveness of the Company's
disclosure controls and procedures. These disclosure controls and procedures are
designed to ensure that information required to be disclosed by the Company in
the reports that it files or submits under the Securities Exchange Act of 1934,
within the time periods specified by the SEC rules and forms, is recorded,
processed, summarized and reported, and is communicated to Management, as
appropriate, to allow for timely decisions based on the required disclosures.
Based on this evaluation, the Company's CEO and CFO concluded that the
Company's disclosure controls and procedures were effective as of May 31, 2008.
41
ITEM 8A(T) - CONTROLS AND PROCEDURES
Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate
internal control over financial reporting as defined in Rule 13a-15(f) of the
Exchange Act. Internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with accounting principles generally accepted in the United States of America.
Under the supervision of the Consultants referred to in Item 8A and with the
participation of Management, the CEO and CFO, an evaluation was conducted of the
effectiveness of the internal control over financial reporting based on the
framework set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) in Internal Control - Integrated Framework. Based on this
evaluation, the Company's CEO and CFO concluded that the Company's internal
control over financial reporting was effective as of May 31, 2008. However,
Management's assessment identified the following weaknesses in the Information
Technology System (IT) at May 31, 2008:
(a) Documenting the procedures performed in the change management area of
our internal control over Information Technology Systems (IT ). During
the first quarter of fiscal 2009, we remediated these weaknesses by
ensuring that processes were documented properly.
(b) Excessive manual adjustments to the inventory module are required. In
fiscal 2009, we will be remediating this with our upgraded accounting
software.
A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. Further, the benefits of controls must be considered relative to
their costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, have been detected. These inherent limitations
include the realities that judgments in decision making can be faulty, and that
breakdowns can occur because of simple errors. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of any system of
controls is also based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions. Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected . This annual report does not
include an attestation report of the Company's Registered Public Accounting Firm
regarding internal control over financial reporting. Management's report was not
subject to attestation by the Company's Registered Public Accounting Firm
pursuant to temporary rules of the Securities and Exchange Commission that
permit the Company to provide only Management's report in this Annual Report.
ITEM 8B - OTHER INFORMATION
None.
42
PART III
ITEM 9 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE
GOVERNANCE; COMPLIANCE WITH SECTION 16 (a) OF THE EXCHANGE ACT.
The information required by this Item is intended to be included in our
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection with our 2008 Annual Meeting of Stockholders and is
incorporated herein by reference.
ITEM 10 - EXECUTIVE COMPENSATION
The information required by this Item is intended to be included in our
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection with our 2008 Annual Meeting of Stockholders and is
incorporated herein by reference.
ITEM 11 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by this Item is intended to be included in our
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection with our 2008 Annual Meeting of Stockholders and is
incorporated herein by reference.
ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The information required by this Item is intended to be included in our
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection with our 2008 Annual Meeting of Stockholders and is
incorporated herein by reference.
ITEM 13 - EXHIBITS
(a) Financial Statements and Financial Statement Schedules
------------------------------------------------------
(1) See Index to Consolidated Financial Statements on page F-1 at
beginning of attached financial statements.
(b) Exhibits
--------
(3) (a) Restated Certificate of Incorporation (2)
(b) By-Laws (1)
(4) (a) Specimen Certificate for Common Stock (1)
(b) Certificate of Designation of the Preferred Stock, Series A (3)
(c) Certificate of Designation of the Preferred Stock, Series B (7)
(d) Form of Rights Agreement dated as of March 9, 1995, between
Registrant and American Stock Transfer & Trust Company (5)
(e) Certificate of Designation of the Preferred Stock, Series C (8)
(f) Certificate of Designation of the Preferred Stock, Series D (15)
(g) Form of Stock Purchase Warrant (18)
(10) (a) 1995 Stock Option Plan (6)
(b) Outside Director Stock Option Plan (6)
(c) Employment Agreement dated February 1, 1995, as amended March 12,
1998, and October 10, 2001, between Registrant and John C.K. Hui
(4) (9) (13)
(d) 1997 Stock Option Plan, as amended (10)
(e) 1999 Stock Option Plan, as amended (11)
(f) 2004 Stock Option/Stock Issuance Plan (12)
(g) Credit Agreement dated February 21, 2002, between Registrant and
Fleet National Bank (12)
(h) Securities Purchase Agreement dated June 21, 2007 between
Registrant and Kerns Manufacturing Corp. (14)
(i) Form of Common Stock Purchase Warrant to dated June 21, 2007 (14)
(j) Registration Rights Agreement dated June 21, 2007 between
Registrant, Kerns Manufacturing Corp. and Living Data Technology
Corporation. (14)
(k) Purchase and Sale Agreement dated June 1, 2007 between 180 Linden
Avenue Corp and 180 Linden Realty LLC.(15)
(l) Lease Agreement dated August 15, 2007 between 180 Linden Realty
LLC and Registrant(15)
43
(21) Subsidiaries of the Registrant
Percentage
Name State of Incorporation Owned by Company
---- ---------------------- ----------------
Viromedics, Inc. Delaware 61%
180 Linden Avenue Corp. New York 100%
(23) Consent of Miller Ellin & Company, 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 Notice of Annual Meeting of Stockholders
dated October 28, 2004.
(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 8-K dated June 21, 2007.
(15) Incorporated by reference to Report on Form 10-KSB for the fiscal year
ended May 31, 2007.
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is intended to be included in our
definitive Proxy Statement, which will be filed with the Securities and Exchange
Commission in connection with our 2008 Annual Meeting of Stockholders and is
incorporated herein by reference.
44
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 25th day of August, 2008.
VASOMEDICAL, INC.
By: /s/ John C.K. Hui
----------------------------------------
John C.K. Hui
President, Chief Executive Officer, Chief
Technology 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 25, 2008, by the following persons in the
capacities indicated:
/s/ John C.K. Hui President, Chief Executive Officer, Chief Technology
------------------------ Officer and Director (Principal Executive Officer)
John C.K. Hui
/s/ Abraham E. Cohen Chairman of the Board
------------------------
Abraham E. Cohen
/s/ Tricia Efstathiou Chief Financial Officer (Principal Financial and
------------------------ Accounting Officer)
Tricia Efstathiou
/s/Joseph Giacalone Director
------------------------
Joseph Giacalone
/s/Photios T. Paulson Director
------------------------
Photios T. Paulson
/s/ Martin Zeiger Director
------------------------
Martin Zeiger
/s/ Simon Srybnik Director
------------------------
Simon Srybnik
/s/ Jun Ma Director
------------------------
Jun Ma
/s/ Behnam Movaseghi Director
------------------------
Behnam Movaseghi
------------------------ Director
Derek Enlander
Vasomedical, Inc. and Subsidiaries
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Registered Public Accounting Firm F-1
Financial Statements
Consolidated Balance Sheet as of May 31, 2008 F-2
Consolidated Statements of Operations for the years ended
May 31, 2008 and 2007 F-3
Consolidated Statement of Changes in Stockholders'
Equity for the years ended May 31, 2008 and 2007 F-4
Consolidated Statements of Cash Flows for the years ended
May 31, 2008 and 2007 F-5
Notes to Consolidated Financial Statements F-7
i
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Vasomedical, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of Vasomedical, Inc.
and Subsidiaries (the "Company") as of May 31, 2008 and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for the
years ended May 31, 2008 and 2007. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Vasomedical, Inc. and Subsidiaries as of May 31, 2008 and the consolidated
results of their operations and their consolidated cash flow for the years ended
May 31, 2008 and 2007 in conformity with accounting principles generally
accepted in the United States of America.
/s/ Miller Ellin & Company, LLP
MILLER ELLIN & COMPANY, LLP
New York, New York
August 20, 2008
F - 1
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEET
May 31, 2008
ASSETS
CURRENT ASSETS
Cash and cash equivalents $2,653,999
Accounts receivable, net of an allowance for doubtful accounts of $270,183 717,849
Inventories, net 1,652,678
Other current assets 58,933
----------------
Total current assets 5,083,459
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,178,566 57,170
DEFERRED DISTRIBUTOR COSTS, net of accumulated amortization of $101,775 407,101
OTHER ASSETS 213,336
----------------
$5,761,066
================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $822,244
Sales tax payable 149,304
Deferred revenue 1,132,445
Deferred gain on sale of building 53,245
Accrued professional fees 74,320
----------------
Total current liabilities 2,231,558
DEFERRED REVENUE 485,608
ACCRUED RENT EXPENSE 8,656
DEFERRED GAIN ON SALE OF BUILDING 168,610
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; 93,768,004 shares
issued and outstanding 93,768
Additional paid-in capital 48,068,432
Accumulated deficit (45,295,566)
----------------
Total stockholders' equity 2,866,634
----------------
$5,761,066
================
The accompanying notes are an integral part of this consolidated financial
statement.
F - 2
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended May 31,
2008 2007
---------------- -----------------
Revenues
Equipment sales $2,087,365 $2,561,064
Equipment rentals and services 3,095,403 3,793,019
---------------- -----------------
Total revenues 5,182,768 6,354,083
---------------- -----------------
Cost of Sales and Services
Cost of sales, equipment 1,679,632 1,457,279
Cost of equipment rentals and services 1,150,738 1,445,834
---------------- -----------------
Total cost of sales and services 2,830,370 2,903,113
---------------- -----------------
Gross profit 2,352,398 3,450,970
---------------- -----------------
Operating Expenses
Selling, general and administrative 2,626,045 4,051,993
Research and development 474,111 933,316
---------------- -----------------
Total operating expenses 3,100,156 4,985,309
---------------- -----------------
Loss from operations (747,758) (1,534,339)
---------------- -----------------
Other Income (Expenses)
Interest and financing costs (16,616) (69,767)
Interest and other income, net 61,083 53,648
Gain on sale of assets 44,371 --
---------------- -----------------
Total other income (expenses) 88,838 (16,119)
---------------- -----------------
Loss before income taxes (658,920) (1,550,458)
Income tax expense, net (18,045) (20,608)
---------------- -----------------
Net loss $(676,965) $(1,571,066)
================ =================
Net loss per common share
- basic $(0.01) $(0.02)
================ =================
- diluted $(0.01) $(0.02)
================ =================
Weighted average common shares outstanding
- basic 92,211,788 65,198,592
================ =================
- diluted 92,211,788 65,198,592
================ =================
The accompanying notes are an integral part of this consolidated financial
statement.
F - 3
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Additional Total
Preferred Stock Common Stock Paid-in- Accumulated Stockholders'
Shares Amount Shares Amount Capital Deficit Equity
----- ------ ---------- ------- ----------- ------------- ----------
Balance at May 31, 2006 -- $-- 65,198,592 $65,198 $46,148,493 $(43,047,535) $3,166,156
Issuance of stock options in payment of
outside director fees 11,445 11,445
Issuance of stock options in payment of
salaries to company officers 6,060 6,060
Net loss (1,571,066) (1,571,066)
----- ------ ---------- ------- ----------- ------------- ----------
Balance at May 31, 2007 -- $-- 65,198,592 $65,198 $46,165,998 $(44,618,601) $1,612,595
Common stock and warrants (net of
expenses incurred) issued
pursuant to Securities
Purchase Agreement -- -- 21,428,572 21,429 1,354,461 -- 1,375,890
Common stock and warrants issued for
Distribution and Supply agreement -- -- 6,990,840 6,991 461,395 -- 468,386
Common stock issued to a Director -- -- 150,000 150 8,850 -- 9,000
Stock based compensation -- -- -- -- 77,728 -- 77,728
Net loss (676,965) (676,965)
----- ------ ---------- ------- ----------- ------------- ----------
Balance at May 31, 2008 -- $-- $93,768,004 $93,768 $48,068,432 $(45,295,566) $2,866,634
The accompanying notes are an integral part of this consolidated financial
statement.
F - 4
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended May 31,
2008 2007
------------- ---------------
Cash flows from operating activities
Net loss $(676,965) $(1,571,066)
------------- ---------------
Adjustments to reconcile net loss to net cash used in operating
activities
Depreciation and amortization 187,628 315,269
Amortization of deferred gain on sale of building (44,371) --
Provision for doubtful accounts 42,837 (38,178)
Amortization of deferred distributor costs 101,776
Reserve for excess and obsolete inventory (83,124) --
Stock based compensation 86,728 17,505
Changes in operating assets and liabilities
Accounts receivable (27,031) 147,805
Inventories 592,427 606,580
Other current assets (24,172) 265,408
Other assets -- (1,072)
Deferred distributor costs (40,490) --
Accounts payable, accrued expenses and other current
liabilities (163,246) (721,970)
Other liabilities 15,982 (253,575)
------------- ---------------
644,944 337,772
------------- ---------------
Net cash used in operating activities (32,021) (1,233,294)
------------- ---------------
Cash flows provided by (used in) investing activities
Proceeds from the building sale 1,400,000 --
Expenses paid for sale of building (89,143) --
Purchase of property and equipment -- (10,593)
------------- ---------------
Net cash provided by (used in) investing activities 1,310,857 (10,593)
------------- ---------------
Cash flows provided by (used in) financing activities
Payments on long term debt and notes payable (851,015) (291,603)
Proceeds from Securities Purchase agreement 1,500,000 --
Expenses paid in relation to Securities Purchase Agreement
(124,110) --
------------- ---------------
Net cash provided by (used in) financing activities 524,875 (291,603)
------------- ---------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 1,803,711 (1,535,490)
------------- ---------------
Cash and cash equivalents - beginning of year 850,288 2,385,778
------------- ---------------
Cash and cash equivalents - end of year $2,653,999 $850,288
============= ===============
The accompanying notes are an integral part of this consolidated financial
statement.
F - 5
Vasomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
Years ended May 31,
2008 2007
--------------- -------------
NON-CASH INVESTING AND FINANCING ACTIVITIES WERE AS FOLLOWS:
Inventories transferred to)/from property and
equipment, attributable to operating leases - net $(44,354) $(24,534)
Issuance of note for purchase of insurance policy $-- $192,120
SUPPLEMENTAL DISCLOSURES:
Interest paid $16,616 $69,767
Income taxes paid $11,685 $10,079
The accompanying notes are an integral part of this consolidated financial
statement.
F - 6
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
NOTE A - ORGANIZATION AND PLAN OF OPERATIONS
Vasomedical, Inc. was incorporated in Delaware in July 1987. Unless the
context requires otherwise, all references to "we", "our", "us", "Company",
"registrant", "Vasomedical" or "management" refer to Vasomedical Inc. and its
subsidiaries. Since 1995, we have been primarily engaged in designing,
manufacturing, marketing and supporting EECP(R) enhanced external
counterpulsation systems based on our unique proprietary technology currently
indicated for use in cases of stable or unstable angina (i.e., chest pain),
congestive heart failure (CHF), acute myocardial infarction (i.e., heart attack,
(MI)) and cardiogenic shock. The EECP(R) therapy system is a non-invasive,
outpatient therapy for the treatment of diseases of the cardiovascular system.
The therapy serves to increase circulation in areas of the heart with less than
adequate blood supply and helps to restore systemic vascular function. The
therapy also increases blood flow and oxygen supply to the heart muscle and
other organs and decreases the heart's workload and need for oxygen, while also
improving function of the endothelium, the lining of blood vessels throughout
the body, lessening resistance to blood flow. We provide hospitals, clinics and
physician private practices with EECP(R) equipment, treatment guidance, and a
staff training and equipment maintenance program designed to provide optimal
patient outcomes. EECP(R) is a registered trademark for our enhanced external
counterpulsation systems. For more information, visit www.vasomedical.com.
We have Food and Drug Administration (FDA) clearance to market our EECP(R)
therapy for use in the treatment of stable and unstable angina, congestive heart
failure, acute myocardial infarction, and cardiogenic shock, however, our
current marketing efforts are limited to the treatment of chronic stable angina
and congestive heart failure. Medicare and other third-party payers currently
reimburse for the treatment of angina symptoms in patients with moderate to
severe symptoms who are refractory to medications and not candidates for
invasive procedures, including patients with serious comorbidities, such as
heart failure, diabetes, and peripheral vascular disease. Patients with primary
diagnoses of heart failure, diabetes, and peripheral vascular disease are also
reimbursed under the same criteria, provided the primary indication for
treatment with EECP(R) therapy is angina symptoms.
During the last several years we incurred operating losses. We have
attempted to achieve profitability by reducing operating costs and halting the
trend of declining revenue, to reduce cash usage through bringing its cost
structure more into alignment with current revenues by engaging in
restructurings during March 2007 and April 2007 to substantially reduce
personnel and spending on sales, marketing and development projects. In
addition, the Company was seeking to obtain a strategic alliance within the
sales and marketing areas and/or to raise additional capital through public or
private equity or debt financings.
During the first quarter of fiscal year 2008, the following events took
place which allowed us to raise additional capital through a private equity
financing and by the sale of our facility under a leaseback agreement.
o On June 21, 2007, we entered into a Securities Purchase Agreement with
Kerns Manufacturing Corp. (Kerns). Concurrently with our entry into
the Securities Purchase Agreement, we also entered into a Distribution
Agreement and a Supplier Agreement with Living Data Technology
Corporation, an affiliate of Kerns (Living Data).
We sold to Kerns, pursuant to the Securities Purchase Agreement,
21,428,572 shares of our common stock at $.07 per share for a total
purchase price of $1,500,000, as well as a five-year warrant to
purchase 4,285,714 shares of our common stock at an initial exercise
price of $.08 per share (the Warrant). The agreement further provided
for the appointment to our Board of Directors of two representatives
of Kerns. In furtherance thereof, Mr. Jun Ma and Mr. Simon Srybnik,
Chairman of both Kerns and Living Data, have been appointed members of
F - 7
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
our Board of Directors. Pursuant to the Distribution Agreement, we
have become the exclusive distributor in the United States of the
AngioNew ECP systems manufactured by Living Data. As additional
consideration for such agreement, we agreed to issue an additional
6,990,840 shares of our common stock to Living Data. Pursuant to the
Supplier Agreement, Living Data now is the exclusive supplier to us of
the ECP therapy systems that we market under the registered trademark
EECP(R). The Distribution Agreement and the Supplier Agreement each
have an initial term extending through May 31, 2012.
Pursuant to a Registration Rights Agreement, we granted to Kerns and
Living Data, subject to certain restrictions, "piggyback registration
rights" covering the shares sold to Kerns as well as the shares
issuable upon exercise of the Warrant and the shares issued to Living
Data.
o On August 15, 2007, we sold our facility under a five-year leaseback
agreement for $1.4 million. The net proceeds from the sale were
approximately $425,000, after payment in full of the two secured notes
on our facility, brokers fees, closing costs, and the opening of a
certificate of deposit in accordance with the provisions of the new
lease.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies consistently applied in
the preparation of the consolidated financial statements follows:
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.
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, the
realizability of deferred tax assets, and the adequacy of inventory and warranty
reserves. Actual results could differ from those estimates.
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,
we recognize revenue from the sale of our EECP(R) systems in the period in which
we deliver the system to the customer. Revenue from the sale of our EECP(R)
systems to international markets is recognized upon shipment, during the period
in which we deliver the product to a common carrier, as are supplies,
accessories and spare parts delivered to both domestic and international
customers. Returns are accepted prior to the in-service and training subject to
a 10% restocking charge or for normal warranty matters, and we are not obligated
for post-sale upgrades to these systems. In addition, we use the installment
method to record revenue based on cash receipts in situations where the account
receivable is collected over an extended period of time and in our judgment the
degree of collectibility is uncertain.
In most cases, revenue from domestic EECP(R) 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. We follow the provisions of Emerging Issues
Task Force Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables"
("EITF 00-21"). The principles and guidance outlined in EITF 00-21 provide a
framework to determine (a) how the arrangement consideration should be measured
(b) whether the arrangement should be divided into separate units of accounting,
and (c) how the arrangement consideration should be allocated among the separate
units of accounting. We determined that the domestic sale of our EECP(R) systems
includes a combination of three elements that qualify as separate units of
accounting:
F - 8
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
i. EECP(R) equipment sale,
ii. provision of in-service and training support consisting of equipment
set-up and training provided at the customer's facilities, and
iii. a service arrangement (usually one year), consisting of: service by
factory-trained service representatives, material and labor costs,
emergency and remedial service visits, software upgrades, technical
phone support and preferred response times.
Each of these elements represent individual units of accounting as the
delivered item has value to a customer on a stand-alone basis, objective and
reliable evidence of fair value exists for undelivered items, and arrangements
normally do not contain a general right of return relative to the delivered
item. We determine fair value based on the price of the deliverable when it is
sold separately or based on third-party evidence. In accordance with the
guidance in EITF 00-21, we use the residual method to allocate the arrangement
consideration when it does not have fair value of the EECP(R) system sale. Under
the residual method, the amount of consideration allocated to the delivered item
equals the total arrangement consideration less the aggregate fair value of the
undelivered items. Assuming all other criteria for revenue recognition have been
met, we recognize revenue for:
i. EECP(R) equipment sales, when delivery and acceptance occurs based on
delivery and acceptance documentation received from independent
shipping companies or customers,
ii. in-service and training, following documented completion of the
training, and
iii. the service arrangement, ratably over the service period, which is
generally one year.
In-service and training generally occurs within a few weeks of shipment and
our return policy states that no returns will be accepted after in-service and
training has been completed. The amount related to in-service and training is
recognized as service revenue at the time the in-service and training is
completed and the amount related to service arrangements is recognized ratably
as service revenue over the related service period, which is generally one year.
Costs associated with the provision of in-service and training and the service
arrangement, including salaries, benefits, travel, spare parts and equipment,
are recognized in cost of equipment sales as incurred.
The Company also recognizes revenue generated from servicing EECP(R)
systems that are no longer covered by the service arrangement, or by providing
sites with additional training, in the period that these services are provided.
Revenue related to future commitments under separately priced extended service
agreements on our EECP(R) system are deferred and recognized ratably over the
service period, generally ranging from one year to four years. Costs associated
with the provision of service and maintenance, including salaries, benefits,
travel, spare parts and equipment, are recognized in cost of sales as incurred.
Amounts billed in excess of revenue recognized are included as deferred revenue
in the consolidated balance sheets.
Revenues from the sale of EECP(R) systems through our international
distributor network are generally covered by a one-year warranty period. For
these customers we accrue a warranty reserve for estimated costs to provide
warranty parts when the equipment sale is recognized.
The Company has also entered into lease agreements for our EECP(R) 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(R) 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, 2008.
Shipping and Handling Costs
All shipping and handling expenses are charged to cost of sales. Amounts
billed to customers related to shipping and handling costs are included as a
component of sales.
F - 9
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
Research and Development
Research and development costs attributable to development are expensed as
incurred. Included in research and development costs is amortization expense
related to the capitalized cost of EECP(R) systems under loan for clinical
trials.
Stock-Based Employee Compensation
As of June 1, 2006, the Company has adopted Statement of Financial
Standards No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123 (R)"),
which is a revision of SFAS No. 123. SFAS No. 123 (R) supersedes APB Opinion No.
25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95,
Statement of Cash Flows.
Generally, the approach to accounting for share-based payments in SFAS No.
123(R) is similar to the approach described in SFAS No. 123. However, SFAS No.
123(R) requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the financial statements based on
their fair values. Pro forma disclosure of the fair value of share-based
payments is no longer an alternative to financial statement recognition.
Prior to first quarter of fiscal 2007, the Company accounted 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 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 prior to
fiscal 2007.
During the twelve-month period ended May 31, 2008, the Board of Directors
granted non-qualified stock options under the 2004 Stock Option/Stock Issuance
Plan to four directors to purchase an aggregate of 600,000 shares of common
stock, at an exercise price of $.12 per share, which represented the fair market
value of the underlying common stock at the time of the respective grants. These
options vested immediately and expire ten years from the date of grant.
During the twelve-month period ended May 31, 2008, the Company's Board of
Directors granted 150,000 shares of common stock under the 2004 Plan to one
director of the Company having a fair market value of $0.06 per share at the
time of the respective grant.
Stock-based compensation expense recognized under SFAS 123(R) for the
fiscal year ended May 31, 2008 was $81,406, which comprised the fair value of
the stock options issued during the year. 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 changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
employee stock options.
F - 10
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
The fair value of the Company's stock-based awards were estimated using the
following weighted-average assumptions:
Years Ended May 31,
2008 2007
--------------- -------------
Expected life (years) 5 5
Expected volatility 103.25% 99%
Risk-free interest rate 4.95% 4.5%
Expected dividend yield 0.0% 0.0%
Cash and Cash Equivalents
Cash and cash equivalents represent cash and short-term, highly liquid
investments either 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.
Dividend and interest income are recognized when earned. The cost of securities
sold is calculated using the specific identification method.
Certificates of Deposit
Included in this caption are all certificates of deposit that have original
maturities of greater than three months. Realized and unrealized gains and
losses and declines in value, if any, are included in earnings. Dividend and
interest income are recognized when earned. The cost of securities sold is
calculated using the specific identification method.
Accounts Receivable, net
The Company's accounts receivable 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 that remain 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 its 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
our 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:
May 31, 2008
-------------------
Beginning balance $364,809
(Reversal)/Provision for losses on
accounts receivable (53,142)
Direct write-offs, net of recoveries (41,484)
-------------------
Ending balance $270,183
===================
Concentrations of Credit Risk
We market the EECP(R) system principally to hospitals and physician private
practices. We perform credit evaluations of our customers' financial condition
F - 11
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
and, as a consequence, believe that our receivable credit risk exposure is
limited. Receivables are generally due 30 to 90 days from shipment. For the year
ended May 31, 2008, no customer accounted for 10% or more of revenues or
accounts receivable.
Our revenues were derived from the following geographic areas:
Years Ended May 31,
-----------------------------------
2008 2007
--------------- ---------------
Domestic (United States) $4,347,222 $5,363,138
Non-domestic (foreign) 835,546 990,945
--------------- ---------------
$5,182,768 $6,354,083
=============== ===============
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(R) systems at various field locations for demonstration, training,
evaluation, and other similar purposes at no charge. The cost of these EECP(R)
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(R) systems and critical components at cost plus the cost of refurbishment.
The Company 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 its products as well as forecasts of future product demand.
We have adopted the provisions of Statement of Financial Accounting
Standards No. 151, "Inventory Costs" (SFAS 151). The statement clarifies that
abnormal amounts of idle facility expense, freight, handling costs, and wasted
materials (spoilage) should be recognized as current-period charges and requires
the allocation of fixed production overhead to inventory based on the normal
capacity of the production facilities. As a result of adopting SFAS No. 151, we
absorbed approximately $158,000 less in fixed production overhead into inventory
during fiscal year 2008 as compared to fiscal 2007.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and
amortization. Major improvements are capitalized and minor replacements,
maintenance and repairs are charged to expense as incurred. Upon retirement or
disposal of assets, the cost and related accumulated depreciation are removed
from the consolidated balance sheet. Depreciation is provided over the estimated
useful lives of the assets, which range from two to thirty-nine years, on a
straight-line basis. Accelerated methods of depreciation are used for tax
purposes. We amortize leasehold improvements over the useful life of the related
leasehold improvement or the life of the related lease, whichever is less. (See
Note E.)
Deferred Revenue
We record revenue on extended service contracts ratably over the term of
the related warranty contracts. Under the provisions of EITF 00-21, we began to
defer revenue related to EECP(R) 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. (See Note F.)
Warranty Costs
Equipment sold is generally covered by a warranty period of one year. Under
the provisions of EITF 00-21, for certain arrangements, a portion of the overall
system price attributable to the first year service arrangement is deferred and
recognized as revenue over the service period. As such, we do not accrue
warranty costs upon delivery but rather recognize warranty and related service
costs as incurred.
F - 12
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
Equipment sold to international customers through our distributor network
is generally covered by a one-year warranty period. For these customers, we
accrue a warranty reserve for estimated costs of providing a parts only warranty
when the equipment sale is recognized.
The factors affecting our warranty liability include the number of units
sold and the historical and anticipated rates of claims and costs per claim.
(See Note G.)
Income Taxes
Deferred income taxes are recognized for temporary differences between
financial statement and income tax bases of assets and liabilities and loss
carryforwards for which income tax benefits are expected to be realized in
future years. A valuation allowance is established, when necessary, to reduce
deferred tax assets to the amount expected to be realized. In estimating future
tax consequences, we generally consider all expected future events other than an
enactment of changes in the tax laws or rates. The deferred tax asset is
continually evaluated for realizability. To the extent our judgment regarding
the realization of the deferred tax assets changes, an adjustment to the
allowance is recorded, with an offsetting increase or decrease, as appropriate,
in income tax expense. Such adjustments are recorded in the period in which our
estimate as to the realizability of the asset changed that it is "more likely
than not" that all of the deferred tax assets will be realized. The
"realizability" standard is subjective and is based upon our estimate of a
greater than 50% probability that the deferred tax asset can be realized.
Deferred tax assets and liabilities are classified as current or
non-current based on the classification of the related asset or liability for
financial reporting. A deferred tax asset or liability 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.
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.
Net Loss Per Common Share
Basic loss per share is based on the weighted average number of common
shares outstanding without consideration of potential common stock. Diluted loss
per share is based on the weighted number of common and potential dilutive
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.
Reclassifications
Certain reclassifications have been made to prior years' amounts to conform
with the current year's presentation.
F - 13
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
The fair value of the Company's stock-based awards were estimated using the
following weighted-average assumptions:
Years Ended May 31,
2008 2007
------------- -------------
Expected life (years) 5 5
Expected volatility 103.25% 99%
Risk-free interest rate 4.95% 4.5%
Expected dividend yield 0.0% 0.0%
Recently Issued Accounting Pronouncements Not Yet Effective
The Company does not believe that adoption of any relevant accounting
pronouncements that have been issued but are not yet effective will have a
significant effect on future financial statements.
The following is a list of accounting pronouncements issued but not yet
effective.
Statements of Financial Accounting Standards (SFAS):
SFAS 141 (R), "Business Combinations"
SFAS 157, Fair Value Measurements
SFAS 159, The Fair Value Option for Financial Assets and Financial
Liabilities - Including an Amendment to FASB Statement No. 115
SFAS 160, "Noncontrolling Interests in Consolidated Financial Statements"
SFAS 161, "Disclosures about Derivative Instruments and Hedging Activities
- an Amendment of FASB Statement 133"
SFAS 163, "Accounting for Financial Guarantee Insurance Contracts"
FASB Staff Positions (FSP):
FSP APB 14-1, "Accounting for Convertible Debt Instruments That May Be
Settled in Cash upon Conversion (Including Partial Cash Settlement)"
FSP FAS 140-3, "Accounting for Transfers of Financial Assets and Repurchase
Financing Transactions"
FSP FAS 142-3, "Determination of the Useful Life of Intangible Assets.
FSP FAS 157-1, "Application of FASB Statement No. 157 to FASB Statement No.
13 and Other Accounting Pronouncements That Address Fair Value Measurements for
Purposes of Lease Classification or Measurement under Statement 13"
FSP FAS 157-2, "Effective Date of FASB Statement No. 157"
FSP FIN 46(R)-7, "Application of FASB Interpretation No. 46(R) to
Investment Companies"
FSP SOP 94-3-1 and AAG HCO-1, " Omnibus Changes to Consolidation and Equity
Method Guidance for Not-for-Profit Organizations " -- makes several changes to
F - 14
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
the guidance on consolidation and the equity method of accounting in AICPA
Statement of Position 94-3, "Reporting of Related Entities by Not-for-Profit
Organizations", and the AICPA Audit and Accounting Guide, "Health Care
Organizations.
FSP SOP 07-1-1, -- indefinitely delays the effective date of AICPA
Statement of Position 07-1, "Clarification of the Scope of the Audit and
Accounting Guide Investment Companies and Accounting by Parent Companies and
Equity Method Investors for Investments in Investment Companies."
FSP EITF 03-6-1, -- "Determining Whether Instruments Granted in Share-Based
Payment Transactions Are Participating Securities"
EITF Consensuses (EITF):
EITF Issue No. 07-1, "Accounting for Collaborative Arrangements "
EITF Issue No. 07-4, "Application of the Two-Class Method under FASB
Statement No. 128, Earnings per Share, to Master Limited Partnerships"
NOTE C -LOSS PER COMMON SHARE
The following table sets forth the computation of basic and diluted loss
per share:
Years Ended May 31,
2008 2007
--------------- ---------------
Numerator:
Net loss $(676,695) $(1,571,066)
--------------- ---------------
Denominator:
Basic - weighted average shares 92,211,788 65,198,592
Stock options -- --
Warrants -- --
--------------- ---------------
Diluted - weighted average shares 92,211,788 65,198,592
=============== ===============
Loss per share - basic $(0.01) $(0.02)
=============== ===============
- diluted $(0.01) $(0.02)
=============== ===============
Options and warrants to purchase 12,000,462 and 8,846,876 shares of common
stock were excluded from the computation of diluted earnings per share for the
years ended May 31, 2008 and 2007, respectively, because the effect of their
inclusion would be antidilutive.
NOTE D - INVENTORIES, NET
Inventories, net of reserves consist of the following:
May 31, 2008
-----------------
Raw materials $936,035
Work in process 603,925
Finished goods 112,718
-----------------
$1,652,678
=================
F - 15
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
At May 31, 2008 and 2007 the Company reserves for excess and obsolete
inventory of $594,042 and $677,166, respectively.
NOTE E - PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
May 31, 2008
----------------
Office, laboratory and other equipment $1,368,170
EECP(R) systems under operating leases or under loan
for clinical trials 719,401
Furniture and fixtures 148,165
----------------
2,235,736
Less: accumulated depreciation 2,178,566
----------------
Property and equipment - net $57,170
================
Depreciation expense amounted to $140,724 and $300,532 for the years ended
May 31, 2008 and 2007, respectively.
NOTE F - DEFERRED REVENUE
The changes in the Company's deferred revenues are as follows:
May 31, 2008
------------------
Deferred revenue at beginning of year $1,756,351
Additions
Deferred extended service contracts 1,849,831
Deferred in-service and training 47,500
Deferred service contract promotion 9,150
Deferred service arrangement obligations 213,750
Recognized as revenue
Deferred extended service contracts 2,046,823
Deferred in-service and training 40,000
Deferred service contract promotion 13,950
Deferred service arrangement obligations 157,756
------------------
Deferred revenue at end of year 1,618,053
Less: current portion 1,132,445
------------------
Long-term deferred revenue at end of year $485,608
==================
NOTE G - SALE-LEASEBACK
In August 2007, the Company sold its warehouse and corporate facility for
$1,400,000. Under the agreement, the Company is leasing back the property from
the purchaser over a period of five years. The Company is accounting for the
leaseback as an operating lease. The gain of $266,226 realized in this
transaction has been deferred and is being amortized to income ratably over the
term of the lease. At May 31, 2008, the unamortized deferred gain of $221,855 is
shown as "Deferred gain on sale of building" in the Company's consolidated
balance sheet. The short-term portion of $53,245 is shown in current liabilities
and the long-term portion is in other liabilities. The amount recognized as a
gain in fiscal 2008 was $44,371.
F - 16
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
NOTE H - WARRANTY LIABILITY
The changes in the Company's product warranty liability are as follows:
May 31, 2008
---------------------
Warranty liability at the beginning of the year $ 15,750
Expense for new warranties issued 39,000
Warranty claims (37,500)
---------------------
Warranty liability at the end of the year 17,250
---------------------
Long-term warranty liability at the end of the year $--
=====================
NOTE I - LONG-TERM DEBT
The Company purchased its headquarters and warehouse facility with secured
notes of $641,667 and $500,000, respectively, under two programs sponsored by
New York State. These notes, which bore interest at 7.8% and 6%, respectively,
were payable in monthly installments consisting of principal and interest
payments over fifteen-year terms, expiring in September 2016 and January 2017,
respectively, and were secured by the building.
On August 15, 2007, we sold our facility for $1.4 million under a sale with
a five-year leaseback agreement. The net proceeds from the sale was
approximately $425,000, after payment in full of the two secured notes in the
amount of $851,015, brokers fees, closing costs, and the opening of a
certificate of deposit in accordance with the provisions of the new lease
NOTE J - RELATED-PARTY TRANSACTIONS
On June 21, 2007, we entered into a Securities Purchase Agreement with
Kerns Manufacturing Corp. (Kerns). Concurrently with our entry into the
Securities Purchase Agreement, we also entered into a Distribution Agreement and
a Supplier Agreement with Living Data Technology Corporation, an affiliate of
Kerns (Living Data).
We sold to Kerns, pursuant to the Securities Purchase Agreement, 21,
428,572 shares of our common stock at $.07 per share for a total purchase price
of $1,500,000, as well as a five-year warrant to purchase 4,285,714 shares of
our common stock at an initial exercise price of $.08 per share (the Warrant).
The agreement further provided for the appointment to our Board of Directors of
two representatives from Kerns. In furtherance thereof, Mr. Jun Ma and Mr. Simon
Srybnik, Chairman of both Kerns and Living Data, have been appointed members of
our Board of Directors. Pursuant to the Distribution Agreement, we have become
the exclusive distributor in the United States of the AngioNew ECP systems
manufactured by Living Data. As additional consideration for such agreement, we
agreed to issue an additional 6,990,840 shares of our common stock to Living
Data. Pursuant to the Supplier Agreement, Living Data now is the exclusive
supplier to us of the ECP therapy systems that we market under the registered
trademark EECP(R). The Distribution Agreement and the Supplier Agreement each
have an initial term extending through May 31, 2012.
Pursuant to a Registration Rights Agreement, we granted to Kerns and Living
Data, subject to certain restrictions, "piggyback registration rights" covering
the shares sold to Kerns as well as the shares issuable upon exercise of the
Warrant and the shares issued to Living Data.
On July 10, 2007, the Board of Directors appointed Mr. Behnam Movaseghi,
Treasurer and Chief Financial Officer of Kerns Manufacturing Corporation, to our
Board of Directors.
As affiliates of Living Data and Kerns, Mr. Ma, Mr. Movaseghi and Mr.
Srybnik have each been directly involved in the transactions between Living Data
and Kerns, and the Company, with respect to the Securities Purchase Agreement,
the Distribution Agreement and the Supplier Agreement, as well as consulting
servicesto the Company with no compensation.
F- 17
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
During fiscal 2008, the Company purchased ECP therapy systems under the
Supplier Agreement for $120,000 from Living Data, which was paid in full by the
Company as of June 2008. In addition, Living Data purchased $5,000 worth of ECP
therapy system components from the Company, which was paid in full by Living
Data as of June 2008.
During fiscal 2009, Living Data assigned to Vasomedical, Inc.all of its
rights and interests under its distributorship Agreement with a corporation
organized and existing under the laws of the People's Republic of China that
manufactures Ambulatory Blood Pressure Monitors, Ambulatory ECG Recorders and
Holter & ABPM Combiner Recorders, for $20,000 payable to Living Data based on
certain terms and conditions. The Company must also pay to Living Data 5% of the
selling price or 5% of the cost of all goods sold (whichever is higher), and 5%
of the cost of all goods transferred but not sold under the Assignment Agreement
to Living Data based on sales of this equipment. The Company intends to sell
these systems in the United States and other countries subject to obtaining
regulatory clearance.
During fiscal 2009, Living Data assigned to Vasomedical, Inc. all of its
rights and interests under its Distributorship Agreement with a corporation
organized and existing under the laws of the People's Republic of China, that
manufactures Ultrasound Scanners, for $20,000 payable to Living Data based on
certain terms and conditions. The Company must also pay to Living Data 5% of the
selling price or 5% of the cost of all goods sold (whichever is higher), and 5%
of the cost of all goods transferred but not sold under the Assignment Agreement
to Living Data based on sales of this equipment. The Company intends to sell
these systems in the United States and other countries subject to obtaining
regulatory clearance.
In July of 2008, Vasomedical, Inc. has agreed to purchase ECP therapy
systems under its Distributorship Agreement with Living Data for $360,000
payable over 18 months.
Further, Kerns is providing the Company, free of charge, part time use of
one of its Information Technology (IT) employees as well one of their IT
consultants to provide the Company with IT and database support services. In
addition a clinical applications support specialist and a service engineer from
Living Data may be used by Vasomedical, Inc. to provide customers with clinical
training and technical service.
NOTE K - SERIES D PREFERRED STOCK AND WARRANTS
On July 19, 2005, we entered into a Securities Purchase Agreement that
provided us with gross proceeds of $2.5 million through a private placement of
preferred stock with M.A.G. Capital, LLC through its designated funds, Monarch
Pointe Fund Ltd., Mercator Momentum Fund III, LP, and Mercator Momentum Fund, LP
(the Investors). The agreement provided for a private placement of 25,000 shares
of Vasomedical's Series D Preferred Stock at $100 per share. The preferred stock
was convertible into shares of Vasomedical's common stock at 85 percent of the
volume weighted average price per share for the five trading days preceding any
conversion, but not at more than $0.6606 or less than $0.40 per share. The
Investors also acquired warrants for the purchase of 1,892,219 shares of common
stock. The warrants may be exercised at a price of $0.69 per share for a term of
five years, ending July 19, 2010. As of February 28, 2006, all of the Series D
Preferred Stock had been converted into 6,112,209 shares of common stock.
Under the terms of a Registration Rights Agreement with the Investors,
Vasomedical filed a Form S-3 registration statement with the Securities and
Exchange Commission (SEC) on August 22, 2005, for 10,787,871 shares of common
stock representing up to 8,533,333 shares issuable in connection with conversion
of our Series D Convertible Preferred Stock and up to 2,254,538 shares issuable
upon the exercise of our common stock purchase warrants. The SEC declared the
registration statement effective on September 1, 2005. The total number of
shares registered was based on a conversion price of $0.30 per share, which
would only have an affect in the event of default by Vasomedical of its
obligation to holders of the Series D Convertible Preferred Stock.
F - 18
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
These securities were offered and sold to the Investors in a private
placement transaction made in reliance upon exemptions from registration
pursuant to Section 4(2) of the Securities Act of 1933. The Investors are
accredited investors as defined in Rule 501 of Regulation D promulgated under
the Securities Act of 1933. Vasomedical applied the funds to working capital.
Warrants and Beneficial Conversion Feature
The Company applied Emerging Issues Task Force Issue No. 98-5 "Accounting
for Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios"(EITF No. 98-5) and Emerging Issues Task Force
(EITF 00-27) Application of Issue No. 98-5 to Certain Convertible Instruments in
accounting for the preferred stock issuance. EITF No. 98-5 provides that
detachable warrants issued with convertible securities are valued separately,
and that the beneficial conversion feature of the convertible security be
measured and recognized over the minimum period over which the shareholders can
realize the return.
The Task Force reached a consensus that convertible preferred securities
with a non-detachable conversion feature that is in-the-money at the commitment
date represents an embedded beneficial conversion feature that should be
recognized as a dividend and recorded to additional paid-in capital. That amount
should be calculated at the commitment date as the difference between the
allocated portion of the gross proceeds to the convertible preferred stock and
the fair value of the common stock or other securities into which the security
is convertible, multiplied by the number of shares into which the security is
convertible (intrinsic value method).
The beneficial conversion feature is treated analogous to a dividend and is
recognizable immediately over the minimum period during which the preferred
shareholders can realize that return. The imputed dividend will increase the
Company's loss for the purpose of computing the loss-per-share applicable to
common shareholders. The beneficial conversion feature is calculated at its
intrinsic value at the commitment date (that is, the difference between the
total gross proceeds allocated to the preferred stock as compared to the total
market value of the common stock into which the Preferred Stock is convertible
on the commitment date). The computed value of the beneficial conversion feature
is treated as a deemed dividend immediately with a corresponding increase to
paid-in capital. No additional amount will be recognized at the conversion date
in recognition of an increase in the fair value of the stock conversion.
In circumstances in which convertible securities are issued with detachable
warrants, the Task Force noted that in order to determine the amount to be
allocated to the beneficial conversion feature, the issuer must first allocate
the proceeds between the convertible instrument and the detachable warrants
using the relative fair value method of APB Opinion Number 14.
The investors and consultants acquired detachable warrants for the purchase
of 1,892,219 and 362,319 shares of common stock, respectively, which were valued
at $345,071 and $66,087, respectively. The warrants may be exercised at a price
of $0.69 per share for a term of five years, ending July 18, 2010. For purposes
of estimating the intrinsic fair value of these warrants as of July 19, 2005, we
utilized the Black-Scholes option-pricing model. We estimated the fair value of
the warrants using the following weighted-average assumptions:
Expected life (years) 2.5
Expected volatility 66%
Risk-free interest rate 4.16%
Expected dividend yield 0.0%
We determined the intrinsic fair value of the convertible preferred stock
as of July 19, 2005, to be $2,941,176 based on the number of common shares that
could be acquired as of the date of closing times $0.63, the closing price of
the common stock on the date preceding the close of the transaction. In applying
EITF No. 98-5, we then allocated the gross proceeds of $2,500,000 between the
warrants and preferred stock based on intrinsic value of each instrument. As a
F - 19
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
result, we allocated $2,154,929 of gross proceeds to the convertible preferred
stock and $345,071 to the detachable warrants. The beneficial conversion feature
of $786,247 was then determined by subtracting the allocated proceeds of
convertible preferred stock from the intrinsic fair value of convertible
preferred stock. The beneficial conversion feature was immediately recognized as
a preferred stock dividend, as the preferred stock can be converted immediately.
Dividends
By the placement of the convertible preferred stock described above, we
became obligated to pay a cash dividend monthly on the outstanding shares of
convertible preferred stock. The dividend rate was the higher of (i) the prime
rate as reported by the Wall Street Journal on the first day of the month, plus
three percent or, (ii) 8.5% times $100 per share, but in no event greater than
10% annually. For the fiscal year ended May 31, 2006, cash dividends of $91,623
were paid. Preferred stock dividends for the fiscal 2006 are summarized as
follows:
Amount
------
Cash dividends paid $91,623
Beneficial conversion feature 786,247
--------------
$877,870
==============
NOTE L - STOCKHOLDERS' EQUITY AND WARRANTS
Common stock
The Company issued 200,000 shares of common stock in lieu of cash for
$126,000 in consultant services associated with the issuance of the Series D
Convertible Preferred Stock. These issue costs were treated as a reduction in
the paid-in capital associated with the preferred stock issuance. On July 19,
2005, we granted warrants for the purchase of 2,254,538 shares of common stock
to investors and consultants associated with the issuance of Series D Preferred
Stock, (See Note I). The warrants may be exercised at a price of $0.69 per share
for a term of five years, ending July 19, 2010. The remaining 200,000 warrants
expired in October 2006.
On June 21, 2007, a five-year warrant to purchase 4,285,714 shares of our
common stock at an initial exercise price of $.08 per share to Kerns under the
Securities Purchase Agreement.
Warrants
Warrant activity for the years ended May 31, 2007 and 2008 is summarized as
follows:
Employees Consultants Total Weighted
Average Price
Balance at May 31, 2006 -- 2,454,538 2,454,538 $0.71
Warrants expired -- (200,000) (200,000) $0.91
--------------- ------------------- ------------------------ ----------------
Balance at 2007 -- 2,254,538 2,254,538 $0.69
--------------- ------------------- ------------------------ ----------------
Warrants issued 4,285,714 4,285,714 $0.08
--------------- ------------------- ------------------------ ----------------
Number of shares exercisable -- 6,540,252 6,540,252 $0.29
=============== =================== ======================== ================
F - 20
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
NOTE M - OPTION PLANS
1995 Stock Option Plan
In May 1995, the Company's stockholders approved the 1995 Stock Option Plan
for officers and employees of the Company for which the Company reserved an
aggregate of 1,500,000 shares of common stock. In December 1997, the Company's
Board of Directors terminated the 1995 Stock Option Plan with respect to new
option grants.
In fiscal 2007, options to purchase 286,000 shares of common stock at an
exercise price of $3.43750 under the 1995 Stock Option Plan were retired or
cancelled.
In fiscal 2008, there was no activity under the 1995 Stock Option Plan.
Outside Director Stock Option Plan
In May 1995, the Company's stockholders approved an Outside Director Stock
Option Plan (the OD Plan) for non-employee directors of the Company, for which
the Company reserved an aggregate of 300,000 shares of common stock. In December
1997, the Company's Board of Directors terminated the OD Plan with respect to
new option grants.
In fiscal 2007, options to purchase 28,250 shares of common stock at an
exercise price of $1.77 under the OD Plan were retired unexercised.
In fiscal 2008, there was no activity under the OD Plan.
1997 Stock Option Plan
In December 1997, the Company's stockholders approved the 1997 Stock Option
Plan (the 1997 Plan) for officers, directors, employees and consultants of the
Company for which the Company has reserved an aggregate of 1,800,000 shares of
common stock. The 1997 Plan provides that 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 expired on August 6, 2007.
In January 1999, the Company's Board of Directors increased the number of
shares authorized for issuance under the 1997 Plan by 1,000,000 shares to
2,800,000 shares.
In May 2006, the Board of Directors accelerated the vesting period for all
unvested options to May 31, 2006.
In fiscal 2007, the Board of Directors granted non-qualified stock options
under the 1997 plan to a Director to purchase 150,000 shares of common stock at
an exercise price of $0.09 per share (which represent the fair market value of
the underlying common stock at the time of the respective grants). These options
expire 10 years from grant date. In fiscal 2007, there were no options to
purchase shares of common stock under the 1997 Plan. In fiscal 2007, options to
purchase 494,167 shares of common stock under the 1997 Plan at exercise prices
ranging from $0.88 to $1.91 were retired or cancelled.
In fiscal 2008, the Board of Directors did not grant any non-qualified
stock options under the 1997 plan, and there were no options to purchase shares
of common stock under the 1997 plan. In fiscal 2008, options to purchase 714,601
shares of common stock under the 1997 Plan at exercise prices ranging from $0.88
to $1.91 were retired or cancelled.
F - 21
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
1999 Stock Option Plan
In July 1999, the Company's Board of Directors approved the 1999 Stock
Option Plan (the 1999 Plan), for which the Company reserved an aggregate of
2,000,000 shares of common stock. The 1999 Plan provides that a committee of the
Board of Directors of the Company will administer it and that the committee will
have full authority to determine the identity of the recipients of the options
and the number of shares subject to each option. Options granted under the 1999
Plan may be either incentive stock options or non-qualified stock options. The
option price shall be 100% of the fair market value of the common stock on the
date of the grant (or in the case of incentive stock options granted to any
individual principal stockholder who owns stock possessing more than 10% of the
total combined voting power of all voting stock of the Company, 110% of such
fair market value). The term of any option may be fixed by the committee but in
no event shall exceed ten years from the date of grant. Options are exercisable
upon payment in full of the exercise price, either in cash or in common stock
valued at fair market value on the date of exercise of the option. The term for
which options may be granted under the 1999 Plan expires July 12, 2009. In July
2000, the Company's Board of Directors increased the number of shares authorized
for issuance under the 1999 Plan by 1,000,000 shares to 3,000,000 shares. In
December 2001, the Board of Directors of the Company increased the number of
shares authorized for issuance under the 1999 Plan by 2,000,000 shares to
5,000,000 shares.
In May 2006, the Board of Directors accelerated the vesting period for all
unvested options to May 31, 2006.
In fiscal 2007, the Board of Directors granted non-qualified stock options
under the 1999 Plan to directors to purchase an aggregate of 450,000 shares of
common stock, at an exercise price of $0.09 per shares (which represented the
fair market value of the underlying common stock at the time of the respective
grants). In fiscal 2007, there were no options to purchase shares of common
stock under the 1999 Plan. In fiscal 2007, options to purchase 996,279 shares of
common stock under the 1999 Plan at exercise prices ranging from $0.20 to $5.00
were retired or cancelled.
In fiscal 2008, the Board of Directors did not grant any non-qualified
stock options under the 1999 Plan. In fiscal 2008, there were no options to
purchase shares of common stock under the 1999 Plan. In fiscal 2008, options to
purchase 1,006,500 shares of common stock under the 1999 Plan at exercise prices
ranging from $0.20 to $5.00 were retired or cancelled.
At May 31, 2008, there were 1,068,532 shares available for future grants
under the 1999 Plan.
2004 Stock Option and Stock Issuance Plan
In October 2004, the Company's stockholders approved the 2004 Stock Option
and Stock Issuance Plan (the 2004 Plan), for which the Company reserved an
aggregate of 2,500,000 shares of common stock. The 2004 Plan is divided into two
separate equity programs: (i) the Option Grant Program under which eligible
persons ("Optionees") may, at the discretion of the board of directors, be
granted options to purchase shares of common stock; and (ii) the Stock Issuance
Program under which eligible persons ("Participants") may, at the discretion of
the board or directors, be issued shares of common stock directly, either
through the immediate purchase of such shares or as a bonus for services
rendered to the Corporation.
Options granted under the 2004 Stock Plan shall be non-qualified or
incentive stock options and the exercise price is the fair market value of the
common stock on the date of grant except that for incentive stock options it
shall be 110% of the fair market value if the Optionee owns 10% or more of our
common stock. The term of any option may be fixed by the board of directors or
committee but in no event shall exceed ten years from the date of grant. Stock
options granted under the 2004 Plan may become exercisable in one or more
installments in the manner and at the time or times specified by the committee.
Options are exercisable upon payment in full of the exercise price, either in
cash or in common stock valued at fair market value on the date of exercise of
the option. The term for which options may be granted under the 2004 Plan
expires July 12, 2014.
F- 22
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
Under the stock issuance program, the purchase price per share shall be
fixed by the board of directors or committee but cannot be less than the fair
market value of the common stock on the issuance date. Payment for the shares
may be made in cash or check payable to us, or for past services rendered to us
and all shares of common stock issued thereunder shall vest upon issuance unless
otherwise directed by the committee. The number of shares issuable is also
subject to adjustments upon the occurrence of certain events, including stock
dividends, stock splits, mergers, consolidations, reorganizations,
recapitalizations, or other capital adjustments. The term for which shares may
be issued under the 2004 Plan expires July 12, 2014.
The 2004 Plan provides that a committee of the Board of Directors of the
Company will administer it and that the committee will have full authority to
determine and designate the individuals who are to be granted stock options or
qualify to purchase shares of common stock under the 2004 Stock Plan, the number
of shares to be subject to options or to be purchased and the nature and terms
of the options to be granted. The committee also has authority to interpret the
2004 Plan and to prescribe, amend and rescind the rules and regulations relating
to the 2004 Plan.
In May 2006, the Board of Directors accelerated the vesting period for all
unvested options to May 31, 2006.
In fiscal 2007, the Company's Board of Directors granted non-qualified
stock options under the 2004 Plan to an officer to purchase an aggregate of
200,000 shares of common stock, at an exercise price of $0.11 per share (which
represented the fair market value of the underlying common stock at the time of
the respective grants). These options expire ten years from the date of grant.
In fiscal 2007, options to purchase 733,716 shares of common stock under the
2004 Plan at exercise prices ranging from $0.20 to $0.58 were retired or
cancelled.
In fiscal 2008, the Company's Board of Directors granted non-qualified
stock options under the 2004 Plan to four directors to purchase an aggregate of
600,000 shares of common stock, at an exercise price of $0.12 per share (which
represented the fair market value of the underlying common stock at the time of
the respective grants) and the Company's Board of Directors granted 150,000
shares of common stock under the 2004 Plan to one director of the Company having
a fair market value of $0.06 per share at the time of the respective grant.
These options expire ten years from the date of grant. In fiscal 2008, options
to purchase 236,461 shares of common stock under the 2004 Plan at exercise
prices $0.57 and $0.58 were retired or cancelled.
At May 31, 2008, there were 593,928 shares available for future grants
under the 2004 Plan.
Stock option activity under all the plans for the years ended May 31, 2007
and 2008 is summarized as follows:
Outstanding Options
------------------------------------------------------------
Shares Range of Weighted
Available for Number of Exercise Average
Grant Shares Price per Share Exercise Price
----------------- ------------------- ---------------------- -----------------
Balance at May 31, 2006 749,872 8,012,075 $0.20 - $5.15 $1.20
Options granted (800,000) 800,000 $0.09 - $0.11 $0.10
Options exercised -- -- -- --
Options canceled 1,747,987 (2,219,737) $0.20 - $5.00 $1.28
----------------- ------------------- ---------------------- -----------------
Balance at May 31, 2007 1,697,859 6,592,338 $0.20 - $5.00 $1.04
Common shares granted (150,000) -- -- --
Options granted (600,000) 600,000 $.12 $.12
Options exercised -- -- -- --
Options canceled 714,601 (1,737,128) $.20-$3.96 $1.29
----------------- ------------------- ---------------------- -----------------
Balance at May 31, 2008 1,662,460 5,455,210 $.09-$4.28 $.86
(1) May be issued under the Stock Issuance Program.
F - 23
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
The following table summarizes information about stock options outstanding
and exercisable at May 31, 2008:
Options Outstanding Options Exercisable
--------------------------------------------------- --------------------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Outstanding at Contractual Exercise Exercisable at Exercise
Range of Exercise Prices May 31, 2008 Life (yrs.) Price May 31, 2008 Price
------------------ ---------------- --------------- ----------------- --------------
$0.09 - $0.58 2,561,710 7.8 $.21 2,345,044 $.21
$0.71 - $0.95 614,500 3.6 $.88 614,500 $.88
$1.00 - $1.31 1,760,000 5.2 $1.09 1,760,000 $1.09
$1.69 - $2.49 75,000 1.1 $1.69 75,000 $1.69
$2.91 - $4.28 444,000 2.8 $3.57 444,000 $3.57
------------------ ---------------- --------------- ----------------- --------------
5,455,210 4.4 $.86 5,238,544 $.88
================== ================ =============== ================= ==============
The weighted-average fair value exercise price of options and warrants
granted during fiscal years 2008 and 2007 was $0.08 and $0.10, respectively. At
May 31, 2008, there were approximately 2,569,074 remaining authorized shares of
common stock after reserves for all stock option plans and stock warrants.
NOTE N - INCOME TAXES
During the fiscal years ended May 31, 2008 and 2007, we recorded a
provision for income taxes of $18,045 and $20,608, respectively.
As of May 31, 2008, the recorded deferred tax asset was $19,819,352,
reflecting an increase of $230,000 during fiscal 2008, which was offset by a
valuation allowance of the same amount.
The Company's deferred tax assets are summarized as follows:
2008 2007
--------------- ---------------
Net operating loss and other carryforwards $17,952,000 $18,120,000
Accrued compensation -- 2,400
Bad debts 91,900 125,000
Other 1,775,452 1,341,952
--------------- ---------------
Total gross deferred tax assets 19,819,352 19,589,352
Valuation allowance (19,819,352) (19,589,352)
--------------- ---------------
Net deferred tax assets $-- $--
=============== ===============
At May 31, 2008, the Company had net operating loss carryforwards for
Federal and state income tax purposes of approximately $52,800,000, expiring at
various dates from 2009 through 2028. In fiscal 2008 $558,968 of net operating
loss carryforwards expired. Future expirations of net operating loss
carryforwards are as follows:
F - 24
Vasomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 2008 and 2007
Fiscal Year Amount
------------------- --------------
2009 $ 470,994
2010 2,454,162
2011 5,449,051
2012 6,084,213
2013 4,386,716
Thereafter 33,954,864
--------------
Total $52,800,000
==============
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 will 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:
2008 2007
% %
----------------- ----------------
Federal statutory rate (34.0) (34.0)
State taxes, net 2.7 1.3
Permanent differences 1.8 2.7
Change in valuation allowance
relating to operations 28.6 31.4
Other (1.8) (2.7)
----------------- ----------------
(2.7) (1.3)
================= ================
NOTE O - COMMITMENTS AND CONTINGENCIES
Leases
On August 15, 2007, we sold our facility under a five-year leaseback
agreement. Future rental payments under the operating lease are as follows:
For the years ended:
May 31, 2009 $142,777
May 31, 2010 148,488
May 31, 2011 154,427
May 31, 2012 160,604
May 31, 2013 40,540
-----------------
Total $646,836
=================
F - 25
Litigation
The Company is currently, and has been in the past, a party to various
routine legal proceedings incident to the ordinary course of business. The
Company believes that the outcome of all such pending legal proceedings in the
aggregate is unlikely to have a material adverse effect on the business or
consolidated financial condition of the Company.
NOTE P - 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 2008
and 2007, the Company made discretionary contributions of approximately $9,000
and $15,000, respectively, to match a percentage of employee contributions.
F - 26