UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB (MARK ONE) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 0-14210 COMPUMED, INC. -------------- (exact name of small business issuer as specified in its charter) DELAWARE 95-2860434 ----------------------------------- -------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 5777 WEST CENTURY BLVD., SUITE 1285, LOS ANGELES, CA 90045 ---------------------------------------------------------- (Address of principal executive offices) (310) 258-5000 -------------- (issuer's telephone number) Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 in for the past 90 days. Yes [ X ] No [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ] As of April 30, 2006, we had 24,141,466 shares of Common Stock outstanding. Transitional Small Business Disclosure Format (check one): Yes [ ] No [ X ] 1 COMPUMED, INC. AND SUBSIDIARIES TABLE OF CONTENTS PAGE ---- PART I. FINANCIAL INFORMATION -------------------------------- Item 1. Financial Statements. 3 Item 2. Management's Discussion and Analysis or Plan of Operation. 7 Item 3. Controls and Procedures. 10 PART II. OTHER INFORMATION ---------------------------- Item 1. Legal Proceedings. 11 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 11 Item 3. Defaults Upon Senior Securities. 11 Item 4. Submission of Matters to a Vote of Security Holders. 11 Item 5. Other Information. 11 Item 6. Exhibits and Reports on Form 8-K. 11 2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. INDEX COMPUMED, INC. AND SUBSIDIARIES FINANCIAL INFORMATION BALANCE SHEETS COMPUMED, INC. March 31, September 30, 2005 2005 ----------- ----------- (UNAUDITED) ----------- ASSETS CURRENT ASSETS Cash and cash equivalents $ 321,000 $ 281,000 Marketable securities, at fair market value . . . . . . . . . . 382,000 290,000 Accounts receivable, less allowance of $26,000 (March and September 2005). . . . . . . . . . . . . . . . . . 445,000 323,000 Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,000 31,000 Prepaid expenses and other current assets. . . . . . . . . . . . 20,000 18,000 ----------- ----------- TOTAL CURRENT ASSETS . . . . . . . . . . . . . . . . . . . . . . 1,191,000 943,000 PROPERTY AND EQUIPMENT Machinery and equipment. . . . . . . . . . . . . . . . . . . . . 1,253,000 1,252,000 Furniture, fixtures and leasehold improvements . . . . . . . . . 78,000 78,000 Equipment under capital leases . . . . . . . . . . . . . . . . . 183,000 183,000 ----------- ----------- 1,514,000 1,513,000 Accumulated depreciation and amortization. . . . . . . . . . . . (1,308,000) (1,273,000) ----------- ----------- TOTAL PROPERTY AND EQUIPMENT 206,000 240,000 OTHER ASSETS Patents, net of accumulated amortization of $6,000 (March 2006) and $5,000 (September 2005) . . . . . . . . . . . . . . . . . . 110,000 77,000 Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . 13,000 13,000 ----------- ----------- TOTAL OTHER ASSETS. . . . . . . . . . . . . . . . . .. . . . . . 123,000 90,000 TOTAL ASSETS $1,520,000 $1,273,000 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 140,000 $ 159,000 Accrued liabilities. . . . . . . . . . . . . . . . . . . . . . . 148,000 148,000 Current portion of capital lease obligations . . . . . . . . . . 36,000 33,000 ----------- ----------- TOTAL CURRENT LIABILITIES. . . . . . . . . . . . . . . . . . . . 324,000 340,000 Capital lease obligations, less current portion 108,000 126,000 STOCKHOLDERS' EQUITY Preferred Stock, $.10 par value - authorized 1,000,000 shares Preferred Stock- Class A $3.50 cumulative convertible voting - issued and outstanding - 8,400 shares. . . . . . . . . . . . 1,000 1,000 Preferred Stock- Class B $3.50 cumulative convertible voting - issued and outstanding - 300 shares . . . . . . . . . . . . . - - Common Stock, $.01 par value - authorized 50,000,000 shares, issued and outstanding - 23,123,143 shares (March 2006) issued and outstanding - 22,920,609 shares (September 2005) 242,000 230,000 Additional paid in capital . . . . . . . . . . . . . . . . . . . 33,592,000 33,154,000 Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . (32,731,000) (32,589,000) Accumulated other comprehensive income . . . . . . . . . . . . . 5,000 17,000 Deferred stock compensation. . . . . . . . . . . . . . . . . . . (21,000) (6,000) ----------- ----------- TOTAL STOCKHOLDERS' EQUITY . . . . . . . . . . . . . . . . . . . 1,088,000 807,000 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,520,000 $1,273,000 =========== ===========See notes to condensed financial statements. 3 STATEMENT OF OPERATIONS (UNAUDITED) COMPUMED, INC. Three Months Ended Six Months Ended March 31, March 31, ------------------------- ------------------------- 2006 2005 2006 2005 ----------- ----------- ----------- ----------- REVENUE FROM OPERATIONS ECG services 427,000 451,000 860,000 850,000 Product sales 42,000 71,000 103,000 341,000 OsteoGram(R) sales and services 76,000 12,000 233,000 20,000 ----------- ----------- ----------- ----------- 545,000 534,000 1,196,000 1,211,000 ----------- ----------- ----------- ----------- COSTS AND EXPENSES Costs of ECG services 146,000 154,000 290,000 292,000 Cost of goods sold-ECG 33,000 48,000 75,000 269,000 Cost of goods sold-OsteoGram(R) - 2,000 3,000 3,000 Selling expenses 118,000 62,000 223,000 130,000 Research and development 69,000 55,000 167,000 117,000 General and administrative expenses 262,000 226,000 569,000 500,000 Depreciation and amortization 17,000 18,000 35,000 36,000 ----------- ----------- ----------- ----------- 645,000 565,000 1,362,000 1,347,000 ----------- ----------- ----------- ----------- OPERATING LOSS (100,000) (31,000) (166,000) (136,000) Interest Income and dividends 4,000 2,000 34,000 8,000 Other miscellaneous income - - - 8,000 Interest expense (5,000) (4,000) (10,000) (6,000) ----------- ----------- ----------- ----------- NET LOSS (101,000) (33,000) (142,000) (126,000) ----------- ----------- ----------- ----------- NET LOSS PER SHARE (Basic and diluted) (0.00) (0.00) (0.01) (0.01) Weighted average number of common shares outstanding 23,531,022 20,308,016 23,239,778 20,093,325 4 STATEMENTS OF CASH FLOWS (UNAUDITED) COMPUMED, INC. Six Months Ended March 31, 2006 2005 ----------- ----------- OPERATING ACTIVITIES: Net loss (142,000) (126,000) Net adjustments to reconcile net loss to net cash used in operating activities: Amortization of deferred stock compensation 3,000 - Depreciation and amortization 35,000 36,000 Decrease (Increase) in accounts receivable (122,000) 26,000 Decrease in inventory and prepaid expenses 6,000 21,000 Decrease in accounts payable and other liabilities 13,000 20,000 ----------- ----------- NET CASH USED IN OPERATING ACTIVITIES (207,000) (23,000) CASH FLOW FROM INVESTING ACTIVITIES: Investments in purchase of marketable securities (104,000) (8,000) Purchase of other asset (33,000) (5,000) Purchase of property, plant and equipment (1,000) (20,000) ----------- ----------- NET CASH PROVIDED BY USED IN INVESTING ACTIVITIES (138,000) (33,000) CASH FLOW FROM FINANCING ACTIVITIES: Proceeds from exercise of stock option 148,000 48,000 Issuance of stock to Dutchess per agreement 252,000 75,000 Payments on capital lease obligations (15,000) (9,000) ----------- ----------- NET CASH PROVIDED BY FINANCING ACTIVITIES 385,000 114,000 NET INCREASE IN CASH 40,000 58,000 CASH BEGINNING OF PERIOD 281,000 62,000 ----------- ----------- CASH AT END OF PERIOD 321,000 120,000 SUPPLEMENTAL DISCLOSURES: Interest paid 10,000 6,000 Original cost of fixed assets disposed of - 84,000 5 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) COMPUMED, INC. NOTE A - BASIS OF PRESENTATION AND ACCOUNTING POLICIES The accompanying interim unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six-month period ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending September 30, 2006. For further information, refer to the financial statements for the year ended September 30, 2005 and the notes thereto included in the Company's Annual Report on Form 10-KSB. The balance sheet at September 30, 2005 has been derived from the Company's year-end audited financial statements but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The Company has historically used existing cash and readily available marketable securities balances to fund operating losses and capital expenditures. The Company raised these funds in 1997 through 2000 through the sale of Preferred Stock issuances and proceeds from the exercise of certain stock options and warrants. During the second quarter of fiscal 2006, we raised $141,000 through the sale of 209,983 shares to Dutchess Private Equities Fund, LLP. STOCK-BASED COMPENSATION ------------------------- The Company accounts for employee stock option grants in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations (APB 25), and has adopted the "disclosure only" alternative described in Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, amended by SFAS No. 148 Accounting for Stock-Based Compensation-Transition and Disclosure. SFAS No. 123, Accounting for Stock-Based Compensation, requires pro forma information regarding net income (loss) using compensation that would have been incurred if the Company had accounted for its employee stock options under the fair value method of that statement. During the six months ended March 31, 2006 and 2005, the Company granted options to purchase 50,000 shares and 35,000 shares to a consultant, and 310,000 shares and 235,000 shares to directors, officers and employees, respectively. The fair value of 50,000 and 35,000 options were valued at $18,000 and $8,000, respectively. The fair value of 310,000 and 235,000 options were valued at $111,000 and $39,000, respectively. These options were valued in accordance with SFAS and the fair values were estimated using Black-Scholes option pricing method with the following assumptions: For The Six Months Ended March 31, 2006 March 31, 2005 ----------------- ----------------- Risk free interest rate 4.47% 4.23% Stock volatility factor 37 % 33 % Weighted average expected option life 10 years 10 years Expected dividend yield None None The pro forma net loss and loss per share had the Company accounted for the options using FAS 123 would have been as follows: Three Months Ended March 31, Six Months Ended March 31, 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Net loss as reported (101,000) (33,000) (142,000) (126,000) Basic and diluted loss per share as reported (0.00) (0.00) (0.01) (0.01) Add: stock based employee compensation cost 2,000 - 3,000 16,000 included in determination of net loss reported Deduct: stock-based employee compensation cost (27,000) (20,000) (63,000) (36,000) that would have been included in the determination of net loss if the fair value method had been applied to all awards Pro forma net loss if the fair value based method (126,000) (53,000) (202,000) (146,000) had been applied to all awards Basic and diluted pro forma loss per share if the fair value based method had been applied for all awards (0.01) (0.00) (0.01) (0.01) A summary of the stock options activity and related information for the six months ended March 31 follows: 2006 2005 ---------------------------- ----------------------------- Weighted- Weighted- Average Average Exercise Exercise Shares Price Shares Price ------------- ------------- ------------- ------------- Options outstanding, beginning of period 6,571,934 0.25 6,437,217 0.22 Options exercised (777,105) 0.19 (525,869) 0.09 Options granted 360,000 0.64 270,000 0.32 Options forfeited/canceled (466,666) 0.27 (10,879) 0.71 ------------- ------------- ------------- ------------- Options outstanding, end of period 5,688,163 0.28 6,170,469 0.24 ============= ============= ============= ============== Options exercisable, end of period 3,754,839 0.28 4,093,809 0.25 ============= ============= ============= ============== The following summarizes information concerning stock options outstanding at March 31, 2006: Weighted Weighted Average Number Weighted Average Remaining Average Average Range of Exercise Prices Number Contractual Exercise Number Outstanding Life Price Exercisable ------------ ------------ ------------ ------------ 0.000000 - $0.425000 4,465,478 7.48 $ 0.15 2,892,154 0.425100 - $0.850000 1,191,435 5.18 $ 0.67 831,435 0.850100 - $1.275000 31,250 1.64 $ 1.15 31,250 ------------ ------------ ------------ ------------ 5,688,163 6.97 $ 0.28 3,754,839 ============ ============ ============ ============ 6 PER SHARE DATA ---------------- The Company reports its earnings (loss) per share in accordance with Statement of Financial Accounting Standards No.128, "Accounting for Earnings Per Share" ("FAS 128"). Basic loss per share is calculated using the net loss divided by the weighted average common shares outstanding. Shares from the assumed conversion of outstanding warrants, options and the effect of the conversion of the Class A Preferred Stock and Class B Preferred Stock are omitted from the computations of diluted loss per share because the effect would be anti-dilutive. NOTE B - OTHER AGREEMENTS On February 25, 2004, we entered into an Investment Agreement with Dutchess Private Equities Fund. That agreement provides that, following notice to Dutchess, we may sell to Dutchess up to $5 million in shares of our Common Stock for a purchase price equal to 95% of the average of the three lowest closing bid prices on the Over-the-Counter Bulletin Board of our Common Stock during the five day period following that notice. The number of shares that we are permitted to sell pursuant to the Investment Agreement is either: (A) two hundred percent of the average daily volume of our Common Stock for the ten trading days prior to the applicable sale notice, multiplied by the average of the three daily closing best bid prices immediately preceding the day we issue the notice, or (B) $25,000; provided that in no event will the sale be more than $1,000,000 with respect to any single sale. Dutchess' obligation to purchase our Common Stock is contingent upon certain closing conditions. Such conditions relate to the Investment Agreement and include: (i) that our representations and warranties are true and correct as of the funding date, (ii) that we have performed all of our covenants, agreements and conditions required to be performed by us, (iii) that trading of our Common Stock has not been suspended, (iv) that no statute, rule, regulation, executive order, decree, ruling or injunction is in force against the transactions contemplated in the Investment Agreement, (v) that no pending or threatened litigation exists, and (vi) that the SEC has declared effective a registration statement covering the shares to be purchased by Dutchess. On October 28, 2005, we declared a dividend of one Common Stock Purchase Right for each outstanding share of common stock. The dividend is payable to holders of record at the close of business on August 1, 2005. Each Right entitles the registered holder to purchase shares of common stock at a purchase price of $0.40, subject to adjustment. Initially, the Rights will not be exercisable, certificates for the Rights will not be issued and the Rights will automatically trade with our common stock. Until the close of business on the earlier of (i) the tenth day following the public announcement that a person or group of affiliated or associated persons ("Acquiring Person") other than us, our subsidiary or any employee benefit plan or employee stock plan ("Exempt Person") has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of our outstanding common stock or (ii) the tenth business day following the commencement by any person (other than an Exempt Person) of, or the announcement of the intention to commence, a tender or exchange offer that would result in the ownership of 15% or more of our outstanding common stock (the earlier of such dates in clauses (i) and (ii) being called the "Distribution Date"), the Rights will be evidenced, with respect to any of the common stock certificates outstanding as of August 1, 2005, by such common stock certificate, together with a copy of the Summary of Rights. The Rights are not exercisable until the Distribution Date. The Rights will expire at the close of business on October 28, 2009, unless redeemed or exchanged. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION. SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS ---------------------------------------------- This Report on Form 10-QSB contains forward-looking statements, including, without limitation, statements concerning our possible or assumed future results of operations. These statements are preceded by, followed by or include the words "believes," "could," "expects," "intends," "anticipates," or similar expressions. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons including, but not limited to, product and service demand and acceptance, changes in technology, ability to raise capital, the availability of appropriate acquisition candidates and/or business partnerships, economic conditions, the impact of competition and pricing, capacity and supply constraints or difficulties, government regulation and other risks described in this report. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made, and our future results, levels of activity, performance or achievements may not meet these expectations. We do not intend to update any of the forward-looking statements after the date of this document to conform these statements to actual results or to changes in our expectations, except as required by law. OVERVIEW -------- Our traditional core business is providing remote ECG (electrocardiogram) interpretation services to medical facilities that may not have access either to trained physicians that can interpret ECG results or to self-interpreting ECG equipment. Our customers are typically correctional facilities, ambulatory surgery centers, occupational health clinics and physician offices. Although self-interpreting ECG equipment is widely available, many of our customers like the optional feature of automatically sending their ECG results to one of our cardiologists for an overread when the results are abnormal. This overread feature is a key advantage that enables us to market our services in segments of the market where physicians may not be available on a routine basis. We are evaluating new opportunities for our ECG business; however, we could lose customers who choose to receive services from a competitor or who purchase a self-interpretive machine and no longer need our ECG interpretations. If we were to lose existing customers, they may be difficult to replace, and that could have a material adverse impact on our operations and financial condition. Our other business is the development and marketing of medical imaging software tools that automatically make accurate and precise measurements to diagnose bone disease. Our target markets for these products are hospitals, imaging centers and orthopedic office practices. Our initial product, the OsteoGram , is an automated system for the rapid screening, diagnosis and monitoring of osteoporosis, a disease that affects more than 200 million people worldwide. Osteoporosis is a "silent disease" that costs the U.S. healthcare system over $17 billion annually contrasted to the $6 billion spent annually on breast cancer. Fifty percent of all women will suffer an osteoporosis-related fracture in their lifetime, and Medicare is currently scrutinizing methods to lower the costs of fighting this largely preventable disease by working with the National Committee for Quality Assurance to stimulate point-of-care testing of "at risk" patients. We believe that convenient, low-cost methods of screening and diagnosing will become increasingly desirable as hospitals comply with recent initiatives directing them to test for and treat this insidious disease. The OsteoGram was originally marketed as a film-based product that utilized a standard hand x-ray film that is digitized on a desktop scanner. The image is then analyzed on a personal computer by means of the patented OsteoGram software. This system is still marketed to small hospitals, clinics and physician's offices. In 2004, we released the first DICOM (Digital Imaging and Communications in Medicine) version of the OsteoGram software. The DICOM OsteoGram was developed to take advantage of the growing market for digital, or filmless, x-ray equipment. DICOM is the information standard that allows digital imaging equipment to interconnect, enabling clinicians to readily move, archive and retrieve images and diagnostic information over networks. By residing on the workstations of these advanced digital systems, the OsteoGram software can automatically capture and analyze images directly from either the x-ray equipment or the network. We license our DICOM OsteoGram software to manufacturers of digital x-ray and network equipment to place at the point-of-sale. In addition, we enlist dedicated imaging distributors to sell our products in the after sale market. During the previous quarter we signed an important licensing agreement with FUJIFILM Medical Systems, USA, Inc. (Div. Fuji Photo Film Co., Ltd.) that enables FUJIFILM Medical Systems USA, Inc. (Fuji) to integrate CompuMed's proprietary OsteoGram osteoporosis screening and diagnostic software with its market-leading computed radiography (CR) systems. Fuji has the largest installed base of CR systems in the U.S., and they exhibited a new, low-end CR targeted towards small hospitals and orthopedic clinics late last year. In order to implement our integration strategy, it was necessary to upgrade our OsteoGram software product to be compatible with the latest version of the Fuji workstation. In addition, the OsteoGram was required to pass the rigorous Fuji QA protocol prior to market release. Therefore, the majority of the R&D activities for the quarter were spent in developing version 1.35 of the OsteoGram software with the latest in DICOM functionality. This version was made available in late March 2006, which allowed us to ship the first units to FujiMed USA. In addition, we shipped upgraded versions of our software to the remaining DICOM customers, including those of Swissray International. OsteoGram enhanced Fuji CR systems were showcased at the 2006 Annual Meeting of the American Association of Orthopaedic Surgeons in Chicago March 22-26, 2006. The OsteoGram was also featured in the exhibits of Swissray International and the Kodak Health Group, division of the Eastman Kodak Company. Our German distributor installed the first OsteoGram trial systems in key reference sites during the second quarter, and we anticipate positive feedback in the coming months. Germany is a key market for us in the EU, since the market is rapidly transitioning to digital radiography and PACS networks. Our Beijing, China distributor sold the first OsteoGram system on a Kodak CR in the western sector of the country. Kodak is the market leader in CR sales in China. Transmission revenue from our ECG business continued to grow this quarter, as we expanded our relationship with Correctional Medical Services (CMS), a leading provider of comprehensive medical care to state and local correctional facilities. CMS added more than 68 new sites to our existing agreement, and our ECG support staff spent most of the quarter installing and training the new CMS facilities in the use of our CardioGram product. We believe that transmissions and overreads should continue on an upward trend as the new sites come online during the third quarter of our fiscal year. 7 RESULTS OF OPERATIONS FOR THE QUARTER AND THE SIX MONTHS ENDED MARCH 31, 2006 -------------------------------------------------------------------------------- COMPARED TO THE SAME PERIOD OF FISCAL 2005. -------------------------------------------------- Revenues from ECG services decreased by 5% for the second quarter of fiscal 2006 to $427,000 from $451,000 in fiscal 2005, and during the six months ended March 31, 2006 increased by 1% to $860,000 from $850,000. The quarterly decline was due to the loss of rental revenue from the ECG equipment sold to New York Department of Corrections (NYDOC) in fiscal 2005. The one-time purchase of ECG equipment by NYDOC in fiscal 2005 also resulted in the product sales decline of 41% for the quarter to $42,000 in 2006 from $71,000 in 2005, and 70% for the first six months to $103,000 from $341,000. Revenues from the OsteoGram(R) sales and services for the second quarter of fiscal 2006 increased by 533% to $76,000 from $12,000 in fiscal 2005, and for the six months ended March 31, 2006 increased by 1,065% to $233,000 from $20,000, due to the shipments to OREX Computed Radiography and FUJIFILM Medical Systems USA. Cost of services and goods sold consists of the costs of ECG services provided, supplies, electrocardiograph equipment sold and OsteoGram(R) systems sold. Costs of services of ECG for the second quarter of fiscal 2006 decreased by 5% to $146,000 from $154,000 in fiscal 2005, and for the six months ended March 31, 2006 decreased slightly by 1% to $290,000 from $292,000, due to decreased expenses related to shipping new ECG equipment to NYDOC. Cost of goods sold of ECG for the second quarter of fiscal 2006 decreased by 31% to $33,000 from $48,000 for the same period of fiscal 2005, and during the six months ended March 31, 2006 decreased by 72% to $75,000 from $269,000, due to decreased ECG equipment sales after the one-time sale in 2005 to the NYDOC. The cost of goods sold for OsteoGram(R) for the second quarter of fiscal 2006 was none compared to $2,000 for the same period in 2005, decreased by 100% due to due to sales that do not include hardware, and was $3,000 for the six months ended March 31, 2006 and March 31, 2005. Selling expenses for the second quarter of fiscal 2006 increased by 90% to $118,000 from $62,000 in fiscal 2005, and for the six months ended March 31, 2006 increased by 72% to $223,000 from $130,000, primarily due to the hiring of the Vice President Sales for the OsteoGram(R) business. General and administrative expenses for the second quarter of fiscal 2006 increased by 16% to $262,000 from $226,000 in fiscal 2005, and for the six months ended March 31, 2006 increased by 14% to $569,000 from $500,000, mainly due to expensing the value of the restricted shares issued to the investor relations firm Porter LeVay and Rose, Inc. Research and development costs for the second quarter of fiscal 2006 increased by 25% to $69,000 from $55,000 in fiscal 2005, and for the six months ended March 31, 2006 increased by 43% to $167,000 from $117,000, due to the hiring of the Vice President of Engineering. Interest income and dividends for the second quarter of fiscal 2006 increased by 100% to $4,000 from $2,000 in fiscal 2005, and for the six months ended March 31, 2006 increased by 325% to $34,000 from $8,000, due to increased investments in marketable securities. Other miscellaneous income for the second quarter of fiscal 2006 and 2005 was none, and for the six months ended March 31, 2006 was none compared to $8,000 in fiscal 2005, decreased by 100% due to a reversal of a reserve related to operating business expenses. Interest expense for the second quarter of fiscal 2006 increased by 25% to $5,000 from $4,000, and for the six months ended March 31, 2006 increased by 67% to $10,000 from $6,000, due to increased financing of ECG equipment. Net loss for the second quarter of fiscal 2006 increased by 206% to $101,000 from $33,000 in fiscal 2005, and for the six months ended March 31, 2006 increased by 13% to $142,000 from $126,000, for the reasons stated above. The primary factor influencing the net loss was increased costs relating to staffing additions in the Sales and Research and Development departments. 8 FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES --------------------------------------------------------- At March 31, 2006, we had approximately $703,000 in cash and marketable securities, as compared to a balance of $571,000 at September 30, 2005, a net increase of $132,000, due to fund raised through Dutchess Private Equities Fund and exercise of stock options by directors and employees. The purchases of property, plant, and equipment during the second quarter of 2006 were $1,000 compared to $20,000 for the same period in fiscal 2005. We have historically used existing cash and readily available marketable securities balances to fund operating losses and capital expenditures. We also raise funds through the sale of Common and Preferred stock issuances and proceeds from the exercise of stock options and warrants. CAPITAL COMMITMENTS We lease our corporate offices at a monthly rental of $11,822 per month with 3% annual increase. We entered into a long-term agreement with John McLaughlin effective November 2, 2002 through September 30, 2004. This agreement provides a base salary of $150,000 per year and a bonus up to $150,000 based on performance factors including revenue, profit and accomplishment of certain key milestones. In addition, Mr. McLaughlin received standard employee options to purchase 50,000 shares of Common Stock at an exercise price of $0.20 per share upon acceptance of the agreement. On September 24, 2004, the Board passed a resolution to extend this contract for an additional year to 2005. On September 9, 2005 the Board passed a resolution to continue Mr. McLaughlin at a monthly salary of $14,500 starting October 1, 2005. Each of our Directors receives an annual Board of Directors fee of $12,000, which is paid to each Director in equal monthly installments. The Chairman receives an additional $4,800. In addition to the Board of Directors fee, Directors receive $1,000 per Board meeting and per Committee meeting when they serve as a member of the Executive, Audit or Compensation Committee. Such amount is reduced to $350 if the Committee meeting is held by teleconference or on the same day as a Board meeting. FINANCING ACTIVITIES On February 25, 2004, we entered into an Investment Agreement with Dutchess Private Equities Fund. That agreement provides that, following notice to Dutchess, we may sell to Dutchess up to $5 million in shares of our Common Stock for a purchase price equal to 95% of the average of the three lowest closing bid prices on the Over-the-Counter Bulletin Board of our Common Stock during the five day period following that notice. The number of shares that are permitted to sell pursuant to the Investment Agreement is either: (A) two hundred percent of the average daily volume of our Common Stock for the ten trading days prior to the applicable sale notice, multiplied by the average of the three daily closing best bid prices immediately preceding the day we issue the notice, or (B) $25,000; provided that in no event will the sale be more than $1,000,000 with respect to any single sale. Dutchess' obligation to purchase our Common Stock is contingent upon certain closing conditions. Such conditions relate to the Investment Agreement and include: (i) that our representations and warranties are true and correct as of the funding date, (ii) that we have performed all of our covenants, agreements and conditions required to be performed by us, (iii) that trading of our Common Stock has not been suspended, (iv) that no statute, rule, regulation, executive order, decree, ruling or injunction is in force against the transactions contemplated in the Investment Agreement, (v) that no pending or threatened litigation exists, and (vi) that the SEC has declared effective a registration statement covering the shares to be purchased by Dutchess. During the second quarter and the six months ended March 31, 2006, we sold 209,983 and 375,429 shares of Common Stock to Dutchess Private Equities Fund at an average of $0.68 per share. The gross proceeds were $141,000 and $252,000, respectively. PLAN OF OPERATIONS -------------------- Our business strategy includes an increase in OsteoGram(R) revenue through sales to manufactures of digital x-ray equipment and through sales via domestic and international distributors. We intend to finance this business strategy by using our current working capital resources and cash flows from existing operations, including the ECG and OsteoGram(R) businesses. There can be no assurance that the ECG and OsteoGram(R) sales will be sufficient to offset related expenses. We anticipate that our cash flow from operations, available cash, and marketable securities will be sufficient to meet our anticipated cash requirements for at least the next 12 months. However, in certain circumstances we may need to raise additional capital in the future, which might not be available on reasonable terms or at all. If we raise additional capital, we will likely utilize a portion of the $5,000,000 available through the Investment Agreement with Dutchess Private Equities Fund. Failure to raise capital when needed could adversely impact our business, operating results, and liquidity. If additional funds are raised through the issuance of equity or convertible securities, the percentage of ownership of existing stockholders will be reduced. Furthermore, some equity and convertible securities might have rights, preferences or privileges senior to our Common Stock. Our Common Stock is currently traded on the over-the-counter bulletin board, which makes it more difficult to raise funds through the issuance of equity or convertible securities because our Common Stock is thinly traded and those who wish to sell shares of our Common Stock may have difficulty locating buyers. Additional sources of financing may not be available on acceptable terms, if at all. We intend to pursue additional research and/or sub-contractor agreements relating to our development projects. Additionally, we may seek partners and acquisition candidates of businesses that are complementary to our own. Such investments would be subject to our obtaining financing through issuance of debt or other securities. Acquisitions could be dilutive to stockholders. 9 MATERIAL TRENDS AND UNCERTAINITIES ------------------------------------- The rate of progress in commercializing the DICOM (digital) OsteoGram accelerated at the end of the first quarter of fiscal 2006, mainly due to an order from Orex Computed Radiography. This trend continued in the second quarter as FUJUIFILM Medical Systems USA placed a stocking order. There is no assurance that the increasing OsteoGram sales trend will continue. CRITICAL ACCOUNTING POLICIES ------------------------------ Our discussion and analysis of our financial condition and results of operations, including the discussion on liquidity and capital resources, are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we re-evaluate our estimates and judgments, particularly those related to the determination of the estimated recoverable amounts of trade accounts receivable, impairment of long-lived assets, revenue recognition and deferred tax assets. We believe the following critical accounting policies require our more significant judgment and estimates used in the preparation of the financial statements. We maintain an allowance for doubtful accounts for estimated losses that may arise if any of our customers are unable to make required payments. Management specifically analyzes the age of customer balances, historical bad debt experience, customer credit-worthiness, and changes in customer payment terms when making estimates of the uncollectability of our trade accounts receivable balances. If we determine that the financial conditions of any of our customers deteriorated, whether due to customer specific or general economic issues, increases in the allowance may be made. Accounts receivable are written off when all collection attempts have failed. We have a significant amount of property, equipment and intangible assets, including patents. In accordance with Statement of Financial Accounting Standards, or SFAS, No. 144, Accounting for the Impairment or Disposal of Long Lived Assets, we review our long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability of long-lived and amortizable intangible assets to be held and used is measured by a comparison of the carrying amount of an asset to the undiscounted future operating cash flows expected to be generated by the asset. If these assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying value of the assets exceeds their fair value. We follow the provisions of Staff Accounting Bulletin, or SAB 101, "Revenue Recognition in Financial Statements", for revenue recognition. Under SAB 101, four conditions must be met before revenue can be recognized: (i) there is persuasive evidence that an arrangement exists, (ii) delivery has occurred or service has been rendered, (iii) the price is fixed or determinable and (iv) collection is reasonably assured. In December 2003, the SEC issued Staff Accounting Bulletin SAB No. 104, "Revenue Recognition", which revises and rescinds certain sections of SAB No. 101, "Revenue Recognition", in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have a material effect on our results of operations, financial position or cash flows. ITEM 3. CONTROLS AND PROCEDURES. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES Our management evaluated, with the participation of our Chief Executive Officer and Principal Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-QSB. Based on this evaluation, our Chief Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our disclosure controls and procedures are designed to provide reasonable assurance that such information is accumulated and communicated to our management. Our disclosure controls and procedures include components of our internal control over financial reporting. Management's assessment of the effectiveness of our internal control over financial reporting is expressed at the level of reasonable assurance that the control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control system's objectives will be met. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING There was no change in our internal control over financial reporting during our second quarter of fiscal 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 10 LIMITATION ON THE EFFECTIVENESS OF CONTROLS Our management, including our Chief Executive Officer and Principal Financial Officer, does not expect that our disclosure controls and internal controls will prevent all error and all fraud. 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 design of a control system must reflect the fact that there are resource constraints, and 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, within the company 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 error or mistake. 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 also is 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. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. None. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. During the second quarter and the six months ended March 31, 2006, we sold 209,983 and 375,429 shares of Common Stock to Dutchess Private Equities Fund at an average of $0.68 per share. The gross proceeds were $141,000 and $252,000, respectively. All sales were made pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 of Regulation D promulgated hereunder. All proceeds received were added to our working capital. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. ITEM 5. OTHER INFORMATION. None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. NUMBER DESCRIPTION OF EXHIBIT -------------------------------- 3.1 Certificate of Incorporation (filed as Exhibit 3.1 to the Form S-1 effective May 7, 1992, and incorporated herein by reference). 3.2 Certificate of Amendment of Certificate of Incorporation (included as Exhibit 3.1a to the Form S-2/A filed June 28, 1994, and incorporated herein by reference). 3.3 Certificate of Amendment of Certificate of Incorporation (included as Exhibit 3.1b to the Form S-2/A filed November 7, 1994, and incorporated herein by reference). 3.4 Certificate of Correction of Certificate of Amendment (included as Exhibit 3.1c to the Form S-2/A filed November 7, 1995, and incorporated herein by reference). 3.5 By-Laws (included as Exhibit 3.5 to the Form 10-QSB filed February 13, 2004, and incorporated herein by reference). 3.6 Amendment to By-laws (included as Exhibit 3.6 to the Form 10-QSB filed February 13, 2004, and incorporated herein by reference). 4.1 Certificate of Designation of Class A Preferred Stock (included as Exhibit 4.5 to the Form 10-KSB filed December 29, 1995, and incorporated herein by reference). 4.2 Certificate of Designation of Class B Preferred Stock (included as Exhibit 4.6 to the Form 10-KSB filed December 29, 1995, and incorporated herein by reference). 4.3 Certificate of Designation of Class C Preferred Stock (included as Exhibit 3.1 to the Form 8-K filed January 9, 1998, and incorporated herein by reference). 4.4 Certificate of Correction for Class C Preferred Stock (filed as Exhibit 3.2 to the Form 8-K filed January 9, 1998, and incorporated herein by reference). 4.5 Registration Rights Agreement between the Company and Dutchess Private Equities Fund, L.P., dated February 25, 2004 (included as Exhibit 10.10 to the Form SB-2 filed February 27, 2004, and incorporated herein by reference). 4.6 Rights Agreement between the Company and U.S. Stock Transfer Corporation dated October 28, 2005 (filed as Exhibit 4.1 to the Company's Form 8-A filed on November 2, 2005 and incorporated herein by reference). 10.1 Commercial Office Lease between the Company and L.A.T. Investment Corporation, dated August 16, 1999 (included as Exhibit 10.24 to the Form 10-KSB filed December 29, 1999, and incorporated herein by reference). 10.2 Form of Stock Option Agreement (included as Exhibit 10.5 to the Form 10-QSB filed August 14, 2002, and incorporated herein by reference). 10.3 Employment Agreement between the Company and John McLaughlin, dated November 2, 2002 (included as Exhibit 10.6 to the Form 10-QSB filed February 14, 2003, and incorporated herein by reference). 10.4 Amendment to Employment Agreement between the Company and John McLaughlin (included as Exhibit 10.5 to the Form 10-KSB filed December 29, 2004, and incorporated herein by reference). 10.5 Amendment to Commercial Office Lease between the Company and L.A.T. Investment Corporation (included as Exhibit 10.6 to the Form 10-KSB filed December 29, 2004, and incorporated herein by reference). 10.6 Investment Agreement between the Company and Dutchess Private Equities Fund, L.P., dated February 25, 2004 (included as Exhibit 10.9 to the Form SB-2 filed February 27, 2004, and incorporated herein by reference). 10.7 Placement Agent Agreement between the Company, Charleston Capital Securities, and Dutchess Private Equities Fund, L.P., dated February 25, 2004 (included as Exhibit 10.11 to the Form SB-2 filed February 27, 2004, and incorporated herein by reference). 10.8 Amended and Restated 2003 Stock Incentive Plan (included as Exhibit 10.1 to the Form S-8 filed April 13, 2005, and incorporated herein by reference). 31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Officers pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 11 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMPUMED, INC. Date May 15, 2006 By: /s/ John G. McLaughlin --------------------------- John G. McLaughlin President and Chief Executive Officer Date May 15, 2006 By: /s/ Phuong Dang ------------------- Phuong Dang Secretary, Controller and Principal Financial Officer 12