Indicate by check mark if the registrant
is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Indicate by check mark if the registrant
is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated
filer,” “accelerated filer” and “smaller reporting” in Rule 12b-2 of the Exchange Act.
Documents Incorporated By Reference:
Portions of the Company's Proxy Statement to be delivered to the Company’s stockholders in connection with the Company’s
2016 Annual Meeting of Stockholders, which the Company plans to file with the Securities and Exchange Commission pursuant to Regulation 14A
promulgated under the Securities Exchange Act of 1934, on or prior to April 30, 2016, are incorporated by reference in Part III
(Items 10, 11, 12, 13 and 14) of this Form 10-K.
PART I
FORWARD-LOOKING STATEMENTS
Some of the statements under the captions
of this report on Form 10-K titled “Risk Factors,” “Management's Discussion and Analysis of Financial Condition
and Results of Operations” or “Business,” contained or incorporated by reference elsewhere in this report, and
in our other reports filed with the Securities Exchange Commission (“SEC”) constitute “forward-looking statements”
within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of
1934, as amended, which involve risks and uncertainties. These statements are made pursuant to the safe harbor provisions 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:
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adverse
economic conditions;
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loss
of market share due to competing products and services;
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unexpected
costs, lower than expected sales and revenues, and operating defects;
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study
cancellations and delays in the startup of trials;
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adverse
results of any legal proceedings;
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the
volatility of our operating results and financial condition;
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inability
to attract or retain qualified senior management and scientific personnel;
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inability
to recognize all of the revenue included in our backlog
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inability
to raise sufficient additional capital to operate our business, if necessary;
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changes
in government regulations; and
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other
specific risks that may be referred to in this report.
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All statements, other than statements
of historical facts, included in this report 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 “Risk Factors” and elsewhere in this report. These risk factors qualify
all forward-looking statements attributable to us or persons acting on our behalf.
Information regarding market and industry
statistics contained in this report is included based on information available to us that we believe is accurate. It is generally
based on academic and other publications that are not produced for purposes of securities offerings or economic analysis. We have
not reviewed or included data from all sources, and we cannot assure our stockholders or potential investors of the accuracy or
completeness of the data included in this report. Forecasts and other forward-looking information obtained from these sources
are subject to the same qualifications and the additional uncertainties accompanying any estimates of future market size, revenue
and market acceptance of products and services. We have no obligation to update forward-looking information to reflect actual
results or changes in assumptions or other factors that could affect those statements. See “Risk Factors” for a more
detailed discussion of uncertainties and risks that may have an impact on future results.
ITEM 1: Business
We are a provider of quantitative imaging
services currently serving the pharmaceutical and biotechnology industries in early and late stage clinical trials. We have created
a suite of image analysis software tools and applications which are used in detecting and measuring specific anatomical structures
and metabolic activity using medical images. Our proprietary software and algorithms provide measurement capabilities designed
to improve clinical research and development. We focus on applying our imaging technology to improve the efficiency and effectiveness
of the pharmaceutical research and development processes. We believe our technology can also be used in improving the treatment
planning for patients with cancer and other debilitating diseases. We are a Delaware corporation formed in 1988.
Business Overview
Our image-based measurement and visualization
tools enable accurate and reproducible measurement of minute changes that occur in anatomic structures in oncology, cardiology,
neurology, and musculoskeletal diseases. These tools can significantly alleviate or reduce clinical development bottlenecks by
increasing the speed, accuracy and reliability of the demonstration of a new compound’s efficacy. Further, these measurements
can be used to assess the viability of continuing a drug development project and eliminate as soon as possible further investigation
of a drug that is likely to fail. Early termination is critical to the pharmaceutical industry to prevent the expenditure of research
and development (R&D) funds on a drug that will not perform as expected. We believe that this is especially important today
with the large number of compounds that are awaiting evaluation.
On March 25, 2016, the Company entered
into a definitive merger agreement with Biotelemetry, Inc. pursuant to which BioTelemetry proposes to acquire VirtualScopics. The
transaction is structured as a tender offer for the Company’s outstanding voting shares followed by a second-step merger.
The total consideration is $15.5 million dollars, payable in cash, which includes a price per share to common shareholders of $4.05
per common share. We expect the transaction, which is subject to customary closing conditions, to be completed in the second quarter
of 2016.
Benefits to Pharmaceutical and Biotech
Companies
The benefits to pharmaceutical companies
from using our services, which are performed with our image analysis tools, can include shorter clinical development time and
earlier determination of the effectiveness or ineffectiveness of a new drug or compound. Our technology helps to curtail trials
that are not likely to be beneficial and to avoid mistaken termination of the investigation of compounds that are likely to prove
efficacious, through:
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improved
precision in the measurement of traditional imaging biomarkers resulting in shorter observation
periods, with beneficial cost savings within a clinical trial;
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advanced
imaging biomarkers, which are better correlated with disease states, again reducing trial
length and therefore costs; and
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reduced
processing time for image data analysis through semi-automation.
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In addition, our technology reduces aggregate
clinical development costs through:
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improved
precision of traditional imaging biomarkers, thus requiring smaller patient populations
and lower administrative costs; and
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advanced
imaging biomarkers that serve as better correlates, leading to better early screening
and elimination of weak drug candidates in pre-clinical and early phase trials.
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Our Technology Solution
We have a database-driven workflow and image analysis system,
which keeps Title 21 Code of Federal Regulations (CFR) Part 11-compliant electronic records (a complete audit trail) of all data
intervention and events that the image data go through while at VirtualScopics. Our software engineers and scientists have developed
and validated a series of fully-integrated programs for project set-up, execution, and delivery. The VirtualScopics Production
Platform has been in continuous use in our core lab since April 2003, and has been successfully audited by numerous leading pharmaceutical
and biotechnology companies.
Oncology Applications
Automated Measurement of Tumor Structure in Oncology
Volumetric imaging modalities such as
X-Ray, Computed Tomography (CT), Magnetic Resonance Imaging (MRI), and Positron Emission Tomography (PET) can provide a wealth
of information about tumor size, structure, and function. However, the standard for clinical assessment of both tumor response
to therapy and disease progression, the Response Evaluation Criteria in Solid Tumors (RECIST), focuses on the measurement of a
single diameter in the axial plane for each measurable tumor, ignoring much of the additional structure and volume information.
VirtualScopics has developed a system which allows the rapid and efficient assessment of oncology patients per standard RECIST
criteria, while also permitting the measurement of more sensitive measures including tumor volume, tumor metabolic rate via FDG-PET,
tumor mitotic rate via FLT-PET, or tumor cellular density via diffusion MRI. VirtualScopics’ flexible workflow engine allows
us to efficiently handle both large Phase III studies for which RECIST evaluation is the only endpoint, and smaller Phase I and
Phase II studies where sponsors may need much more detailed information in order to make go/no-go decisions based on small patient
populations.
Innovation in Image-Based Biomarkers
With a multidisciplinary team of medical
professionals (including staff radiologists), scientists and software developers, we deliver unparalleled innovation in the analysis
of specific biomarkers. Measurements may include specific Food and Drug Administration (FDA) acknowledged (e.g. RECIST) biomarkers
as well as secondary or exploratory endpoints such as cavitation/necrosis, cellular density, or metabolic rate. By extracting
substantially more information from existing imaging modalities such as CT or MRI, we believe we offer a more definite and efficient
basis for determining the course of clinical trials.
Whether a trial is assessing longest diameter,
sum of the products of diameters (SPD), tumor volume or other oncology endpoints, VirtualScopics analyzes imaging data and delivers
structural and volumetric measurements for a variety of oncology assessment criteria including:
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IWG
Criteria for Assessment of Lymphoma (Cheson Criteria)
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Criteria
for Assessment of Malignant Glioma (MacDonald Criteria)
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Response
Assessment in Neuro-Oncology (RANO)
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Immune-Related
Response Assessment Criteria (irRC and irRECIST)
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In addition, VirtualScopics will implement
sponsor-requested modifications to published criteria, and provide additional quantitative analysis utilizing custom algorithms
to measure tumor volume or organ volume.
Measurement of Blood Flow and Metabolic
Activity
A number of anti-cancer drugs both on
the market and under development are designed to reduce the blood supply available to tumors, thereby depriving them of the ability
to grow and spread. During development, evaluation of these compounds requires the ability to accurately measure blood flow and
vascular permeability in
vivo,
in order to determine dose-response relationships and compound efficacy. In the clinic,
this same capability is necessary in order to determine whether a particular patient is responding to treatment. We have developed
a method, using dynamic contrast enhanced magnetic resonance imaging (DCE-MRI), to accomplish this. This technique involves repeated
imaging, generally every two to six seconds, for a period of several minutes before and after the injection of a gadolinium-based,
FDA-approved, contrast agent. Contrast concentration changes over time can then be measured both in normal and cancerous tissues,
and based on this information parameters such as blood flow, blood volume and vascular permeability can be derived. These parameters
have been shown to relate directly to the activity of anti-angiogenesis and anti-vascular cancer drugs, and to allow the prediction
of response or failure after only a few days of treatment.
Immuno-Oncology
While using the body’s own immune
system as a therapeutic approach to fight cancer is not a new concept in oncology, recent successes in clinical studies are making
immunotherapy a reality. Immunotherapy represents a paradigm shift. Instead of targeting cancer cells directly like radiation,
chemotherapies, and some other targeted therapies, immunotherapy exploits the antitumor capabilities of resident immune cells
within the body. Recent therapies have focused on using vaccines, oncolytic viruses, and antibodies aimed at blocking immune checkpoints
to initiate antitumor responses. The latter of these, immune checkpoint inhibitors, are being considered the “game changers”
in cancer immunotherapy. Although clinical experience with this type of immunotherapy is still in its infancy, the potential for
immune checkpoint inhibitors to elicit durable cures has brought new hope to oncology. VirtualScopics provides unparalleled imaging
solutions for immunotherapeutic clinical trials. In addition to having the experience and knowledge to help sponsors meet their
imaging endpoints, our highly experienced and well trained radiologists provide accurate assessments of response and disease utilizing
many different response criteria including Immune-Related Response Criteria
(
irRC) or Immune-Related
Response Evaluation Criteria in Solid Tumors (irRECIST).
Musculoskeletal Applications
Our image analysis provides a degree of
accuracy and reproducibility that cannot be duplicated by manual techniques. Traditional radiologic interpretation of medical
images is qualitative and subjective. Using semi-automated, computer-assisted assessment techniques produces quantitative results
that are accurate, reproducible and objective. Unlike manual assessment methods, our computer-aided approach allows the user to
track the boundary location of each structure in a data set from one scan to another, even if the patient is not positioned in
precisely the same way for each scan, or if there have been some anatomical changes between scans. For cartilage volumes and thickness
measurements, the Coefficient of Variation (CV) typically falls between 2% and 4% - we can detect minute changes with statistical
confidence, allowing our clients to reduce study populations or shorten study durations. For changes in muscle volume, our semi-automated
algorithms decrease the variability to below 1%. With our semi-automated analysis, researchers can more confidently make the go/no
go decision for a compound early in the evaluation process, allowing scarce resources to be allocated to the most promising candidates.
The reason for this is two-fold: the algorithms that identify the boundaries are both accurate and reproducible, and the time-savings
produced by the algorithm reduces reader fatigue – instead of spending six hours reading a case, the reader is able to complete
their analysis in about 25% of the time or less.
Reproducible medical image analysis is
driven by computer image analysis algorithms that enable quantitative measurement of different structural parameters. Guided by
the information present in the images, as well as embedded anatomical knowledge, the algorithms enable segmentation of different
structures. From an MRI knee scan, for instance, it is possible to produce a three-dimensional reconstruction that graphically
distinguishes cartilage from underlying bone, as well as from ligaments, fluid, degenerated menisci or inflamed synovium. This
capability provides a valuable assessment tool for clinical research in osteoarthritis - a disease with multiple endpoints - because
it allows sensitive and specific measurement of all the components of the knee joint and detects small changes in any of those
components over time.
Fatty Liver Disease
Many diseases and safety assessments benefit
from the ability to calculate accurate hepatic fat fractions. As an example, non-alcoholic fatty liver disease (NAFLD) has become
increasingly prevalent with an estimated of 19% of adults in the US (28.8 million) suffering from NAFLD. Traditional methods for
determining hepatic fat fraction are either extremely invasive (liver biopsy), qualitative (ultrasound), not widespread in clinical
practice (magnetic resonance spectroscopy or MRS), or not particularly accurate (in- and out-of-phase dual-echo magnetic resonance
imaging or MRI). VirtualScopics worked with a research organization and a sponsor to demonstrate that there is a much more accurate,
non-invasive, quantitative technique utilizing MRI that works on most clinical magnets. The results of this study were published
in the Journal of Magnetic Resonance Imaging in June of 2013. VirtualScopics has utilized this technique to evaluate the hepatic
fat fraction of clinical trial subjects nearly 2,000 times.
Cardiovascular Applications
Cardiovascular disease is one of the leading
causes of mortality within most developed countries. Cardiac toxicity is also one of the most common and most dangerous side-effects
of a wide range of drugs. Oncology drugs in particular are known to often have adverse effects on cardiac function, and assessment
of changes in cardiac function is an important part of the safety evaluation of nearly all oncology drugs. It is therefore very
important to have efficient and accurate methods for assessing cardiac function in a clinical trial setting. VirtualScopics has
integrated third party cardiac imaging software packages, which are FDA-approved medical devices, with our workflow engine and
analysis platform. This allows us to provide a wide range of cardiovascular safety and efficacy endpoints to our customers in
a reliable and efficient manner, including:
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Automatic
import of measurement values from ultrasound systems
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Availability
of all current 2D Echo-, M-Mode- and Doppler measurements
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Measurement
of up to five values for each parameter
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Fast
and flexible composition of relevant image data ensured by intuitive user interface
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Side-by-side
comparison of current and previous examinations (DXA and Echo)
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Comfortable
analysis of image sequences using video functions
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Export
of image-data to AVI, BMP, JPEG or DICOM format
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The capabilities provided by these software
packages, combined with VirtualScopics’ team of cardiologists and radiologists, have allowed VirtualScopics to take on trials
which include a wide variety of cardiovascular endpoints including change in left ventricular ejection fraction, change in valve
and wall motion, and cardiac strain assessment.
Neurology Applications
Evaluating diseases such as multiple sclerosis
(MS), epilepsy, and Alzheimer’s requires the identification and measurement of neurological structures and lesions. Manual
tracing, especially of abnormal neurological structures, requires considerable expertise and time. Tracing introduces significant
variability even when all measurements are made by one individual, an effect that is compounded with multiple operators. Intra-
and inter-operator variability poses a major obstacle for researchers attempting to take advantage of the power of MRI analysis
in the study of neurological disease. VirtualScopics eliminates these problems with semi-automated, statistically driven feature
analysis. Our algorithms employ the two types of knowledge that expert radiologists use to measure structures within the brain:
differentiation of various tissue types and knowledge of structure, size, location, and shape. Our software incorporates
a
priori
model of neurological anatomy that enables the measurement of structures with indistinct boundaries such as the hippocampus.
Knowledge of anatomical structures also improves reproducibility, allowing disease progression to be precisely monitored over
time.
Operational Excellence
VirtualScopics strives for operational
excellence using Lean Six Sigma methodologies and specific metrics that drive improved efficiencies and repeatable processes.
The Operations team becomes involved as early as the quoting process to identify the best methods to meet project deliverables.
Our Operations team is driven to make deliveries that are complete, on time and right the first time. We developed a customized
resource planning tool to forecast peak project resource requirements and key performance indicators to successfully monitor all
timelines and milestones. We offer the scientific guidance to provide imaging assistance during protocol development and throughout
the study. All processes are designed for maximum flexibility to meet the changing needs of any project team. Scientists, radiology
staff, technologists, trainers and project management are readily available for quick-turnaround responses to site and sponsor
questions/issues. Discussions around escalations, priorities and study updates are part of our daily routine and weekly meetings
to provide a forum for lessons learned, experience sharing and cross training.
Project Management
Project managers work with the sponsor
team to identify and mitigate risks as well as to ensure project milestones are met. The VirtualScopics team takes the extra time
and effort to fully understand clinical trial imaging protocols and deliverables at the inception of each project. Each project
has a dedicated project manager and senior project manager. Other resources, such as an associate project manager, are available
to join the project as needed. The project manager uses VirtualScopics’ databases to deliver key site status and subject
trackers to the clinical teams as requested.
Ensuring Accurate Image Acquisition
Timely and accurate image acquisition
is crucial to executing an efficient clinical trial. VirtualScopics’ site management group has developed a systematic site
qualification process to ensure our radiologists have the correct data required for image analysis including choosing and qualifying
the proper site equipment, customizing imaging personnel training with a variety of methods available to properly fit the study
requirements, providing technical support to the site(s) including assistance in managing, monitoring and coordinating the conduct
of the imaging portion of the study, and continuing communication and feedback with site personnel and study teams.
Confidence through Collaboration
and Quality Data
Receiving quality images from sites is
key to running successful clinical trials. From image acquisition to image analysis, the quality of the data impacts the quality
of decisions made. Our experienced in-house technologists inspect 100% of incoming images and ensure that image acquisition adheres
to study protocols. VirtualScopics has the expertise to properly handle the imaging modalities required for all of our key therapeutic
areas. Our inspection team can receive images in multiple ways including courier, sFTP or third-party electronic image transfer
systems. Each image is loaded onto our 21 CFR Part 11-compliant platform which provides a full audit trail of analyses performed.
Our Image Inspection department provides cross training to the entire inspection team. Cross training ensures that images are
processed efficiently and within contracted timelines. Each technologist is trained to the department standard operating procedures
as well as the individual project protocol and image acquisition requirements. The department manager performs monthly audits
of the technologists’ work to ensure that the team is following appropriate processes and procedures.
Collaboration of Science, Software
and Medicine
Our Image Analysis team consists of certified
technologists working alongside in-house radiologists and an extensive global network of contract radiologists. Each radiologist
has broad experience with the disease/indication response criteria in order to fulfill specific study requirements. VirtualScopics
will also leverages the Scientific Advisory Board to stay up to date on new imaging endpoints and response assessment criteria.
Board members also foster strong relationships with a global network of key opinion leaders (KOLs). In collaboration with the
sponsor, VirtualScopics’ strong medical and imaging expertise is used to draft the Imaging Review Charter (IRC). This charter
outlines the image acquisition and medical image analysis specifications, enabling the flexible operational teams to rapidly deliver
quality image analysis results using our proven read paradigm designs. In addition, our robust image analysis team has developed
proven processes to conduct analyses with quick turnaround times (TATs) for patient eligibility and/or confirmation of disease
progression requirements.
Image Analysis Transfer
Timely, accurate results are vital to
our sponsors and enable clinical trials to stay on schedule. We work with sponsors to provide data in the form and format requested
and on time and on budget.
Sales and Marketing
Our business development strategy is focused
on the publication and presentation of our technology and services at targeted industry conferences along with an active marketing
effort aimed at pharmaceutical and biotechnology companies. It is based on a segmented and targeted approach relative to account
type, sales channel, therapeutic area, and study phase. The Sales plan consists of the positioning of our core imaging services
through direct selling efforts and through our sales channels with PPD, IXICO, and Micron. We focus on building relationships
with our customers as collaboration partners providing them with operational excellence in the performance of their studies which
increases the opportunity for repeat business.
In late 2010 we aligned with PPD, a leading
global clinical research organization (CRO), to provide our customers with a complete solution encompassing all services for clinical
trial execution. We have recently amended the alliance too eliminate the marketing exclusivity portion of the agreement. Clients
can choose from our standalone offering (with the CRO of their choice) or the joint solution offered in conjunction with PPD.
In 2014, VirtualScopics and IXICO, plc, two established science-led Imaging CROs, came together in a formal commercial alliance
to deliver world class imaging services to the pharmaceutical industry. Together we have extensive clinical trial experience and
provide global capabilities with offices in Rochester (New York) and New Hope (Pennsylvania) as well as London (UK). In 2015,
VirtualScopics entered into a collaborative agreement with Micron Inc., a Tokyo-based imaging core lab. The relationship between
VirtualScopics and Micron provides a solution to mitigate the risks often associated with running a clinical study in the Asia-Pacific
region. The alliances and collaborations we have with PPD, IXICO, and Micron has furthered our global reach while allowing us
to advance our collaborative culture, expand our knowledge and enhance our efficiency.
During 2015, we performed services on
new and existing contracts with 8 of the 10 leading pharmaceutical and biotechnology companies. In total, we performed services
on 160 projects for 35 customers. We continue to grow our business through referrals and by leveraging relationships with our
current customers and through referrals. As a result, our current customers have been instrumental in introducing us to other
therapeutic groups within their organizations. Our marketing efforts are instrumental in broadening the awareness of VirtualScopics
throughout the industry and educating current customers on the breadth of our services.
Backlog
Backlog represents anticipated service
revenue from work not yet completed or performed under signed contracts. Once work commences, revenue is generally recognized
over the life of the contract as services are provided. Backlog at December 31, 2015 was approximately $36 million, compared with
approximately $29 million at December 31, 2014, an increase of 24%. Subject to the matters addressed in the following paragraph,
we believe that approximately $23 million of the backlog will not be recognized as revenue in our fiscal year ending December
31, 2016.
We believe that backlog is a useful measure
for management and investors to evaluate our business activity. Nonetheless, there are several factors that can affect whether
we will realize the full benefits of projects included in the backlog and the time over which we will realize that revenue. These
factors include customers terminating, delaying, or changing the scope of a project for a variety of reasons including, among
others, the failure of drugs being tested to satisfy safety requirements, unexpected or undesirable clinical results, client decisions
to forego a particular study, and insufficient patient enrollment or investigator recruitment. 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. As a result, we cannot assure you amounts included in our backlog will be indicative
of future results.
Industry Background and Market Trends
Industry Overview
The global pharmaceutical market is expected
to reach nearly $1.4 trillion by 2020, an increase of about 29-32 percent over the 2015 level. Volume growth will be driven by
demographic trends such as an aging population in developed markets and rising incomes and expanded access to healthcare in pharmerging
markets (i.e. developing markets where the use of pharmaceuticals is growing rapidly). The remainder of the increase in spending
will be driven by the costs of medicines which increase due to the wider adoption of newer more expensive therapies and an increase
in prices per unit which occur in some countries, notably the United States.
1
The
Center for Drug Evaluation and Research (“CDER”) approved 45 new molecular entities
or
“NMEs” in 2015, which is more than the average number approved annually during the past decade. For instance from
2006 through 2014, CDER has averaged about 28 NME approvals per year.
2
On average, it takes more than 10 years
for a new medicine to go through the entire R&D process, from the time the compound is identified to when it receives approval
from the US FDA. The average cost to develop a new medicine is estimated to be $2.6 billion. This number accounts for the cost
of failures, as many of the initial investigative compounds that are developed will not make it through to FDA approval. Reflecting
the growing complexity of the process, the total cost of development more than doubled in the last decade. Only 12% of the investigative
medicines that enter phase I clinical trials will make it to FDA approval.
3
Drug Development Process
Typically, most functions of the drug
R&D process are managed by clinical research organizations, or CROs. Most biopharma companies are at the end of multi-year
patent cliffs and are stepping up investments in their late stage pipelines. The sector is expecting growth with a CAGR of 5-6
percent through 2018. The market is highly concentrated with the top ten players accounting for more than 50% of the CRO Market.
The leading CROs by amount of estimated market share are Quintiles (15%), Covance (9%), Parexel (8%), PRA International (7-8%),
and PPD (6-7%).
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Although the FDA has reduced the average
approval time for new drugs, clinical development time has been increasing over the years, resulting in total development time
being fairly flat in recent years. Growing complexities in protocol design leading to longer clinical development times has been
the major contributor to the rising costs that sponsors are facing.
The current trend
in drug development is for pharmaceutical companies to shift towards a niche market. The 'one size fits all' approach is being
replaced by a more targeted, innovative approach to develop treatments for small patient groups with complicated diseases such
as cancer, rheumatoid arthritis and immune disorders. Such 'niche buster drugs' are expected to exploit new technologies such
as biomarkers and theranostics, the integration of therapeutics and diagnostics.
With the U.S.
administration implementing health care reform, increased regulatory oversight and pressure on drug companies to reduce prices,
we believe there is a need for R&D to become more efficient and reduce costs to prevent an innovation slowdown in the industry.
Due to these
factors, we believe our quantitative imaging analyses offer solutions to these issues within drug development by providing more
precise and reliable information in the assessment of compounds being developed. We believe our increased precision and reproducibility
enable our customers to make more confident decisions on the efficacy of their compounds.
1
IMS Institute for Healthcare Informatics –
The Global Use of Medicines: Outlook through 2020
2
Food and Drug Administration – 2015 Novel
New Drugs Summary
3
2015 Profile Biopharmaceutical Research Industry
4
Results Healthcare – 2013 CRO’s and Other Outsourced Pharmaceutical Support Services
Quantitative Image Analysis Services
We have conducted research to determine
the size of the market for image analysis services in clinical trials supporting the pharmaceutical and biotech industries. Based
on our research and discussion within the imaging CRO and drug development industries, we have found that the market is highly
competitive and fragmented, with approximately $750 million in total annual revenues projected for 2016. As competition increases,
we will look to provide value-added services and undertake marketing and sales programs to differentiate our services based on
our technology, expertise, and experience in specific therapeutic areas. Competition has resulted in additional pressure
being placed on price, service and quality with the recent consolidations within the industry over the past few years.
Intellectual Property
We consider our proprietary and patented
technology and the technology for which we have applied for patent protection to be of importance to our business plan. We hold
eight patents issued by the United States Patent and Trademark Office. These patents will expire between 2020 and 2028. We have
also applied for a number of other patents, both domestically and in foreign jurisdictions. To protect our proprietary technology,
we rely primarily on a combination of confidentiality procedures and copyright, trademark and patent laws. Our policy is to require
employees and consultants to execute confidentiality and invention assignment agreements upon the commencement of their relationship
with the Company. These agreements provide that confidential information developed or made known during the course of a relationship
with the Company must be kept confidential and not disclosed to third parties except in specific circumstances and for the assignment
to VirtualScopics of intellectual property rights developed within the scope of the relationship.
Competition
Our main competitors are imaging CROs
(iCROs) providing clinical trial services to pharmaceutical companies. As of the date of this report, we believe that none of
the leading imaging CROs have technology capabilities that are comparable to our technology. iCROs typically provide manual and
non-differentiated interpretation of medical images for the pharmaceutical industry. As a result, we believe that currently there
is an opportunity for us to establish a technology advantage and a set of differentiated services in the advanced image-based
biomarker market.
The main CROs which participate in imaging
trials are Perceptive, Icon, and BioClinica. Additionally, some academic centers have worked on software that has applications
for neurological diseases. However, we believe these academic centers lack the required FDA compliance standards and ability to
scale their operations to meet customer demand and we believe they offer inferior technology. Nonetheless, larger enterprises such
as these have greater resources and efficiencies than our company and have other competitive advantages. This increases our need
to invest in our infrastructrue to compete with these larger enterprises.
Our technology competition is largely
comprised of a limited number of university research centers that are developing the next generation of image analysis tools.
Aside from university centers, there are a few commercial entities that have a desire to provide these advanced imaging services.
However, we believe they are constrained by a lack of technical capabilities.
Government Regulation
Healthcare in the United States is heavily
regulated by the federal government, and by state and local governments. The federal laws and regulations affecting healthcare
change constantly, thereby increasing the uncertainty and risk associated with any healthcare-related company.
The federal government regulates healthcare
through various agencies, including the following:
|
·
|
the
Food and Drug Administration, or FDA, which administers the Food, Drug, and Cosmetic
Act, or FD&C Act, as well as other relevant laws;
|
|
·
|
Centers
for Medicare & Medicaid Services, or CMS, which administers the Medicare and Medicaid
programs;
|
|
·
|
the
Office of Inspector General, or OIG, which enforces various laws aimed at curtailing
fraudulent or abusive practices, including by way of example, the Anti-Kickback Law,
the Anti-Physician Referral Law, commonly referred to as Stark, the Anti-Inducement Law,
the Civil Money Penalty Law, and the laws that authorize the OIG to exclude health care
providers and others from participating in federal healthcare programs; and
|
|
·
|
the
Office of Civil Rights which administers the privacy aspects of the Health Insurance
Portability and Accountability Act of 1996, or HIPAA.
|
All of the aforementioned are agencies
within the Department of Health and Human Services, or HHS. Healthcare is also provided or regulated, as the case may be, by the
Department of Defense through its TriCare program, the Public Health Service within HHS under the Public Health Service Act, the
Department of Justice through the Federal False Claims Act and various criminal statutes, and state governments under the Medicaid
program and their internal laws regulating all healthcare activities.
FDA
The FDA regulates medical devices. A “medical
device,” or device, is an article, including software and software associated with another medical device, which, among
other things, is intended for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment or prevention
of disease, in man or other animals. Computer software to analyze a CT or MRI scan, such as VirtualScopics’, we believe
is considered a medical device and is therefore subject to FDA regulation. To date, our sales have been to the pharmaceutical
and biotech industries to support their clinical trials. We would need to obtain FDA clearance or approval, as discussed below,
before using our technology and services for diagnostic or treatment planning in a clinical setting.
Devices are subject to varying levels
of regulatory control, the most comprehensive of which requires that a clinical evaluation be conducted before a device receives
approval for commercial distribution. In the United States, we generally are able to obtain permission to distribute a new device
in two ways. The first applies to any new device that is substantially equivalent to a device first marketed prior to May 1976.
In this case, to obtain FDA permission to distribute the device, we generally must submit a premarket notification application
(a section 510(k) submission), and receive an FDA order finding substantial equivalence to a device (first marketed prior to May
1976) and permitting commercial distribution of that device for its intended use. A 510(k) submission must provide information
supporting its claim of substantial equivalence to the predicate device.
If clinical data from human experience
are required to support the 510(k) submission, these data must be gathered in compliance with investigational device exemption
(IDE) regulations for investigations performed in the United States. The FDA review process for premarket notifications submitted
pursuant to section 510(k) takes on average about 90 days, but it can take substantially longer if the agency has concerns, and
there is no guarantee that the agency will “clear” the device for marketing, in which case the device cannot be used
for diagnosis and distributed in the United States. Nor is there any guarantee that the agency will deem the article subject to
the 510(k) process, as opposed to the more time-consuming and resource intensive and problematic, premarket approval (PMA), process
described below.
The second, more comprehensive, approval
process applies to a new device that is not substantially equivalent to a pre-1976 product. In this case, two steps of FDA approval
generally are required before we can market the product in the United States. First, we must comply with IDE regulations in connection
with any human clinical investigation of the device. Second, the FDA must review our PMA application, which contains, among other
things, clinical information acquired under the IDE. The FDA will approve the PMA application if it finds there is reasonable
assurance the device is safe and effective for its intended use.
Certain changes to existing devices that
do not significantly affect safety or effectiveness can be made with
in vitro
testing under reduced regulatory procedures,
generally without human clinical trials and by filing a PMA supplement to a prior PMA. Exported devices are subject to the regulatory
requirements of each country to which the device is exported, as well as certain FDA export requirements.
After approval or clearance to market
is given, the FDA and foreign regulatory agencies, upon the occurrence of certain events, have the power to withdraw the clearance
or require changes to a device, its manufacturing process, its labeling or additional proof that regulatory requirements have
been met.
A device manufacturer is also required
to register with the FDA. As a result, we may be subject to periodic inspection by the FDA for compliance with the FDA’s
Quality System Regulation requirements and other regulations. In the European Union, we are required to maintain certain International
Organization for Standardization (ISO) certifications in order to sell product and to undergo periodic inspections by notified
bodies to obtain and maintain these certifications. These regulations require the Company to manufacture products and maintain
documents in a prescribed manner with respect to design, manufacturing, testing and control activities. Further, we are required
to comply with various FDA and other agency requirements for labeling and promotion. The Medical Device Reporting regulations
require that we provide information to the FDA whenever there is evidence to reasonably suggest that a device may have caused
or contributed to a death or serious injury or, if a malfunction of the device were to occur, it could cause or contribute to
a death or serious injury. In addition, the FDA prohibits the Company from promoting a medical device for unapproved purposes.
We currently meet the requirements of
Good Clinical Practices: Consolidated Guidance
, which governs the conduct of clinical trials, and our software complies
with the FDA’s Regulation Title 21 CFR Part 11 (Electronic Records; Signatures) and Title 21 CFR Part 820.30, which outline
the requirements for design controls in medical devices.
Privacy Provisions of HIPAA
HIPAA, among other things, protects the
privacy and security of individually identifiable health information by limiting its use and disclosure. HIPAA directly regulates
“covered entities” (healthcare providers, insurers and clearinghouses) and indirectly regulates “business associates”
with respect to the privacy of patients’ medical information. All entities that receive and process protected health information
are required to adopt certain procedures to safeguard the security of that information. It is our policy to comply with HIPAA
requirements.
Research and Development Costs
We incurred $1,283,321 and $1,245,264
in research and development costs for the years ended December 31, 2015 and 2014, respectively.
Customers
The following table sets forth information
as to revenue and percentage of revenue for our largest customers in 2015 and 2014:
|
|
For the Years Ended December 31,
|
|
|
|
2015
|
|
|
2014
|
|
Customer 1
|
|
$
|
2,960,902
|
|
|
|
23
|
%
|
|
$
|
2,699,978
|
|
|
|
26
|
%
|
Customer 2
|
|
$
|
2,876,145
|
|
|
|
23
|
%
|
|
$
|
2,158,828
|
|
|
|
21
|
%
|
Customer 3
|
|
$
|
1,987,439
|
|
|
|
16
|
%
|
|
$
|
2,083,135
|
|
|
|
20
|
%
|
Customer 4
|
|
$
|
-
|
|
|
|
-
|
%
|
|
$
|
1,082,844
|
|
|
|
10
|
%
|
Employees
As of December 31, 2015 we had 96 employees,
95 of which were full-time. We are not party to any collective bargaining agreements and we believe that our relationships with
our employees are good.
ITEM 1A: Risk Factors
You should carefully consider the following
risk factors before making an investment decision. If any of the following risks actually occur, our business, financial
condition, or results of operations could be materially adversely affected. In such cases, the trading price of our
common stock could decline, and you may lose all or part of your investment.
Risks Relating to Pending Transaction
Failure to complete the planned BioTelemetry
merger could negatively impact our stock price and financial condition and our future business and financial results.
If the planned BioTelemetry
merger is not completed, our ongoing business may be adversely affected, and we may be subject to several risks, including the
following
|
·
|
being
required to reimburse BioTelemetry for the costs and expenses relating to the merger
under certain circumstances as provided in the merger agreement;
|
|
·
|
our
stock price could decline to the extent that the current market price reflects a market
assumption that the planned BioTelemetry merger will be completed; and
|
|
·
|
having
had the focus of our management on the planned BioTelemetry merger instead of on pursuing
other opportunities that could have been beneficial to us.
|
If the planned BioTelemetry
merger is not completed, we cannot assure you that these risks will not materialize and will not materially adversely affect our
business, financial results, stock price and financial condition.
We will be subject to various uncertainties
while the planned BioTelemetry merger is pending that may cause disruption to our business.
Uncertainty about the impact of the planned
BioTelemetry merger may have an adverse effect on us. Although we intend to take steps designed to reduce any adverse effects,
these uncertainties may impair our ability to attract, retain and motivate key personnel until the planned BioTelemetry merger
is completed. It could also cause vendors and customers and others that deal with us to seek to change existing business relationships
with us. For more information about the planned BioTelemetry merger, see Business Overview - Planned BioTelemetry Merger.
The pursuit of the
planned BioTelemetry merger and the preparation for the integration may place a significant burden on management and internal
resources. The diversion of management’s attention away from day-to-day business concerns and any difficulties encountered
in the transition and integration process could adversely affect our financial results.
If our services do not continue
to attract interest from new and existing customers, we may not maintain our current level of business or achieve future growth.
If we are unable to
continue to attract interest in the industry for our services, we could fail to maintain our current level of business or achieve
future growth. This would have a detrimental effect on our business. Our ability to generate revenues is highly dependent on building
and maintaining relationships with leading pharmaceutical and biotechnology companies. No assurance can be given that a sufficient
number of such companies will maintain or increase their demand for our services, which could limit the overall market and not
enable us to increase our revenue. In addition, the rate of the growth of MRI and CT image-based biomarkers is difficult to predict.
Failure to attract and maintain a significant customer base would have a detrimental effect on our business, operating results
and financial condition.
The majority of the contracts we
have with customers are cancelable for any reason by giving 30 days advance notice.
Our customers typically
engage us to perform services for them on a project-by-project basis and are required by us to enter into a written contractual
agreement for the work, labor and services to be performed. Generally, our project contracts are terminable by the customer for
any or no reason on 30 days’ advance notice to us. If a number of our customers were to exercise cancellation rights, our
business and operating results would be materially and adversely affected.
Our reported amounts of anticipated
service revenue to be earned from the backlog may not be indicative of future results.
As of December 31, 2015, the amount of
anticipated service revenue remaining to be earned from the backlog was approximately $36 million as compared to approximately
$29 million as of December 31, 2014.
Backlog represents anticipated service
revenue from work not yet completed or performed under signed contracts. The majority of contracts we have with customers are
cancelable for any reason by giving 30 days advance notice. We cannot assure you that this amount will be indicative of future
results. 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. There are several factors that can affect whether we will
realize the full benefits under a contract or award and the time over which we will realize that revenue including:
|
•
|
Customer cancellation due
to performance reasons with their compounds in development;
|
|
•
|
Change in
the scope of a project;
|
|
•
|
Timing of
performance, including over multiple years;
|
|
•
|
Timing of
patient recruitment and image site identification and training.
|
Also, if clients delay projects, we will
not generate revenue at the rate originally expected. Accordingly, the historical relationship of our reported backlog to revenues
may not be indicative of future results.
If we are unable to manage and sustain
growth in our business, our operating results would be adversely affected.
We have seen a growing
demand for our image analysis services in clinical trials for pharmaceutical companies over the past year. Although there can
be no assurance that growth in demand will continue or that customers will complete the clinical trial projects as awarded to
us, if it does continue we may be unable to scale our capacity efficiently to meet this demand. If we are unable to do so, we
may fail to maintain our operating margins or achieve expected operating margins. This may have a material and adverse effect
on our operating results.
Our services may become obsolete
if we do not effectively respond to rapid technological change on a timely basis.
Our services depend
on the needs of our customers and their desire to utilize image-related services in drug and medical device development. Since
the image-based biomarker industry is characterized by evolving technologies, uncertain technology and limited availability of
standards, we must respond to new research findings and technological changes affecting our customers. We may not be successful
in developing and marketing, on a timely and cost-effective basis, new or modified products and services, which respond to technological
changes, evolving customer requirements and competition. If we are unsuccessful in this regard, our business and operating results
could be materially and adversely affected.
We have a history of operating losses
and future profitability is uncertain.
We have incurred losses
from operating activities. As we work to grow our business, we may face risks and difficulties in our business including uncertainties
of maintaining our current customers, further market penetration, competition, cost increases and delays in achieving business
objectives. There can be no assurance that we will succeed in addressing any or all of these risks or that we will achieve future
profitability. The failure to do so would have a material adverse effect on our business, financial condition, and operating results.
Although we believe that our services
do not and will not infringe upon the patents or violate the proprietary rights of others, it is possible such infringement or
violation has occurred or may occur which could have a material adverse effect on our business.
Portions of our business
are reliant upon patented and patentable systems and methods used in our image analysis and related intellectual property. In
the event that we are deemed to infringe upon the patents or proprietary rights of others, we could be required to modify our
products and services or obtain a license for the manufacture and/or sale of such services. In such event, there can be no assurance
that we would be able to do so in a timely manner, upon acceptable terms and conditions, or at all, and the failure to do any
of the foregoing could have a material adverse effect upon our business. Moreover, there can be no assurance that we will have
the financial or other resources necessary to enforce or defend a patent infringement or proprietary rights violation action.
In addition, we could be subject to injunctive relief and, under certain circumstances, become liable for damages, which could
also have a material adverse effect on our business.
We are subject to pharmaceutical,
medical device and healthcare industry regulations, which could adversely affect the nature and extent of the products and services
we offer.
Many aspects of the
pharmaceutical, medical device and healthcare industry are subject to regulation at the federal level. From time to time, the
regulatory entities that have jurisdiction over the industry adopt new or modified regulations or take other actions as a result
of their own regulatory processes or as directed by other governmental bodies. This changing regulatory environment could adversely
affect the nature and extent of the services we are able to offer.
Our failure to compete effectively
in our industry could cause our revenues to decline.
The image analysis
industry is highly competitive. We face numerous competitors in our business. If we fail to compete effectively, we will lose clients,
which would cause our business to suffer. Our ability to successfully compete is dependent on many factors, including: timely and
quality performance; expertise and experience in specific therapeutic areas; the scope of service offerings; strength in various
geographic markets; the price of services; our competitors’ service and product offerings; our operating efficiencies in
relation to other companies; the reliability of our IT infrastructure and operating system to our core business; and, our ability
to upgrade our services in comparison to the service and product offerings of our competitors. If our services are not competitive
based on these or other factors, our business, financial condition and results of operations could be materially harmed.
We may in the future experience competition from academic
sites, imaging CROs, and other competing technologies.
Competition in the
development of imaging solutions may become more widespread as with emerging technologies such as proteomics and genomics which
can serve as predictive tools of drug efficacy. Competitors range from university-based research and development projects which
would develop advanced tools to development stage companies and major domestic and international companies which would commercialize
the tools. Some of these entities have greater financial, technical, marketing, sales, distribution and other resources than ours.
There can be no assurance that we can continue to develop our technologies or that present or future competitors will not develop
technologies that render our image-based biomarker industry obsolete or less marketable or that we will be able to introduce new
products and product enhancements that are competitive with other products marketed by industry participants.
We have experienced significant
demand from certain customers, thereby increasing our dependence on these customers until we can further diversify our customer
base.
While we continue
to serve a broad range of customers, we have experienced strong demand from three of our customers in 2015 as compared to four
of our customers in 2014. We depend on these customers to sustain our growth. In 2015 and 2014, these customers accounted for
62% and 77% of our revenue, respectively. We continue to see demand from other customers but not at the same significant pace
as these three customers. As with all of our contracts, these customers may terminate their contractual relationships with us
for any or no reason on 30 days’ advance notice. A decision by any of these customers to cancel all of its studies with
us could have an adverse impact on the growth of our business.
Consolidation within the pharmaceutical industry and
changes within healthcare regulation may have an adverse impact on our business.
Over
the past few years, there have been several mergers and acquisitions among pharmaceutical and biotechnology companies. Historically,
these transactions have positively impacted our business due to the ability to use our strong relationships within one of the
merged entities to better penetrate the combined entity. However, there can be no assurance that consolidation within the industry
will continue to be beneficial to us. Additionally, with the recent political landscape and changes within the healthcare industry,
there may be an adverse impact on our business if the cost of imaging significantly increases or no longer becomes standard of
care for patients. Although, we do not believe imaging will decline in its level of use, if it does we may need to reduce prices
or invest in research to advance the education and science of medical imaging.
Consolidation among our competitors
could cause us to lose customers or could exert additional pressure on the prices of our services.
There
has been a significant amount of consolidation among providers of clinical trial imaging services and other services such as ours.
Larger enterprises created through this consolidation have greater resources and efficiencies than our company and have other
competitive advantages. As a result of this consolidation, competition to provide goods and services to customers has increased.
Further consolidation in the industry could exert additional pressure on the prices of our products.
Loss of key personnel, or failure
to attract and retain additional personnel, could have a material adverse effect on our business.
Our
success will be dependent on our continued ability to attract, retain and motivate highly skilled employees. The Board of Directors
appointed director Eric Converse to serve as President and Chief Executive Officer and Jim Groff to serve as Chief Financial Officer
during 2014. Leadership transitions can be inherently difficult to manage and may cause disruption to our business or further
turnover in our workforce or management team. The loss of services of one or more other members of senior management would likely
have a material adverse effect on our business.
Furthermore,
our performance also depends on our ability to attract and retain management and qualified scientific and technical operating
staff. Competition for these skilled personnel is intense. The loss of services of any key executive, or inability to continue
to attract and retain qualified staff could have a material adverse effect on our business, results of operations and financial
condition. We do not maintain any key employee insurance on any of our executives.
The trading price of our stock may be adversely affected
if we are not able to maintain and grow our business.
We intend to continue
to use our cash on hand to broaden our market penetration of our services within the industry. If our plans or assumptions with
respect to our business change or prove to be inaccurate, we may be required to use part or all of our cash to fund general operating
expenses and/or reduce costs within the organization.
We currently do not
plan to raise additional capital. However, if we need to raise additional capital, it may not be available on acceptable terms,
or at all. Our failure to obtain required capital, or the acquisition of capital on less favorable terms, would have a material
adverse effect on our business. If we issue additional equity securities in the future, there could be a dilution or a reduction
in priority of our outstanding securities.
The market price of our common stock may fluctuate significantly.
The market price of
our common stock may fluctuate significantly in response to factors, some of which are beyond our control, such as the announcement
of new products or product enhancements by us or our competitors; developments concerning intellectual property rights and regulatory
approvals; quarterly variations in our competitors’ results of operations; changes in earnings estimates or recommendations
by securities analysts; developments in our industry; product liability claims or other litigation; and general market conditions
and other factors, including factors unrelated to our own operating performance.
Our common stock may be considered
a “penny stock” and may be difficult to sell.
The SEC has adopted
regulations which generally define “penny stock” to be an equity security that has a market or exercise price of less
than $5.00 per share, subject to specific exemptions. The market price of our common stock is currently below $5.00 per share
and therefore may be designated as a “penny stock” according to SEC rules. This designation requires any broker or
dealer selling these securities to disclose certain information concerning the transaction, obtain a written agreement from the
purchaser and determine that the purchaser is reasonably suitable to purchase the securities. These rules may restrict the ability
of brokers or dealers to sell our common stock and may affect the ability of our stockholders to sell their shares.
Our strategic alliance with PPD
is an important aspect of our growth, and the market may not value our strategic alliance with PPD as we anticipate.
In 2010, we formed
an alliance with PPD to provide a joint solution to provide clients with an integrated and customized clinical development and
medical imaging solution for oncology clinical trials. The alliance was expanded in January 2012 to include cardiovascular, central
nervous system and medical device studies. In 2016, the alliance was amended to eliminate the marketing exclusivity portion of
the agreement. If the market does not value this model as we anticipate, our ability to grow our business may be negatively impacted.
Additionally, the agreement may be terminated by either party on 90 days’ notice. In the event PPD terminates the agreement,
we may also experience a negative impact in our ability to experience the level of growth we have historically achieved.
The inability to maintain our NASDAQ
listing may adversely affect the trading market for our common stock.
There can be no assurance that we will
be able to maintain compliance with NASDAQ listing requirements, including the $1.00 minimum bid price requirement. If our common
stock is delisted from NASDAQ, trading in our common stock could be conducted on the OTC Bulletin Board or in the over-the-counter
market in what is commonly referred to as the "pink sheets." If this occurs, a shareholder will find it more difficult
to dispose of our common stock or to obtain accurate quotations as to the price of our common stock. Lack of any active trading
market would have an adverse effect on a shareholder's ability to liquidate an investment in our common stock easily and quickly
at a price acceptable to the shareholder. It might also contribute to volatility in the market price of our common stock and could
adversely affect our ability to raise additional equity or debt financing on acceptable terms or at all.
A significant number of the shares
of our common stock are eligible for sale, and their sale could negatively affect the market price of our common stock.
Sales of a significant
number of shares of our common stock in the public market or the possibility of such sales could harm the market price of our common
stock and impede our ability to raise capital through the issuance of equity securities. As of December 31, 2015, we had 3,011,534
shares of common stock outstanding. These shares are eligible for resale in the public market either immediately or subject to
applicable limitations of Rule 144. In addition to these outstanding shares of common stock, we also have shares to be issued upon
the conversion or exercise of 443,847 outstanding options to purchase common stock, 136,132 warrants to purchase common stock and
462,094 shares of preferred stock that are convertible into common stock. We have registered on Form S-8 the sale of up to 690,000
shares issued or to be issued pursuant to our Amended and Restated 2006 Long-Term Incentive Plan, of which 443,847 are subject
to outstanding option awards. Sales of our common stock in the public market may have an adverse effect on the market for the shares
of our common stock.
Our principal stockholders have
significant voting power and may take actions that may not be in the best interests of other stockholders.
Our officers, directors,
principal stockholders (greater than 5%) and their affiliates control approximately 30% of our outstanding voting securities.
If these stockholders act together, they will be able to exert significant control over our management and affairs requiring stockholder
approval, including approval of significant corporate transactions. This concentration of ownership may have the effect of delaying
or preventing a change in control and might adversely affect the market price of our common stock. This concentration of ownership
may not be in the best interests of all our stockholders.
We do not anticipate paying dividends
on our common stock in the foreseeable future, and the lack of dividends may have a negative effect on the stock price.
We currently intend
to retain our future earnings to support operations and to finance expansion and meet dividend obligations on our series C-1 and
series B convertible preferred stock. In addition, the terms of our series C-1 and series B preferred stock limit our ability
to pay dividends to the holders of our common stock. Therefore, we do not anticipate paying any cash dividends on our common stock
in the foreseeable future.
ITEM 2: Properties
In July 2007 we began
leasing approximately 19,500 square feet of office space at our corporate headquarters in Rochester, New York. In June 2012, the
Company renewed its lease for five years with a lease commencement date of July 1, 2012. The base annual rent under the lease
is $309,075, and increases two percent (2%) per year over the term of the lease.
In May 2014, the Company
entered into a lease for approximately 2,190 square feet of office space in New Hope, Pennsylvania. The lease term is for three
years with a lease commencement date of June 1, 2014. The base annual rent under the lease is $54,000, and increases three percent
(3%) per year over the term of the lease.
ITEM 3: Legal Proceedings
None.
ITEM 4: Mine Safety Disclosures
Not applicable.
The accompanying notes are an integral
part of these consolidated financial statements
The accompanying notes are an integral
part of these consolidated financial statements
The accompanying notes are an integral
part of these consolidated financial statements
The accompanying notes are an integral
part of these consolidated financial statements
Notes to Consolidated Financial Statements
NOTE 1 - Organization and Basis of
Presentation
Nature
of Business
The Company’s headquarters
are located in Rochester, New York. The Company has created a suite of image analysis software tools and applications which are
used in detecting and analyzing specific structures in medical images. The Company’s developed software provides measurement
and visualization capabilities designed to improve clinical research and development.
On March 25, 2016, the Company
entered into a definitive merger agreement with Biotelemetry, Inc. pursuant to which BioTelemetry proposes to acquire VirtualScopics.
The transaction is structured as a tender offer for the Company’s outstanding voting shares followed by a second-step merger.
The total consideration is $15.5 million dollars, payable in cash, which includes a price per share to common shareholders of $4.05
per common share. We expect the transaction, which is subject to customary closing conditions, to be completed in the second quarter
of 2016.
Basis of Presentation
A
Certificate of Amendment to decrease the Company’s number of authorized common stock from 85,000,000 shares to 20,000,000
shares and to decrease the number of authorized and undesignated preferred stock from 15,000,000 shares to 1,000,000 shares was
approved by the Company's stockholders at its Annual Meeting of Stockholders on June 17, 2014. The authorized share information
presented in these consolidated financial statements and accompanying footnotes reflects such change.
NOTE 2 – Liquidity and Financial
Condition
The
Company had a net loss attributable to common stockholders of $1,210,121 for the year ended December 31, 2015. At December 31,
2015, the Company’s accumulated deficit amounted to $18,172,685 and the Company had working capital of $2,493,000. On August
7, 2015, the Company entered into a Loan and Security Agreement with a financial institution pursuant to which the Company obtained
a revolving line of credit. The maximum amount that the Company may borrow at any time under the line of credit is $2,000,000.
See Note 7.
The
Company’s future plans and growth are dependent on its ability to increase revenues and continue its business development
efforts surrounding its contract award backlog. If the Company continues to incur losses and revenues do not generate from the
backlog as expected, the Company may need to raise additional capital to expand its business and continue as a going concern.
The Company currently anticipates that its cash will be sufficient to meet its working capital requirements to continue its sales
and marketing and research and development efforts for at least 12 months. If in the future our plans or assumptions change or
prove to be inaccurate, the Company may need to raise additional funds through public or private debt or equity offerings, financings,
corporate collaborations, or other means. The Company may also be required to reduce operating expenditures or investments in
its infrastructure.
NOTE 3 - Summary of Significant Accounting
Policies
Principles of Consolidation
The accompanying consolidated
financial statements include the accounts of VirtualScopics, Inc. and its wholly-owned subsidiary, VirtualScopics New York, LLC.
All significant intercompany balances and transactions have been eliminated in consolidation.
Use
of Estimates
The preparation of financial
statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the year.
Actual results could differ from those estimates. Estimates included in these consolidated financial statements relate to assessing
the collectability of accounts receivable, the valuation of securities underlying share-based compensation, realization of deferred
tax assets, tax contingencies and any related valuation allowance, and the useful lives and potential impairment of the Company’s
property and equipment and intangible assets. Estimates and assumptions are reviewed periodically and the effects of revisions
are reflected in the period that they are determined to be necessary.
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Cash and Cash Equivalents
The Company considers all highly
liquid investments when purchased with a maturity of three months or less to be cash equivalents. At December 31, 2015 and 2014,
the Company had no cash equivalents.
Concentration of Credit
Risk
Financial instruments that
potentially subject the Company to significant concentrations of credit risk consist of cash. At times, our cash may be uninsured
or in deposit accounts that exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance limits.
Accounts Receivable
Accounts receivable are stated at estimated net
realizable value. Accounts receivable are comprised of balances due from customers net of estimated allowances for uncollectible
accounts, if any. In determining collectability, historical trends are evaluated and specific customer issues are reviewed to
arrive at appropriate allowances, if any. The Company determined that no allowance for doubtful accounts was necessary at December
31, 2015 and 2014.
Patents
Costs incurred to acquire and
file for patents, including legal costs, are capitalized as long-lived assets and amortized on a straight-line basis over the
lower of the estimated useful life or legal life of the patent, which is 20 years.
Property
and Equipment, net
Property and equipment are
carried at cost less accumulated depreciation. When retired or otherwise disposed of, the related cost and accumulated depreciation
are removed from the respective accounts and any resulting gain or loss is recognized and included in the consolidated statements
of operations.
Expenditures for maintenance and repairs, which
do not generally extend the useful life of the assets, are charged to expense as incurred. Gains or losses on disposal of property
and equipment are reflected in other expense in the consolidated statements of operations in the period of disposal.
Depreciation is computed using the straight-line
method over the following useful lives:
|
|
Years
|
Leasehold improvements
|
|
2-3
|
Office/computer equipment
|
|
3-5
|
Furniture and fixtures
|
|
5-7
|
Software
|
|
3
|
Leasehold
improvements, which are included in property and equipment, are recorded at cost less accumulated depreciation. Depreciation on
leasehold improvements is computed using the straight-line method over the shorter of their estimated useful lives or the lease
term.
VirtualScopics,
Inc. and Subsidiary
Notes to Consolidated Financial Statements
Impairment of Long-Lived Assets
The Company reviews long-lived
assets, including intangible assets other than goodwill, for impairment whenever events or changes in circumstances indicate that
the carrying value of the asset may not be recoverable. In connection with this review, the Company also re-evaluates the periods
of depreciation and amortization for these assets. The Company assesses recoverability by determining whether the net book value
of the related asset will be recovered through the projected undiscounted future cash flows of the asset. If the Company determines
that the carrying value of the asset may not be recoverable, it measures any impairment based on the projected future discounted
cash flows as compared to the asset’s carrying value. Through December 31, 2015, the Company has not recorded any impairment
charges on its long-lived assets.
Revenue
Recognition
The Company recognizes revenue
when it is realized or realizable and earned. The Company considers revenue realized or realizable and earned when an agreement
exists, services are performed, prices are fixed or determinable, and collectability is reasonably assured. Revenues are reduced
for estimated discounts and other allowances, if any.
The Company provides advanced
medical image analysis on a per analysis basis, and recognizes revenue when the image analysis is completed. Revenue related to
project, data, and site management services is recognized as the services are rendered and in accordance with the terms of the
contract. Consulting revenue is recognized once the services are rendered and typically charged as an hourly rate.
Reimbursements received and related
costs incurred for out-of-pocket expenses are separately reported as reimbursement revenues and cost of reimbursement revenues,
respectively, in the consolidated financial statements.
Income Taxes
Income taxes are accounted for
under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable
to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases,
and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected
to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment
date. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will
not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income and
the reversal of deferred tax liabilities during the period in which related temporary differences become deductible. The benefit
of tax positions taken or expected to be taken in the Company’s income tax returns are recognized in the consolidated financial
statements if such positions are more likely than not of being sustained.
Research
and Development
Research and development expense
relates to the development of new applications and processes, including improvements to existing applications. These costs are
expensed as incurred.
Preferred Stock
The Company applies the accounting
standards for distinguishing liabilities from equity when determining the classification and measurement of its preferred stock.
Preferred shares subject to mandatory redemption are classified as liability instruments and are measured at fair value. Conditionally
redeemable preferred shares (including preferred shares that feature redemption rights that are either within the control of the
holder or subject to redemption upon the occurrence of uncertain events not solely within the Company’s control) are classified
as temporary equity. At all other times, preferred shares are classified as stockholders’ equity.
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Convertible Instruments
The Company applies the accounting
standards for derivatives and hedging and for distinguishing liabilities from equity when accounting for hybrid contracts that
feature conversion options. The accounting standards require companies to bifurcate conversion options from their host instruments
and account for them as free standing derivative financial instruments according to certain criteria. The criteria includes circumstances
in which (i) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related
to the economic characteristics and risks of the host contract, (ii) the hybrid instrument that embodies both the embedded
derivative instrument and the host contract is not re-measured at fair value under otherwise applicable generally accepted accounting
principles with changes in fair value reported in earnings as they occur and (iii) a separate instrument with the same terms
as the embedded derivative instrument would be considered a derivative instrument. The derivative is subsequently marked to market
at each reporting date based on current fair value, with the changes in fair value reported in results of operations.
Conversion options that contain
variable settlement features such as provisions to adjust the conversion price upon subsequent issuances of equity or equity linked
securities at exercise prices more favorable than that featured in the hybrid contract generally result in their bifurcation from
the host instrument.
The Company also records, when
necessary, deemed dividends for the intrinsic value of the conversion options embedded in preferred stock based upon the difference
between the fair value of the underlying common stock at the commitment date of the transaction and the effective conversion price
embedded in the preferred stock.
Common Stock Purchase Warrants
and Other Derivative Financial Instruments
The Company classifies as equity
any contracts that (i) require physical settlement or net-share settlement or (ii) provides a choice of net-cash settlement
or settlement in the Company’s own shares (physical settlement or net-share settlement) providing that such contracts
are indexed to the Company's own stock as defined in ASC 815-40 "Contracts in Entity's Own Equity" (“ASC 815-40”).
The Company classifies as assets or liabilities any contracts that (i) require net-cash settlement (including a requirement
to net cash settle the contract if an event occurs and if that event is outside the Company’s control) or (ii) gives the
counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement). The
Company assesses classification of common stock purchase warrants and other free standing derivatives at each reporting date to
determine whether a change in classification between assets and liabilities or equity is required.
Recently Issued and
Adopted Accounting Pronouncements
In May 2014, the Financial
Accounting Standards Board (“FASB”) issued ASU 2014-09, Revenue from Contracts with Customers, which amends revenue
recognition requirements for multiple deliverable revenue arrangements. This update provides guidance on how revenue is recognized
to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity
expects to be entitled in exchange for the goods or services. This determination is made in five steps: (i) identify the
contract with the customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction
price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue
when (or as) the entity satisfies a performance obligation. The update is effective for annual reporting periods after December 15,
2016 and for interim reporting periods within that reporting period. Early adoption is not permitted. The Company has not yet
adopted this update and is currently evaluating the impact it may have on its financial condition and results of operations.
The
FASB has issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties
about an Entity’s Ability to Continue as a Going Concern. The guidance, which is effective for annual reporting periods
ending after December 15, 2016, extends the responsibility for performing the going-concern assessment to management and contains
guidance on how to perform a going-concern assessment and when going-concern disclosures would be required under U.S. GAAP.
The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position
and results of operations.
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
In April 2015, the FASB issued
Accounting Standards Update (“ASU”) 2015-03,
Interest–Imputation of Interest-Simplifying the Presentation
of Debt Issuance Costs (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs
(“ASU 2015-03”).
ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as
a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement
guidance for debt issuance costs are not affected by this update. Debt issuance costs related to revolving lines of credit are
not within the scope of this new guidance. Additionally, in August 2015 the FASB issued guidance expanding the April 2015 update
(ASU 2015-15) stating that, given the absence of authoritative guidance within ASU 2015-03, the SEC staff would not object to
an entity deferring and presenting debt issuance costs as an asset for revolving lines of credit and subsequently amortizing the
deferred debt issuance costs ratably over the term of the arrangement, regardless of whether there are any outstanding borrowings
on the line of credit. This guidance is effective for financial statements issued for fiscal years beginning after December 15,
2015, and interim periods within those fiscal years, with early adoption permitted for financial statements that have not been
previously issued. Full retrospective application is required. The adoption of this standard did not have an impact on the Company’s
consolidated financial position and results of operations. The Company has adopted this standard and in connection with the execution
of the Loan and Security Agreement, incurred costs of $41,802. The Company included those costs in prepaid expenses and other
current assets on the accompanying consolidated balance sheet.
In November 2015, the FASB
issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes ("ASU 2015-17"), which requires entities to present
deferred tax assets and deferred tax liabilities as noncurrent in a classified balance sheet. The ASU simplifies the current guidance
in ASC Topic 740, Income Taxes, which requires entities to separately present deferred tax assets and liabilities as current and
noncurrent in a classified balance sheet. ASU 2015-17 is effective for fiscal years beginning after December 15, 2016, and interim
periods within those annual periods. Early adoption is permitted for all entities as of the beginning of an interim or annual
reporting period. The adoption of this standard is not expected to have a material impact on the Company’s consolidated
financial statements.
In February 2016, the FASB
issued ASU 2016-02, Leases ("ASU 2016-02"). The standard amends the existing accounting standards for lease accounting,
including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting.
ASU 2016-02 will be effective beginning in the first quarter of 2019. Early adoption of ASU 2016-02 is permitted. The new leases
standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of
initial application, with an option to use certain transition relief. The Company is currently evaluating the impact of adopting
ASU 2016-02 on our consolidated financial statements.
Stock-Based Compensation
The Company accounts for share-based
awards exchanged for employee services at the estimated grant date fair value of the award. The Company estimates the fair value
of employee stock awards using the Black-Scholes option pricing model. The Company amortizes the fair value of employee stock
options on a straight-line basis over the requisite service period of the awards. Compensation expense includes the impact
of an estimate for forfeitures for all stock options.
The Company accounts for equity
instruments issued to non-employees at their fair value on the measurement date. The measurement of stock-based compensation is
subject to periodic adjustment as the underlying equity instrument vests or becomes non-forfeitable. Non-employee stock-based
compensation charges are amortized over the vesting period or as earned.
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Loss Per Share
Basic loss per share is computed
by dividing the net loss available to common stockholders by the weighted average number of common shares outstanding during the
period. Diluted loss per share is computed using the weighted average number of common shares and, if dilutive, potential common
shares outstanding during the period. Potential common shares consist of the incremental common shares issuable upon the exercise
of stock options (using the treasury stock method) and the conversion of the Company’s convertible preferred stock and warrants
(using the if-converted method). Diluted loss per share excludes the shares issuable upon the conversion of preferred stock, the
exercise of stock options and warrants from the calculation of net loss per share as their effect would be anti-dilutive.
Securities that could potentially
dilute loss per share in the future that were not included in the computation of diluted loss per share consist of the following
numbers of shares into which preferred stock could have been converted and shares for which outstanding options and warrants could
have been exercised during the years ending December 31, 2015 and 2014:
|
|
2015
|
|
|
2014
|
|
Convertible preferred stock
|
|
|
462,095
|
|
|
|
478,701
|
|
Warrants to purchase common stock
|
|
|
136,132
|
|
|
|
136,132
|
|
Options to purchase common stock
|
|
|
443,847
|
|
|
|
404,612
|
|
Total
|
|
|
1,042,074
|
|
|
|
1,019,445
|
|
NOTE 4 - Property and Equipment, net
Property and equipment consisted of the following
as of December 31:
|
|
2015
|
|
|
2014
|
|
Office/computer equipment
|
|
$
|
1,212,798
|
|
|
$
|
967,791
|
|
Furniture and fixtures
|
|
|
293,318
|
|
|
|
293,318
|
|
Software
|
|
|
807,924
|
|
|
|
629,342
|
|
Leasehold improvements
|
|
|
122,318
|
|
|
|
122,318
|
|
|
|
|
2,436,358
|
|
|
|
2,012,769
|
|
Less: accumulated depreciation
|
|
|
(1,893,865
|
)
|
|
|
(1,681,896
|
)
|
|
|
$
|
542,493
|
|
|
$
|
330,873
|
|
Depreciation expense amounted
to $211,969 and $176,369 for the years ended December 31, 2015 and 2014, respectively.
NOTE 5 - Patents
On May 24, 2002, the Company
purchased from the University of Rochester, a related party, certain patents developed by the Company’s founders and previously
licensed by the Company under an Exclusive Right Agreement. The Company paid $1,500,000 and issued warrants to acquire 357,075
shares of common stock to the University of Rochester for the full right and title to the patents. The warrants, which have since
expired, were recorded at fair value which totaled $157,000. Since May 24, 2002, the Company has invested an additional $1,095,016
in connection with improving and expanding its patent portfolio. These costs consist predominately of legal and filing fees and
historically been capitalized as long-lived assets.
For the years ended December
31, 2015 and 2014, the Company capitalized $23,153 and $15,230, respectively, of legal expenses and filing fees associated with
the maintenance of its patents. During the year ended December 31, 2014, the Company reviewed the remaining estimated useful lives
of its patent portfolio and determined that the remaining useful lives of four of its patents held should be reduced due to the
Company’s future planned use of this intellectual property which resulted in accelerated amortization during the year ended
December 31, 2015.
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Accumulated amortization on
the patents amounted to $1,719,199 and $1,517,093 as of December 31, 2015 and 2014, respectively. Amortization expense for the
years ended December 31, 2015 and 2014 amounted to $202,106 and $137,880, respectively. The weighted-average remaining amortization
period of the Company’s complete patent portfolio is approximately 6.8 years as of December 31, 2015. The estimated future
amortization of the patents is as follows:
For the Years Ending
|
|
|
|
December 31,
|
|
Amount
|
|
2016
|
|
$
|
174,974
|
|
2017
|
|
|
174,974
|
|
2018
|
|
|
159,475
|
|
2019
|
|
|
132,428
|
|
2020
|
|
|
94,562
|
|
Thereafter
|
|
|
296,404
|
|
Total
|
|
$
|
1,032,817
|
|
NOTE 6 – Capital Lease Obligation
On July 29, 2015, the Company
entered into a Master Equipment Lease Agreement (the “Lease”) in connection with financing the purchase of $144,775
of certain specialized hardware equipment. The Lease calls for interest at a rate of 6.23% per year and payments on the Lease
are due in quarterly installments of $9,159 including sales tax. The Lease matures in five years. The Company has the option to
purchase the leased equipment at the maturity for $1.
On December 15, 2015, the Company
entered into a Lease Agreement (the “Second Lease”) in connection with financing the purchase of $56,651 of certain
specialized hardware equipment. The Second Lease calls for interest at a rate of 7.99% per year and payments on the Second Lease
are due in monthly installments of $1,917 including sales tax. The Second Lease matures in three years. The Company has the option
to purchase the leased equipment at the maturity for $1.
The future minimum payments
under the Company’s capital lease obligations consist of the following:
For the Years Ending December 31,
|
2016
|
|
$
|
55,226
|
|
2017
|
|
|
55,226
|
|
2018
|
|
|
55,227
|
|
2019
|
|
|
33,924
|
|
2020
|
|
|
25,443
|
|
|
|
|
|
|
Total minimum payments
|
|
|
225,046
|
|
Less: Amount representing interest
|
|
|
(29,845
|
)
|
Present value of net minimum payments
|
|
$
|
195,201
|
|
|
|
|
|
|
Current portion
|
|
$
|
43,285
|
|
Non-current portion
|
|
|
151,916
|
|
Total capital lease obligation
|
|
$
|
195,201
|
|
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
NOTE 7 – Financing Arrangements
On August 7, 2015, the Company
entered into a Loan and Security Agreement with a financial institution pursuant to which the Company obtained a revolving line
of credit. The maximum amount that the Company may borrow at any time under the line of credit is $2,000,000 subject to a borrowing
base equal to a percentage of the Company’s eligible accounts receivable. Initially, the borrowing base is equal to 80%
of eligible accounts receivable. The decision to extend credit under the line of credit, the percentage of eligible accounts making
up the borrowing base and the accounts eligible for inclusion in the borrowing base are all subject to the discretion of the financial
institution. Interest on the principal amount outstanding under the line of credit accrues at the prime rate published by the
Wall Street Journal plus 1.00% per annum and is payable monthly. The line of credit requires the Company to comply with various
affirmative and negative covenants, including a covenant regarding minimum “Adjusted EBITDA” as defined in the agreement.
The Company incurred debt issuance
costs of $41,802 and included those costs in prepaid expenses and other current assets on the accompanying consolidated balance
sheet. The Company amortized $17,420 of debt issuance cost during 2015.
The line of credit terminates
and all amounts outstanding thereunder are due and payable on August 6, 2016. The obligations of the Company under the line of
credit are secured by a first priority security interest in all assets of the Company other than intellectual property. The Company
has no outstanding borrowings under the line of credit.
On September 16, 2015, the
Company entered into a Transaction Finance Agreement (the “Note Payable”) for $205,000 with an interest rate of 8.33%
per year in connection with financing the acquisition of certain specialized software. Payments on the Note Payable are due in
monthly installments of $6,972 and the note matures in three years.
The future minimum payments
under the Company’s note payable consist of the following:
For the Years Ending December 31,
|
2016
|
|
$
|
77,466
|
|
2017
|
|
|
77,466
|
|
2018
|
|
|
51,643
|
|
|
|
|
|
|
Total minimum payments
|
|
|
206,575
|
|
Less: Amount representing interest
|
|
|
(21,913
|
)
|
Present value of net minimum payments
|
|
$
|
184,662
|
|
|
|
|
|
|
Current portion
|
|
$
|
64,505
|
|
Non-current portion
|
|
|
120,157
|
|
Total note payable
|
|
$
|
184,662
|
|
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
NOTE 8 – Stockholders’
Equity
Common Stock
The Company has authorized
20,000,000 shares of common stock, par value $0.001. Each share of common stock entitles the holder to one vote.
Preferred Stock
The Company has authorized
1,000,000 shares of preferred stock, par value $0.001 per share, of which 8,400 are designated as Series A Convertible Preferred
Stock (“Series A”), 6,000 are designated as Series B Convertible Preferred Stock (“Series B”), 3,000 are
designated as Series C-1 Convertible Preferred Stock (“Series C-1”), and 3,000 are designated as Series C-2 Convertible
Preferred Stock (“Series C-2”) as specified in the Certificate of Designation (the “Certificate”).
Each share of Series A is convertible
into 83.036 shares of the Company’s common stock and is senior in liquidation preference in comparison to shares of the
Company’s common stock. During the year ended December 31, 2015, 200 shares of Series A Preferred Stock were converted to
16,606 shares of common stock. During the year ended December 31, 2014, 25 shares of Series A Preferred Stock were converted to
2,075 shares of common stock.
Each share of Series B is convertible
into 83.036 shares of the Company’s common stock and has a liquidation preference that is pari passu with the Company’s
Series A and senior to the Company’s common stock. Cumulative dividends on the Series B accrue on the stated value of $1,000
per share at an annual rate of 8%, payable monthly in cash and/or shares of the Company’s common stock at the option of
the Company. During the years ended December 31, 2015 and 2014, the Company accrued $48,000 of Series B dividends per year and
paid cash dividends of $48,000 and $36,000, respectively. As of December 31, 2015 and 2014, $96,000 of dividends were accrued
to the holders of Series B were included in accrued dividends on the consolidated balance sheet.
Each share of Series C-1 is
convertible into shares of the Company’s common stock at a conversion rate, which is determined by dividing (i) the stated
value per share of $1,000, plus, if consented to by the Company, all accrued and unpaid dividends, by (ii) the conversion price
of $12.043. The conversion price of the Series C Preferred Stock and exercise price of the Series C Warrants is subject to customary
anti-dilution provisions. The Series C-1 Preferred Stock has a 4% cumulative dividend and is senior in liquidation preference
to the existing preferred stock and common stock. The Series C-1 holders elected to receive cash dividends during 2015 and 2014.
Additionally, the Series C-1 holders elected to accrue the dividends during 2013 and 2012 making these dividends payable on the
earlier of the liquidation of the corporation according to the Series C Certificate of Designation or upon the conversion of the
Series C-1 into common stock. Subject to certain exceptions, the Series B holders are only entitled to be paid dividends, if full
dividends are first paid or concurrently paid to the holders of the Series C-1 Preferred Stock. During the years ended December
31, 2015 and 2014, the Company accrued $120,000 of Series C-1 dividends per year and paid cash dividends of $120,000 and $90,000
respectively. As of December 31, 2015 and 2014, $239,333 of dividends were accrued to the holders of Series B and Series C-1 Preferred
Stock were included in accrued dividends on the consolidated balance sheet.
Warrants
A summary of the warrant activity
for the year ended December 31, 2015 is as follows:
|
|
Number of
Warrants
|
|
|
Weighted
Average
Exercise
Price
|
|
Weighted-
Average
Remaining
Contractual
Term
|
|
Aggregate
Intrinsic
Value
|
|
Warrants outstanding at January 1, 2015
|
|
|
136,132
|
|
|
12.04
|
|
4.25
|
|
$
|
-
|
|
Expired
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Warrants outstanding at December 31, 2015
|
|
|
136,132
|
|
|
12.04
|
|
3.25
|
|
$
|
-
|
|
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
NOTE 9 – Share-Based Compensation
Long-Term
Incentive Plans
As of December 31, 2015, the
Company had reserved 690,000 shares for its 2006 long-term incentive plan. As of December 31, 2015, the Company’s 2006 Long-Term
Incentive Plan had a total of 443,847 in stock option grants outstanding.
In May 2007, the stockholders
of the Company approved the adoption of the Company’s 2006 Stock Plan (the “Plan”). The Plan provides for the
grant of incentive stock options, within the meaning of Section 422 of the Internal Revenue Code, to employees and for the grant
of non-statutory stock options, restricted stock, and stock appreciation rights to employees, directors, and consultants. The
Compensation Committee of the Company’s board of directors administers the Plan and has the authority to make awards under
the Plan and establish vesting and other terms, but cannot grant stock options at less than the fair value of the Company’s
common stock on the date of grant or re-price stock options previously granted. As of December 31, 2015, 191,445 stock options
remained eligible for grant under the 2006 Long-Term Incentive Plan.
Stock options issued under
the Plan are granted with an exercise price equal to no less than the market price of the Company’s stock at the date of
grant and expire up to ten years from the date of grant. These options generally vest over a three or four year period.
Stock Options
The fair value of stock options
granted was determined on the grant date using assumptions for risk free interest rate, the expected term, expected volatility,
and expected dividend yield. The risk free interest rate is based on U.S. Treasury zero-coupon yield curve over the expected term
of the option. The expected term of stock options represents the average period the stock options are expected to remain outstanding
and is based on the expected term calculated using the approach prescribed by the Securities and Exchange Commission's
Staff Accounting Bulletin No. 110 for “plain vanilla” options. The Company estimates its expected volatility
using the trading volume of its historical stock prices. The Company’s model includes a zero dividend yield assumption,
as the Company has not historically paid nor does it anticipate paying dividends on its common stock. The Company’s model
does not include a discount for post-vesting restrictions, as the Company has not issued awards with such restrictions. The periodic
expense is then determined based on the valuation of the options, and at that time an estimated forfeiture rate is used to reduce
the expense recorded. The Company’s estimate of pre-vesting forfeitures is primarily based on the Company’s historical
experience and is adjusted to reflect actual forfeitures as the options vest. The estimated forfeiture rates applied during the
years ended December 31, 2015 and 2014 ranged from 12.1% to 12.2%.
The following assumptions
were used to estimate the fair value of options granted for the years ended December 31, 2015 and 2014 using the Black-Scholes
option-pricing model:
|
|
December 31,
|
|
|
|
2015
|
|
|
2014
|
|
Risk free interest rate
|
|
|
1.75
|
%
|
|
|
1.84
|
%
|
Expected term (in years)
|
|
|
6.03
|
|
|
|
5.93
|
|
Expected volatility
|
|
|
61.36
|
%
|
|
|
64.45
|
%
|
Expected dividend yield
|
|
|
-
|
|
|
|
-
|
|
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
During the years ended December
31, 2015 and 2014, the Company granted options to employees to purchase 130,642 and 185,267 shares of common stock, respectively.
Of the total granted, the executive officers of the Company were granted 112,017 options in 2015 and 2014. These options generally
vest ratably during the first four years following their issuance and have a ten-year life. No options were exercised in 2015
and 2014.
A summary of the employee stock
option activity for the year ended December 31, 2015 are as follows:
|
|
Number of
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
Weighted-
Average
Remaining
Contractual
Term
|
|
Aggregate
Intrinsic
Value
|
|
Options outstanding at January 1, 2015
|
|
|
404,612
|
|
|
10.03
|
|
6.31
|
|
$
|
-
|
|
Granted
|
|
|
130,642
|
|
|
2.53
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(26,714
|
)
|
|
(7.80)
|
|
|
|
|
|
|
Expired
|
|
|
(64,693
|
)
|
|
(19.88)
|
|
|
|
|
|
|
Options outstanding at December 31, 2015
|
|
|
443,847
|
|
|
6.52
|
|
7.27
|
|
$
|
85,193
|
|
Options exercisable at December 31, 2015
|
|
|
186,125
|
|
|
10.73
|
|
4.85
|
|
$
|
-
|
|
Additional information with
respect to the outstanding employee stock options as of December 31, 2015 is as follows
|
|
Options Outstanding
|
|
|
Options Exercisable
|
|
Exercise Prices
|
|
Number
Outstanding at
December 31,
2015
|
|
|
Weighted
Average
Remaining
Life
(Years)
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Number
Exercisable
at
December
31, 2015
|
|
|
Weighted
Average
Exercise
Price
|
|
$ 2.19 – 2.71
|
|
|
114,042
|
|
|
|
9.61
|
|
|
|
2.38
|
|
|
|
-
|
|
|
|
-
|
|
$ 2.72 – 4.14
|
|
|
115,367
|
|
|
|
8.41
|
|
|
|
4.00
|
|
|
|
30,444
|
|
|
|
4.07
|
|
$ 4.15 – 4.95
|
|
|
70,100
|
|
|
|
8.22
|
|
|
|
4.25
|
|
|
|
20,225
|
|
|
|
4.37
|
|
$ 4.96 – 11.80
|
|
|
68,725
|
|
|
|
4.09
|
|
|
|
9.40
|
|
|
|
62,205
|
|
|
|
9.57
|
|
$ 11.81 – 41.50
|
|
|
75,613
|
|
|
|
4.03
|
|
|
|
16.12
|
|
|
|
73,251
|
|
|
|
16.25
|
|
|
|
|
443,847
|
|
|
|
7.27
|
|
|
|
6.52
|
|
|
|
186,125
|
|
|
|
10.73
|
|
The weighted-average grant-date
fair value of options granted during the years ended December 31, 2015 and 2014 was $190,010 and $451,884, respectively.
For the years ended December
31, 2015 and 2014, the Company’s consolidated statements of operations reflect $159,933 and $149,894, respectively, of stock-based
compensation expense relating to the amortization of stock options granted under its long-term incentive plans, which is allocated
as follows:
|
|
For Years Ended December 31,
|
|
|
|
2015
|
|
|
2014
|
|
|
|
|
|
|
|
|
Cost of service revenues
|
|
$
|
26,161
|
|
|
$
|
40,766
|
|
Research and development
|
|
|
28,800
|
|
|
|
36,178
|
|
Sales and marketing
|
|
|
1,890
|
|
|
|
10,140
|
|
General and administrative
|
|
|
103,082
|
|
|
|
62,810
|
|
Total stock-based compensation
|
|
$
|
159,933
|
|
|
$
|
149,894
|
|
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
As of December 31, 2015, there
was $355,747 of total unrecognized compensation cost related to non-vested share-based compensation arrangements. This cost is
expected to be recognized over a weighted-average period of 2.73 years.
Restricted Stock Awards
The Company incurred $0 and
$558 in compensation expense during the year ended December 31, 2015 and 2014, respectively, related to the restricted stock awards
granted to Board members and former officers of the Company. During the year ended December 31, 2014, 984 restricted stock units
vested as part of the former CFO’s consulting agreement.
NOTE 10 - Benefit Plan
The Company has a defined contribution
plan which covers all of its full-time employees. The employees’ annual contributions are limited to the maximum allowed
under the Internal Revenue Code. During 2012, the Company discontinued the matching contribution and reinstated the program in
2014. The matching contribution to participants 401k plans is equal to 50% of the participants’ contributions up to a maximum
3% of annual wages. The Company contributed $143,816 and $59,040 during the years ended December 31, 2015 and 2014, respectively
to participant’s accounts representing the employer contribution amount.
NOTE 11 - Income Taxes
The Company has identified
its federal tax return and state tax returns for New York and Pennsylvania as “major” tax jurisdictions, as defined.
Based on the Company’s evaluation, it has been concluded that there are no significant uncertain tax positions requiring
recognition in the Company’s consolidated financial statements. The Company’s evaluation was performed for the tax
years ended 2013 through 2015, the only periods subject to examination. The Company believes that its income tax positions and
deductions will be sustained on audit and does not anticipate any adjustments that will result in a material change to its financial
position. The Company does not expect its unrecognized tax benefit to change during the next 12 months. As of December 31, 2015
and 2014, all of the Company’s deferred tax assets were fully reserved by a valuation allowance equal to 100% of the net
deferred tax assets. The Company will continue to assess the likelihood of recognizing a portion of its deferred tax assets and
will make an assessment of whether it should reduce the valuation allowance.
The Company has significant
net operating loss and business credit carryovers which are subject to a valuation allowance due to the uncertain nature of the
realization of the losses. Section 382 of the Internal Revenue Code imposes certain limitations on the utilization of net operating
loss carryovers and other tax attributes after a change in control. The Company has completed a study to assess whether a change
in control occurred from November 4, 2005 through December 31, 2015, in order to determine whether an “ownership change”
as defined in Section 382 occurred as a result of equity transactions. The Company, after considering all available evidence,
concluded that an ownership change has not occurred. An ownership change does not occur until the 5% shareholders have a cumulative
ownership shift of greater than 50%.
The Company will recognize
interest and penalties accrued related to unrecognized tax benefits as components of its income tax provision. The Company does
not have any interest and penalties accrued related to unrecognized tax benefits.
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
The Company accounts for income
taxes in accordance with ASC 740, Income Taxes. Under ASC 740, deferred income taxes and liabilities are recognized based on temporary
differences between the financial statement and tax basis of assets and liabilities using the enacted tax rates in effect in the
years in which the differences are expected to reverse. ASC 740 requires recognition of net deferred tax assets to the extent
it is more likely than not that such net assets will be realized. To the extent that the Company believes that its net deferred
tax assets will not be realized, a valuation allowance must be recorded against those assets.
The income tax provision consists
of the following:
|
|
2015
|
|
|
2014
|
|
Current
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
|
-
|
|
|
|
-
|
|
|
|
|
-
|
|
|
|
-
|
|
Deferred
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(336,759
|
)
|
|
|
(735,191
|
)
|
State
|
|
|
674,489
|
|
|
|
(89,118
|
)
|
Change in valuation allowance
|
|
|
(337,730
|
)
|
|
|
824,309
|
|
|
|
|
|
|
|
|
|
|
Total income tax provision
|
|
$
|
-
|
|
|
$
|
-
|
|
The Company has net operating
loss carryforwards (“NOLs”) of approximately $16,145,000 as of December 31, 2015 that will be available to offset
future taxable income. Approximately $677,000 of the NOL carryforward, if realized, will result in a benefit to be recorded
in APIC. The NOLs are due to expire in 2023 through 2035. The Company has concluded that a full valuation allowance was
appropriate for the NOLs at December 31, 2015 and 2014 as it is more likely than not that they will be utilized prior to their
expiration. The Company has reduced the state deferred tax asset as a result of the change in law effective in 2015 for the major
jurisdiction of New York. The state apportionment rules changed from cost of performance to market based sourcing, thus reducing
the apportionment percentage rate. The change in tax rate has a direct impact on the presentation of the effective income tax
rates for the year ended December 31, 2015.
The total net deferred tax
asset as of December 31, 2015 and 2014 consists of the following:
|
|
2015
|
|
|
2014
|
|
Net operating loss carryforwards
|
|
$
|
5,319,270
|
|
|
$
|
5,501,926
|
|
Property and equipment
|
|
|
16,783
|
|
|
|
17,283
|
|
Intangible assets
|
|
|
391,289
|
|
|
|
532,716
|
|
Accrued expenses
|
|
|
132,870
|
|
|
|
140,691
|
|
Credit carryforwards
|
|
|
355,314
|
|
|
|
316,651
|
|
Stock-based compensation
|
|
|
417,996
|
|
|
|
461,985
|
|
Total deferred tax asset
|
|
|
6,633,522
|
|
|
|
6,971,252
|
|
|
|
|
|
|
|
|
|
|
Less: valuation allowance
|
|
|
(6,633,522
|
)
|
|
|
(6,971,252
|
)
|
Total net deferred tax asset
|
|
$
|
-
|
|
|
$
|
-
|
|
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
The difference between the
federal statutory and effective income tax rates for the years ended December 31, 2015 and 2014 is as follows:
|
|
2015
|
|
|
2014
|
|
Federal statutory tax rate
|
|
|
34.00
|
%
|
|
|
(34.00
|
)%
|
State and local income taxes, net of federal benefit
|
|
|
(4.05
|
)%
|
|
|
(2.60
|
)%
|
Impact of change in state rate, net of federal benefit
|
|
|
(60.68
|
)%
|
|
|
-
|
|
Stock-based compensation
|
|
|
(4.93
|
)%
|
|
|
14.12
|
%
|
Research and development credit
|
|
|
3.71
|
%
|
|
|
(0.84
|
)%
|
Other
|
|
|
(0.47
|
)%
|
|
|
(0.77
|
)%
|
|
|
|
(32.42
|
)%
|
|
|
(24.09
|
)%
|
|
|
|
|
|
|
|
|
|
Less: valuation allowance
|
|
|
32.42
|
%
|
|
|
24.09
|
%
|
Provision for income taxes
|
|
|
-
|
%
|
|
|
-
|
%
|
NOTE 12 - Commitments and Contingencies
Operating Leases
In July 2007 the Company began
leasing approximately 19,500 square feet of office space at its corporate headquarters in Rochester, New York. In June 2012, the
Company renewed its lease for approximately 19,500 square feet of office space at the corporate headquarters in Rochester, New
York. The lease term is for five years and commenced on July 1, 2012. The base annual rent under the lease is $309,075, and increases
two percent (2%) per year over the term of the lease.
In May 2014, the Company entered
into a lease for approximately 2,190 square feet of office space in New Hope, Pennsylvania. The lease term is for three years
with a lease commencement date of June 1, 2014. The base annual rent under the lease is $54,000, and increases three percent (3%)
per year over the term of the lease.
In August 2014, the Company
entered into a lease agreement for certain equipment. The lease was for 36 months and expires in August 2017. The base annual
rent under the lease was $5,221.
Total rent expense for the
years ended December 31, 2015 and 2014 was $358,549 and $356,320, respectively.
Future minimum rental commitments
under non-cancelable operating leases are as follows:
For the Years Ending
|
|
|
|
December 31,
|
|
Amount
|
|
2016
|
|
|
376,549
|
|
2017
|
|
|
187,073
|
|
Total
|
|
$
|
563,622
|
|
Employment Agreements
On July 23, 2014, (the
“Effective Date”), the Company entered into an employment agreement with Eric T. Converse who was appointed
President and Chief Executive Officer (the “CEO Employment Agreement”). The CEO Employment Agreement begins as of
the Effective Date, has an initial term of one year and will be extended automatically for one-year periods so long as Mr. Converse
remains fully employed by the Company. Mr. Converse will receive an annual salary of $325,000 during the term of the CEO
Employment Agreement. Mr. Converse is also eligible to receive an annual incentive bonus tied to the achievement of Company
goals approved by the Compensation Committee of the Company’s Board of Directors. The Company accrued $0 and $74,202 toward
the annual incentive bonus during 2015 and 2014, respectively. On the Effective Date, Mr. Converse was also granted an option
to purchase 87,017 shares of the Company’s common stock with a $4.22 exercise price, four year vesting period, and ten year
term. On August 7, 2015, the Company awarded Mr. Converse an option to purchase an additional 87,017 shares of the Company’s
common stock with a $2.43 exercise price, four year vesting period, and ten year term. Mr. Converse, if employed twenty-four months
after the Effective Date, then the Company will also award an option to purchase an additional 43,510 shares. Each award is subject
to the terms of the Company’s Amended and Restated 2006 Long-Term Incentive Plan. The options will vest at the rate of 25%
on each anniversary of each award while Mr. Converse is employed by the Company.
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
The CEO Employment Agreement
provides that if the Company terminates Mr. Converse’s employment without cause, then the Company is required to pay
his annual salary and benefits for a period of six months. If a change in control (as defined in the CEO Employment Agreement)
occurs on or before the third anniversary of the Effective Date, then the Company is required to pay Mr. Converse an amount
equal to 75% of his annual salary for the year in which the change in control occurs.
On August 19, 2014 (the “Second
Effective Date”), the Company entered into an employment agreement with James A. Groff, pursuant to which Mr. Groff
agreed to serve as the Company’s Chief Financial Officer (the “CFO Employment Agreement”). The term of the CFO
Employment Agreement begins as of the Second Effective Date, and will be extended automatically for one-year periods so long as
Mr. Groff remains fully employed by the Company. Mr. Groff will receive an annual salary of $150,000 during the term
of the CFO Employment Agreement. Mr. Groff is also eligible to receive an annual incentive bonus tied to the achievement
of Company goals approved by the Compensation Committee of the Company’s Board of Directors. The Company accrued $0 and
$25,842 toward the annual incentive bonus during 2015 and 2014, respectively. On the Second Effective Date, Mr. Groff was
granted an option to purchase 25,000 shares of the Company’s common stock with a $4.20 exercise price, four year vesting
period, and ten year term. On August 19, 2015, the Company awarded Mr. Groff an option to purchase an additional 25,000 shares
of the Company’s common stock with a $2.19 exercise price, four year vesting period, and ten year term. Mr. Groff, if employed
twelve months after the Second Effective Date, then the Company will also award an option to purchase an additional 25,000 shares.
Each award is subject to the terms of the Company’s Amended and Restated 2006 Long-Term Incentive Plan. The options will
vest at the rate of 25% on each anniversary of each award while Mr. Groff is employed by the Company.
The CFO Employment Agreement
provides that if the Company terminates Mr. Groff’s employment without cause, then the Company is required to pay his
annual salary and benefits for a period of six months. If a change in control (as defined in the CFO Employment Agreement) occurs
on or before the third anniversary of the Second Effective Date, then the Company is required to pay Mr. Groff an amount
equal to 50% of his annual salary for the year in which the change in control occurs.
Other Agreements
On June 26, 2014, the Company
entered into an Alliance Framework Agreement (the "Framework Agreement") and Master Subcontract Agreement with IXICO
Technologies Limited (“IXICO”) as part of a strategic alliance between the two companies. The Framework Agreement
provides a framework under which the parties will work to provide imaging contract research services related to clinical trials
of drugs and medical devices across a range of therapeutic areas and modalities. For projects awarded under the alliance, one
party will generally be the lead and the other will provide imaging services as a subcontractor. This will depend upon, among
other things, existing contacts and the therapeutic area of the project. Generally, VirtualScopics will be the service provider
for oncology projects and IXICO will be the service provider for neuroscience projects. As part of the alliance, IXICO will use
space at VirtualScopics’ new office in New Hope, Pennsylvania.
The Framework Agreement has
a one-year term with automatic one year renewals. Either party may terminate the Agreement for any reason on at least 30 days’
notice. Either may also terminate for cause due to a material breach not cured within 30 days. The Framework Agreement may also
be terminated immediately if an insolvency event occurs. In the event of termination, each party agrees for 120 days not to solicit
any opportunities the other party brought to the alliance. Upon notice of termination, existing work orders shall continue and
the parties shall generally continue to pursue any awards and proposals received prior to notice of termination.
VirtualScopics, Inc. and Subsidiary
Notes to Consolidated Financial Statements
On December 11, 2014, the Company
signed a multi-year software license and support agreement with alliance partner, IXICO plc, for their proprietary imaging data
and query management digital platform, TrialTracker™. Under the terms of the agreement, VirtualScopics will pay IXICO to
implement and support the use of TrialTracker™ in its clinical trial business both as part of and separate to the Alliance.
The terms of the agreement included a set up fee of approximately $200,000 that was incurred during 2014. Starting in 2015, there
is a yearly license fee of $40,000 and a minimum support fee of $90,000 in each of the first two service years and thereafter
reduced to a minimum of $25,000.
NOTE 13 - Related Parties
In April 2012, the Company
issued Merck Global Health Innovation Fund, LLC (a wholly-owned subsidiary of Merck & Co, Inc. (“Merck”)) 3,000
shares of Series C-1 Preferred Stock which are convertible into 249,107 shares of common stock and Series C-1 Warrants which are
exercisable to purchase 136,132 shares of common stock. Revenues generated from Merck were $601,626 and $204,688 during the years
ended December 31, 2015 and 2014, respectively. The accounts receivable balance due from Merck was $105,634 and $95,985 as of
December 31, 2015 and 2014, respectively.
NOTE 14 – Concentrations of Credit
Risk
The Company’s top three
customers accounted for approximately 23%, 23%, and 16% of total revenue for the year ended December 31, 2015. The Company’s
top four customers accounted for approximately 26%, 21%, 20% and 10% of total revenue for the year ended December 31, 2014.
Three customers accounted for
approximately 26%, 22%, and 18% of accounts receivable as of December 31, 2015 as compared to three customers accounting for approximately
27%, 19%, and 18% of accounts receivable as of December 31, 2014.
NOTE 15 – Subsequent Events
The Company evaluates events
that have occurred after the balance sheet date but before the financial statements are issued. Based upon the evaluation, the
Company did not identify any recognized or non-recognized subsequent events that would have required adjustment or disclosure
in the condensed consolidated financial statements, except as disclosed below.
On January 16, 2016, the company
entered into a non-cancellable capital lease agreement for certain specialized hardware equipment. The total purchase value of
the equipment was $44,943, at an interest rate of 7.66%, and a $1.00 buyout option with the lease maturing in 3 years. The payments
are scheduled monthly in the amount of $1,401.
On March 25, 2016, the Company
entered into a definitive merger agreement with Biotelemetry, Inc. pursuant to which BioTelemetry proposes to acquire VirtualScopics.
The transaction is structured as a tender offer for a majority of the Company’s outstanding voting shares followed by a second-step
merger. The total consideration is $15.5 million dollars, payable in cash, which includes a price per share to common shareholders
of $4.05 per common share. We expect the transaction, which is subject to customary closing conditions, to be completed in the
second quarter of 2016.
On March 24, 2016, the Company
entered into a “First Loan Modification Agreement” with Silicon Valley Bank to modify the EBITDA covenants on its
line of credit facility. The modification changed the EBITDA covenants to a negative $300,000 for the rolling three month periods
ending December 31, 2015 and January 31, 2016, a negative $500,000 for the three month periods ending February 29, 2016, and March
31, 2016, and a negative $750,000 for the three month periods ending April 30, 2016, May 31, 2016, and June 30, 2016.