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VSCP > SEC Filings for VSCP > Form 10-K on 27-Mar-2013All Recent SEC Filings

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Form 10-K for VIRTUALSCOPICS, INC.


27-Mar-2013

Annual Report


ITEM 7: Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with VirtualScopics' consolidated balance sheet, and related consolidated statements of operations, changes in stockholders' equity and cash flows for the years ended December 31, 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 in "Risk Factors" 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 our customers to make better decisions faster.

Since inception, revenues have been derived primarily from image processing services in connection with pharmaceutical drug trials. For these services, we have been concentrating in the areas of oncology and osteoarthritis. We have also derived a small portion of revenue from consulting services, and pharmaceutical drug trials in the neurology and cardiovascular areas. We expect that the concentration of our revenue will continue in these services and in those areas in 2013. Revenues are recognized as the medical images that we process are quantified and delivered to our customers and/or the services are performed. Beginning in 2011, we began to pursue the personalized medicine market, however, we do not anticipate significant revenues from this market opportunity in 2013 as we are in the early stages of commercialization including our strategy relative to regulatory approval and validation of our software.

As of December 31, 2012, the amount remaining to be earned from active projects and awards was approximately $22 million. The reduction in backlog when compared to prior year is due to the generation of revenue from the backlog, softness in new project awards in 2012 and the ordinary close out of projects with balances remaining. Once we enter into a new contract for participation in a drug trial, there are several factors that can effect 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 performance reasons 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 the award is made. Recognition of revenue under the contract may also be affected by the timing of patient recruitment and image site identification and training. Additionally, the majority of contracts we have with customers are cancelable for any reason by giving 30 days advance notice.

Results of Operations

Results of Operations for Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Revenues

We had revenues of $12,963,000 for the year ended December 31, 2012 compared to $14,282,000 for the year ended December 31, 2011, representing a 9% decrease. The decrease in revenues is related to a slowdown in the amount of new projects awarded in 2012 and delays in decisions being made by new and reoccurring customers on outstanding proposals as well as delays in the initiation of previously awarded and contracted projects. In July of 2012 we hired two individuals to augment our sales efforts in Europe and the US West Coast, two areas which we believed had been underserviced in the past. 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 did see an increased number of requests for proposals in 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. As of December 31, 2012, we had active projects with 10 of the leading 15 pharmaceutical and biotechnology companies in the world.

Gross Profit

We had a gross profit of $5,251,000 for the year ended December 31, 2012 compared to $6,274,000 for the comparable period in 2011. The gross margin for the year ended December 31, 2012 was 41% compared to 44% for the year ended December 31, 2011. Our margins declined year over year primarily as a result of the decrease in revenues encountered during 2012 as discussed above. During 2012, we performed work for 31 customers, representing 123 different projects, in connection with their pharmaceutical drug trials primarily in the fields of oncology and musculoskeletal diseases (osteoarthritis and rheumatoid arthritis) along with various other projects. This compares to 36 customers representing 133 projects in 2011.

In 2012, 48% of our revenues were generated from Phase III studies compared to 51% in 2011. Additionally, for the year ended December 31, 2012, oncology, musculoskeletal and other projects represented 69%, 21%, and 10%, respectively, of our revenues. This compares to 77%, 18%, and 5%, respectively, for 2011.

Research and Development

Research and development costs increased in 2012 by $153,000, or 11%, to $1,603,000, when compared to 2011. The increase was due to hiring within our software development group and consultant and professional fees in support of our personalized medicine initiative, along with our efforts to secure our first 510k with the FDA. Our research and development efforts within our core business 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 and improve our gross margin. Additionally, we continue to invest in the commercialization of new imaging techniques across various imaging modalities and therapeutic areas. As of December 31, 2012 and 2011, there were 14 and 12 employees in our research and development group, respectively, which includes the algorithm and software development groups.

Sales and Marketing

Sales and marketing costs increased in 2012 by $292,000, or 26%, to $1,411,000, when compared to 2011. The increase was the result of hiring two experienced sales individuals to cover the European and West Coast US territories in 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. During 2012, we made further investments in driving awareness of our strategic alliance with PPD and the benefits it provides the pharmaceutical and medical device industries. The PPD alliance was expanded in January 2012 to include cardiovascular, central nervous system and medical device studies. As December 31, 2012 and 2011, there were 7 and 4 individuals in our sales and marketing department, respectively.

General and Administrative

General and administrative expenses for the year ended December 31, 2012 were $3,060,000, representing a decrease of $118,000 or 4%, when compared to 2011. The decrease was driven by a reduction in non-cash stock compensation costs and general cost controls within our core business offset by hiring within our quality control group and consultant fees in support of our personalized medicine initiative. 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 decreased for the year ended December 31, 2012 by $58,000 or 12%, to $421,000, when compared to 2011. The reduction is due to the complete amortization of our right to use an MRI unit at the University of Rochester (a related party) during 2011. Offsetting this reduction was higher depreciation charges related to recent capital purchases, including the purchase and installation cost of an ERP system in 2011. The amortization and depreciation costs are based on the timing and life of patents and property and equipment. We continue to invest in our patent portfolio, however, we do not anticipate significant expenditures are necessary to support our current business and future strategies. Our IT systems are the basis of our operating platform, therefore, we will continue to invest in our IT infrastructure to ensure we have a robust and reliable operating system.

Other income(expense), net

Interest income for the year ended December 31, 2012 was $3,000, representing interest derived on the Company's operating and savings accounts, compared to interest income of $18,000 in 2011. The decrease in interest income was due to lower interest rates earned on the account balances in 2012. Other expense for the years ended December 31, 2012 and 2011 remained relatively consistent, decreasing to $24,000 from $32,000. Additionally, we recognized an unrealized loss of $265,000 related to the fair value of certain warrants that were issued in connection with our 2007 Series B offering (see Financial Statement Note 5). During 2011, we recognized an unrealized gain of $669,000 related to the fair value of those warrants. The aggregate decrease of $934,000 when compared to 2011 is attributable to the higher average price of our common stock prior to closing the Series C-1 financing in April 2012 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 December 31, 2012, the Company had 214,229 warrants outstanding subject to the anti-dilution adjustment provision as compared to the 902,038 at December 31, 2011.

Net Income (Loss)

Our net loss for the year ended December 31, 2012 was $1,529,000 compared to a net income of $703,000 for the year ended December 31, 2011. The decrease in our net income over the prior period was attributable to lower revenues and gross profit in addition to the non-cash unrealized loss on the change in fair value of derivative liabilities, as discussed above.

Liquidity and Capital Resources

Our working capital as of December 31, 2012 and 2011 was approximately $8,972,000 and $6,353,000, respectively. The increase in working capital was primarily a result of the financing agreement we entered into during 2012 with Merck GHI that resulted in the receipt of net proceeds of approximately $2,700,000. Additionally, there was cash provided by operating activities of $43,000 in 2012 as compared to $1,443,000 in 2011 due to the timing differences of non-cash expenses and the receipt of accounts receivables during the years.

We invested $194,000 in the purchase of equipment and the acquisition of patents in 2012, compared to $419,000 for the investment in these items in 2011. The decrease represents prior year investments in our IT and IS infrastructure and the costs associated with the acquisition of a new IT storage system to support our services that did not reoccur in 2012. We anticipate that our IT related costs will increase in 2013 as we continue to invest in our operating system and infrastructure in connection with our personalized medicine initiative and support of our core business. During 2012 we incurred $23,000 in patent costs associated with filing costs for intellectual property, as compared to $7,000 in 2011. The increase is due to the timing of office actions within our existing patent filings.

Net cash provided in financing activities was $2,937,000 and $137,000 in 2012 and 2011, respectively. The increase is a result of proceeds received from the exercise of options and warrants and the closing of the financing with Merck GHI during 2012.The terms of the Merck GHI financing provide for a second closing of series C-2 preferred stock, if, among other things, we meet certain milestones toward the development of a quantitative imaging center on or before April 3, 2013. We do not expect that this second closing will occur, however, we intend to continue to pursue our efforts in support of obtaining FDA acceptance.

We currently expect that existing cash will be sufficient to fund our existing operations for the next 12 months and foreseeable future. Although we believe we have sufficient capital to continue our efforts to commercialize our personalized medicine solutions in the short term, our capital requirements will depend on the feedback we receive from the FDA and insurance providers (payers). As a result, there can be no assurance that we will have sufficient capital available to successfully commercialize our personalized medicine applications. If in the future our plans or assumptions change or prove to be inaccurate, we may be required to seek additional capital through public or private debt or equity financings. If we need to raise additional funds, we may not be able to do so on terms favorable to us, or at all. If we cannot raise sufficient funds on acceptable terms, we may have to curtail our level of expenditures and our rate of expansion.

Off Balance Sheet Arrangements

We have no off-balance sheet arrangements, other than operating leases (as described in "Contractual Obligations" below) that have or are reasonably likely to have a current or future effect that is material to investors on our financial condition, revenues or expenses, results of operations, liquidity, capital resources or capital expenditures.

Contractual Obligations

The following table summarizes our contractual obligations at December 31, 2012 which we expect to have an effect on our liquidity and cash flow in future periods. (See Item 2: Description of Property for a full description of our lease obligations.)

                             Payments Due by Period
                                   Less than
                      Total          1 Year        1-5 Years

Operating Leases   $ 1,455,206     $  313,471     $ 1,141,735

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