UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934.
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2006
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NUMBER 0-14210
COMPUMED, INC.
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(Name of Small Business Issuer in Its Charter)
DELAWARE 95-2860434
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
5777 WEST CENTURY BLVD., SUITE 1285, LOS ANGELES, CA 90045
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(Address of principal executive offices) (Zip Code)
(310) 258-5000
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(Issuer's Telephone Number)
Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange Act: COMMON STOCK,
$0.01 PAR VALUE
Check whether the Issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities 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 for the past 90 days.
[X] YES [ ]NO
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB
[X] YES [ ]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]
State the issuer's revenues for its most recent fiscal year: $2,114,000.
As of November 30, 2006, the issuer had 24,259,879 common shares outstanding.
The aggregate market value of the common shares held by non-affiliates of the
issuer (22,850,245 shares) was approximately $8,454,591 based upon the average
bid and asked prices ($0.37) on such date.
Transitional Small business issuer Format: [ ] YES [X] NO
TABLE OF CONTENTS
PART I PAGE
Item 1 Description of Business 2
Item 2 Description of Property 8
Item 3 Legal Proceedings 8
Item 4 Submission of Matters to a Vote of Security Holders 8
PART II
Item 5 Market For Common Equity and Related Stockholder Matters 9
Item 6 Management's Discussion and Analysis or Plan of Operation 11
Item 7 Financial Statements 16
Item 8 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 16
Item 8A Controls and Procedures 16
PART III
Item 9 Directors, Executive Officers, Promoters and Control
Persons; Compliance With Section 16(a) of the Exchange Act 17
Item 10 Executive Compensation 18
Item 11 Security Ownership of Certain Beneficial Owners and
Management And Related Stockholder Matters 19
Item 12 Certain Relationships and Related Transactions 22
Item 13 Exhibits 22
Item 14 Principal Accountant Fees and Services. 23
Signatures. 24
Financial Statements F-1
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PART I
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ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
We are a developer of Computer Aided Diagnostic (CAD) solutions for the
healthcare industry that provide medical imaging software and remote,
computer-aided interpretation of electrocardiograms. Our two main products are
the OsteoGram(R) and CardioGram systems. The OsteoGram(R) is our proprietary
image processing software that utilizes either digital or film-based x-rays of
the hand to screen, diagnose and monitor osteoporosis, a disease that affects
more than 200 million people worldwide. The CardioGram consists of
computer-aided telemedicine services that offer on-line interpretation of
electrocardiograms to physicians, government and corporate healthcare providers.
We view our two businesses as a converging platform for specialized services,
and our goal is to be the leading provider of remote analysis in cardiology and
radiology. In May 2006 we retained Synthetica, LTD to assist us in developing a
strategic plan to grow our business.
We incorporated in the State of Delaware on July 21, 1986.
RECENT EVENTS
Our traditional core business is the remote interpretation of
electrocardiograms, or ECGs coupled with a feature that allows customers to have
a cardiologist overread of abnormal results. Data is sent over telephones or the
Internet to our state-of-the-art analysis center for interpretation.
-2-
Our ECG workflow and analytics capability are scalable, and we believe we can
readily add other measurement metrics to our cardiology service offering.
We believe that the future of our underlying OsteoGram(R) technology is in the
development of medical software applications that can either be integrated into
the operating systems of digital imaging equipment or be utilized for remote
interpretation at our centralized lab. Digital x-ray and mammography machines
are a high growth segment of the medical imaging field. Our OsteoGram technology
can be expanded to fit a number of applications to automate tedious procedures
that can dominate a busy radiologist's time. By developing new applications,
such as following the progression of arthritic disease, we can build a toolbox
for clinicians that can be directly licensed or remotely accessed over the
Internet.
Our research and development team devoted the majority of their time this fiscal
year to integrating our software application into several digital imaging
platforms, including a new digital x-ray platform from Kodak Electronics
Products Shanghai, Co., LTD. This was a significant event for us, since the
integration project required us to break our software into modules that would
fit seamlessly into the Kodak software system. The resulting modularized
OsteoGram system is now amenable to a wider range of platforms and radiology
networks.
THE OSTEOGRAM(R)
GENERAL
The OsteoGram(R) is a medical image processing software system that enables
healthcare providers to screen, diagnose and monitor osteoporosis using digital
hand images from filmless x-ray equipment or conventional, film-based x-rays.
Osteoporosis is diagnosed by measuring bone mineral density. A low bone mineral
density is indicative of the disease. The OsteoGram(R) is based on a bone mass
measurement technique called radiographic absorptiometry, which was cited in the
2004 Surgeon General's report on bone disease. Radiographic absorptiometry uses
a conventional x-ray of the hand, scanned at high resolution, to measure bone
density. The radiographic absorptiometry technique not only measures bone mass,
but also the cortical thickness of bones. Recent studies affirm the importance
of cortical thickness as an additional measure of bone strength and overall
fracture risk. Several prominent pharmaceutical manufacturers are developing
products that will strengthen cortical bone. Cortical bone is the outer shell
that gives bone strength, much like the hollow tubes from which bicycles are
constructed. Our technology has the capability to measure bone mineral density
in both cortical and trabecular bone, and we believe this is an important
feature to add to the OsteoGram(R) system in the future. Dual energy x-ray
absorptiometry, or DXA, is considered the "Gold Standard" of bone mineral
density measurement, but it cannot differentiate between cortical and trabecular
bone. We believe that the OsteoGram(R) could become a key tool for some
pharmaceutical manufacturers, not only in the clinical trial phase, but also in
monitoring therapy once a drug is approved. Our development team worked
diligently to add cortical thickness measurement to the existing OsteoGram(R)
report, and we launched a preliminary product in China.
In May 1999, we received clearance from the United States Food and Drug
Administration, or FDA, to market an automated version of the OsteoGram(R)
software for use as a stand-alone product by physicians. In 2004 we launched the
Digital Imaging and Communications in Medicine, or DICOM, a digital version of
the product. Using digital or film-based x-ray equipment, two posterior-anterior
views of the left-hand fingers are taken with an aluminum alloy reference wedge
in each exposure. The calibration wedge is used to adjust for any differences
among x-ray equipment, exposures and other variables. In the case of the
film-based version of the OsteoGram(R), the developed film is scanned with a
high-resolution desktop scanner, and the OsteoGram(R) software analysis program
rapidly produces an accurate and precise bone mineral density report. With a
filmless x-ray system the digital image is captured on a workstation for
analysis. We developed the DICOM-compliant version of the OsteoGram(R) for use
on filmless systems, which have become a high growth segment in the medical
imaging market. DICOM is the industry-consortium established information
standard that allows the new generation of digital medical imaging equipment to
interconnect.
The foremost near-term market opportunity that we have identified for our
OsteoGram(R) is in coupling our product with filmless x-ray and mammography
systems plus the computer networks that tie imaging modalities together. Our
application can reside on a workstation, just like Microsoft(R) Word on a
personal computer. There is no need for expensive, dedicated equipment or
redundant computers. Clinicians can launch the OsteoGram(R) application and
diagnose osteoporosis at the same time an x-ray is taken for a bone fracture,
making it far easier to implement and use than expensive DXA equipment that
requires a dedicated room and specially trained technicians who are usually not
available around the clock.
Since we already have an infrastructure in place to remotely interpret ECGs, it
makes sense to offer our OsteoGram application and its spin-offs in a service
model, as well. Our strategy is to offer a platform of specialized services for
a wide spectrum of musculoskeletal and cardiovascular diseases beginning in
calendar 2007.
The OsteoGram(R) test is reimbursable by Medicare, adding value to the bundled
solution manufacturers of digital radiography equipment can offer to their
customers. The OsteoGram(R) not only helps to solve the public health problem of
lack of convenient osteoporosis testing, but it also increases revenue for the
end user. The projected revenue can be positioned as a means to offset the
monthly lease costs of the manufacturer's equipment, allowing the manufacturers
and their dealers an attractive sales paradigm.
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STRATEGIC PARTNERSHIPS
As a small company, it is difficult to create global demand for our products;
therefore we rely on our strategic partners to market the OsteoGram(R) to
end-users. Our strategy is to establish distribution and product development
partnerships with the major manufacturers of digital imaging platforms and to
launch the integrated solution in a timely manner. Although we have become adept
at integrating the OsteoGram(R) into various digital modalities, the process is
gated by our partners' schedules, the timing of product launches and market
conditions. Orex Computed Radiography was one of our earliest licensees. The
company was acquired by the Health Group of the Eastman Kodak Company in early
2005, and the subsequent integration of Orex into the Kodak system slowed our
expected progress in the field. The Orex licensing agreement was transferable
upon the sale of Orex, and Kodak is a key player in the digital radiography
field with platforms in computed radiography (CR), digital radiography (DR) and
computer aided diagnostic, or CAD mammography. The terms of our licensing
agreement with Orex allow Kodak to effortlessly license the OsteoGram(R) for
their existing digital products.
In fiscal 2006 we signed several OsteoGram(R) licensing agreements. Aside from
the Orex/Kodak agreement, we licensed the OsteoGram to Fujifilm Medical Systems
USA, the market leader in computed radiography (CR) systems. Fuji recently
gained FDA approval for their computed radiography mammography system, and the
terms of our agreement allow them to sell our software in conjunction with their
new digital mammography product. In April we signed a one-year exclusive
licensing agreement with Kodak Electronics Products Shanghai, Co., LTD for the
Peoples Republic of China.
COMBINED BUSINESS MODEL
Another facet of our OsteoGram strategy is to leverage the workflow and
analytics capability of our ECG business by offering our radiology applications
as a remote service business with recurring revenues. According to Frost and
Sullivan, the number of imaging procedures in the U.S. is increasing annually at
a rate exceeding 14%, while the number of radiologists to interpret the scans is
not keeping pace. Many of the methods used by radiologists are manual and
subjective in nature; therefore there is a pressing need for automation. The
Internet is an opportunity to provide analyses and overreads remotely as a
service. We currently use the Internet as an ECG transmission tool, and we plan
to utilize our ECG infrastructure to expand into specialized radiology services.
We also believe we can expand our cardiology offering by adding new services.
The telecardiology market is highly fragmented, and there exists an opportunity
for consolidation. As fiscal 2006 drew to a close, we began to investigate
strategic acquisitions that will add to our current cardiology business.
RESEARCH AND DEVELOPMENT
Fiscal 2006 was a challenging year for our research and development group. The
changing needs of our strategic partners and a turnover in one of our key
positions caused us to reevaluate the skill sets required for our team. Coupled
with the degree of difficulty in hiring suitable software engineers in the
current job market, we are pleased with our results in this area.
Early in fiscal 2006, we completed a small clinical trial to assess the results
of utilizing the OsteoGram(R) software with images taken on a market leading
Full Field Digital Mammography unit. The trial was conducted at a major teaching
hospital, and we were encouraged by the strong correlation between the
OsteoGram(R) results on digital mammography equipment and the original
OsteoGram(R) film-based product. One of the major issues preventing routine
osteoporosis testing is the lack of convenient testing sites. We believe that,
by integrating the OsteoGram(R) into Full Field Digital Mammography platforms,
women can be conveniently tested for osteoporosis at the same time and on the
same equipment as their routine mammogram. Our goal in this area is to employ
the dual strategy of licensing our product to key industry players and to offer
our application on a cost-per-test basis. We believe there is a growing
conviction that CAD applications, such as the OsteoGram, would be greeted
enthusiastically by clinicians on a service business model. We believe that
there is a strong market for our product on digital mammography platforms, and
we filed a preliminary patent application in November 2005 to protect our
intellectual property rights in that regard.
As fiscal 2006 progressed, we focused on releasing Version 1.3.5 of the DICOM
OsteoGram software that solidified the foundation of the system and allowed it
to work on all configurations of the OREX computed radiography operating
software, including their latest release.
Our research and development team devoted the latter half of the year to
integrating our software application into a new digital x-ray platform from
Kodak Electronics Products Shanghai, Co., LTD. This was a significant event for
us, since the integration project required that we break our software into
components that would fit within the Kodak software system. The resulting
modularized OsteoGram system is now amenable to a wider range of platforms and
radiology networks.
We continue to invest in research and development efforts for the OsteoGram(R)
technology by planning new applications and filing key patents to protect our
intellectual property rights. We are actively engaged in the development of
potential diagnostic products based on the technologies covered by our first and
second patents awarded by the U.S. Patent and Trademark Office in June 2001 and
April 2004.
In fiscal 2006, we spent $340,000 on research and development, as compared to
$293,000 in fiscal 2005. None of these costs were borne directly by our
customers.
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OSTEOPOROSIS
Osteoporosis is a disease characterized by low bone mass and structural
deterioration of tissue leading to bone fragility and an increased
susceptibility to fractures of the hip, spine and wrist. While there is
increased global awareness of osteoporosis, the disease is under-diagnosed
and under-treated.
According to the International Osteoporosis Foundation, osteoporosis affects
more than 200 million people worldwide, 80% of which are women. Osteoporosis is
a major public health threat for 44 million Americans, and the disease costs the
U.S. healthcare system in excess of $17 billion annually, compared to breast
cancer at $6 billion. In fact, more people die as a result of
osteoporosis-related fractures each year than die from breast cancer, and one of
every two women will suffer an osteoporosis-related fracture in her lifetime.
In July 2002, the National Institutes of Health halted a large, in-progress
study examining the effects of hormone replacement therapy. The study, which was
one of the five major studies that comprise the large clinical trial called the
Women's Health Initiative, was discontinued because the hormones appeared to
increase a woman's risk of breast cancer as well as heart disease, blood clots
and stroke. This news caused the medical community to question one of the
long-accepted practices in the treatment of female menopausal symptoms. Hormone
replacement therapy is known to protect women against bone loss; however, the
negative implications of increased heart disease, stroke and cancer were largely
unknown. Subsequently millions of women discontinued hormone replacement
therapy, which increased concern about bone loss. As a result, there was an
increased awareness of bone mineral density testing and testing methods.
Following the Women's Health Initiative announcement, the U.S. Preventative
Services Task Force published its own recommendations that women over the age of
65 be tested for osteoporosis. Soon afterwards the National Osteoporosis
Foundation reaffirmed their more comprehensive recommendations for osteoporosis
testing. In July 2003 the American Association for Orthopaedic Surgeons posted a
policy statement on their web site urging their members to test for underlying
bone disease when presented with a fragility fracture. In addition, Medicare is
now enacting a new measure requiring health care providers to test for
osteoporosis when a fracture is diagnosed. Failure to test or treat osteoporosis
may have negative implications for a hospital's accreditation.
We believe that the global awareness of osteoporosis is increasing, and that
there is a resurgence of interest in bone mineral density testing as a result of
the increased publicity. We also believe that osteoporosis testing is a
significant public health care issue that can best be dealt with in a routine
manner at a point-of-care care setting.
COMPETITION-OSTEOGRAM(R)
Bone mineral density measurements are the primary methods used to assist
physicians in detecting osteoporosis. Bone mineral density is measured by
passing x-ray beams or ultrasound through bone and determining how much energy
the bone absorbs.
Dual energy x-ray absorptiometry, or DXA is currently the mostly widely used
osteoporosis detection technology, with a worldwide installed base in 2003
exceeding 16,000 units according to Frost & Sullivan. The DXA market is divided
into axial or central machines, which are designed to measure bone mass and
density at a variety of skeletal sites, primarily the hip and spine, and
peripheral machines, which measure bone mass and density at appendicular sites
such as forearm, hand or heel.
The leading manufacturers of whole-body DXA scanners include General Electric's
Lunar Division U.S. and Hologic, Inc. U.S., which together command most of the
worldwide DXA market. The leading manufacturers of peripheral DXA machines are
General Electric, Hologic, Norland and Osteometer (a subsidiary of OSI Systems,
U.S.). Whole body DXA products typically cost from $70,000-$150,000 and require
specially trained technicians, who must be licensed in most states, and who are
not available on a 24-hour, 7 days a week basis.
During fiscal 2006 Medicare considered proposed cuts in DXA reimbursement.
Although the final decision has yet to be appealed, it appears that DXA
reimbursement will be reduced by 40% by January 1, 2007 and will plummet to
$35.48 when the proposed fee schedule is fully implemented in 2010. This amounts
to a 75% cut in DXA reimbursement, which will have a profound effect on new
system sales and the incentive to use DXA on an ongoing basis. Reimbursement for
the OsteoGram is unaffected by these latest cuts.
We experience extensive competition for the OsteoGram(R) from companies that
offer DXA machines, primarily because they are considered the "Gold Standard"
for measuring bone mineral density and have a large installed base worldwide. We
compete by offering cost effective testing and a product with a unique digital
format. The OsteoGram(R) was developed to enhance the use of existing
radiological equipment for generating bone mineral density reports comparable to
tests performed on the expensive, dedicated DXA equipment generally found in
hospitals and specialty practices. The OsteoGram(R) test is reimbursed by
Medicare and most medical insurance plans.
Other competition for the OsteoGram(R) comes from less accurate ultrasound and
other peripheral devices. Our competition also uses single-energy x-ray
absorptiometry, quantitative computed tomography, peripheral quantitative
computed tomography, and radiographic absorptiometry. All radiographic
techniques in use today have been validated through extensive clinical studies
and are currently approved in the U.S. for Medicare reimbursement. We employ the
radiographic absorptiometry technology because of its accuracy, ease of use and
relative low cost.
Quantitative Computed Tomography. Quantitative computed tomography (QCT)
utilizes existing computed tomography, CT or CAT scanners that have been
upgraded with specialized software, while peripheral quantitative computed
tomography (pQCT) utilizes specialized peripheral computed tomography equipment.
Quantitative computed tomography and peripheral quantitative computed tomography
are expensive to perform and require a high degree of expertise to operate
properly. In addition, the radiation dose of quantitative computed tomography is
remarkably high compared to the OsteoGram(R) process.
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Quantitative Ultrasound. Quantitative ultrasound (QUS) bone densitometers were
introduced in the early 1990s, and they are widely available. General Electric
Lunar and Hologic are leaders in the ultrasound market segment; however, the
market also includes numerous regional manufacturers. We believe that there are
now approximately 10,000 quantitative ultrasound machines installed worldwide.
Quantitative ultrasound has U.S. FDA clearance for screening in the U.S., but
unlike the OsteoGram(R), is not recommended by the National Osteoporosis
Foundation for diagnosis.
To our knowledge, the only manufacturer using radiographic absorptiometry, other
than us, is Alara, Inc. U.S. In 2000, the FDA approved Alara's self-contained,
tabletop system that performs digital radiographic absorptiometry of the hand.
We believe Alara is currently focused on developing computed radiography
systems.
Our existing and potential competitors consist principally of companies that
have substantially greater financial, technical, marketing, distribution and
other resources, greater current market penetration and longer-standing
relationships with customers than us. We believe that our ability to compete
successfully depends on a number of factors, both within and outside of our
control, including the price, quality and performance our products and those of
our competitors. Other factors include the timing and success of our new product
introductions and our competitors, the development of technical innovations, the
number and nature of our competitors in a given market, and general market and
economic conditions. We may not be able to compete successfully in the future.
ELECTROCARDIOGRAM SERVICES
GENERAL
We have been a supplier of telemedicine services for more than twenty years and
have established one of the nation's largest telecommunications networks for
processing electrocardiograms on a real time basis. Using our customized
electrocardiogram terminals, an electrocardiogram is acquired from a patient,
transmitted to our central computers, analyzed and received back on the
electrocardiogram terminal where the electrocardiogram trace and computer
interpretation are printed- all within three minutes. If necessary, we can
provide an "overread" by a cardiologist and return the results within an hour.
We bill for this service on a per-use basis, and we sell a full range of
electrocardiogram supplies including electrodes, recording paper, gel, and
patient cables.
Electrocardiogram analysis services are available to end-users 24 hours a day,
seven days a week. Our ECG laboratory is staffed or on-call at all times and has
been recently upgraded to provide additional features and faster turn around
time for "overreads" by replacing telephone requests with electronic
notification over the latest hand-held systems.
We currently provide electrocardiogram equipment and services to more than 500
government and corporate healthcare facilities, clinics, and hospitals
nationwide. Our customers include physicians, correctional healthcare
facilities, ambulatory surgery centers, clinics, rural hospitals, occupational
health facilities, and behavioral health facilities.
Electrocardiogram terminals are available for purchase, rental or lease, and
transmission fees are charged on a per-use basis. Customers who choose to
purchase an electrocardiogram terminal are charged either hardware maintenance
fees or repair fees for maintaining and repairing the equipment.
MARKETING - ELECTROCARDIOGRAM SERVICES
Our goal in fiscal 2006 was to capture 100% of the state correctional contracts
up for bid. We are pleased that we accomplished that goal by renewing our
contracts with the Nevada, Oklahoma, Iowa and Nebraska Departments of
Corrections and by working in conjunction with our correctional healthcare
partners to renew the state correctional contracts for Idaho, Maryland and
Wyoming The successful renewals for Wyoming, Idaho and Maryland were noteworthy,
since we participated with Correctional Medical Systems and Prison Health
Services in winning the overall healthcare award for the three state systems.
Our relationships with Correctional Medical Systems and Prison Health Services
were solidified during fiscal 2006, and we plan to continue working with these
firms to solicit new correctional business. During fiscal 2005 we installed more
than 150 new Schiller terminals in the New York and Florida State Departments of
Corrections. The New York contract called for the outright purchase of nearly
100 new Schiller terminals, which resulted in a short-term revenue increase that
helped boost fiscal 2005 ECG revenue by 27%. This was a one-time event.
We target our sales efforts for electrocardiogram products and services toward
physicians, correctional healthcare facilities, ambulatory surgery centers,
rural hospitals and occupational health facilities located throughout the U.S.
We maintain a long-standing customer base with contracts for services generally
extending between one to five years. New customers are generated mostly by our
direct sales efforts. We attend national medical conventions as needed to
generate leads for selling our services, equipment and supplies.
-6-
COMPETITION - ELECTROCARDIOGRAM SERVICES
Our primary competitors are the Laboratory Corporation of America, Biomedical
Systems, Inc. and Covance, Inc. These companies all offer electrocardiogram
terminals that provide electrocardiogram interpretation and data storage
services at a central location. We estimate that our centralized
electrocardiogram analyses constitute less than 1% of the total number of
electrocardiograms taken each year in the U.S.
The overall domestic electrocardiogram market is mature. However, we believe
that the demand for the centralized cardiology services that we provide may
increase due to the trend toward decentralized diagnostic testing with central
interpretation and data storage, especially in clinical drug trials, where the
federal government is likely to approve more automated procedures. Our
intentions are to expand our offering in this area and to investigate strategic
acquisitions that will roll up this highly fragmented market.
The principal methods under which we compete are service, ease-of-use, and
price. Our existing and potential competitors consist principally of companies
that have substantially greater financial, technical, marketing, distribution
and other resources, greater current market penetration and longer-standing
relationships with customers than us. We believe that our ability to compete
successfully depends on a number of factors, both within and outside of our
control, including the price, quality and performance our products and those of
our competitors. Other factors include the timing and success of our new product
introductions and our competitors, the development of technical innovations, the
number and nature of our competitors in a given market, and general market and
economic conditions. We may not be able to compete successfully in the future.
ASSEMBLY, REPAIR AND CUSTOMER SERVICE
We repair and maintain most of the electrocardiographs rented, leased or sold to
our customers. All repair and assembly operations are conducted at our
headquarters in Los Angeles. Our internal customer service staff handles
customer equipment and training problems, and our customer service department
handles initial installation and set-up, usually over the telephone.
GOVERNMENT REGULATION
The Centers for Medicare and Medicaid Services approve diagnostic tests for
reimbursement by Medicare. The OsteoGram(R) is approved for reimbursement by
Medicare as a centralized laboratory test and as a stand-alone system.
Government regulations may change at any time and Medicare reimbursement for the
OsteoGram(R) test, as well as for other bone mineral density tests, may be
withdrawn or reduced. Furthermore, other forms of testing for bone mineral
density as an indicator of osteoporosis have been or may be approved for
reimbursement, which may reduce our market share or profit margins for these
services.
Our OsteoGram(R) test and automated software have been cleared by FDA for use
and sale. In addition, the OsteoGram(R) is approved for use in China, Korea, and
a number of other countries, including the European Union through the award of a
CE Mark. The OsteoGram(R) software is subject to regulation as a medical device
and is ISO 13485 certified. Our electrocardiogram computer interpretation
services are also regulated by the FDA and are compliant.
ECG testing is FDA and Medicare approved.
PATENTS AND PROPRIETARY RIGHTS
The U.S. Patent and Trademark Office awarded us our first OsteoGram(R) patent in
June 2001 with a duration of 20 years. The patent covers twenty aspects of
method and apparatus for determining bone mineral density. In April 2004 we were
awarded a second patent with a duration of 20 years, which includes twenty-four
claims covering image processing and bone segmentation technology.
In July 2004, we filed final action on a provisional U.S. patent application for
our Digital Communications and Imaging in Medicine DICOM version of the
OsteoGram(R) product, which we believe will be a key patent in our field. We are
unaware of any other patent to utilize standard or digital x-ray equipment and a
DICOM image to evaluate bone mineral density and bone degenerative disease. In
September 2004, we filed final action on an additional provisional U.S. patent
application on a method to determine the percentage cortical versus trabecular
bone utilizing a DICOM image. This is important, since many clinicians are
turning their attention to bone microstructure for a more precise diagnosis and
prediction of fracture risk. Dual energy x-ray absorptiometry, or DXA
technology, which is considered the "Gold Standard" in bone mineral density
testing, is unable to distinguish between cortical and trabecular bone. We
believe that our ability to assess bone quality and other emerging parameters
will help us to compete effectively with DXA, as clinicians become more aware of
fracture risk assessment using parameters beyond bone mineral density.
In November 2005 we filed the final action on our patent application to protect
our intellectual property rights relating to the integration of the OsteoGram(R)
with mammography equipment. We believe a strong market exists for coupling
mammography and bone mineral density testing onto a single platform. Women often
do not get tested for osteoporosis, since the disease is silent in nature and
testing is inconvenient. Women do, however, get mammograms, so coupling the two
tests is a winning combination for patients, imaging centers and digital imaging
manufacturers.
The OsteoGram(R) trademark has been our registered trademark since July 2, 2002.
We filed and were awarded trademark protection for the OsteoClick, our remote,
pay-per-use system utilizing the OsteoGram(R) software positioned on a central
server.
EMPLOYEES
As of September 30, 2006, we had 15 full-time and 2 part-time employees, in
addition to our network of independent sales representatives and distributors.
None of our employees is represented by a labor union and we have experienced no
work stoppages. We consider our relations with our employees to be good. We also
retain consultants from time to time when necessary. Independent cardiologists
are retained for electrocardiogram "overreads" on a per-diem basis.
-7-
INSURANCE
We maintain liability insurance on our current products and are not aware of any
claims based on the use or failure of our products that are expected to have
material adverse effect on our operations or financial condition. Claims made in
the future with respect to our products may not be successfully defended or our
insurance may not be sufficient. Furthermore, liability insurance may not
continue to be available to us on acceptable terms.
ITEM 2. DESCRIPTION OF PROPERTY
Our corporate office, computer center and warehouse facilities are located in
9,496 square feet in an office building located at 5777 West Century Blvd., Los
Angeles, CA 90045. This facility is leased through August 2007 at a monthly
rental of $12,177. This is a full service lease that includes utilities,
maintenance and taxes on the property, janitorial and security service.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to stockholders during the fourth quarter of the
fiscal year ended September 30, 2006.
-8-
PART II
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ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is currently quoted on the over-the-counter bulletin board
under the symbol "CMPD.OB". Prior to December 1, 1999, our common stock was
listed on the NASDAQ National Market System. The following table sets forth the
range of high and low bid prices for our common stock during the periods
indicated. The prices set forth below represent inter-dealer prices, which do
not include retail mark-ups and markdowns, or any commission to the
broker-dealer, and may not necessarily represent actual transactions.
Year Ended September 30, 2006
Quarter Ended: COMMON STOCK
----------------------------- -----------------------
HIGH LOW
--------- ---------
December 31, 2005 $ 0.87 $ 0.35
March 31, 2006 0.89 0.50
June 30, 2006 0.76 0.43
September 30, 2006 0.51 0.27
Year Ended September 30, 2005
Quarter Ended: COMMON STOCK
----------------------------- -----------------------
HIGH LOW
--------- ---------
December 31, 2004 $ 0.43 $ 0.34
March 31, 2005 0.27 0.26
June 30, 2005 0.33 0.25
September 30, 2005 0.40 0.38
As of September 30, 2005, there were approximately 521 record holders of our
common stock, which does not include common stock held in "nominee" or "street"
name.
-9-
DIVIDENDS
We have not paid cash dividends on our common stock since our inception. At the
present time, we intend to follow a policy of retaining any earnings in order to
finance the development of our business and do not anticipate paying cash
dividends in the foreseeable future.
STOCK OPTION PLANS
2003 STOCK INCENTIVE PLAN
----------------------------
Options generally become exercisable at a rate of 33% of the shares subject to
an option one year after its grant. The remaining shares generally become
exercisable over an additional 24 months. The duration of options may not exceed
ten years. Options are generally non-assignable, except in the case of death and
may be exercised only while the optionee is employed by us or, in certain cases,
within three months after termination of employment or six months after death or
disability. The purchase price and number of shares of common stock that may be
purchased upon exercise of options are subject to adjustment in certain cases,
including stock splits, recapitalizations and reorganizations.
Both the amount of options granted and to whom they are granted, are determined
by the Board of Directors with the recommendation of the Compensation Committee,
at their discretion. There are no specific criteria, performance formulas or
measures applicable to the determination of the amount of options to be granted
and to whom these options are to be granted.
2006 STOCK INCENTIVE PLAN
----------------------------
There are 2,500,000 shares of common stock available for issuance under the 2006
Stock Incentive Plan. Options generally become exercisable at a rate of 33% of
the shares subject to an option one year after its grant. The remaining shares
generally become exercisable over an additional 24 months. The duration of the
options may not exceed ten years, and in the case of an incentive stock option
granted to a 10% stockholder, shall not exceed five years. Options are
generally non-assignable, except in the case of death and may be exercised only
while the optionee is employed by us or, in certain cases, within twelve months
after death or disability. The purchase price and number of shares of common
stock that may be purchased upon exercise of options are subject to adjustment
in certain cases including stock splits, recapitalizations and reorganizations.
Both the amount of options granted and to whom they are granted are determined
by the Board of Directors with the recommendation of the Compensation Committee,
at their discretion. There are no specific criteria, performance formulas or
measures applicable to the determination of the amount of options to be granted
and to whom these options are to be granted.
-10-
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion and analysis compares our results of operations for the
year ended September 30, 2006 to the same period in 2005. This discussion and
analysis should be read in conjunction with the consolidated financial
statements and notes thereto.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This Report on Form 10-KSB 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.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED SEPTEMBER 30, 2006 AS COMPARED TO 2005
Total revenues for fiscal 2006 were $2,114,000 as compared to $2,284,000 in
fiscal 2005, a decrease of 7%. The decrease was mainly due to a one-time sale of
ECG terminals to the New York State Department of Corrections in fiscal 2005,
partially offset by increased OsteoGram sales.
ECG services revenue, consists of ECG processing, equipment rental, overread and
maintenance, during fiscal 2006, decreased by 3% to $1,669,000 from $1,726,000
due to three fewer correctional healthcare providers.
ECG product and supplies sales decreased by 59% in fiscal 2006 to $180,000 from
$440,000 due to the above mentioned one-time sale of ECG terminals to the New
York State Department of Corrections.
-11-
OsteoGram (R) revenues increased by 125% to $265,000 from $118,000 due to
orders from our original equipment manufacturer, or OEM, licensing partners.
In proportion with the decrease of ECG services referenced above, cost of ECG
services decreased by 9%, $548,000 in fiscal 2006 compared to $602,000 fiscal
2005, and cost of goods sold of ECG decreased by 61%, $128,000 in fiscal 2006
compared to $327,000 fiscal 2005.
Cost of goods sold for OsteoGram (R) decreased by 13% during fiscal 2006 to
$7,000 from $8,000 for fiscal 2005 due to elimination of hardware sales.
Selling expenses increased by 18% for fiscal 2006 to $369,000 from $313,000 for
fiscal 2005 due to the hiring of the Vice President of Sales.
General and administrative expenses in fiscal 2006 increased by 8% to $1,104,000
from $1,024,000 from fiscal 2005, due to increased in costs related to the
investor relations, $152,000 compared to $66,000 in fiscal 2005, and consulting
services, $38,000 compared to $17,000 in fiscal 2005.
Research and development costs increased for fiscal 2006 increased by 16% to
$340,000 from $293,000 for fiscal 2005 due to the hiring of the Vice President
of Engineering.
Interest income and dividends for fiscal 2006 increased by 206% to $49,000 from
$16,000 in fiscal 2005 due to increased investments in marketable securities.
The net loss for fiscal year 2006 increased by 26% to $424,000 from $336,000 in
fiscal 2005 due to lower equipment sales in the ECG business and increased
research and development and sales expenses.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2006, we had approximately $578,000 in cash and marketable
securities, as compared to a balance of $571,000 at September 30, 2005, a net
increase of $7,000 or 1%.
During fiscal year 2006, purchases of property and equipment decreased to
$41,000 from $176,000 for fiscal 2005, due to new acquired and renewed contracts
with several Departments of Corrections in fiscal 2005.
We have historically used existing cash and readily marketable securities
balances to fund operating losses and capital expenditures. We have raised these
funds in 1997 through 2006 through the placement of Preferred Stock issuances
and proceeds from the exercise of certain stock options and warrants. Currently,
we raise funds through the Investment Agreement with Dutchess Private Equities
Fund and during 2006 we raised $252,000 through the sale of 375,000 shares of
common stock.
We have incurred recurring losses and had net losses aggregating $760,000 in
fiscal years ended September 30, 2006 and 2005. However, we anticipate that our
cash flow from operations, available cash and marketable securities will be
sufficient to meet our anticipated financial needs for at least the next 12
months. We may need to raise additional capital in the future, which might not
be available on reasonable terms or at all. Failure to raise capital when needed
could adversely impact our business, operating results and liquidity. If
additional funds were raised through the issuance of equity securities, the
percentage of ownership of existing stockholders would be reduced. Furthermore,
these equity securities might have rights, preferences or privileges senior to
our common stock. Our common stock is currently quoted on the over-the-counter
bulletin board, which will make it more difficult to raise funds through the
issuance of equity securities. These additional sources of financing may not be
available on acceptable terms, if at all.
Our primary capital resource commitments at September 30, 2006 consist of
capital and operating lease commitments, primarily for computer equipment,
electrocardiogram terminals and for our corporate office facility. We lease our
corporate offices at a monthly rental of $12,176 which expires August 31, 2007.
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. These
investments would be subject to our obtaining financing through issuance of debt
or other securities. An acquisition may be dilutive to stockholders.
FINANCING ACTIVITIES
On February 25, 2004, we entered into an Investment Agreement and a Registration
Rights Agreement with Dutchess Private Equities Fund, L.P., pursuant to which
Dutchess agreed to purchase up to $5,000,000 of shares of our common stock over
a three-year period. The purchase price of the shares of our common stock equals
95% of the three lowest closing best bid prices of our common stock during the 5
days after we deliver a put notice to them. As of September 30, 2006, we have
sold 3,674,623 shares and raised $973,000.
-12-
MATERIAL TRENDS AND UNCERTAINITIES
We are disappointed by the rate of progress in commercializing the Digital
Communications and Imaging in Medicine (DICOM) OsteoGram (R). In order to
accelerate the efforts of our OEM partners, in October 2006, we hired a new
sales director whose prime directive will be to manage these relationships and
stimulate growth.
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 and deferred tax valuation allowance. 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 uncollectibility 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 (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
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.
ECG sales and services revenue is recognized in accordance with SAB 104 as the
following criteria have been met: (1) persuasive evidence of an arrangement
exists, (2) the product has been delivered or the services have been rendered,
(3) the fee is fixed or determinable, and (4) collectibility of the fee is
reasonably assured.
ECG SERVICES are comprised of ECG processing, Overread, Rental and Maintenance.
ECG Processing and Overread revenue is recognized monthly on a per-usage basis
after the services are performed. Equipment rental and maintenance revenue is
recognized monthly over the terms of the customer's agreement.
ECG PRODUCT AND SUPPLIES SALES revenue is recognized upon shipment of the
products and passage of title to the customer.
OsteoGram software revenue is recognized in accordance to paragraph 8 of SOP
97-2 as the following criteria have been met: (1) persuasive evidence of an
arrangement exits, (2) the software has been delivered, (3) the fee is fixed or
determinable, and (4) collectibility of the fee is probable.
OsteoGram PCS revenue is recognized in accordance to paragraph 59 of SOP 97-2 as
we met the following criteria: (1) the PCS is part of the initial license
(software) fee, (2) the PCS period is for one year, (3) the estimated cost of
providing the PCS is immaterial, (4) we do not offer upgrades and enhancements
during the PCS arrangement. Our policy is to accrue all estimated costs of
providing the PCS services.
Income taxes are accounted for under the asset and liability method. Under this
method, to the extent that we believe that the deferred tax asset is not likely
to be recovered, a valuation allowance is provided. In making this
determination, we consider estimated future taxable income and taxable timing
differences expected to reverse in the future. Actual results may differ from
those estimates.
-13-
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the SEC released Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" (SAB 108). SAB 108 provides
interpretive guidance on the SEC's views regarding the process of quantifying
materiality of financial statement misstatements. SAB 108 is effective for
fiscal years ending after November 15, 2006. The adoption of this accounting
pronouncement is not expected to have a material effect on our financial
statements.
In September 2006, the FASB issued FAS 157 (SFAS 157), Fair Value Measurements.
This standard defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles, and expands disclosures about
fair value measurements. This statement is effective for financial statements
issued for fiscal years beginning after November 15, 2007. Earlier application
is encouraged. The adoption of this accounting pronouncement is not expected to
have a material effect on our financial statements.
In March 2006, the FASB issued FAS 156 (SFAS No. 156), Accounting for Servicing
of financial Assets - an amendment of FASB Statement No. 140. This standard
clarifies when to separately account for servicing rights, requires servicing
rights to be separately recognized initially at fair value, and provides the
option of subsequently accounting for servicing rights at either fair value or
under the amortization method. The standard is effective for fiscal years
beginning after September 15, 2006 but can be adopted early as long as financial
statements for the fiscal year in which early adoption is elected, including
interim statements, have not yet been issued. The adoption of this accounting
pronouncement is not expected to have a material effect on our financial
statements.
In February 2006, the FASB issued FAS 155 (SFAS No. 155), Accounting for Certain
Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140.
This statement permits fair value remeasurement for any hybrid financial
instrument that contains an embedded derivative that would otherwise have to be
accounted for separately. The new statement also requires companies to identify
interests in securitized financial assets that are freestanding derivatives or
contain embedded derivatives that would have to be accounted for separately,
clarifies which interest-and principal-only strips are subject to Statement 133,
and amend Statement 140 to revise the conditions of a qualifying special purpose
entity due to the new requirement to identify whether interests in securitized
financial assets are freestanding derivatives or contain embedded derivates.
This statement is effective for all financial instruments acquired or issued
after the beginning of an entity's first fiscal year that begins after September
15, 2006, but can be adopted early as long as financial statements for the
fiscal year in which early adoption is elected, including interim statements,
have not yet been issued. The adoption of this accounting pronouncement is not
expected to have a material effect on our financial statements.
In March 2005, the FASB issued Interpretation No. 47 (FIN No. 47), Accounting
for Conditional Asset Retirement Obligations, and Interpretation of FASB
Statement No. 143. This interpretation clarifies the timing for recording
certain asset retirement obligations required by FASB Statement No. 143,
Accounting for Asset Retirement Obligations. The provisions of FIN No. 47 are
effective for years ending after December 15, 2005. The adoption of this
accounting pronouncement did not have a material effect on our financial
statements.
-14-
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections - a replacement of Accounting Principles Board Opinion ("APB")
Opinion No. 20 and FASB Statement No. 3. This statement applies to all voluntary
changes in accounting principle and changes required by an accounting
pronouncement where no specific transition provisions are included. SFAS 154
requires retrospective application to prior periods' financial statements of
changes in accounting principle, unless it is impracticable to determine either
the period-specific effects or the cumulative effect of the change.
Retrospective application is limited to the direct effects of the change; the
indirect effects should be recognized in the period of the change. This
statement carries forward without change the guidance contained in APB Opinion
No. 20 for reporting the correction of an error in previously issued financial
statements and a change in accounting estimate. However, SFAS 154 redefines
restatement as the revising of previously issued financial statements to reflect
the correction of an error. The provisions of SFAS 154 are effective for
accounting changes and corrections of errors made in fiscal periods that begin
after December 15, 2005, although early adoption is permitted. The adoption of
this accounting pronouncement did not have a material effect on our financial
statements.
In December 2004, the FASB issued SFAS No. 123R (revised 2004), "Share-Based
Payment." SFAS No. 123R addresses the accounting for share-based payment
transactions in which a company receives employee services in exchange for
either equity instruments of the company or liabilities that are based on the
fair value of the company's equity instruments or that may be settled by the
issuance of such equity instruments. SFAS No. 123R eliminates the ability to
account for share-based compensation transactions using the intrinsic method
that is currently used and requires that such transactions be accounted for
using a fair value-based method and recognized as expense in the consolidated
statement of operations. The effective date of SFAS No. 123R is for our year
beginning October 1, 2006. The impact of adoption of SFAS No. 123R cannot be
predicted at this time because it will depend on levels of share-based payments
granted in the future.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29." SFAS No. 153 is based on the
principle that exchanges of nonmonetary assets should be measured based on the
fair value of the assets exchanged. APB Opinion No. 29, "Accounting for
Nonmonetary Transactions," provided an exception to its basic measurement
principle (fair value) for exchanges of similar productive assets. Under APB
Opinion No. 29, an exchange of a productive asset for a similar productive asset
was based on the recorded amount of the asset relinquished. SFAS No. 153
eliminates this exception and replaces it with an exception of exchanges of
nonmonetary assets that do not have commercial substance. The provisions of this
Statement are effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. The adoption of this accounting
pronouncement did not have a material effect on our financial statements.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an amendment
of Accounting Research Bulletin No. 43, Chapter 4." SFAS No. 151 requires that
abnormal amounts of idle facility expense, freight, handling costs and wasted
materials (spoilage) be recorded as current period charges and that the
allocation of fixed production overhead to inventory be based on the normal
capacity of the production facilities. SFAS No. 151 was effective for the fiscal
year beginning on October 1, 2005. The adoption of this accounting pronouncement
did not have a material effect on our financial statements.
-15-
ITEM 7. FINANCIAL STATEMENTS
The financial statements are included as a separate section following the
signature page to this Form 10-KSB.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 8A. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
Our management evaluated, with the participation of our Chief Executive Officer
and our Principal Financial Officer, the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this Annual
Report on Form 10-KSB. Based on this evaluation, our Chief Executive Officer and
our Principal Financial Officer have 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 our 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.
CHANGE IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no changes in our internal control over financial reporting that
occurred during our last fiscal year that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting. However, as discussed above we are committed to a process of change
and improvement throughout the enterprise intended to optimize our operations,
and this process will necessarily entail improvements to our financial controls
over the coming year.
OTHER INFORMATION
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,
together the "Acquiring Person" other than us, our subsidiary or any employee
benefit plan or employee stock plan, together an "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 with 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.
The terms and conditions of the Rights are contained in a Rights Agreement
between U.S. Stock Transfer Corporation and us. A copy of the Rights Agreement
was filed with the Securities and Exchange Commission as an Exhibit to a
Registration Statement on Form 8-A on November 2, 2005. This summary description
of the Rights does not purport to be complete and is qualified in its entirety
by reference to the Rights Agreement, as amended from time to time, which is
incorporated in this summary description by reference.
In July 2006, the FASB issued Interpretation No. 48 (FIN No. 48), Accounting for
Uncertainty in Income Taxes. This interpretation requires recognition and
measurement of uncertain income tax positions using a "more-likely-than-not"
approach. The provisions of FIN 48 are effective for fiscal years beginning
after December 15, 2006. The adoption of this accounting pronouncement is not
expected to have a material effect on our financial statements.
-16-
PART III
--------
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information concerning our directors and
executive officers as of September 30, 2006:
YEAR
BECAME
NAME POSITION WITH COMPANY DIRECTOR AGE
------------------------- ------------------------ -------- ---
Robert Stuckelman . . . . Chairman of the Board 1973 74
John G. McLaughlin. . . . President and
Chief Executive Officer 58
John Minnick. . . . . . . Director 1985 58
John Romm, M.D. . . . . . Director 1997 76
Stuart L. Silverman, M.D. Director 1999 59
Phuong Dang . . . . . . . Principal Financial Officer
and Secretary 50
The terms of the Board of Directors will expire at the next annual meeting of
stockholders. Our officers are elected by the Board of Directors and hold office
at the will of the Board.
BACKGROUND EXPERIENCE OF DIRECTORS AND OFFICERS
Mr. Stuckelman founded our company in 1973 and served as our President until
1982. From 1982 through 1989, Mr. Stuckelman was a business consultant for small
and medium size companies. In 1989, he rejoined us as President and Chief
Executive Officer, in which capacities he served until October 1994. Mr.
Stuckelman has been our director since our incorporation. He became Chairman of
the Board in April 2002. From 1994 to present, he has been President of
Technical Management Consultants, which provides business consulting services to
many companies. He holds an M.S.E.E. from the University of Southern California
and a B.E.E. from Cornell University.
Mr. McLaughlin joined us in May 2002 as President and Chief Executive Officer.
He has thirty years of experience in the medical products arena, most recently
as President of the Great Circle Consulting Group, Inc. from May 1998 through
May 2002. There he provided strategic and operational guidance to domestic and
international firms in the medical device, diagnostic and biotech markets. Mr.
McLaughlin's prior experience includes five years as an officer and Vice
President of Marketing and Sales at Diagnostic Products Corporation (NYSE:DP), a
global leader in the design, manufacture and marketing of clinical laboratory
instrumentation. He served in that capacity from February 1993 to February 1998.
Prior to that, Mr. McLaughlin was the President of Biometric Imaging, which was
subsequently acquired by Becton Dickinson in 1999. He holds a B.S. in Pharmacy
from the State University of New York at Buffalo.
Mr. Minnick has been the President of Minnick Capital Management, an investment
management firm from 1972 to present. Mr. Minnick is a member of the Kansas and
Federal Bars. He is a member of the Association for Investment Management and
Research. Mr. Minnick is a graduate of Washburn University (B.A.) and the
Washburn University School of Law (J.D.).
Dr. Romm has practiced internal medicine and gastroenterology in private
practice from 1962 to present. He earned his M.D. at Wayne State College of
Medicine and also holds a B.S. in biology. He is an associate professor of
medicine at the University of California, Los Angeles and is an attending
physician at Cedars-Sinai Medical Center.
Dr. Silverman has been the Medical Director of the Osteoporosis Medical Center
in Beverly Hills, CA, from 1986 to present. The Osteoporosis Medical Center is a
nationally recognized clinical research center for osteoporosis and is also a
Clinical Professor of Medicine at the UCLA School of Medicine. Dr. Silverman is
a graduate of the Johns Hopkins University Medical School (1973) and earned his
undergraduate degree from Princeton University (1969) Cum Laude in biology. He
is an internationally recognized authority on osteoporosis and related fields
and has been principal investigator for six research grants in the field of
osteoporosis and has authored numerous published articles in the field.
Ms. Dang has a degree in Accounting and been employed by us since 1990. She has
served as Controller, Secretary and Principal Financial Officer since 1997. Ms.
Dang has 26 years of corporate accounting and finance experience in the
healthcare field, mail order and retail stores . Prior to joining to us, she
served as Accounting Manager for the Maxicare Medical Center from 1984 to 1990.
From 1978 to 1984, she served as Bookkeeper and Senior Staff Accountant for
Sunset House/ Gadget Tree a division of Carter Hawley Hale.
BOARD MEETINGS AND COMMITTEES
Our Board of Directors held a total of twelve meetings during the fiscal year
ended September 30, 2006. All of our Directors attended each meeting.
AUDIT COMMITTEE
The Audit Committee is primarily responsible for approving the services
performed by our independent auditors and reviewing reports of our external
auditors regarding our accounting practices and systems of internal accounting
controls. This Committee currently consists of Mr. Stuckelman and Dr. Romm. The
Audit Committee met five times during the fiscal year ended September 30, 2006.
Mr. Stuckelman has been approved by our Board of Directors as the independent
Audit Committee Financial Expert.
-17-
COMPENSATION COMMITTEE
The Compensation Committee reviews and approves our compensation policy and has
assumed responsibility for administration of our Stock Option Plans. This
Committee currently consists of Mr. Minnick and Dr. Silverman. The Compensation
Committee met two times during the fiscal year ended September 30, 2006.
EXECUTIVE COMMITTEE
The Executive Committee is comprised of Dr. Silverman and Mr. Stuckelman and
meets monthly with the Chief Executive Officer to review company strategy and
our financial condition. The Executive Committee met eleven times during the
fiscal year ended September 30, 2006.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Section 16(a) of the Exchange Act, as amended, requires our executive officers,
directors and persons who beneficially own more than 10% of our common stock to
file reports of their beneficial ownership and changes in ownership (Forms 3, 4
and 5, and any amendment thereto) with the SEC. Executive officers, directors,
and greater-than-ten percent holders are required to furnish us with copies of
all Section 16(a) forms they file. Based on our review of the activity of our
officers and directors for the fiscal year ended September 30, 2006, we believe
Forms 3, 4 or 5 were timely filed.
CODE OF ETHICS
We have adopted a Code of Ethics that applies to our principal executive officer
and controller. A copy of the Code of Ethics is available on our website at
http://www.compumed.net/info/index.html. We intend to disclose any amendment or
waiver to the Code of Ethics on our website at
http://www.compumed.net/info/index.html. We will provide to any person without
charge, upon written request to our above address, a copy of such code of
ethics.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth the compensation for the fiscal years ended
September 30, 2006, 2005 and 2004 for our chief executive officer and all
executive officers whose compensation exceeded $100,000.00 for such fiscal year.
Long Term
Compensation
Annual Awards Payouts
Compensation
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Name and Principal . Year Salary Bonus Other Annual Restricted Securities LTIP All Other
Position ($) ($) Compensation ($) Stock Underlying Payouts Compensation ($)
Award(s)($) Options/SARs(#) ($)
John G. McLaughlin, 2006 $ 174,000 - - - 210,000 - -
President and CEO
2005 $ 150,000 - - - 45,000 - -
2004 $ 150,000 7,200 - - 245,000 - -
Phuong Dang 2006 $ 104,000 - - - 170,000 - -
Principal Financial
Officer and Secretary
STOCK OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth the stock options granted to our executive
officer named during the fiscal year ended September 30, 2006.
-18-
INDIVIDUAL GRANTS
------------------------
NUMBER OF SECURITIES % OF TOTAL OPTIONS
(SHARES OF COMMON STOCK) GRANTED TO EXERCISE
UNDERLYING OPTIONS EMPLOYEES/DIRECTORS PRICE EXPIRATION
NAME GRANTED(1) IN FISCAL ($/SHARE) DATE
------------------ ------------------------ -------------------- --------- ----------
John G. McLaughlin 60,000 19% $ 0.64 2015
150,000 24% $ 0.39 2016
Phuong Dang 45,000 15% $ 0.64 2015
125,000 20% $ 0.39 2016
------------------ ------------------------ -------------------- --------- ----------
(1) The options are vested over a three-year period.
EXERCISE OF STOCK OPTIONS AND YEAR-END OPTION VALUES
During fiscal year ended September 30, 2006, the Board of Directors exercised
379,000 shares of options. The proceeds were $66,000.
The following table sets forth certain information regarding options of the
named executive officer outstanding as of September 30, 2006.
YEAR-END OPTION VALUES
---------------------------------------------------------
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS/WARRANTS AT OPTIONS/WARRANTS AT
SEPTEMBER 30, 2006 SEPTEMBER 30, 2006 (1)
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---------------------- ------------------ ------------------ ------------ -------------
John G. McLaughlin 712,558 321,667 142,224 13,567
Phuong Dang 110,283 205,000 8,550 700
---------------------- ------------------ ------------------ ------------ -------------
(1) Based on a fair market value of $ 0.35 per share, the closing
price per share of our common stock on September 30, 2006.
COMPENSATION OF DIRECTORS
Each of the 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 an additional $1,000 per meeting when they serve as a member
of the Executive, Audit or Compensation Committee. This amount is reduced to
$350 if the committee meeting is held by teleconference or on the same day as a
board meeting.
EMPLOYMENT AGREEMENT
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.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table sets forth information as of September 30, 2006 regarding
shares of our common stock subject to outstanding options or authorized for
issuance under our currently existing equity compensation plan.
-19-
NUMBER OF
SECURITIES
REMAINING AND
AVAILABLE FOR
NUMBER OF FUTURE ISSUANCE
SECURITIES TO BE UNDER EQUITY
ISSUED UPON WEIGHTED AVERAGE COMPENSATION
EXERCISE OF EXERCISE PRICE OF PLANS (EXCLUDING
OUTSTANDING OUTSTANDING SECURITIES
OPTIONS, WARRANTS OPTIONS, WARRANTS REFLECTED IN
AND RIGHTS AND RIGHTS COLUMN (A))
(A) (B) (C)
------------------ ------------------ -----------------
Equity compensation plans approved by security holders . . 1,731,215 0.44 -0-
Equity compensation plans not approved by security holders 5,023,613 0.25 1,933,810
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . 6,754,828 0.30 1,933,810
NARRATIVE DESCRIPTION OF THE 2003 STOCK INCENTIVE PLAN
Options generally become exercisable at a rate of 33% of the shares subject to
an option one year after its grant. The remaining shares generally become
exercisable over an additional 24 months. The duration of options may not exceed
ten years. Options are generally non-assignable, except in the case of death and
may be exercised only while the optionee is employed by us or, in certain cases,
within three months after termination of employment or six months after death or
disability. The purchase price and number of shares of common stock that may be
purchased upon exercise of options are subject to adjustment in certain cases,
including stock splits, recapitalizations and reorganizations.
Both the amount of options granted and to whom they are granted, are determined
by the Board of Directors with the recommendation of the Compensation Committee,
at their discretion. There are no specific criteria, performance formulas or
measures applicable to the determination of the amount of options to be granted
and to whom these options are to be granted.
NARRATIVE DESCRIPTION OF THE 2006 STOCK INCENTIVE PLAN
There are 2,500,000 shares of common stock available for issuance under the 2006
Stock Incentive Plan. Options generally become exercisable at a rate of 33% of
the shares subject to an option one year after its grant. The remaining shares
generally become exercisable over an additional 24 months. The duration of the
options may not exceed ten years, and in the case of an incentive stock option
granted to a 10% stockholder, shall not exceed five years. Options are
generally non-assignable, except in the case of death and may be exercised only
while the optionee is employed by us or, in certain cases, within twelve months
after death or disability. The purchase price and number of shares of common
stock that may be purchased upon exercise of options are subject to adjustment
in certain cases including stock splits, recapitalizations and reorganizations.
Both the amount of options granted and to whom they are granted are determined
by the Board of Directors with the recommendation of the Compensation Committee,
at their discretion. There are no specific criteria, performance formulas or
measures applicable to the determination of the amount of options to be granted
and to whom these options are to be granted.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table sets forth, to our knowledge, certain information concerning
the beneficial ownership of the our common stock as of November 30, 2006 by: (a)
each director of the Company; (b) the executive officer named in the Executive
Compensation Table; (c) our directors and executive officer as a group; and (d)
each person known to us who beneficially owns 5% or more of our common stock.
-20-
NAME AND ADDRESS* OF
BENEFICIAL OWNER AMOUNT AND NATURE
BENEFICIAL OWNERSHIP(1) PERCENT OF CLASS (2)
----------------------- -----------------
John G. McLaughlin. . . . . . . . . . . . . . . . 762,558 (3) 3%
Phuong Dang . . . . . . . . . . . . . . . . . . . 136,950 (4) **
John Minnick. . . . . . . . . . . . . . . . . . . 1,011,856 (5) 4%
John Romm, M.D. . . . . . . . . . . . . . . . . . 846,967 (6) 3%
Stuart L. Silverman, M.D. . . . . . . . . . . . . 1,131,720 (7) 5%
Robert Stuckelman . . . . . . . . . . . . . . . . 1,441,592 (8) 6%
All officers and Directors as a group (6 persons) 5,331,643 (9) 21%
Except as otherwise indicated, each person named in the table has sole voting
and investment
power (or such power together with any spouse of such person, if they are
joint tenants), with
respect to securities beneficially owned by such person as set forth opposite
such person's name.
(1) Includes options exercisable as of or within 60 days following
November 30, 2006.
(2) The number of shares of common stock issued and outstanding on
November 30, 2006 was 24,259,879 shares.
The calculation of percentage ownership for each listed beneficial
owner is based upon the number of
shares of common stock issued and outstanding on November 30, 2006.
(3) Includes 762,558 shares subject to stock options.
(4) Includes 136,950 shares subject to stock options.
(5) Includes 635,333 shares subject to stock options.
(6) Includes 585,799 shares subject to stock options.
(7) Includes 881,105 shares subject to stock options.
(8) Includes 920,264 shares subject to stock options.
(9) See notes (3) through (7)
(*) c/o CompuMed, Inc, 5777 West Century Blvd, Suite 1285, Los
Angeles, CA 90045
(**) Less than 1%
-21-
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We retained the services of an investment advisor, who is also a member of the
Board of Directors, to provide advice on the investment portfolio. During the
fiscal years ended September 30, 2006 and 2005, we incurred $3,000 and $2,000
for these services, respectively.
ITEM 13. EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
3.1 Certificate of Incorporation (included 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 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 (included as Exhibit
3.2 to the Form 8-K filed January 9, 1998 and incorporated herein by
reference).
4.5 Rights Agreement between the Company and U.S. Stock Transfer Corporation
dated October 28, 2005 (included as Exhibit 4.1 to the Form 8-A filed
November 2, 2005 and incorporated herein by reference).
-22-
4.6 Form of Class A Common Stock Purchase Warrant between the Company and
Synthetica (America) Ltd., dated June 27, 2006 (included as Exhibit 4.1 to
the Form 10-QSB filed August 14, 2006 and incorporated herein by
reference).
10.1 Form of Non-Qualified Stock Option Agreement (included as Exhibit 10 to the
Form S-8 filed October 14, 1995 and incorporated herein by reference).
10.2 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).
10.3 Form of Stock Option Agreement (included as Exhibit 10.5 to the Form 10-QSB
filed August 14, 2002 and incorporated herein by reference).
10.4 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).
10.5 2003 Stock Incentive Plan (included as Exhibit 99.2 to the Form S-8 filed
June 2, 2003 and incorporated herein by reference).
10.6 Investment Agreement between the Company and Dutchess Private Equities
Fund, LP, 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 Registration Rights Agreement between the Company and Dutchess Private
Equities Fund, LP, dated February 25, 2004 (included as Exhibit 10.10 to
the Form SB-2 filed February 27, 2004 and incorporated herein by
reference).
10.8 Placement Agent Agreement between the Company, Charleston Capital
Corporation and Dutchess Private Equities Fund, LP, dated February 25, 2004
(included as Exhibit 10.11 to the Form SB-2 filed February 27, 2004 and
incorporated herein by reference).
10.9 Amendment to Commercial Office Lease between the Company and L.A.T.
Investment Corporation, dated July 13, 2004 (included as Exhibit 10.6 to
the Form 10-KSB filed December 29, 2004 and incorporated herein by
reference).
10.10 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).
10.11 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).
10.12 Amendment to Commercial Office Lease between the Company and L.A.T.
Investment Corporation, dated August 12, 2005 (included as Exhibit 10.6 to
the Form 10-KSB filed December 27, 2005 and incorporated herein by
reference).
10.13 2006 Stock Incentive Plan (included as Exhibit 10.1 to the Form S-8 filed
August 23, 2006 and incorporated herein by reference).
10.14 Third Amendment to Commercial Office Lease between the Company and L.A.T.
Investment Corporation, dated August 10, 2006 (filed herewith).
21.1 Subsidiaries (filed herewith).
23.1 Consent of Independent Registered Public Accounting Firm (filed herewith).
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.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees. The aggregate fees billed for professional services rendered by our
principal accountants for the audit of our annual financial statements and
review of our quarterly financial statements were $54,000 and $49,000 for fiscal
years 2006 and 2005, respectively.
Audit-Related Fees. None.
Tax Fees. The aggregate fees billed to us for professional services rendered by
our principal accountants for tax related services were $5,000 each for fiscal
years 2005 and 2004.
All Other Fees. None
-23-
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
COMPUMED, INC.
By: /s/ John G. McLaughlin
----------------------------
John G. McLaughlin, President and Chief Executive Officer
Date: December 29, 2006
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
SIGNATURE TITLE DATE
---------------------- -------------------------- -------------
President, Chief Executive
Officer (principal
/s/ John G. McLaughlin executive officer) December 29, 2006
---------------------- -----------------
John G. McLaughlin
Secretary and Controller
(principal financial
/s/ Phuong Dang officer) December 29, 2006
---------------------- -----------------
Phuong Dang
/s/ Robert Stuckelman Chairman of the Board December 29, 2006
---------------------- -----------------
Robert Stuckelman
/s/ John D. Minnick Director December 29, 2006
---------------------- -----------------
John D. Minnick
/s/ John Romm Director December 29, 2005
---------------------- -----------------
John Romm
/s/ Stuart Silverman Director December 29, 2006
---------------------- -----------------
Stuart Silverman
-24-
COMPUMED, INC.
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Balance Sheet as of September 30, 2006
Statements of Operations for the years ended September 30, 2006 and 2005
Statements of Stockholders' Equity for the years ended September 30, 2006 and
2005
Statements of Cash Flows for the years ended September 30, 2006 and 2005
NOTES TO FINANCIAL STATEMENTS
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
CompuMed, Inc.
Los Angeles, California
We have audited the accompanying balance sheet of CompuMed, Inc. as of September
30, 2006, and the related statements of operations, stockholders' equity, and
cash flows for the years ended September 30, 2006 and 2005. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards established by the
Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audits to obtain reasonable assurance about
whether the financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion. An audit
also includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of CompuMed, Inc. as of September
30, 2006, and the results of its operations and its cash flows for the years
ended September 30, 2006 and 2005, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Rose, Snyder & Jacobs
-----------------------------
Rose, Snyder & Jacobs
A Corporation of Certified Public Accountants
Encino, California
November 21, 2006
F-2
COMPUMED, INC.
BALANCE SHEET
September 30,
2006
ASSETS
CURRENT ASSETS
Cash and cash equivalents 193,000
Marketable securities, at fair market value 385,000
Accounts receivable, less allowance of $26,000 246,000
Other receivables 7,000
Inventory 22,000
Prepaid expenses and other current assets 16,000
TOTAL CURRENT ASSETS 869,000
PROPERTY AND EQUIPMENT
Machinery and equipment 1,189,000
Furniture, fixtures and leasehold improvements 76,000
Equipment under capital leases 221,000
1,486,000
Accumulated depreciation and amortization (1,278,000)
TOTAL PROPERTY AND EQUIPMENT 208,000
OTHER ASSETS
Patents, net of accumulated amortization of $7,000 114,000
Other assets 13,000
TOTAL OTHER ASSETS 127,000
TOTAL ASSETS 1,204,000
LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES
Accounts payable 64,000
Accrued liabilities 151,000
Current portion of capital lease obligations 45,000
TOTAL CURRENT LIABILITIES 260,000
Capital lease obligations, less current portion 116,000
Commitments and Contingencies, Note E
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
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 - 24,171,479 shares (September 2006) 243,000
Additional paid in capital 33,618,000
Accumulated deficit (33,013,000)
Accumulated other comprehensive income 2,000
Deferred stock compensation (23,000)
TOTAL STOCKHOLDERS' EQUITY 828,000
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 1,204,000
F-3
STATEMENTS OF OPERATIONS
COMPUMED, INC.
Year Ended September 30,
2006 2005
REVENUE FROM OPERATIONS
ECG services 1,669,000 1,726,000
ECG product and supplies sales 180,000 440,000
OsteoGram (R) sales and services 265,000 118,000
2,114,000 2,284,000
COSTS AND EXPENSES
Costs of ECG services 548,000 602,000
Cost of goods sold-ECG 128,000 327,000
Cost of goods sold - OsteoGram (R) 7,000 8,000
Selling expenses 369,000 313,000
Research & development 340,000 293,000
General and administrative expenses 1,104,000 1,024,000
Depreciation and amortization 71,000 81,000
2,567,000 2,648,000
OPERATING LOSS (453,000) (364,000)
Interest Income and dividends 49,000 16,000
Other miscellaneous income - 7,000
Realized gain on marketable securities - 19,000
Interest expense (20,000) (14,000)
NET LOSS (424,000) (336,000)
NET LOSS PER SHARE (Basic and diluted) (0.02) (0.02)
Weighted average number of common
shares outstanding 23,702,613 20,963,081
F-4
ADDITIONAL OTHER
PREFERRED COMMON PAID IN ACCUMULATED CONPREHENSIVE DEFERRED STOCK
STOCK STOCK CAPITAL DEFICIT INCOME COMPENSATION TOTAL
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balances at
September 30, 2004 1,000 197,000 32,520,000 (32,253,000) 53,000 - 518,000
Unrealized loss
on marketable securities (36,000) (36,000)
Stock options issued
for services 8,000 (8,000) -
Amortization of 2,000 2,000
deferred compensation
Issuance of common
stock to Dutchess 23,000 538,000 561,000
Exercise of options 10,000 88,000 98,000
Net Loss - - - (336,000) - - (336,000)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balances at
September 30, 2005 1,000 230,000 33,154,000 (32,589,000) 17,000 (6,000) 807,000
Unrealized loss
on marketable securities (15,000) (15,000)
Stock options issued
for services 1,000 62,000 (24,000) 39,000
Amortization of
deferred compensation 7,000 7,000
Issuance of common
stock to Dutchess 4,000 248,000 252,000
Exercise of options 8,000 154,000 162,000
Net Loss - - - (424,000) - - (424,000)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balances at
September 30, 2006 1,000 243,000 33,618,000 (33,013,000) 2,000 (23,000) 828,000
============ ============ ============ ============ ============ ============ ============
Comprehensive losses for the years ended September 30, 2006 and 2005 were ($439,000) and ($372,000), respectively.
F-5
COMPUMED, INC.
STATEMENTS OF CASH FLOWS
Twelve Months Ended September 30,
2006 2005
-------------- --------------
OPERATING ACTIVITIES:
Net loss (424,000) (336,000)
Net adjustments to reconcile net loss to net cash used in operating activities:
Loss on disposal of fixed asset 2,000 -
Realized gain on marketable securities - (19,000)
Amortization of deferred stock compensation 7,000 2,000
Depreciation and amortization 71,000 81,000
Decrease/(Increase) in accounts receivable 70,000 (26,000)
Decrease/(Increase) in inventory and prepaid expenses 11,000 20,000
Decrease in accounts payable and other liabilities (51,000) 59,000
-------------- --------------
NET CASH USED IN OPERATING ACTIVITIES (314,000) (219,000)
CASH FLOW FROM INVESTING ACTIVITIES:
Proceeds from selling of marketable securities - 55,000
Investments in purchase of marketable securities (110,000) (197,000)
Purchase of other asset (39,000) (14,000)
Purchase of property, plant and equipment (3,000) (44,000)
-------------- --------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (152,000) (200,000)
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock option 162,000 98,000
Net offering of the investment agreement with Dutchess Private Equities Fund 252,000 561,000
Payments on capital lease obligations (36,000) (21,000)
-------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 378,000 638,000
NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS (88,000) 219,000
CASH AND CASH EQUVALENTS AT BEGINNING OF PERIOD 281,000 62,000
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD 193,000 281,000
SUPPLEMENTAL DISCLOSURES:
Interest paid 20,000 14,000
Disposal of fixed assets 67,000 99,000
Equipment acquired under capital lease 38,000 133,000
See notes to financial statements and report of Independent Registered Public
Accounting Firm.
F-6
COMPUMED, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE A - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business: CompuMed, Inc. (the Company) is a medical diagnostic
product and services company focusing on the diagnosis, monitoring and
management of several costly, high incidence diseases, particularly
cardiovascular disease and osteoporosis. The Company's primary business is the
development and marketing of its osteoporosis testing technology OsteoGram (R)
and the computer interpretation of electrocardiograms ("ECGs"). The Company
applies advanced computing, medical imaging, telecommunications and networking
technologies to provide medical professionals and patients with affordable,
point-of-care solutions for disease risk assessment and decision support.
The Company generated negative cash flows from operations and had net losses
aggregating $760,000 in fiscal years ended September 30, 2006 and 2005. The
Company's business strategy includes an increase in OsteoGram (R) sales through
domestic and international marketing and distribution efforts. The Company
intends to finance this business strategy by using its current working capital
resources and cash flows from existing operations. There can be no assurance
that the OsteoGram (R) sales will be sufficient to offset related expenses.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. This basis of accounting contemplates the
recovery of the Company's assets and the satisfaction of its liabilities in the
normal course of conducting its business. The Company's ability to continue as a
going concern is dependent upon various factors including, among others, its
ability to generate profits and reduce its operating losses and negative cash
flows. No assurance can be given that the Company will be able to accomplish
these objectives. The Company uses existing cash and readily available
marketable securities balances to fund operating losses and capital
expenditures. The Company had raised these funds in 1997 through 2006 through
the placement of Preferred Stock issuances and proceeds from the exercise of
certain stock options and warrants. Currently, the Company raises fund through
the Investment Agreement with Dutchess Private Equities Fund.
Management believes the Company will be able to generate sufficient revenue,
reduce operating expenses or obtain sources of financing in order to fund
ongoing operations through at least September 30, 2007. Accordingly, the
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability or classifications of liabilities that may
result from the outcome of this uncertainty.
CASH EQUIVALENTS:
------------------
The Company considers investments in all highly liquid debt instruments with
maturity of three months or less when purchased, and investments in money market
accounts to be cash equivalents. Cash and cash equivalents also consist of cash
on hand and demand deposit accounts.
MARKETABLE SECURITIES:
-----------------------
Marketable securities consist of common stock of publicly traded domestic
companies and are stated at market value based on the most recently traded price
of these securities at September 30, 2006. All marketable securities are
classified as available for sale at September 30, 2006 and 2005. Unrealized
gains and losses, determined by the difference between historical purchase price
and the market value at each balance sheet date, are recorded as a component of
Accumulated Other Comprehensive Income in Stockholders' Equity. Realized gains
and losses are determined by the difference between historical purchase price
and gross proceeds received when the marketable securities are sold.
As of September 30, 2006, the Company's investments in marketable securities
were valued at $385,000. The Company had no realized gain in the fiscal year
ended September 30, 2006 and recorded $19,000 for the year ended September 30,
2005. As for unrealized gains, the Company recorded $2,000 and $17,000 in the
fiscal years ended September 30, 2006 and 2005, respectively (net of
reclassifications adjustments of $0 and $19,000 of realized gains above), net of
income taxes of $0 for the years ended September 30, 2006 and 2005.
F-7
ACCOUNTS RECEIVABLE:
---------------------
The Company maintains an allowance for doubtful accounts for estimated losses
that may arise if any of its 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 uncollectibility of the Company's trade
accounts receivable balances. If the Company determines that the financial
conditions of any of its 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.
INVENTORY:
----------
Inventory consists of ECG terminals, component parts and ECG medical supplies
and OsteoGram (R) hardware. Inventory, primarily finished goods, is stated at
the lower of cost (first-in first-out method) or market.
PROPERTY AND EQUIPMENT:
-------------------------
Property and equipment are stated at cost. Depreciation and amortization are
computed on the straight-line basis over 3 to 5 years. As of September 30, 2006,
the property and equipment being leased to customers had a historical cost of
$1,122,000. Amortization of assets leased under capital leases is included in
Depreciation and Amortization Expenses.
REVENUE RECOGNITION:
---------------------
ECG sales and services revenue is recognized in accordance with SAB 104 as the
following criteria have been met: (1) persuasive evidence of an arrangement
exists, (2) the product has been delivered or the services have been rendered,
(3) the fee is fixed or determinable, and (4) collectibility of the fee is
reasonably assured.
ECG SERVICES are comprised of ECG processing, Overread, Rental and Maintenance.
ECG Processing and Overread revenue is recognized monthly on a per-usage basis
after the services are performed. Equipment rental and maintenance revenue is
recognized monthly over the terms of the customer's agreement.
ECG PRODUCT AND SUPPLIES SALES revenue is recognized upon shipment of the
products and passage of title to the customer.
OsteoGram software revenue is recognized in accordance to paragraph 8 of SOP
97-2 as the following criteria have been met: (1) persuasive evidence of an
arrangement exits, (2) the software has been delivered, (3) the fee is fixed or
determinable, and (4) collectibility of the fee is probable.
OsteoGram PCS revenue is recognized in accordance to paragraph 59 of SOP 97-2 as
the Company met the following criteria: (1) the PCS is part of the initial
license (software) fee, (2) the PCS period is for one year, (3) the estimated
cost of providing the PCS is immaterial, (4) the Company does not offer upgrades
and enhancements during the PCS arrangement. The Company's policy is to accrue
all estimated costs of providing the PCS services.
PATENTS:
--------
Patents are amortized over 15 years, starting from their approval date.
INCOME TAXES:
--------------
The Company utilizes the liability method to determine the provision for income
taxes, whereby deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse.
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 antidilutive.
FINANCIAL INSTRUMENTS:
-----------------------
The carrying value of short-term financial instruments such as cash equivalents,
accounts receivable, accounts payable, accrued liabilities and capital leases
approximates their fair value based on the short-term maturities of these
instruments.
LONG-LIVED ASSETS:
-------------------
Long-lived assets used in operations are reviewed periodically to determine
whether the carrying values are not impaired and, if indications of impairment
are present or if long-lived assets are expected to be disposed of, impairment
losses are recorded. Any impairment is charged to expense in the period in which
the impairment is determined. The Company has not recorded impairment charges
during the years ended September 30, 2006 and 2005.
USE OF ESTIMATES:
-------------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions affecting the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-8
STOCK BASED COMPENSATION:
---------------------------
The Company accounts for employee and director's stock option grants using the
intrinsic method. Generally, the exercise price of the employee stock options
equal or exceeds the market price of the underlying stock on the date of grant
and no compensation expense is recognized. If the option price is less than
market value, the Company records compensation expense over the vesting period
of the option.
The Company accounts for equity instruments issued to non-employees in exchange
for goods or services using the fair value method and records expense based on
the values determined.
CONCENTRATION OF CREDIT RISK:
--------------------------------
The Company sells its products throughout the United States and in the
international markets. The Company performs periodic credit evaluations of its
customers' financial condition and generally does not require collateral. Credit
losses have been within management's expectations. For the year ended September
30, 2006, total revenue from four customers accounted for approximately 58% of
the Company total revenue, and one customer accounted for 27% of total accounts
receivable at September 30, 2006. The Company maintains cash balance at a
financial institution which accounts are insured by the Federal Deposit
Insurance Corporation of $100,000. The portion in excess of the federally
insured limit amounted to approximately $81,000 at September 30, 2006.
NOTE B - INCOME TAXES
At September 30, 2006, the Company has available for federal income tax
purposes, net operating loss carry forwards of approximately $7 millions, which
expire between 2007 and 2026. The utilization of the above net operating loss
carry forwards are subject to significant limitations under the tax codes due to
changes in ownership and portions may expire prior to utilization. The
difference between the Company's effective income tax rate and the statutory
federal rate for the years ended September 30, 2006 and 2005 relates primarily
to losses incurred for which no tax benefit was recognized, due to the
uncertainty of its realization. The valuation allowance was $2,569,000 and
$2,451,000 at September 30, 2006 and 2005, respectively, representing an
increase of $118,000 for the year ended September 30, 2006. This increase is
mainly explained by loss carry forwards for which no tax effect was recognized
due to the uncertainty of its realization, offset by loss carry forwards that
expired at September 30, 2006.
Significant components of the deferred tax liabilities and assets as of
September 30, 2006 are as follows:
2006 2005
----------- ------------
Deferred tax liabilities: : . . . . . . . . 0 0
Deferred tax assets:
Net operating loss carry forwards . . . . . 2,533,000 2,400,000
Other asset and liabilities . . . . . . . . 36,000 51,000
----------- -----------
Total deferred tax assets 2,569,000 2,451,000
Valuation allowance for Deferred tax assets (2,569,000) (2,451,000)
----------- -----------
Net deferred tax assets . . . . . . . . . . 0 0
Total . . . . . . . . . . . . . . . . . . . $ 0 $ 0
=========== ===========
NOTE C - STOCKHOLDERS' EQUITY
CLASS A $3.50 CUMULATIVE CONVERTIBLE VOTING PREFERRED STOCK:
-------------------------------------------------------------------
The holders of Class A Preferred Stock are entitled to receive, when and as
declared by the Board of Directors, dividends at an annual rate of $.35 per
share, payable quarterly. Dividends are cumulative from the date of issuance.
Total cumulated dividends not declared at September 30, 2006 amounted to
$19,000. Every two shares of the Class A Preferred Stock are presently
convertible, subject to adjustment, into one share of Common Stock. In the event
of any liquidation, the holders of the Class A Preferred Stock are entitled to
receive $2.00 in cash per share plus accumulated and unpaid dividends out of
assets available for distribution to stockholders, prior to any distribution to
holders of Common Stock or any other stock ranking junior to the Class A
Preferred Stock. The Class A Preferred Stock may be redeemed by the Company,
upon 30-days' written notice, at a redemption price of $3.85 per share. Class A
Preferred Stock stockholders have the right to convert their shares into Common
Stock during such 30-day period.
F-9
Shares of Class A Preferred Stock have one vote each. Shares of Class A
Preferred Stock vote along with shares of Common Stock and shares of Class B
Preferred Stock as a single class on all matters presented to the stockholders
for action except as follows: Without the affirmative vote of the holder of a
majority of the Class A Preferred Stock then outstanding, voting as a separate
class, the Company may not (i) amend, alter or repeal any of the preferences or
rights of the Class A Preferred Stock, (ii) authorize any reclassification of
the Class A Preferred Stock, (iii) increase the authorized number of shares of
Class A Preferred Stock or (iv) create any class or series of shares ranking
prior to the Class A Preferred Stock as to dividends or upon liquidation. A
total of 4,200 shares of Common Stock are currently issuable upon conversion of
the remaining 8,400 shares of the Class A Preferred Stock.
CLASS B $3.50 CONVERTIBLE VOTING PREFERRED STOCK:
-------------------------------------------------------
In August 1994, the Company issued 52,333 shares of Class B $3.50 Convertible
Preferred Stock ("Class B Preferred Stock") in connection with the acquisition
of certain property. The holders of Class B Preferred Stock are entitled to
receive dividends only, when and as declared by the Board of Directors. Each
share of Class B Preferred Stock is convertible, subject to adjustment, into ten
shares of Common Stock. In the event of any liquidation, the holders of the
Class B Preferred Stock are entitled to receive $3.50 in cash per share plus
accumulated and unpaid dividends out of assets available for distribution to
stockholders, prior to any distribution to holders of Common Stock or any other
stock ranking junior to the Class B Preferred Stock. Each share of Class B
Preferred Stock may be redeemed by the Company, upon 30-days' written notice, at
a redemption price of $3.85 per share. Class B Preferred Stock stockholders have
the right to convert their shares into Common Stock during this 30-day period.
Shares of Class B Preferred Stock are entitled to one vote each. Shares of Class
B Preferred Stock vote as a single class on all matters presented to the
stockholders for action except as follows: Without the affirmative vote of the
holder of a majority of the Class B Preferred Stock then outstanding, voting as
a separate class, the Company may not (i) amend, alter or repeal any of the
preferences or rights of the Class B Preferred Stock, (ii) authorize any
reclassification of the Class B Preferred Stock, (iii) increase the authorized
number of shares of Class B Preferred Stock or (iv) create any class or series
of shares ranking prior to the Class B Preferred Stock as to dividends or upon
liquidation. A total of 3,000 shares of Common Stock are currently issuable upon
conversion of the remaining 300 shares of Class B Preferred Stock.
ISSUANCE OF COMMON STOCK - EQUITY LINE OF CREDIT
--------------------------------------------------------
The Company entered into an Investment Agreement with Dutchess Private Equities
Fund, also referred to as an Equity Line of Credit. That agreement provides
that, following notice to Dutchess, The Company may put to Dutchess up to $5
million in shares of its 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 the Company's common stock during the five day period following that
notice. The number of shares that the Company will be permitted to put pursuant
to the Investment Agreement will be either: (A) two hundred percent of the
average daily volume of the Company's common stock for the ten trading days
prior to the applicable put notice, multiplied by the average of the three daily
closing best bid prices immediately preceding the day the Company issues the
put, or (B) $25,000; provided that in no event will the put amount be more than
$1,000,000 with respect to any single Put. In turn, Dutchess has indicated that
it will resell the Company's shares in the open market, resell the Company's
shares to other investors through negotiated transactions or hold the Company's
shares in its portfolio. This prospectus covers the resale of the Company's
stock by Dutchess either in the open market or to other investors through
negotiated transactions.
During fiscal year 2006, the Company issued 375,000 shares of common stock to
Dutchess and realized net proceeds of $252,000.
NOTE D - STOCK OPTIONS AND WARRANTS
The Company has adopted two non-stockholder approved stock incentive plan, the
2003 Stock Incentive Plan (the "2003 Plan") and the 2006 Stock Incentive Plan
(the "2006 Plan"), and two stockholder approved stock options plans, the 1992
Stock Option Plan ("1992 Plan") and the 2002 Stock Option Plan (the "2002 Plan")
(collectively, the "Plans"). The 1992 Plan expired in March 2002 and the 2002
Plan was suspended on the effective date of the 2003 Plan in June 2003. Awards
are outstanding under the Plans, but awards may be granted in the future only
under the 2003 Plan and 2006 Plan. The 2003 Plan provides for the granting of
options, stock awards and other forms of equity compensation to key employees,
officers and certain individuals. Only nonqualified options may be granted under
the 2003 Plan. The 2006 Plan provides for the granting of options and stock
awards to any officer, director, employee and certain individuals. Both
nonqualified and incentive options may be granted under the 2006 Plan.
Options granted under the Plans generally become exercisable at a rate of 33% of
the shares subject to an option one year after the date of grant and the
remaining shares generally become exercisable over an additional 24 months. The
duration of options may not exceed ten years beyond the date of grant.
In addition to options issued pursuant to these Plans, the Company has granted
non-qualified stock options to certain members of the Board of Directors,
management and consultants. Such options have been granted with exercise prices
equal to the market prices of the common stock at the date of grant and are for
a term of ten years.
F-10
During fiscal year ended September 30, 2004, the Company issued options to
purchase 26,087 shares of common stock to a consultant in exchange for services
over three-month period. These options were valued according to SFAS 123 at
$8,000 of which $8,000 was expensed in fiscal 2004. The Company also granted
options to purchase 1,785,000 shares of common stock to directors and employees.
These options were recorded at $0 using the intrinsic method and they were
valued at $188,000 in accordance with SFAS 123.
During fiscal year ended September 30, 2005, the Company issued options to
purchase 35,000 shares of common stock to a consultant. These options were
valued according to SFAS 123 at $8,000 of which $2,000 was expensed in 2005 and
$3,000 in 2006. The Company also granted options to purchase 1,160,000 shares of
common stock to directors and employees. These options were recorded at $0 using
the intrinsic method and they were valued at $124,000 in accordance with SFAS
123.
During fiscal year ended September 30,2006, the Company issued warrants and
options to purchase 175,000 shares of common stock to consultants. These
warrants and options were valued according to SFAS 123 at $31,000 of which
$15,000 was expensed in 2006. The Company also granted options to purchase
1,375,000 shares of common stock to directors and employees. These options were
recorded at $0 using the intrinsic method and they were valued at $236,000 in
accordance with SFAS 123.
SFAS 123 "Accounting for Stock-Based Compensation", amended by SFAS 148 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. Warrants to purchase 50,000 shares of common stock
was issued during fiscal year 2006 had an exercise price of $0.65 and will
expire in June 30, 2008. Options to purchase 1,500,000 and 1,195,000 shares of
common stock were granted during the year ended September 30, 2006 and 2005,
respectively. The fair value of these warrants and options has been estimated at
$267,000 and $132,000 using the Black-Scholes Option pricing model, with the
following assumptions:
2006 2005
--------------- ---------------
Risk free interest rate. . . . . . . . 4.47% to 4.88% 4.00 to 4.50%
Stock volatility factor . . . . . . . . 21.8% 18% to 33%
Weighted average expected option life 5 years 10 years
Expected dividend yield . . . . . . . . None None
A summary of the stock option activity, and related information for the years
ended September 30 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 (825,441) 0.20 (1,026,354) 0.10
Options granted 1,500,000 0.45 1,195,000 0.25
Options forfeited/canceled (491,665) 0.28 (33,929) 0.46
------------- ------------- ------------- -------------
Options outstanding, end of period 6,754,828 0.30 6,571,934 0.25
============= ============= ============= =============
Options exercisable, end of period 4,264,834 0.26 4,353,609 0.26
============= ============= ============= =============
F-11
The pro forma net loss and loss per share had the Company accounted for its
options using FAS 123 would have been as follows:
Twelve Months Ended September 30,
2006 2005
---------- ----------
Net loss as reported (424,000) (336,000)
Basic and diluted loss per share as reported (0.02) (0.02)
Add: stock based employee compensation cost 15,000 2,000
included in determination of net loss reported
Deduct: stock-based employee compensation cost (122,000) (79,000)
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 (531,000) (413,000)
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 (0.02) (0.02)
The following summarizes information concerning stock options outstanding at
September 30, 2006:
Weighted Weighted
Weighted Average Average
Average Exercise Exercise
Remaining Price Price
Range of Exercise Prices Shares Contractual of Shares Shares of Shares
Outstanding Life Outstanding Exercisable Exercisable
------------------------ ----------- ----------- ----------- ----------- -----------
$0.000000 - $0.425000 5,547,143 7.54 $0.21 3,402,149 $0.15
$0.425100 - $0.850000 1,176,435 4.59 $0.66 831,435 $0.67
$0.850100 - $1.275000 31,250 1.15 $1.15 31,250 $1.15
------------------------ ----------- ----------- ----------- ----------- -----------
6,754,828 6.99 $0.30 4,264,834 $0.26
======================== =========== =========== =========== =========== ===========
NOTE E - COMMITMENTS AND CONTINGENCIES
The Company has capital leases for machinery and equipment that expire in 2012
and has operating lease for a facility that expired in August 2004, with an
option to extend the term of this lease for an additional five years. The
Company exercised the option to extend the lease to August 2007. The following
is a summary as of September 30, 2006 of future minimum lease payments together
with the present value of the net minimum lease payments on capital leases:
CAPITAL OPERATING
YEAR ENDING SEPTEMBER 30 LEASES LEASES
----------------------------------------------------------- -------- ---------
2007. . . . . . . . . . . . . . . . . . . . . . . . . . . . 64,000 132,000
2008. . . . . . . . . . . . . . . . . . . . . . . . . . . . 64,000 10,000
2009. . . . . . . . . . . . . . . . . . . . . . . . . . . . 59,000 8,000
2010. . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,000 9,000
2011. . . . . . . . . . . . . . . . . . . . . . . . . . . . - 6,000
---------- ---------
Total minimum lease payments. . . . . . . . . . . . . . . . $ 198,000 $ 165,000
========== =========
Less amount representing interest . . . . . . . . . . . . . 36,000
----------
Net minimum lease payments. . . . . . . . . . . . . . . . . $162,000
Less current portion. . . . . . . . . . . . . . . . . . . . 46,000
----------
Present value of net minimum payments, less current portion $116,000
==========
F-12
During the year ended September 30, 2006, the Company entered a capital lease
obligation for equipment at the cost of $37,000. This obligation bears an
average interest of 14.72 % and a monthly payment of $1,000 and matures in
October 2010.
Rental expense under operating leases was $129,000 and $127,000 in fiscal years
2006 and 2005, respectively.
LITIGATION
----------
From time to time the Company is involved in litigation and threatened
litigation arising in the ordinary course of business. The Company is not aware
of any material unsettled litigation.
EMPLOYMENT AGREEMENT
---------------------
The Company entered into a long-term agreement with John McLaughlin effective
November 2, 2002 through September 30, 2004. This agreement provided 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.
NOTE F - SAVINGS AND RETIREMENT PLANS
The Company has a Savings and Retirement Plan (the "Plan") under which every
full-time salaried employee who is 18 years of age or older may contribute up to
100 percent of his or her eligible annual salary to the Plan. For an employee
contribution of up to but not exceeding 6 percent of the employee's annual
salary the Company makes a matching contribution of $0.25 for every $1.00 of the
employee's contribution. The Company's contributions are 100 percent vested
after 36 months of contributions to the Plan. Benefits are payable under the
Plan upon termination of a participant's employment with the Company or at
retirement. The Plan meets the requirements of Section 401(k) of the Internal
Revenue Code. The Company's matching contribution, which was charged to expense,
was $14,000 and $16,000 for fiscal 2006 and 2005, respectively.
NOTE G - RELATED PARTY TRANSACTIONS
The Company has retained the services of an investment advisor, who is also a
member of the Board of Directors, to provide advice on the investment portfolio.
During fiscal years ended September 30, 2006 and 2005, the Company incurred
$3,000 and $2,000 for these services, respectively.