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VSCP > SEC Filings for VSCP > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for VIRTUALSCOPICS, INC.

Form 10-Q for VIRTUALSCOPICS, INC.


14-Nov-2012

Quarterly Report


ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with VirtualScopics' condensed consolidated balance sheets as of September 30, 2012 and December 31, 2011 and the related condensed consolidated statements of operations and cash flows for the three and nine months ended September 30, 2012 and 2011, included elsewhere in this report. This discussion contains forward-looking statements, the accuracy of which involves risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons including, but not limited to, those discussed under the heading "Forward Looking Statements" below and elsewhere in this report. We disclaim any obligation to update information contained in any forward-looking statements.

Overview

VirtualScopics, Inc. is a leading provider of imaging solutions to accelerate drug and medical device development. We have developed a robust software platform for analysis and modeling of both structural and functional medical images. In combination with our industry-leading experience and expertise in advanced imaging biomarker measurement, this platform provides a uniquely clear window into the biological activity of drugs and devices in clinical trial patients, allowing pharmaceutical, biotechnology and medical device companies to make better decisions faster. Additionally, our technology is believed to help curtail trials that are not likely to be beneficial and to avoid mistaken termination of compounds that are likely to prove efficacious, as well as allow our customers to expedite compounds that are demonstrating response. This is done through:

improved precision in the measurement of existing imaging-based biomarkers resulting in shorter observation periods, with beneficial cost savings within a clinical trial;

new imaging biomarkers, which are better correlated with disease states, again reducing trial length and therefore costs; and

reduced processing time for image data analysis through automation.

In addition, we believe our technology helps reduce aggregate clinical development costs through:

improved precision for existing biomarkers, thus requiring smaller patient populations and lower administrative costs; and

new biomarkers that serve as better correlates, leading to better early screening and elimination of weak drug candidates in pre-clinical trials.

In July 2000, VirtualScopics was formed after being spun out of the University of Rochester and in June 2002, VirtualScopics purchased the underlying technology and patents created by VirtualScopics' founders from the University of Rochester. VirtualScopics owns all rights to the patents underlying its technology.

Revenues since inception have been derived primarily from image analysis services in connection with pharmaceutical drug trials. For these services, we have been concentrating in the areas of oncology and musculoskeletal diseases. We have also derived a portion of revenue from consulting services and pharmaceutical drug trials in the neurology and cardiovascular therapeutic areas. Revenues are recognized as the services are performed and as images are analyzed.

We continue to submit proposals and bids for new contracts, however, there can be no assurance that we will secure contracts from these efforts or that any such contracts or any of our existing contracts will not be cancelled by a customer.

Additionally, once we enter into a new contract for participation in a drug trial, there are several factors that can affect whether we will realize the full benefits under the contract, and the time over which we will realize that revenue. Customers may not continue our services due to many reasons including lack of demonstrated efficacy with their compounds in development. Furthermore, the contracts may contemplate performance over multiple years. Therefore, revenue may not be realized in the fiscal year in which the contract is signed or awarded. Recognition of revenue under the contract may also be affected by the timing of patient recruitment and image site identification and training.

We have also begun pursuing the application of one of our technologies into the personalized medicine market. Specifically, we believe there could be further benefit of our blood flow and vascular permeability software tool in assisting patients and oncologists in determining whether an anti-angiogenic therapy is having the desired effect. We believe this application will assist oncologists with treatment planning for patients undergoing anti-angiogenic cancer therapies. We have begun the regulatory process for obtaining 510(k) clearance from the FDA for our application to be used as a tool to analyze Dynamic Contrast-Enhanced Magnetic Resonance Images (DCE-MRI). On April 3, 2012, we entered into an agreement with Merck Global Health Innovation Fund, LLC, or GHI, for equity financing of up to $6,000,000. The transaction is part of an investment by GHI to provide funding for our efforts to expand our quantitative imaging technology into the personalized medicine market. We completed the first closing on April 3, 2012 for financing of $3,000,000 less issuance costs of approximately $334,000. We plan to use the proceeds from the financing from GHI to develop this personalized medicine initiative and establish our IT and software platform to create a quantitative imaging center. We also plan to use the proceeds to further validate our blood perfusion module, which is our first personalized medicine application. We will continue to assess the best mechanism for channeling our quantitative imaging software applications into the market; however, there can be no assurance that approval will be granted or we will experience significant demand for our services.

Results of Operations

Results of Operations for Quarter Ended September 30, 2012 Compared to Quarter Ended September 30, 2011

Revenues

We had revenues of $3,328,000 for the quarter ended September 30, 2012 compared to $3,269,000 for the comparable period in 2011, representing a $59,000, or 2% increase. The slight increase was related to higher image analysis services in 2012 compared to 2011. In July of this year we hired two individuals to augment our sales efforts in Europe and the US West Coast. We believe these individuals will help enable us to better attack the market and provide us greater visibility in those regions. In addition to hiring sales representatives, we have reorganized our sales function which will allow our sales personnel more time to pursue opportunities and interface with existing and prospective customers. Although the amount of new project awards has been slower than we experienced in previous years, we have seen an increasing number of requests for proposals throughout 2012, in particular through the PPD channel. We believe that this increase in requests for proposals and our strategic alliance with PPD, Inc. will help increase the level of business activity from what we have experienced in 2011 and 2012, however, we anticipate that the slowdown in project awards that we've been experiencing will continue to have an impact on our revenue growth for the remainder of 2012.

During the third quarter of 2012, we performed work on 93 different projects, in connection with our pharmaceutical drug trials in the fields of oncology, osteoarthritis and various other therapeutic areas. This compares to 103 projects during the same period in 2011. During the third quarter of 2012, 72% of our business was in oncology services and 18% in musculoskeletal, the remaining 10% was in other therapeutic areas. This compares to 73%, 23% and 4%, respectively, in 2011. During the third quarter of 2012, 75% of the revenues were derived from Phase II and III studies compared to 71% during the comparable period in 2011. The gross margin we are able to realize on our revenues is impacted by the nature of the service mix during the reported quarter, as well as the therapeutic area and phase of study. Incoming image processing and image analysis activities tend to produce higher margins, while we are experiencing lower margins within our project management and site initiation activities. Therefore, our margins may vary from quarter to quarter depending on the mix of services.

Gross Profit

We had a gross profit of $1,462,000 for the third quarter of 2012 compared to $1,497,000 for the comparable period in 2011, representing a $35,000, or 2%, decline. Our gross profit margin was 44% during the quarter ended September 30, 2012 compared to 46% during the third quarter of 2011. Excluding reimbursed charges, which yield no margin, our gross margin was 47% for the third quarter of 2012 compared to 49% in the third quarter of 2011. Our margins declined year over year due to the 30% increase in our staff throughout 2011 within our operations group in order to better support the mix of projects we are experiencing.

Research and Development

Research and development costs increased in the quarter ended September 30, 2012 by $62,000, or 18%, to $415,000, when compared to the quarter ended September 30, 2011. The increase resulted from the hiring within our software development group in late 2011 and our work to support our personalized medicine applications including our 510k filing with the FDA. We now have three dedicated software developers working on our personalized medicine platform. Our other research and development efforts center around refining our processes through the use of our software platform in order to allow for greater reporting capabilities by our customers and to gain efficiencies which we believe will better allow us to standardize our processes as we scale the business. We believe the investments in personnel we made within our development group will better enable us to efficiently deliver on Phase III studies and enhance our productivity. Additionally, we continue to invest in the commercialization of new imaging techniques across modalities and therapeutic areas to best serve our customers.

Sales and Marketing

Sales and marketing costs increased in the quarter ended September 30, 2012 by $55,000, or 21%, to 315,000 when compared to the quarter ended September 30, 2011. The increase was the result of hiring two experienced sales individuals to cover the European and West Coast US territories during the third quarter of 2012. Currently, there are 6 individuals within our sales and marketing department. Our sales and marketing initiatives encompass attendance and presentations at leading industry conferences, frequent educational webinars and active calling on existing and new customers.

General and Administrative

General and administrative expenses for the quarter ended September 30, 2012 were $684,000, a decrease of $67,000 or 9%, when compared to the quarter ended September 30, 2011. The decrease was mainly attributed to lower stock compensation charges and reductions in IT expenses during the third quarter of 2012 as compared to the same period in 2011. General and administrative expenses include both personnel and non-personnel costs. Departments included within general and administrative function are finance, information technology, quality, human resources and the CEO position. Non-payroll related costs included within general and administration include stock option expense, audit and legal fees, regulatory and compliance fees, Nasdaq listing fees, board fees, non-capitalizable hardware and software costs and licenses and non-sales related travel costs.

Depreciation and Amortization

Depreciation and amortization charges were $101,000 for the quarter ended September 30, 2012 compared to $114,000 during the quarter ended September 30, 2011. The reduction is due to the complete amortization of our right to use an MRI unit at the University of Rochester during the quarter ended September 30, 2011. Offsetting this reduction was higher depreciation charges related to recent capital purchases, including the purchase and installation cost of an ERP system.

Other (Expense) Income

Other expense for the quarter ended September 30, 2012 was $26,000 compared to other income of $543,000 for the quarter ended September 30, 2011. During the third quarter of 2012, we recognized a marked to market loss of $20,000, relating to the increase in fair value of warrants that were issued in connection with our 2007 Series B offering (see Financial Statement Note 4) compared to a non-cash marked to market gain of $548,000 for the quarter ended September 30, 2011. The aggregate decrease of $569,000 when compared to the third quarter of 2011 is attributable to the lower average price of our common stock during the third quarter of 2012 compared to the third quarter of 2011 and the decrease in the number of derivative instruments outstanding due to the elimination of the anti-dilution adjustment provision in certain Series B warrants as part of the Series C-1 financing. As of September 30, 2012, the Company had 214,229 warrants outstanding subject to the anti-dilution adjustment provision as compared to the 902,038 at September 30, 2011.

Net (Loss) Income

Net loss for the quarter ended September 30, 2012 was $79,000 compared to net income of $563,000 for the quarter ended September 30, 2011. The decrease in our net income was primarily related to the non-cash loss recognized for the marked to market adjustment for certain warrants outstanding during the third quarter of 2012 as compared to the gain recognized in the third quarter of 2011.

Results of Operations for the Nine Months Ended September 30, 2012 Compared to the Nine Months Ended September 30, 2011

Revenues

Our revenues for the nine months ended September 30, 2012 were $10,366,000, a decrease of $414,000 or 4% over the first nine months of 2011. The decrease was related to a reduced level of new project awards in 2011 and 2012 due to general market conditions and delays in study initiations and recruitment within existing studies. In July of this year we hired two individuals to augment our sales efforts in Europe and the US West Coast. We believe these individuals will help enable us to better attack the market and provide us greater visibility in those regions. In addition to hiring sales representatives, we have reorganized our sales function which will allow our sales personnel more time to pursue opportunities and interface with existing and prospective customers. Although the amount of new project awards has been slower than we experienced in previous years, we have seen an increasing number of requests for proposals throughout 2012, in particular through the PPD channel. We believe that this increase in requests for proposals and our strategic alliance with PPD, Inc. will help increase the level of business activity from what we have experienced in 2011 and 2012, however, we anticipate that the slowdown in project awards that we've been experiencing will continue to have an impact on our revenue growth for the remainder of 2012.

We performed services for a total of 114 projects in the first nine months of 2012, as compared to 127 in the first nine months of 2011. During the first nine months of 2012, 75% of our revenues were generated from Phase II/III projects compared to 75% during the first nine months of 2011. We expect that a majority of our revenues from pharmaceutical and medical device clinical trials will be derived from Phase II and III studies throughout the remainder of 2012.

Gross Profit

We had a gross profit of $4,217,000 for the nine months ended September 30, 2012 compared to $4,917,000 for the comparable period in 2011, representing a $700,000, or 14%, decline. Our gross margin for the nine months ended September 30, 2012 was 41% compared to 46% for the first nine months of 2011. Our gross margin fluctuations are largely a result of the mix of services performed during a given period and the decrease in revenues. Historically, we have experienced lower margins in our musculoskeletal projects than our oncology projects. Also impacting our 2012 margins is the increase in the amount of staff we employ in our operations group by 30% in order to better support the mix of projects we are experiencing.

Research and Development

Total research and development expenditures were $1,172,000 in the first nine months of 2012 compared to $1,081,000 for the comparable period in 2011, an increase of 8%. The increase was due to consultant and professional fees related to the continued development of the personalized medicine applications. Our other research and development efforts center around refining our processes through the use of our software platform in order to gain efficiencies which we believe will better allow us to standardize our processes as we scale the business. Additionally, we continue to invest in the commercialization of new imaging techniques across many modalities and therapeutic areas to best serve our customers and the demand in the market.

Sales and Marketing

Sales and marketing costs for the nine months ended September 30, 2012 were $962,000 compared to $879,000 for the first nine months of 2011, an increase of 9%. The increase was the result of hiring two experienced sales individuals to cover the European and West Coast US territories during the third quarter of 2012. Our sales and marketing efforts include conference attendance and presentations, technically-focused webinars, customer webinars and related travel along with advertising in key scientific journals and occasional consulting and other costs associated with market research activities. During the third quarter of 2012, we have hired two seasoned sales individuals to cover the European and West Coast US territories. Currently, there are 6 individuals within our sales and marketing department.

General and Administrative

General and administrative expenses for the nine months ended September 30, 2012 were $2,202,000, a decrease of $202,000 or 8%, over the first nine months of 2011. The decrease is largely driven by a reduction in non-cash stock compensation costs and general cost controls during the first nine months of 2012. General and administrative expenses include both personnel and non-personnel costs. Departments included within general and administrative function are finance, information technology, quality, human resources and the CEO position. Non-payroll related costs included within general and administration include stock option expense, audit and legal fees, regulatory and compliance fees, Nasdaq listing fees, board fees, non-capitalizable hardware and software costs and licenses and non-sales related travel costs.

Depreciation and Amortization

Depreciation and amortization charges were $320,000 for the nine months ended September 30, 2012 compared to $364,000 during the first nine months of September 30, 2011. The slight reduction is due to the complete amortization of our right to use an MRI unit at the University of Rochester. Offsetting this reduction was higher depreciation charges related to recent capital purchases, including the purchase and installation cost of the financial and accounting component of an ERP system.

Other (Expense) Income

Other expense for the nine months ended September 30, 2012 was $317,000 compared to other income of $501,000 in the same period in 2011. The increase in other expense was a reflection of the recognition of a marked to market loss of $306,000 related to the increase in fair value of certain warrants that were issued in connection with our 2007 Series B offering (see Financial Statement Note 4). During the first nine months of 2011, we recognized an unrealized gain of $510,000 due to the decrease in fair value of those warrants. The aggregate decrease of $818,000 when compared to the first nine months of 2011 is attributable to the higher average price of our common stock during the first nine months of 2012 compared to the first nine months of 2011 and the decrease in the number of derivative instruments outstanding due to the elimination of the anti-dilution adjustment provision in certain Series B warrants as part of the Series C-1 financing. As of September 30, 2012, the Company had 214,229 warrants outstanding subject to the anti-dilution adjustment provision as compared to the 902,038 at September 30, 2011.

Net (Loss) Income

Our net loss for the nine months ended September 30, 2012 was $756,000 compared to a net income of $690,000 for the same period in 2011. The decrease in our net income was primarily related to the non-cash loss recognized for the marked to market adjustment for certain warrants outstanding during the first nine months of 2012 as compared to the gain recognized in 2011 and the decrease in revenues and gross profit in 2012.

Liquidity and Capital Resources

Our working capital as of September 30, 2012 was approximately $9,511,000 compared to $6,353,000 as of December 31, 2011. The increase in working capital was primarily a result of the financing agreement with GHI that resulted in the receipt of net proceeds of approximately $2,700,000.

Net cash used in operating activities totaled $474,000 in the nine months ended September 30, 2012 compared to net cash provided by operating activities of $837,000 in the comparable 2011 period. The decrease is mostly due to the increase in the net loss for the nine months ended September 30, 2012 compared to the prior period as well as the timing of advance payments on new projects and receipts from customers in the first nine months of 2012 as compared to the first nine months of last year. Our days sales outstanding increased to 68 in the nine months ending September 30, 2012 as compared to 66 at December 31, 2011 due to increasingly longer payment terms required by our larger customers. We do not expect, nor have we experienced, significant write-offs within our receivables.

We invested $140,000 in the purchase of equipment and the acquisition of patents in the first nine months of 2012, compared to $389,000 for the investment in these items in the first nine months of 2011. The decrease reflects investments in our IT and IS infrastructure in the first nine months of 2011 for the acquisition of a new IT storage system that did not reoccur in 2012.

Cash provided by our financing activities in the nine months ended September 30, 2012 was $2,937,000 compared to cash provided of $149,000 in the nine months ended September 30, 2011. The increase is a result of proceeds from the exercise of options and warrants during the first nine months of 2012, and the closing of the financing agreement with Merck GHI.

We currently expect that existing cash will be sufficient to fund operations for the next 12 months. If in the next 12 months our plans or assumptions change or prove to be inaccurate, or if we are unable to meet the milestones for the second closing of the investment by GHI, we may be required to seek additional capital through public or private debt or equity financings. If we need to raise additional funds, we may not be able to do so on terms favorable to us, or at all. If we cannot raise sufficient funds on acceptable terms, we may have to curtail our level of expenditures and our rate of expansion.

Off Balance Sheet Arrangements

We have no off-balance sheet arrangements (other than the consulting agreements and operating leases) that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital resources or capital expenditures that is material to investors.

Forward Looking Statements

Certain statements made in this discussion are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements that address activities, events or developments that we expect, believe or anticipate may occur in the future, including the following risk factors:

adverse economic conditions;

inability to raise sufficient additional capital to operate our business;

unexpected costs, lower than expected sales and revenues, and operating defects;

adverse results of any legal proceedings;

the volatility of our operating results and financial condition;

inability to attract or retain qualified senior management personnel, including sales and marketing, and scientific personnel;

the risk that we may not meet the milestones for the second closing of our financing with GHI for funds to pursue our personalized medicine initiative; and

other specific risks that may be referred to in this report.

All statements, other than statements of historical facts, included in this report including, without limitation, statements regarding our strategy, future operations, financial position, estimated revenue or losses, projected costs, prospects and plans and objectives of management are forward-looking statements. When used in this report, the words "may," "believe," "anticipate," "intend," "estimate," "expect," "project," "plan," "could," "would" and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. All forward-looking statements speak only as of the date of this report. We do not undertake any obligation to update any forward-looking statements or other information contained in this report. Existing stockholders and potential investors should not place undue reliance on these forward-looking statements. Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements in this report are reasonable, we cannot assure our stockholders or potential investors that these plans, intentions or expectations will be achieved. We disclose important factors that could cause our actual results to differ materially from our expectations under the heading entitled "Risk Factors" in our annual report on Form 10-K for the fiscal year ended December 31, 2011 filed with the Securities and Exchange Commission ("SEC") and elsewhere in this report. These risk factors qualify all forward-looking statements attributable to us or persons acting on our behalf.

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