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.
Unless the context requires otherwise, all references to "we", "our", "us", "Company", "registrant", "Vaso" or "management" refer to Vaso Corporation and its subsidiaries
General Overview
Vaso Corporation
("Vaso")
was incorporated in Delaware in July 1987.
We principally operate in three distinct business segments in the healthcare 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 GEHC into the health provider middle market; and
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Equipment segment, operating through a wholly-owned subsidiary VasoMedical, Inc., primarily focuses on the design, manufacture, sale and service of proprietary medical devices.
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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, 2016 as filed with the SEC on March 30, 2017.
Results of Operations – For the Three Months Ended March 31, 2017 and 2016
Revenues
Total revenue for the three months ended March 31, 2017 and 2016 was $16,374,000 and $17,542,000, respectively, representing a decrease of $1,168,000, or 7% year-over-year. On a segment basis, revenue in the IT segment increased $73,000, while revenue in the professional sales service and equipment segments decreased $975,000 and $266,000, respectively.
Revenue in the IT segment for the three months ended March 31, 2017 was $9,800,000 compared to $9,727,000 for the three months ended March 31, 2016, an increase of $73,000, of which $355,000 resulted from growth in the operations of NetWolves, partially offset by a $282,000 decrease in the healthcare IT VAR business, due to fewer installations in the first quarter of 2017. Our monthly recurring revenue in our managed network services operations continues to grow month over month as we add new customers and expand our services to existing customers. The backlog of orders in our IT VAR operations was $8.3 million at March 31, 2017 compared to a backlog of $3.5 million at March 31, 2016. We anticipate that as we continue to develop the IT VAR operations and become fully enabled in all phases of the sales and service delivery process, the backlog will go to revenue in more timely fashion and profitability will be significantly improved in this segment.
Commission revenues in the professional sales services segment were $5,871,000 in the first quarter of 2017, a decrease of 14%, as compared to $6,846,000 in the first quarter of 2016. The decrease in commission revenues was due primarily to a decrease in the volume of equipment delivered by GEHC during the period. The first quarter of each year is typically lower in deliveries than in later quarters of the year, with the fourth quarter of each year typically the strongest, therefore we expect that deliveries and revenue will improve significantly through the remainder of 2017. 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, 2017, $18,891,000 in deferred commission revenue was recorded in the Company's condensed consolidated balance sheet, of which $9,813,000 was long-term. At 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.
Revenue in the equipment segment decreased by $266,000, or 27%, to $703,000 for the three-month period ended March 31, 2017 from $969,000 for the same period of the prior year. The decrease was principally due to a decrease in EECP
®
revenues as a result of lower sales volume.
Gross Profit
Gross profit for the three months ended March 31, 2017 and 2016 was $9,070,000, or 55% of revenue, and $10,012,000, or 57% of revenue, respectively, representing a decrease of $942,000, or 9% year-over-year. On a segment basis, gross profit in the IT segment increased $16,000, while gross profit in the professional sales services segment and equipment segment decreased $826,000 and $132,000, respectively.
IT segment gross profit for the three months ended March 31, 2017 was $4,022,000, or 41% of the segment revenue, compared to $4,006,000, or 41% of the segment revenue for the three months ended March 31, 2016, with the increase primarily resulting from higher sales at NetWolves.
Professional sales services segment gross profit was $4,609,000, or 79% of segment revenue, for the three months ended March 31, 2017 as compared to $5,435,000, or 79% of the segment revenue, for the three months ended March 31, 2016, reflecting a decrease of $826,000, or 15%. The decrease in absolute dollars was due to
lower volume of GEHC equipment delivered during the first quarter of 2017 than in the same period last year
, as well as lower commission expense in the first quarter of 2017 compared to the same period of 2016.
Cost of commissions of $1,262,000 and $1,411,000, for the three months ended March 31, 2017 and 2016, respectively, reflected commission expense associated with recognized commission revenues. The decrease was due primarily to lower delivery volume. Commission expense associated with deferred revenue is recorded as deferred commission expense until the related commission revenue is recognized.
Equipment segment gross profit decreased to $439,000, or 62% of segment revenues, for the first quarter of 2017 compared to $571,000, or 59% of segment revenues, for the same quarter of 2016. Gross profit decreased due to lower sales volume and gross profit margin increased due mainly to a proportionately larger volume of higher margin products in the sales mix in 2017, compared to the first quarter 2016.
Operating Income (Loss)
Operating income (loss) for the three months ended March 31, 2017 and 2016 was $(1,841,000) and $159,000, respectively, representing a decrease of $2,000,000, primarily due to higher operating costs and lower gross profit. On a segment basis, operating income in the equipment segment increased $295,000, while operating income in the professional sales service segment and IT segment decreased $2,074,000 and $176,000, respectively, and an increase of $45,000 in corporate expenses
Operating loss in the IT segment increased in the three-month period ended March 31, 2017 as compared to the same period of 2016 due to higher research and development costs, partially offset by higher gross profit.
The professional sales service segment had a loss in the three-month period ended March 31, 2017 as compared operating income in the same period of 2016 due to lower gross profit combined with higher selling, general, and administrative ("SG&A") costs. Operating loss in the equipment segment decreased in the three-month period ended March 31, 2017 as compared to the same period of 2016 due to lower SG&A costs, partially offset by lower gross profit.
SG&A costs for the three months ended March 31, 2017 and 2016 were $10,690,000 and $9,706,000, respectively, representing an increase of $984,000, or 10% year-over-year. On a segment basis, SG&A costs in the equipment segment decreased $389,000 due to a provision for loan loss made in the first quarter of 2016, while SG&A costs in the professional sales service segment increased $1,247,000 due to increased headcount and other personnel-related costs. SG&A costs in the IT segment increased by $78,000 to $4,827,000 in the first quarter of 2017 from $4,749,000 in the same quarter of the prior year due to increased personnel costs in the IT VAR business. Corporate costs not allocated to segments increased by $45,000 from $388,000 for the three months ended March 31, 2016 to $433,000 for the three months ended March 31, 2017, due primarily to higher accounting and director fees.
Research and development ("R&D") expenses were $221,000, or 1% of revenues, for the first quarter of 2017, an increase of $74,000, or 50%, from $147,000, or 1% of revenues, for the first quarter of 2016. The increase is primarily attributable to higher product development expenses in the IT segment.
Adjusted EBITDA
We define Adjusted EBITDA (earnings (loss) before interest, taxes, depreciation and amortization), which is a non-GAAP financial measure, as net income (loss), plus interest expense (income), net; tax expense; depreciation and amortization; and non-cash expenses for share-based compensation. Adjusted EBITDA is a metric that is used by the investment community for comparative and valuation purposes. We disclose this metric in order to support and facilitate the dialogue with research analysts and investors.
Adjusted EBITDA is not a measure of financial performance under U.S. GAAP and should not be considered a substitute for operating income, which we consider to be the most directly comparable U.S. GAAP measure. Adjusted EBITDA has limitations as an analytical tool, and when assessing our operating performance, you should not consider Adjusted EBITDA in isolation, or as a substitute for net income or other consolidated income statement data prepared in accordance with U.S. GAAP. Other companies may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.
A reconciliation of net income to Adjusted EBITDA is set forth below:
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(in thousands)
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Three months ended March 31,
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2017
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2016
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(unaudited)
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(unaudited)
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Net loss
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$
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(2,131
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)
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$
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(104
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)
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Interest expense (income), net
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165
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155
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Income tax expense
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109
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102
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Depreciation and amortization
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582
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523
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Share-based compensation
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219
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33
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Adjusted EBITDA
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$
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(1,056
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)
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$
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709
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Adjusted EBITDA decreased by $1,765,000, to $(1,056,000) in the quarter ended March 31, 2017 from $709,000 in the quarter ended March 31, 2016. The decrease was primarily attributable to the lower net income, partially offset by higher fixed asset depreciation in the IT segment and higher share-based compensation.
Interest and Other Income (Expense)
Interest and other income (expense) for the three months ended March 31, 2017 was $(181,000) as compared to $(161,000) for the corresponding period of 2016. The increase was due primarily to higher interest expense and lower other income in 2017, partially offset by lower pro-rata share of a quarterly loss at VSK.
Income Tax Expense
For the three months ended March 31, 2017, we recorded income tax expense of $109,000 as compared to income tax expense of $102,000 for the corresponding period of 2016. The increase arose mainly from higher state taxes.
Net Loss
Net loss for the three months ended March 31, 2017 and 2016 was $2,131,000 and $104,000, respectively, representing an increase of $2,027,000. Our net loss per share was $0.01 in the three month period ended March 31, 2017, and $0.00 per share in the three month period ended March 31, 2016. The principal cause of the decrease in net income is the decrease in revenue in the professional sales service segment combined with the increase in SG&A costs. As discussed earlier, as revenues in the professional sales service segment increase through the balance of the year and the IT segment continues to grow we expect that the Company will again be profitable for the year.
Liquidity and Capital Resources
Cash and Cash Flow
We have financed our operations from working capital. At March 31, 2017, we had cash and cash equivalents of $6,713,000 and negative working capital of $4,003,000 compared to cash and cash equivalents of $7,087,000 and negative working capital of $567,000 at December 31, 2016. $7,226,000 in negative working capital at March 31, 2017 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 $744,000, which consisted of net loss after adjustments to reconcile net loss to net cash of $1,158,000 and cash provided by operating assets and liabilities of $1,902,000, during the three months ended March 31, 2017, compared to cash provided by operating activities of $1,883,000 for the same period in 2016. The changes in the account balances primarily reflect a decrease in accounts and other receivables of $3,361,000, partially offset by decreases in accounts payable of $1,039,000 and accrued commissions of $606,000.
Cash used in investing activities during the three-month period ended March 31, 2017 was $839,000 for the purchase of equipment and software.
Cash used in financing activities during the three-month period ended March 31, 2017 was $286,000 as a result of $189,000 in net repayments on our line of credit and $97,000 in payments of notes and capital leases issued for equipment purchases.
Liquidity
The Company expects to be profitable for the year ending December 31, 2017 and expects to maintain sufficient liquidity through its cash on hand, availability of funds under its lines of credit, and positive cash flows generated primarily through its operations under the GEHC Agreement.