ITEM 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations
The following discussion should be read
in conjunction with VirtualScopics’ condensed consolidated balance sheets as of June 30, 2014 and December 31, 2013 and
the related condensed consolidated statements of operations and cash flows for the three and months ended June 30, 2014 and 2013,
included elsewhere in this report. This discussion contains forward-looking statements, the accuracy of which involves risks and
uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons
including, but not limited to, those discussed under the heading “Forward Looking Statements” below and elsewhere
in this report. We disclaim any obligation to update information contained in any forward-looking statements.
Business Overview
We are a provider of clinical trial imaging
solutions currently serving the pharmaceutical, biotechnology and medical device industries. We have created a suite of image
analysis software tools and applications which are used in detecting and measuring specific anatomical structures and metabolic
activity using medical images. Our proprietary software and algorithms provide measurement capabilities designed to improve clinical
research and development. We focus on applying our imaging technology to improve the efficiency and effectiveness of the pharmaceutical
and medical device research and development processes. We believe our technology can also be used in improving the treatment planning
for patients with cancer and other debilitating diseases.
Revenues since inception have been derived
primarily from image analysis services in connection with pharmaceutical drug trials. For these services, we have been concentrating
in the areas of oncology, fatty liver disease, neurology, cardiovascular, and osteoarthritis. We have also derived a small portion
of our revenue from consulting services. We expect that the concentration of our revenue will continue in these services and in
those areas in 2014. Revenues are recognized as the medical images that we process are quantified and delivered to our customers
and/or the services are performed.
We are focused on strengthening our core
business and increasing the number of contract awards we receive. This effort includes investments in our infrastructure and sales
function. We continue to submit proposals and bids for new contracts, however, there can be no assurance that we will secure or
maintain contracts from these efforts. Additionally, due to recent consolidation within the industry, our pricing and services
may not stay competitive with companies that have a stronger global presence.
There are several factors that can affect whether we will realize
the full benefits under any contract and the time over which we will realize that revenue. Customers may not continue our services
due to many reasons including lack of demonstrated efficacy with their compounds in development. Furthermore, the contracts may
contemplate performance over multiple years. Therefore, revenue may not be realized in the fiscal year in which the contract is
signed or awarded. Recognition of revenue under the contract may also be affected by the timing of patient recruitment and image
site identification and training.
Results of Operations
Results of Operations for Quarter Ended June 30, 2014
Compared to Quarter Ended June 30, 2013
Revenues
We had revenues of $2,649,000 for the
quarter ended June 30, 2014 compared to $3,707,000 for the comparable period in 2013, representing a $1,058,000, or 29%, decrease
in revenues. The decrease in revenues was affected by a six week, phase III breast cancer study which generated over $1 million
in revenues during the second quarter of 2013 and the related slowdown in the amount of new projects awarded in 2012, the timing
of the initiation of projects, and the large number of studies that ended during 2013 and the first six months of 2014. A project’s
revenue cycle is dependent on a number of factors, including the time it takes for a drug trial to begin, which varies due to
the time required to set up trial sites and to recruit participants. Also, during the life of a project, it is not uncommon for
there to be an expansion in the size of the study, which can increase our potential revenue. However, there are also situations
when the sponsor does not recruit the number of subjects or sites as originally budgeted, or a drug fails and the study therefore
comes to a premature end. In those cases, there are remaining budget dollars at the end of the study that will not be recognized
as revenue.
We continued our investments in our sales
function by the recent opening of a satellite office in New Hope, Pennsylvania. This office is primarily for sales and project
management, allowing our representatives to be closer to our customers in the Pharma corridor. During the second quarter of 2014,
we performed work on 98 different projects, in connection with our pharmaceutical drug trials in the fields of oncology, osteoarthritis
and various other therapeutic areas. This compares to 90 projects during the same period in 2013. During the second quarter of
2014, 54% of our business was in oncology services, 29% in musculoskeletal services, and the remaining 17% was in other therapeutic
areas. This compares to 68%, 20% and 12%, respectively, in 2013. During the second quarter of 2014, 84% of the revenues were derived
from Phase II and III studies compared to 82% during the comparable period in 2013.
Gross Profit
We had a gross profit of $940,000 for
the second quarter of 2014 compared to $1,770,000 for the comparable period in 2013, representing a $830,000, or a 47% decrease.
Our gross profit margin was 36% during the quarter ended June 30, 2014 compared to 48% during the second quarter of 2013. Our
margins decreased year over year due to the volume of business. During the second quarter of 2013, we achieved higher gross margins
due to a large Phase III study that we delivered in six weeks, aided by our 2013 software release that enables quick, efficient
and reliable analysis of traditional Phase III imaging endpoints.
Research and Development
Research and development costs decreased
in the quarter ended June 30, 2014 by $43,000, or 12%, to $306,000, when compared to the quarter ended June 30, 2013. The decrease
was largely due to approximately, $47,000 in professional fees to support our previous 510k filing with the FDA during the quarter
ended June 30, 2013, which did not reoccur during the second quarter of 2014. We believe our investments within the development
group will help enable us to more efficiently deliver on Phase III studies and enhance our productivity. Our research and development
efforts center around refining our processes through the use of our software platform in order to allow for greater reporting
capabilities by our customers and to gain efficiencies which we believe will better allow us to standardize our processes as we
scale the business. Additionally, we continue to invest in the commercialization of new imaging techniques across modalities and
therapeutic areas to best serve our customers. We recently finalized the recruitment of our Scientific Advisory Board which we
believe will help enhance and deepen our knowledge base in our core competencies and allow for an exchange of ideas and knowledge
in each therapeutic area.
Sales and Marketing
Sales and marketing costs increased in
the quarter ended June 30, 2014 by $53,000, or 12% to $483,000, when compared to the quarter ended June 30, 2013. The increase
is related to the timing of trade shows and conferences and higher commissions during the three months ended June 30, 2014 as
compared to the previous year. Currently, there are 6 individuals within our sales and marketing department. Our sales and marketing
initiatives encompass attendance and presentations at leading industry conferences, frequent educational webinars and active calling
on existing and new customers as well as our continued efforts to attract new business through the PPD channel. The Company recently
formed an alliance with IXICO, plc located in London, which provides clinical trial solutions focusing on neurology. The alliance
enables the Company to access IXICO’s expertise on neurology and provides a European presence. In addition, the integration
of the Companies’ complementary technologies will provide more comprehensive and scalable capabilities.
General and Administrative
General and administrative expenses for
the quarter ended June 30, 2014 were $808,000, an increase of $30,000 or 4%, when compared to the quarter ended June 30, 2013.
The increase was largely attributable to legal and investor relations costs incurred as part of negotiating the office lease in
Pennsylvania and finalizing the Scientific Advisory Board and IXICO alliance agreements. This was offset by a decrease in professional
fees incurred to support our previous 510k filing with the FDA during the quarter ended June 30, 2013, which did not reoccur during
the second quarter of 2014. Additionally, there was a decrease in stock compensation expense and additional salary savings during
the second quarter of 2014 that resulted from the resignations of the former Chief Financial and Chief Executive Officers during
the third and fourth quarters of 2013. General and administrative expenses include both personnel and non-personnel costs. Departments
included within general and administrative function are finance, information technology, quality, human resources and the CEO
position. Non-payroll related costs included within general and administration include stock option expense, audit and legal fees,
regulatory and compliance fees, Nasdaq listing fees, board fees, non-capitalizable hardware and software costs and licenses and
non-sales related travel costs.
Depreciation and Amortization
Depreciation and amortization charges were $76,000 for the
quarter ended June 30, 2014 compared to $91,000 during the quarter ended June 30, 2013. The reduction was due to a number of capital
assets being completely depreciated during the first six months of 2014 and by decreases in capital purchases during 2013.
Other Income
Other income for the quarter ended June
30, 2014 was $364 compared to $12,000 for the quarter ended June 30, 2013. During the second quarter of 2014, we recognized a
mark to market unrealized loss of $50, relating to the increase in fair value of warrants that were issued in connection with
our 2007 Series B Convertible Preferred Stock offering compared to a non-cash mark to market unrealized gain of $9,000 for the
quarter ended June 30, 2013.
Net Loss
Net loss for the quarter ended June 30,
2014 was $732,000 compared to net income of $134,000 for the quarter ended June 30, 2013. The increase in our net loss was primarily
related to the volume of revenue and a large phase III study that was completed during the second quarter of 2013, as discussed
above.
Results of Operations for the Six Months Ended June 30,
2014 Compared to the Six Months Ended June 30, 2013
Revenues
Our revenues for the six months ended
June 30, 2014 were $5,002,000, a decrease of $1,238,000 or 20% over the first half of 2013. The decrease in revenues was affected
by a six week, phase III breast cancer study which generated over $1 million in revenues during the second quarter of 2013 that
did not reoccur in 2014. Additionally, there was a related slowdown in the amount of new projects awarded in 2012, the timing
of the initiation of projects, and the large number of studies that ended during 2013 and the first six months of 2014.
The Company continues to focus on strategies
that we believe will lead to increased revenue and profitability. First, the Company finalized an alliance with IXICO, plc located
in London, which provides clinical trial solutions focusing on neurology. The alliance enables the Company to access IXICO’s
expertise on neurology and provides a European presence. In addition, we believe the integration of the Companies’ complementary
technologies will help provide more comprehensive and scalable capabilities. Secondly, the Company finalized the recruitment of
a Scientific Advisory Board which we believe will enhance and deepen our knowledge base in our core competencies and allow for
an exchange of ideas and knowledge in each therapeutic area. Thirdly, we continued our investments in our sales function by the
recent opening of a satellite office in New Hope, Pennsylvania. This office is primarily for sales and project management, allowing
our representatives to be closer to our customers in the Pharma corridor.
During the first six months of 2014, we performed work on 109
different projects in connection with our pharmaceutical drug trials in the fields of oncology, osteoarthritis and various other
therapeutic areas. This compares to 100 projects on which we performed work during the same period in 2013. During the first six
months of 2014, 50% of our business was in oncology services and 28% in musculoskeletal, and the remaining 22% was in other therapeutic
areas. This compares to 65%, 22% and 13%, respectively, in 2013. During the first six months of 2014, 80% of the revenues were
derived from Phase II and III studies compared to 76% during the comparable period in 2013.
Gross Profit
We had a gross profit of $1,698,000 for
the six months ended June 30, 2014 compared to $2,555,000 for the comparable period in 2013, representing a $857,000, or 34%,
decline. Our gross margin for the six months ended June 30, 2014 was 34% compared to 41% for the first half of 2013. Our margins
decreased year over year due to the volume of business. Specifically, during the first six months of 2013, we achieved improved
gross margins due to a large Phase III study that we delivered within a six week timeframe, aided by our 2013 software release
that enables quick, efficient and reliable analysis of traditional Phase III imaging endpoints.
Research and Development
Total research and development expenditures
were $592,000 in the first half of 2014 compared to $803,000 for the comparable period in 2013, a decrease of 26%. The expenditures
were lower due to approximately $213,000 in consultant and professional fees incurred during the six months ended June 30, 2013,
related to the personalized medicine application, that did not reoccur in the first half of 2014. Our research and development
efforts center around refining our processes through the use of our software platform in order to gain efficiencies which we believe
will better allow us to standardize our processes as we scale the business. Additionally, we continue to invest in the commercialization
of new imaging techniques across many modalities and therapeutic areas to best serve our customers. We recently finalized the
recruitment of our Scientific Advisory Board which we believe will enhance and deepen our knowledge base in our core competencies
and allow for an exchange of ideas and knowledge in each therapeutic area.
Sales and Marketing
Sales and marketing costs for the six
months ended June 30, 2014 were $828,000 compared to $788,000 for the first half of 2013, an increase of 5%. The increase is related
to the timing of trade shows and conferences and higher commissions during the first half June 30, 2014 as compared to the previous
year. Our sales and marketing initiatives encompass attendance and presentations at leading industry conferences, frequent educational
webinars and active calling on existing and new customers as well as our continued efforts to attract new business through our
strategic alliance with PPD, Inc and IXICO, plc.
General and Administrative
General and administrative expenses for
the six months ended June 30, 2014 were $1,495,000, a decrease of $278,000 or 16%, over the first half of 2013. This was attributable
to a decrease of approximately $197,000 in consultant and professional fees, during the six months ended June 30, 2013, related
to the personalized medicine application that did not reoccur in the first half of 2014. Additionally, there was a $163,000 decrease
in stock compensation expense and additional salary savings during the second quarter of 2014 that resulted from the resignations
of the former Chief Financial and Chief Executive Officers during the third and fourth quarters of 2013. This was offset by a
$75,000 increase in legal and investor relations costs incurred as part of negotiating the office lease in Pennsylvania and finalizing
the Scientific Advisory Board and IXICO alliance agreements. General and administrative expenses include both personnel and non-personnel
costs. Departments included within general and administrative function are finance, information technology, quality, human resources
and the CEO position. Non-payroll related costs included within general and administration include stock option expense, audit
and legal fees, regulatory and compliance fees, Nasdaq listing fees, board fees, non-capitalizable hardware and software costs
and licenses and non-sales related travel costs.
Depreciation and Amortization
Depreciation and amortization charges
were $162,000 for the six months ended June 30, 2014 compared to $187,000 during the first half of June 30, 2013. The reduction
was due to a number of capital assets being completely depreciated during the first six months of 2014 and by decreases in capital
purchases during 2013.
Other Income (Expense)
Other income for the six months ended
June 30, 2014 was $593 compared to $16,000 for the six months ended June 30, 2013. During the six months ended 2014, we recognized
a mark to market unrealized loss of $19, relating to the increase in fair value of warrants that were issued in connection with
our 2007 Series B Convertible Preferred Stock offering compared to a non-cash mark to market unrealized gain of $14,000 for the
six months ended June 30, 2013.
Net Loss
Our net loss for the six months ended
June 30, 2014 was $1,378,000 compared to a net loss of $979,000 for the same period in 2013. The increase in our net loss was
primarily related to the volume of revenue and a large phase III study that was completed during the second quarter of 2013, as
discussed above.
Liquidity and Capital Resources
Our working capital as of June 30, 2014
was approximately $5,357,000 compared to $6,731,000 as of December 31, 2013. The decrease in working capital was primarily a result
of decreased revenue resulting in additional cash used in operations. We do not expect, nor have we experienced, significant write-offs
of our receivables, however, we continue to see an extension of payment terms within the industry and with several of our largest
customers.
Net cash used in operating activities
totaled $1,576,000 in the six months ended June 30, 2014 compared to net cash used in operating activities of $1,374,000 in the
comparable 2013 period. The increase in the use of cash in operations during the first six months of 2014 compared to the first
half of 2013 is mainly due to the increases in our net loss and the timing of cash receipts from customers, partially offset by
a decrease in our accrued payroll as a result of bonuses paid to our employees during the first quarter of 2014.
We invested $139,000 in the purchase of
equipment and the maintenance of patents in the first six months of 2014, compared to $32,000 for the investment in these items
in the first six months of 2013. Our IT systems are the basis of our operating platform. Therefore, we plan to continue to invest
in our IT infrastructure during 2014 to ensure we have a robust and reliable operating system to further support our core business.
There was $42,000 in cash used by our
financing activities during the six months ended June 30, 2014 compared to no cash provided or used in the six months ended June
30, 2013. The Series C-1 and B preferred stock cash dividends resulted from the Series C-1 stockholders electing to receive cash
dividends in 2014.
We currently expect that existing cash
will be sufficient to fund our existing operations for the next 12 months and foreseeable future. If in the future our plans or
assumptions change or prove to be inaccurate, we may be required to seek additional capital through public or private debt or
equity financings. If we need to raise additional funds, we may not be able to do so on terms favorable to us, or at all. If we
cannot raise sufficient funds on acceptable terms, we may have to curtail our level of expenditures, our rate of expansion or
our business operations.
Off Balance Sheet Arrangements
We have no off-balance sheet arrangements
(other than our consulting agreements and operating leases for our corporate headquarters, satellite office and certain equipment)
that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition,
revenues or expenses, results of operations, liquidity, capital resources or capital expenditures that is material to investors.
Forward Looking Statements
Certain statements made in this discussion are “forward-looking
statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements
include statements that address activities, events or developments that we expect, believe or anticipate may occur in the future,
including the following risk factors:
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adverse
economic conditions;
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inability
to raise sufficient additional capital to operate our business;
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unexpected
costs, lower than expected sales and revenues, and operating defects;
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adverse
results of any legal proceedings;
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the
volatility of our operating results and financial condition;
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inability
to attract or retain qualified senior management personnel, including sales and marketing,
and scientific personnel;
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our
products and services require ongoing research and development and we may experience
technical problems or delays and we may not have the funds necessary to continue their
development;
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a
decline in new bookings and awards, or our ability to convert bookings into revenues
at acceptable profit margins, causing a decrease in our revenues and cash flows;
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our
new products and service offerings which are subject to government regulation and approval
may cause us to incur additional costs in order to obtain such approval; and
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other
specific risks that may be referred to in this report or in our report on Form 10-K for
the year ended December 31, 2013.
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All statements, other than statements
of historical facts, included in this report including, without limitation, statements regarding our strategy, future operations,
financial position, estimated revenue or losses, projected costs, prospects and plans and objectives of management are forward-looking
statements. When used in this report, the words “may,” “believe,” “anticipate,” “intend,”
“estimate,” “expect,” “project,” “plan,” “could,” “would”
and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain
such identifying words. All forward-looking statements speak only as of the date of this report. We do not undertake any obligation
to update any forward-looking statements or other information contained in this report. Existing stockholders and potential investors
should not place undue reliance on these forward-looking statements. Although we believe that our plans, intentions and expectations
reflected in or suggested by the forward-looking statements in this report are reasonable, we cannot assure our stockholders or
potential investors that these plans, intentions or expectations will be achieved. We disclose important factors that could cause
our actual results to differ materially from our expectations under the heading entitled “Risk Factors” in our annual
report on Form 10-K for the fiscal year ended December 31, 2013 filed with the Securities and Exchange Commission (“SEC”)
and elsewhere in this report. These risk factors qualify all forward-looking statements attributable to us or persons acting on
our behalf.