ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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; continuation of the GEHC agreements and the risk factors reported from time to time in the Company's SEC reports, including its recent report on Form 10-K. The Company undertakes no obligation to update forward-looking statements as a result of future events or developments.
U
nless the context requires otherwise, all references to "we", "our", "us", "Company", "registrant", "Vasomedical" or "management" refer to Vasomedical, Inc. and its subsidiaries
General Overview
Vasomedical, Inc.
("Vasomedical")
was incorporated in Delaware in July 1987.
We principally operate in three distinct business segments in the healthcare equipment and information technology industries. We manage and evaluate our operations, and report our financial results, through these three business segments.
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IT segment, operating through a wholly-owned subsidiary VasoTechnology, Inc., primarily focuses on healthcare IT and managed network technology services;
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Professional sales service segment, operating through a wholly-owned subsidiary Vaso Diagnostics, Inc. d/b/a VasoHealthcare, primarily focuses on the sale of healthcare capital equipment for large OEMs into the health provider middle market; and
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Equipment segment, operating through wholly-owned subsidiaries Vasomedical Global Corp. and Vasomedical Solutions, Inc., primarily focuses on the design, manufacture, sale and service of proprietary medical devices.
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VasoTechnology
VasoTechnology, Inc.
was formed in May 2015, at the time the Company acquired
all of the assets of NetWolves, LLC and its affiliates, including the membership interests in NetWolves Network Services LLC (collectively, "NetWolves")
, to address a major issue facing the healthcare IT industry. It currently consists of a managed network and security service division and a healthcare IT application VAR (value added reseller) division. Its current offering includes:
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Managed diagnostic imaging applications (national channel partner of GEHC IT).
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Managed network infrastructure (routers, switches and other core equipment).
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Managed network transport (FCC licensed carrier reselling 175+ facility partners).
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Managed security services (IBM's first security white label partner).
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VasoTechnology uses a combination of proprietary technology, methodology and best-in-class third-party applications to deliver its value proposition.
VasoHealthcare
VasoHealthcare commenced operations in 2010, in conjunction with the Company's execution of its exclusive sales representation agreement with General Electric Healthcare ("GEHC"), which is the healthcare business division of the General Electric Company ("GE"), to exploit the sale of certain healthcare capital equipment in the health provider middle market. Sales of GEHC equipment by the Company have grown significantly since then.
VasoHealthcare's current offering consists of:
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GEHC diagnostic imaging capital equipment.
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GEHC service agreements.
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GEHC and third party financial services.
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VasoHealthcare has built a team of approximately 90 highly experienced sales professionals who utilize highly focused sales management and analytic tools to manage the complete sales process and to increase market penetration.
Vasomedical Global and Vasomedical Solutions
Vasomedical Global was formed in 2011 to combine and coordinate the various design, development, manufacturing, and sales operations of medical devices acquired by the Company. These devices primarily consist of cardiovascular diagnostic and therapeutic systems. Its current offering consists of:
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Biox™ series Holter monitors and ambulatory blood pressure recorders .
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ARCS™ series analysis, reporting and communication software for physiological signals such as ECG and blood pressure.
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MobiCare™ multi-parameter wireless vital-sign monitoring system.
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EECP
®
therapy systems, used for non-invasive, outpatient treatment of ischemic heart disease.
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This segment uses its extensive cardiovascular device knowledge coupled with its significant engineering resources to cost-effectively create and market its proprietary technology. It works with a global distribution network of channel partners, as well as a global joint venture arrangement, to sell its products.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon the accompanying unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). The preparation of financial statements in conformity with U.S. GAAP requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and the related disclosures at the date of the financial statements and during the reporting period. Although these estimates are based on our knowledge of current events, our actual amounts and results could differ from those estimates. The estimates made are based on historical factors, current circumstances, and the experience and judgment of our management, who continually evaluate the judgments, estimates and assumptions and may employ outside experts to assist in the evaluations.
Certain of our accounting policies are deemed "critical", as they are both most important to the financial statement presentation and require management's most difficult, subjective or complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain. For a discussion of our critical accounting policies, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2015 as filed with the SEC on March 30, 2016.
Results of Operations – For the Three Months Ended March 31, 2016 and 2015
Total revenue for the three months ended March 31, 2016 and 2015 was $17,542,000 and $7,453,000, respectively, representing an increase of $10,089,000, or 135% year-over-year. The revenue increase was primarily due to $9,727,000 in revenue in the IT segment, of which $9,238,000 resulted from the operations of NetWolves, which the Company acquired at the end of May 2015. Net loss for the three months ended March 31, 2016 was $104,000, compared to a net loss of $252,000 for the three months ended March 31, 2015, representing an improvement of $148,000. Our total net loss was $0.00 per basic and diluted common share for the three months ended March 31, 2016 and 2015.
Revenues
Commission revenues in the professional sales services segment were $6,846,000 in the first quarter of 2016, an increase of 7%, as compared to $6,390,000 in the first quarter of 2015. The increase in commission revenues in the first quarter of 2016 was due primarily to an increase in equipment delivered by GEHC during the quarter, partially offset by lower commission rates on such deliveries. The Company recognizes commission revenue when the underlying equipment has been accepted at the customer site in accordance with the specific terms of the sales agreement. Consequently, amounts billable under the agreement with GE Healthcare prior to customer acceptance of the equipment are recorded as deferred revenue in the condensed consolidated balance sheet. As of March 31, 2016, $16,744,000 in deferred commission revenue was recorded in the Company's condensed consolidated balance sheet, of which $8,206,000 was long-term. At March 31, 2015, $20,114,000 in deferred commission revenue was recorded in the Company's condensed consolidated balance sheet, of which $9,420,000 was long-term.
Revenue in the IT segment for the three months ended March 31, 2016 was $9,727,000 compared to $0 revenue for the three months ended March 31, 2015, of which $9,238,000 resulted from the acquisition of NetWolves in the second quarter 2015, and $489,000 resulted from growth in the healthcare IT VAR business.
Revenue in our equipment segment decreased by $94,000, or 9%, to $969,000 for the three-month period ended March 31, 2016 compared to the same period of the prior year. The decrease was principally due to a decrease in EECP
®
revenues and international sales by our China operations as a result of lower sales volume.
Gross Profit
The Company had a gross profit of $10,012,000, or 57% of revenue, in the first quarter of 2016 compared to $5,567,000, or 75% of revenue, in the first quarter of the prior year, an increase of $4,445,000, or 80%. The increase is principally due to $4,006,000 in gross profit in the IT segment, of which $3,883,000 resulted from the acquisition of NetWolves, combined with higher revenues and gross profit margin in the professional sales services segment.
Professional sales services segment gross profit was $5,435,000, or 79% of the segment revenue, for the three months ended March 31, 2016 as compared to $4,867,000, or 76% of the segment revenue, for the three months ended March 31, 2015. The increase in absolute dollars and margin percentage was due to
higher delivery volume of GEHC equipment during the first quarter of 2016 than in the same period last year
, as well as lower commission expense in the first quarter of 2016. Cost of commissions of $1,411,000 and $1,523,000, for the three months ended March 31, 2016 and 2015, respectively, reflected commission expense associated with recognized commission revenues. The decrease was due to lower commission expense rates on certain deliveries in the first quarter 2016 compared to the same period in 2015. Commission expense associated with deferred revenue is recorded as deferred commission expense until the related commission revenue is recognized.
IT segment gross profit for the three months ended March 31, 2016 was $4,006,000, or 41% of revenue, compared to $0 gross profit for the three months ended March 31, 2015, with the increase primarily resulting from the acquisition of NetWolves
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Equipment segment gross profit decreased to $571,000, or 59% of equipment segment revenues, for the first quarter of 2016 compared to $700,000, or 66% of equipment segment revenues, for the same quarter of 2015. Gross profit margin in the equipment segment decreased due mainly to lower average selling prices.
Operating Income (Loss)
Operating income was $159,000 for the three months ended March 31, 2016, compared to an operating loss of $286,000 for the three months ended March 31, 2015, an improvement of $445,000. The improvement in operating income is due to the increase in gross profit and lower selling, general and administrative, or SG&A, costs relative to revenue. SG&A costs were 55% of revenue for the three months ended March 31, 2016, compared to 77% of revenue for the three months ended March 31, 2015. Operating income in the professional sales services segment increased by $902,000 to $1,989,000, compared to $1,087,000 in the first quarter of the prior year, due mainly to a higher gross margin combined with lower SG&A costs. In addition, operating loss in the equipment segment increased by $65,000, or 10%, to $700,000 compared to $635,000 in the same quarter of the prior year, due primarily to a one-time charge of $412,000, included in SG&A expense, to reserve a loan receivable, and $129,000 lower gross profit, partially offset by a $487,000 decrease in all other SG&A costs in the current year quarter. Our IT segment had an operating loss of $742,000 in the first quarter of 2016 as compared to an operating loss of $355,000 in the same quarter of the prior year. The increase of $387,000 was primarily due to an increase of $349,000 attributable to the inclusion of NetWolves.
SG&A expenses for the first quarter of 2016 and 2015 were $9,706,000, or 55% of revenues, and $5,719,000, or 77% of revenues, respectively, reflecting an increase of $3,987,000 or approximately 70%. The increase in SG&A expenditures in the first quarter of 2016 resulted primarily from $4,749,000 in costs attributable to the IT segment in 2016 mainly due to the inclusio
n of NetWolves operations during the quarter, and higher sales and marketing expenses in the GEHC VAR business, partially offset by lower costs in the professional sales services and equipment segments
. Despite the inclusion of a one-time charge of $412,000 recorded in the first quarter of 2016 related to the reserving of a loan receivable, equipment segment SG&A decreased to $1,125,000 in the first quarter of 2016 from $1,200,000 in the same period of 2015.
Research and development ("R&D") expenses were $147,000, or 1% of revenues (15% of Equipment segment revenues), for the first quarter of 2016, an increase of $13,000, or 10%, from $134,000, or 2% of revenues (13% of Equipment segment revenues), for the first quarter of 2015. The increase is primarily attributable to higher product development expenses in the first quarter of 2016.
Adjusted EBITDA
We define Adjusted EBITDA (earnings (loss) before interest, taxes, depreciation and amortization), which is a non-GAAP financial measure, as net income (loss), plus interest expense (income), net; tax expense; depreciation and amortization; and non-cash expenses for share-based compensation. Adjusted EBITDA is a metric that is used by the investment community for comparative and valuation purposes. We disclose this metric in order to support and facilitate the dialogue with research analysts and investors.
Adjusted EBITDA is not a measure of financial performance under accounting principles generally accepted in the United States ("GAAP") and should not be considered a substitute for operating income, which we consider to be the most directly comparable GAAP measure. Adjusted EBITDA has limitations as an analytical tool, and when assessing our operating performance, you should not consider Adjusted EBITDA in isolation, or as a substitute for net income or other consolidated income statement data prepared in accordance with GAAP. Other companies may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.
A reconciliation of net loss to Adjusted EBITDA is set forth below:
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(in thousands)
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Three months ended March 31,
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2016
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2015
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(unaudited)
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(unaudited)
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Net loss
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$
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(104
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)
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$
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(252
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Interest expense (income), net
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155
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(7
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)
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Income tax expense
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102
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6
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Depreciation and amortization
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523
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212
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Share-based compensation
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33
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19
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Adjusted EBITDA
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$
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709
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$
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(22
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)
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Adjusted EBITDA increased by $731,000 to $709,000 in the quarter ended March 31, 2016 from $(22,000) in the quarter ended March 31, 2015. The increase was primarily attributable to the lower net loss and higher fixed asset depreciation in the IT segment and amortization of intangibles associated with the NetWolves acquisition in May 2015, as well as higher interest expense arising from the MedTech Note used to partially fund the NetWolves acquisition and higher income tax expense.
Interest and Other Income (Expense)
Interest and other income (expense) for the first quarter of 2016 was $(161,000) as compared to $40,000 for the first quarter of 2015. The change from income to expense was due primarily to higher interest expense from debt associated with the Genwell and NetWolves acquisitions.
Income Tax Expense
During the first quarter of 2016 we recorded income tax expense of $102,000 as compared to income tax expense of $6,000 for the first quarter of 2015. The increase arose from higher U.S. income taxes associated with tax amortization arising from the NetWolves purchase.
Liquidity and Capital Resources
Cash and Cash Flow
We have financed our operations from working capital. At March 31, 2016, we had cash and cash equivalents of $4,667,000 and negative working capital of $3,478,000 compared to cash and cash equivalents of $2,160,000, short-term investments of $38,000 and negative working capital of $3,696,000 at December 31, 2015. $7,038,000 in negative working capital at March 31, 2016 is attributable to the net balance of deferred commission expense and deferred revenue. These are non-cash expense and revenue items and have no impact on future cash flows.
Cash provided by operating activities was $1,883,000 during the first quarter of 2016, compared to $6,259,000 for the same period in 2015, which consisted of net loss after adjustments to reconcile net loss to net cash of $1,055,000 and cash provided by operating assets and liabilities of $828,000. The changes in the account balances primarily reflect a decrease in accounts and other receivables of $2,979,000, partially offset by decreases in deferred revenue of $613,000, accrued expenses of $760,000, and accrued commissions of $725,000. Significantly higher commission billings and recognized revenue were generated in the fourth quarter of 2014, resulting in significant cash inflows early in 2015.
Cash used in investing activities during the three-month period ended March 31, 2016 was $391,000. We invested $100,000 in the VSK joint venture as part of our capital contribution, and, $329,000 was used for the purchase of equipment and software. This was partially offset by the redemption of short-term investments of $38,000.
Cash provided by financing activities during the three-month period ended March 31, 2016 was $1,005,000 as a result of borrowings on our line of credit, partially offset by $14,000 in repayments of notes issued for equipment purchases.
Liquidity
The Company expects to be profitable for the year ending December 31, 2016 and to continue to generate positive cash flow through its existing professioinal sales services operations, from the operation of NetWolves, and improved operating efficiency and growth in its China operations and by expanding its market presence and product portfolio. The Company has reorganized its EECP
®
business model, both domestically and internationally, including the start of operations of the joint venture VSK Medical, intended to reduce costs and achieve profitability in this business. The Company will continue to pursue acquisitions and partnership opportunities in the international and domestic markets and will look to expand its sales representation business.