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VIRTUALSCOPICS, INC. - 10-K - : Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) 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, 2013 and 2012, 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. 22 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, fatty liver disease, neurology, cardiovascular, and osteoarthritis. We have also derived a small portion of revenue from consulting services. We expect that the concentration of our revenue will continue in these services and in those areas in 2014. Revenues are recognized as the medical images that we process are quantified and delivered to our customers and/or the services are performed. As of December 31, 2013, the amount remaining to be earned from active projects and awards was approximately $24 million. 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, 2013 Compared to Year Ended December 31, 2012 Revenues We had revenues of $11,174,000 for the year ended December 31, 2013 compared to $12,963,000 for the year ended December 31, 2012, representing a 14% decrease. The decrease in revenues is related to the slowdown in the amount of new projects awarded in 2012, the effects of which slowdown carried over into 2013. Revenues were also impacted by the timing of the initiation of awarded and contracted projects and the large number of studies that had been completed in 2013. During the life of a project, quite often there is an expansion in the size of the study. However there are also situations where the sponsor does not recruit the number of subjects or sites as originally budgeted and in those cases there are remaining dollars at the end of the study that will not be realized into revenue. These amounts are reconciled and removed from the backlog. Over the past 15 months we have reorganized our sales function, which allows our sales personnel more time to pursue opportunities and interface with existing and prospective customers. As a result of these changes, we have experienced an increased number of proposals to 257 during 2013 as compared 216 from the same period in 2012, in particular through our strategic alliance with PPD, Inc. We believe that this increase in requests for proposals and our strategic alliance with PPD, Inc. will continue to increase the level of business activity into 2014. As of December 31, 2013, 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 $4,419,000 for the year ended December 31, 2013 compared to $5,251,000 for the comparable period in 2012. The gross margin for the year ended December 31, 2013 was 40% compared to 41% for the year ended December 31, 2012. Our margins declined year over year primarily as a result of the decrease in revenues encountered during 2013 as discussed above and the mix of services performed during 2013. Historically, we have experienced lower margins in our musculoskeletal projects than our oncology projects. 23 During 2013, we performed work for 35 customers, representing 138 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 31 customers representing 123 projects in 2012. In 2013, 47% of our revenues were generated from Phase III studies compared to 48% in 2012. Additionally, for the year ended December 31, 2013, oncology, musculoskeletal and other projects represented 59%, 26%, and 15%, respectively, of our revenues. This compares to 69%, 21%, and 10%, respectively, for 2012. Research and Development Research and development costs decreased in 2013 by $92,000, or 6%, to $1,511,000, when compared to 2012. The decrease was the result of three employees terminating employment without being replaced in early third quarter of 2013 and no additional monies being spent on the personalized medicine initiative during the fourth quarter of 2013. These cost reductions were partially offset by an increase in employment incentives during the twelve month ended December 31, 2013. We are currently reevaluating our approach in this personalized medicine opportunity and have delayed any additional work on this application. 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, 2013 and 2012, respectively, there were 11 and 14 employees in our research and development group. Sales and Marketing Sales and marketing costs increased in 2013 by $145,000, or 10%, to $1,556,000, when compared to 2012. 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. Additionally, we experienced an increase in bookings, due to our sales and marketing initiatives, which resulted in higher commissions during the year ended December 31, 2013 as compared to the same period in 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 2013, 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. General and Administrative General and administrative expenses for the year ended December 31, 2013 were $3,749,000, representing an increase of $669,000 or 22%, when compared to 2012. The increase was driven by expenses realized as part of the former CEO's separation agreement and the associated search for a replacement, and the legal, franchise, and other fees associated with the reverse stock split transaction and business initiatives, offset by a decrease in stock compensation. 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, 2013 by $54,000 or 13%, to $367,000, when compared to 2012. The reduction was due to a number of capital assets becoming completely depreciated during 2013 and reductions in spending for capital purchases during 2012. 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. 24 Other income (expense), net Interest income for the year ended December 31, 2013 was $6,000, representing interest derived on the Company's operating and savings accounts, compared to interest income of $3,000 in 2012. Additionally, we recognized an unrealized gain of $16,000 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 2012, we recognized an unrealized loss of $265,000 related to the fair value of those warrants. The aggregate increase of $281,000 when compared to 2012 is attributable to the lower average price of our common stock during 2013 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 that occurred in April 2012. Net Loss Our net loss for the year ended December 31, 2013 was $2,745,000 compared to a net loss of $1,529,000 for the year ended December 31, 2012. The increase in our net loss over the prior period was attributable to lower revenues and gross profit during 2013 in addition to the expenditures relating to the former CEO's separation, search for a replacement, and fees incurred in connection with our reverse stock split. Liquidity and Capital Resources Our working capital as of December 31, 2013 and 2012 was approximately $6,731,000 and $8,972,000, respectively. The decrease in working capital was primarily a result of the decline in revenue resulting in additional cash used in operations. We do not expect, nor have we experienced, significant write-offs within our receivables, however, we continue to see an extension of payment terms within the industry and with several of our largest customers. Net cash used in operating activities totaled $1,126,000 in the twelve months ended December 31, 2013 compared to net cash provided in operating activities of $43,000 in the comparable 2012 period. The increase in the use of cash is mostly due to the decrease in revenues and the timing of receipts from customers in 2013 as compared to the previous year. We invested $67,000 in the purchase of equipment and the costs in patent applications and their maintenance in 2013, compared to $194,000 for the investment in these items in 2012. The decrease reflects investments in our IT and IS infrastructure in 2012 that did not reoccur in 2013. In 2014, we are planning to investment in our operating systems and infrastructure in connection with our core business. We believe these planned investments will help further enhance our abilities as a Phase III provider and continue to improve our operational efficiencies. During 2013 we incurred $18,000 in patent costs associated with filing costs for intellectual property, as compared to $23,000 in 2012. The decrease is due to the timing of office actions on our existing patent filings. Net cash provided in financing activities was $0 and $2,937,000 in 2013 and 2012, respectively. The decrease was a result of no financing transactions occurring during 2013 as compared to the previous year when we received proceeds from the exercise of options and warrants and the closing of the investment by Merck Global Health Innovation Fund, LLC in 2012. 25 We currently expect that existing cash will be sufficient to fund our existing operations for the next 12 months and foreseeable future. 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, our rate of expansion or our business operations. 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, 2013 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 1-4 Years Operating Leases $ 1,141,735 $ 318,409 $ 823,326 |